this week to the American Bankers Association. In it he revealed his theory about the causes of the regulatory failure that led to the financial crisis—and proposed an idea of how to fix the global financial system.
And he was absolutely right!
Geithner pointed to the UK’s “light touch” financial regulations. But rather than argue that this had bad effects for the rest of world—the classic ‘race to the bottom’ theory of deregulation—he pointed out that this turned out to be bad for the UK
“The United Kingdom’s experiment in a strategy of ‘light touch’ regulation to attract business to London away from New York and Frankfurt ended tragically. That should be a cautionary note for other countries deciding whether to try to take advantage of the rise in standards in the United States,” Geithner said.
It sounds like Geithner was challenging the theory that regulatory competition inevitably leads to deregulation. That theory has almost no historical support. It’s an academic fantasy. But the lack of facts has not prevented it from becoming widely held.
Worse, the theory leads to a very wrong-headed policymaking focus on centralization and harmonization. In fact, better regulation is almost always a product of governments going it alone rather than agreeing with each other about what to do.
Just look at what happened in the US when it came to regulating mortgage lending. Various states attempted to crack down on predatory lending practices. The federal bank regulators fought this crack down every step of the way. This is the opposite of what the theory of deregulatory competition would predict.
Geithner seems to realize this. At the end of his speech he emphasized that, if need be, the US is willing to Got It Alone when it comes to financial regulation:
But it is important to note that the strength of the United States financial system in the decades that followed the Great Depression was that we had the highest standards for disclosure and investor protection, we had the strongest protections for depositors and against money laundering, and we had the best exchanges. We did not lower our sights to match the more limited ambitions of others. We knew we would be more vulnerable if we did.
So we will do what we need to do to make the United States financial system stronger. We will do so carefully. And as we do it, we will bring the world with us.
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