A Jedi mind trick and money -- lots of money
It's hard to remember now, but there was a time when some people thought Tim Geithner wouldn't be long for the Treasury.
It was March 2009, and the world still looked like it was about to end. There had been TARP. There had been an alphabet soup of Fed lending programs. And there was President Obama's big fiscal stimulus that was just about to kick in. But despite all of that money rushing into the banks and the economy (but mostly the banks), the banks and the economy kept collapsing (but especially the banks). It was a vicious circle, with the credit crunch hurting the real economy, which hurt the value of bank assets, which made banks pull back lending even more, which, well, you get the point. Enter Tim Geithner. Coming from the Treasury and New York Fed, he had a sterling resume ... but made an underwhelming debut as Secretary, coming across as timorous and vague when he tried to explain his plan to avert a second Great Depression.
Four years later, Geithner can say mission accomplished. His tenure has hardly been without fault, from not enough action on housing to fear of invisible bond vigilantes, but he got the biggest thing right -- ending the banking panic. Or rather, he helped Ben Bernanke do so. As you can see in the chart below of the KBW bank stock index, it took the Fed and Treasury throwing all of their combined money and credibility at the banks to restore some degree of normalcy to financial markets. That was no easy task back when Citigroup was a penny stock.
There's a standard story about how we saved the banks, and it goes something like this. Although he never came up with a credible plan to further recapitalize the banks, Geithner did come up with a credible plan to restore their credibility -- the stress tests -- and that was enough to get the financial system off life support. This is all true, but it's only half the story. It ignores that we did further recapitalize the banks. Well, at least Ben Bernanke did.
-- Geithner lays out his plan, markets boo. It was supposed to be a two-pronged plan. First, the Treasury would inspect the books of the big banks to figure out how much extra capital they needed, and, second, they would launch the Private Public Investment Program (PPIP) to raise that extra capital. This is where things got derailed. PPIP was supposed to give private investors a subsidy to buy up the banks' toxic assets, because private investors would presumably be able to value them better -- but Treasury couldn't get investors to go along without a subsidy so big the public would view it as a handout. Geithner had hoped it would raise over $1 trillion of capital (and not from a coin), but it only scaled up to about $40 billion. Markets were none too pleased with this ambiguous first draft of a plan, and bank stocks paid the price.
-- The Fed signals it will start buying up consumer debt. There was a simple, unresolvable problem when it came to buying up toxic assets. Paying face value would have been a giveaway to the banks, but paying market value would have bankrupted the banks. That left the banks stuffed with toxic assets -- and that pushed their stock prices perilously close to zero. And then things turned around on March 6. Jon Hilsenrath of the Wall Street Journal, who's something of an unofficial spokesperson for the Fed, reported that the central bank was going to start buying up consumer debt, in addition to the mortgage bonds it was already buying. In other words, the Fed would buy up some of the banks' questionable assets the Treasury would not. Bank stocks bottomed out, and two weeks later, the Fed officially announced it would buy $1.25 trillion more mortgage-backed securities.
-- The Treasury looks under the hood of the banks' balance sheets. The banks were looking better, but markets weren't sure how much better. Yes, the Fed was buying bonds, and yes that bond-buying, together with the stimulus, meant more growth, which meant fewer defaults ... but it was far from clear that would be enough to save the banks. That's where the stress tests came in. The idea was the Treasury would look at the banks' balance sheets, and model how their assets would supposedly hold up under economic scenariors of varying doom. Now, there was more than a bit of kabuki to this -- valuing these assets is always something of a guessing game, as Frank Partnoy and Jesse Eisinger argue -- but it was kabuki that worked. Bank stocks melted up when the stress test results first got leaked, and then were subsequently released. The Treasury's stamp of approval was all the markets needed to hear to trust the world as we knew it wasn't going away. Crisis over.
Counterfactuals are always tricky, but it's best not to judge Geithner on what happened the past four years, but rather on what didn't happen. There wasn't a repeat of the Great Depression, with the financial system dragging the rest of the economy down into oblivion with it. As Noam Scheiber of The New Republic argued in late 2009, Geithner's stress tests didn't get enough credit at the time for ending the panic -- and without costing the government money! -- but neither did Bernanke's actions to stabilize the banks and markets. It could have been better -- much better -- but it could have been far, far worse, too. And that's his greatest legacy: Two and a half years after he first said so, Geithner can still welcome us to the recovery.
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