If the people of the Cayman Islands believe the worst is over when it comes to economic woes they need to think again and prepare for worse to come. This is unless a whole new mindset in the US is embraced, according to Simon Johnson, former chief economist with the International Monetary Fund turned super blogger, keynote speaker at last month’s Cayman Business Outlook, writes Business Editor Lindsey Turnbull.
“The US economy is heading for very serious trouble,” warned Simon Johnson, senior fellow at MIT’s Sloane School of Management and co-author of the blog BaselineScenario.com, speaking to a packed audience representing a cross section of Cayman’s business fraternity at the Cayman Business Outlook held at The Ritz-Carlton in January.
Johnson spoke of an “oligarchy” taking over the US financial system.
“I’m not some crazy left-winger; I’m the former chief economist with the IMF,” he said. “I’m the technocrat’s technocrat and I believe that big banks in the US have become too big and too powerful.”
Johnson said such banks needed to be reigned in because the destructive boom and bust cycle that they promulgate was forcing the US to take on key characteristics of an emerging market, quite unlike the developed country it purported to be, which should have meant a much more stable and less volatile financial system.
Although Johnson was delighted with the news announced co-incidentally on the day of the conference by the White House that US President Obama would indeed be looking to restrict the size of banks, he feared that any move by the US to reign in these huge institutions would take a long time to implement.
“This has been the biggest intellectual fight in my career,” he acknowledged. “If we don’t fix the incentive problem, i.e. that certain banks feel they are “too big to fail” we will have another financial crisis on our hands. The 2008 to 2009 financial crisis was not the crisis to end all crises and there is nothing to say that The Great Depression is the only Great Depression.”
Johnson believed that the rot set in around 30 years ago with the Reagan Administration’s push toward deregulation.
“I actually think much of the deregulation was sensible such as the deregulation of the airlines in a move to free the market. But financial deregulation is different,” he said.
Johnson said that Reagan began the push while Clinton led the charge in the 1990s. More recently, Larry Summers, director of the White House’s National Economic Council for Obama had pushed hard for deregulation and in particular the deregulation of the derivatives market.
This pro-risk-taking approach had been disastrous for the economy, according to Johnson, as he detailed the top six banks in the US with assets totally around 20 per cent of GDP in the 1990s versus 60 per cent plus of GDP now.
“Before the crisis this figure was 58 per cent,” he said. “And so their size has actually increased as a result of the US bailout by the government, given to the banks on incredibly easy terms, giving them the ability to buy up failing banks and thus expand further.”
Big banks, he said, expect an unconditional bailout with money provided without any strings attached. “CEOs were not sacked; banks think they’re invincible,” he stated.
Putting the spotlight on Citibank, a US bank that had failed multiple times in recent years, Johnson said that at its peak the bank employed 347,000 staff worldwide. “That’s two Icelands [a country that failed disastrously as a result of the recent economic crisis]. How can you run a company of this size without meaningful risk control?” he pondered.
Johnson equated Citibank to a giant nuclear power station located in Cayman “that refuses to be shut down. It’s dangerous and irresponsible, but, hey, it produces cheap electricity!”
The baseline scenario
Johnson’s baseline scenario was of the firm belief that if this pattern of extreme highs and lows was allowed to continue in the US, the US could conceivably turn into another Mexico, with all its inherent financial issues.
“Net job losses since December 2007 have been eight million,” he said. “Why? Because the financial sector has got too big and too dangerous and hasn’t been reigned in.”
Johnson believed that if his former employer, the IMF, could speak it would state that if this problem was not fixed it would create a huge economic problem. As a result, Johnson could see the day when the US dollar would not be treated as the predominant reserve currency.
“My proposition is that there is no evidence to suggest a bank is any more successful if it gets above US$100 billion in assets. In that way it cannot destroy the financial system if it fails,” he said.
Johnson furthered that he thought no bank should have more than 10 per cent of US retail deposits and no bank should have assets more than three per cent of the total US GDP.
“In the 1990s Goldman Sachs was one of the best investment banks in the world and was about one fifth of the size it is now,” he ventured.
Breaking up the bank into four, five or even more separate pieces would be a sensible move, but this would take between three to five years.
“The problem will not be fixed soon because those who run Goldman Sachs don’t want to fix the problem,” he said.
Changing a mindset
Johnson was of the opinion that business as usual was not a viable option moving forward to solve the economic issues of our time. Referring to the deeply rooted belief that has been entrenched into US political and economic life of the ‘too big to fail’ mentality, Johnson said that there would be no massive shift in public opinion any time soon. “I think that we will win the debate but it will take 10 years,” he admitted.
Moves in Cayman
Speaking to the Cayman Business Outlook audience, Johnson said he believed he was addressing a very important set of constituents: “You should be really scared,” he said. “I don’t think you should evacuate in light of the oncoming storm either physically or financially but you are exactly the right people to argue this situation out and take action.”
He warned that if reasonable reform did not take place within the US, jurisdictions such as the Cayman Islands will continue to be the scapegoat, which would be, in his words “horribly inappropriate.”