There was a time not so long ago that America’s federal financial ‘uber-menschen’ really were widely regarded as the masters of the universe – able to leap tall buildings at a single bound, and by sheer dint of their abundant grey matter, unscramble financial calamities almost before they happened. Then, in 2008, such financial wizards were revealed for what they were – some really smart people caught up in fast-moving events quickly spinning beyond their control. J. BROOKS SPECTOR contemplates those newly released transcripts from the US’ Federal Reserve Bank’s Open Money Committee, just as the apocalypse seemed to be at hand.
Around fifteen years ago, Time magazine featured a group portrait of Federal Reserve Bank Chairman Alan Greenspan, Secretary of the Treasury Robert Rubin and his deputy, Larry Summers. The cover photo appeared with the sobriquet, “The Committee to Save the World”. Pretty modest, eh? But what a difference a monstrous recession made, eh?
The threesome had originally been featured in that superhero-esque poster on 15 February 1999 for, among other feats of strength, holding the Asian financial crisis at bay in 1997 and then goosing the global economy into overdrive – moving into the slipstream of the great commodity boom and China’s economic explosion, with its insatiable demand for imported raw materials of almost every kind. As the 1990s slid into the 21st century, both the Clinton and Bush administrations had encouraged a great American home-ownership boom. For the liberals, it was their agenda of wanting to help lower income people move out of the uncertainties of rental life and into the security of owning their own homes. For the Republicans it was in aid of engineering such people into becoming card-carrying members of the respectable middle class lifestyle.
In either case – or both of them, perhaps – the housing boom, and the mortgages issued to finance them, created a flood of hot money (and debt) that was scooped up and turned into increasingly arcane investment vehicles like those soon-to-be-derided collateralised debt obligations. Through the legerdemain of go-go investment banking, these mortgages were packaged, repackaged, diced, sliced, and finally spun into these CDOs.
The whole thing, of course, was built upon the slippery foundation of these overstretched mortgage bonds, but they were transformed into AAA commercial paper that could be aggressively marketed around the world to be the perfect investment for otherwise stodgy German regional banks, Norwegian local government employee pension funds, as well a very tidy, very remunerative, and very secure income stream for widows, orphans and miscellaneous charities.
But like the earlier South Sea bubble, that Great Mississippi bubble and those infamous tulip investments, and despite Wall Street’s enticing whispers, “Laissez les bons temps rouler”, the good times simply couldn’t roll on forever – and they didn’t. We all know what happened. First one investment bank – Bear Stearns – then another and another, like huge dominoes, started to tumble, with each one threatening the next in line because they had each bought each others’ CDOs and other even fancier and less comprehensible financial instruments.
And in the fullness of time, the financial wizards began to sweat, to lose sleep and then to panic about the abyss. Their panic soon spread to those “Masters of the Universe” in the George Bush administration. In the past week, the Federal Reserve Bank has released full transcripts of the meetings of its Open Market Committee – the veritable “Holy of Holies” inside the Federal Reserve Bank – to explain to the rest of us how they responded to the chaos of the unfolding financial crisis in 2008.
As a parenthetical comment, this same website now also has extensive explanations about how it is rigorously audited, how it releases data routinely, and how close – even ruthless – congressional oversight takes place over it as well. These explanations seem to be in response to a Tea Party drumbeat calling for an audit of the Fed, as if the bank was some sort of foreign occupying force under the thumb of those hateful Wall Street bankers.
On the face of it, this burst of information seems a slightly odd thing. The banks – and bankers – and their tight, money-grubbing ways used to be stalwarts of Republicanism, as opposed to the party’s enemy; at least that was until Wall Street bought into the idea of a mortgage in every householder’s hand and lots of globalised investment opportunities. We’ll see how the Tea Party and Republicans more generally react to all this Fed info as the days ahead unfold.
Anyway, as the Fed’s managers gathered in their huddles back in 2008, what these transcripts really seem to show – for the most part – is the incredulity of officials about what was happening. The myth of the “Masters of the Universe” has shattered into a million pieces.
Moreover, the transcripts also show how slowly the extent of the disaster became fully understood, that there was a realisation that the weakest of the financial herd would have to be sacrificed on the altar of merger and bankruptcy to save the rest of the financial community. And then, finally, there was that the brutal fact was that this newest financial collapse was like nothing America had seen since 1929.
In fact, it would come perilously close to becoming worse than the Great Depression – because of the near-instantaneous globalised linkages between Trondheim, Norway’s retirement accounts and a firm like Goldman Sachs in New York City and Goldman Sachs’s ties to every overextended mortgage holder in America, and then on from that huge crowd to everyone who owned shares of corporate stock or mutual funds traded on the NYSE or NASDAQ as the primary support for their retirement accounts.
Interestingly, one of other things the transcripts show is that of all the people who gathered in those FOMC meetings, Janet Yellen, the newly appointed chair of the Federal Reserve Bank, was one of the few who was quick to catch on that this event was no “normal” economic downturn. That is to say, the 2008 event was not the kind of thing that happens relatively routinely and that is usually amenable to the normal tools of countercyclical spending and easier monetary policy. The transcripts reveal that Janet Yellen, then president of the San Francisco Fed, had told committee members in January 2008, “the risk of a severe recession and credit crisis is unacceptably high.” And that Yellen later said in October of 2008, “The downward trajectory of economic data has been hair-raising. It is becoming abundantly clear that we are in the midst of a serious global meltdown.”
In a way, it seems especially interesting that while Yellen rather quickly “got it”, her predecessor, Ben Bernanke, the then-head of the Fed, and, in fact, one of the country’s pre-eminent scholars on the economic history of the Great Depression, seems to have been torn by doubts as to what was really happening – let alone how to bring it to a halt. Of course these quandaries were not Bernanke’s alone – most of the Bush administration’s economic team was just as torn, as were many hot-shot, go-getters on Wall Street as well – even the heads of the investment banks that were about to go under could barely believe their bad luck after years of easy, gargantuan profits.
Bernanke had told on Fed March meeting, “I do think that the downside risks are quite significant and that this so-called adverse feedback loop is currently in full play”. But he seems to have struggled with the task of convincing other Fed officials – it is not an organisation that is run like an absolute monarchy – of the need for forceful action and, as the New York Times described it, the “consensus-building approach might have slowed the central bank’s response time. Several officials hoped that the spill over from the financial crisis could still be contained” and some even worried aggressive action by the Fed would make it harder to pull back later on as things improved quickly enough.
In fact, a few months before Bernanke had voiced his fears, according to the transcripts, per the New York Times’ reporting on them, “Dallas Fed President Richard Fisher [the Federal Reserve System has twelve regional branches across the country rather than simply one all-knowing, all-powerful central bank] said in late January that the central bank’s reactions were not reassuring markets but scaring investors. ‘My CEO contacts tell me that we’re very close to the “creating panic” line,’ Fisher said. ‘They wonder if we know something that they do not know.’ ” By September, apparently, some of its officials had even began to think that after Lehman Brothers crumpled, the worst was finally over and that it was time to rein in the Fed and return it to its core function of holding inflation in check. That, obviously, in retrospect, was probably the least of its problems.
As the New York Times noted, “The nation was nearly a year into the Great Recession before then-Federal Reserve Chairman Ben S. Bernanke accepted the magnitude of the country’s economic distress. The financial system was rapidly unravelling in September 2008. Investment bank Lehman Brothers had collapsed, and the Fed was rescuing insurance giant AIG from the brink of insolvency with an $85 billion bailout. Wall Street was panicking, with stock markets falling more than 4 percent in a day. More than a million workers had lost their jobs. Even so, Bernanke thought the Fed had probably done enough, according to newly released transcripts. So he recommended that the central bank leave its key interest rate unchanged — a move the Fed would come to regret. ‘I think that our policy is looking actually pretty good,’ he told his colleagues around the mahogany table at the Fed’s headquarters in Washington.”
In a way, even more than these transcripts even do, Hollywood has already managed to convey the panic and queasiness – right down to Treasury Secretary Henry Paulson’s increasingly nervous, upset stomach – as the full scale of the fatal winnowing was becoming clearer – in a made-for-TV movie, “Too Big to Fail”. Okay, that film got some things wrong, yes, but it found the fear factor and the sweaty palms.
Yes, “Too Big to Fail” had made a kind of ordinary-man-cum-superhero out of Timothy Geithner, then head of the Fed in New York City, and in somewhat earlier days a key economic policy wunderkind in the Clinton administration. (Remember, they had given a push to help along the home mortgage boom in the first place. Good grief, but there was enough blame to go around in all this mess, of course.)
And the film had also rather turned Hank Paulson into a kind of feckless foil for Geithner and the other really smart, good guys, the ones with the ice water in their veins for when things really got rough. But it also did a rather good job of illuminating the shark-infested waters of Wall Street and the way the toughest banks on the block ruthlessly elbowed out the weak sisters – and how the heads of the biggest banks had ethylene glycol in their veins. Overall, “Too Big to Fail”, like a similar, earlier, made-for-TV flick about Enron’s collapse, managed to deliver a visceral sense of the churning complexity and panic as officials thrashed around, and as they tried to figure out what there was to do next, once their previous, backs-up-against-the-wall final measures had had so little impact.
In fact, reading some of the transcripts and interpretative articles already published on this material, can make one think back to the granddaddy of economic panics, the Great Depression that kicked off in 1929 and how economic policy was handled then, when financial ructions first washed over the nation. Economic historians like Milton Friedman remind that while the stock market’s collapse had hit market investors hard, it was really the bank panic of 1930 that really semt things into a death spiral of a major downward trajectory.
And this takes us to the nearly forgotten circumstances of the Bank of United States (with no ‘the’ in its name). Founded by immigrant German Jews back at the turn of the century, and based on false rumours of its insolvency, the bank underwent a major run on its deposits that ultimately led to its collapse. Meanwhile, other major Wall Street bankers waved off recapitalisation and merger plans for this bank in order to save it, and once the Bank of United States had to shut its doors, the run on hundreds of other banks followed. And that is when the Depression truly took hold.
Among the more than six hundred banks that closed between November and December 1930, the Bank of United States accounted for a third of the total $550 million deposits lost by the banks. Once the Bank of United States had to close, bank failures reached a critical mass. People flocked to withdraw their money from yet other banks, forcing them all to call in loans or sell assets they were holding – at any price they could get – in an increasingly desperate effort to stay liquid. Kind of rings a bell with how 2008 unravelled, now doesn’t it?
As the late Milton Friedman wrote in an article on the collapse of the Bank of United States, “The Bank of United States was a sound bank. Its troubles stemmed from rumours that produced a temporary run on it. If the immediate crisis had been overcome, the bank would almost surely have survived.” Friedman adds that the New York superintendent of banks had urged the state’s interbank clearing house “to save the bank and correctly warned of the dire consequences that would follow if it did not. As it was, though liquidated during the worst years of the Depression, the bank ultimately paid off 83.5 per cent of its liabilities. Anti-Semitism almost surely played a role in the decision of the Clearing House to reject the New York Reserve Bank’s plan.”
But, Friedman continues, that while, “For most members of the Clearing House, the evidence to this effect is indirect. It is much less so for those members dominated by JP Morgan & Co. We know how John Pierpont Morgan, Jr., the head of the House of Morgan [one of the country’s preeminent investment banks], felt about Jews, thanks to an entry in the diary of Charles Hamlin — a Federal Reserve Board member from 1914 to 1936 and, fortunately, a lover of gossip.” Hamlin’s diary notes Morgan’s plan to get even with the Jewish bankers on the charge they had killed Morgan’s father. By stopping any rescue plans, “JP Morgan Jr. finally got ‘even with them’ —but at what a cost to the nation.”
Perhaps economic officials in 2008 were even recalling this banking and policy folly of seventy-eight years earlier, once they finally grasped the enormity of the more recent shambles, when they had shut down some Wall Street firms to forestall the entire system’s collapse. But, in the midst of all these furious rescue efforts, the little guy was often left out in the cold.
Many homeowners, now held newly-underwater mortgages (when the value of the homes dropped below the cost of the mortgages being carrying and owners found they couldn’t make their monthly payments once jobs started to dry up). Many sold such homes at a loss, lost them via foreclosures, or – in some cases – simply gave up and walked away from the homes that had been their dreams, up until the moment they drove away, never to see those homes again.
The economists – and the economic policy makers – seem more confident now than six years ago. Maybe it is because the illusion that a great financial panic in America can’t happen again after 1929 has finally been shattered. But, by the same token, there now exists a great divide between today’s Democrats and Republicans in America about whether the stimulus package that was finally launched at the beginning of the Obama administration was ultimately successful in holding back the worst excesses of the financial crisis – or that it had “failed.”
Over five years after the panic truly took hold, unemployment is now finally back to about 6.5% (although the percentage of people active in the labour force, overall, has fallen too), and economic growth figures and business confidence levels are rising again. As far as the stimulus package introduced by Barack Obama after he became president, the truth may well be that the package was actually too small to give the real shot of adrenalin needed to shock the economy back on track.
As a New York Times 23 February editorial argues, “Of all the myths and falsehoods that Republicans have spread about President Obama, the most pernicious and long-lasting is that the $832 billion stimulus package did not work. Since 2009, Republican lawmakers have inextricably linked the words ‘failed’ and ‘stimulus,’ and last week, five years after passage of the Recovery Act, they dusted off their old playbook again. ‘The “stimulus” has turned out to be a classic case of big promises and big spending with little results,’ wrote Speaker John Boehner. ‘Five years and hundreds of billions of dollars later, millions of families are still asking, “where are the jobs?” ’ The stimulus could have done more good had it been bigger and more carefully constructed. But put simply, it prevented a second recession that could have turned into a depression. It created or saved an average of 1.6 million jobs a year for four years.”
But, what this set of charges and resulting debate has also done is put the fear of God in politicians of both parties that almost any kind of countercyclical stimulus activity the next time there is an economic downturn will be a hill too high and a bridge too far. If that remains the case for future economic crises (and there will certainly be one some day), about the only tools left will be adjustments in the Fed’s monetary policies like lowering the prime interest rate and a new round of quantitative easing. And that will be a real challenge for a president’s ability to support an economic recovery. DM
Fed transcripts from 2008 reveal inner workings as US teetered on the brink at the Guardian
Fed Fretted Over Reaction to Demise of Lehman at the New York Times
As Crisis Loomed, Yellen Made Wry and Forceful Calls for Action at the New York Times;
Transcripts show Federal Reserve’s struggle to deal with 2008 financial crisis as it unfolded at the Washington Post;
This is how history should judge Ben Bernanke at the Washington Post;
The Second Great Depression: Why the Economic Crisis Is Worse Than You Think, review article by J Bradford DeLong of Alan Blinder’s After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead at Foreign Affairs
“AntiSemitism and the Great Depression” by Milton Friedman at Newsweek
The 2008 Meltdown Movie at the Wall Street Journal
Six Films on the Financial Crisis at BillMoyers.com;
FOMC: Transcripts and Other Historical Materials, 2008, at the Federal Reserve website (the full transcripts);
What the Stimulus Accomplished at the New York Times;
Main photo: US Treasury Secretary Henry Paulson (L) and Chairman of the Federal Reserve Ben Bernanke (R) testify before the House Financial Services Committee about credit market turmoil and the government economic bailout on Capitol Hill in Washington September 24, 2008. REUTERS/Kevin Lamarque.
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