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 at the Roosevelt Institute. He’s the new executive director of the INET (Institute for New Economic Thinking), which you’re doing with George Soros.
ROBERT JOHNSON, DIRECTOR OF FINANCIAL REFORM, ROOSEVELT INSTITUTE: That’s right.
JAY: So last segment of the interview, we talked about the idea that President Obama had a choice when the banks were crashing: instead of just pumping up money in the name of saving and defending Main Street and pumping up money into the big banks, he could have taken the functions of those banks and essentially nationalized them, let the bankers and the shareholders pay the price of speculation, which means if you gamble and you lose, too bad—you can leave the casino without your money. But instead he pumped money in. What I want to ask you, if we follow your suggestion, it would be more or less nationalize them, but only for three, four years, and then take them back to the private sector. But given the private sector so inherently seems to be prone to wild speculation, why privatize them? Why not keep those functions public?
JOHNSON: Well, I think there’s dangers on both sides. If you have inappropriate rules governing financial regulation in the private sector, the banks will malfunction or they will engage in excessive speculation. So the first thing you’ve got to do is change the rules that govern the entire capital market to put things on a healthier footing. Secondly—.
JAY: Let’s do firstly before we do secondly.
JAY: Can you, in the realpolitik of this Senate and the House, can you actually have effective financial reform, given how powerful Wall Street lobbying seems to be? I mean, if you look at the kind of financial regulation they’re trying to get through Barney Frank’s committee, by the time it’s done, it’s going to look like the public option’s going to look like in health-care reform; like, there’s not going to be much left.
JOHNSON: That’s right.
JAY: So do you not need to do something more radical, because in the real world you can’t create those kind of rules?
JOHNSON: What you need to do is campaign finance reform. And you need, probably, public donation of [inaudible]
JAY: [inaudible] Supreme Court decision coming, you know, in a few weeks which is probably going to make it easier for corporations to spend money now.
JOHNSON: In other words, if you can buy and sell the making of the rules, you’re never going to get good rules. And you’ve got a bill that’s come out of Frank’s committee that looks quite pleasing to the industry, and that’s no surprise. A lot of people in the Democratic Party—as you know, many Republicans didn’t vote for this bill, and God knows what they would’ve produced if they had had their way, so I’m not exonerating them here at all. But the Democrats proposed a bill. They put it forward. They’re in power. They have to make changes. And so-called new Democrats, the most conservative wing, many of whom won their House seats in 2006, 2008, in traditional Republican districts, are a little bit scared right now, ’cause they’re going to have 10 percent unemployment next year when they’re up for reelection.
JAY: A 10 percent in terms of the kind of low end of the official number. But if you’re looking for work [inaudible]
JOHNSON: [inaudible] 17, 18, 20.
JAY: Seventeen, eighteen. And some of these states, it’s maybe into 30 or 40 percent.
JOHNSON: [inaudible] percent now. It’s a dire circumstance.
JAY: And we were talking off camera, but when the stimulus money that’s been helping the states and cities wears out or is out of money, there’s a massive ‘nother shoe to drop in terms of unemployment.
JOHNSON: So you have a situation that’s very delicate for these public policy officials, these congressmen and senators, and the only thing they can think to do is build a war chest for marketing, ’cause they know they’re going to face a heck of a battle. Where they get that money from? As Dick Durbin said, the banks own the place. So that’s what you might call refracting the rules relative to what would be good public policy. That’s the root of what needs to change in health care, in energy, defense procurement, pharmaceutical legislation and regulation, and financial regulation. It’s across the whole spectrum.
JAY: In a broad way—I mean, I agree with you, but in these peculiar moments like when Detroit is bankrupt and on its knees or when Wall Street was bankrupt and on their knees, there’s these little windows where you could do something more radical, and he had a window like that.
JOHNSON: The progressives were not prepared with policy at the time that that window opened.
JAY: You need an Institute for New Economic Thinking.
JOHNSON: Naomi Klein quotes Milton Friedman, saying you’ve got to have ideas on the rack so that when the crisis comes, those ideas can be implemented or accepted.
JAY: Let’s talk about, then, if one could get a rational bill through Congress, what would it look like. What should be in a bill that isn’t in the current bills?
JOHNSON: First of all, there’s nothing said about rating agencies. Rating agencies which blessed everything as AAA, some 30,000 securities, they need to have their incentives changed.
JAY: So let’s—just to make that concrete, one of the examples, we did report on, together with McClatchy newspaper chain, you had a mortgage company in California that in the 1990s was 100 percent of people applying for mortgages had their mortgages reviewed to see whether they could pay them off or not. And by I believe it was by 2003, 2004, only 10 percent of the mortgages were even being looked at. They were just being put through. And then that gets bundled, Goldman Sachs buys the bundle, and the rating agencies give them AAA.
JOHNSON: And they get paid by Goldman Sachs, who then distributes them with a fat profit margin.
JAY: So what kind of reform do you want to see in terms of the rating agencies?
JOHNSON: The sell side has to stop being their customer. You know, the buy side has to be their customer, or they should become public utilities.
JAY: Expand that idea about a rating agency as a public utility.
JOHNSON: The idea is that quality of information is a public good, and you would have government agencies rate these securities.
JAY: So something like what the budget office is doing with all this legislation: they take it, they give it to them, and they rate it. You’d have a public utility that would rate it. Is anyone even talking about that on the Hill?
JOHNSON: No, and you have some very interesting things coming up. Berkshire Hathaway owns a very large municipal bond insurance company, and they are also one of the largest stockholder in Moody’s. I’m wondering when Moody’s is going to downgrade some of the municipalities that Berkshire Hathaway has insured and lead to what you might call a deterioration in their balance sheet, however small. I mean, Buffett manages his money very well, but it’s an interesting set of possibilities. I don’t see anything happening on the rating agency reform right now. I don’t see derivatives instruments, which we talked about in an earlier segment—.
JAY: You said, and you testified in front of a Congressional committee, and you said the regulation of the derivatives trading is at the core of the whole issue.
JOHNSON: Yeah. I call it the San Andreas Fault of the current financial system.
JAY: So explain that.
JOHNSON: Complex and opaque derivatives, as we talked about in the earlier segment, are what create fear and fear of default risk and lead to the seizing up of the credit system. Complex, opaque derivatives are what scare a Treasury secretary or a Fed chairman and make it so that he is reluctant to resolve a too-big-to-fail institution. So you make these things simple and clear rather than complex and opaque.
JAY: So give a specific example of what that would look like.
JOHNSON: What you would do is you would take these derivatives instruments, and instead of having them marked to model, which means a fictitious pricing from a computer model derived by a so-called rocket scientist, you would actually make them trade [inaudible]
JAY: [inaudible] often 23-year-old kid making it up.
JOHNSON: Yeah. But what you would want to do is have these instruments trade on an exchange, so at two o’clock in the afternoon you know what the price is.
JAY: Break it down again for someone who doesn’t follow this. What’s the instrument? And how would this mechanism—?
JOHNSON: You have a derivative, which is essentially designed to give somebody insurance [inaudible]
JAY: [inaudible] insurance policy, so if someone makes an investment, they want to insure the downside.
JOHNSON: Right. And the value of that, if it’s done marked-to-model, meaning by the fictitious rocket scientist’s method, has never really traded on an exchange, so you don’t know what you can get for it. When you put that through the model, you can kind of set the dials where you want them to be; then nobody knows what the value of your asset really is, and they don’t know what kind of capital you should be setting aside as a buffer. When you make it actually trade on the exchange, what that does is it makes people realize what it’s worth today. Over six months, something might go from 100 down to 20; but when you’re doing mark-to-model, you just keep it at 100 until it falls off a cliff.
JAY: So in one of the examples of that is Goldman Sachs insured—like, they bundled all these lousy mortgages from Florida and California. They insured them with AIG. But AIG had no idea how much capital they actually had to put aside in case something went south. So when it did go south, everything went south.
JOHNSON: No, they didn’t put anything aside. They booked it as income. They took the premiums in from the credit default swaps that they sold and booked it as [snip] It’s like an insurance company that takes in your premium but doesn’t keep any money around to pay you in the event of an accident. It was fraudulent insurance.
JAY: So what you’re talking about would change that?
JOHNSON: What I’m talking about would make it easier to understand what was happening in that insurance market, what kind of accidents were unfolding on a continuous, day-to-day basis. It would also make it easier for regulators to understand when a major institution was crossing through the goal line of insolvency and needed to be restructured.
JAY: Because if it turns out whenever there’s a crash and public money’s going to get thrown at it, then why not just start with public money and let the public money insure it and have real regulation on what people are doing with their investments? One or the other, either don’t ask for the public money, or why not make it a public utility with real regulations and oversight?
JOHNSON: Well, if you make it a real public utility, in other words, if you nationalize the banking system, you do run into a problem, which, as you and I talked earlier in this segment, about the complications of when government controls things and fundraising for political purposes takes us off—what you might say is it takes us in the direction of representing special interests, not the general interest. And that’s a danger whenever the government controls the credit allocation process. Benito Mussolini did a very good job of distorting the Italian economy when he was a fascist dictator and nationalized many of the banks. I tend to think—I go again to Tom Ferguson’s writings—that social democracies that have broad political participation and represent broad segments of the population do a much better job of resolving banks than kind of oligarchic democracies that are ruled by dollars rather than voters.
JAY: So in the next segment of our interview, let’s drill a little bit more into what would a regulatory environment look like that would make derivative trading not so crazy and not so susceptible to ruining the whole economy. 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.