A year ago it would have been hard to imagine a book about the Federal Reserve and Treasury Department making it onto people’s must-read summer reading lists. But the financial calamities of last autumn put the global economy on the brink of disaster and led to continuing fiscal woes. Understanding what happened has become vitally important not just for bankers and economists, but for everyone affected by the fallout, which means ... well, just about everyone.
For all of us then, David Wessel’s new book “In Fed We Trust” is essential, lucid — and, it turns out, riveting — reading.
In these pages Mr. Wessel, the economics editor of The Wall Street Journal, chronicles how the Fed chairman Ben S. Bernanke, with Henry M. Paulson Jr., then the Treasury secretary, and a small group of associates, frantically worked to shore up the United States economy, capturing how this handful of people — “overwhelmed, exhausted, beseeched, besieged, constantly second-guessed” — tried to catch and stabilize one toppling fiscal domino after the next.
In this volume Mr. Wessel uses his narrative gifts and a plethora of sources to give readers a vivid, highly immediate sense of what transpired in last-minute, high-pressure, seat-of-their-pants meetings in Washington and New York while placing these events in a broader historical context. He examines the Fed’s increasingly important (and increasingly debated) role as an economic first responder, looks at how personality and personal philosophy can inform policy making and offers a concise explication of the causes of what he calls “The Great Panic.”
At the same time Mr. Wessel assesses the efficacy of Fed and Treasury moves — which, in the heat of battle, were often improvised and contradictory — and offers a telling analysis of decisions made on critical matters like the implosion and rescue of Bear Stearns in March 2008, the failure of Lehman Brothers in September 2008 (after the Fed and Treasury Department declined to commit public funds to support the institution), the bailout of A.I.G., and Congressional passage in October of a $700 billion economic bailout package.
His overall assessment: “Every time officials at the Treasury or the Fed thought they finally had gotten ahead of the Great Panic, they turned out to be insufficiently pessimistic. This would be a distinguishing characteristic of this chapter in American economic history: even when officials thought they were planning for the worst-case scenario, they weren’t.”
Three policy makers in particular receive low scores from Mr. Wessel. He argues that Mr. Paulson’s abrupt changes of course and failure to understand “the theater” of crisis management hurt his credibility and undermined public confidence. He says that President George W. Bush was “largely a spectator” to “the biggest threat to American prosperity in a generation” possibly because he knew how unpopular he was and figured “he would make Paulson’s job tougher if he appeared to be calling the shots” or because the Bush White House, “stumbling through its last few months, was simply exhausted and understaffed.” And he takes the former Fed chairman Alan Greenspan to task for allowing economic conditions to develop that fueled the credit crisis in the first place.
Mr. Wessel argues that the Greenspan Fed “kept interest rates too low for too long,” missed warning signs that subprime mortgages were a growing problem and was reluctant to use its powers to restrain subprime lending. He adds that the former Fed chairman, revered during his tenure as an economic wise man, made the incorrect assumption that a national decline in house prices was extremely unlikely and “put too much faith in markets,” failing to use the Fed’s “regulatory clout and rhetoric to restrain the shortsighted, excessively ebullient players in financial markets and to at least try to resist the worst of the abuses in the subprime lending market.”
Mr. Greenspan’s successor, Mr. Bernanke, along with Mr. Paulson and Timothy F. Geithner, then the president of the Federal Reserve Bank of New York (and now President Obama’s Treasury secretary), Mr. Wessel says, all “had a gut sense that the U.S. economy was overdue for a financial crisis of some sort” before the catastrophic events of last fall, but “no one at the Fed” rang “the gong and warned investors, lenders, business executives, and consumers that years of easy credit even for risky borrowers, placid markets, and shared optimism were unsustainable.”
While Mr. Wessel suggests that Mr. Bernanke was initially timid in his response to brewing problems, he gives the Fed chief credit for being “creative and bold” once he realized the risks, pushing “the Fed to places it had never gone before or at least to places it hadn’t visited since the Great Depression.” A conscientious student of that calamity, Mr. Bernanke was determined, Mr. Wessel writes, that “he would not go down in history as the chairman of the Federal Reserve who dithered and delayed during a financial panic that threatened American prosperity,” and he “adopted a new mantra: whatever it takes.”
In this book Mr. Geithner emerges as a usually cool deliberator, admired by his colleagues at the Fed for his “capacity to size up a situation and lay out options coherently and calmly.” His experience dealing with the United States government’s response to the Mexican and Asian financial crises of the 1990s, Mr. Wessel writes, taught him “a lot about crisis management and an enduring lesson: smart people solve crises one at a time and worry about dealing with unintended consequences tomorrow.”
As for Mr. Paulson, Mr. Wessel describes him as “a deal maker”: “Like many on Wall Street, he could shout ‘No! No!’ before, citing changed circumstances, abruptly saying ‘Yes!’ The approach provided flexibility in negotiating the best business deal; it didn’t build lasting credibility in Washington.” In contrast, Mr. Wessel says, Mr. Geithner understood “that a tough bargaining stance in a room full of investment bankers made sense, but that the press, the markets, and foreign officials abroad couldn’t distinguish a bargaining position from a policy position.”
In Mr. Wessel’s view the collapse of Lehman Brothers on Sept. 14 “caused — or coincided with — so much financial turmoil in large part because of the lack of a consistent story.” It was unclear whether the government let Lehman fall “to teach Wall Street a lesson” about moral hazard or whether it was “legally powerless to save it.” It was unclear whether the earlier rescue of Bear Stearns was a one-time thing and whether the government would intervene to save other major financial firms teetering on the brink.
Mr. Wessel quotes Alan Blinder, a Princeton economist and former Fed vice chairman: “People in the market often say they can make money under any set of rules, as long as they know what they are. Coming just six months after Bear’s rescue, the Lehman decision tossed the presumed rulebook out the window. If Bear was too big to fail, how could Lehman, at twice its size, not be? If Bear was too entangled to fail, why was Lehman not? After Lehman went over the cliff, no financial institution seemed safe. So lending froze, and the economy sank like a stone. It was a colossal error, and many people said so at the time.”
Although an enormous amount of recent attention has been understandably focused on why the government let Lehman Brothers go under, an equal amount of attention might understandably be focused on why Lehman — and other firms like Bear Stearns and A.I.G. — were ever allowed to engage in the sort of reckless, illogical, self-destructive gambling that turned them from Wall Street behemoths into combustible houses of cards in the first place.
Why, in an increasingly interconnected and globalized world where financial woes can spread virally like swine flu, was there so little regulation of derivatives, the complex financial instruments that the financier Felix Rohatyn once described as “financial hydrogen bombs”? Why was there so little oversight of the rating agencies that drastically underrated the risk of such flammable, infectious products? Why did the top management of these companies overleverage their firms, why did they willfully ignore the warnings of experts, and why did they fail to take quick, corrective action when the dangers their companies faced became self-evident?
Such questions are all raised and italicized by “A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers” by Lawrence G. McDonald, a former vice president of that firm, with an assist from the writer Patrick Robinson. Mr. McDonald approaches the story not as a journalist but as a former employee, a member of a group of dissidents who believed that Richard S. Fuld Jr., the company’s chairman and chief executive, and its president, Joseph M. Gregory, were leading Lehman off a cliff.
Mr. Fuld and Mr. Gregory, Mr. McDonald contends, ignored the warnings of three of the company’s “cleverest financial brains”: “Mike Gelband, our global head of fixed income, Alex Kirk, global head of distressed trading research and sales, and Larry McCarthy, head of distressed-bond trading.”
“Each and every one of them laid it out, from way back in 2005,” Mr. McDonald writes, “that the real estate market was living on borrowed time and that Lehman Brothers was headed directly for the biggest subprime iceberg ever seen, and with the wrong men on the bridge. Dick and Joe turned their backs all three times. It was probably the worst triple since St. Peter denied Christ.”
Mr. McDonald depicts Mr. Fuld and Mr. Gregory as out of touch and in denial: arrogant, reckless, eager to embrace “risk, more risk, and if necessary bigger risks” in pursuit of short-term profits, willing to borrow more and more money (on the way to leveraging the firm to “44 times our value”) in order to buy commercial and residential real estate at the top of the market, even though one of his lieutenants had warned in 2005 that the housing market was on steroids and headed for serious trouble.
At times Mr. McDonald’s rage or Mr. Robinson’s penchant for melodrama leads to some hyperbolic writing. Mr. Fuld, for instance, comes across as a sort of Lord Voldemort, a “strange wraithlike presence,” an “oddball demigod who ruled everyone’s lives.”
Over all, however, Mr. McDonald’s book gives the reader a visceral sense of what it was like to work at Lehman Brothers and the fateful decisions and events that led to the company’s death spiral — decisions that turned the once-proud firm into a grim illustration, in the words of one of the author’s colleagues, of the “colossal failure of common sense.”
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