In FED We Trust (2 page)
Authors: David Wessel
“No one in a democracy, unelected, should have $800 billion to spend as he sees fit,” he said.
The Great Panic exposed the alchemy of central banking: the Fed could create money from nothing. Printing money, they called it, although it was actually creating money with electronic keystrokes that showed up in the account of a bank somewhere. In the early stages, the Fed came up with over $115 billion to get Bear Stearns sold to JPMorgan Chase and to prevent insurance company AIG from rushing to bankruptcy court. By early 2009, with some help from the $700 billion financial-rescue fund that Congress eventually agreed to give the Treasury, it was prepared to create more than $3 trillion.
Whatever it takes
.
The Great Panic challenged the competency of those best equipped to calm it. Yet for all that the Fed did, it was often clumsy. Bernanke at times deferred so much to Paulson — always forceful, often impulsive, sometimes politically inept — that he undermined the Fed’s credibility as the one economic institution of government that does what is necessary regardless of the politics of the moment. Tim Geithner often said that at times of crisis, the government had to get both the
substance
and the
theater
right. How a line was delivered and how a policy was framed — the setting, tone, and backdrop — could matter as much in a media-saturated environment as the actions themselves. At its best, this approach made wise policy decisions more effective; at its worst, it led Geithner to overestimate his ability to use words — detractors would call it “spin” — to disguise a mistake or to explain away actions that were not always
consistent. Bernanke, Geithner, and, even more so, Paulson muffed the theater. Because they didn’t tell a convincing story about what was happening or offer a clear explanation of what they were doing, other accounts of varying plausibility filled the vacuum on cable TV, on the Internet, on trading floors, in executive suites, and in the imaginations of frightened investors.
At the outset, the Fed did not do enough soon enough to prevent what has become the most painful recession in more than a generation: Once Bernanke did step up, the Fed became such a whirlwind of activity that it took President George W. Bush, Treasury Secretary Paulson, and the U.S. Congress off the hook, allowing them to avoid timely, but politically uncomfortable, measures that might have prevented some of the worst of the damage.
But with no textbook or contingency plan beyond Ben Bernanke’s lifelong obsession with the Great Depression, he and those closest to him responded aggressively and creatively enough to reduce the chances of the Great Panic becoming another Great Depression. Using tools invented by discredited financial engineers, the Fed devised ways to lend money and buy assets that Bernanke’s predecessors hadn’t dared to contemplate.
Despite resistance from inside the Fed — and a sluggish start — Bernanke ultimately took to heart his own critique of the Japanese central bank, which over a decade earlier had proved unwilling to experiment or try any policy that wasn’t absolutely guaranteed to work. “Perhaps it’s time for some Rooseveltian resolve in Japan,” Bernanke had suggested in 1999. “Many of [FDR’s] policies did not work as intended, but in the end FDR deserves great credit for having the courage to abandon failed paradigms and to do what needed to be done.”
This is the story of the Bernanke Fed abandoning “failed paradigms” in order “to do what needed to be done.” It is the story of what the Fed saw and what it missed, what it did and what it didn’t, what it got right and what it got wrong. It is a story about Ben Bernanke deciding to do
whatever it takes
. Above all, it is a story about a handful of people — overwhelmed, exhausted, beseeched, besieged, constantly second-guessed — who found themselves assigned to protect the U.S. economy from the worst economic threat of their lifetimes.
T
he Fed’s embassy on Wall Street is an iron-barred, neo-Florentine fortress built in the 1920s. Even before completion, it was criticized as so “luxurious and lavish” that it “will make Solomon’s temple of old seem quite cheap in comparison.” The building sits atop $195 billion worth of gold in a vault that rests fifty feet below sea level on the bedrock of Manhattan. Carved into the lobby wall, the Fed’s mission statement includes some archaic words (“to furnish an elastic currency”) and some still relevant (“to unite the resources of many banks for the protection of all”). A center of power itself, the Federal Reserve Bank of New York also is a key nexus between the worlds of Wall Street finance and Washington politics. Few dramas in its building have played out as momentously as the events of September 13 and 14, 2008, when the building played host to the death of Lehman Brothers, the shotgun marriage of Merrill Lynch to Bank of America, and the preparations to effectively nationalize AIG, the nation’s largest insurance company.
Lehman and Merrill Lynch had been on worry lists around the globe since the Fed had brokered the sale of failing investment bank Bear Stearns to JPMorgan Chase seven months earlier. As the financial rot from the housing market spread during the summer of 2008, Lehman’s basic problem was not uncommon: a huge pile of bad real estate loans that it couldn’t sell. What was
unusual was the size: in just six months, it had taken $6.7 billion in losses on its commercial real estate portfolio. Its shares had fallen by 90 percent since the beginning of the year.
Both Paulson, the hyperactive Treasury secretary, and the New York Fed’s coolly analytical president, Tim Geithner, had been fielding calls from Lehman’s longtime CEO, Dick Fuld, for months — even before the firm announced a couple of days after the Bear Stearns rescue that its first-quarter earnings were down 57 percent from the year before. Both Paulson and Geithner told him to raise capital or find a buyer. Fuld looked — with all of Wall Street watching intently.
At one point, Fuld suggested that Lehman could split into two pieces — putting the rotting real estate assets in a separate entity — if only the government would come up with $4 billion. Lehman had flirted with becoming “a bank-holding company,” a way to wrap itself in the Fed’s protective blanket and assure investors that it would always have access to Fed loans in a crunch. The Fed listened, but Geithner, among others, was skeptical that an identity change would solve Lehman’s underlying problem. “No naked bank-holding companies,” he told Lehman. (Translation: a change in legal status without a fundamentally different business strategy wouldn’t suffice.)
Paulson, who never thought much of Lehman when he was running Goldman Sachs, found Fuld unrealistically optimistic. But unlike some, even among his own staff, Paulson didn’t think the problem was that Fuld was asking too much for his company. “Everyone out there knew that Lehman was sitting there. If they wanted to do a deal with Lehman, they weren’t going to be constrained by the price Dick was asking,” Paulson said later. A last-minute attempt to raise equity from a Korean bank fell through.
Lehman’s time was running out.
OMMANDERS IN
C
HIEF
Just a few days after orchestrating the government takeover of mortgage giants Fannie Mae and Freddie Mac — a maneuver that would have consumed all their attention for months in ordinary times — Ben Bernanke and
Paulson met for their usual weekly breakfast. This week, they sat in a small antiques-furnished conference room adjacent to Paulson’s larger corner office in the Treasury building. In calmer times, the two would have chewed over the surprisingly smooth execution of their plan to seize control of Fannie Mae and Freddie Mac, which were in danger of losing their ability to borrow money because of mounting losses on mortgages they held in their portfolios or had guaranteed. But Lehman pushed itself to the top of the worry list. At midmorning, Bernanke and Paulson convened a conference call to talk Lehman strategy with their top lieutenants and Christopher Cox, the former California congressman who was chairman of the Securities and Exchange Commission and ostensibly Lehman’s regulator.
With Lehman clearly struggling for survival, Paulson and Bernanke assured each other — and the others on the call — that all the companies and traders that did business with Lehman had been given time to protect themselves from a possible Lehman bankruptcy. They comforted themselves that, since the Bears Stearns bailout, the Fed had found new ways to lend to other investment houses that might be hurt by a Lehman collapse. They were wrong.
Paulson and Bernanke were directing the entire response of the U.S. government. There had been no high-powered, explore-all-the-options meeting at the White House to contemplate a looming problem as significant as Lehman. Oddly for an administration that had made a habit of interventions and micromanagement throughout the government, Bush and his team had delegated almost unconditional responsibility for managing the Great Panic to the Treasury and the Fed.
Paulson called the plays and kept the White House informed, most commonly through phone calls to Keith Hennessey, the economic-policy coordinator, or Joel Kaplan, the deputy White House chief of staff. Paulson didn’t do e-mail. When the Smithsonian’s National Museum of American History later asked for his BlackBerry, Paulson said he didn’t have one and gave the museum his overused cell phone.
After meeting with Bernanke, Paulson flew to New York on a private plane he paid for himself. He could afford it. He had earned $40 million as Goldman’s
CEO in 2005 and had sold nearly $500 million worth of Goldman shares accumulated over his thirty-two years at the firm when he took the Treasury job in 2006. Goldman Sachs had sent so many alumni to positions of power in both Democratic and Republican administrations that it was sometimes called “Government Sachs.”
Paulson had played on the offensive line of the Dartmouth College football team, and had a permanently bent little finger on his left hand as a result. After getting an M.B.A. from Harvard, he worked in the Pentagon and later in the Nixon White House as a liaison with the Treasury and Commerce departments. A Christian Scientist with a passion for nature, Paulson initially worked in Goldman’s Chicago office, and he and his wife raised their son and daughter on his family farm in illinois.
Paulson was a physically restless man, even when sitting down, and brought to the Treasury the impatience and drive that had taken him to the top of Goldman Sachs. He issued orders to his secretaries while they were on the phone talking to someone else. He made assignments to staffers and then checked on progress ten minutes later. He convened Sunday-afternoon meetings at his house and focused so intently on the work that he didn’t offer drinks or snacks. And he had a tendency to talk more than listen, thinking through a problem by talking about it out loud instead of reflecting quietly or making a list of issues on a legal pad as Bob Rubin, a previous Goldman Sachs executive turned Treasury secretary, did. His closest advisers learned that he often stopped listening to them before they stopped talking, prompting them to tell him explicitly when they were making a crucial point.
With him were Dan Jester, a forty-three-year-old Goldman Sachs investment banker Paulson had drafted out of retirement, and Steve Shafran, another Goldman alum. “Our purpose,” Paulson said, “was to either get a deal done for Lehman or have the rest of the industry help one of their competitors make an acquisition.”
Paulson wanted a deal for Lehman, and he was prepared for tough negotiations, but he did not want a huge taxpayer-funded bailout: “We said: ‘If you’re not going to do the acquisition, you’re going to need to figure out what you’re going to do to help with the wind-down of Lehman because … you have to understand the powers that we have and we don’t have.’”
Bernanke stayed in Washington, in nearly constant touch by phone. His immediate interests in New York would be represented by his lieutenant, Kevin Warsh, a role Warsh filled during several pivotal moments of the Great Panic. A young and ambitious former investment banker, Warsh split his time between his Washington office at the Fed — the same office that Bernanke had occupied earlier in the decade when he was a Fed governor — and an office he had commandeered next to Geithner’s temporary quarters on the thirteenth floor of the New York Fed. (The Great Panic coincided with the renovation of the cavernous, wood-paneled, tenth-floor executive suite at the New York Fed, its arched hallways modeled on those of the fifteenth-century Palazzo Strozzi, built by a rival of the Medici, the greatest banking family of the Renaissance.)
As Paulson and Jester rode from the Teeterboro, N.J., airport to the New York Fed, a gaggle of Bank of America executives called Jester’s cell phone. Bank of America and Britain’s Barclays bank were the two potential Lehman buyers — and the best remaining hope for doing for Lehman what had been done earlier for Bear Stearns. For weeks, Paulson had brought all his energy and training as a mergers-and-acquisitions banker to the effort, pressing Bank of America’s CEO, Ken Lewis, to buy Lehman without any government help.