The Next Financial Crisis

• Date: 01 September 2011
• Author: Simon Johnson
• Published date: 01 September 2011
• DOI: http://doi.org/10.1111/j.1467-8683.2011.00874.x

Commentaries

The Next Financial Crisis

Simon Johnson

Kurtz Professor of Entrepreneurship, MIT Sloan School of Management

The topic of my talk is the next f‌inancial meltdown. There

are three important questions. First, is the f‌inancial

crisis over? Is the previous meltdown–namely the crisis that

really broke out in earnest in the fall of 2008–over? Are we

moving fully into recovery phase? And I am afraid that my

answer to this question is going to be “no.”

The second question is: If we are not out of the previous

crisis, have we at least f‌ixed the problems that led to that

crisis? Although the recovery may be painful, because the

f‌inancial system around the world almost collapsed, have

we learned the lessons? Have we changed the policies? Have

we changed our attitudes towards the key variables? And

there, I am afraid my answer is also going to be, and prob-

ably more emphatically, “no.”

The third question is: If we are not in the recovery period

and if we have not f‌ixed the problems, is the worst thing we

have to fear a repeat of what happened before? I am afraid

the answer there again is “no.” It could be seriously worse.

Let me give you the bottom line right now. This was an

interaction I had with the board of directors of a big bank –

not a US bank. This particular bank is serious and handled

itself very well ahead of the crisis and, therefore, came

through it. I was talking to the board of directors, and one of

the directors with a great deal of experience in this area said,

“Look, Simon. Too big to fail is here to stay. There’s nothing

you can do about it right now.That problem of banks believ-

ing and creditors believing that the banks cannot fail, it’s just

a done deal. Live with it.”

And in response I said, “Well, I actually agree with that

assessment. I agree that we cannot change and I’ll tell you

why we can’t change it. I’ll tell you what my experience on

the policy side has been over the last two, three, four years,

and why I draw that conclusion. But that’s not the worst of

our problems. Too big to fail, if you continue down that

route it becomes too big to save. If you don’t believe it or

don’t understand what thatmeans, let me go back to my f‌irst

question. Are we out? Are we recovering?”

I am afraid that we are not def‌initely out of the f‌inancial

morass right now because of the situation, in part, in Ireland.

Ireland, as part of the overall f‌inancial boom and the particu-

lar version of the property boom that we saw in some parts

of Europe, including Spain, Ireland, and some parts of the

United States – allowed their three largest banks to build up

a balance sheet, roughly speaking, two times the size of the

Irish GDP. Specif‌ically, it was about a 200 per cent ratio of

assets to GDP.

A similar issue occurred in Iceland. Iceland had banks

with assets relative to GDP of 11 or 13 times. These failed,

and that f‌inancial crisis became a f‌iscal crisis. The Swiss

banking system became about eight times that of the Swiss

GDP, and the British system at its peak wasaround six times

the British GDP. Those countries have obviously skirted

around disaster. However, they are still skating on thin ice,

but hopefully, they will escape. But in Ireland two times the

GDP in the assets of the failed banks, were taken overby the

government. Their debts are, as we speak today, understood

to be guaranteed by the government. Thathas turned private

debt, bank debt, into an obligation of the sovereign that it

probably cannot pay.

Now in this regard, I would emphasize – perhaps not to

your surprise – that the Irish government disagrees with me

quite strongly, and – in public – so does the IMF, and so do

other off‌icials on the European level. However, the f‌inancial

markets are moving in this direction. I am observing this,

pointing it out, and doing the math.I doubt that Ireland is on

a f‌iscally sustainable trajectory.The f‌inancial crisis becomes a

f‌iscal crisis. That is why I conclude that the f‌inancial crisis is

not over.

So did we f‌ix it? It is not over. Something of a recovery is

coming, obviously not as fast in jobs in the United

States as we would like. However, there is something of a

recovery coming back through the private sector through

parts of the corporate sector. And you see this, also, in some

of the overall aggregate numbers. So did we f‌ix the problem

two years, roughly, after the collapse of Lehman Brothers?

Well, what was the problem? There are two competing

versions of this. One story is that this was a 50-year f‌lood. It

does not happen very often. It is a very rare event. It was a

particular conf‌luence – what one might refer to as a “perfect

storm” – of excessive incentives to buy homes in the United

489

Corporate Governance: An International Review, 2011, 19(5): 489–491

© 2011 Blackwell Publishing Ltd

doi:10.1111/j.1467-8683.2011.00874.x