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Fighting America's 'Financial Oligarchy'
TERRY GROSS, host:
This is FRESH AIR. Iâm Terry Gross. The bailout of the banking system is
entering a new phase, and itâs likely to include a showdown between the
banks and the government, according to my guest, Simon Johnson.
Johnson is the former chief economist of the International Monetary
Fund, the IMF. Heâs a professor at MITâs Sloan School of Management, a
senior fellow at the Peterson Institute for International Economics, the
co-founder of the global economics Web site Baseline Scenario, and he
recently started writing for the New York Times economics blog.
In the May edition of the Atlantic, Johnson has an article titled âThe
Quiet Coup,â in which he says that in order to get out of our financial
crisis, we have to break the power of the financial oligarchy that is
Simon Johnson, welcome back to FRESH AIR. The Obama administration said
yesterday that it would reveal some of the results of the stress tests
itâs administered to the banks. So letâs start with what the stress
tests are designed to do and what function they serve.
ProfessorÂ SIMON JOHNSON (MIT): The stress tests are totally sensible.
Itâs like going to the doctor because you think there may be a problem
with your heart and they put you on a treadmill and they put your heart
under some stress, carefully, and they look at the effects of that.
Well, itâs the same thing with banks.
They go in and they look at the â whatâs really on the balance sheet,
and they think about how the balance sheet would look if the economy is
worse or substantially worse or dramatically worse than its current
performance. And so in that sense theyâre stressing. Itâs an imaginary
thing, obviously; theyâre stressing how the banks will do if we have a
really severe recession.
GROSS: And whatâs the final purpose of doing this?
Prof. JOHNSON: Well, itâs to see if the financial system is going to
have a heart attack or is in danger of having a heart attack or should
get some different medicine in order to reduce the risk of the kind of
financial meltdown that we saw back in September, October of last year.
So itâs an attempt to assess whoâs in good shape and whoâs in bad shape,
who needs to work out more, including work out some of that toxic debt
GROSS: And is it a survival-of-the-fittest thing that the banks that
fail a stress test basically either get bailed out or are allowed to
Prof. JOHNSON: Well, you could use a stress test to do that. You could
use it to support, to sort of divide the banks into the ones that are
going to go forward and the ones that are going to be taken over or
I donât think the governmentâs going to do that. Theyâve sent very
strong signals that â they said itâs not pass/fail, and they said that â
now theyâre saying, the latest indications are all banks will pass to
I think thereâs going to be some B-minuses and some A-pluses, but
everybody gets to pass, and they may get different instructions, if you
like, health warnings or things to do from the doctor, as we move
GROSS: Why do you think the Obama administration originally planned to
keep the results of the stress tests secret and now plan on revealing
some of the information from those stress tests?
Prof. JOHNSON: Well, any time you reveal this kind of very sensitive
information, you run the risk of destabilizing markets. For example, if
they tell you that certain banks have a B-minus or even a D-minus, and
they assure you itâs still a passing grade, I think the markets might
take a negative view on that bank.
And so they wanted to manage the flow of this information very
carefully, but it does seem that, particularly over the last week or so,
that the big banks have forced the governmentâs hand by actually
revealing some of the information themselves or, you know, in the case
of Goldman Sachs, basically stating how theyâre going to do in the
And you know, this means that if you donât reveal information about
other banks, theyâre going to be at a competitive disadvantage. People
are going to assume the worst about banks that donât speak out on this
issue. So the government, I think, feels a need to try and even the
playing field here.
GROSS: So you think that the government is responding to Goldman Sachs
basically saying weâre doing good?
Prof. JOHNSON: Well, itâs not just Goldman. Itâs â Wells Fargoâs been
quite aggressive in its language, and Citigroup and Bank of America have
also made positive statements, statements that it seems the government
didnât actually want them to make because it would exactly tilt the
playing field to their advantage.
GROSS: Now Goldman Sachs wants to give back the $10 billion in TARP
money that it got, and it sold $5 billion in new stock, which it intends
to put toward returning the TARP. Why is Goldman anxious to return the
Prof. JOHNSON: Well, Goldmanâs motivation, which theyâre quite clear
about, is that they would like to go back to having the same kind of
compensation scheme that they had before, with very big bonuses in
Thatâs not currently allowed, or thereâs a lot of restrictions on that,
under the TARP program. If they â they think, theyâre arguing, that if
they pay back this capital, if theyâre allowed to pay it back, then they
will be able to run very high bonus schemes again, attract talent, and
basically take a lot of market share away from their competitors.
So itâs an attempt to really make a very big competitive move on their
GROSS: Why might the Obama administration be concerned about this and be
less than enthusiastic about letting Goldman give back the TARP money? I
mean, it sounds like a good thing. The governmentâs getting $10 billion
in TARP money back if this happens. Like, why wouldnât they want it?
Prof. JOHNSON: Well, we do want our TARP money back. Thereâs no question
about that, and of course there have been worries about that money being
lost, and so this is quite reassuring on that front.
But at the same time, itâs not clear that you want Goldman Sachs to get
a big jump on the competition; this could be potentially destabilizing.
Banks that are not in a position to pay back their TARP money could
actually find their business models further undermined, their ability to
raise further capital, and of course we could end up paying more out of
the total TARP program if other banks come under pressure.
It also seems â you know, the governmentâs making the very reasonable
point, and this is actually being articulated nicely in a New York Times
article this morning, that these banks exist or are using substantial
other forms of government assistance right now, including in some cases
credit from the Federal Reserve. But also theyâre stressing the program
that the Federal Deposit Insurance Company, the FDIC, put in place where
they are basically guaranteeing some of these banksâ debt, and that was
something that was done in the fall under emergency circumstances. Itâs
And in addition, of course, the government still owns some warrants or
options to buy the stock in these large banks, and again, you know, if
you withdraw that support, what happens to the big banks, and what
happens to their competitors? Thatâs the hot topic.
GROSS: So in other words, what Goldman would be doing is still getting
some government backup, even though it was giving back the TARP money,
and it would no longer have any strings attached.
Prof. JOHNSON: Exactly. You know, thereâs a very old saying that Wall
Street owns the upside, and the taxpayer owns the downside. This seems
like a pretty blatant demonstration that that holds today more than
GROSS: But what Goldman is saying is that the FDIC program doesnât come
with strings attached; Goldman, when it accepted participation in that,
didnât know that there would ever be strings attached; so why should it
be punished for staying in that program?
Prof. JOHNSON: Itâs a fascinating showdown between the big banks, led by
Goldman in this instance, and the government. Basically the government
is trying to act in the interests of the system. The government saved
the day back in the fall at tremendous cost to the taxpayer, but it had
to be done. and they want the banks to sort of cooperate with them in
getting the financial system as a whole back on its feet.
The big banks donât really want to do this in the way that the Federal
Reserve and the FDIC and the Treasury are asking. So itâs a
confrontation. Itâs a demonstration or a showdown. The two sides are, I
think, going to bare their teeth and make various kinds of statements.
Weâll see who will prevail here. Personally, Iâm on the side of the
GROSS: Itâs â I know you wonât have the answer to this, but I canât help
but wonder whatâs going through the minds of the people behind the TARP
who are now seeing â like, you know, they took this risk. They gave all
this money to the banks, and now they might be seeing the banks as
trying to undermine the program by paying the money back and getting out
of the restrictions and adding new uncertainties into the system.
Prof. JOHNSON: I donât know what theyâre thinking, but my guess and my
reading of the stories that are coming out and the way that various
newspapers have been briefed on this is that the government officials,
particularly the Fed, Federal Reserve and the Treasury, are very
frustrated at this point.
They went to extraordinary lengths, they worked very hard to save the
banks. They bent over backwards to really accommodate the banks and to
help them out as much as possible. I personally think theyâve gone a bit
too far. I think they couldâve been tougher on the banks, you know, a
couple of months ago or even four months ago. But you know, thatâs all
water under the bridge. Right now I think theyâre going to be very
frustrated that these banks are not playing ball.
And you know, whoâs in charge here? Whoâs calling the shots? Whoâs
making the big strategic decisions about the U.S. financial system and
its future? Is it the people running the Treasury and the Fed, or is it
Goldman Sachs? I think maybe weâll find out a little bit more about that
this week and next.
GROSS: Some people are concerned that Goldman Sachs has special
connections to the government. Thereâs even like conspiracy theories
floating around about this. For example, Robert Rubin, who was Treasury
secretary under President Clinton, was a head of Goldman. Hank Paulson,
who was Treasury secretary under President Bush, was with Goldman.
Timothy Geithnerâs chief of staff was formerly with Goldman. The new
head of the Commodity Futures Trading Commission - formerly with
Goldman. The new CEO of AIG had been on the board of Goldman.
So what do you make of that, and do you think that this gives Goldman
Sachs a special advantage on the playing field?
Prof. JOHNSON: I donât â Iâm not a fan of conspiracy theories in
general. I donât think thereâs a conspiracy in the financial sector. I
think there is a system of belief, in Washington, perhaps more dangerous
than a conspiracy, a system of belief that whatâs good for Wall Street
is good for Washington and good for the country.
And in that system of belief, Goldman Sachs, without doubt, plays a
particular role as a thought-leader, as an innovator in all kinds of
interactions with government, and they have had some particular
individuals whoâve played important roles. As you identified, Mr.Â Rubin
and Mr.Â Paulson stand out.
But I wouldnât, you know, go overboard stressing itâs just about Goldman
Sachs or just about those individuals. Itâs much broader, deeper and
problematic beliefs that somehow we should always accommodate these
banks, bend over backwards, do what we can to help them back on their
feet, and whenever they get into trouble we the taxpayer are going to
take the risks, bear the cost of that.
I donât think thatâs a good system going forward, and if weâve really
built banks â we have banks, obviously, clearly, that are too big to
fail, shouldnât we start asking whether theyâre also too big to exist?
GROSS: You think thatâs what we should be asking?
Prof. JOHNSON: Thatâs what Iâm asking, and I think â and Iâm surprised
and kind of pleased by how many people, very technocratic, centrist
people, people who used to work in the U.S. Treasury, people who used to
work for the IMF or people who still work for the IMF, people who are
economic historians, spent their life studying the structure of the
U.S., people who are not very political and certainly not of the left or
of the right. People are saying to me, yes, you know, I think you have a
This too big to fail has a lot of implications in terms of the structure
of the financial industry going forward, and assuming that we can come
up with a better tweaking of the regulatory system seems kind of
illusory because itâs never happened in the past.
So either we come up with a better, more magical regulator than has ever
existed in the history of humankind, or we have to go about this
differently, in a somewhat cruder fashion. And one â not a panacea, but
one piece of that approach could well be smaller banks or making it
harder for banks to become so big that they threaten the financial
GROSS: My guest is Simon Johnson, former chief economist of the
International Monetary Fund and a professor at MITâs Sloan School of
Management. Weâll talk more after a break. This is FRESH AIR.
(Soundbite of music)
GROSS: Weâre talking about the next phase of the financial bailout with
Simon Johnson, former chief economist of the IMF, the International
Monetary Fund. Heâs a professor at MIT and co-founded the global economy
Web site Baseline Scenario.
When we left off, we were talking about Goldman Sachs, which wants to
pay back the TARP money it got from the government bailout. But the
situation is more complicated than it may seem.
So even if Goldman Sachs gives back $10 billion in TARP money to the
government and says now weâre free of the TARP so we donât want
restrictions anymore, it still got, I think, around $13 billion through
the AIG bailout because it was a counter-party to AIG.
So in other words, AIG owed Goldman money, and it paid that money
through its bailout. So Goldman Sachs has been able to get to this point
through several phases of the bailout, and itâs certainly not going to
be giving back the AIG money that it got through the bailout.
Prof. JOHNSON: Thatâs right. They wonât. Look, Goldman Sachs and the
other, the rest of the financial system, certainly the big banks,
received a huge amount of support both through the government stepping
in to save AIG or to protect its obligations in the derivatives markets
- those are credit default swaps, for which Goldman was the counter-
party back in September - but there was also a lot of other forms of
assistance provided. Goldman Sachs was allowed to change its legal form
so they could have access to the Federal Reserve and get a large amount
of credit when the system was under duress.
I mean, weâre talking about trillions of dollars that were provided by
the taxpayer to save the financial system, and I think that was fine. It
was needed. The banks, you know, probably would have â many of them
would have failed without that support.
So you know, now the question is: why donât the banks want to play ball?
Not with me, not with my suggestions for reform. Iâm sure they would
consider those far too radical. Why donât they want to cooperate with
the Treasury and with the Fed, the people whoâve really saved their
Itâs quite strange and I think a little bit close to being
incomprehensible, the attitude and the hubris of the banks under these
GROSS: So Goldman is saying it wants to give back the TARP money largely
because it wants to be free of the restrictions, and those restrictions
include limits on executive compensation.
And of course the argument is that if theyâre free of limits on
executive compensation, they can offer more to the people they want to
hire. They can keep people, and they can hire people and thereby have a
competitive advantage by getting the best people.
But a lot of people are skeptical about this because, I mean, the quote
âbest peopleâ with the biggest compensation packages are the people who
kind of made the decisions that helped get us into this mess in the
Prof. JOHNSON: Yes, itâs a very good point. And of course what theyâd
like â the limits theyâd like to remove and not just on executive
compensation for the very top people but also on the compensation
schemes and the bonus schemes for people throughout the organization.
And of course, you know, actually I think thereâs a lot of agreement on
the following point - that the nature of compensation in these big
banks, the way in which people were encouraged and rewarded for taking
risk, really pushed, really brought the system to the brink of absolute
failure and meltdown, because who take risks today get cash bonuses
today by putting together deals and transactions that would lead to
problems down the road.
Sometimes people call it picking up nickels in front of a bulldozer, the
idea being that most of the time youâll get the nickel, sometimes you
get run over by the bulldozer. And of course, if itâs the next guy to
have your job who actually gets run over, you know, so much the better,
would go that attitude.
So there is a real question about whether they should be allowed to
rebuild essentially the same system as before. No doubt they will say
theyâve tweaked it. They will say theyâve addressed some of these
issues, but nobody has yet been convinced. Nobody from the outside has
yet been convinced that theyâve really done that.
GROSS: Do you think that the American public will be angry if things go
back to those really oversized compensation packages that existed before
Prof. JOHNSON: I think the American people mostly care about their jobs
and being able to afford their mortgages, and if the economy turns
around as a recovery, they probably will be willing to let the banks go
about their business again.
The danger there, of course, is if you have the same system and the same
vulnerabilities, then at some point in the future â I donât know if itâs
in two years or five years or 10 years, you can have another financial
catastrophe of this nature.
Remember, this crisis is probably going to push up our national debt
from around 40 percent of GDP â thatâs where weâre starting. Thatâs a
reasonably moderate level of debt. I think by the time weâre done with
this, if you include fiscal stimulus, bailout packages, the whole works,
weâll probably be closer to 80, maybe 90 percent of GDP, debt-to-GDP
Thatâs quite a lot, and thatâs not all. Right? If we rebuild or allow to
continue the same financial structure as before, we are looking for
trouble, and we should expect to have another big financial meltdown at
some point, and that one we may not be able to afford.
GROSS: So what choices does the Obama administration have to make now
regarding Goldman and whether it lets Goldman pay back the TARP and free
itself of restrictions, government restrictions on compensation and
Prof. JOHNSON: Well, I think thatâs exactly the decision that they have
to make. It is for the government to decide, not for Goldman Sachs to
decide. Itâs for the government to decide if Goldman Sachs is
sufficiently strong to be allowed to pay back the TARP money and
discharge its other obligations or claim the other obligations donât
come with restrictions on executive compensation on bonuses.
I would strongly suggest that the government can draw a line here and
say, no, weâre not ready for this, youâre not ready for this, the system
is not ready for this; we have a responsibility to the system. I think
itâs a showdown.
I think if the government can face down Goldman Sachs on this key issue,
which Goldman Sachs cares a lot, and theyâve raised the stakes by making
these public statements about what theyâre going to do, if the
government, if the Treasury, if the Fed and if the White House can face
down Goldman on this one, then Iâm going to feel much more optimistic
about the future.
Prof. JOHNSON: Because this is about power, and this is about telling
the financial sector that they do not run this country. The country is
run by people who have been elected to run the country, and having the
financial sector build up massive vulnerabilities, create enormous
dangers, generate big, big costs for the taxpayer and then walk away as
if nothing had happened and go back to getting the upside while we, you
know, got a hold of any future downside risk, that to my mind is not
GROSS: Are there risks to the Obama administration if it says no to
Goldman, if it says weâre not ready to let you give back the TARP money
and be free of the government restrictions yet?
Prof. JOHNSON: I am sure that the financial sector will make two points
to them, are making two points to them. First of all that, you know, you
need healthy banks in order to have a recovery. Everybodyâs been saying
that. And if you let us go back to our previous incentive schemes, weâll
be healthier. Weâll be able to attract better people. Youâll get more of
a recovery. And, by the way, if you donât do this, if you take actions
that undermine us and at all destabilize us, this could jeopardize the
financial system and cause further panic and collapse.
So there is an element of â you can call it blackmail in this situation,
and thatâs why itâs a showdown. Itâs not because Goldman Sachs is
threatening to take over the government. Itâs because Goldman Sachs is
saying, well, you know, itâs up to you guys. If you donât do as we say,
then youâre not going to have a recovery. Youâre going to have lots of
unemployment, and weâll make sure everybody knows itâs all your fault.
GROSS: Could Goldman sabotage the recovery?
Prof. JOHNSON: No, I donât think so. Itâs not â itâs a system. Itâs a
very big system and itâs subject to all kinds of forces domestically and
globally. But thereâs no question that they can position themselves and
they can convey certain messages, and people who work with them and are
favorable to them can convey messages that would make the administration
look less good or make it look more good.
So they have tremendous influence. They have a lot of say on Capitol
Hill. I think that the game is played at a subtle and deep level with
all kinds of interesting, you know, communications strategies and lots
of sort of movement with events, lots of things happening you donât
expect. But these big financial players are very serious. Theyâre very
sophisticated, and they see this as their economy, and they want it
GROSS: Simon Johnson will be back in the second half of the show. Heâs a
professor at MITâs Sloan School of Management, a senior fellow at the
Peterson Institute for International Economics, and co-founder of the
global economics Web site Baseline Scenario. Iâm Terry Gross, and this
is FRESH AIR.
(Soundbite of music)
GROSS: This is FRESH AIR. Iâm Terry Gross.
Weâre talking about the economic crisis and the next stage of the
bailout with Simon Johnson, former chief economist of the International
Monetary Fund, the IMF. He is also a professor at MITâs Sloan School of
Management and a senior fellow at the Peterson Institute for
International Economics. He has an article in the Atlantic titled âThe
Quiet Coupâ about what he describes as the financial oligarchy that is
blocking economic reform in the U.S.
In the Atlantic article that youâve - in the current edition, the May
edition of the Atlantic - you make several comparisons between our
economic crisis and the crisis you saw at the International Monetary
Fund when youâre working with emerging markets. And you say, you know,
you work with a lot of countries ruled by oligarchies and letâs just
define our term oligarchy here.
(Soundbite of laughter)
GROSS: Iâll ask you the question so: When you say oligarchy, what do you
Prof. JOHNSON: I mean a pretty small group of people who have a lot of
economic power and tremendous political influence in any country.
GROSS: So you say in emerging markets when the country is in economic
crisis, itâs usually because the powerful elites - the oligarchies
within them overreach in good times and took too many risks. You see a
parallel here in our country?
Prof. JOHNSON: Yes, I do. I think itâs a pretty standard pattern around
the world when you have major booms that people who start out with, you
know, some resources, some access, some sort of profile, politically and
opportunities, economically - they make big investments. They make a lot
of money and they plow it back in - both into the economic side of
things, but also into political side of things and they build up more
influence. And of course a lot of investors, people supporting various
kinds of oligarchs, like that.
And foreign investors are delighted when you have more access to the
president, for example, and that lets you get your hands on more
capital, make more investments and the whole boom, or bubble, goes on
for quite a while until, of course, it explodes.
GROSS: You think that part of the problem we have in the United States
is that the finance sector became more powerful under Presidents Reagan,
Clinton, and Bush. In what way did that sector become more powerful?
Prof. JOHNSON: Well, I think the financial sector has always been
important in this country, itâs always been involved in economic policy-
making. But if you look at the data, the government data, from 1980, you
see a dramatic increase in how much of corporate profits are earned in
the financial sector. And of course you see a very big increase in the
average compensation in that sector, relative to the rest of the
country. So I think that it was â it was a boom that made sense.
There was some deregulation initially that, you know, probably was also
sensible. But as the firms made this money and as the individuals
involved made this money, they plowed it back into political access, and
of course they were able to shape a lot of the regulation environment,
particularly around derivatives, which was a new technology that came
along - late â80s and particularly in the 1990s. They were able to
really convince government, and the rest of us, that they should be
allowed a free hand in building these markets. And that, obviously, has
not gone very well for us, at least.
GROSS: If one is concerned, as you are, that people on Wall Street have
too much power when it comes to determining what kind of regulations
Wall Street will have, and if they have, like, too much power
politically in terms of lobbying, what do you think could be done to
change that? If you consider that there is something of an â of a
financial oligarchy in the United States, what do you think could change
Prof. JOHNSON: Well, my - my concern is not about Wall Street as a
whole. I think that â that the financial sector is going to become
smaller because it over-expanded in the very long boom and thereâs now
some natural contraction. My - my concern is about the power of
relatively few massive players on Wall Street. And of course after the
crisis, with Bear Stearns going out of business and Lehman also having
disappeared and some other reshaping, the big financial players who
remain are even larger, relative to key markets and more influencial, I
think, on central decisions, for example, around the bailout.
So Iâm talking about Goldman Sachs, JP Morgan and Citigroup, Bank of
America arguably as well, and some other players. So I think that there
is a case for finding ways to constrain the size of these banks. They
are â they â they have peaked. Some of them peaked with the size or
total balance sheet, around 20 percent of the U.S. economy. And, you
know, itâs clear from the discussions about too big to fail, that this,
you know, creates lots of problems and lots of potential obligations for
the taxpayer going forward.
So I think we should find ways to make these â the biggest banks â
smaller. And thereâre various ideas out there - for example, a tax on
bigness, having to pay more tax or having to put up more capital when
you become large, relative to the system. I think we want to get away
from a situation where the failure of one, two or five players can
really jeopardize the entire U.S. and global economy.
GROSS: Is that a new way of looking at too big to fail? I mean Iâve
heard several people lately talking about how there needs to be a
special way of treating these institutions that could put a whole
economy in jeopardy because theyâre too big to fail. Have ideas about
treating those institutions differently surfaced before or is this only
since the crisis that people have been talking about that?
Prof. JOHNSON: I think the discussion of this issue has become intense
since the crisis. Ideas like this had been around for long time and
obviously there is a tradition in the United States of being very
suspicious of big industrial or financial power. And if you go back to
the 19th century and you look, for example, at the work of Steve Haber,
whoâs an economic historian at Stanford - he documents, very carefully,
in a fascinating manner, how the U.S. struggled - the U.S. political
forces - you can call it populism if you want - but there was lots of
mainstream people as well, mainstream business people who didnât want
there to be massive finance and they struggled against this.
And the 19th century, you can argue, was won by these rather more
diffuse democratic forces - which we remember that, in terms of the
anti-trust movement, and remember the breaking up of John D.
Rockefellerâs massive oil company, Standard Oil - what we donât remember
quite as clearly is the way in which financial power was constrained.
But it was, and I think we should go back to that 19th century
philosophy basically on which this country was built.
GROSS: My guest is Simon Johnson, former chief economist of the IMF -
the International Monetary Fund - and a professor at MITâs Sloan School
of Management. Weâll talk more after a break. This is FRESH AIR.
(Soundbite of music)
GROSS: If youâre just joining us, my guest is Simon Johnson, and he is
the former chief economist at the International Monetary Fund. He
teaches at MIT. Heâs a senior fellow at the Peterson Institute. Heâs the
cofounder of a Web site about the global economy called Baseline
Scenario. And he recently became a writer for the New York Times
One of the new faces of the bailout is the â the plan to â for the
government to help investors purchase toxic assets, so that these toxic
assets, which are so hard to value and are such a problem, can be taken
off the bankâs books. This is called the PPIP - the Public-Private
So just give us a short summary of how this plan is supposed to work and
then weâll - weâll talk about it.
Prof. JOHNSON: Sure. The basic idea is pretty simple. Itâs that banks
have assets that are worth letâs say 85 cents. Letâs say they have an
asset that in principle, when it was issued, was â was worth a dollar.
Theyâve marked it down to about 85 cents, (unintelligible) view of what
itâs worth. And there are people out there in the market, letâs call
them hedge funds, itâs much broader group. Thereâre people out there in
the market who think these things are really worth 40 cents. So thereâs
a gap between the 40 cent view and the 85 cent view.
The PPIP is supposed to bridge that gap by throwing in a subsidy,
subsidy from you and me, the taxpayer, by the Treasury, to try and close
that gap and â and, you know, perhaps you could get the â you could
provide the subsidy in such a fashion that â that the bank will be
willing to sell and the hedge fund will be â will be willing to buy at
60 cents. Youâre trying to close the gap that exists in the market
between these two price views.
GROSS: And what are the reasons why the banks may or may not be willing
to bridge that gap and sell the assets?
Prof. JOHNSON: Well, thereâs obviously some real tensions in the
Geithner Treasury approach here. One is how hard the banks are being
pushed. If youâve given the banks a lot of space and a lot of
forbearance, youâre saying, guys, just relax, the economy will recover
and thatâll take care of it. They donât really have a big incentive to
sell for anything less than what theyâve already marked these assets at.
So for them their view may well be, look, 85 cents is the price, take it
or leave it, we - we donât need to sell these things because weâre not
under a lot of pressure from our supervisor and from the Treasury from
the angle of â of looking at the solvency and seeing how much capital
GROSS: Well, what are the problems of holding on to these assets if
nobody really wants to buy them at the price that the banks have priced
Prof. JOHNSON: Well, the issue is, I think, that they â they hang over -
that the bankâs futures â theyâre sort of the Sword of Damocles that
dangles over you and makes you very worried about how â how youâre going
to be judged in the future. And generally speaking in â in any kind of
massive banking crisis like this one, itâs better to clean up the
balance sheets, which means remove the â the toxic assets. Theyâre not
really toxic, by the way, theyâre just bad.
(Soundbite of laughter)
Prof. JOHNSON: Toxic makes them sound a little too sophisticated and â
and â and scary. Theyâre just bad assets, theyâve gone bad. They were
bad decisions made by these banks and itâs, generally speaking, better
to get those out of the picture and let the banks concentrate on â on
new business going forward.
GROSS: And what are the risks and benefits for hedge funds and investing
in these bad assets?
Prof. JOHNSON: Well, it â itâs quite a good deal, depending on the,
obviously on â on the prices that you end up paying. The government is
providing so-called nonârecourse loans, which means that if â if you put
up a billion dollars to play, you can leverage that tremendously,
depending on exactly the â the transaction youâre doing; you may be able
to leverage that, you know, roughly or almost 10 times. And if it goes
well, you keep a lot of the upside, you keep a lot of the profits. You
have to share those to some degree with the Treasury, itâs true. If it
goes bad, then you â you lose your billion dollars that you put in as
capital for this venture.
But you donât lose anything else. Thereâs no other claim on you because
your venture defaulted on this â on this big loan you got from the U.S.
government. So, it - itâs a pretty good deal. Itâs a much better deal if
you pay a lower price for these securities. And â and thatâs what I
think the â the people who are doing their due diligence on this right
now are thinking about it.
GROSS: Is there a precedent for this kind of program any place in the
world that youâre aware of?
Prof. JOHNSON: Not really. Simply not an â not an anything like a scale
thatâs currently â currently being proposed. It is another great
American financial innovation.
GROSS: So, say the â this program is successful and investors purchase
these bad assets, the bulk of them are taken off the banksâ books. How
does that change things?
Prof. JOHNSON: Well, ideally if these toxic or bad assets disappear -
oh, by the way, weâre not supposed to call them that anymore, weâre
supposed to call them legacy assetsâ¦
GROSS: I know.
Prof. JOHNSON: Rebranding.
(Soundbite of laughter)
GROSS: Rebranding, yes.
Prof. JOHNSON: Anyway, if the legacy assets disappear, then depending on
â on the price of which they disappear, the banks may be fully help you
again. And the prospect of further losses could vanish. So, you know,
there â there is a way for â for us to magically remake our banks. Itâs
a little hard and it would involve a massive taxpayer subsidy. And
apparently weâre not going to â weâre not allowed to get substantial
amount of stock in return for that. So you know, itâs a great deal for
the banks if it happens, not just a good deal for the taxpayer.
GROSS: Well, you â you used the term magically. Are you using that with
â with cynicism, that it would require magic for this to work?
Prof. JOHNSON: Well, I believe in magic. It, you know, the Easter Bunny
does come once a year with some help from parents. Itâs a kind of - itâs
the magic of government subsidies - and yes, I am being a little bit
cynical about it.
GROSS: The Obama administration is considering offering the opportunity
to individual investors to participate in this plan and buy these bad
assets - probably through vehicles like mutual funds and I â Iâd be
interested in hearing your analysis of that possibility.
Prof. JOHNSON: I think itâs a great idea. I mean if it really is an
investment with tremendous upside, which of course is how theyâre
selling it to the hedge funds, then you should let individuals
participate. Another good idea, by the way, thatâs got a lot of
attraction, that at least one origination was â was our Web site - was
encouraging or allowing or â or telling bankers that they have to take
that bonuses going forward in the form of these toxic assets. After all,
they claim that these things are massively under-priced by the market
and theyâre going to recover. So it should be a good deal for them on
the bonus side too.
GROSS: Whoâs proposed that?
(Soundbite of laughter)
Prof. JOHNSON: We proposed that.
GROSS: Oh, you proposed that?
(Soundbite of laughter)
Prof. JOHNSON: Somewhat humorously. But I believe it has â it has got
some traction in some of the big banks. And Iâm not claiming â weâre not
claiming that we were the absolute first originators of that. I donât
think itâs an idea you can patent. But it is a very appealing idea for
symbolic as well as substantive reasons.
GROSS: And the odds that banks would agree to that are?
Prof. JOHNSON: Not zero. I think thereâs â thereâs one bank thatâs
seriously considering it, or some reports say theyâre actually trying to
â trying to implement it. Havenât heard the reaction from the executives
to whom they made this proposal. But it is completely consistent with
their belief system and the way that theyâve framed this issue to the
government. Theyâre saying that these markets are illiquid, that theyâre
temporarily giving lower prices than these assets are actually worth. So
it sounds perfect for a bonus scheme.
GROSS: Now, I think it was on your Web site, Baseline Scenario, your Web
site about the global economy, that I read that a lot of people are now
using credit default swaps to basically bet against the banks. What does
Prof. JOHNSON: So if you think - in the old days if you thought a bank
was going to fail, you lined up outside the bank to take your money out.
And a bank run was literally a run to the bank, as in run on your own
two feet. Now, that doesnât happen very often. Itâs extremely rare,
because we have the FDIC and that guarantees retail deposits, and those
guarantees are, I would emphasize, absolutely sound and they have plenty
of support from the Treasury that there wonât be a problem there.
But if you think that banks are going to get into trouble, if you think
that theyâre going to fail and â and have to restructure their debts -
and there are some indications that the government may be edging in this
direction, for example with a new resolution authority that theyâre
requesting from Congress. Then you want to bet on â on the debts getting
into trouble, on there being solvency issues. You donât do that by
pulling out your deposits. That doesnât work. You could sell the stock,
but sale price can move around due to other forces.
And so that the credit defaults swamp market is a relatively
sophisticated market. Itâs really open to - mostly to professional
investors, and you can trade in that market in such a way that youâre
gambling on â on the risk of default going up, and when you place your
bets, and if everyone else increasing takes the view thereâs going to be
more risk of default, youâll make money, and then you can get out of
that market. You donât actually care in the end whether they default.
Youâre betting on peopleâs perceptions moving in a certain direction.
GROSS: So if people are betting against the banks now with the credit
default swaps, does that â does that indicate anything? Does that
indicate belief in the financial sector that some of these banks are
going to fail?
Prof. JOHNSON: Yes, it does. It indicates that people feel that the
government is going to be forced to stop providing bailout money and to
encourage or allow or even take charge of these banks converting debt
into equity. So they will essentially default on the debt. And
bondholders will get some share of the company instead. So itâs like
going through a bankruptcy process, going through Chapter 11, but that
probably wonât happen for these big banks because that will be very
messy and very complicated.
And so either with or without this new resolution authority thatâs being
requested, the bank - bank bondholders will take some losses. That is
the â that is the view thatâs being expressed in this market. And itâs a
view thatâs increasingly putting pressure on some of the â some of the
very largest banks.
GROSS: So is that seen as a kind of vote of no confidence in some of the
large banks? Does that have like an echoing response? Like if thereâs a
vote of no confidence, does that increase the lack of confidence? Is
that a spiraling effect?
Prof. JOHSNSON: Yes, it is spiraling. And so people sometimes call these
self-fulfilling runs or self-fulfilling expectations, so the idea is â
again, if you think about old-fashioned bank runs, you run of the bank
and you stand in a line, other people see the line and they join the
line because they get â oh, these people must know something, so we sort
of join the panic.
And the bank may run out of cash. The bank may actually be solvent but
not have enough cash. So the run itself triggers more people running and
that triggers the failure of the bank, or the bank runs out of
Now, that doesnât have any more. We figured out the technology for
protecting banks and providing them enough liquidity and providing
depositors with insurance. But what can happen in the credit default
swap market is people - you see the credit defaults swaps spread, as
itâs called â widening. That means the probability of default is going
up. You think, ooh, something is going on here, the people must know
something. You jump in and make your own bets on that probability going
up further. And that increases - this credit default swap spread
increases the cost of doing business, particularly in derivative
transactions for these major banks. So it undermines the business model
of these big â of the big banks that are under attack.
And so the run can become self-fulfilling very much like a run on a
bank. Or weâve seen it â we see it many times when countries have fixed
exchange rates and people run out of that currency towards another -
they run to what they regard as a safer currency; for example, from
Russian rubles into U.S. dollars. Self-fulfilling speculative runs are
unfortunately not behind this. Some of them â some of the big ones seem
to lie in front of us now.
GROSS: Just one of the things that surprises me most about this story is
that credit default swaps still exist. I mean they have been so aligned.
The word toxic has become so â so connected to credit default swamps,
Iâm surprised they still exist, Iâm surprise people are still buying
them. And will they be paid out, since thereâs been such problems with â
with that in the past, thatâs part of the reason why weâre in this
economic crisis? I think I donât understand it well enough to articulate
this any better than that. But â but Iâm just so surprised that theyâre
still, you know, one of the, like, driving like factors in â in our
future, considering how they have already messed this up.
Prof. JOHNSON: Well, the toxicity â itâs a good question. The toxicity,
of course, mostly comes from simpler things, from bad loans
(unintelligible) housing, and from securities that were built out of
those loans that really didnât make any sense, they were very vulnerable
an economic slowdown.
The credit default swaps havenât failed or havenât shown themselves to
be toxic in the same way. They have shown themselves to be very complex
and very scary. And we do know that when AIG was taken over by the
government, they went to some lengths to make sure there wasnât default
by AIG on its obligations.
So thereâs a sense in which itâs a â itâs a bomb at the center of our
financial system. And youâre totally right. It hasnât been defused.
There are attempts now to make these transactions more transparent, to
bring them onto exchanges, and thereâs a hope that this sort of
technical step will defuse the bomb. That remains to be seen. And
thereâs also â you can also argue - I think we can argue all day about
how to balance the fact that these contracts, these kinds of swaps, are
a legitimate way to insure yourself against risks that you face.
At the same time, theyâre a speculative instrument, and the speculative
instrument can actually potentially, and obviously ironically, end up
ruining some of the big banks that helped create the credit default swap
market. So Iâm saying itâs a little bit like Frankensteinâs monster
coming back to give Frankenstein a hard time.
GROSS: If youâre just joining us, my guest is Simon Johnson. Heâs the
former chief economist of the International Monetary Fund. He teaches at
MIT and he is the co-founder of the global economy Web site, baseline
scenario. Letâs take a short break here and then weâll talk more. This
is FRESH AIR.
(Soundbite of music)
GROSS: If youâre just joining us, my guest is Simon Johnson and he is
the former chief economist of the International Monetary Fund; he
teaches at MIT, he writes for the New York Times economics blog, he is a
senior fellow at Peterson Institute, and he has a story in the current
edition of the Atlantic, the May edition, about the bank bailout.
You have kind of inspired a new movement as a result, in part, of an
interview that you did with Bill Moyers in which you compared the
financial sector and the revolving door between government and the
financial sector to an oligarchy. A new movement was inspired called A
New Ways Forward that had their first series of demonstrations on
Saturday, and their goal is, quote, âdismantling the power of the
financial elites.â So I guess Iâm wondering what itâs like for you to
know that you in part inspired this movement?
Prof. JOHNSON: Itâs very strange. Itâs not at all what I expected. Iâm a
very centrist technocratic person and I think Iâm speaking on behalf of
a lot of my friends, a lot of people I worked with at the IMF, a lot of
people who worked on crises around the world. Iâm kind of struck by the
support that weâre getting from people who are across the political
spectrum. I think New Way Forward, you know, from what Iâve seen and
what Iâve been able to glean has picked up on some of our sensible,
reasonable centrist ideas and has put them out there in a more popular
But I would emphasize there is people on the left and on the right who
think that weâve got some points here, particularly about the
disproportionate power of the financial sector and the ways in which
that could be quite carefully and over time, in a way thatâs not
disruptive, that could be dismantled.
GROSS: You know, thereâs many ways of seeing the financial crisis that
weâre in and what got us here. And one way is - and I think this is your
way, that, you know, the oligarchy, that thereâs a group of like really
powerful people who were in it for self-interest, who kind of played the
system for personal and institutional gain, and they got us into a lot
Another way of seeing it is that people were involved with really
complex financial instruments that nobody quite understood. There
werenât bad intentions here. Itâs just that no one could have quite
predicted how things would have played out, how we kind of could have
ended up in this perfect storm. And it wasnât just about like, you know,
greed and people playing the system. Itâs about a group of circumstances
coming together in such a way that created a mess.
Prof. JOHNSON: I think thatâs an - itâs an interesting way of framing
the question. I donât have any problem with that. Basically the second
view is that itâs not people became too powerful; itâs just that they
create organizations that became stupid. And I think the, you know, the
stupid organizations obviously has some validity. But you have to ask,
you know, how did we get to a situation where the regulators had no
control over this, the legislation that we had, you know, obviously
facilitated the development of stupidity, and the executive branch was
unable to deal with the consequences of stupidity as it was - as it
So I think I would encompass the stupid organizationâs view in a broader
framework in which you really say that it was possible and that people
could make these mistakes - and of course get massive amounts of cash
compensation for making these mistakes - because of the way the system
was built. And you know, was it was an accident that derivatives were
not properly regulated when there was an opportunity to do that in the
1990âs? No, I donât think it was an accident. I think it was a very
conscious decision. So to me itâs all embedded in a political framework,
in how these big firms became economically powerful and turned that into
political influence, which then allowed further massive acts of
GROSS: Well, Simon Johnson, I want to thank you for coming back to FRESH
AIR. Thanks very much.
Prof. JOHNSON: Thank you.
GROSS: Simon Johnson is a professor at MITâs Sloan School of Management,
a senior fellow at the Peterson Institute for International Economics,
and co-founder of the global economics Web site Baseline Scenario. His
article, âThe Quiet Coup,â is in the May edition of the Atlantic.
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