One of the more damning articles on the US financial sector to emerge lately is a piece by the former IMF chief economist, Simon Johnson, now a professor at MIT’s Sloan School of Management. The article was published in The Atlantic Monthly. I came across it via a link in Yves Smith’s excellent blog, Naked Capitalism.
Johnson, as he relates in the piece, has had a massive amount of experience with emerging market governments and their oligarch friends, coming to the IMF for loans. How is this relevant to the US financial sector? Simple. It presents an intriguingly parallel case, Johnson argues.
His basic point is that where the oligarchs in an emerging economy are massively benefiting from the existing status quo, fixing a bust economy is extremely difficult. It can only be done when things have got so bad that the government of the country concerned, which is always more or less in thrall to its oligarch friends, can no longer afford to bail all of them out and is facing the prospect of defaulting on its debts – thus shutting itself out of the global capital markets and rendering further borrowing hideously expensive.
The IMF is then able to fix things because it can recapitalise the bust economy on terms which help to put it back on track, usually by forcing the government to throw a good number of the oligarchs to the wolves. This doesn’t make the IMF very popular, and, as Johnson says, it certainly doesn’t make it the first port of call for financing. For example, fixing Thailand’s bust economy, he points out, turned out to be an exercise in getting the Thai government and the oligarchs to decide which leading Thai families were going to lose their banks. Starting to see where this is going?
Here is Johnson on how the oligarchs crank their nation’s debt problems into existence:
“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. But, inevitably, emerging-market oligarchs get carried away; they waste money and build massive business empires on a mountain of debt.”
Much the same process of delirium, it seems, afflicts bankers. Sir Fred Goodwin’s disastrous, hubristic purchase of ABN Ambro being a case in point. Johnson’s argument about US banks is rather more subtle. He points to a good deal of cronyism and swapping of personnel between the big banks, government and the regulatory agencies, which, he argues, led over time to the capture of the US governmental decision-making process by the financial sector.
How are matters to be put right? In emerging economies it is a matter of the IMF dishing out “tough love”.
"From long years of experience, the IMF staff knows its program will succeed—stabilizing the economy and enabling growth—only if at least some of the powerful oligarchs who did so much to create the underlying problems take a hit. This is the problem of all emerging markets."
The problem for the US is that there is no IMF to step in and sort matters out. The same financial elite who, Johnson says, “played a central role in creating the crisis, making ever larger gambles with the implicit backing of the government until the inevitable collapse”, are now reacting exactly as emerging market oligarchs do in the early phase of an emerging market disaster. They do everything they can to continue the status quo and to resist the inevitable reforms that will see some of them thrown to the wolves. The US financial sector elite is now “using [its] influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the US economy out of its nosedive”. And without an IMF in the wings, the US government seems “helpless, or unwilling, to act against them”.
Part Two, published soon, considers Johnson’s analysis of how rapidly the financial sector has enriched itself over the last 25 years, versus other sectors of the economy, which in turn shows how difficult any future correction is going to be.
Further reading on financial regulation and emerging markets:
- Costs and Benefits of Accounting-Based Regulation in Emerging Capital Markets by Wang Jiwei
- US Financial Regulation: A Hopeless Tangle, or Complexity for a Purpose? by Lawrence J. White
- Why Organizations Need to be Regulated—Lessons from History by Bridget Hutter
Tags: ABN Ambro , emerging capital markets , emerging markets , financial sector , financial sector reform , IMF , Indonesia , International Monetary Fund , MIT , Naked Capitalism , oligarchs , oligopoly , regulation , Russia , Simon Johnson , Sir Fred Goodwin , Sloan School of Management , South Korea , Thailand , US debt , US deficit , US economy