Monday, December 23, 2019

Stress Test

It’s widely believed that the U.S. government bailed out the bankers who caused the financial crisis just over a decade ago and left the American people to suffer. President Obama’s secretary of the Treasury, Timothy F. Geithner, defends his team’s actions in his book Stress Test: Reflections on Financial Crises. What makes the book so believable are his admissions of mistakes and how uncertain they were about the correct actions to take throughout the crisis. However, he is very clear that protecting banks was a necessary evil to avoid cascading failures that would have led to meltdown in the greater economy. There was a very real possibility of a depression and massive unemployment. “Our only priority was limiting damage to ordinary Americans and people around the world.”

We’re familiar with the anger over bailing out the bankers who caused the problems in the first place, but less well known is the anger banks had for the government. “Conventional wisdom holds that we abandoned Main Street to protect Wall Street—except on Wall Street, where conventional wisdom holds that President Obama is a radical socialist consumed with hatred for moneymakers. The financial reform law that he wrote and pushed through a bitterly divided Congress after the crisis, the most sweeping overhaul of financial rules since the Depression, is widely viewed as too weak, except in the financial world, where it is described as an existential threat.”

Given the perception that bank bailouts cost taxpayers trillions of dollars, the truth is surprising. “In early 2009, the IMF estimated the U.S. government would end up spending nearly $2 trillion rescuing the financial system. In fact, the U.S. government’s crisis response not only prevented the collapse of the financial system and helped revive the broader economy, but as of the end of 2013 it was projected to generate about $166 billion in positive returns for taxpayers.”

The ratings agencies played an important role in creating the financial mess. “The AAA label ended up being very misleading. The ratings agencies were not exceedingly competent. Their ratings typically lagged cycles in finance, staying too optimistic too long. Since the issuers rather than the purchasers of securities paid them, they had some incentive to give generous ratings that kept issuers happy.”

The government was often criticized for not being tougher on the banks. However, being too tough on one bank would have caused more runs on other banks. By signaling that the government would back the banks, investors would be in less of a panic to get their money out. “A lot of firms that didn’t deserve saving still needed to be saved.”

“We provided extraordinary support to the financial system in general and some very poorly managed financial firms in particular. We didn’t do it to help their executives buy fancier mansions and sleeker jets. We did it because there was no other way to prevent a financial calamity from crushing the broader economy. When financial systems stop working, credit freezes, savings evaporate, and demand for goods and services disappears, which leads to layoffs and poverty and pain.”

As someone who spent much of his time in government trying to get out of politics, Geithner has little incentive to play politics with his account of the financial crisis. This is an important factor in making this book a good read. Warren Buffett says “Tim’s book will forever be the definitive work on what causes financial panics and what must be done to stem them when they occur.”

10 comments:

  1. Not fair to say that bankers caused the crisis. It was the government who pushed for mortgages to be given to people who couldn’t afford them. Derivatives, ratings, etc... clearly played a part but the primary cause was political will to defy common sense.

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    1. @BHCh: The primary cause of the crisis was the actions of the shadow banking system. Government, traditional banks, and ratings agencies did dumb things but were minority players.

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  2. It was the government policy to set up mortgages that were bound to fail - for political reasons. And it was the government that created the instrument.

    https://en.m.wikipedia.org/wiki/Federal_Housing_Enterprises_Financial_Safety_and_Soundness_Act_of_1992

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    1. @BHCh: The government created the conditions, and the bankers enriched themselves at the expense of everyone, even their own firms. Bankers deserve the bulk of the blame.

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  3. I think that’s harsh. If the President tells you “go and give mortgages to the poor so they can own a home and earn a good living out of that”, most people would comply.

    Hard to jump up and say “I am not going to do my job” when the government wants you to and everyone else around you is doing it.

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    1. @BHCh: Nonsense. What "most people" would do is irrelevant. CEOs don't burn down their companies over some government initiative. They did what they did to enrich themselves and their companies.

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    2. CEOs are driven by profit? Never! They are unlike everyone else and got the job to never ever make any profit.

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  4. One has the wonder about Canada. Housing affordability is a political issue and the answer is easier borrowing. HELOCs and mortgages are being turned into derivatives which look remarkably familiar.

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    1. @BHCh: I don't know how things will end in Canada. There definitely are some similarities to the U.S. from a decade or so ago. Fortunately, the Canadian government has tightened mortgage lending rules while bankers and real estate people howl about these rules.

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    2. Actually it wasn’t the government that tightened the rules. It was the bureaucracy. And the government is planning to overwrite the rules. Realtors “howling” is irrelevant; the rules are there to protect the banks. Not aware that the bankers are “howling” to relax.

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