In 1995, Geithner’s career took another propitious turn when Robert Rubin became Treasury secretary. Rubin was lured away from the co-chairmanship of Goldman Sachs by way of the National Economic Council, and brought with him a style of management that flattened Treasury’s hierarchical culture, giving more of a voice to young staffers like Geithner. By the mid-1990s, policy makers were becoming aware of the esoteric dangers that derived from the burgeoning global economy. The Mexican currency crisis that struck just as Rubin was taking over was typical in that it was a distant and unanticipated event that nonetheless imperiled American interests. An overriding concern of Treasury became defending the long boom against foreign incursions. OASIA was the laboratory for figuring out how.
As with the U.S. crisis later on, Mexico’s trouble began with irresponsible borrowing, and spiraled when investors panicked. The reason this mattered to the United States government was the probable knock-on effects of a Mexican default—what was worriedly referred to in financial circles as the “tequila effect.” A default would frighten investors into abruptly pulling out of emerging markets around the world, wrecking their economies. Since developing countries bought about 40 percent of U.S. exports, the pain would register here in the form of massive job losses, economic contraction, and a sharp rise in illegal immigration. Geithner was part of the Treasury team that put together a response on the fly. The initial plan was to rally investors by providing Mexico $25 billion in loan guarantees (later upped to $40 billion). In a now-familiar pattern, Congress sent early signals of support, then refused to fund a “bailout.” So the Clinton administration, again foreshadowing what was to come, put together $40 billion in loan guarantees from the International Monetary Fund and Treasury. This improvisation worked: the crisis subsided, and Mexico repaid its loans early, at a small profit to the U.S. government.
Mexico was the first in a series of crises that would go on to sweep Asia, beginning in 1997 when Thailand devalued the baht. Thailand, too, had financed itself on unsustainable short-term borrowing, burned through its foreign reserves, and watched helplessly as investors fled. This time, concern about “moral hazard” kept the U.S. from stepping in, and an IMF intervention failed. Malaysia, Singapore, the Philippines, and Hong Kong all came under similar pressure, and then the crisis spread to larger economies, like Indonesia and South Korea, and eventually reached Brazil and Russia. Russia’s default on its bonds brought the hedge fund Long-Term Capital Management crashing down, briefly destabilizing the U.S. economy. Geithner became a sort of bureaucratic adrenaline junkie, racing between the front lines. By the end of the Clinton era, a basic method had emerged for responding to financial crises: quickly flood the market with money to restore confidence. Buy time to work out debts by not upsetting investors. Make stringent reform a condition of rescue—shut down weak banks, bust up oligarchies, and clean up corruption. Then withdraw.
Geithner and Summers emerged as Rubin’s most trusted aides. Summers was the senior figure, of course, but there was another difference between them, which was that Geithner was career staff. Although Treasury’s civil service works closely alongside its politically appointed leadership, the two groups exist on parallel planes and inhabit distinct social classes. It is almost unprecedented to cross from one to the other. Geithner made the leap. Rubin promoted him all the way up to assistant secretary for international affairs. Then, just before Summers succeeded Rubin in 1999, Geithner rose again, to the job Summers had occupied when they met, undersecretary for international affairs.
One of the great mysteries of the Clinton years is how a team so adept at bringing financial order around the world imagined that it would be a good idea to strip away so many of the rules governing banks and investment firms here at home, rules that dated back to the New Deal. How did Washington get it so wrong?
Much of the thinking about the current crisis goes like this: the problem proceeded directly from the deregulation of the financial industry in the 1980s and ’90s, which was orchestrated by a handful of free-market academics and conservative think tanks that conspired with Wall Street to seduce Washington into going along. That’s true, but it doesn’t tell the whole story. The intellectual history of the movement to deregulate finance features radicals along with conservatives, and the process began being implemented under Jimmy Carter, not Ronald Reagan. It wouldn’t have happened without Democrats.
Throughout most of American history, banking crises were frequent, debilitating occurrences that ranked as a first-order concern in national politics. Only when the New Deal reforms of the 1930s assigned the federal government an active role in managing risk did that change. There followed a long spell with no major upheavals, and banking receded as a popular concern. The impetus for doing away with regulations that gave every appearance of being remarkably effective came from two distinct realms of the academy that would appear, at a glance, to be extremely unlikely to find accord.
In the late 1960s, conservatives in the University of Chicago’s economics department, led by George Stigler, began arguing against New Deal regulatory agencies on the grounds that the businesses they were overseeing invariably dominated them, with the result that competition was inhibited. This idea was called “regulatory capture.” It became axiomatic among Chicago School types that if regulation couldn’t function as a disinterested public good, it should be abolished.
At roughly the same time, a group of New Left historians, many at the University of Wisconsin, rejected the prevailing liberal view that the Progressive era and New Deal reforms were a landmark achievement in the public interest. What the New Deal had really done, they decided, was sanctify an economic order that favored corporate interests. Their critique went by the name “corporate liberalism.” Where conservative neoclassical economists and Marxist historians converged was in their desire to “sever the corrupting ties between industry and government,” as Eduardo Canedo, an economic historian at Princeton University, puts it.
The corporate-liberal critique might never have made its way from Marxist historiography to Washington policy had it not resonated with someone who had an unparalleled ability to take ideas from outside the mainstream and force them to the center of public debate, someone who happened to be, right then, at the very apex of his influence: Ralph Nader. In the early 1970s, Nader’s attention was shifting from social regulations like automobile safety to economic regulations. He condemned what he called “corporate socialism,” but added a twist that horrified the Marxists. As a liberal who held no brief for unions, Nader began attacking government agencies for favoring the interests of business and labor over those of consumers. (Though he dropped his attacks on labor, he continued to advocate the abolition of a host of regulatory agencies, which he wanted to replace with a single superagency.) Jimmy Carter, who positioned himself a notch to the right of New Deal liberalism, also found appeal in undoing regulations. In 1978, working with the Democratic Congress, he deregulated the airline industry. Rail, trucking, and natural gas followed. It was Carter who struck the first big blow against banking rules, by signing the Depository Institutions Deregulation and Monetary Control Act of 1980, which loosened interest-rate limits and allowed more bank mergers, and he gave every sign that he would have kept going had he been able to.
Reagan’s victory ought to have hastened what Carter had begun—but it didn’t. Canedo, who studies the history of deregulation, has a persuasive theory about why: opposition from the Democratic Congress. “Reagan wanted to undo not just economic regulation,” he says, “but social regulation—environmental and workplace safety rules—and was so flagrant with some of his appointees, and the lack of enforcement, that he bred a backlash. It was too ideological.” Democrats recoiled. But liberal antipathy toward Reagan did not abolish the impulse to deregulate; it simply held it in check. “The intellectual orientation of the mainstream of the Democratic Party in the Reagan years was much closer to Wall Street than anyone admits today,” Canedo says. When Bill Clinton was elected, pent-up Democratic desire, gladly facilitated by the new Republican leadership in Congress in 1995, unleashed the wave of deregulation that culminated in 1999 with the repeal of the Glass-Steagall Act, the seminal New Deal banking reform.
The financial industry was anything but a bystander. Its size relative to other sectors of the economy exploded, increasing its Washington heft. The assets of securities brokers and dealers, for instance, which represented less than 2 percent of gross domestic product in 1980, grew to 22 percent in 2007. In the mid-1980s, the Democratic Party began soliciting from Wall Street in earnest, and contributions climbed steadily from then on. In the 2006 election cycle, Democrats got more money from financial interests than Republicans did—an amazing development given the party’s historic disposition toward Wall Street, and a significant factor in its takeover of Congress and the White House soon after.
Critics today focus overwhelmingly on this money as the driver of Democratic behavior, a tendency that conforms a bit too easily to stereotype—it isn’t wrong, but it assigns all the blame to a sleazy quid pro quo when a lot more was happening. One factor was that George Stigler’s idea about regulatory capture was widely accepted. Another was that the thrust of what emerged from the academy argued strongly for placing faith in financial markets. Government failure, not market failure, became the big source of concern. “Traditionally,” David Moss, a historian of risk management at Harvard Business School, told me, “the notion that risk could be left entirely to the private market to manage was often greeted with a certain amount of skepticism by lawmakers. The regulatory philosophy of the last three decades—that the government should step aside, almost completely—was really guided more by theory than by historical experience.”
Politicians don’t get much credit for being thoughtful, but they do respond to new ideas. Most of the new ideas said regulation was unnecessary. The Brookings Institution and the American Enterprise Institute, respectively the premier think tanks of the left and the right, were compatible enough in outlook to establish a Joint Center for Regulatory Studies in 1998. (It shut down in 2008, during the crisis.) Wall Street money alone didn’t convince Democrats they were on the virtuous path. The financial, intellectual, and political indicators were all pointing in the same direction: toward deregulation. This consensus narrowed the parameters of respectable debate to the point that criticizing Wall Street came to be considered unsophisticated.
A former Democratic Senate staffer explained the effect this way: “Before the 2008 crisis, [the Banking Committee] was seen as a place where you could go, serve a couple years, and end up going to lobby. Everyone thought that financial services was the perfect industry, where you had a harmonization of progressive values with money. It was a way to be a good Democrat and a good liberal while making lots of money. The mark-to-market accounting changes, the loosening of bank capital requirements, harmonizing international standards—all that stuff was seen as, like, ‘Where’s the harm in this?’ If banks are making a little more money to keep up with their international competitors, what’s the big deal?”
Geithner arrived at the New York Federal Reserve Bank in 2003, after a stint at the International Monetary Fund, which means he arrived at the epicenter of finance just as Wall Street was roaring into its unbridled latter-stage boom. He was an unusual hire. The New York Fed embodies everything connoted by the phrase “clubby Wall Street institution.” It is the most powerful of the 12 regional banks composing the Federal Reserve system, intended to function as the Fed’s outpost on Wall Street. But its shares are owned by the same financial institutions it oversees. Its president is chosen by (and reports to) a board of directors typically drawn from top executives of these firms.
The presidency of the New York Fed is a job insiders give to one of their own. Geithner wasn’t a Wall Street insider. But he knew somebody who was, and that somebody had the ear of Pete Peterson, the New York Fed’s chairman of the board, who was searching for a new president. “Pete asked me if I had any thoughts,” Rubin told me, “and I said, ‘Yeah, I have a heck of an idea: Tim Geithner.’” Peterson arranged a meeting and came away impressed, although he confided to Rubin, “He looks very young.”
Geithner won over his new constituents with characteristic diligence, arranging a series of personal meetings with CEOs. Once he’d settled in, Geithner chose to focus on derivatives, delivering over the next few years a series of prescient speeches about their risks. This class of abstruse, largely unregulated financial instruments, including credit-default swaps, grew enormously in the run-up to the crisis; panic over whether institutions like AIG and Lehman Brothers would honor their derivatives contracts helped trigger the collapse. As early as 2004, Geithner was warning of “fat tails,” a term that suggests that catastrophic events at the far end of a bell curve are more likely to occur than statistical models imply. I told him that it sounded as though he had been predicting the crisis. He nodded. “I felt like my entire time in New York,” he said, “there was a fear that this was going to end badly.”
Others, too, were alarmed at the growth of derivatives trading, most notably Brooksley Born, the head of the Commodity Futures Trading Commission during Clinton’s second term. In 1998, Born’s determination to issue a paper warning of the dangers of derivatives had precipitated a small Washington scandal when Alan Greenspan and senior Treasury officials, strenuously opposed to regulating derivatives, tried to talk her out of it. Summers is reputed to have called Born to say: “I have 13 bankers in my office and they say if you go forward with this, you will cause the worst financial crisis since World War II.” She issued the paper, and nothing happened. Last year, Born received a Profile in Courage Award from the John F. Kennedy Library Foundation.
Geithner took a different approach. As derivatives trading took off, the technical infrastructure underlying it remained worryingly primitive. Banks still confirmed deals by fax. Buried in the backlog of paperwork, trades took weeks to clear. As long as everything went well, this was mostly a matter of housekeeping. But were crisis to strike, the unsettled trades could cause chaos and freeze the market, to potentially devastating effect. Geithner spent two years building consensus among the banks to update the system, which they finally did. When Lehman failed, its hundreds of billions in derivatives contracts were settled within 72 hours, sparing untold amounts of anxiety and money (a panic would have driven down the market even further). Geithner’s actions were shrewd, but also disconcerting, since they addressed the problem only insofar as met the banks’ self-interest. He took no drastic steps to warn the public.
Why didn’t he? “I don’t believe in the Chicken Little stuff,” he conceded when I asked him. “It wasn’t my place, and I tried to focus on changing the things that I could affect.”