Major traumas in history are relived in song and story, with each different point of view adding layers of complexity and understanding, until you can’t absorb any more. My friend Anne said she’s full up and never wants to read another book about the Civil War or World War II, but perhaps she’s just not that interested in military history.
As historical traumas go, the 2008-2009 global financial crisis is still fresh, and, especially for those of us interested in financial sectors, it is well worth examining from many different vantage points. No viewpoint could be more central than Tim Geithner’s. Geithner was the head of the New York Federal Reserve Bank when the crisis began and Secretary of the Treasury as the Obama Administration inherited the disaster. The span of his involvement allows his book, Stress Test, to cover the whole sequence from the initial red flags when Countrywide Financial and other actors in the subprime mortgage market went down in the summer of 2007 to the wrap-up with the passage of the Dodd-Frank Act in 2010. Simply as storytelling, Stress Test is a well-written, gripping narrative – a ringside seat at the crisis.
But because Geithner, perhaps more than any other single person, was the point man on the crisis, Stress Test is also about explaining how and why the Fed and later the Administration acted as it did. While Geithner clearly justifies the majority of the decisions taken, unlike many post-service memoirs, self-justification does not get in the way of the book’s ultimate purpose: to explore Geithner’s philosophy of financial crisis management, as advice to future generations.
That philosophy has two basic tenets. First, when a financial panic arises, regulators and government must demonstrate to everyone concerned that they will step in to contain the damage, thus halting the spread of the panic. This requires evidence of what Geithner calls “money in the window” – a show of sufficient resources to reassure those with money at stake that they will not lose out. Ironically, Geithner argues, the more a government demonstrates that it is prepared to spend, the less it will have to spend, because the show of strength limits the scale of the panic. He sets this perspective against the views of the “moral hazard fundamentalists” and “Old Testament” advocates for punishment of wrongs. Both these perspectives favor allowing failing firms to fail, or at the least allowing investors in those firms to lose portions of their funds (take haircuts). In Geithner’s view, the extensive social and economic damage of recession or depression makes controlling panic the necessary top priority. Geithner claims, and this is when he drifts toward whining, that his approach opened him – and the Administration – to criticism for being soft on banks. No, he argues, we had to protect Wall St. in order to save Main St.
Geithner’s second basic tenet is that crisis prevention is all about capital – no surprise there. Overleverage throughout the financial system (and especially in the AIG case with credit default swaps) was a major contributor to crisis. His stress test approach, of which he is clearly quite proud, aimed to ensure that major financial institutions would have sufficient capital to withstand dire macroeconomic scenarios. One important point he makes about capital requirements is that too-stringent requirements for regulated institutions will push financial transactions into non-regulated segments of the financial system, as was the case in the U.S. mortgage market prior to the crisis.
Geithner is not an analyst of the causes of the crisis. I have always believed that the trigger (the shooting of the Archduke), if not the root cause, was a failure of consumer protection in the subprime mortgage market – too many people received mortgages they should never have been sold. While Geithner does not give much airtime to this issue, he does affirm the importance of creating the Consumer Financial Protection Bureau, and he wonders, as I have also wondered many times, why banks were so opposed to it. In typically blunt language, Geithner comments:
“The big banks and much of the traditional business lobby decided to wage war on the new consumer protection agency. This was helpful for us, and quite dumb of them. A stronger regime of consumer oversight posed no serious risk to competent, ethical banks, and could even help them avoid losing business to less regulated competitors. But some of Washington’s most powerful trade groups chose to direct their opposition to our only reforms that enjoyed broad public support.”
For those of us working in financial inclusion, a book like Stress Test is an important reminder that the dominant narrative in financial sector development is – and must always be – about safety and soundness. We don’t need to reach very far back in history to learn this lesson: when we advocate bringing people into the financial system, we must always consider whether the system we are attracting people into is a safe investment.
Have you read?