Stress Test

  In the congressional negotiations on TARP, Sheila had insisted on expanding FDIC insurance to cover checking accounts and other business transaction accounts at the seven thousand commercial banks in her jurisdiction. And she was now willing to provide guarantees for commercial banks insured by the FDIC. She just didn’t want to extend them to the holding companies of banks and their nonbank affiliates, entities outside the formal boundaries of the bank safety net. That would have just added to the run on the most vulnerable parts of the system, which in turn would have put more pressure on the banking system.

  After more haggling, we worked out a messy but acceptable compromise. The FDIC would backstop the new unsecured debt of bank holding companies as well as their commercial bank subsidiaries, but not of their broker-dealer subsidiaries, and not their existing debt. Ultimately, commercial banks would issue only about 20 percent of the debt guaranteed by the FDIC, so if we had agreed to limit coverage to those institutions, the guarantees would have packed much less power. Then again, they would have packed more power if the FDIC had agreed to guarantee existing as well as new debt; instead, we left existing creditors wondering whether more defaults and haircuts could be coming if the system ran into more problems. But the guarantees would help banks continue to finance themselves, which was critical.

  Our other challenge that weekend was to figure out the structure of the capital investments—what kind of capital, who would get it, how to price it, and so forth. This would be the most sweeping government intervention in the private markets since the 1930s, and we had two days to design it. My bias was toward simple, workable, and powerful. Fed staff had floated several elegant pricing options for the capital injections, including a “co-investment” plan where private investors would do the valuations and put some of their own capital at risk alongside taxpayer dollars. It was a cool idea, and we would return to the concept later in the crisis, but it was way too complex a program to set up overnight. My staff often joked that whenever I referred to an idea as “elegant,” I meant it was either too complicated or too difficult to implement, and therefore off the table.

  “Important thing here is not to get hung up on the precise details but to get it done by Monday with the capital going in,” Bill Dudley wrote me late Saturday night.

  Ultimately, we decided the Treasury would buy up to $250 billion worth of preferred stock in participating firms from the first tranche of TARP. It would receive a 5 percent annual dividend, rising to 9 percent after five years to encourage firms to pay the government back. Treasury would also receive warrants to buy common stock, so taxpayers could get some upside if the firms recovered. Current purchases would be limited to nonvoting preferred stock, which would ease fears of nationalization. But preferred stock is less loss-absorbing than common equity, the most resilient form of capital, so the money we injected into the companies would look more like low-interest loans than true investments in their long-term health, reducing its power. We also decided that the terms of the injections would be the same for everyone—partly because differential pricing would have been too complex to design on the fly, mostly because we didn’t want to slap weaker firms with the burden and the stigma of costlier capital.

  Stigma was a real danger, which is why we also decided to make the capital all but mandatory for the largest firms. The United Kingdom had just announced a voluntary program, and only weak firms initially accepted the capital, prompting markets to punish them. The FDIC team argued it would be unfair to force capital into stronger U.S. firms. But the system as a whole was undercapitalized, and unless the broader shortfall was addressed, the crisis would keep migrating from the relatively weak to the relatively strong. The fire had not burned itself out when it consumed Bear or Lehman or AIG. It had gained strength, and no one was fireproof. Recapitalizing the entire system would benefit everyone, so allowing firms to opt out and still enjoy those benefits would have been truly unfair.

  While we worked out the details of the capital and guarantees, the Fed’s team was also finalizing our new commercial paper program, as well as an unprecedented expansion of our foreign exchange swaps that made unlimited dollars available to European, British, Swiss, and Japanese banks through their central banks. As important as the details were, we knew it could be even more important to convey a sense of overwhelming force, to reassure the markets and the public that the U.S. government stood behind the fragile system. We had to show we had the capacity and the will to end the repeated bouts of escalating panic.

  In that email late Saturday night, after discussing where we stood on all of those programs, Dudley pointed out that a “coherent explanation of how it all fits together” could be as vital as any individual piece of the puzzle.

  “This is about confidence mainly,” he wrote.

  BANKS WERE closed on Columbus Day, so Mitsubishi’s executives personally delivered a $9 billion check to Morgan Stanley that Monday morning to close their deal and avoid a Lehman-style collapse. Hank and I had helped persuade the Japanese to close through some back-channel diplomacy, but we barely had time to breathe a sigh of relief that day. Hank had summoned the CEOs of nine of America’s largest financial firms to the Treasury for a meeting that would help determine the fate of the global economy.

  We wanted to inject $125 billion, half the initial program, into those nine institutions, which held more than half of the banking system’s assets; our hope was that smaller institutions would then feel free to apply for TARP funding without stigma. We would invest up to 3 percent of each firm’s risk-weighted assets: $25 billion for JPMorgan, Wells Fargo, and Citi; $15 billion for Bank of America; $10 billion for Morgan Stanley, Goldman Sachs, and Merrill Lynch, which was not yet part of BofA; $3 billion for Bank of New York; and $2 billion for State Street. We spent much of the morning stage-managing the meeting and refining the terms, focusing on how to make sure all nine banks accepted the new capital.

  We agreed that Hank would begin with an overview of our plan, followed by Ben discussing its importance for stability. Sheila would then give the details of the guarantees, which we knew would be welcome news for the financiers. It would fall to me to explain the capital program, which would be less welcome for some of them, even though our investments in banks would be what most Americans saw as “bailouts.” As we developed our scripts, I pushed hard to make the capital investments sound as close to mandatory as possible. We couldn’t force participation, but we could make it sound inevitable. I expected some firms to resist taking new capital with government strings attached. But in a financial crisis, no firm is ever as well capitalized as it thinks. Lehman thought it had plenty of capital until it didn’t.

  Sheila and I also suggested that Hank should make the CEOs sign pledges to use their new capital to do more lending, which would help the economy; modify more mortgages, which would help struggling homeowners; and abide by the compensation provisions of TARP, which would appeal to some Old Testament impulses. Critics correctly identified these pledges as largely irrelevant shiny objects that we could point to when we were accused of ignoring Main Street. Politically, though, these fig leaves were better than nothing. Hank, Ben, and I believed the real way to help Main Street would be to prevent a financial meltdown that would launch a global depression, but that was harder to explain.

  By 3 p.m., the nine bankers were seated at the long mahogany table in the Treasury secretary’s historic conference room. The room was decorated with Renaissance Revival furniture and gas-lit chandeliers from the post–Civil War period, along with stately portraits of George Washington and Salmon Chase, the Civil War Treasury secretary whose face was on the first greenback. It had been the dignified setting for some of our brainstorming clusterfucks at Treasury during the emerging-market crises. This time, the crisis was in our own market, and we were about to engineer the most aggressive government intervention in our economy in nearly eighty years.

  Hank was typically direct in his introduction, outlining the program and informing the bank
ers that they were all expected to accept the capital as well as the guarantees. “We’re planning to announce that all nine of you will participate,” he said. He suggested that there might be regulatory consequences for firms that didn’t, and that any subsequent government interventions would be much less generous.

  “This is the right thing to do for the country,” Hank said.

  When it was my turn, I announced how much each bank would receive, in alphabetical order from Bank of America to Wells Fargo. I emphasized that no one who rejected the capital would be eligible for the guarantees. It was a package deal, not an à la carte plan.

  “You have to opt in to both for the program to work,” I said. “We have designed this package to meet the needs of the system, and that should make it overwhelmingly compelling to each of your institutions individually.”

  I warned the bankers that if they all didn’t accept the capital, TARP would become stigmatized, the system would remain undercapitalized, and they all would remain at risk. I also said it wasn’t just “the system” that needed capital in this climate. Their individual firms did, too, even the ones that seemed strong. If the economy kept deteriorating, they would all need bigger capital buffers to finance themselves on reasonable terms and reassure the markets about their resilience.

  “Some of you may say this is too much, but each of you may need to raise more, some of you a meaningful amount more, given the likely evolution of the economy,” I said. “And if you wait, you will be raising it on substantially less favorable terms.”

  The two strongest firms in the room were JPMorgan and Wells Fargo. Jamie Dimon understood that in a crisis, banks can never have too much capital, and that JPMorgan would benefit from a healthier system. But Dick Kovacevich of Wells was openly hostile to our offer, even though he had just bought Wachovia and its mess of mortgages.

  “Why would I need twenty-five billion dollars more capital?” he asked.

  “Because you’re not as well capitalized as you think,” I replied.

  That only seemed to make him angrier. Otherwise, though, the summit went much better than we had feared. The bankers seemed a bit shocked by the force of our actions, but they understood the existential imperative. “This is very cheap capital!” Citi’s Vikram Pandit exclaimed. Merrill’s John Thain, incredibly, asked for assurances about executive compensation, but his soon-to-be boss, Bank of America’s Ken Lewis, scoffed that it was crazy at that moment to be discussing comp—or anything else, for that matter.

  “We’re all going to do this, so let’s not waste time,” he said. “Let’s cut the BS.”

  Morgan Stanley’s John Mack, hours after his firm was saved by a ten-figure check from a Japanese bank, was the first to sign his term sheet. He knew how hard it was to raise private capital in this market. By early evening, all the other CEOs had signed, too.

  Even before we announced the terms, the market reaction was effusive. As news leaked out that we were taking action, the stock market soared more than 11 percent. The S&P 500 had its biggest one-day point increase ever.

  We did a formal announcement the next day, then went to meet President Bush. The President was crisp, engaging, and gracious to all of us. He pulled me aside afterward to compliment me, presumably at Hank’s request. “I hear you’re the smart guy,” he said. I didn’t think much of Bush’s tax cuts, his war in Iraq, or his conservative views on social issues, but I admired how he acted during the crisis. It couldn’t have been easy for an ideological Republican to preside over such extraordinary government intervention in private enterprise. Bush was steady and calm, and he deserves great credit for being so supportive of Hank and the rest of us—in contrast to Senator McCain and many other Republicans on the Hill.

  For the first time since the Bear rescue, I felt a sense of relief. I still felt numb, exhausted, and apprehensive about the dangers ahead. But we were finally trying to get ahead of the crisis. For weeks, I had been clamoring for us to do more, to take more risk, to provide more help to the financial system. And now we were acting more forcefully. I felt so grateful to Hank and Ben, who had to endure the slings and arrows of public outrage, while I got to stay behind the scenes, occasionally playing the heavy.

  I guess I was starting to get a reputation. On Wednesday, Assistant Treasury Secretary David Nason forwarded me an email from a press aide: “CNBC just said that Tim Geithner was Paulson’s Luca Brasi!” I wasn’t entirely familiar with Don Corleone’s savage hit man from The Godfather, but I had a feeling I wasn’t being compared to a magnificent humanitarian.

  “My cultural references are impaired,” I joked. “Was he a really sweet guy?”

  “Sure, as he killed people, he was quite kind,” Nason told me.

  THE MARKETS were happy about TARP, but they did not stay happy. The huge rally on Monday was wiped out Wednesday. The S&P 500 had an even worse day than it had after the House initially rejected TARP.

  This time, the problem was not stress in the financial system. The measure of fear in interbank lending actually declined that week. Now the problem was stress in the broader economy. The new retail sales report was abysmal, consumer confidence had fallen off a cliff, and various measures of business confidence were hitting new lows. The September jobs report was the worst in over five years: 159,000 jobs lost, which would later be revised to 459,000 jobs lost, the worst in over three decades. Homes weren’t being built, and cars weren’t being sold. General Motors was so strapped for cash it was delaying payments to suppliers, and its stock price had dropped to the lowest levels since the Korean War. Chrysler’s outlook was just as bad. The post-Lehman financial shocks had delivered such a massive blow to confidence that companies of all kinds were cutting jobs and costs and capacity as fast as they could, preparing for a prolonged economic contraction.

  This is what we had been talking about when we had warned that Wall Street’s problems could damage Main Street.

  Meanwhile, the presidential campaign, once expected to be a referendum on a brutal quagmire in Iraq, had become a referendum on a brutal economy. And shortly after we announced the start of TARP, I got a call from my former Treasury colleague Mike Froman, a Citigroup executive who had gone to law school with Barack Obama and was now advising his presidential campaign.

  The senator wanted to meet.

  IN FEBRUARY, I had shown up at my polling station at a Larchmont elementary school to vote for Senator Obama. I had forgotten that as a registered independent, I wasn’t eligible to vote in the New York Democratic primary. I had been a straight-ticket Democratic voter since the Clinton years, when the Republicans started veering far to my right. It was just my allergy to partisan politics that kept me from becoming a Democrat. And Senator Obama seemed like my kind of candidate—liberal on social issues, moderate on economic issues, pragmatic above all. I had read his memoir, Dreams from My Father, and found him appealing and impressive.

  I was also impressed by Senator Obama’s calm and responsible approach to the crisis, especially compared to Senator McCain’s erratic pandering. Senator Obama kept in constant contact with Hank, who had nothing but praise for him. He never distanced himself from TARP, rounding up Democratic votes in Congress, passing up the opportunity to run against the Bush bailouts. Franklin Roosevelt had refused to lift a finger to help the outgoing administration relieve the suffering of the Depression, so he could draw a starker contrast with President Hoover after his own inauguration. Senator Obama did not follow that politically shrewd but costly example. He did whatever he could to help support our efforts to save the economy on President Bush’s watch, even though it blurred his message of change.

  I had heard about media reports floating my name as a possible Treasury secretary for Senator Obama, which seemed almost as implausible as the media reports floating my name as a possible Treasury secretary for Senator McCain. But I was flattered by his interest, and curious to meet him. On Friday, October 17, I went to see him in his room at the W Hotel in midtown Manhattan, and we talked for
an hour. Just three weeks before the election, with the world watching his every move, he seemed totally relaxed.

  He began by asking for an update on the crisis. Overall, I felt as upbeat as I had in fourteen months. I finally felt somewhat confident that we could avoid a reprise of the 1930s, but upbeat was a relative term.

  “We’ve broken the back of the panic,” I said. “But this thing isn’t over. It’s still terrible, and it’s going to be for a long time.”

  Senator Obama then asked me a few questions about my background, so I described the arc of my childhood in India and Thailand. We discussed an odd family coincidence: When my father was running the Ford Foundation’s Asia programs, the foundation had funded the work of Senator Obama’s late mother, Ann Dunham, while she built a microfinance program in Indonesia.

  Senator Obama asked all the questions, and he didn’t reveal much, but we bonded a bit over our shared family tradition of international development work. He seemed genuinely curious, and I felt a lot more comfortable talking about myself than I normally would with someone I had just met. I explained that as cool and enriching as it had been to move around and live apart from my country as a kid, at some point I had decided I wanted to be an American. I had seen the outsized impact the United States had on the world, for better and for worse, and I wanted to be a part of making it better. He seemed to understand that. The senator then cut to the chase: “Tim, I might have to ask you to come to Washington.”

  “You shouldn’t do that,” I said. “Let me talk you out of that.”

  I wasn’t being coy. I meant it. I liked my current job and my current life. I gave Senator Obama five reasons why he shouldn’t try to make me Treasury secretary.

  The first was the most important to me, though obviously less relevant to him. I had promised my family after I uprooted them from Washington that I wouldn’t make them move again. They felt comfortable in Larchmont. Elise was a senior in high school, Ben was a freshman, and Carole had a rewarding job as a grief counselor. I didn’t want to break my word.