Stress Test

  Both options had their theoretical merits, but I didn’t think Larry’s approach was feasible or desirable. Somehow, though, Larry had talked Lee and Kabaker into making his strategy sound like a cool hawkish approach that would make the President a populist hero, while ours sounded like an equivocating dovish approach that would make the President seem cowed by the banks.

  “There’s no way you can present it like that! You’re making the dominant option look pathetic!” I said over the crackling on the line. “You can’t say we’re dove and he’s hawk. There’s no dove. You’ve got to make it Hawk One and Hawk Two!”

  I was concerned that everyone on board could hear me, including Robert Zoellick, the Republican diplomat whom President Bush had chosen to run the World Bank. I didn’t want to advertise our internal divisions and add to the sense of disarray. But Hawk One/Hawk Two was important. It wasn’t just about framing an arcane debate over resolving failed banks; it was about framing the larger debate about our plan. Larry and others were suggesting we were shying away from tough choices just as Japan had done after its banking crisis, setting up the United States for a Japan-style lost decade. We thought our strategy was plenty tough.

  After all, we intended to force big banks to raise the capital they needed whether they wanted it or not. A credible stress test would ensure that the shareholders of the banks that needed the most capital would face the most dilution. The banks least capable of filling their gaps on their own would end up with the largest proportion of government ownership, but even the banks that did manage to raise capital from private investors would dilute the ownership stakes of existing shareholders. I remember once while Larry and I were sitting outside the Oval Office, I tried to convince him that this meritocratic form of triage would be brutal to the shareholders of the institutions that most deserved brutality, while avoiding the panic-inducing consequences of nationalization or liquidation.

  “I don’t see why you want to portray this as so generous to the banks,” I said. “They’re going to be diluted in proportion to their sins.”

  But Larry wasn’t impressed by that argument, and he was a formidable debating opponent. He knew the President liked the idea of firm, decisive action that would end the bailout era and put the mess behind us. He often implied that while the President stood for bold problem solving, I stood for tentative half-measures. At one meeting in the Oval Office, Larry explained that the President was over here, as he extended his arm to his side, while Tim was over here, as he extended his opposite arm.

  “I’m much closer to you, Mr. President,” Larry said.

  ON SUNDAY, March 15, from 3 p.m. until well past 10 p.m., President Obama and more than a dozen of his economic and political advisers discussed our financial crisis response in the Roosevelt Room. Lee and Kabaker had edited their deck to make it clearer that both options were hawkish, but Larry was in classic form, disparaging our strategy as “watchful waiting” for a patient that needed “radical surgery.” Echoing the President’s own words on my first day as secretary, he said the time had come to rip off the Band-Aid and let the system begin to heal. His recurrent theme was that our plan was too reminiscent of Japan, which had kept its zombie banks alive and suffered the consequences of its timidity, and not enough like Sweden, which had nationalized banks and enjoyed a buoyant recovery.

  The President was sympathetic to Larry’s views, which some accounts of the Obama administration have used to suggest that he wanted to abandon our plan.

  “We don’t want to do Japan,” he said at one point.

  The Roosevelt Room meeting was a spirited debate at a time when I was not exactly at the commanding heights of influence. My team and I spent most of the meeting on defense. The relentless criticism of “Tim’s plan” was a reminder that this all was on me, that even my colleagues inside the administration—led by Larry, who had supported my career since I was his noisy scribe—were unimpressed. The President clearly wanted to hear what disturbed them about our plan, and he let them vent for hours.

  But we had already announced the outline of our plan. We had launched several specific components of the plan. We couldn’t scrap or dramatically revamp it before we knew the results of the stress test without risking even more turmoil in the markets. The Roosevelt Room meeting was an opportunity for our colleagues who felt uneasy about the plan to express their criticisms and angst. It was also a chance for the President to get immersed in the debate in case he wanted to adjust our plan down the road. It wasn’t a referendum on whether to proceed.

  The main policy issue we debated was the Hawk One/Hawk Two hypothetical of what to do if the government needed to take a majority stake in a bank, either before or after its stress test and capital-raising period were complete. Larry and others wanted us to commit to forceful restructuring policies in advance—breaking up or carving up the hobbled banks, replacing management, unloading assets, perhaps even haircutting certain creditors to help cover the losses.

  My basic response was: Sure, that might make sense in some cases. We’ll see. We couldn’t know what would be optimal months in advance; it would depend on the bank and the state of the world at the time. We couldn’t decide now, and it made no sense to tie our hands. We were also constrained by the limits of our authority, which didn’t really allow preemptive nationalization. We still had no way to wind down large complicated financial firms, and the FDIC could step in to take over smaller banks only when they were on the verge of failure or technically insolvent under existing regulatory requirements, which none of them were at that point. We were also constrained by the limits of our remaining financial resources. Whatever the possible virtues of a “rapid resolution” strategy, it would be expensive. Hours into the meeting, we got to the last slide in our deck, which noted almost in passing that Hawk Two could require $200 billion to $400 billion in additional capital, more than we had left in TARP.

  Rahm practically leapt out of his seat.

  “What are you talking about?” he said. “There’s no more fucking money!” The last thing he wanted was to force the President to ask Congress for another TARP.

  The skeptics had a lot of legitimate concerns, but few feasible solutions. Larry and Christy made economic arguments that the banks were in worse shape than we thought. Political advisers made political arguments for more Old Testament justice. Again, my response was: You might be right, and you might get what you want. We’ll see. The results of the stress test would reveal the health of the banks. Their success or failure in raising private capital would determine how tough we would be. We couldn’t responsibly short-circuit the process before we knew how it would play out. For now, the debate was purely theoretical.

  It was certainly a theoretical debate worth having. I wanted the President and our internal critics to understand exactly what we were doing. And the President was right: We didn’t want to do Japan. Although it wasn’t entirely fair to Japan, that was shorthand for turning a blind eye to the remaining capital hole in our banking system, for hoping that if we waited around long enough the economy would improve enough for the assets to recover their value and lift the banks out of trouble. That’s what Larry meant by “watchful waiting.”

  But that wasn’t our strategy. The stress test was the opposite of turning a blind eye; it would subject the banks and their assets to unprecedented scrutiny and transparency. And unlike the early Japanese strategy of “regulatory forbearance,” their see-no-evil approach of letting undercapitalized banks slide, we would make sure banks ended up with enough capital to survive a severe downturn, whether the capital was injected voluntarily by investors or forcibly by us. Finally, if a bank did turn out to be insolvent, we didn’t intend to follow the Japan model of letting it limp along for years, too weak to lend, dragging down the economy. Our approach to banks that needed another significant dose of government capital, whether it mirrored Hawk One or Hawk Two, would look more like Sweden than Japan.

  Among the opponents of “doing Japan,” there wa
s a lot of enthusiasm for “doing Sweden,” shorthand for biting the bullet and nationalizing up front. This affection, however, was based on a bit of myth about what actually happened in Sweden. Lee and Kabaker explained that Sweden had exhausted every other option during the first two years of its crisis before turning to nationalization. Then it nationalized only two of its six major banks—and only after it fully guaranteed the liabilities of its entire banking system to prevent the fire from spreading. Sweden’s banks were also much smaller and less global than ours, at a time when the rest of the world economy was much healthier and the global financial system was much less fragile.

  What we tried to push back against was the idea that preemptive nationalization was an appealing option, a cool way to look muscular and advertise our determination to tackle problems. We thought it would be a financial, political, legal, and logistical nightmare. We knew it might eventually be necessary for the weakest institutions. The government had already placed Fannie and Freddie into conservatorship and their CEOs had been replaced. AIG had to replace its CEO, and it was in the process of dramatically downsizing its sprawling businesses. But the notion that we should even consider nationalizing a large swath of the banking system as anything but a last resort, just because it felt resolute and cleansing, seemed irresponsible and unwise.

  If we nationalized a major bank, we would not only own all its legacy losses and risks, which could be hugely expensive for taxpayers; we would own its management issues and compensation messes and who knew what other surprises. Congress would feel like it owned them, too, and would be tempted to interfere in the bank’s business decisions for political purposes. Bill Isaac, a former FDIC chairman, had put it well in a Wall Street Journal op-ed that had resonated with me, recounting how the 1984 nationalization of Continental Illinois, a tiny bank by modern standards, had been a terrible mess that lost taxpayer money and dragged on for seven years. Lee compared nationalizing a big bank to invading Iraq.

  “If you want to go in, you better be sure there are WMDs,” he said. He echoed Colin Powell’s famous Pottery Barn rule: If you break it, you own it.

  In other words, before we decided to take responsibility for a troubled bank, we’d better be sure it was truly insolvent. And we thought the best way to judge that was through the stress test. Our critics said we should just take over Citigroup, to signal discontinuity and intolerance for Wall Street excess. That struck me as a rash effort to claim a scalp; we had just orchestrated the share conversion to strengthen the company, going out of our way to avoid taking a majority stake, and Citi was actually starting to show signs of stability.

  More important, we had already announced a process through the stress test that would give the world a better sense of how much more capital Citi and the other banks would need, and would give them a chance to raise that capital on their own. Why would we go out of our way to abandon that process, another wrenching lurch in strategy, in order to take over a multi-trillion-dollar international banking operation? How would that help the rest of the still-fragile financial system? What impact would it have on the markets, particularly the shareholders and bondholders of other banks awaiting stress test results? My team thought the most likely result of a preemptive nationalization of Citi would be a run on Bank of America, potentially followed by Wells Fargo, Morgan Stanley, and Goldman Sachs. We could quickly end up owning half the banking system. In a crisis, you can’t nationalize one firm and haircut its creditors unless you are prepared to guarantee the obligations of every other similarly situated firm. Sweden had done that, but it’s not the kind of thing you do if you have other options.

  In any case, our plan was already in motion. We knew it had risks. We couldn’t be sure it would work. But our critics didn’t have feasible plans of their own. As they kept pushing the President to be proactive and tough, I kept asking them to flesh out the alternatives and walk us through them. How would that work? Where would you get the authority? How about the money? Then what happens? What’s the exit strategy? I tried to remind everyone that concern is not a strategy, and that plan beats no plan. I wanted the President to see there weren’t plausible alternatives to proceeding with the stress test, and we were still preserving all our options for the next stage.

  After a few hours of asking hard questions and listening to the debate, President Obama said he was going to get a haircut and dinner. He told us to get on the same page before he got back. As the meeting broke up, I thought I heard him ask if five guys could follow him to the Oval Office. What he in fact asked was whether anyone wanted Five Guys, a hamburger chain I had never heard of, although I would later discover my son Ben liked it, too.

  Once the President left, Rahm, Axelrod, and Robert Gibbs ordered cheeseburgers from the White House mess, but the economic team just sat around arguing, fueled only by occasional dips into a bowl of Hershey’s Kisses. Rahm returned to the subject of Hawk One/Hawk Two. He made it clear that if we needed hundreds of billions of extra dollars to resolve banks Larry’s way, then we weren’t going to do it Larry’s way. Period. Someone then asked Larry what we should do if we couldn’t get more money.

  “We’ll have to do Tim’s plan,” Larry said.

  I was later asked about an author’s claim that the President decided in the Roosevelt Room that we should nationalize Citi, and that I had slow-walked his instructions. That was not true. The plan for Citi was no different from the plan for the other firms, which was to see how it did in the stress test, see if it could raise capital privately, then figure out if we needed to do more. The President understood the risks of lurching into a preemptive nationalization strategy, and he never told me to pursue that path.

  I remember an amusing moment during the break, when Larry suddenly looked perplexed, as if he had just discovered something unexpected in a familiar place.

  “You know, this stuff is really hard,” he said.

  “Welcome to my world,” I replied.

  We thought we showed the President we had a good plan, not just a plan. It wasn’t just the least-bad option. But the President certainly got a crash course in its risks. Many of his senior advisers, the people he trusted to promote his interests and philosophy, thought it was bad policy and bad politics. And our newest controversy was going to do more damage to confidence in the wisdom of our overall strategy.

  “Mr. President,” I said near the end of the meeting, “this AIG thing is going to get ugly.” We discussed the problem with the bonuses, and why we didn’t believe we could stop them.

  “Let me get this straight,” the President said. “We’re going to pay bonuses to the very people who caused all this damage to the financial system? And, by the way, a lot of them live in London so we won’t even collect taxes on their bonuses?”

  Yeah, basically. The President winced. He had been remarkably supportive of our approach. He had been amazingly supportive of me. He had already shown his willingness to stand behind deeply unpopular decisions that made his political advisers cringe. But it would be hard to top the unpopularity of this one.

  THE NEXT day, the President and I announced a new small business lending initiative in the East Room. After I laid out the details in my usual colorless fashion, the President said he wanted to take a moment to discuss his outrage about the AIG bonuses.

  “I’ve asked Secretary Geithner to use [our] leverage and pursue every single legal avenue to block these bonuses and make the American taxpayers whole,” he said. “I want everybody to be clear that Secretary Geithner has been on the case.”

  I read a draft of those remarks the morning of the event, and I wasn’t pleased. We didn’t think we could claw back the bonuses that had already been obligated, and even if we could modestly reduce future payouts, raising public expectations seemed unwise. I thought the President should stay as far away from the issue as possible. I didn’t see the need to remind everyone that I was “on the case,” either.

  But the country wanted blood. That week, the House of Representative
s rode the wave of populist anger by passing a confiscatory 90 percent tax on Wall Street bonuses, though the bill would die quietly in the Senate. While grilling CEO Ed Liddy at a hearing, Barney Frank, usually a paragon of reason, demanded the names of AIG’s bonus recipients; Liddy, who had joined the firm after its downfall out of civic duty and had agreed to a one-dollar salary, had to read aloud an anonymous letter threatening to track down AIG executives and strangle them with piano wire before Frank backed off.

  The AIG bonuses quickly became shorthand for government coddling of Wall Street, and I was perceived as the coddler-in-chief. Once when Paul Volcker saw me talking on my cell phone as he walked down the aisle of the New York–Washington shuttle, he mock-whispered: Just say no! Volcker was joking, mostly, but the general perception—dating back to a Washington Post column during my confirmation calling me a “Goldman Sachs alum”—had hardened that I was just another banker at the helm of Treasury, doing the bidding of the banks. New York Mayor Michael Bloomberg once introduced me at a public event as a Goldman guy; CBS newsman Harry Smith referred several times to my Goldman past during an interview; even Rahm’s wife once told me I must be looking forward to returning to Goldman.

  Around that time, Senate majority leader Harry Reid—the only politician I knew who could match my clipped brevity on the phone—invited me to attend the regular lunch of the Senate Democratic caucus, our supposed allies on the Hill. But liberal populists dominated the room, and they didn’t display much affection toward me. I remember Senator Bernie Sanders, the lefty firebrand from Vermont, yelling about how the President had only Wall Street people around him. I listed some of the progressive economists on the President’s team, including Christy Romer, Jared Bernstein, Gene Sperling, and Alan Krueger, my chief economist at Treasury. I explained that I had never worked on Wall Street. But the prevailing mood was dismissive. Afterward, I told Pete Rouse, a legendary behind-the-scenes Senate power broker who was now the President’s counselor, how badly the meeting had gone. I said I thought I should tell the President.