Q&A With Simon Johnson On Financial Reform

Economist Simon Johnson responds to our questions about Washington's financial regulation effort.

Last May, former chief economist of the IMF, Simon Johnson, wrote an Atlantic article explaining how policymakers should act to avoid allowing banks to break the U.S. economy again. Now that financial reform is finally underway in Washington, we thought it might be useful to touch base with Johnson to get his views on the reform effort thus far. Our questions and his answers are below:

Atlantic Business: In your mind what's the single most important regulatory measure that Washington's policymakers have proposed?

Johnson: The big change in policy this week is the move by the president to reduce the size of our largest banks. "Too big to fail" banks have to be reduced in size; that's the only way to reduce system risk to more reasonable levels.

Are there any lessons from health care reform that Congress should note in pursuing financial reform?

Seeking the middle ground - that last Senator - perhaps made sense for health care reform. It was never going to work as a way to achieve meaningful financial reform. You have to change the terms of debate and confront concentrated power much more directly. That is now where we are headed.

The Obama plan tries to retrace the bright line between commercial and investment banks. But banks like Lehman and Bear didn't have a commercial charter when they got into trouble. So how would the Obama plan have prevented their failure?

It probably wouldn't - and this is why the details of the Obama plan (or the "Volcker Rule") need to be looked at. I don't think what they have put forward is the last word. Rather is a sensible general idea - that the largest banks should become smaller - and it is a clear signal that the president is willing to fight on this issue.

Is compensation getting too much attention or not enough?

Compensation, particularly bonuses, in the financial sector are a symptom of a deeper problem - distorted incentives for big banks to take reckless risks. They reflect the real problem, but you have to deal with that problem directly - TBTF financial institutions.

How important is deficit reduction for Congress in achieving a healthy U.S. economy?

Over the medium-term (call it 5-10 years) it's very important to reduce the deficit and keep government debt under control. High deficits and runway debt lead to inflation and other serious economic problems.

What do you say this argument: Our very very big banks have to be very very big because they deal with a wide range of services. If you force them to be smaller, you'll unnecessarily strangle credit simply to avoid a once-in-a-century event?

Major international crises occur every 5-7 years according to Jamie Dimon (head of JPMorgan Chase) and every 3-5 years according to Larry Summers (chief economic guru in the administration). No one can show you any social benefits to banks growing beyond $100 billion in assets - and we see the social costs quite plainly (8 million net jobs lost since December 2007). Capping the size of our largest banks - at 1/5th or 1/10th of their current level - would not strangle credit.

Who should regulate the biggest banks?

Great question with no easy answer. You need a tough regulator who can stand up to the banks. Someone who is not captured by their ideology. At this time, we have neither such people nor such an institution in the United States.

Many of the banks that failed or almost failed in 2008 were subject to significant regulation from a variety of agencies in Washington, but they didn't catch the meltdown. How would you reorganize our regulatory structure to prevent the next crisis?

Another good question with no obvious answer. I would bring in a new Fed chair - someone who would be much tougher on too big to fail institutions, like Tom Hoenig, president of the Kansas City Fed. I would give him the power, the people, and the resources. And I would break the biggest banks into much smaller units. Then at least it would be a fair fight.