Stress Test: Reflections on Financial Crises

523 Pages·2014·4.21 MB·English

by  Timothy F. Geithner

Copyright © 2014 by Timothy F. Geithner
All rights reserved.
Published in the United States by Crown Publishers, an imprint of the Crown Publishing Group, a
division of Random House LLC, a Penguin Random House Company, New York.
www.crownpublishing.com
CROWN and the Crown colophon are registered trademarks of Random House LLC.
Cataloging-in-Publication Data is on file with the Library of Congress.
ISBN 978-0-8041-3859-8
eBook ISBN 978-0-8041-3860-4
Jacket design: Christopher Brand
Jacket photograph: Brooks Kraft
Charts: Joe LeMonnier
v3.1
For the intrepid public servants at the Treasury and the
Federal Reserve who worked with great skill and devotion
to help guide their country through the crisis
CONTENTS
Cover
Title Page
Copyright
Dedication
INTRODUCTION: The Bombs
ONE: An American Abroad
TWO: An Education in Crisis
THREE: Leaning Against the Wind
FOUR: Letting It Burn
FIVE: The Fall
SIX: “We’re Going to Fix This”
SEVEN: Into the Fire
EIGHT: Plan Beats No Plan
NINE: Getting Better, Feeling Worse
TEN: The Fight for Reform
ELEVEN: Aftershocks
EPILOGUE: Reflections on Financial Crises
TRIBUTE TO THE CRISIS TEAM
Photo Insert
ACKNOWLEDGMENTS
AUTHOR’S NOTE
NOTES
INTRODUCTION
The Bombs
O
n the morning of January 27, 2009, my first full day as secretary of
the Treasury, I met with President Barack Obama in the Oval Office. The
worst financial crisis since the Great Depression was still raging, and he
wanted to put out the fire for good. The banking system was broken. The
broader economy was contracting at a Depression-level rate. Consumer
confidence had sunk to an all-time low, and millions more Americans
were in danger of losing their jobs, their savings, even their homes. The
President looked calm and reasonably comfortable after a week in the
White House, despite all the bad news he was getting.
I was about to give him some more.
First, I thanked him for coming to my swearing-in the night before, a
nice gesture of personal confidence in me. We had met just three months
earlier, and I was in many ways an unorthodox choice to lead Treasury. I
wasn’t a banker, an economist, a politician, or even a Democrat. I was a
registered independent without much of a public profile—and the profile
I had didn’t exactly signal Obama-style hope and change. As head of the
Federal Reserve Bank of New York, I had spent the past year working
with a Republican Fed chairman, Ben Bernanke, and a Republican
Treasury secretary, Henry Paulson, Jr., to design a series of spectacularly
unpopular rescues of financial firms. I didn’t look like a Treasury
secretary, either. I was forty-seven. I lacked gray-haired gravitas. Barney
Frank, one of my closest allies in Congress, later observed that when I
spoke in public, I looked like I was at my own bar mitzvah.
And I was already politically damaged goods. I had been portrayed
throughout my confirmation hearings as a tax cheat, a tool of Wall
Street, an enemy of Main Street. Even though I had spent the previous
two decades in public service, I was routinely described as a venal
investment banker. Some thought I might be the first Treasury nominee
rejected since before the Civil War, and I had considered withdrawing
before the vote. I was eventually confirmed, by the narrowest margin
since World War II; I already felt crushing guilt about the humiliation I
was forcing on my family, and the political capital the President had to
spend on me.
But now it was time to get to work. I took a seat on a sofa facing away
from the Rose Garden, the seat I would take hundreds of times over the
next four years. The President sat in his official chair to my right. On the
couch across from me was the renowned economist Larry Summers, a
former Treasury secretary who had met me when I was a junior civil
servant in the department and had helped promote me up the ranks.
Now Larry was running the President’s National Economic Council, so
we would fight the crisis together. It should have been an exciting
moment for me—a career technocrat entering the epicenter of power,
alongside a brilliant former boss and an inspiring new president.
It didn’t feel exciting. It felt dark and daunting.
I had spent much of my career dealing with financial crises—in
Mexico, Thailand, Indonesia, Korea, and beyond—but this was the big
one, the hundred-year storm. Bernanke, Paulson, and I had already
engineered a series of emergency interventions for a variety of financial
giants, culminating in the Troubled Asset Relief Program (TARP), a $700
billion intervention for the entire financial system. But we hadn’t ended
the crisis. The index measuring the risk of corporate defaults was even
higher than it had been after the chaotic collapse of the Lehman Brothers
investment bank in September 2008, when stock markets crashed, bond
markets went haywire, and even supposedly safe money market funds
were overwhelmed. Foreclosures were at an all-time high. The economy
was shedding more than 750,000 jobs a month.
We had slowed the post-Lehman panic, but the financial system was
still frozen. Banks that had overextended themselves during the boom
were now in defensive retreats, hoarding cash, depriving businesses of
financial oxygen. There was virtually no private credit available for
ordinary borrowers who wanted to finance a new car or a college
education, much less a new home. We had slipped into a vicious cycle,
as the financial earthquake began to ripple through the broader
economy. As laid-off workers and other nervous consumers spent less,
businesses were laying off more workers and investing less, prompting
families and businesses to cut back even more. The crippled financial
system was making the recession worse, while the deepening recession
was making the financial system worse. Wall Street and Main Street
were going down together. I had recently started reading Liaquat
Ahamed’s Lords of Finance, a history of the policymakers whose mistakes
helped create and prolong the Great Depression, but I had put it down
after a few chapters. It was too scary.
The President knew he couldn’t fix the broader economy without
fixing the financial system. Banks are like the economy’s circulatory
system, as vital to its everyday functioning as the power grid. No
economy can grow without a financial system that works, safeguarding
the savings of individuals, moving money where it’s needed, helping
families and businesses invest in their futures. And ours was still a mess.
“Now that I’m official, I can tell you how bad it really is,” I said.
FOR STARTERS, I told the President, we still had five “financial bombs” to
defuse.
By bombs, I meant huge, far-flung, overleveraged institutions whose
failure could spark the kind of global panic the Lehman bankruptcy had
sparked in the fall. I listed them: Fannie Mae, Freddie Mac, AIG,
Citigroup, and Bank of America. They all were much larger than
Lehman. All five had received major infusions of government cash to
save them from failure; AIG had been rescued three times in four
months. But they all were in trouble again, and we needed to make sure
they didn’t explode—not to protect them from the consequences of their
mistakes, but to prevent another messy failure from ravaging the rest of
the economy. The politics would be awful. People hated the idea of
government bailouts for mismanaged financial behemoths. But if their
creditors or the markets in general lost confidence that any of them
could meet their obligations, we’d be looking at a worldwide financial
meltdown, and a much deeper economic crisis.
Fannie and Freddie, the Washington-based housing giants that backed
most U.S. mortgages, needed the most help. They were quickly burning
through nearly $200 billion in taxpayer aid, and without another $200
billion or so—the equivalent of more than three years’ worth of federal
education department spending—they risked catastrophic defaults. Even
a modest increase in that risk would push mortgage rates higher and
home prices lower, intensifying the recession.
AIG was the closest to exploding, and the most egregious financial
basket case. But while the century-old insurer had become a three-letter
symbol of excessive risk, AIG also had tens of millions of innocent
policyholders and pensioners who depended on it, plus tens of thousands
of derivatives contracts with businesses around the world. A default on
its debts or even a downgrade of its credit rating would reignite the
panic.
Citi and Bank of America were the biggest of the bombs, Exhibits A
and B for the outrage over “too big to fail” banks; my aides called them
the Financial Death Stars. But the world was so fragile, and they really
were so big, that if we didn’t want a reprise of the Depression—an
obliterated banking sector, 25 percent unemployment, thousands of
businesses shuttered—we had to make sure they didn’t drag down the
system, even if it looked like we were rewarding the reckless.
That was a lot to dump on a new president’s plate. But the problem
was bigger than the bombs.
We weren’t just dealing with five severely undercapitalized firms that
could blow up the financial system. We were dealing with a severely
undercapitalized system. Even after the TARP investments and our other
emergency assistance, it did not have enough capital to cover its
potential losses, much less finance an economic recovery. And Larry and
I were concerned that our new administration didn’t have enough cash—
or enough authority—to repair it.
My former New York Fed colleagues had privately calculated that the
banking sector alone might need another $290 billion to survive a bad
recession, and as much as $684 billion to survive an “extreme stress
scenario.” Those numbers didn’t include the potential cost of stabilizing
“nonbank” financial institutions such as AIG. They didn’t include the
potential cost of rescuing General Motors and Chrysler, which were also
on the verge of bankruptcy. And we had only about $300 billion left in
uncommitted TARP funds.
Larry and I told the President we might have to ask for another TARP,
at a time when Congress had zero interest in more bailouts.
I couldn’t claim I knew exactly what would work. There hadn’t been a
crisis this severe in seventy-five years, and never in a financial system
this complex. Repairing our banks and other financial institutions, while
necessary, would not be sufficient to fix the economy. That’s why the
President was already pushing a massive fiscal stimulus bill—$800
billion in government spending and tax cuts—to offset lost income and
wealth, revive demand, and create jobs. The Fed was also expanding the
frontiers of stimulus through monetary policy. Financial rescue, fiscal
stimulus, and monetary stimulus—along with the President’s efforts to
prop up the beleaguered auto and housing sectors—would all have to
work together, if they were to work at all.
But stabilizing the financial system was our most immediate problem.
A renewed banking panic would quickly overwhelm any fiscal and
monetary support we could provide. Larry and I were convinced we had
to try to get ahead of the crisis, instead of continuing to chase it from
behind. We told the President we had to err on the side of doing too
much, even though the public thought we were already doing too much.
In an emergency, temporizing half-measures would be riskier than
overwhelming force, and ultimately more expensive for taxpayers—not
only in dollars, but in lost jobs, failed businesses, and foreclosed homes.
The President took all this in quietly, patiently, seemingly unfazed. His
instinct was to move quickly to repair and restructure the entire
financial system, not to let it limp along or sweep its problems under the
rug. He wanted to be aggressive and comprehensive.
“We need to rip the Band-Aid off,” he said. “I want to do this right,
and get it over with.”
I agreed, but with a qualification. There was intense pressure on us to
punish the Wall Street gamblers who had gotten us into this mess—to
nationalize or liquidate floundering firms, or force bondholders to accept
“haircuts” rather than the face value of their bonds. Those get-tough
actions would feel resolute and righteous, but in a time of uncertainty,
they would damage confidence and accelerate the downward spiral. As
we had seen in the panic of the fall, that would hurt Main Street, not just
Wall Street. We wanted to avoid the long, sideways drift that Japan had
experienced after its crisis in the 1990s, but also the trauma of another
Great Depression.