MIT's Simon Johnson, an outspoken critic of the risks of the Too Big To Fail, aka Global Bernanke Put, doctrine sat down with Bloomberg's Tom Keene to discuss the changes (just kidding) to the financial system on the one year anniversary of the worst legislation to pass Congress since the repeal of Glass-Steagall.
Q: Where are we with Dodd-Frank one year on? Are we still in a framework of bank consolidation?
A: We’re in a framework where the biggest banks, JPMorgan, Citi, Bank of America are too big to fail. You can’t handle them within the existing resolution framework. Maybe we’ve made some progress on the medium-sized guys, the medium to big. But the mega-banks, cross border, we can’t doanything about them when they go down.
Q: The banks are clearly fighting back to stay big. Is there something you’re looking for in the next six months to change the dialogue of too-big-to-fail?
A: Well, there is a dialogue. It’s with the FDIC around this so-called Title I of Dodd- Frank, which is the living will provision. And the FDIC could decide that some big banks need to simplify and slim down. We will see whether they can do that, whether they have the political backing to do it. I’m encouraging them. I’m fairly discouraged myself.
Q: Where do you draw the line between too big to fail and not too big to fail?
A: That’s a great question. CIT Group, which is the largest institution we let fail since the class of Lehman and since those really crazy days of before 2008. That was about an $80 billion bank in terms of assets, 8-0. Goldman Sachs fluctuates between $800 billion and $1 trillion. And I don’t think we’d let Goldman Sachs fail. So somewhere between $80 and $800 billion. Where exactly is that line? Great question. I hope we don’t have to find out. But we should know and we should know how to handle it.
Q: CIT wasn’t exactly a bank. It was a finance company.
A: It wasn’t exactly. You’re absolutely right. But, it did have a lot of banking type activities and it did argue very strongly that it needed a bailout, said it was systemic and there were people within the administration who actually wanted to help them out and other people like Sheila Bair decided ‘no, we don’t want to do that’ and they let them go and that was a good call.
Q: Well, another angle is the biggest company that got bailed out was an insurance company, AIG.
A: Absolutely. I’m not of the opinion that too big to fail is limited to banks, and that’s maybe a nice segue to Europe because look at where their implications are there. It includes insurance.
Q: The research we’ve seen is unlike with AIG, Europe is much more about bonds, solvency and the sovereign debt versus the credit default swaps. Do you buy that?
A: I’m not sure. I mean the European officials are so nervous about the CDS and they seem to be working hard to make sure it’s not a credit event from a CDS contract point of view. I wonder why they’re doing that. I know what you know on this, or maybe or less. I hope it’s not a CDS story.
Q: Where are we in terms of the unintended consequences or the surprise, the exogenous shock that can hit a system?
A: It’s going to stay ugly until the Europeans really come up with a definitive solution. It’s all about the spillovers and the unintended consequences of what they are doing and what they’re signaling about Greece. Unless they go back to a regime where they provide unconditional bailout, meaning complete credit protection to Greece, then people are going to say, ah, Greece take some losses therefore on XYZ country, which includes Italy at this point. We may have some probability of a loss and we need a higher interest rate to compensate from that and maybe this is not a riskless bond, anyways it’s clearly not a riskless bond anymore. But what is it? Where should it trade? Is it how close are we to some sort of emerging market situation?
Q: When you look at the ability to measure risk, there seems to be a great distinction between the European banking system and the U.S. Is it cultural? Is it legal? Why are they taking so long to get this cleared out?
A: I don’t think they have enough capital, in the first instance. They had less capital. They had more leverage, as you know they didn’t have an effective leverage cap. And of course, they had a very low risk rate, maybe near zero risk rate on holding bonds from their own governments.