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Stress Test: Reflections on Financial Crises 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 le 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: Reections on Financial Crises TRIBUTE TO THE CRISIS TEAM Photo Insert ACKNOWLEDGMENTS AUTHOR’S NOTE NOTES INTRODUCTION The Bombs On the morning of January 27, 2009, my rst full day as secretary of the Treasury, I met with President Barack Obama in the Oval Oce. The worst nancial crisis since the Great Depression was still raging, and he wanted to put out the re for good. The banking system was broken. The broader economy was contracting at a Depression-level rate. Consumer condence 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 condence 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 prole—and the prole 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 nancial rms. 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 conrmation 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 rst Treasury nominee rejected since before the Civil War, and I had considered withdrawing before the vote. I was eventually conrmed, 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 ocial 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 ght 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 nancial 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 nancial giants, culminating in the Troubled Asset Relief Program (TARP), a $700 billion intervention for the entire nancial 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 nancial system was still frozen. Banks that had overextended themselves during the boom were now in defensive retreats, hoarding cash, depriving businesses of nancial oxygen. There was virtually no private credit available for ordinary borrowers who wanted to nance a new car or a college education, much less a new home. We had slipped into a vicious cycle, as the nancial earthquake began to ripple through the broader economy. As laid-o workers and other nervous consumers spent less, businesses were laying o more workers and investing less, prompting families and businesses to cut back even more. The crippled nancial system was making the recession worse, while the deepening recession was making the nancial 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 x the broader economy without xing the nancial 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 nancial 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 ocial, I can tell you how bad it really is,” I said. FOR STARTERS, I told the President, we still had ve “nancial bombs” to defuse. By bombs, I meant huge, far-ung, 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 ve 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 nancial behemoths. But if their creditors or the markets in general lost condence that any of them could meet their obligations, we’d be looking at a worldwide nancial 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 nancial 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 ve severely undercapitalized rms that could blow up the nancial 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 nance an economic recovery. And Larry and I were concerned that our new administration didn’t have enough cash—or enough authority—to repair it.
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