Stress Test not only graces the cover of this book about an unparalleled time in modern American economic history—as seen through the eyes of one of the major participants—but sums up the national experience, too.
Timothy Geithner was president of the Federal Reserve Bank of New York when the crisis erupted in 2007. From January 2009 through early 2013 he served as President Obama’s Secretary of the Treasury. Geithner was a participant and contributing architect in every major initiative taken by the American government to combat the crisis.
Stress Test is not meant to be a comprehensive history and analysis of the financial crisis. Nor will anyone reading it find a necessarily definitive or causative treatise on the Great Recession. Rather, it’s the story of one man’s efforts, seen and told entirely through his perspective, of what it was like to be in the middle of the maelstrom.
Geithner writes in a self-deprecating style, displaying his wry humor as well as his command of a “salty” vocabulary.
The author acknowledges as much, relating that he told a close friend after leaving office that he was starting work on a book. His friend quickly suggested that he title it “The Bonfire of the Profanities.”
Living inside a cauldron
This is an inside/out view of a financial storm. Geithner leads the reader through the series of financial problems developing for two years before 2007-2008. The economy reached a crescendo in 2008, a period during which banking panics, failures, near failures, and rescues of major commercial and investment banks occurred in rapid succession.
The high water mark of these months is seen as the failure of Lehman Brothers in September 2008. But along the way, major milestones included two government rescues of Citibank, the failure of WaMu, a private-sector rescue of Wachovia, and the absorption of Merrill Lynch by Bank of America.
As 2009 began it became clear that the U.S. economy was severely strained. The unemployment rate that had been at 4.4% at the end of the first quarter 2007 rose to a high of 9.8% in October 2010. Budget deficits skyrocketed to proportions not seen since World War II. Political gridlock greatly complicated effective efforts to craft and implement solutions to address the problems.
Major milestones of this phase were the bankruptcies of General Motors and Chrysler, the placing of Fannie Mae and Freddie Mac in conservatorship, and the collapse of the housing markets on a national scale.
Geithner was nominated to be Treasury Secretary by President-elect Obama in November 2008 and confirmed by the Senate on Jan. 26, 2009.
For the next three years, he was one the Administration’s principal economic spokesmen and a leading member of the group devoted to reforms of regulatory structures of the economy, principally the enactment of major governmental initiatives such as the Dodd-Frank Wall Street Reform and Consumer Protection Act. While these are virtually complete and fully implemented today, the political aftershocks continue to reverberate.
Understanding the liquidity challenge of the crisis
While the entire book is interesting and useful in providing a perspective of the breadth and severity of the crisis, as a commercial banker I personally found the descriptions of dealing with the financial system’s liquidity crises during 2008 the most interesting.
My own experience includes extensive problem asset work for two large (for their time) regional commercial banks as a senior manager involved in special asset administration and recovery activities. FDIC closed one of these two banks, while the other had a near-death experience.
I watched the crush of customers crowding the lobby of the big bank in Midland, Texas, in October 1983, the day before it was closed. I remember 30 years later the sound that they made—a collective snarl or perhaps more like a dull roar of fear and frustration.
A few years later I stood helplessly by in the wire room of my bank in Oklahoma City on the day before a long holiday weekend, watching the staff wire millions of dollars of wholesale deposits to other banks. I’m convinced that if that wire room run had occurred on an ordinary workday, the outcome likely would have been calamitous for the bank and its customers.
Banks and indeed most of the institutions comprising the financial infrastructure of our economy run largely on short-term funds—consisting primarily of deposits and short- term IOUs such as commercial paper. As an industry, banks operate primarily on an unsecured basis where confidence in the counterparty’s willingness and ability to execute the other side of the individual transaction is paramount.
Geithner argues persuasively that when we lose confidence in the ability of an individual component or of the whole systems’ ability, confidence is shattered.
Perhaps a better way to understand what’s at risk is to label it as “trustworthiness.”
Without trust in each other’s capacities, our system freezes up.
And that’s what nearly happened on a systemic scale during the late summer of 2008.
Life among the financial tribes
The tortuous and 11th hour negotiations over terms of government assistance to firms including those who were an integral part of the solution no doubt leave some of us wondering why bankers would even deal with the federal government or venture into a business thicket that is often politically so dense and difficult. These issues in a variety of forms are a major sub theme of the book and they continue to resonate today in various ways.
Secretary Geithner developed ways of describing or labeling the biases and strongly felt convictions of many of his critics during his time in office.
Those who feel that the federal government should not have rescued individual firms and institutions he refers to as “Old Testament types.” By that he means the “eye for an eye” sort of retribution found in the Hebrew Scriptures.
Those who feel that many government responses to fight the crisis exacerbated the climate of “moral hazard” he refers to as “moral hazard fundamentalists” or simply “Fundamentalists.”
These and other descriptors in context make considerable sense. And they become a comfortable shorthand in helping the reader better understand the conflicting views and politics surrounding these issues.
In offering his views on containing the banking panic of 2008, Geithner tells how he believed in “overwhelming force” to be sure that it’s enough to “kill” short-term debt holders’ concerns quickly rather than allowing them to fester.
He readily admits that many things he advocated and that were implemented contributed to an increase in moral hazard. But he says that in his view, the risks were worth it. This no doubt will be a long-lasting debate among pundits and practitioners.
The book contains a catalogue of his views of what was done and why. While he is clearly telling his side of an occasionally controversial story, he does so without rancor or with any sense of “gotcha” toward other government officials.
He was sensitive to the political realities and to the political potholes and his frustration with this environment is clearly on display. One of Geithner’s memorable quotes: “We did enough for the right to hate but not enough for the left to like.”
Life inside the maze of TARP, and more
The more spectacular political dustups during those years include the payment of $165 million in performance bonuses to AIG personnel. The payouts ultimately came from TARP money and created howls of outrage in and out of the Congress. Geithner and others in government believed that AIG was contractually liable and that the payments could not be abrogated without serious damage to the ability of the government to have its word relied upon in future circumstances.
Readers will find many interesting explanations of what were then and now confusing and sometimes convoluted solutions and remedies introduced in 2007 and 2008.
For example, TARP started out as a fund to be used to buy distressed assets from banks and other financial intermediaries to rid their balance sheets of toxic assets. But things didn’t happen that way.
What became quickly evident was that it was a more efficient use of finite TARP funds—under a very minor provision in the law—to inject them as capital into individual banks.
This allowed the government to refrain from involving itself in the political minefield of trying to determine the fair value of distressed assets remaining on the books of the financial institutions.
It was against a backdrop of widely varying practices of large institutions in realistically assessing the values of toxic assets. In this context Geithner referred to Dick Fuld, CEO of Lehman Brothers, during the summer of 2008 as “delusional.”
A valuable view inside the head of N.Y. Fed
Geithner’s years as Treasury Secretary receive considerable attention in the book. While they are informative and a valuable contribution to the record, they are probably not nearly as relevant to the day-to-day work experiences of commercial bankers as his record as president of the Federal Reserve Bank of New York.
He became head of the bank in 2004, well in advance of the crisis climaxing in 2008. But he was an eyewitness to the growing problem of financial leverage and excessive risk taking within the banking system.
Candidly—and to his credit—he acknowledges that he didn’t appreciate the gravity of the developing situation. All practicing bankers will find his account of the unfolding crises of 2008 fascinating and instructive.
Although he was several times mistakenly identified as having a banking background, Geithner never worked for a bank or investment banking house before his appointment as president of the New York Fed.
But, fortunately for the nation, his work experience included considerable time as a young staff member at the Treasury during the Clinton administration, dealing with overseas monetary crises concluding his Treasury service for the first time with the election of George W. Bush. By then Geithner was a political appointee and left government with the change of administrations. After a three-year stint at the International Monetary Fund, he became president of the NY Fed.
Core of Stress Test … its namesake
In my opinion, Geithner’s greatest personal contribution toward resolving the financial crises was his insistence that the 19 largest banking companies be subjected to a formal stress testing process administered by the Federal Reserve.
I can recall at the time thinking that he’d better be sure of the answer before asking the question.
It appears that he wasn’t.
Going by Stress Test, Geithner did not know whether all of most of the group of largest banks were solvent. He explains at considerable length that not only did he not know, but that the answer could not be known for the several months required to conduct the testing and that the political and economic uncertainty in the interim seemed overwhelming.
The markets were somewhat critical initially of the testing criteria with principal criticism leveled at what were judged as relatively benign assumptions on unemployment rates. However, the day after the results of the stress tests were made public, a prominent economic advisory firm endorsed the results.
This was a major victory for Secretary Geithner and ultimately vindicated his persistence in independently verifying the capital adequacy of the nation’s largest financial institutions.
Of the 19 banks tested, nine needed no further capital and were subsequently allowed to leave the TARP program. Nine more were shown to need more capital and were believed capable of raising it. One, GMAC, was considered unlikely to accomplish a recapitalization without government assistance.
The Federal Reserve concluded that the 19 banks faced approximately $600 billion in additional losses and that $115 billion of additional capital collectively would be needed to meet minimum acceptable capital thresholds.
The stress tests had accomplished what virtually no other program or plan could have done: It defined in a quantifiable way that the industry’s largest institutions were solvent and capable of withstanding further assaults that were modeled into the stress testing criteria.
Secretary Geithner observed that from the spring of 2010 forward, the banking crises began to noticeably abate, though it would be several more quarters before his job got appreciably easier.
Something like a happy ending—for now
There is much else in the book that will be of interest to a wide audience of readers. Geithner’s many observations on the poisonous political environment and his observations about several of his critics and colleagues in government range variously from matter of fact to very amusing.
The strong takeaway for me is that our government and economic system faced draconian consequences between 2008 and 2011 and avoided the worst outcomes that many of the separate and individual crises could have brought.
There’s no sense, however, that we’ve fixed all the issues for the future.
Some day we’ll likely readdress many similar institutional and industrywide problems, including potentially excessive financial leverage and unhealthy concentrations of liabilities in “runnable” form.
But at a minimum, it looks like the shock absorbers and buffers within the system have been strengthened.
And that should serve us well in the coming years.
Editor’s note: Reviewer and veteran banker Ed O’Leary blogs nearly every week in “Talking Credit.”