By Simon Johnson
Speaking to the American Enterprise Institute, Treasury Secretary Tim Geithner had some good lines yesterday,
“The magnitude of the financial shock [in fall 2008] was in some ways greater than that which caused the Great Depression. The damage has been catastrophic, causing more damage to the livelihoods and economic security of Americans and, in particular, the middle class, than any financial crisis in three generations.”
Like Ben Bernanke, Mr. Geithner also finally grasps at least the broad contours of the doom loop,
“For three decades, the American financial system produced a significant financial crisis every three to five years. Each major financial shock forced policy actions mostly by the Fed to lower interest rates and to provide liquidity to contain the resulting damage. The apparent success of those actions in limiting the depth and duration of recessions led to greater confidence and greater risk taking. “
But then he falters.
In part, the Secretary of the Treasury seems hung up on the final cost of TARP
“Reasonably conservative estimates suggest that the direct fiscal costs of this crisis will ultimately be less than 1 percent of GDP, a fraction of the over half a trillion dollars estimated by CBO and OMB just a year ago.”
But everyone agrees that the true fiscal cost of the crisis (and bailout) of 2008-09 is the increase in net government debt held by the private sector – closer to 40 percent of GDP (i.e., nowhere near 1 percent of GDP).
This matters because, by low-balling the true fiscal cost, Treasury plays down the need for the toughest safeguards in the future.
If the cost was one percent of GDP, then perhaps the measures they have in mind would be enough. But if the cost is a doubling of our national debt – pushing us close to the danger level on that dimension – then we should think about what we need quite differently.
We agree completely with the administration’s approach – actually, with Elizabeth Warren’s approach – to consumer protection. (We make this clear in 13 Bankers.)
But the sticking point is “too big to fail.” Mr. Geithner’s Treasury (and Senator Dodd’s bill) continue to rely on the complete illusion that a resolution authority (i.e., an augmented bankruptcy process for banks) based on US law will do anything to help manage the failure of a large cross-border financial institution. It simply will not.
I’ve discussed this specific point with top technical people from G20 countries, as well as with our most experienced international bankers and leading lawyers who specialize on this very issue. They agree that a US resolution authority would be a complete illusion – at least with regard to the big cross-border banks.
Mr. Geithner gave a good speech yesterday. But someone needs to give another speech, walking us through – step-by-step – how exactly this resolution authority would have prevented the cross-border chaos that followed the collapse of Lehman in September 2008. Break it down into pieces and expand on every legal nicety.
Then tell us how the resolution authority will work for Citigroup in 5 or 7 years, when that bank will likely be twice its current size.
And the next speech might also explain why Mr. Geithner no longer mentions the Volcker Rules – there was nothing about proprietary trading and nothing about even prospective caps on bank size. Have they been withdrawn? What exactly happened on the way to the Senate?
Mr. Geithner wanted to sound tough yesterday. But is he really coming out to fight? Or did he and his colleagues already throw in the towel?