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June 2, 2014 12:45 pm
In May 2014 the FT’s chief economics commentator Martin Wolf interviewed Tim Geithner, the former US Treasury secretary, in New York. This is the full transcript of their discussion.
Martin Wolf: How does it feel to be out of public service after all those years? Did you feel withdrawal symptoms? Do you sleep enough?
Tim Geithner: Oh, yes. I mean, I did this all my life and I loved it but I knew I wasn’t going to do it beyond this horizon, so I had a long time to think about it, prepare for it. And I had, I feel, more than my share of great experiences, great opportunities in life. And, as you know, I tried to leave earlier, unsuccessfully to leave earlier. So, I was prepared for it, been thinking about it a lot and I spent a year writing a book and thinking about what I’d done and speaking about it but also I took ten trips with my wife and it was great.
MW: And how busy are you with your new job?
TG: I’m quite busy but I still have another month of my book rollout stuff to get through which is not quite a full-time job, but it’s like a half-time job.
MW: So, you’re travelling all over the country, making speeches and lectures and so forth?
TG: Starting on the day of the book launch, I start with two weeks of travel for that.
MW: You’ve timed it perfectly to hit the Piketty storm.
MW: So, that’s going to be an interesting contrast, though, actually, of course, the books are very different. Does that concern you, that everybody’s moved on from the crisis and are now interested in completely different issues?
TG: No, it doesn’t. I mean: I wrote the book because I wanted to explain what we did and try to explain why panics are different, why they require that kind of different and counterintuitive response. And I wanted to do it for the long term, because I thought it important to leave not just to my successors, but to the broader public, a better record of what motivated the choices we made and to lay out a basic framework for how to think about making decisions in this context.
And, I think, a pretty novel set of tools too for applying those choices in ways that I think have the potential to deliver much better outcomes to crises than we’ve seen in the last hundred years. And I think that has enduring value. It may take some time but I think it’ll have some enduring value.
MW: So, this isn’t just an attempt to put the record straight, as it were. It brings us to the question I was going to ask if you’re trying to explain to somebody who hasn’t read the book, which I pretty well have done – I can’t say every page, since 600 pages is quite a lot to get through in one day but I read quite a lot of it – what can you say is the message you really want people to get out of this book so that they understand it correctly?
TG: Well, financial crises are devastating – terrible collateral damage, huge human cost, long-lasting damage, but it’s not beyond the capacity of mankind to mitigate that damage, to limit the damage, and if you’re aggressive upfront in the design and the application of your shock absorbers to constrain risk such as capital, design them right and apply them broadly, and if you make sure you equip yourself with a forceful set of tools and use them aggressively in the face of a panic, then you can dramatically limit the damage to the average person relative to what we’ve seen in the last century of financial crises.
I think the hardest thing to understand in this is that panic runs are different and they require a fundamentally different response, a much more counterintuitive response, than is typical in a normal financial crisis. And to get the chance of getting those better outcomes, you have to recognise that basic paradox and lean against those basic instinctive reactions you have and that most people have in a normal crisis, which is that you should let it burn itself out, or you should be indifferent to the failure of individual firms, or you should embrace austerity quickly, or not take any risk, which is the typical instinct of a policy maker, or even an economist in some ways, in that context.
So, that’s the main thing I wanted to explain because those are the primary motivations for why we made those choices we made. And I think the big persistent perception – I think it’s a misperception – is that we acted out of an excessive concern for the banks, rather than out of recognition that if you leave the country vulnerable to a panic and the failure of the financial system, you leave the average person exposed to much greater damage even than we saw in this crisis. That’s my story.
MW: I’m, of course, very sympathetic to that view since I certainly wasn’t in favour of letting everything collapse. But, as your book – which actually I must say I enjoyed and which very much seemed to me to have your voice in it – makes clear, in this and the previous crises you were involved in – the Mexican crisis and the East Asian crisis – you were thwarted to a significant degree by actors who disagreed with you, domestic and foreign. So, in some sense it suggests that what you see as the ideal solution, at least for the complicated crises we now seem to have, is not politically possible.
TG: Well, I think there’s a risk of that, not just because what’s probably right and just in the midst of a panic is so offensive to most people, so counterintuitive at the beginning, but because there’s some risk people look at this experience and they say, the political costs of what we did were so massive – and they were very substantial – that they will wait too long to embrace that inevitable strategy, because of fear of those costs.
So, I worry about that but you’ve just got to keep at it, keep hoping, and I think, again, we had a unique set of strengths approaching this crisis because we’re the United States, we could afford the losses, we could afford to borrow at low rates, we could afford to deploy overwhelming force. And our financial system was very small in relative terms. It’s a large financial system but very small relative to, say, the UK financial system. So, we had strengths that many countries don’t have in this context but also we had a set of challenges most countries didn’t have because our financial system was much more complicated because banks were only at 40 per cent of credit.
And, in some sense, that was the core of our story because the panic, of course, began outside the traditional banking system and then set in place a set of dynamics that imperilled the core of the system. Very few countries have a system with that structure and that vulnerability, although that may change in the future.
So, the reason why I think this is worthwhile and not quixotic and not hopeless is because, by giving people this broader set of tools that you can deploy and a strategy for deploying it, that was really very novel relative to what had been tried in past crises, at least you give people something they can look to.
They can choose not to do so. They may believe the political costs are terrible and they may wait too long, they may misdiagnose the severity of the crisis, there’s a big risk of that. But they won’t have the excuse of saying “we have no idea what to do”, because we’ve given them something that, in its messy imperfection, was very effective and powerful and is replicable. It’s not something that was so unique that it cannot be used elsewhere.
MW: Just to make it clear what you consider to be the special technique, my reading of the book is that the core thing which you obviously spent your time arguing with Larry and others on was the stress test. Is that what you mean by the core new tool that you deployed? Is that right?
TG: Well, can I give you a slightly longer answer to that?
MW: Of course.
TG: I would say we did three different types of things that were pretty different from the past playbook people have used. One is something I know you very much embrace. It seems obvious, although rarely embraced, which is we used monetary policy, fiscal policy and the financial strategy in concert together.
MW: Of course.
TG: In most cases people use one instrument, not the others or they use them in conflict with each other. Simple thing.
MW: You’ve seen that in Europe, haven’t you?
TG: Europe’s a good example. Japan’s another example. It’s rare you’re able to achieve that level of strategic co-ordination across those instruments. That was very important, maybe decisive.
Second thing we did is about, let’s call it, the broader use of guarantees. Again, a typical strategy people deploy in a crisis is they leave in place and maybe they harden slightly this big implicit guarantee in the existing banking system and don’t do anything else that can slow a run or stop a run. But that leaves you adrift without fundamentally addressing all these constraints on demand going forward.
Since so much of our system was outside banks, we had a much more complicated set of backstops to design – commercial paper, money-market funds, asset-backed securities markets, things like that. And how we lent against collateral across the financial system. So, the second thing that was novel was the basic credit facilities we invented and they took time and that time was costly to us. We took a couple of weeks to invent them, sometimes a couple of days, but you couldn’t do them right off the shelf.
The third thing, the stress test, was novel as a device for trying to recapitalise the financial system and restructure it as quickly as you could and in a way that to the extent possible reduced the risk to the taxpayer from having to take all that equity risk.
So, we wanted to design something that maximised the chance that private markets would recapitalise the system and we did that with this approach to disclosure and transparency, which was very novel and I think remarkably effective, much more effective than we thought it would be. But, to give credit to the broader strategy, it would not have worked in the absence of those two other things, because the force of the macroeconomic policy response helped take out the extreme tail of a Great Depression-like economic outcome and the framework of guarantees we provided made it easier for the capital strategy to work. If the guarantees are infirm, it’s much harder to get equity to come in.
And, again, these things all bolt together.
A strategy of naked guarantees, which is the typical forbearance strategy, is a very inefficient, very damaging strategy. The strategy of capital only doesn’t really work, unless you just want the taxpayer to recapitalise everything. So, if you do them together, there’s less moral hazard in the guarantees because you’re putting a bunch of private capital in there ahead of the government and you make it much more likely also that private capital comes in for that.
So, those were the novel things in our strategy. And, again, I’m not claiming perfection and, of course, we suffered a huge amount of damage; some of that avoidable, some of it unavoidable. Our outcomes are so much better than history. But we’re still, six years beyond the adverse peak, with long-term unemployment still very high in this country.
MW: Well, I’ll come in a minute to the question of the longer-term legacy and “secular stagnation”, quote unquote, and other issues of this kind. I suppose critics would argue – and, of course, this is before we get into the programme – that essentially the political and regulatory community of which the Fed, obviously, was a huge part but not the only part, was left to take these extraordinary measures because of quite extraordinary incompetence beforehand.
TG: Are you saying your comments of the Fed?
MW: I mean: the political community and the regulatory community together over a fairly lengthy period – I’m not talking just about your period at the New York Fed, so this goes back before – allowed the most important financial system in the world, and personally I was very astonished because it’s not something I’d been working on, to get itself into a position in which, one, it had no capital to all intents and purposes and, two, it had exposed itself to all sorts of risks it didn’t understand and this should never have been allowed to happen.
MW: It’s not clear how you think it was allowed to happen. I mean, I know you discuss it was a grotesque situation to be in but how did it happen? How would you defend yourself and your colleagues from the charge, well, you did a pretty decent rescue job on something that should never have been permitted to happen.
TG: Well, it’s a good question and I’ll try to lay out why I think we got ourselves in that position. So, let’s just do the long arc of our boom and the achievements of our system. So, we had this 50-70-year “quiet period” in American finance. And people say it really wasn’t that quiet because we had a bunch of idiosyncratic financial shocks, but these shocks that we had over time, they were modest shocks, easily absorbed. Recessions became shorter and shallower and it bred this vast degree of excess confidence and it was pervasive and it became global too; it wasn’t just a US thing. But somehow we escaped the risk of systemic panic.
And those, as I write in the book, were the fundamental conditions that allowed these two dangerous things to happen. One is a long period of rapid growth in debt relative to income. Just for the record, there’s no history, I think, of countries effectively pre-empting long booms in credit and slowing them down. We’re all going to try that in the future but …
MW: Yes, we’ll come to that.
MW: It makes me a bit nervous.
TG: It should make you nervous. And the second thing that happened is that in the US – and this is what you’re referring to, I think – most of that risk ended up in a very dangerous financing structure that’s vulnerable to panic, outside the core of the banking system. So, in the US the banking system, where there were constraints on risk, those constraints on risk were strong enough.
And, remember, all these banks had capital levels well above regulatory capital – even in middle-2008 they did. But what happened is that all that risk migrated outside the banking system into what were very dangerous forms, made possible only because of this period of excess confidence that the liquidity was permanent, that asset prices would never decline by a certain magnitude.
MW: All that “great moderation” nonsense.
TG: Exactly, all that stuff. So now you ask yourself why was it the American political system allowed the GSEs [Government-Sponsored Enterprises (Fannie Mae and Freddie Mac)] to operate without capital, the investment banks to operate not just without much capital but without regulatory capital or AIG …
MW: Without, really, a regulator.
TG: Without a regulator. And in our system vast swaths of the financial system, even the most risky parts of it, operated without an accountable authority to constrain risk-taking. Now, you’re saying why was that allowed to persist? It’s just for the obvious reason, that for 70 years there was no evidence that you could stare people in the face with and say that that left our country vulnerable to a systemic panic that we hadn’t thought about.
So, let’s come back to me and the Fed. So, I was asked to come on the New York Fed in the fall of 2003. As I write, my greatest fear at that moment, since I’d grown up watching a bunch of financial panics unfold, was that mismatch between the scope of not just the Fed’s constraints on risk-taking, which were very limited or applied to a very limited piece of the financial system, but also the limits on our lender-of-last resort tools in a crisis, because, again, those tools were designed to reach what was a pretty small fraction of the “runnable” stuff.
That was 2003, 2004 and 2005 and that was the right thing to be worried about and I’m very proud of, frankly, and pleased, even in retrospect, by the scale of the things at the New York Fed we tried, even though they didn’t have enough traction ultimately. But I’m very pleased by the scale of things we tried to deal with that fundamental mismatch between where there was risk and where there was authority.
And we did some very important work in derivatives, which was very valuable; and we did some very important pioneering work on stress testing – again, not sufficiently strong, but we did it not just to our banks, where we were holding the authority of the supervisor, but we got the British authorities and the German authorities and the Swiss authorities and the SEC [Securities & Exchange Commission] in the process with us, to try to broaden the scope of that stress testing; and we pushed for more conservative risk management across those universal firms.
But those things came too late and they were too weak in their effects. And it was with the knowledge of those failures in some ways that we were able to design the stress test in 2009 to be more powerful and more credible.
So, it’s a long story. To come back to your thing about Piketty. I haven’t read Piketty yet, so I’m doing it just in the context of the reviews of it. If you run a financial system where you allow people to compete with banks without oversight, they’re going to build up big franchise value and that can come with substantial political power in countries where politicians can’t be indifferent to money.
Look at money-market funds today. They have huge franchise value and they are very powerful enough to be able to effectively fight and slow and limit the well-intentioned and completely justifiable desire to try to extend something more like prudential supervision to those institutions.
MW: They still don’t really have any capital.
TG: They still don’t really have any capital and they’re very vulnerable to runs and they do maturity transformation, not in an extreme form…
MW: And for very good reasons you saved them.
TG: And we had to save them in the panic.
MW: Yes, otherwise the industry would have disappeared and you wouldn’t have these problems.
TG: Well, we didn’t care about the industry disappearing, we just cared about the collateral damage. So, I guess the short answer to your question is that long period of “great-moderation” type expectations created the conditions that made the system very vulnerable while masking that vulnerability. And there was huge franchise value, economic power built up in the institutions outside bank supervision that made it, still is making it hard, frankly, to extend the scope of regulation to them. That’s the best explanation I have.
There’s many theories of financial booms and financial crises and there’s enough crap in our crisis to support almost any theory, if you look at it, but ours was not really a story of acute moral hazard systemically across the system, although we had pockets at the GSEs. And it wasn’t really a story you can explain by a set of really bad incentive problems and it’s not really a story you can explain in terms of the scale of the fraud and the stuff that happened in the Wild West of our system, although this was material and very damaging.
This was fundamentally a Minsky-Kindleberger long, mania-fuelled expansion. And the important thing about a systemic financial crisis is to recognise that the world is inherently vulnerable to these and there’s, in my view, no way to design a system where you can expect central banks or supervisors to be able to come in and lean against and pre-emptively diffuse or cap that growth and borrowing of leverage, for reasons you know better than I do.
But that does not leave you powerless against them. You want to make sure that the shock absorbers you build and design upfront are thick enough, conservative enough and applied broadly enough that you have much more protection against the extreme event. That will never be sufficient. It’ll never be sufficient because in the 100-year flood or the 75-year or 50-year flood where you’re not going to eliminate that risk of panic, never going to do that, and so you have to be able to be prepared to deploy this set of macroeconomic tools and capital and guarantees if you want to do what’s preventable, which is prevent a Great Depression.
MW: There seem to me very, very simply three explanations people get behind.
Well one, from your right and left, is that these are a bunch of crooks and they brought the Congress – If you go to the right they think it’s the Democrats who did so and if you go to the left they think it’s more the Republicans – they brought the Congress and they stole from us and they’re going on stealing from us. Its all about fraud and rent-extraction.
The second view, which is very much that of economists, is if something like this happens, it’s because of perverse incentives, because basically markets are efficient and in the normal course of events self-stabilising, so if anything like this happened, it’s because we provided them with the wrong incentives – moral hazard, and so forth.
The third point of view, which is mine and yours, is that people just make fundamental mistakes, particularly after 60 good years, and then they come to believe “this time is different”.
But this last view is the one with which the economists and the bulk of the people are least happy because it implies that it happens because ultimately we’re all fools and some of the time some of the biggest fools are running some of the most powerful institutions. That is a difficult story to sell.
TG: It is a difficult story to sell, although it depends who your sample is, who you’re talking to, and in a big credit boom like we had, people, if they weren’t doing it themselves, they had their neighbour they could watch and judge.
MW: And everybody’s doing so well.
TG: And they’re doing so well. So it’s not really because people are fools, it’s more because people are human and the future is uncertain and one’s view about the future is shaped by experience and if you had a long period of time where incomes are rising and unemployment is lower and more stable, you’re going to borrow more against income in that context and the world will finance it willingly. They’ll just do that willingly.
And, again, the vulnerability is magnified dramatically in the absence of periodic panic. The absence of periodic panic is a remarkable success of central banking and policy – I guess, until this crisis, a remarkable success. But in some ways, unless you have the memory of crisis that is strong and sustained, people will inevitably build too far on the flood plain.
MW: But isn’t it also possible, and this must concern you, not that it is in any way a criticism, but by acting, I think, successfully and correctly, to prevent a Great Depression – And the Great Depression is not something I would, obviously, recommend – but the fact is it frightened the wits out of people for a generation and that was both among the regulators and the practitioners, one of the reasons the quiet period, as Gary Gorton [of Yale] calls it, existed.
MW: Now you’ve essentially prevented a Great Depression and confidence is returning, we read this every day. And doesn’t it worry you that we might be back there?
TG: Yes, but let’s be fair – the economic costs and the financial costs of this crisis, even though they weren’t at Great Depression level, were the worst in 57 years. And my own view is that we’re going to have something in the memory for some time. I think the bigger risk for some time still is that there’s this overhang of insecurity and lack of confidence that leads to suboptimal growth outcomes for a longer period of time. Sure, you’re right, at some point that memory will fade and we’ll be back. But I don’t think our errors were in preventing too much failure.
I mean, you’re sort of saying that … In some ways you’re making the smart question which is, did we basically not allow enough failure? We allowed – and that wasn’t by intention, it was by a lack of tools and other things – but we allowed pretty dramatic levels of damage. You said that banks are profitable, making money again. We’ve dramatically changed the economics of banking in the sense that the expected return on equity in a bank is half its pre-crisis level, maybe less than half of its pre-crisis level, because capital requirements are so much more conservative.
So, I don’t think it would be fair to say that we’re back to the same level of risk, same level of vulnerability. I think we’re in a much stronger position and that will endure for some time. Over time the forces of confidence will work their way around these constraints and you should try to adapt them. You’ll be behind them, but you can try and adapt and expand the scope of these things. Stress-testing is a way to help mitigate that risk because stress-testing is designed to keep trying to anchor those future expectations and some judgment of the risk of another extreme event.
Again, I have a more optimistic view about what’s possible. We’re human: we’re inherently vulnerable to manias and confidence but that’s just part of human nature and it only happens when policies have been very successful for a long time in improving economic outcome. But the fact that you can’t eliminate the risk of systemic crises and panics doesn’t mean you don’t have enormous capacity to limit their effects, again, just by better policy choices in the midst of the storm.
MW: As you rightly pointed out, if you’re running the United States you have choices which are exceptional, not necessarily true for other countries. So, it seems to me one of the lessons from this is it confirms the wisdom of developing countries in going far further in being cautious because they don’t have these capacities and that has some implications for the way they run their policies.
But, before I go into that, let’s go back to how we got there. One of the stories you tell very convincingly is how slowly the policy makers in 2007 and 2008, up to Lehman, got it and the continuing war within the Fed and more broadly. Isn’t that probably an inevitable part of this sort of process, realising that you’re in a systemic event rather than just another of those market corrections? Is it inevitably a slow process which almost guarantees that the reaction, when it comes, will be too late?
TG: Well, the reaction was late in our crisis mostly because of the limits of the tools we had going into it, because it took, as you said, even with our tremendous financial resources as a country, we didn’t have the authority until the panic scared people to death to do what we needed to do to put it out. If you equip yourself ex ante – and most countries have the tools ex ante because in parliamentary systems in most other countries there’s much more flexibility – you’re much more able to do it.
So, I tried to explain that since you have this inherent fog of diagnosis at the beginning – you don’t know if the shock is systemic – the optimal response should be gradual initially, because you learn something from that and it does some initial triage for you and it cleans out the worst parts of the thing and you don’t want to be prematurely generous. So, it is optimal to go slow and you can afford to do that because there’s good value in that, as long as you have this thing you can do to reduce the risk that it turns into panic.
And we can say to ourselves, well, you’d never calibrate that. But that’s not true. I mean: you could. Panic happens very quickly but you can see its signs. In some ways we could say, well, what’s so remarkable about us is that it took 12 months for a slow burn to escalate to the point of a systemic panic.
So, a long answer to your question: the reason why we were late in some ways you could say – some people thought we were way too early – but the reason why we were late to fully deploy the ultimately necessary set of tools to break the panic was more a function of limited authority than the diagnostic challenges, in my view.
MW: I think from your point of view that might be right, because from the way you tell the story the conclusion I drew was that there was a desire in the administration to not to be seen as the “we will bail out everybody” people.
TG: Yes, right.
MW: So, Lehman in particular was in some way a sacrifice to that cause and, furthermore, you might make the additional argument without the Lehman failure you would never have got the authority to act anyway. So, you needed the dire stuff before you could actually deal with the problem, which is rather depressing …
TG: It is, but …
MW: You would have the same problem in future. I mean, it’s not just a theoretical point. Even if you have the tools, there’ll always be political resistance to your using it.
TG: There will be, yes.
MW: And so you might actually have decided to do the same thing with a Lehman. And other countries made the same sorts of mistakes, by the way, while they had the tools, simply to prove that you needed to do the opposite.
TG: That’s right. I think there’s a huge risk in that and maybe it’s the dominant risk and maybe it’s inevitable, but we should aspire to do better than that and, again, I’m hopeful – I’m trying to make the optimistic case – I do think that a huge reason why – Let’s put our experience aside, Because we had a complicated system and limited tools and we’ve got a presidential model of government, constitutional authority for economic things rests with the Congress, etc – Let’s take the example of Europe – very complicated institutional thing in some ways but …
MW: In some ways not so different, even worse. Like negotiating government of the US between your states.
TG: Yes, in some ways much worse but within countries maybe a little bit more scope. I really believe that a part of the reasons why policy was messy and late and wrong, misdirected, was not just because of the political constraints or the natural political aversion to risk-taking of a politician and the offensiveness of these kind of things to the average person, but was the level of ignorance. I may be being unfair but just remember that no one had been through this before.
And so people were deeply distrustful of two different things. One was the possibility things could be terrible. They denied the possibility that things could be terrible. This crisis will help correct that for some time. But the other was just a lack of understanding, an appreciation of what to do, how you would do it.
We had a tremendously collaborative relationship between the Fed and the Treasury in that period of time, really remarkably collaborative and exceptionally talented people. But I can tell you that the knowledge base, the practical knowledge base in those institutions of what you do in a systemic panic was very limited; in Europe, much more limited.
The knowledge of markets, the fragility of markets, the fragility of systems like that was extremely limited in Europe and that knowledge was part of the hesitation. It wasn’t just the politics. I’m sort of a believer – maybe it’s quixotic – that with the experience comes knowledge and with a better set of examples of what to do and what not to do, maybe you can improve the outcomes in the future.
MW: And one answer to that, which might be encouraging or discouraging since we won’t be around, is that you have your grandfather’s crisis but not your father’s. And that’s perhaps the crucial thing about the situation that evolved in the US and other countries, is that every single person with a living memory of the Great Depression was dead.
TG: Exactly right. But we had an advantage because we’re in a more globalised world. Take two examples. Larry and I had lived through and watched a bunch of things and Larry, to his overwhelming credit, he was sort of the architect of the modern application of that classic intuitive presumption of the Powell doctrine [after General Colin Powell] of overwhelming force in financial panics.
He didn’t invent it, but his was the best way of describing its force and in some ways we were able to take the experience we had, however messy it was and imperfect, we were able to take the experience we had in those more recent experiences of financial panic and use them to, you might say, ironic effect in the strongest country on the planet.
MW: Well, actually, though it didn’t involve government finance, one of the most interesting parts of Lombard Street, since you cite Bagehot is his statement, which is actually just a quotation of the governor of the Bank of England about the 1868 panic, I think, because we just bought everything and quote unquote “we were not overly nice”
MW: And that’s essentially the same point at least on the central banking side of this though, as you pointed out in your book, a lot of this involved actual capital. But it’s important now to remember, and that’s a very important point, that the levels of capital with which our institutions were allowed to operate have essentially no 19th century equivalent.
TG: That’s right.
MW: No 19th-century financial institution was allowed to operate with that level of capital allowed by the shareholders, their owners.
TG: But there wasn’t free deposit insurance.
MW: And in some cases – many cases, clearly including the US – liability wasn’t limited and the implications of that I’ll come to in a second.
If you look back at the crisis itself, I think many critics thought that what you do in the financial sector would not be as successful as it was, partly because, as you yourself have admitted, the policy wasn’t as clear as it might be.
Actually, looking back on it – this is just a comment – because of the longstanding commitment of your predecessor [Hank Paulson] to purchasing or in other ways managing the overhang of toxic assets, it was quite difficult to see in early 2009 that that was just a marginal part of your plan rather than a central one, and it always seemed to me a giant mistake. It was obvious it would be politically and economically impossible to buy every bad asset in the system, so that wasn’t going to go anywhere and Paulson continued that, really, until the very end. So, that was a confusion, I think, a very important confusion. That’s just a comment.
But looking back on what was done, two things stand out, which was in your discussion which seems to me incredibly important for the crisis and future crises and they’re linked, not so much on the financial side, some more on that, but this is the question of what you do on the fiscal side, the stimulus issue.
And in a crisis, as we know, you have huge fiscal deficits. It’s actually one of the few things I did get right before the crisis. I wrote a column saying that if things went really bad, the US might have a fiscal deficit of 8 per cent of GDP and I thought I was being incredibly bold to say this, it was about 2006 or something, and I turned out to be much too optimistic. It was just based on an idea of what could happen to the private sector if a crisis happened, given the debt accumulations.
So in the crisis, you’ve got very large fiscal deficits, you’ve got tremendous popular anger and yet I did, of course, think your initial stimulus was actually too small, not too large.
You make the argument convincingly, and I think others have made it, you couldn’t have got more, but wouldn’t it at least have been sensible from a political point of view – and this is linked to my second question, the politics of all it, which turned out, as you describe so well to be so poisonous – wouldn’t it have been better at least to have asked for more than you could get?
So, you could then say instead of being crucified, as you made so clear, on the argument that stimulus didn’t work, because things then got worse, you could at least have said, “well, we asked for much more and you didn’t give it to us. So, you didn’t give us the tools, obviously it was bound to fail.”
And that then led to this – what does seem to me genuinely frightening legacy – but I think in the body politic of the United States – the public, the Republican Party, possibly part the Democrats, I don’t know – they don’t view all this as a great success. They think the economy is doing worse than it would have done if you hadn’t done anything, almost.
TG: There is a tribal view that …
MW: There is a tribal view that the economy is actually very miserable, that your recipes were essentially unsuccessful, that stimulus was pork barrel for unsuitable people. And they still feel that everybody should be punished.
MW: And this was my big point in the column you referred to in your book which asked “Has Obama already failed?” – were you asking for enough? That was the point. Were you asking for enough? How would you respond?
TG: There are three or four complicated points in there.
Look, on the question about whether we should have asked for more than we got – than we knew we could get in some ways – just to be able to blame them or later come back for more, I really believe that, one, we had the right incentives, in the sense that our interests were to maximise not just the initial amount but the capacity for more. In the US we had the masters of the craft of legislating in politics at that point, at the ascendance of their power. You could say we were in a transition, that made it a little bit awkward, because the president had not yet come in, and we had a set of economists who are really good on this and knew what we wanted to do.
MW: Best team imaginable.
TG: I’m saying in that context we made the choice that we’d get as much as we could as quickly as we could. We thought we were over the abyss and so we didn’t want to put ourselves in the position where we were fighting a protracted war with uncertain outcome and, although I don’t think we debated this internally, Martin, you could make the argument that, since confidence was so important at that moment, to have a risk of something defined as an early failure would have been very bad and hurt our political capital. That’s one point.
On your second set of things, I think you’re right to characterise the predominant perception of how Americans feel about the economy now. I mean, it’s true that confidence is a little bit better and it’s true that you’re seeing for the first time now a little wage acceleration at the median income level and that’s sort of encouraging. And short-term unemployment is back down to normal levels.
But generally I think they would say that they’re disappointed in how the economy has performed and I would say that they viewed the overall response with confusion and ambivalence, if not outright disaffection, and I think that both those things are totally understandable for the reasons, again, which are obvious to you, which are, one, this recovery was going to disappoint everybody, because of Rogoff and Reinhart’s evidence on the impact of such a big debt overhang [in their book, This Time is Different]. It was just going to do that and we had the additional burdens of excessive austerity fever too quickly and some bad luck from Europe.
Another way to think about it is the economy has actually done pretty remarkably well, given the overhang of deleveraging and those shocks to policy. The economy is growing modestly, about 2 per cent on average, steadily for this period of time. It’s a pretty exceptional achievement, coming out of financial crises, but why would people understand that? How would you expect them to think: “Gee, I should be encouraged by that”?
MW: You don’t win arguments on counterfactuals.
TG: Exactly. But the other thing, and this may be much more than that, is that perceptions matter a lot and the inescapable overwhelming perception created by what you have to do to break a panic leads to this sense of deep unfairness, rewarding the unjust, rewarding the arsonist, and there’s no way to heal that because once that impression is corrected, does it help to explain to people?
I tell a story in the book about Erin Burnett, a CNN correspondent, going on TV and recounting a story where she goes up to an Occupy Wall Street protestor holding a Tarp sign saying, “did you know the taxpayer earned a positive return on the investments in the banks?” “No.” “If that were true, would it change your view?” “Yeah, it would.”
But the fact that people thought we would lose $2 trillion and, in fact, we made the financial companies pay the taxpayer for the assistance we gave them, it’s counterintuitive to people when you explain it and they see the numbers. It doesn’t really change the basic perception that it was still fundamentally unfair and, they’re right, it was unfair. It’s just relative to the alternatives – the counterfactual point.
The other thing is that the wheels of justice move slowly and we have in the US a very strong enforcement response, that got traction a little bit late. Now, it may not be in the forms people think are the most just but there’s well over $100 billion in fines on banks coming back to the taxpayer and if you look at the shape of the American financial system today, even though it’s not that apparent to everybody, large parts of it have disappeared.
But if you look at the financial systems of Europe or of Japan today in some sense, in terms of institutions, structure, market share, size, they’re largely in place still. I mean, they’re a little smaller and maybe a little smaller relative to GDP in Switzerland in some ways, but…
So, we did actually pretty wrenching and dramatic restructuring which is good for future incentives but it’s not that accessible to people. People can’t see it and so…
So, anyway, I think those were inherent in the challenge and that’s why you’re right to worry about whether we’re consigned to repeat bad outcomes in the future because, not just because the memory fades, but because people look at the costs and the reaction to these things and they’re unconvinced.
I think it should be compelling to people because even if they don’t remember the Great Depression, you can point to it and say, that would have been terrible, and if you ask yourself how did you feel in late 2008-2009 as a person, it was devastating, existential, and even if the memory of that faded very quickly in some sense – that acute fear faded very quickly – when you talk to people about it and they remember that, it hasn’t faded completely; it’s sort of there still.
MW: But if you look at the …
TG: Let me do it one more time, differently – I don’t think you were asking it this way -The fact that five years later people may still feel that what we did was unjust, because they couldn’t imagine the counterfactual is, of course, not an argument for not doing it.
MW: That comes out perfectly well but I’d be interested to know your comment, since you’re now out of this, on the politics, as they evolved in the United States from the beginning of the crisis onwards. Everybody’s politics are strange but if you do look, it is very peculiar. Fairly early on, as you pointed out, Mr Rick Santelli succeeded in persuading people that the biggest threat to the future of America was that a few poor people would be able to default and this formed the whole Tea Party movement, which then …
TG: Prevented from defaulting.
MW: Sorry, precisely. This sort of movement became sufficiently successful, sufficient anger about the stimulus as well; healthcare too, of course, which is even more fascinating, to lead to the bloodbath for the Democrats in 2010. Then you got into a series of, look, almost existential fiscal fights over the debt ceiling and attempts to close the budget and so forth.
Here’s the United States faced with the sort of existential implosion of its financial sector as a result of extraordinary excesses in which, obviously, the financial elite was a big part and the response has been a quite astonishing form of anti-federal-government populism and the federal government actually saved the country. To me, as I say, this looks completely scary, sort of off the reservation, and one wonders where it’s going to go.
You described these negotiations. I talked to colleagues of yours about these negotiations and I’ve written a lot about the most recent debt-default actions. What should we make of this and what should our readers, not mostly Americans, make of this? What does it mean for the future of the West? Is this a temporary hysterical response to something they felt just couldn’t have happened or is there something more profound?
TG: What’s happened in American politics has had a long fuse, a long set of things that caused a lot of damage in people’s confidence in government in the United States. The crisis made it all worse and it’s sort of a typical thing in history, I think, when you have acute recessions like this, with just terrible damage to people’s basic sense of security, it often produces very divisive political moments. It’s a common thing.
But if you look through that, and you do have to look through the noise of that, the political noise and the political theatre of this, the policy outcomes the US has been able to produce, even in the face of that, have actually been in a relative sense quite good and I don’t just mean relative to what you saw in Europe or Japan, I mean relative to our challenges because our challenges are more modest than theirs.
So, let’s just do the more reassuring case. Again, we were very aggressive and very effective in preventing the collapse of the financial system and we got the economy growing again in six months, a really remarkable thing, pretty moderate and stable growth. And at the same time we helped pull the world back too by lending freely, on the scale of trillions of dollars, to the rest of the world [from the Federal Reserve].
So, we were able, even in the midst of all that paralysis and dysfunction, to run a pretty aggressive policy response and in that same period the president laid the foundation for – enormously important, economically and socially – the provision of a basic healthcare benefit to what ultimately would be 20 to 30 million Americans.
There’s tremendous innovation happening in education in the United States, not just at the younger end but at the higher end. Although the long-term fiscal picture is still very daunting for us – it is less daunting than many countries face but daunting for us – there’s enough innovation in the provision of healthcare that healthcare costs have slowed and some of that will be durable and our ten-year deficits are now at levels that are fully sustainable after being at 10 per cent of GDP in the midst of the panic.
And so if you look through the terrible, distracting, discouraging noise of our adolescent political theatre, there’s been a pretty remarkable amount of messy, not perfect, but well-designed policy. I didn’t mention the financial reforms which are messy too but at their core very valuable and good. So, our political system, as many British politicians have observed over time, famously, was able to deliver when it’s most important, the necessary thing.
It may not be ideal, it may come late, it may come with some damage. But I’m very optimistic that that’s something that our country hasn’t lost. Even if you think about the last 18 months or a year of politics in the United States, the fever that was so discouraging, so evident in the default threats, I think that’s broken. I think the Republican leadership have figured out a way to break that and I think it’s evidence of … again, uncertain in its outcome now ... a core pragmatic impulse in American government, which at important moments has reasserted itself and I think we have some chance that that’s happening now and we can build on that.
MW: I had once written that FDR (Franklin Roosevelt) had the “great advantage”, quote unquote, of becoming president in 1932 by which time the Republican alternative had completely discredited itself.
MW: And you had the disadvantage that you inherited the country when it was still going down and the Republican alternative had not been discredited, so you’re blamed for the recession. So, the problem was the government was elected two years too soon. Of course, the upside of that is you actually stopped the Great Depression. So, I’m not recommending this as a political strategy.
TG: You’re right to remind people about that. I tried to remind people about that in the book. Roosevelt – it wasn’t just a timing thing – he took advantage of the five months [between the election and inauguration] to stop so they [the Republicans] would “own” everything.
MW: Well, you can’t do anything about the timing and I will accept your optimism ...
TG: It’s a qualified optimism.
MW: Some of the craziness has been so extreme that it’s been at moments quite scary. You are right. I’m actually a considerable admirer of the president and I am probably, apart from you, the only person left in the world who is an admirer of the president. He seems to me to be a grown-up … I’ve never met him – a grown-up human being in a world of children but it’s tough, isn’t it?
TG: It’s tough but you’re …
MW: You’re elected to lead and you have to make decisions which are desperately unpopular and everybody …
TG: He was an excellent – he is an excellent, I believe, decision maker in a crisis, – willing to decide and not paralysed by indecision, putting a lot of pressure on debate, trying to get better outcomes.
MW: And not posturing.
TG: No posing, no posturing and willing to take a long view of politics. Maybe not long enough, but a long view of politics.
MW: I think there is a good chance that austerity will look wrong here…
TG: I think so too.
MW: And, in fact, if the health reform stands, which seems more likely now, as a president who prevented Great Depression II and passed health reform, it seems to me that he is one of the more transformative presidents in the last 50 years, really, only LBJ and Reagan compare in terms of substantive achievements, even if one of Obama’s is negative [preventing a Depression]. But then Reagan’s support for breaking inflation was also a negative achievement.
TG: I have the same view but I want to be fair, that – Again, this is a great strength of the United States – that the stuff that worked came in two stages and that first stage that mattered a lot was something that [Hank] Paulson and [George W.] Bush made possible. Of course, the Democrats gave him the votes and the president [Obama] supported them – the then-candidate for president – supported them but they acted exceptionally bravely and sensibly. And you could say it was easier for them because they weren’t going to be in office, he was at the end of his term, but they get credit too.
MW: Let’s look at the future and some of the underlying challenges that we now have in the last 15 minutes. Larry [Summers] has particularly sharply raised the question in the following guise – if you look at the US, and it’s true of other developed countries, in aggregate the economy has only been doing rather well in the last 15 years or so – we can discuss the dates – when a credit boom’s been going on.
So, we either have slow-growing economies or we have unsustainable economies.
This is a pretty miserable choice and I have argued in the book that I am also just finishing that this is the consequence of a combination of forces, external and domestic which have eroded domestic demand and the most obvious are the global imbalances and the massive shift in internal income to high-saving individuals. So, it’s deeply structural and it goes along with what looks like a structural willingness to invest in the corporate sector.
One, do you share that analysis and, if you do, to the extent that you do, what are the policy options because presumably the whole point of your reforms is not to start another unsustainable credit boom, even if it’s the only way, though I happen to think that that is actually what we are doing in the UK – that’s why I’m being so critical of the chancellor of the exchequer. Anyway, what is your view on this set of debates?
TG: Well, you’re in a much better position to debate this with Larry than I am, I don’t think it really changes your view or should change your view. It doesn’t change my view on what you should do.
MW: In a crisis?
MW: In normal times?
TG: Now. Because at least – again, I’m not an economist, I’m just in some ways an observer, a participant in how you govern facing these choices, but we are so far short of the frontier of what we think would be better policy, to get a better mix of growth and maybe better distribution of the benefits of growth, better distribution of opportunity, than we have today.
And I would be much more pessimistic about the world we lived in today if I thought we were at the frontier of those things. Our political systems were delivering those policies and we were left with these results. We’re so far short of the frontier. Again, if you take two good compelling examples in the United States: if we could legislate a larger long-term programme of public investments, that would be good for demand growth, good for income growth.
MW: It would be wonderful.
TG: So, there’s no rocket science in that, no mystery in that. And if we could do a better job of equipping people from when they’re very young to have a better chance of having the skills they need to work, that can make a big difference too.
So, I guess my view is will that be enough. Will we know that’s enough? Can we deliver it? I don’t know. Let’s work on those things. You might be right. I think Martin, the dark view – you might be right. You’re taking the last two decades view but …
MW: It’s not just the US, it’s even more … Whether Japan or Europe, if you step back and say, something is going wrong with the high income countries – is it globalisation, whatever? – but somehow we seem to have lost our mojo.
Now, the US has more mojo than anybody else, yet when it wanted to get its economy going, it did crazy things. Being dependent on crazy things worried me. I agree with you completely – doing sensible things will be better but we seem to be more willing to build houses nobody needs than to build infrastructure we obviously need. That’s part of this political dysfunction. Is this a loss of pragmatism?
TG: Yes, maybe it’s that. Yes, I guess you could say the simple obvious statement is that what you worry about is: are political institutions everywhere able to deliver a set of policies that are responses to these concerns and you have to be pessimistic about that now, although historically over time the US has been okay at it, sometimes late but quite good at it? And in a relative judgment, I will take our mix of those challenges relative to anybody else’s because we have, again, a terrible set of challenges in relative terms for us.
MW: I agree. How could you not?
Second question. You’ve described a financial sector which has the capacity to go seriously out of control. In the last three decades … say just two decades we’ve had a series, and you’ve dealt with many of them, of enormous financial crises, the last being the biggest and worst. They’ve devastated quite a number of emerging countries and now even core countries, almost no major countries being unaffected.
Isn’t it really rather hard, against that background, to argue that globalisation of this system with this capacity for misery is a good idea, that actually the emerging countries and others say: “Well, we really don’t want to be open to this sort of system, we’ve got to insure ourselves, we manage our exchange rates, we accumulate colossal currency reserves. You can deal with it because at least you have resources, but even you found it difficult. We can’t deal with it at all.” Is that quite a big problem now, the legitimacy of the system, which is somehow seen as the core of globalisation?
TG: I don’t know. It’s an interesting experiment because you can look at the choices that are being made by governments with a lot of technocratic competence and have some political power to act. China is an example. But you’ve had other examples like that. Mexico is a good example now, Chile’s a good example.
There’s a bunch of countries that have elected – or put the reins of power over economics in the hands of – people with what you would consider very good training in the practical applications of economic policy and if you look at the choices they’re making, they’re making better choices than their predecessors in those contexts and most of the vulnerability of countries to those crises in the past was not from the pressures of globalisation on a country run exceptionally well, they were the vulnerabilities that were terrible, amplified by the consequences of globalisation.
So, I am much more optimistic that you can get a better mix of institutions and policies in emerging economies, and you’re getting them now much more substantially, that will make it possible to run those economies more safely, even in a world of global capital mobility.
And, again, on what basis would I have that evidence? Just, again, if you look at those crises of a previous period of time, it’s not like they had policy that were really optimal. They had no self-insurance. They had all the classic things you’ve written about eloquently and there’s knowledge in that.
Again, let’s think about our “quiet period” in the United States, which was a pretty good period for income growth and for relative financial calm. That was a very long period. Now, you could say the world was less global then but it also mattered less because it was much smaller relative to us.
So, I don’t know, I’m just not that pessimistic about it but I think you know me well enough to know that one of my weaknesses is that I basically say, okay, there’s certain things we’re not going to change – I don’t know how to solve, so let’s figure out what to do within those constraints and since, again, we’re so short of the frontier, what you can do within those constraints, I tend to focus on those things.
MW: My final question is – we could go on for hours, obviously – about where you’ve gone now. People will say, well, here’s another guy who was in the Treasury and now he’s waltzed off to Wall Street.
TG: Most people thought I came from Wall Street.
MW: I know. That was very interesting. I hadn’t been aware how taken for granted – well, in a way it’s not surprising, because the assumption is anybody doing a top job in Washington is from Goldman Sachs, so you must be from Goldman because, after all, they’re just so prominent. Now we have somebody from Goldman running the Bank of England – they’re everywhere.
Anyway, are you just another guy who’s gone and got a nice political job and ended up making an immense amount of money on Wall Street? What are you trying to do?
TG: I did public service my entire professional life and I loved it, it was a great, meaningful thing, I was lucky to do it, but I knew I couldn’t do it forever and I was going to have to do something different, wanted to do something different, face other challenges, and I’m young enough that I could do something completely different and have some time to figure out how to be good at it.
I was very worried about the perception you referred to of the way our system works, so I tried to do a few things to counteract that, although we can’t prevent it, which is I decided I would not work for a firm we’d regulated or rescued, so not in the banking system or the most dysfunctional parts of our system and I was very careful in choosing a firm with a very good ethical reputation, people I really trust and who were doing something I think as a valuable part of finance and I think the part of finance that this business is in is a very well–functioning, very good valuable form of finance. So, those are the reasons I joined.
MW: Are you enjoying it?
TG: I am enjoying it. I find it – it’s an incredibly great thing for the curious. I’m a very curious person. It’s early still but the way I learnt to think about making decisions is something that’s very familiar – makes that world very familiar to me.
MW: And no longer 18-hour days?
TG: People work very hard in it but it’s a different kind of challenge.
MW: So, you can finally go home to your family in the evening when your children have left home, basically.
TG: Exactly right. It’s a little bit tragic. I’m late, I’m late, it’s a terrible thing. It’s nice, though, to protect them – I can give my family more privacy now, because I’m not in the public eye, which is good.
MW: It sounds as though it was very tough for them.
TG: It was very tough for them, much harder for them than for me, because I was acting.
MW: Well, I have spoken to politicians in the UK, which is always a bear pit, though different, and one of the points they make, even now, is how tough it is on their kids. That’s a pretty basic form of guilt, I would imagine, because you can’t do anything to protect your children. It must be very hard.
TG: Yes. You put a huge burden on your spouse and you miss vast swaths of their lives. I think those are the biggest things. My kids are very strong and well-adjusted kids and they didn’t get too wrapped up in the excitement of high office. They’re pretty normal people. So, mostly I think for me it was the loss of …
MW: I loved the quote from your daughter when you were in hospital.
“Who the fuck is POTUS? Why should I put him on?” I think that was really a wonderful moment. Well, best of luck with the book.
TG: Thank you, Martin. Nice to see you.
MW: Did you ever regret not having done a doctorate in economics or did you think it actually made you, as I suspect it did, a much more sensible human being because you were not crippled by believing these ludicrous models economist have?
TG: I think Larry would say that no way I was smart enough to get a doctorate in economics, so in that sense …
MW: Larry would say it, but I don’t think he would actually mean it.
TG: No, I don’t regret that because I was so lucky, because I was surrounded all the time with these exceptionally cool, smart economists and I got to learn a lot from them. And, yes, I could say I was disadvantaged by the fact that I didn’t have the craft. I had other things because of luck.
MW: And you’re not going to do it now, so …
TG: My daughter wanted me to go to medical school with her. My daughter’s going to be a doctor. She wanted me to go to med school.
MW: Is she?
MW: You probably would have been a very good doctor because you have the capacity to cope with extreme tension. You’re not dealing with protecting hundreds of millions of people: it’s an individual, and it’s life and death. So, I can’t even begin to imagine taking on that sort of responsibility.
TG: I thought about that.
MW: But I admire people who can.
TG: I do too. I really admire them. I read about the fact that there’s this great surgeon in the Americas, a wonderful writer named Atul Gawande, and the former Indian central bank governor, YV Reddy, gave his book Complications to me once. He said this is the best book for a central banker and it’s because he writes as a doctor/as a surgeon about how you make choices when you can’t know and the margins there are so. It was a great and fascinating book, in part because he described how in that profession they do things that in economics we don’t do that well, as central bankers we don’t do very well.
They have these things in US they call morbidity–mortality review every Friday where they go over mistakes. So, every week they’re together as a group and they go through the catastrophic errors and they examine them, they look at them and that was a very powerful thing to me. I loved reading that book.
MW: I don’t think the Fed has done that about the crisis. I know our Bank of England hasn’t, though I think there’s a little attempt now. It is difficult when most of the people involved in the decisions are still there.
Your Financial Crisis Review Commission actually devoted remarkably little attention to monetary policy, the Fed and so forth. It was much – although very useful, I thought – but much more about how did the crooks get up with all their crookedness and so on, which I think is all absolutely true, but it’s mistaking symptoms for cause ultimately.
And then there’s another school of thought, which is that the crisis was just because the Fed’s interest rates were a bit too low in the early 2000s. So, economists will be arguing about this forever.
TG: I did a lot of travelling and speaking in my last year and I went to twelve universities that had faculty that were good in this area and I went to Chicago and had dinner with Eugene Fama [this year’s Nobel laureate] and a diverse group of economists in that case. And I thought they were at least comfortable with how I explained my framing diagnosis.
MW: That’s interesting.
TG: They weren’t trying to say this was fundamentally a moral hazard thing or fundamentally another form of incentive failures. But, hey, I’m not an economist, so I can’t even debate. So, I think you’re right, that a lot of this stuff is still highly contested in the economics profession and unresolved and it probably will be forever but I think there’s more of a core consensus on things that I’m comfortable with than it looks like from a distance.
MW: Even John Cochrane [of Chicago University] has agreed that leverage is a problem. Also it was a panic and that’s been recognised in economics for a long time, though it doesn’t fit into standard models very well. In theory this could lead to a considerable improvement in economics. Whether it does is another matter but I’m very much with you that the Minsky/Kindleberger view of the world is the right view, even if you can’t fit it into models easily.
Stability destabilises in the end. We make mistakes. So, you’re trying to make a system that is as resilient as possible. I would probably want to make it even more resilient but at least it’s moving a little bit in the right direction. And I’ve been very supportive, as you know, of your attempt to make the straight leverage ratio a central part of the regulatory tools, because one of the things I’ve learnt is that risk–weighting is so unreliable.
TG: But don’t go too far on the capital leverage ratio because, in the US context, you’ll just make banks a smaller share of the system and you’ll think that’s good for all times but not really.
MW: But I would apply higher capital ratios to everything.
I will tell you when this is going to be published. I hope not too long in the future but we have a little juggling to do.
TG: Good to see you.
MW: Lovely to see you.
Read Martin Wolf’s Lunch with the FT with Tim Geithner
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