Simplistic idiologies,
left or right, won’t
solve complex
problems 

Books on economics and finance are usually yawners, so it’s surprising that “Stress Test,” former Treasury Secretary Timothy Geithner’s recently-published memoir about his role in battling the 2008 financial crisis, surges with the high-tension electricity of “The Bourne Identity”. More importantly, Geithner’s work serves as a cautionary tale for those who believe that the messiness of real-world problems can be solved through the application of simplistic ideologies, either of the right or left.

As Secretary of the Treasury, Geithner was President Obama’s point man on the economy – a herculean task since, by Obama’s inauguration on Jan. 20, 2009, the U.S. economy was already plunging towards the most ominous black hole since the Great Depression. A career civil servant, Geithner also chaired the New York Federal Reserve Bank under President George W. Bush when the crisis began and previously held international posts at Treasury where he dealt with financial melt downs in Japan, Mexico, Thailand, Indonesia and South Korea.

Perhaps no one in the Obama administration, aside from the president himself, was as reviled as Geithner. He was portrayed by the left as a Wall Street insider, plundering taxpayer dollars to rescue fat-cat bankers while leaving struggling workers and homeowners to fend for themselves, and by the right as a big-government advocate, responsible for introducing a morass of regulation into the financial sector and massive red ink into the federal budget.

Critics on all sides faulted him for injecting “moral hazard” into the financial system – rewarding the bad business judgment and reckless behavior of large financial institutions by bailing them out rather than allowing them to fail (hence the expression “too big to fail”).

On Geithner’s watch, the government committed $200 billion in capital to shore up housing mortgage giants Fannie Mae and Freddie Mac, injected billions more to rescue mega-banks and insurance giant AIG, provided loans to GM and Chrysler to keep them afloat, created public-private investment funds to buy distressed assets from financial institutions, initiated home mortgage relief programs, devised “stress” tests to measure the solvency of individual banks and successfully pushed financial regulatory reform (leading to what became known as the Dodd-Frank bill).

It was the boldest period of economic experimentation in Washington since FDR’s New Deal.

Geithner insists that a government rescue and regulatory effort on this immense scale was not only necessary but probably less-than-adequate in size and scope (due to political compromises), thereby slowing the pace of recovery. The reason for that necessity can be summarized in one word – confidence.

Our financial system consists of a huge superstructure of credit in which traditional banks as well as bank-like institutions (such as government-sponsored housing lenders and finance companies) lend sums far exceeding their assets or collateral based on confidence that those loans will be repaid. When general confidence in the ability to repay evaporates, panic sets in and a “run” occurs. Lenders, depositors and investors stop distinguishing between solvent, well-managed borrowers and imprudent, overextended ones and scramble to claw back their money in order to park it in safe places (like gold or Treasury bills). Lenders, who are also borrowers, run out of cash to satisfy the urgent demands of their creditors and depositors. The credit superstructure collapses, and the economy, normally lubricated by credit, grinds to a halt.

During the Great Depression, such “runs” were typified by customers queuing in long lines to withdraw their savings from local banks. Today’s runs often happen through instantaneous electronic transfers and involve national and international, not just local, transactions.

The latest failure of confidence, which began in 2008, represented the bursting of a bubble – one inflated by a long spell of easy credit, economic stability and naïve over-confidence that growth would continue indefinitely. The bubble’s size was expanded even more by lax capital, reserve and lending standards adopted by regulated depository banks, the rapid growth of bank-like institutions almost entirely outside government oversight or control, speculative fever in the real estate market, and overreliance on complex securities (known as “derivatives”) as hedges or bets against a downturn in asset values.

When credit suddenly dried up, businesses were unable to finance their operations and consumers were unable to purchase. This led increased business failures, high unemployment, plunging stock prices, and soaring bankruptcies and mortgage foreclosures.

The only solution to such an existential crisis, Geithner and others on Obama’s economic team believed, was prompt massive intervention by the Treasury, Federal Reserve, FDIC and other agencies to restore confidence and credit, including public loans and guarantees to banks and other financial institutions, government purchases of devalued assets held as collateral, and large-scale federal deficit spending.

The alternative, in their view, would have been a catastrophe of the magnitude of the 1930s. As painful as the 2008 crisis turned out to be, with peak unemployment of about 10 percent and gross domestic product contraction of about 4 percent, it paled by comparison with the Great Depression, when unemployment reached 25 percent and GDP negative 26percent.

The Depression lasted nearly a decade. Not so the 2008 crisis. By late 2009, the worst of it was over and credit was flowing again. At the time of Geithner’s departure as Treasury Secretary at the start of Obama’s second term in 2013, the stock markets had recovered to pre-crisis levels, the federal deficit was nearly halved, unemployment was below 7 percentand GDP was 6 percent higher than before the crisis and outperforming that of Japan, the U.K. and the Eurozone.

The icing on the cake, according to Geithner, is that government “bailout” programs have more than paid for themselves and are projected to a generate a positive return to the taxpayer of $166 billion.

It’s fortunate that the nation had a pragmatic Treasury Secretary (backed by a pragmatic President) at the helm during this crisis. By Geithner’s own admission, he “didn’t have a purist’s faith in the genius of the free market.” A Tea Party libertarian or Occupy Wall Street activist might have adopted a more doctrinally pure approach – a government hands-off policy at one extreme or nationalization of banks at the other. Either approach would almost certainly have led to disaster.

Geithner’s pragmatism is in keeping with an historical pattern, one that explains why the U.S., for all its excesses and foolishness, always seems to land on its feet. It’s a willingness to experiment and to sacrifice consistency for the sake of success.

British statesman Winston Churchill, whose mother was American, summed it up neatly when he said, “You can always count on Americans to do the right thing – after they’ve tried everything else.”

Elliott L. Epstein, a local attorney, is the founder of Museum L-A and author of “Lucifer’s Child,” a book about the notorious 1984 child murder of Angela Palmer. He is currently a candidate for Androscoggin County Judge of Probate. He may be reached at [email protected].