The years of living dangerously

In this autobiography , Timothy Geithner is self-effacing about his role in resolving the 2008-09 financial crisis. He talks of himself as being gauche with little gravitas to be acknowledged as someone who matters.

But for anyone who has read Andrew Ross Sorkin’s Too Big to Fail , Geithner is evidently the hero all the way.

Geithner was not quite the fancied Treasury Secretary, with a number of critics badgering him for being a man who supported banks against the people and Wall Street against Main Street.

This was the conclusion drawn by the public when any rescue plan was mooted for failed investment banks as they believed in the Old Testament’s concept of retribution. Or at a more rational level, they used the argument of moral hazard to criticise any move to resuscitate these institutions.

This was a cross that the author has had to carry — which he has done quite willingly because he truly believed that this was the lesser evil. More importantly, Geithner has never been apologetic about his stance and believes that at the end of the day these actions saved the nation from a worse catastrophe.

What lies beneath Geithner traces the reasons behind financial crises in this period. Interestingly, he points out that the Mexican crisis of 1994 followed by the Asian crisis of 1997, which started in Thailand and spread sequentially across Indonesia, Malaysia, South Korea and later to Russia (which reneged on loans) and to Brazil before coming back to US all had the same indications.

Countries that are over-leveraged and borrow short-term to finance long-term run the risk of a bubble being created, which has to burst at some point of time. Add the icing of a fixed exchange rate and the burst of the bubble is cacophonic. But the fact that the US and IMF, where Geithner had worked a couple of years, played their role in reviving these nations created a moral hazard which was to strike a decade later.

What was the basic issue with the US financial system that led to the crisis? There was a large shadow banking system that was largely unregulated; there were rules in place to protect investors but not institutions. The logic was that when it comes to equity and there is a failure, owners who are shareholders, lose, which is a fair deal. However, when debt is involved, the same cannot be applied as it jeopardises the entire system.

Therefore, the US Fed had to bail out the institutions. While moral hazard was accepted, the view of Geithner was that not doing anything, merely to teach the failed institutions a lesson, would have affected everyone.

So the Fed stance of buyback of assets and providing funds through TARP (troubled assets relief programme) was laudable and worked finally.

The fact that no money was lost and the Big Five time bombs — Freddie Mac and Fannie Mae, Citi, AIG and Bank of America — have all turned around to return a profit to the public is a vindication of the stance taken by the government and the Fed. The author calls these institutions collateral beneficiaries.

The author points towards the clear case of regulatory arbitrage which was exploited by the players in the market. The Fed supervised holding companies of banks, while the Office of Controller of Currency supervised banks.

Market regulator SEC oversaw investment banks while everyone shared regulation with State regulators and local bodies and went across frontiers to regulators in Zurich and London.

Hence, when the crisis struck and the Fed carried out capital tests, banks were well capitalised, while investment banks had ratios of 3 per cent and players such as Freddie Mac and Fannie Mae had 1 per cent.

Money market mutual funds were regulated by SEC but they had no capital requirements. Insurance companies were regulated by state insurance departments and out of the Fed’s purview. Therefore, the real stress was getting through this mirage and getting the institutions in order.

Many dilemmas Geithner, who headed New York Federal Reserve during 2003-2009, also takes us to the conundrums the regulators faced. First, should they be intervening or not? If they do, when should they step in? Doing so early may increase moral hazard, but doing it late may make the rescue irrelevant. Again, how much should they intervene and should it be calibrated or a one-shot business?

The logical answer is to wait and watch the response, but one would never know which the right time was. Similarly, which institutions had to be rescued? They had let Bear Sterns and Lehman go down but rescued the Big Five. These were tough decisions to take as prima facie there are no simple answers and everything depends on the situation.

When Geithner became the Treasury Secretary in 2009, the economy was already in a recession. While stimulus through fiscal and monetary policies was advocated by the Republicans, they opposed the same when in the opposition.

Similarly, the fiscal cliff and ‘shutdown’ became issues as the Republicans wanted expenditure cuts through healthcare reforms while President Barack Obama favoured tax hikes. Manoeuvring these political pressures forms another part of his interesting story line.

The author was back on the hot seat when stress tests had to be carried out for all banks. Given that the Fed structure has bank representatives on the Fed who have had strong links with investment banking, it was always a challenge to convince the people that the exercise was a fair one and that it was not being rigged.

Geithner also shares some amusing anecdotes.. He says the IMF is an organisation driven by a lot of “papers and endless discussions”. One never knew how to spend time as discussions never ended.

He also reveals that his friend, and chief economist of the IMF, Ken Rogoff, had said that being a chess buff was useful as he spent time during these meetings playing several games in his mind! His take on the Fed culture is also light-hearted where the feudal system prevailed with the chairman being served on a silver tray; he also had access to the first glass of wine at a party.

Though quite voluminous, Stress Test is an excellent read and serves as a guide on financial crises. It may not sound too fresh given that several people have written on the subject, but because Geithner is an insider, it is interesting.

Geithner does make several recommendations on the safeguards that must be applied and reiterates that while crises cannot be prevented, we can blunt the negative impact if we have our structures in place.

He takes a pride in the bailout packages pursued by the authorities and acknowledges that moral hazard is an issue to think about.

He is to the point when he says that while moral hazard is an issue (in bailouts) which increases when there is a government which will act, the question would be whether or not it is right to conclude that fires take place merely because we have fire stations.

The reviewer is chief economist at CARE Ratings

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