[This article was published in the Winter 2014 issue of The Journal of Social, Political and Economic Studies, pp. 494-521.]




A Preeminent Book on the Financial Crisis: Timothy F. Geithner’s Memoir as Secretary of the Treasury

Dwight D. Murphey

Wichita State University, retired


Stress Test: Reflections on Financial Crises

Timothy F. Geithner

Crown Publishers, 2014


Timothy F. Geithner served as the United States’ Secretary of the Treasury during Barack Obama’s first term as president.  Before that, Geithner was president of the Federal Reserve Bank of New York, the leading bank in the Federal Reserve system.  Together with Henry Paulson, Jr., who preceding him in the Treasury position, and Ben Bernanke, chairman of the Federal Reserve, Geithner was at the heart of the U.S. government’s response to the financial crisis that began in 2007 and picked up steam in 2008.  That makes his memoir Stress Test one of the preeminent books on the crisis.  The article here will examine that book and the many issues it raises, foremost among which are Geithner’s conviction that governments and central banks must consider their policies controlled by the threat of financial panic and that, accordingly, few strings should be attached to any bailout.  His views are compared with those of several other authorities.

Key Words: Timothy F. Geithner, the Great Recession, bank bailout policy, financial panic, Populism, bank “stress tests,” U.S. policy toward “the main economy,” economic “stimulus,” mortgage modification, alternatives to bailouts, financial reforms, Sheila Bair, Neil Barofsky, financial crisis authors.                   

The role played by Timothy Geithner as Treasury Secretary during President Barack Obama’s first term was central to the U. S. government’s response to the financial crisis.  Before that, he had for eight years been the president of the Federal Reserve Bank of New York.  All this gives Stress Test, a memoir of those years, an automatically preeminent place among the books about the Great Recession.  A vast literature has developed about the crisis, written by the principal actors such as Geithner, some of secondary rank who occupied only a slightly less exalted place, and numerous academic and financial commentators.[1] 

Geithner stepped down as Treasury Secretary in January 2013.  It was from 2003 through 2008 – i.e., until his elevation to the Treasury position – that he was president of the New York Federal Reserve Bank.  That bank is considered “first among equals” among those in the Federal Reserve, and has major responsibilities that include carrying out monetary policy, regulating the financial system, and handling the United States’ payment systems.  This means that Geithner had already been a key figure in U.S. economic policy for several years before his service in the Obama administration.

A surprising thing about Geithner is that, contrary to a widely-held assumption, he was never an investment banker.  He didn’t come into the jobs we’ve mentioned from Goldman Sachs or any other Wall Street firm.  In fact, it isn’t altogether apparent from his book just what qualifications he had for the monetary-system positions he held, although he was superbly qualified for work in international trade.  His upbringing and education gave him a wide knowledge of the world.  Geithner’s father’s work for the U.S. Agency for International Development (USAID) involved taking his young son to Rhodesia, Zambia and India.  Although the boy returned to the United States after the sixth grade, he wound up attending high school at the American School in Bangkok.  It’s worth noting that the same leadership qualities that must have led to his being entrusted with his later positions were soon evident to his peers, as was reflected in his serving as president of both his junior and senior classes.  He majored in government and Asian studies at Dartmouth, and included some study at Beijing University during those undergraduate years.  It’s doubtful whether anyone was ever better prepared than he was to obtain a Masters in East Asian Studies and international economics at Johns Hopkins.

Before we examine what Stress Test tells us about his role in the financial crisis, it will be valuable to know where Geithner is “coming from” on politics and ideology.  He says “I’ve always been pretty much pragmatic, suspicious of ideology in any form,” which tells us more than it seems to: it doesn’t really mean that he didn’t have an ideology, but rather that he unconsciously received by osmosis the prevailing ideology common to educated people among his contemporaries.  His mother, he says, was a “bleeding heart liberal,” his father a “conservative Republican” who nevertheless in the 1980s directed the Ford Foundation’s microfinance programs in Indonesia in which Obama’s mother was a moving force, and voted for Obama in 2008.  At Dartmouth, Geithner felt a “strong aversion” to the outspoken conservative student movement on campus; and later in life he found the ceremony inspirational in which President Obama signed the repeal of “don’t ask, don’t tell,” a repeal that opened the U.S. military to service by openly-avowed homosexuals.  He wasn’t a socialist and didn’t want (or effect) a nationalization of the banks, and says Obama wasn’t, either.  In fact, he saw Obama as “a moderate, market-oriented Democrat.”  Although “I didn’t have a purist’s faith in the genius of the free market,” he favored global free trade and opposed protectionism.  He says he has “been a straight-ticket Democratic voter since the Clinton years.”  He saw Obama as “my kind of candidate – liberal on social issues, moderate on economic issues, pragmatic above all.”

A part of his thinking that is especially pertinent to his actions at the Federal Reserve and Treasury has been his heartfelt opposition to “populism.”[2]  Geithner believed it vital to bail out the big banks, and to do so with few strings attached.  This perception necessarily caused him to adopt policies that were thoroughly supportive of the “too big to fail” banks, and led a number of commentators to see him as “a tool of Wall Street.”  Whether the criticism is justified depends on who was right as between him and his critics.  We will review the pro’s and con’s of that argument in the course of this article.

It was in the context of this debate that he vehemently characterized his critics as “populists.”  There is, of course, an implication that comes from his labelling them with that word, since it suggests they were on the side of the public at large and that he himself championed an elite.  If this were simply an ill-chosen semantic, it would be unfortunate from his own point of view because it detracts from the possible merit of his economic stance.  It would seem, however, to go beyond semantics.  It reveals a personal alignment in which he identifies with the large financial institutions and those who head them, while he looks with disdain on those outside of that community who see themselves as championing “the main economy.”  This suggests there is more than a little truth to the criticism that his perception of the crisis was at least in part caused by his personal affinities. 

There are, moreover, wider implications.  Because it was President Obama who caused Geithner to be one of the people at the pinnacle of economic policy during the financial crisis, and who kept him there for his full first term, the conclusion is unavoidable that the attitude was not just Geithner’s, but also the President’s.[3]  This is to be seen in a broad political, social and economic context.  What we have in mind is the widespread complaint among leading commentators on both the Right and the Left that each of the major American political parties, the federal government, big money, and the people who go back and forth between them, are intermeshed in a symbiotic system that has come to be called “crony capitalism.”  That Obama should have so placed himself, in one of the central aspects of his administration, runs counter to the “man of the people” image conveyed to the public.

Geithner’s memoir contains much that goes beyond the three main points we are about to discuss, but the issues that seem most to distinguish this book from the rest of the literature on the crisis are:

1.  The remarkable extent to which Geithner and the other main actors were unprepared for and caught by panicky surprise by the serial distress of the major financial institutions a full year after the housing crisis had become apparent.

2.  The much-debated question of whether a bailing out of those firms was imperative, both for the financial system itself and for the main economy.

3.  The further question of whether the emergency assistance needed to be given without strings attached.

One after another in the fall of 2008, major firms on Wall Street came within hours of collapse, with each seen as posing a crisis so systemic that it  threatened to create a panic in world finance.  Here’s a brief recounting of the chronology, as told by Henry Paulson, the Treasury Secretary during that fall, in his memoir On the Brink: Inside the Race to Stop the Collapse of the Global Financial System:

The housing crisis had already roiled the stock market in August 2007.  In January 2008, the troubled mortgage lender Countrywide Financial was rescued through a purchase by Bank of America.  In March, JPMorgan bought Bear Stearns for a pittance.  There was a hiatus until September, when on the 7th the two quasi-public mortgage giants “Fanny Mae” and “Freddie Mac” were put into conservatorship.  The crisis for Lehman Brothers came in mid-month, and it was later considered a devastating mistake for the U.S. government to have allowed it to fall, resulting in the “biggest bankruptcy in U.S. history.”  Only a day later, the government seized the enormous insurance giant, AIG.  Later in the month, JPMorgan was prevailed upon to buy up Washington Mutual, which the Federal Deposit Insurance Corporation (FDIC) had seized on the 25th.  When, immediately thereafter, a run started on Wachovia, Wells Fargo bought it.  Before the month was out, the Big Three auto companies needed a $25 billion government loan.  Eventually, General Electric’s finance subsidiary, GE Capital, was saved by an FDIC guarantee of $139 billion of its debt; Citigroup, despite more than $2 trillion in assets and another $1.2 trillion held “off its balance sheet,” was “teetering” and received a bailout; Chrysler and General Motors were bailed out; and in early January 2009 Bank of America was given a bailout similar to Citigroup’s.     

The unpreparednes

Paulson tells how in a conversation with President George W. Bush in March 2008 he told the president that “the whole system is so fragile we don’t know what we might have to do if a financial institution is about to go down.”  He says the president, to his credit, “always…wanted to know what our long-term plan was.”  When told that “an enormous amount of leverage – and risk – [had been allowed] to creep into the financial system,” Bush asked “How did this happen?,” about which Paulson says “it was a humbling question… after all, we were the ones responsible.”  Paulson was aware, at least in part, of the looming threats, pointing specifically to “credit default swaps,” whose growth “had increasingly alarmed me over the past couple of years.”  Just the same, he felt himself able to say on a Sunday morning talk show in the same month as his conversation with Bush that “our financial institutions, our banks and investment banks, are very strong.”  He says he “misread the cause, and the scale, of the coming disaster.  Notably absent in my presentation [to President Bush] was any mention of problems in housing or mortgages.”  Accordingly, when the crisis struck, he applied a “case-by-case approach” [i.e., bank-by-bank]  that “was driven by necessity, not ideology” [which we may take to mean “not according to a plan”].  In seems incredible that it was only when the housing crisis struck that “Bob Hoyt, our general counsel, asked his team in the legal department to begin examining the statutes and historical precedents to see what authorities the Treasury – or other agencies – might have to deal with market emergencies.” [4]  One would think that sort of information would long-since have been implanted in the DNA at Treasury, and at the fingertips of the Secretary. 

Others have commented on the unpreparedness.  In The Age of Turbulence, Alan Greenspan mentioned how the failure of a major financial institution would catch the Fed “with little time for thoughtful analysis or deliberation.”  And in The Crisis of Capitalist Democracy, Richard Posner writes that even though “there were plenty of public warnings of a housing bubble…,  most economists missed the bubble…, [and] the failure of the Federal Reserve…  to prepare contingency plans in the event that the ascent of housing prices proved indeed to be a bubble… was inexcusable.  As a result of the Fed’s unpreparedness, when the banks began falling like ninepins in September 2008 the government was caught by surprise, improvised spasmodically….”[5] 

Geithner, at that time the head of the New York Fed, says that “we went into our crisis with a toolbox that… wasn’t remotely adequate.”  He went on to say that “I felt like I was watching a disaster unfold in slow motion, with no ability to prevent it and weak tools to limit the damage.”  The problem was that it was too late.  Niall Ferguson says the financial expert Henry Kaufman had “warned time and again of the dangers inherent in the rise of the very large financial conglomerates” and had pointed to the dangers from “the growth of securitization of mortgages and other consumer debt…, the explosion of derivatives… and, above all, the vast increase of leverage on bank balance sheets.”   As early as 1985, Kaufman had “called for a National Board of Overseers of Financial Institutions and Markets, with a comparable entity operating at the international level.”  Kaufman himself writes that “I expressed these concerns in several papers I presented at the Jackson Hole conferences [held annually by the Fed] in Wyoming.”[6]  These warnings went unheeded because, as Kaufman says, “the Federal Reserve and other regulatory officials [were] under the sway of the prevailing free-market ideology – continued to deregulate financial markets and took no real actions to rein in speculative behavior or the dangerously rising tide of securitized debt.”[7]  Geithner sees all this now, so that his memoir recapitulates the many things that have been said in the post-crisis literature about the causes, running the gamut from moral hazard, to problems with the credit rating agencies, to the abandonment of lending standards, to the vast worldwide credit expansion – and to many other facets. 

What he especially sees is that “nobody was accountable for the stability of the entire system.”  The Securities Exchange Commission (SEC) had a limited mandate; the Treasury had surprisingly little authority “to try to avert a major financial crisis”; and “huge swaths of the financial system [‘non-banks’ and ‘shadow banks’]… were outside the Fed’s jurisdiction as well as the Fed’s safety net.”  Nor, of course, was there anyone looking beyond the financial system to the health of the main economy. 

In light of warnings by people such as Kaufman, this was not only a striking insufficiency in regulatory structure, but was also – and preeminently – an intellectual failure.  There had been, so to speak, a mental “herd effect.”  A tidal wave of “rational market theory” (also called “efficient market theory”) had for several years swept over the economics profession and had become the guiding light for policy makers.  The result had been a “deregulation” movement that had stripped the financial world of the regulation it so greatly needs.  The result, as Sheila Bair (then head of the Federal Deposit Insurance Corporation)  says, was that “one of the saddest things about the financial crisis is that it could have been so easily avoided with a few commonsense measures.  If we had raised capital requirements during the good times…, if the Fed had imposed lending standards for bank and non-bank lenders…, and if Congress had not tied the hands of the CFTC, SEC, and state insurance regulators to impose some basic, commonsense regulatory controls on credit default swaps, the trillions of dollars of trading losses would have been much reduced.”[8] 

Whether the financial bailouts were imperative 

Geithner says that as the crisis unfolded “we finally deployed overwhelming force to stand fully behind the financial system… We had defused the bombs of Citi, Bank of America, Fannie, Freddie, and even AIG.”  The response, Geithner says, started with “ad hoc emergency interventions,” but moved to “a more coordinated approach.”  He subjected each major bank to a “stress test,” which he considered “the centerpiece of our approach.” [9]  Among a variety of measures, “we persuaded the FDIC to provide powerful guarantees for the banking system, and we began providing huge infusions of new capital for vulnerable institutions.”  He says that “by early 2009… we had backstopped tens of trillions of dollars’ worth of financial liabilities” (our emphasis).  (He observes that this did not involve actually spending such a vast sum; “in fact, the financial system repaid all our assistance, and U.S. taxpayers have turned a profit from the crisis response.”)   The “overwhelming force” was not limited to combatting the American crisis; Geithner says “a powerful stimulus effort would require a serious mobilization of resources for emerging economies” (our emphasis).  He proposed that the United States put $500 billion into an IMF emergency fund.  This formed part of a $1.1 trillion flow of “new international financing to fight the crisis” provided through the G-20 consortium of leading economies.  The Fed also loaned “$540 billion to foreign central banks.”

What most fundamentally drove the frantic day-to-day reaction to the big banks’ plight during the fall of 2008 was the sense that there was a Sword of Damocles hanging over the heads of central bankers and national treasuries.  Anything startling, it was thought, might set off a cascading world financial panic.  Rather than being in control, governments were the tail wagged by a distempered dog.  Geithner, Paulson and Bernanke felt they literally had no choice but to react, and to do so urgently and preemptively.  Their actions were forced, too, by the worry that a financial institution might suffer stigma, or that key employees might flee a given firm, if the crisis responders didn’t walk on eggs to avoid violating the firm’s or employees’ interests.  There, again, the responders were governed by forces they considered controlling.  

One of the central questions, theoretical and practical, about the response to the crisis has been whether this perception was justified.  Oddly, there is a yawning intellectual void about it.  This reviewer has of course not been able to read everything written about the crisis; it is likely that no one has.  But among the many books he has read none has sought to track what the specific consequences would have been, sector by sector, to the main economy and to people’s lives if the financial institutions had been allowed to go into bankruptcy or some form of “resolution.”  World capital flows are breathtakingly large, as described by William Greider in One World, Ready or Not: the Manic Logic of Global Capitalism (1997).  If it is true (and it may well be) that governments and their central banks are at the mercy of panicked herd-effects within that ocean of money and credit, it means the global economy looks perpetually into an abyss.  This should then call for some far-reaching rethinking of the entire web of global finance.

A number of critics of the bailouts obviously don’t share the conviction that the threat of panic should control policy.  David Stockman, the budget director under President Ronald Reagan, says “the relevant facts show that an AIG bankruptcy would not have started a chain reaction – and there never was a financial doomsday lurking around the corner.  In fact, none of the bailouts were necessary because the meltdown was strictly a matter confined to the canyons of Wall Street.”  As to AIG, “any modest hit to the balance sheets of a handful of its huge, global banking customers owing to the collapse of its bogus credit default insurance (CDS) would have caused a healthy purge of busted assets.  At the same time, its millions of insurance policy holders were never in harm’s way… 90 percent of AIG was solvent.  Its $800 billion balance sheet consisted mostly of high-grade stocks and bonds that were domiciled in a manner which utterly invalidated the ‘contagion’ theory.”  Stockman likewise says about Goldman Sachs and Morgan Stanley that “their bankruptcy would have resulted in no measurable harm to the Main Street economy.”  He argues that “the Washington bailouts rescued the perpetrators” and that “the bailout benefits were captured almost exclusively by the Wall Street insiders and fund managers who owned the common stock and long-term bonds….”  Looking back to the bailout of LTCM (Long-Term Capital Management) in 1998, he says “the insidious idea of shielding financial markets from alleged ‘systemic risk’ contagions became an open objective of monetary policy.”[10]  The respective subtitles of Sheila Bair’s and Neil Barofsky’s[11] books indicate rather graphically that they did not share the urgency over preventing a financial meltdown: Fighting to Save Main Street from Wall Street and Wall Street from Itself (Bair) and An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street (Barofsky).

This reviewer won’t try to resolve the conflict between these two schools of thought.  There is need for a meticulous study of the harm that would have resulted from massive bank and hedge fund failures.  In what we have quoted from Stockman, he has given some details that are helpful, but much more is essential if we are to know the full consequences.  Who would have been hurt?  To what extent?  To what effect?  If it were to be rich bankers only, that’s one thing; if it would have been millions of people’s jobs, pension funds, IRAs and annuities, among many other possibilities, that would be something else.

Whether the bailouts needed to be given without accompanying conditions 

Geithner held strongly to the view that few requirements should be placed upon those receiving a bailout.  This was based on his perception, which we have already noted, that the risk of cascading collapse required doing nothing that might stir panic.  Looking back to the responses to the 1994 Mexico peso crisis and the 1997 Asian crisis, he says “I was usually on the aggressive side of our team when it came to intervention – and permissive side when it came to conditionality.”  About the Great Recession’s 2008 crisis, he writes that “there was intense pressure on us to punish the Wall Street gamblers who had gotten us into this mess.”  He reasoned, though, that “get-tough actions would feel resolute and righteous, but in a time of uncertainty, they would damage confidence and accelerate the downward spiral.”  Elsewhere: “It’s terribly counterproductive in a financial crisis… to impose losses on reckless borrowers and lenders… The FDIC’s insistence on haircutting WaMu’s [i.e., Washington Mutual’s] creditors instantly panicked other creditors….”   It is on this ground that he defends “our failure to impose haircuts on AIG’s counterparties… [including] financial giants such as Goldman Sachs.”  When the point was made by the chairman of the U.S. Senate’s Finance Committee that there should be “some executive compensation restrictions” for bailout recipients, Geithner responded that “I didn’t think Congress should mess around with TARP [the bailout] as a way to reform executive compensation.”  An example of the type of compensation that was at issue comes when Geithner tells us that “Merrill CEO Stan O’Neal was forced out, although he did receive a $161.5 million severance to ease the blow.”

Those who didn’t embrace the “contagion” rationale found this every bit as shocking, and perhaps even more so, than the bailouts themselves.  Sheila Bair writes that “I was appalled that all of those institutions paid out big bonuses to their executives within months of receiving generous government assistance.”   She says that after AIG “had received $170 billion in taxpayer bailout money… The New York Times broke the story that AIG management planned to pay out $165 million in bonuses, mostly to employees of the financial products division… I was aghast… There was some suggestion that they needed to pay the bonuses to retain those folks… Really?  Who in the world would want to hire those yahoos?”  In response to the argument that AIG was contractually committed to pay the bonuses, Bair says that “with our bankruptcy-like resolution process, we could break all those contracts.”  It all amounted, she says, to “bailing out the big guys.”[12]

Nobel Prize-winning economist Joseph Stiglitz complains that “even the collapse of the system did not curb their avarice… Nine lenders that combined had nearly $100 billion in losses received $175 billion in bailout money… and paid out nearly $33 billion in bonuses, including more than $1 million apiece to nearly five thousand employees.  Other money was used to pay dividends….”  He observes that “the executives find ways to get paid well even when the firm floundered.”  Further: “Last year [presumably 2009], the top 50 hedge and private equity fund managers averaged $588 million each, more than 19,000 times as much as typical U.S. workers earned.”[13]  We would have a hard time believing this if it didn’t come from such a reputable source.

Political economist Pat Choate takes the outrage some giant-steps further.  Speaking of the mortgage debacle, he writes that “the current wave of mortgage fraud eventually involved America’s largest banks and their top officials… Virtually all the participants knew they were involved in a massive scheme.”  From this, he concludes that “in a fair world where justice is impartial, unearned bonuses, high salaries, and lavish corporate indulgences would be recouped from the executives of failed financial organizations,” and says they should be subject to “a lifetime ban.” (our emphasis).   “Those who would automatically qualify are the CEOs and all board members from every bank, insurance company, and investment house of that era that failed because of the corporation’s overexposure to subprime mortgages… [and the] leadership (CEOs and boards) of all the major banks that had to take federal bailout monies because of their subprime mortgage activities.”  He would even bar “all those in the federal government who are managing, or who are responsible in any way, for this bailout” [and this would include Geithner] from going to work in the financial industry for a period of five to ten years.  He doesn’t want them to take part in the “revolving door” that sees people go from government into lobbying or high finance, and vice versa.  What his proposals suggest, of course, is an outlook diametrically opposed to Geithner’s.  Rather than giving primacy to the worry that draconian measures would produce a panic, Choate would like to root out the avarice, while also blocking the expectation that misbehavior is profitable because it will be given a free pass (which is the same thing as to say that he wants to eliminate what in the financial literature is called “moral hazard”).   

Bair, Stiglitz and Choate are just three of the many voices that have expressed outrage on this subject.  There is perhaps nothing that more justifies the perception that Geithner was “a tool of Wall Street” than his conviction that little or nothing could be done to punish the abuses or stop the flow of what has so often been called “obscene” remuneration.

A feature in Bloomberg’s Business Week in October 2014 indicates that some actions have recently been on-going against abusers: “In the past year, the Justice Department has extracted almost $37 billion in penalties from three of Wall Street’s largest banks – JPMorgan Chase, Citigroup, and Bank of America – for failing to warn investors about the toxic mortgages packaged into securities they sold before the 2008 crisis.”  It tells of a deputy associate attorney general in the U.S. Justice Department, Geoffrey Graber, who in early 2013 filed a civil suit, which was still pending, against the credit rating firm Standard & Poor’s, charging that it “inflated the ratings of mortgage-backed securities.”  The feature continues: “Now he’s going after the executives whose companies originated subprime loans.” 

Actions directed to “the main economy”

There was much distress in areas of the American economy outside the financial community.    Geithner tells readers that “$15 trillion in household wealth had disappeared, ravaging the pensions and college funds of Americans… Nearly 9 million workers lost jobs; 9 million people slipped below the poverty line; 5 million homeowners lost homes.”  It had been expected that saving the big banks would cause them to continue to service the American economy, but instead, as of January 2009, “banks… were in defensive retreats, hoarding cash, depriving businesses of financial oxygen.  There was virtually no private credit available for ordinary borrowers.” 

This tells us the bailout didn’t accomplish what was arguably its primary purpose.  Even with it, the federal government found it necessary to provide massive aid to the main economy.  Economics editor David Wessel says that as early as the end of 2008 “the Fed had more than $2.2 trillion of loans and securities on its books… The Fed was lending not only to conventional commercial banks, but also to investment banks, to insurance companies, to auto finance outfits like GMAC, to industrial companies like General Electric, and indirectly to homeowners and consumers.”  It provided liquidity to the commercial paper market, he says, by creating a “special purpose vehicle,” the Commercial Paper Funding Facility.[14]

In addition to the actions of the Fed (including the massive “quantitative easing” that has continued for several years) and the bailing out of the banks, there was the $787 billion package of “stimulus” spending (the “American Recovery and Reinvestment Act” known by its ARRA acronym) passed in the first weeks of the Obama administration, and the residential mortgage program known as the “Home Affordable Modification Program” (HAMP). 

Despite all this, Elizabeth Warren, chair of the Congressional Oversight Panel (COP) to monitor the bailout, points out how devastated the main economy remained: “According to the Business Journals of US Census Bureau data, more than 170,000 small businesses closed in the United States between 2008 and 2010.”[15]  Much of what was done was done very poorly, or for purposes distinct from economic recovery per se.  Warren says “HAMP has failed to make a significant dent in the number of foreclosures,” citing the COP report for December 2010.[16]  This is not surprising in light of what a press account in October 2009 told us: “Eight months into the program, the Treasury [which had for that period been headed by Geithner] had filled fewer than half the positions in a key modification office,” and that by October only twelve percent of the nation’s three million defaulted-upon mortgages had even “begun the process of being reworked.” [17]  The bailout’s Special Inspector General Neil Barofsky gives further details: “By the end of 2011, Treasury had spent only $3 billion of the $50 billion originally allocated to HAMP.  In other words, nearly three full years after HAMP was launched, home owners across the country had benefitted less from TARP... than American Express.”  He says the performance of the “servicers” handling the mortgage modifications was “abysmal”… “they routinely ‘lost’ or misplaced borrower’s documents… [with the result that] the servicers would claim that the documents had never been received and then foreclose.”[18]

For its part, the “stimulus” only incidentally had economic recovery in mind, but was geared instead toward serving a variety of the Obama administration’s social objectives.  The spending, though front-end loaded with $185 billion the first year, was spread out over a planned ten years, far longer than would be needed for a shot-in-the-arm economic boost.  Columnist Thomas McClanahan observed that the spending was on “a long list of items that had nothing to do with economic recovery, including a system of carbon limits and health care reform.”[19] 

Geithner himself acknowledges this about the stimulus, saying “the President-elect wanted to use the stimulus to promote his long-term agenda.”  He refers to Rahm Emanuel’s much-quoted statement that “a crisis would be a terrible thing to waste.”[20]  (Emanuel was Obama’s first presidential Chief of Staff.)  Nevertheless, Geithner defends his stewardship and the Obama administration from the “conventional wisdom [that] still holds that we abandoned Main Street to protect Wall Street.”  He points to “all the money President Obama poured directly into the Main Street economy.  In his first term,… about $1.4 trillion worth of tax cuts, government investments that boosted employment, and direct aid to low-income and middle-class families.”  There was also the “rescue of the auto industry… and lifelines for Fannie and Freddie, which kept mortgage rates low.”  There is a surprising disconnect between all this and the devastation we have just seen Warren cite, and there is even more disconnect when Geithner asserts that “the stabilization of Wall Street and the rest of the financial system [i.e., the bailout] saved the Main Street economy from the trauma of another depression.”  The explanation no doubt lies in the definition of “depression.”

What were the alternatives? 

Needless to say, those who objected to the bailouts had alternatives to suggest.  The merit of the suggestions varies greatly.

Some of the suggestions went to the heart of the crisis.  The cancer from which the financial crisis metastasized lay in the subprime mortgages, which had been bundled together through securitization and sold to investors worldwide.  Bair says there were “nearly half a trillion dollars’ worth of such loans [speaking of “subprime hybrid adjustable rate mortgage loans,” which would trigger escalating home owner payments] that were scheduled to reset in 2007 and 2008.”[21]  Economist Paul Craig Roberts wrote at a crucial time (mid-October 2008) that “the U.S. Treasury estimates that as few as 7 per cent of the mortgages are bad.”[22]  Perhaps referring to a somewhat larger batch, financial commentator Charles Morris says “the risky mortgages… account for no more than 15 to 20 percent of all outstanding mortgages.”[23]   Whatever percentage it may have been, David Smick adds that “the issue was not the size of the subprime mess… [but rather] where the toxic waste was located.  Who had the cancer and who was healthy?... The crisis unfolded precisely because suddenly nobody could say which financial institutions held the subprime mess, and at what price.”[24]     

Why not start by removing that cancer so that the trillions of dollars’ worth of securities based on the mortgages would no longer be suspect?  The thought of going to the source as an essential first step didn’t come to Paulson, Bernanke or Geithner in their panic to save each of the large banks, which was an approach that tackled the problems at the far end after the uncertainty over the toxic mortgages had spread like a giant fan across the financial system.  It did appeal to the likes of Bair, Roberts and Stiglitz.  Bair wrote an op-ed piece for The New York Times in October 2007 [after the housing crisis had set in in August of that year, but notably a year before the domino-like crises of the big banks].  She writes that “the answer seemed obvious: eliminate the reset [in the escalation of the mortgage interest rates] and simply extend the starter rate.  In other words, convert the loan into a thirty-year fixed-rate mortgage…  We weren’t really proposing that [lenders’] payments be reduced, just that they give up a payment increase….”  What she wanted was “some kind of systematic approach… to mortgage restructuring,” rather than the mortgage-by-mortgage modification that eventually occurred (and, as we’ve seen, was done slowly, poorly and only partly).[25] 

Paul Craig Roberts, who was assistant secretary of the Treasury during Ronald Reagan’s first term as president, made this point in his usual outspoken manner in a column published on October 8, 2008: “Instead of wasting $700 billion on a bailout of the guilty that does not address the problem, the money should be used to refinance the troubled mortgages, as was done during the Great Depression.  If the mortgages were not defaulting, the income flows from the mortgage interest through the holders of the mortgage-backed securities would be restored.  Thus, the solvency problem faced by the holders of these securities would be at an end.”  He told how “during the Great Depression of the 1930s, the Home Owners’ Loan Corporation refinanced 1 million home mortgages in order to prevent foreclosure.”  He reiterated his point in a second column on October 17.   (The dates of these columns are important because they show the alternative was being pointed out contemporaneously with the bank-by-bank rescues.  Indeed, the op-ed piece by Bair was published a year earlier, as we’ve noted, and was based on what was already obvious about the housing crash.)  Roberts added that “two more simple acts would have completed the rescue…: an announcement from the Federal Reserve that it will be the lender of last resort to all depository institutions including money market funds, and an announcement reinstating the uptick rule.”  That rule, he explained, is one that “prevents short-selling any stock that did not move up in price during the previous trade.”[26]  Not surprisingly, Roberts has had much more to say.[27]

Looking at what he thinks should have been done after Obama took office in January 2009 and unemployment had risen dramatically, Joseph Stiglitz has written in a vein similar to Bair and Roberts: “The government didn’t do enough to help on an issue that went to the heart of the crisis: the unemployed can’t make mortgage payments.  Many of the unemployed lost their homes soon after they lost their jobs… The Obama administration should have provided a new kind of ‘mortgage insurance’ that… would pick up the mortgage payments – allowing most of them to be deferred until the homeowner is back at work.”[28]

Other alternatives were offered that would come into play if the crisis were not solved (as we know it was not) by an early systemic solution to the mortgage-and-contaminated-securities problem.  Bair found participating in the bailouts of the big banks “the most distasteful thing I have ever done in public life,” but says “we clearly had to do something, and they [the bailouts] did achieve their intended short-term objective of stabilizing the system.”  She would have preferred a different course, though, and regretted that “the government [hadn’t provided itself with] the legal tools to wind down the truly sick institutions in an orderly fashion.  Citi, Merrill, and AIG were insolvent and should have been put into our bankruptcy-like resolution process… The Lehman experience demonstrated that bankruptcy was not an option for the orderly resolution of large, interconnected financial institutions.  The government needed a process similar to the one we had for insured banks.”  She is pleased that the later Dodd-Frank financial reforms have included “resolution tools… to resolve both bank and nonbank systemic entities.”  We can see the difference between her and Geithner’s approaches when she writes that “throughout 2009, even after the financial system stabilized, we continued generous bailout policies instead of imposing discipline on profligate financial institutions by firing their managers and boards and forcing them to sell their bad assets.”[29]

The Austrian school of economics offers, of course, very different prescriptions from those we have described.  Before we see what one of its leading spokesmen would have done in the crisis, we should note that the stoutly pro-capitalist Austrian school cautions that crises should be prevented in the first place by being on the gold standard and greatly reducing the credit expansion that the school believes is the essential precursor of a crash.  One of its leading thinkers, Murray Rothbard, and others have wanted to do away with “fractional reserve banking,” which  allows the banking system to create money through credit expansion.  If, however, such steps are not taken to remove the causes of a panic, the school calls for a harsh, but they think wholesome, “hands off” policy, allowing things to go to smash quickly so the economy can begin bouncing back.  An analogy would be allowing a forest fire to burn without restraint, getting it over with with the expectation that the green shoots of regrowth will start the next spring.  Here is a representative passage from Llewellyn H. Rockwell, Jr.’s, piece in the Mises Daily on September 10, 2008: 

What should have happened in 1929 is precisely what should happen now… The government should completely remove itself from the course of action and let the market reevaluate resource values.  That means bankruptcies, yes.  That means bank closures, yes.  But these are part of the capitalistic system… If the government did nothing but sell off the assets of the mortgage giants, we do not know for sure what would happen, but the market has a way of finding value and readjusting.  I would expect about 18 months of difficulties… But the process of readjustment would be smooth and rational.

The author of our present article has long been a student of the Austrian school, and attended Ludwig von Mises’ seminar at New York University in 1956.  He has, however, long held a respectful disagreement with the point just made, thinking that a market economy’s collapse should be considered intolerable to those who support capitalism.  A market economy, he thinks, involves millions of people striving to live individually responsible lives who have a vital interest in the system’s stability.  He went to study under Mises precisely because he believed another Great Depression could destroy the legitimacy of capitalism and bring down the system itself.  Be this author’s thoughts as it may, it would seem that much of the outrage that has been expressed against the bailouts has been based on the “let the bottom fall out” preference.

More than a few critiques have been made of the recent crash, and we know we aren’t mentioning many proposals they have included.[30]  An idea that is gaining traction that could take much of the sting out of economic dislocations and thereby help assure the continued legitimacy (i.e., the society’s general acceptance) of a market economy is that a “common dividend” be paid regularly to all citizens.  Since that is an important subject in itself, it will be best to leave it to readers to peruse Peter Barnes’ With Liberty and Dividends for All, reviewed in our Fall 2014 issue.

Financial reforms discussed by Geithner 

Stress Test discusses many potential reforms, but before we review them it is worth noting Geithner’s overall dictum: “Financial crises cannot be reliably predicted, so they cannot be reliably prevented.  They’re… triggered by manias and fears and human interactions… We can’t outlaw stupidity or irrational exuberance or herd behavior.” 

This observation is pregnant with significance.  It suggests, as so many authors have told us, that the financialization of the global economy, with its many trillions of dollars sloshing to and fro, has created what must be considered a monster.  It is one that is beyond the control of central banks (as is evident in Geithner’s having been driven by his worry about doing anything that might spread panic) and that puts the world economy in perpetual jeopardy.  We said above that in our opinion an acceptance of panics is intolerable for a market economy.  If that is so, the brinkmanship posed by global finance is even more intolerable, as a vast expansion of the same thing.  It threatens herd-driven panics at any time.  Of all the economic conundrums posed by today’s world, this is almost certainly the most pressing.

Transaction tax.  Many commentators have recommended a worldwide financial “transaction tax” as a way to inhibit easy speculation.  In 1997, William Greider wrote that “a plausible alternative to catastrophe is for nation-states to reclaim power and responsibility from manic investors… National governance and broader social priorities could be swiftly reasserted over capital and its movements in the old-fashioned way: by taxing it.”  A transaction tax could “moderate the gargantuan daily inflows and outflows of capital across national borders.”  The idea behind such a tax and other capital controls would be to “raise the cost of short-term transactions” and thereby “take the fun out of currency trading and other speculative activities….”  He noted that this “would not inhibit the long-term flows of capital for foreign investment.”  He gave credit to Yale economist James Tobin for proposing such a tax in the early 1980s.  Greider was prescient when he predicted that the idea wouldn’t be seriously entertained in America because “the orthodoxy reigns confidently despite gathering signs of systemic stress.”[31]

We might think it surprising that Geithner isn’t at all favorable to such a tax, which he refers to by its common name: “the so-called Tobin tax.”  But he writes it off as “a perennial populist favorite,” argues that it can easily be evaded, would have “no effect on speculation,” and has “no realistic prospect” of being accepted.  He doesn’t address the question of how to tame global finance, and his many suggested reforms speak primarily to what can be done to improve the financial system within the United States.  We are left with the impression of a severe and perhaps catastrophic intellectual limitation, almost an insouciance.  It will fall to others to think with Geider-like breadth.

Comprehensive reforms.  As we look at Geithner’s preferences for internal reform, we run into a contradiction between what he tells us and what Sheila Bair writes.  Geithner says “I hoped that we could channel the country’s populist outrage into support for comprehensive long-term reforms of the financial system.”  To the contrary, Bair says this: “Dodd-Frank [the reform legislation passed in 2010] is a good, albeit imperfect law.  Many of its provisions were watered down as a result of industry lobbying and, in some instances, at the behest of Timothy Geithner and his surrogates.”[32]

Capital, liquidity.  Common ground would seem to exist between Geithner and Bair when Geithner says that “forcing banks to hold enough capital and liquidity to absorb significant losses is the best defense against future crises.”  Bair concurs, telling how “numerous government and academic studies have shown that stronger capital standards will… reduce the risk of large-bank failures and the huge credit contractions we experienced in 2008.”  She says, however, that a meaningful capital requirement in the Dodd-Frank Act was retained by the Congress only “in the face of opposition from Tim, the Fed, the big banks and their trade groups.”[33]

“Shock absorbers.”  Geithner writes that “the most important safeguards” to “make the system safe” are “the constraints on risk-taking that I’ve described as ‘shock absorbers,’ starting with strict capital requirements… Other shock absorbers include liquidity requirements that limit financial institutions’ reliance on runnable short-term financing, deposit insurance and discount window access for depository institutions, margin requirements for derivatives and other financial instruments, and mortgage down-payment requirements that restrict leverage for ordinary borrowers.”   

“Resolution” authority.  He says the “vital tools” that are needed include “resolution authority to allow the orderly winding-down of failing financial firms.”  This would seem to put him in agreement with Bair, for whom “resolution authority” is a central feature.  What Bair says in Bull by the Horns, however, tells of disagreement over a contentious aspect.  She proposed a “resolution fund” that “would be built from assessments on big hedge funds, investment banks, nonbank mortgage lenders, and others.”  Geithner, she says, opposed this, disparaging it as a “bailout fund,” and argued in place of it that “giving the FDIC a line of credit from taxpayers to support resolution activities would be fine.”  She goes on: “Protecting taxpayers wasn’t Tim’s priority.  Having control over the resolution process was.”[34]

An overall systemic-risk monitor.  To address the problem that no person or agency was charged with responsibility to keep tabs on the systemic health of the financial system, Geithner says “I thought the Fed should be made the nation’s ‘systemic risk regulator,’ with the authority and responsibility for identifying dangers across the entire financial system.”   He discussed Bair’s views about this: “One of her crusades… was for an interagency council to get many of the powers to oversee systemic risk.”  He considered this inherently weak: “I saw the council as a way to avoid any centralized accountability.”  Bair’s discussion of the issue, however, says that Congressman Barney Frank, chair of the House of Representative’s Financial Services Committee, “liked my idea of a systemic risk council,” and points out that “even if Frank had wanted to give the Fed those major new powers, he probably didn’t have the votes to do so.  The members of his committee were still quite angry about the Fed’s regulatory failures leading up to the crisis.”  She adds that “I believe strongly that vesting all power in a single agency would make it more prone to capture by the industry.  Having a diversity of views… is a good check….”  In her proposal, “the heads of each of the major regulatory agencies would serve on the council,” the head of which “would have his or her own staff and be empowered to write rules for the financial system” (subject to approval by a majority of the council).  What was the outcome of this debate?  “Unfortunately,” Bair writes, “the Financial Stability Oversight Council created by Dodd-Frank is chaired by the Secretary of the Treasury, not an independent chairman.  In addition, it has very little authority to write systemwide rules.”[35]

Creation of a financial consumer protection agency.  Elizabeth Warren had long made consumer financial protection a focus of her law school career.  She wrote a 2007 article, Geithner says, “advocating that mortgages and other financial products should be regulated like toasters and other consumer products,” which are regulated for safety.  Obama shared Geithner’s enthusiasm for Warren’s idea, and creation of the Consumer Financial Protection Bureau was a major provision in Dodd-Frank.  That Act gave the Bureau “an even stronger and broader mandate than Elizabeth Warren had envisioned.”  Although financial industry opposition kept Warren from being named head of the new Bureau, she was put in charge of setting it up, and Geithner, despite his irritation that she “hired away a bunch of our staffers” for the purpose, credits her with doing “an excellent job getting [it] off the ground.”

Many other reforms have been proposed that we haven’t included in the above list, which we can’t intend to be exhaustive.  Before we leave the subject of reforms, it is worth noting that important areas are left unresolved in Geithner’s discussion.  One has to do with an anomaly in the financial products that have been developed in recent years, and that especially cries out for correction.  This is the lack of an “insurable interest” requirement for contracts insuring financial products.  In insurance law in general, the concept of “insurable interest” is what distinguishes insurance from gambling.  The requirement is that anyone taking out insurance on property or on someone’s life must have a potentially loss-suffering relationship – such as ownership, a leasehold interest, being a relative of the person, or being the person’s employer or partner – with the subject of the insurance.  The insurance is then to protect against loss to that separately existing interest.  This long-standing rule of insurance law has not been held to, however, so far as financial products are concerned.  To understand this, one needs to know that “credit default swap” contracts (CDSs) are, despite their esoteric name, nothing more than contracts insuring a financial product from loss.  Bair tells us that “hedge funds and other speculators could buy CDS protection against the default of mortgage-backed investments, without actually owning them.” She explains that “that created trillions of dollars in speculative trading, many multiples of the size of the underlying subprime mortgage market (our emphasis).  That is why hundreds of billions of dollars’ worth of mortgage losses translated into trillions of dollars of trading losses.”  Her conclusion: “I believe that speculative uses of CDSs should be banned.”   She says the way to do that is to require the insured to have an insurable interest.  It’s significant that it was “AIG [that] sold a lot of that kind of protection, eventually leading to its failure and need for a bailout.”[36]


We encourage readers to study Geithner’s Stress Test, while keeping in mind the many issues discussed here.  The general reader benefits from the fact that none of the memoirs relating to the financial crisis are steeped in the mathematical analysis that is so common in today’s academic economics.  Even though that’s a benefit, a criticism that can be made of this entire literature is that each commentator relates his or her own views or policies without spelling out the intellectual background for them.  They come down ex cathedra, as though without academic or other theoretical predecessors.  At least it can be said that all of them, including Geithner’s, are made easier to read by this absence.

Maybe the “easy to read” aspect is being taken too far.  Geithner joins some other prominent authors these days, such as Robert Gates in his memoir as Secretary of Defense and Elizabeth Warren in her recent book, in “dumbing down” the intellectual level by patronizing readers with lots of four-letter words and their variations.  That has become common in movies.  It’s appropriate to ask, must it now become standard in serious writing?  It is almost certainly one of the legacies of the 1960s, especially of Mario Savio and his Berkeley “Free Speech movement.” 










[1]   Several of these books have been reviewed in these pages.  They have included those by central figures such as Alan Greenspan (The Age of Turbulence) and Henry Paulson (On the Brink).  Greenspan was chairman of the U.S. Federal Reserve until January 2006, shortly before the crisis, and Paulson was Treasury secretary under President George W. Bush.  We await, of course, the eventual memoirs of Ben Bernanke, who took Greenspan’s place at the head of the Federal Reserve and served through the first  year of President Obama’s second term.  The many reviews published in this Journal may be found on the Internet at www.dwightmurphey-collectedwritings.info.  

[2]   His anti-“populist” rhetoric appears in several places, such as where he speaks of “the populist outrage” over “our failure to impose haircuts on AIG’s counterparties.”  He writes of “showy populist head fakes” that “indulge the public’s Old Testament cravings.”  He saw “a genuinely populist approach to the crisis” as one in which “punitive conditions would demonstrate toughness at the expense of economic stability.”  

[3]  This is borne out by Geithner’s statement that “the President once told me he felt uncomfortable playing a populist.”  An interesting feature of this statement is that Obama saw that if he were to act as a “populist” it would be a form of play-acting.

[4]   Henry M. Paulson, Jr., On the Brink (New York:  Business Plus, 2010), pp. 92, 109, 166, 45-6, 63, 12, 47.

[5]   Alan Greenspan, The Age of Turbulence (New York: Penguin Books, 2008), p. 515.  Richard A. Posner, The Crisis of Capitalist Democracy (Cambridge: Harvard University Press, 2010), p. 29.

[6]   See Ferguson’s Foreword to Henry Kaufman, The Road to Financial Reformation: Warnings, Consequences, Reforms (Hoboken: John Wiley & Sons, Inc., 2009), pp. xii, xiii; and also Kaufman’s own statement at p. xx. 

[7]   Kaufman, The Road to Financial Reformation, p. xx.

[8]   Sheila Bair, Bull by the Horns (New York: Free Press, 2012), p. 356.

[9]    It is likely that the name “Stress Test” given to the memoir refers to this tool to which Geithner assigned so central a place.  It seems reasonable to think, too, that it has a secondary meaning, referring to the incredible stress under which Paulson, Bernanke and Geithner were acting.  Each of their memoirs is a tale of human drama.

[10]   David A. Stockman, The Great Deformation: the Corruption of Capitalism in America (New York: PublicAffairs, 2013), pp. 4, 5-7, 10, 15, 22.

[11]   Barofsky was the Special Inspector General in Charge of Oversight of TARP [the bailout].


[12]   Bair, Bull by the Horns, 119, 181-2, 159.

[13]   Joseph E. Stiglitz, Freefall: America, Free Markets, and the Sinking of the World Economy (New York: W. W. Norton & Company, 2010), pp. 80, 152, 350.

[14]   David Wessel, In Fed We Trust: Ben Bernanke’s War on the Great Panic (New York: Crown Business, 2009), pp. 251, 6. 

[15]   Elizabeth Warren, A Fighting Chance (New York: Metropolitan Books, 2014), p. 302.

[16]   Warren, Fighting Chance, pp. 302, 304.

[17]   The Wichita Eagle, October 4, 2009.

[18]   Barofsky, Bailout, pp. 199-200, 151.

[19]    Column by E. Thomas McClanahan of the Kansas City Star, in The Wichita Eagle, July 17, 2009.

[20]   An interesting historical parallel is that the Franklin Delano Roosevelt administration did much the same thing, including into its New Deal program several of the programs that American “progressives” had advocated in the 1920s.  Among them: the Tennessee Valley Authority, the Securities Act of 1933 and Securities Exchange Act of 1934, unemployment insurance, Social Security, and the Wagner Act on labor relations  See Dwight D. Murphey, Liberalism in Contemporary America (Washington: Council for Social and Economic Studies, 1992), pp. 48-51.

[21]   Bair, Bull by the Horns, p. 62.

[22]   Paul Craig Roberts, How the Economy was Lost (Petrolia, CA: CounterPunch and AK Press, 2010), p. 43.

[23]   Charles R. Morris, The Two Trillion Dollar Meltdown (New York: PublicAffairs, 2008), p. 72.

[24]   David M. Smick, The World is Curved: Hidden Dangers to the Global Economy (New York: Penguin, 2008), pp. 12, 14.

[25]   Bair, Bull by the Horns, pp. 62, 67.

[26]   Paul Craig Roberts, column of October 9, 2008, to be found at www. vdare.com/Roberts/081009 solution; also, Roberts, How the Economy was Lost, pp. 43, 169.

[27]   See our review of the Roberts book just cited in the Fall 2010 issue of this Journal, pp. 381-388.  The review can be accessed without charge at www.dwightmurphey-collectedwritings.info as Book Review 140 (BR140).

[28]   Stiglitz, Freefall, p. 68.

[29]   Bair, Bull by the Horns, pp. 118, 7.

[30]   Many of these suggestions are discussed in this author’s book that contains reviews of 14 books on the Great Recession.  See Dwight D. Murphey, The Great Economic Debacle – and Beyond: Reviews and Commentary (Washington: Council for Social and Economic Studies, 2011).  The reviews are also included on Murphey’s website, cited in an earlier footnote.

[31]   Greider, One World, Ready or Not, pp. 257-8, 317.  See also p. 319.

[32]   Bair, Bull by the Horns, caption on the unnumbered page two pages ahead of p. 247. 

[33]   Bair, Bull by the Horns, p. 225. 

[34]   Bair, Bull by the Horns, pp. 217, 218.

[35]   Bair, Bull by the Horns, pp. 337, 338.

[36]   Bair, Bull by the Horns, pp. 54, 55, 334.