If it was too much to expect serious conditions from the Fed or Treasury, the next best solution would have been a full-fledged collapse that would have permanently alleviated the country from the burden of a bloated financial sector. Geithner is very proud of the fact that he managed to keep the sector largely intact.
In this respect it is perhaps worth noting that contrary to the implication of the book, Warren Buffet apparently didn't buy the second Great Depression story either. Geithner proudly recounts how Buffett told him after the Bear Stearns bailout that Geithner had done the right thing for the country (page 161). According to Geithner, Buffett said that if there had been no rescue of the investment bank he personally stood to make lots of money by buying things up after the crash, but Geithner had done the right thing by preventing the crash.
Of course if Buffett anticipated that a decade of double-digit unemployment would follow from a financial crisis then he probably would not have made money from buying stocks on the cheap. They would stay cheap for long into the future, meaning that Buffett's money would likely be better placed elsewhere. But stories about second Great Depressions are not invented for people like Warren Buffett.
Geithner's other central theme about making money on the bailouts also deserves a healthy dose of derision. In the middle of a financial crisis the government privileged the largest financial institutions with a set of implicit and often explicit guarantees. As Geithner says repeatedly throughout the book, there would be no more Lehmans.
As a result these banks were able to borrow at far lower costs than those firms that did not enjoy the "no more Lehmans" guarantee from the Fed and Treasury. This gave these firms an enormous advantage over others in the market and it meant that through time in almost every case they would eventually be able to earn enough to repay the money lent. This speaks more to the value of government guarantees in a crisis than the wisdom of the loans. If the government had offered to guarantee loans to Baker's Lemonade Stand in 2008, it would have soon been one of the titans of corporate America.
The Housing Bubble: Who Could Have Known?
Geithner's discussion of the housing bubble and its collapse is sufficiently naïve that one hopes he is not being honest. He recounts research from the New York Fed from the period in which he was its president that concluded there was no bubble in house prices. This research rested largely on the premise that real house prices actually were not rising because conventional measures were not picking up quality improvements. This claim was laughable at the time since we had data showing that spending on quality improvements had actually fallen relative to the value the housing stock. A decade later Geithner really wants to hold this up as the basis for his failure to see the bubble?
In the same vein he tells us that he and his colleagues at the Fed were surprised that house prices would slump nationwide based on "seven decades of history." Did his colleagues not know that there had not been a nationwide run-up in house prices over the prior seven decades? You can't fall off a mountain unless you have climbed up a mountain.
He tells that even with a sharp decline in house prices their stress tests showed no large-scale defaults or serious impact on the financial system or the economy. Really? The National Association of Realtors reported that almost half of first-time homebuyers put zero down or less in 2005, the Fed's models didn't show these loans defaulting in response to 20-30 percent declines in price?
It should have been pretty obvious to anyone involved in economic policymaking that the housing bubble was driving the economy in the years 2002-2006. Residential construction, which had averaged 4.0-4.5 percent of GDP, exceeded 6.0 percent of GDP in 2005. The savings rate out of disposable income had averaged more than 8.0 percent in the years before the wealth effect from the stock bubble drove it down to 4.0 percent by 2000. While the saving rate rose following the stock crash, the wealth effect from the housing bubble drove saving rates even lower than had the stock bubble, with the rate averaging just 3.0 percent from 2005-2007.
The simple arithmetic showed that the bubble adding as much as 5 percentage points of GDP ($850 billion a year in today's economy) to demand. With housing likely to fall below its historic norm due to the overbuilding from the bubble years, a collapse in house prices was certain to create a huge hole in demand.
What could Geithner and his colleagues at the Fed possibly think would fill this gap? That's a serious question with a very short list of potential answers. Demand comes from consumption, residential investment, non-residential investment, government and net exports. With drops in the first two being the source of the problem, we are left with the last three categories.
Did Geithner and his colleagues at the Fed think that the collapse of the housing market would set off an investment boom? (There was also a bubble in non-residential construction that burst in 2008, making the situation worse.) We could have addition government spending, but we know that Geithner felt we had to be cautious on stimulus.
That just leaves net exports. We could have hoped to fill the gap in demand by a large fall in the trade deficit. (We actually have seen a substantial decline in the deficit, from 6.0 percent of GDP in 2006 to 3.0 percent of GDP at present.) The main mechanism for this would be a fall in the dollar, reversing the rise that came about as a result Geithner and company's "successful" East Asian bailout.
Incredibly net exports don't appear anywhere in this long book. It is almost as though Geithner does know the basic income accounting identities taught in every intro macroeconomics class. Anyhow, if he and his Fed colleagues had a route through which the demand gap created by a collapse of the housing bubble could be filled, there is no hint of it in the book.
Creative Reconstructions of History