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Why Simon Johnson Makes Me Slightly Queasy

Like a lot of other bloggers, I strongly recommend you read Simon Johnson's piece about the financial crisis in the latest The Atlantic. Johnson works his way to some provocative but hard-to-disagree-with conclusions based on the knowledge he soaked up at the IMF, where he was chief economist until recently.

Having said that, there's something that bothers me ever-so-slightly about the piece. It turns up as Johnson shifts from the political economy of an emerging-market financial crisis to the political economy of American finance over the last 25 years to the political economy of this particular crisis.

Just to review for those who haven't read the piece: Johnson argues that financial crises in developing countries result from overreach by local elites, who assume their buddies in government will bail them out if their bets go bad. So resolving the crisis typically means breaking the grip of these elites. So far so good.

In the United States, Johnson argues, the situation is even more insidious in some ways. Our own financial elites have not only been politically ascendant for the last generation, but intellectually ascendant, too. Policymakers blithely adopted the view that vast unregulated flows of capital were in the national interest--a view that just happened to overlap with Wall Street's self-interest. "A whole generation of policy makers has been mesmerized by Wall Street, always and utterly convinced that whatever the banks said was true," Simon writes. A bit hyperbolic, I'd say, but definitely a kernel of truth here.

It's the last pivot where Johnson loses me. Well, he doesn't exactly lose me, because I worry he may be right. But he certainly leaves me a little cold. Johnson concludes that American financial elites "are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive." He adds that we're afflicted by "a political balance of power that gives the financial sector a veto over public policy, even as that sector loses popular support." Johnson's preferred solution--one I'm sympathetic to--is that the government seize weak banks, recapitalize them, and sell them off in pieces. But he thinks this is next-to-impossible so long as Wall Street stays so powerful.

Now, certainly there are a lot of data points consistent with the financial sector having a veto over public policy. As Johnson notes, a lot of the bailouts the Fed and  Treasury have arranged left the banks basically intact. By most reasonable measures, the terms have been more favorable to bankers than to taxpayers, which raises questions about who controls whom. Likewise, the Geithner plan certainly goes to elaborate lengths to avoid seizing banks, which also looks on its face like the work of an overly-solicitous policy mind.

On the other hand ... we just don't know. Johnson has performed a service by marshalling the available data points and drawing some provocative connections, but he's not great at establishing what's driving what. Isn't it just as plausible that Geithner and the administration haven't adopted his preferred prescription because: 1.) there are enormous practical complications associated with nationalization (see here), or 2.) there are huge political obstacles having nothing to do with the bank lobby (for example, maybe the administration wants to pass the rest of its agenda before getting bogged down with the banks in Congress)?

Johnson might say that pretty much everything you need to know is right there in the open--Geithner and Summers have repeatedly said they don't think it's a good idea for the government to control banks. What more do you want? But, then, Summers has also suggested he wants to rein in the financial sector, as in his recent speech at Brookings. So the indications are hardly clear.

Even Johnson's own data points are open to interpretation. He writes, for example, that "In October, John Thain, Merrill Lynch’s final CEO, reportedly lobbied his board of directors for a bonus of $30 million or more, eventually reducing his demand to $10 million in December; he withdrew the request, under a firestorm of protest, only after it was leaked to The Wall Street Journal." But isn't that a sign financial elites don't enjoy the status they once did, even if they still act like they do? Johnson also writes: "In September, we saw ... the takeover and immediate sale of Washington Mutual to JP Morgan." But, setting the sale aside, isn't this the kind of takeover we've been rooting for? The government was pretty tough with WaMu, wasn't it? It mostly wiped out shareholders and bondholders.

The point is that figuring out whether financial interests control public policy is a question that needs to be answered directly--with documents and testimony. You can't just infer it from a bunch of circumstantial evidence. I'm not blaming Johnson for failing to do this--he's a commentator, not a reporter or an investigator. But I do feel like his rhetoric gets about 10-20 percent ahead of what he can support. It's something I'd like to see him avoid because, as I say, I often agree with the rest of what he says and worry that he's undercutting it.

--Noam Scheiber