Mpumelelo Mkhabela

The stress test Obama used to save the economy

2016-11-11 15:15

Timothy Geithner, US President Barack Obama’s first Treasury Secretary, hit the nail on the head when he diagnosed the cause of the 2008 financial crisis.

“Our crisis, after all, was largely a failure of imagination. Every crisis is,” he wrote in his book Stress Test: Reflections on Financial Crises.

Geithner was referring to the failure of American bankers and regulators to imagine worst case scenarios where banks that over-extended high risk loans and other instruments could go bust.

Lending and gambling with shareholder money without backup capital was what drove the worshippers of profit-at-all-costs on Wall Street. The idea of so-called “capital adequacy ratios” that are used to determine whether or not a bank has enough money to withstand a shock was foreign at the time.

Geithner and a team of Treasury officials supported by Obama led the US out of the crisis by initiating a system where regulators subjected banks to “stress tests”. The title of Geithner’s book is derived from the stress test exercises that the Treasury prescribed on banks. But it could just as well have been derived from the stress Geithner and his family went through to fix the American banking system.

The stress test exercises that were conducted would ensure banks had enough capital to survive shocks. So, as part of the exercises bankers were made to “imagine the unimaginable”. 

At a personal level Geithner was subjected to a hostile press, short-sighted bankers and conservative ideologues in Congress. “We were still in political no-man’s-land, doing enough for the right to hate but not enough for the left to like,” Geithner writes.

He adds: “Conservatives thought we were profligate socialists [for bailing out private banks], and liberals thought we were in bed with the banks [because some bankers cashed in during the crisis].”

Geithner passed the personal stress tests, but he had considered resigning earlier. He got the banks to pass their stress tests. He put them – and by extension the economy –  on track, though a fragile one.

At the heart of the solution was Obama’s leadership. He insisted that policy must trump politics. In addition, he repeatedly told Geithner and the Treasury team to do the right thing even if it wasn’t the popular thing. (Finance Minister Pravin Gordhan can only wish.)

The US economy has since pulled out of recession and has been registering marginal growth and creating jobs since then. This is good. A healthy American economy is good for the global economy. Don’t listen to Robert Mugabe and the “look East” brigade who claim to owe allegiance to Asia but they would do anything to go shopping in New York. The wealthy West, led by the US, still rules the world despite the “rise of the rest”, to borrow a phrase from Fareed Zakaria.

The current capital adequacy requirements that apply to banks globally, including in South Africa, to ensure banks don’t collapse, can be traced to the work of Geithner and Obama. The current rules were adopted by the G20 where the US under Obama played a leading role.

As Obama prepares to vacate office after eight years at the helm, he can safely say that during his first term, he had an excellent Treasury Secretary who had the skill to help rebuild America’s broken banks and restore confidence in the economy. He gave them space to do their work.

So, if you are looking for Obama’s legacy, look no further than the current global financial architecture with built-in mechanisms to deal with banking stresses. In South Africa, we take this for granted because we haven’t had a banking crisis in decades. Our banks are well regulated. Thanks to the Obama team for imagining the unimaginable, our banking system got a proactive shield when the new rules on banking were adopted at the G20.

But some ungrateful South African politicians have the audacity to randomly lash out at the National Treasury who has done a great job overseeing the financial sector from a policy point of view.

There have even been attempts to “demystify” – whatever that means – the National Treasury. But the most daring of all challenges for the Treasury was for me not 9/12 as some might think. Nor was it the push by the Hawks to arrest the Finance Minister.

Yes, both were deplorable. The real constitutional danger was, however, the attempt to annex by stealth National Treasury’s authority and transfer it to the department of mineral resources.

This unconstitutional conduct aimed at usurping Treasury’s policy oversight function of the financial sector happened under the watch of our democratic parliament. After Mineral Resources Minister Mosebenzi Zwane announced that Cabinet had decided to institute an inquiry on the closure of Gupta-linked accounts by the banks, Parliament should have called him to explain his source of authority.

His source of authority was certainly not the law. As it turned out, it wasn’t cabinet either. Unlike other departments, the role of the Treasury is enshrined in the Constitution. Parliament should have asked questions on why the powers of Treasury were being threatened. Parliament’s failure to put its foot down on this adds to political uncertainty – at a cost to the economy.

If there is a lesson we can learn from Obama and his team, it is that nothing substitutes leadership when it comes to resolving economic crises. He provided leadership at the most difficult of times in the US. A good leader sources the best skill from among the best and he allows his team space to come up with creative solutions. He allows them to “imagine the unimaginable”. 

Disclaimer: News24 encourages freedom of speech and the expression of diverse views. The views of columnists published on News24 are therefore their own and do not necessarily represent the views of News24.

Read more on:    banking industry  |  treasury


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