Sunday, September 25, 2011

Simon Johnson, chief economist at the IMF, and the Wall St protests

One thing that truly unexpected thing about the Occupy Wall Street protest is that it finds itself on the same side as the IMF.

The IMF is the International Monetary Fund. They are well known for their work coordinating last-resorts loans to bankrupted countries. The IMF has frequently come under severe criticism from social justice groups, since their loans are always attached to strict conditions on the country's policies. It's always a loss of national sovereignty, and people resent that, and the demands often seem to be set against the interest of the people, such as forcing them into mono cultures (in the name of specialization and market efficiency,) which leaves farmers vulnerable to pest epidemics.

Simon Johnson was the chief economist at the IMF until 2008. He wrote a very nice Op-ed in The Atlantic describing how the United States' economic ills are very much of the same nature as that of the 3rd world countries they restructure all the time.

The summary of his thesis is that, in the absence of enough watchfulness on the part of the people, over time the finance industry eventually succeeds in capturing the regulatory agency in the government. Once the regulation is disabled, the banks proceed to pursue their selfish interests (as businesses should.) But the sum total of the effort takes down the economy, and everybody ends up worse off than when they started.

Things worsen further when the banks socialize their losses, as it was done in the United States. There is no moral justification for this; to the contrary, it is the canonical example a ‘moral hazard’ in economy theory. Plus, it doesn't address the problem. It solves individual banks’ problem, up to the scope of responsibility of the businessmen who run them, but it leaves the banking system as a whole dysfunctional.

Simon Johnson’s words for this are:

The first problem is a desperately ill banking sector that threatens to choke off any incipient recovery that the fiscal stimulus might generate.

His prescription is to use the standard Federal Deposit Insurance Corporation process (basically a government-managed bankruptcy procedure for banks):
  • Wipe out bank shareholders;
  • Replace failed management;
  • Clean up the balance sheets;
  • and then sell the banks back to the private sector.
Once that's done, it remains necessary to fix the regulatory capture. Simon Johnson’s words for this are:
The second problem is a political balance of power that gives the financial sector a veto over public policy, even as that sector loses popular support.

His recommendations are:
  • Big banks should be sold in medium-size pieces, divided regionally or by type of business;
  • Where this proves impractical, break them up within a short time;
  • And banks that remain in private hands should also be subject to size limitations.
I had the chance to spend some time amongst the crowd at the Wall Street Occupation. I participated in a group conversation which attempted to discover a consensus (if any) diagnosis for what exactly is the problem with Wall Street, amongst the 30 or so people present. I am quite thankful to the two talented moderators who skillfully ensured everyone’s contribution could be heard. In the end my presentation of Simon Johnson’s 2-paneled diagnosis (socialized losses plus regulatory capture) was received with a cheerful round of applause.

It was at that moment that it occurred to me that those people on the street, those who speak for the 99%, have found themselves on the same side as the IMF. And that's a remarkable thing.

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