Breaking the Oligararchs

Capitalism is as unsafe as the Bank. --G. K. Chesterton

Simon Johnson knows something about banking. In particular, he knows when banking goes wrong. As the former Chief Economist of the IMF, it was his job to know that. Nations that had gotten themselves into trouble would come to him hat in hand and ask for a bailout. He knows why these nations get into trouble, for the trouble is always the same, and he recounts the troubles in an article in the Atlantic Monthly. The trouble with these economies is oligarchy, the control of the many by the few:

But inevitably, emerging-market oligarchs get carried away; they waste money and build massive business empires on a mountain of debt. Local banks, sometimes pressured by the government, become too willing to extend credit to the elite and to those who depend on them. Overborrowing always ends badly, whether for an individual, a company, or a country. Sooner or later, credit conditions become tighter and no one will lend you money on anything close to affordable terms.

The downward spiral that follows is remarkably steep. Enormous companies teeter on the brink of default, and the local banks that have lent to them collapse. Yesterday’s “public-private partnerships” are relabeled “crony capitalism.” With credit unavailable, economic paralysis ensues, and conditions just get worse and worse. The government is forced to draw down its foreign-currency reserves to pay for imports, service debt, and cover private losses. But these reserves will eventually run out. If the country cannot right itself before that happens, it will default on its sovereign debt and become an economic pariah. The government, in its race to stop the bleeding, will typically need to wipe out some of the national champions—now hemorrhaging cash—and usually restructure a banking system that’s gone badly out of balance. It will, in other words, need to squeeze at least some of its oligarchs.

We have normally associated these conditions with “Banana Republics” and third-world kleptocracies. But these nations were only doing on small-scale what the American Bankers were doing on a grand-scale:

But there’s a deeper and more disturbing similarity: elite business interests—financiers, in the case of the U.S.—played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them.

Remarkably, the solution Dr. Johnson advocates is exactly the same one that Distributism does, break up the oligarchies:

The challenges the United States faces are familiar territory to the people at the IMF. If you hid the name of the country and just showed them the numbers, there is no doubt what old IMF hands would say: nationalize troubled banks and break them up as necessary.

Ideally, big banks should be sold in medium-size pieces, divided regionally or by type of business. Where this proves impractical—since we’ll want to sell the banks quickly—they could be sold whole, but with the requirement of being broken up within a short time. Banks that remain in private hands should also be subject to size limitations.

As things now stand, the Obama Administration is mortgaging the future to restore the oligarchs to their positions of power, in the naïve belief that only oligarchy can save us. Even if the plans were to work, the best they could do is restore the conditions that created the current crises. Why this failure of vision? Johnson identified the reason last night on the Bill Moyers Journal:

I think the banks have control of the state, Bill. Not the state control of the bank. If the state had control of the banks, the banks wouldn't be able to turn around and say, no on your Chrysler deal and no way on modifying the rules about mortgages and allowing bankruptcy judges to modify mortgages in bankruptcy. These are two hot issues this week. The banks are saying no to the government.

While Dr. Johnson does advocate the Distributist solution, his analysis does not go as deep as does that of the Distributists. G. K. Chesterton identified the problem: Capitalism is as unsafe as the Bank. Modern banking is an inherently unstable business; you borrow short to lend long, which as any investor can tell you is a recipe for disaster. The problem is exacerbated by the fractional reserve system: the banks take the depositor's money and leverage it by printing 10 times the amount to lend out. This makes it a very profitable business in good time, but it also means that even a small amount of defaults can wipe out a bank's capital. Further, since the banks can print such enormous amounts of money, we need a “central bank” to control the level of lending with all sorts of Rube Goldberg financial contraptions. On this inherently unstable financial base rests the entire system of modern capitalism.

Since the banks do hold the system hostage, they can get whatever they want from the government. In fact, the more dire their situation, the stronger their bargaining position. They demand—and get—a veto power over the government; they are, in effect, the effective rulers of the state. But it is a state that is no longer sustainable. Johnson makes it clear that the oligarchies must be broken before economic order can be restored.

And if they are not? Simon Johnson leaves us with a dire warning:

The conventional wisdom among the elite is still that the current slump “cannot be as bad as the Great Depression.” This view is wrong. What we face now could, in fact, be worse than the Great Depression—because the world is now so much more interconnected and because the banking sector is now so big. We face a synchronized downturn in almost all countries, a weakening of confidence among individuals and firms, and major problems for government finances. If our leadership wakes up to the potential consequences, we may yet see dramatic action on the banking system and a breaking of the old elite. Let us hope it is not then too late.