Passages from the
Stress Test Playbook

“Financial crises are perilous, and this won’t be the last one. Yet the United States has no standing army for fighting financial wars, no Joint Chiefs of Staff, no War College. It also has no playbook. All financial crises are different, but they have a lot in common, and there are lessons to learn from this extreme one that can help policymakers and the public during the next one. I hope this story can help illuminate them.” 

—Timothy F. Geithner


“Plan beats no plan.”

“I like to say that concern is not a strategy, but it’s often a prerequisite for good strategy.”

“If you want peace or stability, it’s better to prepare for war or instability.”

“There’s no way to solve a financial crisis without creating some moral hazard, without protecting investors and institutions from some of the consequences of excessive risk taking.”

“It is impossible to design an effective rescue for the intended beneficiaries—the people who live and work in those countries—without some collateral beneficiaries.”

“We learned it could be costlier to offer too little money than too much; as [Mexican President Ernesto] Zedillo put it, when markets overreact, policy should overreact, too.”

“…just because a problem didn’t have an obvious solution didn’t mean it wasn’t a problem.”

“Financial crisis response is, after all, an exercise in triage. The goal is not to save every major firm regardless of its viability; that’s a recipe for the kind of moral hazard that can sustain bloat in the system and increase the risk and magnitude of future crises. The goal is to make sure contagion doesn’t get out of control, killing the healthy along with the terminally ill.”

“It would be easier to correct the mistake of doing too much, I argued, than to escalate too slowly, let the situation burn out of control, and have to correct the mistake of doing too little.  It made more sense to err on the side of averting a financial meltdown, to buy insurance against a macroeconomic disaster.”

“Markets that overshoot on the way up tend to overshoot on the way back down.”

“The natural human instinct in a financial crisis, and especially the political instinct, is to avoid unpopular interventions, to let the market work its will, to show the world you’re punishing the perpetrators. But letting the fire burn out of control is much more economically damaging, and ultimately more politically damaging, than taking the decisive actions necessary to prevent it from spreading beyond the weakest institutions into the core of the system.”

“When you can credibly commit to protect people from a catastrophic outcome, they don’t have to act in anticipation of it. When you eliminate the incentive to run, you don’t have to finance a run.”

“As the emerging market crises and the entire history of financial crises made clear, imposing haircuts on bank creditors during a systemic panic is a sure way to accelerate the panic.”

“In a financial crisis, uncertainty is the enemy of confidence.”

“Even bad news can be more stabilizing to markets than no news. During a crisis, investors and lenders without information tend to assume the worst and run.”

“In a financial crisis, when people think things are bad, things can get really bad, but once people decide things are getting better, that can be self-reinforcing too.”

“Financial crises cannot be reliably predicted, so they cannot be reliably prevented. They’re kind of like earthquakes that way, or they would be if earthquakes were triggered by manias and fears and human interactions.”

“We couldn’t squelch the natural cat-and-mouse game between innovation and regulation, but more conservative capital and liquidity requirements could provide a baseline of safety, especially if we built in the capacity to improve them over time, and we required financial firms to take periodic stress tests based on genuinely dark scenarios. The crisis was a reminder that they wouldn’t prepare for a storm while the sun was shining unless regulators forced them.”

“We couldn’t end bailouts by proclaiming an end to bailouts, or, worse, by stripping away the government’s bailout power; we couldn’t eliminate panics by promising not to act in the face of the next panic.”

“Taking away the fire department’s equipment certainly ensures that the equipment won’t be used, but it isn’t much of a strategy for reducing fire damage. When it comes to financial crises, taking away the tools of first responders is a good way to ensure that the next crisis will burn out of control, culminating in bigger bailouts and greater cost to taxpayers. The more power the government has, the more credibly it can commit to avert catastrophic outcomes; that makes it less likely that it will need to use its power and less likely that catastrophes will occur.”

“‘It’s more dangerous to escalate gradually and incrementally than with massive preemptive force,’ I said. ‘If you can show you’re willing to do what needs to be done, you’re more likely to have the private markets bear the burden of the financing, and you’ll reduce the risk that taxpayers take on too much.’”

“You should also plan for a long war. Long credit booms can produce a lot of damage that can require years of sustained government support for the economy to heal. The deleveraging process makes post-crisis recoveries slow and fragile. Governments tend to step on the brakes too early, weakening the recovery, adding to the economic costs as well as the fiscal costs of the war.”