CRISIS MANAGEMENT
Fed’s Fireman
On Wall Street
Feels Some Heat

Debate Over Bear Stearns Rescue Puts
Geithner in Spotlight; Bernanke’s War Room

By GREG IP
May 30, 2008; Page A1

NEW YORK — As the credit crisis batters Wall Street, Timothy Geithner has been the Federal Reserve’s man on the front lines. The president of the Federal Reserve Bank of New York has worried more about the economic impact of the crisis than most of his Fed colleagues and has pressed hard for aggressive action, say people close to the central bank.

A LOOK BACK

 

• Timeline: New York Fed presidents have played central roles in managing financial crises

His involvement culminated in the March rescue of Bear Stearns Cos., which is expected to be taken over on Friday by J.P. Morgan Chase & Co. in a deal brokered primarily by Mr. Geithner and Treasury Secretary Hank Paulson. (Please see related article.)

Controversy over that move has Mr. Geithner feeling some heat. Many on Wall Street say he helped avert a catastrophic loss of confidence. But even with the crisis seeming to ebb, criticism over the rescue has lingered.

Many argue that the deal creates so-called moral hazard: It could encourage market participants to take more risk because they expect the Fed to rescue them if they fail. Privately, a few Fed officials share those concerns, according to people close to the central bank.

In April, 17 Republican congressmen called for a hearing on the bailout, saying it “exposed the American taxpayers to unknown amounts of financial loss.” Vincent Reinhart, a former top Fed staffer who worked with Mr. Geithner, said recently that the rescue “eliminated forever the possibility that the Federal Reserve could serve as an ‘honest broker.’” When the Fed tries to manage another crisis, he said, market players will expect it to contribute money.

As early criticism of the rescue swirled, the president of the Dallas Fed, Richard Fisher, sent Mr. Geithner an email in Latin: “Illigitimum non carborundum,” along with his translation, “Don’t let the bastards get you down.” Mr. Geithner replied that his grandfather had the same slogan on his kitchen wall.

Mr. Geithner, 46 years old, has had a hand in responding to financial crises for nearly 15 years — first at the Treasury Department, and since 2003, in his current post at the New York Fed.

Fed Chairman Ben Bernanke has set the Fed’s overall strategy during the current crisis, and Mr. Geithner has been instrumental in executing it. At times, Mr. Geithner has counseled Mr. Bernanke against acting too aggressively, which would risk signaling panic, and on other occasions about the danger of not acting aggressively enough.

Associated Press

From left, Fed Chairman Ben Bernanke, SEC Chairman Christopher Cox, Treasury Undersecretary for Domestic Finance Robert Steel, and New York Fed President Timothy Geithner at a hearing on the government bailout of Bear Stearns.

In an interview at his office in lower Manhattan, Mr. Geithner, who looks younger than his years, slouched in an armchair, clicking his pen, shifting his feet and running his hand through his dark brown hair. He said that the impetus for action often came from him, but not always. “At some points we [at the New York Fed] were the accelerator, at other times the brakes.”

In August, Mr. Geithner mediated a dispute between mortgage lender Countrywide Financial Corp. and Bank of New York Mellon that could have cut off Countrywide’s access to vital short-term credit. At other times, he has kept to the sidelines, turning down pleas from bankers to assist in a bailout of insurers that guarantee complex mortgage bonds.

Unprecedented Move

But more than any other government action, it is the Fed’s unprecedented move to save Bear Stearns from bankruptcy, by lending $29 billion to aid its takeover by J.P. Morgan, that bears Mr. Geithner’s personal stamp. Final judgments about that move could make or break his reputation.

Mr. Geithner, whose father worked for the U.S. government and the Ford Foundation, was raised in the U.S., Asia and Africa. After college, he worked for Henry Kissinger’s consulting firm, then joined the Treasury Department in 1988. As a key international aide to Treasury Secretary Robert Rubin, then to his successor, Lawrence Summers, Mr. Geithner was involved in bailouts of Mexico, Indonesia and Korea.

After a stint at the International Monetary Fund, Mr. Geithner was recruited to become president of the New York Fed. He was an unusual choice in some ways. He had never been a banker or trader, and lacked a Ph.D. in economics.

At first, he didn’t make much of a mark on the Federal Open Market Committee, where the Fed’s 12 regional bank presidents and seven governors set interest rates. Colleagues remember him speaking so softly that his microphone had to be cranked up to record his remarks. He was sometimes so cryptic that listeners wondered whether he was for or against the proposal under discussion.

He assembled an informal advisory group that grew to include Mr. Rubin, Mr. Summers, former Fed chairmen Alan Greenspan and Paul Volcker, former New York Fed President Gerald Corrigan, and investment banker Pete Peterson. Mr. Geithner would phone them individually, asking: What should we think about an issue? What are the best three arguments for and against? What do smart people think?

He also initiated a series of dinners at the New York Fed’s executive dining room, in which five or six executives from a major Wall Street firm would meet his own top people. When the credit crisis deepened, he began calling chief executives nearly every week, asking: What’s changed? What’s better? What’s worse? What worries you?

After the credit crisis began last August, Mr. Bernanke assembled a war room composed of Mr. Geithner, Fed Vice Chairman Donald Kohn, who had been Mr. Greenspan’s top adviser, and Kevin Warsh, a Fed governor and former investment banker and White House aide. The four would brainstorm over ideas before Mr. Bernanke floated them with all Fed policy makers.

At first, Mr. Bernanke looked for ways to restore confidence other than simply cutting interest rates, such as expanding loans made to banks through the Fed’s “discount window.” Mr. Geithner cautioned that such moves might not be enough to solve the problem — but could sow fear among investors about the stability of the financial system. He stressed the need to get the right “ratio of drama to effectiveness.”

As the crisis worsened, the differences between the two men narrowed. Mr. Bernanke began to cut interest rates sharply, with Mr. Geithner’s firm backing. The New York Fed became instrumental in designing new lending programs for banks. Investment banks, which weren’t entitled to such loans and aren’t regulated by the Fed, began asking Mr. Geithner to persuade Mr. Bernanke to open the discount window to them as well.

Mr. Geithner says he told them all: “We had not done it since the 1930s. The moral-hazard consequences of doing it are hugely significant. We would not want to do it unless we got to the point we really felt it was the best of a set of bad options.”

Part One: Missed Opportunities As the firm’s fortunes spiraled downward, executives squabbled over raising capital and cutting its inventory of mortgages.

Part Two: Run on the Bank Executives believed they were about to turn a corner, but rumors and fear sent clients, trading partners and lenders fleeing.

Part Three: Deal or No Deal? The Fed pressured Bear Stearns to sell itself, but a misstep in the hastily drawn agreement nearly scuttled the deal.

• The Fall of Bear Stearns: News, slideshows, video, more

He also began getting calls from financial institutions looking for the Fed to broker fixes in the credit markets. Mr. Geithner’s predecessor, William McDonough, had played just such a role in 1998, when he gathered financial institutions in a room and persuaded them to recapitalize the giant hedge fund Long-Term Capital Management, preventing a chaotic liquidation that likely would have hurt them all.

In January, trouble was brewing for municipal-bond insurers that had branched into insuring mortgage bonds. Banks relied on the insurers to backstop their own obligations. Bankers and others grew concerned about broader fallout if insurers couldn’t meet their obligations, and they wanted Mr. Geithner to help broker a solution. But in Mr. Geithner’s view, the problem didn’t lend itself to a collective solution. It was too hard to pin down the scale of the problem, and the interests of the players were too disparate. “We can’t LTCM it,” he told the bankers at one point, according to a participant in the discussions.

“Few problems are really amenable to that type of solution,” Mr. Geithner explained recently. “It’s really rare when we can just get people in a room and hope to solve the problem through that single act.”

By January, Mr. Bernanke was deeply concerned about the economic outlook, as was Mr. Geithner. On Jan. 22, with stock markets falling world-wide, the Fed cut interest rates by 0.75 percentage point, just eight days before a regularly scheduled meeting.

A few days later, Mr. Geithner flew to Davos, Switzerland, for the annual World Economic Forum. Many participants there viewed the rate cut as a clumsy move that suggested panic. In a closed-door session for central bankers and academics, Mr. Geithner forcefully defended it.

According to people who were in the room, he said that the Fed had to “buy a significant amount of insurance” against a “rising probability of a really bad macroeconomic outcome.” He didn’t deny that steep rate cuts risked fueling inflation. “The choice,” he said, “is between which mistake is easier to correct: underdoing it or overdoing it.”

To attendees, the message was clear: The Fed would do whatever it took to avert a financial meltdown. Inflation would be dealt with later.

Caught Off Guard

The speed at which the crisis enveloped Bear Stearns caught Mr. Geithner off guard. Late in the evening of March 12, New York lawyer Rodgin Cohen, chairman of Sullivan & Cromwell, called Mr. Geithner on behalf of Bear Stearns Chief Executive Alan Schwartz. Mr. Cohen told him the firm was deeply concerned about its situation, according to people familiar with the matter. “If Alan is worried, he needs to call me,” Mr. Geithner responded, according to these people.

Mr. Schwartz called Mr. Geithner the following day and told him that Bear Stearns had retained an investment bank to seek a long-term financing solution. That day, a full-blown run began, with customers and lenders yanking billions of dollars from the firm. That night, officials from the Securities and Exchange Commission and Bear Stearns told Mr. Geithner the firm saw little option but to file for bankruptcy protection the next morning.

Mr. Geithner’s staff worked through the night to map the consequences of a Bear Stearns failure. At 7:30 in the morning, $80 billion of short-term loans to the firm would come due. If Bear Stearns sought bankruptcy protection, lenders would get back collateral instead of cash, and they might sell the collateral en masse and pull back on trillions of dollars of similar loans to other investment banks. Bear Stearns had trading positions with some 5,000 other firms. Those firms would be left wondering how to get their money back or settle their positions.

Around midnight, Mr. Geithner slipped away to a nearby hotel to grab an hour and a half of sleep, then he returned to the office, still in his suit and necktie. At 5 a.m., he initiated a conference call with Mr. Bernanke, Mr. Kohn, Treasury Secretary Paulson and other regulators and staffers to talk about what to do. Their main options: let Bear Stearns fail and try to mop up the damage by pouring cash into the financial system, or extend a loan just long enough for Bear Stearns to pursue a merger.

As 7 a.m. approached, Mr. Geithner warned: “We’ve got to make a call here, because markets open at 7:30. What’s it going to be?”

Mr. Bernanke did a head count. All the top officials agreed a loan was the best option. “Let’s do it,” Mr. Bernanke said.

By Sunday night, Bear Stearns had struck a deal to be sold to J.P. Morgan for $2 a share, and the Fed had agreed to lend Bear Stearns $30 billion, backed by the assets on its balance sheet, more than it had ever lent to any institution. The Fed also said it would open its discount window to investment banks, a step Bear Stearns officials complained would have saved their firm had it come a few weeks sooner.

One week later, J.P. Morgan agreed to raise its price to $10 a share, in part to address complaints by Bear Stearns shareholders who were resisting the deal. Mr. Geithner got J.P. Morgan to assume the first $1 billion in potential losses on the Fed’s $30 billion loan.

Averted Disaster

To many on Wall Street, the actions spearheaded by Mr. Geithner helped avert an industrywide disaster. “Thank God the capital markets had him,” says Richard Fuld, chief executive of Lehman Brothers Holdings Inc.

On April 3, Mr. Geithner, with dark circles under his eyes, appeared before the Senate Banking Committee with Mr. Bernanke, SEC Chairman Christopher Cox and Treasury Undersecretary Robert Steel to explain the action. “An abrupt and disorderly unwinding of Bear Stearns,” he said, “would have added to the risk that Americans would face lower incomes, lower home values, higher borrowing costs for housing, education, other living expenses, lower retirement savings and rising unemployment.”

Although fears about a full-blown financial crisis have begun to recede, scrutiny of the Fed’s role continues. On April 8, Mr. Geithner sat on the dais at a New York hotel at a meeting of the Economic Club of New York. Mr. Volcker, the former Fed chairman, took the podium and told the gathering that the Fed had gone to “the very edge of its lawful and implied powers, transcending certain long embedded central banking principles and practices.” Many in the audience interpreted it as a criticism, although Mr. Volcker said in a later interview he did not mean it as such.

When Mr. Volcker was done, Mr. Geithner buttonholed Columbia University economist Glenn Hubbard, the club’s chairman, and asked to address the same group about the same issues.

Mr. Geithner will get his chance on June 9.

Write to Greg Ip at greg.ip@wsj.com

http://online.wsj.com/article/SB121210816211631323.html?mod=googlenews_wsj

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