The intellectual underpinnings of President Obama’s financial regulation reform.
With audacity and flourish, Time magazine on February 15th, 1999 dubbed the trio of Robert Rubin, Alan Greenspan, and Lawrence Summers, “The Committee to Save the World.” Today, that cover reads like a joke – instead of saving the world, this trio, more than any other, helped to create the conditions that nearly destroyed it: the volatile mix of low interest rates, lax regulation, and esoteric financial instruments that nearly obliterated the banking sector in 2008 and then tanked the U.S. economy in the years since. Rubin, then the Treasury Secretary, Greenspan, then the Chairman of the Federal Reserve, and Lawrence Summers, the soon-to-be Treasury Secretary, were disciples of the economic ideology of the time. By the mid-90’s, economists in influential posts in the government, academia and wall street were assuring anyone who would listen that competition between self-interested firms could be “self-regulating” and, therefore, any government regulation would only create problems. As Harvard Business School Professor David Moss said in interview with the HPR, “there was a mindset which tended toward the extreme – that almost all regulation is bad regulation.” In this belief, of course, they were mistaken, as we now know. In the words of Greenspan, testifying before Congress in 2008, “Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief…. The whole intellectual edifice [of risk-management in financial markets]…collapsed last summer.”
President Obama’s economic rescue team emerged from the wake of this collapse. Tasked with leading the financial relief effort was the new Treasury Secretary Timothy Geithner, the bureaucratic wunderkind who worked under Rubin and Summers in the Clinton administration. Summers continues to play an influential role, albeit one less public than that of Geithner, as the director of the National Economic Council. And returning to public service is former Fed Chairman Paul Volcker, now the chair of the newly formed Economic Recovery Advisory Board. To understand where we stand today we must first explore where these men stood (and in what offices they sat) before this crisis shook the prevailing economic faith. These men were the chief architects of the financial legislation that is making its way through Congress; to understand the nature of this reform, we must understand both where these men are coming from, and where they want us to go.
Clamor for Treasury Secretary Tim Geithner’s head began during the TARP bailouts and then reached a fever pitch by the week of the “AIG bonus scandal.” Protesters were following the Treasury Secretary everywhere; the online prediction site Intrade opened up betting markets about Geithner’s termination date. For a while, it seemed that the Obama administration had accomplished a feat considered unthinkable in today’s polarized Washington: unanimous dislike and anger. The Left decried the symbiotic relationship between Capitol Hill and Wall Street; the Right sounded the alarms about a socialist takeover of industries; and ordinary Americans looked to Geithner as a symbol of the hypocrisy of the moment, bailing out the industries that started the mess in the first place. But the anger obscured the bottom-line: the fix worked. The Obama administration effectively calmed financial markets, secured the major banks, and prevented total economic catastrophe, all at a lower cost than anyone thought possible. By resisting bank nationalization, Obama’s team kept to a policy of faith in private capital over government takeovers, ironically relieving the crisis by the same core economic ideology that caused it.
Despite their success, the flurry of actions carried out by Geithner, Summers, Paul Volcker, and Ben Bernanke leave the financial industry in uncharted waters. One thing, however, is clear: the financial bailout was implemented under a particular worldview advanced by individuals with nuanced and evolving ideological background. At their ideological core, Geithner and Summers subscribe to the tenets of free market capitalism — but with a twist. While they hold faith in the separation between public service and markets, their experiences in Washington have taught them the necessity of bold, decisive action by the government in preventing private financial collapse. This “activist conservatism,” with its unique public-private tenets and its reliance on both the powers of the government and the powers of the market, was at the core of our financial regulation reform efforts and will be, ultimately, the defining ideology of a new Wall Street.
Geithner
Understanding Geithner begins by identifying his deeply pragmatic perspective on markets. As the aide de camp to the likes of Rubin and Summers in the Treasury Department in the nineties, Geithner managed financial crises flaring up in places like Mexico and Thailand. His experiences with these cases and his observation of Japan’s “Lost Decade” provided the basis for his philosophy; he noted how the indecisiveness and timidity of the Japanese government resulted in the downward spiral of confidence and subsequent economic stagnation.
However, equally important is his professional maturation during the era that stressed the harmful effects of government regulation of financial markets. He worked in Washington when financial instruments such as derivatives and credit default swaps were wealth generating machines, and there was significant opposition to the notion of containing their potential. In advocating relatively loose restrictions on firms accepting bailout money and critiquing the notion of bank nationalization, Geithner expressed the idea that the government should avoid areas, such as price-setting and business management, best performed by private forces.
This belief in the power of the private sector explains Geithner’s response to the crisis. Contrary to the more interventionist solution proposed by critics like Joseph Stiglitz, the key aspect of Geithner’s plan was the bank stress test. Designed to evaluate the solvency of the nineteen largest financial institutions in the event of an economic downtown, the tests provided much needed information to investors, calming the pervasive anxiety and pessimism. As Geithner put it in an interview with Newsweek, “the stress tests this spring forced people to raise capital and have a more realistic sense of losses going forward. We’re going to have $175 billion of the $240 billion in TARP payments back by the end of next year.” His reaction to these difficult times reflects his fundamental philosophy that the government, while maintaining personal restraint and respect for the private market, must act swiftly and confidently times of urgent need.
Summers
Hailed as a wunderkind since his college days, Lawrence Summers is widely considered a brilliant economist and a skilled policy-maker. Yet his ideological position is tough to pin down. Obama has characterized him as a “champion of the middle class”; in 2007, he remarked to the New York Times, “I think the defining issue of our time is: Does the economic, social and political system work for the middle class? Because the system’s viability, its staying power and its health depend on how well it works for the middle class.” Yet those familiar with Summer’s tenure in the Clinton administration invariably point to his affinity for protecting Wall Street’s interests. In the Treasury Department in the late nineties, Summers led the opposition to federal management of risky trading instruments; he wrote that the recommendation for increased government regulation “has cast the shadow of regulatory uncertainty over an otherwise thriving market-raising risks for the stability and competitiveness of American derivative trading.” His statements are indicative of the philosophy that reigned in the nineties, the era which bred Geithner’s outlook too.
In April, Summers’ former advisee Bill Clinton admitted that he erred by following the advice to leave these complex financial instruments to their own devices. Summers defended his position as appropriate given the information available at the time, arguing that credit default swaps and the like seemed to pose little threat in their infancy. Although this plea of ignorance may appear disingenuous coming from an expert operating in an environment so familiar with banking interests, Summers’ statements reflect a sea change in the economic philosophy of the times. Admitting that his views change with the conditions at hand, just a decade after his adamant deregulatory remarks, Summers has taken an entirely opposite view on the financial devices that caused the economic meltdown. By urging banks to accept regulation for the sake of the American people, Summers shows that he has indeed learned from past mistakes, both his own and those of the private sector.
Geithner and the Public
The Geithner-Summers duo was a politically volatile choice for Obama. In trying to persuade the public that he would not exploit an economy in free fall by pushing an ideological agenda, the president choose a technocrat and a scholar, two eminently pragmatic men who nonetheless had checkered ideological pasts, distinct PR weaknesses, and would be forced to make extremely difficult political moves. To the public, the bailout punished the taxpayers not the bankers, and rewarded avarice and incompetence. Geithner has repeatedly said that he was more concerned with making the right moves than with pleasing the right people; as the media pounced on his plans, he stayed true to his principles. Public disapproval of his performance reached the point where the President himself had to write a memo expressing his confidence in his appointee. Geithner is no politician; he has poor rhetorical skills and is unskilled in framing his initiatives in politically correct terms. Unveiling the government’s plan of actions at a conference in February 2009, Geithner spectacularly underwhelmed the crowd of New York bankers, causing the stock market to plunged by nearly five percent. Investors received the impression that the Obama administration was incompetent, and rumors shot around that in the general public that he was everything from anti-business to outright socialist. But Obama chose Geithner for his talents as an implementer. Geithner cares little for popular soundbites or political expediency. In his mindset, he was appointed to solve the financial crisis, and his pragmatism carried him from premises to conclusions with no little fear of repudiation. Summing up this worldview in an interview with Newsweek, Geithner said that “the test is whether you have people willing to do the things that are deeply unpopular, deeply hard to understand, knowing that they’re necessary to do and better than the alternatives.” With this attitude, Geithner was unfazed by the politics of rescue and instead focused on applying his past experience to solve this crisis in the best way he knew how.
The Future
As both houses undertake efforts to reconcile their bill on financial sector reform, it’s clear that the policies going forward will bear the mark of the public-private ideology forged Geithner and his team. For instance, the bill would create the Financial Stability Oversight Council to facilitate the organizational restructuring of failing firms. It would also allow the Fed to demand that banks hold higher capital reserves to cushion possible asset devaluations. In addition, transactions of derivatives and other complex trading instruments will be made more transparent to openly expose potential risks.
Far from a government takeover, this bill creates a financial environment working under greater oversight from Washington yet still powered by the dynamics of the market. The tenets of reform are hardly radical; an amendment to force the breakup of the largest banks failed by a vote of 61 to 33 with stiff opposition from Summers and Geithner from within the administration. The bill is effectively moderate and reflects the economic worldview championed by the men who shaped the bailout. Looking forward, there will be a new regulatory climate overlooking a financial industry that operates under new rules. Geithner, Summers, and other influential members of the Obama economic team played a mighty role in shaping the nature of this reform; they deserve much credit for helping a reeling financial world regain its footing. So while the Time cover in 1999 appears foolish in retrospect, perhaps we can say that it was released a decade too early. While that committee certainly did not save the world in 1999, it seems that one of their ideological disciples just might do it now, ten years later.
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