The Quiet Coup

By Simon Johnson

The tenet: The finance industry has effectively captured U.S. government and emerged as a financial oligarchy. The recovery will fail unless we break this financial oligarchy that is blocking essential reform. Unfortunately were running out of time to prevent a true recovery. Key words: financial industry, Wall Street, financial crisis, financial oligarchy, elites, deregulation, capture of the state. Summary All Financial Crises Have both Economic and Political Aspects In financial crises, the IMF helps countries in crisis need to find economic solutions and learn to live within their means after a period of excess. But the biggest obstacle to recovery is almost invariably the politics of countries in crisis. Emerging-market governments and their private-sector allies commonly form a tight-knitand, most of the time, genteeloligarchy, running the country rather like a profit-seeking company in which they are the controlling shareholders. But inevitably, emerging-market oligarchs get carried away; they waste money and build massive business empires on a mountain of debt. The public-private partnerships often turned into crony capitalism. The government will typically need to wipe out some of the national champions and restructure a banking system. It will need to squeeze at least some of its oligarchs. The IMF often insists at least some of the powerful oligarchs take a hit. A Unique Oligarchy Emerged in U.S. The financial industry has not always enjoyed such favored treatment. But for the past 25 years or so, finance has boomed, becoming ever more powerful. The boom began with the Reagan years, and it only gained strength with the deregulatory policies of the Clinton and George W. Bush administrations. Wall Street ran with these opportunities. The financial sector created and concentrated great wealth that gave bankers enormous political weight. Quiet recently an American financial oligarchy reemerged. The great democracy in U.S. looks more like a Banana Republic. In a primitive political system, power is transmitted through violence, or the threat of violence, in a less primitive system more typical of emerging markets, power is transmitted via money. Instead, the American financial industry gained political power by amassing a kind of cultural capitala belief system. Over the past decade, the attitude took hold that what was good for Wall Street was good for the country. Washington insiders already believed that large financial institutions and free-flowing capital markets were crucial to Americas position in the world. The U.S., as a unique superpower with the worlds most advanced economy, military, and technology, has its most advanced oligarchy.

One channel of influence was, of course, the flow of individuals between Wall Street and Washington. 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. Wall Streets seductive power extended even (or especially) to finance and economics professors. From this confluence of campaign finance, personal connections, and ideology there flowed, in just the past decade, a river of deregulatory policies. Americas Oligarchs and the Financial Crisis In emerging countries and the U.S.: elite business interestsfinanciers, 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. The oligarchy and the government policies that aided it did not alone cause the financial crisis. Many other factors also contributed. In a financial panic, the government must respond with both speed and overwhelming force. Yet the principal characteristics of the governments response to the financial crisis have been delay, lack of transparency, and an unwillingness to upset the financial sector. Throughout the crisis, the government has taken extreme care not to upset the interests of the financial institutions, or to question the basic outlines of the system that got us here. Looking just at the financial crisis, we face at least two major, interrelated problems. The first is a desperately ill banking sector that threatens to choke off any incipient recovery that the fiscal stimulus might generate. The challenges the United States faces are familiar territory to the people at the IMF: nationalize troubled banks and break them up as necessary. Nationalization would not imply permanent state ownership. It would allow the government to wipe out bank shareholders, replace failed management, clean up the balance sheets, and then sell the banks back to the private sector. The second is a political balance of power that gives the financial sector a veto over public policy, even as that sector loses popular support. Big banks, it seems, have only gained political strength since the crisis began. The banks have been exploiting this fear as they wring favorable deals out of Washington. The power of the oligarchy is just as important as the immediate crisis of lending. And the advice from the IMF on this front would again be simple: break the oligarchy. Two Paths Emerging-market countries must make difficult decisions; ultimately, aggressive action is baked into the cake. But the U.S., of course, is the worlds most powerful nation, rich beyond measure, and blessed with the exorbitant privilege of paying its foreign debts in its own currency, which it can print. As a result, it could very well stumble along for years never summoning the courage to do what it needs to do, and never really recovering. In my view, the U.S. faces two plausible scenarios. The first involves complicated bank-by-bank deals and a continual drumbeat of (repeated) bailouts. The administration will try to muddle through, and confusion will reign. Our future could be one in which continued tumult feeds the

looting of the financial system, and we talk more and more about exactly how our oligarchs became bandits and how the economy just cant seem to get into gear. The second scenario goes like this: the global economy continues to deteriorate, a dramatic worsening of the global environment forces the U.S. economy, already staggering, down onto both knees, the prospect of a national and global collapse. The elite still holds a wrong view that the current slump cannot be as bad as the Great Depression. What we face now could, in fact, be worse than the Great Depressionbecause the world is now so much more interconnected and because the banking sector is now so big. 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. Maybe we are running out of time. This article available online at: http://www.theatlantic.com/magazine/archive/2009/05/the-quietcoup/307364/, Copyright 2013 by The Atlantic Monthly Group. All Rights Reserved.