by Ron Suskind
“If you’re the policymaker, you need to show overwhelming evidence that a market is not functioning, in a profound and disastrous way, to merit an intervention. The default is to go back to the first principle, of market efficiency, and to let matters mostly continue as they’ve been.”
As presidents often note in their memoirs, every major decision that arrives at the Oval Office is difficult, filled with imponderables and inconsistencies. Otherwise, it wouldn’t hit their desk. But not since Franklin Roosevelt has a president had to face the twin crises, inextricably linked, of the economy’s collapse and the rescue of the U.S. financial system.
Despite Obama’s clear expression of his will about the primacy of health care reform, most of his senior advisers were in agreement with Orrin Hatch—and not only about someone such as Tim Geithner showing up at the Health Care Summit. Their underlying doubts were about Geithner’s boss, the president, and whether he should be conducting such a summit now at all. The fear, growing inside the uppermost reaches of the White House through late February, was not just that this was the wrong ordering of priorities, but that it might ensure that none of the three great battles could possibly be done well, a concern that seemed to be quietly stoked by this long day of performances to launch the health care campaign.
Krueger, like most other senior officials, was happy to get back to what he considered more pressing business. At 5:00 p.m., in the midst of Citigroup’s woes, the NEC wrestled with “too big to fail.” Taken together, the assets of the largest six banks, which included Citi, were now a stunning 60 percent of the country’s overall GDP, significantly more concentration than before the great panic. The issue of systemic risk, of how these still-fragile institutions were linked to one another, was all but impossible to fathom. And no one doubted that if the economy were imperiled by the failure of one of the largest banks, the government would be hard-pressed not to step up for a rescue.
Which is precisely why Tim Geithner came late to the meeting: more trouble at Citi. He was in crisis-management mode. He had to excuse himself early: another call to Bernanke.
Meanwhile, Austan Goolsbee, who was trying to revive some of the spirit of reform that was abandoned after the campaign, pushed a proposal about a tax on bank size: that the big banks start getting taxed on assets above a certain threshold. If the so-called externality—econ-speak for the side effect of a company practice—“is size,” Goolsbee said, “then you tax it, and it shrinks away.”
Members of the legislative affairs team, sitting in, were enthusiastic. Congress, they noted, was looking to forcefully engage with the issue of preventing more bailouts and the threats of systemic risk. This proposal also raised revenue, which meant it was doubly saleable!
Summers listened to Goolsbee—no threat in his diminished role—elegantly sketch out the sort of market intervention he tended to oppose, as did Geithner. But Geithner was gone. Romer and Krueger were with Goolsbee, discussing the mechanics of various taxing techniques. The key with any such intervention was to structure it soundly and tightly, so it did what it was intended to—never an easy task. Of course, the political folks, the legislative team and Rahm, would view intended outcomes through a shorter lens: something that could be pushed through Congress and look like sound policy. Most important, there was the president—not in attendance for this meeting, but still arguing gamely through the end of February for bold action of some kind, still pressing his case that would have America acting more like Sweden than like Japan.
Based on their long history together, and general agreement on principle, everyone in the room felt that Summers—even as he kept his cards close—was in Geithner’s camp.
Geithner, though, was quietly beginning to worry by early March that it might be otherwise. What he saw gathering through February was what his deputy, Lee Sachs—a former Treasury official under Clinton who’d worked at Bear Stearns and then ran a hedge fund—later called an “unholy alliance between the hedge funds and the academics, who were all now calling for tough measures on the banking system.” Sachs, who’d been brought in during the transition to head “crisis management” of the financial meltdown, had created models to show how government intervention would drive down the already low price of the toxic assets. The fact that the toxic assets were difficult to value didn’t mean that, if pressured to, the market wouldn’t come up with a price. In a market with few buyers, it would be a low price, making the “hole” the federal government was looking at even deeper. Several reliable estimates of the amount of toxic assets across the banking system put the figure above $2 trillion. “We realized early on that a two-trillion-dollar hole was more than we could fill with the $350 billion left in TARP,” said Sachs. “We were going to need to draw in private money with incentives and guarantees that we knew would make us look like we were in the pockets of the banks.”
While Romer was talking to the academics, Summers was on the phone to the hedge funds, many of which had built up significant short positions on bank stocks. Any federal intervention into banking would drive down bank stocks. The shorts would clean up. Though Summers would surely know this, the more worrisome issue was the case the hedgers were making about how the government could force the kind of efficiency and shakeout that Summers felt the banking industry needed. In other words, the banking industry—like everyone else—should get what it deserves.
A few days after the Health Care Summit, Summers made his move at a briefing with the president. His “first, do no harm” test had been satisfied, he said. He joined Romer in support of the president’s belief that a major federal intervention into the banking system was now needed.
Geithner pushed back.
“The confidence in the system is so fragile still,” he said. “The trust is gone. One poor earnings report, a disclosure of a fraud, or a loss of faith in the dealings between one large bank and another—a withdrawal of funds or refusal to clear trades—and it could result in a run, just like Lehman.”
Geithner tamped down frustration. Romer, Summers, and even the president couldn’t understand what he and Bernanke had lived through—the nights of sleepless panic, terrified phone calls from once-unflappable bankers, secretaries standing in the street holding boxes with paperweights and framed photos. He thought it was unwise for the government to pick a troubled bank and dissolve it, a precedent that would create fear and undermine confidence, rather than promote it.
The president, however, seemed undeterred. In fact, he was enlivened: Summers was now on his side. It wasn’t consensus, but it was close. “I think it’s time to step up and show what government can do,” Obama remarked. “I want to deal with these toxic assets across the entire banking system. Let’s do it now, let’s do it right.”
In certain ways, Obama was reaching for what senior advisers had begun to call that “rare combination” where the president decided that a sound policy was also politically advantageous. When the two came together, Obama acted. His words of anger at Wall Street had not been followed with actions. But now a tough-love approach to the banks—much like what Volcker had talked about with Obama in the months after the Cooper Union speech—could show his words backed up with action.
There were general discussions about how much it might cost: another $500 billion, maybe more. “We’ll find the money, somewhere,” Obama said. “When you have a crisis, you find the money.” Obama mentioned what everyone already knew: that in February they had put a placeholder of an additional $750 billion in the proposed budget for further government interventions into the broken financial system. The Congressional Budget Office had already “scored” the cost of any such allocation at $250 billion (under a calculus that $500 billion of that money would eventually be returned) though no one was anticipating that this just-in-case budgetary “placeholder” was slated to be filled.
No one, now, except Obama.
Geithner, meanwhile, said that many of the president’s desires for action could find a home, at much lower costs, in his �
�stress tests,” the planning for which were well underway. Geithner’s team at Treasury had been working on the structure of the stress tests, in conjunction with Bernanke, since before Geithner mentioned them in his nightmare early-February press conference. They would empower government to assess the health of the large banks over the next few months, almost the way a rating agency would, and then tell the banks how much more capital they needed to continue as going concerns. The government could then decide whether to give a bank a cash infusion or to take it down, with a ratings system that the markets would consider credible. The question on the table was complex. Should they wait for the results of the stress tests—which Summers and Romer doubted would be credible—and then decide whether, or how, to take down a few banks that were troubled and unable to raise capital? Or should they move more preemptively, taking several large troubled institutions through “resolution”—a term that implied a controlled bankruptcy and brief government takeover—sooner rather than later? Either way, the president was interested in thinking creatively about how to take down some of the nation’s largest banks.
Obama listened. “Okay, we should work this out,” he said. “Why don’t people pull together their proposals.”
Geithner left the meeting incensed. Larry had no idea what he was doing or whom he was up against. A meeting was set for Sunday, March 15, in the Roosevelt Room. That meant the teams from Treasury and the White House would have just a week to pull together their presentations. Staffers in the two buildings immediately started calling it The Showdown.
On the afternoon of March 9, Sheila Bair girded herself for the next conference call. It was almost one a day—she would be the only woman on the phone with an army of men, many of them with close ties to Wall Street or an unshakeable belief in the miracle of the markets, the freer the better.
And she would be the scourge.
Tension between Bair and the men managing the town’s other regulatory warships was rapidly looking like a redux of the battles Brooksley Born fought in the late 1990s with the fraternity of like-minded regulators allied with Wall Street over derivatives regulation.
If there was one difference, it was that Born had been alone. Now there was a small but powerful contingent of the sisterhood, and a gender battle, long simmering just beneath the surface of cordial relations among regulatory colleagues, was finally starting to draw notice. With Born, now a Washington lawyer, as their inspirational hero, a team of women—led by Bair; Mary Schapiro, chairwoman of the SEC; Elizabeth Warren, heading the TARP Oversight Panel; and the irrepressible Maria Cantwell—was asserting its primacy. They had virtually all been right, and right early, about the way America’s financial system was drifting toward crisis. All of them had been shooed away or shouted down by the men, both those manning Wall Street and those atop Washington’s regulatory or economic policy posts, who quietly asserted that high finance might be the final mountaintop stronghold of “man’s work.”
While 58 percent of college undergraduates are now women, and many of the most prized professions and skill-based industries are approaching gender equality, virtually all the top posts on Wall Street and at the largest national banks have long been held by men. Though most of the men won’t say it, they feel that the nexus of math and risk—and the gaming of both, without flinching—is an area of male inclination. In fact, many of the women agree. They say that’s part of the problem.
Few could, at this point, challenge the idea that the country’s male-dominated financial industries had powerfully self-destructive impulses. But Geithner was just the latest in a succession of regulatory men, many with a past (or a bright future) in managing money and risk, who felt the town’s few female regulators often didn’t understand them or the way Wall Street’s male Mecca really worked—knowledge that is crucial to being an effective regulator who can alter ruinous behavior.
The women’s response, of course, was that they understood the men better than the men understood themselves.
History’s judgments, of late, seemed to be bending toward the ladies.
Bair, for one, was not bashful about pointing out precisely where she’d been right, across nearly three decades. A Kansas Republican who spent most of the ’80s working both in campaign and senior staff roles for that state’s avatar, Senator Bob Dole, Bair was named one of three commissioners of the CFTC in 1991 by the first President Bush. In the deregulatory environment of that period, Bair—who was once a bank teller in Kansas and waxes nostalgic about kids’ opening passbook savings accounts and the pride people felt in meeting their obligations with each month’s mortgage payment—took her first turn as skunk at the garden party. She was especially skeptical of a fast-growing Houston-based firm called Enron, a diversified energy company that was pressing the CFTC to exempt what the firm called its “sophisticated” futures contracts from antifraud provisions, a move that would have shielded Enron’s burgeoning exchange-trading business from CFTC oversight. Bair, voted down 2 to 1, offered a scathing dissent: “If we are to rationalize exemptions from antifraud and other components of our regulatory scheme on the basis of the ‘sophistication’ of market users, we might as well close our doors tomorrow.”
When, in 2001, Enron’s trading business was exploding into a historic fraud—a harbinger of the derivatives disasters to come—Bair had little time to gloat. At that point, as assistant Treasury secretary for financial institutions, under Bush, she was intensely interested in the growth of “nontraditional lenders,” free-floating finance companies, funded by Wall Street speculators, that were offering loans with low “teaser” rates and hidden fees. What struck Bair was that these subprime lenders generally had responsibility for the loans for only ninety days—three months of payments—before the traditional fiduciary bond between lender and borrower dissolved and the loan was “securitized” and sold off to other investors. Bair sensed trouble along many links of this chain, but found that the defaults by borrowers who were encouraged to take out larger mortgages than they could afford were lower than she expected. That’s because they were constantly refinancing, at ever lower rates, and often using the proceeds for general purchasing. Her concerns that this couldn’t last, and would end badly, were drowned out in the naysaying of Alan Greenspan, his cheap-money policies, and the rising real estate values that were fueling wider consumption.
It wasn’t until 2006, though, when Bush unexpectedly selected her to run the FDIC, an independent agency whose director serves a five-year term, that Bair found the freedom to be . . . just Bair. Having spotted early troubles in both the derivatives and subprime markets—and then launching flares that were ignored—she could now be an independent actor. And act she did. She analyzed all the subprime data the FDIC could buy and closed one of the most egregious subprime lenders, the California-based Freemont Investment and Loan, in March 2007. Seeing a wave of defaults on the way, especially as tens of billions in “teaser-rate” loans readjusted upward, she pressed the banking industry to restructure the mortgages, which would make more of them sustainable, even as it shrank the banks’ profit margins from the often onerous rates. The banks said they would, but didn’t. She unloaded on them at a mortgage industry conference in October 2007: “Moody’s recently reported that less than one per cent—less than one per cent—of subprime mortgages that are having problems were being restructured in any meaningful way,” she implored them. “We have a huge problem on our hands . . . I think some categorical approaches are needed, and needed urgently.”
The fact that no one budged and disaster soon reigned only increased her ire, especially at Citigroup and Bank of America, the industry leaders, which she felt exhibited anything but industry leadership, especially when they should have known better—after all, she herself had warned them of what was ahead.
But by the fall of 2008 she found herself rushing into a place where regulators rightly fear to tread: cutting deals to buy and sell banks, especially in a volatile market where share prices could drop from respectab
le to abysmal on an errant rumor. The specific case that snagged her was the sale of the failed Wachovia to Citigroup, a transaction, requiring government assistance, that she and Geithner provisionally approved in late September. But when Wells Fargo arrived with a richer offer in November, and one not needing federal assistance, she opted for Wells. Citi’s stock summarily plummeted, along with its overall capitalization, pushing it into the arms of regulators and summoning the fierce disdain of a vast community of Citi officials, past and present, from Bob Rubin on down. Bair demurred that she couldn’t stop the Wells deal—it was better for Wachovia, an appropriately arm’s-length transaction that didn’t need help from the government. But former Clinton-era regulators with net worth in Citi stock, many of them now cycling back into the Obama administration, were incensed.
Bair, they cried, just didn’t get it—didn’t understand how the world, resting on projections of confidence, really worked. All she could talk about was tier-one capital, and how things used to be in the sleepy 1970s. In fact, Sheila Bair, who’d been around long enough to have used Paul Volcker as her role model, had little respect for the “we’re all in this together” bond built across three decades between Washington and Wall Street, a relationship of shared interests in which Citi, like Goldman, was a central actor. Her positions on key issues such as shrinking banks to make sure they weren’t “too big to fail” and curbing Wall Street’s excesses were generally aligned with Volcker’s, and her criticisms of Vikram Pandit and Citi’s current management were specific and pointed. She thought both should be replaced, and said so publicly.
Geithner’s response to a deputy at Treasury: “She keeps up that kind of talk, we’ll have a run on Citi—then, I suppose, she’d finally be happy.”
