Stress-Testing Stress Test

I decided to take the easy route and read Stress Test before Piketty. The story of this book is particularly important to me. I came of age in the throes of financial crisis. I was just starting high school the fall that Lehman Brothers fell. I was somewhat (though not very) precocious and could feel the current of the time around me, but had neither the motivation nor sophistication to really understand everything that was taking place. In fact, I would remain an economic muggle through much of the European crisis, and maybe it was the summer of “whatever it takes” when I finally started reading more carefully.

This is all to say that while of course I knew many theories of all that went wrong by reading reflections in retrospect, I was largely starved of any overarching narrative of the crisis itself. And yet it was largely what thrust me towards economics to begin with and, at least in that sense, Geithner paints a great picture of the war against financial panic.

It was a book that was a little too long. The theme of the book pits Geithner and other weary veterans of previous emerging market crises in a war against the “moral hazard fundamentalists”. The bailouts were of course a public relations debacle, though Geithner makes as compelling a case as is possible in their favor.

Geithner had the misfortune of releasing his book simultaneously with Amir Sufi and Atif Mian’s masterpiece on household debt which fairly thoroughly debunks Geithner’s claim that household relief wouldn’t have made a big difference. (He considered liquidity, not solvency, to be the central issue).

However, many of the critical reviews of Stress Test have unfairly pointed to House of Debt as some sort of counterpoint. While it certainly is, the strength of Geithner’s argument lies in the counterfactual – what would have happened if we let the financial system burn down – that no one seems to address.

Geithner certainly has history on his side when noting that far more benign banking crises have caused far more pain when confidence is missing. And, indeed, expectations are everything – putting cash in the window makes depositors less worried about taking it out now.

The really damning part of Stress Test is its total disregard for monetary policy. In the sprawling seven hundred pages, there wasn’t even one fully devoted to understanding the importance of the Fed in stabilizing not just the financial system but stimulating the economy. Geithner admits that Obama almost always heeded his advice, which makes Geithner’s own apathy towards the economics, not just finance, of the Fed that much more astonishing.

The long unfilled vacancies and a bias towards bubble-bursters rather than economy-growers really redoubles the view that the Obama administration neither knew nor cared about monetary policy beyond as an immediate bandaid for Wall Street. I’m not sure what the lesson here is, but I think it militates in favor of more academic expertise within high politics. While finance is certainly well-represented, the Federal Reserve’s goal goes beyond financial stability, and no one in the administration seemed to realize this.

Ultimately, unlike Sufi and Mian, Geithner is unable to provide a theoretical justification behind his policy action as so much of it is predicated on huge counterfactuals. The many reviewers out there criticizing Geithner for not writing-off underwater mortgages better ask themselves whether that would be enough to undo an unraveling of the world’s largest financial center.

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