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Two events of my life linger with me. One is 9/11 and the other is the financial crisis of 2008. For the first I watched a plane bank over New York harbor and followed it all the way into Tower II. For the second I watched on TV, while I was on business in Zurich, Congress deciding whether to approve TARP. On the one hand I knew U.S. taxpayers were saving scoundrels. On the other hand I knew it had to be passed otherwise the world economy would plunge into a depression. Like many Americans I swallowed hard and hoped Congress would do what was necessary.

Earlier that Fall I had attended an annual M&A Conference at a major NYC law firm. It draws major players in the insurance industry and on that day many had returned from a meeting with the government about providing the initial bailout of AIG. They were given a loan with interest that had too many points above Libor. The Libor rate was spiking as there was no trust left in the markets. I ran across the head of the law firm’s insurance section and he smirked when I asked them whether the intent was to drive AIG into bankruptcy. Unlike the banks, there was no moral hazard involved in loaning to the AIG holding company, although Warren Buffett did provide support to Swiss Re (which also dabbled in the same markets as AIG) and Munich Re. Subsequently, Hank Greenberg, the dethroned fabled head of AIG, sued the Federal government, ostensibly because the government was using AIG to help fund other bailouts. Many of the bailouts were of foreign banks (who did not take a haircut). There was some truth to Greenberg’s belief, particularly after Lehman, whose bankruptcy the author believes was a defining moment in the crisis and a major error on the part of the Fed and Treasury.

I have not read any other books about the 2008 financial crisis besides Alan Blinder’s “After the Music Stopped”. I have no point of comparison. The book provides a good survey of the crisis for laymen, particularly offering a basic understanding of monetary policy. I commend that you read “The Lords of Finance: The Bankers Who Broke the World” as a companion read. It discusses the role of Central Bankers in the period leading up to the Great Depression. It is a cautionary tale for today, particularly because Fed Chairperson Yellen has not ruled out negative interest rates by the Fed (deflation was a concern during the job-loss recovery after the 2001 recession). Reading “The Lords of Finance” makes me wonder whether Chairman Bernanke was truly a student of the Great Depression, or if he chose to look away, as the Fed doled out funds without strings attached to major money center banks.

The best parts of the book are in the lead up to the bailouts, rather than the aftermath of remedies. The author does not name one perpetrator of the crisis or of the slow recovery. There are many.

The house of cards began in the 1990s and continued through 2007. It was based on “asset-price bubbles, exaggerated by irresponsible leverage, encouraged by crazy compensation schemes and excessive complexity, and aided and abetted by embarrassingly bad underwriting standards, dismissal performance by statistical rating agencies and lax financial regulation.” The author was Vice-Chairman of the Federal Reserve Board of Governors from 1994-96 and a member of President Clinton’s Council of Economic Advisors.

The reason for financial crisis are generally the same: too much leverage (without requisite collateral/capital); insufficient transparency; and not enough time to combat irrational contagion (insufficient circuit breakers). At the meeting I attended at that law firm, the concern of all the players was that they all had too many conflicts of interest. They were afraid of being sued. These fears were necessarily ignored, as was the law, as rationales were spun from air. The Fed first expanded its reach using Section 13(3) of the Federal Reserve Act to make emergency loans to “any individual, partnership or corporation” under “unusual and exigent circumstances”. It went beyond this to buy from J.P. Morgan a portfolio of mortgage assets that the bank felt was too risky to hold for its shareholders. Then came shareholding of AIG, through Fed and Treasury action. Then the use of the Exchange Stabilization Fund (meant for stabilizing the U.S. dollar in the currency markets) to support money market funds after the “buck had been broken”. This was critical because losses at money market funds was causing a crisis in commercial paper (short-term borrowing by corporations to meet cash flow needs). A collapse of the commercial paper market would transfer the crisis Wall Street to Main Street, as did the near collapse of GM.  Crises demand action. Players “expanding” the law know there is more personal safety through collective action. Means and  results are necessarily ugly in a crisis.

Government remedies were often callous; protecting the balance sheets of the debtor financial institutions and the ultimate returns of the U.S. government, rather than those homeowners subject to foreclosure proceedings. There were no “haircuts” (principal reductions) on the mortgages. Any discount was marginalized. Reduced interest payments were delayed, but with recoupment through balloons in the end. Courts were not aggressive in holding the banks accountable for their transgressions. Regulators ultimately penalized these institutions through fines, but most of these went into state coffers, rather than to homeowners. Shareholders of these institutions (and some insurers) bore the cost of these fines, not the executives who walked away with often walked away with large bonuses, even though they bore paper losses on stock options.

The book is replete with interesting historical facts and statistics. From 1991 to the 1st quarter of 2007 losses on mortgages were flat (mostly a .25 loss rate save for 2001 when it rose to .5). Between 2007-09 it spiked to about 2.75%. Mortgage backed securities were often modeled on 3 years of default data which was insufficient (subprime mortgages grew from 7% of all mortgages in 2001 to 20% by 2005, and only 20% of these were issued by regularly supervised financial institutions). Such models failed to account for catastrophic spikes (so-called fat tails). But even these default spikes should not have led to catastrophic cascading panic without excessive leverage in the markets. Derivatives (particularly CDS, most of which were naked and not hedges) contributed to this. Banks were under-capitalized as well (even today, if banks had to hold capital equivalent the percentage of collateral often asked of consumers of home mortgages they would not survive).

While I believe that for better or worse, those who worked to try to right the ship under extraordinary pressures and time constraints are all heroes in terms of personal sacrifice, there is only one regulator that stands out as being close to a hero in actual terms. This was the head of the FDIC, Sheila Bard. She tried to put teeth into loans and was generally rebuffed or ignored by the Fed Chair, the Secretary of the Treasury, and other boys in the club. There was plenty of  subterfuge to go around. Secretary Paulson pulled a bait and switch on Congress, who believed TARP was to be used to inject capital into the banks and to help distressed homeowners. There was no such language in the 451 page Bill that created Tarp. In lieu of such capital language the Bill Congress passed allowed the Treasury Secretary, after consultation with the Chairman of the Fed, to purchase “any other financial instrument that the Secretary… determines the purchase of which is necessary to promote financial market stability.” Capital was injected into the banks without strings attached and they did not loan nor modify principal on toxic assets (syndication of these assets made it more difficult to do). All real estate is cyclical, so Congress directly purchasing these toxic assets at their low might have been a better investment for taxpayers and provide more relief to homeowners rather than as TARP funds were employed. Nonetheless, TARP itself was an illusion. Although $700 billion was authorized, the most ever disbursed was $430 billion, and at any one time no more than $360 billion was outstanding. Treasury and the Fed also did the same with the TALF program, which had a limit of $1 trillion, but only used $70 billion. A bit of smoke and mirrors to alter perception and create confidence. Unfortunately, foreclosure mitigation never saw much money at all. In the end the TARP $700 billion did not cost the U.S. taxpayers money, although this is not likely heard in political circles (it was authorized to be 4.7% of GDP, but never lent out more than 3%, and returned all principal with interest). Was it misdirected- little doubt.

The book delves into the first Quantitative Easing program by the Fed, Dodd-Frank and the Volcker Rule, stress testing of the banks, SIFIs, the various weak government foreclosure “mitigation” programs, and the Euro problem.

What is more telling for the near future are CBO’s US debt projections in October 2000 which shows the impact through 2070. It then showed the US going into deficit depending on whether the surplus at the time was saved in whole, in part, or not at all. This is the entitlement debate. It is a story about bad stewardship of government funds causing the depth of future deficits owing to demographic changes. Equally, interesting is that the Feds independence was political cover for Congress during the crisis. Congress was too slow to act and lacked the will. The Fed’s borrowing did not technically add to the government’s deficit, because banks technically own the shares in the Fed. Despite all the posturing those in Congress who wish for control over the Fed, should read this book and be careful what they wish for. Accounting is a form of alchemy.

All that truly happened during and after the crisis might be for historians to uncover, if any paper trails are left to be found. This book is an informative read and an interesting survey of the period, even if you lived through it.

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