The inside story of America’s economic ‘fire fighters’
Andrew Ross Sorkin entertainingly describes the dithering and panic at the heart of the US financial system as the 2008 banking crisis unfolded, but is too generous to those who allowed it to happen in the first place.
‘Paulson, who had been living on barely three hours of sleep a night for a week, was beginning to feel nauseated. Watching the financial industry crumble in front of his eyes – the world he inhabited his entire career – was getting to him. For a moment, he felt light-headed. From outside his office, his staff could hear him vomit.’
Andrew Ross Sorkin’s Too Big to Fail provides a richly detailed, behind-the-scenes account of the unravelling of the financial crisis in the US in 2008. Puking, swearing, infighting – it’s all here. Sorkin, a New York Times journalist, gained remarkable inside access to the key players. His book reads like a gripping novel, and he manages to keep the dramatic tension high even though we know the outcome.
Too Big to Fail focuses on the US government’s response to the crisis, from the aftermath of the Bear Stearns rescue in March 2008 to capital infusions directly into banks in October 2008. The central character is the treasury secretary, Henry Paulson, with support from Federal Reserve chairman Ben Bernanke and New York Federal Reserve head Timothy Geithner (who is now treasury secretary under Obama). Sorkin also draws detailed portraits of the leading bankers, especially the gloomy head of Lehman Brothers, Dick Fuld, who becomes something of the villain of the piece.
Sorkin’s tale is useful because it provides raw material for understanding how American government officials sought to respond to this extraordinary crisis. A number of people have credited the US authorities with taking decisive action to prevent the system from collapsing. In particular, Paulson and Bernanke’s establishment of the $700billion Troubled Asset Relief Program (TARP) is often cited as a creative and daring move to stabilise the financial sphere. But Sorkin’s tale reveals the opposite: a disoriented and panicked group of regulators whose actions were dithering and indecisive.
Paulson, Bernanke and Geithner changed tack frequently – even from one day to the next – leading to confusion in the markets and compounding the problems of the crisis. The government’s support for Bear Stearns – the Federal Reserve provided a huge emergency loan and, with the Treasury, arranged its fire sale to JP Morgan Chase – in March 2008 suggested that it believed that investment banks that were big and interconnected should not fail, lest their collapse should wreak havoc on the wider economy. The Bear Stearns deal would set a precedent that they could not escape: throughout the crisis officials found it hard to arrange for stronger banks to acquire weaker ones, as the potential buyers would all hold out for a ‘Jamie deal’ – referring to the generous terms provided to JP Morgan Chase CEO Jamie Dimon when he bought Bear Stearns for a song.
In early September 2008, US officials took over the teetering Fannie Mae and Freddie Mac, the quasi-government mortgage agencies, once again suggesting that the government would step in. However, in mid-September they reversed course and let investment bank Lehman Brothers go to the wall, arguing that they did not want to create ‘moral hazard’ (whereby companies could make bad decisions and not pay the consequences). With markets freezing up in response, Paulson et al’s principled stand lasted 48 hours, before they announced that the government was taking a 79.9 per cent stake in the insurance giant American International Group (AIG).
As Sorkin writes, this vacillation had negative consequences: ‘The confidence that had supported the financial system had been upended. No one knew the rules of engagement anymore. “They pretended they were drawing a line in the sand with Lehman Brothers, but now two days later they’re doing another bailout”, Nouriel Roubini, a professor at New York University’s Stern School of Business, complained that morning.’
After the AIG takeover, the officials decided that they needed to take a more systemic approach, and thus created the TARP. But even at this point there was disarray. Sorkin reveals that the $700billion requested for TARP was a made-up number, with no support in analysis. A trillion sounded too high; $700 billion was the most they thought they could get approved by Congress. When presented to legislators, TARP was a plan to buy so-called ‘toxic’ assets from the banks. But then Paulson and crew changed their minds, and decided to inject capital into banks: ‘Of course, what none of the Congress members or the public knew was that TARP was being completely re-thought within Treasury, as [administrators] began developing plans to use a big chunk of the $700billion to invest directly into individual banks.’
Sorkin also shows how fear was a motivating factor. On one hand, the government officials were uncertain, and feared the worst; Paulson said ‘this is an economic 9/11′. On the other, they cynically used the fear of the unknown consequences as a stick to beat Congress. As one of Paulson’s advisers told him before he met with congressmen to discuss the TARP proposal: ‘This is only going to work if you scare the shit out of them.’ And rather than spell out the specifics of the financial situation, Paulson, according to Sorkin, followed that ‘scare the shit’ line, repeating more than once to representatives: ‘I don’t want to think about what will happen if we don’t do this.’
Sorkin also depicts US officials as myopically parochial, nearly oblivious to the international aspects of the crisis. The Treasury and the Fed thought they had arranged the sale of Lehman to Barclays Capital, only to find at the last minute that neither Callum McCarthy, the head of the UK Financial Services Authority, nor Alistair Darling, the UK chancellor of the exchequer, would approve the deal, saying they did not want to ‘import’ the US ‘cancer’. The jilted Paulson told a room full of American bank CEOs that the British had ‘grin-fucked us’, but he and Geithner only had themselves to blame.
The real problem, however, was not day-to-day tactical errors, but a lack of strategic vision. At one point, Fed chairman Bernanke is quoted as saying: ‘We’re working on a number of initiatives. We’re just trying to stay ahead of this thing.’ But the reality was that he and others were continually behind the curve. Lehman had significant subprime mortgage exposure and was clearly next in line after Bear Stearns’ fall in March 2008, yet as Sorkin shows, there was no decisive government intervention for months (and then its rescue attempts in September failed to save Lehman). Only in mid-summer did the Treasury appoint a liaison with the Fed and the Securities and Exchange Commission to consider a contingency plan for a Lehman bankruptcy. A high-level ‘break the glass’ plan for dealing with systemic collapse was created in April 2008, but sat on the shelf.
Instead of facing up to the problem, the officials resorted to attempting short-term fixes, such as playing matchmaker to try to arrange mergers. In this, Paulson operated like the dealmaker he was earlier in his career at Goldman Sachs, but Bernanke and Geithner were actively pushing deals too (bankers gave Geithner the nickname ‘eHarmony’ behind his back, after the internet dating service, because of all the calls they received from him).
Given that Paulson and Bernanke, like many in the American establishment, upheld the ideal of the ‘free market’, it is understandable that they would seek to avoid government bailouts (Paulson insisted ‘I can’t be Mr Bailout’). But once they recognised they faced a problem of bank insolvency and not just liquidity, and that government action was necessary to avoid financial collapse, they needed to get over criticisms of ‘nationalisation’ and ‘socialism’. For instance, a decisive and early-on state takeover of failing financial institutions – whereby the government facilitated their sorting out and oversaw the bankruptcy process – would have been a huge task, but would have shown leadership. But, as we know, they shied away that.
While Sorkin’s investigative approach provides valuable insights, it also has its limitations. The book does not provide much in the way of analysis. In particular, its starting point in March 2008 means that it has little to say about the roots of the crisis, which began well before 2008. In the epilogue, Sorkin is critical of how Paulson handled the crisis once it emerged, but he is quite generous to him (and Bernanke) when he argues that Paulson could not have prevented the crisis or done much to minimise its damage before its onset.
As Sorkin notes, Paulson did warn of potential financial unravelling shortly after his appointment as treasury secretary in 2006. But Sorkin downplays the fact that Paulson did not take steps to address this problem. Bernanke was even more complicit in the making of the crisis: he argued that asset price bubbles were not a problem to be addressed, and pursued a low-interest-rate policy that fuelled the credit expansion. In March 2007, when problems were in evidence, Bernanke said: ‘The impact on the broader economy and the financial markets of the problems in the subprime markets seems likely to be contained.’
Some may argue that the American officials’ approach, while clumsy, nevertheless worked. Financial markets have indeed stabilised. But there has been a price to pay. First and foremost, there is the actual cost, which has increased US debt levels substantially. Even if the TARP money is being re-paid and the government is making a profit on some investments, the tab is increasing in other areas, such as the investment in AIG.
Furthermore, the government solutions have not addressed the key underlying problems, and thus hold out the possibility of future crises. For example, a key issue throughout the subprime crisis has been that the securitised bundles of assets are opaque – that is, it’s not clear whether they contain healthy underlying assets or not. Private industry could not find a way, and government has avoided this task. And so today we still have toxic assets – in fact, speculation in them has picked up thanks to government programmes – but no one has yet figured out how to assess their true worth and overcome this blockage in the credit markets.
Likewise, the problem noted in Sorkin’s title – ‘too big to fail’ – remains unresolved. Paulson and company argued that TBTF was the reason they had to intervene. But in response they encouraged the consolidation of the industry, which means they contributed to making the banks even bigger and more interconnected than before.
Perhaps most importantly, there has been little in the way of longer-term strategic thinking. The Obama administration has proposed new regulations of the financial sphere, but these exhibit short-termist tinkering rather than overhaul. And while some question why finance blew up, few are asking why finance became such a big part of our overall economy in the first instance.
Much of the drama in Too Big to Fail comes from following Paulson, Geithner and Bernanke’s frantic fire-fighting. But the more you know about their hand in the crisis (which isn’t drawn out in the book), the less you sympathise with their efforts. It reminds me of when, as a teenager, I woke to see my family’s barn garage engulfed in flames. Standing in our pyjamas outside, my parents, four siblings and I were very grateful to the firemen, whose swift arrival prevented the fire from reaching our house. But, when I later learned that two firemen had set off the fire, my perspective changed. I’m not saying that Paulson, Geithner and Bernanke were ‘arsonists’ or personally to blame for the crisis, but the fires they were putting out were, in part, of their own making.
Obama’s appointment of Geithner to replace Paulson as treasury secretary signalled that this short-term, fire-fighting outlook would continue. America’s political leaders are so wedded to the past that their instinct is to try to restore the financial house of cards that existed before the crisis and hope for the best. This seems like a good way to ensure that there will be a fire next time, and sooner rather than later.
Sean Collins is a writer based in New York.
Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System from Crisis – and Themselves, by Andrew Ross Sorkin, is published by Allen Lane. (Buy this book from Amazon(UK).)
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