Servants of the Universe

i had friends on that deathstarSimon Johnson, currently a professor in MIT Sloan School of Management and formerly the chief economist of the IMF has published a long but very accessible and interesting overview of the financial crisis from a somewhat unusual viewpoint – namely what would IMF tell the US government if it could tell them anything. Johnson, by the virtue of having worked for the said organisation and having seen the unfolding of several crises in different countries up close and personal, is very disillusioned over how easy it is going to be to deal with deeper reasons and implications of this particular one. Now that the US should take the same medicine that the IMF has long been advocating in different places all over the (mostly Third) world, we will likely see how difficult it is going to be to administer it.

The main point of the article is that, just like in places like Indonesia, Ukraine, Philippines or Argentina before, the US has a similar (if somewhat more subtle and not as obvious) oligarchy that has a huge vested interest in dealing with the crisis in a particular way that would preserve the structure of the economy and society at large. The problem is, of course, that this particular way is not compatible with necessary structural adjustments and, instead of writing off losses where they originated, aims to distribute them over all the economic and social strata. And the relative subtleness of American oligarchy (which I think applies to the Western capitalist societies in general) compared to, say Russian or Indonesian one, makes it both much harder to see as well as to deal with – it relies on cultural rather than financial or economical foundations. Its rise to dominance is actually relatively recent development. This is illustrated by two particularly telling charts in the article.

Despite not being overly optimistic on how easy they would be to put into practice, Johnson does offer some solutions. Like Paul Krugman Kenneth Rogoff, he believes that the financial system needs to be recapitalised to a much larger extent that it currently is, and has previously maintained that doing that without also taking control (i.e. nationalising) would amount to a huge handout of public funds. This – the so-called “Swedish solution” that has also been supported in principle by Alan Greenspan and Kenneth Rogoff, and recently mentioned in passing and then dismissed on cultural grounds by Obama – entails nationalisation of banks, subsequent recapitalisation and then selling them back to the private sector once the storm has passed. There is a marked stress on noting that nationalisation is temporary, as permanent state ownership of the banking system runs very much counter to what most of the politicians, economists and population in general in the West would intuitively recognise as a good idea. However, regardless of whether the financial system would remain private or would be re-privatised if the nationalisation were to actually take place at some point, there seems to be a strong consensus that this should not mean turning back to “business as usual” under the same rules and regulations that we have had before. Johnson has underlined the need to “break the financial oligarchy” and suggested that the way to go would be to have, instead of current financial behemoths, a network of small institutions. However, I think there is an alternative to this, which would amount to a much more comprehensive solution.

If the current system were to be broken up, it could be done not by splitting the current giants into smaller, hopefully more manageable copies, but instead by splitting it along the lines of infrastructure and, for the lack of a better word, “merchant banking”. The “merchant banking” assets could indeed be split further into smaller units, in order to avoid piling up of financial risks that could once again undermine the whole system. The “infrastructure” part – basically retail banking along with plain vanilla lending – should be treated as a utility, just like our water and electricity companies or transport infrastructure. Those can all well be in private hands and don’t need to be micromanaged by the state. However, they often do operate under a specific kind of a constraint: their profitability is capped. Before crying foul and predicting the collapse of the financial system and the whole world, consider the utility companies – their profits being capped has not caused the quality of the service decline or even stagnate, nor have the investors turned away in disgust – quite to the contrary. Utility companies are, with their security and usually excellent earnings visibility, very much sought after investments.

As it happens, this would also take care of the perceived problem with “bonus culture”. Although I am sure that the relationship with bankers’ bonuses and banks’ profits is to some degree a mutual one, it is also clear that if banks were to become utilities it would also mean the disappearance of huge bonuses that seem to cause so much anger and resentment right now. It would certainly make the whole industry a lot less lucrative for certain people or at least for certain aims, but this is not necessarily a bad thing. I recently read an article somewhere that compared the current generation of bankers to the military of 18-19th century Europe – who used to be masters of their respective universe but are now perceived and treated as a public service. Another similar example could be Japanese samurai class, who, from their initial rise to power and eminence with Kamakura shogunate, became simple bureaucrats by late Tokugawa, and then were finally disbanded even as a nominally ruling class by Meiji Restoration. And although this would be quite against my own personal interest, I do believe that in the wider perspective this is what also needs to happen to bankers – they need to become servants, rather than masters of the universe.

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14 thoughts on “Servants of the Universe

  1. Hi, can you please stop referring to Krugman as if he’s an authority on anything other than international trade. Thanks.

    Cheers,

    S

  2. Hm. I think he was pretty much spot on with Asian crisis in 90s.. and in this particular case (i.e. how and to what extent recapitalise the US banking system) I simply happen to think that he does make a lot of sense. The fact that he hasn’t done much formal work on financial policy doesn’t mean that he wouldn’t be able to understand it, now does it?

    And actually it is a good question – who would you consider an expert on the current state of affairs? Alan Greenspan? He happens to agree with Krugman on this particular topic (which of course doesn’t make Krugman an expert, but still). Maybe Bernaeke? To me he looks even less convincing than Greenspan – although he has done some work on Great Depression.

    It seems to me that any kind of formal training in economics or finance is of rather limited use right now, as although there certainly are many different opinions on what to do and, even more importantly, on what NOT to do, there seems to be a pretty solid consensus on the point that we’re sailing the uncharted waters and that there is very little conventional theory that one can take for granted right now.

  3. Come on, Krugman is a ideologically motivated hack with a Nobel prize. And even a broken clock is right twice a day, hence by sheer chance he might have been right on the Asian crisis (also would appreciate link to what exactly was he right about).

    –“And actually it is a good question – who would you consider an expert on the current state of affairs?”

    No one I know. My personal opinion is perhaps not doing much on the stimulus front and letting a market-based (and government stabilised perhaps) adjustment of capital bases of banks run its course, with FDIC taking care of its insured depositors. All other alternatives have terrible moral hazard issues, severely misplaced motivations for desicion makers and run agrain of what I believe is the “good” american capitalism. Which was hidden for many years, as a matter of fact…

    But there’s a guy agree with, search for Ken Moelis interview on FT.com “View from the top”.

  4. Ahem.. “right” is as much of an ideological standpoint than “left” and in this regard if you’d find an opinion on how to deal with the financial crisis that is NOT ideological it is in all likelihood also irrelevant. Krugman has never made his ideological leaning a secret and is also very much aware of it himself – as he is aware that he is not infallible.

    Regarding Moelis’ interview – he seems to have rather similar view on the crisis as Krugman does (and indeed, let’s get over Krugman here as he hardly stands alone on this), where they differ is how to deal with it. Letting everything go down in flames and then re-emerge anew and stronger is certainly a choice – a choice that is going to work fine for you, me, Moelis and Krugman, but it’s a choice that will mean a lot of pain and misery for most of the population. Which may of course well spill over, hit the streets and make your life miserable as well, but that’s really not the point. The point where I don’t agree with Moelis is that I really don’t see “economy” as “weather”. Quite clearly we are able to cause economical calamities so why would it be that once it does happen we should opt for a “raincoat” rather than try to fix what has been done?

    And on “market-based (and government stabilised perhaps) adjustment of capital bases” of the current plan, here’s what another ideologically motivated hack has to say about it: http://www.huffingtonpost.com/jeffrey-sachs/the-geithner-summers-plan_b_183499.html. Yet another hack with a Nobel prize, this time Joseph E. Stiglitz, has recently referred to Geithner plan as “far worse than nationalization: it is the privatizing of gains and the socializing of losses.”

  5. –“Letting everything go down in flames and then re-emerge anew and stronger is certainly a choice – a choice that is going to work fine for you, me, Moelis and Krugman, but it’s a choice that will mean a lot of pain and misery for most of the population.”

    Or it may not.

  6. Sarunas, the usefulness of comments such as “Stiglitz is an idiot” is negligible at best – although it does indeed conform with popular standards of online forum participation. If you actually want to convince someone (me, for instance) you really have to do a bit more than that. As it is right now, it is just pretentious display of arrogance. I understand that you may not have time nor inclination to share your valuable insights with the rest of us, but unless you have something more substantial to say than “It may not” then I’d really rather you didn’t.

    Of course “it may not”, Einstein.

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  8. And my “it may not” came as a response to a boldly asserted “sky is 100% falling” passage, and I quote:

    “will mean a lot of pain and misery for most of the population”

    I may not, in aggregate. Multipliers may turn out to be below zero, hyperinflation MAY come, Ricardian equivalence MAY (will?) turn out to be a fact of life etc. etc. etc. I stand by my words 🙂

    Seriously, I really don’t know for sure. There is a lot of pressure on political types to “do something”. Rarely helps unequivocally in the short term, and at all in medium or long run. Then again, sometimes it does.

    I promise to either post long, clever posts like this or refrain from doing it.

  9. Well, this is a lot better than “it may not”.

    Regarding inflation – I actually think that this would be a good thing to happen, given the other choices, so this is not a part of the “sky is falling” scenario. What would be very much part of that scenario, however, is for instance letting the banks go – Moelis also seems to agree that if the government had not acted there it would have led to a complete meltdown. I also think that simply watching the asset prices to adjust (and this leading to majority of the mortgage-owning population running into negative equity) combined with steeply rising unemployment is very very likely to create exactly what I said: “a lot of pain and misery for most of the population”. Indeed, it may not, but I would bet a lot of money on that it would.

    Incidentally, this is what the financial sector appears to be betting on as well. They realise full well that governments cannot let it happen and are forced to bail them out – and are thus able to maintain poker faces and say “we’re adequately capitalised, if you don’t agree then let’s go through it and find out”.

  10. Call me cold hearted, but I feel little sympathy for houseflippers whose equity is wiped out.

    Recapitalising banks is probably unavoidable from a macro risk management POV. There just are too many unknowns in letting chapter 11 work its way through the banking sector mess. Also, US federal government is not without blame (to say the least) the financial crisis so perhaps it’s “fair” or “just” for them to solve it. Problem is, the loser is this are responsible people who did not buy houses they cant afford, did not max out on their 6 credit cards to deck thei McMansion in flatscreen LCDs and were investing in mutual funds, deposits and corporate bonds for a rainy day. This is what pisses me off immensely – the bailout of the wicked will be paid by the just. And their collective offspring. Yuck.

  11. As we have discussed before, it is not really an emotional rather than a pragmatic point. Quite regardless of feeling sympathy, if there is enough of those houseflippers whose equity is being wiped out it at one point becomes everybody’s problem – as those houseflippers have the same one vote per person as you and me. Plus one has to be blind for failing to see how the problem that may indeed have been caused by overleveraged houseflippers is by now affecting a much much broader group of people – who may well be overleveraged as well, but not because they decided to speculate on the rising house prices in order to strike it rich rather than in order to school their children.

    This also leads us back to Stiglitz (and I did check the frankenblog link now). This really shouldn’t be some kind of an economical whodunnit, and there I agree that Stiglitz has some funny ideas. But on the point of Geithner plan being a handout, wrought with a huge potential free ride, Stiglitz’s broken clock may well be hitting one of those two moments in a day that it is spot on. Jeffrey Sachs’ post in Huffinton raises a few really obvious points that are quite apart from who is to blame and to what extent – and while we may debate on this I think nobody really sees the financial system as a hapless victim here. And EVEN IF IT WAS, from a purely pragmatical point of view it is a window of opportunity to do something that needs to be done anyway (and namely reduce the influence and importance of the financial establishment).

    In terms of bank nationalisation I happily discount the opinions of Stiglitz and Krugman for them being non-specialist socialists. But I’d be really interested to hear on what grounds will you dismiss Greenspan and Rogoff who have advocated the same thing.

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