the quiet coup

Simon Johnson, former chief economist at the IMF and frequent contributor to Planet Money has a fairly distressing article in the Atlantic that's pretty similar to Matt Taibbi's Rolling Stone piece on the growth of the Treasury Department and the Federal Reserve, in the pocket of Wall Street, as a new 'shadow government'. Johnson's setup isn't too surprising at this point:

• Production from the financial sector began to dominate GDP (helped by Volcker-induced volatility in interest rates, deregulation under Reagan, Bush, Clinton, and Bush, and finally, via generation of complex instruments that rewarded risky behavior - securitization, interest-rate swaps, and credit-default swaps)
• The dominance of the financial sector was transmitted directly to the government, as both the Treasury Department and the SEC became dominated by products of Wall Street. This, combined with the growing complexity of managing risk and debt, led to the prevailing theory that banking institutions were the only ones capable of regulating themselves. This led to unregulated leveraging and assumption of incredibly high levels of debt, such that a small economic failure in a market previously thought of as bulletproof would lead to a collapse (cue: housing).
  

Johnson's assessment for what needs to be done tacitly indicts the current administration's policy of offering unregulated assistance while taking great care not to disturb the natural order. His prescription is somewhat different:

1) temporarily nationalize the banks in order to restore confidence.

The government needs to inspect the balance sheets and identify the banks that cannot survive a severe recession. These banks should face a choice: write down your assets to their true value and raise private capital within 30 days, or be taken over by the government. The government would write down the toxic assets of banks taken into receivership—recognizing reality—and transfer those assets to a separate government entity, which would attempt to salvage whatever value is possible for the taxpayer. The rump banks—cleansed and able to lend safely, and hence trusted again by other lenders and investors—could then be sold off.

2) smash these oversized financial behemoths, Hulk-style.

The second problem the U.S. faces—the power of the oligarchy—is just as important as the immediate crisis of lending. Oversize institutions disproportionately influence public policy; the major banks we have today draw much of their power from being too big to fail. Nationalization and re-privatization would not change that; ultimately, the swapping-out of one set of powerful managers for another would change only the names of the oligarchs. Ideally, big banks should be sold in medium-size pieces, divided regionally or by type of business. Banks that remain in private hands should also be subject to size limitations. Of course, some people will complain about the “efficiency costs” of a more fragmented banking system, and these costs are real. But so are the costs when a bank that is too big to fail—a financial weapon of mass self-destruction—explodes. Anything that is too big to fail is too big to exist.

The only sensible arguments I've ever heard over this issue came (naturally) from This American Life and Planet Money. This American Life had a really insightful piece where they followed the actual mechanics of an FDIC takeover of a small bank, and then wondered if the FDIC would even have the capacity to deal with institutions as large as Citigroup. Of course, Planet Money then followed up on this (below), with an interview with John Bovenzi, the chief operating officer of the FDIC, who insisted that they could in fact handle the load. So. Interesting.