This is a little late, but we just passed the one-year anniversary of the pinnacle of the financial crisis: the Lehman failure.  This milestone prompted an excellent article in The New Yorker by James B. Stewart, titled “Eight Days.” It is an extremely well-sourced, inside look at the day-to-day activities during the collapse of Lehman Brothers Holdings, Inc.

I came away from it with not so much a revelation, but more of a confirmation of something I had thought several times before.  A thought that was wildly unpopular during this time frame: Thank god for Henry Merritt Paulson, Jr. and Ben Shalom Bernanke.

It becomes clear after reading this that we truly were standing on the precipice of complete financial collapse.  The major unintended consequence of letting Lehman fail was the panic that caused a run on money-market funds.  I’ve written on this topic before, but actually reading accounts from how scared some high-level executives were is astonishing:

[Timothy] Geithner said, “It’s hard to describe how bad it was and how bad it felt.” He got a call from a “titan of the financial system,” who said he was worried but he was doing fine. His voice was quavering.  After hanging up, Geithner immediately called the man back. “Don’t call anyone else,” Geithner said. “If anyone hears your voice, you’ll scare the shit out of them.”

In the end, what saved us from disaster was three extraordinarily bold moves by the Fed, the Treasury, and ultimately, albeit slowly and painfully, Congress.  The first was the virtual nationalization of AIG by the Fed, with an initial price tag of $85 billion.  AIG’s Financial Products division had amassed nearly $500 billion dollars worth of credit default swaps, most of which were protecting other banks’ rapidly deteriorating mortgage-backed assets.  A failure of AIG would cause an unstoppable panic and run on every investment bank on Wall Street.  Bernanke and Paulson approached Congressional leaders with this decision:

[Harry] Reid put his face in his hands. “I hope you understand this does not constitute formal approval by Congress to take action,” he said.

“Do you have eighty five billion?” Representative Barney Frank asked.

“I have eight hundred billion,” Bernanke said, referring to the Fed’s balance sheet.

Senator Christopher Dodd twice asked how the Fed had the authority to lend to, and take control of, an insurance company.  Bernanke argued that the Fed had emergency powers to aid any company as long as there was a “systemic risk,” and gave a brief tutorial on a little-known section of the Fed’s authorizing statute.

With an AIG collapse under control, there was still the issue of money-market funds.  The collapse of Lehamn caused the original and most respected money-market fund to “break the buck,” which effectively meant it was losing money.  Panic spread quickly.  Even funds that had zero exposure to AIG or Lehman were being run.  Interest rates for short-term Treasury bills dropped below zero.

Keith Hennessy racalls…”The money funds were experiencing a run. People were literally pulling their money out and putting it in a mattress.  Treasury rates went negative! People were locking in a loss just to protect their money.”

Steven Shafran and others at Treasury were charged with finding a solution.  They came up with allowing money-market funds to borrow from the Fed window, solving a liquidity crisis.  Paulson thought it was too technical.  He wanted something simple.

“We could always just guarantee the money-market funds,” Shafran said.

Paulson looked up. “Could we?”

“I think so,” Shafran said.

Paulson slammed his hand down on his desk. “Then that’s what we’re going to do.”

A few participants were aghast.  The risks seemed enormous: it was a four-trillion-dollar guarantee! [...]

But others argued that the risk of not doing anything, or of doing too little, was far worse.  Palson embraced the boldness and simplicity of the notion.  As someone said, it “passed the USA Today test.”

In order to get ahead of the next storm, Paulson discussed forther options with Bernanke.  Bernanke pushed for more authority from Congress.  Paulson was hesitant:

“I spoke to Harry [Reid] and Nancy [Pelosi]…and the poltical advisers,” [Paulson] said. “If the Treasury and the Fed say it’s an emergency and we need help, and help doesn’t come, it would further destabilize the markets. You don’t go public until you’re reasonably certain you’ll get what you’re asking for.”

Bernanke was growing agitated. “Hank! Listen to me,” he interrupted. “We are done!”

It was the first time Fed officials had heard him raise his voice.

“The Fed is already doing all that it can with the powers that we have,” Bernanke continued. One participant recalled, “Ben gave an impassioned, linear, rigorous argument explaining the limits of our authority and the history of financial crises in the U.S. and abroad.” That history showed that efforts to resolve such crises “are successful only when overwhelming force from all parts of government is brought to bear,” the participant said. “It was an encyclopedic tour de force.”

It was as though Bernanke were the professor and Paulson the student.  Bernanke’s comments lasted about fifteen minutes, and Paulson was uncharacteristically silent until near the end.

“Got to go,” he said, and hung up.

The next day, TARP was born.  And the rest of this story you all know.

To me what is remarkable about all three of these decisions is that they were big, bold decisions, with a lot of detractors.  You’ve got Congress against the AIG bailout, you’ve got some in Treasury and the money-market firms against the guarantee, and you’ve even got Paulson initially against TARP, but in each of these cases, the proponent (Bernanke, Paulson, and Bernanke respectively) stood tall and got it done.

And it worked.

Meanwhile, the economy is still in a deep recession, with unemployment at nearly ten percent.  But the simple fact is this: America did not plunge into the economic abyss it faced that Thursday night.  The bold stroke of guaranteeing the money-market funds stopped the panic and halted withdrawals from the funds.  The commercial paper market slowly came back to life and, with it, the credit markets. [...] The details and mechanics of the TARP legislation proved less important than the sense that a comprehensive plan to address the crisis was under way.  The reprieve bought enough time for the reemergence of reason over unbridled fear.

During the debate over TARP, I very publicly slammed Markos Moulitsas in this post.  I haven’t been back to DailyKos since, which may seem childish (ironic, seeing as I called him a child in that post), but I can’t seem to get over this remarkable lack of intellectual honesty.  For many on the left, myself included, this bailout of the rich and powerful was definitely morally unpalatable.  But at some point, reason must overcome populist outrage, and on one of the biggest issues of our time, kos let his ideology run amok over reason.

This is not something I respect.

Tags: Ben Bernanke, financial crisis, Henry Paulson

This entry was posted on Sunday, September 27th, 2009 at 5:05 pm and is filed under Lots of Pulp. You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.