Book Reivew: Stress Test by Tim Geithner

Few people were closer to the action in the recent financial crisis than Tim Geithner. First as New York Fed President while Bush was in charge, and then as Obama's Treasury secretary, Geithner was perhaps the most influential government policy maker during the crisis. In Stress Test, he describes the events he faced in his roles and how he believes he helped reduce the economic fallout from what could have been another depression.

The book is very interesting for several reasons. First, Geithner is willing to throw people under the bus. If someone did something stupid or selfish or went back on his word, Geithner was not afraid to name him.

Second, it gives you a very good idea of how various branches of government behaved during the crisis, and are likely to behave in the future. Turf wars between various departments, the influence of campaign donors and partisan politics all played major roles in influencing policy. Geithner, of course, and Obama play the role of heroes; according to the book, they were uninfluenced by politics and only wanted to do what was right for the country.

Third, Geithner unapologetically spells out why all the bailouts took place and why they were necessary. Geithner strongly believes that creditors in crises should never have to face haircuts, as that creates runs on the financial institutions that are considered the next weakest. I sympathize much more with this viewpoint now than I did before reading the book. If one's goal is to get things back to the way they were, then I believe Geithner's approach to have a lot of merit.

But I remain unconvinced that the policy of getting everything back to how it was is indeed the right approach. By involving the government to keep in place the status quo (with a few added capital requirements), new entrants and new innovations were effectively blocked. A system less reliant on short term liabilities to fund long-term assets may have emerged, for example. Or perhaps non-recourse agreements would have become more common. Institutions may have had to be broken up and be sold into firms that were well-capitalized, putting better and more prudent stewards of capital in charge of the financial system. These are just guesses, though; I don't know what would have emerged from the wreckage, but I suspect it would have been a better system than the status quo.

I also was surprised at Geithner's policies with respect to unemployment. He was willing to bail-out even non-financial firms that were bested by their competition, in the name of creating jobs. The government can always "create" jobs by throwing money at the problem: just pay some guys to dig a hole every morning, and pay a bunch of other guys to fill it up every evening. But should the government do that? Probably not, because while the individual workers would benefit, it is at the expense of society. A better policy would apply the same money to allow the private market to create jobs, rather than bail-out firms where the jobs are essentially not valued by society.

To that end, there are a number of avenues Geithner could have pursued. For example, there were certain industries that still saw tight labour conditions through the crisis. Making it easier for workers to move, paying people to re-educate themselves, streamlining the immigration process for educated workers, expanding the country's educational capacity, reducing regulations that create barriers to entry, relaxing import/export regulations, temporarily lifting minimum wage requirements for new jobs, allowing foreign earnings that were already taxed at source to be repatriated, and other policies all could have helped create jobs that, instead of costing our society, benefit it.

Instead, the administration chose to do what may have been politically expedient; they chose to invest a crap load of taxpayer money to try to get things back to how they were. The opportunity cost of this policy is difficult to see, but it's there nonetheless.Enjoy!