By Michael Hirsh, National Journal
It was a little noted event when last fall, during the height of the presidential election campaign, the Treasury Department released Timothy Geithner’s phone records. To the extent anyone paid attention at all—and let’s face it, almost no one did—financial reporters were struck that the Treasury secretary’s most frequent contact was Larry Fink of BlackRock, the world’s largest money manager and Geithner’s principal conduit to his many friends on Wall Street. But the even more telling name of Geithner’s regular confidants, as the Financial Times noted, was the second one on the frequent-contact list: Robert Rubin.
That might seem odd; after all, it’s been nearly a decade and a half since Geithner worked for Rubin, who is long retired from public life. But Bob Rubin was no ordinary employer. The former Treasury secretary under Bill Clinton all but created Timothy Geithner as we know him today, raising him from a junior Tokyo Embassy staffer to undersecretary of the Treasury in the mid-to-late-’90s, and later sponsoring the still-boyish bureaucrat as president of the New York Fed in 2003 (against resistance from the head of the search committee, Paul Volcker, who according to The Wall Street Journal barked: “Who’s Geithner?”). As he almost always has, Rubin prevailed, and for nearly four years his former protégé has lorded over America’s financial system.
Rubinomics: It’s the cult that never quits. Now the nation is faced with a potential new acolyte. Is Jacob Lew, who is expected to be named Thursday as the replacement for Geithner, yet another Rubinite who will largely follow the policies of his predecessor? Calm, brilliant, competent at everything he’s tried—from the Office of Management and Budget to deputy secretary of State to chief of staff—Lew has smoothly run the White House in the year since William Daley left. He has a reputation for unimpeachable integrity and total honesty, as well as a mastery of the budget that will be critical over the next four years of fiscal fights. But many critics fear that the picture is different when it comes to Wall Street. On financial reform, Lew is a virtual cipher who, in his few public pronouncements, has appeared to toe the Rubin-Geithner line of minimal interference with America’s giant banks.
And Lew is taking over as Treasury secretary at a critical time. Two and a half years after enactment, the Dodd-Frank financial law is still not fully implemented. Even as the winds of financial turbulence threaten from Europe, financial-industry officials admit the Federal Deposit Insurance Corp. has not developed the capacity to liquidate banks in the event of a crisis. Although it never became a 2012 campaign issue, financial regulation has lagged well behind schedule (no one even seemed to care, for example, when Mitt Romney failed to propose an alternative to Dodd-Frank, even though he had promised to do so). Wall Street’s lobbyists have managed to delay the “Volcker Rule” —the closest thing we have today to a Glass-Steagall law separating federally insured commercial banking from risky investment banking—by six months. The banks are also engaged in a behind-the-scenes effort to escape U.S. oversight of their derivatives activities overseas.
Into this den of super-sophisticated—and savage—lions of finance will walk the gentle-mannered figure of Jack Lew, who is expected to be easily confirmed. Hopes for change—any real progress in containing the power and systemic size of the banks—are not high. “By going with Jack Lew, Obama is making the decision: ‘I don’t want a fight over Treasury secretary. I want someone who’s going to maintain the status quo.’ That’s what Jack Lew represents,” says Jeff Connaughton, who as a senior Senate staffer fought for financial reform and later, in despair, wrote a book titled Wall Street Always Wins.
A Brief History of Rubinomics
From the very beginning of Obama’s presidency, when Rubin made a cameo appearance at Obama’s first financial crisis meeting—held in September 2008 next to a college gym in Florida—and then kvelled from the sidelines as his two proudest protégés, Geithner and former Treasury Secretary Larry Summers, took over the new administration, Rubin’s influence has continued to be strong. At the same time, however, the ex-Treasury secretary’s reputation has never recovered from the lingering aftermath of a disaster he and his hands-off approach to Wall Street did so much to create. In her stunningly frank new memoir about her major battles with Geithner over the past four years, Sheila Bair, the widely admired former FDIC director, calls Geithner’s surprise appointment in 2008 “a punch in the gut” that made sense to her for only one reason: Rubin’s shadowy power. “I did not understand how someone who had campaigned on a ‘change’ agenda could appoint a person who had been so involved in contributing to the financial mess that had gotten Obama elected,” Bair writes. “The only explanation I could think of was that Robert Rubin had pushed him.”
Over the next several years, Bair continues, Geithner and Summers gradually cut Obama off from other voices, other regulators who wanted to do more to clean up the subprime-mortgage mess or crack down more harshly on the banks that did so much to generate it. To date, not a single financial executive has been indicted in what is widely seen as probably the biggest financial fraud in history, and the biggest banks responsible for the disaster are now even bigger, their trading practices every bit as mysterious. As a result, a number of experts say that, as incredible as it sounds, they may pose an even greater systemic risk to the American economy than they did before.
It is trend that troubles and upsets many progressives. Obama has shown a penchant for making bold Cabinet choices in areas he is personally comfortable with or has a passion for—such as foreign policy—while taking the line of least interference (read: Rubinite) approach on the financial sector and delegating most decisions to Geithner. Exhibit A: In recent weeks, a huge debate erupted in Washington over whether Obama should pick a maverick Republican, Chuck Hagel, as his Defense secretary. Obama did. But if the president wanted a Republican in his Cabinet for the second term, then why not Bair, the tough and prescient head of the FDIC under Bush who irritated Geithner to no end by pushing for harsher reforms? Or Thomas Hoenig, who as a GOP-appointed Federal Reserve governor earned plaudits from the Right and Left for calling for a breakup of the biggest banks?
And where are the bold-minded Democrats like Brooksley Born, the farsighted head of the Commodity Futures Trading Commission who took on Rubin and Alan Greenspan in the ’90s? Or Gary Gensler, Obama’s CFTC chief and a rare renegade Rubinite who has led a brave and lonely battle to rein in the murkiest market of all, over-the-counter (or privately traded) derivatives, but who leaves office at the end of 2013. (“No one has mentioned his name for Treasury or any other post,” laments a close ally of Gensler’s at CFTC.)
Instead, Obama wants to appoint a man who appears to be something of a naïf on financial reform and who, while he may not be as much a part of the Rubin cabal as Geithner was, worked with Rubin in the Clinton administration and later became one of a throng of former Clintonites recruited by Rubin at Citigroup. Liberal analyst Bob Kuttner’s pronouncement back in 2010 still rings true today: When it came to finance, Kuttner wrote, “instead of the team-of-rivals model that Obama had often invoked, Obama hired a team of Rubins.”
The Results Are In
Over the past four years Geithner has come through for the team big time, and the results of his hands-off approach to the chief perpetrators of the worst financial hangover since the 1930s are now in: The basic structure of Wall Street has not changed and arguably has gotten more dangerous. Geithner will likely go down in history as the Treasury secretary who helped avert a second Great Depression—it’s how he sees his own legacy, and he deserves a lot of credit for that—but also as the man who allowed Bob Rubin’s baby, Wall Street, to resurrect itself as a place dominated by the giant, too-big-to-fail banks that still loom over our collective future.
“Banks today are bigger and more opaque than ever, and they continue to behave in many of the same ways they did before the crash,” writes Frank Partnoy, a former Wall Street trader-turned-Cassandra who has been warning since the late ’90s that the U.S. public is getting shafted by banks dealing in OTC derivatives. “It’s what you can’t figure out that’s terrifying,” Bill Ackman, one of the most sophisticated hedge-fund managers in the world, tells Partnoy and coauthor Jesse Eisinger in their article in the current Atlantic magazine, “What’s Inside America’s Banks?” In the gargantuan derivatives-trading positions, Ackman says, “you can’t figure out whether the bank has got it right or not.” Much of the new worry comes in the wake of revelations that even Jamie Dimon, the head of JPMorgan Chase and one of the most respected CEOs on Wall Street, didn’t comprehend the huge loss his London unit took last year. “If JPMorgan can have a $5.8 billion derivative problem, then any of these guys could—and $5.8 billion is not the upper bound,” Ackman says.
This is sometimes known as the Too-Big-to-Fail problem, but a little-noted corollary is the Too-Complex-to-Understand problem. And that poses a big systemic risk for the global economy, if no one knows which are the stronger or weaker banks in the next crisis—which, sooner or later, will come. “What is really dangerous is that investors cannot discriminate between banks anymore,” says Robert Johnson, a former Soros fund manager who now runs the progressive Institute for New Economic Thinking. “It’s like the Greek crisis, but many times larger. Everybody has to back away from all the banks because they know they’re interconnected. They know there are derivatives exposures, and they know the derivatives are not confined by the scale of outstanding debt. None of us as investors in financial institutions can ever say we’re confident they don’t have this stuff.”
The Obama administration consciously let this happen, its many critics say. Geithner and Co. is “enthralled with Wall Street,” says Dennis Kelleher, the head of Better Markets, an advocacy group. “None of [the Rubinites] have been able to come grips to with fact that they laid the seeds” for the 2008 financial crisis, and “that has prevented accountability anywhere down the line.” It has also blinded the administration from addressing the deeper systemic nature of Wall Street’s pathology, Kelleher says. Or as Johnson puts it: “The whole culture of the White House and Treasury is still a Wall Street trading culture.”
What Will Lew Do?
As Rubin was in his day, Jacob Lew may well be the most liked and admired man in Washington. Even so, he should not be dismissed as a patsy. Lew, a former aide to Speaker Tip O’Neill, clawed his way to senior positions through sheer intellect (Harvard, Georgetown Law) and hard work. Republicans are still smarting from his often uncompromising bargaining during two bruising budget battles. “He’s a prince, but his good manners belie how tough he is. I’ve seen him get mad, very stern. It’s not like he’s sort of this happy mensch,” says a former senior Obama administration official.
The real issue is whether Lew is just too far behind to catch up, whether he’ll be a babe in the woods of financial arcana. According to one senior financial-industry lobbyist in Washington, Lew’s appointment is a huge relief precisely because Wall Street executives believe they’ll get something close to another Geithner, or someone even more pliable. Lew “is not a markets guy,” this executive, who would speak only on condition of anonymity, told National Journal. “We could do a lot worse. He’s not openly hostile to the financial sector.”
Until now, Lew has given only the barest hints of his views on finance. At his 2010 Senate confirmation hearing to become head of OMB, Lew was asked by Sen. Bernie Sanders, I-Vt., whether he believed that the "deregulation of Wall Street, pushed by people like Alan Greenspan [and] Robert Rubin, contributed significantly to the disaster we saw on Wall Street." Lew responded that he didn't "personally know the extent to which deregulation drove it, but I don't believe that deregulation was the proximate cause." (For the record, a plethora of experts and Obama himself have said that, as the then-presidential candidate put it in 2008, “it's because of deregulation that Wall Street was able to engage in the kind of irresponsible actions that have caused this financial crisis.")
Like others from the Clinton era, Lew checked his box at Citigroup, working during the two years directly before the 2008 collapse as chief operating officer of the bank’s Alternative Investments unit, which engaged in proprietary trading and invested in hedge funds and private equity groups. Although Lew merely oversaw the books, The Huffington Post reported in 2010 that Lew's unit invested in John Paulson’s hedge fund, which made billions correctly predicting that U.S. homeowners would not be able to make their mortgage payments.
Lew’s defenders say it’s wrong to see him as just another Rubinite. “I don’t think he’s a member of any club,” says Bowman Cutter, the former head of the National Economic Council under Clinton, and a close associate of Lew’s. “Tim was much more a part of that club. He knew all of those people, was close to them. I worked for Rubin.... Tim, Larry were all sort of in the inner circle of that group. But there is absolute no way you could ever say that about Jack Lew. He spent the formative part of his career as a senior staffer on the Hill. That doesn’t mean on substantive issues he’ll have different views, of course. Most of it he’s not going to disagree with it for sake of doing so.”
More tellingly, Obama, by all evidence, is not unhappy with the financial status quo. The president clearly has other issues he wants to spend his political capital on: a deficit-reduction deal, gun control, immigration reform. And Obama seems fairly satisfied with what Geithner has wrought. In a revealing interview with Rolling Stone last fall, Obama sounded the straight Geithner-Rubinite line on Wall Street: “I've looked at some of Rolling Stone’s articles [by acerbic critic Matt Taibbi] that say, 'This didn't go far enough; we didn't institute Glass-Steagall' and so forth, and I pushed my economic team very hard on some of those questions. But there is no evidence that having Glass-Steagall in place would somehow change the dynamic. Lehman Brothers wasn't a commercial bank; it was an investment bank. AIG wasn't an FDIC-insured bank, it was an insurance institution. So the problem in today's financial sector can't be solved simply by reimposing models that were created in the 1930s.”
Connaughton calls Obama’s view “financially illiterate,” and he’s right. The point was not that the repeal of Glass-Steagall caused the crisis. Instead it laid the groundwork—planted the “seeds,” to use Kelleher’s term, along with other key moves by the Rubinites in the 1990s. A crisis of size of what happened 2008 doesn’t occur because of just a Lehman or an AIG is out of control. It happens because the entire financial system is infected by risk, and there are no more islands of safety, such as commercial banking, or any firewalls. This what Rubin’s signature policy, the repeal of Glass-Steagall, began to accomplish in 1999; it ensured there would no longer be any strong firewalls and capital buffers between Wall Street institutions and their affiliates, and between banks and nonbanks and insurance companies. A year later, in 2000, Summers and Geithner pushed for the Commodity Futures Modernization Act, which created a global laissez faire market worth trillions in unmonitored trades. So with the repeal of Glass-Steagall, systemic failure was entirely forgotten while at the same time, with the passage of the CFMA, huge new systemic risks were being created. As Eric Dinallo, the former superintendent of the New York State Insurance Department who dealt with the collapse of AIG, once put it: Deregulation "created a perfect storm of financial disaster."
This was largely the doing of the Rubinites. Yet Geithner and Summers have remained in defiant denial of their responsibility, thus permitting Wall Street to recreate itself in its old image. While Lew was not directly involved, as Clinton’s OMB chief from 1998 until January 2001 it was his office that was responsible for overseeing new legislation and policy, which would have included Glass-Steagall repeal (the Financial Services Modernization Act of 1999) and the Commodity Futures Modernization Act.
In his defense today, Geithner argues that he couldn’t do the first thing he is justly credited with—saving the nation from Depression—without keeping the banks intact. He and his Treasury Department also like to point proudly to the payback for the American taxpayer, since almost all the TARP money has been repaid. But neither of these arguments stands up well to scrutiny. First, the crisis cost the economy trillions of dollars, which has never been regained. And while Geithner’s bailout measures were undoubtedly necessary in the heat of the crisis, by the time the Congress began debating serious reform in late 2009, the banks were somewhat healthy, and yet even then Geithner refused to tamper with their balance sheets. As Bair writes, “I couldn’t think of one Dodd-Frank reform that Tim strongly supported. Resolution authority, derivatives reform, the Volcker and Collins amendments—he had worked to weaken or oppose them all.” (A Treasury spokeswoman refused to comment directly on the Bair book.)
Despite the Obama administration’s inertia, however, simmering resistance to the too-big-to-fail problem appears to be growing stronger. Recently, in a remarkable instance of Right-Left unity, Sens. Sherrod Brown, D-Ohio, and David Vitter, R-La., asked the Government Accountability Office to study the subsidies given to the biggest banks. (Brown is also proposing to limit non-deposit liabilities to 2 percent of GDP, a level that would force the nation’s top five banks to shrink significantly). Obama’s own appointee, Federal Reserve Board Governor Dan Tarullo, called in a recent speech for “a set of complementary policy measures” to go with Dodd-Frank, including a cap on banks’ size, a view endorsed more stridently by several Fed governors (but not by the Obama administration). Perhaps the most startling moment in this rising tide came last summer when Sanford I. Weill, the founder of Citigroup who once proudly hung a sign in his office that read “the Shatterer of Glass-Steagall,” called for a breakup of the big banks, including his own creation.
For Lew, the challenge will be whether he decides that the growing number of dissidents in high places—from Brown and Vitter to Dan Tarullo—are really onto something. The options are there: Lew could decide to endorse the Tarullo proposal, which involves, in part, limiting the expansion of big banks by restricting the funding they get from sources other than traditional deposits. He could personally take up the cause of the Volcker Rule, ensuring that it is implemented as intended, barring federally insured banks from the riskiest trading behavior. Or Lew could simply do what financial officials did the last time around: wait for the next crisis to hit, and then respond.
Remembrance of Rubinomics Past
The man mainly responsible for all this kid-gloves treatment of Wall Street, Robert Rubin, was once the most admired secretary since Alexander Hamilton. That’s what Bill Clinton called him upon Rubin’s departure in 1999. Rubin quickly went to work at Citi for Weill, who wrote frankly in his memoirs that he had hired Rubin to secure a “highly visible public endorsement” for the repeal of Glass-Steagall later that year. Back then this approach to Wall Street was considered enlightened. It was the “globalization” era of the ’90s, when the bond market became known as the benign taskmaster of Washington (recall James Carville’s endlessly quoted line about wanting to “come back as the bond market” in his next life).
There was a style about Rubin that everyone loved—judicious, calm, untouched by the rancor.
And his advice always sounded sage: Don’t tamper too much with finance or the flow of capital; don’t threaten banks’ balance sheets; keep changes minimal. As Barney Frank, the brilliantly caustic former chairman of the House Financial Services Committee, once summed up the Clinton administration’s view to me: “The way to a good life was to leave capital alone. Do not tax it, do not regulate it. If you do that, it will take care of you.” This became known as the “Washington Consensus,” a set of reform policies that Rubin and Co. simplified into a three-pronged formula: rapid liberalization of markets, privatization, and a demand for fiscal austerity from governments.
Like Jack Lew, Rubin was admired by everyone for his low-key personal style. Rubin always had a big heart and a gentle manner: He was a liberal Democrat who, as a young trader at Goldman Sachs, used to show up at New York community meetings on the inner-city poor. Later on he opposed Clinton’s welfare “workfare” reform—a much-criticized compromise with the GOP—as too harsh. He also performed brilliantly as a crisis manager during the 1997-98 Asian contagion; yet somehow he could not see or appreciate its deeper causes, just as he would later miss the crisis developing under his nose as a senior counselor at Citigroup in the 2000s. And in the end he could not bring himself to lay a restraining hand on his former colleagues from Wall Street.
In the year 2010, in an interview with me a decade after his star turn as Treasury secretary, as the floodwaters of the subprime disaster lapped at his executive suite in the Citigroup building on Manhattan’s East Side, Rubin mulled over the consequences of what he had wrought. “We have a market-based financial system, and yet we have a whole bunch of institutions that are too big or too interconnected to fail,” Rubin said in puzzled tones. “Yet the market-based system is the way to go. How do you reconcile all that? The fundamental theory of the [market] case is premised on the notion that failure or success reaps their own rewards. But now that’s not happening.” Indeed, it remains the central pathology of our times: we have created a free-market system dominated by institutions so huge and systemically important that they no longer have to play by free-market rules.
Robert Rubin and his team, including Tim Geithner, did more than anyone to create that reality. It’s probably a fair bet that Jacob Lew will not tamper too much with it.