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An Insider’s Indictment of the Financial and Political Fortress

Posted by Larry Doyle on July 6, 2009 11:02 AM |

Simon Johnson

Why is the public at large so suspect of politicians and bankers? Why has the general media taken an enormous hit for not more fully exposing the holes in our economic foundation?

There is nothing like a 40% selloff across a wide array of assets to bring out cries for transparency and integrity. In that spirit, thankfully we have a former ‘insider’ within the financial and political fortress motivated to shed some real light on these pressing issues.

The Financial Times recently interviewed Simon Johnson, former chief economist at the IMF and currently a professor at the MIT Sloan School of Management (along with being a fellow contributing author at Wall Street Pit), and published Why Hopes of a Fast Recovery Have Been Much Exaggerated.

Johnson comments on the constraints he experienced at the IMF:

“I was trying to speak out while I was at the IMF,” he recalls, “but certain constraints come with position, and I found it was time to speak more bluntly than I could as an official.” (LD’s highlight)

While the economy and markets are screaming for transparency and integrity, Johnson succinctly puts forth what many have long held true–don’t believe any of what you hear from a politician or a banker, and only half of what you see.

Johnson does not stop there as he boldly further implicates the power base both on Wall Street and Washington:

And blunt he was in a recent article in The Atlantic entitled, The Quiet Coup, in which he noted a disturbing similarity between emerging market failures and the US. “Elite business interests – financiers in the case of the US – have played a central role in creating the crisis,” wrote Mr Johnson, “making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse.”

What he finds even more unnerving is that these special interests “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.”

This theme of an incestuous, coordinated relationship between our financial and political industries is one I have worked to highlight often. I appreciate Johnson doing the same. While Johnson gives Washington some credit for utilizing a variety of tools to combat our economic troubles, he simultaneously indicts the Obama administration for being far too generous to the banks:

he says the president “bent over backwards not to really annoy the banks or to do anything harmful to their interests”. And to Mr Johnson, this could be Mr Obama’s Achilles heel. He thinks the so-called bank stress tests underestimated the worst-case scenarios by as much as a factor of two.

In regard to the Bank Stress Tests, recall that the results speculated that the Wall Street banks would incur a further $600 billion in losses under the ‘worst case’ scenario. That ‘worst case’ employed an unemployment rate of 10.3%, a figure most analysts and economists now take as a given.

Johnson offers piercing insights on a number of other topics, including:

1. the rally in the equity market

Mr Johnson thinks it is mostly a response to the end of the panic phase of the crisis and calm returning to financial markets.

But he does not think those two features alone can carry stocks very far. “We’ll need to see a turnaround in the real economy before investors believe the current rally is sustainable.”

2. the economic outlook

He fears that hopes of an immediate recovery have been greatly exaggerated, and thinks there is still a lot of nastiness that has to work its way through the system.

Nastiness? Read that as MASSIVE EMBEDDED LOSSES!!!

3. European outlook

he is sceptical about western European prospects. He anticipates anaemic growth for some time to come due to the European Central Bank’s refusal to sufficiently lower interest rates and embrace quantitative easing

4. emerging markets

“I like Brazil, Mexico, India, and South Korea,” says Mr Johnson, “countries that have made systemic changes, which have helped them to hold up much better than most people anticipated.” With an eye on good management, he would have between 20 to 30 per cent of a model portfolio in such places.

5. equities in general

he would be underweight equities in general. “I can’t imagine a return to the kind of equity growth we had seen over the past two decades, but I can imagine a 10-15 year period where stocks go nowhere.”

6. prospects for inflation

he believes quantitative tightening will be no easy feat to ensure impending inflation is contained, Mr Johnson agrees with many financial advisers that commodities will likely prove an effective hedge to future rising prices. But he cautions investors about the likely reinflating of commodity bubbles.

For the same reason, he also likes inflation-linked government bonds.

While we get more of the same political doublespeak from the likes of Joe Biden (“the Obama administration misread how bad the economy was…”), fortunately we have a respected economist, like Simon Johnson, who is free of the political and financial shackles and motivated to spread the truth.

I commend him!

LD

  • Mike

    How long can this current rally possibly last? DJ bubble burst @ 9500 perhaps?

    Do you think that the revision of FASB’s mark-to-market accounting rules will give banks an edge for this quarter as well? Certainly they won’t be able to rely on that crutch for much longer…

    I think the longer that U.S. and Goldman Sachs artificially extend this rally the harder we will fall. It seems that governmental skepticism is starting to become more and more mainstream.

    • Banks are “managing earnings” as much as they are “reporting them.”

      I see that Credit Suisse expects BofA’s loan chargeoffs to increase by 10%.

      Death by a thousand cuts…

  • JP

    LD, wondering if you read the Rolling Stone article about Goldman and your reaction to if you have. Thanks.

    • JP,

      On the to do list. Will have a full commentary within 24 hrs if not sooner.






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