Tim Geithner's Stress Test: Reflections on Financial Crises will be read mainly for its take on the 2008 financial crisis, as the author was head of the New York Federal Reserve and then US Treasury Secretary during this dramatic period. But Geithner was also present at the scene of all the financial crises of the past twenty years (starting with Mexico in 1994). He should have something interesting to say about the common threads that run through them. What did he learn from the early ones that helped him handle 2008?
In this aspect, his book is a disappointment. It records the struggle of hard-working and talented bureaucrats (he is fawningly laudatory of nearly all his colleagues) striving to make the problematic world a better place, battling the forces of unstable financial markets and a recalcitrant Congress. But it is a Sisyphean task. If the early crises provided him with any lessons in 2008, Geithner doesn't draw them out. Each crisis is faced anew, with policy combining first principles with ad hocery to weave a path through the thicket of complexity, half blinded by the fog of war.
Others are dissecting Geithner's narrative of recent events. I'll focus here is on the earlier episodes: Mexico and the Asian crisis. What might we learn?
- When a financial crisis arrives, it's always bigger than previously experienced or anticipated. Mexico had an IMF quota of just US$2.6 billion as a crisis backup, but needed US$40-50 billion to restore confidence.
- Cobbling together this sort of support on the fly creates challenges and hostages to future policy-making. In putting together the Mexican rescue package, Congressional approval was bypassed. This so incensed Congress that the US had no funds to draw on when Thailand and Indonesia needed help in 1997. This didn't stop the US from taking the leading role in directing the rescue. For example, the US strongly opposed the formation of an Asian Monetary Fund which might have mobilised much greater funding from Japan, motivated by the self interest of channeling funds to its own ailing banks.
- Financial markets are powerfully pro-cyclical, with ignorant over-confidence replaced by total funk in the blink of an eye. Contagion spreads quickly and widely. The Mexican 'Tequila Crisis' was felt in Brazil and Argentina. We saw this repeated in Greece and the European periphery in 2010.
- The success of the 1994 Mexican rescue was a victory for what Larry Summers called the economic version of the Powell Doctrine: decide who matters to you, and support the ones who matter with overwhelming resources. Mexico had just joined NAFTA, was a US neighbour (with potential for huge additional cross-border migrant flows) and was a test bed of the Washington Consensus market-oriented economic policies.
- The Asian crisis may have been a demonstration of the economic Powell Doctrine too: Thailand and Indonesia received inadequate rescue packages, but South Korea (with 35,000 US troops on the ground) got an adequate package and additional measures (see next dot-point). But was the absence of the US in the Thai rescue (and the empty promise on the Indonesian pledge) simply an unfortunate consequence of Congressional anger at being bypassed on Mexico, or an application of the Powell doctrine? A clue may be found in the background comment of Ted Truman, US crisis veteran, on Indonesia: 'The quicker this f…ing regime goes, the better.'
- When you really want to help, ways can be found. IMF assistance to Korea easily broke all previous records, at 19 times its quota. Korea also required a US-orchestrated concerted standstill of foreign bank creditors, where foreign governments leaned on their home banks (including an Australian bank) to delay calling in the money owed, giving Korea crucial breathing space.
- Doctrine has to be cast aside: the Korea standstill went against the strong antipathy towards any form of capital controls. Before the crisis, free-market advocates gave stern 'Old Testament' warnings about the dangers of 'moral hazard', the virtues of 'market discipline' and the logic of 'bailing in' creditors to punish foolish lenders. When the crisis arrives, these principles are cast aside with arguments about the 'least-worst solution' (this from Alan Greenspan, free market cheerleader). A rescue inevitably helps some who don't deserve it ('collateral beneficiaries'), often the very people who argued most vehemently against any interference in the market.
- 'Bailing in' creditors remains logically attractive but elusive in practice. When the crunch comes, the creditors are a vocal lobby. Their threat of spreading the contagion to other vulnerable situations usually wins the day (as it did so often in 2008). Was it a matter of high principle or Japanese self interest that prevented bail-in being a part of the Thai rescue?
- Geithner acknowledges that the fiscal lever was pushed the wrong way (towards more austerity) in the Asian crisis, but glosses over it as a minor issue. At the same time, he regrets that the US didn't 'sustain the initial power of the (fiscal) stimulus' after 2009.
- Similarly, no one would now repeat the sharp rise in interest rates and harsh tightening of liquidity that was a central plank of policy in 1997. Now the US can't get interest rates low enough and has to flood the financial system with liquidity through quantitative easing (QE). It is now acknowledged that trying to restore collapsing exchange rates with higher interest rates would be like trying to get the audience to return to a burning theatre by offering discount tickets.
- We've come to understand that exchange rates, when under pressure, overshoot. We're ready now with intervention to support an overshooting exchange rate. We're even ready to weaken the exchange rate with QE, if that suits.
- Imposing economic reforms as part of rescues ('conditionality') is problematic. 'In general, crisis managers have to be careful about tying too many strings to emergency assistance', Geithner says. He says efforts to abolish the clove and cashew monopolies as part of the Indonesian rescue package were excessive. The nearest he comes to criticising one of his close colleagues is to say that David Lipton (now one of the most senior IMF officials) was 'playing General MacArthur, trying to reshape the Indonesian economy'.
- When the crisis arrives, the safety net has to be drawn more widely. In Indonesia, the initial depositor guarantees covered only the banks which had already been closed. In 2008, just about everyone in the financial sector was covered.
- Above all, the lesson is that it's cheaper to rescue than to clean up afterwards. Indonesia still bears the scars of the 1998 collapse.
Crisis rescue underwent a revolution during Geithner's time at the centre of the action. Mexico was the initial step towards expanding the scope and scale of the rescue process, which has now been extended to hopelessly insolvent countries (Greece in 2010) and to a country which seems to be in the process of dismemberment, the Ukraine. How did we get here and where is this going? You won't learn the answers from Stress Test.