Institute for New Economic Thinking President Rob Johnson | The Meltdown of Trust, Bank Closures 🏦

By Kirk Enbysk on March 23, 2023

In this interview, we speak with Rob Johnson, the President of the Institute for New Economic Thinking, about the state of the U.S. economy in 2023 and the recent closure of Silicon Valley Bank. Johnson shares his insights on a range of topics, including:

– The overall health of the U.S. economy and its prospects for growth in the coming year
– The impact of inflation on consumers and businesses, and whether it is likely to persist
– The role of the Federal Reserve in shaping economic policy and its response to recent events
– The closure of Silicon Valley Bank and what it says about the state of the tech industry and the broader economy

Johnson brings a wealth of experience to these topics, having served as Chief Economist of the Senate Banking Committee and as a Managing Director at Soros Fund Management. He is a leading voice on economic policy and has been featured in numerous media outlets.
#economy2023 #economicpolicy #techindustry

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Full Transcript:

Alex Moazed (00:05):
Hello and welcome to today’s episode of Winner Take All. Very delighted to have special guests with us. Rob Johnson, the president of the Institute for New Economic Thinking. Rob, great to have you with us today.

Rob Johnson (00:19):
It’s my pleasure.

Alex Moazed (00:20):
And we have Nick Johnson, managing partner in Applico and co-author with me on the book, Modern Monopolies here as well. Nick, great to have you with us.

Nick Johnson (00:26):
Good to be here. So Rob, maybe we start with what is INET and why is it relevant to today’s conversation, which is obviously we’re going to get to Silicon Valley Bank here, but I think really interesting tie in and great to have you here given your experience in the area.

Rob Johnson (00:43):
Well, I think the Institute for New Economic Thinking’s purpose is to explore and challenge the notions or the visions or the parables that come out of the economics profession, which has been almost a form of secular religion in the period since World War II, and particularly since the election of Ronald Reagan.

(01:10):
What happens to be, we might call the traumatic birth experience, which is analogous to today was the great financial crisis, 2008, the Lehman Crisis and the follow on to that.

(01:28):
I will emphasize that we’re not just talking about technical finance, we’re talking about the coherence of our society. And I’ll point you to my many times partner Alex Gibney, and a man named David Sirota made an audible podcast and it’s called Meltdown.

(01:45):
And Meltdown is not about the meltdown of the financial markets, it’s about the meltdown of trust in expertise in governance that followed the bailouts, which as the famous economist Joe Stiglitz said, the polluters got paid.

(02:03):
And a lot of the people who suffered saw that and felt a very powerful sense of, we’ll call, deep corruption and injustice. And how that disintegration spawned occupy Wall Street on the left, the tea party on the right, a transformation to a Republican house, a Republican senate, and the election of Donald Trump.

(02:27):
And I have emphasized that even Steve Bannon, who was part of the campaign for Trump, used to talk about how Donald Trump would never have been president if he’d had a just bailout. And his own father, I believe had been an employee AT&T and lost much of his pension.

(02:48):
But the catastrophe at that time unmasked some very, very simplistic notions about unfettered finance. And there were people, like our founding funder, George Soros wrote a book, Alchemy of Finance.

(03:13):
Earlier than that, a man named Frank Knight, Risk, Uncertainty and Profit and the notion of what’s called Radical Uncertainty, something that Donald Rumsfeld referred to as a defense secretary.

(03:26):
It’s not only there are unknowns, there are unknowable unknowns in the future. And in that kind of context, what kind of behavior or logic can be employed to protect the platform of financial markets for the good of a broader society, not just for the mother of all moral hazards, which is too big to fail banks taking too much risk and then getting bailed out.

Alex Moazed (03:57):
How does the past week’s events line up against that rubric?

Rob Johnson (04:01):
At that time, I’ll try a little more focus on the first round, which is 2008 Lehman and the TARP legislation, it was very important, despite who created the problem, to stabilize the financial system.

(04:19):
In other words, had they just allowed all the big banks to fail, we would have all go down the pipe with it. So you have to say regardless of what mistakes were made in the past, what’s the best thing to do now?

(04:37):
But what I think now is, and we’ll talk about where the fault lines were in a moment, but we’ve come to a place now where not only are the fault lines evident and the need, as Treasury Secretary Yellen and President Biden and others talk have talked about guaranteeing the deposits so that we don’t have a run on the banks, but we also have the hostility that Gibney and Sirota talked about in Meltdown right there.

(05:17):
In other words, are we making the same mistakes twice? Well, it’s just like the old time, first thing you got to do is stabilize the system, then you got to learn the lessons that maybe we should have learned and didn’t learn.

(05:30):
But you can’t just start frying people and engaging in divisive hostility, which is very present in our political culture right now and let the whole system sink.

(05:43):
And then the other dimension of this, which is newer in terms of its vitality or danger, is that the use of the dollar as the platform of global currency and particularly emerging market finance has created a very, very dangerous constellation of potential bank runs.

(06:12):
If as the United States is raising interest rates as the dollar is getting stronger, the tension in a place like in Latin America or China or whatever, where many companies have borrowed in dollars and then transferred through Ford Exchange market into their local currency.

(06:35):
Let’s just say money comes in through Hong Kong, which is pegged to the dollar, the Hong Kong currency, then it’s transformed into renminbi and deployed for development in China.

(06:48):
When the United States starts raising interest rates and so forth, it creates a currency mismatch where your liabilities are going up in value relative to your assets and can create a collapse, a bank run, and a collapse.

(07:04):
So what I’m saying is this isn’t just something in the continental United States, this is something that could propagate into Africa, lots of places in Asia and others which have depended upon a dollar system, which is now in question.

Alex Moazed (07:19):
Yeah, so a lot to unpack there. Maybe we back up. What’s your understanding of what really brought about the collapse of SVB?

Rob Johnson (07:29):
We have had very low interest rates for a very long time and a very powerful, what I’ll call tech sector momentum trade where people got long stocks and got rewarded for it, but the funding costs were very low.

(07:48):
Now some things are not necessarily already in the stock market as you guys will know. Some entities are hoping to go public at some point, but getting primary funding now at very low rates.

(08:03):
A bank like Silicon Valley Bank is taking in money, taking in deposits, but essentially where they were storing their liquidity was in long bonds, taking the money at zero in those days. Investing it at 2.6% and allowing people to do their transactions in that region, Silicon Valley or other regions that engage with their financial services there.

(08:42):
And everything’s moving along okay until when the Federal Reserve raises interest rates from essentially zero during the pandemic to 4-5%. Then the bonds start to sell off, now if you take a snapshot of Sun Valley Bank… Sun Valley, I used to have a house in Sun Valley. Silicone Valley Bank. Every time I see SV, I get confused.

(09:10):
But Silicone Valley Bank, you take a snapshot and what’s happened is they got a whole lot of deposits. They have assets that if they sell them, since interest rates have gone up, they start accumulating huge losses. If they don’t sell them, they say quote, hold till maturity. They got to find a way of stopping the run on the bank.

(09:39):
If they’re forced to liquidate to market there four losses, there’s a huge hole. And by the way, it doesn’t just pertain to that bank. There are all kinds of financial institutions.

(09:51):
I saw an estimate this morning, a man named Chris Wayland who’s a very, very good financial analyst. Talked, I believe, about something in the neighborhood of $12 trillion dollars of bond holdings by financial institutions.

(10:08):
And so the Silicon Valley Bank can be an example. They’ve now stepped forward and said, “That’ll be guaranteed.” The question is, how will that guarantee be realized if the Federal Reserve continues to fight inflation by raising interest rates? Or at some level, will the deglobalization that created the supply chain that created inflation now be offset by a recession in the West because the confidence in financial institutions will create a sense of investment caution and slow down our economy without needing to raise interest rates further.

(10:53):
I do think the key thing that that’s very hard for the Federal Reserve is if demand overheats relative to supply, it drives up inflation and then they crank up the interest rates to pull it back down.

(11:08):
But the reason of this inflation was not because demand overheated, it was because of the problems in the aftermath of the pandemic and the Ukraine crisis.

(11:19):
We had a supply shock, higher oil prices and de-globalization. That isn’t easily offset with interest rate hikes because they emanate from the supply side, not from the demand side. You want to rebuild the supply side now to bring inflation down, you want to create peace in the Ukraine to bring oil prices down.

(11:45):
You want to see the United States and China particularly work together on climate change. But the polarity, the adversarial chemistry, which has some deep philosophical basis, I’m not dismissing it, but to address what caused the inflation is not an overheating of demand or out of control wages.

(12:11):
On the other hand, now that the inflation is there, people want to mark things up, they want to catch up with inflation, they want to a wage adjustment and it can take on a dynamic which has to be stabilized itself…

(12:30):
So this is not easy in everyone’s stupid kind of stuff. This is really complex, yin and yang dilemmas about how to create the platform or for a prosperous society. And if you said to me what was wrong and I’ll say what was wrong is interest rates stayed way too low for way too long. People didn’t want to get away of the good feeling of the momentum bubble.

Alex Moazed (12:59):
Well no, I thought inflation was transitory.

Rob Johnson (13:03):
And by the way, then the pandemic turbocharged it. In other words, had there been no pandemic, that might have been the time when the central banks were raising rates to stabilize things, but they had to go the other way. And now those overhangs are coming home to roost, if you will.

Alex Moazed (13:26):
Want to double click on this kind of HTMAFS, right, Held To Maturity Available For Sale. I’m not an economist, but if I was to repeat this to you, how would you critique it?

(13:39):
My understanding is these banks, all of them, large, mid-size, are are all doing stress tests on their balance sheet. They all are complying with FDIC and banking regulations on needing to have a certain amount of their assets liquid, treasury bills and other kind of liquid assets.

(13:59):
And SVB and Signature had all been meeting these requirements, but my understanding is you could still have a liquid asset, be qualified to hit that ratio, that minimum threshold, even if it’s marked as held to maturity. And when a security is marked as held to maturity, even if it’s actually depreciated in value, you don’t have to mark to market that loss because you’re going to hold it to maturity.

(14:30):
And there’s a stat that more and more banks over the past 12 months have been marking more and more of their assets as being held to maturity so they don’t have to mark to market, they don’t have to book these losses.

(14:42):
So it seems like a little bit of a loophole. I don’t know if maybe I’m missing that, right? If you can technically hold a short term liquid asset but market as held to maturity, which means you’re not going to sell it anytime soon, don’t those things seem to conflict or I’m sure I’m missing something, like what am I missing?

(15:01):
And this problem, to your point earlier, seems to be present not just in SVB or Signature but the entire US, and really seems like global banking system where there are a bunch of assets that have depreciated tremendously and what do you do about it?

Rob Johnson (15:17):
Well, as some people have said, if the Federal Deposit Insurance Corporation and the Federal Reserve guarantee all these assets, then those losses may propagate to their balance sheet. They then report to the treasury and then it’s what I’ll call a socialized loss for society.

(15:35):
Now that hurts if you’re thinking about the future of public school education or addressing climate change or what other priorities we have. But on the other hand, if we don’t do those stabilizing bailouts given where we are, the depression, the collapse of the financial system could make things even worse. So it may not be a happy outcome but may be the best we’ve got.

(16:04):
Now going back to your mark to market, the idea that you can hold something to maturity and there won’t be a bank run is a hypothesis. And you can say if all of that coheres and nobody ever runs on the bank, then you limp your way. Not short term assets, they’re two to five to 10 year bonds.

(16:36):
But the question then comes, does the Federal Reserve keep raising rates, which is in a mark to market sense, downgrading those assets and expecting there to be no run on the system? There’s a dilemma that they face.

(16:51):
One is the goods market inflation that we talked about moments ago with in the aftermath of the supply shocks and the oil prices. The second one is do they accelerate the fear of bank failure on the part of depositors and provoke or run?

(17:12):
And then if they do that, does the public clean it up to the detriment of all and the detriment of our capacity to meet future challenges? And I don’t think there’s an obvious answer or that anyone’s stupid. I think we are cleaning up after interest rates that were too low for too long and now we’re in a place where, what you might call the feel good optimism.

(17:43):
And by the way, there are some beautiful podcasts that I want to turn your audience onto. There’s a man named Howard Marks, M A R K S, not like Karl Marx, but a different spelling.

(17:56):
Brilliant man in understanding the psychology of finance and he’s got a podcast on all the major platforms called The Memo. There’s a wonderful article right now by my board member at INET, Richard Vague, who’s been a financier and been very involved in many things, including being a commissioner of securities and banking regulation for the state of Pennsylvania.

(18:27):
Richard’s written a book called, I think it’s called The Brief History of Doom. It’s about how you can see these things coming if you really are a financier, and he’s got an article in the journal called Democracy right now about SVB and the ramifications, which I think is very mature and intelligent.

(18:46):
So there are lots of ways to explore, but it’s not obvious what to do when we’re not doing it. What might have been obvious, and I remember Senator Elizabeth Warren protesting this. She is among the most sophisticated people in the US Senate about finance.

(19:07):
She ran the Congressional oversight panel after the TARP legislation and her knowledge… She’s a lawyer from Harvard Law School, but her knowledge in that realm, regardless of what you think are other aspects of her politics.

(19:20):
In 2018 when all kinds of banks basically at $250 billion in assets in lower asked not to be subject to stress tests and other things, she protested that legislation. It was passed despite her protests. But we have made mistakes, but what’s the best we can do now is the way I would frame the question.

Nick Johnson (19:49):
You spoke on this issue I think back when INET launched, I remember at the 2010 inaugural conference. You had a presentation that you shared with Alex and I where you spoke about what was the kind of true nature of the bailout then, which wasn’t just…

(20:06):
We’d have recapitalizing the banks, but also there are few other things like guarantees on contingent claims, expansion of central bank balance sheets and then also, which I think gets to the mark to market issue we were just talking about, forbearance on accounting standards. Which lets you for example, not mark down losses right away, which in the short term increases profits but socializes the risk.

(20:30):
Do you see that exact same thing happening today? I think we’re playing a bit of a word game on you. Was there a bailout? Was there not a bailout? Are the taxpayers taking on risk? Are they not in the political sphere? How would you kind of characterize what happened here versus what happened in 2008-09?

Rob Johnson (20:46):
I would say that as I mentioned earlier, the resentment of now and the socializing of risk is based on not having learned the lessons in 2008.

(20:56):
I do think there is some sense in which the collective, meaning the federal government, meaning all of the taxpayers, are bearing a burden to underwrite the stabilization of a platform that affects everybody.

(21:12):
In other words, the polluters should have paid, but once there’s pollution, we all got to clean it up. And so what I would say is this, to say I’m not a cause is correct for the average citizen and they can be resentful of being taxed. But to say I will not benefit from a stabilized system, meaning the externalities that economists call it, of the side effects of something that originated elsewhere.

(21:52):
I think that’s a misconception to pretend that if I don’t pay for it and it’s not paid for it, I will be unharmed. In essence, we’re all being invoked now to make the best of a bad situation in a way that doesn’t do us harm in the future.

(22:15):
So some of our taxes unfortunately are being utilized, or our capacity to be taxed is being utilized, to offset a danger that would affect you and I. So I don’t know where justice lies in all of this.

Alex Moazed (22:34):
I thought the FDIC said this wasn’t going to be paid by taxpayers, so I guess that’s fake news.

Rob Johnson (22:41):
I think it’s hopeful. What I would say, I Marty Gruenberg and I work together on the Senate banking committee. I think he’s a good guy. I think what he’s trying to say is if we can nip this in the bud and it doesn’t propagate and things settle down, then it’s probably at a scale now where the taxpayers won’t get drowned.

Alex Moazed (23:08):
Do you think it was too extreme of a response to guarantee all deposits? I was in some Twitter spaces over the weekend and Mark Cuban joined one of the spaces. And the sentiment there was best case scenario was that 50% of your money is available irrespective of the $250,000 limit, 50% of your money is available on Monday with a path to get back…

(23:36):
If you look at it, Silicon Valley Bank still has a bunch of good assets. So it wasn’t a scenario where even if you have $50 million in the bank that that’s going to go to zero. But maybe it was a scenario where that goes to $.90 cents on the dollar, $.85 cents on the dollar.

(23:53):
But it seems like we just went all the way to saying, yep, everything is secured. I saw the former head of the FDIC came out and said that this seemed way too drastic.

(24:06):
Again, it’s not like the fed has been batting a thousand on their calls the past few years. Was this the right decision to go this aggressive with the protection?

Rob Johnson (24:16):
Well, I guess there’s a dilemma here, which is if you go half-assed into the challenge, the run may continue and ultimately you’ll have to do more. If you go big in the promise and it deters a run, the ultimate amount that you will expend is diminished.

(24:41):
On the other hand, just as you point out from your conversations, going big at the start seems above and beyond and with the resentments that are the aftermath of the 2008, it’s going to trigger those wounds, those disputes.

(25:06):
So I don’t know what the answer is here. I think that if you said to me, okay, promise everybody a little bit and stuff, and the runs all continue, the runs get deeper, the eventual system de deteriorates, the economy slows down and we bail out more.

(25:23):
But you got to believe for me to play on the other side of that ledger that the promises we made will put out the fire preemptively, and so it’ll be a brush fire, not burn the whole forest.

Alex Moazed (25:36):
But did we put out the fire because you were just saying we might need to guarantee all of these depreciated assets and what was the number? I think that was a global number. I don’t know, in the trillions of dollars. I think CNN came out with the article and said, there’s $600 billion of unmarked to market losses.

Rob Johnson (25:57):
Yeah, that was the FDIC. That was Marty Gruenberg at the FDIC in November said that. Yes. And so the question is once the bank run starts to 620 go up fourfold… It’s not that some imbalances aren’t there and haven’t been focused on. It’s now at the starting gate of fear that’s been triggered by these episodes. Will it get bigger?

Alex Moazed (26:33):
It seems like we keep kicking the can down the road. We’re putting band-aids on what is a much bigger problem, which is when you put trillions and trillions of dollars it’s going to create imbalances and there’s going to be pain.

Rob Johnson (26:48):
Well, let’s separate two dimensions of this. I think you’ve done a very good job of emphasizing the dilemmas associated with the bailout, given the problems. That does not obviate the need to systemically fix the problems of the financial markets for the future.

(27:09):
In other words, whatever we’ve learned from the second round of mistakes, 2008 and the present, now needs to be applied to restructuring the financial system, the question of regulation, the question of enforcement…

(27:28):
When you have money in politics, which means senators and presidents and stuff got to raise a lot of money, a whole lot of interests will come with deep pockets to try to make sure who gets appointed to regulate them or to monitor them or to examine them or to enforce them or to make laws will be favorable to them. And if those concentrated interests succeed, the kind of fault lines that we’re experiencing today can continue.

Nick Johnson (28:04):
Is that part of what happened here? I know there was a rule that got put in place in the post of the financial crisis last time that said basically the threshold for being systemically important was much lower.

(28:17):
Eventually it got raised to $250 billion and of course magically SVB had $219 billion in assets. So it fell under that threshold. Did you see that playing a role here?

Rob Johnson (28:27):
Yes. I suspect when I talk about politicians needing money, it’s not isolated to the banking sector. And one of the big energies that the Democratic Party has relied upon is the tech sector in Silicon Valley.

(28:48):
And I don’t know necessarily that the people inside of SVB are what you might call the mega donors, but I think that their sector includes the mega donors. And obviously you can look at some people in the realm of this tech sector who have acted as if libertarian Free markets are the only pathway to success.

(29:22):
And I would say that we don’t need a market for politicians, a market for experts, meaning university endowments, and a market for the private media that defers to its large advertisers and doesn’t examine the problems that affect society.

(29:55):
In other words, I’d say we sometimes have too many markets, because when markets embedded in democracy, the long term health depends upon it representing people rather than just representing concentrated money power.

(30:16):
And when you do that and represent concentrated money power, I’m talking about long-term dynamic now, you can get into a place where concentrated money power is concentrated in fewer and fewer hands. And when you experience broad-based despair, and Donald Trump did a very good job of acknowledging that despair, “The system is rigged” was the mantra of his 2016 campaign.

(30:44):
I grew up in Michigan, a whole lot of people think the system is rigged. A whole lot of people are suffering, whether it’s from globalization, automation, machine learning, financial volatility, a large part of the population gets very despondent.

(31:01):
The danger, as my friend and author and columnist, Martin Wolf at the Financial Times talks about, the danger is authoritarianism. When you lose faith in government, you want somebody that comes in to stabilize the system. And you might be abandoning democratic institutions because you don’t think they work.

(31:31):
Do you repair why they don’t work, when I talk about money concentration or do you just overthrow them in ways that have very, very adverse side effects?

(31:47):
Martin Wolf came from a family that had suffered at the hands of the Nazis rise, and maybe that’s not appropriate analogy for now, but people are afraid of authoritarian rule. And as you know, many people now citing the difference between US and Chinese leadership refer to a lower authoritarian structure in China and what that portends.

(32:13):
I think that American integrity of governance is now being challenged again by the episode that we’re talking about today. You’ve got to make the platforms.

(32:28):
There’s a friend of mine at Union Theological Seminary once said to me, markets are not a god. Markets are a tool to achieve the prosperity. And yes, there’s a basis for believing in markets, but if you deify them…

(32:49):
And there’s a gentleman at Columbia University, Bernard Harcourt who wrote a wonderful book called The Illusion of Free Markets. Markets have to be embedded in governance, which is about equitable justice. I don’t mean redistribution. When you make a big difference and you get rich, but you’re helping society, that’s a good thing. If you’re making money from wealth extraction and you’re destroying people, you’re tempting authoritarian alternatives and that’s very dangerous.

Alex Moazed (33:19):
It’s interesting, this isn’t the first time this country has encountered any of the things that you just described. Literally everything you just described, this country has seen it all probably multiple times over. In these kinds of scenarios, I try and think back to other prior periods and I think about…

(33:39):
You’re very familiar Rob with Volcker and when he took over and had massive interest rate acceleration. Do you see parallels between now and then? Obviously there’s a bunch of differences, but where does your mind go when you think about past periods?

Rob Johnson (33:55):
Okay, we’ll talk about Paul Volcker, who I knew and greatly admired and worked with closely in many different contexts throughout my life.

(34:06):
When Paul came in, it was similar today in one respect, the inflation that ignited that was extinguished, say starting in 1980 came from a supply shock in some significant part, which was the OPEC rise.

(34:26):
I worked as an undergraduate for the famous oil economist, Morris Edelman, and I remember when University of Chicago was saying the Phillips Curve is dead, and Morris Edelman and Bob Solar were saying, no, it isn’t. It’s just the production function has a second input or a third input besides capital and labor, it’s called energy.

(34:47):
And so the supply shock there is not unlike, not specifically the same, but it is also it’s a supply shock now like it was a supply shock then.

(35:00):
I think the difference between that time and this time is very clear. Which was coming out of the sixties in the midst of the turmoil related to Vietnam and then problems in Iran during say the Carter presidency, there was a lot of fear that the republic was spiraling out of control, but labor share relative to capital share was much higher and unionization was much stronger.

(35:35):
So as we talked about earlier, you can get an inflation jolt from a supply shock. The question is, does it become part of the ongoing dynamic of marking up wages, which marks up costs and then the spiral continues.

(35:50):
Volcker approached a world where labor’s power and labor share was much higher than what J Paul is facing in the present time. And so I think there is some similarities, but I think invoking Paul Volcker as a hero and then going off super hawkish now is not paying attention to the subtleties that are very important about this situation.

(36:22):
And by the way, Paul Volcker wasn’t slamming the brakes on in the aftermath of quite such a big financial bubble as we’ve had since essentially 2010 since the reducing of interest, quantitative almost zero-

Nick Johnson (36:41):
Quantitative easing

Rob Johnson (36:43):
Yeah, quantitative easing is a good way to put it. So the other thing I would say, I don’t know J Paul, so I can’t comment there, but Paul Volcker was amazingly sensitive to all these different dimensions and aware. And number two, he wasn’t a dogmatic economist who took out the kind of recipe book that INET was created to challenge.

(37:14):
Paul Volcker was very subtle. And by the way, at the formation of INET, Paul Volcker was one of the donors. And then he built something called the Volcker Alliance, which was the last act in his life.

(37:26):
And other people like the famous investor, Ray Dalio and others supported him. Which is we need to create a senior career well-paid civil service that administers this market system with a depth of training and intellect and experience that Paul feared was not being promoted. Where the best and the brightest weren’t seeking roles in financial administration and regulation.

Alex Moazed (38:00):
I found this analysis looking at bank closures. And so if you look at the eighties, there’s a massive spike to the point where you had almost 250-300 banks and like 87 close.

(38:14):
But I guess what you’re kind of positing is if we were to have a lot of bank closures, does this thing spiral out of control? I don’t know. Or are some bank closures needed? And I guess what’s also, I didn’t even really know this, that there’s still more banks closed in the Great Depression. I guess this is saying almost 4,000 banks closed relative to about 1,600 banks closed kind of in that Volcker period of time.

(38:40):
So still a lot less than if we go back almost a hundred years. But compared to today, just seems like, I don’t know if we have a more fragile economy because we’ve printed so much money and then the reverberations are just so much greater because of the money printing. The concept of QE didn’t exist 40 years ago.

Rob Johnson (39:02):
Yeah, well first of all, I worked as the chief economist at the US Senate Banking Committee from essentially 1986 to 1989 under William Proxmire. That was the ’87 stock market crash. And that was what’s called the savings and loan crisis.

(39:23):
Many of the financial institutions that collapsed at that time were part of the savings and loan crisis. There were questions of regulatory appropriateness around savings and loans.

(39:39):
There were a lot of savings and loans that were supported by the FDIC, the Federal Savings and loan, the FSLIC, the analog to the FDIC, but nothing on the asset side was being monitored or restricted. And when they spiraled out of control, I was part of the design of William Seedman that ran the FDIC and Volcker and then his successors at the Fed.

(40:11):
We worked on essentially how to not make that mistake again. And the savings and loan bailout was, I can’t remember, a $100-$150 billion of budget, but the institutions, none of them were too big to fail.

(40:35):
There were elements you go back to what’s called the Keating five episode, Lincoln savings from Arizona. Charles Keating was active in trying to persuade, I believe the Keating Five were five senators, to lay off the regulation of the asset side of savings and loans. And the Keating five episode put the zoom lens on that dimension.

(41:09):
Maybe we didn’t go far enough and so years later, the Keating Five episode is like 1988 to 1990, so you’re talking almost 20 years later, those same kind of things that we saw… And Charles Keating’s, not alone, it’s the parable, the highlight reel of that time. But we started seeing that at the too big to fail banks in 2006, ’07 and ’08.

(41:47):
And I guess it might be that this episode, if it doesn’t turn into a broad base run, is closer to the savings and loan structure than it is to the too big to fail structure.

(42:02):
A lot of people now feel that the too big to fail banks are going to be the beneficiaries because when there’s fear of default, everybody will shift their deposits in under that umbrella because they believe they will be guaranteed.

Alex Moazed (42:15):
Chase just got $15 billion in fresh deposits in a week, and I think Bank of America also.

Nick Johnson (42:22):
The ones in trouble are the regional banks or the niche banks like an SVB. It seems like the ones that are winning somewhat ironically, given that we have some of the deregulation that was passed in, I think it was five years ago now or six years ago now, was intended to help the regional banks and the smaller guys, and now it’s put them at risk, which has swung the pendulum back in the other direction to the too big to fail banks, so to speak.

Alex Moazed (42:51):
Should we end on a positive note? Let’s talk about the global knock on effects you teased us with in the beginning here. So we can really project out what this doomsday scenario could look.

Rob Johnson (43:01):
Well, let’s focus for a moment on Hong Kong. If, as I’ve read, a whole lot of dollar loans, went into the Hong Kong banking sector and then are transformed into renminbi and used to develop firms in China, and we have a global recession and the dollar continues with higher interest rates to strengthen, do we see an outbreak of the default of Hong Kong banks?

(43:41):
Was the Hong Kong financial sector, and I’m using Hong Kong as one analogy. There were things going on in Latin America, there were things going on in Eastern Europe and et cetera, but if that were to happen in Hong Kong, would the Hong Kong banking sector be wiped out with the financial center of China that’s renminbi based, migrate to Shanghai, and it further distances Chinese finance from Western finance.

(44:11):
Their currency is not convertible, and many people had hoped that the sophisticated firms, the leading firms, the leading brand names in the west would be able to inhabit the Chinese financial market, but they had opted to maintain that distance. But is Hong Kong going to be the sacrificial lamb of this dollar crisis and will China then further decouple from the United States or from the dollar system?

Alex Moazed (44:47):
If there’s any silver lining to the amount of money printing that the Fed has been doing, the Chinese put us to shame, right? So is that what you’re kind of getting at if we’re talking about kind of fragility and these reverberations throughout the financial system that, you may not think it because they’re the global production powerhouse of the world, but they’ve been printing probably two or three X the amount of money that we have.

(45:13):
And if this shock spreads into China, they basically need to decouple, right? Because they can then sustain the dream inside of their bubble, but they got to close the bubble some more or something to that effect. Is that kind of what you’re getting at?

Rob Johnson (45:27):
I’m going to recommend that people pay attention to two gentlemen that I’ve recently made podcasts with. The first is Steven Roach who used to run Morgan Stanley Asia, he’s now at Yale University. And in particular Jim Chanos who was a famous short seller and deep, deep focus on China.

(45:50):
And I know that Jim’s work, he was one of the people who really illuminated the Enron scandal, the off balance sheet things and so forth that we learned about there. He played an enormous role in that unmasking.

(46:07):
But what people have said to me, like these two gentlemen, is that the Chinese dynamic started with export led growth, was moving towards building their own tech sector, but the power, the thrust of recent years, started out with infrastructure development, trains, highways and so forth, and then moved to primarily residential but also commercial real estate.

(46:37):
And now that in China, the real estate boom is decelerating, they have growth challenges as well. And whether foreign cutoff in having China be… I won’t say a closed economy, that’s not right, but having it being segmented, particularly in the financial sector in this next phase may mean that if they had a slowdown and they had a real estate crisis, an awful lot of the Chinese population would be subject to those losses either, as owners of real estate or as people seeking employment in a stagnant economy. So I think there are a lot of challenges in China as well.

Nick Johnson (47:33):
You mentioned the Chinese tech sector. What do you see as part of this crisis… Emanated from the flow down of the tech sector which drained the deposit base of SVB over time, what do you see as the impact of how this propagated on the tech sector, both in the US as well as globally and then particularly China?

Rob Johnson (47:54):
That’s a very powerful and important question, Nicholas. I would say that I’ve had meetings over the years with many of the leaders in the Chinese government, high level officials, not Xi Jinping, but high level officials.

(48:12):
And many of them said to me, we are facing a challenge because the technological platforms provide a service, say like Amazon and Google and others, but they also create data, which can be an asset to the intelligence community, to the national security people.

(48:38):
So the Chinese were very reluctant to open up digital commerce to the United States… I mean firms from the United States, private sector firms, you know, the Apples, Googles and so forth… And then feel like they were being watched.

(48:58):
Similarly, I think the United States, I know a lot of people when I worked in the Senate primarily with Pete Domenici on the Republican side who’ve been made very, very powerful careers in national security realm.

(49:14):
And they talk about the concerns they had when they felt Chinese tech firms were coming to Silicon Valley to learn about and accelerate the diffusion of the knowledge about technology which they could take back home, and that it would invigorate their national security apparatus.

(49:42):
In other words, by not adhering to the national boundaries of the national security community, American tech firms were facilitating making China more dangerous. That was the view of these people.

(50:00):
And a lot of these people, by the way, who are more like my generation, not your own, in the national security apparatus, they viewed themselves as the co-authors of Silicon Valley.

(50:19):
DARPA, the NSA and other things created something and they often found it quite ironic that many of the Silicon Valley leaders became libertarians because their birth experience was fostered by the government.

(50:37):
But I think there are a lot of people who are wise in Silicon Valley and understand that collaborative dimension, but the Chinese curiosity surrounding Silicon Valley ignited the fears that technology would be diffusing to China and used in ways that were dangerous for the United States.

Alex Moazed (51:04):
That’s a great point to end on. Robert’s been a pleasure having you on today. I think lots of developing dynamics with this story. Hope to have you back on and really appreciate your insights today.

Rob Johnson (51:16):
Well, thank you. I want to just say to you, I don’t think demonization is helpful here. I think there are things that are wrong, but there are very large challenges that have to be understood and corrected now.

(51:34):
And I don’t think simplistic polarity and hostility within the financial sector between sectors in the United States, between the US and China, the challenges on the horizon are enormous and we have to diagnose things. My dad was a doctor, you got to diagnose things before you can prescribe a proper remedy.

(52:05):
But doing the diagnostics is different than demonizing and I really want to warn against demonizing. We can hurt ourselves and everybody around us. We can sink the ship of life on planet earth if we’re not careful here.

(52:23):
So next time, if I come back on, I promise you it’s 55 minutes of good news and 5 minutes of bad news. But right now I think the challenges are ominous and I appreciate your including me in the conversation.

Alex Moazed (52:37):
Absolutely, Rob. Nick, thanks for joining today. That’s it for us on Winner Take All. We’ll talk to you soon.

 

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