When Robert Rubin stepped down as Treasury secretary in 1999, Timothy Geithner and other members of Rubin’s team collected their mentor’s wisdom in a framed document, “The Rubin Doctrine of International Finance.” Among its ten principles: “Borrowers must bear the consequences of the debts they incur—and creditors of the lending they provide”; and “never let your rhetoric commit you to something you cannot deliver.” Rubin appreciated the gift, but he recognized that his students’ education was incomplete. In his 2003 memoir, Rubin added “another important rule of mine that Tim and his colleagues neglected. . . . Reality is always more complex than concepts and models.” We may be fond of our analytic prowess, but we cannot count on the world to fit our designs and prejudices.
If Geithner hadn’t learned that lesson during Rubin’s tenure as Treasury secretary, he would not lack for opportunities to absorb it firsthand, the hard way. In the decade to come, as president of the Federal Reserve Bank of New York and then Treasury secretary, Geithner would confront crises far greater than even Rubin had faced in the 1990s. In Stress Test, his new memoir, Geithner recounts these episodes and attempts to justify the actions that he took to avert disaster.
If Geithner hadn’t learned that lesson during Rubin’s tenure as Treasury secretary, he would not lack for opportunities to absorb it firsthand, the hard way. In the decade to come, as president of the Federal Reserve Bank of New York and then Treasury secretary, Geithner would confront crises far greater than even Rubin had faced in the 1990s. In Stress Test, his new memoir, Geithner recounts these episodes and attempts to justify the actions that he took to avert disaster.
During Geithner’s tenure at the Treasury, another veteran financial regulator was getting a financial reeducation—this time from a distance. As chairman of the Federal Reserve from 1987 to 2006, Alan Greenspan had fought the 1990s financial battles at Rubin’s side. In 1999, after navigating through financial storms in Latin America and Asia, Rubin, Greenspan, and Rubin’s deputy secretary, Larry Summers, appeared on the cover of Time under the headline THE COMMITTEE TO SAVE THE WORLD. But when the financial system melted down in 2007 and 2008, much of the public concluded that the “committee” had not saved the world but had, in fact, doomed it, by laying the regulatory and monetary groundwork for the crash.
Greenspan himself would come to question his well-known premises. Long a believer in markets’ power to regulate themselves, he now saw validity in modern behavioral economists’ (and twentieth-century economist John Maynard Keynes’s) belief that markets are driven not just by rational choices but also by inefficient instincts and counterproductive emotions. And last year, he, too, offered a new book to explain both the crisis behind us and the path ahead: The Map and the Territory.
Geithner and Greenspan disagree on many things, and their books point readers in very different directions. But they both present their stories as almost exclusively technocratic affairs, ill-suited to popular meddling. Indeed, their substantial disagreements should not overshadow their basic agreement on the nature of financial policy and the government that formulates and implements it. They share a fundamental belief that financial policy is developed best when it is insulated from politics and politicians. When it comes to making decisions in a financial crisis, the people and their elected representatives should just get out of the experts’ way. (...)
From this trial by fire, Geithner concluded that the basic source of financial catastrophe is cyclical mania: “a general overconfidence that a long stretch of calm and stability foreshadowed more calm and stability,” leading to increasingly aggressive risk taking, exacerbated by debt (or “leverage”). Geithner also settled upon a basic narrative mind-set, pitting pragmatic financial regulators against both benighted, pitchfork-wielding populists and doom-and-gloom prophets of “moral hazard.” Moral hazard is a theory of incentives: when the government rescues you from a problem of your own making, it may have the perverse effect of fostering expectations among others that the government will save them from similar straits. In banking, the government’s rescue of one troubled bank or fund may encourage others to take on still greater risks, confident that the government will step in if things go wrong.
“There’s no way to solve a financial crisis,” Geithner contends, “without creating some moral hazard, without protecting investors and institutions from some of the consequences of excessive risk taking.” And sometimes, this requires even rescuing particularly bad actors in service of the greater good because “trying to mete out punishment to perpetrators during a genuinely systemic crisis—by letting major firms fail or forcing senior creditors to accept haircuts—can pour gasoline on the fire.” The public may cry out for “Old Testament vengeance,” but “the truly moral thing to do during a raging financial inferno is to put it out. The goal should be to protect the innocent, even if some of the arsonists escape their full measure of justice.” (...)
As Geithner acknowledges in Stress Test, Walter Bagehot’s 1873 classic, Lombard Street—“the bible of central banking”—urges that to stop a run on the banks, the central bank should “lend freely, boldly,” to convince the public that banks are liquid. It also should take care to make those loans at “a penalty rate” in order to deter banks from continuing to borrow after the crisis passes. Geithner and Fed chairman Ben Bernanke, working closely together to ease the crisis, chose to ignore Bagehot’s second point. “We decided to try something unusual right away,” Geithner explains, “to reduce the penalty rate that banks paid to borrow from the Fed’s discount window” in order to “reduce the stigma for banks who feared that using the window would signal distress.” This approach drew criticism from what Geithner describes as “a group of hawkish regional Fed presidents . . . whose main concerns were preserving the Fed’s inflation-fighting credibility and avoiding moral hazard.” Worse still, in Geithner’s opinion, these critics “frequently deployed populist arguments against our lender-of-last-resort initiatives.”
To say that such critics frustrated him would be an understatement. In a theme that dominates Stress Test, Geithner paints them as unserious ideologues—and himself, much in the manner of the man who would become his boss, President Obama, as a practical problem solver:
Greenspan himself would come to question his well-known premises. Long a believer in markets’ power to regulate themselves, he now saw validity in modern behavioral economists’ (and twentieth-century economist John Maynard Keynes’s) belief that markets are driven not just by rational choices but also by inefficient instincts and counterproductive emotions. And last year, he, too, offered a new book to explain both the crisis behind us and the path ahead: The Map and the Territory.
Geithner and Greenspan disagree on many things, and their books point readers in very different directions. But they both present their stories as almost exclusively technocratic affairs, ill-suited to popular meddling. Indeed, their substantial disagreements should not overshadow their basic agreement on the nature of financial policy and the government that formulates and implements it. They share a fundamental belief that financial policy is developed best when it is insulated from politics and politicians. When it comes to making decisions in a financial crisis, the people and their elected representatives should just get out of the experts’ way. (...)
From this trial by fire, Geithner concluded that the basic source of financial catastrophe is cyclical mania: “a general overconfidence that a long stretch of calm and stability foreshadowed more calm and stability,” leading to increasingly aggressive risk taking, exacerbated by debt (or “leverage”). Geithner also settled upon a basic narrative mind-set, pitting pragmatic financial regulators against both benighted, pitchfork-wielding populists and doom-and-gloom prophets of “moral hazard.” Moral hazard is a theory of incentives: when the government rescues you from a problem of your own making, it may have the perverse effect of fostering expectations among others that the government will save them from similar straits. In banking, the government’s rescue of one troubled bank or fund may encourage others to take on still greater risks, confident that the government will step in if things go wrong.
“There’s no way to solve a financial crisis,” Geithner contends, “without creating some moral hazard, without protecting investors and institutions from some of the consequences of excessive risk taking.” And sometimes, this requires even rescuing particularly bad actors in service of the greater good because “trying to mete out punishment to perpetrators during a genuinely systemic crisis—by letting major firms fail or forcing senior creditors to accept haircuts—can pour gasoline on the fire.” The public may cry out for “Old Testament vengeance,” but “the truly moral thing to do during a raging financial inferno is to put it out. The goal should be to protect the innocent, even if some of the arsonists escape their full measure of justice.” (...)
As Geithner acknowledges in Stress Test, Walter Bagehot’s 1873 classic, Lombard Street—“the bible of central banking”—urges that to stop a run on the banks, the central bank should “lend freely, boldly,” to convince the public that banks are liquid. It also should take care to make those loans at “a penalty rate” in order to deter banks from continuing to borrow after the crisis passes. Geithner and Fed chairman Ben Bernanke, working closely together to ease the crisis, chose to ignore Bagehot’s second point. “We decided to try something unusual right away,” Geithner explains, “to reduce the penalty rate that banks paid to borrow from the Fed’s discount window” in order to “reduce the stigma for banks who feared that using the window would signal distress.” This approach drew criticism from what Geithner describes as “a group of hawkish regional Fed presidents . . . whose main concerns were preserving the Fed’s inflation-fighting credibility and avoiding moral hazard.” Worse still, in Geithner’s opinion, these critics “frequently deployed populist arguments against our lender-of-last-resort initiatives.”
To say that such critics frustrated him would be an understatement. In a theme that dominates Stress Test, Geithner paints them as unserious ideologues—and himself, much in the manner of the man who would become his boss, President Obama, as a practical problem solver:
I don’t think I’m hawkish or dovish by nature. I’ve always been pretty pragmatic, suspicious of ideology in any form, and I took both halves of the Fed’s dual mandate [i.e., employment and steady prices] seriously. But I found the more hawkish obsessions with moral hazard and inflation during a credit crunch bizarre and frustrating.To Geithner, his critics were not just economists wary of moral hazard. They were—to borrow a phrase he uses throughout his book—“moral hazard fundamentalists.”
by Adam White, NY Magazine | Read more:
Image: Pablo Martinez Monsivais/AP
