The bias toward creditors
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On Sunday, I was a panelist on ‘Up With Chris Hayes.” Among the guests was Robert Johnson, director of the Institute for New Economic Thinking. Right before a commercial break, Johnson said that one of the dynamics in the financial crisis is that the political systems in Europe and the United States are better at representing the interests of creditors than debtors. We didn’t get to return to that topic, but I asked Johnson to explain his thinking a bit more in an interview. A lightly edited transcript of our conversation follows.
Ezra Klein: So you say that both here and in Europe, the political systems are more responsive to creditors than to debtors. Can you expand on that a bit?
Robert Johnson: There are two dimensions to it. The first is what you might call the 99 percent versus the 1 percent. That is to say, our politics, our lawmaking institutions, are set up to disproportionately represent people who have money.
The second dimension is that our financial system now is so unwieldy and frightening that one does not need to be a class warrior working at the central bank or finance ministry to say, when given the choice between forcing Greek citizens through the grinder of austerity or attempting a debt restructuring that can unleash unknowable consequences in the credit default swap market or the relations between large banks, to choose austerity. They don’t understand what kind of collateral damage will be done when you resort to restructuring rather than imposing more austerity.
EK: That’s an interesting argument. Another way to put it, I guess, is that a risk-averse bureaucrat knows how to answer complaints about what will happen if Italy has to cut another 10 percent from its budget. He doesn’t necessarily know what will happen if the banks lending to Italy need to write down their loans. And he’s faced with a very smart, very well-dressed representative from the banks who is making persuasive, jargon-filled argument he doesn’t totally understand, that it’s rational for him to go with the risks he understands rather than the risks he doesn’t.
RJ: On any given Thursday, it’s probably right to acquiesce to the banks’ scenario, but if you tolerate that bullying from financiers over 20 years, then finance’s role ends up completely and violently disproportionate to its value to society. I can understand why in February 2009 nobody wanted to shut Citibank. It was easier to do forbearance. But the moral hazard we always talk about with debtors is only one side of moral hazard. The other side is when the creditors know they will always win those arguments, they know they can take more risk. So it might never be convenient to back these people down, but if you never do it, our society will suffer tremendously.
EK: And are the bankers wrong? Is there a case to be made, not just after Lehman, but in a political context where it’s very difficult to bail out any other banks, that we should be really, really careful about putting further stress on the financial system?
RJ: That’s right. If I were in Tim Geithner’s chair and had experienced the kind of hostility he and other government officials have experienced over the last few years, the idea that I could go into the president’s office and say we need to let some banks fail and go to congress for a bailout and resolution, the president would look at me like the marbles had fallen out of my head. In my opinion, that’s why they should have put something like Citigroup into receivership in 2009, because it would have given the public some hope that this could be done. But it would have been very scary to do. Citigroup is in something like 120 countries and all of them were scared and fragile in 2009. But at some point, this game has to stop.
EK: A discussion like this takes as its implicit premise that the interests of creditors and debtors are opposed, or that the interests of the 99 percent and the one percent are opposed. But over the long run, creditors will have trouble prospering if debtors don’t have money, and the one percent will have trouble turning a profit if the 99 percent can’t purchase their products.
RJ: A lot of this is what Paul Krugman calls the businessman’s fallacy: if I can get out of this trouble by putting pressure on my creditors or laying off my employees, I’ll be okay. But if everyone is doing it, not everyone can be okay. And this isn’t a zero-sum game. It’s not just you pay or I pay. Negative losses can occur, and so can mutually beneficial outcomes. So it will be interesting to see if there’s more cooperation going forward.
But the thing that surprises me most right now is why the big banks and bondholders aren’t much more aggressive in favor of fiscal stimulus. I mean things like 10-year infrastructure programs. I understand there are different philosophies of government between the right and the left, but I’m surprised more bankers aren’t saying we need to get people back to work. Austerity is never the endgame., It never works in the long run. You do it until something else breaks, whether financial calamity or social instability, and then you change course.
EK: Give me an example of the way that being too favorable to creditors can actually increase the losses they eventually will need to face.
RJ: I want to be clear: Greece has a serious, serious problem. They don’t have enough revenue. They could leave the EU and still need budget cuts. But Italy’s deficits are not out of control. But they will spiral out of control if their interest rates go from 50 basis points over Germany to 500 basis points over Germany. That’s where the new losses come from. Now Italy is paying so much interest when their debts roll over they are on an unstable trajectory.
EK: When all this ends, will the Eurozone have survived?
RJ: Imagine that a year ago, the European Central Bank had engaged in very aggressive bond buying, and they had created a common Eurobond, and a common set of rules and restrictions on deficits. If this had happened a year ago, and surrounded places like Greece and Portugal, then places like Spain and Italy would not have gone into this spiral. It’s as if people can’t make the preemptive decisions and can only take crisis-induced actions.
I think the Eurozone is going to look different. If I had to guess there will be a Northern Eurozone and France and Italy will sit right at the cusp and I don’t know if they’ll be in or out. But I don’t think the Eurozone will look like it is now unless we see signs of major restructuring very soon. Now, I think there are plenty of ways to keep the Euro from falling apart. But I don’t think they’ll choose to use them. I hope I’m wrong. But that’s what I think.