Tuesday, December 20, 2011

Simon Johnson rejects the 'ideology' for the ongoing gifts to bankers

In a must read column in the Guardian, Simon Johnson looks at the 'ideology' behind bailing out banks and concludes that this ideology harms the real economy as it justifies an ongoing stream of gifts to the bankers.

Regular readers know that your humble blogger has been very critical of this ideology.  Specifically, I have used historical evidence to show that the assumption underlying the ideology that banks must have a positive book value in order to make loans is simply false.

By showing that assumption is false, the rest of the ideology including the need to a) bailout the banks or b) hide the losses on the banks' balance sheets crumbles with it.
To be sure, the [Washington Mutual] executives lost their jobs and now must drop claims for additional compensation. But, according to the FDIC, the four still earned more than $95m from January 2005 through September 2008. So they are walking away with a great deal of cash. 
This is what happens when financial executives are compensated for "return on equity" unadjusted for risk. The executives get the upside when things go well; when the downside risks materialise, they lose nothing (or close to it). 
At the same time, their actions – and similar actions by other bankers – are directly responsible for both the run-up in housing prices and the damaging collapse that followed. 
That collapse has impacted non-bankers in many negative ways, including through the loss of more than 8 million jobs. 
It is also leading to austerity – taxes are increasing and government spending is falling at the local and state level around the country. A difficult fiscal conversation still lies ahead at the federal level, but cuts and contractions of various types seem likely.
Some people argue that Americans need to tighten their belts. That's an interesting discussion, particularly at a time with unemployment is still above 8% (with recent declines largely the result of many jobless workers' decision to stop looking and drop out of the labour force altogether). Precipitate austerity is hardly likely to help the economy find its way back to higher employment levels. 
But what about government support for the big banks? 
Is this contracting in the light of our current fiscal pressures? Unfortunately, it is not; much government support remains, implicitly through allowing banks to be "too big to fail," and explicitly through various kinds of backing provided by the Federal Reserve. 
The rationale – or perhaps we should call it ideology – behind supporting big banks is that they are needed for the economy to recover. But this position looks increasingly doubtful when the banks are sitting on piles of cash while creditworthy consumers and businesses are reluctant to borrow. 
The same situation exists in Europe today, where the reality is even starker. Banks are receiving ever-larger bailouts, while countries that borrowed are cutting social programmes and face rising social tensions and political instability as a result. Countries like Greece, Italy, and arguably Portugal over-borrowed, and now their citizens face severe consequences. But the bankers face no consequences whatsoever for over-lending. 
To be sure, some major European financial institutions may now face difficulties, and – who knows – perhaps some of their executives will end up being fired. But does anyone think that the people who ran European banks into the ground will leave their positions with anything less than considerable wealth? There is no real austerity – now or possibly in the future – for leading bank executives.... 
Big banks represent the ultimate in concentrated economic power in today's economies. They are able to resist all meaningful reform that could really change their compensation schemes. Their executives want to get all the upside while facing none of the true downside. 
But capitalism without the prospect of failure is not any kind of market economy. We are running a large-scale, nontransparent, and dangerous government subsidy scheme for the benefit primarily of a very few, extremely wealthy people.... 
concentrated financial power is a gift that keeps on giving – but not to you.

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