Geithner Passes His Own Test
The Washington memoir of a recently retired or ousted Cabinet figure usually can be counted on to have a few defining characteristics. A little personal score-settling, for sure. The sense that the book was constructed by a committee from loose talking points and note cards, probably. A few gossipy nuggets scattered amid a largely conventional treatment of the events in question, typically. Suitable flattery of, if not fawning sycophancy for, the Boss, naturally.
Timothy Geithner’s Stress Test: Reflections on Financial Crises,1 his memoir of the financial crisis of 2008 and the policies enacted in its wake, hews to the formula in many ways. Still, the former Treasury secretary’s book has value, if often inadvertently, in the way it reveals a certain technocratic cast of mind—what the financial journalist James Grant has called the ascendance of the “Ph.D. Standard” among economic mandarins. Stress Test has a number of thoughtfully nuanced interpretations, as well as some that seem highly arbitrary and inconsistent. Perhaps the most astonishing feature of this memoir, notwithstanding its subtitle, is Geithner’s unwillingness to reflect on the risks and still unresolved potential costs embedded in the response to the financial crisis of 2008.
Geithner’s view is surprisingly varied and apolitical, certainly in relation those of President Obama and Geithner’s public persona (with which, he indicates, he was not always comfortable). The most frequent popular assessments of blame for the crisis focus either on a small coterie of Wall Street CEO-criminals or on misguided bank regulators. For his part, Geithner sees a wide range of human actors, honest miscalculations of risk, regulatory and market failure, as well as pockets of actual malfeasance:
It started with a long mania of overconfidence, the widespread belief that house prices would not fall, that recessions would be mild, that markets would remain liquid. The mania fueled too much borrowing, too much leverage, and too much runnable short term financing…Borrowers took too many risks; creditors and investors were way too willing to finance those risks; the government failed to reign in those risks, and then was unable to act quickly or forcefully enough when the panic hit.
Moreover, while there was some serious mortgage fraud, “the bulk of the huge boom in borrowing that caused the crisis was between consenting adults who took risks they believed would pay off, risks that did pay off for a long time, risks fueled by genuine but imprudent beliefs that rising real-estate values would make future defaults extremely unlikely.”
Geithner views himself as a crisis manager, a determined firefighter (he is partial to pyro-centric metaphors), desperately trying to prevent a total conflagration of the economy. While he predictably expresses a number of liberal platitudes, he is not ideological—an approbation which he clearly finds distasteful, certainly for someone who had his responsibilities.
He portrays his time in office—both as Treasury secretary in the Obama administration and, prior to that, as the head of the New York Federal Reserve—as a struggle against “moral hazard fundamentalists” on both the right and the left. He believes they assigned excessive value to the imposition of economic losses, the avoidance of “bailouts,” and the lodging of civil and criminal sanctions as the guiding principles for dealing with the crisis. “The natural human instinct in a financial crisis, and especially the political instinct, is to avoid unpopular interventions, to let the market work its will, to show the world you’re punishing the perpetrators,” he believes. “But letting the fire burn out of control is much more economically damaging.”
Geithner insists that the crisis the nation faced during this period was of unprecedented scope, speed, and danger. The only relevant considerations were taking immediate concrete actions to stop the self-fulfilling nature of financial crises. Specifically, “you never want to allow a messy liquidation of a financial institution unless you can draw a circle of protection around the rest of the system’s core, a firebreak to contain the flames.” If that meant that some irresponsible borrowers, lenders, or Wall Street executives would not immediately suffer the “just” outcome that they might ideally deserve, then so be it. 2 Such considerations, he makes clear, have no place in the firefighter’s handbook, for they risk undermining the objective of controlling the blaze and stabilizing the financial system, with the nation days away from ATMs not having sufficient funds.
And yet, throughout, there is a marked arbitrariness and inconsistency in Geithner’s approach. For example, only a few pages after plaintively lamenting the government’s inability to rescue Lehman Brothers in September 2008—“we had been powerless, not fearless” in allowing its failure—Geithner is scrambling to save American International Group, the global insurance company. Letting AIG fail “seemed like a formula for a second Great Depression.” He says he acknowledged at the time that such a rescue would lead to an enormous public-relations challenge of explaining “the zig and the zag” contrast with the treatment of Lehman Brothers. But while it would look like a random “lurch” in policy, “it was our only hope of averting unimaginable carnage.”
Stress Test is rife with such provocative, empty adjectives, instead of new anecdotes and information, and they do not add to our understanding of the situation as it existed. Many have speculated that the government made a conscious choice to allow Lehman’s failure and that the sudden change in approach reflected policymakers’ belated realization of the consequences of defaults by large institutions. Under this interpretation, Lehman Brothers was thus an experiment that no one wanted to repeat. Like the other principals in the crisis, Geithner adamantly denies this. Unfortunately, he does not convincingly establish the contrasts between the circumstances of each firm for this assertion to be satisfying.
The legal freelancing continued. Soon after, Geithner recounts, he was urging Ben Bernanke to have the Federal Reserve purchase unsecured commercial paper of private nonfinancial corporations such as Verizon, McDonald’s, and Caterpillar because they and other leading corporations were facing a liquidity crisis and might soon be unable to meet payroll. Commercial paper is an unsecured I.O.U. that “by definition is not backed by collateral.” While the Federal Reserve’s financing of commercial paper may indeed have been pivotal in providing essential working capital and stabilizing the crisis, the perceived lack of legal authority to lend to private companies on an unsecured basis was among the most salient reasons Geithner offers for the constrained response to the Lehman collapse.
At critical times, our “constant zigzags looked ridiculous,” Geithner acknowledges. “We were lurching all over the place, and no one had any idea what to expect next.” This spasmodic response was primarily the handiwork, according to Geithner, of people such as Sheila Bair, the then-chairwoman of the Federal Deposit Insurance Corporation, and the book’s villain. Geithner faults Bair for her focus on moral hazard and what he alleges was a parochial concern for the FDIC. The practical consequence of this unpredictability was that “we left existing creditors wondering whether more defaults and haircuts could be coming,” which, in his view, further destabilized the system.
Geithner’s dismissal of those who had the temerity simply to ask questions about the legal authority behind unprecedented government actions undermines his own credibility when he relies on legal technicalities to explain or justify his own actions or inactions. By his own account, he was more than willing to push Bair to put the FDIC at risk on untested legal authority, to justify the reinterpretation of Troubled Asset Relief Program (TARP) after he realized that purchasing troubled assets alone would not do the trick, and to mock those who questioned the constitutional authority of Congress to enact TARP at all. Geithner may or may not be right, legally and prudentially, when it comes to these judgments, but he portrays them as logically consistent with each other and suggests he got the balance just right every time. His own account undermines that conclusion.
For example, many claim that the government’s insistence that the largest financial institutions had to accept TARP funds was unnecessary, interfered with the market’s ability to self-correct, and unfairly wiped out significant private-shareholder wealth. Geithner’s account certainly confirms the inherently coercive nature of what went on in that famous meeting wherein the heads of the largest financial institutions were summoned to see Geithner’s predecessor at Treasury, Hank Paulson, and were told, Godfather-style, that their signatures were expected on papers providing for a TARP investment. He insists that the resort to such tactics was necessary under the circumstances but provides no other strong defense.
One of Geithner’s “proofs” of the wisdom of the AIG bailout is that many of its holdings were able, over time, to recover significant value, thereby allowing the government to earn a positive return on its investment. Here, he essentially acknowledges that the government anointed itself as the ultimate credit analyst, whose judgments would transcend the markets and be final.3 He writes: “If AIG had been forced to mark all its assets to their depressed market prices during a selling frenzy, then sure, it would’ve been insolvent. Just about every financial firm would’ve been insolvent. But we thought that once the crisis passed and assets prices once again reflected some notion of their true underlying value, there was a reasonable chance AIG’s assets would be worth more than its liabilities. We were ultimately right.”
This argument is a double-edged sword. It buttresses the case that the government’s financial risks did not cost the taxpayers, but it’s less helpful when considered in light of the claims made by others that the government’s bailout mechanism was coercive and in effect stole value from existing private shareholders as it bailed out creditors.
If Bair is the book’s villain, then Ben Bernanke is its hero. In explaining why he recommended that President Obama re-nominate Bernanke after the expiration of his term in 2010, Geithner claims: “Ben had done an outstanding job fighting the crisis, keeping his promise to do whatever he could to help avoid Depression 2.0…He was now presiding over a creative experiment through QE1, buying $1.75 trillion in Treasuries…I still talked to him just about every day, and I doubt there’s ever been a closer relationship between a Treasury secretary and a Fed chairman.”
This description is perhaps one of the most jarring in the book, given its matter-of-factness, dispassion, and lack of irony. In reality, the relationship between Geithner and Bernanke formed the largest and most unprecedented vendor-customer relationship in human history. Bernanke’s central bank acquired trillions of dollars’ worth of Treasury securities issued by the Treasury Department, largely funding the nation’s fiscal deficit during this period. The Federal Reserve is now the largest creditor of the United States. The ultimate fate of the Treasury bonds purchased by the Fed is still to be determined, as are their possibly significant unintended consequences for interest rates and inflation. About these gargantuan unresolved questions, Geithner has disappointingly little reflection to offer.
The acute part of the crisis ended. A depression was averted. If that were the end of history, the efforts of the crisis-management team that included Geithner and Bernanke would be viewed heroically. But many of the “extraordinary” crisis measures remain in place; the Federal Reserve continues to purchase billions of Treasury securities even if at a reduced rate; there is still lack of clarity about the fate of too-big-to-fail banks; and moral hazard appears to have returned. And, of course, America’s long-term fiscal situation is still problematic.
But with the U.S. 10-year Treasury bond yielding well under 3 percent, ample liquidity, and a slow but apparently accelerating recovery in the real economy, Geithner may yet earn some of the “mission accomplished” valedictory musings he allows himself. Still, he and we would do well to recall what he says he advised his colleagues during a lull in the crisis in 2008: “Just because it feels calm, doesn’t mean it is calm.”
1 Crown, 592 pages.
2 Refreshingly, Geithner notes that for most of the companies and individuals that were, according to the popular perception and some of our more demagogic politicians, “bailed out,” shareholders and managers in fact suffered catastrophic losses or at least substantial dilution in value. The “bailout” of Bear Stearns, for example, left little value for the shares owned by its executives, some of whose holdings were once worth hundreds of millions or billions of dollars on paper.
3 In this context, it is odd that Geithner later takes great pride that a large hedge fund whose macroeconomic views are widely respected would later endorse the calculations the government used in subjecting bank balance sheets to “stress tests.” The front page of that firm’s research report is triumphantly reprinted in the book.