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.