JULY 22, 2019
THE TRAGEDY OF THIS slim, self-satisfied little memoir about the 2007–2008 financial crisis is not what it gets wrong. Indeed, four of its central arguments are important and exactly right: (1) that extraordinary measures and creative innovation and improvisation saved the entire financial system from melting down; (2) that without such interventions the crash would have been much, much worse (a complete financial collapse and second Great Depression); (3) that widespread perception that those emergency measures actually failed, coupled with a now deeply dysfunctional political system, will prevent officials from accessing the tools necessary to contain a major crisis in the future; and (4) that this political failure is especially concerning since the financial sector is generally and inherently vulnerable to crisis.
The problem with Firefighting, a justly pessimistic, three-headed lament co-written by financial first-responders Ben Bernanke (chairman of the Federal Reserve during the crisis), Henry Paulson (Treasury Secretary to George W. Bush), and Timothy Geithner (Treasury Secretary to Barack Obama), is what it fails to say, refuses to acknowledge, and is too timid (or blissfully unaware) to look in the eye. A straight line can be drawn from the financial crisis to our current political catastrophe: that crisis was the product of an elite, bipartisan, political-economic culture of contentment, in which each of our firefighters was deeply enmeshed. This is a book whose authors take turns politely praising each other in the third person, but it has nothing to say about the gilded revolving door between Washington and Wall Street, or the role of the inbred legal corruption that riddled the financial sector (credit rating agencies, for example, go virtually unmentioned); nor are Bernanke, Geithner, and Paulson much inclined to take a hard look at their own missteps along the way.
Most of Firefighting is well and properly devoted to four chapters that describe the tumultuous, heart-pounding, cliff-hanging, world-in-the-balance confusion of emergency crisis management that stretched across two administrations, from the “first flames” of the upheaval in subprime mortgage markets in the summer of 2007 through the series of cascading catastrophes (Bear Stearns, Lehman Brothers, AIG) and the desperate, inventive emergency measures (the Troubled Asset Relief Program [TARP], ad-hoc currency swap lines with foreign central banks, quantitative easing) that were finally able to “douse the fire” by May 2009.
As the authors note, forgetting is one of the causes of financial crises, and it is too easy to lose sight of how close the financial system came from spiraling into utter free fall; the first phase of the crisis was arguably worse than the one that led to the Great Depression. And we were lucky — damn lucky — to have someone like Ben Bernanke as chairman of the Fed when the financial system was on the brink of implosion. Not only was Bernanke a world-class macroeconomist, he was a leading expert on the Great Depression (his last academic publication before entering government service was the widely lauded volume Essays on the Great Depression ). Certainly he shared the original sin of modern macroeconomics — the misguided embrace of Rational Expectations Theory, which provided intellectual succor for the deregulations of the 1990s that invited financial catastrophe — but when that crisis came knocking, few if any were better prepared to take on the monumental challenge that followed. (A couple of years ago, in line behind Bernanke at the Brookings Institution cafeteria, I was set to approach him with a word of thanks before shyness intervened.)
Firefighting fulfills its obligation to the reader, walking through all of the emergencies and the frantic, creative, seat-of-the pants responses crafted by its tireless protagonists, who were bearing the weight of the world in real time while fighting upstream against a constant barrage of criticism from grandstanding politicians and showboating talking heads. Disappointingly, however, this “inside story” does not reveal much beyond what has been covered in a dozen or so fine academic and journalistic accounts, and the authors’ self-confidence precludes moments of deep introspection.
Nevertheless, the tale is well (re)told. There is a difference between abstract academic theory and real-world practice, and all hands quickly understood that heroic measures would be essential to meet the crisis, as “severe financial panics are not usually self-correcting” and “[s]ystemic crises are not the time for free market absolutism.” The usual suspects get their (relatively gentle) perp-walks — e.g., Bear Sterns, which was “mostly just a collection of fragile businesses and risky assets” that, as it approached insolvency, had 5,000 counterparties and 750,000 open derivatives contracts, a state of affairs that ought to scare the free-market pants off the most die-hard libertarian. Who would be exposed if Bear collapsed? It was hard, if not impossible, to say. Here Bernanke and company remind us (with a bit more sheepishness, one would have hoped) of what Keynes knew almost a century ago: “In a panic, it can be difficult to tell whether a troubled firm is truly insolvent. Markets are not always right or rational.”
The Bear intervention soothed markets but contributed to a political pushback against government intervention, putting the authorities in a tight spot when it soon became clear that Lehman Brothers (“loosely regulated, heavily overleveraged, deeply interconnected”), which was even bigger than Bear and boasted an even larger derivatives book, was the next financial giant set to collapse. This was one of the pivotal — and controversial and interesting — moments of the crisis. Bailing out Lehman, especially in retrospect, would have been prudent; letting Lehman go was another option, and a gutsy one — a shot across the bow to other financial firms to get their acts in order, a stern warning that they could not count on Uncle Sugar to bail them out. In the moment, a strong case could be made for either strategy. But it’s hard to imagine that policymakers who fully understood the extent to which the entire US financial system had become not a house, but a towering skyscraper of cards would not have intervened. Paul Krugman was surprised by the non-bailout, writing in his column at the time that he assumed he’d be opening with the line: “When life hands you Lehman, make Lehman aid.” Presciently, he added, “Mr. Paulson seems to be betting that the financial system […] can handle the shock of a Lehman failure. We’ll find out soon whether he was brave or foolish.”
In discussing this crucial episode (certainly the moment I was most eager to read about), Firefighting punts, falling back on its unconvincing, if oft-repeated, trope that the Fed at least had no statutory authority to rescue the firm. (Again, surely if they knew what would follow, they would have found a way to pull it off.) Unwilling to venture beyond protesting that they “did not choose to let Lehman fail,” the authors regain their footing with the essential observation that “even if we had somehow found a solution for that firm, something else was eventually going to break.” The unregulated US financial system was rotten to the core, and it was only a question of which shoe would fall next, and when. The answer, of course, was AIG, with its “irresponsible financial products division” and its $2.7 trillion in derivatives. Once again, “[i]t seemed like everyone was exposed to AIG, and no one was sure how exposed anyone else was.” But one thing was not in doubt: AIG was too big (and too interconnected) to fail; statutory limits on financial firefighting would no longer be an issue.
Despite a hand-waving acknowledgment that the financial crisis “inflicted tremendous pain,” the central takeaway of Firefighting is, basically, “We saved the world. You’re welcome.” Which is true and should be appreciated — as far as it goes. The problem is that it only goes so far, as illustrated by the book’s introductory and concluding sections, which frame the crisis narrative. The first two chapters provide a fine primer on financial crises in general and why the 2008 crisis — however cataclysmic — was a garden-variety exemplar of that common beast. The crisis was “a classic financial panic,” which should not be all that surprising given that “[f]inancial systems are inherently fragile.” This one was brought about by “rapid financial innovations” (especially securitization) that encouraged the accumulation of unchecked systemic risk, “vulnerabilities were allowed to fester by America’s balkanized financial regulatory bureaucracy.” In an implicit rebuke to blame-shifting revisionists, the authors remind readers that the subprime market was a “small corner” of the financial system; the fundamental problem, plainly, was the fact that that market was sitting atop “a fragile system vulnerable to disaster.”
And Firefighting earns more points still for permitting cameo appearances by Charles Kindleberger, whose 1978 treatise Manias, Panics, and Crashes: A History of Financial Crises reads as if it were describing step by step the events that would occur 30 years later (because, as Kindleberger taught, financial crises are “a hardy perennial”), and Hyman Minsky, another prophet of financial instability (a 2008 article in The New Yorker labeled the subprime crisis “the Minsky Moment”). The authors also give a welcome nod to the observation, often attributed to Keynes, that “the herd mentality is powerful” in asset markets.
But Bernanke and friends are pulling a fast one when chastising financial institutions for “bingeing on risk and leverage” (where were our firefighters then?), or when they retreat to the passive voice to describe the “creaky and fragmented” regulatory system, or when they observe that “many in Wall Street, Washington and academia believed that serious financial crises were a thing of the past.” The banishing of Keynes, Kindleberger, and Minsky from graduate syllabi, the desiccation of regulatory capacity, and hubris about the unquestionable wisdom of untended financial markets did not happen on their own. Professor Bernanke, for one, not only drank but served the financial-markets-know-best Kool-Aid that treated the timeless wisdom of those old classics as vestigial and obsolete. Bernanke’s famous 2002 birthday toast to Milton Friedman made these points explicitly: “The best thing that central bankers can do for the world” is to take measures to assure low inflation and otherwise get out of the way. A careful reading of Firefighting serves as a chastening reminder that there is actually much more to central banking than that: the financial sector needs to be attentively supervised and regulated, or it will bring ruin.
The book’s concluding chapter, “The Fire Next Time,” is even more disheartening than intended. Bernanke, Geithner, and Paulson want to sound an alarm — and they do so convincingly: should another crisis arise, due to the perceived failure of the emergency measures they introduced, the tools of financial firefighting will not be available to their successors. They offer a chilling review of the powers that have been withdrawn from the Treasury and Fed, observing as well that recent, irresponsible macroeconomic policy choices (such as massive tax cuts), which have caused deficits and the federal debt to soar, have “significantly depleted” the vital resources that would be necessary to counter the challenges of a new upheaval. It was very good fortune, they note, that before the 2007–2008 crisis, “America’s Keynesian arsenal was reasonably well stocked.”
So there’s good reason to be scared — very scared, actually, and even more concerned than our erstwhile firefighters, whose expansive analytical blind spots regarding financial reform, the roots of public rage, and their own culpability in contributing to our contemporary political crisis tend to obscure a bigger and even darker picture. Simply put, Bernanke, Geithner, and Paulson are overly optimistic about the financial reforms put in place after the crisis, and they fail to understand the extent to which, in saving the world, they saved it more for some rather than others.
With regard to the former issue, a public policy disaster occurred at the site of the Global Financial Crisis, one that took place after the fire was extinguished (there is much still to do in the aftermath of a catastrophic fire; just ask the local residents). Certainly, the firefighting itself was a remarkable, day-saving accomplishment. But this success came at a price, as Barry Eichengreen persuasively argues in his 2015 book, Hall of Mirrors: The Great Depression, the Great Recession, and the Uses — and Misuses — of History. There was no second Great Depression, true, but by (thankfully) avoiding such a complete implosion, we also missed out on the opportunity for real reforms of the financial system, like the ones introduced in the 1930s — reforms that contributed to an unprecedented half century of financial stability and safe (and boring) banking. Thus, as Eichengreen explains, although this time around some “modestly useful measures” were introduced (which are now being rolled back), “little was done to make the world a safer financial place.”
Firefighting sees things quite differently, repeating half a dozen times that “our financial fire codes are stronger today” due to post-crisis reforms. The authors thus display an insouciance regarding financial governance that is incongruous with the smart primer on inherent financial fragility and the deceptively lulling danger of periods of apparent stability on offer in the book’s early pages. Worse, the mantra of “better safeguards in place” is repeated so often that the authors, like bluffing poker players with an obvious tell, finally seem to be protesting too much. Their confident boasts about improved safeguards and greater capital requirements are qualified by acknowledgments that political resistance inhibited more ambitious reforms, and are invariably peppered with reminders that “no building is ever fireproof.” But although it is undeniable that “stronger rules and stricter oversight will never prevent all financial crises,” that’s not a good way to run a railroad. It is also true that anti-lock brakes, airbags, and seatbelts won’t prevent all traffic fatalities, but the public is well served and much safer with those protections in place (despite industry resistance to such invasive requirements). This is a sobering thought, especially given that, as the authors note, Wall Street, as it did in the 1990s and also after the financial crisis, is again dropping millions of dollars in Washington in furious lobbying “for regulatory relief.”
Our firefighters can fairly protest that, even though they saved the world, they would be prohibited from riding to the rescue again if in positions of authority today. But their very narrow field of vision also allows them to overlook how intimately enmeshed they were (and are) with the arsonists responsible for the fire last time. Consider these pearls of wisdom from chapter one: “Ideally, there should have been a stronger and more comprehensive regulatory system, as well as tougher and more proactive regulators,” and, “Another critical gap was that none of these agencies was responsible for analyzing or protecting against systemic risk.” If this were a horror movie (and perhaps it is), this is the moment for a terrified teenager to scream: “The deregulations are coming from inside the house!” Why were regulators not tougher? What explains the shocking inattentiveness to systemic risk?
In 2005, at the annual gathering of financial titans in Jackson Hole, Wyoming, Raghuram G. Rajan (then chief economist at IMF, later governor of the Reserve Bank of India) presented a paper postulating that recent financial innovations — which, he emphasized, have “made the world better off” — nevertheless might be contributing to an increase in systemic risk, and gently suggested that “we need to pay attention to this” potential danger. He was virtually booed off the stage — most famously by Larry Summers, who opened the barrage of criticism that followed by claiming to find “the basic, slightly Luddite premise of this paper to be largely misguided.” Also in attendance that year were Ben Bernanke (then chairman of George W. Bush’s Council of Economic Advisers), Timothy Geithner (then president of the New York Fed), and other key players in the looming crisis, including William Dudley (Geithner’s successor at the New York Fed, then cooling his heels as the chief economist for Goldman Sachs) and Robert Rubin, Bill Clinton’s financial-deregulation-championing Treasury Secretary, then director of Citigroup, who pushed the firm into its ruinous embrace of exotic CDOs (collateralized debt obligations). It’s not that these luminaries weren’t warned; rather, they chose to ignore the warnings.
Firefighting also stumbles, egregiously, in its failure to understand the widespread revulsion about the crisis — and its cleanup. “Today, much of the American public remembers the government’s interventions as a bailout for Wall Street,” they complain, “but our goal was always to protect Main Street from the fallout of a financial collapse.” And about this there is no doubt. But when they unveil the fact that US taxpayers ultimately “made a profit [twice later ungraded to “sizeable profit”] on the financial rescue,” as if dropping the mic on their uninformed critics, their blind spot becomes harrowingly dangerous. The residents of Main Street are not kept up at night by slight tremors of the needle that measures the federal debt. They are seething at what Financial Times columnist Martin Wolf, in his 2014 book The Shifts and the Shocks: What We’ve Learned — and Have Still to Learn — from the Financial Crisis, accurately described as a system where “well-connected insiders” are “shielded from loss but impose massive costs on everybody else.”
Ultimately left unsaid, in the passages of Firefighting that describe buying up the billions in Citigroup’s toxic assets accumulated in its orgy of reckless risk taking (a bailout necessary to save the skin of the venerable old institution), is the fact that the wealthy, well-connected principals of the firm (like Robert Rubin) would come out the other side just fine. As for our firefighters, Ben Bernanke currently advises the hedge fund Citadel and is a senior advisor to PIMCO; Tim Geithner is president of the private equity firm Warburg Pincus, a position from which he established an intimate financial relationship with JPMorgan Chase, the giant bank he was not long before charged with regulating; and Hank Paulson is still enjoying the massive payoff from his days as CEO of Goldman Sachs (a post he held before his stint as Treasury Secretary). So, yes, the public is wrong to think that the bailouts failed or that they were not essential. But Main Street was force-fed the Great Recession that inevitably followed the financial crisis, while the bankers who caused it continued to dine at the Four Seasons — often in the company of once and future firefighters.