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  But my main recollection from that era was how scary it was, how little we knew, how we struggled to figure out what mix of money and conditions could restore confidence in a particular country. The economic damage was brutal, even when our interventions worked. It was scarring to see how quickly markets could overwhelm even an aggressive rescue program, how debilitating one wrong move could be during a panic, how indiscriminately contagion could spread, how reluctant most politicians were to approve the unpopular actions needed to contain it. The most important thing I learned about financial crises is that they’re awful.

  SO WHAT caused the Asian contagion? Some of our partners in Europe—and some conservative critics at home—believed that we did, by creating moral hazard. In their view, we were arsonists pretending to be firemen. By bailing out Mexico, we supposedly sent a message to government leaders—and the creditors who financed their risky bets—that they would be bailed out again if their bets went bad again. To the moral hazard fundamentalists, that’s why governments continued to make risky bets and creditors continued to finance them.

  That story had a lot of power over a lot of people, but it wasn’t a very credible explanation. Throughout history, financial crises have always caused tremendous economic and political carnage. A politician might be tempted to borrow too much and leave the consequences to his successor, although the emerging-market crises cost the leaders of Mexico, Thailand, Indonesia, and Korea their jobs. But what foreign bank or investor would finance a weak government or a weak bank in an emerging economy on the belief that the IMF would step in quickly to protect them from losses? Before Mexico, the IMF had lent only relatively small amounts of money to countries in trouble, and the economic and financial damage from their crises was typically extensive. Even in Mexico, there was a lot of pain and losses for ordinary families and investors before and after our rescue began to work. It should have been a cautionary tale, not an attractive model to emulate.

  It is true that the overall losses to banks and investors were lower than they might have been without the IMF’s rescues, but still they had little reason to feel confident they would be protected again. Before Mexico, plenty of banks around the world had been nationalized or liquidated, often wiping out shareholders and bondholders in the process. Even after Mexico, there was no reasonable expectation of a safety net, no way to know which investments would or wouldn’t remain at risk even if the IMF did get involved. When Russia was teetering on the brink of default, some investors did buy its bonds as a “moral hazard play,” but their assumption that a rescue was inevitable turned out to be wrong and expensive.

  It is possible that at the margin, the success of the Mexico program made investors somewhat more confident about financing the Asian boom, not because they thought it marked the end of crises or they expected protection from losses, but because we had demonstrated a way to reduce the depth of the crisis—the extent and duration of the decline in economic activity. But there’s no way to solve a financial crisis without creating some moral hazard, without protecting investors and institutions from some of the consequences of excessive risk taking. They were, in Ted Truman’s phrase, collateral beneficiaries of an effective emergency program. It was impossible to design an effective rescue for the intended beneficiaries—the people who lived and worked in those countries—without some collateral beneficiaries.

  But the success in Mexico did not produce Asia’s boom or the willingness of investors to help finance it. During one meeting in Manila early in the Asian crisis, when some of Europe’s finance bureaucrats were invoking Mexico and moral hazard to argue against a generous financial response, Stan Fischer, the excellent American economist who was the IMF’s deputy director—I would later recommend him to Obama as a potential Fed chair as well—passed me a note pointing out that condoms don’t cause sex. Stan’s point was that the IMF loan program didn’t cause financial crises. It’s hard to believe that the existence of firehouses causes fires.

  I thought a better explanation of the core problem was a set of beliefs, a general overconfidence that a long stretch of calm and stability foreshadowed more calm and stability. Less charitably, you could call this a mania. Years of dramatic growth convinced investors that the Asian tigers and other emerging markets would keep recording dramatic growth, that past was prologue. While we were firefighting in Asia, I read Charles Kindleberger’s classic history of financial crises, Manias, Panics, and Crashes, and his explanation of the recurrence of crises over centuries was the most consistent with what I had observed. In Asia, credit nearly doubled in the three years before the crisis. The sustained period of rapid economic growth caused investors to ignore the vulnerability of fixed exchange rates and forget that capital inflows could become outflows in a hurry. They assumed that past performance would indicate future results. As the American economist Hyman Minsky explained in work I would read a decade later, stability can produce excessive confidence, which produces the seeds of future instability.

  This penchant for self-delusion is inherently human, but it does not inevitably lead to financial and economic crises. At the time, a similar dynamic was fueling the U.S. dot-com bubble, as investors enthralled by winners like eBay threw cash at losers like Pets.com. But the bursting of that bubble didn’t cause a major crisis, because it was financed mostly with equity rather than bank debt. Investors lost their money when their Internet stocks tanked, but the broader economy suffered only a modest slowdown.

  To cause a severe crisis, a mania must be financed by concentrated leverage, by excessive debt. When financial institutions or governments get overextended, they become vulnerable to creditors demanding their money back. This is especially dangerous when their borrowing is in the form of short-term debt that can run when the mania ends. The classic example is a bank that borrows short from its depositors, who can demand their money back at any time, and lends long to businesses and homeowners. This kind of “maturity mismatch”—the use of short-term funding to finance long-term investments—is how George Bailey got into trouble in It’s a Wonderful Life, and it’s why we now have deposit insurance to avoid bank runs. But a lot of short-term loans to financial institutions can look a lot like uninsured bank deposits, and they can run when confidence goes. When creditors call in the loans and the institutions can’t recover the money they had lent to finance longer-term investments, they can fail in a hurry. This is unfortunate if it happens to a single bank, but devastating if it happens to the banking system as a whole.

  That was the combustible combination in Asia: mania plus leverage in runnable forms. The overconfidence that fuels bubbles can become panic when bubbles pop, as investors who thought certain types of investments were perfectly safe suddenly decide that nothing that even resembles those investments is safe. Markets stop discriminating among loans, among banks, among countries. They become as blind to strengths as they had been blind to weaknesses. The more money runs, the more pressure mounts on other money to run. That’s how financial fires spread. And that’s when you need a good fire department, with strong leaders and modern equipment.

  We eventually managed to set up the IMF’s new firefighting fund, which wasn’t easy. We had to negotiate for months with congressional Republicans, who held up the U.S. contribution by attaching completely unrelated abortion restrictions on U.S. foreign aid to our funding bill. I also helped lead a push to create the Group of Twenty, an expanded international forum for financial cooperation, including emerging economies such as China, India, and Brazil alongside the more advanced economies. In the Obama administration, we would go a step further and make the G-20 the main arena for global economic issues, eclipsing the outdated G-7.

  Just about every debate we had during the Asian crisis would recur in the global crises a decade later: tough love versus unconditional love, Old Testament justice for arsonists versus pragmatic concern for innocents, transparency versus reassurance, austerity versus stimulus, liquidity versus solvency. In every country, we debated how long t
o let the fire burn before we should intervene aggressively, what the likelihood was that it would spread, and whether the people we wanted to save could be trusted to do what they promised. We learned it could be costlier to offer too little money than too much; as President Zedillo put it, when markets overreact, policy should overreact, too. We also learned that while no one wants to hand out money without strings attached, too many strings could strangle.

  There was no foolproof formula for crisis response. It was more art than science, more shades of gray than black and white. It required flexibility and creativity and humility, not unswerving principle. I liked to paraphrase the boxer and philosopher Mike Tyson: Everyone’s got a strategy until they get punched in the face.

  I DIDN’T go into government to be a reforming crusader. I just wanted to do interesting and consequential work. I wanted to be part of something larger than myself. At Treasury, I had the great privilege to help craft policies that would shape the fortunes of nations and improve millions of lives. And when the emerging-market crises were over, I got to turn my attention to a new set of challenges that didn’t involve rescuing investors or enraging the public, the kind of challenges that had first drawn me to public service.

  As the end of the millennium approached, Pope John Paul II and other religious leaders were calling for rich nations to forgive the debts of poor nations, where nearly three billion people were living on $2 a day or less. This “Jubilee” movement had a powerful moral case, and I had seen the evidence growing up abroad. Globally, one in three kids was malnourished, and their leaders routinely mortgaged their futures to finance wars and villas and Swiss bank accounts. In many countries, interest payments exceeded health and education budgets. I believed—as did Larry, who became Treasury secretary after Rubin stepped down in 1999—that there were also economic and strategic reasons to help poor countries escape crushing debts that hurt their people and destabilized their regions. So we proposed to substantially reduce the loans of the IMF and the World Bank to the poorest countries, and to write off the U.S. government loans entirely over time. We also proposed some creative conditions. To qualify for debt relief, governments would have to divert the money they saved on interest payments into health care and other services for their people.

  There was strong resistance among some Treasury staff and from finance ministries around the world, where forgiving debt was seen as an expensive gesture and a moral hazard-inducing precedent. The IMF had never forgiven debts; it raised money from member countries by assuring them its loans would always be senior and paid back in full. The same was true of the World Bank. And some Europeans argued that relief would only encourage irresponsibility in developing countries.

  But we didn’t think the rich countries that had provided the corrupt dictators of those developing countries with money and weapons had the moral or economic high ground. When I met the U2 rock star and debt relief activist Bono, he did a funny impression of moral hazard fundamentalists lecturing the poor. I told him it was weird to hear a Scottish guy speak in a German accent. Bono, of course, is Irish, but he apparently forgave my faux pas; when I left Treasury, his suggestion for my next job was drummer for his band.

  I handled most of the global negotiations over debt relief. I also did much of the political negotiating on Capitol Hill, which I thought would be even harder. Republicans had just impeached the president over an extramarital affair. They had held up a routine increase in the U.S. debt ceiling to try to get President Clinton to slash domestic spending, and when Secretary Rubin had taken a series of creative financial measures to avoid a catastrophic government default, they had threatened to impeach him, too. Republicans tended to view the IMF as a U.S.-funded welfare program for the world. And many liberal Democrats were just as hostile to the IMF, seeing it as a tool for imposing laissez-faire economics and austerity in the name of “structural reform.” I hired an excellent Oxfam activist, Lydia Williams, to help design our strategy and reach out to the left. But after the trauma of impeachment, the partisanship on the Hill seemed too nasty to overcome.

  Implausibly, though, the cause of global debt relief brought together an extraordinary coalition of evangelical Republicans and liberal Democrats who wanted to do the right thing for people in need. We worked successfully with southern conservatives such as Dick Armey of Texas as well as northeastern liberals such as Barney Frank of Massachusetts. On November 6, 2000, the day before an election that would inspire a month of partisan litigation, I was part of a bipartisan group that watched President Clinton sign legislation forgiving loans to twenty-two poor countries.

  “I believe this will put our country squarely on the side of humanity for a very, very long time to come,” he said that day in the East Room of the White House.

  It was a cool thing to celebrate. In my twelve-year initial stint at Treasury, I caught many glimpses of Washington’s pettiness and dysfunction, but I also got a somewhat unrealistic view of the positive impact that public servants could have on the world. That debt relief legislation, for example, included a $50 million U.S. contribution to a global vaccination fund that Sheryl Sandberg, Larry’s chief of staff, and I had championed. These were good causes, and we were able to do something valuable for countless people we would never meet.

  I HAD started at Treasury as a civil servant, but I was now an appointee in a Democratic administration. So when President Bush took office, it was time for me to leave. The Council on Foreign Relations graciously offered me a position at my government salary while I tried to figure out what to do with the rest of my life.

  I talked to a few financial firms, but I still felt no attraction to that work. One friend who had left Treasury for an investment bank advised me that if I wanted a finance job, I should decide where to go solely according to which firm would pay me the most, because that would be the best measure of how much they valued me. It sounded like a bizarre way to think about work. I never considered trying to get rich, and it never really occurred to me to choose a job based on what I would make rather than what I would do. We lived very comfortably, and even as a public servant, my salary was higher than the vast majority of American paychecks. Carole never put pressure on me to earn more. She just wanted me around more.

  I ended up right back in the world of financial crises. When my friend Stan Fischer stepped down as the IMF’s number two, a job traditionally held by an American, Horst Koehler, the German head of the fund, proposed me for the job. But John Taylor, a Stanford economist who had replaced me at Treasury, blocked my appointment. I was now considered part of the Clinton crowd; Taylor thought we had created too much moral hazard in the emerging-market crises, and the Bush administration wanted to signal a departure in policy. They proposed a Republican from Stanford, Anne Krueger, instead. Koehler then asked me to take another senior job, as head of policy and review. I accepted. Larry and some of my other friends thought it was a step down in prestige, but the job came with real responsibility. My department was the arbiter of policy, and had to sign off on every commitment of financial resources. I was pleased to have the chance to keep doing compelling work.

  The IMF was a more formal and less fun place to work than Treasury. The meetings were endless, with crushing bureaucracy, an intrusive and fractious executive board, an appalling amount of paper, and a lot of factional conflict among various fiefdoms. The salaries were exceptionally generous for the public sector, which was awkward given the public mission of the institution and our interventions in poverty-ridden and crisis-stricken countries. The pace was much slower than I was used to. And I was not that good at sitting still.

  The IMF was full of smart and dedicated people, but not many had experienced the burden of making policy decisions as government officials. There was a lot of paper and bureaucracy and talking. I once asked my colleague Ken Rogoff, the IMF’s excellent chief economist, how he made it through all the long meetings with senior officials. Rogoff, who had been a chess prodigy as a kid, told me he survived by playing a d
ozen games simultaneously in his head.

  Still, I got to work on some consequential issues. I helped design a set of principles to guide lending decisions in future financial crises, to better distinguish when we should force countries to restructure their debts and when we should help them meet those obligations. I helped define a set of limits for IMF assistance, an effort to mitigate moral hazard while preserving room for aggressive actions in truly systemic crises. I helped call more attention to the vulnerabilities that come from risky forms of financing, alongside the IMF’s traditional focus on large fiscal deficits and inflation. And while the Bush team liked to criticize the bailouts of the Clinton era, they ultimately supported large IMF rescue packages for Brazil, Uruguay, and Turkey with the familiar wall-of-money strategy. That was what the IMF was for.

  Years later, Mervyn King, the governor of the Bank of England, joked at a farewell dinner that I was a textbook proof of the difference between correlation and causation. “Tim was present at all the crises,” he said. “But he didn’t cause the crises. The crises caused him.” Again and again, I got to see how indulgent capital financed booms, how cracks in confidence turned boom to bust to panic, how crisis managers could help contain panics with decisiveness and overwhelming force, and how the kind of actions needed to defuse crises were inherently unpopular and fraught with risk.

  That turned out to be valuable experience.

  THREE

  Leaning Against the Wind

  In early September 2003, I was in London on IMF business when I got a call from Pete Peterson, the billionaire cofounder of the Blackstone Group private equity firm. Peterson was the chairman of the board of the Federal Reserve Bank of New York, and he asked if I’d be interested in talking to the board about running it.