Brazen Tunneling and Inflation

In most societies it is traditional to be somewhat sneaky in squeezing your shareholders or the government.  You might set up a complicated transfer pricing scheme or perhaps you arrange for a family-owned firm to acquire assets on the cheap from the publicly traded corporation that you control.  Or you could always arrange for the Kremlin to provide foreign exchange at a “special” price.

In the New United States, life is much simpler and bank tunneling considerably more brazen.

I’m starting a bank blotter.  Here are some early entries, from the WSJ on Wednesday:

  1. We’ll pay ourselves very high wages, rather than substantial bonuses (p.C3 in print edition).  This is brilliant.  These banks are supposed to be recapitalizing themselves, which means earning profit – and this is usually harder to do if you increase wages.  Lower wages would mean the exit of employees at some of the world’s least well run firms – entities consistently plagued also by the world’s most blatant agency problems – but the banks simply assert that would be a bad thing.
  2. We’ll use the PPIP money to buy toxic assets from ourselves and thus “participate in the upside” (p.C1 in print edition; reviewed here yesterday).  In any decent society, this would set the red flags flying, but the banks have apparently lost all sense of moderation.  Look carefully at (perhaps) the most fantastic angle here – these assets will be moved “off balance sheet”, as if that does anyone any good; remember many such assets started off there and moved on balance sheet as the crisis developed.  Come to think of it, the complexity inherent in the implicit conflicts of interest in this scam scheme would go over well in Russia.

What does any of this have to do with inflation?  If you want to the Fed ever to be able to tighten, you need a healthy enough financial sector – i.e., given what we now know about policymakers’ preferences, banks in the “too big to fail” category better not be close to failing.

Big banks that pay higher wages will have less capital for the next round of difficulties.  Banks that keep legacy assets close at hand will likely find out (again) why these loans and securities were called toxic.  A weaker set of big banks will encourage the Fed to allow the yield curve to steepen, so monetary tightening happens later and perhaps too late to prevent inflation from taking off.  Tunneling makes it harder for the Fed to tighten when inflationary pressures appear.

And if you think that inflation is not possible in the US any time soon, please see my column on NYT’s Economix (usually appears at around 7am Thursday morning, New York time) – post comments there or here.

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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