Stress Test

1. Financial Crises Are Inevitable and Require Humility

I had learned one thing from previous crises, it was the importance of humility—about our ability to figure out exactly what was going on, and our ability to parachute in with a simple solution.

Recurring Pattern. Financial systems are inherently unstable, prone to manias, panics, and crashes. Human psychology, with its tendencies toward irrational exuberance and herd behavior, plays a significant role. Policymakers must acknowledge the limits of their knowledge and avoid hubris.

Lessons from History. Geithner's experiences in emerging-market crises taught him valuable lessons about the dynamics of financial instability. He learned that crises are always unpredictable and shrouded in fog, requiring a flexible and adaptive approach. Reading Kindleberger's "Manias, Panics, and Crashes" reinforced the cyclical nature of financial crises.

Humility in Action. Policymakers should approach crises with a sense of humility, recognizing the limits of their ability to fully understand the situation or impose a simple solution. This humility should inform their decisions, leading them to prioritize flexibility and adaptability over rigid adherence to ideology.

2. Government Intervention Is Necessary to Break the Cycle of Fear

The government can stand behind faltering firms, removing the incentives that turn fear into panic.

Restoring Confidence. Financial crises are fundamentally crises of confidence. When people lose faith in the safety of their money, they rush to withdraw it from the system, exacerbating the crisis. Government intervention can restore confidence by standing behind faltering firms and guaranteeing financial liabilities.

Money in the Window. Governments can reduce the danger they'll have to use it by putting enough "money in the window." Deposit insurance, for example, removes the incentive for depositors to run on banks. During the 2008 crisis, the government backstopped trillions of dollars' worth of financial liabilities through TARP and other emergency measures.

Taking Catastrophe Off the Table. Financial crises don't end without governments assuming risks that private investors won't, taking catastrophe off the table. This requires policymakers to be willing to act decisively, even when their actions are unpopular or politically risky.

3. The Politics of Crisis Response Are Brutal

We did save the economy, but we lost the country doing it.

Unpopular Decisions. Rescuing financial firms is deeply unpopular, even when it's necessary to prevent a broader economic collapse. Policymakers face intense public anger and criticism, regardless of their actions. The public often believes that bailouts reward the arsonists who set the system on fire.

Political Opportunism. Politicians may initially support crisis response measures, but they often abandon their support when public opinion turns against them. This can damage confidence in the government's ability to keep its commitments and make it harder to resolve the crisis.

Communication Challenges. It's difficult to explain the rationale behind unpopular decisions to an angry public. Even when policymakers succeed in saving the economy, they may lose the public's trust in the process. Geithner acknowledges his failure to effectively communicate the rationale behind the government's actions during the crisis.

4. A Strong International Financial Architecture Is Essential

We weren’t a controlling force. … we could block things, but we couldn’t make things happen unless we persuaded our partners that they made sense.

Global Interconnectedness. Financial crises can quickly spread across borders, making international cooperation essential for effective crisis response. A strong international financial architecture, including institutions like the IMF, is needed to coordinate responses and provide financial assistance to countries in crisis.

The IMF's Role. The IMF can provide countries in crisis with sufficient cash to overwhelm the crisis as well as tough conditions to restore confidence in the markets. The United States should work to strengthen the IMF and ensure it has the resources and authority to respond effectively to future crises.

Building Consensus. The United States cannot act alone in addressing global financial crises. It must work with its international partners to build consensus for effective policies. This requires diplomacy, persuasion, and a willingness to compromise.

5. Financial Regulation Must Evolve to Keep Pace with Innovation

Financial innovation was driving risk and leverage into corners of the financial system with weaker supervision, and that our tools for monitoring systemic risk weren’t keeping up.

Regulatory Gaps. The financial system is constantly evolving, with new products and practices emerging all the time. Regulators must be vigilant in identifying and addressing regulatory gaps that allow excessive risk-taking to go unchecked.

Shadow Banking. The growth of the "shadow banking system," consisting of nonbank financial institutions that engage in bank-like activities without being subject to bank regulations, was a major factor in the 2008 crisis. Regulators must extend their oversight to these institutions to prevent future crises.

Systemic Risk. Regulators must focus on systemic risk, the risk that the failure of one financial institution could trigger a cascade of failures throughout the system. This requires a holistic approach to regulation that considers the interconnectedness of financial institutions and markets.

6. Effective Crisis Management Requires Decisiveness and Overwhelming Force

In an emergency, temporizing half-measures would be riskier than overwhelming force, and ultimately more expensive for taxpayers—not only in dollars, but in lost jobs, failed businesses, and foreclosed homes.

The Powell Doctrine. The Powell Doctrine for military intervention—deploy overwhelming force, but only when American interests are at stake, and only with a clear exit strategy—should also apply to U.S. financial intervention. This means acting quickly and decisively to contain crises, rather than temporizing with half-measures.

Money in the Window. Putting a lot of "money in the window," enough to look big compared to the liabilities that could run, is crucial for restoring confidence. This requires policymakers to be willing to commit large sums of money to crisis response, even when it's politically unpopular.

Avoiding Gradual Escalation. Gradual escalation is a recipe for defeat in a financial crisis. Policymakers must be willing to act aggressively and comprehensively to address the root causes of the crisis, rather than simply trying to manage its symptoms.

7. Transparency and Communication Are Crucial, Even When Unpopular

Uncertainty is also at the heart of all financial crises. They simply don’t end without governments assuming risks that private investors won’t, taking catastrophe off the table.

Reducing Uncertainty. Uncertainty is the enemy of confidence in a financial crisis. Policymakers must provide clear and consistent communication about their plans and actions to reduce uncertainty and restore confidence.

Honest Assessments. Policymakers should be transparent about the risks and challenges facing the financial system, even when it's unpopular. This requires them to be willing to deliver bad news and avoid sugarcoating the situation.

Explaining Complex Issues. Policymakers must find effective ways to explain complex financial issues to the public. This requires them to avoid jargon and technical terms and to focus on the real-world consequences of their decisions. Geithner acknowledges his failure to effectively communicate the rationale behind the government's actions during the crisis.

8. Financial Rescues Must Balance Moral Hazard with Systemic Stability

The truly moral thing to do during a raging financial inferno is to put it out. The goal should be to protect the innocent, even if some of the arsonists escape their full measure of justice.

Moral Hazard. Providing government assistance to troubled firms can create moral hazard, encouraging excessive risk-taking in the future. Policymakers must be mindful of this risk and design interventions that minimize moral hazard.

Protecting the Innocent. During a systemic crisis, the priority should be to protect the innocent, even if some of the arsonists escape their full measure of justice. This means focusing on putting out the fire, rather than trying to punish the perpetrators.

Collateral Beneficiaries. It's impossible to design an effective rescue for the intended beneficiaries—the people who live and work in those countries—without some collateral beneficiaries. The goal should be to minimize the benefits to those who engaged in reckless behavior, while still protecting the broader economy.

9. Strong Leadership and Competent Technocrats Are Vital

Our outcomes were not in line with the experience of other nations, in past crises or this crisis. They were much better.

Competent Leadership. Effective crisis management requires strong leadership at the highest levels of government. Leaders must be able to make tough decisions under pressure, communicate effectively with the public, and build consensus among diverse stakeholders.

Experienced Technocrats. Competent technocrats with expertise in finance, economics, and regulation are essential for designing and implementing effective crisis response measures. These individuals must be able to analyze complex data, develop innovative solutions, and execute those solutions effectively.

Non-Partisan Approach. A non-partisan "get-the-right-answer ethic" is crucial for effective crisis management. Policymakers must be willing to put aside their political differences and focus on finding the best solutions to the problems at hand.

10. The Best Crisis Response Balances Short-Term Needs with Long-Term Goals

We do have to rip the Band-Aid off,” I said. “But we have to make sure we don’t break the financial system.

Short-Term Stability. The immediate priority during a financial crisis is to stabilize the system and prevent a collapse. This may require taking actions that are unpopular or that have long-term consequences.

Long-Term Reform. While addressing the immediate crisis, policymakers must also focus on long-term reforms to prevent future crises. This requires addressing the root causes of the crisis and creating a more resilient and sustainable financial system.

Balancing Act. The best crisis response balances the need for short-term stability with the goal of long-term reform. This requires policymakers to be both pragmatic and visionary, willing to take bold action while also keeping an eye on the future.

Last updated: March 12, 2025