by Obama Barack
Tim’s particular problem had to do with taxes: During the three years he’d spent working for the International Monetary Fund, it turned out, neither he nor his accountants had noticed that the organization did not withhold its U.S. employees’ payroll taxes. It was an innocent and apparently common mistake, and when an audit surfaced the problem in 2006, a full two years before he was even considered for the Treasury job, Tim amended his returns and paid what the audit said he owed. Yet given the political climate—and the fact that as Treasury secretary, Tim would be overseeing the IRS—the reaction to his error was unforgiving. Republicans suggested that he had purposely committed tax fraud. Late-night comics made jokes at his expense. Tim grew despondent, telling Axe and Rahm that perhaps I should nominate someone else, which led me to call him late one night to buck him up and insist that he was “my guy.”
Although he was confirmed a few days later, Tim was aware that it was by the smallest margin of any Treasury nominee in U.S. history, and that his credibility both at home and internationally had been damaged. I wasn’t as worried about all that; nobody remembered confirmation votes, and I was certain his credibility would quickly rebound. But the confirmation drama reminded me that Tim was still a civilian, a lifelong technocrat who had always operated behind the scenes. It would take him some time—just as it had taken me—to get accustomed to the glare of the spotlight.
The day after Tim’s confirmation, he and Larry came to the Oval Office to brief me on the grim state of the financial system. Credit remained frozen. The markets were precarious. Five massive institutions—“five big bombs,” Tim called them—were in particular peril: Fannie Mae and Freddie Mac, which had become virtually the only sources of housing finance and were burning through the $200 billion in taxpayer funds Treasury had injected into them the previous year; the insurance giant AIG, which had massive exposure as a result of insuring mortgage-based derivatives and had required $150 billion in TARP over the previous four months just to stay afloat; and two banks, Citigroup and Bank of America, which together constituted about 14 percent of America’s bank deposits and had seen their stock drop 82 percent over the previous four months.
A renewed run on any one of these five financial institutions could tip it into insolvency, which in turn could trigger a global financial earthquake even bigger than the one we’d just weathered. And despite the hundreds of billions the government had already devoted to their rescue, there was no way that the remaining $300 billion in TARP funds could cover the current pace of losses. A Federal Reserve analysis predicted that, unless the entire system stabilized soon, the banks might need an additional $300 to $700 billion in government cash infusion—and those numbers didn’t include AIG, which would later announce a $62 billion quarterly loss.
Rather than pouring more taxpayer dollars into a leaky bucket, we had to find a way to patch its holes. First and foremost, we needed to restore some semblance of market confidence so that investors who’d fled to safety, pulling trillions of dollars in private capital out of the financial sector, would return from the sidelines and reinvest. When it came to Fannie and Freddie, Tim explained, we had the authority to put more money into them without congressional approval, in part because they’d already been placed in government conservatorship. Right away, we agreed to a new $200 billion capital commitment. This wasn’t a comfortable choice, but the alternative was to let the entire U.S. mortgage market effectively vanish.
As for the rest of the financial system, the choices were dicier. A few days later, in another Oval Office meeting, Tim and Larry outlined three basic options. The first, most prominently advocated by FDIC chair and Bush holdover Sheila Bair, involved a reprise of Hank Paulson’s original idea for TARP, which was to have the government set up a single “bad bank” that would buy up all the privately held toxic assets, thereby cleansing the banking sector. This would allow investors to feel some form of trust and banks to start lending again.
Not surprisingly, the markets liked this approach, since it effectively dumped future losses in the lap of taxpayers. The problem with the “bad bank” idea, though, as both Tim and Larry pointed out, was that no one knew how to fairly price all the toxic assets currently on the banks’ books. If the government paid too much, it would amount to yet another massive taxpayer bailout with few strings attached. If, on the other hand, the government paid too little—and with an estimated $1 trillion in toxic assets still out there, fire-sale prices would be all the government could afford—the banks would have to swallow massive losses right away and would almost certainly go belly-up anyway. In fact, it was precisely because of these pricing complications that Hank Paulson had abandoned the idea back at the start of the crisis.
We had a second possibility, one that on the surface seemed cleaner: to temporarily nationalize those systemically significant financial institutions that—based on the current market price of their assets and liabilities—were insolvent and then force them to go through a restructuring similar to a bankruptcy proceeding, including making shareholders and bondholders take “haircuts” on their holdings and potentially replacing both management and boards. This option fulfilled my desire to “tear the Band-Aid off” and fix the system once and for all, rather than letting the banks limp along in what was sometimes referred to as a “zombie” state—technically still in existence but without enough capital or credibility to function. It also had the benefit of satisfying what Tim liked to refer to as “Old Testament justice”—the public’s understandable desire to see those who’d done wrong punished and shamed.
As usual, though, what looked like the simplest solution wasn’t so simple. Once the government nationalized one bank, stakeholders at every other bank would almost certainly dump their holdings as fast as they could, fearing that their institution would be next. Such runs would likely trigger the need to nationalize the next-weakest bank, and the one after that, and the one after that, in what would become a cascading government takeover of America’s financial sector.
Not only would that cost a whole lot of money; it also would require the U.S. government to manage these institutions for as long as it took to eventually sell them off. And while we were busy contending with a million inevitable lawsuits (filed not just by Wall Street types but also by pension funds and small investors angry over the forced “haircut”), the question would be who would we put in charge of these banks—especially given that almost everyone with the requisite experience was likely to be tainted by some involvement with subprime lending? Who would set their salaries and bonuses? How would the public feel if these nationalized banks just kept bleeding money? And to whom could the government ultimately sell these banks, other than to other banks that might have been similarly complicit in creating the mess in the first place?
In part because there were no good answers to these questions, Tim had cooked up a third option. His theory was this: Although nobody doubted that banks were in bad shape and had a whole bunch of bad assets on their books, the market panic had so deeply depressed all asset prices that their condition might look worse than it really was. After all, the overwhelming majority of mortgages wouldn’t end up in default. Not every mortgage-backed security was worthless, and not every bank was awash in bad bets. And yet as long as the market had trouble discerning genuine insolvency from temporary illiquidity, most investors would simply avoid anything related to the financial sector.
Tim’s proposed solution would come to be known as a “stress test.” The Federal Reserve would set a benchmark for how much capital each of the nineteen systemically significant banks needed to survive a worst-case scenario. The Fed would then dispatch regulators to pore over each bank’s books, rigorously assessing whether or not it had enough of a financial cushion to make it through a depression; if not, the bank would be given six months to raise that amount of capital from private sources. If it still fell short, the government would then step in to provide enough capital to meet t
he benchmark, with nationalization coming into play only if the government’s infusion exceeded 50 percent. Either way, the markets would finally have a clear picture of each bank’s condition. Shareholders would see their shares in a bank diluted, but only in proportion to the amount of capital needed for the bank to get well. And taxpayers would be on the hook only as a last resort.
Tim presented this third option more as a framework than a detailed plan, and Larry voiced some skepticism, believing that the banks were irredeemable, that the markets would never believe in the rigors of a government-managed audit, and that the exercise would do little more than delay the inevitable. Tim acknowledged those risks. He added that any stress test would require about three months to complete, during which time the public pressure for us to take more decisive action would only build; in the meantime any number of events could send the markets into an even sharper tailspin.
Larry and Tim stopped talking and waited for my reaction. I sat back in my chair.
“Anything else on the menu?” I asked.
“Not right now, Mr. President.”
“Not very appetizing.”
“No, Mr. President.”
I nodded, pondered the probabilities, and after a few more questions decided that Tim’s stress-test approach was our best way forward. Not because it was great—not even because it was good—but because the other approaches were worse. Larry compared it to having a doctor administer a less invasive treatment before opting for radical surgery. If the stress test worked, we could fix the system faster and with less taxpayer money. If it didn’t, we’d probably be no worse off and would at least have a better sense of what more radical surgery would entail.
Assuming, of course, that the patient didn’t die in the meantime.
* * *
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A COUPLE OF weeks later, on February 10, Tim addressed the public for the first time as Treasury secretary, speaking in a grand hall inside the Treasury Building called the Cash Room, which for more than a century following the Civil War had operated as a bank, dispensing currency directly from government vaults. The idea was that Tim would unveil the framework for the stress test and outline other measures we were taking to stabilize the floundering banks, sending a signal that despite the uncertainty of the times, we were calm and had a credible plan.
Confidence, of course, is hard to convey if you don’t fully feel it. Still bruised by the confirmation hearings, having spent his first few weeks on the job working with only a skeleton staff, and still sorting out the details of how the stress test would work, Tim stepped before a bank of TV cameras and financial journalists that day and promptly tanked.
By every estimation, including his own, the speech was a disaster. He looked nervous, was awkwardly using a teleprompter for the first time, and spoke in only vague terms about the overall plan. The White House communications team had been pressing him to emphasize our intent to get tough on the banks, even as our economic team emphasized the need to reassure the financial markets that there was no need for panic. Meanwhile, the alphabet soup of independent agencies responsible for regulating the financial system had not coalesced around Tim’s proposal, and several agency heads, like Sheila Bair, kept pushing their own pet ideas. The result was a classic speech by committee, full of hedged bets and mixed messages, reflecting all the contradictory pressures. And in the rush to get it finished, Tim—who was running on fumes at this point—had devoted almost no time to practicing his delivery.
As he was speaking, the stock market dropped by more than 3 percent. By day’s end, it was down almost 5 percent, with financial stocks falling a full 11 percent. Tim’s speech was all over the news, being parsed every which way. As Larry had predicted, many analysts viewed the stress test as nothing more than an elaborate whitewash, a new string of bailouts. Commentators across the political spectrum were now openly wondering whether Tim’s tenure, my presidency, and the global financial system were headed for the dumpster.
As much as Tim blamed himself during the next morning’s postmortem, I recognized it as a systems failure—and a failure on my part to put those who worked under me in a position to succeed. A day earlier, speaking at a press conference of my own, I’d unthinkingly and unfairly put a good deal of advance hype on Tim’s speech, telling reporters that he’d be announcing “clear and specific plans” and was set to have “his moment in the sun.”
The lessons all around were painful but useful. In the months that followed, I’d drive our team to run a tighter process, with better communications between relevant parts of the administration; to anticipate problems and resolve disputes before we took any plans public, allowing our ideas appropriate time and space to germinate regardless of external pressure; to pay careful attention to how big projects were staffed; and to sweat the details not just of substance but of stagecraft as well.
And one more thing: I told myself not to ever open my big mouth again to set up expectations that, given the circumstances, could not possibly be met.
Still, the damage was done. The world’s first impression of my hardworking, all-star economic team was that of a gang that couldn’t shoot straight. Republicans crowed. Rahm fielded calls from nervous Democrats. About the only positive thing I could draw from the fiasco was Tim’s reaction to it. His spirit could have been crushed, but it wasn’t. Instead, he had the resigned air of someone who would take his punishment for the poor speech performance but at the same time was confident that on the bigger stuff, he was right.
I liked that in him. He was still my guy. The best we could do now was hunker down, execute, and hope that our damn plan actually worked.
* * *
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“MADAM SPEAKER…the President of the United States!”
For reasons that still aren’t entirely clear to me, a newly elected president’s first speech before a joint session of Congress isn’t technically considered a State of the Union address. But for all intents and purposes, that’s exactly what it is—the first of that annual ritual in which a president has the chance to speak directly to tens of millions of fellow Americans.
My own first address was scheduled for February 24, which meant that even as we were scrambling to get our economic rescue plan in place, I had to steal whatever scraps of time I could to review the drafts Favs worked up. It wasn’t an easy assignment for either of us. Other speeches could traffic in broad themes or focus narrowly on a single issue. In the SOTU, as West Wing staffers called it, the president was expected to outline both domestic and foreign policy priorities for the coming year. And no matter how much you dressed up your plans and proposals with anecdotes or catchy phrases, detailed explanations of Medicare expansion or tax credit refundability rarely stirred the heartstrings.
Having been a senator, I was well versed in the politics of standing ovations at the SOTU: the ritualized spectacle in which members of the president’s party leapt to their feet and cheered to the rafters at practically every third line, while the opposition party refused to applaud even the most heartwarming story for fear that the cameras might catch them consorting with the enemy. (The sole exception to this rule was any mention of troops overseas.) Not only did this absurd bit of theater highlight the country’s divisions at a time when we needed unity; the constant interruptions added at least fifteen minutes to an already long speech. I had considered beginning my address by asking all those in attendance to hold their applause, but unsurprisingly, Gibbs and the comms team had nixed the idea, insisting that a silent chamber would not play well on TV.
But if the process ahead of the SOTU left us feeling harried and uninspired—if at various points I told Favs that after an election night speech, an inauguration speech, and nearly two years of nonstop talking I had absolutely nothing new to say and would be doing the country a favor by emulating Thomas Jefferson and just dropping off my remarks to Congress for the people to read at their leisure—it all
vanished the instant I arrived at the threshold of the ornate House chamber and heard the sergeant at arms announce my entrance onto the floor.
“Madam Speaker…” Perhaps more than any others, those words and the scene that followed made me conscious of the grandeur of the office I now occupied. There was the thundering applause as I stepped into the chamber; the slow walk down the center aisle through outstretched hands; the members of my cabinet arrayed along the first and second rows; the Joint Chiefs in their crisp uniforms and the Supreme Court justices in their black robes, like members of an ancient guild; the greetings from Speaker Pelosi and Vice President Biden, positioned on either side of me; and my wife beaming down from the upper gallery in her sleeveless dress (that was when the cult of Michelle’s arms truly took off), waving and blowing a kiss as the Speaker lowered her gavel and the proceedings commenced.