In this article he compares the recent US crisis with previous crisis in emerging economies and says how the two are so similar. And he does not look at all those jazzy macroeconomics variables etc. He simply says the crisis in each case got worse as the first certain businessmen took too much risk and became too powerful in the economic frameworks (oligarches). They knew all along that if risks go bad they will be bailed out by the government. In Russia it was the oil companies, in Korea it was Chaebols etc and in current US crisis it is the financial sector.
the real concern of the fund’s senior staff, and the biggest obstacle to recovery, is almost invariably the politics of countries in crisis.
Typically, these countries are in a desperate economic situation for one simple reason—the powerful elites within them overreached in good times and took too many risks. Emerging-market governments and their private-sector allies commonly form a tight-knit—and, most of the time, genteel—oligarchy, running the country rather like a profit-seeking company in which they are the controlling shareholders. When a country like Indonesia or South Korea or Russia grows, so do the ambitions of its captains of industry. As masters of their mini-universe, these people make some investments that clearly benefit the broader economy, but they also start making bigger and riskier bets. They reckon—correctly, in most cases—that their political connections will allow them to push onto the government any substantial problems that arise.
He then points how the oligarches then try and get all the benefits towards themselves. IMF tells the Govt to fix the oligarchy but you know how difficult it is. The end result is those which manage oligarchy faster recover faster, otherwise it is a mess. Now in US case, it does not really need IMF help but financial oligarches are ensuring all the plans suit them.
He tracks how financial sector gained prominence and became so powerful
In a primitive political system, power is transmitted through violence, or the threat of violence: military coups, private militias, and so on. In a less primitive system more typical of emerging markets, power is transmitted via money: bribes, kickbacks, and offshore bank accounts. Although lobbying and campaign contributions certainly play major roles in the American political system, old-fashioned corruption—envelopes stuffed with $100 bills—is probably a sideshow today, Jack Abramoff notwithstanding.
Instead, the American financial industry gained political power by amassing a kind of cultural capital—a belief system. Once, perhaps, what was good for General Motors was good for the country. Over the past decade, the attitude took hold that what was good for Wall Street was good for the country. The banking-and-securities industry has become one of the top contributors to political campaigns, but at the peak of its influence, it did not have to buy favors the way, for example, the tobacco companies or military contractors might have to. Instead, it benefited from the fact that Washington insiders already believed that large financial institutions and free-flowing capital markets were crucial to America’s position in the world.
One channel of influence was, of course, the flow of individuals between Wall Street and Washington. Robert Rubin, once the co-chairman of Goldman Sachs, served in Washington as Treasury secretary under Clinton, and later became chairman of Citigroup’s executive committee. Henry Paulson, CEO of Goldman Sachs during the long boom, became Treasury secretary under George W.Bush. John Snow, Paulson’s predecessor, left to become chairman of Cerberus Capital Management, a large private-equity firm that also counts Dan Quayle among its executives. Alan Greenspan, after leaving the Federal Reserve, became a consultant to Pimco, perhaps the biggest player in international bond markets.
These personal connections were multiplied many times over at the lower levels of the past three presidential administrations, strengthening the ties between Washington and Wall Street.
This anecdote is just excellent
Throughout my time at the IMF, I was struck by the easy access of leading financiers to the highest U.S. government officials, and the interweaving of the two career tracks. I vividly remember a meeting in early 2008—attended by top policy makers from a handful of rich countries—at which the chair casually proclaimed, to the room’s general approval, that the best preparation for becoming a central-bank governor was to work first as an investment banker.
He takes on fin economists:
Wall Street’s seductive power extended even (or especially) to finance and economics professors, historically confined to the cramped offices of universities and the pursuit of Nobel Prizes. As mathematical finance became more and more essential to practical finance, professors increasingly took positions as consultants or partners at financial institutions. Myron Scholes and Robert Merton, Nobel laureates both, were perhaps the most famous; they took board seats at the hedge fund Long-Term Capital Management in 1994, before the fund famously flamed out at the end of the decade. But many others beat similar paths. This migration gave the stamp of academic legitimacy (and the intimidating aura of intellectual rigor) to the burgeoning world of high finance.
And then came the crisis and all things became apparent. Plans after plans were made on the weekends in a piecemeal approach. Each plan only seemed to benefit the oligarches. All this gives Prof Johnson a sense of dejavu. The article is so well written that it deserves to be expanded into a book (a bestseller right away).
What is also interesting is all this points to a complete reversal of interest group theory of financial development. This was advocated by Raghu Rajan and Luigi Zingales in their paper and Stephen Haber in this paper. They look at political reasons for non-development if financial systems in developing economies. However, the recent developments and comments from top economists (Solow, Rogoff) made me write a post whether this political economy is reversed?
Going by Prof Johnson’s article it indeed seems to be the case. The financial system has become so powerful that we have oligarches trying to corner whatever government support is available. The academic economists need to urgently look at revisit their theories of financial systems. Moreover, this trend is not just in US but is applicable across the world. The financial system and its players have become powerful wherever you look at.
Superb article. Highly recommended reading.