UC Berkeley Econ Prof, Brad DeLong, to whom many of us are indebted for his patient, persistent, and lucid efforts to educate us about macroeconomics, furthers the cause of public transparency by publishing a previously internal February 2009 analysis by Citigroup that was about to disappear. The analysis focused on how difficult it would be for the mega-banks to "pass" the "stress tests" being proposed by Tim Geithner and the Obama economics team.
Citigroup’s answer was: This doesn’t look that hard, and it’s a good idea to ask these questions.
The bank’s internal analysis confirms the views of various outside observers at the time — Krugman, Yves Smith and friends, Mike Konczal, et al — that Treasury’s "stress test" scenarios would not be particularly stressful — and reality was already overtaking the "adverse" assumptions and headed south — and thus wouldn’t really tell us how much risk the banks were facing if things got a lot worse. Indeed, despite all the subsequent industry whining about the Administration being "anti-business," the bank’s analysts seemed to realize early on that Treasury’s purpose in running the tests was not to expose them but to save them, to help the banks convince investors they were not about to collapse and didn’t need to be taken over and would be helped if needed.
Beyond that confidence building goal, the tests were sold to the public as a responsible step to alert banks and regulators to the banks’ need for additional capital to withstand possible adverse changes in economic conditions. Given this guidance, and further efforts to rebuild the banks’ capital, investors could be confident the banks could withstand further shocks or significant forecast errors.
It’s hard to argue with the prudence of that concept: you need to think about and plan for the possibility things could get much worse.
What I find interesting, indeed surprising (shocking?) in light of what’s happened to the economy, the Administration’s stalled economic recovery efforts and the dreadful prospects of extended unacceptably high unemployment, is the economic team’s failure to apply the same stress test concept to their own economic recovery policies.
Certainly, by the time the stress tests were developed, Christina Romer would already have told Tim, Larry and team that the employment and GDP assumptions they used when designing the first stimulus were by then (February 2009) too optimistic. And even if the original forecasts were still holding in February (they weren’t), the argument for testing the stimulus adequacy under worse scenarios would still have applied to the Administration’s original recovery plans.
Indeed, when Summers’ reportedly argued against a stimulus large enough to fill the (by then, under-forecast) expected GDP gap but instead for a smaller "insurance" policy, there must have been some notion of what they were insuring against and how much damage the insurance would leave uncovered.
They needed their own stress tests and a Plan B or C for those contingencies. And that would have included not merely the size and politics of further stimulus, but the sequencing of Obama’s agenda and even thoughts about what they’d need from the Federal Reserve and what types of appointments would support it.
But apparently that didn’t happen, or was never made public. Even if Romer was running what if scenarios internally, I’ve seen little indication Tim and Larry had a Plan B or thought through what Plan B should look like or how (and when) Plan B might be triggered and approved.
With the frustrated Romer’s exit, and Summers’ announced departure, lots of folks are debating Summers’ tenure and indeed the competence of the entire Tim and Larry show. So I think a relevant question is why, given what they were asking the banks, they didn’t ask the same types of questions of their own efforts and have a credible backup plan if they turned out to be badly wrong.
And that question is not just for the economic team. Why didn’t Obama’s political advisers demand their own "political stress tests," knowing that if Tim and Larry’s economic recovery plan stalled after a year of trying, it might tank Congressional Democrats in 2010 and the President’s agenda or re-election beyond?
Since there were very good economists warning them about this from the beginning, not doing such tests/planning looks like political malpractice.
And yet we’re being told that it’s okay for Rahm Emanuel to remain in the White House when he’s reportedly focused on what’s best for his own political future — and thus not what’s best for the country or the Obama Presidency — while the President’s political advisers are already planning their departure to work on Obama’s 2012 campaign.
What all of this tells me is that even now there’s no one working on Plan B even though it’s long been obvious Plan A failed. The mini-Bs they’ve been begging Presidents Snowe and Collins to pass are clearly not enough, but they’re not telling the public.
And with everyone focused on leaving or their next gig, who’s minding the store? In the words of our Vice President, someone needs to wake up.