We know that Simon Johnson and James Kwak have hit a nerve because Larry Summers, the administration's principal economic adviser and the man that carries water for what the authors rightly call the financial "oligarchs" -- has been forced into an open defense of the oligarchs' rule. Summers has kept a low profile and protected the oligarchs from substantive reform by using his power as gatekeeper to minimize the presentation of views by those that support effective financial regulation. Summers' ability to marginalize Paul Volcker demonstrates his power and success -- and the harm he causes the nation.
The issue that has caused Summers to publicly carry water for the oligarchs is the inherent insanity of allowing systemically dangerous institutions (SDIs) to continue. The oligarchs are all SDIs. Under the administration's own logic, if any SDI fails it creates a serious potential of causing a global financial crisis.
The administration (implicitly) asserts that the power to resolve failed SDIs removes this systemic risk. Treasury Secretary Geithner's prepared testimony before the House on April 20, 2010 argued:
No regulatory regime will be able to prevent major financial firms from reaching the point of insolvency. But a well-designed regulatory framework must put in place shock absorbers to contain the damage caused by a major firm's default (p.1).
The first sentence is a devastating admission that the administration's embrace of the oligarchs will, as the authors have warned, produce recurrent global financial crises. We know that "private market discipline" is an oxymoron -- the lenders and investors that are supposed to "discipline" fraudulent enterprises actually fund their growth. That means we have to rely on regulators to prevent future epidemics of "control fraud" (frauds in which those that control seemingly legitimate entities use them as "weapons" to defraud). But Geithner admits that "no regulatory regime" can be counted on to prevent the failure of an SDI -- which they claim exposes us to a global crisis.
Note the extreme vagueness of Geithner's solution to the future failures, which he concedes are inevitable, of the DSIs. What "shock absorbers" does he plan to put in place to prevent the failure of an SDI from causing the global crisis that he says their failure would normally cause?
Consider the not-so-hypothetical failure of Citicorp. It is the counterparty to tens of thousands of transactions. If it fails due to accounting control fraud -- and that is the most common reason an SDI fails -- then its capital requirement will be meaningless even if its increased. Accounting control fraud produces guaranteed, record (albeit fictional) "income" which can flow through to "capital" and meet any capital requirement under consideration. Alternatively, a bank can follow the Iceland strategy and lend the funds to those that will purchase its stock. This creates whatever level of fictional capital is required. Capital is an accounting concept. If you game the accounting the capital can be fictional. Capital requirements cannot stop accounting control frauds -- the principal cause of major bank failures. Note that Geithner implicitly admits this, because he admits that no regulatory regime can guarantee closure prior to insolvency -- even though the regulators are required by the Prompt Corrective Action Act to do so.
We demonstrated during the reregulatory phase of the S&L debacle that regulators that understand accounting control fraud can identify and close the frauds before they cause catastrophic failures, but Geithner and Summers cannot even bring themselves to use the "f word" -- fraud -- much less identify, constrain, and prosecute it.
Absent effective anti-fraud regulators, there is only one "shock absorber" that can be used once the looters have caused the catastrophic failure of an SDI. If Citicorp is insolvent by $400 billion there is only one "shock absorber" that can reduce (1) cascade failures among the counterparties and (2) sending a shock throughout the financial system as investors and creditors realize that there is an enormous bubble (whatever bubble comes next), that asset values are grossly inflated, and that there is widespread fraud covering up losses at many banks. That shock absorber is money -- massive amounts of money. The reality, which politicians like to assume away, is that most of this money will come from public funds. As long as banks are allowed to be so large that their failure can cause a crisis they will be bailed out. If, like Lehman, they are not bailed out their failure will cause so much damage that the subsequent SDI failures will be bailed out.
The authors correctly explain that the issue isn't simply economics. The oligarchs will be failed out because of their political power. As long as they are allowed to be SDIs they will have exceptional political power and they will use it to harm the public.
Simon Johnson and James Kwak have identified the financial oligarchs as the greatest threat to the global economy and our democracy. (I would add that their frauds create a criminogenic environment that also threatens our integrity.)
We know that the authors have scared the oligarchs and their political allies in both parties because of the money the oligarchs are spending to fend off serious regulatory reform and the fact that Summers has found it necessary to go public in his effort to protect the oligarchs. He was interviewed recently on PBS' Newshour.
JEFFREY BROWN: The too-big-to-fail issue, why not go further? Why not just limit the size of banks?
LAWRENCE SUMMERS: Jeff, that was the approach America took to banking before the Depression. That was the approach that America took to lending in the thrift sector before we had the S&L crisis.
Most observers who study -- who study this believe that to try to break banks up into a lot of little pieces would hurt our ability to serve large companies and hurt the competitiveness of the United States.
But that's not the important issue. They believe that it would actually make us less stable, because the individual banks would be less diversified and, therefore, at greater risk of failing, because they would haven't profits in one area to turn to when a different area got in trouble.
And most observers believe that dealing with the simultaneous failure of many -- many small institutions would actually generate more need for bailouts and reliance on taxpayers than the current economic environment.
The administration, rather than repudiating this ode to the oligarchs, joined Summers' chorus.
"Banks in the United States are proportionately smaller than in Canada and in many European countries," writes Matthew Vogel, a White House spokesman, in an e-mail to HuffPost. "We propose nothing to increase the size of financial institutions. In fact, we tighten the limit on liabilities to further prevent firms from growing excessively large and require firms to separate out their riskiest, proprietary trading activities."
Summers' comments are not honest. Economists and regulators have reached a consensus -- the SDIs are inefficiently large (as well as dangerously large). They harm our international competitiveness. His continued embrace of the regulatory "race to the bottom" is appalling. This is precisely the (logic-free) logic that Rubin, Summers, Greenspan and Patrick Parkinson used to convince Congress pass the Commodities Futures Modernization Act of 2000 that destroyed Brooksley Born's effort to protect the public from credit default swaps (CDS).
Summers' argument rests on a (doubly) false dichotomy. First, the alternative to SDIs is not a nation of 100,000 banks that each has $1 million in assets. Banks can reach efficient scale without becoming so large that they become SDIs or oligarchs. Second, SDIs tend to survive not because they are more stable than smaller banks, but because they are bailed out when they get in trouble because of their power as oligarchs. It was the larger S&Ls, for example, that caused the severe losses during the S&L debacle.
The White House argument that there is no reason to take on the U.S. banking oligarchs because the banking oligarchs in some other nations also have dominant power in their nations is bizarre. The administration does not get the most basic fact that Johnson & Kwak have documented - the financial oligarchs are bad for America. The fact that they are also bad for Germany, Iceland, Ireland, Japan and the UK adds to the case for destroying the power of our oligarchs.
The administration may be proposing no new laws to make the oligarchs even bigger, but it (1) has encouraged their growth through acquisitions of failed banks and (2) stood silent and useless as many of the SDIs have continued to grow. It is insane to allow the SDIs to continue to exist and it is doubly insane to allow, much less encourage, them to grow. Encourage everyone you know to read this book and learn why defeating the oligarchs is imperative for our economy and our democracy.