Stress Test

  Many financial executives, facing a much more stable but somewhat less profitable future, see Dodd-Frank as a radical assault on capitalism, and they still resent the administration’s role in their postcrisis vilification. Many liberal activists, appalled by our financial rescues and the rapid recovery of the financial industry, have ignored the objective safety improvements to the banking system while continuing to portray us as defenders of big banking interests. Even the President’s steadfast support for a consumer protection bureau, a progressive victory for the ages, was overshadowed by controversy over who would lead it.

  THE LEFT wanted Elizabeth Warren.

  She was a thoughtful and passionate consumer advocate, and the bureau grew out of her idea. As soon as Dodd-Frank passed, labor leaders and liberal activists began circulating petitions and lobbying the administration, arguing that naming Warren to lead the new agency would prove we cared about protecting the public in the financial marketplace.

  I had a complicated relationship with Warren. Her criticisms of the financial rescue, if well intentioned, were mostly unjustified, and her TARP oversight hearings often felt more like made-for-YouTube inquisitions than serious inquiries. She was worried about the right things, but she was better at impugning our choices—as well as our integrity and our competence—than identifying any feasible alternatives. On the other hand, she really was smart and innovative about consumer protection, with sophisticated ideas about reform. She had a gift for explanation, which would be important as we created the agency and tried to help the public understand its mission. When we met for dinner in downtown Washington that summer shortly after Dodd-Frank passed, her proposals for redesigning consumer protection were thoughtful—and more market-oriented, incentive-based, and practical than her detractors realized.

  There was a lot to be said for making Warren the first CFPB director, but one consideration trumped all others: The Senate leadership told the White House there was no chance she could be confirmed. Republicans were vowing to block anyone we tried to appoint to run the bureau, to try to strangle it in its crib. We couldn’t afford divisions on our own side, and some moderate Democrats opposed Warren as well. They didn’t want to vote for a controversial liberal at a conservative moment. They were also worried about the intense opposition in the business community. Senate Democrats, even her supporters, were not confident she would get a majority, much less the necessary sixty votes.

  Mark Patterson and I thought about options, and after a few discussions with Rahm and Pete Rouse, I proposed that we make Warren the acting director, with responsibility for building the new bureau, while we continued to look for alternative candidates. This would give her a chance to be the public face of consumer protection, which she was exceptionally good at, and the ability to recruit a team of people to the new bureau right away, which she wouldn’t have been allowed to do if she had been in confirmation limbo. Over time, maybe her prospects for confirmation by the Senate would improve. Rouse had another idea: Maybe she could run for the Senate herself, taking on Scott Brown in Massachusetts.

  The temporary position seemed like a reasonable solution, but it took an enormous amount of time and energy to get there. We had endless discussions about whether to bring Warren in, whether to mount a futile confirmation battle that would leave no one in place to set up the agency, whether the President should give her a recess appointment, what kind of role and responsibilities she might accept. “We have a lot more pressing issues,” Rahm wrote in an email. “We are all spending a lot of time on one person.”

  The President was torn. Progressives were turning Warren into another whose-side-are-you-on litmus test. The head of the National Organization for Women publicly accused me of blocking Warren, calling me a classic Wall Street sexist. Valerie Jarrett, the President’s confidante from Chicago, was pushing hard for Warren, too, and she was worried I would stand in the way. At a meeting with Rahm and Valerie, I told the group that if the President wanted to appoint Warren to run the CFPB, I wouldn’t try to talk him out of it, but everyone in the room knew she had no chance of being confirmed. The President, who almost never called me at home, made an exception on this issue. It was really eating away at him. He had a huge amount of respect for Warren, but he didn’t want an endless confirmation fight, and he was hesitant to nominate someone so divisive that it would undermine the agency’s ability to get up and running, as well as its ability to build broader legitimacy beyond the left.

  Eventually, the option Patterson and I had floated prevailed. We would ask Warren to come in on an interim basis, reporting to me as well as the President. She was skeptical that I’d let her have a substantive role after our conflicts over TARP; I had to call and assure her I really wanted her involved. The President announced her appointment with huge fanfare at a Rose Garden ceremony. On her first day of work, I gave her a police hat to signify the new cop on the beat.

  We were initially amused, and eventually a bit annoyed, when Warren, who had spent so much time bemoaning Treasury’s nefarious work against the public interest, quickly began trying to hire away a bunch of our staffers. She was unapologetic when my team finally confronted her about it, and you had to respect her determination to get things done. We ended up having a productive working relationship, and she did an excellent job getting the bureau off the ground. And Rouse, in his deft and mysterious way, helped persuade her to run for Senate, which delighted the left while avoiding an unwinnable confirmation war.

  Instead, the President nominated former Ohio Attorney General Richard Cordray, another impressive lawyer with credibility on the left, to be the CFPB’s first director. When Senate Republicans blocked his nomination, the President gave him a recess appointment so he could start work right away, and he moved quickly to try to build support among moderate Republicans. He wouldn’t be officially confirmed until 2013, but he has helped make the CFPB a prominent new force in the American economy. The bureau has already secured more than $3 billion in relief for ten million wronged consumers. It has created disclosure requirements, standardized documents, and online tools that are helping Americans comparison shop for mortgages, credit cards, and financial aid for college. Rouse’s plan worked out well for Warren, too. She’s now a U.S. senator, still watchdogging the financial industry, still occasionally attacking the administration from the left.

  The U.S. financial crisis was over, and we had done what we could to prevent it from happening again. But we still had to deal with its aftermath—a European crisis, a deeply wounded Main Street economy, swollen fiscal deficits, and a political nightmare.

  ELEVEN

  Aftershocks

  In August 2010, two weeks after the President signed financial reform into law, I wrote a New York Times op-ed summing up our economic progress to date. The U.S. economy had been growing for a year, and adding jobs since March. Banks were much stronger, and our bank rescues were on track to make money for taxpayers. The slimmed-down auto industry was generating profits again.

  “We suffered a terrible blow,” I concluded, “but we are coming back.”

  I was careful not to strike a celebratory tone when so many families were still suffering: “We all understand and appreciate that these signs of strength in parts of the economy are cold comfort to those Americans still looking for work.” I noted that the share of workers who had been unemployed for at least six months was at a record high; that small businesses were struggling; that recoveries after financial crises are always slow and painful. “The process of repair means economic growth will come slower than we would like,” I wrote.

  No one would remember any of that. What people would remember was the snarky headline the New York Times editor chose for my column: “Welcome to the Recovery.” It made me look like I was declaring mission accomplished.

  In fact, private-sector job growth was faltering again, casting a shadow over what the White House had touted as a “Recovery Summer.” Economic analysts thought we might be stumbling toward a double-di
p recession. Political analysts knew we were stumbling toward a disastrous midterm election. House Minority Leader John Boehner, campaigning to become Speaker, called on Larry and me to resign, calling us the public faces of “the President’s job-killing agenda.”

  Some of the swoon resulted from a natural and necessary deleveraging after a credit boom and bust. Americans were reducing their debts rather than buying new stuff. Banks weren’t lending to marginal borrowers. Residential construction, the economy’s jet fuel for so long, was now sugar in its tank, dropping from two million new homes a year during the bubble to just half a million after it popped. The aftermath of a financial crisis is always brutal, and this was an exceptionally brutal crisis. Americans had emerged with less wealth, less disposable income, and less confidence about the future.

  But there were two additional anchors dragging down our recovery, and I would spend the rest of my time at Treasury dealing with their consequences.

  The first was fiscal austerity. The Recovery Act was still pumping hundreds of billions of dollars into the economy, but state and local governments were offsetting the federal stimulus with spending cuts and tax hikes that sucked cash out of the economy. We were at risk of repeating the mistake of 1937, when President Franklin D. Roosevelt hit the fiscal brakes before a recovery could sustain itself; despite the Recovery Act, the United States had shed more than three hundred thousand government jobs since President Obama took office. And the politics of stimulus had turned toxic. The $1.3 trillion federal deficit sounded gigantic and indefensible to Americans who were cutting their own spending to make ends meet. Republicans were clamoring for austerity, and many Democrats were unwilling to push back, wary of being tarred as big spenders. Congress had no appetite for additional stimulus.

  The second drag on our recovery was Europe, which was in financial and economic disarray. The eurozone was America’s largest trading partner, and our financial systems were also inextricably linked, so the European mess was a serious threat to us. Greece was in the midst of a devastating sovereign debt crisis. Ireland and Portugal were heading for similar trouble for different reasons. Markets were also running from Italy and Spain, the world’s seventh-largest and ninth-largest economies. The statistics were staggering. Spain had 20 percent unemployment; Ireland poured more than 20 percent of its GDP into rescues for its troubled banks; Greece’s national debt was approaching 150 percent of its GDP. Confidence was dwindling that these countries could avoid default, and that the entire eurozone—the monetary union launched just a decade earlier—could avoid collapse.

  We were feeling their pain. Europeans had less money to buy U.S. goods, which hurt our economy. As global fears of a European meltdown sent investment capital scurrying into safe Treasuries, the dollar got stronger and U.S. goods got more expensive, which further hurt our economy. And in the same way the fall of Lehman had pounded European banks, the renewed turmoil in Europe threatened the U.S. financial system; even the possibility of contagion was shaking confidence, tightening credit, and depressing growth in the United States.

  The fever for austerity and the mess in Europe were both sizable aftershocks from the financial crisis, and they would be the central economic dramas of the rest of President Obama’s first term. The dominant domestic narrative would revolve around a series of intense fiscal negotiations with Republican leaders, who would threaten to shut down the government and even force the Treasury to default on the nation’s debts if we didn’t agree to deep cuts in the safety net. The dominant international narrative would revolve around our efforts to prevent European leaders from reigniting the financial crisis and pushing the global economy back into the abyss.

  America’s stimulus-versus-austerity fiscal wars had been raging since President Obama took office, but the chaos in Europe took me by surprise. I couldn’t believe that Europe’s governments would set themselves on fire and risk another worldwide inferno so soon after we put out the flames of the initial crisis.

  I remember when I first got very worried, because I was in an unusual place.

  THERE’S NEVER been a G-7 meeting in a less likely location than Iqaluit, the tiny Canadian outpost just south of the Arctic Circle where we convened in early February 2010. Temperatures routinely dipped to 25 degrees below zero that time of year, so the central bankers and finance ministers in attendance dressed more casually than I had ever seen them. Japan’s finance minister wore a bright orange sweater over a turtleneck; Canada’s wore one of those snowflake sweaters your aunt gives you for Christmas; my ragged gray pullover was no less fashionable. There were opportunities for us to tour igloos, ride dogsleds, and eat seal blubber in Iqaluit, though I left those particular diversions to the others.

  Just before the opening dinner, I checked the market report on my BlackBerry. Europe was imploding. European bank stocks had plunged, mainly because Greece looked like it might be heading toward default. A newly formed Greek government had announced that its 2009 budget deficit had been three times as large as the previous government had claimed. Now the cost of insuring against a Greek default had soared 60 percent in just a month, approaching the levels faced by the largest U.S. banks in the weeks after Lehman fell.

  The sudden panic in Europe was shocking. And the discussion over dinner was not reassuring. The Europeans spent most of the meal complaining about Greek profligacy and mendacity. There were strident calls for austerity and Old Testament justice, determined vows to avoid moral hazard, confident assertions that the crisis could be contained to Greece. The outrage about Greece’s fiscal irresponsibility was justified, but we had just witnessed the dangers of big messy defaults, especially when other borrowers appeared to be in similar positions. If it began to look like the eurozone wouldn’t stand behind one of its members, investors would run from other weak countries. Countries on the “periphery”—Portugal, Ireland, Italy, and Spain, which along with Greece were being derided as “the PIIGS”—were already seeing higher borrowing costs, a troubling sign of contagion.

  I told the Europeans that if they were planning to keep their boots on Greece’s neck, they also needed to assure the markets they wouldn’t allow defaults by sovereign countries or the collapse of entire banking systems.

  “Just don’t overdo it,” I said. “If you don’t take out the risk of catastrophic failure, you have no chance of solving this.”

  They didn’t seem to agree. I had known several of them for more than a decade, and after hearing me advocate for so many financial rescues, they surely thought of me as the walking embodiment of moral hazard. Germany and France didn’t want lectures from the United States, anyway; they still blamed our Wild West financial system for the meltdown of 2008. They weren’t going to be swayed by suggestions from the reckless Americans that they should take it easy on the reckless Greeks. In reality, Europe had enjoyed a wild credit boom of its own, with much of the risky borrowing in the periphery funded by risky lending by banks in the German and French “core.” After the bust, the Fed’s swap lines for European banks and loans to U.S. operations of European banks had helped prevent the collapse of the European banking system, which had borrowed way too many dollars—no favor to us—in order to invest in U.S. mortgage assets during the boom.

  Now Europe was burning again, and it did not seem to have the tools or the desire to contain the fire. The eurozone was sixteen nations with sixteen fiscal policies and sixteen banking systems, all joined together under a common monetary policy. A default by one would affect them all, but they all had different priorities, and it wasn’t clear how the stronger and weaker nations could coordinate a response that could be approved by sixteen parliaments. When I wrote my first paper at Treasury on European economic integration twenty years earlier, I had noted that it was at heart a political project, designed to bind disparate nations together to avoid another world war. For all the flaws of the U.S. system, our fragmented regulatory agencies were at least part of the same nation, with a common language and traditions, and we routinely tran
sferred resources to economically weak regions through our national budget. The Germans felt no obligation to help the Greeks—and their politicians knew that excessive generosity could get them booted out of office.

  It was perhaps fitting that our military plane out of Iqaluit couldn’t get us home—not because of weather in the Arctic, but because of weather in Washington, which was in the throes of the historic “Snow-mageddon” blizzard. I once again had a terrible sense of foreboding, a feeling that the world was relapsing. This time, it wasn’t all on me; in fact, it was largely out of my hands. In some ways, that felt worse. Europe needed overwhelming force but didn’t seem willing to apply it.

  Two weeks later, the Europeans floated an absurdly stingy package of bilateral loans for Greece—at most 25 billion euros, which wouldn’t even cover its borrowing needs through the spring—combined with harsh demands for tax increases, spending cuts, wage freezes, and other austerity measures. The proposed conditions sparked strikes and riots in Athens. Some German politicians suggested Greece should auction the Acropolis to pay its bills, which did not calm the furor. Clearly, Greece needed to rein in a budget deficit that had exceeded 15 percent of its GDP in 2009. But imposing too much austerity too quickly would be counterproductive, further depressing its economy, shrinking its tax revenues, and actually increasing its deficit.

  By the spring, European leaders had made some concessions to reality, committing alongside the IMF to a rescue of 110 billion euros. That at least seemed like enough for Greece to meet its obligations for a couple of years. But they were still insisting on draconian budget cuts, and their harsh Old Testament rhetoric was roiling the markets, undermining the power of their aid. On April 25, our new undersecretary of the Treasury for international affairs, Lael Brainard, a former Clinton White House economist who had just been confirmed after a maddening yearlong wait, sent me a wire story headlined “Germany, France Signal Hard Line with Greece.” The German finance minister, Wolfgang Schäuble, had warned that severe fiscal austerity would be “unavoidable and an absolute prerequisite” for aid. His French counterpart, Christine Lagarde, warned that if Greece defaulted, “we will immediately put the foot on the brake.” Lael was particularly unhappy about the reference to default, the kind of talk that makes bondholders panic.