Stress Test

by Timothy F. Geithner

  Our obligation was not to be different for the sake of being different, but to clean up the mess.

  THE PRESIDENT-ELECT met with his senior advisers in Chicago on December 16, a four-hour meeting that would later attain mythic status as the opening scene of the Obama administration. Christy Romer, a noted scholar of the Great Depression, began with an overview of an economy careening toward another one.

  “Mr. President-elect,” she famously said, “this is your holy-shit moment.”

  If the main theme that day was the mess we were about to inherit, the main topic was the Recovery Act. We all felt the stimulus should be as big as possible and passed as soon as possible. Governments always face political pressure to tighten their belts during crises, because families and businesses are tightening theirs. But for countries that can afford to borrow, austerity in a crisis is a dangerously misguided approach. Keynes recognized this “paradox of thrift,” the idea that saving by individuals, considered virtuous in normal times, can cripple society’s demand for goods and services during a downturn if everyone pulls back at once. One family’s spending is another family’s income; the less people spend, the less people earn, and the less people earn, the less they have to spend. That’s when government needs to pump money into the economy to revive demand and restore confidence, even though politically, deficit spending can seem as profligate and counterintuitive in tough times as financial rescues.

  I did not have strong convictions about the Recovery Act’s exact contents. I was fine with well-targeted tax cuts, which can quickly get money into people’s pockets and the broader economy. I was also fine with public works projects, which are slower but pack more economic punch. Direct aid to the unemployed and other victims of the recession would be fast and powerful, since they would be likely to spend the money right away. I was leery of the varied demands from congressional Democrats—as well as some members of the President-elect’s staff—who wanted to plus up their favorite programs after eight years in the wilderness. But we didn’t have time for protracted negotiations to optimize the package. I thought we should get as much as we could, as quickly as we could. The economic team seemed to agree on the big picture, so I didn’t get too involved in the substantive details or the legislative strategy.

  My focus was the financial system. In my part of the briefing for President-elect Obama, I warned that credit was still frozen and many major firms were still in danger. The system was broken, and if we couldn’t fix it, the economy wouldn’t recover no matter how much we spent on stimulus. I told the President-elect that we’d need to do more to recapitalize the banking sector, revive the flow of credit, and reassure the markets there would be no more Lehman-style fiascos.

  I also discussed our early ideas for financial reform, pointing out that there was some tension between our long-term goals for the system, such as stricter limits on leverage, and our immediate crisis-fighting priorities, such as slowing down the deleveraging process. Eventually, we’d want financial firms to take fewer risks, but in this time of intense fear, we wanted them to take more risks in lending rather than pull back their credit. The financial system needed a version of Saint Augustine’s plea: Lord, give me chastity, but not yet.

  If the slow burn leading up to Bear Stearns had been phase one of the crisis, and the panic of Lehman followed by the emergency programs of the fall had been phase two, we were now entering a third phase, where the recession was accelerating, and the broader economy and the financial system were dragging each other down. I didn’t lay out a new strategy during that Chicago briefing, because I was still working through a variety of ideas with Lee Sachs, Meg McConnell, and a talented young investor from the Blackstone private equity firm named Matt Kabaker. What I mostly tried to convey to the President-elect was that the situation remained terrible, and that we would have to do some terribly unpopular things, because a lot of firms that didn’t deserve saving still needed to be saved.

  Austan Goolsbee, a University of Chicago economist who had advised Obama ever since his original Senate campaign, then outlined our thinking on housing. It was a brutally complicated problem, affecting the profligate along with the merely unfortunate, and we felt intense pressure to do something big. There had been three million foreclosure filings in 2008, and, so far, federal efforts to ease the crisis had been limited in ambition and impact. One congressionally designed program known as Hope for Homeowners, an effort to reduce the mortgage debt of families in distress, had attracted only 312 applicants nationwide. And the futures markets suggested real estate prices still had a long way to sink, which meant a lot more suffering ahead—not just for speculators who had assumed the boom would never end and conspicuous consumers who had bought bigger houses than they could afford, but for hardworking homeowners who were underwater through absolutely no fault of their own.

  I was no housing expert, but, again, my bias was to do the most aggressive interventions that were sensible and feasible. We had a team of talented and experienced progressives working on housing—including Michael Barr, a University of Michigan law professor who would become one of my assistant Treasury secretaries; Diana Farrell, a McKinsey director who would become one of Larry’s deputies; and Shaun Donovan, who had run New York City’s housing programs and would become secretary for Housing and Urban Development—but there were no easy solutions.

  We looked carefully at all the grand plans floating around for universal mortgage refinancing or widespread principal reductions, but even if there had been some way to get them through Congress, we didn’t think any of them would be a fair or economically effective use of taxpayer resources. Too much of the assistance would go to people who didn’t need it, and the economic bang for the buck would be much less powerful than other stimulus alternatives, such as funds for infrastructure projects or preventing layoffs of teachers and first responders. The housing team had come up with a more targeted mortgage modification plan that would give lenders incentives to help at-risk borrowers (but not borrowers who could afford their mortgages or borrowers likely to default no matter what) by reducing monthly payments (but not overall principal amounts) in order to prevent some (but not all) foreclosures. We thought that could be done with $50 billion in TARP money, with the contributions of Fannie, Freddie, and the private sector multiplying that amount.

  Orszag then laid out the harrowing budget situation. Tax revenues were drying up, automatic spending on safety-net programs such as food stamps and unemployment insurance was rising, and the 2009 deficit would exceed 9 percent of GDP. That wouldn’t even include the cost of our stimulus plan. And our long-term budget deficits, driven in large part by rising health care costs, were completely unsustainable.

  I stayed out of most of our arguments over specific programs, but I did push strongly for long-term discipline in our overall budget strategy—essentially, a fiscal version of Saint Augustine’s chastity-but-not-yet prayer. I fully supported the Keynesian imperative of increasing short-term deficits to offset the cataclysmic fall in private demand, but I thought we had to reassure the markets that the stimulus would be temporary, that we would dial back deficits once the crisis passed, that we weren’t drunken sailors. I argued for a credible medium-term plan to cut deficits to 3 percent of GDP, the level where our overall debt burden would stop rising as a share of the economy. Peter and Larry agreed. We got some pushback from Christy, Austan, and the most liberal member of our team, Jared Bernstein, Vice President Biden’s chief economist. They worried about reining in President Obama’s agenda before he even got to Washington. But the President-elect took our side. He had been critical of President Bush for putting expensive tax cuts and new spending on the national credit card, and he was serious about change.

  I thought the President-elect seemed substantive, realistic, and comfortably in command. I liked his focus on getting the policy right first and worrying about the politics later; his pragmatic, whatever-works approach; his calm, no-drama attitude. But I didn’t leave that meeting with
much of the yes-we-can enthusiasm so prevalent in Obamaworld in those days. I felt weary and dark. It seemed like I was always sucking the hope out of the air in our meetings, explaining why the awesome new ideas weren’t that awesome, and how the storm we were sailing into was even worse than we thought.

  And I had my own brewing storm to deal with.

  THE DAY after my nomination had leaked in late November, I got a call from Les Samuels, an assistant Treasury secretary for tax policy during the Rubin era. He was helping the Obama transition team with vetting, and he said he had a few questions about my tax returns.

  He didn’t sound too worried. I had made some careless mistakes, but they were innocent mistakes; I had disclosed them all to the campaign’s vetting team in early November, and Samuels thought my accountants should have caught them. The Senate had not rejected a nominee for Treasury secretary since 1844, and during an epic financial crisis it seemed unthinkable. But Mark Patterson, a former Senate staffer who coordinated Obama’s confirmations, told me afterward that the transition team had been instantly worried. The Senate Finance Committee, under Chairman Max Baucus and Republican ranking member Chuck Grassley, was known for putting tax records under the microscope; a nominee to run Treasury, which oversees the IRS, would be sure to get extra scrutiny. And in the partisan battlefield of modern Washington, there’s no such thing as an innocent mistake. Patterson actually suggested to top transition officials that the President-elect ought to switch the jobs of Larry and me, so that I wouldn’t have to face the Senate. He was told that unfortunately, that horse was already out of the barn.

  My main problem involved unpaid payroll taxes from my time at the International Monetary Fund, a problem I thought I had already dealt with. American employees of the IMF had a complicated tax status—we were treated almost as if we were self-employed—and I screwed it up the whole time I was there. The IMF didn’t withhold income taxes or payroll taxes, and its employees received bare-bones W-2 forms that didn’t indicate that our wages were subject to payroll taxes. I paid my income taxes every quarter, but not my payroll taxes. After preparing my own returns for 2001 and 2002, I had accountants prepare my returns in 2003 and 2004, but they never corrected my error. In 2006, the IRS had audited me, and I had paid $17,230 in back taxes and interest, but I did not have to pay any penalties. My mistake was so common that the IRS announced a general settlement for IMF employees in my situation later that year.

  The vetters also noticed that my back payments to the IRS had covered only my 2003 and 2004 returns. The IRS hadn’t charged me for 2001 and 2002, because the statute of limitations had expired. I had simply paid what they asked. I hadn’t stopped to think about whether I should pay for the prior years, another mistake. Samuels thought I should pay back taxes and interest for those earlier years, to go beyond mere letter-of-the-law compliance, and I agreed. I had my returns amended immediately, and wrote the IRS another check for $25,970 the day my nomination was announced.

  On December 19, before my tax problems became public, I visited a Senate office building to answer questions from the finance committee’s extremely thorough staff. I explained how I made my mistakes. I said they were dumb but honest mistakes. But the lead questioner, an IRS manager on detail to the committee, wasn’t buying it. She suggested there was no way I could have missed the payroll tax problem, as if the only possible explanation was that I was venal, deliberately trying to evade taxes. I pointed out that my accountants had missed the problem, too.

  “You should sue your accountants,” said one of Senator Grassley’s aides.

  He sounded almost sympathetic. But the general tenor of the meeting was distrust bordering on contempt. One of “the Grassleys,” as his staff was known, pointed out that there was no statute of limitations for fraud, prompting Patterson to ask if he was seriously accusing me of fraud. He just glared. Grassley’s team grilled me relentlessly about the immigration status of a Brazilian woman who had cleaned our house once a week for a year. We had made sure when we hired her that she was a legal resident with a valid work permit, and we had paid our share of her payroll taxes. Her permit had expired a few months before she left us, and the Grassleys hammered me about that, but we would later prove that she had applied for the necessary paperwork and became a permanent U.S. resident a short time later.

  It was my own screw-ups that made the inquisition possible, and I felt sick that I had put the President-elect in this position. Still, the IRS would soon send me a letter informing me that I wasn’t liable for the 2001 and 2002 taxes I had just voluntarily paid, and explaining that I was entitled to apply for a refund. I decided not to avail myself of that particular privilege.

  Grassley later admitted to another nominee that he wouldn’t be able to pass his own committee’s tax vetting. Another Republican senator privately commiserated with me about the hazing ritual.

  “No one up here could withstand a tenth of this scrutiny,” he said.

  THE COMMITTEE released my tax information on January 13, 2009, and the reaction was as unpleasant as we expected. Jay Leno compared me to the actor Wesley Snipes, who was in jail on tax charges, and mocked me for copping to an honest mistake. “So the guy who’s going to be in charge of the IRS is not a criminal,” Leno quipped. “Phew, just incompetent.” A relatively favorable New York Times story on my travails began: “If Timothy F. Geithner were a bank, he might well be considered ‘too big to fail.’ ” A Pew poll had just found that only 1 percent of Americans knew who I was, so this would be my introduction to the public.

  I met with the Senate Finance Committee to apologize and explain, but many of the Republicans were skeptical and derisive. One exception was Orrin Hatch of Utah, who promptly told the press he believed me and supported me. I don’t know why he went out on that limb, but I was grateful. Another Republican privately told me not to take his opposition personally; it was just payback for Democratic opposition to President Bush’s nominees. Yet another told me he would back me if I truly needed his vote, but otherwise he would oppose me to avoid looking Obama-friendly and potentially attracting a primary opponent.

  Traditionally, Treasury secretaries had enjoyed a fair amount of bipartisan support. It worried me that my credibility was already under attack, when I was about to become the public face of our past and future rescues. I knew that any time I weighed in on tax policy I’d create a punch line for late-night comics. And it hurt to have my motives questioned. My daughter, Elise, was taking my new infamy especially hard; she’s so protective of me, and took every slight personally. My mother ached over bad stories about me, too. For Carole, it was torture. The committee staff accused her of lying about our housekeeper, which was absurd, and she was furious and frustrated that she couldn’t defend herself or me in public. She told me she wished she hadn’t been so careful to hire legal workers over the years; otherwise, I could have been disqualified from my position. Ben said less, as teenage boys tend to do, but I knew this was tough on him, too.

  As the frenzy swirled, I went to see Baucus and Grassley to ask if I would have their support. “If I don’t have your confidence,” I said, “I’m not sure I can do this job effectively.” Baucus was critical but supportive. Grassley remained noncommittal. As Patterson said, even Republicans without real objections to me had political incentives to let me twist in the wind.

  “They’re going to wait and see how this plays out,” Patterson said.

  Around that time, I ran into David Axelrod in a narrow hallway in the transition office and suggested that it might make sense to withdraw my nomination to protect the President-elect.

  “Axe, I don’t want to be a burden,” I said. “If you guys decide you want to go a different direction, I’ll be OK with that.”

  “No, we’re sticking with you,” he replied.

  I made a similar offer to Rahm. He was similarly unmoved, although I’m sure he and Axelrod thought about whether it might make sense to pull the plug.

  “You’re going to be fine,” R
ahm said. “They just want to cut you and make you bleed.”

  I tried not to wallow too much in the furor. I remember one day Larry, who had endured his share of public controversies, stuck his head into my office to say hey, you’re handling this well. He said I “presented a good sense of equanimity,” a nice and very Larry way to put it. But my confirmation was a real drain on my time and mental energy. I had constant meetings with lawyers and accountants, hearing-prep sessions with a “murder board” of role-playing colleagues, plus a series of obligatory courtesy calls with senators. I remember one awkward meeting with Senator Bunning, who had repeatedly denounced our crisis response as socialism. We talked about baseball—he was a Hall of Fame pitcher—and mused about moral hazard, but we both knew we weren’t going to bridge our differences.

  I was also devoting a lot of time to recruiting. I was going into the world’s most powerful finance ministry at the most perilous time in generations, and Treasury was very thin. The office most critical to the financial rescue had only a handful of career civil servants, compared to about two hundred in the international division where I had first worked. And Treasury’s top twenty leadership positions all required Senate confirmation.

  Early on, those senior jobs were hard to fill. Jack Lew, President Clinton’s former budget director, initially seemed interested in being my deputy, but changed his mind after Secretary of State Hillary Clinton asked him to be her deputy. Tom Nides, a Morgan Stanley executive, seemed willing to come help me run the department, but he decided to stay in New York until his firm was in better shape. There was plenty of interest in joining the administration, but it was hard to find candidates with financial experience who were confirmable, given the prevailing fever of loathing for the financial sector. And it seemed like half the candidates we considered for Senate-confirmed positions failed our internal vet because of their own tax issues, which would have been ironic if it hadn’t been so debilitating.