In a recent interview, US Treasury Secretary Tim Geithner laid out his view of the nature of world economic growth and the role of the US financial sector. It is a deeply disturbing vision, one that amounts to a huge, uninformed gamble with the future of the US economy — and that suggests that Geithner remains the senior public official worldwide who is most in thrall to the self-serving ideology of big banks.
Geithner says the world will now experience a major “financial deepening,” owing to growing demand in emerging markets for financial products and services. He is thinking, of course, of “middle income” countries like India, China and Brazil. And he is right to emphasize that all have made terrific progress and now offer great opportunities for the rising middle class, which wants to accumulate savings, borrow more easily (for productive investment, home purchases, education, etc) and, more generally, smooth out consumption.
However, Geithner then takes a leap. He wants US banks to take the lead in these countries’ financial development. His words are worth quoting at length.
“I don’t have any enthusiasm for … trying to shrink the relative importance of the financial system in our economy as a test of reform, because we have to think about the fact that we operate in the broader world … It’s the same thing for Microsoft or anything else. We want US firms to benefit from that … Now, financial firms are different because of the risk, but you can contain that through regulation,” he said.
There are three serious problems with this view. First, Geithner ignores everything that we know about the pattern of financial development around the world. It is very rare for financial systems to develop without major crises. In fact, experience in recent decades confirms what should have been obvious from previous centuries: As countries grow and accumulate savings, they become increasingly prone to financial collapse.
Given Geithner’s extensive international crisis-fighting experience at the US Treasury, the IMF and the New York Federal Reserve, his current naivete on this point is simply stunning.
Second, Geithner assumes that risks at the largest US firms can be contained through regulation, when all our knowledge points directly to the contrary. Even the strongest supporters of the Dodd-Frank reform legislation emphasize that it only went part way toward reducing the incentives for major financial institutions to take big risks. Looking at the combined effect of the new law, plus the weak additional capital requirements agreed under Basel III and the hands-off approach already signaled by the Financial Stability Oversight Council (which Geithner chairs), it is hard to believe that anything has really improved.
In fact, given that our largest banks are now undoubtedly too big to fail, they have even more incentive to increase their debt levels relative to their equity. Higher leverage increases their payoffs when times are good — as executives and traders are paid based on their “return on equity.”
When times are bad, for example in a crisis episode, losses are transferred to creditors. If those creditor losses are large and spread so as to undermine the broader financial system, pressure for a government bailout will mount. Bankers get the upside and taxpayers (and people laid off as credit is disrupted) get the downside.
The US financial sector went mad for high-risk loans to emerging markets during the 1970s — arguing that this was the new frontier. This loan portfolio blew up in the debt crisis of 1982. A version of the same thoughtless cross-border lending is again underway, extolled by leading financial sector executives (eg, Jamie Dimon from JPMorgan Chase) — who have apparently persuaded Geithner to tag along intellectually.
Third, Geithner completely overlooks what has brought significant parts of Europe to its economic knees. He should spend more time with the authorities in Iceland or Ireland or Switzerland, countries where “financial globalization” allowed banks to become big relative to the economy.
In Iceland, the three largest banks built global balance sheets that were between 11 and 13 times the size of the economy. Then they collapsed.
In Ireland, the three largest banks went crazy for commercial real estate — financed by large-scale borrowing from other eurozone countries (including Germany). The politicians looked the other way — or were paid off, some claim — while these banks built balance sheets valued at twice the Irish GDP. Then they collapsed, causing enormous damage to the government’s own solvency.
In Switzerland, the two largest banks (UBS and Credit Suisse) had a combined balance sheet in the fall of 2008 of about 8 times Swiss GDP — mostly based on their global activities. Mortgage traders in London — not many of whom were Swiss — took on enormous risks that almost brought down UBS. The Swiss government could afford the bailout, just. And now the Swiss National Bank is moving in the exact opposite direction to Geithner — they are pushing these big banks to become smaller and to finance more of their activities with equity, rather than debt.
Geithner is a very smart and experienced public servant. His views concerning the future of finance will help shape what happens. And that is why we are headed for trouble.
Simon Johnson, a former chief economist of the IMF, is co-founder of BaselineScenario.com, a professor at MIT Sloan and a senior fellow at the Peterson Institute for International Economics.
COPYRIGHT: PROJECT SYNDICATE
Two sets of economic data released last week by the Directorate-General of Budget, Accounting and Statistics (DGBAS) have drawn mixed reactions from the public: One on the nation’s economic performance in the first quarter of the year and the other on Taiwan’s household wealth distribution in 2021. GDP growth for the first quarter was faster than expected, at 6.51 percent year-on-year, an acceleration from the previous quarter’s 4.93 percent and higher than the agency’s February estimate of 5.92 percent. It was also the highest growth since the second quarter of 2021, when the economy expanded 8.07 percent, DGBAS data showed. The growth
In the intricate ballet of geopolitics, names signify more than mere identification: They embody history, culture and sovereignty. The recent decision by China to refer to Arunachal Pradesh as “Tsang Nan” or South Tibet, and to rename Tibet as “Xizang,” is a strategic move that extends beyond cartography into the realm of diplomatic signaling. This op-ed explores the implications of these actions and India’s potential response. Names are potent symbols in international relations, encapsulating the essence of a nation’s stance on territorial disputes. China’s choice to rename regions within Indian territory is not merely a linguistic exercise, but a symbolic assertion
More than seven months into the armed conflict in Gaza, the International Court of Justice ordered Israel to take “immediate and effective measures” to protect Palestinians in Gaza from the risk of genocide following a case brought by South Africa regarding Israel’s breaches of the 1948 Genocide Convention. The international community, including Amnesty International, called for an immediate ceasefire by all parties to prevent further loss of civilian lives and to ensure access to life-saving aid. Several protests have been organized around the world, including at the University of California Los Angeles (UCLA) and many other universities in the US.
Every day since Oct. 7 last year, the world has watched an unprecedented wave of violence rain down on Israel and the occupied Palestinian Territories — more than 200 days of constant suffering and death in Gaza with just a seven-day pause. Many of us in the American expatriate community in Taiwan have been watching this tragedy unfold in horror. We know we are implicated with every US-made “dumb” bomb dropped on a civilian target and by the diplomatic cover our government gives to the Israeli government, which has only gotten more extreme with such impunity. Meantime, multicultural coalitions of US