[This article was published in the Winter 2014 issue of The Journal of Social,

Political and Economic Studies, pp. 494-521.]

BOOK REVIEW ARTICLE

A Preeminent Book on the Financial Crisis: Timothy F. Geithners Memoir
as Secretary of the Treasury
Dwight D. Murphey
Wichita State University, retired
Stress Test: Reflections on Financial Crises
Timothy F. Geithner
Crown Publishers, 2014
Timothy F. Geithner served as the United States
Secretary of the Treasury during Barack Obamas first term as
president. Before that, Geithner was president of the Federal
Reserve Bank of New York, the leading bank in the Federal
Reserve system. Together with Henry Paulson, Jr., who
preceding him in the Treasury position, and Ben Bernanke,
chairman of the Federal Reserve, Geithner was at the heart of
the U.S. governments response to the financial crisis that
began in 2007 and picked up steam in 2008. That makes his
memoir Stress Test one of the preeminent books on the crisis.
The article here will examine that book and the many issues it
raises, foremost among which are Geithners conviction that
governments and central banks must consider their policies
controlled by the threat of financial panic and that, accordingly,
few strings should be attached to any bailout. His views are
compared with those of several other authorities.
Key Words: Timothy F. Geithner, the Great Recession, bank
bailout policy, financial panic, Populism, bank stress tests,
U.S. policy toward the main economy, economic stimulus,
mortgage modification, alternatives to bailouts, financial
reforms, Sheila Bair, Neil Barofsky, financial crisis authors.
The role played by Timothy Geithner as Treasury Secretary during
President Barack Obamas first term was central to the U. S. governments
response to the financial crisis. Before that, he had for eight years been the
president of the Federal Reserve Bank of New York. All this gives Stress Test, a
memoir of those years, an automatically preeminent place among the books about

the Great Recession. A vast literature has developed about the crisis, written by
the principal actors such as Geithner, some of secondary rank who occupied only
a slightly less exalted place, and numerous academic and financial commentators.1
Geithner stepped down as Treasury Secretary in January 2013. It was
from 2003 through 2008 i.e., until his elevation to the Treasury position that
he was president of the New York Federal Reserve Bank. That bank is considered
first among equals among those in the Federal Reserve, and has major
responsibilities that include carrying out monetary policy, regulating the financial
system, and handling the United States payment systems. This means that
Geithner had already been a key figure in U.S. economic policy for several years
before his service in the Obama administration.
A surprising thing about Geithner is that, contrary to a widely-held
assumption, he was never an investment banker. He didnt come into the jobs
weve mentioned from Goldman Sachs or any other Wall Street firm. In fact, it
isnt altogether apparent from his book just what qualifications he had for the
monetary-system positions he held, although he was superbly qualified for work
in international trade. His upbringing and education gave him a wide knowledge
of the world. Geithners fathers work for the U.S. Agency for International
Development (USAID) involved taking his young son to Rhodesia, Zambia and
India. Although the boy returned to the United States after the sixth grade, he
wound up attending high school at the American School in Bangkok. Its worth
noting that the same leadership qualities that must have led to his being entrusted
with his later positions were soon evident to his peers, as was reflected in his
serving as president of both his junior and senior classes. He majored in
government and Asian studies at Dartmouth, and included some study at Beijing
University during those undergraduate years. Its doubtful whether anyone was
ever better prepared than he was to obtain a Masters in East Asian Studies and
international economics at Johns Hopkins.
Before we examine what Stress Test tells us about his role in the financial
crisis, it will be valuable to know where Geithner is coming from on politics
and ideology. He says Ive always been pretty much pragmatic, suspicious of
ideology in any form, which tells us more than it seems to: it doesnt really mean
that he didnt have an ideology, but rather that he unconsciously received by
osmosis the prevailing ideology common to educated people among his
contemporaries. His mother, he says, was a bleeding heart liberal, his father a
conservative Republican who nevertheless in the 1980s directed the Ford
1 Several of these books have been reviewed in these pages. They have included

those by central figures such as Alan Greenspan (The Age of Turbulence) and
Henry Paulson (On the Brink). Greenspan was chairman of the U.S. Federal
Reserve until January 2006, shortly before the crisis, and Paulson was Treasury
secretary under President George W. Bush. We await, of course, the eventual
memoirs of Ben Bernanke, who took Greenspans place at the head of the Federal
Reserve and served through the first year of President Obamas second term. The
many reviews published in this Journal may be found on the Internet at
www.dwightmurphey-collectedwritings.info.

Foundations microfinance programs in Indonesia in which Obamas mother was

a moving force, and voted for Obama in 2008. At Dartmouth, Geithner felt a
strong aversion to the outspoken conservative student movement on campus;
and later in life he found the ceremony inspirational in which President Obama
signed the repeal of dont ask, dont tell, a repeal that opened the U.S. military
to service by openly-avowed homosexuals. He wasnt a socialist and didnt want
(or effect) a nationalization of the banks, and says Obama wasnt, either. In fact,
he saw Obama as a moderate, market-oriented Democrat. Although I didnt
have a purists faith in the genius of the free market, he favored global free trade
and opposed protectionism. He says he has been a straight-ticket Democratic
voter since the Clinton years. He saw Obama as my kind of candidate liberal
on social issues, moderate on economic issues, pragmatic above all.
A part of his thinking that is especially pertinent to his actions at the
Federal Reserve and Treasury has been his heartfelt opposition to populism.2
Geithner believed it vital to bail out the big banks, and to do so with few strings
attached. This perception necessarily caused him to adopt policies that were
thoroughly supportive of the too big to fail banks, and led a number of
commentators to see him as a tool of Wall Street. Whether the criticism is
justified depends on who was right as between him and his critics. We will
review the pros and cons of that argument in the course of this article.
It was in the context of this debate that he vehemently characterized his
critics as populists. There is, of course, an implication that comes from his
labelling them with that word, since it suggests they were on the side of the public
at large and that he himself championed an elite. If this were simply an ill-chosen
semantic, it would be unfortunate from his own point of view because it detracts
from the possible merit of his economic stance. It would seem, however, to go
beyond semantics. It reveals a personal alignment in which he identifies with the
large financial institutions and those who head them, while he looks with disdain
on those outside of that community who see themselves as championing the
main economy. This suggests there is more than a little truth to the criticism that
his perception of the crisis was at least in part caused by his personal affinities.
There are, moreover, wider implications. Because it was President Obama
who caused Geithner to be one of the people at the pinnacle of economic policy
during the financial crisis, and who kept him there for his full first term, the
conclusion is unavoidable that the attitude was not just Geithners, but also the
Presidents.3 This is to be seen in a broad political, social and economic context.
What we have in mind is the widespread complaint among leading commentators
on both the Right and the Left that each of the major American political parties,
the federal government, big money, and the people who go back and forth
2 His anti-populist rhetoric appears in several places, such as where he speaks

of the populist outrage over our failure to impose haircuts on AIGs

counterparties. He writes of showy populist head fakes that indulge the
publics Old Testament cravings. He saw a genuinely populist approach to the
crisis as one in which punitive conditions would demonstrate toughness at the
expense of economic stability.

between them, are intermeshed in a symbiotic system that has come to be called
crony capitalism. That Obama should have so placed himself, in one of the
central aspects of his administration, runs counter to the man of the people
image conveyed to the public.
Geithners memoir contains much that goes beyond the three main points
we are about to discuss, but the issues that seem most to distinguish this book
from the rest of the literature on the crisis are:
1. The remarkable extent to which Geithner and the other main actors
were unprepared for and caught by panicky surprise by the serial distress of the
major financial institutions a full year after the housing crisis had become
apparent.
2. The much-debated question of whether a bailing out of those firms was
imperative, both for the financial system itself and for the main economy.
3. The further question of whether the emergency assistance needed to be
given without strings attached.
One after another in the fall of 2008, major firms on Wall Street came
within hours of collapse, with each seen as posing a crisis so systemic that it
threatened to create a panic in world finance. Heres a brief recounting of the
chronology, as told by Henry Paulson, the Treasury Secretary during that fall, in
his memoir On the Brink: Inside the Race to Stop the Collapse of the Global
Financial System:
The housing crisis had already roiled the stock market in August 2007. In
January 2008, the troubled mortgage lender Countrywide Financial was rescued
through a purchase by Bank of America. In March, JPMorgan bought Bear
Stearns for a pittance. There was a hiatus until September, when on the 7th the
two quasi-public mortgage giants Fanny Mae and Freddie Mac were put into
conservatorship. The crisis for Lehman Brothers came in mid-month, and it was
later considered a devastating mistake for the U.S. government to have allowed it
to fall, resulting in the biggest bankruptcy in U.S. history. Only a day later, the
government seized the enormous insurance giant, AIG. Later in the month,
JPMorgan was prevailed upon to buy up Washington Mutual, which the Federal
Deposit Insurance Corporation (FDIC) had seized on the 25th. When,
immediately thereafter, a run started on Wachovia, Wells Fargo bought it. Before
the month was out, the Big Three auto companies needed a $25 billion
government loan. Eventually, General Electrics finance subsidiary, GE Capital,
was saved by an FDIC guarantee of $139 billion of its debt; Citigroup, despite
more than $2 trillion in assets and another $1.2 trillion held off its balance
sheet, was teetering and received a bailout; Chrysler and General Motors were
bailed out; and in early January 2009 Bank of America was given a bailout similar
to Citigroups.
3 This is borne out by Geithners statement that the President once told me he

felt uncomfortable playing a populist. An interesting feature of this statement is

that Obama saw that if he were to act as a populist it would be a form of playacting.

The unpreparednes
Paulson tells how in a conversation with President George W. Bush in
March 2008 he told the president that the whole system is so fragile we dont
know what we might have to do if a financial institution is about to go down. He
says the president, to his credit, alwayswanted to know what our long-term
plan was. When told that an enormous amount of leverage and risk [had
been allowed] to creep into the financial system, Bush asked How did this
happen?, about which Paulson says it was a humbling question after all, we
were the ones responsible. Paulson was aware, at least in part, of the looming
threats, pointing specifically to credit default swaps, whose growth had
increasingly alarmed me over the past couple of years. Just the same, he felt
himself able to say on a Sunday morning talk show in the same month as his
conversation with Bush that our financial institutions, our banks and investment
banks, are very strong. He says he misread the cause, and the scale, of the
coming disaster. Notably absent in my presentation [to President Bush] was any
mention of problems in housing or mortgages. Accordingly, when the crisis
struck, he applied a case-by-case approach [i.e., bank-by-bank] that was
driven by necessity, not ideology [which we may take to mean not according to
a plan]. In seems incredible that it was only when the housing crisis struck that
Bob Hoyt, our general counsel, asked his team in the legal department to begin
examining the statutes and historical precedents to see what authorities the
Treasury or other agencies might have to deal with market emergencies. 4
One would think that sort of information would long-since have been implanted in
the DNA at Treasury, and at the fingertips of the Secretary.
Others have commented on the unpreparedness. In The Age of
Turbulence, Alan Greenspan mentioned how the failure of a major financial
institution would catch the Fed with little time for thoughtful analysis or
deliberation. And in The Crisis of Capitalist Democracy, Richard Posner writes
that even though there were plenty of public warnings of a housing bubble,
most economists missed the bubble, [and] the failure of the Federal Reserve
to prepare contingency plans in the event that the ascent of housing prices proved
indeed to be a bubble was inexcusable. As a result of the Feds unpreparedness,
when the banks began falling like ninepins in September 2008 the government
was caught by surprise, improvised spasmodically.5
Geithner, at that time the head of the New York Fed, says that we went
into our crisis with a toolbox that wasnt remotely adequate. He went on to
say that I felt like I was watching a disaster unfold in slow motion, with no
ability to prevent it and weak tools to limit the damage. The problem was that it
was too late. Niall Ferguson says the financial expert Henry Kaufman had
4 Henry M. Paulson, Jr., On the Brink (New York: Business Plus, 2010), pp. 92,

109, 166, 45-6, 63, 12, 47.

5 Alan Greenspan, The Age of Turbulence (New York: Penguin Books, 2008), p.

515. Richard A. Posner, The Crisis of Capitalist Democracy (Cambridge:

Harvard University Press, 2010), p. 29.

warned time and again of the dangers inherent in the rise of the very large
financial conglomerates and had pointed to the dangers from the growth of
securitization of mortgages and other consumer debt, the explosion of
derivatives and, above all, the vast increase of leverage on bank balance
sheets. As early as 1985, Kaufman had called for a National Board of
Overseers of Financial Institutions and Markets, with a comparable entity
operating at the international level. Kaufman himself writes that I expressed
these concerns in several papers I presented at the Jackson Hole conferences [held
annually by the Fed] in Wyoming.6 These warnings went unheeded because, as
Kaufman says, the Federal Reserve and other regulatory officials [were] under
the sway of the prevailing free-market ideology continued to deregulate
financial markets and took no real actions to rein in speculative behavior or the
dangerously rising tide of securitized debt.7 Geithner sees all this now, so that
his memoir recapitulates the many things that have been said in the post-crisis
literature about the causes, running the gamut from moral hazard, to problems
with the credit rating agencies, to the abandonment of lending standards, to the
vast worldwide credit expansion and to many other facets.
What he especially sees is that nobody was accountable for the stability
of the entire system. The Securities Exchange Commission (SEC) had a limited
mandate; the Treasury had surprisingly little authority to try to avert a major
financial crisis; and huge swaths of the financial system [non-banks and
shadow banks] were outside the Feds jurisdiction as well as the Feds safety
net. Nor, of course, was there anyone looking beyond the financial system to the
health of the main economy.
In light of warnings by people such as Kaufman, this was not only a
striking insufficiency in regulatory structure, but was also and preeminently an
intellectual failure. There had been, so to speak, a mental herd effect. A tidal
wave of rational market theory (also called efficient market theory) had for
several years swept over the economics profession and had become the guiding
light for policy makers. The result had been a deregulation movement that had
stripped the financial world of the regulation it so greatly needs. The result, as
Sheila Bair (then head of the Federal Deposit Insurance Corporation) says, was
that one of the saddest things about the financial crisis is that it could have been
so easily avoided with a few commonsense measures. If we had raised capital
requirements during the good times, if the Fed had imposed lending standards
for bank and non-bank lenders, and if Congress had not tied the hands of the
CFTC, SEC, and state insurance regulators to impose some basic, commonsense
regulatory controls on credit default swaps, the trillions of dollars of trading
losses would have been much reduced.8
6 See Fergusons Foreword to Henry Kaufman, The Road to Financial

Reformation: Warnings, Consequences, Reforms (Hoboken: John Wiley & Sons,

Inc., 2009), pp. xii, xiii; and also Kaufmans own statement at p. xx.
7 Kaufman, The Road to Financial Reformation, p. xx.
8 Sheila Bair, Bull by the Horns (New York: Free Press, 2012), p. 356.

Whether the financial bailouts were imperative

Geithner says that as the crisis unfolded we finally deployed
overwhelming force to stand fully behind the financial system We had defused
the bombs of Citi, Bank of America, Fannie, Freddie, and even AIG. The
response, Geithner says, started with ad hoc emergency interventions, but
moved to a more coordinated approach. He subjected each major bank to a
stress test, which he considered the centerpiece of our approach. 9 Among a
variety of measures, we persuaded the FDIC to provide powerful guarantees for
the banking system, and we began providing huge infusions of new capital for
vulnerable institutions. He says that by early 2009 we had backstopped tens
of trillions of dollars worth of financial liabilities (our emphasis). (He observes
that this did not involve actually spending such a vast sum; in fact, the financial
system repaid all our assistance, and U.S. taxpayers have turned a profit from the
crisis response.) The overwhelming force was not limited to combatting the
American crisis; Geithner says a powerful stimulus effort would require a serious
mobilization of resources for emerging economies (our emphasis). He proposed
that the United States put $500 billion into an IMF emergency fund. This formed
part of a $1.1 trillion flow of new international financing to fight the crisis
provided through the G-20 consortium of leading economies. The Fed also
loaned $540 billion to foreign central banks.
What most fundamentally drove the frantic day-to-day reaction to the big
banks plight during the fall of 2008 was the sense that there was a Sword of
Damocles hanging over the heads of central bankers and national treasuries.
Anything startling, it was thought, might set off a cascading world financial panic.
Rather than being in control, governments were the tail wagged by a distempered
dog. Geithner, Paulson and Bernanke felt they literally had no choice but to react,
and to do so urgently and preemptively. Their actions were forced, too, by the
worry that a financial institution might suffer stigma, or that key employees might
flee a given firm, if the crisis responders didnt walk on eggs to avoid violating
the firms or employees interests. There, again, the responders were governed by
forces they considered controlling.
One of the central questions, theoretical and practical, about the response
to the crisis has been whether this perception was justified. Oddly, there is a
yawning intellectual void about it. This reviewer has of course not been able to
read everything written about the crisis; it is likely that no one has. But among
the many books he has read none has sought to track what the specific
consequences would have been, sector by sector, to the main economy and to
peoples lives if the financial institutions had been allowed to go into bankruptcy
or some form of resolution. World capital flows are breathtakingly large, as
described by William Greider in One World, Ready or Not: the Manic Logic of
It is likely that the name Stress Test given to the memoir refers to this tool to
which Geithner assigned so central a place. It seems reasonable to think, too, that
it has a secondary meaning, referring to the incredible stress under which Paulson,
Bernanke and Geithner were acting. Each of their memoirs is a tale of human
drama.
9

Global Capitalism (1997). If it is true (and it may well be) that governments and
their central banks are at the mercy of panicked herd-effects within that ocean of
money and credit, it means the global economy looks perpetually into an abyss.
This should then call for some far-reaching rethinking of the entire web of global
finance.
A number of critics of the bailouts obviously dont share the conviction
that the threat of panic should control policy. David Stockman, the budget
director under President Ronald Reagan, says the relevant facts show that an
AIG bankruptcy would not have started a chain reaction and there never was a
financial doomsday lurking around the corner. In fact, none of the bailouts were
necessary because the meltdown was strictly a matter confined to the canyons of
Wall Street. As to AIG, any modest hit to the balance sheets of a handful of its
huge, global banking customers owing to the collapse of its bogus credit default
insurance (CDS) would have caused a healthy purge of busted assets. At the same
time, its millions of insurance policy holders were never in harms way 90
percent of AIG was solvent. Its $800 billion balance sheet consisted mostly of
high-grade stocks and bonds that were domiciled in a manner which utterly
invalidated the contagion theory. Stockman likewise says about Goldman
Sachs and Morgan Stanley that their bankruptcy would have resulted in no
measurable harm to the Main Street economy. He argues that the Washington
bailouts rescued the perpetrators and that the bailout benefits were captured
almost exclusively by the Wall Street insiders and fund managers who owned the
common stock and long-term bonds. Looking back to the bailout of LTCM
(Long-Term Capital Management) in 1998, he says the insidious idea of
shielding financial markets from alleged systemic risk contagions became an
open objective of monetary policy.10 The respective subtitles of Sheila Bairs
and Neil Barofskys11 books indicate rather graphically that they did not share the
urgency over preventing a financial meltdown: Fighting to Save Main Street from
Wall Street and Wall Street from Itself (Bair) and An Inside Account of How
Washington Abandoned Main Street While Rescuing Wall Street (Barofsky).
This reviewer wont try to resolve the conflict between these two
schools of thought. There is need for a meticulous study of the harm that
would have resulted from massive bank and hedge fund failures. In what we
have quoted from Stockman, he has given some details that are helpful, but
much more is essential if we are to know the full consequences. Who would
have been hurt? To what extent? To what effect? If it were to be rich bankers
only, thats one thing; if it would have been millions of peoples jobs, pension
funds, IRAs and annuities, among many other possibilities, that would be
something else.
10 David A. Stockman, The Great Deformation: the Corruption of Capitalism in

America (New York: PublicAffairs, 2013), pp. 4, 5-7, 10, 15, 22.
Barofsky was the Special Inspector General in Charge of Oversight of TARP
[the bailout].
11

Whether the bailouts needed to be given without accompanying

conditions
Geithner held strongly to the view that few requirements should be placed
upon those receiving a bailout. This was based on his perception, which we have
already noted, that the risk of cascading collapse required doing nothing that
might stir panic. Looking back to the responses to the 1994 Mexico peso crisis
and the 1997 Asian crisis, he says I was usually on the aggressive side of our
team when it came to intervention and permissive side when it came to
conditionality. About the Great Recessions 2008 crisis, he writes that there
was intense pressure on us to punish the Wall Street gamblers who had gotten us
into this mess. He reasoned, though, that get-tough actions would feel resolute
and righteous, but in a time of uncertainty, they would damage confidence and
accelerate the downward spiral. Elsewhere: Its terribly counterproductive in a
financial crisis to impose losses on reckless borrowers and lenders The
FDICs insistence on haircutting WaMus [i.e., Washington Mutuals] creditors
instantly panicked other creditors. It is on this ground that he defends our
failure to impose haircuts on AIGs counterparties [including] financial giants
such as Goldman Sachs. When the point was made by the chairman of the U.S.
Senates Finance Committee that there should be some executive compensation
restrictions for bailout recipients, Geithner responded that I didnt think
Congress should mess around with TARP [the bailout] as a way to reform
executive compensation. An example of the type of compensation that was at
issue comes when Geithner tells us that Merrill CEO Stan ONeal was forced
out, although he did receive a $161.5 million severance to ease the blow.
Those who didnt embrace the contagion rationale found this every bit
as shocking, and perhaps even more so, than the bailouts themselves. Sheila Bair
writes that I was appalled that all of those institutions paid out big bonuses to
their executives within months of receiving generous government assistance.
She says that after AIG had received $170 billion in taxpayer bailout money
The New York Times broke the story that AIG management planned to pay out
$165 million in bonuses, mostly to employees of the financial products division
I was aghast There was some suggestion that they needed to pay the bonuses to
retain those folks Really? Who in the world would want to hire those yahoos?
In response to the argument that AIG was contractually committed to pay the
bonuses, Bair says that with our bankruptcy-like resolution process, we could
break all those contracts. It all amounted, she says, to bailing out the big
guys.12
Nobel Prize-winning economist Joseph Stiglitz complains that even the
collapse of the system did not curb their avarice Nine lenders that combined
had nearly $100 billion in losses received $175 billion in bailout money and
paid out nearly $33 billion in bonuses, including more than $1 million apiece to
nearly five thousand employees. Other money was used to pay dividends. He
observes that the executives find ways to get paid well even when the firm
floundered. Further: Last year [presumably 2009], the top 50 hedge and private
12 Bair, Bull by the Horns, 119, 181-2, 159.

equity fund managers averaged $588 million each, more than 19,000 times as
much as typical U.S. workers earned.13 We would have a hard time believing
this if it didnt come from such a reputable source.
Political economist Pat Choate takes the outrage some giant-steps further.
Speaking of the mortgage debacle, he writes that the current wave of mortgage
fraud eventually involved Americas largest banks and their top officials
Virtually all the participants knew they were involved in a massive scheme.
From this, he concludes that in a fair world where justice is impartial, unearned
bonuses, high salaries, and lavish corporate indulgences would be recouped from
the executives of failed financial organizations, and says they should be subject
to a lifetime ban. (our emphasis). Those who would automatically qualify are
the CEOs and all board members from every bank, insurance company, and
investment house of that era that failed because of the corporations overexposure
to subprime mortgages [and the] leadership (CEOs and boards) of all the major
banks that had to take federal bailout monies because of their subprime mortgage
activities. He would even bar all those in the federal government who are
managing, or who are responsible in any way, for this bailout [and this would
include Geithner] from going to work in the financial industry for a period of five
to ten years. He doesnt want them to take part in the revolving door that sees
people go from government into lobbying or high finance, and vice versa. What
his proposals suggest, of course, is an outlook diametrically opposed to
Geithners. Rather than giving primacy to the worry that draconian measures
would produce a panic, Choate would like to root out the avarice, while also
blocking the expectation that misbehavior is profitable because it will be given a
free pass (which is the same thing as to say that he wants to eliminate what in the
financial literature is called moral hazard).
Bair, Stiglitz and Choate are just three of the many voices that have
expressed outrage on this subject. There is perhaps nothing that more justifies the
perception that Geithner was a tool of Wall Street than his conviction that little
or nothing could be done to punish the abuses or stop the flow of what has so
often been called obscene remuneration.
A feature in Bloombergs Business Week in October 2014 indicates that
some actions have recently been on-going against abusers: In the past year, the
Justice Department has extracted almost $37 billion in penalties from three of
Wall Streets largest banks JPMorgan Chase, Citigroup, and Bank of America
for failing to warn investors about the toxic mortgages packaged into securities
they sold before the 2008 crisis. It tells of a deputy associate attorney general in
the U.S. Justice Department, Geoffrey Graber, who in early 2013 filed a civil suit,
which was still pending, against the credit rating firm Standard & Poors,
charging that it inflated the ratings of mortgage-backed securities. The feature
continues: Now hes going after the executives whose companies originated
subprime loans.
Actions directed to the main economy
13 Joseph E. Stiglitz, Freefall: America, Free Markets, and the Sinking of the

World Economy (New York: W. W. Norton & Company, 2010), pp. 80, 152, 350.

There was much distress in areas of the American economy outside the
financial community. Geithner tells readers that $15 trillion in household
wealth had disappeared, ravaging the pensions and college funds of Americans
Nearly 9 million workers lost jobs; 9 million people slipped below the poverty
line; 5 million homeowners lost homes. It had been expected that saving the big
banks would cause them to continue to service the American economy, but
instead, as of January 2009, banks were in defensive retreats, hoarding cash,
depriving businesses of financial oxygen. There was virtually no private credit
available for ordinary borrowers.
This tells us the bailout didnt accomplish what was arguably its primary
purpose. Even with it, the federal government found it necessary to provide
massive aid to the main economy. Economics editor David Wessel says that as
early as the end of 2008 the Fed had more than $2.2 trillion of loans and
securities on its books The Fed was lending not only to conventional
commercial banks, but also to investment banks, to insurance companies, to auto
finance outfits like GMAC, to industrial companies like General Electric, and
indirectly to homeowners and consumers. It provided liquidity to the
commercial paper market, he says, by creating a special purpose vehicle, the
Commercial Paper Funding Facility.14
In addition to the actions of the Fed (including the massive quantitative
easing that has continued for several years) and the bailing out of the banks,
there was the $787 billion package of stimulus spending (the American
Recovery and Reinvestment Act known by its ARRA acronym) passed in the
first weeks of the Obama administration, and the residential mortgage program
known as the Home Affordable Modification Program (HAMP).
Despite all this, Elizabeth Warren, chair of the Congressional Oversight
Panel (COP) to monitor the bailout, points out how devastated the main economy
remained: According to the Business Journals of US Census Bureau data, more
than 170,000 small businesses closed in the United States between 2008 and
2010.15 Much of what was done was done very poorly, or for purposes distinct
from economic recovery per se. Warren says HAMP has failed to make a
significant dent in the number of foreclosures, citing the COP report for
December 2010.16 This is not surprising in light of what a press account in
October 2009 told us: Eight months into the program, the Treasury [which had
for that period been headed by Geithner] had filled fewer than half the positions in
a key modification office, and that by October only twelve percent of the
nations three million defaulted-upon mortgages had even begun the process of
being reworked. 17 The bailouts Special Inspector General Neil Barofsky gives
further details: By the end of 2011, Treasury had spent only $3 billion of the $50
14 David Wessel, In Fed We Trust: Ben Bernankes War on the Great Panic

(New York: Crown Business, 2009), pp. 251, 6.

15 Elizabeth Warren, A Fighting Chance (New York: Metropolitan Books, 2014),

p. 302.
16 Warren, Fighting Chance, pp. 302, 304.

billion originally allocated to HAMP. In other words, nearly three full years after
HAMP was launched, home owners across the country had benefitted less from
TARP... than American Express. He says the performance of the servicers
handling the mortgage modifications was abysmal they routinely lost or
misplaced borrowers documents [with the result that] the servicers would
claim that the documents had never been received and then foreclose.18
For its part, the stimulus only incidentally had economic recovery in
mind, but was geared instead toward serving a variety of the Obama
administrations social objectives. The spending, though front-end loaded with
$185 billion the first year, was spread out over a planned ten years, far longer than
would be needed for a shot-in-the-arm economic boost. Columnist Thomas
McClanahan observed that the spending was on a long list of items that had
nothing to do with economic recovery, including a system of carbon limits and
health care reform.19
Geithner himself acknowledges this about the stimulus, saying the
President-elect wanted to use the stimulus to promote his long-term agenda. He
refers to Rahm Emanuels much-quoted statement that a crisis would be a
terrible thing to waste.20 (Emanuel was Obamas first presidential Chief of
Staff.) Nevertheless, Geithner defends his stewardship and the Obama
administration from the conventional wisdom [that] still holds that we
abandoned Main Street to protect Wall Street. He points to all the money
President Obama poured directly into the Main Street economy. In his first term,
about $1.4 trillion worth of tax cuts, government investments that boosted
employment, and direct aid to low-income and middle-class families. There was
also the rescue of the auto industry and lifelines for Fannie and Freddie, which
kept mortgage rates low. There is a surprising disconnect between all this and
the devastation we have just seen Warren cite, and there is even more disconnect
when Geithner asserts that the stabilization of Wall Street and the rest of the
financial system [i.e., the bailout] saved the Main Street economy from the trauma
of another depression. The explanation no doubt lies in the definition of
depression.
17 The Wichita Eagle, October 4, 2009.
18 Barofsky, Bailout, pp. 199-200, 151.

Column by E. Thomas McClanahan of the Kansas City Star, in The Wichita

Eagle, July 17, 2009.
19

20 An interesting historical parallel is that the Franklin Delano Roosevelt

administration did much the same thing, including into its New Deal program
several of the programs that American progressives had advocated in the 1920s.
Among them: the Tennessee Valley Authority, the Securities Act of 1933 and
Securities Exchange Act of 1934, unemployment insurance, Social Security, and
the Wagner Act on labor relations See Dwight D. Murphey, Liberalism in
Contemporary America (Washington: Council for Social and Economic Studies,
1992), pp. 48-51.

What were the alternatives?

Needless to say, those who objected to the bailouts had alternatives to
suggest. The merit of the suggestions varies greatly.
Some of the suggestions went to the heart of the crisis. The cancer from
which the financial crisis metastasized lay in the subprime mortgages, which had
been bundled together through securitization and sold to investors worldwide.
Bair says there were nearly half a trillion dollars worth of such loans [speaking
of subprime hybrid adjustable rate mortgage loans, which would trigger
escalating home owner payments] that were scheduled to reset in 2007 and
2008.21 Economist Paul Craig Roberts wrote at a crucial time (mid-October
2008) that the U.S. Treasury estimates that as few as 7 per cent of the mortgages
are bad.22 Perhaps referring to a somewhat larger batch, financial commentator
Charles Morris says the risky mortgages account for no more than 15 to 20
percent of all outstanding mortgages.23 Whatever percentage it may have been,
David Smick adds that the issue was not the size of the subprime mess [but
rather] where the toxic waste was located. Who had the cancer and who was
healthy?... The crisis unfolded precisely because suddenly nobody could say
which financial institutions held the subprime mess, and at what price.24
Why not start by removing that cancer so that the trillions of dollars worth
of securities based on the mortgages would no longer be suspect? The thought of
going to the source as an essential first step didnt come to Paulson, Bernanke or
Geithner in their panic to save each of the large banks, which was an approach
that tackled the problems at the far end after the uncertainty over the toxic
mortgages had spread like a giant fan across the financial system. It did appeal to
the likes of Bair, Roberts and Stiglitz. Bair wrote an op-ed piece for The New
York Times in October 2007 [after the housing crisis had set in in August of that
year, but notably a year before the domino-like crises of the big banks]. She
writes that the answer seemed obvious: eliminate the reset [in the escalation of
the mortgage interest rates] and simply extend the starter rate. In other words,
convert the loan into a thirty-year fixed-rate mortgage We werent really
proposing that [lenders] payments be reduced, just that they give up a payment
increase. What she wanted was some kind of systematic approach to
mortgage restructuring, rather than the mortgage-by-mortgage modification that
eventually occurred (and, as weve seen, was done slowly, poorly and only
partly).25
21 Bair, Bull by the Horns, p. 62.
22 Paul Craig Roberts, How the Economy was Lost (Petrolia, CA: CounterPunch

and AK Press, 2010), p. 43.

23 Charles R. Morris, The Two Trillion Dollar Meltdown (New York:

PublicAffairs, 2008), p. 72.

24 David M. Smick, The World is Curved: Hidden Dangers to the Global

Economy (New York: Penguin, 2008), pp. 12, 14.

25 Bair, Bull by the Horns, pp. 62, 67.

Paul Craig Roberts, who was assistant secretary of the Treasury during
Ronald Reagans first term as president, made this point in his usual outspoken
manner in a column published on October 8, 2008: Instead of wasting $700
billion on a bailout of the guilty that does not address the problem, the money
should be used to refinance the troubled mortgages, as was done during the Great
Depression. If the mortgages were not defaulting, the income flows from the
mortgage interest through the holders of the mortgage-backed securities would be
restored. Thus, the solvency problem faced by the holders of these securities
would be at an end. He told how during the Great Depression of the 1930s, the
Home Owners Loan Corporation refinanced 1 million home mortgages in order
to prevent foreclosure. He reiterated his point in a second column on October
17. (The dates of these columns are important because they show the alternative
was being pointed out contemporaneously with the bank-by-bank rescues.
Indeed, the op-ed piece by Bair was published a year earlier, as weve noted, and
was based on what was already obvious about the housing crash.) Roberts added
that two more simple acts would have completed the rescue: an announcement
from the Federal Reserve that it will be the lender of last resort to all depository
institutions including money market funds, and an announcement reinstating the
uptick rule. That rule, he explained, is one that prevents short-selling any stock
that did not move up in price during the previous trade.26 Not surprisingly,
Roberts has had much more to say.27
Looking at what he thinks should have been done after Obama took office
in January 2009 and unemployment had risen dramatically, Joseph Stiglitz has
written in a vein similar to Bair and Roberts: The government didnt do enough
to help on an issue that went to the heart of the crisis: the unemployed cant make
mortgage payments. Many of the unemployed lost their homes soon after they
lost their jobs The Obama administration should have provided a new kind of
mortgage insurance that would pick up the mortgage payments allowing
most of them to be deferred until the homeowner is back at work.28
Other alternatives were offered that would come into play if the crisis
were not solved (as we know it was not) by an early systemic solution to the
mortgage-and-contaminated-securities problem. Bair found participating in the
bailouts of the big banks the most distasteful thing I have ever done in public
life, but says we clearly had to do something, and they [the bailouts] did
achieve their intended short-term objective of stabilizing the system. She would
have preferred a different course, though, and regretted that the government
[hadnt provided itself with] the legal tools to wind down the truly sick
26 Paul Craig Roberts, column of October 9, 2008, to be found at www.

vdare.com/Roberts/081009 solution; also, Roberts, How the Economy was Lost,

pp. 43, 169.
27 See our review of the Roberts book just cited in the Fall 2010 issue of this

Journal, pp. 381-388. The review can be accessed without charge at

www.dwightmurphey-collectedwritings.info as Book Review 140 (BR140).
28 Stiglitz, Freefall, p. 68.

institutions in an orderly fashion. Citi, Merrill, and AIG were insolvent and
should have been put into our bankruptcy-like resolution process The Lehman
experience demonstrated that bankruptcy was not an option for the orderly
resolution of large, interconnected financial institutions. The government needed
a process similar to the one we had for insured banks. She is pleased that the
later Dodd-Frank financial reforms have included resolution tools to resolve
both bank and nonbank systemic entities. We can see the difference between her
and Geithners approaches when she writes that throughout 2009, even after the
financial system stabilized, we continued generous bailout policies instead of
imposing discipline on profligate financial institutions by firing their managers
and boards and forcing them to sell their bad assets.29
The Austrian school of economics offers, of course, very different
prescriptions from those we have described. Before we see what one of its
leading spokesmen would have done in the crisis, we should note that the stoutly
pro-capitalist Austrian school cautions that crises should be prevented in the first
place by being on the gold standard and greatly reducing the credit expansion that
the school believes is the essential precursor of a crash. One of its leading
thinkers, Murray Rothbard, and others have wanted to do away with fractional
reserve banking, which allows the banking system to create money through
credit expansion. If, however, such steps are not taken to remove the causes of a
panic, the school calls for a harsh, but they think wholesome, hands off policy,
allowing things to go to smash quickly so the economy can begin bouncing back.
An analogy would be allowing a forest fire to burn without restraint, getting it
over with with the expectation that the green shoots of regrowth will start the next
spring. Here is a representative passage from Llewellyn H. Rockwell, Jr.s, piece
in the Mises Daily on September 10, 2008:
What should have happened in 1929 is precisely what
should happen now The government should completely
remove itself from the course of action and let the market
reevaluate resource values. That means bankruptcies, yes.
That means bank closures, yes. But these are part of the
capitalistic system If the government did nothing but sell
off the assets of the mortgage giants, we do not know for sure
what would happen, but the market has a way of finding
value and readjusting. I would expect about 18 months of
difficulties But the process of readjustment would be
smooth and rational.
The author of our present article has long been a student of the Austrian
school, and attended Ludwig von Mises seminar at New York University in 1956.
He has, however, long held a respectful disagreement with the point just made,
thinking that a market economys collapse should be considered intolerable to
those who support capitalism. A market economy, he thinks, involves millions of
people striving to live individually responsible lives who have a vital interest in
the systems stability. He went to study under Mises precisely because he
29 Bair, Bull by the Horns, pp. 118, 7.

believed another Great Depression could destroy the legitimacy of capitalism and
bring down the system itself. Be this authors thoughts as it may, it would seem
that much of the outrage that has been expressed against the bailouts has been
based on the let the bottom fall out preference.
More than a few critiques have been made of the recent crash, and we
know we arent mentioning many proposals they have included.30 An idea that is
gaining traction that could take much of the sting out of economic dislocations
and thereby help assure the continued legitimacy (i.e., the societys general
acceptance) of a market economy is that a common dividend be paid regularly
to all citizens. Since that is an important subject in itself, it will be best to leave it
to readers to peruse Peter Barnes With Liberty and Dividends for All, reviewed in
our Fall 2014 issue.
Financial reforms discussed by Geithner
Stress Test discusses many potential reforms, but before we review them it
is worth noting Geithners overall dictum: Financial crises cannot be reliably
predicted, so they cannot be reliably prevented. Theyre triggered by manias
and fears and human interactions We cant outlaw stupidity or irrational
exuberance or herd behavior.
This observation is pregnant with significance. It suggests, as so many
authors have told us, that the financialization of the global economy, with its
many trillions of dollars sloshing to and fro, has created what must be considered
a monster. It is one that is beyond the control of central banks (as is evident in
Geithners having been driven by his worry about doing anything that might
spread panic) and that puts the world economy in perpetual jeopardy. We said
above that in our opinion an acceptance of panics is intolerable for a market
economy. If that is so, the brinkmanship posed by global finance is even more
intolerable, as a vast expansion of the same thing. It threatens herd-driven panics
at any time. Of all the economic conundrums posed by todays world, this is
almost certainly the most pressing.
Transaction tax. Many commentators have recommended a worldwide
financial transaction tax as a way to inhibit easy speculation. In 1997, William
Greider wrote that a plausible alternative to catastrophe is for nation-states to
reclaim power and responsibility from manic investors National governance
and broader social priorities could be swiftly reasserted over capital and its
movements in the old-fashioned way: by taxing it. A transaction tax could
moderate the gargantuan daily inflows and outflows of capital across national
borders. The idea behind such a tax and other capital controls would be to raise
the cost of short-term transactions and thereby take the fun out of currency
trading and other speculative activities. He noted that this would not inhibit
30 Many of these suggestions are discussed in this authors book that contains

reviews of 14 books on the Great Recession. See Dwight D. Murphey, The Great
Economic Debacle and Beyond: Reviews and Commentary (Washington:
Council for Social and Economic Studies, 2011). The reviews are also included
on Murpheys website, cited in an earlier footnote.

the long-term flows of capital for foreign investment. He gave credit to Yale
economist James Tobin for proposing such a tax in the early 1980s. Greider was
prescient when he predicted that the idea wouldnt be seriously entertained in
America because the orthodoxy reigns confidently despite gathering signs of
systemic stress.31
We might think it surprising that Geithner isnt at all favorable to such a
tax, which he refers to by its common name: the so-called Tobin tax. But he
writes it off as a perennial populist favorite, argues that it can easily be evaded,
would have no effect on speculation, and has no realistic prospect of being
accepted. He doesnt address the question of how to tame global finance, and his
many suggested reforms speak primarily to what can be done to improve the
financial system within the United States. We are left with the impression of a
severe and perhaps catastrophic intellectual limitation, almost an insouciance. It
will fall to others to think with Geider-like breadth.
Comprehensive reforms. As we look at Geithners preferences for internal
reform, we run into a contradiction between what he tells us and what Sheila Bair
writes. Geithner says I hoped that we could channel the countrys populist
outrage into support for comprehensive long-term reforms of the financial
system. To the contrary, Bair says this: Dodd-Frank [the reform legislation
passed in 2010] is a good, albeit imperfect law. Many of its provisions were
watered down as a result of industry lobbying and, in some instances, at the
behest of Timothy Geithner and his surrogates.32
Capital, liquidity. Common ground would seem to exist between Geithner
and Bair when Geithner says that forcing banks to hold enough capital and
liquidity to absorb significant losses is the best defense against future crises.
Bair concurs, telling how numerous government and academic studies have
shown that stronger capital standards will reduce the risk of large-bank failures
and the huge credit contractions we experienced in 2008. She says, however,
that a meaningful capital requirement in the Dodd-Frank Act was retained by the
Congress only in the face of opposition from Tim, the Fed, the big banks and
their trade groups.33
Shock absorbers. Geithner writes that the most important safeguards
to make the system safe are the constraints on risk-taking that Ive described
as shock absorbers, starting with strict capital requirements Other shock
absorbers include liquidity requirements that limit financial institutions reliance
on runnable short-term financing, deposit insurance and discount window access
for depository institutions, margin requirements for derivatives and other financial
instruments, and mortgage down-payment requirements that restrict leverage for
ordinary borrowers.
31 Greider, One World, Ready or Not, pp. 257-8, 317. See also p. 319.
32 Bair, Bull by the Horns, caption on the unnumbered page two pages ahead of

p. 247.
33 Bair, Bull by the Horns, p. 225.

Resolution authority. He says the vital tools that are needed include
resolution authority to allow the orderly winding-down of failing financial
firms. This would seem to put him in agreement with Bair, for whom resolution
authority is a central feature. What Bair says in Bull by the Horns, however, tells
of disagreement over a contentious aspect. She proposed a resolution fund that
would be built from assessments on big hedge funds, investment banks, nonbank
mortgage lenders, and others. Geithner, she says, opposed this, disparaging it as
a bailout fund, and argued in place of it that giving the FDIC a line of credit
from taxpayers to support resolution activities would be fine. She goes on:
Protecting taxpayers wasnt Tims priority. Having control over the resolution
process was.34
An overall systemic-risk monitor. To address the problem that no person
or agency was charged with responsibility to keep tabs on the systemic health of
the financial system, Geithner says I thought the Fed should be made the nations
systemic risk regulator, with the authority and responsibility for identifying
dangers across the entire financial system. He discussed Bairs views about
this: One of her crusades was for an interagency council to get many of the
powers to oversee systemic risk. He considered this inherently weak: I saw the
council as a way to avoid any centralized accountability. Bairs discussion of the
issue, however, says that Congressman Barney Frank, chair of the House of
Representatives Financial Services Committee, liked my idea of a systemic risk
council, and points out that even if Frank had wanted to give the Fed those
major new powers, he probably didnt have the votes to do so. The members of
his committee were still quite angry about the Feds regulatory failures leading up
to the crisis. She adds that I believe strongly that vesting all power in a single
agency would make it more prone to capture by the industry. Having a diversity
of views is a good check. In her proposal, the heads of each of the major
regulatory agencies would serve on the council, the head of which would have
his or her own staff and be empowered to write rules for the financial system
(subject to approval by a majority of the council). What was the outcome of this
debate? Unfortunately, Bair writes, the Financial Stability Oversight Council
created by Dodd-Frank is chaired by the Secretary of the Treasury, not an
independent chairman. In addition, it has very little authority to write systemwide
rules.35
Creation of a financial consumer protection agency. Elizabeth Warren had
long made consumer financial protection a focus of her law school career. She
wrote a 2007 article, Geithner says, advocating that mortgages and other
financial products should be regulated like toasters and other consumer products,
which are regulated for safety. Obama shared Geithners enthusiasm for Warrens
idea, and creation of the Consumer Financial Protection Bureau was a major
provision in Dodd-Frank. That Act gave the Bureau an even stronger and
broader mandate than Elizabeth Warren had envisioned. Although financial
industry opposition kept Warren from being named head of the new Bureau, she
34 Bair, Bull by the Horns, pp. 217, 218.
35 Bair, Bull by the Horns, pp. 337, 338.

was put in charge of setting it up, and Geithner, despite his irritation that she
hired away a bunch of our staffers for the purpose, credits her with doing an
excellent job getting [it] off the ground.
Many other reforms have been proposed that we havent included in the
above list, which we cant intend to be exhaustive. Before we leave the subject of
reforms, it is worth noting that important areas are left unresolved in Geithners
discussion. One has to do with an anomaly in the financial products that have
been developed in recent years, and that especially cries out for correction. This
is the lack of an insurable interest requirement for contracts insuring financial
products. In insurance law in general, the concept of insurable interest is what
distinguishes insurance from gambling. The requirement is that anyone taking out
insurance on property or on someones life must have a potentially loss-suffering
relationship such as ownership, a leasehold interest, being a relative of the
person, or being the persons employer or partner with the subject of the
insurance. The insurance is then to protect against loss to that separately existing
interest. This long-standing rule of insurance law has not been held to, however,
so far as financial products are concerned. To understand this, one needs to know
that credit default swap contracts (CDSs) are, despite their esoteric name,
nothing more than contracts insuring a financial product from loss. Bair tells us
that hedge funds and other speculators could buy CDS protection against the
default of mortgage-backed investments, without actually owning them. She
explains that that created trillions of dollars in speculative trading, many
multiples of the size of the underlying subprime mortgage market (our emphasis).
That is why hundreds of billions of dollars worth of mortgage losses translated
into trillions of dollars of trading losses. Her conclusion: I believe that
speculative uses of CDSs should be banned. She says the way to do that is to
require the insured to have an insurable interest. Its significant that it was AIG
[that] sold a lot of that kind of protection, eventually leading to its failure and
need for a bailout.36
We encourage readers to study Geithners Stress Test, while keeping in mind the
many issues discussed here. The general reader benefits from the fact that none of
the memoirs relating to the financial crisis are steeped in the mathematical
analysis that is so common in todays academic economics. Even though thats a
benefit, a criticism that can be made of this entire literature is that each
commentator relates his or her own views or policies without spelling out the
intellectual background for them. They come down ex cathedra, as though
without academic or other theoretical predecessors. At least it can be said that all
of them, including Geithners, are made easier to read to this absence.
Maybe the easy to read aspect is being taken too far. Geithner joins
some other prominent authors these days, such as Robert Gates in his memoir as
Secretary of Defense and Elizabeth Warren in her recent book, in dumbing
down the intellectual level by patronizing readers with lots of four-letter words
and their variations. That has become common in movies. Its appropriate to ask,
36 Bair, Bull by the Horns, pp. 54, 55, 334.

must it now become standard in serious writing? It is almost certainly one of the
legacies of the 1960s, especially of Mario Savio and his Berkeley Free Speech
movement.