by Simon Johnson, Peterson Institute for International Economics
and James Kwak, Yale Law School
Op-ed in the Washington Post
April 4, 2010
© Washington Post
In late February 1902, J. P. Morgan, the leading financier of his day, went to the White House to meet with President Theodore Roosevelt and Attorney General Philander Knox. The government had just announced an antitrust suit—the first of its kind—against Morgan's recently formed railroad monopoly, Northern Securities, and this was a tense moment for the stock market. Morgan argued strongly that his industrial trusts were essential to American prosperity and competitiveness.
The banker wanted a deal. "If we have done anything wrong, send your man to my man and they can fix it up," he offered. But the president was blunt: "That can't be done." And Knox succinctly summarized Roosevelt's philosophy. "We don't want to fix it up," he told Morgan, "we want to stop it."
Just over a century later, on March 27, 2009, 13 bankers were summoned to the White House. The global financial system was verging on collapse, in no small measure because of the bankers' concentrated power and their manifest inability to manage the risks of their "financial innovation." Banking had to be rescued—no modern economy can function without credit, of course—and only the Obama administration had the power to save the day.
But instead of specific new regulations or changes in the way they operate—or even any constraints on their power—what did these 13 bankers find waiting for them? On this day and in the months that followed, the administration provided generous expressions of unconditional financial and moral support, both explicit and implicit, along with gentle and nonbinding admonitions.
The headline quote from President Obama sounded tough: "My administration is the only thing between you and the pitchforks," he told the meeting. But the reality was as mild as it could be: All 13 bankers, no matter how discredited, kept their jobs, their salaries, their bonuses, their pensions, their staff, and—most remarkable given the near-complete breakdown of governance—even their boards of directors. Our leading bankers were saved by the generosity and magnanimity of our president.
Since that meeting, the country has seen no discernible changes in the financial management and incentive systems that for 30 years have given Wall Street the benefits of the upside and Main Street the costs of the downside. And politically, our financial titans have bitterly opposed the mild reforms that the Obama administration eventually proposed. Even Citi and Bank of America, which essentially spent 2009 as wards of the state, have engaged in egregious lobbying.
There is no way that Teddy Roosevelt would have stood for this. He saw finance and economics through the lens of political power. In his book, it did not matter how important you were, or claimed to be, to the economy. If you were too powerful, and if your actions were hurting other people in the economy, Roosevelt wanted to take you on—and he instructed his lawyers accordingly.
Roosevelt did not launch the antitrust movement by gently tugging on some low-hanging fruit. He took on J. P. Morgan, the central figure in the burgeoning American financial system, and he won (though just barely, with the Supreme Court voting 5 to 4 to dissolve Northern Securities). And after many twists and turns, the new consensus regarding acceptable business practices led to the breakup of John D. Rockefeller's Standard Oil—arguably the most powerful company in U.S. history to that date.
Of course, Roosevelt did have the 1890 Sherman Antitrust Act on his side. But before 1902, that law had never been used against an industrial trust, and precedent suggested that there was no legal basis for reining in Morgan's ventures. Roosevelt's audacious move seemed against the odds, and it was very much against the advice of top figures in his Republican Party.
In the spring of 2009, Obama and his senior advisers did not seem terribly troubled by the dangerous concentration of power, wealth, and hubris on Wall Street. The president thought it reasonable to find a way forward through amicable accommodation, assuming that big finance really could change. Yet, in memoirs and public statements, the bankers repeatedly submit their defense: The system—the mechanics and incentives of Wall Street—made them do it. Unfortunately, Wall Street and its intimate connections to Washington have not become any safer for the American economy since this crisis began.
In fact, the latest boom-bust-bailout cycle probably worsened matters. We can argue whether before September 2008 the people running huge financial firms really thought they were "too big to fail." Lehman, after all, did go bankrupt; Morgan Stanley and Goldman Sachs were rescued at the eleventh hour. But today, who thinks Goldman could fail?
In the moment of most intense crisis, Goldman became a bank holding company subject to the supervision of the Federal Reserve and able to borrow from the Fed's official "discount window"—effectively gaining government support. Yet today the firm is also allowed to carry out essentially the same activities (including securities and foreign-exchange trading, as well as real estate–related transactions) as it did prior to the meltdown of 2008, when there was supposedly no government backing.
If you were exempt from paying speeding tickets, no matter how fast you drove, what would you do? Perhaps, immediately after observing a horrific crash or having a near-death experience, you would be more careful. But soon you would feel the need to get somewhere quickly. And you might even think that your special legal status merely reflected your advanced skills. How long until the next big accident?
Since Democrats lost the special Senate election in Massachusetts in January, the president has shown some new fire. In a major potential course correction he proposed the "Volcker Rule," named after former Fed chairman and current Obama adviser Paul Volcker, which would constrain the risk taking and the size of the largest US banks. The move blind-sided Wall Street. In the sound bite of January 21, Obama sounded just like Teddy: "If these folks want a fight," he said, "it's a fight I'm ready to have."
It is now time for that fight. Senate Democrats have proposed a financial overhaul that includes the Volcker Rule, and White House spokesman Robert Gibbs said Tuesday that passing regulatory reform by late May is realistic. But to make progress in this legislative cycle, the president needs to go all in, as he did with healthcare reform. The potential political message here is powerful: If opponents of reform think they are "too big to fail," then we will prove them wrong.
It doesn't help that Wall Street has vast amounts of cash to spend on lobbying and political ads. Yet, if framed correctly, the reform message cuts across the political spectrum. If there is one thing that the left and the right agree upon, it is that a "get out of jail free" card distorts the free market. Massive banks have access to cheaper financing because the credit markets understand that the government stands behind them. This is unfair competition, pure and simple.
Will the administration stand up and fight now, before we have another crisis? Surely this is what Theodore Roosevelt would have done. He liked to act preemptively; when he saw excessive power, he took it on, creating his own moments of political opportunity.
Of course, there is always the other Roosevelt. When FDR took power in March 1933, he took aim at the banks. As historian Arthur Schlesinger wrote in The Coming of the New Deal—"No business was more proud and powerful than the bankers; none was more persuaded of its own rectitude; none more accustomed to respectful consultation by government officials. To be attacked as antisocial was bewildering; to be excluded from the formation of public policy was beyond endurance."
By the mid-1930s, Franklin Roosevelt had become skeptical of powerful financiers, but he was only able to translate those feelings into policy after a major global depression. Obama shouldn't wait for another one before pushing for the changes that matter.
Simon Johnson is a senior fellow at the Peterson Institute for International Economics and a professor at MIT.
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