Geithner on the Need of Reform

The treasury secretary misdiagnoses the financial crisis and offers the wrong solutions.

American treasury secretary Timothy Geithner spoke at the American Enterprise Institute about financial reform on Monday, saying “market discipline is not enough” to safeguard the stability of American business.

Geithner began his speech with an utter misdiagnosis of the causes of the recession, calling George W. Bush “a president with abiding faith in markets” and claiming that the American government was “forced” to bail out banks and auto makers.

President Bush was no capitalist. Under his administration, the federal government grew enormously in scope and costs and his economic policies lay at the root of the financial meltdown: the effort to shape an “ownership society” which demanded that both the government-sponsored entities Fannie Mae and Freddie Mac and private banks provide Americans with mortgages they simply could not afford.

This system was unsustainable. Near the end of 2008, it collapsed, prompting multibillion dollar bailouts of those financial institutions that had participated in the frenzy; bailouts which Geithner believes were necessary.

Yet in spite of this unprecedented government intervention, “the magnitude of the financial shock,” he said, “was in some ways greater than that which caused the Great Depression.”

Geithner disagrees that ill-conceived housing policies were responsible. “It wasn’t just that a lot of people lent too much and borrowed too much,” he claimed. “This crisis was the result of failures in government policy and oversight.” Unsurprisingly, he calls for more of the same policy and oversight that previously failed, to prevent history from repeating itself.

Things could have been handled differently by allowing failing banks to fail and letting the market take care of itself. No business is “too big to fail.” There will always be competitors ready to absorb the vacuum left by a bankrupted company.

Not according to Geithner. Market discipline, he professed on Monday, “cannot effectively compensate for failures in financial regulation.” Yet how different things began to look when that very regulation turns out to be the cause of the problem!

Equating “market discipline” with “regulation” only to establish that they aren’t interchangeable represents nothing short of a deep-rooted misunderstanding of the meaning of free-market capitalism. The market isn’t supposed to achieve the politician’s goals. The market won’t ever bring about the sort of predictable business environment dreamed of by the likes of Geithner. The market only fails, if in part, when subject to government controls, not in their absence.

Geithner happily quoted Judge Richard Posner, a Chicago School economist, who wrote last year, “We need a more active and intelligent government to keep our model of a capitalist economy from running off the rails.”

This is a contradiction in terms. We need a less freer market to keep the free market from “running off the rails”?

This is what has been done, in the United States and in many developed countries around the world, yet each time it fails to deliver — only for the market to take the blame again.

Today is no exception. According to Geithner, throughout the past decades, “the American financial system produced a significant financial crisis every three to five years.” Every time, policymakers were “forced” to act, especially the Federal Reserve which consequently lowered interest rates and provided liquidity — only to fail to reverse those policies when things got better, producing, in effect, the next bubble.

If we take Geithner’s word for it, we’re all much impressed with the government’s taming of the beast. This time, the government has just to try a little harder and it will work.

What will the future look like? Reform, Geithner predicted, will “generate innovation, efficiency and economic growth,” because entrepreneurship always prospers under restraint. The government will be “channeling savings to finance future innovation,” because Washington bureaucrats know best what investments are viable.

“We are going to come out of this crisis more quickly and more strongly than any of the major economies caught up in this mess,” said Geithner. And if you don’t believe that, here’s a warning: “Without reform, risk will build up again where it is not effectively constrained, and future governments will have to act again to socialize private losses in the interest of preventing catastrophic damage.”

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