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Economist: America Is Just Like An Emerging Market, Wall Street Oligarchs And All

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America may be more like an emerging market than we realize.

That is the analysis by an increasingly vocal and influential professor at MIT, Simon Johnson. In an interview with the Huffington Post, Simon Johnson, the former chief economist at the International Monetary Fund, said that just like the emerging markets he has spent his life studying, the U.S. has created a system whereby Wall Street "oligarchs" have monopolized and cannibalized the economy. At the same time, Washington regulators have been rendered ineffective, seduced by their aura of wealth and power.

Johnson's solution is, in part, to use anti-trust laws to break up these too-big-to-fail institutions, and for regulators to intensify their oversight of the smaller banks that result.

"In the last decade, the attitude took hold in the U.S. that what was good for Big Finance on Wall Street was good for the United States," Johnson testified before the Joint Economic Committee earlier this week. According to this "belief system," Wall Street "benefited from the fact that Washington insiders already believed that large financial institutions and free-flowing capital markets were critical to America's position in the world."

Demonizing Wall Street is the nation's latest obsession, and Johnson's stance seems to fit right in with the zeitgeist. But the idea of deconstructing the system that has created these Wall Street oligarchs, such as we haven't seen since the days of J.P. Morgan (the man), is not a perspective from the far-left fringe. On the contrary, it is gaining support both among well-respected economists and Washington insiders.

Columbia professor and Nobel Laureate, Joseph Stiglitz, agrees with Johnson's views: As the former chief economist of the World Bank, "if I had come and visited the United States, we would have cut off all aid to the United States. It wouldn't have passed muster," he testified at the Joint Economic Committee hearing.

He added, "we've seen in the midst of crises in so many developing countries massive redistributions from the ordinary taxpayers to the financial sector. What we are seeing in the United States is a pattern that happens over and over again."

Even the president of the Federal Reserve of Kansas City, Thomas Hoenig, concurred that the banking system must be fundamentally re-thought.

"No one did a particularly stellar job in supervising these institutions," Hoenig testified at the same hearing, referring to Wall Street. "We had an environment where deregulation was the watchword and you went forward with that. You had these very large institutions. And we, in a sense, allowed ourselves to think that sophisticated methods of financial transactions was a substitute for fundamental principles."

Johnson argues his views straddle the line between right and left: While it's understandable that liberals would embrace dismantling Wall Street power brokers, some on the right are also supporters. That's because they oppose corporate welfare, which has resulted from the bank bailout. "They don't like corporate welfare because it leads to higher taxes," Johnson told the Huffington Post. "So I am getting feedback from those perceived as more conservative that they agree with me."

Johnson, who earned his PhD in economics from MIT and his BA from the University of Oxford, spent about 18 months as the chief economist at the IMF before becoming a professor of entrepreneurship at MIT.

"I have spent all my time studying these other economies and it's clear that the U.S. is following a similar path," Johnson says.

The path to economic ruin begins with fear. In the case of an emerging markets crisis, it is the fear that a country cannot pay back its debt. Investors balk at lending to the country, and it becomes a self-fulfilling prophecy, as the country can no longer borrow money to pay its debt.

It is the same scenario that played out with Lehman Brothers last September, Johnson argues. Investors grew fearful and pulled out of the bank, which then became unable to cover its debt. When it failed, investors grew fearful that the whole banking industry was insolvent and pulled back. Nearly overnight credit dried up and the Federal Reserve was forced to step in and provide funding.

It was this succession of events that gave Johnson his "Aha! moment, when I realized I had seen this all happen before," he says.

While the U.S. economy has always suffered booms and busts, this time was different because of the sheer size of the financial services industry. In 1986, for example, Wall Street's profits made up just 19% of total domestic corporate profits. During this decade, that number reached as high as 41%.

Wall Street had grown so large because of deregulation during the Reagan era, the decision to not regulate derivatives during the Clinton administration and Greenspan's low interest rates, according to Johnson.

At the same time, the size and wealth of Wall Street translated into political heft. Financiers and Washington players became more interchangeable, furthering the creation of an oligarchy. Two prominent examples include Robert Rubin, co-chair of Goldman Sachs and former Treasury Secretary under Clinton, who later joined the executive committee of Citigroup and Henry Paulson, who ran Goldman Sachs during the boom years, and later became Treasury Secretary under President George W. Bush.

"The emergence of a financial oligarchy during a long boom is typical of emerging markets," Johnson notes.

The solution to solving the current financial crisis is for the government to take over failed banks and deal with them through a receivership much like the Resolution Trust Corporation, which helped solve the Savings and Loans debacle in the 1980s.

The other step is to break up the oligarchy. This entails selling off the banks piecemeal to private equity firms and imposing restrictions on size so the new, smaller banks cannot grow to the size of the current mega-banks.

"Anything that is 'too big to fail' is now 'too big to exist,'" Johnson says, adding, "the Obama Administration's fiscal stimulus invokes FDR, but we need at least equal weight on Teddy Roosevelt-style trust-busting."


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Around the Web

The Baseline Scenario

Simon Johnson on the Economic Crisis - MIT Sloan Newsroom

Bill Moyers Journal . Simon Johnson | PBS

The Quiet Coup - The Atlantic (May 2009)

YouTube - TPMtv: A Talk With Simon Johnson

The Ideas of Simon Johnson - Finance Blog - Ryan Avent - Market Movers - Portfolio.com