Review of “Stress Test: Reflections on Financial Crises” by Timothy F. Geithner

Note:  This review is by my husband Jim.

Stress Test Is Timothy Geithner’s Apologia for his handling of the financial crisis of 2008 as well as his four years as Barak Obama’s Secretary of the Treasury and his previous three years as President of the Federal Reserve Bank of New York.  The financial crisis weathered in those years was the worst since 1929 and created the most severe general economic recession since the Great Depression of the 1930’s.  

Geithner’s background had been working in the U.S. Treasury Department to rescue foreign countries like Mexico and Thailand from default on sovereign debt when their governments found themselves in financial crises.  That experience was to serve him well once he assumed significant responsibility with the Federal Reserve and later as Secretary of the Treasury. 

The financial crisis of 2008 was brought about by the issuing of hundreds of thousands of very risky sub-prime mortgages.  Residential real estate prices had been increasing at an unsustainable rate for about a decade.  Banks made mortgage loans (often to borrowers with no realistic hope of repaying them) based on what they thought prices would be after more increases.  Lenders rarely kept such mortgages to term, preferring to sell them shortly after entering into them, after siphoning off a profitable “commission.”  Thus the initial lenders made a profit, and were not concerned about what happened down the line.  Risk analysis was minimal because the original lenders had no intention of waiting years to be repaid.  The process has been called a “Wall Street securitization Ponzi scheme” for good reason.

After being resold, the mortgages were then “sliced and diced” into tranches (portions of pooled assets) and then combined or repackaged by investment banks into exotic derivatives known as collateralized debt obligations (CDOs).  Those CDOs were thought by the rating agencies to be investment grade because they spread the risk of default over many different mortgages.  The amount of trading in such securities reached an astonishing $530 trillion (that’s right, trillions) of dollars before the underlying mortgages began to default en masse.  The banks, especially the investment banks, were thinly capitalized.  Significantly, their capital was largely in short term borrowings that could flee with the merest hint or rumor of insolvency, while their assets were primarily in longer term instruments like home mortgages or the complicated securities derived from or backed by such mortgages.     

The financial crisis became acute when Bear Stearns, a major global investment bank, found itself illiquid in 2008 and ready to default on many billions of dollars of obligations.  Geithner, as head of the New York Fed, feared that such a default could spread throughout the entire global financial system and start a panic of major proportions.  Unfortunately, the Fed did not have sufficient statutory powers to compel an influx of capital that could have saved the firm.  Instead, at the clever suggestion of one of Geithner’s staffers, and after much arm twisting, the moribund firm was sold to J.P. Morgan Chase.  Much criticism followed in the financial press because saving improvidently run firms was thought to create “moral hazard,” i.e., an incentive for other firms to engage in risky behavior knowing that the government would intervene to save them if they misguessed the market.  

 

But the securities and derivatives that were the cause of Bear’s woes only became less valuable as the underlying sub-prime mortgages that were to fund them began to default.  Real estate prices crashed as many foreclosed properties came on to the market.  The next big financial institution to face insolvency was Lehman Brothers, an even bigger investment bank than Bear Stearns.  Geithner writes that he and his staff strove mightily to save Lehman, but they could not find a willing or able buyer and had no other statutory weapons to effect a rescue.  Lehman filed for bankruptcy, and roiled the financial markets for months thereafter. 

Things went from bad to worse after the Lehman bankruptcy.  An additional five huge companies [American International Group (AIG), Bank of American (BoA), Citigroup, Fannie Mae, and Freddie Mac] with truly enormous financial exposure were on the verge of failing.  Geithner contended that he learned in foreign financial crises that it was important to provide rescue funds in large amounts quickly, before panic spread and investors insisted on being repaid short term capital.  Fiscal responsibility could follow later, after the crisis had abated.  Like St. Augustine and chastity, he wanted the government ultimately to exercise financial prudence, but not yet!

Geithner then recounts the ways in which he, along with his BFFs Ben (Bernanke), Larry (Summers), and Hank (Paulson), basically saved the world in 2008 from Armageddon.  The first thing they had to do was get statutory authority to infuse money into the troubled firms.  They lobbied hard for, and ultimately received such authority with the Troubled Assed Relief Program (“TARP”), which authorized the Treasury either to purchase so-called “toxic” assets or to invest directly in the capital of troubled firms.  Geithner is adamant that the financial crisis was not the time to worry about “Old Testament style” punitive measures for those who caused and/or benefitted from the situation leading to the financial meltdown.   He and the others were firemen!  This was a raging inferno!  It would have been irresponsible, he says, to devote time and attention to wringing concessions from banks, such as reductions in insurance payments for credit defaults, executive compensation, golden parachutes, or severance packages that enabled many individual culprits who caused the crisis to get rich while their institutions failed or had to be rescued by governmental intervention.  

Henry Paulson, Ben Bernanke, and Timothy Geithner. Illustration by Mark Ulriksen for New Yorker Magazine

Geithner’s ultimate “solution” to the financial crisis (and the eponym for the book) was the stress test.  This is was an audit of the major commercial and investment banks to measure the effects a hypothetical crisis would have on banks’ regulatory capital.  The test found most of the institutions to be solvent AND liquid, and the financial crisis passed with the influx of private money.  (Some sources, however, such as this Bloomberg analyst, contend that the test wasn’t credible.) 

Geithner retired from Treasury in 2012, shortly after Obama was reelected.  His contributions to the welfare of the country may have been substantial, but he has been severely criticized for allowing most of the malfeasors to escape punishment and even to prosper.   Specifically in the case of AIG’s payment of huge bonuses to its executives shortly after receiving the multi-billion infusion of TARP funds, Geithner argues he had no authority to prevent the payment of the bonuses, which the firms had contracted to pay before receiving governmental assistance. 

 

Geithner also makes a point of attacking what he considered to be the posturing and abject stupidity exhibited by various congressmen, particularly Republicans who claimed that their priority was in obstructing Obama rather than dealing with the crisis. He is especially vitriolic in describing the foolishness of the Republicans’ threat to cause the U.S. government to default on its obligations as a bargaining position against the implementation of ObamaCare.   

Discussion:  This is an interesting, important, and provocative book.  Geithner has a nice, even self-deprecating sense of humor, although his humility doesn’t extend to his vision of himself as Superman rescuing Gotham City.  He is nonplussed by the fact that critics on the left see him as the embodiment of a Wall Street toady, while critics on the right (and much of Wall Street) see him as a communist or socialist. (He takes advantage of this contradiction to imply neither side could possibly be correct.)

While he tries very hard to claim he and Paulson, Bernanke, and Summers were not in the pocket of Wall Street and big business, he refrains from delineating all the close ties among them and the top banks and investment firms.  Indeed, protecting the market has always been a top priority for the dons of American finance.  As MIT Professor Simon Johnson wrote in 2009:

… Over the past decade, the attitude took hold that what was good for Wall Street was good for the country.”

And in fact, Geithner now serves as president of Warburg Pincus, a Wall Street private equity firm.  (You can read more about the revolving door between Wall Street and the government here.)

Geithner’s focus, rather, was on the aggressive measures that were (very probably) necessary to save the large firms. He does not emphasize the cupidity, imprudence, and stupidity that put those firms at risk. Nor does he dwell on the irony that all of the firms that required huge influxes of taxpayer money were particularly expert in avoiding taxes themselves, largely through the use of off-shore tax havens. And finally, he at no time considers the profound injustice of extending rescue measures to those with huge assets, while the majority of “average” Americans struggled with the repercussions of their actions.

Evaluation: Whether or not you are happy with Geithner’s omissions and assertions, the fact that he has been such an influential player in America’s politics and economics for the past decade is justification enough to learn about what he was thinking.

Rating:  4/5

A Few Notes on the Audio Production:

We listened to an audio recording of the book, read by the author.  Geithner has some quirks in his speech patterns — he rushes some syllables together in an unusual manner.  And he admits that he is not a good public speaker.  He might have been better off to have a professional actor read the book, but his own sincerity comes through his delivery. 

Published unabridged on 15 CDs (18.5 listening hours) by Random House Audio, 2014