In FED We Trust (41 page)

Few, if any, of them envied the task that Geithner had been given. The Fed had cut interest rates to zero. It had more than doubled the size of its balance sheet. It had rushed to the rescue of some of the nation’s largest financial institutions. It had done nearly everything it could, and now it was going to
be up to the new president — and his new Treasury secretary — to take charge of the battle to arrest the recession and repair the banking system before the Great Panic turned into another Great Depression.

A few weeks later, Bernanke reflected on the Bank of America rescue, the disintegration of one of the few things that had seemed to go well during one of the worst weeks of the Great Panic. “It was disheartening,” he said.

He looked back to the beginning of 2008. “We hoped by stabilizing Bear Stearns, and by stepping up our provision of liquidity to the financial system, that we would give the economy and the financial system time to try to find its feet,” he said. “And that seemed to be the case for about three or four months. We hoped that the injections of TARP capital in the fall would give the banking system the breathing space it needed. But then the economy and financial markets deteriorated sharply, and more banking problems continued to surface.”

Without prompting, Bernanke recited the criticism he took for rescuing Bear Stearns and then the criticism he took for not rescuing Lehman Brothers. “The people who were initially saying, ‘You should just let these guys fail’ have turned their complaint to, ‘Well, the government’s inconsistent responses have been a problem and have prevented recovery.’” He didn’t say to whom he was referring, but he didn’t have to: it was the argument that, among others, Richmond’s Jeff Lacker and Philadelphia’s Charles Plosser were making.

“My reply to that is twofold,” he said. “First, we did the best we could with the powers we had. Perfect consistency simply wasn’t possible given our limited powers and the differences in the various circumstances. If we had a clear legal framework for resolving big financial institutions other than banks, that would have been a different matter. We didn’t have one. Second, the dominant cause of the crisis was not what the Fed did or what other parts of the government did. It was the losses that followed the collapse of the credit boom. When losses pass $1 trillion and continue to rise, one can hardly expect anything other than a worsening situation.”

“It has to be fixed,” he said soberly. “It will not fix itself.”

M
ore than eighteen months after the Great Panic began, more than a year after Bear Stearns was rescued, more than six months after Lehman collapsed and AIG became a ward of the state, more than a hundred days into the Obama presidency, it was still not entirely clear that Ben Bernanke and his allies at the U.S. Treasury, Hank Paulson and then Tim Geithner, had succeeded at preventing what Bernanke called Depression 2.0.

Given all that the Fed and the rest of the government had done, this fact alone was stark testimony to the severity of the financial crisis that provoked what the International Monetary Fund declared to be “by far the deepest global recession since the Great Depression.” After all, the Bernanke Fed had not repeated the mistakes of the 1920s and 1930s; it had been neither passive nor stingy with credit. The Fed had decided to do
whatever it takes
. It had cut interest rates from 5.25 percent to 3 percent by the end of January 2008 and then to zero in December 2008, and promised to keep them there for a long time. It had force-fed more than $2 trillion of credit into the economy and promised as much as $1 trillion more lending for everything from cars to mortgages to the debt of the U.S. government itself. The Fed had begged Congress to spend $700 billion in taxpayer money to
rebuild the foundations of the banking system and leveraged that with hundreds of billions of Fed-created money. It had endorsed and welcomed the Obama-backed $787 billion package of tax cuts and spending increases to offset weak demand from consumers, companies, and overseas markets.

But history is a harsh judge. Fed officials and sympathetic academics frame the question reasonably, but narrowly: How well did Bernanke and his fellow Musketeers do, given the information and authority they had at the time? To nearly everyone else, outcomes matter, not intentions. It may someday be said, with substantial accuracy, that after some initial hesitation, Ben Bernanke and his team did all they could to defeat the Great Panic. But if the ultimate result is years of painfully slow economic growth and widespread unemployment, they will be judged by many Americans to have failed. Earning an A for effort is not enough. As Paulson put it a few months after leaving office: “We succeeded in keeping the financial system from collapse, but people were unhappy that we didn’t prevent a recession. It’s hard to get kudos for what didn’t happen.”

To be told that the Fed did what it could isn’t much comfort to a family who loses its house to foreclosure, a businessman forced into bankruptcy, a sixty-five-year-old whose retirement fund is devastated, a would-be borrower turned away by a beleaguered bank, a new college grad who can’t find a job, any job. For those victims and all the others, a final verdict on the Fed’s response to the Great Panic must await the health of the U.S. economy in 2010 and 2011 and beyond.

By early summer 2009, the economy still appeared to be in recession and the unemployment rate was still rising.

Tim Geithner was still trying to find his footing at the U.S. Treasury, demonstrating that years of whispering in the ear of the Treasury secretary doesn’t fully prepare anyone for assuming the role himself. It turned out looks do matter. Appearing younger than his forty-seven years, just two weeks younger than Obama, made it hard for Geithner to project wisdom and experience, and difficult for him to calm the fears of the people and the markets. His habit of answering questions in public as if he were giving a
deposition didn’t help. Geithner found himself ridiculed on
Saturday Night Live
, mocked on YouTube videos, lampooned in political cartoons. The
Indianapolis Stars
Gary Varvel showed Geithner as an airline pilot, poking his head through the cockpit door and telling alarmed passengers: “I’m Captain Geithner. We’re going to have to try things we’ve never tried before. We will make mistakes.” Mike Luckovich’s take in the
Atlanta Journal-Constitution
was a bit more sympathetic: “Now, girls,” Michelle Obama tells her daughters, “you know who’ll be in charge of cleaning up the new puppy’s messes, don’t you?” Their reply: “Yes, Mommy. Tim Geithner.”

Though Geithner’s headline-making mistakes on his tax returns didn’t block his confirmation by the Senate, they had lasting effects. They forced extraordinary scrutiny of every potential nominee for a Treasury job, disqualifying some able people with minor blemishes and leading to months of delay in staffing Treasury’s top ranks. AIG was a continuing nightmare. The retention bonuses it paid its executives stirred a massive political uproar, and the complexity of overseeing its business was a constant struggle. Given his initial role in the takeover of the firm and his current role as steward of taxpayers’ investment in the company, Geithner couldn’t escape the AIG cloud. Yet, in private, he exuded impressive calm and self-confidence, and, importantly, appeared to hold on to the president’s confidence.

Paulson, meanwhile, occupied a spacious, plain office at Johns Hopkins University’s School of Advanced International Studies, about a mile from the Treasury building. With hours and hours of help from his former Treasury staff, he was writing his own account of the Great Panic. He took silent satisfaction from watching Obama and his economic team, which had been so harshly critical of his strategy during the campaign, struggling to do better and, in many cases, relying on people he had hired and tactics he had adopted. Paulson had gained back some of the weight he lost during the most stressful weeks of the Great Panic. And he was, slowly, gaining perspective. Paulson remained grateful to Bernanke for consistently putting the country’s interests ahead of the Fed’s institutional interests, even though that sometimes made Bernanke appear weak or politically naive. Paulson was, still, an unabashed Geithner admirer. In a characteristic locker-room compliment, he said of Geithner: “I’ve been in the trenches with him. He can take a punch.”

At the New York Fed, Bill Dudley, the former Goldman Sachs economist who had run the New York Fed’s markets desk, was establishing himself as Geithner’s successor as president of the New York Fed. He was determined to do better than Geithner at explaining what the Fed was doing and why. To take his place on the markets desk, Dudley hired rising star Brian Sack, thirty-eight, an MIT-trained economist with long-standing ties to the Fed. As a Fed staff economist, Sack had worked closely with then-governor Bernanke before leaving to work for former Fed governor Larry Meyer’s consulting firm in 2004.

In fact, the only top-tier economic actor whose job title hadn’t changed was Bernanke himself. But Bernanke had changed in one very visible way. The man who arrived at the Fed determined to be the un-Greenspan was going beyond anything Greenspan ever did to raise his public profile and establish himself as the symbol and voice of the Fed. Bernanke was reaching beyond bond traders and financial journalists to the broader public. Shattering tradition, he spoke to the National Press Club and took questions from reporters. He went to Morehouse College and fielded questions on live TV from economics majors. And he went on CBS’s popular
60 Minutes
in what he described as a “chance to talk to America directly.”

The new Bernanke served both personal and institutional purposes.

Bernanke’s four-year term as Fed chairman expires January 31, 2010, and though he was reluctant to admit it, even privately, he hoped Obama would reappoint him for a second four years. That depended on much that was beyond Bernanke’s control: the health of the economy in late 2009 when the president would make a decision and the president’s opinion of Larry Summers, the smart but self-centered former Treasury secretary who was working in the White House and eyeing Bernanke’s chair. The more Bernanke is seen by the public as being calm, competent, and seasoned, the more likely that Obama will reappoint him. But if the economic news gets worse and Summers can maintain rapport with the president, the more likely that Obama will replace Bernanke with Summers. Bernanke insisted in April 2009 he wasn’t thinking about reappointment. That was the prudent if unconvincing thing to say. Instead, he said, he was focused on “the best possible outcome for the U.S. economy. Everything I do is with that in mind.”

Bernanke’s institutional purposes were twofold. The Fed and the Treasury
had not succeeded in building public and investor confidence in their efforts to restart the economy, to reignite securitization markets where consumer and business loans were traded, and to shore up the banks so they could and would lend more. Bernanke easily dismissed some of the criticism, particularly attacks from those who hadn’t been on the battlefield when he’d had to make instant decisions about Bear Stearns, Lehman Brothers, and AIG. But even sophisticated people were having trouble deducing a game plan from the Fed’s and the Treasury’s actions and the proliferation of acronym-labeled initiatives. Bernanke knew that if business executives, consumers, and investors around the world were confused, they would hesitate in ways that diluted the Fed’s efforts. His 1979 Ph.D. dissertation at MIT, after all, had argued that “increased uncertainty provides an incentive to defer investments in order to wait for new information.”

“I think it is important for the public to understand what is going on and to know that the government is trying to solve the problem,” he explained later. “They should know we have a plan and we have a strategy.”

But that wasn’t the whole story. The Fed’s aggressive response to the Great Panic had called unwelcome attention to its enormous power and to its capacity to act as the fourth branch of government. Its willingness to come up with money for Bear Stearns and AIG when the Treasury and the president couldn’t and its ability to create trillions of dollars in credit surprised many members of Congress. The Fed, it was increasingly clear, could and would act when the political system was frozen. Even in the face of strong political resistance to more taxpayer money to rebuild the banking system, Bernanke demonstrated that the Fed was neither paralyzed nor out of ammunition: he pressed the FOMC, the committee of Fed governors and regional Fed bank presidents, to increase the cap on Fed purchases of mortgage-backed securities from $500 billion to $1.25 trillion and, for the first time in the Great Panic, to okay the purchase of $300 billion of longer-term Treasury debt securities.

Buying Treasury bonds was a step that Bernanke had resisted earlier, but circumstances had changed. The economy and banking system were still struggling. The Treasury’s huge borrowing was beginning to push up interest rates on long-term Treasury debt, a development that the Fed found unwelcome because those rates filter through to corporate and consumer
borrowing rates. And Congress was hardly rushing to offer assistance. Instead, it was putting conditions on Fed and Treasury aid to banks that Bernanke and Geithner feared would be counterproductive, and showing no interest in approving more money. As Bernanke told the
60 Minutes
interviewer: “The biggest risk is that we don’t have the political will, that we don’t have the commitment to solve this problem, and that we let it just continue. In which case, we can’t count on recovery.” Buying enough Treasury debt to finance two months’ worth of the federal government’s budget deficit at that point showed that the Fed could still act when politicians wouldn’t.