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Fighting America's 'Financial Oligarchy'

Economist Simon Johnson discusses the next phase of the financial bailout. In the May issue of The Atlantic Monthly, Johnson insists that the U.S. government will have to get rid of its "financial oligarchy" to regain economic stability.



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Fighting America's 'Financial Oligarchy'


This is FRESH AIR. I’m Terry Gross. The bailout of the banking system is
entering a new phase, and it’s 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. He’s a professor at MIT’s 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 “The
Quiet Coup,” 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
blocking reform.

Simon Johnson, welcome back to FRESH AIR. The Obama administration said
yesterday that it would reveal some of the results of the stress tests
it’s administered to the banks. So let’s start with what the stress
tests are designed to do and what function they serve.

Professor SIMON JOHNSON (MIT): The stress tests are totally sensible.
It’s 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, it’s the same thing with banks.

They go in and they look at the – what’s 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 they’re stressing. It’s an imaginary
thing, obviously; they’re stressing how the banks will do if we have a
really severe recession.

GROSS: And what’s the final purpose of doing this?

Prof. JOHNSON: Well, it’s 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 it’s an attempt to assess who’s in good shape and who’s 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
wound down.

I don’t think the government’s going to do that. They’ve sent very
strong signals that – they said it’s not pass/fail, and they said that –
now they’re saying, the latest indications are all banks will pass to
some degree.

I think there’s 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 it’s 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 government’s hand by actually
revealing some of the information themselves or, you know, in the case
of Goldman Sachs, basically stating how they’re going to do in the
stress test.

And you know, this means that if you don’t reveal information about
other banks, they’re going to be at a competitive disadvantage. People
are going to assume the worst about banks that don’t 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 we’re doing good?

Prof. JOHNSON: Well, it’s not just Goldman. It’s – Wells Fargo’s been
quite aggressive in its language, and Citigroup and Bank of America have
also made positive statements, statements that it seems the government
didn’t 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
TARP money?

Prof. JOHNSON: Well, Goldman’s motivation, which they’re 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

That’s not currently allowed, or there’s a lot of restrictions on that,
under the TARP program. If they – they think, they’re arguing, that if
they pay back this capital, if they’re 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 it’s 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 government’s getting $10 billion
in TARP money back if this happens. Like, why wouldn’t they want it?

Prof. JOHNSON: Well, we do want our TARP money back. There’s 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, it’s 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 – you know, the government’s 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 they’re stressing the program
that the Federal Deposit Insurance Company, the FDIC, put in place where
they are basically guaranteeing some of these banks’ debt, and that was
something that was done in the fall under emergency circumstances. It’s
still there.

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? That’s 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, there’s 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 doesn’t come
with strings attached; Goldman, when it accepted participation in that,
didn’t know that there would ever be strings attached; so why should it
be punished for staying in that program?

Prof. JOHNSON: It’s 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 don’t really want to do this in the way that the Federal
Reserve and the FDIC and the Treasury are asking. So it’s a
confrontation. It’s a demonstration or a showdown. The two sides are, I
think, going to bare their teeth and make various kinds of statements.
We’ll see who will prevail here. Personally, I’m on the side of the

GROSS: It’s – I know you won’t have the answer to this, but I can’t help
but wonder what’s going through the minds of the people behind the TARP
who are now seeing – 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 don’t know what they’re 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 they’ve gone a bit
too far. I think they could’ve been tougher on the banks, you know, a
couple of months ago or even four months ago. But you know, that’s all
water under the bridge. Right now I think they’re going to be very
frustrated that these banks are not playing ball.

And you know, who’s in charge here? Who’s calling the shots? Who’s
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 we’ll 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. There’s 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 Geithner’s 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 don’t – I’m not a fan of conspiracy theories in
general. I don’t think there’s 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 what’s 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 who’ve played important roles. As you identified, Mr. Rubin
and Mr. Paulson stand out.

But I wouldn’t, you know, go overboard stressing it’s just about Goldman
Sachs or just about those individuals. It’s 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 don’t think that’s a good system going forward, and if we’ve really
built banks – we have banks, obviously, clearly, that are too big to
fail, shouldn’t we start asking whether they’re also too big to exist?

GROSS: You think that’s what we should be asking?

Prof. JOHNSON: That’s what I’m asking, and I think – and I’m 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 it’s 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 – 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 MIT’s Sloan School of
Management. We’ll talk more after a break. This is FRESH AIR.

(Soundbite of music)

GROSS: We’re talking about the next phase of the financial bailout with
Simon Johnson, former chief economist of the IMF, the International
Monetary Fund. He’s 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 we’re free of the TARP so we don’t 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 it’s certainly not going to
be giving back the AIG money that it got through the bailout.

Prof. JOHNSON: That’s right. They won’t. 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, we’re 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 – many of them
would have failed without that support.

So you know, now the question is: why don’t the banks want to play ball?
Not with me, not with my suggestions for reform. I’m sure they would
consider those far too radical. Why don’t they want to cooperate with
the Treasury and with the Fed, the people who’ve really saved their

It’s 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 they’re 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
“best people” with the biggest compensation packages are the people who
kind of made the decisions that helped get us into this mess in the
first place.

Prof. JOHNSON: Yes, it’s a very good point. And of course what they’d
like – the limits they’d 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 there’s 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 you’ll get the nickel, sometimes you
get run over by the bulldozer. And of course, if it’s 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
they’ve tweaked it. They will say they’ve addressed some of these
issues, but nobody has yet been convinced. Nobody from the outside has
yet been convinced that they’ve 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
the bailout?

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 – I don’t know if it’s
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 – that’s where we’re starting. That’s a
reasonably moderate level of debt. I think by the time we’re done with
this, if you include fiscal stimulus, bailout packages, the whole works,
we’ll probably be closer to 80, maybe 90 percent of GDP, debt-to-GDP

That’s quite a lot, and that’s 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
other practices?

Prof. JOHNSON: Well, I think that’s exactly the decision that they have
to make. It is for the government to decide, not for Goldman Sachs to
decide. It’s 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 don’t
come with restrictions on executive compensation on bonuses.

I would strongly suggest that the government can draw a line here and
say, no, we’re not ready for this, you’re not ready for this, the system
is not ready for this; we have a responsibility to the system. I think
it’s a showdown.

I think if the government can face down Goldman Sachs on this key issue,
which Goldman Sachs cares a lot, and they’ve raised the stakes by making
these public statements about what they’re 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 I’m going to feel much more optimistic
about the future.

GROSS: Because?

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 we’re 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. Everybody’s been saying
that. And if you let us go back to our previous incentive schemes, we’ll
be healthier. We’ll be able to attract better people. You’ll get more of
a recovery. And, by the way, if you don’t 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 – you can call it blackmail in this situation,
and that’s why it’s a showdown. It’s not because Goldman Sachs is
threatening to take over the government. It’s because Goldman Sachs is
saying, well, you know, it’s up to you guys. If you don’t do as we say,
then you’re not going to have a recovery. You’re going to have lots of
unemployment, and we’ll make sure everybody knows it’s all your fault.

GROSS: Could Goldman sabotage the recovery?

Prof. JOHNSON: No, I don’t think so. It’s not – it’s a system. It’s a
very big system and it’s subject to all kinds of forces domestically and
globally. But there’s 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 don’t
expect. But these big financial players are very serious. They’re 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. He’s a
professor at MIT’s 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. I’m Terry Gross, and this

(Soundbite of music)

GROSS: This is FRESH AIR. I’m Terry Gross.

We’re 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 MIT’s Sloan School of
Management and a senior fellow at the Peterson Institute for
International Economics. He has an article in the Atlantic titled “The
Quiet Coup” about what he describes as the financial oligarchy that is
blocking economic reform in the U.S.

In the Atlantic article that you’ve - 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 you’re working with emerging markets. And you say, you know,
you work with a lot of countries ruled by oligarchies and let’s just
define our term oligarchy here.

(Soundbite of laughter)

GROSS: I’ll 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, it’s 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 it’s 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, it’s 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 – 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 ‘80s 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 – 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 – that the financial sector is going to become
smaller because it over-expanded in the very long boom and there’s 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 I’m 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 – they – 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, it’s 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 – the biggest banks –
smaller. And there’re 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 I’ve
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 they’re 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,
who’s 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 didn’t 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.
Rockefeller’s massive oil company, Standard Oil - what we don’t 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 MIT’s Sloan School
of Management. We’ll talk more after a break. This is FRESH AIR.

(Soundbite of music)

GROSS: If you’re just joining us, my guest is Simon Johnson, and he is
the former chief economist at the International Monetary Fund. He
teaches at MIT. He’s a senior fellow at the Peterson Institute. He’s the
cofounder of a Web site about the global economy called Baseline
Scenario. And he recently became a writer for the New York Times
economic blog.

One of the new faces of the bailout is the – the plan to – 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 bank’s books. This is called the PPIP - the Public-Private
Investment Program.

So just give us a short summary of how this plan is supposed to work and
then we’ll - we’ll talk about it.

Prof. JOHNSON: Sure. The basic idea is pretty simple. It’s that banks
have assets that are worth let’s say 85 cents. Let’s say they have an
asset that in principle, when it was issued, was – was worth a dollar.
They’ve marked it down to about 85 cents, (unintelligible) view of what
it’s worth. And there are people out there in the market, let’s call
them hedge funds, it’s much broader group. There’re people out there in
the market who think these things are really worth 40 cents. So there’s
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 – and, you know, perhaps you could get the – you could
provide the subsidy in such a fashion that – that the bank will be
willing to sell and the hedge fund will be – will be willing to buy at
60 cents. You’re 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, there’s obviously some real tensions in the
Geithner Treasury approach here. One is how hard the banks are being
pushed. If you’ve given the banks a lot of space and a lot of
forbearance, you’re saying, guys, just relax, the economy will recover
and that’ll take care of it. They don’t really have a big incentive to
sell for anything less than what they’ve 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 don’t need to sell these things because we’re not
under a lot of pressure from our supervisor and from the Treasury from
the angle of – of looking at the solvency and seeing how much capital
they have.

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 – they hang over -
that the bank’s futures – they’re sort of the Sword of Damocles that
dangles over you and makes you very worried about how – how you’re going
to be judged in the future. And generally speaking in – in any kind of
massive banking crisis like this one, it’s better to clean up the
balance sheets, which means remove the – the toxic assets. They’re not
really toxic, by the way, they’re just bad.

(Soundbite of laughter)

Prof. JOHNSON: Toxic makes them sound a little too sophisticated and –
and – and scary. They’re just bad assets, they’ve gone bad. They were
bad decisions made by these banks and it’s, generally speaking, better
to get those out of the picture and let the banks concentrate on – 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 – it’s quite a good deal, depending on the,
obviously on – on the prices that you end up paying. The government is
providing so-called non‑recourse loans, which means that if – if you put
up a billion dollars to play, you can leverage that tremendously,
depending on exactly the – the transaction you’re 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, it’s true. If it
goes bad, then you – you lose your billion dollars that you put in as
capital for this venture.

But you don’t lose anything else. There’s no other claim on you because
your venture defaulted on this – on this big loan you got from the U.S.
government. So, it - it’s a pretty good deal. It’s a much better deal if
you pay a lower price for these securities. And – and that’s what I
think the – 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 you’re aware of?

Prof. JOHNSON: Not really. Simply not an – not an anything like a scale
that’s currently – currently being proposed. It is another great
American financial innovation.

GROSS: So, say the – this program is successful and investors purchase
these bad assets, the bulk of them are taken off the banks’ books. How
does that change things?

Prof. JOHNSON: Well, ideally if these toxic or bad assets disappear -
oh, by the way, we’re not supposed to call them that anymore, we’re
supposed to call them legacy assets…

GROSS: I know.

Prof. JOHNSON: Rebranding.

(Soundbite of laughter)

GROSS: Rebranding, yes.

Prof. JOHNSON: Anyway, if the legacy assets disappear, then depending on
– 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 – there is a way for – for us to magically remake our banks. It’s
a little hard and it would involve a massive taxpayer subsidy. And
apparently we’re not going to – we’re not allowed to get substantial
amount of stock in return for that. So you know, it’s a great deal for
the banks if it happens, not just a good deal for the taxpayer.

GROSS: Well, you – you used the term magically. Are you using that with

– 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. It’s a kind of - it’s
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 – I’d be
interested in hearing your analysis of that possibility.

Prof. JOHNSON: I think it’s a great idea. I mean if it really is an
investment with tremendous upside, which of course is how they’re
selling it to the hedge funds, then you should let individuals
participate. Another good idea, by the way, that’s got a lot of
attraction, that at least one origination was – was our Web site - was
encouraging or allowing or – 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 they’re going to recover. So it should be a good deal for them on
the bonus side too.

GROSS: Who’s 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 – it has got
some traction in some of the big banks. And I’m not claiming – we’re not
claiming that we were the absolute first originators of that. I don’t
think it’s 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 there’s – there’s one bank that’s
seriously considering it, or some reports say they’re actually trying to
– trying to implement it. Haven’t 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 they’ve framed this issue to the
government. They’re saying that these markets are illiquid, that they’re
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
that mean?

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 doesn’t happen very often. It’s 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 won’t be a problem there.

But if you think that banks are going to get into trouble, if you think
that they’re going to fail and – 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 they’re
requesting from Congress. Then you want to bet on – on the debts getting
into trouble, on there being solvency issues. You don’t do that by
pulling out your deposits. That doesn’t 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. It’s really open to - mostly to professional
investors, and you can trade in that market in such a way that you’re
gambling on – on the risk of default going up, and when you place your
bets, and if everyone else increasing takes the view there’s going to be
more risk of default, you’ll make money, and then you can get out of
that market. You don’t actually care in the end whether they default.
You’re betting on people’s perceptions moving in a certain direction.

GROSS: So if people are betting against the banks now with the credit
default swaps, does that – 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 it’s like
going through a bankruptcy process, going through Chapter 11, but that
probably won’t happen for these big banks because that will be very
messy and very complicated.

And so either with or without this new resolution authority that’s being
requested, the bank - bank bondholders will take some losses. That is
the – that is the view that’s being expressed in this market. And it’s a
view that’s increasingly putting pressure on some of the – 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 there’s 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 –
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 – 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 doesn’t 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
it’s called – 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 – 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 we’ve seen it – 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 – 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 – so connected to credit default swamps,
I’m surprised they still exist, I’m surprise people are still buying
them. And will they be paid out, since there’s been such problems with –
with that in the past, that’s part of the reason why we’re in this
economic crisis? I think I don’t understand it well enough to articulate
this any better than that. But – but I’m just so surprised that they’re
still, you know, one of the, like, driving like factors in – in our
future, considering how they have already messed this up.

Prof. JOHNSON: Well, the toxicity – it’s 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 didn’t make any sense, they were very vulnerable
an economic slowdown.

The credit default swaps haven’t failed or haven’t 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 wasn’t default
by AIG on its obligations.

So there’s a sense in which it’s a – it’s a bomb at the center of our
financial system. And you’re totally right. It hasn’t been defused.
There are attempts now to make these transactions more transparent, to
bring them onto exchanges, and there’s a hope that this sort of
technical step will defuse the bomb. That remains to be seen. And
there’s also – 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, they’re 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 I’m saying it’s a little bit like Frankenstein’s monster
coming back to give Frankenstein a hard time.

GROSS: If you’re just joining us, my guest is Simon Johnson. He’s 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. Let’s take a short break here and then we’ll talk more. This

(Soundbite of music)

GROSS: If you’re 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, “dismantling the power of the
financial elites.” So I guess I’m wondering what it’s like for you to
know that you in part inspired this movement?

Prof. JOHNSON: It’s very strange. It’s not at all what I expected. I’m a
very centrist technocratic person and I think I’m 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. I’m kind of struck by the
support that we’re getting from people who are across the political
spectrum. I think New Way Forward, you know, from what I’ve seen and
what I’ve 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 we’ve 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 that’s not
disruptive, that could be dismantled.

GROSS: You know, there’s many ways of seeing the financial crisis that
we’re in and what got us here. And one way is - and I think this is your
way, that, you know, the oligarchy, that there’s 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
of trouble.

Another way of seeing it is that people were involved with really
complex financial instruments that nobody quite understood. There
weren’t bad intentions here. It’s 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 wasn’t just about like, you know,
greed and people playing the system. It’s about a group of circumstances
coming together in such a way that created a mess.

Prof. JOHNSON: I think that’s an - it’s an interesting way of framing
the question. I don’t have any problem with that. Basically the second
view is that it’s not people became too powerful; it’s 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
manifested itself.

So I think I would encompass the stupid organization’s 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
1990’s? No, I don’t think it was an accident. I think it was a very
conscious decision. So to me it’s 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 MIT’s 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, “The Quiet Coup,” is in the May edition of the Atlantic.
Transcripts are created on a rush deadline, and accuracy and availability may vary. This text may not be in its final form and may be updated or revised in the future. Please be aware that the authoritative record of Fresh Air interviews and reviews are the audio recordings of each segment.

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