In an Uncertain World

IN AN
UNCERTAIN WORLD

TOUGH CHOICES
FROM WALL STREET
TO WASHINGTON

ROBERT E. RUBIN AND JACOB WEISBERG

   RANDOM HOUSE | NEW YORK

CONTENTS

Title Page

Dedication

A Note from the Author

1 The First Crisis of the Twenty-first Century

2 A Market Education

3 Inside and Outside Goldman Sachs

4 A Political Education

5 White House Life

6 Confidence and Credibility

7 Talking Softly

8 World on the Brink

9 A Crisis Considered

10 Hitting Bottom

11 Politics and Business

12 Greed, Fear, and Complacency

13 They Called It Rubinomics

14 A Declaration of Interdependence

Acknowledgments

About the Authors

Copyright

To my parents, Sylvia and Alexander, who have given me so much,
and
to my wife, Judy, my one certainty in an uncertain world

A NOTE FROM THE AUTHOR

PEOPLE WHO HAVE WORKED with me know that I don't believe in certainty. But one thing I thought I was sure of during my six and a half years in government was that I wouldn't write a book after I left. The idea seemed uncomfortably self-focused to me. Yet by the time I departed Washington and the Clinton administration in the summer of 1999, my feelings had begun to shift.

Both in Washington and on Wall Street, I found myself at the center of periods of great change and momentous issues and events. As I thought more about those times, I realized I had much yet to learn from what I had lived through. Writing a book seemed a way to think more systematically about that involvement and to understand it better. More important, I hoped my experiences and reflections might be of some interest and utility to others.

Today, markets are more important to the lives of more people than at any previous time in history. Government is vital to all of us. An integrated understanding of both worlds is necessary to deal with the economic and political issues we face. Having crossed over from business and the realm of markets to government, and now crossed back again, I thought I might be in a position to shed some light on these two worlds and their interaction.

The growing feeling that I had something I wanted to say coincided with an approach from a journalist named Jacob Weisberg, who proposed that we work together on a book growing in part out of an article he had written in
The New York Times Magazine.
That story had at its core a discussion of my fundamental view that nothing in life is certain and that, consequently, all decisions are about probabilities. Talking to Jacob, I became intrigued by the idea of trying to convey to others how my approach to decision making and my view of life permeate all that I do.

After considerable discussion, we decided to collaborate on a book that would draw on my personal history—twenty-six years at Goldman Sachs; six and a half in the White House and Treasury; then four at the world's largest financial institution, Citigroup—to express my views on questions of future importance to policy makers, investors, businesspeople, and all of us as citizens. As we began writing, debate continued to swirl around many of the same policy and political issues that had come to the fore during the Clinton years. For example: What are the merits of fiscal responsibility versus tax cuts as a core economic strategy for the future? Are globalization and market-based economics the right policy paths for the world economy? How can the international community best prevent or respond to the periodic financial crises that so far seem to be an inevitable feature of the advancement of developing nations? Central to all of these issues is the question of how markets behave, a matter also of interest to the average person investing in stocks.

Through narrative and reconsideration of my own experience as a decision maker, I hope to contribute to choices others will make in the future, individually and collectively. That is the primary purpose of this book. I'll share some of the views I've formed through the course of a life in these two worlds—about the psychology of markets, how government functions in relation to the economy, and how to make decisions and work effectively within vast organizations on both sides of the divide.

The second purpose is to explain my method of decision making. A probabilistic approach is far from unusual and, at some level, merely describes what most people do, or think they are doing, when they describe weighing the pros and cons of an issue. But somehow or other, the discussion in Jacob's
New York Times Magazine
piece resonated, and since then people in all kinds of circumstances have told me it affected them. Two years after its publication, I met a money manager on a tennis court who told me he had pinned the key section of the article on his office wall. Someone else I know told me that a manager of a baseball team had also posted that part of the article in his office. (I don't know where that team finished in the standings.)

The best explanation I can offer for why this discussion drew the response it did is something Larry Summers once suggested when we were both at the Treasury Department: that while a great many people accept the concept of probabilistic decision making and even think of themselves as practitioners, very few have internalized the mind-set. For me, probabilistic thinking has long been a highly conscious process. I imagine the mind as a virtual legal pad, with the factors involved in a decision gathered, weighed, and totaled up. To describe probabilistic thinking this way does not, however, mean that it can be reduced to a mathematical formula, with the best decision jumping automatically off a legal pad. Sound decisions are based on identifying relevant variables and attaching probabilities to each of them. That's an analytic process but also involves subjective judgments. The ultimate decision then reflects all of this input, but also instinct, experience, and “feel.”

This book also provides an opportunity for me to explore the thinking that underlies my approach to decision making and to life more generally. At the core of this outlook is the conviction that nothing can be proven to be certain. Modern science says this is so even in physics and chemistry, where the most familiar and fundamental precepts are based on assumptions about perception and reality that cannot be proven. That outlook runs like a thread throughout this book. It has, I suppose, been taking shape from my early college days in Professor Raphael Demos's Philosophy I course at Harvard, to arguments with classmates in the Coke lounge at Yale Law School, to some of the discussions during four years of breakfast meetings with Larry Summers and Alan Greenspan while I was at Treasury.

And once you enter the realm of probabilities, nothing is ever simple again. A truly probabilistic view of life quickly leads to the recognition that almost all significant issues are enormously complex and demand that one delve into those complexities to identify the relevant considerations and the inevitable trade-offs. Some people I've encountered in various phases of my career seem more certain about everything than I am about anything. That kind of certainty isn't just a personality trait I lack. It's an attitude that seems to me to misunderstand the very nature of reality—its complexity and ambiguity—and thereby to provide a rather poor basis for working through decisions in a way that is likely to lead to the best results.

Although the fundamental purpose of this book is to help readers think more clearly about the future, it is grounded in narrative about the past. While this isn't a history or an academic text, my recollections of issues, events, debates, and my own reactions to them may contribute something to the work of historians who study the Clinton years and other times I've lived through. Public service provided me with an unparalleled opportunity to apply my experience to issues that matter to vast numbers of people, here and around the world, and to see how our system of government operates by working at the intersection of policy, politics, and communication. Perhaps in relating my own experiences in government, and providing some sense of the great ability and commitment of so many of the political appointees and career public servants I worked with, this book will encourage young people to consider spending at least part of their careers in public service—for the good of the country and to enrich their own lives. More broadly, I would like to prompt readers to get more involved in our political system by supporting candidates, ideas, and causes they believe in.

For me, the opportunity to reflect back systematically has led to a refinement and a greater rigor in many of the views I hold. The ideas expressed here are mine, but on virtually every matter they have been strongly influenced by many others. I have been fortunate in all phases of my life—in my education, on Wall Street, and in government—to have had colleagues and friends who, through their insight, experience, intellectual power, and philosophical mind-set, contributed to my own understanding. Many of those people combine an ironic attitude toward human pretension, including their own, with a strong sense of purpose and commitment. That mixture of seriousness and irreverence, which especially marked my colleagues and my time at Treasury, is as good an attitude toward daily life as I know. You learn more by listening than by talking, and I've had the opportunity to listen to many who had much of great value to say. My hope is that the views I've developed through a lifetime of such interaction will be of use to others in dealing with the personal, professional, and policy challenges that lie ahead.

Robert E. Rubin

New York City

September 30, 2003

At various points in this book, I relate comments from private conversations or meetings with fellow members of the Clinton administration, business colleagues, and other public figures. The people have graciously granted me permission to quote or paraphrase their remarks. But of course these are my own recollections and any inaccuracies they contain remain my responsibility alone.

CHAPTER ONE

The First Crisis of the Twenty-first Century

ON THE EVENING OF January 10, 1995, I stood on the Great Seal woven into the carpet of the Oval Office and swore to uphold the Constitution of the United States as Secretary of the Treasury. Confirmed earlier that day, I had been waiting all afternoon for the official document that would allow me to take the oath of office. Once the papers arrived from Capitol Hill, a small group of family, friends, and colleagues assembled at the White House for a hasty ceremony.

As soon as the formalities were over, I said good-bye to my wife, Judy, and our other guests and remained behind with President Bill Clinton, Treasury's top international official, Larry Summers, and a few of Clinton's senior advisers, for an emergency meeting about the financial crisis in Mexico.

I told the President that the Mexican government faced an imminent threat of default and that, in the hope of preventing it, we were recommending that he support a massive, potentially unpopular, and risky intervention: providing billions of dollars to the Mexican government to avoid a collapse in its currency and economy. Then I asked Larry to explain the situation in more detail. It took him ten minutes to spell out our essential analysis and recommendation, which we'd finished formulating in a meeting with Fed chairman Alan Greenspan hours earlier. If our government didn't step in to help, and help quickly, the immediate and long-term consequences for Mexico could be severe. But the real reason for acting was that critical American interests were at stake.

The alternatives to the massive intervention we were recommending were not promising. If Mexico defaulted on its foreign obligations, Larry and I went on to explain, the flow of capital out of Mexico would probably accelerate and the peso would collapse, likely triggering severe inflation, a deep and prolonged recession, and massive unemployment. And that would surely have a substantial impact on the United States. Mexico was our third-largest trading partner, which meant that many American companies and workers would be hurt. We presented estimates that a Mexican default could increase illegal immigration by 30 percent, a half-million additional refugees a year. The flow of illegal drugs could intensify as well.

A crisis in Mexico might also hurt us indirectly, by affecting other countries. Fears of a Mexican default were already producing wobbles in developing markets throughout the hemisphere, a phenomenon that came to be known as the “Tequila Effect.” Such a chain reaction could lead investors to pull back from emerging markets around the world indiscriminately. That, in turn, could affect economic conditions in the United States—since roughly 40 percent of our exports went to developing countries. According to an estimate made by the Federal Reserve Board, a Mexican default and the consequent “contagion” that was possible could, in a worst-case scenario, reduce growth in the United States by ½ to 1 percent a year. We weren't proposing intervention for the sake of Mexico, despite our special relationship, but to protect ourselves. That was our case for asking Congress to provide billions of dollars in loan guarantees, as part of a package to be coordinated with the International Monetary Fund (IMF).

As Treasury Secretary, I avoided using words such as “panic” and “meltdown,” preferring less vivid terms such as “contagion” and “loss of confidence.” I'd learned while working in the White House as director of the National Economic Council (NEC) that the words public officials use can make an enormous difference, and that was even truer at the Treasury. I had to describe what was happening in Mexico accurately without being inflammatory. A meltdown, though, is precisely what we were worried about—and not only because of its effect on current economic conditions. With the implementation of the North American Free Trade Agreement (NAFTA), Mexico was hailed as a role model for developing countries pursuing economic reform. The public failure of that model could deal an enormous setback to the spread of market-based economic reforms and globalization.

But there were arguments against intervention as well, which we also laid out for the President. I emphasized that, for a variety of reasons, our rescue package simply might not work. What's more, intervention would almost surely be criticized as “bailing out” wealthy American and European investors who had speculated on developing markets. Putting public funds on the line was likely to be massively unpopular and politically risky. Leon Panetta, the White House chief of staff, was even more blunt in warning Clinton about the downside risk. Leon favored intervention, but he told Clinton that a failed rescue effort could cost him the election in 1996.

When we finished our presentation, the room was heavy with a collective sense of how big a problem this had rapidly become. Larry had tossed out a figure of $25 billion as the amount of U.S. assistance that might be necessary. George Stephanopoulos, a senior adviser to the President, said that surely we meant $25 million. No, Larry said, we meant “billion with a
B.
” That was more than the annual budget of the Department of Justice, enough to buy a fleet of B-2 “Stealth” bombers.

Sitting on a sofa in the Oval Office during my first hour on the job, I was answering questions from the President that I had been asking others only a couple of weeks before. Larry had phoned me in December, while I was on vacation in the Virgin Islands, to bring me up to speed on the unfolding Mexican situation. I didn't know much about Mexico's economic problems, and I didn't understand why a peso devaluation was urgent enough to interfere with fishing. I assumed that Mexico was one of a large number of countries with similar problems and that Larry, a consummate professional in the field of international economics, would take care of whatever needed to be done. But I intended to be a hands-on Secretary, and I liked that Larry was including me, even though I was still in the netherworld of being designated but not yet confirmed as Treasury Secretary.

It didn't occur to me that day that Mexico's problems would shortly blossom into a full-blown economic crisis that embodied the heightened risks of a more global economy. In retrospect, the Mexican episode also offers much insight into the Clinton presidency. The Bill Clinton I watched come to the aid of Mexico was one the public too seldom saw. His seriousness of purpose, his depth of substantive understanding, and his keen intellectual quest for the right decision on Mexico are a continuing reminder to me of the way in which he remains, in important respects, a misunderstood figure. At a broader level, the dilemma Clinton faced with Mexico suggests to me that our politics may not be well suited to coping with the new risks of the global economy.

   

GETTING MY ARMS AROUND a problem like the Mexican crisis meant thinking about it as systematically and dispassionately as possible. The situation, as I rapidly came to understand following my preconfirmation conversation with Larry, was this: After the outgoing Salinas government had spent over $15 billion in a futile attempt to prop up the peso at the fixed rate of around 3 pesos per U.S. dollar, the newly installed government of Ernesto Zedillo had, in late December 1994, surrendered to overwhelming pressure in foreign exchange markets and allowed the Mexican currency to float freely. With only around $6 billion of its foreign exchange reserves left and far more than that in short-term debts coming due, Mexico had little choice. But with the government no longer providing support, the peso fell rapidly to around 5 pesos to the dollar. As the Mexican currency continued to slide, doubts grew about whether the government would be able to repay its debt, much of it very short term and linked to the dollar. Fearing a possible government default, investors were selling Mexican bonds, as well as the peso. In sum, Mexican authorities had lost control of their country's finances.

All of us working on the problem agreed that Mexico, now essentially cut off from private lenders, almost surely could not solve the crisis through its own policies alone. The Mexican government's bond auctions were attracting few bidders, even at dollar interest rates approaching 20 percent. In the short term, the private sector was very unlikely to produce loans on the scale needed to prevent default.

Nor, with requirements this large, could the international financial institutions—the IMF and World Bank—arrange a rescue on their own, as they had in many other cases. Michel Camdessus, the French managing director of the IMF, was unknown to most Americans despite his tremendous influence. Skillful and audacious, Camdessus was prepared to weather the anger of his organization's European shareholders to make a stabilization loan to Mexico of unprecedented size. But the sums needed exceeded the IMF's available capability. The only realistic chance of avoiding disaster was help from the United States. The questions for me then became the possible consequences of financial chaos and default in Mexico, the danger of the program failing, and the possible costs of that failure.

What has guided my career in both business and government is my fundamental view that nothing is provably certain. One corollary of this view is probabilistic decision making. Probabilistic thinking isn't just an intellectual construct for me, but a habit and a discipline deeply rooted in my psyche. I first developed this intellectual construct in the skeptical environment of Harvard College in the late 1950s, in part because of a yearlong course that almost led me to major in philosophy. I started to employ probabilistic decision making in practice at Goldman Sachs, where I spent my career before entering government. As an arbitrage trader, I'd learned that as good as an investment prospect might look, nothing was ever a sure thing. Success came by evaluating all the information available to try to judge the odds of various outcomes and the possible gains or losses associated with each. My life on Wall Street was based on probabilistic decisions I made on a daily basis.

This was the background I brought to the question of whether we should intervene in Mexico. With an enormous number of competing considerations, the key to reaching the best possible decision was identifying all of them and deciding what odds and import to attach to each—probabilistic decision making at work. Doing that also meant recognizing that our knowledge would never be as complete or perfect as I—or the rest of the team at Treasury—would like. Moreover, even with the most systematic and thorough work, a decision, though informed by the facts and analysis, would never emerge automatically from the yellow pad on which I scribbled notes. The final component of decision making was the intangible of judgment. The process of decision making that we evolved in the Mexican crisis—and that I would use over and over again in my time at Treasury—was familiar to me from my life in the private sector. But the range of considerations was much broader. For example, we had to think about the damage that a failed intervention could do to America's credibility. If we attempted to help Mexico and did not succeed, our backing would be a less useful tool in some future crisis.

Success had dangers as well. Even if our efforts helped stabilize Mexico, we might create a problem of what is known as “moral hazard.” Investors, after being insulated from the consequences of risk in Mexico, might pay insufficient attention to similar risks the next time, or operate on the expectation of official intervention. In Mexico, investors had become complacent, following a herd mentality in buying short-term dollar-linked bonds throughout 1994 without paying sufficient attention to the danger that the central bank's currency reserves might not be sufficient to maintain their promised convertibility into dollars. We worried that our program to prevent Mexico's failure might encourage investors to make similar mistakes again in the future.

It was my good fortune to be able to think through these issues with Alan Greenspan and Larry Summers. In our backgrounds, our professional training, and our temperaments, the three of us were alike and very different. Alan is a conservative free-marketeer and an economist grounded in both macro policy and an acute empirical understanding of the American economy. Before entering government, he had his own private-sector consulting firm and traded actively for his own account. He is a precise man with an exceedingly good and understated wit. Larry, whose parents are both Ph.D. economists and who has two uncles who won Nobel Prizes in economics, was one of the youngest professors ever to receive tenure at Harvard. He is a forceful, self-assured theoretical economist with a good feel for the practical, both in politics and in markets. I had a pretty good conceptual understanding of economics, had spent a career in trading operations and management on Wall Street, and had been involved in Democratic politics. People who know me are familiar with my distrust of definitive answers and my habit of asking questions. While our personalities differed, they meshed—perhaps because our analytical approaches to a problem like Mexico proved highly compatible. Equally important was the spirit in which we worked. Though none of us is without ego, there was a remarkable lack of it in our meetings. Each of us tried to work with the others to find the best answer, not to show off his intellect or defend preconceived notions. Another crucial component of our relationship was the mutual trust we developed. For four and a half years, Alan, Larry, and I had breakfast or lunch at least once a week, along with many other meetings and discussions. After I resigned in 1999, Larry and Alan continued the tradition. To the best of my knowledge, nothing any of us said in any of those private meetings ever leaked out. (For this book, they gave me permission to refer to these conversations.)

I had seen Greenspan periodically during my time at the White House but hadn't known him very well before I became Treasury Secretary. When we were both thrown into the peso crisis, we got to know each other rather quickly. I was deeply impressed with the way he thought about the problem. Alan, who believes strongly in the discipline of markets, was very focused on the issue of moral hazard. This was why he had opposed the government rescue of the Chrysler Corporation in 1979. But, despite his opposition to the idea of government intervention in markets, Alan weighed the moral hazard against the risk of having Mexico go into default. He was a pragmatist, trying to find the best way to balance competing considerations.