Felix Salmon, unreliable narrator, takes on Geithner
Felix, like all the other cool kids, finds Tim Geithner just despicable - and he is thrilled to catch Tim foolishly trying to act cool when everyone knows that Tim is just a dork
But here’s the thing: we can read the speech, it’s archived on the Fed’s website. And so it’s pretty easy to tell whether Geithner did indeed try to push back against complacency, in his speech, and warn of the rise of the shadow banks.
Spoiler: he didn’t.
Ooh, what a burner! Man. Here’s what Tim said back in 2004 - my bold:
The same developments in financial technology that have improved the sophistication of risk management and the ability to transfer risk can create positive feedback mechanisms that, for at least short periods of time, amplify large moves in asset prices. There have been substantial increases over the past decade in the capacity of the market, meaning the principal dealers, to handle very large increases in hedging-related flows. This dimension of the financial infrastructure is critical to the capacity of our markets to absorb and respond to large shocks. Dynamic hedging of options and other similar strategies, however, depend on the availability of sufficient liquidity to work effectively. Stressful periods, of course, are marked precisely by a material reduction in market liquidity.
Well, um, that sounds like a pretty fucking precise prediction, on the money, of what happened in 2007-2008. Here’s a little more (my bold):
The financial innovations that have made risk transfer and hedging possible have increased the complexity of risk management, both financial and operational. The seemingly simple structure of a loan or bond issue can now involve a complex series of additional transactions that seek to allocate risks and responsibilities along specialized lines. This increased number of transactions that need to be separately settled and tracked by themselves create new risks that must be managed.
The economies of scale inherent in certain activities have led to a significant degree of concentration in some markets. A relatively small number of dealers account for a very large share of the over-the-counter derivatives business, with higher degrees of concentration in specific markets such as interest-rate options. Two institutions dominate the government securities clearing business. The growth in the size of government-sponsored mortgage entities creates a high degree of concentration in a market with very large systemic implications. Concentration has benefits, but it necessarily increases the vulnerability of the system to an operational or financial disruption in a single institution, or the decision by a single institution to exit a particular business. Moreover, to the extent that the same set of firms play dominant roles in multiple markets, this concentration can also give rise to linkages between markets that are not apparent in normal circumstances and that could potentially affect how the financial system functions in conditions of acute stress.
Strangely, Mr. Salmon does not quote any of this. Instead he gives us this summary:
"Or, to put it another way, “yay derivatives! Please use lots more derivatives!”
Let me just repeat a part of what Geithner actually said again:
Dynamic hedging of options and other similar strategies, however, depend on the availability of sufficient liquidity to work effectively. Stressful periods, of course, are marked precisely by a material reduction in market liquidity.
And how the fuck we are supposed to have a serious debate on the finance system in the presence of slippery bullshit like that “to put it another way” is something I do not get. But Mr. Salmon saves the best for last, finding a way to bring in the even more hated Larry Summers
[Salmon] And rather than concentrate on the risks being built up in the financial system, Geithner chose to end on his mentor Larry Summers’s favorite global risk at the time.[Geithner] The stability of the financial system also depends significantly on the quality of macroeconomic policy, not only in terms of the credibility of monetary policy, but also in the degree of confidence investors have in U.S. fiscal management. The current deterioration in the U.S. fiscal position and the acute decline in the net national savings rate represent risks to the financial system and the economy as a whole. These risks are magnified by the size of the U.S. external imbalance and the unprecedented scale of financing requirements it reflects.
[Salmon] Summers — and Geithner too, it seems — was very worried that America’s “twin deficits”, the fiscal deficit and the current-account deficit, could end up causing a major global crisis.
Here Salmon, in his eagerness to condemn Emanual Goldstein, I mean Tim and Larry completely mis-states or misunderstands the plain sense of Geithner’s speech. Geithner’s main point here is “the acute decline in net national savings rate” during GW Bush’s and Alan Greenspan’s efforts to use massive government, consumer and business debt to float the economy and disguise the continued drop in worker income. The external balance is the TRADE BALANCE as the US manufacturing collapse accelerated in the Bush decade. This was all very important stuff and still is, no matter how much the Cool Kids sneer. And, just for the record, starting in 2000, Larry Summers identified wealth inequality as the critical economic issue of the age. Maybe when Mr. Salmon grows up, he can stop snickering and think about that issue.