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Off With the Bankers—A Commentary by Simon Johnson and James Kwak ’11

The following commentary was published in The New York Times on March 20, 2009.

Off With the Bankers
By Simon Johnson and James Kwak ’11

Simon Johnson is a professor at the M.I.T. Sloan School of Management and a former chief economist at the International Monetary Fund. James Kwak is a student at Yale Law School.

A.I.G. can hardly claim that its generous bonuses attract the best and the brightest. So instead, it defends the payments by arguing they're needed to retain employees who are crucial for winding down transactions that are ''difficult to understand and manage.'' In other words, only the people who stuck the knife into the American International Group can neatly extract it for a decent burial.

There is no reason to believe this.

Similar arguments made during the 1997 Asian financial crisis, when currencies and stock markets collapsed in much of Southeast Asia, turned out to be a smokescreen to protect the executives who were partly responsible for the mess. Recovery from that crisis required Indonesia, South Korea and Thailand to close or consolidate banks. In all three countries, bankers protested, claiming that their connections with borrowers were critical to recovery.

In South Korea, cozy relationships between banks and the large conglomerates called chaebols were a major reason for the crisis. But after the crisis hit, Korean bankers and companies insisted that the complexity of chaebols like Samsung and LG -- with their many separate but interwoven businesses -- meant that outsiders would not be able to distinguish good loans from bad.

In Thailand, some argued that the preponderance of family-owned businesses -- and the lack of clarity about precisely which family members were really in charge -- meant that only bankers already working in big institutions like Bangkok Bank and Siam Commercial Bank could determine which borrowers were creditworthy.

The leaders of Thailand and South Korea did not listen to such arguments, and thank goodness. Some of the leading Thai banks were taken over by the government. After the crisis, a civil servant in charge of one such bank noted that its bad loans were much bigger than had been indicated before the takeover, largely because of an internal coverup. Only when outsiders took over did the public discover the full scope of the losses.

The South Korean government also demanded that the banks and the chaebols make a clean break. This generated a great deal of political noise -- particularly when foreign managers were brought in, as when the Carlyle Group bought a stake in KorAm Bank in 2000 and Lone Star Funds purchased the Korea Exchange Bank in 2003.

But these reforms made all the difference. Banks became healthy and resumed lending within a few years after the crisis broke. The chaebols that survived are stronger than they were before the crisis. They are now withstanding the severe pressure of the global recession because they were forced to become better regulated, and more separate from banks.

Indonesia did not respond to the crisis so wisely, and the costs were severe. In 1997, Bambang Trihatmodjo, a son of President Suharto, had to close his troubled bank, Bank Andromeda, but proceeded to continue essentially the same operation under a different bank's name. The new bank was only a small player in the overall economy, and the ruling elite seemed to think that no one would care. But Indonesia lost the support of the United States when it reneged on promises to replace failed bankers with more competent and honest ones.

The lesson of all this is that when insiders have broken a financial institution, the most direct remedy is to kick them out. Traders are hardly in short supply, and you don't need to rely on the ones who made the toxic trades in the first place. Companies must always plan around the potential departure of even their star traders, or they are certain to fail. A.I.G. does not need to keep all of its traders, especially since it takes far fewer people to unwind a portfolio than to build it up.

If A.I.G. wants to argue that complex transactions, hedging positions and counterparty relationships require employees who are intimately familiar with those trades, it should at least provide evidence that the arguments for doing so are sounder than the ones made in Indonesia in 1997, when leading bank-owning conglomerates claimed that only they understood their financing arrangements, which certainly were complex. Or the Russian bankers in 1998 who were convinced that only they and their friends could possibly close the deals that they had taken on. We heard variants of the same idea in Poland in 1990, Ukraine in 1994 (and in the Ukrainian crises subsequently), and Argentina in 2002.

Any grain of truth in these arguments must be weighed against the costs of allowing discredited insiders to manage institutions after they have blown them up. Even if the conclusion is that a few experts need to be retained, offering guaranteed bonuses to virtually the entire operation is hardly the way to achieve the desired results. We should not let people think that the best way to guarantee job security is to lose lots of money in a really complicated way.

The argument that A.I.G.'s traders are the people that we must depend on to save the United States economy is as weak and self-serving as it was in Thailand, Korea or Indonesia. A.I.G. is essentially advocating survival of the weakest. Thankfully, the American people are not buying it.