The Quiet Coup

Simon Johnson, ex-chief economist at the IMF, lays bare some home truths about financial crises over at The Atlantic. He’s writing about the USA but lessons could certainly be learnt closer to home.

The crash has laid bare many unpleasant truths about the United States. One of the most alarming, says a former chief economist of the International Monetary Fund, is that the finance industry has effectively captured our government—a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises. If the IMF’s staff could speak freely about the U.S., it would tell us what it tells all countries in this situation: recovery will fail unless we break the financial oligarchy that is blocking essential reform. And if we are to prevent a true depression, we’re running out of time.

The conclusion is chilling

The conventional wisdom among the elite is still that the current slump “cannot be as bad as the Great Depression.” This view is wrong. What we face now could, in fact, be worse than the Great Depression

He has solutions, go read them.

Update : David McWilliams in the Indo on a similar theme, the silent takeover of the Irish state by the banks. He argues with the establishment of NAMA the bank guarantee must be rescinded.
From the article itself –

Yet the economic solution is seldom very hard to work out.

No, the real concern of the fund’s senior staff, and the biggest obstacle to recovery, is almost invariably the politics of countries in crisis.

Typically, these countries are in a desperate economic situation for one simple reason—the powerful elites within them overreached in good times and took too many risks. Emerging-market governments and their private-sector allies commonly form a tight-knit—and, most of the time, genteel—oligarchy, running the country rather like a profit-seeking company in which they are the controlling shareholders. When a country like Indonesia or South Korea or Russia grows, so do the ambitions of its captains of industry. As masters of their mini-universe, these people make some investments that clearly benefit the broader economy, but they also start making bigger and riskier bets. They reckon—correctly, in most cases—that their political connections will allow them to push onto the government any substantial problems that arise.

Anglo-Irish Bank anyone?

  • Sultanofswing

    A very very good appraisal of the global economic situation and its causes, probably the best I have read.

    One message seems to be that we should nationalise errant banks. I would add that we introduce ‘Banking windfall’ taxes targeted at those who engineered extra large pensions and bonuses for themselves. Rather like G. Brown had the one off oil company windfall tax a few years ago.

    However not all banks behaved irresponsibly, as I understand it, whether by design or own country regulation, so let’s not stymie them.

  • OC

    ‘Banks that remain in private hands should also be subject to size limitations… Of course,
    some people will complain about the “efficiency
    costs” of a more fragmented banking system…’

    Just another Paradox Of Efficiency.

    Large corporate farms, and Walmart, should be broken up, too.

    Economic concentration is inimical to democracy.

  • Greenflag

    Mack ,

    Thanks for the Atlantic article . It gives an excellent precis of how the USA economy got to be where it is and if I’ve read it correctly he seems to be suggesting the Krugman approach -i.e bank nationalisation and possible break up of the larger units even if such nationalisation is of a temporary nature .

    ‘The challenges the United States faces are familiar territory to the people at the IMF. If you hid the name of the country and just showed them the numbers, there is no doubt what old IMF hands would say: nationalize troubled banks and break them up as necessary. ‘

    The point was made by Krugman in his Depression Era Economics that the problems now facing the USA are a combination of all the financial crises that have effected emerging markets in the past 15 years Russia , Indonesia , Malaysia , etc and the first world Japanese economy AND the outsourcing of whole sectors of the American ‘real ‘ economy .

    ‘Each time a loan was sold, packaged, securitized, and resold, banks took their transaction fees, and the hedge funds buying those securities reaped ever-larger fees as their holdings grew.’

    Johnson ‘missed out’ on the lower level pay offs whereby real estate agents (American realtors ) could make 18,000 dollars on upselling an ordinary 3 bedroom ranch house with ahem granite counter tops for 250,000 dollars to a NINJA (no income no job and no assets) Of course most of the money in this giant ponzi scheme was made by those at the top of the financial pyramid .

    Historically as per Kevin Phillips in his book ‘Bad Money’ tells us the emergence of the financial services sector as the ‘dominant ‘ from both an absolute and state policy making sector has been the precursor to loss of empire , economic power and a sure indicator of relative decline . Phillips gives trenchant examples from the Spanish , Dutch and British experiences and then brings the American present predicament into focus .

    As a former Republican party policy wonk Phillips saw the darkness before the lights were switched off 😉

    Sultanofswing’s point that not all banks behaved irresponsibly is of course correct . Neither did all members of the German Wehrmacht in WW2 but the slaughter brought about by the SS more than made up for the ‘gentlemanly ‘ conduct of 95% of the Wehrmacht ? Similarly the shadow banking and hedge fund sectors the financial sectors of mass destruction were aided and abetted by the Houses of Congress – Westminster and indeed our own Dail as the ‘people’s parliaments rushed to grab as many dodgy financial services jobs for their respective countries as they could .

    OC makes a good point re the break up of large corporations and some of the huge banking and insurance conglomerates. It’s been my personal experience in the USA and other countries that the small to medium size businesses are usually the most ‘moral ‘. It seems that once hundreds of millions start flowing across the revenue desk of any company that somehow what is called ‘fair play’ or humanity goes out the door . It would probably be a benefit to employees to have compulsory unionisation for companies over a certain size .

    I agree with Johnson’s assessment that the west could yet stumble into a situation worse than the Great Depression . In that situation we can expect political unrest and probable revolution on a scale which would make late 1960’s look tame indeed .

  • Mack

    A lot of what Johnson says fits neatly with other pundits who have also – em, covered themselves in glory in this crisis. Nouriel Roubini is primarily an expert on emerging markets, he foresaw the current crisis when he scoured the globe for the next emerging market to submerge and realized it would be the USA!

    Nassim Nicholas Taleb makes similar points about the break up of large institutions, the danger of too big to fail, and of the incompatibility of high efficiency and high leverage. See his 10 principles for a Black Swan proof world :-

    http://www.ft.com/cms/s/0/5d5aa24e-23a4-11de-996a-00144feabdc0.html

    (Discussed on Slugger here –
    http://sluggerotoole.com/index.php/weblog/comments/fixing-capitalism/)

    The Krugman approach seems to be the favoured approach of many of our economists (Karl Whelan and others at irisheconomy.ie, lefty Michael Taft at Notes From the Front, and right-winger Constantin Gurdgriev at True Economics) all seem to favour some form of nationalisation (I suspect Michael Taft is the only one who thinks that state of afairs should be permanent).

    Over at iTulip.com they’ve been banging on about the dangers presented by the unbalanced FIRE economy (meaning the rest of the US economy was being hollowed out by Finance, Insurance, Real Estate).

  • Greenflag

    From the bottom up there is an excellent article by Simon Geoghegan in the April edition of Harper’s magazine titled ‘How Predatory Lenders Ruined the Economy ‘ and also in the same issue Daniel Brook in a letter from Tennessee (Usury Country) writes a detailed description of the birthplace of payday lending and the inventors of 400% interest rates .

    If anybody has a subscription out there these two articles are worth linking to .

  • OC

    GF: None of this would surprise William Hollingsworth Whyte, author of the 1956 classic, “Organization Man”.

    http://www.writing.upenn.edu/~afilreis/50s/whyte-main.html

    He lamented the emerging business paradigm: finance and market hype trumped engineering, production, and quality control.

    BTW Simon Johnson also decries the free movement of capital across borders.

  • Greenflag

    OC

    ‘He lamented the emerging business paradigm: finance and market hype trumped engineering, production, and quality control.’

    As I understand it the Japanese got the engineering , production and quality control and pricing right up to the nineties but allowed themselves to be hoodwinked by the ‘property hype ‘ salesmen . I believe it was only in densely populated and short of ‘lebensraum’ Japan that the multi generational mortgage took root and ‘prospered ‘ for a little while anyway 🙁 Not only were the Japanese persuaded to buy into the property bubble but they were persuaded to sign up the children and quite possibly grandchildren to keep the ‘bankers ‘ happy with the ‘return ‘ on their investment .

    Johnson may well decry the free movement of capital across borders but this is not going to end anytime soon . This is an area which is probably now being looked at (hopefully ) by the G-20 Finance Ministers not to prevent capital movement but to ensure that such movements do not precipitate currency devaluations or inflation or affect interest rates to the extent that various countries are held to ‘ransom’by international financiers . Every country that went through the industrial revolution did so with the help of ‘foreign ‘ capital . Even the first i.e the British industrial revolution took off with the capital accumulated from the sugar and slave trades and from the flight of Dutch capital and French Huguenot commercial and industrial expertise .

    Instead of exporting actual goods and services the USA started to export post 2000 pieces of paper based on hyped up real estate values and promised investors / buyers a triple A rated high interest return . Which is why banks all around the world got stung by the shadow banking sector both in Wall St and the City .

    Seriously what the USA needs is for it’s entire property owning population to stop paying insurance , property taxes, and generally going on a national slowdown or complete work stoppage until the Government nationalises the banks , abolishes the private health insurance sector and instead of bailing out the financial sector criminals fire the bastards .

    Uunfortunately many politicians in the present administration as in the previous one owe their elected position to guess who ? Yep the financial services sector . VP Biden is in the lap of the credit card usurers and he’s probably not the only one .

    I can see this ‘debt ‘ mountain being paid back until such time as the pips squeak and bloody revolution is provoked . I read a Freddie Mac top executive has done the decent thing and followed the honourable Japanese exit strategy albeit by hanging himself instead of by ritual hari kari .

  • OC

    “triple A rated”

    It is the failure of the ratings agencies that tripped up the system, IMO.

    If they had properly done their jobs, no way would these securities been rated anything but high risk junk.

    Non-feasance, misfeasance, or malfeasance?

    Right now, the problem is that the efficiencies of mass production only work with mass consumption.

    Is this the right time to move towards Ghandi’s microeconomic self-suffiency embodied in the spinning wheel symbol on the Indian flag?

    How much oil is being burned shipping raw materials to China, who then ship finished products to the USA?

  • Mack

    OC – I tend to think microeconomic self-sufficiency would equal poverty, we’ve already been down that road to some degree with Dev in Ireland – didn’t work out so well…

    Higher energy prices will purge transport ineffiencies from the system eventually, unless another cheap alternative is discovered.

    One problem with our globalised world is the concentration of critical activities in particular areas. That leaves the entire system open to severe stress if a disaster occurs in one of those areas or they experience political upheaval there. It would be better if we had a higher degree of redundancy in the system i.e.multiple ‘Chinas’ for goods production, and multiple ‘Indias’ for IT services dispersed throughout the globe.

  • Mack

    OC – Also, a lot of the raw materials being shipped to China are being used to build roads, houses, bridges, offices, hospitals, ports, airports, telecoms infrastructure etc. rather than simply being recycled back into consumer goods. Mongolia on China’s northern border is also incredibly resource rich – but not as developed as the Brazil, Canada and Australias of this world.

  • Alistair Darling

    The Gods That Failed

    available at all good book stores now.

    (TestWord british)!

  • Greenflag

    OC ,

    ‘Non-feasance, misfeasance, or malfeasance?’

    Probably all three to different degrees in different financial centres .

    ‘Right now, the problem is that the efficiencies of mass production only work with mass consumption.’

    The problem is not the efficiencies of mass production the problem is the lack or diminishing of mass consumption given a ‘maxed out’ indebted USA /UK etc taxpayer . What appears to be the case in the USA is the ‘mass consumer’ has stopped or slowed down his/her mass consumption for several reasons some of which are directly related to the property bubble , stock market collapse etc but others are of a more ‘rooted’ cause which goes back to the gradual emisseration of the US ‘middle and working classes’ over the past 25 years . The median wage in the USA has not increased either in line with inflation but has in fact declined in real terms relative to health care costs , education costs , property taxes , insurance costs etc etc .

    Henry Ford once made the point that if he paid his workers 5 dollars a day they would be able to afford to buy his cars . Large Corporations in the USA and worldwide in recent decades seem to believe that if they can keep their wages and salaries down and pay their CEO’s huge salaries that somehow the ‘impoverished ‘ American consumer will continue to spend on their products or will at least be able to ‘borrow ‘ the money to do so . That’s a zero sum game which has now ended . It’s why GM in Detroit will close their plants in Michigan for 9 weeks this summer instead of the traditional 2 weeks because of the huge unsold inventory clogging up the car sales parks around the USA . I read that Walmart employees in the USA the country’s biggest employer cannot afford to buy the clothing which Walmart sells but have to go to ‘charity ‘ stores?

    The main problem facing President Obama’s recovery plan is to get the ‘mass consumer ‘ to buy /spend more . It’s becoming increasingly apparent that the mass consumer can’t at least not to the extent he or she did in the past . With mass unemployment and meagre short term unemployment /welfare benefits the American consumer is rapidly relearning the thrift lessons of the Great Depression . The banks are still witholding credit despite the taxpayers bailing them out and their allied credit card companies are slashing people’s credit even those with excellent records -this making the situation worse ?

    IMO – the USA Government will sooner or later HAVE to nationalise Bank of America and Citibank among others . They are now ‘quietly’ closing down failed banks and selling them off to prevent runs which could bring down the entire system.

    There are some signs of a recovery in the Stock Market but this is a correction of the previous too low index which went down to 6500 or some 48% of the peak of 14000 two years ago .

    ‘Is this the right time to move towards Ghandi’s microeconomic self-suffiency embodied in the spinning wheel symbol on the Indian flag?’

    There’s no going back to micro self sufficiency at least not with current populations . Zimbabwe can probably feed up to 30 million people by using modern technology and high tech agricultural processing methods . If it returned to ‘traditional ‘ methods which to an extent has happened as a result of Mugabe’s insane policies it can probably feed maybe 3 million at most . In a country of formerly 14 million and now maybe 10 million ( 4 million have fled) the ‘food ‘ security of at least half the present population is tenous to say the least and entirely dependent on foreign ‘aid’
    I’m not saying that micro efficiency does not have a role to play in some countries and perhaps in local ‘industrialisation’ but on a world wide basis the population of the world is entirely dependent on mass production methods of food production.

  • Greenflag

    mack ,

    ‘One problem with our globalised world is the concentration of critical activities in particular areas. ‘

    This is part of the nature of capitalism and not just of the ‘current ‘ globalised world . The concentration of economic power in certain regions or countries or continents has always been a factor in determining ‘winners and losers ‘ at the political and economic table . Concentration of activities and population is indeed why London emerged as the chief city in these islands .

    There was a similar concentration in the world of 1900 with the UK and Germany ( Europe ) and an emerging Japan in the east and an emerging USA in the west . The failure of ‘globalisation ‘ then to find solutions for the disparities between those who favoured ‘free trade’ (The British Empire ) and those who still favoured protection for emerging industries (Japan ,Germany and the USA ) was a major factor in provoking WW1 and later WW2.

    What will the rest of the world ‘live on’ if all manufacturing is outsourced to China ( as it was to Britain during it’s heyday as workshop of the world ) and all IT to India . We can’t all be civil servants or take in each others washing or fast feed ourselves to death or chill out on a two acre potato plot ? Can we ?

    The problem facing the West and those countries striving to be westernised at least in the economic sense may be just an updated version of the old fallacy of composition dilemma . What can work for an indivual or a region or even an entire country or part of a continent may not be able to work for the world as whole – Well not at least without a ‘world ‘ political order ?

  • Mack

    Greenflag –

    By and large I agree with the problem you’ve summed up – I disagree that it’s a problem with capitalism or globalisation per se. I think it’s much more fundamental than that.

    I notice on another thread you recommend Jared Diamonds “Guns, Steel and Germs”. One of the points he makes is that a concentration of economic development (whether agricultural, industrial, military, or modern private capitalism) leads to increases in power. The regions of the world that develop better technologies, economies and infrastructure of state tend to defeat those that don’t. The cause of the increase in power is the ‘superior’ economic development – not the inverse. It has always been this way.

    China’s breakneck speed development is providing it with increasing global power, eventually she will flex her muscles. Britain was the world’s manufacturing base, because she industrialized first and for the time, best. What we in the West are experiencing now is a dramatic relative decline, the pain of which up until 2007 was masked by incredibly loose monetary policy. Not anymore.

    But yet the countries that are catching up aren’t catching up fast enough, so concentrations of our industries move their in hubs leaving us vulnerable and prone to clustering ‘higher value’ industries at home. Which in the case of financial derivatives appears to be poisonous snake oil.

    Yet even in the midst of a global depression it doesn’t feel like the end of the world yet. Our welfare state is holding up, this doesn’t look like 1930. I don’t know what we can do about the global imbalances, maybe we just have to live with it?

  • Greenflag

    mack ,

    ‘I think it’s much more fundamental than that’

    How much more fundamental can that be ? BTW I/m not suggesting ‘capitalism ‘ needs to be replaced or that globalisation should cease fortwith 😉

    I recommended a read of Jared Diamonds as good intro to how the world is currently carved up in terms of say the relative development of say Europe and East Asia as compared to sub saharan Africa . Diamond’s interest is that of an anthropologist and not an economic seer for the future . The accumulation of capital be it financial , industrial , human or personal is the toughest task usually facing most individuals and so it is for that collection of individuals known as nation states .

    ‘What we in the West are experiencing now is a dramatic relative decline’

    Niall Ferguson in his War of the Worlds gives a credible rationale that the relative decline vis a vis Asia actually began circ 1900 with the ruinous wars of the early and mid 20th centuries helping to accelerate the decline . In a larger time context it may be just a case of a much older trend back to a time when Asia exceeded the West in terms of material culture , population etc to a greater extent than today ?

    ‘But yet the countries that are catching up aren’t catching up fast enough’

    Fast enough for what ? To become loci of mass consumer demand for the higher value products being produced by the western states ? I read that China has just become the world’s biggest manufacturer of cars in terms of units . Assuming economic growth continues there, even at say half it’s former double digit rate then in a generation Chinese ‘demand ‘ alone will influence the price of everything from petrol (gas) to medical operations .

    ‘ Yet even in the midst of a global depression it doesn’t feel like the end of the world yet.’

    Summer 1914 was very pleasant at least up to August of that year when the entire european continent imploded on itself in a mass orgy of death and destruction . And from those ruins emerged the totalitarian regimes which wreaked even further havoc on the continent .

    ‘Our welfare state is holding up’

    Yes but this can only continue as long as there is an economy (predominantly private sector ) which can earn the incomes and pay the taxes to finance the system . Eventually there could come a time when ‘borrowing ‘ to continue to finance the welfare state at present levels may be no longer possible . That realisation may or may not come before the public sector realises that the Emperor on which they have cast their hopes is showing his birthday suit to the world 😉

    ‘I don’t know what we can do about the global imbalances, maybe we just have to live with it? ‘

    We may decide to live with it . Those however at the far end of an imbalanced world spectrum may decide to right the balance by whatever means they can .

    No it’s not the end of the world as we know it . But it could be closer than we think .

  • Mack

    How much more fundamental can that be ?

    The very basic level Jared Diamond describes, global imbalances with disastrous consequences long predate capitalism or global trade. (E.g. Eurasian growth and the decimation of American and Australian populations on contact with Eurasians).

    Niall Ferguson in his War of the Worlds gives a credible rationale that the relative decline vis a vis Asia actually began circ 1900

    True, the pace has just accelerated a lot recently – or reached the stage where it affects me rather than British imperialists! Graham Turner describes modelling the Western and Asian economies trade relationships and concluded that had the West not inflated it’s recent bubbles the alternative would have been an incredibly painful recession as proportionally much more jobs migrated East (in The Credit Crunch: Housing Bubbles, Globalisation and the Worldwide Economic Crisis).

    Those however at the far end of an imbalanced world spectrum may decide to right the balance by whatever means they can

    Yep and given the current dynamics, by the time they are spurred to action – those poor impoverished saps at the far end of the spectrum could well be Westerners!

  • Greenflag and Mack, terrific posts, even for an economic numbskull like myself it seems the hight of stupidity to allow the very same people who got us into this mess to run and own the banks. The Banks have become to important to be left to the mercy of an unstable market, thus nationalization is the only proper option.

    To allow the banks to remain in the private sector is infantile and I do not say this out of dogmatic reasoning, but after looking at the facts, some of which you two have highlighted so well.

    I think the bankers and the city are making an attempt to take the pressure off themselves by getting their gofers in politics and the media’s to increasinly demand that the public debt must be reduced now.

    Yes, I have no doubt there will have to be cuts in public spending, but not in the welfare state or health care as the Tory’s intend.

    The French, British and other EU nations duplicate what their armed forces do, thus there is massive room to maneuver and make cuts in that sector.

    That the UK is still thinking of renewing its nuclear weapons etc is preposterous.

    Attacks on the welfare state and public health care, is simply the rich and powerful attempting to make the masses pay for the economic catastrophe they have created, as has always happened in the past, it is nothing more than a repeat of the old three card trick.

    Any political party who advocates this method should be poked with a very long stick, as they are in the pocket of the financial oligarchy mentioned above.

  • Greenflag

    mack ,

    ‘or reached the stage where it affects me rather than British imperialists! ‘

    Indeed – these things can get nasty when it’s personal 😉 I’m not complaining -I made a tidy sum over the past few weeks in the market 🙂

    (9/11) came just in the nick of time to save the first GW Bush presidency from being remembered as a time of recession instead of being remembered by voters as a time of glorious imperial overeach /crusading for democracy / and unlimited credit etc in the all important 2004 presidential election . The hangover arrived perhaps fortunately in August 2007 when the card holders of the previous adminstration were seen as holding a pair of deuces /dunces :(?

    We live in interesting times . I look forward without too much expectation however to living in ‘less’ interesting times 😉

  • Greenflag

    mickhall ,

    ‘it is nothing more than a repeat of the old three card trick.’

    Now you’ve seen where the money – look again -hey presto it’s gone eh ? Not a bad analogy . I was thinking more of modern day institutional Shylocks ‘ extracting the requisite pound/dollar or euro of flesh from the taxpayers of many countries across the globe . Meanwhile the elected representatives of the people stand aloof to see how much more can the ‘institutional ‘ shylocks squeeze from the populace (american ,british or irish or icelandic ) without provoking revolutionary mayhem or worse ?

  • “We live in interesting times”

    There is a Chinese saying that goes ‘pity those who live in interesting times.’

  • Greenflag

    mickhall ,

    Never mind what they say – watch what they do 😉 and that applies not just to the Chinese but to British , Irish and American bankers , politicians of all nations , and clerics of all persuasions and none , and even non god fearing atheists – not forgetting those who shout power to the people and promise ‘utopia ‘ tomorrow 😉

    Still on balance I’d rather have a tooth extracted by a 21st century dentist than have to rely on say 17th century methods .

    As of now much of what passes for economic forecasting by the pundits of left and right including your scribe is horror of horrors ‘faith based ‘ And that unfortunately means having to have faith in those who no longer deserve our faith and I’m not just talking ‘religion ‘ 😉

  • Driftwood

    Anyone remember Francis Fukuyama? The End of History? seems a bit crap now. more illuminating is this:

    http://en.wikipedia.org/wiki/Clash_of_Civilizations

    BTW Jared Diamond is excellent reading.