Break Up the Banks

By Simon Johnson

Santa Claus came early this year for four former executives of Washington Mutual, which failed in 2008. The executives reached a settlement with the FDIC, which sued them for taking huge financial risks while “knowing that the real estate market was in a ‘bubble.’ ” The FDIC had sought to recover $900 million, but the executives have just settled for $64 million, almost all of which will be paid by their insurers; their out-of-pockets costs are estimated at just $400,000.

To be sure, the executives lost their jobs and now must drop claims for additional compensation. But, according to the FDIC, the four still earned more than $95 million from January 2005 through September 2008. This is what happens when financial executives are compensated for “return on equity” unadjusted for risk. The executives get the upside when things go well; when the downside risks materialize, they lose nothing (or close to it).

At the same time, their actions and similar actions by other bankers are directly responsible for both the run-up in housing prices and the damaging collapse that followed. That collapse has impacted nonbankers negatively in many ways, including the loss of more than 8 million jobs.

It is also leading to austerity: Taxes are increasing and government spending is falling at the local and state level around the country. A difficult fiscal conversation still lies ahead at the federal level, but cuts and contractions of various types seem likely.

Some people argue that Americans need to tighten their belts. That’s an interesting discussion, particularly at a time with unemployment is still above 8 percent (with recent declines largely the result of many jobless workers’ decision to stop looking). Precipitate austerity is hardly likely to help the economy find its way back to higher employment levels.

But what about government support for the big banks? Is this contracting in the light of our current fiscal pressures? Unfortunately, it is not. Much government support remains, implicitly through allowing banks to be “too big to fail” and explicitly through various kinds of backing provided by the Federal Reserve.

The rationale behind supporting big banks is that they are needed for the economy to recover. But this position looks increasingly doubtful when the banks are sitting on piles of cash while creditworthy consumers and businesses are reluctant to borrow.

The same situation exists in Europe today, where the reality is even starker. Banks are receiving ever-larger bailouts, while countries that borrowed are cutting social programs and face rising social tensions and political instability as a result. Countries like Greece, Italy, and arguably Portugal overborrowed and now their citizens face severe consequences. But the bankers face no consequences whatsoever for overlending.

To be sure, some major European financial institutions may now face difficulties, and  perhaps some of their executives will end up being fired. But does anyone think that the people who ran European banks into the ground will leave their positions with anything less than considerable wealth? There is no real austerity—now or possibly in the future—for leading bank executives.

The protesters of “Occupy Albany” issued a powerful consensus statement recently, which reads in part:

The interests of those who purchase influence are rewarded at the expense of the People, from whom the government’s just power is derived. We believe that this failure in our system is at the core of many interconnected issues we face as a society, and its resolution is key to a just future. We therefore demand true democracy, decoupled from the corrosive influence of concentrated economic power, and we call all who share in this common goal to stand with us and take action toward this end.

Big banks represent the ultimate in concentrated economic power in today’s economies. They are able to resist all meaningful reform that could really change their compensation schemes. Their executives want to get all the upside while facing none of the true downside.

But capitalism without the prospect of failure is not any kind of market economy. We are running a large-scale, nontransparent, and dangerous government subsidy scheme for the benefit primarily of a very few extremely wealthy people.

Jon Huntsman, a candidate for the Republican presidential nomination, is addressing this directly—insisting that we should force the largest banks to break up and to become safer. No other candidate is seriously confronting this issue head-on: Just saying “we’ll let them fail” is no kind of answer when the failure of megabanks would cause so much damage.

We should learn from both Washington Mutual and the Occupy movement. In both cases, the lesson is the same: Concentrated financial power is a gift that keeps on giving—but not to you.