Poor Tim Geithner. The Treasury secretary came into office at one of the bloodiest periods in financial history. To say he inherited a mess is an understatement.
Or is it? Before finding his way to the Treasury, Geithner was president of the Federal Reserve Bank of New York. Part of his role there was to regulate much of New York's sprawling financial giants.
This gives people ammunition to accuse Geithner of creating his own mess as banks under his watch went hog-wild. Now that his job encompasses the entire economy, many question why we're giving him a second chance. "Geithner used to be asleep at the wheel in New York. Now he is asleep at the wheel in Washington," as one saying goes.
There's truth to this. But it's only half the story. Yes, Geithner was responsible for banks that eventually did anything they pleased. Blame him. Throw eggs at him. But claiming he was asleep, oblivious, or ignorant of the dangers around him is flat false.
How do I know? Check out Geithner's speeches from 2003 to 2007. The New York Fed has archived almost everything he said during this period. In general, he strikes the optimistic tone of a devoted servant unable to speak poorly of his country. But Geithner did indeed voice warnings about the financial system -- particularly regarding "too big to fail" -- years before things erupted.
A few examples:
January 2005: "The consequence of size is not just that failure or the perceived risk of failure at one of these institutions has larger negative implications for the financial system today than would be the case in a less consolidated world. It is also the case that their greater relative size limits their ability to take actions that would reduce their exposure in the event of a shock without creating the risk of magnifying the shock."
September 2006: "The same factors that may have reduced the probability of future systemic events ... may amplify the damage caused by and complicate the management of very severe financial shocks. The changes that have reduced the vulnerability of the system to smaller shocks may have increased the severity of the large ones."
March 2004: "Concentration ... increases the vulnerability of the system to an operational or financial disruption in a single institution ... Moreover ... concentration can also give rise to linkages between markets that are not apparent in normal circumstances and that could potentially affect how the financial system functions in conditions of acute stress."
October 2004: "The increased size and scope of [banks] exposes them to a wider array of potential shocks and risks and means that the failure of one of them could have a broader impact than in the past and be considerably more difficult to resolve. The implications of such a failure would almost certainly fall outside of the range of experience captured in conventional models."
October 2004: "The degree of concentration at the core of the financial system means that financial institutions have to think more carefully about the implications of the failure of a major counterparty or clearing organization."
Not all of his comments were exactly prescient, but you get the point. While other masters of the house, particularly Alan Greenspan, spoke unendingly of our financial system's glory, Geithner was one of the only ones who warned of its hazards.
Geithner also tried to rein in the burgeoning derivatives market, but the attempt was feeble and fell short. As Bloomberg writes, "As early as 2004, Geithner saw that CDSs were in need of transparency ... In September 2005, Geithner brought together representatives of the 14 largest financial institutions with U.S. and European regulators to devise a self-regulatory plan ... [but] Geithner didn't convince the banks to take the big step of setting up a clearinghouse."
Or as Salon.com more colorfully put it, "without the active support of the White House or a succession of Bush administration Treasury secretaries, [Geithner] was just one man attempting to bring order to an entire territory of outlaws."
That, in short, is what scares me about regulation. I'm not concerned that regulators are a bunch of juvenile louts, oblivious to reality. I'm worried that political obstacles and industry influence makes needed regulation nearly impossible.
Consider this: While Geithner was president of the New York Fed, his immediate supervisors -- the agency's board of directors -- included former Lehman Brothers CEO Dick Fuld and JPMorgan Chase (NYSE:JPM) CEO Jamie Dimon. The agency's 2008 annual report shows its International Advisory Committee included Goldman Sachs (NYSE:GS) CEO Lloyd Blankfein, former Citigroup (NYSE:C) CFO Sallie Krawcheck, and former Merrill Lynch (now Bank of America (NYSE:BAC)) boss John Thain. If you can think of a better example of the fox guarding the henhouse, I'm all ears.
Back in October, Motley Fool co-founder David Gardner and Fool analyst Dayana Yochim interviewed Austan Goolsbee, the White House chief economist for the President's Economic Recovery Advisory Board. The two Fools noted the irony that "too big to fail" financial institutions -- like Wells Fargo (NYSE:WFC), Morgan Stanley (NYSE:MS), and AIG (NYSE:AIG) -- are in some cases getting bigger. I'll let you listen to Goolsbee's response, but in so many words it was essentially: "Yeah, it's unfortunate. We'd love to do something about it, and please accept my talking points showing we have a plan to formulate a plan to fix this, but for the most part, big will stay big."
Not that I blame him or anyone else in Washington who can admit this. The inconvenient fact is that they have reelections to worry about, and powerful, deep-pocketed lobbyists to contend with.
And that's what scares me about regulation. By and large, these aren't dumb, bungling people (though there are exceptions). They're people who either don't have the backbone to install needed change, or are influenced against doing so.
What do you think? Fire away in the comment section below.
