Stress Test Read online

  Our approach did create some moral hazard, although the critics I came to call “moral hazard fundamentalists” tended to overstate our generosity to failed risk-takers. Shareholders in the five bombs had already absorbed huge losses; the leaders of Fannie, Freddie, and AIG had been pushed out; Lehman had ceased to exist. But the larger point, as President Obama later said, was that you shouldn’t refuse to deploy fire engines to a burning neighborhood in order to highlight the dangers of smoking in bed. The President told me to focus on firefighting.

  ON FEBRUARY 9, the President pitched his fiscal stimulus bill in Elkhart, Indiana, where unemployment had soared from 5.2 percent to 19.1 percent in just a year. But that night, at his first press conference as president, he emphasized that stimulus was only part of the solution. Credit needed to start flowing again, and confidence in the financial system needed to come back.

  “Tomorrow, my Treasury secretary, Tim Geithner, will be announcing some very clear and specific plans,” he said. A reporter asked him to elaborate, but he said to wait a day. He could not have been more generous, or raised expectations any higher: “I don’t want to preempt my secretary of the Treasury. He’s going to be laying out these principles in great detail tomorrow.… I want to make sure that Tim gets his moment in the sun.”

  A small team of advisers had been working around the clock with me on a financial stability strategy, but so far we had only a general framework in place. We weren’t actually planning to announce the specifics of our plan. My team had anticipated this problem in an internal memo: “Many details will remain opaque at initial launch. This could create great uncertainty and volatility in markets.” And we had another problem: few of our other colleagues thought highly of our strategy, not even Larry.

  But the President went out of his way to express confidence about my debut, even urging the White House press corps to come see me speak.

  “He’s going to be terrific!” the President said.

  I DOUBTED that.

  Treasury secretaries are supposed to inspire confidence. Our signatures go on dollar bills. And I knew that good theater—being clear and calm, conveying an impression of competence and credibility—could be as important to confidence as good substance. But I had always been a backstage guy. I had spent my career behind the scenes. Ever since high school, I had dreaded public speaking. Now I had to perform for the world for the first time, using a teleprompter for the first time. And I didn’t feel great about my message. I had lived through enough crises to know that they’re always unpredictable and blanketed with fog. Americans desperately wanted assurances that things would get better soon, and I wasn’t sure how to project an air of confidence I didn’t feel.

  Theater aside, it seemed unlikely that an angry public would embrace anything I had to say after my ugly confirmation fight. And what I had to say seemed unlikely to ease the anger no matter who said it. I would be pledging more government support for financial firms, which was not what a bailout-weary nation wanted to hear. The fact that my framework was so contentious inside our administration suggested it probably wouldn’t inspire wild enthusiasm outside the administration.

  Our strategy was also rather novel, which would make it an even harder sell. We didn’t intend to preemptively nationalize major banks, and we didn’t intend to let them fail; both of those familiar strategies would have accelerated the panic, but they would have been a lot easier to explain. The centerpiece of our approach was a “stress test,” which sounded more like analysis than action. Regulators would delve into the books of major financial firms to calculate how much additional capital they would need to survive a truly catastrophic downturn, just as doctors stress-test patients to see how their bodies would respond to strenuous conditions. The firms would then be required to raise enough capital to fill the gap. And if an unhealthy firm couldn’t raise enough from private investors, government would forcibly inject the missing capital.

  This was key. The stress test would be more than a rigorous test. It would be a mechanism to recapitalize the financial system so that banks would have the resources to promote rather than prevent growth. We’d give them a chance to prove they could attract the cash they would need to survive a depression without our help. If they couldn’t, we wouldn’t stand by and let their failure trigger a meltdown. We’d rely on private capital whenever possible, but we’d turn to public financing when necessary. The stress test would provide a form of triage, separating the fundamentally healthy from the terminally ill. And by ensuring the system could sustain depression-like losses, we thought we could make a depression less likely.

  But I wasn’t ready to provide much detail yet. We hadn’t figured out how the stress test would work. And the rest of my speech was just as vague. I would announce a new program to buy some of the distressed assets that were weighing down banks, while acknowledging that it wasn’t ready. I would promise “a comprehensive plan to address the housing crisis,” with little further explanation. And I would signal that we would not allow any more Lehman-style failures, a crucial commitment designed to prevent an even more chaotic run, but that line was hedged and buried in my twenty-sixth paragraph.

  As the President had promised, this would be my moment in the sun. The world wanted to see American leadership. The markets wanted to see a credible plan. The public wanted to see change it could believe in, the “Yes We Can” audacity that had fueled the President’s journey to the White House. And everyone wanted to see if his embattled new Treasury secretary was up to the job. As I took the stage in Treasury’s ornate Cash Room, in front of a profusion of giant flags that made me look like a politician at a campaign event, I knew my reputation was at stake.

  It’s fair to say the speech did not go well.

  I swayed back and forth, like an unhappy passenger on an unsteady ship. I kept peering around the teleprompter to look directly at the audience, which apparently made me look shifty; one commentator said I looked like a shoplifter. My voice wavered. I tried to sound forceful, but I just sounded like someone trying to sound forceful. Early on, I caught a glimpse of Wall Street Journal financial columnist David Wessel, and I could tell from his pained expression that I was in trouble. The President had raised expectations. I was deflating them.

  Stocks plummeted more than 3 percent before I even finished talking and nearly 5 percent by the end of the day—not quite a crash, but not good. Financial stocks would drop 11 percent for the day. After I finished, I sat down with the NBC anchor Brian Williams—my first television interview ever—and saw a graphic on the screen: “Is Geithner’s Neck on the Line?” Williams began by invoking a prominent financial commentator.

  “I heard Larry Kudlow say: ‘Geithner was really kind of a disaster,’ ” he said. “Mr. Secretary, that was among the nicer comments I heard from Larry Kudlow.”

  Kudlow was not an outlier. I didn’t read the reviews at the time, but the phrase “deer in the headlights” appeared in a lot of them. An actor playing me opened Saturday Night Live by announcing that my solution to the crisis was to give $420 billion to the first caller with a solution to the crisis. The substantive critiques were just as withering. “Someone should have told Treasury Secretary Timothy Geithner that the one thing to avoid at a time of uncertainty is raising more questions,” the New York Times editorial board declared. The widely respected Financial Times columnist Martin Wolf actually began his analysis: “Has Barack Obama’s presidency already failed?”

  It was a bad speech, badly delivered, rattling confidence at a bad time. I somehow managed to convince the public we’d be overly generous to Wall Street while convincing the markets we wouldn’t be generous enough. Our populist critics concluded we were more eager than ever to shovel cash to arsonists; former World Bank chief economist Joseph Stiglitz described our plan as “banks win, investors win—and taxpayers lose.” But banks and investors were mostly confused.

  “Investors want clarity, simplicity and resolution,” one financial executive told Reuters. “Th
is plan is seen as convoluted, obfuscating and clouded.”

  After my speech, a friend emailed me Teddy Roosevelt’s “Man in the Arena” quote about how it’s not the critic who counts, but the man “who comes up short again and again … who at the worst, if he fails, at least fails while daring greatly.” I thought it was a nice hang-in-there sentiment, until my inbox began filling up with variations on the Man in the Arena. Another friend called to say that what didn’t kill me would make me stronger, which I didn’t find all that reassuring, either. I knew I’d have to resign if our strategy didn’t work—and more important, the economy was hanging in the balance. At his daily economics briefing the morning after my speech, the President was not happy.

  “How the hell did this happen?” he asked.

  He wasn’t trying to put it all on me, but I knew it was all on me. And there wasn’t much I could do or say to reassure him or anyone else. We just had to start laying out details of our plan, and hope we could convince people it was a good plan. I figured that if we did what we said we would do, and it worked, confidence would eventually come back. And if it didn’t work, the quality of our theater wouldn’t matter much.

  HISTORY SHOWS that even modest financial crises cause horrific pain.

  One study of fourteen severe twentieth-century crises found that, on average, the unemployment rates in the affected countries jumped 7.7 percentage points. Many of them ended up nationalizing most or all of their banking systems. Financial crises have also been exorbitantly costly for taxpayers. The direct fiscal costs—just the money that governments have spent stabilizing their financial systems—have averaged more than 10 percent of GDP. For the United States, that would have amounted to about $1.5 trillion.

  There was nothing modest about our crisis. It began with a colossal financial shock, a loss of household wealth five times worse than the shock that precipitated the Depression. Bond spreads rose about twice as sharply in the Lehman panic as in the panic of 1929. Serious investors were buying gold in bulk and talking about burying it in their yards. Stock markets dropped to more than 50 percent below their 2007 highs.

  Naturally, most analysts expected that U.S. taxpayers would pay an astronomical price to repair our financial system, too. Simon Johnson, a former chief economist of the International Monetary Fund, warned that the government’s price tag could be $1 trillion to $2 trillion, “in line with the experience” of other nations. An IMF study estimated the final tab at nearly $2 trillion. “If we spent a million dollars a day every day since the birth of Christ, we wouldn’t get to $1 trillion,” said Congressman Darrell Issa, the top Republican on the House government oversight committee. “And we’re likely to lose far more than that.”

  But we didn’t.

  Our outcomes were not in line with the experience of other nations, in past crises or this crisis. They were much better. By that summer, we had not only averted a depression, our economy had started growing again. House prices stabilized. Credit markets thawed. And our emergency investments would literally pay off for taxpayers.

  Most Americans still believe we threw away billions or even trillions of their hard-earned dollars to bail out greedy banks. In fact, the financial system repaid all our assistance, and U.S. taxpayers have turned a profit from our crisis response, including our investments in all five of those financial bombs. We had been so worried about our limited resources that the President’s first budget included a $750 billion placeholder for a second TARP, but in the end, we didn’t have to ask Congress for another dime.

  Of course, our goal wasn’t to earn money for taxpayers. Our goal was to save the families and businesses of America from the calamitous pain of a failing financial system. I hoped we wouldn’t have to spend 10 percent of GDP to fix that system, but everyone I know would have gladly paid that fiscal price to avoid reliving the 1930s. As one of my close advisers, Meg McConnell, blurted out during a tense moment in the crisis, we were not far from a rebirth of Depressionera shantytowns. And no one I know—neither critics who thought we were foolish nor supporters who thought we might know what we were doing—imagined that we would put out the financial fire so quickly and actually make money on our investments.

  The recession of 2007 to 2009 was still the most painful since the Depression. At its depths, $15 trillion in household wealth had disappeared, ravaging the pensions and college funds of Americans who had thought their money was in good hands. Nearly 9 million workers lost jobs; 9 million people slipped below the poverty line; 5 million homeowners lost homes. Behind those numbers lies real suffering by real people who didn’t put banks in danger with reckless bets they didn’t understand. I had relatives and friends and relatives of friends who lost jobs and much of their savings, who saw their businesses devastated. Even when they were gracious to me, I could see in their eyes and hear in their voices a sense of: Why couldn’t you protect me from this? Pointing out that the downturn could have been much worse won’t help pay their rent or feed their kids.

  But it’s true.

  Our unemployment rate rose to 10 percent, but not to 25 percent as in the Depression. By the end of 2013, it was below 7 percent. Our recovery began much faster than was typical in previous crises, and it’s been much stronger than the recoveries of other major advanced nations. Our output returned to pre-crisis levels in 2011; output in Japan, Great Britain, and the eurozone had yet to do so by 2014. We’ve had private-sector job growth every month for the past four years, restoring almost all of the 8.8 million jobs lost in the Great Recession. The stock market has exceeded its pre-crisis peak, so retirement funds that lost $5 trillion during the crisis have gained it back. Many Americans are still suffering, but a lot more suffering has been averted.

  And yes, the financial system is alive and flourishing again. That’s partly because of the strategy I helped design and execute, which is why I’m often described as a “Wall Street ally.” The New York Times once did an amusing story about my unearned reputation as a “Wall Street insider.” People still seem to think I cut my teeth at Goldman Sachs. But nothing we did during the financial crisis was motivated by sympathy for the banks or the bankers. Our only priority was limiting the damage to ordinary Americans and people around the world.

  During the crisis, we did a lot of things that would be unthinkable in normal times in a capitalist economy. But we kept our promises that our interventions would be as limited as possible. By the end of 2010, the U.S. government no longer owned a piece of any major bank. By contrast, the federal government’s 1984 takeover of Continental Illinois—the seventh largest U.S. bank at the time, a tiny fraction of the size of some of the troubled banks in our crisis—lasted seven years before the bank returned to private control.

  Our economy is still reeling from the worst financial crisis in generations. Our jobless rate is too high and income growth is too low. But the U.S. recovery has outperformed expectations, history, and most of the developed world. So far, the prophets of doom who have predicted runaway inflation, runaway interest rates, a double-dip recession, a collapse in demand for U.S. government securities, and other horrors for America have been false prophets. I remember half-joking to the President that we had two types of critics attacking us for failing to produce a stronger recovery—people who were blocking our proposals to produce a stronger recovery, and people who believed in unicorns.

  Still, plenty of Americans who don’t believe in unicorns do believe we bungled the crisis. The public despised our financial rescues, to the extent that the President joked at a Washington dinner in mid-2009 that he needed to house-train his dog, Bo, “because the last thing Tim Geithner needs is someone else treating him like a fire hydrant.” And the outrage has endured. Conventional wisdom still holds that we abandoned Main Street to protect Wall Street—except on Wall Street, where conventional wisdom holds that President Obama is a radical socialist consumed with hatred for moneymakers. The financial reform law that we wrote and pushed through a bitterly divided Congress after the crisis, t
he most sweeping overhaul of financial rules since the Depression, is widely viewed as too weak, except in the financial world, where it is described as an existential threat.

  Those perceptions are partly my fault, failures of communication and persuasion.

  I’m proud of most of the decisions we made to try to save the economy. And I’m under no illusions that better marketing or better speechmaking could have made those decisions popular. That said, I never found an effective way to explain to the public what we were doing and why. We did save the economy, but we lost the country doing it. As the crisis was winding down, I suggested to my adviser Jake Siewert that Treasury ought to put out a long white paper explaining the rationale behind all our controversial decisions. He grinned and said: “Sounds great. Why don’t you give it a shot?” I remember when I met Barbra Streisand at a White House state dinner in 2011, she told me: “Mr. Secretary, when I see you on TV, I get the feeling you’re not telling us everything.”

  I laughed and replied: “You have no idea.”

  I can try to remedy that now.

  Our response to the global financial crisis is still wrapped in myth and haze and misperception. And I was in the middle of it from start to finish, from boom to bust to rescue to recovery, leading the New York Fed from 2003 to 2008 and the Treasury from 2009 until I left public service in January 2013. Ben Bernanke, my closest colleague when I served at the Fed and then as Treasury secretary, was the only other principal combatant who fought the entire war. This gives me a particular perspective on how we got into the mess, how we got out of the mess, and how we tried to make future messes less frequent and damaging.