The Quiet Coup

My favorite quote today comes from Michigan Congressman Thaddeus McCotter, who, commenting on the fact that Rick Wagoner had been forced out of GM by the Obama administration, said the following.

“Mr. Wagoner has been asked to resign as a political offering despite his having led GM’s painful restructuring to date. Mr. Wagoner has honorably resigned for the sake of his company’s working families.

When will the Wall Street CEOs receiving TARP funds summon the honor to resign? Will this White House ever bother to raise the issue? I doubt it.”

I don’t know that Wagoner deserves a great deal of sympathy, especially as he’s taking home $20 million in retirement benefits, but McCotter’s right to point out the seeming double standard. It certainly seems as though the auto companies, at least when compared to the firms on Wall Street that have taken billions of dollars from U.S. taxpayers, have been held to a different standard. Some think that a similar fate awaits these financial institutions, but, as of right now, it sure looks as though they’re firmly in control, getting everything that they ask for, as other industries have their feet held to the fire.

Personally, I suspect it’s fear. I think that the auto companies are easy to go after, because we all know that they fucked up by fighting against environmental measures and pushing SUVs on the American people when they damn well knew that the model wasn’t sustainable. Their crimes are easy to understand. When it comes to the Wall Street firms, though, it’s too complicated. Somehow, they have us convinced that we need them in order to survive. So, we do what’s easiest, and we direct our anger and frustration toward the Big 3, telling them that they aren’t acting swiftly and bold enough. And, all the while, we keep writing checks to Wall Street.

Anyway, that’s what I was going to write about tonight, until I got sidetracked by MIT professor Simon Johnson’s article in the “Atlantic”. Johnson, who was the chief economist at the International Monetary Fund during 2007 and 2008, believes he recognizes the root cause of our current situation, and what ultimately needs to be done to remedy it. Here’s a clip:

One thing you learn rather quickly when working at the International Monetary Fund is that no one is ever very happy to see you. Typically, your “clients” come in only after private capital has abandoned them, after regional trading-bloc partners have been unable to throw a strong enough lifeline, after last-ditch attempts to borrow from powerful friends like China or the European Union have fallen through. You’re never at the top of anyone’s dance card.

The reason, of course, is that the IMF specializes in telling its clients what they don’t want to hear. I should know; I pressed painful changes on many foreign officials during my time there as chief economist in 2007 and 2008. And I felt the effects of IMF pressure, at least indirectly, when I worked with governments in Eastern Europe as they struggled after 1989, and with the private sector in Asia and Latin America during the crises of the late 1990s and early 2000s. Over that time, from every vantage point, I saw firsthand the steady flow of officials—from Ukraine, Russia, Thailand, Indonesia, South Korea, and elsewhere—trudging to the fund when circumstances were dire and all else had failed.

Every crisis is different, of course. Ukraine faced hyperinflation in 1994; Russia desperately needed help when its short-term-debt rollover scheme exploded in the summer of 1998; the Indonesian rupiah plunged in 1997, nearly leveling the corporate economy; that same year, South Korea’s 30-year economic miracle ground to a halt when foreign banks suddenly refused to extend new credit.

But I must tell you, to IMF officials, all of these crises looked depressingly similar. Each country, of course, needed a loan, but more than that, each needed to make big changes so that the loan could really work. Almost always, countries in crisis need to learn to live within their means after a period of excess—exports must be increased, and imports cut—and the goal is to do this without the most horrible of recessions. Naturally, the fund’s economists spend time figuring out the policies—budget, money supply, and the like—that make sense in this context. Yet the economic solution is seldom very hard to work out.

No, the real concern of the fund’s senior staff, and the biggest obstacle to recovery, is almost invariably the politics of countries in crisis.

Typically, these countries are in a desperate economic situation for one simple reason—the powerful elites within them overreached in good times and took too many risks. Emerging-market governments and their private-sector allies commonly form a tight-knit—and, most of the time, genteel—oligarchy, running the country rather like a profit-seeking company in which they are the controlling shareholders. When a country like Indonesia or South Korea or Russia grows, so do the ambitions of its captains of industry. As masters of their mini-universe, these people make some investments that clearly benefit the broader economy, but they also start making bigger and riskier bets. They reckon—correctly, in most cases—that their political connections will allow them to push onto the government any substantial problems that arise…

But there’s a deeper and more disturbing similarity: elite business interests—financiers, in the case of the U.S.—played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them…

It’s time, I think, to cut the head off the snake, my friends.

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  1. Brackinald Achery
    Posted March 30, 2009 at 11:24 pm | Permalink

    Mark, would you please sum up the solution in a few sentences or less so I know what we’re agreeing or disagreeing with? I was going to start arguing about what I thought it was, but I wondered if maybe I was jumping to conclusions.

  2. Brackinald Achery
    Posted March 30, 2009 at 11:43 pm | Permalink

    I can say with great confidence, however, that the right thing to do was to not bail out anybody at all in the first place. All this later bullshit is blowback from that first shitty policy.

    “We can’t just do nothing!” they all said.

    Wait till the currency crisis hits from all the monetary inflation they’re using to “stimulate” their rich pals into buying stupider. That literally will affect everything money can buy. No where to run to, baby.

  3. Ol' E Cross
    Posted March 30, 2009 at 11:50 pm | Permalink

    I realize this is veering a little, little off topic but…

    I’ve had this phrase that I’ve tried out, over the years, amongst close friends including those here: “The moral distance of the stock market.”

    I try (believe it or not) to stay off the high soap horse box, but I’ll climb on, for tonight. It has, for a long while, puzzled me how friends will write their congressman opposing, say, big oil but turn a blind eye to the percentage of their 4-0h-whatever investments are in big oil. “Moral distance” I say, “chirp” is the reply.

    I understand the pressure. I had years of feeling irresponsible because I was not investing. I couldn’t (high horse alert) overcome the moral distance. I figured I’d have less because I didn’t invest but hoped for “enough.”

    I’m old-fashioned. A puritan, it’s been said. I work crummy jobs. I bought a house; not as an investment property but as a place to live. I didn’t expect much to change. I still like Jimmy Stewart’s Savings and Loan in a A Wonderful Life. I like, “Billy, your money is in Willy’s home…” I like poor return local credit unions.

    In brief, I’m left feeling like all you that played the high-return retirement game get what you get. The extra dollars always come from somebody, somewhere. And yes, I’m trying not to feel a little bitter because collective, okay let’s call it “greed,” may impact my ability to work a crummy job.

    Mark says, “Off with the head.” I have to ask, really? Just the head? What about the rest of the snake that blindly followed as long as the tummy was fat?

    Who wasn’t complicit? Who wasn’t delighted by returns they didn’t earn? Who didn’t bother to ask questions? The government? The media? Or the millions of (then) contented shareholders?

    If I had a rocket launcher, I’d off the whole fucking thing. Nest eggs and all.

    (This is all just intended as potential fodder for discussion. Feel free to ignore.)

  4. Brackinald Achery
    Posted March 31, 2009 at 12:33 am | Permalink

    I generally agree with you, OEC, that we all do share the blame. I go at it from a lack of vigilance for our liberties point of view, but I’m sure our view aren’t mutually exclusive.

    I didn’t invest in oil or anything else because I just instinctively assumed the stock market would crash again some day and everyone’s retirement would be up in smoke. No shit; since I was a kid I just assumed that. Know-it-all alert.

    I also assumed that FDIC insurence is blowing smoke up your ass to keep you investing money in a ponzi scheme funny money fractional reserve banking system when your instincts should tell you not to. I’m a bit of a hypocrite there, though, since I do reluctantly use banks for checking/debit purposes. I have no illusions that my savings are safe, though. I assume they’re doomed if I don’t find something concrete to put them in soon. Like a lifetime supply of imitation Crystal Lite, or rare misprint Garbage Pail Kids cards.

  5. Meta
    Posted March 31, 2009 at 8:54 am | Permalink

    Since Mr. Achery appears unable to follow the link, here’s how the article ends:

    In some ways, of course, the government has already taken control of the banking system. It has essentially guaranteed the liabilities of the biggest banks, and it is their only plausible source of capital today. Meanwhile, the Federal Reserve has taken on a major role in providing credit to the economy—the function that the private banking sector is supposed to be performing, but isn’t. Yet there are limits to what the Fed can do on its own; consumers and businesses are still dependent on banks that lack the balance sheets and the incentives to make the loans the economy needs, and the government has no real control over who runs the banks, or over what they do.

    At the root of the banks’ problems are the large losses they have undoubtedly taken on their securities and loan portfolios. But they don’t want to recognize the full extent of their losses, because that would likely expose them as insolvent. So they talk down the problem, and ask for handouts that aren’t enough to make them healthy (again, they can’t reveal the size of the handouts that would be necessary for that), but are enough to keep them upright a little longer. This behavior is corrosive: unhealthy banks either don’t lend (hoarding money to shore up reserves) or they make desperate gambles on high-risk loans and investments that could pay off big, but probably won’t pay off at all. In either case, the economy suffers further, and as it does, bank assets themselves continue to deteriorate—creating a highly destructive vicious cycle.

    To break this cycle, the government must force the banks to acknowledge the scale of their problems. As the IMF understands (and as the U.S. government itself has insisted to multiple emerging-market countries in the past), the most direct way to do this is nationalization. Instead, Treasury is trying to negotiate bailouts bank by bank, and behaving as if the banks hold all the cards—contorting the terms of each deal to minimize government ownership while forswearing government influence over bank strategy or operations. Under these conditions, cleaning up bank balance sheets is impossible.

    Nationalization would not imply permanent state ownership. The IMF’s advice would be, essentially: scale up the standard Federal Deposit Insurance Corporation process. An FDIC “intervention” is basically a government-managed bankruptcy procedure for banks. It would allow the government to wipe out bank shareholders, replace failed management, clean up the balance sheets, and then sell the banks back to the private sector. The main advantage is immediate recognition of the problem so that it can be solved before it grows worse.

    The government needs to inspect the balance sheets and identify the banks that cannot survive a severe recession. These banks should face a choice: write down your assets to their true value and raise private capital within 30 days, or be taken over by the government. The government would write down the toxic assets of banks taken into receivership—recognizing reality—and transfer those assets to a separate government entity, which would attempt to salvage whatever value is possible for the taxpayer (as the Resolution Trust Corporation did after the savings-and-loan debacle of the 1980s). The rump banks—cleansed and able to lend safely, and hence trusted again by other lenders and investors—could then be sold off.

    Cleaning up the megabanks will be complex. And it will be expensive for the taxpayer; according to the latest IMF numbers, the cleanup of the banking system would probably cost close to $1.5trillion (or 10percent of our GDP) in the long term. But only decisive government action—exposing the full extent of the financial rot and restoring some set of banks to publicly verifiable health—can cure the financial sector as a whole.

    This may seem like strong medicine. But in fact, while necessary, it is insufficient. The second problem the U.S. faces—the power of the oligarchy—is just as important as the immediate crisis of lending. And the advice from the IMF on this front would again be simple: break the oligarchy.

    Oversize institutions disproportionately influence public policy; the major banks we have today draw much of their power from being too big to fail. Nationalization and re-privatization would not change that; while the replacement of the bank executives who got us into this crisis would be just and sensible, ultimately, the swapping-out of one set of powerful managers for another would change only the names of the oligarchs.

    Ideally, big banks should be sold in medium-size pieces, divided regionally or by type of business. Where this proves impractical—since we’ll want to sell the banks quickly—they could be sold whole, but with the requirement of being broken up within a short time. Banks that remain in private hands should also be subject to size limitations.

    This may seem like a crude and arbitrary step, but it is the best way to limit the power of individual institutions in a sector that is essential to the economy as a whole. Of course, some people will complain about the “efficiency costs” of a more fragmented banking system, and these costs are real. But so are the costs when a bank that is too big to fail—a financial weapon of mass self-destruction—explodes. Anything that is too big to fail is too big to exist.

    To ensure systematic bank breakup, and to prevent the eventual reemergence of dangerous behemoths, we also need to overhaul our antitrust legislation. Laws put in place more than 100years ago to combat industrial monopolies were not designed to address the problem we now face. The problem in the financial sector today is not that a given firm might have enough market share to influence prices; it is that one firm or a small set of interconnected firms, by failing, can bring down the economy. The Obama administration’s fiscal stimulus evokes FDR, but what we need to imitate here is Teddy Roosevelt’s trust-busting.

    Caps on executive compensation, while redolent of populism, might help restore the political balance of power and deter the emergence of a new oligarchy. Wall Street’s main attraction—to the people who work there and to the government officials who were only too happy to bask in its reflected glory—has been the astounding amount of money that could be made. Limiting that money would reduce the allure of the financial sector and make it more like any other industry.

    Still, outright pay caps are clumsy, especially in the long run. And most money is now made in largely unregulated private hedge funds and private-equity firms, so lowering pay would be complicated. Regulation and taxation should be part of the solution. Over time, though, the largest part may involve more transparency and competition, which would bring financial-industry fees down. To those who say this would drive financial activities to other countries, we can now safely say: fine.

    Two Paths

    To paraphrase Joseph Schumpeter, the early-20th-century economist, everyone has elites; the important thing is to change them from time to time. If the U.S. were just another country, coming to the IMF with hat in hand, I might be fairly optimistic about its future. Most of the emerging-market crises that I’ve mentioned ended relatively quickly, and gave way, for the most part, to relatively strong recoveries. But this, alas, brings us to the limit of the analogy between the U.S. and emerging markets.

    Emerging-market countries have only a precarious hold on wealth, and are weaklings globally. When they get into trouble, they quite literally run out of money—or at least out of foreign currency, without which they cannot survive. They must make difficult decisions; ultimately, aggressive action is baked into the cake. But the U.S., of course, is the world’s most powerful nation, rich beyond measure, and blessed with the exorbitant privilege of paying its foreign debts in its own currency, which it can print. As a result, it could very well stumble along for years—as Japan did during its lost decade—never summoning the courage to do what it needs to do, and never really recovering. A clean break with the past—involving the takeover and cleanup of major banks—hardly looks like a sure thing right now. Certainly no one at the IMF can force it.

    In my view, the U.S. faces two plausible scenarios. The first involves complicated bank-by-bank deals and a continual drumbeat of (repeated) bailouts, like the ones we saw in February with Citigroup and AIG. The administration will try to muddle through, and confusion will reign.

    Boris Fyodorov, the late finance minister of Russia, struggled for much of the past 20 years against oligarchs, corruption, and abuse of authority in all its forms. He liked to say that confusion and chaos were very much in the interests of the powerful—letting them take things, legally and illegally, with impunity. When inflation is high, who can say what a piece of property is really worth? When the credit system is supported by byzantine government arrangements and backroom deals, how do you know that you aren’t being fleeced?

    Our future could be one in which continued tumult feeds the looting of the financial system, and we talk more and more about exactly how our oligarchs became bandits and how the economy just can’t seem to get into gear.

    The second scenario begins more bleakly, and might end that way too. But it does provide at least some hope that we’ll be shaken out of our torpor. It goes like this: the global economy continues to deteriorate, the banking system in east-central Europe collapses, and—because eastern Europe’s banks are mostly owned by western European banks—justifiable fears of government insolvency spread throughout the Continent. Creditors take further hits and confidence falls further. The Asian economies that export manufactured goods are devastated, and the commodity producers in Latin America and Africa are not much better off. A dramatic worsening of the global environment forces the U.S. economy, already staggering, down onto both knees. The baseline growth rates used in the administration’s current budget are increasingly seen as unrealistic, and the rosy “stress scenario” that the U.S. Treasury is currently using to evaluate banks’ balance sheets becomes a source of great embarrassment.

    Under this kind of pressure, and faced with the prospect of a national and global collapse, minds may become more concentrated.

    The conventional wisdom among the elite is still that the current slump “cannot be as bad as the Great Depression.” This view is wrong. What we face now could, in fact, be worse than the Great Depression—because the world is now so much more interconnected and because the banking sector is now so big. We face a synchronized downturn in almost all countries, a weakening of confidence among individuals and firms, and major problems for government finances. If our leadership wakes up to the potential consequences, we may yet see dramatic action on the banking system and a breaking of the old elite. Let us hope it is not then too late.

  6. Brackinald Achery
    Posted March 31, 2009 at 10:49 am | Permalink

    Hilarious. The same Government that’s bought and paid for by these financial oligarchs is going to solve all the problems by giving themselves more unconstitutional power over the banking industry and money supply. Then they team up with the sin-free, corruption-proof IMF to create a super oligarchy of infallable financial angels with near total control of the economy, I assume. For our own good.

    Are we still such saps that we really believe this shit? That emergency powers of any sort in the hands of a few (an oligarchy) are necessary and will be relinquished? That the solution to lesser groups of currupt power wielders is bigger, stronger, more centralized groups of corrupt power wielders? How many times can we fall for this shit and remain guilt free of the consequences?

    By the way, OEC, I was wondering what oil company investors have to do with the financial crisis. I guess you did say it was off topic.

  7. Posted March 31, 2009 at 7:26 pm | Permalink

    I’m with you, OEC. In fact, I think I’ll promote your comment to the front page.

  8. Ol' E Cross
    Posted March 31, 2009 at 10:15 pm | Permalink


    According to the 2008 Forbes Global 2000 list, AIG was the 18th-largest public company in the world. It was on the Dow Jones Industrial Average from April 8, 2004 to September 22, 2008. (wikipedia)

    So, my thought process was that AIG is a major publicly traded company, so if you had money in the stock market, you likely were invested in and profited from AIG’s practices before it all went to hell.

    The oil thing was just an easy example.

  9. Ol' E Cross
    Posted March 31, 2009 at 10:17 pm | Permalink

    Oh, and the Quiet Coup article is great, thanks Mark. (I love the idea that “oligarch” may finally enter the public vernacular.)

  10. Brackinald Achery
    Posted March 31, 2009 at 10:48 pm | Permalink

    I think it was a collectivist oligarchy Orwell warned against in 1984, that had its roots in anticapitalism, socialism, and labor movements. That’s where I learned the word.

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