Tim Geithner has taken to the pages of the Washington Post to give us his views on the economic crisis and how we should act now to prevent the next one. Tim Geithner, How to prevent America's next financial crisis, Washington Post, Apr. 13, 2010 at A17.
Much of the op-ed is, as might be expected, the administration's rosy story about how well it thinks it handled the financial blowup. Phrases like "turning the page" "three quarters of positive growth" "beginnings of job creation" "winding down [TARP]" and ending up with "unused TARP resources" are more or less accurate. He makes the token nod to the problems facing ordinary Americans and moves on, also as expected: "While far too many Americans are still out of work and face deep economic hardship".....
But there are clear exaggerations, such as the claim that TARP plus the financial crisis responsibility fee can result in "zero cost of TARP". But of course this ignores real losses that may accrue to us over the next few years that are not necessarily "counted" as TARP losses (the various toxic asset on the Fed's balance sheet, the various guarantees backing losing mortgages, the guarantees backing AIG's business, etc.) and the intangible costs--the now explicit federal guarantee of TBTF banks, the reinvigorated entitlement view of traders on the floors of the nation's big banks who see themselves as entitled to their $750,000 plus in compensation even when they are the primary cause of deep misery for ordinary Americans earning $50,000 a year, the ongoing ability of banks to manipulate their financial statements, and the devastating affirmation of the power of the big banks to command the entire fiscal agency structure of the federal government to protect its profits in spite of its continuing casino mentality. And of course he doesn't mention the fact that the banks are making huge profits now off the consumers' backs, as they refuse to modify mortgage loan principal and charge exorbitant fees.
So then he moves on to reform, stating what we all know--"it is simply unacceptable to walk away from this recession without fixing the system's basic flaws that helped create it" (though I would have said "that created it"). I agree wholeheartedly, and much of what he says in terms of actions we should take in enacting reform I also support. But I think the suggestions and his explanation falls short in two critical dimensions--1) evidence of an understanding of the importance of devising a new financial system that places the ordinary consumer at the center rather than the traders and financial engineers and 2) the need to reduce the size of the banks to protect democratic institutions from financial oligarchy.
What are the specific reforms he discusses?
1) independent consumer financial protection agency. Will it be independent? He says "signs of bipartisan support" are emerging. Let's hope so, but the banks are set to try to kill this, since it could represent a significant constraint on the lack of transparency of financial products and, if done properly, should make financial innovation that allows banks to be predators on their own customers much less profitable. If some kind of "systemic risk council" has the power to negate any consumer-protective policies set by the agency, it will be a weak sister of the other banking agencies and unable to achieve its goal of changing the financial system to work for us rather than for the bankers themselves.
2) authority to "impose stronger requirements on capital and liquidity"
3) Limiting banks from owning, investing or sponsoring hedge funds, private equity funds, or proprietary trading operations for their own profit
4) preventing excess concentration of liabilities--"clear rules that set unambiguous limits on leverage and risk".
5) authority to force the winding down of a financial institution that "does mismangage itself into failure"
6) transparency for users of derivatives (industrial or agriculture companies) that will "bring standardized derivatives into central clearing houses and trading facilities
Note that these do nothing to make TBTF banks no longer too big for a sustainable democracy--instead, they assume that "building stronger shock absorbers" and taking some precautions will sovle the problem. I think that is wrong. Limiting leverage (and taxing it, permanently--not just to make up for TARP losses but because high leverage entails government costs and potential government action in the future, no matter what we say about "no more bailouts) and limiting risk are absolutely necessary. In fact, all of these proposals are important steps. But they are in no way sufficient steps towards bank reform. Some cutting down in size will be necessary to prevent further systemic shocks. We have to reduce possibilities for mergers and consolidations in the banking industry and we have to actively force reductions in size, possibly based on assets held. This is important not just in terms of preventing future financial crises, but in terms of making democracy sustainable by decapitating the powerful banks that tend to stand in positions of enormous power.
Further, the ability to wind down a financial firm after it has failed is likely a much weaker arrow in the bow of reform than it appears. It likely would not prevent a financial crisis (because the government's actual decision to winddown a firm would likely come after the crisis has already become, as in the Bear Stearns and Lehman cases, since the next crisis will most likely come from developments that catch regulators unawares or where regulatory capture by powerful banks has prevented the kind of indepth oversight that is necessary to apply this remedy as a preventive). It may not even remove the implicit federal guarantee (because no one believes that the government will have the political will to do it until after the crisis hits).
Moreover, these four ideas do very little to address the proliferation of financial innovations that enter the market with confounding results--transparency is lacking for most; even bankers lose track of the real risk involved; investors lack the inside information necessary to evaluate the risks; and regulators are either less informed, less competent, or captured. Credit default swaps are a type of insurance and should be regulated nationally. Having transparency (of sorts) for standardized derivatives is a mere piece of windowdressing: derivative contracts can be made customized with simple tweaks that do nothing to change the economic substance but take away the purported transparency. Such manipulations can only be prevented if all or at least most derivatives are required to be traded on exchanges, with customized products tightly constrained and subject to full disclosure. Bank positions in all of these products need to be disaggregated and disclosed in a meaningful way. Proprietary risk models and proprietary valuation models should also be disclosed and tightly constrained through a single regulatory agency.
Finally, Geithner's endorsement of the Senate bill idea of "negotiating a global agreement on new capital requirements by the end of the year...[that] would establish a level playing field with minimum requirements for capital" seems like a pipedream. The big banks have incredible power in the cross-border arena, and are able to convert such discussion into a race to the bottom. We need to think about the importance of decreasing bankers' power in the policy-setting decision-making in which they are today far too often the dominant characters. Increasing capital requirements is one way to force banks to stay smaller. We should not be aiming for the "minimum" capital requirements that we think will be workable. We've been there, done that, and suffered the disaster that ensued. We should start financial reform with the goal of prudential, conservative capital requirement thresholds--without regard to the whining of the big banks about the way that will impinge on their profits. They are, after all, used to the compensation of kings, since kingship is the role they have played in the globalization trend. But we are better off with 10 medium-sized banks working in a syndicate to generate the financing needed by a big company than with one big bank to whom the company goes for financing.