The Failures of Larry Summers and Timothy Geithner: Lessons Learned but Not Applied

By Simon Johnson

In the 1990s, the Clinton administration amassed a great deal of experience fighting financial crises around the world.

Some of the Treasury’s advice at the time was controversial — pressing South Korea to open its capital markets to foreign investors at the height of the crisis — but the broad approach made sense. Failing financial systems needed to be fixed upfront because it offered the best opportunity to address the underlying problems (e.g., banks taking excessive risks). If you delay attempts to change until a recovery has begun, the banks and other crucial players are powerful again, and thus more resistant to change.

In a speech to the American Economic Association in 2000, Lawrence H. Summers — the primary strategist during the crisis — put it this way:

“Prompt action needs to be taken to maintain financial stability, by moving quickly to support healthy institutions. The loss of confidence in the financial system and episodes of bank panics were not caused by early and necessary interventions in insolvent institutions. Rather, these problems were exacerbated by (a) a delay in intervening to address the problems of mounting nonperforming loans; (b) implicit bailout guarantees that led to an attempt to “gamble for redemption”; (c) a system of implicit, rather than explicit and incentive-compatible, deposit guarantees at a time when there was not a credible amount of fiscal resources available to back such guarantees; and (d) political distortions and interferences in the way interventions were carried out…”

Mr. Summers now heads the White House National Economic Council and is the Obama administration’s top economic adviser. He is surrounded by experienced staffers from the 1990s, including Timothy F. Geithner (then the assistant secretary of the Treasury and heavily involved in the details of the Asian financial crisis; now Treasury Secretary) and David A. Lipton (then under secretary of the Treasury for international affairs; now at the National Economic Council and the National Security Council). (Paul Blustein’s “The Chastening” is the best available account on the personalities and policies in the 1997-98 emerging market crises.)
We should ask ourselves whether this group applied in the last 12 months what it learned in the 1990s?

The group pushed early and hard for fiscal stimulus, which played the same role in stabilizing spending in the American economy as properly scaled lending by the International Monetary Fund did for weaker economies in the 1990s. At this level, the Summers group drew sensible lessons from the 1990s — listening finally to Joseph E. Stiglitz (then chief economist at the World Bank and now at Columbia), who stressed the importance of easing fiscal policy.

But in terms of the handling of the financial system, the Summers-Geithner-Lipton approach this time is at odds with the views and actions of a decade ago.

Read the full article here.

Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author with James Kwak of “13 Bankers,” forthcoming in April 2010.