Timothy Geithner, who fought the financial crisis from start to finish as New York Fed president and U.S. treasury secretary, played a leading role in arresting one of history's greatest financial calamities. Yet his legacy suffers from a lack of tangible accomplishments to put on his mantel.
Unlike, say, the late Jim Flaherty, who resigned as Canada's finance minister confident that he had erased the deficit he created while spending his way out of the Great Recession, Mr. Geithner walked away in January 2013 with the U.S. economy still in a bit of a mess. The overhaul of financial regulation that he initiated remains unfinished, and he failed to persuade Congress to lower corporate taxes, despite years of trying.
One thing Mr. Geithner can claim credit for, however, is devising a new way to salvage a wrecked financial system. As President Barack Obama's treasury secretary, Mr. Geithner's first big job was fixing the U.S. banking system. Everyone agreed there were two ways to do so: force struggling financial institutions to put their underperforming assets in "bad banks," or nationalization.
Mr. Geithner liked neither option, so he went looking for a third way. The delay frustrated many, including Mark Carney, Canada's central bank governor at the time. But Mr. Geithner's idea of forcing the U.S.'s biggest banks to undergo public stress tests administered by the Federal Reserve, and then requiring those institutions that failed the tests to boost their capital levels, worked better than most anyone imagined. Confidence in the U.S. financial system was restored, and taxpayers were spared of having to put more money on the line for Wall Street. The European Union now is doing something similar. We can only wonder what the global economy would be like today if the Europeans had followed Mr. Geithner's model sooner.
So when Mr. Geithner talks about how you should go about supervising a financial system – as he is doing this week with the release of his 580-page memoire, Stress Test – we all should listen, especially in Canada, where we are just a little too complacent about our relative good fortune during the crisis. Despite our confidence in the strength of our regulatory regime, we don't follow some Mr. Geithner's best practices.
"The severe [financial crises] are caused by the failure to anticipate the really dark outcome, the deep recession, the classic panic," Mr. Geithner said in a telephone interview Tuesday. "By building periodic stress testing into the capital regime, you have a much better chance of ensuring that your financial system has thick enough shock absorbers to survive the really bad events."
The Office of the Superintendent of Financial Institutions does one macro stress test a year and ad hoc tests on specific issues as necessary. But the results remain private, shared only with the Bank of Canada to help it with its twice-a-year assessments of the financial system.
Mr. Geithner would disapprove of the secrecy. I didn't ask him to comment specifically on Canada, but I did ask how important it was that market participants be allowed to see the stress test results. "It's central," he said. "You need to let private investors, shareholders and creditors of banks, have enough information that they can better discriminate across institutions. You need to make the loss estimates transparent, you need to make the impact to individual markets transparent, if you are going to allow the markets to provide that form of triage."
To make his point, Mr. Geithner uses as an example the notion that to avoid another crisis, bank supervisors should be prepared to tighten lending conditions before bubbles form.
"In that kind of system, you are putting way too much faith in the foresight, in the vision, in the pre-emptive capacity of governments – that I think is unrealistic," Mr. Geithner said. "One virtue of stress testing is it allows you on an ongoing basis to say, 'No, no. We want the system to run with thicker shock absorbers so it is prepared for the stuff we can't imagine,' and just do that consistently."
In Canada, the triage is performed by technocrats and politicians. Fortunately, the group that faced the financial crisis has proven itself to be exceptionally able. But that team has all but disbanded: Mr. Flaherty is gone; Mr. Carney is in London leading the Bank of England; Julie Dickson, the head of OSFI, is about to step aside; and most of their closest deputies have either retired or left government. Will the next group of financial regulators and supervisors be as strong? It's impossible to know, which is why Mr. Geithner thinks regulatory systems should take advantage of the supervisory powers of traders and investors.
That means sharing more information about the state of the financial system with the public, something Ottawa only is willing to do in the broadest terms. This approach has worked so far. Will it always?