What Still Keeps Timothy Geithner Awake at Night?

Gross: After moving to Washington, you put your house in suburban New York on the market for less than you paid for it. Analysts saw that as a great metaphor for the national housing crisis: the Treasury secretary is going to take a loss on his house. Did you manage to sell it?
Geithner: We decided to rent it very early, because rents were better than prices in most of the country, and it was a financially good decision. It wasn't as good a metaphor as people thought.

Before the bust, the financial system was clearly far too big—something like 35 percent of corporate profits in 2007. Has it shrunk enough?
It has shrunk quite a lot already, almost by any measure. The weakest parts of the system washed out quickly, and the leverage at the remaining institutions is much lower than it once was. But don't overdo it. Our financial system is much smaller, as a share of GDP, than the financial systems are in other major economies like the U.K. The profit share of the financial sector was high because U.S. firms were the preeminent global institutions. Ex ante, it's hard to know what the right size of the financial system is, but we need to make sure the system is more stable, less risky, and has a stronger foundation.

Do you think financial-industry leaders get it that they should be less aggressive, less risky?
[Pause] Yes, I do. Our job is not to hope that they decide that, but to ensure it's what happens. There will always be a conflict between what they think is the way to optimize shareholder returns with what works for the system as a whole.

It's common to hear congresspeople complain that "we did the bailout, but this business in my district can't get a loan." Has there been a failure of communication?
I've got lots of weaknesses and failures of communication, but I always tried to say that the capacity to lend will be much stronger because of these [rescue] efforts. In recessions, loan demand falls, and in recessions that follow big financial booms it's going to fall more than usual. You can't view that as an indication of whether policy is working. Our strategy was to make sure that we didn't have a perverse contraction that would starve economically viable firms of credit. We haven't got it perfect yet. But it's been very successful relative to what happened in past crises, and the best measure of that is the sharp fall in the cost of credit.

What about housing? There seems to be universal dissatisfaction with the process for helping people who are facing foreclosure.
We were very careful from the beginning—but the qualifications get lost—to say that we are going to focus the bulk of the financial force on bringing interest rates and mortgage rates down to cushion the fall in housing prices and help stabilize home values, which will feed into people's basic sense of financial stability.?[We tried to make clear] that what we'd do to prevent foreclosure would be very targeted and limited. We wouldn't try to keep people in homes they couldn't fundamentally afford. While we thought we'd lowered expectations, we're still being hung for letting expectations get ahead of policy.

Federal Reserve chairman Ben Bernanke has been batted around in congressional hearings recently. And I hear hedge-fund managers mount critiques of the administration and the Fed that could come out of the pages of The Nation . We're seeing populism from both the right and left.
And the center.

Populism from the center?
Look at independents. The country is torn between these two, not completely unrelated, basic impulses out there. One is that Washington is out of control; those people in Washington did this outrageous, take-over-the-economy type of stuff. And the other is that they haven't done enough to help real people. The crisis came on top of this deep, terrible erosion in the basic level of trust in government and public institutions. That has made it much harder for people to believe that the policies we were [implementing were] going to help.

So you don't think the bailouts were too friendly to Wall Street?
The idea that the strategy was unfair and has principally benefited a small number of institutions in New York is a mischaracterization of the design and result of the strategy. I thought people would have understood this after the failure of Lehman Brothers. But when you do too little and you leave the system with real fear that everything is going to fall apart, like any financial crisis, it hurts the poorest most. A just and fair strategy, even if it is politically hardest to explain and justify, is to use well-designed but massive force to stabilize the system.

How does the assault on the Fed complicate your preference for having it play a bigger role as systemic risk regulator?
It complicates it a lot. But, look, we're not proposing to make the Fed the all-powerful overseer of the entire financial system. We're proposing to trim the Fed's emergency authorities. But the basic principle is that these large, complex institutions need to have a strong set of constraints put on them, designed and applied by the Fed. The Fed got some things wrong, could have done some things better, particularly on the consumer side. But I think basically the Fed was incredibly brave and creative and led central banks around the world away from the dangerous view that this wasn't a serious crisis, and provided a bridge to the government deciding to put the broader economic arsenal to work.

Dial back to March: which of the positive developments that have occurred would you have said would be most surprising?
The [GDP] growth is better and stronger than we expected, than anyone expected, and the dramatic improvement in the strength of the financial system at much lower cost—trillions of dollars of emergency guarantees done, finished, closed down. By adopting a strategy designed to [shore up financial institutions] with private capital, we achieved much better basic results at a much lower cost to the taxpayer. A lot of the insurance we provided came with explicit fees that are going to generate tens of billions of dollars in returns. The stress tests this spring forced people to raise capital and have a more realistic sense of losses going forward. We're going to have $175 billion of the $240 billion in TARP payments back by the end of next year.

There are other costs associated with these efforts, like the weak dollar and the Fed's large balance sheet. Shouldn't we be worried about them?
I don't see that with the dollar. When fear was most acute, people wanted to be in Treasuries and hold dollars. Even today, when you have moments of darkness, people want dollars. The Fed's balance sheet is larger because it understandably decided to run a monetary policy to break the recession. But there are other costs not captured by what we've discussed. The government will bear losses in AIG, the automobile companies, and in Fannie and Freddie. But the losses there will probably be lower than what people think, too.

The biggest downside surprise?
The [high] level of unemployment relative to what was happening in the economy as a whole. I'm not an economist, but almost all forecasters missed that. And that's hugely consequential, because it's the prism through which most people view basic economic health.

What portions of the financial meltdown will the government still be dealing with a year from now?
This was the worst thing that's happened in 70 years, and it's going to have a tail. Unwinding our stakes in autos, in AIG, and in Fannie Mae and Freddie Mac is going to have a somewhat longer fuse. The transition away from this massive government intervention in the housing market is going to take some time. A year from now, the FDIC will still have a large stock of assets from institutions they've taken over.

There's a perception that you regard your portfolio narrowly, as primarily focused on the health of Wall Street, with Main Street a distant second.
My first and essential responsibility was to fix and reform the financial system. That was necessarily going to be the principal part of what people saw. About half my time from the beginning has been spent on the design of the broader economic strategy. The idea that we did not do much for the broader challenges facing the country is completely unjustified. The Recovery Act itself was not just a sweeping, essential force for growth, but included a bunch of targeted investments in education, energy, environment, health care that will have huge long-term benefits.

What keeps you up at night? What do you worry about?
Apart from whether my kids are going to be happy in life? What concerns me is whether we will be able to do well enough on the things that are most important. The hardest thing in governing is to make politically achievable the policies that are economically good, just, and sensible for the country. That's a challenge, partly because of the damage done to the confidence in government and policy in the last two decades, partly because of the populism, and partly because we have to build broad consensus on the Hill in order to do anything meaningful. What countries need in crises the president delivered. He said, this is the plan, and he got it done. But on a range of things that really matter to the future, it requires a coalition to really make legislation happen.

On Intrade, the current-events futures market, there's a contract on a Geithner resignation/firing.
My wife might have created one of those contracts.

There have been, and continue to be, calls for you to go. How do you deal with those?
I spent most of my professional life in this building. Watching the politics of the things we did in the past financial crises in Mexico and Asia had a powerful effect on me. The surveys were 9 to 1 against almost everything that helped contain the damage. And I watched exceptionally capable people just get killed in the court of public opinion as they defended those policies on the Hill. This is a necessary part of the office, certainly in financial crises. I think this really says something important about the president, not about me. The test is whether you have people willing to do the things that are deeply unpopular, deeply hard to understand, knowing that they're necessary to do and better than the alternatives. We'll be judged on how we dealt with the things that were broken in the country. We broke the back of the worst financial panic in three generations, more effectively and at a much lower cost than I think anybody thought was possible.