Firefighting: Book Review
Firefighting: The Financial Crisis and Its Lessons (2019), Ben Bernanke, Tim Geithner, and Hank Paulson. The Big Three, in charge of getting through the subprime meltdown, their take a decade later. All three wrote their memoirs of the crisis and perhaps three dozen books written about it, so it's something of a puzzle why they needed another (in this care, short) book. For the most part, they summarize the events that happened--all of which have been described in detail elsewhere. I suppose this is a united front to demonstrate why they were right in all their actions, despite the multitude of critics who claimed otherwise. The economy and the financial sectors did recover, and that recovery is still going strong. Generally following the three previous memoirs, they discounted the ability to predict the collapse of the mortgage market ("it was a classic panic") and handled it as well as possible given the legal requirement of the time.
I was not one of the happy campers about their actions. They saved the industry all right, but their actions were extraordinarily helpful to most of the financial giants. With the exception of Sheila Bair at FDIC, there were no attempts to give stakeholders "haircuts" or limit executive compensation (not to mention clawbacks). Goldman Sachs, arguably was simultaneously the most competent and most corrupt of the big bank players and much of the actions seemed to particularly benefit Goldman (Treasury Secretary Hank Paulson previously was CEO of Goldman). In Congressional testimony, Goldman CEO Lloyd Blankfein made clear that he and the company had little or no fiduciary responsibility for their customers. Blankfein is still there, making buckets of money--apparently worth more than a billion dollars. The three amigos seem to fit my "blinders hypothesis" of seeing the world through a very restricted perspective. Wall Street and the economy (but especially Wall Street) did recover, but moral hazard remains (or is enhanced) by their actions.
Below is a summary of the book, with limited editorial comments. "We helped shape the American and international response to a conflagration that choked off global credit, ravaged global finance, and plunged the American economy into the most damaging recession. ... We eventually helped stabilize the financial system before frozen credit channels and collapsing asset values could drag the broader economy into a second Depression" (p. 2). "America's balkanized financial regulatory bureaucracy ... helped transform panic about the risks embedded in underlying mortgages into panic about the stability of the entire system" (p. 3). "A one-month period starting in September 2008 included the sudden nationalization of the mortgage giants Fannie Mae and Freddie Mac, the largest and most surprising government intervention in financial markets since the Depression, the failure of the venerable investment bank Lehman Brothers, the largest bankruptcy in US history; the collapse of the brokerage firm Merrill Lynch into the arms of Bank of America; an $86 billion government rescue of the insurer AIG to prevent an even larger bankruptcy than Lehman's; the two largest failures of federally insured banks in US history, those of Washington Mutual and Wachovia; the extinction of the investment bank model; ... the first-ever government guarantees for more than $3 trillion worth of money market funds; the backstopping of a further $1 trillion worth of commercial paper; and congressional approval, after an initial market-crushing rejection of a $700 billion arsenal of government support for the entire financial system" (p. 5). [Because of] "reforms, financial institutions have more capital, less leverage, more liquidity, and less dependence on tenuous short-term financing" (p. 6).
Chapter 1: Dry Tinder. "Much of the risk migrated to firms outside the traditional banking system, where regulation and supervisory oversight were inadequate" (p. 12). "Serious economists were arguing that financial innovations like derivatives, because of their purported ability to better diversify risks, had made crises a thing of the past. ... Long periods of stability can create overconfidence that breeds instability" [Human Minsky] (p. 13). "Loan originators who knew they could sell their mortgages without retaining any of the risk of default had little incentive to seek creditworthy borrowers" (p. 17). "It's hard to fix something before it breaks" (p. 25). "Capital is the shock absorber that can help an institution withstand losses, retain confidence, and remain solvent during a crisis. ... Supervisors failed to recognize how much leverage banks had hidden in complex derivatives and off-balance-sheet vehicles" (p. 26). "During the boom, there wasn't much political appetite for stronger financial regulation of any kind" (p. 27). "The firms were reluctant to reduce their exposure to risky derivatives because they didn't want to lose market share" (p. 28).
Chapter 2: The First Flames. BNP Paribas 2007, collapse of funds with subprime; classic liquidity crunch. Policymakers don't understand the situation. European Central Bank and Fed injected money by buying securities--Bagehot prescription. "Countrywide was a case study about all the vulnerabilities in the system: over reliance on lower-quality mortgages, regulatory arbitrage, and especially runnable short-term financing" (p. 39). Countrywide acquired by BofA. Merrill Lynch and Citigroup writedowns. Securities prices dropping without regard to quality. TAF (p. 42); swap lines with ECB and other central banks; fed rate cuts; TSLF (p. 44).
Chapter 3: The Fire Spreads. Bear Stearns collapses March 14, 2008. "Bear was mostly just a collection of fragile businesses and risky assets' (p. 47). Federal government had no resolution authority for nonbanks, used Morgan and "Maiden Lane." JP Morgan acquired Bear with Fed bailout. PDCF (p. 51). Chapter 4: The Inferno. Lehman "loosely regulated, heavily overleveraged, deeply interconnected nonbank, with too much exposure to the real estate market and too much dangerously runnable short-term financing" (p, 61). Disagreement on tactics and messaging. Bankruptcy September 15. Treasury needed new authorities. AIG and credit default swaps. $85 billion credit line for 79.9% of equity. "Some critics were outraged that the Fed didn't insist on haircuts ..." (p. 74). "Capitalism without bankruptcy is like Christianity without hell. TARP (p. 79): "Big government socialism versus lack of restrictions of exec. compensation (some restrictions added). Sheila Bair on Wa Mu: haircuts for debtholders, acquired by JP Morgan (p. 81).
Chapter 5: Dousing the Fire. TARP. Capitalization, specter of nationalization. "We wanted to make a credible commitment that there would be no more haircuts or defaults, because that's how confidence gets restored" (p. 87). CPFF (p. 88). Money to 9 systemically important financial firms, 3% of risk-weighted assets, $125 billion. Europeans nationalized failing banks: "As a result, their banking system would remain woefully under-capitalized for years, and their economic recovery would be slower than ours" (91). AIG's major creditors: "would not accept even extremely modest haircuts" (p. 93). TALF (p. 94). Lawsuits by AIG shareholders (p. 96). Fed to buy $100 billion of Fannie and Freddie debt and $500 billion of mortgages (p. 97). Stress tests (p. 98). "None of Tim's colleagues seemed happy with his approach" (p. 100). Citi received more TARP funding, lavish bonuses to staff. Quantitative easing in 2009, up to $4.5 trillion (p. 103). HARP (p. 105).
Conclusions. "None of us was ever sure what would work, what would backfire, or how much stress the system would be able to handle" (p 109). 'We believe that the strategy the United States adopted, and we helped shape, worked about as well as could have been hoped, given the constraints and radical uncertainties the country faced. ... The government managed to stop the panic, stabilize the financial system, revive the credit markets, and jump-start a recovery" (p. 110). Good summary: "The basic problems were too much risky leverage, too much runnable short-term financing, and the migration of too much risk to shadow banks where regulation was negligible and the Fed's emergency safety net was inaccessible. There were also too many major firms that were too big and interconnected to fail without threatening the stability of the system. ... America's regulatory bureaucracy was fragmented and outdated, with no one responsible for monitoring and addressing systemic risks" (p. 112). Basel III tripled minimum capital for banks, quadrupled for largest banks.