For many on the right side of the U.S. political spectrum, the financial meltdown that began in 2008 resulted from a government push to bring the American Dream of home ownership to the masses. And while President Clinton made home ownership a central tenet of his economic plan — a goal George W. Bush also embraced — there were greater forces at work, according to Simon Johnson, professor of Global Economics and Management at MIT and the former chief economist at the International Monetary Fund.
In his 2010 bestseller, 13 Bankers: The Wall Street Takeover and The Next Financial Meltdown, which he co-authored with James Kwak, Johnson attributes our economic woes to the “financialization” of the economy. According to Johnson, from 1980 until 2005, financial sector profits outpaced nearly 4 to 1 those of the non-finance sector. But more insidious was financialization’s impact on the American psyche. “As banking became more complicated,” he wrote, “more prestigious and more lucrative, the ideology of Wall Street — that unfettered innovation and unregulated financial markets were good for America and the world — became the consensus position in Washington on both sides of the political aisle.”
Miller-McCune spoke with Johnson for his insights on where we’re headed, what the Obama administration isn’t doing and the Occupy Wall Street movement.
Miller-McCune: We always talk about American exceptionalism. Do you think the financial crises have torn away at some of that thinking, suggesting we’re kind of like everyone else?
Simon Johnson: Well, we are exceptional in the degree to which we can screw things up. (Laughter) And also the way we can achieve things. It can go either way. When we’re great, we’re spectacular, but we can also bring about great disasters. That’s exceptional. We’re certainly not exempt from the same problems that affect other countries, particularly with regard to financial sector excesses and disasters.
M-M: What about the crisis’s impact on the nation’s psyche? We know how it’s impacted the living standards of many people …
SJ: Mostly it affected the poor; the rich were not that much affected. Maybe there were some difficult months in there, but they’re mostly fine. As for the nation’s psyche, obviously it’s been very traumatic. A lot of people believed that things were fine and the economy was rolling along in a reasonable manner in 2005-2006. Then they found out that we were sitting on an enormous time bomb and that the people in charge of the country who purported to be knowledgeable and responsible had actually presided over the greatest calamity since the 1930s.
M-M: We can’t undo the events leading up to the 2008 financial meltdown, but what could we have done differently since then?
SJ: We could’ve done reform. We could’ve limited the power and the ability to inflict damage by the biggest financial institutions — the ones really at the epicenter of the crisis. And we could’ve done it in a fair and reasonable basis without being vindictive, without being seething with anger. There were many responsible, sensible ways to do it, and that’s the kind of thing I worked on when I was at the IMF, with regard of course to other countries. But we didn’t do any of that. The Bush administration didn’t want to do it at the moment of crisis; then the Obama administration said that they couldn’t possibly consider doing that because of the circumstances. Then when attempts to begin some reform began, particularly when the Dodd-Frank legislative debate came to the Senate — when things actually got more interesting than when it was at the House — the Obama administration, particularly the Treasury Department, consistently undermined almost all efforts to rein in the power of the biggest banks.
M-M: So what is happening with Dodd-Frank?
SJ: It’s a very big piece of legislation and parts are rolling out at different speeds. There is a consumer protection agency; I think that’s on the whole positive. However, there was little progress made in reducing what people call “system risk,” meaning the ability for the financial system to blow itself up. And the power of the biggest banks actually became greater following everything, not just Dodd-Frank, but the whole crisis, including the bailout and then reform efforts.
M-M: The right says cutting taxes will spur growth. The left says more spending on stuff like infrastructure will yield more jobs. Obama seems to be taking the middle path. Your comment?
SJ: Unfortunately, I think that fiscal stimulus of the kind that you would get through more spending or cutting taxes is not going to do much for us. We need to bring our deficits under control. We need to limit future health care spending and we need to raise some taxes. To some extent, this was in the cards prior to 2008, but there was just a lot of denial among many people. To a large degree, the urgency of our fiscal situation was brought about by what the banks were allowed to do. Obviously there’s got to be a political debate concerning to what extent at various times people have to pay high taxes. But it would be pretty unfair if you hammered only poor people with the crisis, loss of jobs, loss of homes and then you raise taxes on them or cut their pensions or whatever medical benefits remain.
M-M: What about the Warren Buffet Rule, the idea that sprung from the notion that Warren Buffet’s secretary paid a higher tax rate than her billionaire boss?
SJ: I would address the fairness of the tax system much more broadly than that. I don’t think I’d single out investment income necessarily, but I think we should do a comprehensive tax reform and rebalance it so that richer people pay somewhat more. I think many of them are getting a very good deal. Of course, it’s not just Warren Buffet, but also many other higher income Americans, including many of my colleagues who also say that. I don’t think that’s a crazy, radical approach at this point, but high-end people have done very well the past 30 years. The lower-end people not so much.
M-M: What about the idea that American corporations are overtaxed, making it harder to compete globally?
SJ: I think that’s often exaggerated, but I would support a corporate tax reform that closes loopholes and lowers the corporate tax rate. I would also stress the importance of removing the tax advantage of debt. Right now you can deduct interest payments, but you can’t deduct payments to equity or dividends. As a result, there’s an incentive to borrow a lot and have excessive leverage. It’s more of a problem in some sectors than others but you definitely see it as a problem in banking because excessive leverage creates problems of massive blow-ups. So as part of a comprehensive tax reform, I think we can lower the corporate tax rate and close exemptions. Then you can either eliminate the deduction for interest or trade in that deduction for equity as long as you balance it out so there’s no tax subsidy for debt. That’s because debt at this level is dangerous for companies.
M-M: What about the concept of a flat tax?
SJ: The tax system is already pretty unfair. Why would you want to make it more unfair? The point is you can do sensible tax reform without destroying incentives, without removing the monetary side of why people set up companies and create jobs. I am not at all for punitive taxes; I’m not at all in the camp of people who say let’s go after the rich in this situation. But I think we should rebalance a bit the distribution of income in the country. As I said, the rich have done really well and it’s partly about technology and partly about the way the tax system has evolved. But the people in the middle have been very severely squeezed.
M-M: What about [former GOP presidential candidate] Herman Cain’s 9-9-9 plan?
SJ: I think it’s unworkable, unfortunately. Reforming corporate tax and individual tax is appealing, but to think that you can get some sort of miracle from an overly simplistic plan is just not in line with facts and experience in this area.
M-M: And those who say that “redistribution” is a distinct nod to socialism?
SJ: I would put it differently. I would say that there’s a basic level of social cohesion that you want in any society, including the United States. And that includes an absolutely minimal safety net. I think a lot of people would agree that you should protect relatively old people from becoming destitute because of their medical bills. That safety net has become severely frayed. And by the way, that net is for lots of people who have outlived their assets. A lot of Medicaid goes to middle class individuals because if you happen to live a long time, you’re assets get depleted. So it’s a form of insurance that’s available for all of us. There is no market for someone to pick up your health care tab when you’re 92. Try going out to buy that insurance policy; you can’t and with good reason. It’s an uninsurable risk.
I’m not arguing it should be super generous, but I think it should be kept at some basic level, but it’s become quite severely frayed and increasing health care costs continue to challenge it.
M-M: Who on the roster of Republican presidential candidates is most likely to help the economic situation in your view?
SJ: I think John Huntsman, honestly, is the only one who’s got any kind of grip on the financial sector. He had an op-ed in The Wall Street Journal, “‘Too Big to Fail’ Is Simply Too Big” and he says correctly that what’s happening with the big banks is not a market; it’s a giant subsidy scheme. It’s a very dangerous, inefficient form of subsidy that should be eliminated, and there are various ways to do that. I just gave you one on the leverage. You could put a cap on the size of the banks; you could tax them to offset the funding advantage they get and so on. There’s a menu. But the point is Huntsman’s attempt to hammer away at “too big to fail” is the right way to address the issue, and I’d be strongly supportive of him on that basis. I haven’t heard anything from any of the other candidates that inspire any confidence at all — at least based on their policy statements.
M-M: What about President Obama, if he does have a second term?
SJ: He’d have to change completely his operating philosophy and replace a lot of his key people. At every opportunity to rein in the biggest banks, his administration has said no. One example is the Brown Kaufman Amendment, which would’ve put a binding size cap on the largest banks under Dodd-Frank. The Treasury Department was out there working very hard against it. It ended up getting 33 votes and could’ve got a lot more if the Treasury hadn’t been fighting so hard against it. So I’m not optimistic that this or any future administration would want to take on this issue. They had the opportunity and they punted repeatedly, so why would they now change their mind?
M-M: What do you think will come of Occupy Wall Street?
SJ: I don’t know what will come of it. It’s a protest movement and it’s hard to know. But I think they have a lot of legitimate grievances. I think people are realizing that these problems are not going away quickly. Nothing is transitory about the loss of jobs or about the mortgage disaster. I’ve gone to look at the protests and I’ve followed the progress. They have a lot of different demands. … Their personal stories about being mistreated by the banks are awful.
I think Eric Schneiderman, the New York attorney general, is on exactly the right track, saying that we need to have a proper investigation and a large-scale settlement that would really confront the big problem, which is negative equity and the big losses on mortgages that people are confronting. My point is there’s this traction around the Occupy Wall Street ideas with lots of sensible grassroots people who have completely legitimate concerns and are articulating them, I find, in a very responsible fashion.
Look at the proposals from the Massachusetts group, The Mass Alliance Against Predatory Lending. The No. 1 thing they want is mandatory mediation, so you can’t just get kicked out of your house. They also want judicial review of foreclosures because there have been so many abuses. This is entirely reasonable stuff, and the Obama administration is not on the right side of this. They want to do a small settlement just about robo-signing. Schneiderman and Beau Biden of Delaware want to go big. They want to deal with everything the banks did and the entire process of all the legal violations, which are alleged, not yet proven, but they want to investigate them and to have a comprehensive settlement.
M-M: How do you think the banks would fare if they were investigated?
SJ: Good luck to the banks winning given what we know about what’s happened. I think there’s a connection that people are drawing between the banks’ behavior, individual outcomes, unfairness and the violation of due process. Whenever I make these kinds of points in my columns, I get a lot of hate mail from people who have been around the mortgage industry. But my response is, ‘Guys, you broke the law. What do you want? Just because your banks are big — you can’t possibly do this because then we’ll collapse and it’ll destroy the economy. Well no, actually, it won’t and secondly, what is this, blackmail? So you’re too big to be investigated or prosecuted? I don’t think so.’ There’s a fundamental principle of American democracy that no one is above the law.