The Alchemists: Three Central Bankers and a World on Fire (22 page)

King was quickly coming to the same view; he had a stubborn streak, but was willing to change his views when the world around him offered persuasive evidence that he had been wrong. And the evidence was piling up that the British economy was in free fall due to the global crisis. The committee gathered the afternoon of Wednesday, November 5, to have its initial discussion of the decision it would make the next morning. King started the meeting. “‘I realize where we are,’” Blanchflower recalled him saying. “‘This is a very serious situation. And just to put this on the table, just so we don’t get confused, I have a proposal on the table that we cut by 150 basis points.’”

After reaching a decision at about 11:30 a.m. on November 6, Blanchflower and his colleagues went to their offices, sworn to silence to ensure there were no leaks before the public announcement at noon. In the moments before the central bank shocked the market with its 150-point cut, Blanchflower was awed by the fact that after months of fighting an unsuccessful battle for the bank to cut rates, he had finally won—though it did take a global financial collapse to make it happen. “I’m shaking. I’m absolutely bloody shaking,” he said. There was a countdown to the announcement, scheduled to happen at precisely noon Greenwich Mean Time, so that all news outlets would get the information at exactly the same time. The media, financial markets, and even other Bank of England staff were stunned by the aggressiveness of the move. Finally, the Bank of England, the most reluctant crisis fighter in the 2007 phase of things, was ready to pull out its big policy guns.

At the Federal Reserve, Bernanke wasn’t content to quit at the October rate cut either. But given the slashing of rates the Fed had done earlier in the year, there wasn’t much room for more cuts. After the joint rate cut and another by the Fed three weeks later, the federal funds rate on November 1 was only 1 percent, already a historically low level. In other words, the device three generations of Federal Reserve chairmen had used to prop up faltering economies was no longer working. The Fed could lower rates down close to zero, perhaps, but not below that. If interest rates were negative—meaning savers would actually lose instead of make money over time—people would just take their money out of the banks.

But a decade earlier as an academic, Bernanke had argued that even if
short-term
interest rates hit the so-called zero lower bound, a central bank wasn’t out of options for fighting a slumping economy. It could always lower longer-term interest rates too. In late 2008, the economy was in free fall—but just how much so wasn’t clear. (Gross domestic product was falling at a 9 percent annual rate, but the first data that became available that winter put the pace of contraction at only 3 percent.) On November 25, the Fed’s Board of Governors announced a plan to buy up to $500 billion in mortgage-backed securities guaranteed by government-sponsored companies like Fannie Mae and Freddie Mac. But in their hurry to try to pump money into the financial system, the Fed’s lawyers made a mistake: It wasn’t within the power of the Board of Governors to have made that decision. This was a form of monetary policy, so it had to be decided by the full Federal Open Market Committee, which includes presidents of reserve banks around the country.

In the days before the December 16 meeting, Bernanke called his colleagues across the country. All of them agreed that the economy was in terrible shape. Some were angry that they hadn’t been included in the decision on mortgage securities. Others were already antsy about the vast expansion in Fed lending. Bernanke wanted the next policy announcement to be a show of decisiveness and unity. And he wanted not merely to cut rates, but to cut them to zero and pledge to keep them there for some time, as well as to give a formal blessing to the plan to purchase mortgage-backed securities in order to pump money into the economy through alternate means.

Usually, Bernanke viewed the dissent of one or two policymakers from a decision as the sign of a healthy committee. (“
If two people always agree
,” he’s said, “one of them is redundant.”) But for this move, he very much wanted unanimity. After all, if the Fed could take such action unanimously, it would create greater confidence that it was truly committed to keeping rates low for a long time. Dallas Fed president Richard Fisher was reluctant to go along with the move, however, viewing it as a risky proposition that wouldn’t help the economy much. He initially voted against the action—then, while his colleagues ate lunch and staffers prepared the announcement, approached Bernanke privately and asked to change his vote. “
I felt after going for a walk down the hall
that I didn’t want to pull the legs out from under Ben,” Fisher later said. “I didn’t want to be perceived as not being a team player.”

Bernanke’s years of respectful consensus building had paid off, just when he needed it most.

•   •   •

T
hat fall and winter, the central bankers of the world worked nonstop, in constant touch with each other, the weight of history constantly on their minds. After Liaquat Ahamed’s book
Lords of Finance: The Bankers Who Broke the World,
an account of how the central bankers of the 1920s and ’30s bungled their way into the Great Depression, was released in January 2009, Geithner tried reading it in the evenings. Over and over, he had to put it down and stop, horrified that even highly intelligent, well-meaning policymakers could mishandle a situation badly enough to create mass human misery.

But what the world’s most powerful central bankers did in that fall of 2008 was, piece by piece, build a wall of money, attempt to fight the panic on a scale commensurate with its severity. They did it by lending to banks and investment firms and even individual businesses. They did it by swapping dollars and euros and pounds with each other and their counterparts in emerging nations. They did it by trying to influence their governments to bail out insolvent banks. With people in almost every country on earth hoarding their money, the central bankers created more of it, flooding the financial system, substituting their own bottomless resources for those of newly fearful world investors.

They didn’t prevent a steep decline in the world economy. From May 2008 to March 2009, the global stock market fell in value by almost $27 trillion, a 47 percent drop, wiping out wealth equivalent to the goods and services produced by every human on earth in half a year. If you look at a graph of the U.S. stock market, the period of 1929 to 1931 tracks very closely with that of 2007 to 2009. So do measures of the economy more broadly, such as industrial production. But in the 1930s, the declines continued for years. In the recent episode, they leveled off in the spring and summer of 2009.

There was far more work to do. But the wall of money built by the global central bankers had held.

AFTERMATH, 2009–2010

The Battle for the Fed

T
he hallway outside Room 2128 of the Rayburn House Office Building was crowded with dozens of people sitting on the floor. Dressed in lived-in sweats, skintight shorts, and tattered-looking winter coats, they hardly looked like a crowd waiting to view a hearing of the House Committee on Financial Services. They weren’t. The various students, bike messengers, and even homeless people vying for one of the few dozen seats open to the public were members of an unlikely Washington profession: those who earn money by holding a place in line for well-heeled financial lobbyists. And on March 24, 2009, with the unemployment rate rising, economic output plummeting, and the stock market at 1997 levels, they had some even more unlikely competition: a group of middle-aged women in bright pink shirts and life jackets, holding signs that read
WHERE
’
S
MY
JOB
?,
WHERE
’
S
MY
IRA
?, and
BAIL
US
OUT
.

These representatives of Code Pink, a left-wing group that arose to protest the Iraq War and had broadened its interests to include economic issues, had gotten there first, thus claiming the seats right behind the witness table, which would soon be occupied by Fed chairman Ben Bernanke, Treasury Secretary Tim Geithner, and New York Fed president Bill Dudley. American International Group, the giant insurance company that the Fed had bailed out six months before, would be paying out $165 million in bonuses to its employees, honoring earlier contractual commitments made to retain the people responsible for winding down its cash-sapping financial products division. The wrath of an angry Congress was about to descend upon Bernanke and his two colleagues.

“This is a very important public hearing,” said Massachusetts congressman and committee chair Barney Frank as the proceedings got under way. “It will not be disrupted. There will be no distraction. My own view is that critical conversation, indeed, whole sentences and even paragraphs, advance even a negative view more than bumper stickers, no matter what sort of bumper those stickers are worn on.” The Code Pink protestors held up their signs.

The committee leaders from both parties started by giving long speeches. Then the three witnesses delivered their opening statements. As Geithner proceeded to talk about “a broad set of regulatory reform proposals, specifically related to systemic risk,” Frank interrupted him.

“Will you please act your age back there?” said Frank to the demonstrators. “Stop playing with that sign. If you have no greater powers of concentration, then you leave the room.”

It was Bernanke’s turn. “AIG faced severe liquidity pressures that threatened to force it imminently into bankruptcy—” Frank interrupted again: “The next one that holds a sign will be ejected. I do not know how you think you advance any cause to which you might be attached by this kind of silliness.”

Once the prepared statements were finally done, Frank told his sixty-some committee members how it would be: They would have five minutes each. No exceptions. “I wish we didn’t have the five-minute rule, and I wish we didn’t have so many members. And I wish I could lose weight without dieting,” he said.

Michele Bachmann, the firebrand conservative congresswoman from Minnesota who two years later would have a brief turn as a front-runner for the Republican presidential nomination, wondered if the government was in the midst of “a historic shift, jettisoning the free-market capitalism in favor of centralized government economic planning.” She proceeded to question the constitutionality of the Federal Reserve and ask whether there were plans to abandon the dollar and move to an international currency.

“How do the three of you operate in your own mind?” implored Ron Paul, the Texas congressman who made his own 2012 presidential run and authored the book
End the Fed
. “Do you operate with the idea that capitalism failed, and they need us more than ever before to solve these problems?”

Illinois representative Donald Manzullo confronted Bernanke and Geithner over why the government bailout of AIG helped people whose savings were insured by the company to avoid losing out at a time when Americans’ stock portfolios were being hammered. “The American people have lost 40 to 50 percent of their retirement plans,” he said.

“The purpose of the action we took with AIG,” replied Bernanke, “was not to help any specific counterparty.”

“But you did,” interrupted Manzullo. “That’s what happened.”

Americans were paying $40 billion “so that other people don’t lose any of their retirement plans,” Manzullo said. “That’s what happened, isn’t it?”

“Congressman,” Bernanke said, “those losses the American people would have been—”

“Give me a yes or no, please,” said Manzullo.

“. . . would have been far greater—” continued Bernanke.

“No, did the people who took out—”

“. . . would have been far greater—” Bernanke tried again.

“I’m asking the question,” snapped Manzullo. “Did the people who took out insurance with AIG . . . get reimbursed 100 percent so they suffered very little loss? Yes or no?”

“It depends on the nature of those specific contracts,” said Bernanke.

Frank interrupted once more: “I would ask the people in that second row to stop the gesturing and the conversations . . . If there’s any further disruption, I would ask the officers . . . to simply escort people out.”

To call it a circus would be unfair to Barnum and Bailey.

•   •   •

I
n the spring of 2009, people of opposing parties and differing political ideologies could all agree on one thing: The government agency that most clearly deserved to have its wings clipped in response to the economic crisis was the mighty Federal Reserve.

It was both a convenient and a logical target. To those on the left, the Fed had been blinded by the free-market dogma of its previous chairman, Alan Greenspan, and thus had been unwilling to regulate big banks and protect consumers from taking out irresponsible loans. To those on the right, it had meddled in the free market, pushing too much money into the economy earlier in the decade and then rescuing the banks from their poor decisions when things turned ugly. People in both camps viewed it as a secretive organization with inadequate oversight.
A Gallup poll in the summer of 2009
found that 30 percent of Americans approved of the Fed’s performance, a lower rating than even that of the Internal Revenue Service.

As Bernanke and the Fed made their big decisions during the crisis—the bailouts of Bear Stearns and AIG, the alphabet soup of programs to pump money into the financial system—politics was a second-order concern. Bernanke and his inner circle concluded that they simply had to do what they thought would best support the economy and hope that the politics would work itself out. “If we come out of this with a Hall of Fame batting average, then we’ll be fine,” Bernanke, a baseball fan, told his advisers. Even most of the very best hitters in the Major League Baseball history recorded a hit less than a third of the time. In other words: We’re not going to hit every ball, but we have to keep swinging, doing what we think is best, and as long as the overall results are good, our mistakes will be forgivable.

Many of the decisions were made quickly and in the middle of the night and involved questions that are supposed to be independent of politics. Plus, it’s hard to brief legislators about anything without it soon leaking to the press, making it problematic to talk about questions that were still undecided. Congress was usually an afterthought, briefed only after a decision had been made and announced—despite the fact that it ultimately controls the existence and authorities of the central bank.

Every major financial crisis spurs a rethinking of financial regulation, and as the Panic of 2008 raged, there was little doubt that the pattern would hold. After President Barack Obama was inaugurated in January 2009, he made overhauling the financial system a priority. “
You never want a serious crisis to go to waste
,” Obama’s first chief of staff, Rahm Emanuel, said in November 2008. Initially, the new administration was hoping Congress would pass some form of financial reform in time to take to an international summit in April 2009. That proved unrealistic given the sluggishness of the legislative process, but the White House was still eager to move. When Neal Wolin, the deputy treasury secretary, told Emanuel that it could take weeks to draft a bill, given the hundreds of pages of complex details to work through, Emanuel, who wanted a bill written in days, pointed at Wolin’s computer and said, “Sit down and start fucking typing.”

Christopher J. Dodd, a veteran senator from Connecticut, was chairman of the Senate Committee on Banking, Housing, and Urban Affairs, and he would be the one to try to craft a financial reform bill that could make it through the procedural gauntlet that was the United States Senate in 2009. A single senator out of the one hundred could slow activity on the Senate floor to a crawl on nearly anything, from the confirmation of a midlevel bureaucrat to passing Obama’s signature initiative of overhauling the health care system. In earlier times, there had been an unwritten agreement against using that power except in really important cases, but by 2009 minority parties routinely filibustered anything controversial, requiring a sixty-vote supermajority and days or weeks to overcome objections.

Dodd, the son of a senator and a three-decade veteran of the institution, envisioned financial reform being done the old-fashioned way: with the two parties contributing their best ideas and hammering out a deal across the negotiating table that eighty or ninety senators from both sides of the aisle could happily support. “I don’t want to be sitting on the floor of the Senate begging for a sixtieth vote with sixty guns pointed at my head,” Dodd told an aide in the spring of 2009. “This is different, and it shouldn’t be ideological.”

The key to his strategy was going after the Federal Reserve.

Dodd himself was irritated that the Fed, under Greenspan, had done little to use its regulatory powers to rein in bad mortgage lending during the housing bubble. He didn’t have the deep-seated populist objections to the central bank that some of his colleagues did, but Dodd did see the extraordinary actions the Fed had taken during the crisis as evidence of an organization with too much concentrated power. In one hearing, he compared giving the Fed more power after its failings during the crisis to a parent “
giving his son a bigger, faster car
right after he crashed the family station wagon.”

Dodd also believed that a fundamental reason for the crisis was that the United States had so many different bank regulators—five of them at the federal level alone, plus separate banking authorities in each state. Banks had the ability to choose what type of charter—and hence what regulator—they would have. That in turn gave regulators some incentive to take a hands-off approach, lest banks switch to different charters and a regulator lose relevance and funding.

Dodd viewed cutting back the power of the Fed as an important way to build bipartisan consensus. The Republican leader on the Banking Committee was Senator Richard Shelby of Alabama, a particularly vehement opponent of the central bank. Shelby had refused to negotiate on behalf of Republicans on the Wall Street bailout legislation because he was opposed to passing it in any form, and he believed the Fed’s low-interest-rate policies in the early 2000s were the main cause of the housing bubble. Dodd’s plan was to replace the complex system of overlapping bank regulators with a single, newly created one—that is, to take away one of the core powers that the Fed had long held dear, the ability to supervise banks all over the country. It was, in Dodd’s view, reining in an agency that had grown too powerful. Shelby’s staff described the approach more colorfully: “Fuck the Fed.”

That was in the rarefied confines of the U.S. Senate. As Dodd and Shelby moved in their own way to unmake the modern Federal Reserve, another political threat was emerging from different quarters.

Texas representative Ron Paul was officially a Republican in 2009, though he disagreed with the party on nearly as much as he agreed. He opposed both the Iraq War and high defense spending, for example, and he favored the legalization of narcotics. Paul had previously run for president as the nominee of the Libertarian Party; in 1988 he won 0.5 percent of the national vote, which was good enough for third place. His presidential ambitions found more success in 2008 and, especially, 2012, when his strongly antigovernment stance resonated among Republican primary voters more than party leaders would have liked. So opposed was he to government action of all stripes that when there was a vote in the House on some inoffensive measure such as naming a rural post office after a deceased local official or designating May as Mental Health Month, Paul was very likely to be the one dissenter in a 434–1 vote.

Unsurprisingly, Paul hated the Fed. He was in favor of a strict gold standard and ending the government’s monopoly on issuing money. The idea of paper money issued and guaranteed by the government is, after all, anathema to someone who deeply distrusts government. Paul also had a penchant for conspiracy theories, and he used his position as a member of the House Financial Services Committee to ask questions of Bernanke (and Greenspan before him) that no one else in the Congress would think to pose. At one hearing in 2010, Paul suggested that the Fed had some involvement with the Watergate break-in and funding Saddam Hussein in the 1980s, which Bernanke described as “
absolutely bizarre
.”

But in 2009 Paul’s long-running crusade against the Fed became a cause that seemingly everyone wanted to join. One of his criticisms was that the Fed kept too much information secret from Congress and the public. His answer was legislation that would allow Congress a freer rein to look into the Fed’s business. Under existing law, political authorities didn’t have the ability to demand details of the inner workings of Fed decisions on monetary policy or its dealings with foreign central banks. Central bankers view secrecy as a key to their ability to operate—it gives them the freedom to deliberate away from the pressures of politicians or the public. But this merely magnified the impression held by Paul—and by more and more of his colleagues—that the Fed was up to something nefarious.