The Man Who Saw the Crisis Coming
'No elbows' Fed president is the best pick to run Treasury, Wall Street historian says.
The financial crisis is paying no heed to the historic election of Barack Obama, and that is why the choice of the next Treasury Secretary is so important. What’s clearer than ever since November 4 is the extent to which the cancer, nurtured for years on what used to be called Wall Street, is spreading viciously: General Motors is on the brink if bankruptcy, American Express has become a bank-holding company, AAA-rated GE is looking for federal guarantees on the debt of its finance subsidiary, and the TARP has been switcheroo-ed. The list could go on.
Of the three wise men oft-mentioned these days – Paul Volcker, 81, former Federal Reserve Chairman; Larry Summers, 53, former Secretary of the Treasury and the former president of Harvard University; and, Tim Geithner, 47, the current president of the Federal Reserve Bank of New York – only Geithner has the combination of youthful vigor and direct hands-on experience with the still-unfolding crisis that makes him the best person for the job. He has combined uncommon wisdom with an admirable calm since the ides of March pushed a reeling Bear Stearns into the arms of JPMorgan Chase eight months ago. I have come to this view after getting to know Geithner through the course of writing my soon-to-be-published book, House of Cards, about the current financial crisis.
Geithner has been at the epi-center of the decision-making as the credit bubble was inflating and as it burst. This is a positive.
Who is this guy, anyway? Like Volcker and Summers, Geithner is an insider. He received his undergraduate degree from Dartmouth College and his graduate degree from John Hopkins University, both in Asian studies. He spent three years at Kissinger & Associates before joining, in 1988, the Treasury Department, in international affairs department. In 1999, Geithner was promoted to Undersecretary of the Treasury for International Affairs, one of the only career civil servant to win such a battlefield promotion. He worked for both Robert Rubin and Larry Summers when they were Treasury Secretaries in the Clinton Administration. He saw first-hand the Asian financial crisis that leveled Japan’s economy for a decade.
Let’s face it: The guy is plugged in. But he also has a wry sense of humor, a clear sense of determination and an ability to play well with others. “He’s elbow-less,” Rubin said about him in 2007. “It’s really remarkable.” Rubin, the former CEO of Goldman Sachs and a now senior executive at Citigroup ought to know about that.
Unlike Volcker and Summers, though, Geithner has been at the epi-center of the decision-making as the credit bubble was inflating and as it burst. This is a positive. He knew within months of taking over the New York Fed in November 2003 that trouble was brewing, especially in the unregulated and growing $60 trillion market for credit derivatives. Geithner asked former New York Fed president E. Gerald Corrigan to lead a group of Wall Street bankers to study the potential and growing problems in the credit-derivatives markets and in September 2005, brought them all together to begin to fix the problems they had found. His quiet and effective leadership pushed the bankers to adopt measures to help mitigate some of the risk.
There is no question that Geithner is now The Man on What's Left of Wall Street. This is now more true than ever, after the opening of the Fed window to investment banks on March 16 and the decision by what used to be Wall Street to become bank holding companies. The coming overhaul of the regulations that govern the banking and securities industry will give him even more power. He can -- and does -- speak regularly by phone to any executive he wants to as part of his ongoing efforts to monitor developments. He also has occasional lunches with them downtown.
With more power has come some tough decision-making which hasn't been universally liked on Wall Street. Everything seemed hunky-dory between the regulator and the regulated until Geithner pulled full support from Bear Stearns & Co. and Lehman Brothers.
It's clear to me that Jimmy Cayne - whom I've also met with recently - will never forgive Geithner for not opening the Fed window to Bear Stearns before he opened the window to the rest of Wall Street. Lehman executives are equally irate at him for announcing on September 14 that the Fed window would be opened wider than before and the Fed would take more squirrelly, hard-to-sell securities for the first time -- open to everyone but Lehman, of course. Lehman filed for bankruptcy a few hours after that final nail in its coffin.
With Geithner, it all goes to the whole notion of creditworthiness. And he's not wrong. Isn't it a central banker's job to make judgments about such things? He didn't feel either institution was creditworthy when they came to the Fed in the end, hat in hand. With Bear, he thought the government had the legal authority to buy the $29 billion in assets to facilitate the JP Morgan merger because of the quality of the assets. With Lehman, the asset quality was much worse and the hole much bigger. In his mind, a rescue of that scale needed an act of Congress, which came, although too late for Lehman.
By early 2007, Geithner knew a serious crisis was likely. He could see that a combination of low interest rates, rampant financial innovation and human nature -- which assumed that past stability in the markets would continue indefinitely – made the financial system very fragile. He also knew that Wall Street’s investment banks by and large – although some more so than others – were in the nasty habit of borrowing short and lending long, a habit that gave their overnight repo lenders inordinate power over their future existence.
If he knew so much, you may ask, why didn’t he do anything about it? The answer lies in the fact that the Fed regulates the commercial banking systems. The so-called “run-on-the-bank” risk -- that we have become all too familiar with lately -- built up outside the banking system in the investment banks, such as Bear Stearns, Lehman Brothers and Merrill Lynch. Put simply, Geithner was not the supervisor of the investment banks. That responsibility belonged to Christopher Cox, the chairman of the Securities and Exchange Commission. Geithner could not put an artificial floor under the risks that Wall Street took during the boom. His job was to protect the economy from the damage that might result from the air coming out of the balloon too quickly. His job was not to keep the air in the balloon and let Wall Street continue to operate at the levels of leverage and risk that had been prevalent.
What has happened to Wall Street since March 16 was not a government choice designed to teach somebody a lesson, nor was it a choice the government made because it failed to see the consequences of the various potential defaults. Rather it was a sad and pathetic consequence of the fact that as a nation we allowed a huge financial risk to build up in institutions outside the traditional regulated banking system without any ability for the government or the private sector to deal with the increasing likelihood of systemic blowout and its collateral damage.
Geithner understands what happened and why, making him uniquely well qualified to be this country’s next Secretary of the Treasury at this time of acute need.
William D. Cohan, a former senior-level M&A banker on Wall Street, is the author of The Last Tycoons: The Secret History of Lazard Freres & Co. Cohan's House of Cards: The Fall of Bear Stearns and the End of the Second Gilded Age, will be published by Doubleday in 2009. He also writes for Fortune, ArtNews, The Financial Times and the Washington Post.