Tim Geithner on How to Fight the Next Financial Crisis

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2:03Hello and welcome to another episode of the All Thoughts Podcast. I'm Traci Alloway. And I'm Joe Wazenthal. Joe, you know what sucks about getting old? You know what? I twisted, I hurt my neck the other day. That's right. And I was like, I said, you know, I was washing dishes and I hurt my neck. And I said, getting old is such a crime. I hate it. But what were you going with it? Well, I was going to say you start to lose shared experiences with a lot of people. And I realize this whenever I make a Simpsons joke. There are a lot of people now who do not get that frame of reference. And I was thinking about this in relation to the financial system and specifically in relation to the 2008 financial crisis.

2:44No, I've had this thought in the last year, which is that we're at the point where the 2008 financial crisis is like capital H history. Right. It used to feel like when both of us started our careers that the crisis and the aftermath was current events, including several years in the aftermath. Now, it's like when I was a kid and I heard about Woodstock or the moon landing, stuff that really was not that long before I was born or whatever. But I had – like various things when I was a kid could all have been the same year, the moon landing, Pearl Harbor, et cetera. That was all just like capital H history.

3:19And we're getting to the point now where the great financial crisis to a lot of people is just not something that either feels relevant or anything except out of history books. That's right. And by the way, just to scare you a little bit more, I asked perplexity how many Americans were born after 2008. And it said 70 million. So that's roughly 20 percent of the population. And if you figure the people who are like under 10 before that means nothing to them either. Anyway. All right. So obviously here at Oddbots, we take our jobs as lovers of financial crisis hindsight and I guess purveyors of financial records extremely serious.

3:54And so we should talk about 2008. We should talk about financial crises. They obviously still exist. We haven't had anything on the scale of Lehman Brothers, but we've certainly had incidents like the collapse of SVB. There was also that market sell-off in August, which kind of came out of nowhere. A bunch of people talking about the risks of the carry trade, private credit. We have all these big worries stemming from the amount of debt the U.S. has to refinance to really idiosyncratic things like the basis trade in U.S. Treasuries. So we should talk about it. Let's do it. OK, so we really do have the perfect guest.

4:34We are speaking with Tim Geithner, the former Treasury Secretary, former head of the New York Fed, now at Warburg Pincus, and also chair of the Program on Financial Stability over at Yale, which is why he's here today. The school is launching something called the New Badget Project, which is an online tool or compendium for designing financial crisis interventions. So, Tim, welcome to the show. Nice to be with you both. So first of all, I got to ask, you know, 200 years ago, Walter Badgett said that banks should lend freely against good collateral, and then there would be no problems. So, you know, are we done here?

5:13200 years ago, we should have had this figured out. Yeah, I mean, financial crises have this classic tragic thing. They're crises of beliefs, in a sense, and they're crises of memory. And it's the loss of memory. It's the absence of any personal experience with what happens when things fall apart. It's the loss of memory about how panics start and what it takes to break panics and prevent panics from turning into great depressions, which is really what causes financial. It was Minsky who wrote that stability breeds instability. So you have long periods of expansion, moderation, and recessions, asset prices going up, which creates the seeds for crisis, causes memories to fade, and allows these beliefs.

6:07There's a lot of folk wisdom in these things. Beliefs that get in the way of people doing what they have to do in a crisis to prevent it from turning into something catastrophic. Do you believe that there could be some new academic, like, okay, there's this new project? Can we actually escape this trap of forgetting history? Is there any prospect for humanity to avoid the endless cycle of forgetting? You know, when I went to the New York Fed in 2003, we were sort of in the foothills of that long financial boom. I had spent the previous 18 years or 15 years at the Treasury and the IMF watching countries confront a whole range of different financial crises, just not in the United States.

6:56And there's lots of reasons why, of course, there's lots of parts of policy where the practice of policy, the design of policy is short of the frontier of knowledge. And closing that gap is a really important thing. If you ask yourself, why is it in the graveyard of mistakes that governments make in financial crisis, why do they make those mistakes? Sometimes it's just because the politics are incompatible with what it takes to break a panic. You know the basic challenge, which is it looks like what you need to break a panic or make people feel safe to keep their deposits in a bank looks like you're aiding the arsonist.

7:33It looks like you're rewarding the arsonist or the imprudent. And so there's a bunch of folk wisdom that gets in the way of doing the necessary thing quickly enough to make a difference. But a lot of the gap is because people don't know what to do. Because as I said earlier, because memory fades. So I think there's a hugely compelling case for giving our successors a better body of knowledge about what works and what doesn't so they can act more quickly and be closer to the frontier of good response more quickly. And that's the basic case for what Andrew Metrick and his colleagues had built at Yale.

8:09You know something, Tracy, one thing, just thinking about this, it occurs to me 2020 when COVID hit, you know, there were a lot of tools on the shelf developed in 2008, 2009. And it sounds like part of the idea is like, let's actually make this a shelf. You know, like, let's actually like put that shelf out there. But it does seem like that helped the rapidity of the 2020 response. I was literally about to ask a taking something off the shelf question. Okay, but on this note, how important is speed when you're fighting a financial crisis? Is it more important to have an idea of exactly what you're going to do?

8:44Or is it more important to, you know, say, whatever it takes, allocate? Fill in the details later. Yeah, fill in the details later. Of course, you have to be able to make the credible commitment that you will backstop the financial system and make it safe to stay and to take risk again. You have to be able to make that commitment credible. but it's not enough to state it. People need to see it. And how you design that mix of risk sharing things that go way beyond budget is critical to the efficacy and the credibility of the commitment. So I think you're right, though, to say that if you look back at that early weeks of the pandemic, it was hugely valuable that a bunch of people around the table then were around the table in 07 and 08.

9:28And that memory of like what might work was still alive. And they could draw from a set of cases, examples, and move more quickly to put them in place. But there is a huge value to speed when you're at the edge of panic. You know, it's like the classic thing, these happen very slowly and then way quickly. And you don't know what the margin is for something that is like burning slowly, turning into something that's catastrophic. And so you need to be able to move very, very quickly. And again, one of the barriers to moving quickly, there's lots of barriers. One of the barriers to moving quickly is when people are not really sure because they hadn't lived it.

10:11There's no people around them in the institution they're coming into who have any knowledge of it. When I went to the New York Fed, I remember initially they had something they called the Doomsday Book. The Doomsday Book was the comprehensive set of precedent of what the New York Fed had done in the decades since the Great Depression. How big is it? And I was quite eager to see this book. And it was a quite fat book. But what was remarkable about the book was in those decades between the Great Depression and 2007, the things the U.S. had had to deal with were relatively modest. Nothing like the classic systemic financial crisis.

10:48And so that body of precedent was of limited value. And you could have people sitting around the table saying, but we should do what Sweden did or not do what Japan did. Or people would have all these debates. But if you ask them, what did Sweden actually do? There was no knowledge of that. And you could spend your time calling the person in Sweden who had done that. But that takes some time. It's so funny because now I have this memory and I totally forgot it. I was a business insider at the time and people were like, oh, the Swedish model of bailouts. And people were like debating this. And I was like, I have no idea what this is.

11:22I mean, I saw that term, the Swedish model of bailouts, dozens or hundreds of times. The number of times I actually read something with some substantive. You mentioned that between the Great Depression and the Great Financial Crisis, we didn't really have to deal with too much. But there were a few. Continental Illinois in 1984. Could those have gotten really bad and become financial crisis-like events had intervention been slower? I don't think that you had that mix of factors then, the type of dry tinder that left you vulnerable to that. Why was that? But part of what makes you vulnerable to a classic panic is when the economy as a whole is so unbalanced.

12:01People have borrowed too much relative to income. There's a whole set of expectations that go into leverage and behavior based on a long period of rising house prices or asset prices. And you didn't have this period we call the great moderation where people get used to the expectation that recessions would be short and shallow and that equity price readjustments, you could call them, wouldn't cascade into something. So you need a long period for the economy to get way out of balance, which was true in 07. It was also true that in the decades after the Great Depression, the financial system outgrew the banking system and outgrew the protections in place around the banking system to prevent excess leverage and runs.

12:43And in our system in 07, this is a very important thing to remember, is that in our system in 07, you had a banking system which obviously did not have enough capital to withstand a terrible recession. But the more consequential risk for the system was you had a non-bank financial system with a set of investment banks and non-bank financial institutions like GE Capital and others and a whole bunch of funding vehicles that had classic bank-type run risk that were able to run with a huge amount of leverage because people had thought the last decades suggest the future would be benign. And so that mix of factors, a more unbalanced economy with a financial system very vulnerable to runs, took a long time to build up.

13:23And I don't think we had that mix of factors until 07.

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15:47Chase for business. Make more of what's yours. Accounts subject to credit approval. Restrictions and limitations apply. Cards are issued by JPMorgan Chase Bank and a member FDIC. So one of the big debates when it comes to financial stability is whether emergency funding should be directed at people versus financial institutions. So how do you think about bailing out banks versus maybe bailing out consumers, helping them to pay their mortgage, helping them to survive through the pandemic? Is that better than underwriting bad assets at a bank or a shadow bank, for instance? Yeah, excellent question.

16:25And they really are not – you can't think of them as choices because there is no credible response to a financial crisis that does not come with a huge amount of what we might call classic Keynesian direct support to households, state and local governments, and to business in some way. And you can figure out your financial system stuff and do that well. It will not be sufficient because you need to use that massive Keynesian arsenal of force to help take out some of the risk of the acute recession. But it's also true that doing the Keynesian stuff is not sufficient. No economy can survive the collapse of the banking system.

17:05And the only way to prevent the collapse of a banking system or a financial system is to guarantee deposits, lend freely against collateral to solvent institutions, and sometimes to recapitalize the banking system. So they are necessary things that go together, and it would be a mistake to try one way out the other. And if you look back, and this is the right way to look back, and part of what Andrew Metrogate's team had built at Yale is just to try to do a careful, analytical, dispassionate look back at mistakes and lessons and choices. And it is absolutely fair to say that the U.S. as a political system as a country did not do enough of the classic Keynesian fiscal response early enough and sustained enough to complement the things we did to prevent the collapse of the financial system.

17:53One of the things that we've sort of realized during the podcast over the years is that even like a story like the great financial crisis in 2008, 2009, people are still debating it. You know, people are still debating why and what actually was the cause. And you still get people who say things like, you know, actually, subprime really wasn't that big. And that actually was not as crazy as it sounded when it was asserted at the time. And it's like, actually, you know, the issue was like it was all those like yield hungry German land banks and stuff like that. I'm curious just for you, like, you know, 17 years later or whatever, are there things that you've changed?

18:26Not in, like, necessarily the response, but when you think back, it, like, causes that, like, you see in a different light today than you did at the time. No, I mean, you should never say no. Obviously, you should look fresh at these things all the time. Or is there any conventional wisdom from the time that you don't think has stood up as well as maybe? I think the enduring debate everyone still has is a good debate to have, which is a version of your question, Tracy, which is that, but couldn't we have done more for the individual? And shouldn't we have done more for the individual? And wouldn't it have been more effective and less damaging?

19:07And absolutely, that's the right question. And the fiscal response of the U.S. in the pandemic is just a good counterexample. there's a good set of arguments that we overdid it in the pandemic but the speed and the mix and the overall force and the composition of the fiscal policy measure put in place there are good counterexample and i think that is a very good lesson of course you don't want to be like you know you don't want to overlearn your lessons of these things i think the other big lesson of course is and we've talked about this is just again that um you know we were as a country we were late to escalate on the purely financial dimensions of the crisis.

19:43And part of that was because, as we talked before, people had no memory of what it takes, and people would debate whether we're going to have a crisis for a long period of time, and that got the way of speed. But probably because in our system, a lot of the very powerful things run through the Congress, and that it takes some time. And normally in our system, and uniquely our system in some ways, because of the checks and balances, things have to feel terrible before you can shake the Congress into action. Things have to feel like issues that people will actually vote on. OK, so how do you actually judge the success of a financial crisis intervention?

20:16Because this seems to me to be the real difficulty here. So you're trying to prove that the counterfactual would have been worse. And that's probably impossible. So how do you go about thinking of this was good, this was successful versus we should have done this, this was a total failure, et cetera? Yeah, there's a bunch of different measures you can use. And of course, none of them are perfect. One is you could look at the quality of the macroeconomic outcomes relative to past crises. And it's not a great comparison. It seems like a low bar. But the classic comparison is to say, what was the depth of the recession, its duration, and what was the path of growth in the US in this experience relative to two things, two comparators?

20:58One is the Great Depression, where unemployment peaked to 25%, and you had like a decade of negative, if not terrible growth outcomes. And the other comparison is to look at the other major economies that went through this crisis and what were those outcomes in terms of basic thing. Depth of recession, speed of recovery, rise in unemployment, loss of income, loss of wealth. And those are not perfect comparisons because everything is different. But I think they're pretty good comparisons. And I think that there's a bunch of arguments that – and Ben Bernanke knows it were written about this – that the size of the shock that precipitated the crisis of 07-08 was larger than at the beginnings of the Great Depression.

21:41And I think by that measure, U.S. outcomes were dramatically better. Our outcomes were also significantly better than those of any other major economy went through the crisis. And I said, you know, we made a bunch of mistakes. We were short of the frontier of what was possible. We were late to escalate, didn't do enough fiscal. So I think we should look at those things with open eyes. But on those two measures, I think that the quality of the choices we ultimately made were quite good. There's one other thing you can look at, which is what is the health of the system that emerges from the ashes of the crisis?

22:18What's the quality of the reforms that are put in place? And I think if you look at, again, these are imperfect things. You can't promote perfect comparisons. But our system emerged with much more capital than the peers of the major US institutions. Therefore, we had a much more resilient system. And I think a system able to help finance a more rapid recovery that was from many other countries. And I think we were able to still preserve a system which is still, I think, best in the world at channeling capital to people who have a good idea. And the wave of innovation, massive innovation we've seen in the U.S.

22:57economy in a decade since and its relative concentration in the United States is partly a function of the fact that we were able to repair the damage done to the system relatively quickly and put in place a set of institutions and ways to fund good ideas that still remains the envy of the world. It's interesting. Tracy and I have done like tons of episodes on like how the financial system has changed post-Dodd Frank. And we've talked a lot about multi-strategy hedge funds and private credit, et cetera. And we can all come up in our minds with scenarios where all that good's bad because, right, it's easy to come up with.

23:33But a lot of times I walk away from those conversations. It's like, oh, seems like a lot of risk-taking activity has, in fact, moved away from deposit-taking institutions. But the deposit-taking institutions still have function. I mean, like, you know, I don't want to jinx it, but it does seem like the financial system that exists today, to some extent, is the financial system that was conceived of with Dodd-Frank. Yeah, of course, as you said, you want to always be careful. Right. And because you won't know until you have the more exacting test of resilience. And the more exacting test of resilience is a severe recession.

24:12Right. That starts outside the system, not within the financial system. And we haven't really had that test yet. And the pandemic was not a perfect test of that system. So we won't really know. But I think you're right to say that the system as it looks today has a banking system which has more capital, better set of protections around it, and the non-bank system has more stable foundations. You know, it's a system where the credit that comes outside the banking system is in relatively stronger hands, less leverage, less run risk. Now, of course, there will be some sadness and there will be some pain and people will lose some money and there will be some failure in even modest shocks in the system.

24:58But that's the way the system should work. The test of a system is, I think Larry Summers said, it should be safe for failure. And you want to build a system that is not prevents failure where failure is inconceivable, but where it's safe for failure. And that means you can allow a fair amount of failure to happen without needing to do the massive escalation that we had to do in that crisis. So speaking of banking reform and Dodd-Frank and capital, I wanted to ask you about Basel. Because in the aftermath of the financial crisis, Basel was this huge, huge conversation. And if you wanted to do something or change something, you had to get all these different countries to come in and agree on that specific thing, all these different policymakers.