Can Tim Geithner Lead the Economy Out of Its Mess?

Every year at the end of August, the high priests of the U.S. financial system–the board of governors and staff of the Federal Reserve–gather at a remote resort high in the mountains near Jackson Hole, Wyo., and there, amid the Tetons, listen to lectures by invited economists on a variety of topics, hoping the fresh air and proximity to genuine cowboy bars might lead to clear thinking and sound economic policy.

A good time is usually had by all–except when the global financial markets are sending out warnings of extreme stress to come. By August 2007, the storm known as the subprime crisis had been gathering for much of the year, and inside the Fed, Timothy F. Geithner, president of the New York Federal Reserve Bank and a vice chairman of the Federal Open Market Committee (which sets interest-rate policy), had quietly been raising red flags among his colleagues. Earlier that month, the European Central Bank had startled traders by pumping close to 100 billion euros into the short-term-credit markets–an unexpectedly massive intervention. It was as if the global financial system had had an angina attack, a brief, unexpectedly painful episode that signaled what a few senior Fed officials were beginning to fear: a full-blown economic heart attack might well be coming. During the Jackson Hole meetings, Geithner pressed the view that Fed policy was behind the curve; the problem in the credit markets was big and likely to get worse, and the Fed needed to get out in front of it, to err on the side of being aggressive.

It wasn’t a popular view back then. “He had taken a lot of heat” for the position inside the Fed, a colleague says. Some regional Fed presidents thought he was excessively gloomy. As an insider put it, they thought Geithner had been captured by his constituents–the heads of the largest banks and investment firms in New York, most of whom were leveraged to the hilt and deeply vulnerable to turmoil in the mortgage-backed-securities market. But Geithner’s view prevailed that week with his boss, Ben Bernanke. A few weeks later, the Fed slashed its key interest rate by half a percentage point, and soon it was trying to figure out other, less conventional ways to deal with the growing crisis in the global credit markets. It has been frantically trying to contain that crisis ever since.

It now falls to Geithner to lead the way out of this mess. As Barack Obama’s nominee to be Secretary of the Treasury, Geithner will be tugging on the economic levers himself–levers that are, thanks to outgoing Secretary Hank Paulson, far more powerful than they had been. Colleagues say Geithner privately acknowledges that the U.S. economy is still sinking fast and the root cause of the problem–the housing bust and ensuing credit crunch–is still very much with the nation. Critics will ask at his confirmation hearing how the incoming Administration plans to prevent things from getting even worse. His personal finances may be called into question, in light of the revelation that he initially failed to pay part of his taxes while working for the International Monetary Fund in 2001 and 2002.

All of that may force Geithner, 47, to do some self-evaluation. Along with Paulson and Bernanke, Geithner has been one of the key players overseeing the bailout of the banking industry. Some of the trio’s decisions–like not rescuing Lehman Brothers in mid-September–have come under criticism on Wall Street and Capitol Hill for being hesitant and reactive. Associates say Geithner doesn’t necessarily disagree with the charge that the government’s response “has had an ad hoc, seat-of-the-pants quality to it,” as a senior investment banker in the middle of things puts it. That’s one reason Geithner and the rest of the Obama economic team have indicated that they plan to move more aggressively, on an even broader scale, than the government has to date. Geithner has declined publicly to put a number on just how large a stimulus package the new Administration will seek after Obama takes office on Jan. 20. But associates say he has been emphatic about one thing: the Administration should err on the high side. The package should be big. How big is big? “Big enough,” he has told friends. In this case, he believes, “prudence requires scale.”

Groomed for Success

Most U.S. treasury secretaries come to the job after long careers on Wall Street (Paulson, Robert Rubin), in industry (John Snow, Paul O’Neill) or in politics (Lloyd Bentsen). Geithner, born 14 days after Obama, will, by contrast, be one of the youngest Treasury Secretaries ever, and he will land in the office at one of the most critical junctures in U.S. economic history. But his elevation to the top job at Treasury has long been expected. Geithner has been doing older people’s jobs for years. I first met him 18 years ago, when we were both based in Tokyo. He was 29 years old then and was the deputy financial attaché at the U.S. embassy. We hit it off, as he did with many of the expat journalists in town: he is smart but not arrogantly so and has a wry sense of humor.

Japan was the right place at the right time for Geithner because Tokyo had become a critical post for any U.S. government official. The Soviet Union had collapsed, the Cold War was over, and there was great interest in the alternative Asian economic models that seemed to be performing better than the U.S.’s. Bilateral-trade issues had suddenly become what arms-control talks had been to the Cold War. Geithner made his bones in the U.S. Treasury by helping negotiate a comprehensive deal with Japan that, against all expectations, opened Tokyo’s financial-services sector to foreign companies for the first time.

Those days in Tokyo underpin Geithner’s current worldview. Remember: Japan went from boom to bust because a credit-fueled housing bubble burst. Sound familiar? The result was Japan’s infamous Lost Decade of little to no economic growth. And it was, in part, the withdrawal of Japanese capital from the region that helped set off the Asian crisis in 1997 and ’98–when countries from Thailand to Russia to Indonesia to South Korea devalued their currencies and saw their economies crash. The lesson for Geithner was clear. “From my time in Japan and then dealing with the crisis of the late ’90s,” he once told me, “I got a deep conviction: you don’t want to dither.”

When Bill Clinton entered the White House, Geithner had already returned to Washington, where he worked directly for Larry Summers during the Asian crisis. Summers was Deputy Treasury Secretary at the time and then succeeded Rubin. Now the two will be reunited: Summers will head the National Economic Council at the White House while Geithner runs Treasury. Washington being what it is–even in the midst of an economic crisis, people gossip–there has been much speculation about who will call the economic shots in the new Administration: Summers or Geithner?

The fact is, it’s often hard to tell where one man stops and the other begins. “They had instant chemistry when they started working together in the 1990s,” says a mutual friend. But the question of who will have the most influence on policy is still a fair one. Summers is famously rumpled, brilliant and occasionally rude. During the Asian crisis, he woke up his Japanese counterpart when he found out the Tokyo government was trying to arrange a bailout fund outside the purview of the International Monetary Fund and the U.S. Treasury. “I thought you were my friend!” he told the startled Japanese bureaucrat. Summers was one of the most brilliant economists of his generation at Harvard, getting tenure at age 28–the ultimate economic whiz kid.

Geithner, by contrast, always looks freshly pressed, even dapper. He admits he didn’t care about economics during his undergraduate days at Dartmouth. “I think I took one course,” he says. It is easy, given his relatively young age and his background, to view Geithner as the perpetual understudy to Summers’ intellectual alpha dog. But friends of both say that oversimplifies their relationship. “Tim is whip-smart and has never hesitated to disagree with Larry on substantive issues if he felt Larry was wrong,” says a former Treasury colleague of theirs. Geithner, moreover, has far better political fingertips. “He’s the guy who’d say to Larry, ‘Look, maybe you don’t want to say that men are smarter than women in just this way. You might be misunderstood,'” this colleague says, referring to the imbroglio that cost Summers his job as president of Harvard in 2006.

As it is, there is little apparent daylight between them on the urgency of action once they take office. “I agree with Larry [on macroeconomic policy]–or maybe I should say Larry agrees with me,” Geithner has joked. And as Treasury Secretary, he will oversee the most critical component of any sustainable recovery plan: getting a still wounded financial system functioning again. Colleagues say Geithner is loyal to Paulson, but that doesn’t mean “he would have done things exactly the way [Paulson] did them,” says a source. Geithner, for example, wants to overhaul the dysfunctional, taxpayer-funded Troubled Asset Relief Program (TARP)–initially intended to buy bad assets from banks. The new Administration wants to use the final $350 billion of the bailout program to reduce the number of home foreclosures and funnel additional capital directly to banks and other lenders.

It is clear now that the Paulson team has made mistakes. Not enough of the TARP money that banks have received has been pumped back into the economy in the form of loans. And many question the judgment calls Washington made as the crisis escalated last fall. “No one has yet adequately explained why they bailed out Bear Stearns but not Lehman Brothers,” says the senior investment banker critical of the government’s approach. “That’s not all on Geithner, but some of it is.”

Geithner acknowledges that Treasury and the Fed need to do a better job of explaining their actions. In his defense, he has told friends that there often just hasn’t been time. At key moments, “the overwhelming imperative has been to act,” he has said. “You would have violated the Hippocratic oath if you didn’t.” As the economic crisis deepens, the sense of urgency is undiminished. A friend of Geithner’s says he believes the U.S. “is still not out ahead” of this problem. “We will be,” he has said, “but we’re not there yet.”