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Big Banks Pose “Clear and Present Danger” to U.S. Taxpayers: Simon Johnson

Aaron Task
Editor in Chief
Daily Ticker

The debate over "too big to fail" banks has been back in the spotlight of late.

First, the Dallas Fed tackled the issue head on in its annual report, with President Richard Fisher declaring "the [too big to fail] institutions that amplified and prolonged the recent financial crisis remain a hindrance to full economic recovery and to the very ideal of American capitalism." (See: 'Too Big to Fail': Breaking Up Big Banks Is NOT the Answer, Former Regulator Says)

Second, Chinese Premier Wen Jiabao boldly called for breaking up China's biggest banks. "Let me be frank," he said. "Our banks earn profit too easily. Why? Because a small number of large banks have a monopoly." (See: Chinese Premier Says What Everyone Is Thinking: 'Break Up the Big Banks!')

Wen's comments got people thinking about America's biggest banks, which have come a long way from the depths of the financial crisis but still "pose a very clear and present danger to the U.S. taxpayer," according to Simon Johnson, professor of Entrepreneurship at M.I.T and senior fellow at the Peterson Institute.

In his latest book, White House Burning, co-authored with James Kwak, Johnson details "the damage done to the [fiscal] balance sheet" by the financial crisis of 2008 and its aftermath.

The U.S. incurred an additional $7 to $8 trillion in national debt -- or about 50% of GDP -- because of the financial crisis, Johnson says, citing Congressional Budget Office analysis of the costs of the bailouts -- both direct and indirect -- and the loss of tax revenue during the steep recession that followed the crisis.

While they garner a lot of attention "the TARP and Fed loans are not the big issue," he says. "What happens to tax revenue as you plunge into deep recession; that's what really did damage to us. That's the danger."

According to Johnson, the former chief economist at the IMF, bank executives are still incentivized to take outsized risks because they are paid for return on equity unadjusted for risk.

That's why, he says, banks are fighting so hard against the Volcker Rule and other new regulations aimed at curtailing their risk-taking.

"They want to be able to take a lot of risk again as the economy turns," Johnson explains. "They want to take risk, take it across borders and become big, global interconnected businesses with a lot of complex over-the-counter derivatives."

In other words, very similar to what was in place prior to the 2008 crisis and "exactly the kind of structure we can't handle" with existing bankruptcy laws.

As for the new Resolution Authority granted to the Fed to dismantle failing financial firms by the Dodd-Frank legislation, Johnson notes it is both "completely unproven" and not yet firmly in place.

"I think we're asking for trouble and the trouble next time is unlikely to be smaller than it was in 2008," he says.

Aaron Task is the host of The Daily Ticker. You can follow him on Twitter at @aarontask or email him at altask@yahoo.com