The Bill Daley Problem

http://baselinescenario.com/2011/01/09/the-bill-daley-problem/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+BaselineScenario+%28The+Baseline+Scenario%29
The Baseline Scenario
The Bill Daley Problem
with 40 comments

By Simon Johnson, co-author of 13 Bankers (out in paperback on Monday)

Bill Daley, President Obama’s newly appointed chief of staff, is an  
experienced business executive.  By all accounts, he is decisive, well- 
organized, and a skilled negotiator.  His appointment, combined with  
other elements of the White House reshuffle, provides insight into how  
the president understands our economy – and what is likely to happen  
over the next couple of years.  This is a serious problem.

This is not a critique from the left or from the right.  The Bill  
Daley Problem is completely bipartisan – it shows us the White House  
fails to understand that, at the heart of our economy, we have a huge  
time bomb.

Until this week, Bill Daley was on the top operating committee at JP  
Morgan Chase.  His bank – along with the other largest U.S. banks –  
have far too little equity and far too much debt relative to that thin  
level of equity; this makes them highly dangerous from a social point  
of view.  These banks have captured the hearts and minds of top  
regulators and most of the political class (across the spectrum), most  
recently with completely specious arguments about why banks cannot be  
compelled to operate more safely.  Top bankers, like Mr. Daley’s  
former colleagues, are intent of becoming more global – despite the  
fact that (or perhaps because) we cannot handle the failure of massive  
global banks.

The system that led to the crisis of 2008, and the recession that has  
so severely damaged so many Americans, encouraged excessive risk- 
taking by major private sector financial institutions and, yes, Fannie  
Mae, Freddie Mac, and other Government Sponsored Enterprises (although  
these were most definitely not the major drivers of the crisis – see  
13 Bankers).

Today’s most dangerous government sponsored enterprises are the  
largest six bank holding companies: JP Morgan Chase, Bank of America,  
Citigroup, Wells Fargo, Goldman Sachs, and Morgan Stanley.  They are  
undoubtedly too big to fail – if they were on the brink of failure,  
they would be rescued by the government, in the sense that their  
creditors would be protected 100 percent.  The market knows this and,  
as a result, these large institutions can borrow more cheaply than  
their smaller competitors.  This lets them stay big and – amazingly –  
get bigger.

In the latest available data (Q3 of 2010), the big 6 had assets worth  
64 percent of GDP.  This is up from before the crisis – assets in the  
big six at the end of 2006 were only about 55 percent of GDP.  And  
this is up massively from 1995, when these same banks (some of which  
had different names back then) were only 17 percent of GDP.

No one can show significant social benefits from the increase in bank  
size, leverage, and overall riskiness over the past 15 years.  The  
social costs of these banks – and their complete capture of the  
regulatory apparatus – are apparent in the worst recession and slowest  
recovery since the 1930s.

Paul Volcker gets it; no wonder he has resigned.  Mervyn King,  
governor of the Bank of England, gets it.  Tom Hoenig, president of  
the Kansas City Fed, gets it.  Elizabeth Warren, the tireless champion  
of consumer rights, gets it.   Gene Fama, father of the efficient  
financial markets view, gets it better than anyone.

I discussed the issue in public for two hours at the American  
Financial Association (AFA) meetings in Denver on Friday with two  
presidents of the AFA (Raghu Rajan and John Cochrane) and a Nobel  
Prize winner (Myron Scholes).  This is not a left-wing or marginal  
group – there must have been at least 500 people in the audience  
(video will be available).  The top minds in academic finance  
understand the problem vividly and are articulate about it – there is  
no rebuttal to the points being made by Anat Admati and her  
distinguished colleagues.

This is not a left-right issue – again, look at the list of people who  
co-signed Professor Admati’s recent letter to the Financial Times.   
This is a question of technical competence.  Do the people running the  
country – including both the executive branch and the legislature –  
understand economics and finance or not?

If the country’s most distinguished nuclear scientists told you,  
clearly and very publicly, that they now realize a leading reactor  
design is very dangerous, would you and your politicians stop to  
listen?  Yet our political leadership brush aside concerns about the  
way big banks operate.  Why?

Top bankers, including Bill Daley, have pulled off a complete snow job  
– including since the crisis broke in fall 2008.  They have put  
forward their special interests while claiming to represent the  
general interest.  Business and other groups, of course, do this all  
the time.  But the difference here is the scale of the too big to  
subsidy – measured in terms of its likely future impact on our  
citizenship and our fiscal solvency, this will be devastating.

Most smart people in the nonfinancial world understand that the big  
banks have become profoundly damaging to the rest of the private  
sector.  The idea that the president needed to bring a top banker into  
his inner circle in order to build bridges with business is beyond  
ludicrous.

Bill Daley now controls how information is presented to and decisions  
are made by the president.  Daley’s former boss, Jamie Dimon, is the  
most dangerous banker in America – presumably he now gets even greater  
access to the Oval Office.  Daley is on the record as opposing strong  
consumer protection for financial products; Elizabeth Warren faces an  
even steeper uphill battle.  Important regulatory appointments, such  
as the succession to Sheila Bair at the FDIC, are less likely to go to  
sensible people.  And in all our interactions with other countries,  
for example around the G20 but also on a bilateral basis, we will  
pursue the resolutely pro-big finance views of the second Clinton  
administration.

Top executives at big U.S. banks want to be left alone during  
relatively good times – allowed to take whatever excessive risks they  
want, to juice their return on equity through massive leverage, to  
thus boost their pay and enhance their status around the world.  But  
at a moment of severe financial crisis, they also want someone in the  
White House who will whisper at just the right moment: “Mr. President,  
if you let this bank fail, it will trigger a worldwide financial panic  
and another Great Depression.  This will be worse than what happened  
after Lehman Brothers failed.”

Let’s be honest.  With the appointment of Bill Daley, the big banks  
have won completely this round of boom-bust-bailout.  The risk  
inherent to our financial system is now higher than it was in the  
early/mid-2000s.  We are set up for another illusory financial  
expansion and another debilitating crisis.

Bill Daley will get it done.

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