Behind the Scenes of Fixing the 2008 Financial Crisis
One of the seminal figures tasked with solving the 2008 financial crisis brings readers behind the scenes of managing the worst financial meltdown in modern history.
The most useful lessons that Tim Geithner learned from managing the 2008 financial crisis came from a tug-of-war between two competing goals: solving the crisis and punishing its perpetrators.
Geithner was the president of the New York Federal Bank and became President Obama’s Treasury Secretary in 2009. His book Stress Test covers the decisions he had to make with the limited resources at his disposal.
Some readers will still be furious at some of the decisions Geithner made, but his crisis management experience holds important lessons for anyone in a position of authority.
What Caused the 2008 Financial Crisis
The 2008 financial crisis was caused by the mass trade of derivatives based on mortgage payments and housing prices. Unfortunately, the mortgages packaged in those securities were based on mortgages that were less likely to get paid than others. Credit agencies treated groups of risky mortgages like safe purchases, because the risk of non-payment was spread across many mortgages.
Instead, these risky mortgages created volatile securities with high default rates. Once the housing bubble popped and these securities began to fail, a long string of banks, lending institutions, and other borrowers discovered many debts they would never receive. Every part of the chain called to be paid back, emptying 401k accounts and pensions tied to the stock market.
Ordinary consumers panicked as their banks ran out of money and their savings accounts depleted. Bank runs added to the financial panic, because banks ran out of cash.
As people ran out of money, they spent less money. Then business decreased and laid employees off, who could spend less money, and the spiral continued. In this environment, banks weren’t lending money to help consumers who needed to pay bills or wanted to make large purchases like cars or homes.
To fix the economy, lenders had to feel confident that the money they lent would eventually be paid back. That meant the discredited rating agencies needed to show that certain banks had safe and responsible balance sheets purged of mortgage-backed securities. Consumers also had to feel comfortable leaving their money in the bank instead of rushing to pull it out.
Geithner had his work cut out for him.
Justice vs. Punishment
One of the ways the government addressed the financial crisis was by buying the bad debt. The Troubled Asset Relief Program (TARP) bought mortgage-backed securities from banks to remove the bad debt from banks’ balance sheets. Many saw — and still do — this and related policies as bailouts for the people who caused the crisis. Geithner acknowledged that was true, but it still had to be done:
“Old Testament vengeance appeals to the populist fury of the moment, but the truly moral thing to do during a raging financial inferno is to put it out. The goal should be to protect the innocent, even if some of the arsonists escape their full measure of justice.”
People who received no government aid while the banks received millions in TARP funds and cash to avoid insolvency had every right to be furious. Once the decision had been made to prioritize Americans’ savings accounts over home foreclosures, the bailouts were decisions that had to be made. However, that approach to the Great Recession is also credited with the rise of populism in the United States.
(The United States seemed to learn a lesson from withholding aid to ordinary Americans during a financial crisis. Remember the stimulus checks and rent forgiveness programs during the COVID lockdown?)
Still, when the banks were back to normal, they continued investing funds in retirement and savings accounts, recovering some money for Americans. Geithner’s biggest obstacles were “moral hazard fundamentalists” who didn’t want to help the banks out of a desire to punish the bankers.
Sometimes the urge to punish must be set aside to end a crisis.
Why Save AIG and Not Lehman Brothers?
One of the most infamous moments of the financial crisis was Lehman Brothers’ bankruptcy. It was one of the largest investment banks in the world, and it couldn’t survive the panic caused by mortgage-backed securities and bank runs.
Geithner recalls the praise he received for allowing Lehman to fail. On the outside, he appeared to enforce strict discipline, letting Lehman suffer the consequences of its failures. The reality was much more banal:
“We had tried but failed to prevent a catastrophic default. That’s still poorly understood, in part because Hank [Paulson] and Ben [Bernanke], who had the thankless job of explaining our actions, decided not to admit defeat in public. They thought at the time confessing we didn’t have the firepower to save Lehman would intensify the panic, which may have been right.”
The government just ran out of money to save it.
In contrast, the government rescued AIG by bailing it out and taking an ownership stake in the company. AIG wasn’t a cheap or arbitrary rescue, because it had something that Lehman and Bear Stearnes lacked:
“Unlike the investment banks, whose franchise value consisted mostly of the willingness of other firms to trade with them, AIG had a vast global empire of income-generating insurnace businesses, which over time could offset the losses from its quasi hedge fund.”
AIG’s purchase was a larger lesson in how to prioritize limited resources. Geithner only had so much bailout money, and it had to go to the firms most likely to recover. AIG had a source of income that Lehman didn’t, and in the mid-crisis uncertainty, bailing out AIG seemed the best use of limited funds.
Using limited resources to make unpopular decisions is a difficult skill, and Geithner’s experience managing the 2008 financial crisis is valuable for anyone looking for a robust case study in crisis management. If there’s one takeaway that sums up Geithner’s experience, it’s an observation he makes about a third of the way through the book:
“…a panic tends to make everyone look feckless, in the same way a mania makes everyone look brilliant.”