A conversation with Simon Johnson, an ICBA ally in ending too-big-to-fail
Who better to explain the true impact of the still-growing too-big-to-fail problem on the national economy and community banking than Simon Johnson, professor of entrepreneurship at the MIT Sloan School of Management and senior fellow at the Peterson Institute for International Economics in Washington, D.C.? Having forcefully argued the position that too-big-to-fail banks must be broken up if we want to avoid future financial catastrophe, Johnson is both a supporter and friend to ICBA and community banking issues.
Echoing ICBA’s policy views and actions, Johnson continues to explain, persuasively and persistently, to policymakers in Washington how the additional orderly liquidation authority the Dodd-Frank Wall Street Reform Act provides the FDIC to wind down the largest financial institutions should they fail during another crisis doesn’t address the underlying serious problem of too-big-to-fail. As evidenced by Wall Street’s megabanks growing even larger since the financial crisis, he says, finally ending too-big-to-fail will require specific policy action to significantly break up and downsize the very largest nationwide megabanks and financial conglomerates.
In fact, he adds, our nation’s banking system and economy are even more vulnerable to another financial catastrophe because of too-big-to-fail.
“Independent, unbiased expert voices like Professor Johnson’s are critical to the too-big-to-fail debate and the goal of ending too-big-to-fail,” says Karen Thomas, ICBA’s senior executive vice president, government relations and public policy. “Their independence lends credence to their point of view, and can help move policymakers in the right direction.”
“More than any other financial expert, he has demonstrated to community banks the need to be vigilant regarding the too-big-to-fail issue and to support legislation that ICBA has been advocating that would address the problem,” adds ICBA Senior Vice President and Senior Regulatory Counsel Chris Cole.
At the fall 2013 ICBA Federal Delegate Board meeting, Johnson addressed the group with his usual directness and clarity. He took a few minutes after addressing ICBA leaders to answer a few questions for ICBA Independent Banker. What follows is a condensed version of the conversation.
IB: When did you first recognize the dangers of too-big-to-fail, and when did you first recognize its dangers in financial concentration?
Johnson: Well, I was chief of commerce to the International Monetary Fund in 2007, and as the crisis began to develop we started to understand that some of the very largest financial institutions in the world that were supposed to be very smart and sophisticated had actually made huge mistakes. Of course, as 2007 went on we started to think how hard it would be to resolve these mistakes and equally difficult to resolve insolvency bankruptcy proceedings.
It was the week after Lehman collapsed that just absolutely hammered home just how big these problems had become.
IB: Do you think policymakers in Washington have a hard time understanding how safely breaking up the larger institutions is actually possible?
Johnson: Well, some do, but some simply don’t want to talk about it and they like to use this as an excuse. For example, Richard Fisher from the Dallas Fed has got a very credible approach, one way to do it. [Sens.] Sherrod Brown and David Vitter with the SAFE Banking Act have another alternative, which includes sliding capital requirements. So [under the senators’ ICBA-backed legislation] you would have much higher capital requirements and you would need to use a lot more equity to grow.
From a technical point of view, I think it’s entirely feasible to break up too-big-to-fail without being disruptive.
IB: What do you think will be the result if Congress has still failed to act further to address too-big-to-fail within five years?
Johnson: The biggest banks would become bigger, they’ll become more global and they’ll continue to become more complex. And that is unfortunately what some people in this administration and the regulatory apparatus want to allow. If that’s allowed, then they’ll mismanage their risks on a grander scale—you’ll have another version of an economic and financial disaster with huge collateral damage for the community banks.
IB: One new Pennsylvania community bank has recently opened its doors. However, prior to that, there were no new banks chartered in the past three years—the longest dry spell of new bank charter formations since the Great Depression. Why have there been so few new charters lately?
Johnson: Well, that’s a great question—probably all of the above. It’s gotten very hard to get a license right now, and it’s hard to get permission. The barriers to entry have gone up, which is unfortunate, because ideally we’d have easy entry and easy exit, which is what works in other sectors, like the software industry. It’s also what gives you a more dynamic marketplace. You need the creation of a small bank in-and-out [formation] process.
IB: Should community banking be expanded and enhanced?
Johnson: You know, if we could find ways to expand them, this is absolutely the traditional strength of the American financial system that people have largely forgotten. Big banks were actually a very small part of the American industrialization in 19th century. Additionally, they were not the big driver in the 20th century either, until they learned the way to help themselves first.