Uncertainty has been at the heart of all past financial crises, and almost every government's strategy for coping with them only made the situation worse. That's how the stress test was born in the last crisis.
I had the opportunity to hear Tim Geithner, our Secretary of the Treasury during the Great Recession, speak last night. He is on a national book tour promoting Stress Test, his detailed account, analysis, and explanation of what happened during those years. While it is becoming clear that his actions, among others, saved us from a second Great Depression, you wouldn’t know it from the somber, muted tone in which he writes and speaks.
Never a public figure, he was inserted into the limelight at an acutely difficult time. His/their unprecedented, counterintuitive actions were ultimately successful but he remains an opaque figure about whom there are some misperceptions.
Most tellingly, he was never employed by, or on, Wall Street—neither as a banker nor an economist. He is a registered Independent to boot and for 20 years he was a civil servant who was mentored up through the ranks by no less than Larry Sommers, a previous Secretary of the Treasury.
Geithner speaks of “regrets,” “soul crushing,” and “not understanding that place (Washington).” Ultimately, he did return to Wall Street, not as regulator, but as the head of Warburg, Pincus, a white-shoe private equity firm. At least he now won’t have to worry about retiring upon a civil servant’s pension.
If you are not interested in reading his 500-plus page book—even though it is quite readable—I will give you a summary of his themes. The first is that since Roosevelt regulated the banks in the ’30s, a second, equally large financial system grew up outside of banks, but this one largely unregulated. Private lenders, hedge funds, securitized mortgages, credit default swaps and so on, had Wall Street, and, therefore Congress, feeding at the burgeoning trough, so there was no admitted need to put some limits in place. And that means no political will for proactive change to prevent a financial meltdown.
Many people did see the storm gathering; even I wrote such a column. In The Big Short Michael Lewis details how some few did act on this understanding and made a fortune when the collapse came. The irony at the end of the book is that many of the executives who led their companies, and therefore the country, into great risk—euphemized as “moral hazard”—also made out “like bandits.”
Geithner clearly identifies that the key to all financial crises, whatever their proximate causes, is the failure of confidence. You know, FDR’s “The only thing we have to fear, is fear itself.” The historical “bank runs” where people lost faith in the banks’ ability to pay them back and rushed to withdraw their money have now become virtual ones. At least no more standing in lines fueling each other’s panic. Just reading about it turns out to be bad enough. Banks used to stack cash and gold bars in their windows to visually reassure their depositors. It’s not so easy to shore up flagging confidence in the internet age.
Uncertainty is at the heart of all of these financial crises and, as Geithner recounts, almost every government’s strategy for coping with them only made the situation worse. In a stampede, the herd cannot tell the difference between strong and weak institutions, so they all can get swept away.
So that’s how the titular “Stress Test” came to be. Essentially, it was a means of requiring financial institutions to get recapitalized in the private market, such as Warren Buffet putting billions into Goldman Sachs (and reaping extra billions later as reward, thank you, very much).
The alternate was for the government to intervene and force feed capital into the ailing banks and other financial organizations (AIG, a private re-insurer; Freddie Mac, a semi-private mortgage insurer; etc.) like the livers of French geese to make pate de foie gras. All of this to prevent more cascading failures, the loss of millions more jobs, and the dreaded Depression.
One can never know what history will say about public figures and their acts—as George Bush so ingenuously demurred—but Tim Geithner, the civil servant on the spot, did the best he could and transparently wants us to know what really happened in saving the US and world economy from a lesser fate.