Stress Test

  “I know we’re about 75 percent of what’s going on in the markets,” Trichet said. “But you’re making it worse.”

  EUROPE HAD spent most of 2011 flailing. Portugal got emergency help from the rescue fund to avoid default. Spain and Italy kept deteriorating. And Greece was a wreck. Austerity was further eroding its economy, so it was having trouble meeting its fiscal targets, sparking calls for deeper austerity. Its credit default swaps implied a three-in-four chance of default within five years. Increasing expectations of haircuts continued to drag down markets, as did rumors that Greece could leave the monetary union entirely, the so-called Grexit option.

  On July 21, the same day Boehner announced the end of our grand-bargain talks, the eurozone restructured its aid to Greece, doubling the size of the loan but including conditions that implied a 20 percent haircut for some bondholders. Europe announced some new flexibility for the rescue fund, and Trichet expanded the ECB’s bond-buying program to help prop up Spain and Italy. But Europe was not persuading investors that it had a credible strategy to fix its broken economies or contain the risk of a run on its weaker governments and banks.

  Europe needed a larger and more credible firewall. With Greece’s needs expanding, an internal Treasury report concluded that the 500 billion euro rescue fund would need to be doubled or possibly tripled to provide an effective backstop for the rest of the eurozone. But Chancellor Merkel, facing an anti-bailout backlash at home, was insisting that Germany’s checkbook was closed. She did not like the way recipients of European assistance—Spain and Italy as well as Greece—were backsliding on promises of reform, and she didn’t think giving them more of Germany’s hard-earned money would improve their behavior. I saw her point—I sometimes told the Germans that I was more German than they realized—but the lines she was drawing in the sand were limiting Europe’s options.

  Our preferred solution was for Europe to expand the firepower of its rescue fund by using it to leverage the ECB’s balance sheet. The central bank could provide much more aggressive financing, with the government fund protecting it against potential losses. We had done something similar with the Term Asset-Backed Securities Lending Facility during our crisis, jump-starting U.S. consumer credit markets by using a little government money to leverage a lot of Fed financing. The central bankers for Canada and Switzerland, Mark Carney and Philipp Hildebrand, pitched the idea of a TALF for Europe, but the German government and especially its central bank, the Bundesbank, still didn’t like the idea. At one point, the Europeans began reaching out to Asian governments for financing they could use to augment their rescue fund, a pretty amazing spectacle. Unsurprisingly, Japan and China weren’t eager to write checks to save the European project that the Europeans weren’t willing to write themselves. The request just made them look more desperate.

  That September, the Europeans invited me to speak at an Ecofin meeting of European financial ministers and central bank governors in Poland. It was a scary time in Europe. Spreads on Italian bonds were blowing up, and even France’s credit default swaps had more than doubled in three months. I knew it would be sensitive and unorthodox for an American Treasury secretary to attend a European strategy session, so I checked with some of my European counterparts to make sure they really wanted me there, and that my presence wouldn’t be counterproductive. They said I should definitely come.

  In Poland, I gave a carefully phrased, polite set of remarks about crisis doctrine—speaking with the knowledge of our mistakes, as an American who bore the scars of our own crisis. “This is your crisis,” I said. “You have to decide how to fix it.” I acknowledged that the United States had our own formidable challenges. “You’ve watched us struggle with them,” I said. “Our politics are terrible, maybe worse than in many parts of Europe. We’re not in a particularly strong position to provide advice to all of you, so I come with humility.”

  Still, I was emphatic about some things Europe needed to do, starting with strengthening its firewall. Europe’s most important responsibility, I said, was to take catastrophic risk—of cascading sovereign defaults, bank runs, and the breakup of the eurozone—off the table.

  “Nothing is possible unless you do that,” I said. “The firewall you build has to be perceived as larger than the scale of the problem. You can’t succeed by shrinking the problem to fit your current level of financial commitments.”

  I told them they needed to put money behind their banking system as well as struggling governments, not one or the other. And I said the crisis had to be solved by governments as well as the European Central Bank, working together. We would support more financing from the IMF, but not as a substitute for a more substantial European commitment. I also repeated my warnings against overdoing it with reforms designed to punish the profligate, along with my usual push for the healthier countries to promote growth. My main message, familiar to those who knew me, was that the crisis wouldn’t end until Europe demonstrated the will to end it.

  “It’s more dangerous to escalate gradually and incrementally than with massive preemptive force,” I said. “If you can show you’re willing to do what needs to be done, you’re more likely to have the private markets bear the burden of the financing, and you’ll reduce the risk that taxpayers take on too much.”

  I thought that was basic and obvious advice, but a few European officials complained to the press that I had read them the riot act, asking who I thought I was to harangue them to spend more on bailouts and stimulus. They had invited me to share my views, but those views were clearly unwelcome to many in Europe. Austria’s finance minister said it was “peculiar” that I would try to tell Europeans what to do after our own credit downgrade; Belgium’s finance minister suggested I should listen rather than talk. The New York Times ran a front-page story about declining U.S. influence on global finance, with the requisite photo of me looking grim. The headline was “Advice on Debt? Europe Suggests U.S. Can Keep It.” In fact, the Europeans were continuing their pattern of publicly castigating any American proposal, before eventually adopting a renamed and often mangled version of it.

  We were less concerned about Europe’s resentment of our influence than we were about Europe’s unwillingness to leverage its rescue fund, protect its creditors, and fix its economies. “Momentum faltering again,” Lael wrote me in early October. “ECB has put down a hard line on leverage. Continued squabbling about Greece [haircuts]. No leadership.” On October 26, European leaders announced another revision to their deal for restructuring the Greek debt, this time with 50 percent haircuts. They did announce a modest plan to try to leverage the rescue fund using private money, but it was poorly designed and more than anything else seemed to signal the limits on what Europe was willing to do. It certainly didn’t calm the markets; bond spreads throughout the periphery continued to deteriorate.

  The President talked to European leaders regularly that fall, and Lael and I were in constant touch with our European counterparts. Some of them seemed to resent our intrusions at the same time they were inviting them. They often asked us to intervene to pressure Chancellor Merkel to be less stingy, or the Italians and the Spanish to be more responsible. At one point that fall, a few European officials approached us with a scheme to try to force Italian Prime Minister Silvio Berlusconi out of power; they wanted us to refuse to support IMF loans to Italy until he was gone. We told the President about this surprising invitation, but as helpful as it would have been to have better leadership in Europe, we couldn’t get involved in a scheme like that.

  “We can’t have his blood on our hands,” I said.

  The President spent much of a G-20 meeting in early November in Cannes hosting backroom negotiating sessions, trying to help save Europe from itself. Most of the meeting was about pressure on Berlusconi, but we kept coming back to the need for a stronger firewall, and there was plenty of pressure on Merkel as well. Merkel felt isolated and under attack; I have never seen her so upset. At one point, the President and I stood quietly on a terrace
overlooking the Mediterranean.

  “You know, this would be really interesting if it wasn’t so consequential,” he said.

  In Cannes, we didn’t make much headway on the European firewall or reform on the periphery. But I did have some promising talks about the use of overwhelming force with Mario Draghi, who had just replaced Trichet as the head of the ECB. Draghi was an Italian who had run his country’s central bank and served in its finance ministry, yet he was appointed with the support of the Germans, so he was in a rare position to help bridge the gaps in Europe. And just after Cannes, Greek Prime Minister George Papandreou resigned to make way for a unity government; a week later, Berlusconi was replaced by Mario Monti, an economist who exuded technocratic competence; a week after that, Spain elected an impressive new prime minister, Mariano Rajoy, who had campaigned for fiscal reform. All these changes seemed promising, in part because they helped break down Germany’s resistance to more aggressive measures to attack the crisis.

  In early December, Draghi announced a massive blast of long-term financing for the European banking system, a more expansive version of the TAF lending facility the Fed had launched to address U.S. liquidity shortages back in December 2007. Basically, the ECB agreed to lend banks unlimited amounts of money for three years against a broad range of collateral. This had an instant stabilizing effect. The ECB provided about 1 trillion euros in financing to its banks over the next several months; more important, Europe had shown some force and some will.

  By February 2012, when the G-20 finance ministers and central bankers met in Mexico City, the mood was more upbeat than I had seen it in a while. The Europeans were relieved, with many declaring that the crisis was over.

  I didn’t think so. This felt more like a lull than a resolution.

  THE UNITED States was in a lull, too, economically and politically.

  Growth was steady but unimpressive. Unemployment had declined to 8.3 percent, better than double digits but still way too high. The Fed and other forecasters kept predicting that the recovery was about to take off, but Europe, our fiscal drag, and our other economic headwinds kept holding it back.

  Inside the administration, we had countless meetings to discuss ways to boost jobs and growth. But with Republicans now in charge of the House—and focusing mainly on symbolic votes repealing Obamacare, financial reform, and other Obama achievements—there weren’t many realistic legislative options. It felt a bit like we were hockey goalies, just blocking bad stuff, all defense, no offense, with limited mobility. With Republicans pinning their hopes on a new president in 2013, it wasn’t clear how we could pass good stuff.

  Still, we figured we might as well say what we were for. We thought there was an outside chance that public pressure could move Republicans into supporting policies that might help strengthen growth. Even if it didn’t, Plouffe, Pfeiffer, and the rest of the White House political team were eager to contrast our agenda with the Republican agenda. We began in the fall of 2011 with the American Jobs Act, a $447 billion stimulus bill the President proposed at a joint session of Congress. It was full of measures that were popular as long as they weren’t described as “stimulus”—a massive public works program, a massive school modernization program, aid to states to protect jobs of teachers and first responders, a “Returning Heroes” tax credit for firms that hire unemployed veterans, and so on. The President barnstormed the country campaigning for his jobs plan, but aside from extending the payroll tax cuts and unemployment benefits from the lame-duck deal, Republicans were unmoved, and most of the plan died in Congress.

  In early 2012, we proposed “the Buffett Rule,” a set of measures to ensure that high earners would pay an effective tax rate of at least 30 percent, inspired by Warren Buffett’s observation that he paid a lower tax rate than his secretary. Larry let me know he thought this was a gimmicky appeal to populism and soak-the-rich class warfare. He also thought it was bad politics, letting Republicans portray the President as an anti-success tax hiker. I thought the Buffett Rule was perfectly sensible, especially as an illustration of the need for broader tax reforms. It had the modest aim of limiting the extent to which better-off Americans could take advantage of tax breaks and lower rates on capital gains and dividends to lower their tax burden. The Republicans opposed it, of course, but many Democrats were uneasy, too, and it went nowhere.

  That February, after months of internal debate, we proposed a framework for growth-oriented corporate tax reform that would lower overall rates for businesses while eliminating some of the pork that riddled the tax code. Many of the President’s political advisers argued that it would split the Democratic Party over another plan with no hope of passing, but I thought we had to keep proposing reforms that were good for the economy, even if the likelihood of Republican support was low. To limit the political blowback, we put out a framework rather than comprehensive legislation. But parts of the Democratic base were still furious; the next time Richard Trumka, the head of the AFL-CIO, was in my office, he looked like he wanted to take a bat to my head. Once again, we had angered the left, without getting Republicans to play.

  The election-year gridlock was frustrating, but in some ways oddly freeing. That February, when I testified about our budget before Paul Ryan’s committee—my sixteenth and final budget hearing—I decided not to sit back and be a prop for the usual theater and abuse.

  “We know defending this budget is no easy task, so we really do appreciate your time,” Ryan quipped in his welcoming remarks.

  “Not as hard as your job on your budget,” I shot back.

  Ryan laughed. “It’s going to be a fun day,” he said.

  I laughed, too. “You have my sympathy,” I said.

  The hearing went on like that. I told Tim Huelskamp, a Tea Party Republican from Kansas, that his grand theory of White House failure reflected “an adolescent perspective on how to think about the impact of economic policy.” When another Tea Party Republican, Jason Chaffetz of Utah, tried to get me to blame the Senate for partisan gridlock in Washington, I told him he was using his time poorly, since I wasn’t part of the Senate. He complained that I was smirking.

  I usually loathed Capitol Hill theater, but I did enjoy that last Budget Committee hearing with the fundamentalists. When Ryan tried to wrap up, I asked if we could keep going. Afterward, Ryan told me I had riled up the Tea Party types on his committee. “You just get under their skin,” he said. That weekend, my communications director, Jenni LeCompte, told me someone had tweeted that I was the “Honey Badger of the Obama administration.” I had no idea what that meant, so she sent me a viral YouTube video of “the Crazy Nastyass Honey Badger” devouring snakes and diving into beehives, as a narrator explained that the honey badger doesn’t give a shit what other animals think. A Treasury secretary is supposed to exist above the political fray; I took my honey-badger moment as another indication that I had stayed in Washington too long.

  In 2012, though, almost everything was political; when I was asked about silly Republican economic critiques, I said they were silly. That April, I got asked about a flawed claim by Mitt Romney, the Republican presidential nominee, that women were losing a disproportionate amount of jobs under President Obama. In fact, the economy had regained four million of the private-sector jobs lost in the Great Recession. The public sector was still losing jobs, and women were bearing the brunt of the layoffs of teachers and other government workers, but Republicans were blocking our efforts to reverse those cuts. “It’s a ridiculous way to look at the problem,” I said on ABC’s This Week. “To borrow a line from Mario Cuomo, you’re going to see a lot of politicians campaign in fiction. But we have to govern in fact.”

  I let myself get dragged into the fray again when CNBC asked me about an op-ed by Romney’s economic adviser, Glenn Hubbard, who had claimed that the President’s plan implied an 11 percent tax hike on families earning less than $200,000 a year. In fact, the plan included no tax hikes on those families, but Hubbard argued that since the President wa
sn’t cutting entitlements enough—an ironic argument, since Romney was attacking the President for cutting Medicare—he would eventually have to raise taxes on everyone. “That’s a completely made-up, remarkably hackish observation for an economist,” I said. This caused some consternation on the right; Senator Tom Coburn of Oklahoma called me the most partisan Treasury secretary in history, which was amusing for me, a registered independent, especially given how many Democrats had called for my head.

  Interestingly, a month earlier, at a dinner where I was speaking to the Economic Club of New York, Hubbard had complained to me about our unwillingness to endorse the Simpson-Bowles plan.

  “Really, Glenn?” I asked. “There’s a two-trillion-dollar tax increase in there. When you guys are willing to raise taxes, we can talk about Simpson-Bowles.”

  “Well, of course we have to raise taxes,” Hubbard told me. “We just can’t say that now.”

  BY JUNE 2012, the European crisis was burning hotter than ever.

  Austerity measures were prompting riots and strikes on the periphery while depressing growth across the continent. Spain, with its jobless rate approaching 25 percent, needed a 100 billion euro credit line for its bank rescues. The debt-to-GDP ratios of Italy, Portugal, and Ireland all topped 110 percent, while Greece’s neared 150 percent even after it haircut its bonds. Bank deposits were fleeing those countries as well, and their governments were too deep in debt to do anything about it.

  Europe had failed to persuade the world that it would not allow a catastrophe. Its firewall still looked flimsy. Its politics were still a mess. Every time its leaders announced new measures to try to control the crisis, they undercut their message with bad execution, strict conditions, and moral hazard rhetoric emphasizing their limited ability and desire to rescue their neighbors. Its loan packages were often more stigmatizing than stabilizing. And the markets still thought there was a meaningful possibility of a cascade of defaults by countries or banks, or a devastating breakup of the eurozone.