Tuesday, April 14, 2009

Martin Wolf (and Simon Johnson) on the government and the banking system

The financial sector got too big, and government interference is preventing the crisis from resolve. Why? Here's an excerpt of Martin Wolf's article at the Financial Times, Cutting back financial capitalism is America's biggest test (Financial Times offers a free subscription for users who sign up):
In recent research, Thomas Philippon of New York University’s Stern School of Business and Ariell Reshef of the University of Virginia conclude that the financial sector was a high-skill, high-wage industry between 1909 and 1933. It then went into relative decline until 1980, whereupon it again started to be a high-skill, high-wage sector.* They conclude that the prime cause was deregulation, which “unleashes creativity and innovation and increases demand for skilled workers”.

Deregulation also generates growth of credit, the raw stuff the financial sector creates and on which it feeds. Transmutation of credit into income is why the profitability of the financial system can be illusory. Equally, the expansion of the financial sector will reverse, at least within the US: credit growth and leverage masked low or even non-existent profitability of much activity, which will disappear, and part of the debt must also be liquidated. The golden age of Wall Street is over: the return of regulation is cause and consequence of this shift.

Yet Prof Johnson makes a stronger point than this. He argues that the refusal of powerful institutions to admit losses – aided and abetted by a government in thrall to the “money-changers” – may make it impossible to escape from the crisis. Moreover, since the US enjoys the privilege of being able to borrow in its own currency it is far easier for it than for mere emerging economies to paper over cracks, turning crisis into long-term economic malaise. So we have witnessed a series of improvisations or “deals” whose underlying aim is to rescue as much of the financial system as possible in as generous a way as policymakers think they can get away with..Read the rest of the article here. Source chart from referenced NBER paper.
RW: This is truly amazing: seven months have gone by since the U.S. government put insolvent Fannie Mae and Freddie Mac under conservatorship, and some of our biggest commercial banks are still likely insolvent to a degree. Are we in the resolution phase of the banking crisis (see this IMF paper)? Or still the containment phase? It's hard to tell, but the resolution phase is clearly going to last a while.

Rebecca Wilder


  1. So, with the banks announcing good profits, where does that leave us? They say they will repay their loans soon. Doesn't it seem kind of suspicious? Hope the government is getting some decent interest on those loans!

  2. bankers have always controlled their destiny

    laissez-faire doesn't apply to the banks & non-banks

    they need decidedly restricted in both their assets and their liabilities

    they need nationalized in good times and in bad