Firefighting: A Plea for Discretion

Firefighting, the new primer on the financial crisis by the all-star team of Ben Bernanke, Timothy Geithner and Henry Paulson (BGP), is a well written, short overview of the consensus position on the U.S. financial crisis. The book has a number of good lines:

…financial institutions, unlike other businesses whose success depends primarily on the cost and quality of their goods and services, are dependent on confidence. That’s why the word “credit” comes from the Latin for “belief,” why we say we can “bank” on things we know to be true, why some financial institutions are called “trusts.”

…the most damaging problem with America’s capital rules was not that they were too weak, but that they were applied too narrowly.

Risk, like love, will find a way.

Firefighting offers a summary, consensus view of the causes of the crisis:

…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 too inaccessible. There were also too many major firms that were too big and interconnected to fail without threatening the stability of the system, and the explosion of opaque mortgage-backed derivatives had turned the health of the housing market into a potential vector for panic. Meanwhile, America’s regulatory bureaucracy was fragmented and outdated, with no one responsible for monitoring and addressing systemic risks.

Consult Adam Tooze’s magisterial Crashed for a more European and global view of the crisis,  Hetzel’s The Great Recession for an explanation of the crisis based on monetary rather than financial disorder and Larry Ball’s The Fed and Lehman Brothers: Setting the Record Straight on a Financial Disaster for an exhaustive and different accounting of the politics especially around the decision not to bail out Lehman.

Given that the book takes a consensus view and given that all three authors have written previous books on the crisis, one might wonder why BGP wrote Firefighting. The answer is in two parts. Most importantly, Firefighting is a plea for discretion. At one point BGP write surprisingly directly if euphemistically:

The Fed also reinterpreted its emergency lending authority in creative ways to avert catastrophic collapses of Bear Stearns and AIG…

In other words, the Fed broke the law. That, at least, is how many in Congress saw it after the fact which is why Congress asserted its authority over banking by rewriting the rules but also removed a lot of discretionary authority from the Federal Reserve and the Treasury.

Overall, while the United States has much stronger safeguards against the occurrence of panic than it had before the crisis, it has weaker emergency authorities for responding when a panic occurs. Its crisis managers lack the power to inject capital, guarantee liabilities, or purchase assets without going to Congress…the Fed has lost its power to rescue individual firms and faces new constraints on its lending powers, while the Treasury has lost its ability to use the Exchange Stabilization Fund for guarantees.

What Congress takes it can also give but BGP are not sanguine about the effectiveness of American democracy:

…when an epic crisis does arrive, Congress would have the power to undo the preemptive limitations it has placed on crisis managers. But that is easier said than done in a nonparliamentary democracy where legislative changes require support from the president, the House of Representatives, and a filibuster proof majority in the Senate…it’s hard to look at the bitterly polarized politics of modern America and feel confident that a bipartisan consensus for unpopular but necessary actions would emerge when it mattered most.

Thus, BGP come down solidly on the side of technocracy and discretion rather than democracy and rules.

I believe the second reason that Bernanke, Geithner and Paulson wrote Firefighting is that they want their account of the crisis to be the history taught to the next generation. To that end, Firefighting is indeed a useful guide for teaching the crisis and is particularly good on timelines, major events and policy actions. About a third of Firefighting is a series of standalone charts (which aren’t even referenced within the text). Oddly, however, the book never tells you that the charts are available online, neither does the book’s homepage, but a little Google sleuthing uncovers that the charts were produced in cooperation with the Brookings Institution and can be found here. Anyone wanting to teach the crisis will find what they need in the charts supplemented of course with the discussion of financial intermediation in Modern Principles and the MRU videos on the Great Recession and the various Business Cycle Theories.


“Arsonists proclaim their firefighting skills”.

Plus one.

When they mentioned "shadow banks," FHLMC and FNMA first came to mind.

Do they write about why they didn't bail out Lehman Brothers as they did for numerous other bankrupt banks, brokerage/investment houses, insurance companies, mortgage bankers/brokers, money market mutual funds, . . . ?

Depositors and savers want safety, which they have in FDIC-insured banks and saving institutions. So, they gave them near-zero rates for ten years.

Rewarding bad behavior. Investors and speculators want maximum gains. When the investors/speculators got caught in the subprime mortgage bust, these guys nationalized their losses, bailed them out.

"When they mentioned "shadow banks," FHLMC and FNMA first came to mind."

Regulated public institutions exit in the shadows?

The unregulated private and largely secret retail money funds+unregulated private and largely secret investment banks+plus as of 2003 totally unregulated mortgage originators that are as public as troll farms exist "in the light" far from the shadows?

The below are all quotes from Ben Bernanke:

July, 2005

"We've never had a decline in house prices on a nationwide basis. So, what I think what is more likely is that house prices will slow, maybe stabilize, might slow consumption spending a bit. I don't think it's gonna drive the economy too far from its full employment path, though."

July, 2005

"We've never had a decline in house prices on a nationwide basis. So, what I think what is more likely is that house prices will slow, maybe stabilize, might slow consumption spending a bit. I don't think it's gonna drive the economy too far from its full employment path, though."

March 28, 2007

"At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained. In particular, mortgages to prime borrowers and fixed-rate mortgages to all classes of borrowers continue to perform well, with low rates of delinquency."

May 17, 2007

"All that said, given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system. The vast majority of mortgages, including even subprime mortgages, continue to perform well. Past gains in house prices have left most homeowners with significant amounts of home equity, and growth in jobs and incomes should help keep the financial obligations of most households manageable."

I could go on, but you get the drift. 20-20 hindsight.

Quite so. In spite of Greenspan's many successful years, his record is sullied, and deeply so, by his protoge, Bernanke. They not only allowed the crisis to happen, they actively encouraged it. I can't put a lot of faith in how Bernanke now wants the story told. Although, his account might still be useful, if one has a firmly skeptical mind.

You mean that forcing banks to lend money to people who are equal in assets and income without regard to skin color forced banks to stop making mortgage loans thus paying zero on savings, which drove the growth of the unregulated retail money funds plus unregulated investment banks plus unregulated mortgage boiler rooms who lent other peoples money to borrowers with no income, poor assets, based on high inflation in asset prices?

What being old with a memory of trying to get credit and failing provides me is a view of the "bad old days" of big government control of banks up to circa 1970 with a single bank failing being scandalous, and then the post circa 1980 era of "virtue" of drowning government in the bathtub of banking being redefined, banks faiking being virtue, and government being demanded to fix large scale bank failures, with banks meaning everything from car and industrial manufacturers, and boiller rooms who provided cash to home owners who lost their jobs, but only if the house the unemployed owned had an existing mortgage.

Name the banking crisis from 1935 to 1985 which were noteworthy and that required massive government interventions even half as large as the ones in 1985 to 1990 domestic bank failures, the international bank failures which was addressed by Summers engineering a Rockefeller style investment bank bailout, and the 2005 to 2010 global domestic bank failures.

Congress responded to the 2008 crisis exactly the same way as it did to 1988, just faster, and without sending bankers to jail by the thousand to prevent any future bad banking practices of violating big government bank regulations.

Of course, in the 90s, the cause of the 80s bank failures was the big government regulations used to send bankers to jail by the thousands, so bank fsilures were precennted by cramming deegulation at the last miniute into an omnibus bill sent to Clinton just before Christmas 2000 after Congress fled DC, with a government shutdown looming for the holidays and the new Bush administration if Clinton failed to sign it.

Clinton signed the bill with Sen Gramm's and his bank lobbyist wife gift the Bush, Greenspan, et al to prove deregulation would make banking totally risk free. Ie, no insurance on the majority of savings used to fund lending, and almost zero regulation on the majority of loans.

That the problems were caused by still regulated banks not making any loans because they would be required to be race blind is a rather bizarre argument.

"That the problems were caused by still regulated banks not making any loans because they would be required to be race blind is a rather bizarre argument."

Hey, you're the one making it.

+1 as well

Also, Greenspan and Robert Reich could not be reached for comment....

Anyone else drawing this association between RR and SS?

And HH? Like taken from the Marvel universe!

The forest burnt down before Ben got out of bed in 2009.

For all of us unfamiliar with math and accounting terms, a yield of zero means the entity is broke, doing the claw backs, bankrupt. Double entry accounting sets that rule, and you can fake it and pretend to save firms etc; but the treasury yield was technically less than zero, Congress was broke, still is. We have been in bankruptcy mode for ten years, not one is allowed to recognize the problem.

And I can say with confidence of historical records, that every generation since 1770 has seen US government has gone broke once and effect a monetary regime change with defaults.

I can prove this with 100% certainty, actual legal and historical documents and math proofs to back me up, and the accountants too. There is a one out of one chance that we do our sixth monetary regime change in this cycle or the next. That is what this book is about, covering up for 300 years of misunderstanding banking theory.

Amazing that a decade later not one CEO has gone to prison for what is clearly and plainly fraud. The corruption of our institutions including both political parties is the kind of rot that destroys societies.

At a recent news conference three local teens were proclaimed heroes for putting out a recent large brushfire. When asked about the matches and empty gas cans found in the boys’ bedrooms reporters the youths
were escorted off stage by their parents and reporters were told there would be no further comments.

Then they wrote a book, because they "wanted their account to be what was taught to future generations."

Economists from all corners of GMU proclaimed it to be "a useful guide for teaching the crisis."

Of course, this is what a real GMU economist wrote about teaching the crisis - '... but a little Google sleuthing uncovers that the charts were produced in cooperation with the Brookings Institution and can be found here. Anyone wanting to teach the crisis will find what they need in the charts supplemented of course with the discussion of financial intermediation in Modern Principles and the MRU videos on the Great Recession and the various Business Cycle Theories.'

Isn't it democracy if Congress were to legislatively give the Fed and Treasury more discretion? That sounds like the purpose of the book.

"Thus, BGP come down solidly on the side of technocracy and discretion rather than democracy and rules."

It seems to me that they rather pointedly contrasted with "parliamentary democracy."

Rules matter, in democracies too.

Does the Fed really need "Emergency powers"? or do financial institutions need "emergency safety net"? has an emergency action ever really worked?

It appears that the bottom line problem is mis-priced risk, nobody truly knew the risk of the instruments they were trading. If the financial industry can assign me a "credit score", then surely, financial institutions can also be assigned a "credit score" as well give an indication of the trust that their success is built on.

In New York, even all restaurants carry Sanitation letter grade so people can "trust" that they might not get food poisoning. Financial institutions should also have a score.

The last financial crisis happened when a bunch of AAA rated bonds failed, right?

I believe part of the problem was bad debt was being repackaged with good debt, and thus the rating was being diluted so it became really hard to figure out if the debt you were buying was actually represented by the rating on it.

debt ratings are not the same as rating financial institutions.

I would worry that the principal-agent problem would be the same.

"The last financial crisis happened when a bunch of AAA rated bonds failed, right?"

Sort of. The following will give an idea of what was going on.

Unexpectedly large volumes of the, say, 15,000 underlying mortgages (prime, subprime, alt-A, negative amortization, No-Doc, NINJA, fraudulent) whose contractual monthly payments provided the cash flows to pay interest and principal for the complicated mortgage pass-through investment vehicles (I don't call them derivatives - they don't fit the GAAP definition). Far more underlying mortgages defaulted/stopped paying than the numbers-crunchers ever dreamt would. Ergo, the lower quality tranches defaulted and, as cash flow short-falls worsened, that impairment migrated up to higher, investment grade tranches which were being impaired, not paying according to contractual terms.

The complicated vehicles were broken down into tranches ranging from AAA (short-term, first claims to cash flows) to mezzanine and equity/over-collateralization tranches (last claims to cash flows). I think investors would buy a tranche. The higher ones were "protected" by the lower ones. Of course, it would be bad form (none dare call it fraud) to stick into AAA tranches subprime, NINJA, no-doc/lo-doc, alt-A, negative amortization loans.

That's not quite right. All the mortgages support all the MBS tranches (usually). It isn't a question of putting subprime mortgages into the AAA tranches. Rather, the theory was that even with subprime mortgages, lots of them do perform, so some portion of a subprime mortgage pool can support AAA MBS.

Thanks for the clarification.

The problem was too many subprime and other unconventional loans, which were underwritten (solely on highly inflated collateral - appraisal/FMV values, ignoring the other four C's of loan underwriting) under the myth that RE prices only go up.

Yes, the theory was wrong, especially because a lot of the mortgages were even worse than advertised. I don't think we have a major disagreement; I'm just clarifying how securitizations work.

Or at least more correlated than believed. I *think* they assumed RE prices could go down locally or a little, just not a lot + everywhere.

>Does the Fed really need "Emergency powers"?

And, if they had them, would they use it? For example, in 2007, we had a law on the books that specifically gave BGP the power to seize banks to allow orderly wind-down. The Feds declined to invoke it, preferring the (illegal) bailout approach.

'of the consensus position on the U.S. financial crisis'

Well, of those who really, really hope no one will look behind the too big to fail curtains.

We wished in Europe that JC Trichet had broken the law too. The 2011 crisis would have been avoided.

I guess "Maybe we shouldn't have forced banks to loan trillions of dollars to bartenders looking for their third homes" is just too short for a book.

Maybe you should not form economic or political positions based on complete fantasies.

Could you please document which bank was forced to make loans to bartenders. I know a lot of bartenders (that's a story for another day) and they report to me that from 2004-2006 they received an average of two unsolicited mortgage offers per day via cold calling or direct mailing from various mortgage originators.

On top of all the mortgages there were also scads of HELOC offers, which create a second mortgage, based then on overly inflated real estate assessments.

Let's pretend this is true to amuse our 'markets are always right' friends here. Someone, somehow, 'forced' a bunch of unhappy banks to make loans to bartenders they knew were super risky but, hey, the law's the law.

Why would the stock price of those poor banks go up? I wouldn't buy shares in a bank that was making a lot of poor quality loans, even if it wasn't the bank's fault.

Why would people loan money to those banks? Why wouldn't non-bank mortgage lenders (see Countrywide, not under the same regulations as they didn't take deposits), shun such bad bartender loans?

Of course the flip side to this is why was there massive price increases and bad loans on the top of the market? Subprime didn't just mean giving a bartender a $150K loan to buy an overpriced condo but could also mean giving a rather stretched upper middle class person a $900K loan to buy a McMansion. In terms of dollars those big ticket loans were probably more of a problem. A million dollar mortgage that goes bust has a lot more room for the underlying house to go down in value than a smaller loan. But certainly there was no government regulation requiring banks to make McMansion loans to shaky white guys was there?

"the migration of too much risk to shadow banks"

The risk was already out there, and only "migrated"? Didn't shadow banking pump up mortgage origination, to create more subprime?

Yes, the limitation of politics. And ideology. Thomas Piketty wrote confidently in his book on inequality that central banks and governments will always intervene in a financial crisis and stop the collapse of asset prices and re-inflate asset prices. I believe Piketty is wrong. Why? Politics. And ideology. Of course, Trump is unpredictable, but one can imagine a President and Congress hostile to the Fed and hostile to extraordinary measures to prevent another great depression. Indeed, the two potential governors Trump has considered opposed the extraordinary actions taken by BGP in the last financial crisis, only to promote the same actions now that the financial system and economy are stable. I can imagine a financial crisis in which a hostile President and Congress and loud voices at the Fed opposed to extraordinary actions, some for political reasons and some for misguided ideological reasons. As to the latter, one might recall that the leader of Austrian Economics at Mercatus opposed the extraordinary actions taken by BGP and preferred to let asset prices fall and recover, if at all, on their own. It's that combination, politics and misguided ideology, that could propel us into another great depression. Be afraid, very afraid. [An aside, letting asset prices collapse would have a consequence that only populists on the left and populists on the right would applaud. What might that be?]

I have a hunch this won't be the last word.

Even Nero didn't have the cajones to write a how-to-book on fighting the next attempt to burn down of Rome.

These three . . . "See No Evil. Hear No Evil. Speak No Evil."

"...second reason that Bernanke, Geithner and Paulson wrote Firefighting is that they want their account of the crisis to be the history taught to the next generation."

I bet. It is called covering your ass, this time, for the history classes.

Did they acknowledge that a prolonged period of easy money in the 2000s played a major role in the housing bubble?

Too much banking outside of regulation? Surprise! Three government men blame the lack of regulatory power for the bubble, not their failure as regulators. We had a major stock market / investment collapse in the early 2000s (a very Austrian sounding crisis), and Greenspan and the Fed wanted to fuel a recovery. The Fed gave a green light to bankers to lend permissively in the housing finance, with the blessings of the Bush Administration (the ownership society) and Congressional Democrats like Barney Frank and Chris Dodd. Paul Krugman endorsed the Fed's easy money and light regulation. The idea is that a housing and credit boom would restore full employment. So it did, for a while. And after the house of cards collapsed, these failures decided to blame greedy bankers and demand still more regulation and government discretion.

If you want more Trump, this is how you get more Trump. Populism is a response to elite failure, and we had the biggest elite failure of our lifetime. It is easy to sneer at Trump, and people like Herman Cain, but neither of those men caused the bubble or its collapse.

And none of the Firefighters had a coherent plan for fixing the mess for the first year of the crisis (August 07 through August 08). The Fed needed to lend massively during a run, but it decided to backstop Bear's losses instead and then it permitted Lehman to go bankrupt rather than lend to it. It was a mess.

There was a week in September 2008 that gave us the Lehman failure, the nationalization of AIG, the merger of Merrill Lynch and BofA, the run on Reserve Primary, and the conversion of Morgan Stanley and Goldman Sachs to bank holding companies. The Fed's FOMC met, and decided it did not need to ease!!!!! What were they thinking? They weren't thinking. We needed zero rates then and there.

Most mortgage houses at the time were not even banks (think: Countrywide, New Century) and as such they were barely regulated at all. The worst. most default-prone mortgages came from these firms, which were engaged in classic pyramid scheme practices, driven to write even more risky mortgages until Wall Steet got wise to them and cut them off, triggering the initial wave of failures.

"Did they acknowledge that a prolonged period of easy money in the 2000s played a major role in the housing bubble?"

I've read this idea a lot but no one has been able to intelligently explain how it is supposed to work. Markets are always rational unless there is 'easy money' (whatever that means)? 'Easy money' doesn't generate inflation but bubbles. Why?

Standard economic theory, suppose you started dropping $100 bills from a helicopter. People would pick them up and go out and buy all sorts of things. The price of everything would start to rise.

Bubble theory: You drop $100 bills and for some reason people just want to buy one thing. The price of that one thing goes up and up and up, yet it doesn't occur to anyone to switch their $100 bill spending to any of the numerous other nice things the economy can provide.

If 'easy money' causes a bubble and crash what to make of the fact that money just got even easier after the crash yet mysteriously real estate still went down and came up slowly. Since 'easy money' never stopped where did the bubble go? Where was/is the inflation?

Bagehot's Dictums were developed to counter financial instability. Unfortunately, the actions taken by BGP were the direct opposite, as BGP apparently intended to encourage rather than reduce moral hazard.

If you 'counter financial instability' you 'encourage moral hazard'. For example, you close the banks for a week to prevent people from withdrawing their deposits in a panic. That would give banks that made risky loans in the past breathing room to sort themselves out. Hence 'moral hazard'.

Hats off, Tabs old boy, for the torpedo you launched in your last para.

As for the authors: would you even trust these guys to fill in a tax return properly?

Was there any discussion of how the authors' creative reinterpretations will affect future behavior by banks who will expect future creative reinterpretations to make the rest of us pay for their bad bets?

I wonder if the book includes the way bond holders got raped, or the fact that new homes were being built at unsustainable levels, or the fact that both lenders and consumers were committing egregious fraud and never ever were prosecuted for it? Where was RICO when it would have been appropriate?

Hmm, so we have a bunch of commenters who support the Mellonesque, hands off, "liquidate, liquidate, liquidate" approach, another bunch who think the government should have bailed out Lehman, a bunch who blame subprime mortgages, and another bunch who insist that all prudential regulation is unnecessary because the market can supply its own discipline. But they all agree that BGP handled it wrong. If the stakes weren't so high, I'd like to appoint all those people as a committee to manage the next financial crisis, and laugh.

Great comment. In emergencies, time is of the essence, and it is too much to expect emergency managers to make all the right calls. Here we don't even seem to have consensus on what the right calls would have been given the luxury of hindsight.

Contrary to how BGH's writing portrays it, though, an "epic crisis" doesn't just "arrive." It is at least in part allowed to happen by the stewardship that preceded it. They're not just trying to exonerate themselves for the emergency response but for having failed to stop the emergency from developing.

I think BGP did about as well as they could have, given harsh realities.

I think some commentators believe, that in some perfect world, harsh realities would never appear, but that's pretty deluded. There has never been a civilization of men that did not suffer business cycles.

The harsh realities are the only discipline that can tame the stupidity.

The 2008 financial crisis was a correction of egregious business practices. The bond rating agencies were worse than useless; they put AAA ratings on pure trash. The banks had put together these crazy financial structured products and kept the stuff that they couldn't sell on their own balance sheets, and only found out when the market priced them at $0. The regulators were useless, and Fanny and Freddy were leading the pack with their nonsense. The previous 30 years had seen a pattern of the Fed showing up as firemen with unlimited amounts of cash to make it not hurt too bad when the stupidity was exposed.

The net result was that tax payers wrote massive checks to the richest people in the nation. It was and is a disgusting story, and is the roots of the political upheavals we are experiencing now.

Have to agree. So many people so supremely confident, many with 100% conflicting views. Hey, I have my opinion too and I think BGH screwed up a bit, but I'm coming from the Summers/Erdmann view that a) there was plenty of time for more monetary easing to mitigate the sharp crisis that occurred and b) most of the problem came from believing that housing was *too* expensive when it was really just in short supply and this caused people to ignore the need for monetary easing until it was too late. But working in the framework they had, BGH did a pretty good job. And I don't think for a minute we have solved the fundamental issues that caused the crisis and largely agree with BGH that taking away policy discretion is dangerous. This isn't anti-democratic at all, btw, unless you think super-majorities required to pass new legislation is the only democratic option.

Paulson, in my view, was the real hero, because he was willing (and able) to recognize the depth of the crisis, set aside what must have been his prejudice against government intervention, and work with BG to avert what may well have been the end of capitalism as we know it. BG were technocrats (G describes himself as a crisis manager and, in particular, not an economist) and were trained to do whatever needed to be done, but Paulson, he was different, and he performed extraordinarily well. Of course, Paulson has been subjected to lots of criticism for Lehman's collapse (with the accusation that he wanted Lehman to fail because it was a competitor of Goldman Sachs, but that's preposterous); indeed, it was Paulson who was running around with his hair on fire. BGP deserve the Presidential Medal of Freedom.

Paulson in particular panicked badly and publicly, further roiling the markets, scaring the public, and exacerbating the crisis. One can only hope that he will never be allowed near a position of financial authority again.

>But they all agree that BGP handled it wrong.

I don't think that's quite right....They all agree that the various approaches were more-or-less reasonable, but worry that BGP's discretionary power itself created a ton of uncertainty, and that uncertainty made the whole thing worse.

Going forward, they want to eliminate that uncertainty. Somewhat naively, imho.

quasi edit: For example, we know that Buffet made an offer to take over Lehman a few days before collapse. The Lehman CEO declined, thinking that BGP would bail him out too ala Bear Sterns.

It seems identifying causes of banking/financial crises poses similar problems as pegging the causes of the decline and fall of the Roman Empire. To wit, there are as many theories as there are writers.

Both national political parties had bought into the "ownership society" and everybody was (big-time) making money.

For years, banks and mortgage brokers had made profits (fees) refinancing high rate fixed residential loans as markets interest rates slowly normalized from the 1980's 22% prime rate regime, employed by Volcker, et al to kill inflation.

When refinance income flows ebbed housing bubble was a convenient needed replacement.

The book's subtitle should be, "Don't Let Facts We Don't Like Queer The Buzz."

During the housing bubble's inflation, with hugely soaring house prices, comparatively flat were GDP growth and real incomes growth. Economic data were there for anybody to see.

Just the facts. US Home Ownership Rate increases could have signaled the bubble: 1965: 63.4%; !992: 64.2%; 2000: 67.5%; 2004: 69.2%; 2006: 68.9%.

FHLMC/FNMA provided fuel with (relative to GDP/incomes) massive increases in maximum loan purchase limits: 1992: $220,000; 1999: 240,000 up 19%; 2000: $252,000 up 5%; 2001: $275,000 - up 9%; 2002: $300,000 up 9%; 2003: $322,000 - up 7%; 2004: $333,000 - up 3%; 2005: $359,000 - up 8%; 2006: $417,000 - up 16%.

There was a lot more.

I see the Gasbag Chamber Players are here to blame Dr. Bernanke for the trouble.

Charles Calomiris complained at the time that there was a well understood sequence of steps to manage such crises and the trio above threw out the manual and took to mad improvising. No clue if this is correct or incorrect, but, unlike what you see above, it is an informed opinion. The result of their improvising wasn't bad, but one is left with the anxiety that the institutional resolution failed to address structural problems.

We seemed to get along satisfactorily for many decades institutionally separating deposits-and-loans banking from capital markets from the provision of insurance. Can't help but notice that the most troublesome institutions were AIG and Citigroup. One was an insurance company engaged in derivatives trading and the other was a universal bank. Cannot help but note as well that one of the challenges which faced crisis managers concerned the multiple domiciles of AIG and Citigroup and Lehman. Congress passed gruesomely complicated legislation. Not included therein was an insistence that financial firms divest themselves of overseas subsidiaries or an insistence that universal banks spin off subsidiaries providing insurance, securities underwriting, sales-and-trading, hedge-funds, retail brokerage, prime brokerage &c. Also not included were provisions breaking up the GSE's (maybe because they're all run by Democratic Party insiders) and excising provisions in law which induce an artificial resort to the secondary mortgage market. Not included as well are provisions which provide a means for lawyers and 'activists' to bully banks into making bad business decisions.

"excising provisions in law which provide a means..."

Can you explain to me those provisions: "excising provisions in law which induce an artificial resort to the secondary mortgage market"?

Good post, and I'm enjoying everyone's comments, by the way. The anger this event generated seems to lead to very salutary plain speaking (salutary, at least, to one not versed in finance and econ as the rest of you are).

No clue if the following is correct. Just found it an interesting contention.

See Arnold Kling's commentary on EconLog dated 24 July 2009. I can't get the URL past the bad spam filter they're using.

See Arnold Kling's commentary on EconLog dated 24 July 2009. I can't get the URL past the bad spam filter the moderators use.

>Can't help but notice that the most troublesome institutions were AIG and Citigroup.

To me, it seems like the institutions that failed were the pure plays (Lehman, Merrill, etc). The diversified institutions seemed to weather the storm a bit better... presumably because of diverse revenue/profit streams.

Admittedly, this is just generalizing from a few, high-profile data points. I'd like to see more systematic numbers/analysis someday...

By 'troublesome', I meant a challenge for policy-makers. Washington Mutual also failed, but the resolution of that failure was within the FDIC's skill set.

I don't think there were widespread failures among community banks or regional banks.

Drexel Burnham Lambert was liquidated in 1990 without generating a panic. Failure of a securities firm with a half-dozen lines of business (but no depositors) need not be a disaster.

If I'm not mistaken, one of the problems re Lehman was that there were parallel bankruptcy processes ongoing in Britain and the United States.

presumably because of diverse revenue/profit streams.

Suggest they had better risk assessment. Citigroup was as diversified as you can get. And a mess.

presumably because of diverse revenue/profit streams.

Suggest they had better risk assessment. Citigroup was as diversified as you can get. And a mess.


"Can't help but notice that the most troublesome institutions were AIG and Citigroup"

At the beginning of the crisis, there were 5 pure investment banks: Goldman-Sachs, Morgan-Stanley, Bear Stearns, Lehman Bros, Merill Lynch.

At the end of the crisis, only the first two remained standing.

So, it doesn't seem that the repeal of Glass-Steagall (which is what you are referring to, without saying) had the impact you imply.

I agree with the rest, though.

"financial institutions ... are dependent on confidence." At best this obscures the difference between an institution that's insolvent, and one that's solvent but illiquid. For the Fed especially, that's an essential difference.

"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 too inaccessible. " There was also the apparent inability of financial markets to correctly price risk (for example, a top-tranche CDO paying barely more interest than a Treasury) and the outsourcing of risk onto others (including the U.S. taxpayer). As well as corruption at the ratings agencies that were all too willing to declare a security "AAA" so long as they was paid enough for their "investigation."

At a minimum we learned that many (perhaps most) financial professionals can become so fixated on short-term gains as to become blind to longer-term risks that are all too visible to those who are not directly involved as players.

"At best this obscures the difference between an institution that's insolvent, and one that's solvent but illiquid."

This does seem rather blurry. I'm a bank. I take in $1B in deposits. I make $800M in 5 year auto loans. Let's say these are very high quality loans but people want to withdraw $900M from my bank. I only have $200M on hand. I could in theory borrow or sell those auto loans to raise the cash. But note that implies the rest of the financial system is functioning well.

On the other hand suppose I made a bunch of bad loans. I'm never going to collect $800M and I owe my depositors $1B. But if they don't come looking today for their money I'm still alive....if someone else is willing to put another billion in me, all might work out well if I learned my lesson well and started making good loans. Of course regulation says I have to write off those bad loans sooner or later and unless timing is really good, I'll be insolvent when I do so. But when to write off those bad loans? When people miss their first payment? Their 3rd? What about when we send out the repo men and start selling those cars at auction?

None, I repeat none, of the problems of 2008 would have been serious if financial institutions had adequate capital. Lehman was levered 35 to 1, meaning a 3 percent drop in the value of its assets would be enough to render it insolvent. That was the problem, not the assets or liabilities themselves.

I agree, but wonder what idiot would lend at 35 to 1? Somehow, that seems to be the root problem....

Yes, but this was poor risk assessment. You can overleverage an investment in Treasuries if you misjudge.

If the Fed wants power than the Fed can pay net present value for the right to coin. My number for that is 15 years to default 8 trillion on behalf of Congress. That is my Bernanke/Friedman NPV estimate of the value on that right, over spacetime. That power of default is an opportunistic power of flying Ben's helicopter, really fly it, the loosed money having no equivalent liability except contractual currency losses.

Because I priced that NPV aurately, we can all be assured Congress aill not renege on the contract for 15 years, and might renew it. I can also promise that my default plan results in a cash flow accounting system imposed on government agencies, yielding a 4 trillion dollar productivity increase over the period. This is 8 trillon dollars of discretion, Ben, if you have a better plan let me know.

In other words, the Fed broke the law.

Not unprecedented. Central banks often do that in a crisis.

What's great about Marginal Revolution is that I can look up what I said beginning in October of 2008 and also see what others said. I'll put my comments up against anyone else. I'll read this book even though I've read their books on the crisis, as well as about 30 others. I have the list on my Kindle. By read, many I listened to. The books Alex mentions are excellent. Who was right and who was wrong is evident to anyone with even a modicum of impartiality. One reason I used my name was so that people could see it was me from that time in 2008 until today. It had to do with accountability. So, if you think I'm an ass, I've left you evidence. Be so kind as to return the favor.

They didnt blame it on CRA?

Surprised not to see more blame given to the Fed. Yes, leverage needs to be less; subprime mortgage loans should be unsubsidized, unguaranteed and unsecuritized. But most importantly the Fed was horribly late to start easing and way too slow to 0 and way too inflation-phobic during the recovery. The market monetarists were the only ones to call it correctly every time. This book should have been a plea for MM. Bernanke at least cannot have missed this. If the Fed has been on the ball, the crash would have been just another recession with no drama.

I was hoping the "plea for discretion" was aimed at those creating moral hazard.

Sadly, no. They plea for discretion from those who would reign in the moral hazard dispensers.

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