Geithner On The Banking System

As the Treasury begins a series of stress tests on the nation's biggest banks, Treasury Secretary Timothy Geithner says he wants to ensure that the financial institutions will have enough money to "withstand a more challenging economic environment." Below is a transcript of an interview Wednesday with Geithner by NPR's Adam Davidson.

Adam Davidson: Can you help us understand these stress tests that are starting today? What is it that you want to know that you don't know already?

Timothy Geithner: And ... you could think of these like a health assessment. You know, anybody running a major institution, any supervisor systematically does things they call stress tests. It's sort of an integral part of what these banks do and what supervisors do.

But what we want to do is to bring a more realistic and more conservative, more consistent forward-looking assessment so that we are confident that these institutions are going to have the resources necessary to withstand a more challenging economic environment. And to do that, we're going to make sure that they have support from the government in terms of capital from the government where that is necessary. And this will allow us to target our resources more selectively to where they're most needed. And they'll help lift this cloud of uncertainty that's now weighing on the financial system.

Can you give us a picture of what you know now? And I know you can't speak to any individual bank, but, you know, when we look at the publicly released documents about banks, it's very hard for anyone in the market or anyone in the press to have a sense of which of their assets might be toxic, which might be overvalued. Do you know all of that stuff? How much do you know about the big banks in America?

Well, I think, you know, you're basically right. That source of concern and uncertainty across the market is part of what's weighing on the system. Now, the source of the uncertainty is partly just concern about how deep the recession may be and what ultimate losses may be in that context. And that's something that the president's broad agenda is going to confront directly because, by providing really very substantial support to help create jobs and support private investments for this recovery and reinvestment plan, we're going to make the recession shallower and shorter than it would otherwise have been. And that will help with this uncertainty.

But part of the uncertainty is, as you said, just because it's difficult for people to understand how to read what the relative financial strength of these institutions is. So our approach is designed to try to get ahead of this, bring a more forward-looking approach and therefore lift that cloud of uncertainty over these institutions. And it's going to require not just, again, this carefully designed, more forward-looking assessment about the relative health of the banks, but also that the government provide support in the form of capital so that they are able to withstand the more challenging environment that we may face going forward.

Now, I would think a fair number of citizens could say, wait a second, we're — depending on when you start the clock, you know — two years or one year or six months into this horrible crisis and you're telling me that the government doesn't have a strong, forward-looking, hard-headed assessment of the health of the banking system?

Well, I think that, again, we want to make sure that it's done more consistently and more realistically across banks and across the supervisors. So this is part of what banks do and what supervisors do. But, frankly, it needs to be done more carefully and with a more forward-looking, realistic approach.

Do you know or does your staff know whether or not some banks are likely to be insolvent at current market rates? Is that something you know now or you will only know once the stress test is completed?

Adam, you know, our system is a remarkably diverse system. You know, we have 9,000 banks. A lot of those institutions were not part of the problem; they're going to be a really important source of the solution. You see them expanding as other parts of the system scale down a little bit. And there is a lot of strength in our financial system. And institutions today, as you look at them, hold quite high levels of capital relative to what they would have held in previous downturns.

But, again, what the market is doing is looking forward. And what we want to do is make sure that policy looks forward, too, and provides reassurance to the markets that there is going to be enough capital and resources so that these institutions can play their critical role in the system going forward.

I see. So, I mean, it does seem like —

You should think about it — one way to think about this is: This is a way to provide an additional cushion, an additional buffer of capital, a greater form of insurance against the possibility that we face a more challenging environment going forward because that cloud of uncertainty is now weighing on the system and the best approach we know is to try to get ahead of that, try to resolve that.

Is it possible that there are large banks in the U.S. that are effectively insolvent? That's what we keep hearing from economists and market folks. Is that possible?

Well, let me try it this way again: If you look at our system today, our system has quite high levels of capital relative to what we've had going through a recession like this in the past. But, again, what we want to make is that if you look forward that the market understands that there will be support in terms of capital from the government where that's necessary so that there is enough strength to support credit.

So what is ... the best-case scenario? And then, if you could, paint the worst-case scenario — what would be bad news from the stress test?

Well, I think the stress test will help us restore confidence, reassure the system that, again, where there needs to be some temporary support from the government that it's there and provided and it will help make it clear that we're — that support is not necessary. These institutions are strong enough to go forward on their own.

So you should think about this as a form of contingent support to provide an additional level of comfort so that all of those institutions can do their critical thing to get through a — provide credit in a more challenging environment.

And, again, this is overwhelmingly about trying to make sure there's enough credit to support recovery in the United States. And banks play a critical role — not the only role. You know, we also have a very aggressive program of lending designed to try to get the credit markets going again so that small-business lending, consumer lending, automobile financing also gets going again.

And, you know, this is not a pass-fail test; it's designed to try to make sure that there's the additional buffer of confidence, of capital. You could think of it as a form of insurance. So, again, these institutions were able to play their role. Without that there's a risk that they hoard capital, hoard liquidity, they try to husband their resources and they're not taking enough risk. We want to make sure they're taking the kind of risk they need to make, take responsible risks trying to make sure that recovery comes more quickly than it otherwise would.

Sure. I want to switch a little to these toxic assets. I mean, we at NPR and journalists around the world and certainly people in the regulatory world have looked at a lot of these toxic assets ... these CDOs and CDO-squareds. And I'm just curious, have you spent or does your staff have a sense -– I mean, we're talking about the overall banks' capital structure and the overall banks' ability to withstand shocks? But have you spent time looking at these toxic assets? Do you have staff sort of tracking down the mortgages that underlie some of the other more exotic asset-backed securities that underlie some of them?

Well, the supervisors of the country -– you know, we have a complex network of bank supervisors, banking authorities, financial agencies -– they have examiners in these institutions examining the financial strength of these firms. And as part of that, of course, one of the central jobs they have is to look at the risk in a whole range of different loans and assets these guys have, not just those related to real estate that you are referring to, but everything else, too.

And that job is to try to make sure that, again, people are making appropriate judgments about what the risk in those assets are.

I talk to a lot of people at the IMF, because what's very interesting is, as you know, obviously, they've dealt with tons of banking crises.... As far as I can tell, the IMF technocrat response is, this is actually not that complicated. It's pretty straightforward and it's what we've told many, many countries to do. You need a clear, transparent accounting of the health, today, of the banks.

Which is what our health assessment is designed to do.

So we are doing that with the stress tests. And you'll probably need to shut down a fair number of banks, to -– I hate to use the "N-word" -– well, a lot of people don't use the nationalize word; they say you need to have a supervisory period where you basically take the –- the government backstops the assets and sells them off. Are we following that kind of IMF, technocratic approach?

Well, Adam, what we're doing is following what I think are the basic lessons of history, of governments in financial crises, which is that if you underestimate the problem, if you do too little, too late, if you don't move aggressively enough, if you're not open and honest about trying to assess the true costs of this, then you will face a deeper, long-lasting crisis.

And our judgment is that the necessary response is to try to bring more confidence, more transparency to the strength of the system, to try to make sure that we make capital available where it is necessary to help get credit flowing again and to try to provide the kind of direct support that is necessary to get the credit markets flowing again, because, I think as you know, in our system –- our system relies not just on banks, but you know, 40 percent of the loans in a typical period come from the securitization markets and student lending, small-business lending, automobile financing, commercial real estate financing –- large parts of the mortgage market depend on those markets.

So our approach is designed to move on all those fronts, to do so quickly, on a substantial scale. And I think that approach is the necessary approach and it reflects, again, the very painful lessons we've seen in other countries, where they took the different approach, which is to kind of stretch it out, delay the pain, hope it will be less expensive, less costly over time, and to try to do it with more gradualism and more tentatively. And I think that's the wrong approach and we're not going to take that risk.

Now, I don't have to tell you, there are people screaming that there is a more radical approach and, you know, I'm guessing that you have turned off CNBC many months ago and don't watch all the financial blather out there. But you do know that there is a huge number of people who think that the U.S. government is propping up insolvent institutions, protecting shareholders and bondholders from suffering the loss and putting the taxpayer in the first-loss position.

Adam, we're not going to do that, and that's not our strategy. You know, we are going to make sure that we leave the system stronger, not weaker, that where we do exceptional things, we do so with conditions that are going to make the institutions stronger, with conditions to provide for an appropriate level of accountability, and on terms that make sure that private capital will come and replace public capital as quickly as possible. We're going to be very careful that our approach meets that basic test of principles, because it's not just necessary for confidence that we're using taxpayers' money wisely, but it's the best way to make sure that we fix the system more quickly.

But at the end of the day, isn't there basically three buckets of money? There's shareholders, debt-holders and taxpayers, and you've basically got to pour the money out of one of those buckets. You've got to pick. And it seems like we're picking the taxpayer.

You mean –- no, I don't think that's right. What we're trying to do is to make sure that we solve the crisis at least cost to the taxpayer with the best gain in terms of getting credit flowing again, and the system's stronger for the future. That's the basic tradeoff we're trying to balance, and everything we do is designed, again, to make sure that we're solving this as quickly as possible with the least cost to the taxpayer. And that's why the conditions are so important and that's why we differentiate carefully across institutions; that's why we use the money selectively and that we put it in the ways where it's going to have the biggest effect and get the credit flowing again.

You talk about getting confidence and doing this process -– this stress-test process -– to get the confidence; how do you rate yourself right now –- both you, personally, and just, the administration's efforts? Where are you on getting the confidence of markets in our banking system?

Well, you know, Adam, again, we're making the necessary judgment that the only way to strengthen the system is to put the system through a process where we bring a more realistic, transparent assessment of relative strength of institutions with a clear commitment of support from the government that these institutions will have the resources necessary to play their critical role in the system. That's the judgment we're making and that process is necessary to try to get ahead of this. If we don't do that, the risk is that we're going to keep chasing this, we'll be behind it and we'll leave a bigger cloud of uncertainty over the markets for a longer period of time.

So when you say a clear message that we are behind the banks, I mean, what I'm hearing is the U.S. government will guarantee the debt of the U.S. banking system –- am I way overstating that?

Well, you should view it as I said, and if you looked at the -– you know, we issued a very powerful statement by the secretary of the Treasury, the chairman of the Fed, the chairman of the FDIC on Monday, and the president has said this consistently. And it's really important for people to understand, which is again, to get the credit necessary for recovery to be firmly established, we need to make sure that we strengthen the system and that these institutions have the ability to provide this critical function. I mean, credit is the lifeblood of the economy. Economies don't work without it, and the necessary path to recovery is to make sure that there is enough confidence in these institutions and they have the resources to play that critical role.

Right, we need credit intermediation, obviously. Can you just lay out why is nationalization -– why do we keep hearing that it is not an option, that is not where we're going? Is it a practical problem? Can we leave the politics aside -– what are the practical challenges? Why is that a hard option?

Adam, it's not the right strategy for the country for basic, practical reasons that our system will be stronger if it remains in private hands with support from the government to make sure those institutions can play their critical role going forward. And of course, where we have to do -– where we have to provide a meaningful level of support, we're going to do that with conditions to make sure that support helps benefit the flow of credit, again, comes with conditions to make sure the institutions are stronger, not weaker, as a result of it, and that it comes with appropriate accountability.

And again, the really important thing is ... that we do so in ways that improve the odds that private capital comes in and replaces public capital as soon as possible. And that's a basic, pragmatic judgment about what's going to be most effective in resolving the crisis at least ultimate cost to the taxpayer and to the economy as a whole. And you know, I understand that there are proponents of the alternative approach, but I am confident that that broad strategy would cause more damage to the economy and the financial system –-

The nationalization strategy.

That broad strategy would –- people mean different things by it, but what many people mean –- would be more damaging to the cause of getting the financial system working again more quickly and supporting the kind of flow of credit necessary for recovery -– and again, in a way that minimizes ultimate costs and risks to the taxpayer. That's the central imperative we face.