Ben S. Bernanke, Timothy F. Geithner, and Henry M. Paulson Jr.: Firefighting: The financial crisis and its lessons.
Penguin Books, 2019, ISBN 978-0143134480
The authors of this book were the firefighters on duty when a blaze erupted in the financial system a decade ago: Ben Bernanke was Federal Reserve Chair, Henry Paulson was Treasury Secretary under George W. Bush, and Timothy Geithner was President of the Federal Reserve Bank of New York, and then Treasury Secretary under Barack Obama. There is much to admire in the firefighting performed by the three men. Working under incredible stress, they devised one unprecedented program after another to rescue most of America's large financial institutions, whose failure could have plunged the economy into a depression as severe as the 1930s.
There is also much to admire in the book that Bernanke, Geithner, and Paulson have written about their experience. Their account of the financial crisis is comprehensive, yet concise and readable. They draw hugely important lessons about the causes of the crisis and what policymakers must do to prevent future crises or at least contain their effects.
But there was one big flaw in the firefighting of Bernanke et al., and there is a corresponding flaw in their book. Unfortunately, these flaws concern the most consequential phase of the crisis, the period that the book calls "The Inferno": September and October 2008. During those days of panic, the Federal Reserve rescued many financial institutions with emergency loans, most famously the insurance company AIG, but only after it allowed Lehman Brothers investment bank to fail. The introduction to Firefighting promises to clarify what happened: "We'll try to address some of the lingering questions about our decisions, such as why the government couldn't rescue Lehman Brothers when it did rescue AIG." In fact, the authors merely repeat an account of their Lehman and AIG decisions that they have given over the last decade in speeches, interviews, and their individual memoirs--an account that is contradicted by the record of what actually happened in 2008.
As Firefighting clearly explains, the crises at firms such as Lehman and AIG were twenty-first century versions of bank runs. In a classic run, panicked depositors withdraw cash from a bank until it has none left and is forced to close its doors. Lehman and AIG did not have depositors, but fears about their viability after failed real estate investments led to massive outflows of cash through several channels, including decisions by other financial institutions to cut off loans and to demand increased collateral for financial contracts. The run on Lehman forced it into bankruptcy on September 15. Just a day later, AIG ran out of cash and found that, as its CEO later put it, "nobody would lend us lunch money"--until the Fed lent it $85 billion on the evening of September 16. As panic spread, the Fed also lent heavily to the investment banks Morgan Stanley and Goldman Sachs, primarily through a program called the Primary Dealer Credit Facility (PDCF). In late September, Morgan Stanley had around $50 billion of cash, but it had borrowed $100 billion from the Fed, which suggests that Morgan would have failed without the Fed's help. (1)
The rescues in the fall of 2008 averted a complete breakdown of the financial system, but the bankruptcy of Lehman Brothers was nonetheless, as Bernanke et al. acknowledge, a "nightmare" and a "devastating explosion." The ensuing panic led to a breakdown in the flows of credit that the economy needs to operate, which in turn produced the Great Recession of 2008-2009. If the three policymakers had averted the sudden and chaotic Lehman bankruptcy, so that the firm could have survived or at least been wound down in an orderly way, the whole financial crisis would probably have been less severe. Fewer people would have lost their jobs and fewer lives would have been damaged.
Why didn't the firefighters rescue Lehman and avoid a conflagration? Bernanke, Geithner, and Paulson say that all their decisions were guided by a simple principle: "When panic strikes, policymakers need to do everything in their power to quell it." That principle explains why they rescued so many firms. In their account, they wanted to rescue Lehman, too, but in that case "everything in our power turned out to be insufficient."
The three policymakers point out, as they have on many other occasions, that the Federal Reserve Act requires that Fed loans be secured by collateral, which protects the Fed and taxpayers from losses if the loans are not repaid. The policymakers say that every firm they rescued had enough collateral for the loan it needed, but Lehman did not because it was "deeply insolvent" and faced an "unstoppable run." In Lehman's hopeless situation, a rescue attempt would have violated the law and would have "created huge losses for the government without quelling the panic."
These claims are simply not true. That fact is clear from the public record on the financial crisis, especially the documents gathered by the Congressionally-appointed Financial Crisis Inquiry Commission and by the court-appointed Examiner in the Lehman bankruptcy case. (2) This record shows that the Fed could have kept Lehman afloat with a loan from the PDCF, the same kind of assistance it provided to Goldman Sachs and Morgan Stanley. Lehman had ample collateral for such a loan, so it clearly would have been legal and the risk to taxpayers would have been negligible. Fed officials chose, however, to place arbitrary restrictions on Lehman's access to the PDCF, thereby ensuring the firm's bankruptcy. The evidence on these points is presented in a book on Lehman published last year by the author of this review. (3)
If the adequacy of collateral had really determined who the Fed rescued, AIG might not have received a loan. The collateral that Lehman had available consisted mostly of securities with commonly accepted market values. In contrast, the main collateral that AIG pledged to the Fed were equity shares in the firm's insurance subsidiaries-private companies that are hard to value. Bernanke et al. assert that these shares were "solid collateral," but in fact they may not have been worth the $85 billion that AIG received. (We may never know for sure. The Fed has denied requests for details about AIG's collateral under the Freedom of Information Act, and successfully defended these denials in court.)
If concern about collateral was not the real reason for the Fed's lending decisions, then what was? One big factor was politics. Firefighting declares that policymakers must battle financial panics "regardless of the political ramifications." But the real-time record shows that politics weighed heavily in the Lehman decision.
Lehman's crisis occurred after the Fed's rescue of Bear Stearns and the government takeovers of Fannie Mae and Freddie Mac, which politicians and journalists criticized bitterly. Treasury Secretary Paulson knew that another rescue would be a public relations disaster, so he ruled one out. He is quoted by many sources-including Geithner's 2014 memoir-as saying he didn't want to be known as "Mr. Bailout." Paulson's chief of staff sent a blunt email to Paulson's press secretary: "I just can't stomach us bailing out Lehman. Will be horrible in the press don't u think?" (4) Geithner expressed reservations about Paulson's no-bailout position, but ultimately went along with it.
After Paulson denied assistance to Lehman, why did he turn around and approve a risky loan to AIG? An important factor was the chaos in financial markets after the Lehman failure. Paulson and his colleagues had hoped to limit the damage from the bankruptcy, but it quickly became clear that the financial system was headed for total collapse if more firms were allowed to fail. Henry Paulson's fear that he would be Mr. Bailout was outweighed by the fear of being Mr. 2nd Great Depression.
In promoting their version of history, the three firefighters face a problem: their story conflicts with statements they made right after the Lehman failure. For example, 8 days after the bankruptcy, Ben Bernanke told a Congressional committee that the Fed rescued AIG because its failure "would have severely threatened global financial stability," but that it "declined to commit public funds" to Lehman. In explaining the latter decision, he said that "the troubles at Lehman had been well known for some time," so "we judged that investors and counterparties had had time to take precautionary measures." In this testimony, Bernanke seems to say that policymakers let Lehman fail because they did not expect dire effects-not because a rescue was illegal or Lehman lacked adequate collateral.
In Firefighting, Bernanke et al. acknowledge the discrepancy between their initial statements about Lehman and their current narrative. They say the initial statements were less than candid, and they offer an explanation: "We had agreed among ourselves that at least for the moment, we needed to downplay our inability to save Lehman, because we feared that such an admission would terrify the markets and accelerate the run.... We did help feed the myth that we chose failure, to avoid confessing publicly that we were out of ammunition."
Once again, there is reason to doubt the policymakers' account of their motives. Important evidence comes from a meeting of the Federal Open Market Committee (the group that sets the Fed's interest-rate target) held on September 16, 2008-the day after the bankruptcy. In the transcript of this meeting, several Committee members praise the decision to let Lehman fail, and Ben Bernanke does not tell them that he wanted to rescue the firm but legally could not. Bernanke also does not predict disastrous effects of the bankruptcy, saying rather that the effects are "difficult to assess" and "we may have to wait for some time to get greater clarity." In the meantime, he recommends that the Committee leave the federal funds rate unchanged, which it did. All in all, the non-alarmist discussion at the meeting seems closer to policymakers' contemporaneous public statements than to what they say today.
This evidence is significant because transcripts of FOMC meetings are not publicly released until 5 years later. The participants at the September 16 meeting did not need to worry about terrifying the markets, so they could speak with complete candor. If Bernanke had really wanted to rescue Lehman, had been prevented from doing so by legal constraints, and expected nightmarish consequences, he surely would have explained all of that to his colleagues as they discussed Fed policy.
In a concluding chapter, the three policymakers discuss what might happen the next time a financial panicoccurs. They warn that financial firefighters have "a weaker emergency arsenal" because the Dodd-Frank Act of 2010 imposed new restrictions on Fed lending. This warning is warranted, but there is irony here because in 2008 the policymakers did not use their available arsenal as aggressively as they could. If Firefighting acknowledged that Fed lending could have prevented the Lehman bankruptcy, readers would better understand the imprudence of restricting such lending. But they would also understand that the bankruptcy was a policy mistake, and Bernanke, Geithner, and Paulson are unwilling to accept this blemish on their firefighting record.
Ball, Laurence M. 2018. The Fed and Lehman Brothers: Setting the Record Straight on a Financial Disaster. Cambridge: Cambridge University Press.
Financial Crisis Inquiry Commission. 2011. Report, with Supporting Documents, fcic.law.stanford.edu.
Valukas, Anton. 2010. Lehman Brothers Holdings Inc. Chapter 11 Proceedings Examiner Report, with Supporting Documents, jenner. com/lehman.
Weinberg, John A. 2019. Review of The Fed and Lehman Brothers. Business Economics.
Publisher's Note Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.
(1) For an overview of these events and other milestones in the financial crisis, see the St. Louis Fed's timeline at https://www.stlouisfed.org/financial-crisis/full-timeline.
(2) See FCIC (2011) and Valukas (2010).
(3) See Ball (2018). That book was reviewed in this journal by Wein berg (2019).
(4) The Financial Crisis Inquiry Commission published this email as part of its "Lehman Chronology."
Laurence Ball  (iD)
Published online: 12 July 2019
[mail] Laurence Ball
 Johns Hopkins University, Baltimore, USA
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|Date:||Jul 1, 2019|
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