Book Review: Stress Test

I was already familiar with the Financial Crisis from various other books and sources, but Stress Test provided a perspective from an insider's/regulator's point of view, which I really appreciated.  The beginning of the book provides an overview of Tim's life, as well as his experiences with previous financial crises, such as the Mexican peso crisis, the various asian crises, and Russia.  From Tim's point of view, all of these events provided training and examples for the actions that needed to be taken when the biggest one hit in 2009.  The thesis is that overwhelming monetary and fiscal force must be used in a financial crisis in order to stop the panic of investors--that early guarantees will ultimately cost less than the damage and panic that ensues without them.  I found his points compelling.

After finishing the main points of the U.S. crisis, Tim moves on to the European crisis as well as all the negotiations over the debt ceiling.  Towards the end of the book, it becomes quite opinionated and political.  I was somewhat uncomfortable with the rhetoric, but couldn't really disagree with him either.

The ending of the book feels like he had attempted to write a conclusion over and over and just gave up and put them all in sequence.  It became extremely repetitive and tiresome.

As usual, here are some portions that I enjoyed:
In my Charlotte speech in March 2007, I had expressed concern about subprime mortgage lenders who sold all their loans and didn't face the financial consequences of default.  Some critics later blamed the crisis on this "originate-to-dsitribute" model--on lenders with limited incentives to worry about the long-term creditworthiness of borrowers because they had no "skin in the game".  This was a problem, but Countrywide had plenty of skin in the game.  It hadn't distributed enough of the risks it originated.  It was like a drug dealer who got high on his own supply.  Its main problem was not bad incentives, but bad beliefs--the widespread delusion, profitable for so long, that home prices would defy gravity indefinitely.
The Countrywide episode foreshadowed much of what came later in the crisis.  It was a bracing reminder of the limits of our ability to fix problems outside the traditional banking system--problems that could unleash shocks with the power to harm banks as well as nonbanks.  It also revealed just how dependent the entire financial system had become on fragile short-term funding arrangements, a central vulnerability in every financial crisis.
Goldman Sachs was a particular lightning rod, because Hank and the chairman of my board, Steve Friedman, had both run Goldman, while one of Hank's top aides on AIG issues, Dan Jester, and my markets chief, Bill Dudley, were former Goldman executives.  It has become an article of faith in some circles on the left and right that the AIG rescue was obviously a backdoor bailout for Goldman.  But it wasn't.  The post-crisis investigations documented that Goldman's exposure to AIG through the trades in question was basically flat.  AIG at one point owed Goldman about $14 billion, so the rescue looked like a windfall, but that was mainly part of Goldman's "matched book," where every dollar of insurance it bought from AIG was matched by a dollar it sold to another firm.  So the $14 billion simply passed through Goldman to those other firms.  And even if we hadn't stood behind AIG's side of the bargain, Goldman had protected itself against AIG's failure, too.
But again, the most powerful theory of the crisis was simple.  It started with a long mania of overconfidence, the widespread belief that house prices would not fall, that recessions would be mild, that markets would remain liquid.  The mania fueled too much borrowing, too much leverage, and too much runnable short-term financing, with too much of it happening outside the traditional banking system.  Borrowers took too many risks; creditors and investors were way too willing to finance those risks; the government failed to rein in those risks, and then was unable to act quickly or forcefully enough when the panic hit.
Today, the U.S. economy is still growing modestly.  It's strong enough to create jobs but not to quell the concern that Main Street has been left behind.  The Fed has begun to "taper" its monetary stimulus, reducing its bond-buying by $10 billion every month, and there is no additional fiscal stimulus on that horizon.  But we are getting stronger.  After several years of deleveraging, the average U.S. household is in a healthier financial position, with about 20 percent less debt relative to income.  We still have the world's most innovative, resilient, and diverse economy, and it's considerably more productive than it was before the crisis.  Our divisive and adolescent political culture is still a problem--unable to deliver any policy reforms that could help ordinary Americans, always a threat to make things worse--but most other countries face even more daunting political challenges.