An Interview with Harvey Stephenson
Grand Cayman, Cayman Islands, 20 January 2010
Brown Journal of World Affairs: Can you explain to us, in a nutshell, the role of political capture and financial oligarchy in the financial crisis of 2008?
Simon Johnson: The financial crisis of 2008-2009 was primarily a result of reckless risk-taking by the world's largest banks. The essence of the problem is that they have not changed their behavior. You could argue that before the crisis they saw themselves as too big to fail. Now, post-crisis, the surviving banks are definitely too big to fail. All of the incentive problems-the distorted perceptions-that existed before September 2008 remain with us. In fact, they are actually worse; the problem has been worsened by the crisis.
Journal: You have argued that the crisis was a result of an unfortunate relationship between the financial sector and the government?
Johnson: It is obviously something that has developed over a very long period of time. One needs to go back to the Reagan revolution at the very beginning of the 1980s and look at the move towards deregulation more broadly in the U.S. economy. In that context, some of the deregulation was sensible but the deregulation of banks had the unfortunate consequence of making them generate more money, which they plowed back into developing critical connections and convincing people they were invincible and the front of unstoppable growth. All of that turns out to be not only wrong but also a very dangerous set of beliefs.
Journal: In your article, "The Quiet Coup," which appeared in The Atlantic (May 2009), you refer to this phenomenon as cultural capture. Could you explain this term?
Johnson: It refers to a particularly unusual form of oligarchy in the financial industry that rules not through intimidation or corruption, but through convincing people that more finance is good, more unfettered finance is better, and completely unregulated finance is best.
Journal: You have dealt with similar crises, if on a somewhat smaller scale, in the context of the emerging economies while you were the Chief Economist at the International Monetary Fund (IMF). Did you ever expect to find a comparable situation in an advanced economy?
Johnson: No. It is fair to say that, at least prior to 2005-2006, very few people expected these kinds of problems in the United States. The view that many of us had was that the United States had experienced problems in the past but had matured to a political and financial point at which it could experience problems without repercussions anywhere near as severe as what we are observing today. Obviously we had seen Long Term Capital Management-the collapse of a large hedge fund in 1998-and we have seen U.S. involvement in international financial crises. But to have a crisis of confidence in the heart of the global financial system-that was unexpected. Going back to when I was working at the IMF as Chief Economist in early 2007, it became clear to me that there were deep problems at the heart of the system. I would not say that the crisis of September 2008 was a big surprise coming from that perspective.
Journal: How do you think political capture has affected the policy response during the crisis and in the run-up to the crisis?
Johnson: It had a big effect. The rescue package provided by the U.S. government, both under the Bush administration and again under the Obama administration was one of the most generous in the history of financial bailouts. While shareholders did take some losses, creditors were almost entirely protected. The key is the insiders-the managers the of the big banks who have brought their institutions into massive crisis-who were largely left intact financially, to the extent that they walked away with enormous compensation packages, and, in many cases, kept their jobs. This is reflected in the bonuses that they paid themselves-large bonuses for 2008 and even larger bonuses for 2009-which really reflects the return of risk-taking. …