Geithner at Treasury: Can He Learn?

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Dean Baker
The Guardian Unlimited, November 24, 2008

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President Obama’s pick of Timothy Geithner as Treasury Secretary showed the sort of caution that Obama has displayed in both his campaign and the other top appointments announced to date. Geithner, as President of the New York Federal Reserve Bank and a former Treasury Undersecretary, is certainly a safe pick. He has been lurking in the tops tiers of economic policymaking for more than a decade. The financial markets clearly appreciated the gesture, jumping 5 percent after the announcement of Geithner’s selection.

Given the current economic crisis, there is something to be said for a safe pick. Of course being in the middle of policy making means that he bears part of the responsibility for the current disaster. In fact, one of his first high profile missions was designing the East Asian bailout following the region’s 1997 financial crisis.

In many ways the roots of the current crisis can be attributed to the course that Geithner and his colleagues followed in designing that bailout. The East Asian countries, most importantly Indonesia, Thailand, South Korea, and Malaysia, were hit by a sudden panic beginning in the summer of 1997. Their currencies and stock markets were sent plunging as investors fled from these countries which previously had been some of the fastest growing economies in the world.

The plunge in currency values suddenly made banks and other major companies in the region insolvent, since much of their debt was denominated in dollars. With their profits coming in domestic currency that had fallen by more than 50 percent in value against the dollar, few companies were able to pay back dollar-denominated debt.

One possible solution would have been to encourage large-scale write-downs of debt, with creditors getting back a fraction of the value of their loans. The other solution – and the one chosen by the Treasury/IMF crew – was to give the companies and countries in the region temporary forbearance with short-term loans, but then require that debts be repaid in full.

This forbearance was accompanied by a commitment to keep the U.S. markets open for an enormous volume of exports from the region, which would be facilitated by the now grossly under-valued currencies of the region. The under-valued currencies meant that exports from the region were very cheap for people in the United States. The Treasury/IMF response to the East Asian crisis put some serious muscle behind Robert Rubin’s high dollar policy.

Once the economies of the region recovered from the crisis, they continued to export huge amounts to the United States. These countries, like much of the rest of the developing world, viewed the conditions imposed by the Treasury/IMF crew as being so onerous that they never wanted to be in the same situation again. Therefore, they began to accumulate massive volumes of foreign exchange. This foreign exchange was earned through their huge trade surpluses with the United States.

The jobs that the United States lost because of the trade deficit in turn created the weakness in demand that could only be filled by first the stock bubble and more recently the housing bubble. These bubbles created trillions of dollars of ephemeral wealth that fueled a consumption boom, at least as long as the bubbles persisted. This bubble-driven consumption filled the vacuum in demand that was a direct result of the over-valued dollar.

The other part of the story was the suspension of regulatory oversight of the financial industry. This allowed for huge over-leveraged, predatory mortgages and the other excesses of the financial industry that fueled the bubbles.

Geithner was in the middle of all this, even if not a lead actor. While this should not be forgiven
this recession and the millions of lives that are being ruined is not funny – it is not clear that Obama had very much choice.

In this respect, Obama faced the same sort of problem as those hoping to de-Baathify Iraq following the overthrow of Saddam Hussein. It would have been almost impossible to establish a government without including members of the Baath party, since membership was a virtual requirement for holding a position of responsibility under Saddam Hussein.

Similarly, it would have been almost impossible to get to the top echelons of power, or even the middle ranks, during the Clinton-Bush years without giving lip-service to the policies of one-sided financial deregulation and bubble-driven growth that were so fashionable at the time. The real question is whether Geithner has learned anything.

The jury is out on this point. After Bear Stearns sank in March, Geithner testified about the collapse before the Senate Banking Committee and gave the classic “who could have known” answer. Given the economy’s current economic situation, we really do need a Treasury Secretary who can give answers, not just excuses.

It may not have been feasible for Obama to go the full de-Baathification route. But the real question is whether he wanted to.

Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer. He also has a blog on the American Prospect, "Beat the Press," where he discusses the media's coverage of economic issues.