Top policymakers look back on lessons learnt and mistakes made during 2008 meltdown
Martin Sandbu
From left: US Treasury secretary Henry Paulson, Federal Reserve chairman Ben Bernanke, and president and chief executive of the Federal Reserve Bank of New York Tim Geithner in 2008 announcing that the Treasury Department will take equity stakes in banks totaling about $250bn © Reuters
The authors of Firefighting undeniably have a tale to tell. They held America’s highest economic policymaking offices during the global financial crisis — Ben Bernanke as Federal Reserve chairman, Henry Paulson as the Bush administration’s last Treasury secretary (and before that a Wall Street chief executive), and Tim Geithner as president of the New York Fed and then Paulson’s successor in the Obama administration.
This is the inside story, 10 years on, of how America’s top policymakers tried to contain a financial implosion that threatened to send not just the US but the whole world into a replay of the 1930s Great Depression. Beyond historical interest, the authors insist that without understanding the steps they had to take, we risk being unprepared next time a crisis hits.
Those who want to understand how the US financial system could suddenly collapse, taking seasoned policymakers like these three by surprise, could do a lot worse than this book.
Firefighting is mercifully short and succinct, yet all the key elements of the chronicle are here: the ballooning borrowing and blinding complexity of the boom in mortgage-backed securities, the legally creative Fed loans into frozen markets, the expanding schemes to prop up asset prices, the capital injection and stress tests for banks that calmed investors and the huge fiscal and monetary stimulus that put the economy back into gear.
The book is also surprisingly well-written — not always a given when technocrats and wonks take to the keyboard. Apart from slightly overworking the metaphor in the book’s title, whoever penned the words avoids getting bogged down in technical details and keeps the pace with some felicitous turns of phrase (“The Wild West with better plumbing was still the Wild West” is the verdict on the meagre regulatory efforts before the crisis).
However, for those who followed the crisis more closely the interest does not lie in new information, of which there is really none, but in how the authors assess their own efforts with the benefit of hindsight. Needless to say, they think they got it mostly right, while honourably admitting they had to scramble and improvise given the opacity of the financial sector when the crisis started and the speed at which previously unthinkable events unfolded.
Their overarching imperative was to arrest the financial panic by restoring confidence that US financial institutions could honour their obligations. Put another way, they saw it as the government’s responsibility to forestall as far as possible the propagation of losses through the financial system. They largely avoid the term “bailout”, but that was clearly the policy they pursued. Not, admittedly, without dismay: the authors express their deep dislike of taxpayer support for banks, but argue that in a financial panic, the normal rules do not apply.
So when they hit back at critics who said they should not have let Lehman Brothers go bankrupt they do not challenge the premise that the bank should have been saved — they just claim they did not have the legal powers to do so. But they offer precious little argument to those who think the government was too quick to put all institutions in the “must be saved” category.
In effect, the authors assert that in a crisis, all private financial debt must be treated as the government’s responsibility. By their own admission, they went beyond Walter Bagehot’s rule for stopping liquidity crises: lend freely but at penalty rates, to solvent borrowers and against good collateral only.
Their view that government should prevent losses for banks’ creditors to the fullest extent possible puts Bernanke, Paulson and Geithner in opposition to a person they unfairly relegate to a bit player in the book. That is Sheila Bair, the chair throughout the crisis of the Federal Deposit Insurance Corporation — the agency President Franklin Delano Roosevelt created to wind up failed US retail banks while guaranteeing deposits. Only a few days after Lehman’s collapse, the FDIC wound down Washington Mutual, one of the country’s biggest mortgage lenders. Depositors were protected but other creditors forced to take losses. The authors claim this triggered deposit flight from Wachovia but offer no evidence it could otherwise have stayed out of trouble. It is too easy, given the financial storm that was happening, to blame Wachovia on Bair being more sceptical of bailouts than they.
Whether to try to make private investors share in the losses of banks was the most important divide in the administration. Bair also insisted, for example, that a new guarantee of broad bank liabilities (which the authors pushed her to accept) should only apply to new contracts, not old debt, in an attempt to support new lending to solvent borrowers without saving banks for their past mistakes. This, too, they disliked.
Even as they pick at the FDIC’s wind-down of retail banks, the authors complain there was no resolution regime for the bigger financial companies on their watch. Creating such a regime has since been central to efforts to end the problem of banks that are too big to fail. But they do not seem to have asked for one in the stressful days of 2008 when they were banging down the doors on Capitol Hill to lobby for greater powers. Why did they not ask for resolution powers, which would have allowed them to split up such a bank as Lehman and write down some of its liabilities but not others? They do not tell us, but the answer that presents itself is that this was an authority they did not want to wield.
This deference to Wall Street comes up elsewhere, too. They lament that they did not think they could force financial companies to increase equity capital above the regulatory minimum. Why did they then not raise the regulatory minimum? They do not say. They report leaving 20.1 per cent of insurance company AIG in the hands of its private shareholders because taking more would “force the government to bring the company formally onto its balance sheet”. They do not say why this would be a bad thing.
No doubt these policymakers did a solid job in extraordinarily challenging circumstances. Their policies worked, and they worked rather well. But they were not the only policies available, nor do their choices have a strong claim to being the best ones; bank bailouts have after all fuelled populism. What they do not seriously consider is whether their policies to restart credit flows could have worked even with a less bailout-friendly approach, saving both money and political anger. These are the ideological blind spots revealed by reading Firefighting between the lines.
Firefighting: The Financial Crisis and Its Lessons, by Ben Bernanke, Tim Geithner and Henry Paulson, Penguin, RRP$16, 240 pages
Martin Sandbu is the FT’s European economics commentator
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