Zombie Oligarchs

At this stage in any economic stabilization process, the state-sponsored lifeboat for oligarchs starts to get a little crowded. Governments don't have enough resources to save everyone, and not all major borrowers can have their debts rolled over. In emerging markets, it's usually the shortage of foreign exchange that sets a limit on government largesse (see the start of our Atlantic article for more detail on this cycle); in the United States and other industrial countries, it's more complicated, mostly about constraints around bailout politics (Lorenzo Bini Smaghi made this point effectively in the fall).

The survival-failure decision is taken at the highest level. In April 2008, after the failure of Bear Stearns, Dick Fuld had dinner with Hank Paulson and reportedly concluded, “We [Lehman] have a huge brand with Treasury.” As the broader problems within the financial system worsened, this proved worth less than he thought.

Fuld is still in shock and seething. How could Paulson let Lehman go? “Until the day they put me in the ground, I will wonder [why we weren't saved],” he told Congress.

This week, Daniel Bouton resigned from running Societe Generale, in the face of what he called “incessant” verbal attacks, a reference presumably to lack of support from President Nicolas Sarkozy; it's not good when the President of France calls your proposed pay package “a scandal.” And Ken Lewis may take a further battering, due in part to not being the best connected with top people in Washington.

Some powerful people, naturally, can take this opportunity to elbow others out of the way. A better reputation in the right circles or somewhat deeper pockets or the ability to pay higher compensation will carry you a long way while your competitors are having a hard time getting back on their feet.

Mancur Olson famously argued that crises can break the power of vested interests. That's possible, but it only happens when the crisis brings the right kind of reformer to power. More often, crises lead to greater concentration of economic power and political influence.

This can be consistent with the resumption of rapid growth. After crises, some emerging markets grow just as fast, or even faster, than before. But such an outcome seems unlikely today for the United States and for the world.

There are three reasons why today's surviving oligarchs are not likely to prove immediately dynamic.

1. They have a lot of debt. In emerging markets, this is the prevailing problem. The debts of powerful people are being rolled over, but at high interest rates. There is nothing in this part of our broader balance- sheet issues that points toward new investment and expansion.

1. They are worried about future reshuffling of power. Obviously, the US Treasury is involved in an awkward, parent-adolescent shouting match with big banks (who is who?). The banks likely reckon that they will win on the whole, but individual banks or particular CEOs may still suffer blows, through the politics of stress tests, the way compensation caps are limited, or something else. This kind of uncertainty and continuing struggle is unlikely to encourage expansion.

1. The most significant difference between the United States today and many emerging- market crises in the past is the exchange rate. Postcrisis booms are often triggered by big nominal exchange rate depreciations. If you can hold the line on inflation— the International Monetary Fund can help, and you can blame them for unpopular measures; perfect— then exports become hypercompetitive and you start a new cycle of capital inflows. Even Japan had a strong export sector throughout the zombie bank doldrums of the 1990s. The dollar, of course, is still the world's preeminent reserve currency and problems in the eurozone mean this will continue for the foreseeable future; significant real depreciation is unlikely in the near future. And at the global level, we can't export our way out of this, there is no way that Mars can develop quickly enough as an export market.

Some new entry and productive reallocation of talent is possible in this situation. For example, John Mack is saying that pay caps mean his bankers are leaving, among other things, for “other industries.” But the G-20 policy of stabilization through rollover, at the national and corporate level, means that incumbents' implicit subsidies actually go up. The environment for starting businesses in the United States has not completely collapsed, but it has also definitely not improved.

So we get to keep many of our oligarchs, but relative to the recent past they will hunker down. You might be fine with that, although remember that it does not prevent reckless risk taking and an increase in your taxes down the road. Larry Summers says this happens only twice per century, but his own argument is that we have moved away from the kind of financial system that was built in the mid-20th century. If we've gone back to the wilder days of the 19th century, the cycles could be quite different (look at the NBER's data). If the United States has really become more like an emerging market with a reserve currency, that is also not encouraging.

We're looking at a near term dominated by the existing economic power structure. The remaining big banks (in the United States) and big banks/corporates (elsewhere) are made invincible by campaign contributions, political connections, and everyone's reasonable fear of a Great Depression. It will be hard for outsiders to challenge that structure effectively, either as new companies or with new ideas. But you won't see a great deal of innovation, investment, and growth coming from these survivors.

How do we eventually escape the grip of zombie oligarchs? We'll have a fair amount of time to think that through.

Also posted on Simon Johnson's blog, Baseline Scenario.