From his posts as the President of the Federal Reserve Bank of New York (2003-09) and Secretary of the U.S. Treasury (2009-13), Timothy Geithner was a central figure in planning and executing the rescue of the financial system during the Great Recession of 2008-09. In his new memoir, he explains how limited powers were forcefully used to backstop a system in crises and make it investable again. The book provides a dynamic account of the disaster, the abuses that caused it, and the reasons why extraordinary measures were necessary to stop it.
Born in New York City in 1961, Geithner spent much of his childhood in Africa and Asia, where his father was stationed by the Ford Foundation. Before graduating from Dartmouth, he studied Mandarin at Peking University and Beijing Normal University. After earning his M.A. from Johns Hopkins and working for Kissinger Associates, he joined the International Affairs Division of the U.S. Treasury. At Treasury, he became a protégé of both Robert Rubin and Lawrence Summers.
In the mid-to-late-1990s, Geithner helped orchestrate the U.S. response to the emerging-market financial crises in Mexico, Thailand, Indonesia, and South Korea. These crises provided excellent training when Geithner subsequently found himself embroiled in the 2008 bursting of the U.S. housing bubble.
Geithner deftly explains the market forces which created and then burst the bubble. As a regulator, he states that no one foresaw: (1) that housing prices could slump everywhere simultaneously; (2) how this massive slump could trigger such widespread defaults; and (3) how quickly those defaults could destabilize major financial institutions, whose capital structures were seriously over-leveraged and too dependent on short-term financing.
As the crisis deepened and banks’ sources of financing dried up, the Federal Reserve was called upon to devise solutions. Because several of the major institutions were based in New York, Geithner and the New York Fed played a major role in trying to solve the growing liquidity crisis.
In setting the stage for the coming bailouts, the author explains that the Fed’s power to lend money is quite limited. In a time of normal crisis, the Fed can lend to institutions that need cash, but only if: (1) they are commercial banks with insured deposits; and (2) the institution’s assets are fundamentally solvent.
In times of extraordinary crisis, however, Section 13(3) of the Federal Reserve Act permits the Fed to lend to non-banks which are solvent but in such deep trouble that no one else will lend them money, and even then only if the Fed can secure collateral that is likely to cover the exposure.
Prior to 2008, this “unusual and exigent circumstances power” had not been used by the Fed since the 1930s. Geithner writes that, as the crisis grew in 2008, Section 13(3) became increasingly necessary to fight the spreading wildfires that were sweeping though major non-banks, such as brokerage houses and insurance companies.
The first modern invocation of Section 13(3) came in March 2008 to establish the Term Lending Securities Facility, which allowed the 20 primary dealers in the short-term financing markets to borrow Treasury bonds from the Fed against collateral that the private sector would no longer finance.
Over the next two years, the Section 13(3) power was invoked repeatedly to save several major financial institutions whose default posed a systemic risk. Although these bailouts were politically unpopular, the author argues convincingly that they were necessary to end the crisis, save jobs, limit losses, and reform of the capital markets.
One such reform was the Fed’s adoption in 2009 of the “stress test,” which was applied to the 19 largest banks and designed to stabilize and restructure the financial system. As explained by Geithner, the test disclosed the losses that each firm could face in a terrible downturn, forced financial institutions to raise enough capital to survive that scenario, maximized the likelihood that private investors would re-capitalize the system, minimized the eventual burden to the taxpayer, ensured that the worst-capitalized firms would face the most dilution, and accelerated the restructuring necessary for the financial system to support growth.
The author further explains that the stress test worked and calmed the markets because it was rigorous, provided reassuring results, promoted transparency, and forced the system to raise new private capital. In short, it helped make U.S. financial institutions investable again.
Geithner heaps praise on President Barack Obama for making the tough and unpopular choices to prevent a major economic depression. He notes that Obama was bequeathed an economy in 2009 which was contracting at an annual rate of 8 percent, shedding 500,000 jobs per month, and costing U.S. households $15 trillion in lost savings. Private demand was in a historic free fall. Substantial measures were necessary to offset it.
Geithner is a dedicated Keynesian. He supported Obama’s “playbook” for rescue and recovery: financial repairs, monetary stimulus, and fiscal stimulus through the Recovery Act. He explains that these measures put a floor under housing prices, equity markets, and the economy, breaking the vicious cycle of housing and financial losses that were “chasing one another down the drain.” He also adds that Obama’s international work had a powerful effect on the global economy, restoring trade finance, preventing competitive currency devaluations, and discouraging protectionism.
To support this narrative, the book contains many charts and statistics. The evidence presented seems to support his case. By the end of 2013, the gross domestic product of the U.S. was 6 percent higher than before the crisis, while that of output of Japan and the Euro-zone was still below pre-crisis levels. As of March 2014, the U.S. had enjoyed 48 consecutive months of private sector job growth.
As Obama’s point man on the bailouts and stimulus spending, Geithner took much abuse from Congressional Republicans. He uses the book to respond to his critics in a style that is entertaining and, at times, pungent. His most cutting remarks focus on the fact that President George W. Bush left Obama with a projected $8 billion 10-year deficit, whereas President Bill Clinton left Bush with a $5.6 trillion surplus. He found it rich to hear Republicans “thunder about runaway deficits” and marveled at their “newfound enthusiasm for fiscal discipline,” when Bush’s unfunded wars, tax cuts, and Medicare drug benefit turned the Clinton surplus into a large deficit.
In the end, Geithner acknowledges that the bailouts were politically unpopular. But he claims that they were good policy and effective. He notes that, in 2009, the International Monetary Fund projected that U.S. taxpayers would lose $2 trillion on the bailouts. He concludes with satisfaction, however, that by the end of 2013 taxpayers were on course to earn $166 billion from these investments.
Jeffrey Winn is a partner at Sedgwick.