Stress Test: Reflections on 2008 Financial Crises

Timothy F. Geithner, “Stress Test: Reflections on 2008 Financial Crises” Random House (Large Print), 2014 Paperback, 826 pp.

Author Tim Geithner takes us along during his time at the New York Fed and then as Treasury Secretary through the most harrowing crisis since the Great Depression, from its outbreak in December, 2007 through its resolution in June, 2009.  The financial shock was worse than the one that led to the Great Depression.  Market volatility was more than a third higher than it had been after the crash of 1929; bond spreads would rise more than twice as high; the percentage of household wealth lost would be more than five times worse than in 1929; one of every eight mortgages (a total of 2 million) was in foreclosure or default in the fall of 2009 and another 11 million homeowners were underwater.  Yet, there was almost total opposition by Republicans in congress for any intervention once Obama assumed office, and limited support while Bush was in office.

Note:  the financial programs to save the US economy ended up with a projected positive return for the taxpayer of $150 billion. (P. 753).  But many, if not most, Americans just remember the initial characterization of the financial rescue as a handout.

My Notes:

Pg. 5: In January 2009, after the 2008 Bear Stearns, Lehman, and Washington Mutual failures, Geithner still told the President that they still had five financial bombs to defuse: Fannie Mae, Freddie Mac, AIG, Citigroup, and Bank of America.

Pg. 23:  The recession of 2007 to 2009 was the most painful since the Depression.  At its depths, $15 trillion in household wealth had disappeared, ravaging the pensions and college funds of Americans.  Nearly 9 million workers lost jobs; 9 million people slipped below the poverty line; 5 million homeowners lost homes.  Unemployment rose to 10 percent, but not the 25 percent as in the Depression.  By the end of 2013, it was below 7 percent. US output returned to pre-crisis levels in 2011; output in Japan, Great Britain, and the Eurozone had yet to do so by 2014.

Pg. 123:  Huge swaths of the financial system—investment banks, Fannie Mae and Freddie Mac, and many other large firms that behaved like banks without having to obey bank safety and soundness rules—were outside the Fed’s jurisdiction as well as the Fed’s safety net.  These shadow banks were borrowing short and lending long but were not subject to the capital requirements and other safeguards imposed on banks to limit risk, they did not have deposit insurance to prevent runs, and they would not be able to access the discount window if they faced runs.  The tremendous growth in the financial sector credit from the 1980s through 2007 was almost entirely outside the traditional banking system. 

Pg. 148:  The glut of regulatory agencies encouraged regulatory arbitrage.  Banks often reorganized as thrifts to get the notoriously weak OTS as their supervisor, or shopped for another regulator they thought would give them favorable treatment.  The OTS and the OTC were both funded by fees they collected from the institutions they oversaw.

Pg. 337:  The Troubled Asset Relief Program (TARP) proposed to allow the United States government to purchase $700 billion toxic assets and equity from financial institutions to strengthen its financial sector.  However, when first proposed it went down to defeat in the House, 228-205 with most Democrats supporting it, but two-thirds of the Republicans voting no.  The stock market plunged almost 9 percent that day, wiping out $1 trillion in wealth. This focused some of the opposing Republicans and it was signed into law by President George W. Bush on October 3, 2008.

Pg. 539:  The Stress Test imposed on the banks:

The banking stress tests — which measure whether banks have enough capital and liquidity, management controls and other necessary safeguards to survive various worst-case situations — have been required of banks with more than $50 billion in assets since the passage of the Dodd-Frank Act, which took effect in 2010.

Regulators devise hypothetical future adverse economic scenarios to test banks. These established scenarios are then given to the banks in their jurisdiction and tests are run, under the close supervision of the regulator. They evaluate if the bank could endure the given adverse economic scenario, survive in business, and most importantly, continue to actively lend to households and business. If it is calculated that the bank can absorb the loss, and still meet the minimum bank capital requirements to remain in active business, they are deemed to have passed.

For example, in the U.S. in 2010, the first test used an adverse scenario containing all of the following assumptions:

Loan loss rate of 9.1 percent

Unemployment at 13 percent

50 percent drop in equity prices

21 percent decline in housing prices.

Pg. 562:  The government commitments to the financial system—a combination of guarantees, capital injections, loans, and other support—totaled nearly $7 trillion at their peak  This aggressiveness helped the government end the panic and exit those programs remarkably quickly, with a positive return to the taxpayer.

Pg. 647:  Today banks are subject to what is called Basel III standards, requiring banks to hold much more capital and much higher-quality capital.  The final requirement for common equity is about three times higher than the previous standard and effectively four times higher for the largest banks. 

Pg. 717:  In August 2011 the S&P downgraded the AAA credit rating of the US government announcing its main rationale was political dysfunction—that the debt limit standoff in congress had reduced their confidence that the American political system would be able to agree on more substantial fiscal reforms any time soon.

Pg. 733:  On July 26, 2012, a Citigroup report concluded there was a 90 percent chance that Greece would leave the euro within eighteen months.  And other weak countries in Europe seemed likely to follow.

Pg. 736:  By the end of 2013, unemployment in Spain would be 26 percent.  Overall, unemployment throughout the Eurozone was 12 percent, far worse than in the US, and growth was stagnant, a testament to the dangers of financial turmoil and misplaced austerity.

Pg. 759:  The right has continued to caricature President Obama as an irresponsible big spender, which is bizarre given the actual numbers.  The $1.2 trillion budget deficit he inherited in 2009 shrank to $680 billion by 2013.  Also, the deficit will fall from a scary 10 percent of GDP to about 3 percent in just over five years—partly because of responsible policies like the end of the Bush tax cuts for the most affluent Americans, partly because of premature austerity like the sequester, partly because of the stronger economy. 

Pg. 771:  Responsible policy to deal with a financial crisis is a paradox.  In a brutal financial crisis like 2008, actions that seem reasonable—letting banks fail, forcing their creditors to absorb losses, balancing government budgets, avoiding moral hazard—only make the crisis worse.  And the actions necessary to ease the crisis seem inexplicable and unfair.

Addenda:

Fiscal policy is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation's economy. It is the sister strategy to monetary policy through which a central bank influences a nation's money supply.

Monetary policy is primarily concerned with the management of interest rates and the total supply of money in circulation and is generally carried out by central banks such as the Federal Reserve.

*Nail by nail this account compels the reader to despise our Representatives in congress with only a few exceptions: Barney Frank is one.

*To thrive in a capitalistic democracy without defined pension benefits, it is essential for individuals to be financially literate as well as their government representatives.