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Do Obama’s Financial Reforms Measure Up Against Past Attempts?

May 13, 2010 at 12:00 AM EDT
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In his ongoing series of reports making sense of the financial system, Paul Solman talks to author and MIT economics professor Simon Johnson about how President Obama's attempts to regulate financial firms compare to reform campaigns of past presidents.

JUDY WOODRUFF: Finally tonight: breaking up big banks.

It’s an idea that’s been discussed and debated in the current battle to craft new laws regulating financial institutions. And it’s an idea that past presidents have pushed.

The NewsHour’s economics correspondent, Paul Solman, has our story. It’s part of his ongoing reporting on making sense of financial news.

PAUL SOLMAN: President Obama all over New York recently, his much-publicized mission, to talk turkey to Wall Street.

U.S. PRESIDENT BARACK OBAMA: A vote for reform is a vote to put a stop to taxpayer-funded bailouts. That’s the truth, end of story.

PAUL SOLMAN: But bailouts won’t end, says economist and frequent NewsHour guest Simon Johnson, unless the big banks are made significantly smaller.

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SIMON JOHNSON, former International Monetary Fund chief economist: It’s worse than it was before the crash of September 2008. The biggest banks became bigger. They got these very big bailouts, unconditional bailouts. The Obama administration said it had no alternative, but that, by itself, is an extraordinary admission.

And our attempts to reform the system, our attempts to pass some legislation that will rein in the power of the biggest banks, the strongest banks, the J.P. Morgan Chase, Citigroup, Bank of America, Wells Fargo, Goldman Sachs, Morgan Stanley, those efforts, I think, are going to amount to, unfortunately, not enough.

PAUL SOLMAN: “13 Bankers,” Johnson’s new book with co-author James Kwak argues that America’s big banks have conspired to become too big to fail, and government must therefore break them up.

An amendment to the Senate financial reform bill that would have done just that, tougher terms than the president’s, was voted down last week. With the president and his proposals looming large over the city, Johnson took us on tour of Manhattan to talk about past presidents who took on too- big-to-fail and won.

First up, in a new musical at the public theater…

ACTOR (singing): I’m Andrew (EXPLETIVE DELETED) Jackson!

PAUL SOLMAN: An unlikely hero, given his antipathy to Native and African-Americans

ACTRESS (singing): It’s the early 19th century. We will take the land back from the Indians.

PAUL SOLMAN: But Jackson’s targets also included big banking, a hot issue in the early days of the republic.

ACTOR (singing): So, we will ruin the banks, and we will cripple the courts, and we will take on the world, for America’s sake.

PAUL SOLMAN: A little backstory here: The United States gets started as a great power because of this guy, the guy on the $10 bill, in some sense, Alexander Hamilton, First Bank of the United States. We need a large enough bank to make us one country and to stabilize our economy and direct it in useful ways, no?

SIMON JOHNSON: Absolutely.

There was a big debate between Hamilton and Jefferson at the beginning of the republic on what — how should we organize financing for commerce and for business and for agriculture? Hamilton says, you need to have a big bank, and Jefferson said, no, no, no, that would be dangerous.

Jefferson said, it’s the political power of the financial aristocracy that we’re going to create that we should fear. And he was right on that.

PAUL SOLMAN: But there’s the other side to it, which is the Hamiltonian side, if you will, which is, you do need concentrated power of some sort, financial power, in order to finance the growth of what has, after all, become the richest and most prosperous country in the history of the world.

SIMON JOHNSON: Well, that’s not what this guy thought, Andrew Jackson.

PAUL SOLMAN: Oh, you have got a…

SIMON JOHNSON: I have got a $20.

SIMON JOHNSON: And my $20 is bigger than your $10. And Jackson said that the Second Bank of the United States, which was what they were onto by the time Jackson came in, early — in the early 1830s in particular, the Second Bank of the United States had become far too powerful, that the existence of that power and that ability to control commerce, to control credit, to buy votes in Congress, and to really, he felt, distort the economy, that was unacceptable.

And Jackson took on the Second Bank of the United States and broke it, and put it out of business, actually. And we built the entire 19th century on a much more decentralized financial system and much smaller banks, actually, than Hamilton had envisaged.

PAUL SOLMAN: But big banks and big business were not down for long, says Johnson, who pressed his case at New York’s American Museum of Natural History, built by, among others, the father of President Theodore Roosevelt, out front today, flanked by a clearly subordinate Native and African-American.

T.R. as a Johnson hero?

SIMON JOHNSON: I’m not proposing Teddy Roosevelt for president today. Don’t get me wrong. A lot of the attitudes of that era feel, you know, very alien to us now, with good reason.

But — but Roosevelt certainly didn’t like the part about concentrated financial power and the way that challenged democracy. So, he took J.P. Morgan to the Supreme Court. And everyone thought he was going to lose, because the Senate was called the millionaires club for a reason. And he only won in the Supreme Court for 5-4, the narrowest possible margins. That’s what started modern thinking about antitrust.

PAUL SOLMAN: So, Teddy Roosevelt wins against the great financier J.P. Morgan, against the Standard Oil Trust.

How long does that then become the reigning paradigm in American government business relations?

SIMON JOHNSON: Well, Teddy Roosevelt beats the industrial trust and the railroad trust, and he shifts the consensus, Paul, so that, by 1912, everyone thinks, if you run a massive oil company, that could be dangerous to society.

But Teddy Roosevelt didn’t really fix the banks. We got a strange compromise. The Federal Reserve was a compromise between the government and the big powerful players in the private sector. The bank that came out of that wasn’t particularly in favor of constraining the power of the big bankers, and they came back in the 1920s with a vengeance. They had a great boom. It was a fantastic party, but then it ended badly.

PAUL SOLMAN: In the stock market crash of 1929, that is, and the Great Depression that followed, a crisis that Johnson credits Franklin Delano Roosevelt with resolving. And where to commemorate him?

This is the FDR Drive in downtown Lower Manhattan.

SIMON JOHNSON: Yes. FDR really changed fundamentally the infrastructure of this country, both the physical infrastructure and the financial infrastructure, and did a really good job. The country had a very good 50 years.

But the physical infrastructure got a little bit overwhelmed, and it needs rebuilding, to some degree. So does the financial infrastructure. It’s the same point. Nothing lasts forever. FDR did a great job. We now have to go out and do it again.

PAUL SOLMAN: What’s the financial infrastructure that he built?

SIMON JOHNSON: Well, he really created a modern framework — legal framework that reined in the big powerhouses on Wall Street. So, we got the securities act — we got two securities acts. We had the Glass-Steagall banking restrictions as part of that.

Specifically, it said there is something called commercial banking, which is basically handling payments around the economy and making very simple loans to consumers and families, and then there is something called investment banking, which is about raising money for firms and helping money — helping firms manage their money in a sensible manner.

We’re going to separate these two activities out. They had become very commingled, and the investment banks had really been driving a lot of stock market speculation in the 1920s. So, they thought, if we make this split, we will keep the families safe, and the firms can go out and do things a little more exciting, because they know what they’re doing, but it won’t affect the economy in a big, bad way, like it did in 1929.

PAUL SOLMAN: That split, between commercial and investment banking, was repealed in 1999, when banks were deregulated, laying the groundwork, some say, for the current crisis.

President Obama would restore the split in a measure now being debated in Congress.

BARACK OBAMA: Banks will no longer be allowed to own, invest or sponsor hedge funds, private equity funds or proprietary trading operations for their own profit, unrelated to serving their customers.

PAUL SOLMAN: A necessary reform, says Simon Johnson at our last, rather obvious stop, but, even with the overall reform bill the president is still backing, he says, not sufficient.

SIMON JOHNSON: Look, the reform bill is — it has some good ideas. And I support the consumer protection part. I think the derivatives proposals, hopefully, will be sensible. These are things we need.

But the bill, unfortunately, doesn’t get sufficiently to the heart of the problem, which is the size and the power of the biggest six banks in our economy. It’s only six banks. Fixing this problem would not be hard, but they’re very powerful banks. Their executives are everywhere. Their lobbying money is — is phenomenal, and they would fight very hard and probably block attempts to amend the financial reform bill so as to constrain the power of the biggest banks.

PAUL SOLMAN: That’s the nub of the fight on the bill as of today.