Geithner’s Poor Legacy

It’s my turn to comment on Tim Geithner’s unfortunate legacy at the Treasury Department.

I think that, by and large, that legacy has to be seen through the lens of Wall Street. He was an ally of Wall Street, he bent over backwards to help Wall Street, and will forever be associated with an overly cordial relationship with Wall Street bankers and sympathy for their self-inflicted plight.

The record is unequivocal: Geithner, whenever called upon to choose, chose to back Wall Street’s interests over those of the public at large. In this he simply follows in the footsteps of other Treasury Secretaries – Rubin and Paulson come to mind – who made the tragic mistake of conflating Wall Street and Main Street as if the two shared common cause.

Geithner is a limited person who, having been brought up in the Reagan era, sees nothing wrong with the stranglehold big finance has on the economy. Big gigantic banks betting on both sides of the street, propped up by taxpayer subsidies, and with ineffective, duplicative, and outdated oversight are, in his eyes, perfectly fine.  They represent no threat to our economy. They simply need a periodic tweak, a tad more capital, and a little nudge now and again and they will steer their rivers of cash towards socially beneficial ends.

In all this Geithner is the living epitome of the group thinks that grips our elite whenever it tries to confront the perpetual problems that our big banks create. The first order of the day in this group think is always to save the banks. The hope being that by so doing we will stop them destroying the economy. But, banking being the unstable art it is, banks will forever cause us difficulties. The trick is to mitigate those difficulties and to limit the banks in every way possible. Unfortunately during the Reagan/Clinton/Bush era public policy threw caution to the wind and let the banks do whatever they wanted. The culmination of this was, of course, the epic crisis of 2007/2008 from which we mere non-bankers are still struggling to recover.

The banks?

They recovered.

They recovered and then some.

In our panic over their panic we made several key errors the consequences of which still rumble around. We suspended all judgement over the massive mergers rushed through ostensibly to ‘save’ Wall Street. We didn’t address the key issue of bank size. We still subsidize them. And we lent them massive amounts of short term cash at ridiculous rates to prop them up. Yes we got all that money back, but it was hardly a profitable exercise. The only thing we didn’t get returned to us was the enormous silk bow tied around the wads of cash as it was trucked over to Wall Street.

Now, it’s one thing to criticize, it’s another to offer an alternative.

So I want to remind you of what I was arguing at the time.

Here are the key steps to bear in mind:

• Banking is a volatile sport. It deals with the fundamental uncertainty of the economy. It isn’t just about risk, it is about uncertainty. Those two are very different things as we have all known for a long time.
• Banks create and destroy money. They do this every time they lend and are repaid.
• Our banking system is very highly concentrated with a few behemoths accounting for the lion’s share of loans, deposits, and the operation of our payment system.
• That latter part – the payment system – is a public good, not a private asset.
• Bank’s rely on judgements about their profits and about the value of their assets. This is more art than science and is subject to fads or waves of emotion.
• These waves drive banks herd-like to tighten or loosen credit at the wrong times for the economy. They loosen when the economy is good and can self-finance; they tighten when the economy is bad and needs credit.
• So banks make our economic highs higher, and our economic lows lower.
• This is why they need to be restrained and monitored closely.
• But our banks were let off the hook. First by Reagan; then by Clinton. The restrictions were removed and we relied on so-called market forces to act as a brake on bank activity.
• But those market forces do not work as advertised; are weak at best; and reinforce rather than counteract banking trends.
• Further, modern business management is often at odds with business shareholder interests – there is a disconnect in the agency relationship that market theory likes to see as the source of enforcement.
• This disconnect comes in the form of management’s ability to control both the amount and source of incentives – aka bonuses – which often drive performance away from shareholder interests.
• Add in the fact that modern shareholders tend to be institutions – e.g retirement funds – reluctant to enforce action on bank management, and market forces break down completely.

The financial crisis erupted after we gave up the regulations that restricted banking in the wake of the Great Depression. Those regulations worked well and limited, but did not eradicate, banking problems which will recur because of the factors I listed above.

Where does Geithner fit in all this?

He left Wall Street untouched, and therefore he left us vulnerable to another major crisis. This is his legacy. He failed to deploy more draconian measures – he opposed nationalization of failing banks on ideological rather than practical grounds. He failed to advocate smaller banks. He was not innovative. He obstructed policies that might hinder bank profit making. And he remains steeped in the Wall Street – Treasury nexus that has dogged us for decades.

One last point: I used the hated “n” word back there.

Nationalization is a perfectly legitimate tactic to enforce government policy on lazy shareholders and self-interested and incompetent managers. If shareholders and creditors won’t evict rotten managers then taxpayers have the right to. After all taxpayer subsidies lower the cost of funds for our major banks and allows them to fatten their profits. This constant giveaway entitles us to clean house every so often whenever those banks spill their stupidity onto us all. Nationalization need not be permanent, but merely long enough to clean out the toxic cause of our problems and then to send a then healthy bank back into private hands.

The key to keep in your memory is that our banks are not very well run, and banking is always – always – unstable. So problems will recur every so often. That means we have a right to intervene to protect ourselves. That intervention ought to cause the banks major discomfort, and ought to end the careers and bonus gravy train for bank managers. Geithner didn’t grasp this. Indeed, he disagreed with it. By protecting the banks he protected both lazy shareholders and rotten management teams.

His legacy is thus mediocre at best.