Stress Test: The Indictment of Timothy Geithner

>At one point in his autobiography, Timothy Geithner proudly recounts responding to a question from Damon Silvers, a lawyer with the AFL-CIO who was at the time a member of the Congressional Oversight Panel for the Troubled Asset Relief Program (TARP). Silvers had referred to Geithner's background in banking. As Geithner relates the story, he corrected Silvers by pointing out that he had never worked in banking, never worked in investment banking, but rather had spent his whole career in public service.

Anyone reading this book will forgive Silvers for his confusion. Even if a bank had never officially employed Geithner, his attitudes and concerns clearly reflect those of the financial industry. This comes through in matters big and small.

On the small side, Geithner tells us that Jamie Dimon, the CEO of J.P. Morgan, offered to have his staff draft the financial reform bill. He adds that Dimon later expressed his irritation to President Obama because Geithner would not take him up on this offer, explaining that Dimon apparently did not recognize that having the staff of the country's largest bank draft financial reform legislation was not the message the administration wanted to send the public. Apart from the messaging issue, Geithner doesn't seem to see a problem with having the largest firm in the industry deciding how it will be regulated.

In the same vein Geithner tells us that Robert Rubin didn't like the Volcker Rule. This is a surprise? The Volcker Rule was designed to be a substitute for Glass-Steagall, which Rubin helped repeal as Treasury Secretary. Rubin then went on to personally profit to the tune of more than $100 million as a top executive of Citigroup, the firm that benefitted the most directly from the repeal.

On the more substantive side, Geithner's concerns seem to begin and end with finance. We see this early on in his recounting of the heroics of the Clinton era in engineering various bailouts. For example, he tells us about the twists and turns that the Treasury Department went through to rescue Mexico from its financial crisis in 1994. In his account he saved 90 million Mexicans from default, which would have implied hyperinflation and mass unemployment.

While we can never know the counter-factual, Mexico had the worst per capita growth of any major country in Latin America in the two decades following the Clinton administration's bailout. By contrast, Argentina, which did default in 2001, quickly recovered the ground lost in the ensuing crisis and grew rapidly until the world economic crisis in 2008. Of course the financial industry was much happier with the Mexican route, in which their loans were repaid in full, than the Argentine route where they were forced to take substantial losses.

The confusion of the health of the financial sector with the health of the economy continues with his discussion of the East Asian bailouts. Here also the rules were that the creditors would be repaid in full, with money and guarantees coming from the International Monetary Fund. Geithner presents the bailouts as overwhelming success stories, ignoring the fact that the condition for these countries repaying their loans was a depreciation of their currencies against the dollar, which led to massive trade surpluses for them and massive trade deficits for the United States.

In fact, the harsh terms of the East Asian bailouts led to a change in behavior for developing countries around the world. They begin to accumulate huge amounts of dollars to bolster their reserves as protection against ever being in the same situation as the East Asian countries. This pushed up the value of the dollar, making our goods and services less competitive internationally. As a result, the trade deficit soared from a bit over 1.0 percent of GDP in the mid-1990s to a peak of almost 6.0 percent of GDP in 2006.

This massive trade deficit created a fundamental imbalance in the U.S. economy. Geithner either does not understand or opts to ignore the basic economics. A trade deficit creates a gap in demand that must be filled by either large public deficits or large private deficits, meaning that private investment must exceed private saving.

In the late 1990s the surge in investment associated with the stock bubble, coupled with the consumption boom attributable to the stock wealth effect filled the gap in demand. In the last decade the housing bubble filled the demand gap. This was done both through a construction boom and consumption boom attributable to the housing wealth effect. In the years since the collapse of the bubble, we have partially filled the demand gap with budget deficits. However the budget deficits were never large enough to bring us back to full employment and with their shrinkage we are left with an economy operating almost 6 percent below its potential (@ $1 trillion a year in lost GDP), more than six years after the onset of the recession.

The Second Great Depression Myth

While Geithner occasionally throws out a line to assure readers that he feels their pain, his bottom line is that we should be thankful that we averted a second Great Depression and also that we made back the money we lent out through the TARP. Both of these assertions deserve nothing but derision.

The first Great Depression was not just the result of the Fed's inadequate response at the start of the crisis; it was the result of the persistent failure of the government to spend enough to boost the economy back to full employment. In 1941, the government eventually did spend enough to restore the economy to full employment as it entered World War II. There was no economic reason that this spending could not have taken place in 1931, sparing the country a decade of double-digit unemployment.

The problem was purely political. Letting the banks fail in 2008-09 would have only led to a decade of double-digit unemployment if the government had refused to come forward with a serious spending package in response to the downturn. While anything is possible, even George W. Bush was prepared to act quickly to stimulate the economy as it slipped into recession, signing the first stimulus bill when the unemployment rate was just 4.8 percent.

It is important to deflate the second Great Depression myth because anything looks good by comparison. The myth allows Geithner to celebrate a recovery that has still left us more than 6 million jobs below trend, because at least we don't have double-digit unemployment.

The best route would have been to keep the banks in business, but on terms that would require they fundamentally change the way they operate. The Fed and the Treasury held all the cards in dealing with the financial industry. Any firm that was publicly cut off from access to special Fed lending facilities, and denied Treasury, Fed or FDIC loans or guarantees, would have soon been toast in the crisis atmosphere of this period. The condition for staying in business could have been concrete commitments to downsize and become boring banks, brokerage houses,or insurance companies. As a condition of getting support from the government, banks also could have been required to modify underwater mortgages. From reading Geithner's book, no such discussions ever took place at the Fed or Treasury, except to amuse populist sentiments expressed by members of Congress.