Troubling Details in NYT Account of Official Response to Financial Crisis

The New York Times is publishing a series on the financial crisis, “The Reckoning,” and today’s installment is “Struggling to Keep Up as the Crisis Raced On.” While this is a useful recap, there are some tidbits that merit commentary, such as:

“Ben said, ‘Will you go to Congress with me?’ ” said Mr. Paulson, referring to the Federal Reserve chairman, Ben S. Bernanke. “I said: ‘Fine, I’m your partner. I’ll go to Congress.’ ”

Although it’s no news to anyone who has watched the Fed-Treasury pas de deux as the credit crisis has rolled along, the Fed has completely, utterly lost its independence (see here for an apple pie and motherhood statement of why central bank independence is a Good Thing). What is surprising is how little notice this development has attracted.

As we commented before, based on an article draft provided by former Fed economist Richard Alford:

Few have any memory of America’s central bank having a openly contentious relationship with the Treasury and Congress. Even though Paul Volcker had to withstand considerable pressure, some of his predecessors fought open turf wars. Yet from the end of World War II to the (sadly) supine Arthur Burns era, there were not infrequent pitched battles with the Fed with incidents that would seem unthinkable now. For example, Truman summoned the FOMC to pressure them into a more accommodative policy during the Korean War, then issued a White House press release claiming the Fed had made a commitment that it had not agreed to. The Fed played hardball, leaking its version of the meeting, which contradicted the press release. That led Congress to join the fray, trying to bring the Fed to heel via sharply critical hearings.

While Volcker did endure widespread criticism and harangues from Congress, even for those who lived through that er.. the memories of the ritual roughings up are dim. In addition, there was at least initial support for his harsh measures. Moreover, (unbeknownst to me) Volcker was masterful at defanging Congress long enough for his remedies to take hold. Had someone less adept been at the helm, a firefight might well have ensued.

From Alford’s draft:

Since the first Latin American debt crisis, we have had a Fed that has been eager to lean against financial headwinds, but completely unwilling to take in sail when dealing with strong financial tail winds…

We have a Fed that is willing to incur short-term costs if it reduces inflation, but will not incur short-term costs to achieve financial stability or external balance. This would be less of a problem if another agency or agencies had the willingness and ability to insure financial and external balance, but it is clear that we do not. The Fed was granted independence and insulated from political pressure in order to accept short-term costs in order to enhance the prospects for long term growth. However, the current Fed, like the Fed of the 1970s, failed to use the freedom it was granted….

Compare the behavior of the Chairmen of the 1950s and Volcker to that of Greenspan. Chairman Eccles and McCabe both lost their Chairmanships because they wouldn’t compromise Fed independence. They stood their ground even after being summoned to the White House. Martin, appointed by Truman, was in later life referred to by Truman as “the traitor” presumably for taking the punch bowl away. The public image of Volcker is that of a man who twice a year endured public Congressional assaults, resisted political pressure, and enabled the Fed to stay the course.

Greenspan, on the other hand, jumped at the chance to meet Clinton, traveling to Little Rock before the inauguration. Bob Woodward in his book “Maestro” quotes Clinton telling Gore after the pre-inauguration meeting: “We can do business.” Woodward also quotes Secretary of the Treasury Bentsen telling Clinton that they had effectively reached a “gentleman’s agreement” with Greenspan. The agreement evidently involved Greenspan’s support for budget deficit reduction financed in part by tax increases. It is not clear what Greenspan received.

Even if the deal with Clinton contributed to a good policy mix, Greenspan should never have entered into that agreement/deal/understanding or another agreement/deal/understanding. The very act of negotiating and injecting the Fed into a discussion of budget decisions compromised Fed independence. Why shouldn’t Bush have expected the same? Why shouldn’t every succeeding President expect the Fed Chairman to be a “business” partner?

As the Times makes clear, the annexation of the Fed to the Administration is complete.

This blog and others have noted that the officialdom’s responses to the credit crunch have had an ad-hoc, improvised quality to them. That might have been understandable for the first, perhaps even the second acute phase (August-September 2007, November-December 2007) but after that, lack of aforethought was a symptom of wishful thinking and ideological rigidity. The Times gives credence to these suspicions:

Mr. Paulson defended Treasury’s actions, saying that he and his aides had done everything they could, given the deep-rooted problems of financial excess that had built up over the past decade….

But in contrast with Mr. Paulson’s perspective, other government officials and financial executives suggest that Treasury’s epic rescue efforts have evolved as chaotically as the crisis itself. Especially in the past month, as the financial system teetered on the abyss, questions have been raised about the government’s — and Mr. Paulson’s — decisions. Executives on Wall Street and officials in European financial capitals have criticized Mr. Paulson and Mr. Bernanke for allowing Lehman to fail, an event that sent shock waves through the banking system, turning a financial tremor into a tsunami.

I think these criticisms, although they now seem valid, are missing the point. Lehman was on the ropes for months. Why was there so little understanding of the enormous hole in its balance that was revealed only upon its collapse?

Ah, but there are several problems here. Recall, for Fannie and Freddie, which had less diverse exposures than Lehman, Treasury and OFHEO, the government sponsored enterprises’ regulator, had to engage Morgan Stanley to make an assessment of their viability. You couldn’t send a competitor in to evaluate Lehman, and crawling all over the troubled firm would have heightened alarm unless other firms were subject to special audits too.

The article thus misses a vital point: Bernanke and Paulson are making decisions blind. There are many, hugely important components of this equation that are utterly opaque to them. Merely having Paulson call his buddies for some G2 (even assuming they would and could give a candid answer) does not pass for understanding. Yet, unlike the 1987 crash, when President Reagan signed the executive order that established the Brady Commission to examine the causes of this debacle, there has been no concerted information-gathering (it would need to be international in scope to be effective).

This is worse than the fog of war. At least most generals have a map of the terrain.

And then we have lack of candor and fair dealing:

Mr. Paulson and Mr. Bernanke have been criticized for squandering precious time and political capital with their original $700 billion bailout plan, which they presented to Congressional leaders days after the Lehman bankruptcy. The two men sold the plan as a vehicle for purchasing toxic mortgage-backed securities from banks and others…

In the interview, Mr. Paulson said that even before the House acted, he had directed his staff to start drawing up a plan for using some of the $700 billion to recapitalize the banking system — something that Congress was never told and that he had publicly opposed.

Why? Because in the week before the plan passed Congress, conditions deteriorated significantly, Mr. Paulson said.

The very fact that Bernanke would back the TARP, which was an outrage (a mere three pages and explicit exemption from any review process for an unprecedented commitment?) again demonstrates that he has been completely co-opted. But Paulson had switched gears considerably while the TARP was in play, yet did not deign to tell Congress. I suppose I shouldn’t be surprised. This Administration has been exceptionally aggressive in asserting its privileges, and Congress has rolled over.

But the Times hints that Paulson had asked for sweeping powers without even having much of a plan at all:

But many complain the worst of the turmoil might have been avoided if it hadn’t been for Mr. Paulson sticking with an original bailout plan that they viewed as poorly conceived and unworkable. “They were asking the most basic questions,” said one Wall Street executive who spoke to Treasury officials after the bailout bill was passed. “It was clear they hadn’t thought it through.” Senator Charles E. Schumer, Democrat of New York.

Paulson now claims that the reason that government couldn’t assist Lehman was that it was too far gone. Huh? The bigger the prospective blow-up, the greater the urgency to keep it from happening:

At a White House briefing on Sept. 15, Mr. Paulson shed no tears over Lehman’s failure. “I never once considered it appropriate to put taxpayer money on the line in resolving Lehman Brothers,” he told reporters.

In the interview, however, Mr. Paulson said the main issue was whether it was legal. Under the law, the Fed has the authority to lend to any nonbank, but only if the loan is “secured to the satisfaction of the Federal Reserve bank.” When pressed about why it was legal for the Fed to lend billions of dollars to Bear Stearns and A.I.G. but not Lehman Brothers, Mr. Paulson emphasized that Lehman’s bad assets created “a huge hole” on its balance sheet. By contrast, he said, Bear Stearns and A.I.G. had more trustworthy collateral.

People close to Lehman, however, say it was never told this by the government. “The Fed and the S.E.C. had their people on site at Lehman during 2008,” said a person in the Lehman camp. “The government saw everything in real time involving Lehman’s liquidity, funding, capital, risk management and marks — and never expressed any concerns about collateral or a hole in the balance sheet.”

Paulson’s ex post facto change in rationale sounds very much like the way numerous reasons have been offered for invading Iraq, none of which seem convincing. For Lehman, the most obvious is probably accurate: there was a huge backlash after the Bear bailout and Treasury did not want to rescue another firm unless it was absolutely necessary. It appears they made an error in judgment that they are unable to admit to. But if you do not admit to mistakes, you can never learn from them.

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  1. Anonymous

    This is why the NYT is on the ‘media dinosaur death watch’ list.

    Drawing parallels or contrasts with personalities, I don’t get it. Congress has oversight on all these matters. If they turn and look the other way or pass law in support of a Treasury King then they have no more idea what’s going on than the ones they are paying to do the job.

    It’s not pragmatic or even trial and error. It’s ‘Get me reelected’ and I’ll follow you anywhere.

    NYT just aids and abets in a cover up of greed.

  2. Anonymous


    To impugn the Times at this juncture is fascinating. What other words make you dance? You are not one of those Exceptionalists from Real America, are you?

    B.T.W. not to defend Congress, but they don’t have oversight. They have unaswered subpoenas and contempt charges which Justice refuses to carry through.

    They have an administration which is daring them to ask the high court to intervene, knowing they won’t risk a ruling under a Roberts court, and I don’t blame them.

    The court is all to eager to turn the Executive into a domestic Gimto – opaque and lawless.

    They know a whole crop of fascist morons are out there backing them, just waiting to click their heels.

  3. SilverDollar

    anon of 3:35am,

    With all due respect, Congress not only has oversight of the Federal Reserve through the chairmanship of Barney Frank, they have willingly abdicated their responsibility for the guidance of a sound U.S. currency in 1913 through the creation of the same Federal Reserve.

    Seriously, people need to get off the political bandwagon, for either party, and realize, once and for all, that BOTH parties have sold us down the river. Once we all realize that the government’s sole reason for being, at this point, is to continue to live, via taxation and the re-election of morons from both parties who understand nothing except how to get re-elected, then we will not find a solution to this problem.

    (Yves, sorry for my rant, but sometimes we’ve got to speak up for common sense! There seems to be so little of it these days!)

  4. Richard Kline

    So Anon of 3:35, the concerns you raise re: the squeeze play on Congress between the Supremes and the Executive are real, I don’t dismiss them. But that means the real question is, Why didn’t the same Democratic leadership in Congress resist the composition of said Court when they had the chance? The answer is that the just didn’t give a damn. And that is the real issue now, then. This is leadership failure in Congress; they put themselves in an opposition headlock, and now tell you they can’t do anything because they are in a headlock. Congress has a great deal more power than the present lot are prepared to use, because doing so would make for a nasty-nasty tiff just when they expect to cash in big at the polls as ‘the party of reason.’ Well they may be so, but they are _not_ the party of principles or governance. We don’t have such a political party in this country.

    And re: the jellyfish nature of the Bernanke Fed, I have the clear impression that Ben sees himself as a ‘financial systems scientist.’ His brief, in that conception, is to pull levers, take meter readings, do some calculations, call for some more data, lower or raise control rods on This Thing. He seems to see policy as the Executive’s brief, or at least that was what he signed off on as the price of his appointment. Of course, the _real_ power of the Fed was just it’s power to compel policy, together with the market’s belief in the Fed’s ability to punish and reward. Bernanke abdicated the most powerful tools of his office before he ever took the Chair, in part because he misunderstands what power is and where it lies. Of course he’s played like a piccolo by the policy guys over in the Executive. He’s a sap, is what he is; a very bright, highly credentialed sap. And to be frank, he was appointed for _exactly_ that reason. Think about it.

    We’ll get a better Fed when we get people in sitting around its table who understand that power is their game, not numbers.

  5. CP

    Policy-making that is more reminiscent of 1990s Japan than the Washington Consensus.

    Economic textbooks written on this in 10yrs time will concentrate on the question "To what extent did policy-makers' attempts to avoid moral hazard exacerbate the severity of the financial crisis".

    As a current account deficit country, the US needs to convince overseas unsecured (wholesale) creditors that their rights will be protected. The actions around Lehman & WaMu have hardly done a good job of this.

  6. fresno dan

    I have asked it before, and I’ll keep asking it:
    Did Paulson know how Goldman Sachs made money?
    Any answer is disturbing.

  7. Alan

    I was hopeful that the NYT was talking about the illusion of the Fed's independence from the private banking system.

    After he left office, and in a chance encounter with Martin on the street, Truman used the word "traitor" appropriately, but not for the reason the author intimates. In 1951 the Treasury Accord extracted independence for the Fed for monetary policy and thus led to the Fed Chairman's being the most powerful unelected official in all of democracy.

    This "Treasury Accord" took place in the darkest days of the Korean War, when MacArthur was more popular than Truman and he had just been recalled. Treasury Secretary Simon was in the hospital, and the negotiator for the Treasury was William McChesney Martin.

    It was, in fact, that Martin was perceived to be the Treasury's man that persuaded Truman to go along with the deal.

    Too late he realized that Martin and the Fed had created a fourth branch of government. By which I mean to say that the Fed is entirely too independent of the elected government.

    Unfortunately it is in thrall to the banking sector it is supposed to be regulating. Refusing to execute the commissions it was given by the Congress to regulate mortgages and free market practices was a direct cause of the current crisis, and a direct favor to the banking sector.

    The Fed is not independent, agreed. An independent Fed would be far less inclined to enable ever bigger banks and ratifying the bad practices of the recent past with its massive bailouts.

    The deification of Paul Volcker continues to worry me as well. Volcker took the quantity theory of money from Milton Friedman as a New Testament and created enormous mess with the Latin American debt crisis and an enlarged S&L debacle, not to mention in concert with Reagan huge unemployment and the de-industrialization of America.

    Paulson and Bernanke have had more than a year to deal with this. If they had known what they were doing we would not be drowning in a cascade of crises. Saving Lehman may have delayed the inevitable, but it also proved that the problem was not with a single institution, but with the whole system. What we are doing now is saving institutions that ought to be dismembered and not rewarding those institutions who did not participate in the nonsense.

    Because the Fed is not independent …. of Wall Street.

  8. Anonymous

    Alan refers to over a year to fix the problem. The Fed and Treasury have known about this problems much earlier.

    In August of 2007 the Fed played a burn the shorts game by announcing a change in the discount window rules the night before option expiration just when it would do the most damage and resulted in $800 million from option holders to the other side. It was obvious that this move was leaked because in the face of a declining market the market on the day before two hours before closing turned around with a parabolic rally.

    Instead of being independent and addressing the problems by being a regulator, the Fed has been an active player to enrich the Wall Street mob at the expense of the rest of the nation.

    I have not seen one move by the Fed or the Treasury which reflected any for thought or did not seem to be an attempt of power grab in chaos.

    The nations should wake up and hold people responsible and that includes Paulson and Bernanke. The Treasury, Fed and SEC have become capture regulators of Wall Street.

    Truly traitors to this country.

  9. VoiceFromTheWilderness

    Cozying up to Clinton? I remember seeing a blog somewhere, link to an article somewhere, a few years ago, that looked at Alan Greenspans visits to the white house. in the 2002 time frame they increased from 1/month or so to 1/week. The implication was that Greenspan was actively participating in using FED actions to boost the political fortunes of the Bush WH.

    What would Bush’s approval rating have been, what would his ability to wage war have been if the US had remained mired in a recession in 2002 and 2003? None.

    There seems to be anecdotal evidence that ‘Easy – Free Market – Al’ used unprecedentedly low interest rates to give the economy a short term boost so as to make it look like 1) the Bush Tax cuts ‘wer’re working’, and 2) Americans were rich again.

    The fact that his ideological beliefs were more closely aligned with the goals of those controlling the Bush WH than that of any other prior president, combined with the unprecedented ‘ideological’ cabal like operation that is the Bush WH also make for strong circumstantial evidence that his actions may have had much more to do with his political/ideological beliefs than with regulating the ‘banking industry’, or building a long term stable economy.

  10. zenkat

    Yves —

    I have heard rumors from those who used to work in the financial services that “Lehman was not very well liked” by the other investment banks. (The animosity was based on cultural differences and a perception that Lehman was a vulgar johnny-come-lately, if I remember correctly.)

    If this is true, do you think it’s possible that Paulson (the old head of Goldman Sachs) allowed Lehman to sink out of professional rivalry and bias?

  11. Anonymous


    Again with the “we”? Do you have other people co-writing with you? Who’s “we”? What’s wrong with “I”? Are you trying to boost your self-importance? Are you the queen of England? Are you a sell-side analyst?

  12. tompain

    Was not bailing out Lehman a mistake, or was bailing out Bear the real mistake? In the bailout of Bear, shareholders were left with something and debtholders were made completely whole. In the wake of that Lehman turned up its nose at opportunities to raise capital on terms it viewed as too unfavorable. Perhaps if Bear had not been bailed out, Lehman would have seen what potential fate awaited it, and it would have taken its medicine soon enough and in a large enough dosage to survive. After Lehman was allowed to die, Goldman, MS, and Merrill saw the writing on the wall and did what they had to do. Perhaps if Lehman had been bailed out, we would also now be bailing GS, MS and Merrill.

    On the other hand, perhaps if Paulson had not scared the crap out of equity holders with his confiscation of FNM and FRE, the other banks would not have faced such a high cost of equity that they would have hesitated the way they did. Lehman might be alive, which would mean AIG would be alive, which might mean that we would not be in the crisis we are in now.

  13. Matt Dubuque

    Matt Dubuque

    This NYT article sounds like an attempt to throw red meat to the pitchfork crowd in a desperate attempt to boost sales. Will it succeed over the intermediate term?

    I doubt it.

    In terms of the quote:

    ‘Fine, I’m your partner. I’ll go to Congress.’ , precisely WHAT is Bernanke SUPPOSED to say in the middle of the conflagration, “I’m not going Hank, you are on your own!!”?

    Would that have calmed the markets?

    By contrast, the more sober Fed reporting of Krishna Guha in the FT reveals that from the beginning of the discussions of the TARP package, Bernanke STRENUOUSLY insisted that recapitalization was far more important than buying up toxic assets from banks.

    But is THAT red meat for the NY Times? Of course not. They are trying to sell newspapers in a desperate attempt to stave off bankruptcy.

    They are paying the price for Judith Miller and other scandals.

    In terms of blaming the Fed for lack of oversight of Lehman, the obvious point should be stated that ALTHOUGH the Fed REPEATEDLY tried to gain supervisory jurisdiction over IBs, the SEC had primary supervisory jurisdiction over the investment banks and Cox was a true jihadi trying to keep the Fed at bay.

    But again, that fundamental and sober point doesn’t sell newspapers.

    Matt Dubuque

  14. luther

    “Because the Fed is not independent …. of Wall Street.”

    and neither is the Treasury Dept.

    and therein lies the fundamental issue.

    me likes ‘we’ too, even when me does not agree with ‘we’, because me has an opportunity to make a constructive criticism (or include a larger perspective) of ‘we’ in the comments section.

    and thus me becomes a part of ‘we’.


  15. Anonymous

    fwiw, as this (credit crisis) has played out since last summer it has become apparent that BB is in over his head, and HP has taken charge (Al Haig must be envious). Up until this month I gave HP the benfit of the doubt on the issue of character. He’s obviously a very smart man, but smart doesn’t equal competent or good. He’s obviously not the former, and now I’m convinced he’s neither…

  16. doc holiday

    Re: "Again with the "we"? Do you have other people co-writing with you? "

    > We do wonder why we are all not on the same page, but what are we to do? One thing is for sure, we should not be distracted!

  17. Anonymous

    tompain: "Was not bailing out Lehman a mistake, or was bailing out Bear the real mistake?"

    interesting way to reframe the conundrum tom.

    if that is the question, then that begs the further question:

    why was Bear bailed out?

    one gentleman makes a claim to an answer here:

    although me does recognize the vital importance of maintaining a discerning eye for hyperbole (especially when choosing to put on the tinfoil hat and considering an argument made from a self-styled oracle), the evidence alone referenced there (in the charts & graphs) when combined with the statement from Volker but how letting gold go to $850 an ounce in the late 70's was his biggest mistake…

    …makes me wonder if maybe at least one of the answers can be found on the side of the yellow brick road.

    'we're off to the see the wizard!'

  18. tompain

    Let’s also not forget the role of the rating agencies in creating this conflagration. Although they were properly taken to task at the congressional hearing, the focus was mostly on the falsity of the orginal ratings. There will be a time to continue to point that finger and take action accordingly. But at the moment the bigger problem is that in trying to cover their tracks, the agencies are willy-nilly downgrading companies. Now, some might defend this as free speech or “telling the truth (if a bit late)” but the problem is that the consequences of these downgrades are enormous due to the collateral calls they create in a system that really cannot handle that right now. No one believes the ratings anymore anyway, so nothing was really achieved by threatening to downgrade LEH and AIG (just to pick two examples) except to trigger the collapse of those firms. Are the debtholders of LEH better off because Moody’s notified them that LEH was a few notches less creditworthy than previously believed?

    If our situation is so dire as to require all the actions that have been taken to date, perhaps a moratorium ought to be declared on all collateral posting requirements or other financial claims that are triggered solely by a rating downgrade. We ought not to allow some punks at Moody’s to be deciding whether and when major financial firms should be brought to their knees, imposing massive destruction with little if any corresponding benefit to individuals or the financial system.

  19. luther

    speaking of moodymen, i'm sure many of us here already knew this, but i just discovered yesterday that berkshire owns 19% of moody's & is their largest shareholder.

    things that make you go 'whoa'.

    and look what i just found from 2001:

    Moody's To Acquire Majority Interest In Argentine Credit Ratings Agency

    then there's this one:

    i would be surprised if this list of countries spreads all across the dymaxion map.

    "We ought not to allow some punks at Moody's to be deciding whether and when major financial firms should be brought to their knees,"

    agreed, we ought not.

    however, the $64T question is how 'we' can prevent 'we' from doing that.

    if anyone has a suggestion, we're all ears…

  20. luther

    sorry. would NOT be surprised.

    but then i feel like the day is coming soon when i would NOT be surprised if we wake up one day and see a UFO camped out on the white house lawn.

    but that’s me.


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