2009 1117 - FCIC - Hearing - Financial Crisis Inquiry Commission - Timothy Geithner - Closed Session

  • (p3) - Secretary Tim GEITHNER:  So you guys have a list -- I saw some of the lists you presented that had 21 causes.
  • CHAIR ANGELIDES: 22.
  • Secretary Tim GEITHNER:  22? Those are a pretty good list.
    • I want to kind of give you a hierarchy of what I think was most consequential.
    • I’m not claiming perfect foresight. I’m not claiming unique wisdom.
    • Obviously, I’ve got biases just in a prism of my past, like everybody else. But I think it’s important for you to hear that from me, because you can view everything I say after this, when I get to do this more formally with you guys, and through this prism. Okay?
    • So I think my list has eight or something like that, or seven
    • .......... long period of relative stability.......
      1. Mistakes in Ratings, Risk Management
      2. Second, not different, though, is the basic monetary policy, global imbalance thing.
      3. Third. The simplest way to think about regulatory failure in the United States is, I think, through the following prism: 
        • Shadow Banking - investment banks --  AIG, to some extent, for the guys who are sort of operating as quasi-thrift finance companies. Countrywide is the best example.
          • Again, they were basically banks run with a huge amount of leverage liquidity risk. And when the world turned and people were unwilling to fund these guys, they came crashing down, putting a huge amount of pressure on the rest of the system. 
      4. Incentives - compensation structure, tax regime did to incentives to borrow, accounting system
      5. Moral hazard
      6. Regulations and Enforcement
      7. Inadequate tools for containing the damage - why the
        crisis got so bad
  • (p10-11)  - Secretary Tim GEITHNER - The final-final point, which is not so much about the cause of the underpinning -- underlying vulnerability in the system but mostly about why the crisis got so bad is, you know, we came into this crisis, the United States of America, with deeply inadequate tools for containing the damage. There are two -- to make it simple, there are two types of tools that we did not have as a country. One is for managing failure of large, complex institutions, we had it for banks and thrifts but did not have it.
    • The Secretary of the Treasury at that time, to his enormous credit, proposed legislation in the immediate aftermath of Bear Stearns to remedy that problem. Still don’t have it today, although we’re hoping to get it today, soon.
      • ⇒  And it’s, bankruptcy doesn’t work for financial institutions. It’s a complicated question, but I’m sure that’s right.
      • And lacking that authority made the crisis much more damaging than it should have been.
    • The other thing is the authority to contain financial panics. This was a classic financial panic. A crisis that involved, like, the failure of a couple firms because of just mismanagement are not hard to deal with. But broad-based financial panics, hundred-year floods are very hard to deal with.
      • But because we allowed this enormous banking to grow up outside the banking system itself with no tools to contain panics there, there was much more damage than there should have been.
  • (p15-16) - Secretary Tim GEITHNER: The way -- I should have said it a little, slightly differently. I think there are these two gaps in the system.
    • One is around institutions like, you know, AIG, major investment banks, the Countrywides of the world.
    • The other was around what you might call “markets.”
      • And the way the derivative market evolved and the way the secured lending, the securities lending, tri-party repo markets evolved, you had a system where contagion was going to spread much more broadly when institutions were at risk.
    • ....
    • (p16) - But it’s not for the reason many people talk about because, in fact, the direct exposure these firms had in their derivative positions, their exposure to hedge funds, was pretty modest relative to capital. They actually managed overall exposure relatively  carefully relative to capital. There was just panic-inducing behavior from the way the weakness spread across the system, both through the funding mechanism and in some sense in the derivatives markets.
  • (p17) - COMMISSIONER BORN: Largely, because of a lack of transparency? 
  • SECRETARY GEITHNER: I think part of it is that; but, again, derivatives -- if the monoline insurance companies and AIG were not allowed to -- were not able to write huge amounts of protection with no capital to back it up -- when I said about capital, I meant among the regulated in the areas -- if they had not been able to overwrite those commitments, it would have been a less serious crisis -- a much less serious crisis. And that’s just a more simple thing.
    • It’s not about derivatives so much as being no capital to back a commitment.
      • It doesn’t need a fancy -- it’s not a fancy product or even so much oversight of derivatives.
      • It’s just the regulatory authority responsible for those institutions did not force them to hold capital against their commitments.
  • Secretary Tim GEITHNER: AIG -- inconceivable to me, going into the weekend, that we should or could do anything about AIG. I was completely against it. I thought it would be a mistake, not necessary. But I thought about it a lot.
    • I spent a lot of time over that weekend when we were doing this, looking at the way the insolvency regime would work for a global insurance company, and looking very, very carefully at the alternatives and what their basic balance sheet looks like. And I think there were three things that were sort of clear in the end.
      • One was that it would be a terrible mess, much worse than Lehman. Because they had Lehman-type risks for the entire system, but they also were an insurance company. They had written a huge amount of contracts. They would have the classic retail insurance panic that would have, in our judgment, made it much worse.
      • So it was -- I learned something about it over the weekend. Interesting. The insolvency regime had no capacity of managing.  --   It would have been just a terrible nightmare. Remember, it’s 80 countries, 50 states. Not designed for this.
        • ⇒ We spent a bunch of time with the insurance people, the experts on how this thing would work, it was a terrible, terrible mess.
        • I can’t be sure, but that was our basic deduction.
    • The other thing was, in the eyes of many people, their underlying insurance companies, which are generating a lot of earnings over time, made the whole company basically probably conditionally solvent if they could be funded.
      • So we could make the argument, legal argument, that we had the ability as the central bank because we were lending against collateral.
        • Congress had authorized that in 1930, or nineteen-whenever, when they did that.
      • And as long as there was enough collateral to lend against, we had real companies operating businesses that were generating a huge amount of earnings over time, huge market share.
  • (p45-46) - Secretary Geithner: For two reasons: Because it was systemic and because it was an option for doing so. So if it needed both, okay -- if it wasn’t systemic, we would have been indifferent to it. If it was systemic but we had no option, we wouldn’t have done it.
  • Commissioner Holtz-Eakin Can you give us a metric of systemic?
  • Commissioner Wallison: Yes, what do you mean by “systemic”?
  • Secretary Geithner: “Systemic” is, as you guys know, I’m sure better than anybody, nobody knows what’s systemic. It’s completely –- you can’t say it --
  • Commissioner Wallison: What’s the rest --
  • Secretary Geithner: I know, but you can’t say it -- there’s no objective standard of what is systemic. It’s a --
  • Commissioner Wallison: Well, what specific things did you think would happen, is the big question. What would happen if Bear Stearns had failed? What would have happened?