Larry Summers in 2000: “A Healthy Financial System Cannot be Built on the Expectation of Bailouts”

Simon Johnson points out how hypocritical Summers and Geithner are:

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?

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In the 1990s, they were opposed to unconditional bailouts — providing money to troubled financial institutions with no strings attached. At one point, according to Mr. Blustein’s account, they derided Madeleine K. Albright, Secretary of State, for proposing such an approach in South Korea. The Treasury philosophy was clear and tough: “a healthy financial system cannot be built on the expectation of bailouts,” Mr. Summers said in his American Economic Association speech in 2000.

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In the 1990s, the United States — working closely with the I.M.F. — insisted that crisis countries fundamentally restructure their financial systems, which involved forcing out top bank executives.

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The bank overhaul legislation before Congress could still address “too big to fail” issues, but heavy lobbying has bogged down attempts to limit the power of — and danger posed by — large banks. Postponing a restructuring until the banks were out of intensive care was a mistake — and just what today’s economic leadership once warned against.

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