In FED We Trust, page 24
Based on his years of studying previous financial collapses and telephone conversations with his Swedish and Japanese counterparts who had coped with recent banking crises, Bernanke had suspected for months that he and Paulson would eventually end up asking Congress to spend substantial sums of taxpayer money to rescue the banks. In every major banking crisis he had studied, the government had had to put capital into the banks, take bad loans off the banks’ books, and guarantee the banks’ debts. So far, Bernanke had deferred to Paulson on the timing of going to Congress, while Paulson had been reluctant to propose anything that Congress might, in an election year, reject.
Bernanke and Geithner saw this as the inevitable and costly politics of responding to banking crises in a democracy. The most effective solution always called for lots of taxpayer money upfront — “overwhelming force,” as Geithner called it. Politicians, ever sensitive to public opinion, never responded early enough. The usual political solution was to wait until the crisis was bad enough to dominate the headlines, driving up the ultimate cost. Now, that moment had arrived.
At 7:30 P.M., after a day of nearly constant conference calls, the financial firefighters convened for the last session of the day. Warsh and Kohn sat beside Bernanke in his office, all facing the omnipresent speakerphone. Geithner was on the phone from New York. Paulson was at his desk. More than a dozen Treasury aides stood around him to listen, or huddled in corners in separate conversations.
Bernanke was usually soft-spoken and mild-mannered. He was not this time. “We can’t do this anymore, Hank. We have to go to Congress,” Bernanke told Paulson, according to one of the participants in the call. The Fed was at its limit.
Paulson was uncharacteristically silent. He didn’t argue with Bernanke. He didn’t signal agreement. He didn’t tell Bernanke that he already had scrambled his staff to prepare to go to Congress. They worked all night.
When asked by CBS’s 60 Minutes, in an interview taped September 26, 2008, to name the worst moment of the Great Panic thus far, Paulson would reply: “I’ve had a lot of knots in my stomach, but I would say … Wednesday night [September 17], when the capital markets froze, when there started to be a run on money markets, banks stopped lending to each other. And, I know people in America won’t understand what that means, but if money doesn’t flow freely between financial institutions, then it impacts everyone in the country.”
“The economy had a heart attack in that moment,” the reporter suggested.
“I would say this: whether it had a heart attack or not, the arteries were clogged,” Paulson responded.
Around 9:30 A.M. the following day, September 18, Bernanke, Paulson, and their lieutenants reconvened by telephone. Bernanke launched into his pitch for going to Congress. Paulson cut him off: “We have to go to Congress — today.”
It was time to break the glass.
BUSH’S UH-OH MOMENT
When Bush, with an assist from chief of staff (and Goldman alumnus) Josh Bolten, wooed Paulson from the top of Goldman Sachs to the Treasury secretary’s office overlooking the White House, Paulson let it be known that he had a deal his two predecessors didn’t. The first two Bush Treasury secretaries — Paul O’Neill, a veteran of the Ford White House and a former aluminum company CEO, and John Snow, a former railroad executive — were overshadowed and overruled by the Bush White House staff and the powerful vice president. Paulson, it was said, had the president’s assurances that he, not the White House staff and not Dick Cheney, would be in charge.
Though there was much skepticism in Washington about that arrangement at the time, it turned out to be true. When Paulson arrived, the pendulum of power swung all the way from the White House to the Treasury next door. During the Great Panic, he, Bernanke, and Geithner called the shots, keeping the president’s White House economic team “informed,” as one senior Treasury staffer put it.
Keith Hennessey, a congressional staffer who came to the White House in 2002 and rose to be the coordinator of economic policy there, often fielded Paulson’s telephone calls. He typed them into e-mailed memos — “I just got a Hank call,” he would write — for the rest of the White House staff. Paulson didn’t do e-mail; he did phone calls, frequent ones.
But going to Congress for hundreds of billions of dollars would require more political firepower than either Paulson or Bernanke had. At the same time, Bush aides were growing uneasy with the public perception that the president was a bystander in the biggest economic crisis in a generation. There was no way to keep the White House on the sidelines any longer.
Paulson summoned Joel Kaplan, the deputy White House chief of staff and another of his frequent telephone partners, to Treasury early in the afternoon to listen to the Fed-Treasury-SEC conference call. There wasn’t enough time for bringing him up to speed after the meeting.
Around 2:30 P.M., Edward Lazear, chairman of the president’s Council of Economic Advisers — a lanky, bald Ph.D. economist from Stanford, nicknamed “Stork” by Bush — left the White House compound to go to the Fed’s headquarters to find out what was going on.
The conference call ran until 3:30 P.M., ending abruptly so Paulson and Bernanke — accompanied by Kevin Warsh, on whom the Fed chairman had come to rely for political advice — could go and give the president the bad news: his final months in office were going to look uncomfortably like those of Herbert Hoover.
They made an impression. “I remember sitting in the Roosevelt Room with Hank Paulson and Ben Bernanke and others,” Bush would later recall to ABC News’s Charles Gibson, “and they said to me that if we don’t act boldly, Mr. President, we could be in a depression greater than the Great Depression.”
“But,” asked Gibson, “was there an ‘uh-oh’ moment — and I could probably use stronger language than that [laughter] when you thought this really could be bad.”
“When you have the secretary of the Treasury and the chairman of the Fed say, if we don’t act boldly, we could be in a depression greater than the Great Depression, that’s an ‘uh-oh’ moment,” Bush replied. “But you got to understand, leading up to that we had been bailing water in this way: AIG was failing; other big houses on Wall Street needed to be merged; one failed.”
In the Roosevelt Room meeting, Paulson reminded Bush that the Treasury secretary’s authority to spend or lend money that Congress hadn’t appropriated was extremely limited. The Treasury secretary was agitated, talking a lot about the treacherous politics in Congress. At times the president’s face suggested he wasn’t following Paulson’s line of reasoning, one participant recalled. Bernanke, calling on his years of classroom teaching, calmly made the case so the president could better grasp its dimensions.
At one point, according to participants, Paulson made an oblique reference to the possibility that the Fed could continue to finance the rescue of Wall Street if Congress balked. Someone — several participants recalled it was Bush, but others insisted it was Vice President Cheney or Chief of Staff Josh Bolten — pressed Bernanke. Could the Fed keep doing it if Congress was a problem? No, Bernanke said. He recited the limits of the Fed’s legal authority even in “unusual and exigent circumstances.” He told the president that the sums involved were now so great that the legitimacy of the enterprise required the approval of the entire political system.
With that, Bush gave his assent. The plan was to ask Congress for $500 billion. At the time, that seemed like more than enough.
HUNG OUT TO DRY
On his way back to the Treasury from the White House, Paulson fielded a call from Nancy Pelosi on his cell phone. She proposed a meeting between congressional leaders and Paulson and Bernanke for Friday morning. Paulson said it couldn’t wait. So Bernanke, Paulson, and the SEC’s Cox went to Capitol Hill that Thursday night. No one from the White House accompanied them. The White House was simply irrelevant.
Before the meeting, according to a person who overheard him, Paulson confided to Bernanke: “They’ll kill me up there. I’ll be hung out to dry.” He knew that many members of Congress, influenced by constituents who saw everything he and Bernanke were doing as a bailout of moneyed interests in Wall Street, would resist his plea to give him the power to spend hundreds of billions of taxpayer money.
Bernanke reassured him: “I’ll be with you. I’ll go to any meeting. You can count on me.” They agreed that Bernanke would talk first.
By taking the lead, Bernanke was attempting to leverage congressional trust in not only the Fed but also his personal credibility in a moment of economic terror. The move would inextricably link Bernanke to Paulson, but there was good reason for Bernanke to permit that: at a time of economic crisis, any hint of daylight between the Treasury secretary and the Fed chairman would undermine whatever confidence was left. Nonetheless, Bernanke was risking both his and the Fed’s reputation by sticking so close to the sometimes impolitic Paulson. “Managing Paulson was like riding a bull,” one Fed staffer said.
The meeting of the dozen or so top congressional leaders convened in the conference room off Speaker Pelosi’s offices. She opened the session, then turned it over to Bernanke. “I spent a lot of time as an academic studying the Depression,” he said, according to notes taken by a Hill staffer. “If we don’t act in a very huge way, you can expect another Great Depression, and this is going to be worse.” The financial system was “only a matter of days” away from “a meltdown,” he said. “Our tools are not sufficient.”
Fed chairmen, aware that even their private comments can trigger market turmoil, usually speak delicately, especially when predicting bad things for the economy. Bernanke was not delicate. “No economy has ever faced the financial meltdown we’re facing without undergoing a major recession,” he said. Without congressional action, it would be deep and prolonged.
“I kind of scared them,” Bernanke later said. “I kind of scared myself.”
Paulson then explained what they wanted from Congress. He outlined a plan to get bad real estate loans off the banks’ books — the “break the glass” plan that had been on the shelf at Treasury for months. He talked about auctions where many sellers (the banks) would vie to offer mortgage-linked securities to one buyer (the Treasury), which would turn to private money managers to manage and eventually sell the portfolios. He told the representatives and senators that the Treasury’s purchases of such securities could drive up their price and thus help the banks, a notion that would prove a sticking point later on.
A couple of members of Congress asked about using taxpayer money to invest directly in banks instead of buying what came to be called “toxic assets.” It was an idea popular with academic experts in finance. And it was one that Bernanke quietly favored. Advocates saw rebuilding banks’ capital cushions as a necessary step toward a return to normal lending. The Democrats liked the idea, but for different reasons: they wanted to be sure the taxpayers got some of the upside if they were going to bail out the banks, and they saw ownership as a lever on what banks did. Paulson was discouraging. Bernanke was silent on the point, reluctant to display any disagreement with Paulson.
How much money do you need? Paulson was asked.
“Several hundred billion dollars, for starting off,” he said, refusing to be more precise. No one needed to be told that he was talking a lot of money.
Republican leaders Senator Mitch McConnell and Representative John Boehner as well as Pelosi, all stunned by the bad news, were quick to assure Bernanke and Paulson that Congress would give them what they needed.
Nevada’s Harry Reid, the Senate majority leader, wasn’t so sure. “This is not an easy thing to do. You are coming here to ask taxpayers to spend hundreds of billions of dollars. … We’re elected. You’re not. This needs hearings. … I know the Senate. It takes two weeks to pass a bill to flush the toilet.”
His Senate colleagues, both Republican and Democrat, abruptly contradicted him. McConnell said, “If what’s at stake is saving the country, then we can get it done in record time.”
But there were hints of the political difficulties that lay ahead. Senator Richard Shelby of Alabama, senior Republican on the Banking Committee, said, “It sounds like a blank check. When’s this going to end?”
Barney Frank and Chris Dodd pushed to include something for beleaguered homeowners whose mortgages exceeded the value of their houses. “You aren’t selling this plan to a boardroom. You are selling it to the American people,” Frank said, warning Paulson and Bernanke that Congress would impose conditions.
Asked what would happen if it didn’t pass, Paulson replied, “If it doesn’t pass, then heaven help us all.”
The congressional leaders asked Paulson to submit a written plan over the weekend and then — joined by Paulson and Bernanke — faced the television cameras and stoically promised to do whatever it takes.
As he drove to the office along Washington’s Rock Creek Parkway a few days later, Don Kohn, the Fed vice chairman, thought to himself with relief: as the Treasury stands up, the Fed stands down — a play on a Bush line about Iraq: “As the Iraqis stand up, we will stand down.” With financial wars as with real ones, though, timing can be everything.
In hindsight, the U.S. economy would have been much better off had Bernanke and Paulson gone to the president and Congress sooner and won the power and money that they later won. After Bear Stearns, both men had talked publicly about the need for new laws to cope with the imminent collapse of brokerage houses or other financial firms that weren’t a conventional bank. But they didn’t describe it as an emergency. And from their conversations with Barney Frank and others, they concluded that the odds of Congress acting on any request were very slim.
“Our political calculation was that we had to wait until we got to the point where the case would be palpable and clear — that it would be early enough to do some good, but not so early that it wouldn’t be given serious consideration,” Bernanke said a few months later in an interview. “Our sense and our intelligence was, there was no hope of getting something like this, given the very short legislative schedule, given the complexity of such a thing, given the lack of appetite for such a thing. So we didn’t make a serious attempt to get Congress to pass anything,” he explained.
But then, second-guessing himself for a moment, he added, “If we had, we wouldn’t have gotten it … but at least we would have been able to say we tried.”
BREAKING THE BUCK
The turmoil in the financial markets during the week of September 15 didn’t revolve only around newfangled financial instruments, cross-border sophisticated bets, or the collapse of major financial institutions. In fact, the biggest surprise of Lehman’s collapse came from money market funds, the $1-a-share mutual funds that Americans had come to consider as safe as bank accounts. Money market funds had been on the Fed list of things to worry about for months, dating back to the fragility of the tri-party repo market and the Bear Stearns episode. But with so much advance speculation about Lehman’s frailties, it didn’t occur to Bernanke, Geithner, or Paulson — or any of their staff — that a major money market fund would hold a significant chunk of Lehman’s short-term debt. But the Reserve Primary Fund, the oldest of all the money market mutual funds, had 1.2 percent of its $63 billion in Lehman — holdings that would prove devastating and which couldn’t wait for Congress to act.
In a classic run, Reserve Primary Fund shareholders tried to withdraw $24.6 billion in the first twenty-four hours after Lehman’s bankruptcy, less than half of which the fund actually paid. Shortly after noon on Tuesday, the fund’s directors, desperate to avoid having to cut its share price below $1, decided to ask the Fed for help. Bruce Bent II, president of the fund’s management company, called Geithner’s office and ended up explaining the situation to a secretary who promised to relay the information.
A couple of Fed staffers called back an hour or so later, listened, and said they would pass the request along. “The Fed officials cautioned the participants on the call not to be overly optimistic,” the minutes of the Reserve Fund’s board record drily. Around 3:45, the Fed said, “No.”
At 4:15 P.M., the fund issued a press release. The Lehman paper in its portfolio was worthless and the Fund’s shares were worth not $1, but only 97 cents: breaking the buck. The news triggered a run that spread through the $3.4 trillion industry. (Bruce Bent II and his father, Bruce Bent Sr., were later accused of fraud by the SEC, which said they had misled investors, credit rating agencies, and the money market fund’s trustees in failing to disclose “key material facts” about the fund’s vulnerability when Lehman collapsed, among other transgressions. The elder Bent said in a statement that he remained “confident that we acted in the best interest of our shareholders.”)
The run was another manifestation of the U.S. economy’s dependence on the shadow banking system — major financial intermediaries other than the banks, regulated by the government and covered by deposit insurance. Money market funds were formed in the 1970s to avoid regulation, to allow investors to earn a higher yield than regulations permitted banks to pay. Neither the funds nor federal officials considered them in any way insured by the government. But suddenly the economy was as vulnerable to a run on money market funds as it was to runs on banks.
And it wasn’t only ordinary savers who stood to get trampled. Scores of brand-name industrial companies — General Electric, Caterpillar, Dow Chemical — relied on the money market funds for their short-term borrowing, often issuing the funds IOUs called commercial paper that were backed only by the companies’ promise to pay. The Fed and the Treasury decided that to avoid a stampede out of money market funds, they had to find a way to assure consumers that the Reserve Primary Fund wouldn’t be followed by scores of other money market funds breaking the buck.
At the Fed, Don Kohn took charge of the response while Bernanke went to Capitol Hill and Warsh to New York. At the Treasury, the job fell to David Nason, the assistant secretary for financial institutions. Nason recently had recused himself to look for a job. After AIG imploded, he dropped the job hunt and returned to work.
