Review: A crisis-like evaluation of “Stress Test”
By Breakingviews columnists
The authors are Reuters Breakingviews columnists. The opinions expressed are their own.
To judge the merits of Tim Geithnerâs crises reflections in âStress Test,â six Breakingviews columnists digested different pieces of the book in a short amount of time. Like the regulators who often lacked broader context, the assessments vary. Yet thereâs also consensus itâs a useful tome for the financial library.
Whatever critics say, Tim Geithner canât be accused of having a narrow outlook or partisan blinkers. He grew up in Africa, India and Thailand as well as back home in the United States. He enrolled at preppy Dartmouth and signed up to learn Chinese. His mother is a âbleeding-heart liberal,â his father a lifelong Republican, and Geithner himself now a registered independent. He describes his background as privileged, but not rich.
He accepts in self-deprecating fashion that he gained a reputation as a fan of financial bailouts, despite the âmoral hazardâ precedent they created. But Geithnerâs interest in finance and economics came late, after a more geopolitical focus at graduate school and Henry Kissingerâs consulting firm. It was fired up partly by Larry Summers, whom Geithner met in 1992, four years into his first stint at the Treasury Department, working on trade. Summers, later treasury secretary, âhad earned a reputation for brilliance, if not for concealing it.â
Exposure to the faltering Japanese economy, a crisis in Mexico and another in Asian financial markets also helped shape Geithnerâs worldview. Even as the U.S. economy went from strength to strength in the later 1990s his main recollection, he says, is âhow scary it was, how little we knew.â And that was before he went to work at crisis central, the International Monetary Fund.
There is a certain modesty within the pages of Geithnerâs easy-to-read book that is at once endearing and sometimes infuriating. He acknowledges, seemingly unperturbed, that he wasnât the first choice to run the Federal Reserve Bank of New York (Stanley Fischer, John Taylor and others were ahead of him on the list) and is self-effacing about his own boyish looks, explaining how he was carded trying to buy beer the night before he started working for the regional central bank.
Geithner concedes that he fell back on a âlazyâ argument about regulating derivatives, didnât like public speaking and âwasnât good at it,â and used âtypically impenetrable proseâ to warn of looming systemic troubles. At the same time, Geithner suggests he was prescient about such risks but that the Fed was limited by what it could do. âThere was a widespread perception we had awesome powers to fight financial fires, but when I studied our actual firefighting equipment âŚ I was not particularly impressed.â
He sees regulators at odds with each other, captured by the bankers they are meant to oversee, and a lack of accountability over the wider financial system. âWe certainly could have been more prescient, more forceful, more imaginative,â Geithner says of the mortgage crisis. âBut we were human.â The looming collapse of Countrywide seems mainly to provide yet another reminder of the limitations of watchdogs. The imminent collapse of Bear Stearns does the same, when Treasury Secretary Hank Paulson discovers âhow little authorityâ he has âto try to avert a major financial crisis in the United States.â
Geithner thankfully avoids turning his coverage of the 2008 crisis into a magnum opus. Enough exist already. His account of Lehman Brothersâ failure, however, leaves questions unanswered. Geithner is at pains to point out that he wanted the New York Fed to âclimb inside the investment banksâ to understand their risks right after Bear was subsumed in March. And he informs us his analysts calculated as early as spring that Lehman could need, at worst, $84 billion of new capital to survive.
The regulator did very little with that information and started drawing up a Lehman liquidation plan only a week before the investment bank went under. A report from the firmâs bankruptcy trustee, meanwhile, provided a much less flattering account: the New York Fed and Securities and Exchange officials embedded there were as distracted by interagency rivalry as anything else.
Geithner comes clean about his peers, though. He effectively accuses Sheila Bair, who ran the Federal Deposit Insurance Corp at the time, of âmoral hazard fundamentalismâ for insisting on imposing losses on Washington Mutual bondholders and creating an incident in which âthe U.S. government made things worse.â Her decision later to ditch Citigroupâs offer for Wachovia in favor of Wells FargoâsÂ prompts him to lambast her with: âWe canât act like a Banana Republic.â
Shareholders and bondholders of the various banks may debate the matter for years. But they probably share Geithnerâs scorn for SEC Commissioner Christopher Cox.
The near-failure to launch the crowning achievement of Geithnerâs tenure becomes newly apparent. The stress tests in spring of 2009 ultimately drew a line in the sand for the financial crisis in the United States and fostered a dramatic flow of private capital into the banking sector. Indeed, the reluctance, and institutional complications, around testing banks in Europe arguably extended the continentâs economic woes unnecessarily.
Geithner first expressed the idea while on a family vacation before Barack Obama would inhabit the White House. As a member of the transition team and as former head of the New York Fed, Geithner was already heavily involved in the new administrationâs rescue plans. During a call, Geithner told Summers, his former mentor who would become Obamaâs chief economic adviser, that he was thinking of a âvaluation exerciseâ to create âtransparency on opaque financial institutions and their opaque assets.â This, he reckoned, would reduce the uncertainty fueling the panic.
In hindsight, this proved absolutely correct. By the governmentâs forcing major financial institutions to submit to uniform and stringent scenario testing and to disclose the results, some $200 billion of private capital made its way to U.S. bank balance sheets. Getting there, however, was fraught, as Geithner makes clear.
Summers, who Geithner calls a âworld-class hole-puncher,â proved a surprising obstacle. He believed the banking system was too distressed and feared that a more aggressive approach, even nationalization and forced breakups, would be necessary. That perspective, which Geithner calls the âhedge fund view,â reflected a discrepancy in the way the two valued bank assets, with Summers hewing more closely to a mark-to-market line.
There are other obstacles, too. Geithner liberally takes himself to task. He acknowledges mistakes in communicating and persuading others â within the administration, politicians and the public â of the Treasuryâs plans and positions. Of his debut in early February, Geithner nails his performance: âMy speech âŚ sucked.â
History will judge kindly the Treasuryâs decision to move with relative swiftness and open the books on the banking system five years ago. Geithnerâs account shows how easily that outcome could have shifted in ways that would have been potentially disastrous for global financial markets.
The laudable stress tests eventually were emulated by other countries and became standard practice for regulators once the big American banks largely passed and U.S. financial markets calmed. The former treasury secretary comes off a little too earnest on the subject, though. Geithner could be forgiven for believing those first test results eased investorsâ fears after regulators deemed big banks safe again. Yet it also leaves implicit the suggestion that the comfort is owed to the idea that the government would feel compelled to ride to the rescue again.
Geithner also manages to take credit for the financial reform bill that Congress eventually approved while lamenting its shortcomings. On one hand, heâs right: his Treasury led the charge with a proposal in mid-2009. On the other hand, his biggest criticism of the final version of the law, bizarrely enough, is that it didnât leave regulators enough bailout authority. Rescues are precisely what good reform should aim to avoid.
His assessment that adding much-needed housing finance reform to the legislation would have doomed it politically sounds on the mark, too. In the years that followed, though, his Treasury failed to aggressively advance the cause. Now that Fannie MaeÂ and Freddie MacÂ have begun to generate a profit again, and hedge funds gobbled up their cheap shares in the hopes of political weakness, the opportunity may have passed.
CHAPTER 11, EPILOGUE
Geithnerâs post-crisis analysis reflects a deep Keynesianism, as he blames fiscal austerity for the sluggishness of economic recovery, rather than the continued diversion of massive resources into huge budget deficits. The lack of a significant bounce in U.S. GDP from the 2009 stimulus or the 2011 payroll tax cuts, or fiscal drag from the 2013 tax hikes and âsequesterâ spending cuts, are suggestive of his blind spot.
Itâs also easy to sympathize with Geithnerâs frustrations with the Republican Congress and Europeâs profligacy leading up to the Greek default. And his criticism is well targeted at the continentâs stress-free stress tests. Yet his criticism of the European Unionâs âharshâ rhetoric is off point. The problem in Europe was that central authorities left too many loopholes and hadnât enforced fiscal discipline harshly enough. Geithnerâs overall assessment of the crisis aftershocks at the end of his book lacks the necessary distance to fully assess the faults of principle in the approach.
Geithnerâs central takeaway is that his actions prevented a full-scale depression of a 1929-1933 order, while the weak subsequent recovery was inevitable. Thatâs of course unknowable, even if he deserves some credit for avoiding the policy disasters that emanated from the Hoover administration. The strength of the stock market recovery and the weakness of output and productivity growth do, however, suggest something flawed in the Geithner view. He at least has left behind a useful blueprint to study for when the next stress test comes along.
The reviewers were Richard Beales, Rob Cox, Antony Currie, Jeffrey Goldfarb, Martin Hutchinson and Daniel Indiviglio.