Bill Moyers Journal: Johnson and Kwak Nail the Financial Meltdown (transcript)

[Cromag]

Simon Johnson and James Kwak, authors of 13 BANKERS: The Wall Street Takeover and the Next Financial Meltdown

→ Link to full video interview http://www.pbs.org/moyers/journal/04162010/watch.html

"All regulated industries end up with the industry capturing the regulators." George Stigler

► April 16, 2010

- BILL MOYERS: Welcome to the JOURNAL. With all due respect, we can only wish those tea party activists who gathered this week were not so single-minded about just who's responsible for their troubles, real and imagined. They're up in arms, so to speak, against big government, especially the Obama administration.


But if they thought this through, they'd be joining forces with other
grassroots Americans who will soon be demonstrating in Washington and
elsewhere against high finance, taking on Wall Street and the country's
biggest banks.


The original Tea Party, remember, wasn't directed just against the
British redcoats. Colonial patriots also took aim at the East India
Company. That was the joint-stock enterprise originally chartered by the
first Queen Elizabeth. Over the years, the government granted them
special rights and privileges, which the owners turned into a monopoly
over trade, including tea.


It may seem a stretch from tea to credit default swaps, but the
principle is the same: when enormous private wealth goes unchecked,
regular folks get hurt - badly. That's what happened in 2008 when the
monied interests led us up the garden path to the great collapse.


Suppose the Tea Party folk had dropped by those Senate hearings this
week looking into the failure of Washington Mutual. That's the bank that
went belly up during the meltdown in September 2008. It was the
largest such failure in American history.

WaMu, as we were reminded this week, made sub-prime loans that its
executives knew were rotten, then packaged them as mortgage securities,
and pawned them off on unsuspecting investors.


SEN. CARL LEVIN:
And that was your responsibility to make sure that the securities which
went out to the investors were following notice to the investors of
everything that they needed to know in order that the information be
complete and truthful. That's what your testimony was, under oath.


DAVID BECK:
It's a very real possibility that the loans that went out were better
quality than Mr. Shaw laid out.


SEN. CARL LEVIN:
And you don't -


DAVID BECK:
A very real possibility.


SEN. CARL LEVIN:
And there's a very good possibility that they were exactly the quality
that he laid out, right? Is that right?


DAVID BECK:
That's right.


SEN. CARL LEVIN:
Okay. And you don't know, and apparently you don't care. And the trouble
is, you should have cared.



BILL MOYERS: Then there's Lehman Brothers. During those black September days a year
and a half ago, the Feds decided to let Lehman go. This led to America's
biggest bankruptcy ever. In an admirable work of journalism this week,
the New York Times reported that Lehman secretly controlled a company
called Hudson Castle and used it to borrow money as well as to hide bad
investments in commercial real estate and sub-prime mortgages.


But the week's award for sheer gall goes to a Chicago-area hedge fund
called Magnetar, named after a kind of neutron star that spews deadly
radiation across the galaxies. Thanks to the teamwork of the
investigative reporting website "ProPublica," NPR's "Planet Money"
project and "This American Life," we learned Magnetar worked with
investment banks to create toxic CDO's - collateralized debt obligations
- securities backed by sub-prime mortgages the management knew were
bad. And then Magnetar took that knowledge and bet against the very same
investments they had recommended to buyers. Selling short and making a
fortune.


And late this week the Securities and Exchange Commission charged the
godfather of Wall Street, Goldman Sachs, with fraud in earning a fifteen
million dollar fee involving those complex CDO's, a hedge fund, and the
housing market.


But, since we know all this, why is it so hard to hold Wall Street
accountable? Even as we speak the banking industry and corporate America
are fighting against financial reform with all the money and influence
at their disposal Their effort is to preserve a system that would
enable them to ransack the country once again.


So even if the Tea Party folks saw the light, what can ordinary
Americans do?

That's the question I want to put to my guests, Simon Johnson and James
Kwak.
They have written this new book, 13 BANKERS: THE WALL STREET TAKEOVER
AND THE NEXT FINANCIAL MELTDOWN. It's a must read - already a best
seller -- and it couldn't have come at a better time. This book could
change the debate over financial reform by tipping it in favor of the
public.


Simon Johnson is a former chief economist at the International Monetary
Fund. He now teaches at MIT's Sloan School of Management and is a Senior
Fellow at the Peterson Institute for International Economics.


James Kwak is studying law at Yale Law School - a career he decided to
pursue after working as a management consultant at McKinsey &
Company and co-founding the successful software company, Guidewire.
Together James Kwak and Simon Johnson run the indispensable economic
website BaselineScenario.com



Welcome to you both.


Let me get to the blunt conclusion you reach in your book. You say that
two years after the devastating financial crisis of '08 our country is
still at the mercy of an oligarchy that is bigger, more profitable, and
more resistant to regulation than ever. Correct?



SIMON JOHNSON: Absolutely correct, Bill. The big banks became stronger as a result of
the bailout. That may seem extraordinary, but it's really true.
They're turning that increased economic clout into more political power.
And they're using that political power to go out and take the same
sort of risks that got us into disaster in September 2008.



BILL MOYERS: And your definition of oligarchy is?



SIMON JOHNSON: Oligarchy is just- it's a very simple, straightforward idea from
Aristotle. It's political power based on economic power. And it's the
rise of the banks in economic terms, which we document at length, that
it'd turn into political power. And they then feed that back into more
deregulation, more opportunities to go out and take reckless risks and--
and capture huge amounts of money.



BILL MOYERS: And you say that these this oligarchy consists of six megabanks. What
are the six banks?



JAMES KWAK: They are Goldman Sachs, Morgan Stanley, JPMorgan Chase, Citigroup, Bank
of America, and Wells Fargo.



BILL MOYERS: And you write that they control 60 percent of our gross national
product?



JAMES KWAK: They have assets equivalent to 60 percent of our gross national product.
And to put this in perspective, in the mid-1990s, these six banks or
their predecessors, since there have been a lot of mergers, had less
than 20 percent. Their assets were less than 20 percent of the gross
national product.



BILL MOYERS: And what's the threat from an oligarchy of this size and scale?



SIMON JOHNSON: They can distort the system, Bill. They can change the rules of the
game to favor themselves. And unfortunately, the way it works in modern
finance is when the rules favor you, you go out and you take a lot of
risk. And you blow up from time to time, because it's not your problem.
When it blows up, it's the taxpayer and it's the government that has
to sort it out.



BILL MOYERS: So, you're not kidding when you say it's an oligarchy?



JAMES KWAK: Exactly. I think that in particular, we can see how the oligarchy has
actually become more powerful in the last since the financial crisis.
If we look at the way they've behaved in Washington. For example,
they've been spending more than $1 million per day lobbying Congress and
fighting financial reform. I think that's for some time, the financial
sector got its way in Washington through the power of ideology, through
the power of persuasion. And in the last year and a half, we've seen
the gloves come off. They are fighting as hard as they can to stop
reform.


SIMON JOHNSON:
I know people react a little negatively when you use this term for the
United States. But it means political power derived from economic
power. That's what we're looking at here. It's disproportionate, it's
unfair, it is very unproductive, by the way. Undermines business in
this society. And it's an oligarchy like we see in other countries.



BILL MOYERS: And you say they continue to hold the global economy hostage?



JAMES KWAK: Exactly. Because what's happened- what we learned in 2008 were certain
institutions are so big and so interconnected that if they were to fail,
they would cause systemic shocks throughout the economy. That's
essentially what happened in September 2008 when Lehman Brothers
collapsed. And what's remarkable, and I think what essentially proves
the point of our book is that almost two years later, nothing has
changed.


Or the only thing that has changed is that these banks have gotten
larger, more powerful, both economically and politically. And they've
been flexing their muscles in Washington for the last year and a half.
So Neal Wolin, the Deputy Treasury Secretary gave a blistering speech to
the U.S. Chamber of Commerce in which he said, look, the financial
sector has been spending more than one million dollars per day lobbying
against the reforms we need to fix the financial system. Now, Simon and
I think those reforms that the Administration has proposed do not go
far enough. But we think they're certainly better than nothing. What
Wall Street wants is they want nothing. They want to stop this in its
tracks and go back to where we were five years ago.



SIMON JOHNSON: It's amazing, Bill. But this is this is politics and this is money.
And you know, there's a ground game, which is campaign contributions,
which are surging in. I'm sure on both sides of the aisle. And there's
also the ideological space. It's amazing. The Chamber of Commerce
that claims to represent the broad cross section of American business is
siding with six big banks, who favor policies that are directly
contrary to the interests of most of the membership of the Chamber of
Commerce. And that's just not just me saying that. That's Neal Wolin.
That's Treasury. That's the White House saying that now. Calling
fortunately, they've come to the point where they're willing to call the
Chamber of Commerce on that. But I don't know if that message is
getting through to people.


JAMES KWAK: You see what the bankers have done is they have taken a basic principle
which is more or less true. Which is that free financial markets do
enable money to go to the places where people need it. But on top of
that, they've erected a system that is indescribably complex. And gives
many opportunities to make money at the expense of their customers, at
the expense of their counterparties. Even at the expense of their own
employers. So, one of the things that has happened has been that Wall
Street finance has become so complex and the internal systems of Wall
Street banks has become so complex that if you are a smart banker, who
is out to maximize your own income, you can find the loopholes in the
system and you can exploit them, even if it means taking money from your
own-- from your own company



BILL MOYERS: You've been writing this week on your website-- about this hedge fund in
Chicago that's made a lot of money. In effect, betting against the
American Dream. What was that?



JAMES KWAK: Magnetar is a hedge fund which means that other people gave them money
to invest. And their job is to make as much money as possible. And
these were the smart guys in the room. They saw that the system was
broken. And they found a specific way to exploit it. And they knew
that they could go for example, they could go to Wall Street banks and
the banks would collaborate in making these extremely toxic securities.
Because they knew what the bankers incentives were. They knew that the
banker's incentives were to do the deal, to do the transaction, to get
the fees up front. And they knew that there was nobody watching out for
the investors. There was nobody watching out to make sure that
securities they manufactured were actually good securities. But
essentially what they were doing is they wanted to short the housing
market. And they shorted the market in such a way that they actually
made the problem worse, because what they did is they encouraged they
tried to create these very toxic securities explicitly so that they
could then short those securities. And that's why in a sense, they were
they were shorting the American Dream. But what the real story of
Magnetar, I think, is that they were exploiting a system that was deeply
broken.


So, we like to think that the financial system we have in Wall Street
are set up so that as people try to make lots of money they are they are
indirectly helping the economy by making sure their capital goes where
it's needed most. What the Magnetar story shows us that this is a
casino, where you can make money you can make money exploiting the
weaknesses in the casino. And it has nothing to do with the American
Dream. It has nothing to do with making sure that capital goes to the
places where it's needed most. I have to say that we owe a great to
debt to "ProPublica" and "Planet Money"
and "This American Life" for uncovering this story



BILL MOYERS: Public radio's excellent program, "This American Life", did a terrific
broadcast on this subject, based upon the ProPublica investigation that
you talked about. And there's a song in it that I have to play for the
two of you and for my audience. Take a listen.


UNIDENTIFIED MAN:
Step one. You write a check for 10 million dollars. Hand the check to a
Wall Street bank, and ask them to make us a CDO. Step two: they create
the CDO, using risky stuff, very risky stuff, extremely risky stuff.
Step three: other investors commit hundreds of millions of dollars to
the CDO. Step four: we bet against the CDO, using a credit default
swap. Step five: the housing market crashes. The CDO's value goes to
zero, our bet pays off and we make hundreds of millions of dollars and
before you can say step six, we're rich! We're going to bet against the
American Dream, we're going to be on the winning team, purchase risky
debt on a massive scale. Then place a bet that the debt will fail.
Hundreds of millions for Magnetar, the economy collapsing like a dying
star. No one will know till it's on NPR, and who cares? It's time to
hit the town, this sucker could go down. The housing market's losing
steam. And all we got to do to make our dreams come true is bet against
the American Dream!



BILL MOYERS: You're smiling, James, but is it really that funny?



JAMES KWAK: Well for decades, we've been told that Wall Street and financial
innovation were promoting the American Dream. And what they've I think
what the show and the song have really hit the hit the nail on is that
in fact, you can make even more money betting against the American
Dream. And that's the kind of system we have today.



SIMON JOHNSON: My bumper sticker from this and I hope it does become a bumper sticker
is, "Trust me, I'm a banker."


I mean, you need to break through there's a level of progress here,
Bill. Which is when people can laugh about it. When people can break it
down into pieces. When you've got the 60-second version. And you can
hammer that. And people understand it. Then you're starting to fight
back. This is about ideology. This is about belief. This is about these
guys are smart. These guys are well paid. So they must know what
they're doing. And that's wrong.



BILL MOYERS: You wrote on your website this week about how JPMorgan Chase lost $880
million on one of these kind of whacky obscure deals? But the
executives still paid themselves millions of dollars in up front fees.
And you conclude that bankers placed a ticking bomb on their own bank
balance sheet. It exploded and personally they still made money.



JAMES KWAK: Exactly. Because this is an example so, this is from the "ProPublica"
investigation of Magnetar. essentially the bankers at JPMorgan Chase
involved in the transaction created a new CDO. A new collateralized
debt obligation. Which was very, very toxic. And either they knew at
the time that it was toxic, or they should have known, I have no way of
knowing. JPMorgan decided to hold onto most of this toxic product they--
they had built. A billion dollars worth of toxic product. And then
when the market collapsed, it turned out they lost $880 million on that
position.


So, if we think about it, there are really two possibilities here. The
bankers involved in the transaction either really thought that this was a
good product and a good investment, in which case they're incompetent.
Or they had- they may have doubts, they may have thought it was toxic,
but they knew that the way the internal systems at JPMorgan Chase
worked, they could get the fees front, they could get bonuses based on
those fees, and leave the bomb for later.



BILL MOYERS: Somebody wrote on your blog this week, "If I were to buy an old house.
Make some cosmetic improvements that mask an underlying rot. Got my
insurance company to write an exorbitant homeowners policy exceeding any
leans against the property. Then burned it down, wouldn't that be
fraud?" Did you answer this guy?



JAMES KWAK: I haven't. That would



BILL MOYERS: Would you?



JAMES KWAK: That would be fraud.



BILL MOYERS: That would be fraud. So, explain to me how you manage to lose $880
million on your own company's money to make a quick buck for yourself
and you get away with it?



JAMES KWAK: Well, I think that there are laws in this area. So, for any securities,
there has to be-- for this type of security, there has to be a document
which explains those securities. And that's a document that you give
to the investors who might buy them. And there are laws governing
those. And if you put in facts in there that that are materially false.
That you know to be true, that is fraud. But I think the problem is
that in many of these cases, I don't think that many of these people are
criminals. I get a lot of criticism for saying that I don't think
these people are criminals. But I think it's relatively easy to write
these documents in such a way that you're not saying anything you know
to be false. And so, they pass through, they pass through any kind of
you avoid any possible criminal liabilities there. But yet, they can be
misleading in a way that encourages people to buy them.



SIMON JOHNSON: I think it's actually worse in some instance, Bill. Certainly for
offshore activities. Goldman Sachs was involved in hiding a lot of
Greek government debt. They then sold new Greek government obligations
to people in the United States as far as far as we understand it. And
didn't reveal that they'd hidden the levels of the true levels of
government debt. Now, that is withholding material information. That's
a violation of rule 10B-5. and where is the legal process, you should
ask, that holds them accountable for that? I've talked to lots of very
good lawyers about this. And there are many complicated stories about
why Goldman Sachs won't face any civil action or criminal action. There
are huge loopholes in our legal system with regard to financial
services that need to be closed.




BILL MOYERS: There were some interesting hearings, as I know you saw, before the
Financial Crisis Inquiry Commission. And some of the first, some of the
most interesting testimony came from the former honchos at Citigroup.
Mr. Prince and Mr. Rubin. Take a look.


CHARLES PRINCE:
Let me start by saying I'm sorry. I'm sorry that our management team,
starting with me, like so many others, could not see the unprecedented
market collapse that lay before us.


ROBERT RUBIN: My role at Citi, defined at the outset, was to
engage with clients across the bank's businesses, here and abroad.
Having spent my career in positions with significant operational
responsibility at Treasury and, prior to that, at Goldman Sachs, I no
longer wanted such a role at this stage of my life, and my agreement
with Citi provided that I would have no management of personnel or
operations.


ROBERT RUBIN:
But almost all of us, including me, who were involved in the financial
system, missed the powerful combination of factors that led to this
crisis and the serious possibility of a massive crisis. We all bear
responsibility for not recognizing this, and I deeply regret that.


PHIL ANGELIDES:
The two of you, in charge of this organization did not seem to have a
grip on what was happening. I don't know that you can have it two ways.
You were either were pulling the levers or asleep at the switch.



BILL MOYERS: How can it be that a Robert Rubin, former Secretary of the Treasury,
pulls down $100 million as a senior advisor to Citigroup and claims he
doesn't know the risk that was involved in what he was trying to sell to
clients and foreign officials? How can that be?



JAMES KWAK: I think there are two things. There's a narrow and a broad view of
this. The narrow view is I think Rubin is actually not lying. I think
it is true that Rubin did not know what the risks were. Although he
certainly should have known what the risks were. And that's because he
was fully subscribed to this ideology that free markets are good. That
the market will take care of itself. That, he also suffered from a lot
of the blindness that corporate officers and directors have. Corporate
officers and directors manage these enormous organizations with tens of
hundreds of thousands of people. They have very little idea what's
going on. They're getting their information from subordinates, who are
giving them a filtered view of the world. On the other hand, when he
says, no one could have foreseen this. This is what I call an
intellectual cover up. And I say that because it's very disingenuous.
Over the past 20 years, these banks used their economic power and their
political power to engineer an unregulated financial environment in
which precisely this sort of thing could happen. And in that sense, I
think that this was not an accident. It was not a natural disaster. It
was not unforeseeable. It was the product of the efforts by the sector
over the past 20 years to reshape Washington and to engineer an
environment that would allow them to make as much money as possible.
Simon talked earlier about money. And we know that the financial
sector, especially Wall Street, has been, has made enormous
contributions to both campaign contributions and lobbying expenses. But
I think there were, there were two more potent weapons in their
arsenal. One is the revolving door. So, we've seen an enormous number
of people passing back and forth between Washington and Wall Street over
the past 20 years. This is not a new phenomenon. It happens in every
industry. But there are certain things that make it especially
pernicious when it comes to finance. One is that, one is a question of
incentives. So, compared to other industries, Wall Street can simply
offer enormous amounts of money. I'm not saying that everyone did that.
I'm not saying that even the majority of people did that. But that
is, that is very clear.



BILL MOYERS: The New York Times has a story this week saying that 125 former members
of Congress and staffers are now working for the financial industry in
Washington. One of them is Michael Oxley, whose name is on one of the
most important pieces of business legislation in the last 20 years. The
Sarbanes-Oxley bill, which was designed to impose some very strict
accounting rules after Enron on all of this. And there he is now, he's a
lobbyist for the securities industry.



SIMON JOHNSON: But Bill, it goes even further and deeper than that. Robert Rubin was
Secretary of the Treasury in the 1990s. He oversaw the deregulation.
He fought hard against Brooksley Born, the only regulator in living
memory who tried to prevent derivatives from getting out of control. He
then went to Citigroup. He presided over this nonsense and this mess.
He's now and he was he's clearly éminence grise of this administration.
Mr. Geithner and Mr. Summers are his protégés. But that's, that's not
all. Next week, the Hamilton Project, a project of the Brookings
Institution founded by Mr. Rubin, will have a big public event.
Probably Mr. Rubin's most prominent Washington appearance since the
crisis broke. The headline act at this event will be Vice President Joe
Biden. Now, maybe Mr. Biden will be taking on the view of finance that
we all should fear greatly. But I'm not so optimistic.



BILL MOYERS: You know, I don't get it. Recently when "Newsweek" wanted to give big
space to somebody to explain how we get out of this, who wrote the
piece? Robert Rubin. I mean, are they locked into this worldview so
that they cannot see the consequences of their own actions?



JAMES KWAK: Well, I think there are a couple things going on. One of the things we
talk about in the book is how the Democratic Party became taken over by
this Wall Street friendly view in the 1990s, which is, you know,
extremely important, because in the 1980s, we had a deregulatory
administration that was largely opposed by a Democratic Congress. And
it became very convenient for Democrats, because if you believed in the
ideology of finance, you could sincerely think, I am a Democrat, I am a
servant of the poor and the working class. And yet, I can take campaign
contributions from Wall Street, because I sincerely believe that Wall
Street is doing what's best, what's in the interest of the country.


I think it's been exposed in the last year and a half that a lot of what
Wall Street did was not in the best interest of the country, not in the
interest of the people getting these subprime loans, not in the
interest of the taxpayer who was paying for the immense fiscal costs of
the financial crisis and the recession. But it's, there's a curious
time lag going on in the, in the Wall Street, intellectual and political
establishment, where they think they're still in 2005.



SIMON JOHNSON: As I travel around the country, Bill, I'm really struck by the fact that
while people in Washington talk about populist anger in the country,
most of what I encounter is legitimate, sensible anger. People actually
understand what happened. They understand what went wrong. And they
want to stop it. And the banks don't get this. The belief system on
Wall Street is the same. Jamie Dimon, head of JPMorgan Chase, one of
the most powerful men in the country. If you don't know his name, you
should look him up because this is a man to fear.



BILL MOYERS: Very close to the President. Has dinner- lunch with the President.



SIMON JOHNSON: The President called him a savvy businessman, recently. Jamie Dimon
told his shareholders, we just had probably our best year ever. They
didn't have their best year ever. They went through crisis. They were
saved like the rest of the financial system by the government, by the
taxpayers, but that's not how they see it. That's not what they
believe. That's really important. That belief must be shaken if we're
to make any progress at all.



BILL MOYERS: But we can't compete with those lobbying dollars. We can't compete with
this interlocking oligarchy that you say. That's a fact.



SIMON JOHNSON: Bill, in 1902, when Theodore Roosevelt took on the industrial trusts,
nobody knew what he was doing. Nobody thought he could win. The Senate
was called the Millionaires Club for a reason. And it wasn't even any
theory. The antitrust theory, everything we know and believe about
monopoly, why monopoly is bad for society, didn't really exist,
certainly not in the mainstream consensus, when Roosevelt decided to
take on J.P. Morgan, okay?


Ten years later, the mainstream consensus has shifted completely.
People understood from the debate and from the struggle, from the fact-
from the way the trusts fought back and the way they spent their money,
they began to understand this was profoundly dangerous, politically and
socially. 1912, everyone agreed that breaking up Standard Oil was a
good idea. Had to be done. They broke into 35 companies, most of them
did well. The shareholders actually made money. It's a very American
resolution, Bill. And it's very clear that we've had this confrontation
before in American history: Andrew Jackson against the Second Bank of
the United States in the 1830s, Jackson won, barely; Theodore Roosevelt,
the beginning of the 20th Century; FDR in the 1930s.


The American democracy was not given to us on a platter. It is not ours
for all time, irrespective of our efforts. Either people organize and
they find political leadership to take this on, or we are going to be in
big trouble, okay? Now, I agree, we don't have Theodore Roosevelt. I
agree. The only Senator who speaks complete truth and clarity on this
issue is Ted Kaufman from Delaware, who's an appointed Senator, he got-
he was appointed to Joe Biden's seat, and he's not running for
reelection. He therefore doesn't care about the money. I take that
point. But there are others. There must be others. We must find them
and we must fund them, individually, sufficiently, to fight against this
nonsense from the corporate sector.


I would like to emphasize, Bill, I'm a professional entrepreneurship,
James is a successful entrepreneur. We're not anti-finance. We have
many people endorsing the book, backing us, and you know, they, we put
their blurbs in the book for a reason, who are from finance. Who really
appreciate and understand this key point. Which is the complexity has
gone too far. It's become dangerous. And we need to return our
financial system to a simpler, more direct, easier to manage way.



BILL MOYERS: You both paid attention last week, to the hearings in Washington, on the
Financial Crisis Inquiry Commission. Was there a theme that you heard
emerge there?



JAMES KWAK: I think the biggest theme that I heard emerge was that this was an
innocent mistake. So, what I mean by that is-



BILL MOYERS: You mean the collapse of 2008? All of this? What- was-



JAMES KWAK: Exactly.



BILL MOYERS: An accident?



JAMES KWAK: Yes, an accident in the sense that-



BILL MOYERS: Natural disaster?



JAMES KWAK: As we heard Chuck Prince say and Robert Rubin say, we couldn't see it
coming. These were, there were risks that build up in the system, and
our models didn't account for it. We're sorry that it happened. Not
even, we're sorry that we did it. We're sorry that it happened.


And I think that this is, I mean, it's unfortunate if they really
believe this. Because again, if we just take a very small example, one
of the things that clearly went wrong is these banks were not able to
manage their own risk. They did not know what positions they had. They
did not know what market forces they were exposed to. You would think
that should be the first job of a bank. And I don't think this was an
innocent mistake. And I say that for this reason. It was in the bank's
short term financial interest to underestimate their risk. Because if
they had estimated their risk accurately, they should have had to set
more capital aside, they would have been less profitable.


So, yes, it's possible that the CEOs of these banks honestly did not
understand their risk positions. But that mistake-- there was an
incentive behind that mistake. You know, banks never overestimate their
risk. These mistakes always only go in one direction. Because that's
the direction they have an incentive to make the mistake in.



BILL MOYERS: What do you mean they have an incentive to make a mistake?



JAMES KWAK: So, in the short term, a bank's profitability is going to depend on how
much capital it has to set aside. So, in banking, if I have a certain
position, I have to set aside a certain amount of capital to protect
myself from that position going bad. If I think the position is less
risky than it actually is, I'm going to set aside less capital to cover
that position, and that's going to give me a higher profit margin.


If I'm the head of this bank, that means that in the short term, I'm
going to have higher profits, higher stock price, more money for me, but
I'm underestimating the risk of something blowing up several years down
the line. But we know that the, essentially, the incentive systems
within these banks favor short term profits over long term solvency.



SIMON JOHNSON: The most profound thing, observation, on this structure, inadvertent, I
would say, observation, was by Chuck Prince, the former head of
Citigroup. In July 2007, right before the whole structure began to
crumble. He said, "As long as the music is playing, you've got to get
up and dance." And that's a statement about the incentive structure.
Saying, well, everybody's doing it. That's how we all make money.
We've got to do it, too. I'm just a bank doing what all the other banks
are doing. That's absolutely the heart of the problem. I would also
say and tell you, and emphasize, these people will not come out and
debate with us. The heads of these companies or their representatives,
they will not come out. They're afraid. They don't have the substance.
They don't have the arguments. We have the evidence. They have the
lobbyists. And that's all they have.



BILL MOYERS: They've got the power, the muscle, the money.



SIMON JOHNSON: They have money.



BILL MOYERS: You just have the arguments. You just have the facts. On your side.



SIMON JOHNSON: Absolutely. That's exactly what it comes down to.



BILL MOYERS: Let me show you one of my favorite moments of the week. The commission
on the crisis is looking into two former executives of the big mortgage
giants, Fannie Mae and Freddie Mac. And the Fannie Mae guy tries to
say, what happened was Congress made us do it.


BILL THOMAS:
Was there an opportunity, perhaps, to reprioritize your charter and
focus on those things that were most relevant in the marketplace that
would have made the institution more sound?


ROBERT J. LEVIN:
That wasn't done at my pay grade.


BILL THOMAS:
My understanding is, between 2000 and 2008, you made $45 million. So
only people above 45 thousand-- 45, excuse me, million dollars, between
two and 2008, could answer that question?


ROBERT J. LEVIN:
What I meant by the, what I was addressing was the question of, could we
have affected the charter act--


BILL THOMAS:
Right. And it was above--


ROBERT J. LEVIN:
Of the company--


BILL THOMAS:
Your pay grade.


ROBERT J. LEVIN:
Yes. And my language was sloppy, and--


BILL THOMAS:
No, it wasn't sloppy.


ROBERT J. LEVIN:
And what I meant by that--


BILL THOMAS:
It was flippant, if you want that as a choice.


ROBERT J. LEVIN:
What I meant by that, sir, was that that was in the purview of the
Congress, not the company.



BILL MOYERS: You're laughing.



SIMON JOHNSON: So, look, what I say to my, to all my Republican friends: on Fannie Mae
and Freddie Mac, you were right. They became too big to fail. They
captured Congress. They were known as some of the most formidable
financial lobbyists in the 1990s. They argued for the rights to take on
these kinds of risks, okay?


And the Republicans were right. The Republicans called them on this.
But now it's the big private banks that have the same incentive
structure. That have bulked themselves up so big that you can't let
them fail. That's what we saw in September 2008. Hank Paulson looked
at his options. And they are all pretty awful. And I'm not a big fan
of Hank Paulson, but I think the moment where he looked at it, he was
right. That if you let JPMorgan Chase or Goldman Sachs fail, the
consequences would have been devastating, because they're so big. It's a
Fannie May and Freddie Mac structure come to Wall Street, come to the
top guys on Wall Street. And our Republican colleagues and friends
should recognize this, they should acknowledge it. And then we can all
fix this together.



BILL MOYERS: Well then why is Mitch McConnell, the Senator from Kentucky, who is the
Republican Leader in the Senate saying what he said this week? Let me
show you from his statement.


SEN. MITCH MCCONNELL:
If there's one thing Americans agree on when it comes to financial
reform, it's that it's absolutely certain they agree on this: never
again, never again should taxpayers be expected to bail out Wall Street
from its own mistakes [...] This bill not only allows for
taxpayer-funded bailouts of Wall Street banks, it institutionalizes
them. The way to solve the problem is to let the people who made the
mistakes pay for them. We won't solve this problem until the biggest
banks are allowed to fail.



BILL MOYERS: He seems to be saying what you say, right?



SIMON JOHNSON: It's a clever piece of political manipulation. It's not at all what we
say. What he says is dangerous and deliberately misleading.



BILL MOYERS: How so?



SIMON JOHNSON: He says let the biggest banks fail, go bankrupt, don't do anything,
leave the situation as it is now and when they get in trouble, let them
fail. If you do that, you'll have catastrophe. The bankruptcy system
clearly and manifestly cannot deal with the failure of a complex,
global, financial institution. And we have the evidence before us in
what happened after Lehman Brothers failed. That was bankruptcy. It
caused chaos around the world, Bill. That's what the Republicans are
advocating. Is we just leave things as they are and next time we'll
take that chaos and we'll get a second Great Depression. We're arguing
for reform. We're arguing for change. We're arguing for ways to make
those biggest banks smaller and safer. If they were small enough to
fail, that's a very different story. And that's a much safer place to
be.



BILL MOYERS: What do these big six banks think about what Senator McConnell is
saying?



JAMES KWAK: Well, the big six banks don't want any reform at all, essentially. So, I
think that they are, and there's some evidence that Senator McConnell
has been talking to the big banks and to other people on Wall Street.



BILL MOYERS: There have been published reports that he attended a fundraiser with
hedge funds and other Wall Street poobahs just last week, before he made
this statement. And the reporters, knowing that he had been at this
big fundraiser for hedge fund and Wall Street tycoons a week before,
begin to press him in an unusual, and actually promising way. Take a
look at this.


REPORTER:
How do you push back against this perception that you're doing the
bidding of the large banks? You know, there was a report that you guys
met with hedge fund managers in New York. A lot of people are viewing
this particular line of argument, this bailout argument as spin--


SEN. MITCH MCCONNELL:
You could talk to the community bankers in Kentucky.


REPORTER:
I'm not asking you about the community bankers--


SEN. MITCH MCCONNELL:
But, I'm telling you about the community bankers in Kentucky. This is
not, everybody--


REPORTER:
Have you talked with other people other than community bankers?


SEN. MITCH MCCONNELL:
Well, sure. We talk to people all the time. I'm not denying that. What's
wrong with that? That's how we learn how people feel about legislation.
But the community bankers in Kentucky, the little guys, the main street
guys, are overwhelmingly opposed to this bill.


REPORTER:
Well what would you say to folks who say that this is just spin to
deflect attention from the fact that you're representing the large
banks?



BILL MOYERS: So, he deflects their questions about being at this meeting with the
large banks, the oligarchs, as you called them. And talks about
community banks back in Kentucky. What do you make of that?



SIMON JOHNSON: Well, two things, Bill. First of all, he's embarrassed, as he should
be, and that's good. I don't think they used to be embarrassed. I
think-- I hope Vice President Biden is somewhat embarrassed by the event
he's going to attend next week with Robert Rubin, unless he criticizes
Rubin and goes after Rubin's view of the world. In which case, I'm okay
with that.



JAMES KWAK: This other part of the problem which Simon and I talk about more in the
book, and that we don't think is fully solved by the legislation in the
Senate, is why do you have to have these too big to fail banks in the
first place? So, we think that's the obvious and simplest and almost
unarguable solution that you should simply not have banks that are too
big and too interconnected to fail.



SIMON JOHNSON: There are no benefits to society, Bill, from having banks that are
larger than $100 billion in total assets. This is a well-established
fact. The evidence does-



BILL MOYERS: You make the case.



SIMON JOHNSON: There's nearly 100 pages of footnotes for a reason.



BILL MOYERS: But don't let the facts get in the way.



SIMON JOHNSON: I understand. But there's no evidence, okay? We've let our banks get
to $2 trillion-- Citigroup when it almost failed or did fail in fall
2008 was a $2.5 trillion bank. Jamie Dimon runs a $2 trillion bank at
JPMorgan Chase and says, if we're big, it's 'cause we're beautiful and
efficient. And we should be allowed to get bigger. It's not true.
They're big because of the government subsidy, right? That's what gives
them the profits at this level. If they get bigger, they'll become
more dangerous. That's, those are the costs. On the benefit side,
there's no economy of scale or scope or anything else to support the
case that banks bigger than $100 billion. That's on a pure cost/benefit
basis.



JAMES KWAK: So, there's no way that Jamie Dimon, who according to many observers is
perhaps the savviest bank CEO, the best one out there, there's no way
that he can know what's going on within his organization. There's no
way he can even have an information system that will let him know,
efficiently, all the things that he needs to know. So, why is JPMorgan
Chase so big? One reason is that it's in the interest of CEOs to have
large banks. Because if you have, the larger your bank, the bigger your
salary. But then at the same time, it creates this incentive among the
traders, the people who really make the money or lose the money in
these banks. It creates an incentive to the traders to essentially
exploit the management failings of the company.



BILL MOYERS: The toughest hearing in Washington this week was conducted by Senator
Carl Levin in the Senate, looking into Washington Mutual. That's the
largest bank ever to go under in our history, and there are some friends
of mine in Washington say there's some possible criminal indictments
going to be coming out of this. Let me show you Senator Levin laying
out some of the evidence.


SEN. CARL LEVIN:
To keep that conveyor belt running and feed the securitization machine
on Wall Street, Washington Mutual engaged in lending practices that
created a mortgage time bomb...WaMu built its conveyor belt of toxic
mortgages to feed Wall Street's appetite for mortgage-backed securities.
Because volume and speed were king, loan quality fell by the wayside
and WaMu churned out more and more loans that were high risk and poor
quality.


Destructive compensation schemes played a role in the problems just
described. These incentives contributed to shoddy lending practices in
which credit evaluations took a back seat to approving as many loans as
possible.



BILL MOYERS: He goes on, you know? There's evidence that WaMu knowingly sold
fraudulent loans to investors in the form of securities. That loan
offices were falsifying documentation in order to churn out as many
lousy loans as they could. And that senior management was putting
pressure on the loan officers to do just this. And he claims, what we
were talking about, that destructive compensation schemes were part of
the problem.



JAMES KWAK: I think that some people may go to jail. I think that falsifying loan
documents, I think there's a good chance people could go to jail for
that. I think that if there are- you know, when you get the emails of
people at midlevel managers at these banks saying, you know, falsify the
loan documents. They might go to jail as well. I don't think anyone
who's high up in these banks is going to go to jail for this reason.


I think that, for example, these loans were eventually sold on to
investment banks which used them to manufacture new securities. Those
investment banks were getting documents from Washington Mutual. These
are like representations and warranties. So Washington Mutual is
saying, you know, these loans meet these criteria. And the investment
bank is going to say, I got this document from Washington Mutual. They
told me the loans were good. You can't send me to jail.


And he's absolutely right. So, you've got investment bankers who must
have known. Who should have known that a lot of these loans are bad.
But they've got a piece of paper from the person selling them the loan
saying they meet these criteria. He's pretty much Scott free when it
comes to criminal liability. So--



BILL MOYERS: Mistakes were made, but not by me, right?



JAMES KWAK: Exactly.



BILL MOYERS: I mean, that seems to be the mantra that came through all these hearings
this week: mistakes were made but not by me.



SIMON JOHNSON: Or, no, I think they also say, Bill, well, everyone made mistakes, Bill.
You know, we're just human. This was beyond our control. And that's
not true, these are systems they controlled, they designed. Mr. Rubin
designed this, right? And I want to point out there's something very
interesting in this WaMu conversation.


It's only when a firm collapses that you get full discovery. Now,
Senator Levin is a great voice on this. And I think he's absolutely
nailing this. But he only has the ability to get at this level of
detail and documentation from a company that failed like WaMu. For the
people who were able to keep going. The Goldman Sachses of this world,
you'll never know what they were really up to.


These are incredibly smart people. They're very well paid. They have
ever incentive. The regulators are totally outgunned. It's not an
accident that this complexity allows them to get away with it. It's by
design. That's the system. Not a conspiracy, Bill. Don't say that.



BILL MOYERS: I wouldn't.



SIMON JOHNSON: It's a system of--



BILL MOYERS: A system.



SIMON JOHNSON: It's a system of beliefs and incentives, much more profoundly dangerous
than a conspiracy.



BILL MOYERS: Why?



SIMON JOHNSON: Conspiracies you can unroot. Conspiracies you can have, you know, a
couple of hearings. People can understand it on TV. You get the sound
bite. This is very complex. This is about what many, many PhDs and
specialists in finance have cooked up over 20 years with the active
participation of the people who were supposed to oversee that in
Washington.



BILL MOYERS: Is this what the blogger meant when he posted on "The Baseline Scenario"
this week, "Unnecessary complexity just creates rich opportunities for
systemic corruption"?



JAMES KWAK: That is certainly one of the things he meant.



BILL MOYERS: What should be the purpose of reform? Should it change the behavior of
Wall Street, or should it change the regulation of Wall Street? And
there is a difference, is there not?



SIMON JOHNSON: Absolutely. Look, I don't know if this will work or not. I don't know
if at the end of the day, we will end up supporting the bill. I hope we
will, okay? But whatever happens, this is one legislative cycle.
Theodore Roosevelt did not change the mainstream consensus in this
country with regard to power and monopoly and the dangerous side effects
of big business overnight.


He didn't do it in one year or two years. It was a ten year process.
The consensus has to change, Bill. And regulation, the role of
regulation or understanding of regulation with regard to finance has to
change. The regulation is there to limit the downside to society and to
make sure that all of these activities have as much as possible of the
positive effect on the economy without generating these massive negative
shocks. And we're a long way from that point.



JAMES KWAK: I think the distinction you made is a very good one. Between changing
the regulation of Wall Street and changing Wall Street itself. I think
the bill does a lot of things that will improve the regulatory system.


I think it does not do a lot to change Wall Street. Certainly, better
regulation will change Wall Street a little bit, but some of the basic
fundamental issues, I think, for example, the fact that in many realms,
Wall Street banks knowingly make money by finding, because they want to
put on a trade, they find a sucker to take the other side of that trade.


They're making money directly off of their customers. You can't really
have it any other way when you're engaged in proprietary trading.
These, this is not going to change. The fact that we have these
enormous banks that are too big to manage and that have a competitive
advantage, because they're big. That's not going to change.


And that's one reason I think why it's not going to satisfy the many
people in America right now who are upset and frustrated about what's
happen. Because they're going to see that what we've done is we've made
Washington a little bit better at regulating Wall Street. We haven't
changed the fundamental causes.



BILL MOYERS: Well, I've seen one regulatory agency after another taken over by the
very industries they were supposed to regulate.



SIMON JOHNSON: This is absolutely right, Bill. And, you know, the person who nailed
this intellectually a long time ago was from the University of Chicago.
George Stigler. Not a man of the left. He got a Nobel Prize for his
observation. All regulated industries end up with the industry
capturing the regulators.


And what's happened to us is a Stigler, exactly what Stigler warned
against on a massive scale. And you have to think very hard about this.
The Administration still argues that we should delegate
responsibility, going forward, for lots of things around finance. Like
how much capital you should have. Delegate that to the regulators.


Now, that's crazy. That's not acceptable. That is not what they should
do. Particularly because, and any Democrat should say, well, wait a
minute, next time a free market President who doesn't believe in
regulation comes in will gut the system. And any person from the right
who's read Stigler should say, Well, these regulators are just going to
get captured. You've got to put it in legislation. You've got to
design the legislation. You've got to go after the things that can be
legislated. Congress must not abdicate this responsibility.



BILL MOYERS: So, you would break up the banks. That's what you would do, right?



SIMON JOHNSON: We would set a hard size cap on the banks. And the banks, in order to
comply with that, would have to break themselves up. So, take a bank
like Goldman Sachs, for example. It's about ten times bigger than what
we would be comfortable with. And, you put that cap in-- they have to
figure out how to do it. They have a fiduciary responsibility to their
shareholders not to lose value as they comply with this law, not a
regulation, law, right? Our book is called "13 Bankers" because it was
13 bankers who were pulled into the White House last March, and they
were saved completely and unconditionally in the most amazing deal ever:
their jobs, their pensions, their board of directors, their empires.
But the title is also an echo of a remark made forcefully in 1998 by
Larry Summers, who was then Deputy Treasury Secretary to Brooksley Born,
who was trying to regulate over the counter derivatives.


And she was way ahead of her time, by the way. None of this nonsense
existed. But she had- she saw this coming in a very profound sense.
And she wanted to act in a preemptive and preventive way. Now, Larry
Summers called her up. This is according to the public record and it's
not been disputed by any of the protagonists here.


He called her up and he said, Brooksley, if you do what you want to do,
which is regulate the derivatives. Over- regulate all this over the
counter derivatives, you- I have 13 bankers in my office who say you
will cause the greatest financial crisis since World War II., right?
That was what he believed. That was the prevailing philosophy of the
Rubin wing, the Wall Street wing of the Democratic Party.


That was Alan Greenspan's view. That is what brought us to this point.
The idea that if you regulate, in any fashion, in any form, you will
cause problems, you will prevent growth, you will cause crisis. That
view is profoundly wrong. It has been manifestly and repeatedly
demonstrated to be wrong. And the people who hold that view must change
their minds or they should be voted out of office.


BILL MOYERS:
If Wall Street's behavior doesn't change, can we have another financial
catastrophe like the one in 2008?



JAMES KWAK: The definition of insanity is repeating the same thing over and over
again and expecting a difficult result. And I think one of the core
messages in our book is that the fundamental conditions of the financial
system today are the same as the ones we had leading up to this crisis.
And it would be folly to expect a different outcome.


Now, the legislation will help in certain ways. It will certainly, you
know, it'll bolt the barn door after the horses have fled. The Consumer
Financial Protection Agency will make it much harder to have a bubble
built on subprime mortgages. But we'll have a bubble built on something
else. And it may even be on a market or a product that doesn't even
exist yet.


And that's why, again, legislation is helpful, but if you're going to
have the same kind of incentive structures on Wall Street and the same
degree of concentration, the same degree of political power, it's likely
that we'll have another financial crisis.


The financial world has gotten much more dangerous in the last 30 years.
We had this one. We had the stock market bubble of 2000. We had the
long term capital management crisis. We had the S & L crisis. We
had the Latin American debt crisis. And the question is, are these
crises going to-- are we going to somehow figure out a way to have fewer
of them, or a way to make them less damaging? And I'm not sure I've
seen that.



SIMON JOHNSON: The structure of the system is such that people will take these
egregious risks. That's what they're paid to do. They will mismanage
their companies. That is absolutely in their incentive. And they get
the upside, remember? Goldman Sachs just helped Geely Automotive, a
Chinese car company, buy Volvo from Ford.


Now, that's an interesting investment. It's a very risky investment.
If that goes well, Goldman will get tremendous upside. If it goes badly
or if Goldman's other investments go badly, who gets the downside?
Well, Goldman Sachs is a bank holding company now. They were allowed to
become that in September 2008 as a way to rescue them. They have
access to the Federal Reserve discount window. Okay? If Goldman Sachs
gets into trouble, that's the responsibility of the Federal Reserve and
the downside is for society. That is an untenable, unacceptable
position in America today.



BILL MOYERS: We are moving now toward the decisive moment in this fight for reform,
sometime in the next two or three weeks, we may well have a vote in the
Senate. But what are you going to be looking for over the next two
weeks that will convince you there is some possibility of true reform?



JAMES KWAK: Well, it's going to be a little bit difficult, because right now a lot
of the action is in the fine print. As often happens in the last phase
of bills. But I think there's going to be an attempt to weaken the
Consumer Financial Protection Agency. Even more than it's been weakened
already.


And essentially, what will happen is opponents will try to make the
C.F.P.A. subordinate to some other regulators, who can veto it. I think
that on derivatives, there's going to be a lot of action, essentially
on this issue of exemptions.


So, the derivative legislation looks quite good if you read the first
page and look at the headlines. But then there are exemptions inside
it. And the question is how big are the exemptions. The thing that we
care about most is on the too big to fail issue. So, are we going to
have real constraints on the size and scope of these banks? Things that
the Obama Administration unveiled in principle to great fanfare in
January.


They had a press conference with Paul Volcker and said we're going to
have these Volcker rules. Those rules have been considerably watered
down in the legislation. And I think that, you know, what we would most
like to see are serious constraints on the scope and the size of these
banks. Those are the main issues that I'll be looking at.



SIMON JOHNSON: So, the second Volcker rule was proposed in January was to put a size
cap on our largest banks at their current size. Now, that-



BILL MOYERS: $2 trillion?



SIMON JOHNSON: Yes.



BILL MOYERS: 2 trillion-



SIMON JOHNSON: Now, a size cap is a good idea. Obviously, the current size makes no
sense at all, because that's how we got into this mess. There will be
amendments brought forward to the floor of the Senate, if this process
has any integrity at all. For example, Senator Sherrod Brown has a very
good draft amendment.



BILL MOYERS: Ohio, right?



SIMON JOHNSON: Absolutely. And he will, in that amendment, press for a hard cap on the
size. And I think also restrictions on the scope. And they'll give a
lot more restrictions in legislation, which regulators will have a hard
time getting out to, in terms of what can be allowed in our biggest
financial institutions.


For me, at least Bill, that is going to be the critical moment. How
many people support that amendment or that kind of amendment. Does the
Democratic leadership come out in favor of it? Where does the White
House stand on this? If the White House steps back and the White House
says well, it's all up to the Senate, we're staying out of this. I
think you know what's going to happen. You're going to get mush, right?
Nothing really meaningful will come of it.


If the President takes the lead, the President takes this one, if the
President takes this to the country, takes on the Chamber of Commerce,
goes directly to people. And explains why you need to make our biggest
banks smaller. As one way, that's not a sufficient condition for
financial stability, but it's necessary and it gets at the heart of
their political power. Take on the big banks. Take them on directly.
That's what Jackson did. That's what Theodore Roosevelt did. That's
what Franklin Roosevelt did, too.



BILL MOYERS: Simon Johnson, James Kwak, thank you for being with me. The book is 13
BANKERS: THE WALL STREET TAKEOVER AND THE NEXT FINANCIAL MELTDOWN. We
will link this conversation with your website, BaselineScenario.com.



JAMES KWAK: Thank you.


ROBERT J. LEVIN:
Few, if any, predicted the unusually rapid...


DANIEL H. MUDD:
I did the best that I knew how...


ROBERT J. LEVIN:
In hindsight, if we and the industry as a whole had been able to
anticipate...


CHUCK PRINCE:
Regrettably, we were not able to prevent the losses that occurred...


ROBERT RUBIN:
I was not involved in the interactions between the company and the
regulators...


DANIEL H. MUDD:
Although I was not in the room -- it was executive session [...] I
don't, but I just don't know what the number was.