Stress Test

  Finally, we needed to bolster the government’s ability to fight fires. One top priority was “resolution authority,” what Jamie Dimon called “bankruptcy for big dumb banks,” the power for government to manage the failure of systemic institutions through an orderly process, like the FDIC had for normal banks. With more authority to unwind major firms more deliberately, we’d reduce the danger of catastrophic Lehman-type failures and the need for AIG-type rescues. But we also wanted to preserve the firefighting authorities that helped us stem the panic—most important, the Fed’s general authority to provide liquidity and the FDIC’s authority to guarantee bank debt during times of systemic distress. We couldn’t end bailouts by proclaiming an end to bailouts, or, worse, by stripping away the government’s bailout power; we couldn’t eliminate panics by promising not to act in the face of the next panic. On the contrary, giving crisis responders the power to use overwhelming force to quell a panic makes panics less likely. We needed to try to reduce the risk, in Charles Kindleberger’s framing, that future manias would turn into panics and then crashes.

  We began debating all these financial reform issues in the early days of President Obama’s transition. But the first question we had to answer was a less technical question of sequencing: When should we pursue legislative reforms? Financial reform would consume a lot of political oxygen. Our overriding priorities in those days were ending the crisis and reviving the economy. There were some near-term tensions between financial reform, which would ultimately require banks to take less risk, and economic recovery, which would depend on banks getting out of their defensive crouches and taking risks again. There was a case to be made for Saint Augustine–style caution—tougher capital and liquidity requirements, just not yet. Paul Volcker, the venerable leader of the President’s new economic recovery board, reminded us that getting reform right was more important than passing reform quickly. This was complex stuff, and transformative opportunities like this didn’t come along often.

  Rahm, as usual, wanted immediate action. Politically, he believed that offense, a strategy of relentless initiative, was the best defense. He saw “Wall Street reform” as a great issue to build momentum, set the agenda, and force Republicans to choose between siding with Wall Street and giving the President a bipartisan victory. And regardless of Rahm’s political considerations, I thought it made sense to strike while the pain of the crisis was raw and the financial establishment was weak, rather than wait for memories to fade and the empire to strike back. I wanted to seize the first-mover advantage in setting the terms of the debate, both in the United States and globally. I also believed an early push for reform could provide a productive outlet for the public’s Old Testament anger, a positive expression of what I called “the atonement agenda.” I didn’t want populist fury to muck up our crisis response with damaging short-term conditions, but I thought it could help us pass tough new long-term rules of the road.

  The President decided to push sooner rather than later. I proposed that we should draft the first version of the legislation ourselves, and he readily agreed. We had left the drafting of the stimulus to congressional Democrats, and we would give the Hill even more control over health care reform. But I feared that Congress didn’t have the necessary technical expertise to craft effective financial reforms, and that if we didn’t take the initiative, financial lobbyists as well as ideological extremists on the left and the right would have too much influence over the shape of the bill. So even while the crisis was still burning, our reform team was meeting daily, scrambling to prepare legislation to ease the next crisis.

  We weren’t scrambling fast enough to suit Rahm. He initially hoped to get our legislation through the House before that G-20 summit in London in April 2009, an insanely ambitious timeline. He then said he’d settle for a full legislative draft before the summit. At a meeting in Rahm’s office in March, my deputy Neal Wolin said that wasn’t possible, either. This would be a complex bill, likely to run hundreds of pages. Rahm pointed to a desk with a computer.

  “Sit the fuck down and start typing,” he snapped. “And don’t get up until you’re finished.”

  THE GOAL of financial reform, as Larry liked to say, was to make the system safe for failure. It wasn’t to prevent the failure of individual firms that take on too much risk, but to make the aftershocks of failure less threatening to the system as a whole. I believed the key to achieving that goal would be improving our shock absorbers. In an uncertain world, with fallible human beings running and supervising financial institutions, we needed cushions to protect the system from their inevitable mistakes. In other words, we needed more capital, less leverage, more liquidity.

  But we didn’t want Congress designing the new capital ratios or leverage restrictions or liquidity requirements. Whatever their flaws, regulators were much better equipped than politicians to determine, say, the precise amount of common equity a bank should have relative to its risk-weighted assets, or the amount of cash it should hold to meet potential withdrawals. History suggested that Capitol Hill would be too easily swayed by the clout of the financial industry and the politics of the moment; we didn’t think that was the place for the intricate work of calibrating the financial system’s shock absorbers. The Fed was not a very popular institution at the moment, but it had a lot of technical expertise as well as political independence, and we thought it was much better suited for the job.

  We also thought these problems demanded global solutions. This was a global crisis, and we had been hurt by weak regulatory standards overseas, not just by our failures at home. If we had unilaterally imposed strict new limits on risk, without encouraging higher standards globally, we simply would have reduced the market share of U.S. firms around the world, without making the global system more resilient. So starting at that G-20 summit in London, we began leading the push for tougher international financial reforms, including the new capital, leverage, and liquidity requirements that became known as Basel III; broader oversight of derivatives markets; and better ways to deal with the failures of global banks. This would require a messy, protracted process of behind-the-scenes diplomatic negotiation, but it would be absolutely crucial to strengthening the system.

  We would pursue the rest of our reforms in Washington, and the process there would be messy and protracted as well. There were vast sums of money at stake, and a vast array of powerful lobbies with interests in the outcome. Passing comprehensive legislation in Washington is always a challenge, and it would be even harder at a time when the President faced such determined Republican opposition. The fact that this particular comprehensive legislation involved regulatory reform would only add to the degree of difficulty, because the affected agencies all had congressional defenders looking out for their turf, as well as influential supporters in the financial industry.

  In fact, as we started to debate reform inside the administration and on Capitol Hill, many of our thorniest questions involved which regulators would do what in the future. Just about everyone agreed that the current oversight regime was a ludicrously balkanized mess, but the same tribal warfare that hobbled the regulatory system would hobble our efforts to rationalize it.

  For example, we thought one obvious fix would be to merge the Securities and Exchange Commission and the Commodity Futures Trading Commission, two market regulators whose overlapping mandates routinely produced duplication and confusion. But the CFTC, through a quirk of history, was under the jurisdiction of the congressional agriculture committees, which did not want to surrender their power over a slice of the financial system—or their access to campaign donations from financial interests. I asked House Financial Services Chairman Barney Frank whether he thought we could round up the votes.

  “Sure, you can merge the SEC and the CFTC,” he said. “You just can’t do it in the United States.”

  We faced a similar quandary with bank supervision. The Fed oversaw the holding companies that owned banks, while an individual bank might be regulated by the Fed, th
e Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, a state banking supervisor, or some awkward combination of those choices. This led to venue shopping and other forms of regulatory arbitrage, as well as blind-men-and-the-elephant problems where no regulator had a truly comprehensive view of an institution or the responsibility for monitoring it. Ideally, we would have liked to consolidate the OCC, FDIC, and OTS into a single national regulator for depository institutions, with a dominant ongoing role for the Fed. But we decided that politically, that was another nonstarter.

  I was uneasy about the distractions of trying to reorganize the military while we were fighting a war. With Congress so starkly divided along partisan lines, we couldn’t afford to lose any votes over turf, or waste half our time fighting rear-guard actions against regulators protecting their prerogatives. Ultimately, the only agency we’d propose to eliminate was the hapless OTS, which had invited banks to come under its umbrella to take advantage of its softer supervision, and had brushed off concerns about sinking thrifts such as Countrywide and WaMu.

  In a Roosevelt Room meeting with the President that spring, Diana Farrell, the McKinsey veteran who was Larry’s deputy, made an impassioned plea for a more ambitious regulatory overhaul. The irrationality of the organization chart offended her management-consultant sensibilities, and rightfully so. But I pointed out to the room that in domestic policy as in foreign policy, there are wars of necessity and wars of choice. Reform was a necessity. Reorganization felt like a choice that could mire the bill in the quicksand of interagency warfare; we wanted regulators focused on helping us fix the broken financial system, not fighting for their bureaucratic survival. Farrell was right that we were putting politics ahead of our policy analysis, but the ideal policy wasn’t achievable. That point was neatly illustrated later when Senate Banking Committee Chairman Chris Dodd released a plan to merge the supervision functions of the OCC, OTS, FDIC, and the Fed into one mega-agency. It was dead on arrival.

  Some of the most controversial turf issues involved the Fed, which was facing an intense political backlash over the crisis, the bailouts, and the bad economy. I thought the Fed should be made the nation’s “systemic risk regulator,” with the authority and the responsibility for identifying dangers across the entire financial system, setting broad constraints on leverage and other risks, and even expanding the scope of those shock absorbers and other safeguards over time. As risk migrated in the future, we wanted the Fed to be able to designate the future equivalent of nonbanks such as AIG or GE Capital as systemically important, so they would be subjected to tougher supervision, and could be resolved safely if they got into trouble.

  I had a long history with the Fed, so I was never going to be perceived as an unbiased arbiter of the relative merits of the various supervisors and regulators. For all the Fed’s weaknesses, I still thought it had the smartest staff in the regulatory community, the best vantage point on the system, and the most independence from politics. But Chairman Frank told me anti-Fed sentiment was just too strong to expand its powers. Chairman Dodd, the other key player in the reform bill that would come to be known as “Dodd-Frank,” complained that it would be “like a parent giving his son a bigger, faster car right after he crashed the family station wagon.”

  Sheila Bair was especially aggressive in trying to clip the Fed’s wings and expand the FDIC’s authority, arguing that if the FDIC was going to be stuck taking on the risks of resolving big banks after they failed, it needed a bigger role overseeing them before they failed. She was relentless and effective lobbying Dodd, Frank, and other members of Congress. She also tried to go around me to Rahm without much success. One of her crusades—embraced by most of the other independent regulators and the lobbyists for much of the financial industry—was for an interagency council to get many of the powers to oversee systemic risk that we hoped to bestow on the Fed. This view got a lot of traction on the Hill, but I saw the council as a way to avoid any centralized accountability. I remember testifying before the Senate that you can’t convene a committee to put out a fire. We already had a committee called the President’s Working Group on Financial Markets, and I had seen its limits up close. “There isn’t going to be any fucking council,” I scoffed in one meeting with industry executives. I spoke too soon.

  The one area where we did propose a massive reorganization was consumer protection. The President was especially passionate about defending ordinary families from financial abuse. At one early Oval Office meeting to discuss credit card reform, he told us about the outrageous rates he had paid as a young community organizer. He soon signed a bill forcing transparency into the credit card business, while cracking down on arbitrary fees and rate resets, an important prelude to his more comprehensive consumer reforms.

  On the broader issues, our team of reform architects drew inspiration from a 2007 article by Elizabeth Warren advocating that mortgages and other financial products should be regulated like toasters and other consumer products, perhaps by an agency like the Consumer Product Safety Commission. The case for a new institution to force change and signal a commitment to change was compelling to all of us. It felt like a just cause and a war of necessity.

  Despite our trepidation about turf battles, we decided to try to strip the consumer functions out of the Fed and other regulators, housing everything in a new consumer financial protection agency. Banks certainly liked dealing with bank supervisors on consumer issues, but many consumer experts believed it was unrealistic to expect safety-and-soundness regulators that had to make sure banks were financially stable to be equally vigilant about making sure they weren’t taking advantage of customers. As Larry told the President, the airline safety board shouldn’t be in charge of protecting the financial viability of the airlines.

  The President liked the idea of a new independent agency to protect Americans from financial predations. And his political advisers were happy to take a stand that would please liberal activists, who had been remarkably unenthused about his unprecedented stimulus, his audacious commitment to comprehensive health care reform, and much of the rest of his early presidency. Rahm thought a new consumer agency would resonate with the rest of the public, too, building support for the larger bill and putting our opponents on the defensive. It was a lot easier to understand than inscrutable reforms such as “resolution authority” or “derivatives clearinghouses.”

  The big banks and much of the traditional business lobby decided to wage war on the new consumer protection agency. This was helpful for us, and quite dumb of them. A stronger regime of consumer oversight posed no serious risk to competent, ethical banks, and could even help them avoid losing business to less regulated competitors. But some of Washington’s most powerful trade groups chose to direct their opposition to our only reforms that enjoyed broad public support, invoking ridiculous fears that we were planning to regulate butchers and florists. Later in the process, Neal Wolin would show me a draft of a blistering speech he planned to give at the U.S. Chamber of Commerce, exposing holes in the chamber’s mendacious campaign against the agency. He asked if I was comfortable with it, and I said absolutely.

  “I could not give that speech, but you definitely should,” I told him.

  Many business and financial executives did not wait long after the President helped rescue the economy and their bottom lines to conclude that he was relentlessly hostile to their interests. Carole would sometimes read me quotes in the press from CEOs saying their banks would have been fine without government help, and remind me about their distress calls to our home during the crisis. I hosted regular dinners at Treasury with a changing mix of CEOs from across the country, many of whom genuinely seemed to believe I was an outlier in an implacably anti-business administration. I tried to remind them that the President had paid a huge political price for financial and economic interventions that had provided a huge boost for their businesses and their stock prices. After listening to one long complaint
about government meddling with the private sector, I told the story of Lyndon Johnson’s response to Charles de Gaulle’s demand that the United States remove our soldiers from France: Would you like us to remove the graves, too?

  “That was a good story, but they had no idea what you were talking about,” Neal told me after dinner.

  We knew financiers and other businessmen would fight Dodd-Frank, but at times I was more concerned about the damage caused by opposition from regulators. It wasn’t that I expected them to embrace all the President’s reforms. I had seen plenty of parochialism during the crisis. But I was surprised by the intensity of their self-serving lobbying, not just over consumer issues, but over almost everything. That summer, just as we released an eighty-eight-page white paper detailing our reform proposals and rolled out the bulk of our legislation, the various regulators were swarming the Hill. In late July 2009, I invited them to a meeting at the Treasury, and told them in unusually intemperate language that by going around us to Congress to advance their own interests at one another’s expense, they were undermining the prospects of passing a strong, coherent bill.

  “You’re having a lot of fun right now, fucking with us, trying to protect your own turf,” I said. “You’re going to screw up the chances for meaningful reform. And you should know that at some point at the end of this process, we’re going to be in the room and you’re not.” I wanted them to know that if they kept undermining the cause, we would be in a position to undermine them, although I guess “undermine” might not have been the exact word I used to convey that sentiment. Some of the objects of my affection in the room leaked the highlights of my remarks to the Wall Street Journal, which ran a story about my “expletive-laced critique,” headlined “Geithner Vents at Regulators as Overhaul Stumbles.”