The Alchemists: Three Central Bankers and a World on Fire (20 page)

The program lent out $24 billion on its first day of operation, September 22, 2008, and $217 billion before the panic wound down, routing money through banks like State Street and J.P. Morgan Chase to mutual funds run by household-name companies such as Janus and Oppenheimer. To satisfy the Fed’s lawyers, the program could accept commercial paper backed only by specific assets, such as credit card loans due. But with a buyer in the market for even just a subset of the securities they owned, the money market funds could raise enough money to avoid breaking the buck.

It took a little longer to come up with the next mode of attack. The Commercial Paper Funding Facility, announced on October 7, focused on the other side of the same problem, the difficulty companies were having selling their commercial paper, due in large part to the money market funds not being available as a buyer. With the CPFF, the Fed used its 13(3) authority to lend money in “unusual and exigent circumstances” to fund a “special purpose vehicle” (SPV) that purchased commercial paper from eligible issuers. Participants in the program could sell to the SPV only after paying a fee of 0.1 percent of their total commercial paper balance—a requirement designed to provide the Fed some measure of protection. If some of the borrowers defaulted, the theory went, any losses would be covered by those fees—in other words, by the companies that took part in the program, not taxpayers.

Before it was all over, in early 2010, some $738 billion in commercial paper had been purchased from affiliates of eighty-two different companies. Big banks, both domestic and foreign, were on the list. So were some of the mainstays of the U.S. corporate sector. Verizon used the program on two successive days in late October 2008, borrowing a combined $1.5 billion. The finance arm of Harley-Davidson turned to the CPFF thirty-three times for a combined $2.3 billion, helping ensure it could continue making loans to potential buyers of its motorcycles. The major American auto firms’ finance arms—Ford Credit, GMAC, Chrysler Financial Services—all took part in the program. So did General Electric. Golden Funding Corp., which lends to McDonald’s franchisees so they can build or renovate their restaurants, turned to the CPFF eight times for a total of $203 million, helping ensure the continued availability of Big Macs across the land.

In the Rooseveltian spirit of experimentation, the Fed created so many emergency lending facilities that a document just listing and summarizing them required a legal-sized piece of paper covered in small type. There was even a complex program called the Money Market Investor Funding Facility, announced on October 21, that never lent a single dime. The MMIFF aimed to create another place where the money market funds could dump their holdings—but Fed staff couldn’t figure out how to make the program attractive to participants while also protecting taxpayers against losses, an ongoing problem in emergency lending.

At the time, commentators often asked: Where’s the money going? Exactly who’s borrowing from the Fed? The answers, revealed by information made available only much later, turned out to be everywhere—and everyone. Wrote
Time
magazine, in naming him its “Person of the Year,” Bernanke “
conjured up trillions of new dollars
and blasted them into the economy; . . . lent to mutual funds, hedge funds, foreign banks, investment banks, manufacturers, insurers and other borrowers who had never dreamed of receiving Fed cash; jump-started stalled credit markets in everything from car loans to corporate paper; . . . and generally transformed the staid arena of central banking into a stage for desperate improvisation.”

No wonder his eyes look tired.

The shock of the Lehman failure quickly spread across the Atlantic. The thing that European banks had feared since August 2007—that another major bank might have such grave losses on its books that lending money to it would be dangerous—had happened. If Lehman Brothers could go belly up, couldn’t any big bank? And that being the case, why would a banker willingly lend dollars to one of his competitors for interest rates of only a couple percent? As had been the case in late 2007, dollars were in particularly short supply, a problem for banks that might be headquartered in Frankfurt or Zurich or Paris but had vast quantities of dollar loans on their balance sheets.

The lending rate between banks, which typically wouldn’t have been higher than the 2 percent target the Fed then had in place, soared to over 5 percent in the weeks after the Lehman bankruptcy. That’s a misleading number, though: It really reflects a market that had shut down, with lots of entities out there hoping to borrow dollars but no one willing to lend. Interbank lending just wasn’t happening. As a result, even banks that could easily weather direct losses from money they were owed by Lehman found themselves unable to get the cash they needed to meet their daily obligations. Due to the unusual status of the dollar as the closest thing there is to a global currency, there was a worldwide shortage of dollars that threatened to bring down the entire global economy.

“This is clearly outside the textbook case of a financial crisis,” said Stefan Ingves, governor of Sweden’s central bank, the Riksbank. “We couldn’t just create our own currency to lend to the banks. We can’t produce dollars, and we can’t produce euros.”

The panic quickly trickled down to the retail level, particularly in countries that had unreliable systems for the government insurance of deposits. Ordinary depositors, seeing a major global institution go down and the financial markets gyrate, started pulling their money out of banks far from Lehman’s Manhattan headquarters. Officials were reduced to public pleas to their citizens: “
Irish bank deposits are not in any danger
,” announced Brian Lenihan, the Irish finance minister, on September 19. “People should not be going to their banks and making withdrawals on the basis of unfounded suggestions voiced on radio programs.”

Conference calls among the world’s central banks picked up as they worked through ways they might collectively address the burgeoning crisis. The banks’ markets chiefs—Bill Dudley of the New York Fed, Francesco Papadia at the ECB, and a half dozen counterparts around the globe—worked together to expand the strategy they had first deployed nine months earlier to address the milder form of panic spreading at that time. The calls usually happened early in the morning New York time, when it wasn’t the middle of the night in London, Frankfurt, or Tokyo. They were usually led by Dudley. After all, the central problem was a shortage of dollars—so the one institution in the world with the capability of creating dollars was in the driver’s seat.

The bankers were looking for ways not merely to deal with the panic roiling the financial system, but also to handle, in Geithner’s terminology, the “theater” correctly. Apart from the substance of what they might do, they reasoned, the simple fact that all the world’s central banks were acting in concert might help boost confidence. A German bank would be more inclined to lend dollars to a Swiss bank if it could be confident the Swiss bank wasn’t going to find itself short of cash when it was time to pay the money back. “Making it known that we were getting the fire engines rolling was almost as important as what the engines would do once they arrived at the scene,” said one American official.

Unlike the earlier phase of the crisis, when Mervyn King and the Bank of England were reluctant partners in the crisis-fighting efforts, this time everyone was on the same page. At 3 a.m. New York time on September 18, four days after the Lehman failure, the fire engines cranked up their sirens. At the end of 2007, the Fed had announced a combined $24 billion in swap lines with the ECB, Bank of England, Bank of Canada, and Swiss National Bank. Now, according to an announcement made in time to beat the opening of European markets, that amount would be enlarged by $180 billion. Six days later, again with a middle-of-the-night announcement, the Fed added to the program another $30 billion and another four central banks—those of Australia, Denmark, Norway, and Sweden.

It was the basic strategy of late 2007 blown out: More dollars were pumped into the banking system, in more different countries, on easier terms. There were legal guarantees to make sure American taxpayers wouldn’t lose money on the deal, but the real assurance came not from anything written on paper but from the bonds of trust established in years of talks in Basel and elsewhere. It was unfathomable, Bernanke and his colleagues believed, that their counterparts across national borders would ever try to renege.

When members of Congress asked about the swaps, Bernanke emphasized that the European banks benefiting from the program also made loans in the United States, so the action could be seen as benefiting the U.S. economy directly. But more fundamentally, he was convinced that the world financial system was so deeply interconnected that Europe’s fortunes were the United States’ fortunes too. “In a way,” a European central banker said later, “we became the thirteenth Federal Reserve district.”

By December 10, foreign central banks had borrowed $580 billion of Fed money—a quarter of the U.S. central bank’s total assets.
The Fed also pumped dollars into individual foreign banks
that had U.S. subsidiaries: at peak levels, $85 billion for the Royal Bank of Scotland, $77 billion for Switzerland’s UBS, $66 billion for Deutsche Bank, $65 billion for the UK’s Barclays, $59 billion for Belgium’s Dexia, and $22 billion for Japan’s Norinchukin. The scale of lending to foreign banks, revealed more than two years later only after congressional legislation and a Freedom of Information Act lawsuit that the banking industry appealed to the Supreme Court, was a closely guarded secret even by the standards of the always secretive Fed. Normally, dozens of people within the Federal Reserve System would have been privy to data about which banks were borrowing money. During the panic, this information was so closely held—and, had it been known publicly, so potentially explosive—that only two people at each of the dozen reserve banks were allowed access to it.

Beginning in October, a new round of supplicants came calling. In formal letters to Bernanke, in whispered asides to his deputies in the hallways in Basel, several of the world’s developing nations made a request: Help us out. As late as March 2009, when Fed governor Kevin Warsh was representing the central bank at a meeting of the finance ministers of the Group of 20 economic powers in Horsham, England, emissaries from one after another of the world’s emerging nations tried to buttonhole him in the hallway to make their pleas for help.

Banks in these economies were facing the same shortage of dollars as their counterparts in wealthier neighbors. Behind closed doors, this became the subject of a thorny new debate. The Fed didn’t have the same intimate, long-standing relationships with the Central Bank of Brazil or the Bank of Mexico that it did with the Bank of England or the Bank of Canada. And there had already been rumblings of concern among some of the reserve bank presidents that the lending of dollars across international borders amounts to fiscal, not monetary, policy. The Richmond Fed in particular had a long tradition of dissenting from any type of swap arrangement for that very reason; its president, Jeffrey Lacker, often clashed with the New York Fed’s Tim Geithner on that and many other issues.

But most important, sending money to poorer countries with less stable political systems would be a greater risk. So Bernanke and his colleagues came up with criteria for safely expanding Fed swap lines: The country had to want access to them. (China and India weren’t particularly interested.) The country had to be a significant player in the world economy or a significant financial center, so that Bernanke could justify the assistance to Congress as being in the interest of the U.S. economy. (Brazil, Mexico, South Korea, and Singapore qualified; Peru didn’t.) The country had to have a central bank that was viewed as politically independent and trustworthy. (Russia, for example, would have been ruled out.) On October 29, 2008, came an announcement: “Today, the Federal Reserve, the Banco Central do Brasil, the Banco de Mexico, the Bank of Korea, and the Monetary Authority of Singapore are announcing the establishment of temporary reciprocal currency arrangements.”

Since its founding, the Federal Reserve had been the lender of last resort for the United States. In late 2008, Ben Bernanke’s Fed became the lender of last resort to much of the world.

•   •   •

O
n the evening of Wednesday, September 17, just a day after making the decision to bail out AIG, Bernanke and his staff gathered in his office overlooking the National Mall. The Fed chief had decided it was time to make clear to Paulson that the central bank could no longer bail out individual insolvent firms. It was one thing for the Fed to support illiquid firms or markets, where disruptions were caused by fear rather than balance-sheet facts. It was another for it to support insolvent institutions, a job for Congress and the administration. Bernanke told Paulson in a phone call that he thought they needed to go to Congress to ask for a rescue package. The next morning, Bernanke was prepared to make the same point more emphatically in another call, but Paulson cut him off: The treasury secretary had reached the same conclusion.

That afternoon, the two men met with President George W. Bush at the White House. With his blessing, they then traveled to Capitol Hill to speak with the leaders of Congress. In an ominous meeting in House Speaker Nancy Pelosi’s conference room, they warned congressional leaders that the entire financial system was on the verge of implosion, and that the consequences for the U.S. economy—not yet obvious at that early date—could be disastrous. “It is a matter of days,” Bernanke told the lawmakers, “before there is a meltdown in the global financial system.” Congress needed to enact massive legislation to allow the Treasury the latitude to address the problem—and fast.

That day, and in a series of difficult congressional hearings that followed, Bernanke stood by Paulson’s side, explaining and advocating what would become the $700 billion Troubled Asset Relief Program. His vigorous support was essential. Paulson, a former Goldman Sachs executive, had plenty of intensity, but he also had trouble explaining complex economic concepts to nonspecialists. Reporters covering his hearings often joked about the difficulty of quoting him because of the way his sentences circled back on themselves in an unintelligible mess. (“What we are seeking to address with this,” Paulson said in a September 23 Senate Banking Committee hearing, “is we are seeking to address—first of all, we’re dealing with complicated securities, mortgage and mortgage-related, and we’ve got various asset classes here, and we need different approaches for different asset classes. But when we use the market mechanisms, we want—we’re looking at thousands, you know, of institutions, because to make this run properly, we need to deal with big banks, small banks, S&Ls, credit unions, because what we’re trying to do here, and I think we’ll be successful, is to develop mechanisms where we—where we get values out there, where there’s some value that the market can look at.”)