Do big banks control our government? Thoughts on Johnson and Kwak

by on April 20, 2010 at 5:23 am in Books, Economics, Political Science | Permalink

The Huffington Post asked me to write a quasi-review of the new Simon Johnson and James Kwak book, 13 Bankers.  I also am allowed to cross-post it with a lag, so here it is (the original source is here, with HP comments, since it is me thre is no point in indenting the whole thing):

How much political power do the big banks have? I'd like to air a skeptical note and ask whether they're really running the show.

To most people these days – whether on the left or the right – such a question smacks of insanity or deliberate stupidity. It barely seems worth addressing.

Have we not observed hundreds of billions in bailouts, up to three decades of lax regulation, massive and unjust CEO bonuses, and now the near-immediate return of record bank profitability? Are not many of the Republicans serving up knee-jerk opposition to virtually any kind of meaningful financial reform, perhaps because they receive campaign contributions from banks? On the surface, banks seem to be a nearly invulnerable interest group in American politics.

Yet this last week's SEC civil lawsuit against Goldman Sachs, which caused a thirteen percent decline in the company's stock in one day, should serve a cautionary note. Of all the big banks, Goldman is supposed to be the strongest and most politically connected. It remains to be seen how the charges will proceed, but at the very least it is odd that the Masters of the Universe would have let it come to this at all.

The context for this question is the "public choice" analysis in Simon Johnson's and James Kwak's enlightening new bestseller 13 Bankers. Johnson and Kwak make a major step forward in describing our recent financial crisis as a fundamental problem in political economy, namely by pointing their fingers at an unholy alliance between banks and the U.S. government. Much as I admire their analysis and exposition, I see the problem a bit differently than they do. Whereas they see banks as the puppet master and our government as the fool, I wonder whether it is not more accurate to think of the government as running the show.

Perhaps the strongest piece of evidence for the financial sector dominance of U.S. political economy is the recent bailouts. Yet it's instructive to ask which other groups have received bailouts in the last fifteen years. The list would include Mexico and the numerous countries which have borrowed from the largely U.S.-created International Monetary Fund, such as Indonesia. They are hardly dominant forces of influence in Washington. It was China who made out like a bandit from the bailout of the mortgage agencies, and the validation of their debt issues, but again the Chinese are not in charge.

There's a different way to think about the bailouts, namely that the U.S. government stands at the center of a giant nexus of money raising, most of all to finance the U.S. government budget deficit and keep the whole show up and running. The perception at least is that our country requires the dollar as a reserve currency, requires New York City as a major banking center with major banks, and requires fully credible governmental guarantees behind every Treasury auction and requires liquid financial markets more generally. Furthermore the international trade presence of the United States (supposedly) requires the federal government to strongly ally with major commercial interests, just as our government sides with Hollywood in trade and intellectual property disputes. To abandon banks is to send a broader message that we are in commercial and political decline and disarray, and that is hardly an acceptable way to proceed, at least not according to the standards of the real Washington consensus.

In other words, it's our government deciding to assemble a cooperative ruling coalition – which includes banks — at the heart of its fiscal core. It's our government deciding who belongs to this coalition and who does not, mostly for reasons of political expediency and also a perception – correct or not — of what is best for the welfare of American voters. If we don't in this year "get tough" with banking regulation, it's because our government itself doesn't want to, not because of some stubborn recalcitrant Republicans.

Ask yourself the simple question: who has both the guns and the money, including the ability to print new money at zero cost? It's Washington, not the private banks.

If we look back at the broader stretch of American history, banks are by no means a dominant interest group. They arouse massive suspicion in the Jacksonian era, they are left to rot in the 1930s, they are forbid branching rights for many decades, and they end up as a decentralized sector for most of the postwar era. It's not clear why the fundamental equation of power should suddenly have changed so dramatically in recent times and perhaps it hasn't.

This analysis bears on one of the main policy recommendations of Johnson and Kwak, namely to break up the big banks so they cannot soil Washington with such powerful lobbying and privileges. I believe this recommendation will not achieve its stated ends and that Washington would find another way to assemble privileged financial institutions – no matter what their exact form — within its ruling coalition. Breaking up the large banks would be striking at symptoms rather than at root causes, namely the ongoing growth of political power and the reliance of that power upon an ongoing inflow of capital.

If you do wish to break or limit the power of the major banks, running a balanced budget is probably the most important step we could take. It would mean that our government no longer needs to worry so much about financing its activities. Of course such an outcome is distant these days, mostly because American voters love both high government spending and relatively low taxes.

I commend Johnson and Kwak for their excellent work, but I also conclude that the problems of banking reform are harder than we usually like to think.

Andrew April 20, 2010 at 7:41 am

Not to mention that banks can’t seize the government based on banking rules about government balance sheets.

Maybe I’ll dust off my conspiracy theory that maybe some folks helped precipitate the bank failures, not due to petty loyalties of Paulsen or whatever, but because the government needed cheap money and inflation.

Cue the investigations. People don’t seem to understand relationships. I figure the government likes the banking relationship, but just needed the upper hand for a while.

Bill April 20, 2010 at 8:08 am

I think you have to separate political power from economic power, and also differentiate by time.

During a banking crisis, even of their own making, banks have more economic power because their failure can cause catastrophic damage to the rest of the economy. They do not have political power at that time, witness legislative willingness to fiddle with compensation and send in Ken Feinberg, pay czar.

During the good times, that’s when they have the political power–power of political contributions — politicians can be seen being associated with the the wealthy class, everyone likes, and listens to, successful businesses, and even the stock market will rise, or interest rates will rise, based on the wink or raised eyebrow of a commentating international banker on MSNBC or guest editorial in the WSJ.

But, the economic power is not our own–these banks lend to foreign businesses, put US taxpayers at risk for foreign enterprise, raise money from foreign sovereign wealth funds, and so on.

So, whose power is it anyway? What does power mean if you are hostage to someone’s failure.

I say: stop the practice of having large banks purchase failing institutions with government subsidies…if you are going to subsidize anyway, subsidize the small to grow bigger. That’s one policy.

Second, recognize that when investment banks were owned by their partners, they engaged in syndications (joint ventures) to underwrite. Require that banks carry less risk if projects are over a certain size, and require syndication in that context so risk is distributed ala a market mechanism that disburses, rather than concentrates, risk.

Third, limit US government risk protection mechanisms to transactions that are in the US and not to foreign lenders and require that the foreign transactions be segregated if not limited, while permitting foreign transactions to be syndicated or joint ventured with foreign banks which have their governments protecting part of the transaction.

E. Barandiaran April 20, 2010 at 8:38 am

Tyler, to answer your question, you need a much broader historical perspective that you provide in your review. I’m not planning to read SJ’s book because I read his earlier posts in his blog and I figured out his many biases and his deliberate attempt to ignore history (remember that SJ is well-known because of his research on economic history).
An alternative approach to answer your question is to ask about the political power of the military. In constitutional democracies, the military is a usuful tool to government –not totally controlled by government and often in tense relation with government, but its design and performance largely conditioned by government decisions. And so does the banking system, regardless of how big some banks are. In sum, an analysis of the recent banking crisis in which elected and appointed politicians are not main characters makes nonsense.

Bill April 20, 2010 at 8:41 am

DanC, it wasn’t politicians who were saying that US regulation would hamper the growth of international banks, it was BANKERS who were saying this, including Hank Paulsen. Remember when everyone was goin’ to London?

capitalistimperialistpig April 20, 2010 at 8:52 am

It’s amazing how easy it is to construct an argument once you slip that first whopper in – in this case your claim that the bailouts are the primary evidence of the political power of the big banks. Nothing could be further from the truth – those bailouts are instead evidence that the leaders of the country wanted the economy to survive. The evidence for control consists of (1)the heavy overlap between top bankers and regulators and (2) the consistent manipulation of the regulatory regime to the advantage of those who controlled the big banks.

You further your argument by invoking more strawmen as well, assuming that bank power is either total or non-existent. It’s hard for me to believe one could become a professor of economics with so little grasp of how power works in democracy or oligarchy. Of course bank power is occasionally resisted, and of course the power of its coalition waxes and wanes. You cite a few examples in American history where outcry against bank power and folly led to resistance but there are lots of others where the power of the banks won.

me April 20, 2010 at 9:25 am

To me Goldman Sachs story is just a competition kill.
If a crooked cop sizes a drug dealer, he just clears turf for those who pays him his real wages.

Thomas DeMeo April 20, 2010 at 9:49 am

The banks and the government have a dynamic relationship. The influence of one vs the other is never independent. The governments power is far greater but almost always far less focused and strategic. This means that banks can usually focus on a narrow issue and modify the government’s position, but it cannot stop the government from responding to a widespread populist anger.

The banks don’t need or want to control the government, they just want the ability to push for certain strategic advantages in a cost effective manner

E. Barandiaran April 20, 2010 at 10:00 am

Tyler, this piece of news says much more than the many posts that SJ has written on big banks; from The Examiner:

Candidate Obama made many impossible campaign promises, including his pledge to “close the revolving door between K-Street lobbying shops and the White House.†
Today, we learn from Politico that Obama’s first right-hand man in the White House, former White House Counsel Greg Craig, is now working for Goldman Sachs, the world’s largest investment bank and the target of an SEC complaint.
Between executive orders and federal law, Craig is restricted in the lobbying he is allowed to do, but he can certainly provide air support to Goldman’s lobbying team.
The irony is that Craig left the White House because Obama was too centrist, according to the official Washington tale. Craig has long been a crusading Lefty lawyer — he was an early leader of the Vietnam War protests, he represented Elian Gonzales’s Cuban father, he defended Bill Clinton in the impeachment.
But Craig is a boarding-school, Ivy League, elite, and after time in the halls of power, he’s now at the world’s largest investment bank.

Read more at the Washington Examiner:

Ward April 20, 2010 at 10:48 am

I’m not sure that I understand the either/or logic here. Megabanks have enormous lobbying power and make the rules for their benefit. This is not just a symptom, but a cause. Breaking them up does not rule out making the budget more balanced. So why not do both?

Note that this is not the only reform that is needed in banking. So I agree that it would not be sufficient.

Michael F. Martin April 20, 2010 at 10:58 am

Tyler’s view sounds right to me. Things are not much different now then they were in the early 1790s, right after the Bank of the United States was first established.

“In other words, it’s our government deciding to assemble a cooperative ruling coalition – which includes banks — at the heart of its fiscal core. ”

…and our government is still democratically elected, and we have seen regime change twice in the past two decades.

Still, there can be no doubt that Goldman would not have been indicted had Paulson (Hank!) still be in charge.

Bill April 20, 2010 at 11:55 am

DanC, I think you are attributing to Stevensen what Sen Al DaMato said and did when he was Chairman of the Senate Banking and Senate Finance Committee.

New York finance has been well represented on the deregulatory front.

Bock April 20, 2010 at 12:56 pm

the SEC suit is a case of throwing Brer Rabbit into the briar patch.

the SEC, with their incredibly weak case, knows this.

Matt Matson April 20, 2010 at 1:18 pm

The review’s arguments assume that there is a single, unified “U.S. government.” The government is made up of many actors with influenced by different incentives and having control over different decisions. There is nothing inconsistent with a view that bankers can limit the adoption of legislation and regulations that would limit the risk of another crisis (and profits), while at the same time persons within the SEC are using present laws to prosecute Goldman Sachs.

d4winds April 20, 2010 at 1:55 pm

re: “Whereas they see banks as the puppet master and our government as the fool, I wonder whether it is not more accurate to think of the government as running the show.”

The “government” running the show has been subject to regulatory and lobbyist capture for many years.

re: “who has … the ability to print new money at zero cost?”

The banks. It’s called a fractional reserve banking system. The monetary base is the only money-related item under Washington control; and, it is, alas, endogenous during a boom and irrelevant, when not gratuitously contracted, during the bust.

re: “To abandon banks is to send a broader message that we are in commercial and political decline and disarray.”

Why do repeated FDIC closures of small commercial banks send no such message but ordinary bankruptcies for investment banks bigger than IndyMac do?

re: “Perhaps the strongest piece of evidence for the financial sector dominance of U.S. political economy is the recent bailouts.” and re: “If you do wish to break or limit the power of the major banks, running a balanced budget is probably the most important step we could take.”

Are we to conclude from this syllogism that had the fiasco of W’s fiscal responsibility not occurred, then the big investment banks ability to rally political support for immunity from their irresponsibilities would have been limited? Come on. Just because there are two things you would like to limit–fiscal deficits and bank political power, those two things need not have–and, in this case, do not have–any causal relationship whatsoever.

Austism April 20, 2010 at 2:17 pm

The incentives in the relationship between the government and the banks determines who is running things. The to big to fail banks needed a massive bailout and what was the consequence of this? They gained more power. The SEC civil lawsuit against Goldman Sachs is pure politics. You think that Obama is going to risk hurting the economy? I bet Obama messed himself when he saw Goldman Sachs’s stock drop by 13%. Banks have power because if the U.S. government went after them the collateral damage would be too great. It would damage the U.S. economy and it would also damage the influence it has in the global economy. So who is in control? I see it as the U.S. government being the man and the big banks being the woman. “The man is the head, but the woman is the neck. And she can turn the head any way she wants.”

Bill April 20, 2010 at 2:30 pm

E.Barandiaran, I see I did not answer your question: Why would someone argue for complementing the common law system with regulation and supervision to deal with fraud in finance?

The reason is that fraud can be an act of commission and more difficult to prove as an act of ommission. But, if, by law, you require disclosure, then the act of ommission (as well as commission if you are lying) is actionable. Sometimes we prefer as a society rule in writing rather than rules created by judges for the reason of certain enforceability and for reasons of catching a crook with another hook.

Dan in Euroland April 20, 2010 at 3:27 pm

Broadly, public opinion with a hint of ideology runs the show. So why was there a bank bailout? Because the unwashed masses would have been more pissed at the fall out from not performing a bailout than from performing a bailout. Remember the politicians have to hedge their bets over potential future states of the world.

Reg capture only works in certain areas with high levels of opacity that do not allow the public to actually understand what is going on.

TizzyD April 20, 2010 at 3:59 pm


Assuming you are spot on, how do you see the SEC-Goldy face-off plaing out?

DanC April 20, 2010 at 5:29 pm


Memory can play tricks on you and I was pretty young when Senator Stevenson came to my school.

Still, he did sponsor the International Banking Act of 1978. To a large degree it sought to regulate international banks operating in the United States.

“While the question of international reciprocity in the regulation of foreign banks is addressed in the new legislation, the major emphasis of the Act is on national treatment of foreign banks.”

So I remembered his little talk as being about the need for American Banks to compete with large International banks, it does appear that while he was concerned with that his legislative efforts were more about imposing greater Federal control on international banks.

What I recall from the talk was that American banks were increasingly at a disadvantage in competing with international banks. The picture he painted was that American banks were too small to compete with these behemoth invaders. And he talked about building up US banks not regulating international banks.

However he then went on to say that Japan and their version of crony capitalism was the future. (He didn’t use the term crony capitalism but it fits his description. His desire for joint government private enterprise projects was later reflected in Stevenson Wydler-Technology Innovation Act.

I guess some Democratic ideas are consistent. Regulate it till you have to subsidize it. (Thank you Detroit)

Bill April 20, 2010 at 10:19 pm

DanC, I read the article, the gist of which is that international banks should be treated as domestics when they operate in the US. The Fed Reserve article seemed supportive; I didn’t read it as deregulatory, though, and the regulation it did have was to have foreign firms be treated the same as domestic re interstate branching, etc.

The point I made was what happened in the 1980′s and even 1990′s re deregulation.

The post and comments followed the tact that some person–some corrupt individual–walked through a revolving door and made regulation cause the problem.

My argument is that instead of offering the great man of history hypothesis for this, we should step back and ask if all of us collectively mesmerized ourselves to believe that deregulation and less regulation would solve our problems.

In other words, in the words of POGO, the enemys is US.

No one in this post seems to be saying that deregulation and leaving the banks to act on their own may have gone too far–and its strange they don’t make this argument when they at the same time argue corrupt banks corrupted public officials.

Well, if the banks are corrupt, don’t you think that when they are deregulated they don’t act corrupted in a deregulated environment. Seems strange they are corrupting when they deal with regulators and honest when they operate in a deregulated market.

DanC April 21, 2010 at 1:05 am

Rahm Emanuel after he left Clinton before he worked for Obama

“In 2 1/2 years after joining an investment banking firm headed by Clinton fundraiser Bruce Wasserstein, Emanuel parlayed his role as managing director with the political connections he made in the administration to earn more than $16 million on fees the bank earned off of eight clients involving mergers and acquisitions, according to federal records.

Emanuel also had a profitable stint as a Clinton appointee to the board of mortgage lender Freddie Mac, collecting at least $320,000 in fees and proceeds from stock options. His tenure on the board coincided with a multibillion-dollar accounting scandal at the quasi-public firm, though a government investigation did not implicate him.”,0,5738333.story?page=1

These are the guys who are going to write meaningful regulations that serve the American public?

Barry April 21, 2010 at 10:43 am

Tyler: “If we don’t in this year “get tough” with banking regulation, it’s because our government itself doesn’t want to, not because of some stubborn recalcitrant Republicans.”

So, if I had child-orgy level photos of a half-dozen GOP senators, and told them to vote in favor of banking reform or go to prison for 20 years, there’d be no practical difference in US government policy towards banks?

I agree that Wall St has too much of a reach into both parties, but any statement that they don’t own the GOP close to 100% is just false.

DanC April 21, 2010 at 11:00 am


How can you get things so wrong so often?

I think giving great power to men can corrupt the system. Look at the arguments of our founding fathers.

Much of what you call deregulation was NOT done to increase competition, it was done to protect or enrich some interest group. Indeed much of what you call regulation was done to protect or enrich some interest group.

The goal should be finding ways to increase competition not for the government to find ways to punish enemies and reward friends by concentrating power in the hands of the government. Even if that is the way the Chicago political system works.

So what is this grand powerful idea of which you speak? That the political class should enrich interests groups and in turn they can become rich beyond their wildest dreams (How big did Rahm and Rubin dream)

This Great Man Theory, what the hell are you talking about? Really

Dan B April 23, 2010 at 1:08 am

Tyler has become such a disappointment. Very sad to see an intellectual hero who is so committed to his prior conception of the world that he’s unwilling to change his mind in the face of our current Crony Capitalism, in which the government and zombie banks feed off each other in a symbiotic death spiral. Wake up, Tyler, it’s not 2006!

You all should read The Baseline Scenario or Naked Capitalism if you want to read economists who actually take the current, truly frightening, circumstances in this country into account

Matthew January 25, 2011 at 12:30 pm

I don’t think that the banks do that but there are people who have a great control over banks and governments.It is known that there are different organizations which try to manipulate the whole population and transforming them in to slaves.banks Manchester

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