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Hernando Today

Financial institutions: Our downfall

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By JOHN REINIERS, More Than Words

Hernando Today

Published: June 10, 2009

Updated: 06/10/2009 11:00 am

The International Monetary Fund (IMF) is a United Nations agency, as is the World Bank, and is most often thought of as the lender of last resort to counties which have gone belly-up.

Unfortunately, it has lots of experience. Simon Johnson, a native of England, was the chief economist at the IMF during 2007 and 2008. He is a professor at MIT's Sloan School of Management. He is an expert on the financial sector and economic crisis with 20 years experience. So he is well qualified to judge this economic meltdown.

My view, and I have stated this before, is our economy became captive — and may still be — to the banking and finance sector; that these guys almost destroyed capitalism singlehandedly. As it turns out his view is similar, the difference being I was guessing based on experience, but he's been out there and seen this on a global basis.

What is shocking is his view that "the finance industry has effectively captured our government — a state of affairs that more typically describes emerging markets ... If the IMF's staff could speak freely about the U.S., it would tell us ... recovery will fail unless we break the financial oligarchy that is blocking essential reform ... We're running out of time."

His immediate solution is to break up the big banks and sell them "in medium size pieces, divided regionally or by type of business." This would be accomplished by the FDIC using a government managed bankruptcy. Why? Because "anything that is too big to fail is too big to exist." A corollary to that is bigness means better paid lobbyists to influence public policy.

The real problem is cultural. We have created a self-inflicted belief system that economic success depends upon huge financial systems. To that end we have had a migration of Wall Street wizards to Washington where they took over the Treasury Department. Johnson really doesn't offer a solution for this phenomenon. It is up to the voters to change direction. He does say that "a whole generation of policymakers has been mesmerized by Wall Street, always and utterly convinced that whatever banks said was true." He easily criticizes the powerful oligarchs in emerging market governments; that they need to be neutered before these countries can ever hope to recover — but he doesn't focus on the corruption in our political system caused by political contributions.

Johnson points out the financial world came into its own about 25 years ago, and with favorable government policies they "ran with these opportunities." From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986 that figure reached 19 percent." In the 1990s, it oscillated between 21 percent and 30 percent ...This decade it reached 41 percent."

Astonishing! Concomitantly, executive compensation followed the same path from being slightly above average for all domestic companies from 1973 to 1985 and then "from 1985, it shot upward to 181 percent in 2007."

Look back several decades. First it was the savings and loan crisis of the '80s. Then there was the housing bubble exacerbated by government programs that were the progenitor of "liar's loans," which then inspired the creative derivative financial instruments of the financial wizards.

Why is the focus always on Wall Street and financial institutions? Why not manufacturing? Or more precisely, tangible things such as high tech and the whole panoply of computer science with its infinite applications. Talk about real jobs. Why are our lives ruled by big government and big finance? The Dow Jones index provides an interesting profile of how our priorities have changed. The initial stock average by Charles Dow was composed of all railroads and two industrial stocks!

As to making things, Hernando Today previously published a piece I wrote applauding the German manufacturing system, which has few large cap production companies. The U.S. also has a lot of creative people in small cap start-up manufacturing using system dynamics. We also know how to do things big.

John Reiniers, a regular columnist for Hernando Today, lives in Spring Hill.

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