The 2008 Financial Collapse Was Worse than 1929

Robert LenznerContributor

Former  Treasury Secretary Tim Geithner was  full of the most intense fear  that the  financial and economic abyss of 2008 was going to collapse the system. He shocks us  into the painful awareness that the financial meltdown was worse “than the one that had led to the Great Depression.”  He stunned me by asserting that “the percentage of household wealth lost would be more than five times worse than 1929.” It’s a terrible wake-up call to learn that  the former Treasury Secretary “thought we were looking at another global depression that would hurt billions of people.”

2008 was a dire catastrophe that must never happen again. ” We had slipped into an economic black hole,” Geithner tells us in ” Stress Test, Reflections on Financial Crises.”  This book is an important lesson in making sure the reckless behavior of Wall Street and the inability of regulators to foresee the dangers in front of them be avoided at all costs. ” The loss of wealth from the  declines in stock and home prices, much larger than the  loss of wealth before the Depression, had critically damaged the financial system, almost an understatement..

Geithner admits  that he was unaware of the   vulnerable  bungling of banks like Citigroup C -0.46% that he was supposed to be overseeing. He also was made uneasy by newly elected President Obama’s refusal to recognize the necessity of pouring all energies into stabilizing  the American economy to prevent another Great Depression rather than waxing enthusiastically  over “visionary brainstorming ” that made Geithner “ uneasy.” Obama should have made it  his overwhelming priority to “fix the broken financial system and a large fiscal stimulus package to arrest the economic free fall,” Geithner writes in ” Stress Test.”

One revelation; there was plenty of serious talk about nationalizing some of the troubled banks which would have wiped out shareholders, with creditors taking a  loss as well, and politicians taking over major banks. More money, $750 billion, a greater figure than the Pentagon budget, would be requested for bailout of the banks.

Yet, the reality is  that “ Financial crises cannot be reliably predicted, so they cannot be reliably prevented.” That’s the ugly lesson in ” Stress Test.” The next meltdown cannot be predicted,  and thus cannot be prevented, no matter how we increase bank capital or pass new regulations. Geithner liken financial crises to “ earthquakes” triggered by manias and fears and human interactions. Don’t blame government or the regulators Geithner seems to be saying.  ” We can’t count  on fallible central bankers  or regulators  to stop  financial booms before they become dangerous, because by the time the danger is clear , it’s often too late  to defuse the problem.” Amen.

Geithner  tries to convince us that Wall Street acts as if financial  crises are a phenomenon of the past and will never be repeated, which I honestly doubt. That notion is not in the ascendance today at any rate. Does he not believe that more capital, less leverage, more  restrictions on speculative trading and other fire prevention devices aren’t current protect against another 2008?

More to the point, Geithner  repeats the consensus position that it was the over-leveraged ” shadow banking system” unrestrained by regulatory safeguards  and lacking a government safety net  that were the center of the “ run” in 2008 that led to dangerous withdrawal of short term funds from the financial markets triggering liquidation of risky securities and ensuing panic. The implication is that tighter regulation of shadow banks might well have held the dam without bursting. I doubt it, and to the point, there is still no regulation of  a dangerous part of the financial system. Trouble could arise in the money market mutual funds or the repo market of short term loans or in  hedge funds or parts of the “shadow banking system” not constrained by regulatory safeguards  or protected by   a government safety net. And that vaccum still exists today, which is why there is a spotlight on this little understood part of the financial system.

And here’s Geithner’s take on derivatives, another black hole of finance that still hangs over  the system. “In the midst of the panic  derivatives  did help make it worse…. The complicated spaghetti of the derivatives  market magnified  the fear and uncertainty caused by the implosion of Lehman, Bear Stearns and AIG. The absolute need was to make derivatives trading more transparent  and require firms to put up more collateral in advance . This admirable, necessary goal, has not been achieved yet. Make no mistake of that.

And despite all the clamor for regulation  and  effective oversight of our main financial institutions, I believe that “vast swaths of the financial system”  still have no one in charge and we face confusion and indecision from  a regulatory umbrella ” engaged in tribal warfare.” Geithner claims “ the financial system is safer, but it certainly isn’t perfectly safe.” In particular  he makes plain just how risky it is to have ” a fragmented regulatory structure,”  with 3 federal bank supervisors,  2 market regulators,  5 agencies responsible for reining in proprietary trading and 10 voting members monitoring systemic risks. And systemic risks are often not obvious until it is too late.

Until I read ” Stress Test,” I did not know  that the Dodd-Frank  legislation  took away the Fed’s ability to  intervene when a financial institution gets into trouble, meaning that the bailout of AIG could not take place today.. Nor does the Federal Deposait Insurance Corp. any longer have the authority to make a broad guarantee of deposits in  the financial system. This is deeply worrying for the next crisis that is coming someday.