This is an excellent readable review of the Wall Street bank panic of 2008. It carefully reviews what led up to it and provides a summary overview and explanation of the meltdown without getting bogged down in personalities and specific banks. It then reviews the sad lack of performance of Obama in seizing this opportunity to re-regulate the banks like FDR did. They explain why the reform impulse died, smothered under the ideology of deregulation, bank lobbying, and the fact that Obama relied on the same cast of characters who created the financial meltdown to manage his regulation "reform". This book will make you fully conversant with the disaster and the sad fact that we are set up for a future meltdown.
Here is a sample of the writing style and level of detail:
In the October 13 meeting at Treasury that opened this chapter, $125 billion of TARP money was committed to nine major banks. In addition to investments in smaller banks, another $40 billion was invested in Citigroup and Bank of America, two of the original nine banks, in later rescue operations; more TARP money was used to finance Federal Reserve guarantees of toxic assets held by those two banks; and $70 billion was invested in AIG to allow it to pay down its credit line from the Fed. In addition, the FDIC promised to insure up to $1.5 trillion of new bank debt, and the Federal Reserve committed trillions of dollars to an ever-expanding list of liquidity programs intended to provide cheap money to the financial system: the Term Auction Facility, the Term Asset-Backed Securities Loan Facility, the Money Market Investor Funding Facility, the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, and so on.The book tells an incredible tale. If you had told me in 2007 or even in August 2008 that this catastrophe would happen, I would not have believed you.
Never before has so much taxpayer money been dedicated to save an industry from the consequences of its own mistakes. In the ultimate irony, it went to an industry that had insisted for decades that it had no use for the government and would be better off regulating itself -- and it was overseen by group of policymakers who agreed that government should play little role in the financial sector.
Over the course of the financial crisis, the principal economic policymakers -- first Paulson, Bernanke, and Geithner, then Geithner (as treasury secretary), Bernanke, and Summers (as director of the National Economic Council) -- devised an impressive range of schemes to shore up the banking system. Their hard work and creativity cannot be doubted. But the common feature of these schemes was that they attempted to fill the gaping hole in bank balance sheets with government subsidies, more or less crudely obscured.
The total cost of all those blank checks is virtually incalculable, spread across the more or less direct subsidy programs (preferred stock purchases, asset guarantees, and so on) and the emergency liquidity and insurance programs to unfreeze the markets for commercial paper, asset-backed securities, or bank debt. It is incalculable because the different types of support -- lending commitments, asset guarantees, preferred stock purchases, and such -- cannot simply be added up. At the upper end of the relevant ballpark, the special inspector general for TARP estimated a total potential support package of $23.7 trillion, or over 150 percent of the U.S. GDP. This represents the theoretical potential liabilities of the government; the net cost will be far lower, since not all lending commitments will be used up, most loans will be paid back, most preferred shares will be bought back, most of the assets the government has guaranteed will not become worthless, and so on.
For me, the most troubling aspect of this whole mess is the fact that Obama has not used this catastrophe to re-regulate the big banks. Instead he has papered things over with incredible sums of taxpayer money and allowed the "to big to fail" banks to get even bigger. The worries of Johnson and Kwak about the "next financial meltdown" have me truly worried. This book is very unsettling.
Update 2011aug29: Here is an interview of Johnson and Kwak by PBS's Bill Moyers.
BILL MOYERS: Let me get to the blunt conclusion you reach in your book. You say that two years after the devastating financial crisis of '08 our country is still at the mercy of an oligarchy that is bigger, more profitable, and more resistant to regulation than ever. Correct?And this:
SIMON JOHNSON: Absolutely correct, Bill. The big banks became stronger as a result of the bailout. That may seem extraordinary, but it's really true. They're turning that increased economic clout into more political power. And they're using that political power to go out and take the same sort of risks that got us into disaster in September 2008.
BILL MOYERS: And your definition of oligarchy is?
SIMON JOHNSON: Oligarchy is just- it's a very simple, straightforward idea from Aristotle. It's political power based on economic power. And it's the rise of the banks in economic terms, which we document at length, that it'd turn into political power. And they then feed that back into more deregulation, more opportunities to go out and take reckless risks and-- and capture huge amounts of money.
BILL MOYERS: And you say that these this oligarchy consists of six megabanks. What are the six banks?
JAMES KWAK: They are Goldman Sachs, Morgan Stanley, JPMorgan Chase, Citigroup, Bank of America, and Wells Fargo.
BILL MOYERS: And you write that they control 60 percent of our gross national product?
JAMES KWAK: They have assets equivalent to 60 percent of our gross national product. And to put this in perspective, in the mid-1990s, these six banks or their predecessors, since there have been a lot of mergers, had less than 20 percent. Their assets were less than 20 percent of the gross national product.
BILL MOYERS: And what's the threat from an oligarchy of this size and scale?
SIMON JOHNSON: They can distort the system, Bill. They can change the rules of the game to favor themselves. And unfortunately, the way it works in modern finance is when the rules favor you, you go out and you take a lot of risk. And you blow up from time to time, because it's not your problem. When it blows up, it's the taxpayer and it's the government that has to sort it out.
BILL MOYERS: So, you're not kidding when you say it's an oligarchy?
JAMES KWAK: Exactly. I think that in particular, we can see how the oligarchy has actually become more powerful in the last since the financial crisis. If we look at the way they've behaved in Washington. For example, they've been spending more than $1 million per day lobbying Congress and fighting financial reform. I think that's for some time, the financial sector got its way in Washington through the power of ideology, through the power of persuasion. And in the last year and a half, we've seen the gloves come off. They are fighting as hard as they can to stop reform.
SIMON JOHNSON: I know people react a little negatively when you use this term for the United States. But it means political power derived from economic power. That's what we're looking at here. It's disproportionate, it's unfair, it is very unproductive, by the way. Undermines business in this society. And it's an oligarchy like we see in other countries.
BILL MOYERS: And you say they continue to hold the global economy hostage?
JAMES KWAK: Exactly. Because what's happened- what we learned in 2008 were certain institutions are so big and so interconnected that if they were to fail, they would cause systemic shocks throughout the economy. That's essentially what happened in September 2008 when Lehman Brothers collapsed. And what's remarkable, and I think what essentially proves the point of our book is that almost two years later, nothing has changed.
Or the only thing that has changed is that these banks have gotten larger, more powerful, both economically and politically. And they've been flexing their muscles in Washington for the last year and a half. So Neal Wolin, the Deputy Treasury Secretary gave a blistering speech to the U.S. Chamber of Commerce in which he said, look, the financial sector has been spending more than one million dollars per day lobbying against the reforms we need to fix the financial system. Now, Simon and I think those reforms that the Administration has proposed do not go far enough. But we think they're certainly better than nothing. What Wall Street wants is they want nothing. They want to stop this in its tracks and go back to where we were five years ago.
SIMON JOHNSON: It's amazing, Bill. But this is this is politics and this is money. And you know, there's a ground game, which is campaign contributions, which are surging in. I'm sure on both sides of the aisle. And there's also the ideological space. It's amazing. The Chamber of Commerce that claims to represent the broad cross section of American business is siding with six big banks, who favor policies that are directly contrary to the interests of most of the membership of the Chamber of Commerce. And that's just not just me saying that. That's Neal Wolin. That's Treasury. That's the White House saying that now. Calling fortunately, they've come to the point where they're willing to call the Chamber of Commerce on that. But I don't know if that message is getting through to people.
JAMES KWAK: You see what the bankers have done is they have taken a basic principle which is more or less true. Which is that free financial markets do enable money to go to the places where people need it. But on top of that, they've erected a system that is indescribably complex. And gives many opportunities to make money at the expense of their customers, at the expense of their counterparties. Even at the expense of their own employers. So, one of the things that has happened has been that Wall Street finance has become so complex and the internal systems of Wall Street banks has become so complex that if you are a smart banker, who is out to maximize your own income, you can find the loopholes in the system and you can exploit them, even if it means taking money from your own-- from your own company
BILL MOYERS: You mean the collapse of 2008? All of this? What- was-
JAMES KWAK: Exactly.
BILL MOYERS: An accident?
JAMES KWAK: Yes, an accident in the sense that-
BILL MOYERS: Natural disaster?
JAMES KWAK: As we heard Chuck Prince say and Robert Rubin say, we couldn't see it coming. These were, there were risks that build up in the system, and our models didn't account for it. We're sorry that it happened. Not even, we're sorry that we did it. We're sorry that it happened.
And I think that this is, I mean, it's unfortunate if they really believe this. Because again, if we just take a very small example, one of the things that clearly went wrong is these banks were not able to manage their own risk. They did not know what positions they had. They did not know what market forces they were exposed to. You would think that should be the first job of a bank. And I don't think this was an innocent mistake. And I say that for this reason. It was in the bank's short term financial interest to underestimate their risk. Because if they had estimated their risk accurately, they should have had to set more capital aside, they would have been less profitable.
So, yes, it's possible that the CEOs of these banks honestly did not understand their risk positions. But that mistake-- there was an incentive behind that mistake. You know, banks never overestimate their risk. These mistakes always only go in one direction. Because that's the direction they have an incentive to make the mistake in.
BILL MOYERS: What do you mean they have an incentive to make a mistake?
JAMES KWAK: So, in the short term, a bank's profitability is going to depend on how much capital it has to set aside. So, in banking, if I have a certain position, I have to set aside a certain amount of capital to protect myself from that position going bad. If I think the position is less risky than it actually is, I'm going to set aside less capital to cover that position, and that's going to give me a higher profit margin.
If I'm the head of this bank, that means that in the short term, I'm going to have higher profits, higher stock price, more money for me, but I'm underestimating the risk of something blowing up several years down the line. But we know that the, essentially, the incentive systems within these banks favor short term profits over long term solvency.
SIMON JOHNSON: The most profound thing, observation, on this structure, inadvertent, I would say, observation, was by Chuck Prince, the former head of Citigroup. In July 2007, right before the whole structure began to crumble. He said, "As long as the music is playing, you've got to get up and dance." And that's a statement about the incentive structure. Saying, well, everybody's doing it. That's how we all make money. We've got to do it, too. I'm just a bank doing what all the other banks are doing. That's absolutely the heart of the problem. I would also say and tell you, and emphasize, these people will not come out and debate with us. The heads of these companies or their representatives, they will not come out. They're afraid. They don't have the substance. They don't have the arguments. We have the evidence. They have the lobbyists. And that's all they have.
BILL MOYERS: They've got the power, the muscle, the money.
SIMON JOHNSON: They have money.
BILL MOYERS: You just have the arguments. You just have the facts. On your side.
SIMON JOHNSON: Absolutely. That's exactly what it comes down to.