What we are looking at now is just the beginning of a 5 or 10 year struggle for real change

From The Baseline Scenario:

"Snowball: Strategies For Banking Reform

with 8 comments

I was on a Capitol Hill panel yesterday morning, organized by the National Community Reinvestment Coalition, with Jim Carr and Mike Lux; Nancy Cleeland was the moderator. We had a wide-ranging discussion about the origins of our current economic crisis (the banks, their regulators, their lack of regulation), progress to date with financial sector reform (not much), and what should be the legislative agenda (a long list, ranging from protecting individuals to better safeguarding the system; if you can get any sensible measure past the lobbies, take it).

I was particularly struck by one point made by Mike Lux. Sometimes it seems the administration talks in terms of having limited political capital and of needing to decide where to spend it – perhaps, for example, it has all been stored up to address health care. Mike’s model is somewhat different – once you defeat one powerful industrial lobby, it becomes easier to defeat others; success can snowball. Drawing on the experience of FDR, in particular, Mike stressed that early success (e.g., initial recovery measures that were opposed by industry) laid the political foundations and generated the kind of public support necessary for further achievement (e.g., the introduction of social security).

What does that mean in today’s context?

It means that the banking reform agenda is likely to run for a long while. Sensible measures may not at first succeed and, let’s be honest, the prospects for the fall legislation do not currently look encouraging – various parts of the financial lobby are flexing their muscle already. But that is not necessarily the end of the conversation.

In particular, if banks make further mistakes – even if not on the recent scale – this will shift opinion towards reform. Jamie Dimon, for example, has another brilliant statement on why banking, or at least JP Morgan Chase, should be allowed to go back to “business as usual”. But his reasoning rests largely on the idea that JP Morgan has a culture that can manage risk, forever.

From all accounts, Dimon’s personality and demeanor are a critical determinant of the firm’s culture in general and the fact that it (partly) sat out the housing craze. Everything we know about the evolution of firms is that while some aspects of culture survive growth and a rise to predominance (and JP Morgan is now #1, in case you’re keeping score), generally attitudes change as top people change. And any rise to power brings with it potential sclerosis of various kinds – just ask Citigroup or Bank of America.

So major banks will run into some variety of trouble, probably sooner rather than later – remember there is a potential global credit boom underway (check your local oil prices for details). If enough transparency, accountability, and public discussion is preparing and waiting for that moment, attitudes towards permissible banking behavior can change quickly.

And this administration will at some point, hopefully, prevail against some powerful industrial group or other. If they can just get some political momentum vs. recalcitrant lobbies going, such success can be brought over into the financial sphere.

The wave of “reforms” this fall will likely not solve anything. But this is not the end of attempts to better regulate the functioning of finance and to make sure it can never again run us into a crisis that results in doubling the national debt. What we are looking at now is just the beginning of a 5 or 10 year struggle for real change in the structure of economic and political power around finance in the United States.

By Simon Johnson"

Me:

What I would say is that this crisis has opened up the possibility of further reforms going ahead, by showing that the existing system was unstable in the long run. It will take years to build a coalition for reform that agrees on the best basis for a sustainable, or less catastrophe prone, or more able to withstand catastrophe, system.

So I agree with the point of your post.

Don the libertarian Democrat

June 12, 2009 at 11:39 am

Reply

"There is a real danger that this action plan - within such a short time frame - can actually make the global downturn dramatically worse."

Simon Johnson on The Baseline Scenario on the G2o statement:

"Initial reactions to the G20 summit are fairly positive, in the sense that the communique and associated press conferences conveyed (a) there was no open acrimony, (b) the body language was broadly supportive of countercyclical policies, and (c) there may now be a serious international regulatory agenda.

None of this is really new and it could all have been arranged by finance ministers (probably over the telephone), but I agree there is some useful symbolism in having heads of industrialized and emerging market governments convene for the first time (ever?) on these kind of issues."

This seems correct.

"But there is, unfortunately, another way to read the communique - as a government or international official, for whom this text really is a set of instructions to be implemented. The whole first part of the document is generic and definitely not new, so - as an official - one’s eye skips through that quickly. The real issue is the deliverables in the plan of action, with a pressing deadline at the end of March (this is pretty much like saying “do it tomorrow” to an official). This is where we - an official reader is thinking - must concentrate our immediate attention and efforts. And most of these specific actions are about tightening regulation on and around credit, or beginning processes that definitely point towards many dimensions for this kind of tightening - accounting standards, hedge funds, risk disclosures, financial sector assessments, credit rating agencies, risk management and stress testing models, international standard setters, sanctions for misconduct, reporting to supervisors in different countries, and more."

But I didn't see any specifics.

"But we are still not out of this crisis. And tightening regulations quickly in the midst of a worldwide credit crunch is one good way to make sure that credit contracts further and faster. Lending standards naturally tighten in a crisis; the issue to address going forward is how to prevent standards from loosening too much in the next boom - but this is at least several years down the road. I’m in favor of starting early, but I do not like precipitate action just because you want to look busy and you could not agree on the more pressing issues, such as fiscal policy, support for the IMF, shoring up the eurozone, and so on.

It is true that one (among many) of the stated principles is: “Mitigating against pro-cyclicality in regulatory policy.” But that is a general statement that is not mapped into operational requirements - except that the IMF and FSF should work together on this, which is a good way to make sure it doesn’t happen. What officials have to deliver on, by the end of March, is substantive progress with regards to tougher and tighter regulation of credit. There is a real danger that this action plan - within such a short time frame - can actually make the global downturn dramatically worse."

Based on the document, I wouldn't worry. It isn't clear that they can agree on anything. But point well taken. Regulation in a crisis is worrying on any number of fronts, not the least of which is making the situation far worse.

What Did I Miss In The G20 Statement?

Brad Setser reads the G20 statement ( I still say calling it a communique makes it sound like it's from Subcomandante Marcos ) with a different pair of eyes than I do:

"The G-20’s communiqué offered a surprisingly robust work program for regulatory reform. MIT’s Simon Johnson even worries that it may be too robust – and push banks to scale back their lending in a pro-cyclical way. I am a little less worried about this risk. I assume regulators recognize that a sensible macro-prudential regulatory framework requires raising capital charges in good times (to lean against the boom), not forcing banks to squeeze lending to conserve capital in bad times."

I read it three times, and didn't get any sense of this import.

Here's Niall Ferguson's take which I liked.

Here's Free Exchange:

"PERHAPS you recall that leaders of twenty of the world's largest economies sat down for a meeting this past weekend, in order to hash out what to do about all this financial crisis ado. The Economist has the recap:

JUDGED by the hubristic promises that preceded it, the G20 meeting was bound to disappoint. The leaders of the world’s 20 biggest rich and emerging economies, who had gathered in Washington, DC, on Saturday November 15th, did not remake global finance as some of them had promised. Nor, as others had hoped, did they come up with a detailed set of co-ordinated fiscal measures to counter the deepening global downturn (although they did talk of using fiscal measures “to rapid effect”). Nonetheless, the five-page communiqué contained more than just diplomatic blather.

As well as promising a “broader policy response” to the current crisis, the G20’s leaders laid out a detailed plan for financial reform. They promised to “strive” for a deal on the stalled Doha round of world trade talks by the end of the year and, more importantly, made a collective pledge not to raise any barriers to trade and investment over the coming year. Add in the promises made around the gathering’s fringes, particularly Japan’s pledge to bolster the IMF’s kitty by lending it $100 billion, and the weekend yielded enough to justify the traffic jams in Washington, DC–and to mark an important shift in global economic governance."

I think most observers had very low expectations of the summit, given the lame duck host and his deliberate, expectations-lowering rhetoric, but some still came away disappointed. Like Dani Rodrik:

I was not expecting any substantial agreement on international regulatory coordination or any semblance of a new Bretton Woods, so I am not disappointed on that score. What I was looking for were three things: (i) coordination on fiscal stimulus; (ii) a commitment to provide more liquidity support, as needed, to prevent a further spread of the crisis to emerging nations; and (iii) a clear commitment not to engage in trade protection, with a monitoring mechanism to ensure the pledge is being observed.

How does the statement do in these regards? So-so. There is no coordination in the fiscal arena, the promises made to emerging markets are vague, and even though there is a clear statement on protection and export subsidization, there is no monitoring or enforcement mechanism.

He wanted more. That will have to wait."

They seem to agree with Setser. Rodrik is in the middle. What did I miss? It was simply a laundry list of hopes. I guess that's important. As a piece of prose, it lacked any specificity.