Over $12 trillion. This leviathan—the new combined total of the federal bailout—is enough to launch over 13 wars in Iraq and Afghanistan or buy about 325 Harvard endowments at the height of prosperity.

Aside from its sheer enormity, this heap of cash is also intriguing because of the “public-private investment fund” included in Treasury Secretary Timothy Geithner’s recent proposal. The potentially $1 trillion vehicle would aim to combine public and private capital to buy toxic assets from banks. Though widely criticized in its eight days of life, the fund may succeed in attracting private investors—but only if Geithner offers more specifics to incentivize private financing and subdue historic antagonism between private and public sectors, which is traditionally worse in times of crisis.

Confidence, as many have argued, is crucial during a credit crisis. Derived from the Latin word credere, “to trust, entrust, believe,” credit depends on a threshold of trust to lubricate functioning capital markets. If financial institutions, as creditors, do not trust their debtors—be they individuals, investment funds, or other banks—these institutions will not lend. As the grand dame of economic historians, Anna Schwartz, said in October: “The basic problem for the markets is [uncertainty] that the balance sheets of financial firms are credible.”

And Schwartz should know. In 1963, she and Milton Friedman published the 888-page tome “A Monetary History of the United States.” In it, they argued that the Federal Reserve Board failed to prevent a succession of bank failures and, thus, failed to inspire confidence in the market in 1932 and 1933 because it lacked the “vigorous intellectual leadership” necessary to do so. Weak leadership did not overcome antagonism between the 10-year-old Fed and the New York Clearinghouse—a fate that could befall Geithner’s public-private fund today.

Picture this: a Federalist fortress in the Financial District of Manhattan, whose members represented 52 national and state banks, as well as the U.S. Treasury itself. Not the Federal Reserve Bank of New York, not the Federal Reserve System, not any central bank—this node of finance was the New York Clearinghouse. Established in 1853, the Clearinghouse pooled reserves so that member banks could clear debits and credits daily. It also functioned as a private central bank, which took care of its own in the many banking panics of the late 19th century—especially 1857, 1873, 1893, and 1907—until the Federal Reserve System came to town in 1913.

The animosity between these two competitors, the private Clearinghouse and the public Fed, ensured the failure of the Fed’s intervention in March 1933. At the beginning of March, $700 million were withdrawn from banks, plunging the Dow to only 50 points. In an effort to avoid further turmoil, New York Fed Governor George L. Harrison contacted Clearinghouse Chairman George W. Davison about declaring a bank holiday. With no incentives to act despite the damage this holiday might do to bank reputations, and with much criticism from an increasingly populist Congress, the Clearinghouse had no reason to partner with the Fed. Davison refused to galvanize his member banks in support of a statewide banking holiday. Harrison quickly gave up, delegating responsibility to a lesser state official. As a result, the New York Fed sustained over $350 million in gold and cash withdrawals the following day.

Geithner, fortunately, does not face this old-fashioned run on the bank. Yet cooperation from the private sector is just as crucial today as it was in 1933. Creating an effective public-private fund requires incentives for private investment, and incentives depend on specific terms. This is exactly what Geithner’s fund is missing and exactly why future Friedmans and Schwartzes might criticize Geithner for “absence of vigorous intellectual leadership.”

The only specifics offered about the fund, so far, are speculative. In two parts, the Treasury’s plan describes first the “public-private financing component,” which could “leverage private capital on an initial scale of up to $500 billion, with the potential to expand up to $1 trillion.” Second, the plan proclaims that “private sector buyers [can] determine the price for current troubled and previously illiquid assets.” Why should private investment funds supply this capital? And why would private firms be any better at pricing these toxic securities, when the Fed has had no clear success in that endeavor over the past months?

The plan’s failure to answer these questions is not merely a matter of benign vagueness, which Nobel Prize-winning economist Paul Krugman has called “no harm, no foul.” It is rather a watershed moment that could determine the future of this potential public-private relationship as the United States continues to grapple with recession. Like Harrison’s hasty actions in March 1933, Geithner’s imprecision risks alienating those with whom he hopes to partner.

Both the 1933 panic and the current credit crisis yield the same message: strong, cooperative leadership from the Fed is the key to inspiring confidence in both consumers and major private sector actors. Like any executive action, this leadership demands rationale—a justification for others to invest. Geithner must look to the failures of his predecessors in order to succeed.


Noah M. Silver ’10, a former Crimson associate editorial editor, is a history concentrator in Quincy House. His column appears on alternate Wednesdays.