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Economist Simon Johnson, left, speaks with audience members after his May 20 talk. "Banks have every incentive to take reckless risks," Johnson said in his lecture. "They get the upside. They get the extreme bonuses, and the downside belongs to you.”

Simon Johnson

Kellogg Distinguished Lecture Series: Simon Johnson

The economist and author of <i>Thirteen Bankers</i> warns that banks deemed 'too big to fail' threaten the stability of the financial system

By Sara Langen

6/4/2010 - What would you do if you were told you would never receive a speeding ticket? You’d probably get into your car and drive as fast as you want.

Economist Simon Johnson believes that’s exactly the situation America has created, with banks that have grown so big they can’t be allowed to fail.

“People are afraid of the potential domino effect — is it big enough to bring down the U.S. or global economy?” Johnson said to a Kellogg audience May 20 as the final speaker in this year’s Kellogg Distinguished Lecture Series. “If you were too big to fail, what would you do? It would be tempting to speed because you have a lifetime exemption from speeding tickets. With the system of exemptions … these banks have every incentive to take reckless risks. They get the upside. They get the extreme bonuses, and the downside belongs to you.”

An expert on financial and economic crises, Simon Johnson is the Ronald A. Kurtz Professor of Entrepreneurship at the MIT Sloan School of Management and co-founder of BaselineScenario.com. His speech, “Wall Street, Washington and the Coming Financial Crisis,” was reflective of the views he expressed in his book Thirteen Bankers: The Wall Street Takeover and the Next Financial Meltdown, a major assessment of the U.S. financial sector.

When the government stepped in to stop the economic bleeding with the stimulus packages and bailouts, it only made the situation worse, Johnson said. Banks got bigger and taxpayers ended up footing the bill. Then why did they do it?

“To protect the economy, obviously,” he said. “To prevent the second Great Depression. But that’s just the fiscal side. What about the jobs lost? That’s the down side.”

Americans lost jobs as the economy bottomed out, and yet in 2008 and 2009, Wall Street fared well, with some banks and funds having record years and compensation high, Johnson said.

“This is not about recrimination,” he said. “This is not about me trying to be mean to the bankers. I’m not anti-finance, I want there to be a healthy financial sector. What worries me is the future.”

High compensation packages are just a symptom of a system out of control, he said. When banks were small, compensation was small. After deregulation, wages went up, finance became a more attractive job and banks got bigger. Now with the current bailouts, six banks dominate the financial sector. If the bailouts continue whenever there’s a problem, it becomes a repeated cycle, he said.

“It’s about the expectations of a bailout for creditors by creditors — that’s the heart of the problem,” he said. “Do you just sit back and ride the cycle? Well, you can if you want, but that’s not what I plan to do. What would break that? Reform. Change.”

The recent financial reform legislation helps, but much more needs to be done to break the cycle, Johnson said.

“We need to think and re-think our policy regarding the largest banks,” he said. “The legislation has some good pieces to it. These things are steps in the right direction. This has to change … or we will run through a different version of the same scenario.”