Last October, when the financial crisis was wreaking havoc on the U.S. economy, Congress approved a $700 billion bailout package to prevent major firms from going belly up. The government official in the eye of that storm was Neel Kashkari, a former investment banker from Goldman Sachs, who had followed his previous boss, Henry Paulson, into the Treasury department. Kashkari was responsible for building a team to oversee the bailout and also for deploying government aid to stabilize the financial system.
How did the Treasury department work with the Federal Reserve to make the decisions it did? What kind of regulations should derivatives be subjected to in the future? In an exclusive interview at Wharton San Francisco with Knowledge at Wharton, Kashkari, who left the Treasury two weeks ago, discusses these issues and more.
An edited transcript of the conversation appears below.
Knowledge at Wharton: Our guest today is Neel Kashkari. Neel, thank you so much for joining us.
Kashkari: It’s my pleasure. Thanks for having me.
Knowledge at Wharton: You have a background in aerospace engineering and after you finished your MBA at Wharton, you joined Goldman Sachs. I wonder if we could start by talking a little bit about what you did at Goldman Sachs and what really attracted you to public service?
Kashkari: Sure. As an engineer, I really enjoyed technology development. I went to Wharton to try to find a way to learn about business and marry my technology skills with business. I was a technology investment banker at Goldman in San Francisco advising tech companies on mergers and acquisitions and financings such as IPOs. For as long as I can remember, I’ve had an interest in government. I had been at Goldman for four years. Getting to go with Henry Paulson [to] the Treasury Department was a once in a lifetime opportunity, and I jumped at it as soon as I had the chance.
Knowledge at Wharton: When you joined Henry Paulson at Treasury, what was your expectation about what your job was going to be? When, and how, did it become apparent that basically what you were being called upon to do was to arrest the meltdown of the U.S. financial system?
Kashkari: I didn’t know what my job would be. I came in as senior advisor to Secretary Paulson to work on a variety of policy issues. The first year I was there, I spent a lot of my time on energy policy developing a new alternative energy program to encourage the development of alternative energies to replace oil. I did work with him on India, increasing Treasury’s economic engagement with India.
It was after about a year, in August 2007, that he asked me to lead the Treasury Department’s work on the housing market. We were beginning to see a real strain in the housing market, especially in subprime. As the chief government official in charge of the economy, he wanted to make sure that Treasury had a strong view on housing. So that’s where I first started getting involved in the credit crisis. That then later evolved and developed into my role on financial stability and ultimately the TARP.
Knowledge at Wharton: Help us understand, since you had such an insider’s view of the whole process. As different signs of the economic crisis became apparent and large institutions began to face problems, how was the decision-making process within Treasury and the Fed managed, and how did you develop your strategic response to these situations?
Kashkari: There was very, very close collaboration between Treasury and the Fed, between Secretary Paulson, Chairman Bernanke and then-New York Fed President Geithner. I would call us co-equal partners, where we were literally looking at every tool available and trying to figure out what would be the right policy response for the country — not looking at it from a Treasury perspective or a Fed perspective. I think that collaboration and that trust were absolutely essential.
As the crisis progressed, our tactic shifted. We started out pushing the private sector to raise capital and to recognize losses, hoping that the private sector could adjust and deal with the housing correction on its own. At some point, it became apparent that it couldn’t, and when we realized that risk, we began contingency planning — Treasury and the Fed together — on what we would do if the government had to step in to stabilize the private sector.
Knowledge at Wharton: But how, for example, were decisions made about whether an institution should be allowed to fail or whether it needed a rescue?
Kashkari: Ultimately, that was the combined judgments of Treasury and the Fed — Secretary Paulson, Chairman Bernanke and then-President Geithner at the New York Fed. There was no one test that we looked at. It was a combination of understanding that institution, and understanding how connected that institution was to other institutions. What stresses and strains were in the credit markets and the financial markets? What was the state of the economy?
If you look at Bear Stearns as an example, it is very possible that if Bear Stearns had run into similar trouble two or three years ago, it may have been allowed to fail. But given the state of the credit markets and the broader economy, the decision was made that we needed to step in to prevent a collapse and arrange the merger with J.P. Morgan. So there is no one metric I can point to. Ultimately, it’s the combined judgment of Treasury and the Fed that made those decisions.
Knowledge at Wharton: Did you have any debates on issues, for example, like moral hazard? And how did you arrive at consensus? What did that experience teach you about making decisions under pressure?
Kashkari: We talked about a moral hazard all the time from the earliest days of the credit crisis. It’s known publicly that we offered a perspective that if the government had to step in to help stabilize Bear Stearns, that the Bear Stearns shareholders should not be rewarded for that, specifically because of the moral hazard issue. So it’s something that we’ve been aware of the entire time. At the end of the day though, the test was: Is the cost of the action more or less than the cost of inaction? When the cost of inaction is potentially so damaging to our economy and to every American citizen, then it’s an easy decision to make even if it’s an unpleasant decision to make.
In terms of making decisions under pressure, I learned a lot about myself and my ability to build a team, lead a team under excruciating pressure, and get that team to perform. But at the end of the day, let’s not forget that Secretary Paulson was driving this and was making the ultimate decisions on our big strategic moves. He handles pressure well. He drove us and steered us in the right direction. And Chairman Bernanke ultimately made the tough calls when we had to make the tough calls.
Knowledge at Wharton: In October, Congress approved a $700 billion bailout package. Then you had to head the office for financial stability. Did you have a team in place at that time that could do what needed to be done? How did you go about building that team?
Kashkari: Not at all. Treasury is a policy department. So year-in, year-out, what Treasury is good at is writing papers, writing proposals and doing analyses of policy options. We had to build an investing function to be able to deploy $700 billion in a very short period of time in very complex investments. So we had to build that from scratch. Although I was very involved in the policy making, my primary responsibility was building the team, recruiting the team and executing.
We started out by recruiting the very best senior government officials we could from around the government. We drafted them and said we need you here tomorrow. We were able to recruit the very best from across the government. I would call it bringing on board the best athletes we could find regardless of what their specific skill set was. Each of those folks was charged then with building out their specific operations — let’s say the CFO function or the investing function or the compliance function, getting our operations going and then finding and hiring their replacement. So we drafted great professionals, very experienced people, people who are much more experienced than I am to come in and run different parts of this with me setting the direction for the team, and then building the operation, hiring their successors. That worked extremely well.
By the time I left two weeks ago, after seven months, we had hired about 135 people, all of who were non-political. It was very important for me that we be able to hand the new administration a fully functioning Office of Financial Stability, and that meant I didn’t want political appointees. I wanted the very best career professionals from government and from the private sector so that the new administration would get a fully staffed office. We achieved that.
Knowledge at Wharton: So clearly that goes to the heart of the toughest part of your job, I would imagine. What would you say were your main challenges and how did you overcome them?
Kashkari: We recruited wonderful people who were committed to doing whatever they could to try to help us implement our program successfully. They were not interested in credit or money or glory. It was just about doing the right thing for the country. So that was not the hardest part. That took a lot of effort, but it was solvable because we had wonderful people who were committed to this.
The hardest part was communicating the very complex issues that we were dealing with. The vast majority of Americans had nothing to do with creating this crisis. They didn’t buy homes they couldn’t afford or make risky investments. Yet, because the credit crisis has triggered the recession, it affects every single American family. So everyone is suffering because of this. Trying to explain to the American people why we have to step in to stabilize an institution that made bad decisions with the money of the American people is extremely complex, and our programs are so complex that we have really struggled with that communication challenge. That’s been the hardest part of this.
Knowledge at Wharton: That’s very interesting. And it’s absolutely true, I would guess, that the PR challenge was probably the hardest one. In fact, I saw in the Washington Post that they recently described you as the sponge for Congressional anger. In terms of coming up with your own communication strategy, did you consciously choose not to have too many press conferences and so forth? Or did you weigh the pros and cons between having a high communication strategy and a low communication strategy? How did you think about that?
Kashkari: I didn’t do any television interviews until I left Treasury, and even since, I’ve only done one with Charlie Rose and now this interview. I was focused on getting as much information out to the people, and to the markets, as possible. So I focused my own personal communications on major speeches that I gave once every couple weeks and then on testimony when I testified before Congress. I testified five or six times an average of four to five hours each time. If you would go back and read my speeches or my testimony, it was very detailed because in a crisis, in my experience, people want information. They want to know what we’re doing, the details of what we’re doing and why we’re doing it. So I tried to provide as much detail as possible.
In hindsight, I don’t know if that was the right answer, because while I was providing tremendous details on what we were doing, we were struggling to get some of our broader messages out to the general population in terms of why we had to take this action and what the consequences are if we don’t take this action. If I could do it again, I might change my communication strategy and focus less on details and more on the broader messages. Many experts were asking us for details. I think a lot of my communication was focused on meeting their needs rather than meeting some of the broader needs of why we were taking these actions.
Knowledge at Wharton: That’s very, very interesting. How did you formulate your bailout strategy for TARP? Again, this goes to the communication issue. How did you respond to critics who may have charged that former Wall Street insiders were using billions of dollars in taxpayer money to rescue greedy or incompetent Wall Streeters?
Kashkari: Again, every action that we took was taken to try to minimize damage to our economy for the American people. Not about Wall Street. Not about bankers. That’s the lens through which we look through everything. We have finite resources. Seven hundred billion dollars is a tremendous amount of money, but it’s a finite amount of money. I personally received phone calls from homeowners, from mayors, from governors and from business leaders around the country talking about the stress and strain they feel because of the credit crisis. If we went out to everybody individually who needed help, the money wouldn’t go far enough. Wouldn’t come close.
So we tried to focus our resources on the parts of the financial system that would provide the most bang for the buck. If we could stabilize the system as a whole, then credit would flow out to all the individuals, to businesses and the cities that need it. We were always evaluating where are we going to get the maximum benefit, given our finite resources. We were using every tool in the federal government’s arsenal to try to solve this problem. We also wanted to use the right tool for the right job.
The Fed can lend money, and so there’s no reason that we should use the TARP as a lending facility if the Fed can do that. Again, the TARP was the only facility in the federal government’s arsenal that could inject equity or fundamentally take a risk in our financial system. When the Fed lends money, they need to be secured so they’re not taking much risk. Because the private sector was unwilling to take risk, we needed to take risk in the financial sector.
Knowledge at Wharton: How do you think the situation might play out in the future, because as I understand it, the banks that have these toxic assets will no longer be required to mark them to market. How do you think these toxic assets will get absorbed?
Kashkari: Well, I don’t think that’s true. I think that FASB [Financial Accounting Standards Board] has made some changes on how mark to market is interpreted. I think that it’s too strong a statement to say they will not have to mark them to market.
Knowledge at Wharton: Okay.
Kashkari: I think that the practical implication of that is unclear at this point because it depends on how the accountants and the companies interpret some of these FASB rules. The actions we took in the fall — putting capital in the banks — fundamentally stabilized the system when we were facing financial collapse. Now the focus is on getting lending out to consumers and businesses to minimize damage to our economy.
Secretary Geithner has announced a public-private partnership to combine private sector resources with government resources to go after some of these assets. I’m optimistic that that program will help restart these markets. It’s not a silver bullet and, by itself, will not solve all problems, but I think it’s one important complementary tool.
Knowledge at Wharton: You have a very unique perspective because you were on Wall Street — Goldman Sachs before — but you also were in government. How has your view of some of these exotic financial products changed? Credit default swaps for example. They seem to create the impression that they transfer risk, but, in practice, sometimes they almost appear to make risk invisible. Do you think that we really need these exotic financial products?
Kashkari: I think financial innovation has served our economy very well over the years. I think clearly it got ahead of itself in recent years. I wouldn’t point to the CDS market necessarily. I would point to things like CDOs or CDOs-squared, where people thought that they were distributing risk when they really weren’t. I think that financial innovation is important, but we need to really understand the products and understand how they can behave in unexpected ways.
The fundamental assumption behind almost all the analysis that was done by the rating agencies, by the banks, by hedge funds and by the investors was that home prices could only go up. If all of your models are built on that assumption, and that assumption proves to be false, no financial product will work the way it was intended. I think that we all can do better in terms of understanding risks and testing those risks. Some of those financial products will never come back again. We may never see a CDO-squared again, and maybe that’s a good thing. But I don’t think we should throw out all financial innovation. Our country has really benefited from it.
Knowledge at Wharton: That’s absolutely true. Now moves are afoot to standardize derivatives so they can be traded on exchanges, backed with collateral and so forth. Is there any down side to this in your view? Did we ever really need the high degree of customization that characterizes markets?
Kashkari: I don’t know enough to know for certain. I can see the benefits of customization. If you are an institution, not necessarily a bank, but an industrial company with a specific risk that you’re trying to hedge, it seems rational to me that there may not be a standard product.Nonetheless, I think that more standardization is a good thing. More transparency and more disclosure are good things, I think for all of us. We clearly need to make regulatory changes. My hope is that we do not rush and try to make too many changes in the middle of a crisis. We need to put the fire out, get the crisis behind us with the benefit of hindsight, then take a deep breath and look at what changes we need to make so that we make rational changes going forward.
Knowledge at Wharton: What lessons did your experience teach you about government and Wall Street? Also, what lessons did you learn about yourself?
Kashkari: When I was in the private sector, I foolishly had the perspective that people in government don’t work hard. And let me tell you something. There are people who have been working night and day — career people — again, not for glory, pay or profit — just to try to serve their country and do their best to help the economy — working night and day in Treasury and the Federal Reserve and the regulators. I have tremendous respect for those folks that I didn’t appreciate when I was in the private sector. They work every bit as hard, or harder, than people on Wall Street, without the glory or the pay. So that was an important, humbling lesson for me when I came in and had the privilege of working along side them.
In terms of learning about myself, I feel incredibly blessed to have had this experience, and to get to serve at this important time in our history. I hope that I have the chance in 10 years to come back to government to serve again. I learned a lot about myself, my ability to handle pressure and to try to build a team and motivate people to perform under excruciating scrutiny and excruciating pressure. I’m proud of what we accomplished. I’m proud of the team that I left behind that is now continuing our programs.
Knowledge at Wharton: Just one final question. What advice would you give CEOs about working with the government, and should business schools start teaching MBAs more about government relations?
Kashkari: The latter question I think definitely. I think that careers in government can be incredibly rewarding, and I think that business schools preparing their graduates for potential careers in government will not only help those who go into government, but will also help those who go into the private sector who later have to do business with the government. Better understanding between both sectors, I think, will be helpful. What was the first part of your question?
Knowledge at Wharton: What advice would you give CEOs about working with the government?
Kashkari: I think in this time, the private sector should over communicate to the public sector. Don’t assume that, in government, we’re hearing all the messages from the private sector — all of the perspectives. I would say pick up the phone, call the staff — you don’t have to call the Secretary — make sure your voice is heard so that government has the benefit of the best information we can get from the private sector, so that we understand your perspective and what’s happening in the markets. Then we can design policies that strike the right balance.
Knowledge at Wharton: Neel, thank you so much for joining us today and good luck to you.
Kashkari: Thank you. It’s my pleasure.