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Robert Johnson: Does the White House govern wall street or the other way around?

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PAUL JAY, SENIOR EDITOR, TRNN: Welcome back to The Real News Network. We’re in New York City with Robert Johnson. He’s the director of financial reform for the Roosevelt Institute, and he’s also the new executive director of something called INET, which is the Institute for New Economic Thinking, which you’re doing with George Soros.


JAY: And if you want to know why they’re doing it, watch the first part of the interview. So we left off with talking about how complicated all this stuff that happens on Wall Street is. And it’s also mysterious: you need the wizards of Wall Street to understand it. But if I’m an autoworker in Detroit or I’m a coal miner in West Virginia, I’ve been told I need all of this in Wall Street to happen, because they’re—they provide sort of the lubrication for the economy to work, that we wouldn’t have credit without them. Is this true? Do we need all this?

JOHNSON: In my opinion, no. Paul Volcker is about right. He said, “The only financial innovation that I can see that’s made a difference is the ATM machine.” What this is really about is the market for insurance, insurance against different types of risk. And what people have done as market makers is they’ve tried to make these things much more complex. And the reason they try to make them complex is, once they’re complex, they defy imitation. I’m reminded of a story of the bebop musicians and 1930s. Thelonious Monk, Charlie Parker, Dizzy Gillespie, they made very, very complicated music. And when you read their autobiographies, what were they doing? White guys used to get the recording contracts, but the black guys created the music. So they went out and created something complex. Why? So that if you like the music, you had to hire them to record it, ’cause the other guys couldn’t imitate it. Derivatives engineers are trying to make really complex financial instruments so that they can’t be imitated and they can protect their profit margin. But those complex instruments come at a huge price.

JAY: So we’ve got a company like Goldman Sachs, and they have clients. They have pension funds come and rich people come, and they say, “Here, take my money and go make me more money.” And they want to sell them products that will make them money, and they want them to bring the pension fund to Goldman Sachs and not to somebody else down the street, so they kind of create these investment vehicles that said, “We’ll make you more money than they will.” So you make it more complicated, you’ve got a more proprietary product, except as soon as you got one that works, everybody copies it anyway.

JOHNSON: But if you make them real complex, the other teams can’t diagnose them and figure out how to compete with them.

JAY: It takes them a while. So you’ve got to keep creating new ones, ’cause—.

JOHNSON: New ones and more complicated ones.

JAY: So let me get another piece of this. So you’ve got speculation, and then you get speculation on speculation. Essentially, let’s insure the speculation, which becomes a layer of speculation on speculation.

JOHNSON: That’s right.

JAY: And then make it complicated

JOHNSON: That’s right.

JAY: Alright. So we don’t need all this.

JOHNSON: Yup. Well, the problem is, when it’s complicated and the system gets kicked with a negative shock like the housing downturn, then all the big institutions are chock-full of all this complex, opaque stuff, and they look at each other and they say, “Damn. I don’t know if I’m solvent, and I don’t know if you’re solvent. As a matter of fact, you can’t even tell me if you’re solvent,” and they get scared. So then the credit market freezes up, ’cause everybody’s afraid of what they call “counter-party default risk”, “counter-party” meaning the other bank, “default risk” meaning when I can’t diagnose what you are, and I know you got hit with a negative shock, you might be bankrupt.

JAY: So Goldman Sachs doesn’t know whether they can loan money to Lehman, or the other way around.

JOHNSON: Correct.

JAY: The big investment houses can’t even deal with each other, ’cause they don’t know whether their books are completely full of it or not.

JOHNSON: So all these layers of interpenetrated positions and connections to one another all become suspect, and no one can prove that their balance sheet is wholesome, simple, and clear.

JAY: They hit a wall. They speculated on all this real estate, mostly in California and Florida. They figured real estate could never go down in California and Florida, so who cares if people can actually pay back their loans or not? We’ll package all these loans up and speculate on them and sell them all over the world as sort of reinsuring them, ’cause we know, oh, geez, even if Joe Someone in Florida goes down, we can always pick up their house and sell it for profit. That all crashes. Why is all this public money coming in? Who cares if all these people go down? Why throw all this public money to save all this?

JOHNSON: Here’s the problem. That’s a very good question. The problem is, if you take the nerve center down, which is this constellations of large financial institutions, you can tear down the real economy, too. All the trade credit, your banking deposits, commercial working capital, all freeze up at the same time as those big institutions go bankrupt. So if you destroy your credit-allocation process, you send your society into a depression. That’s what we learned in the ’30s. The point is to save the functions, not the bankers and not their stockholders. But in fact what we did was we bailed out stockholders, bailed out executives.

JAY: How would you have saved the functions and not the stockholders and the bankers? What would you have done?

JOHNSON: I would have restructured them through a government receivership process, where the government became the owners in return for the bailout funds. And then, in a three-to five-year period, I would have taken them back into the private sector.

JAY: Which was done, I think, in Sweden.

JOHNSON: It’s been done in Sweden. It’s been done in Norway. It was done in a place called the United States of America by the Reconstruction Finance Corporation in the 1930s. It has to be much tougher on managements and the creditors. Some of these guys are levered at 50-to-1. That means you’ve got a 2 percent cushion. The other 48 percent got bailed out in whole when they don’t have real guarantees, ’cause everybody’s afraid. Going back to your complexity, all these derivatives spiderwebs are caught between all these firms. When the officials come up on deck and they know somebody’s insolvent, they do what’s called forbearance, induced forbearance: they just give them some money and walk away, ’cause they’re afraid that if they start to tear away at—unbuckling this firm, it will take everybody down with them.

JAY: Two questions. First question is: when President Obama and his advisors are making this decision, there were people saying what you’re saying. You were saying it then, but a lot of people were saying it then, that he should follow this method of just take the functions, forget the—. Shareholders and bankers took their risk; let them pay the price of losing. They didn’t do that. So what’s the politics of this? Why didn’t they do this?

JOHNSON: Well, I’d say there are two dimensions in the politics. The first was the large banks tend to be international, and they didn’t have an international negotiated regime for resolving and burden-sharing of these institutions. So what are you going to do? Make whole all the guys that invested in Switzerland, but penalize all the American bond funds? It just was very messy, and they were reluctant to take that on. Now, everybody says that’s very complicated. I say there’s a will, there’s a way. What I mean is you have WTO. [If] the multinational corporations wanted free-trade agreements, they could get them. If we had the will, meaning our public and those of the other industrial countries wanted to put together an international agreement for bankruptcy burden sharing, we could have one. But the bankers don’t quite want that.

JAY: But they didn’t at that moment. [inaudible]

JOHNSON: They didn’t have it at that moment, so it deterred them from taking the action I would like to see, which was restructuring.

JAY: And do you agree with that judgment?

JOHNSON: No, I don’t. I think that I would have what you might call braved wading into the waters and restructured a couple of institutions. There’s a couple of reasons for that. The first one is, when you don’t do that, you still have the too-big-to-fail zombies afterwards. And the second thing is you demoralize the public. I think Obama, by not what you might call abruptly changing course from what the Bush-Cheney years have done, hurt himself, because whether he’s trying to protect society from a real calamity or whether he’s pandering to bankers, the public can’t know, and when a new guy comes in, made a lot of promises—there was a lot of romance, there is a lot of enthusiasm about this man, but he didn’t—.

JAY: I mean, he had such political capital, he could have made a big turn, and he would have had public support.

JOHNSON: The public was asking a question when he came in: does Wall Street govern Washington, or does the Obama administration govern Wall Street? And when he went with the forbearance, when he didn’t resolve these institutions, when they were perhaps afraid of the complex web of derivatives exposures and the international consequences, they look like they pander to the bankers, and it created credibility problems that continue to this day.

JAY: And it didn’t just look like it. The substance of it was—.

JOHNSON: Well, it’s indistinguishable from corruption.

JAY: Okay. In the next segment of our interview, I want to take up part two of your answer, which is: if we followed your path, why take them private again in four years? Don’t answer now; we’ll do it in the next segment. So please join us for the next segment of our interview with Robert Johnson.


Please note that TRNN transcripts are typed from a recording of the program; The Real News Network cannot guarantee complete accuracy.

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Dr. Robert A. Johnson - Executive Director of The Institute New Economic Thinking (INET) and a senior fellow at the Roosevelt Institute. Dr. Johnson served on the United Nations Commission of Experts on International Monetary Reform under the Chairmanship of Joseph Stiglitz. He is also the Director of Economic Policy for the Franklin and Eleanor Roosevelt Institute (FERI) in New York. Dr. Johnson was previously a managing director at Soros Fund Management where he managed a global currency, bond and equity portfolio specializing in emerging markets. Prior to that time, Johnson was a managing director of Bankers Trust Company managing a global currency fund. He also served as Chief Economist of the U.S. Senate Banking Committee under the leadership of Chairman William Proxmire (D. Wisconsin) and before that, he was Senior Economist of the U.S. Senate Budget Committee under the leadership of Chairman Pete Domenici (R. New Mexico).