One of the events at the IMF annual meetings is a Per Jacobsson Lecture on issues involving finance, usually delivered by a prominent or current policymaker. The quality of these lectures varies; I have attended three, and one was particularly boring. (Information about the Per Jacobsson foundation can be found here, and a list of the lectures is here.)
This year former Treasury Secretary Tim Geithner gave the lecture. (Links: prepared text, slides, and video.) Previously, I had not been overly impressed with Geithner as a public speaker, but I was pleasantly surprised about how good this speech was, both substantively and as a performance.
The title was “Are We Safer? The Case for Updating Bagehot.” Geithner’s main point is that improved regulation has made a financial crisis less likely than before the crisis beginning in 2007, but that the emergency authorities for government officials in the U.S. to use if there is a crisis are more restricted than in the last crisis. If there is a major, financial crisis, officials would have to go to Congress to ask for more emergency authority.
One of the reasons for the restrictions on emergency authorities is to deal with the moral hazard problem. The thinking is that, if the government does not have the legal authority to bail out financial institutions, they will be more careful. Geithner recognizes that argument, but he argues that you have to rely on both regulation and a commitment to use the emergency authorities in the event of a systemic crisis. He argues that, just as you do not convene a meeting of the town council to decide whether to send fire trucks to a burning house, you should not have to go to the legislature to deal with a massive, fast moving financial crisis.
Geithner is correct, but he did not address some other issues. For example, he did not address the too big to fail issue or whether resolution of a failing institution would work for a large, complex financial company with a global business. There is some question of how this would work with multiple regulators from different countries trying to protect their citizens and companies with business with the failing entity. Also, the insolvency regimes and commercial codes of different countries vary, which would pose challenges that might be difficult to resolve quickly.
As a last criticism, Geithner did not mention the problem of regulatory capture or regulatory structure. As readers of this blog know, I have been concerned about the issue of regulatory capture in the U.S., which is made worse by having too many regulators. This has caused each regulator to advocate for its regulatees. After all, the primary regulator’s significance and budget shrinks (with the exception of the Fed, which controls its own budget), if the business it regulates contracts. Also, the many contacts between the staff of a regulatory agency and the staff of the entities it regulates provides many opportunities for the regulated entities to convince regulatory staff of the correctness of their views. This does not imply that anything illegal or unethical is taking place; regulatory capture does not need that and regulatory capture is never total. Regulatory agencies and their staffs do try to do their assigned jobs, but partial capture did contribute to the last financial crisis. Regulatory agencies did have authorities that they did not use to curtail the recklessness that was taking place. They apparently did not see the magnitude of the risks that were piling up, and the regulated institutions, which to some extent may have been fooling themselves, probably played a role in convincing the regulators that everything was fine.
Nevertheless, Geithner’s speech is worth reading or viewing. I have not summarized everything he said. Clearly, he has given a lot of thought to the subject of financial crises, and what he has to say is worth paying attention to.
Unfortunately, while in his spoken lecture, he ends by saying “we can do better,” it is unlikely that any legislation will be enacted in the U.S. to deal with his legitimate concerns. This is not a top legislative priority, and legislation in this area is difficult to pass, given the diverse interest of various interest groups. It may take another crisis to make changes, and that is something none of us wants.