One of the more intriguing questions Professor Ball tackles is why Mr. Paulson, rather than Mr. Bernanke, appears to have been the primary decision maker, when sole authority to lend to an institution in distress rests with the Fed. The answer, he suggests, is to be found more in psychology than data.
“By many accounts, Paulson was a highly assertive person who often told others what to do, and Bernanke was not,” Professor Ball writes. “Based on these traits, we would expect Paulson to take charge in a crisis.”
Pointer from Mark Thoma.
Stewart, who did his own reporting on the events, supports Professor Ball’s view. My reading of Paulson is that he is a high-testosterone guy. My reading of Bernanke is that he isn’t. I have always viewed Paulson as the great villain of the financial crisis response. I do not believe that any of the bailouts were justified, and I view him as the driver of the bailouts.
Suppose you take a Bagehot view, which is that in a crisis the central bank should lend freely, on good collateral, at a penalty rate. In the case of Bear Stearns, my recollection is that the Fed took on crummy collateral. Ball claims that Lehman had good collateral that the Fed could have lent against.
Cult of personality fail. Nobody has fixed it yet. That means they don’t want to.
When they follow Bagehot, it isn’t a bailout. It is doing what having a monopoly on fiat money requires you to do to fulfill a basic duty.
You can almost view Buffett as a “back up central bank.” When he lends it’s on terms that are expected to produce a strong ROI. The Fed should be the same. As a taxpayer I have no problem lending to a distressed bank, but if you’re calling us in, expect harsh terms.
Probably not coincidental that I thought about offering Buffett as the opposite of the “levers out of the money puts with stagged strikes” mumbo jumbo from the thread about anti-fragility.
Buffett doesn’t come to the market with a razor knife, he comes with a bushel basket.
The central bank should be counter-cyclical but non-confiscatory.
A fantasy. They had already borrowed against everything they owned. They couldn’t borrow against it two or three times. Their only option was to exchange equity for capital at an extremely high cost. They chose bankruptcy.
There is disagreement over whether they were illiquid versus insolvent. But it still doesn’t matter, The Fed can take a loss.
It isn’t really a question of whether it could be saved or how it could be saved but why it should have been saved. Lehman could have had a rapid liquidation like Bear Stearns with the Fed absorbing losses, but that would just have set up the next to fail. The Fed needed to do much more but wanted the justification to do so; Lehman provided that justification. Afterwards they powered up all their lending facilities. They could have done so after Bear, they could have waited until it reached the commercial banks. The Fed feels it needs positive capital to operate and knew it could not depend on Congress to provide it short of a bankruptcy.
But the Fed can print money. Their job is to prevent monetary contagion (after not causing it in the firest place). If there was no panic then it doesn’t really matter. One-offs aren’t going to hurt the system or The Fed. If there was impending panic then I’m asking them to do nothing more or less than their job.
Overall, I still don’t see the 2008 Financial Crisis could have been avoided as it was 1983 – 2005 Reagan/Clinton Private Growth hit a wall. Additionally, this is a lot of heresy evidence which completely leaves out all the other players:
1) In September 2008, Lehman did not have good assets as collateral much like Bear Stearns.
2) Right behind Lehman was Merril Lynch and AIG who was probably the worst one of them all.
3) Throw in Fannie and Freddie one week before as well as lots national name
like Wachovia and WaMu will failing as well.
So, you dismissed Google: fed funds rate versus mortgage rates?
They cut rates near zero following the internet bubble. Mortgage rates fell. Then they slammed rates up and rates went up. This is incidental and/or coincidental and didn’t affect a mortgage boom/busy?
I wonder if, in addition to personality, a logistical reason for Paulson to take the lead was (1) he was retiring (to lobbyist) soon and (2) taking the blame preserves the appearance of propriety for The Fed and (3) safeguarded Bernanke.
A few points, from memory.
(1) The Fed did not just lend to Bear, it backstopped it. The Fed took the first tranche on losses to make the merger happen. The Fed exceeded its authority in doing so. In emergencies, it can lend freely, but that is different from directly absorbing losses. That is why the Fed had to get permission from Paulson, because it was making fiscal policy.
(2) It is not clear at all that Lehman was truly insolvent. Some of its assets had fallen in value because of the panic and fire sales, and asset price recovery was likely. The Fed could have have lent funds and taken a chance, and I wish it had.
(3) Bernanke and Paulson may have decided to sacrifice Lehman as the only way to get Congress to approve something like TARP. Until Lehman, Congress was willing to let the Fed do all the work. Paulson, formerly from Goldman Sachs, may have had personal reasons to see Lehman die.
(4) I think Bernanke and Paulson did not understand that the entire commercial paper market would collapse after a Lehman default, and take the money market mutual fund industry down with it. They had to catch up to the panic quickly. Commercial paper and money market funds shares are part of “money,” and we saw a monetary collapse.
(5) I am as distressed by the bailouts as anyone, but the time to fix bailout policy is during normal times, not in the middle of a panic. You don’t restructure the fire department in the middle of a wildfire. Bernanke is a monetary historian, and he seems not to have remembered the Fed’s blunder with the Bank of United States in 1931.
(6) I agree with John Taylor that the on-and-off inconsistent and incoherent bailout actions had a destabilizing impact.
(7) Finally, I will add that Dodd-Frank has done nothing useful to prevent a future panic, nor to prevent future bubbles. Dodd-Frank enshrines too big to fail. But the federal government is once again encouraging low downpayment mortgages.