Too Politically Connected to Fail in Any Crisis

Over the past 30 years Wall Street captured the thinking of official Washington, persuading policymakers on both sides of the aisle not to regulate (derivatives), to deregulate (Gramm-Leach-Bliley), not enforce existing safety and soundness regulations (VaR), and to stand idly by while millions of consumers were misled into life-ruining financial decisions (Alan Greenspan).

This was pervasive cultural capture or, to be blunter, mind control.  But when the crisis broke it was not enough.  Having powerful people generally on your side is not what you need when all hell breaks loose in financial markets.  Official decisions will be made fast, under great pressure, and by a small group of people standing up in the Oval Office.

If you run a big troubled bank, you need a man on the inside – someone who will take your calls late at night and rely on you for on the ground knowledge.  Preferably, this person should have little first-hand experience of the markets (it was hard to deceive JP Morgan and Benjamin Strong when they were deciding whom to save in 1907) and only a limited range of other contacts who could dispute your account of what is really needed.

Goldman Sachs (NYSE:GS), JPMorgan (NYSE:JPM), and Citigroup (NYSE:C), we learn today, have such a person: Tim Geithner, Secretary of the Treasury.

We already knew, from the NYT, that most of Geithner’s contacts during 2007 and 2008 were with a limited subset of the financial sector – primarily the big Wall Street players who were close to the New York Fed (including on its board).  And the announcement of his appointment was widely regarded as very good news for those specific firms.

But Geithner himself has always insisted that his policies are intended to help the entire financial system and thus the whole economy.

“SECRETARY TIMOTHY GEITHNER: I’ve been in public service all my life. I’ve spent all my life working in government on ways to make our financial system stronger, better economic policy for this country. That’s the only thing I’ve ever done. And I would never do anything and be part of any policy that’s designed to benefit some piece of our financial system. The only thing that we care about and the only obligation I have is try to make sure this financial system is doing a better job of meeting the needs of businesses and families across the country.”  Interview on Lehrer NewsHour, May 8, 2009

Geithner’s defenders insist that his specific contacts while President of the NY Fed were a function of that position; “he was only doing his job.”

But today’s AP report, based on looking at Geithner’s phone records, from the inauguration through July, suggest something else.  How can anyone build an accurate picture of conditions in the entire crisis-ridden financial sector primarily from talking to a few top bankers?

The list of phone calls is not the largest banks, because some of the biggest are hardly represented —  [e.g., Wells Fargo (NYSE:WFC)], it’s not the most troubled banks — [e.g., Bank of America (NYSE:BAC) had little contact], and it’s not even investment banker-types who were central to the most stressed markets (Morgan Stanley (NYSE:MS) was not in the inner loop).  And small and medium-sized banks (and others) always bristle at the suggestion that their interests are in alignment with those of, say, Goldman Sachs.

Geithner’s phone calls were primarily to and from people he knew well already – who had cultivated a relationship with him over the years, shared nonprofit board memberships, and participated in the same social activities.  These are close professional colleagues and in some cases, presumably, friends.

The Obama administration had to rescue large parts of the financial sector, given the situation they inherited.  But it absolutely did not have to run the rescue in this exact fashion – bending over backwards to be nice to leading bankers and allowing their banks to become even larger.   Saving top executives’ jobs under such circumstances is not best practice, it’s not what the US advises to other countries, it’s not what the US tells the IMF to implement when it helps clean up failed banking systems, and it’s not what the FDIC implements for failed banks under its auspices.

The idea that you could leave big US bank bosses in place (or let them get stronger politically) and do meaningful regulatory reform later has always seemed illusory – and this strategy now appears to be in serious trouble.  But presumably Mr. Geithner’s financial advisers told him this was the right thing to do.

About Simon Johnson 101 Articles

Simon Johnson is the Ronald A. Kurtz (1954) Professor of Entrepreneurship at MIT's Sloan School of Management. He is also a senior fellow at the Peterson Institute for International Economics in Washington, D.C., a co-founder of BaselineScenario.com, a widely cited website on the global economy, and is a member of the Congressional Budget Office's Panel of Economic Advisers.

Mr. Johnson appears regularly on NPR's Planet Money podcast in the Economist House Calls feature, is a weekly contributor to NYT.com's Economix, and has a video blog feature on The New Republic's website. He is co-director of the NBER project on Africa and President of the Association for Comparative Economic Studies (term of office 2008-2009).

From March 2007 through the end of August 2008, Professor Johnson was the International Monetary Fund's Economic Counsellor (chief economist) and Director of its Research Department. At the IMF, Professor Johnson led the global economic outlook team, helped formulate innovative responses to worldwide financial turmoil, and was among the earliest to propose new forms of engagement for sovereign wealth funds. He was also the first IMF chief economist to have a blog.

His PhD is in economics from MIT, while his MA is from the University of Manchester and his BA is from the University of Oxford.

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