Geithner On the Fed’s Role in Creating the Crisis

There is a not so silent battle going on in the blogosphere, punditry circles, academia, and world of ideas to write the story for how The Financial Crisis happened. There have already been several books on the topic and the matter remains hot on daily commentary feeds. While the story has shifted in blame a bit over the past six months, there is at least one trend generally agreed upon: both the private sector and government share blame and responsibility. The question is to what degrees and how?

Neither are small questions.

Judge Richard Posner argues in part in his book “A Failure of Capitalism” that government policies created perverse incentives for the market and thus should take the brunt of blame, while the market bears responsibility for not rising above those incentives and acting more prudently.

A counter story might say that banker’s greed (their desire for profits above some arbitrary understand of what enough wealth is) cause them to play around with other people’s money with out fear of repercussions if things went wrong. And as such government control (regulations) should be increased to stop this from happening again.

Well, last week, Treasury Secretary Tim Geithner on the Charlie Rose show admitted to the government playing a key role:

“… monetary policy around the world was too loose too long. And that created this just huge boom in asset prices, money chasing risk. People trying to get a higher return. That was just overwhelmingly powerful.”

And as the WSJ commented to this:

“The Washington crowd has tried to place all of the blame for the panic on bankers, the better to absolve themselves. But as Mr. Geithner notes, Fed policy flooded the world with dollars that created a boom in asset prices and inspired the credit mania. Bankers made mistakes, but in part they were responding rationally to the subsidy for credit created by central bankers.”

Hopefully this will shed some light on the truth in the writing of history. Government is largely to blame for the too low interest rates, which in turn created the environment for mistakes to be made. If the rules were bad, of course the game would have problems. As such the government rightly is revising regulations, though there is a right and wrong way to handle that (as I’ve discussed here).

A slightly more nuanced view comes from former Jersey City Mayor Bret Schundler (currently COO of my alma matter The King’s College, NYC), who sees Fed monetary policy as a problem causer, but one that didn’t necessarily have to have caused problems as many would contend:

“A case can be made that what I think were policy errors were not errors at the time, just like a pharmaceutical may be the right prescription for an ailment, but then lead to problems when other pharmaceuticals, with which it doesn’t mix well, are prescribed later. […]

In the wake of the post-9/11 global recession … Central bankers faced a conundrum. Should they raise short-term interest rates, presuming rising commodity prices to be a harbinger of future inflation, or should they keep short-term rates low to spur economic growth? They chose the latter course […]

Credit-sensitive demand for housing and automobiles naturally ticked up given this extended period of low interest rates, but given that general inflation remained under control, what makes low interest rates and people being able to afford a new house or a new car a bad thing? What makes non-inflationary prosperity a bad thing?”

Read more from my interview with Mayor Schundler here. The whole matter still needs time to be worked out.