Thursday, January 17, 2013

Geithner sees no evil in the bubble

Two moments in Tim Geithner's exit interview with the Wall Street Journal's David Wessel struck me as noteworthy. First, this:
MR. WESSEL: Is there a risk that a combination of the backlash to the bailouts and the changes to the authorities of the Treasury and the Fed has been your successors, if confronted with something like 2008, will be unable to respond as effectively?

MR. GEITHNER: [One risk is that] they're not willing to respond . If you look at the history of crises, what most distinguishes how countries fare is whether people who are willing to do those tough things really do them or whether they sit there and wait—hope it burns itself out, decide to try to teach people a lesson, worry about moral hazard, not protecting the innocent. So one risk is that people are going to be more tentative about that because they just looked at the backlash in this crisis, and they decide to try to wait a little bit, and hope they don't have to do the hard thing.
Geithner appears here to set up an either/or: either the regulator "worries about moral hazard" or he or she "protects the innocent."  The "worry" about moral hazard, of course, is that it may precipitate the next crisis by shielding those who triggered the last one from the consequences of their recklesssness.

To be fair, Geithner says at a different point, "if you’re in policy or you’re in markets, you should always worry about moral hazard"-- so it would appear that his point above is limited -- that in the crisis hour moral hazard should not be the primary concern.  But it's fair to wonder whether moral hazard is ever a primary concern of Geithner's, given that he doesn't see much moral transgression in our banking system. Which brings us to the next  moment:

MR. WESSEL: There were repeated accusations about not enough bankers were punished to pay for what they did. You never were comfortable with that.

MR. GEITHNER: No, I felt from the beginning, and I think this was always a great strength of our system, that you had to have an overwhelmingly strong, powerful, credible enforcement response for the rules that they had to live with. And two things happened. One is that the enforcement response, which is still unfolding, took a lot of time to get traction because these things are very complicated. And the public saw a long lag. And of course, the other thing is that a huge part of what happened across the system was just a mixture of ignorance and greed, or hope over experience, and not illegal. Most financial crises are not caused by fraud or abuse. They're caused by people taking on risks they don't understand, too much risk.
The late great crisis was not caused by fraud or abuse? As has been massively documented, fraud was rampant throughout the U.S. mortgage market. For two or three years, if you were seeking a mortgage, it was difficult not to be incited to commit fraud. A neighbor of mine bought his house in 2006. He walked out of the first closing because the lender, one of the country's largest banks, unilaterally tripled his reported income to get him a slight rate reduction; the inflated income appeared without warning on the closing document. And that was a mild infraction compared to practices that were normal at the time.  On the other end of the food chain, meanwhile, the largest banks were plainly aware that they were packaging bad loans into deceptive securities, as the SEC suit against Goldman Sachs over its sale of the Abacus CDO demonstrated.

Geithner can make a credible case that his crisis management took the banking system and the economy out of their tailspin more quickly and at lower cost than most government responses to other banking crises. But his bank-centric world view, his lack of "worry" over moral hazard, is plainly in evidence here.

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