The Alchemists: Three Central Bankers and a World on Fire (23 page)

Paul’s name for his legislation was particularly inspired: “Audit the Fed.” After all, every corporation gets audited; any institution of the Fed’s size should be held to such routine accountability. In fact, on financial matters the Fed was already audited, with an independent inspector general in house, oversight by Congress’s investigative arm, and reserve bank audits carried out by the same major accounting companies that audit every major corporation in America.

Paul wanted something more than the prevention of fraud and theft, though: He wanted Congress to be able to stick its nose into the decisions the Fed made on interest rate policies, foreign currency swaps, and emergency lending to banks. To Fed officials, Paul was asking for a tool with which Congress could bring political influence to bear on monetary policy. It’s one thing to make an unpopular move knowing you’ll have to explain yourself in a congressional hearing a few months later, quite another to know that investigators will soon subpoena every document that was created in the course of reaching that decision. To Paul, Audit the Fed was just a way to add a bit more democracy to an antidemocratic body.

Three hundred twenty of 435 representatives—nearly three quarters of the House—eventually signed on as cosponsors of the Federal Reserve Transparency Act. Vermont’s Bernie Sanders, the lone socialist in the U.S. Congress, took up the cause in the Senate, and by the spring of 2009 the effort to audit the Fed was picking up momentum.

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W
ith the Fed under attack, the man at its helm was called to become a politician himself. It wasn’t a natural fit.

Ben Bernanke wasn’t born to be a Washington operator. He had little inclination—or skill—for glad-handing and backslapping. Unlike Greenspan, who frequented the Georgetown social circuit with his wife, NBC newscaster Andrea Mitchell, Bernanke preferred a quiet evening at home with his Kindle or a trip to the theater with his wife. Bernanke took the Fed chairmanship hoping to add greater anonymity to the role—to be less the all-powerful deity that Greenspan sometimes seemed, more the quiet functionary.

The financial crisis ruled out that possibility. In a crisis, people want someone to step up and be in charge, and Bernanke did exactly that. But his newness to Washington and discomfort with the trappings of power were obvious, particularly early on. When dealing with members of Congress, Bernanke simply acted like himself, addressing questions as forthrightly as the confines of his office would allow, explaining economics and the Fed’s decisions with the same simple language he once used to teach Princeton undergraduates. Before a congressional hearing, he would sit for “murder boards”—prehearing sessions lasting hours during which advisers fired off questions on the full range of subjects he might encounter, occasionally imitating the style of one of the more distinctive members of Congress. He developed a style of detached reserve that was effective in sometimes hostile hearings, responding calmly and deliberately even when his questioner was in a blind rage. Only on the rarest of occasions did he become testy or combative himself. But for the legislative battle in the offing, mere politeness wouldn’t be enough.

The Fed wasn’t set up for a legislative war. Its legislative affairs office comprised only five people—compared with about three thousand lobbyists employed by the financial industry as a whole—and the Fed did not play the hardball game of using press leaks and veiled threats to get its way on Capitol Hill. The Fed style was more to state its case as directly and repetitively as it needed to and hope that its technical competence and straightforward arguments would win the day. In preparation for political combat, in the summer of 2009 Bernanke hired a new chief lobbyist, Clinton treasury department veteran Linda Robertson. He also paid particular attention to maintaining a personal touch with key lawmakers. When Tennessee senator Bob Corker wanted to personally review hundreds of pages of confidential documents about the Fed’s bailout of AIG, Bernanke welcomed him to the Fed’s headquarters, joined him for breakfast, and prepared a room in which Corker could comfortably spend hour upon hour going through pages.

Bernanke readily admitted that the Fed had made mistakes, in particular not using its regulatory powers to reduce bad mortgage lending and otherwise protect consumers in the years just before the crisis. He agreed that the bailout actions the Fed had taken during the crisis were unpalatable, even as he defended them as having been absolutely necessary to prevent an even worse economic situation. But he viewed the approaches being dreamed up by Dodd and Shelby as potentially disastrous. He’d seen how other bank regulators, in the run-up to the crisis and then during it, had suffered from tunnel vision, focusing on the individual banks they regulated rather than thinking about more important economic interconnections.

“
Mr. Chairman, I understand your objectives here
—but I do believe it’s a very, very serious matter to take the Fed essentially out of financial-stability management,” Bernanke told Dodd in one hearing. “I do think that taking the Federal Reserve out of active bank supervision would be a mistake for the country.”

But with the politics of the moment what they were, Bernanke and the Fed seemed ready to lose big. “
If the Fed were running for reelection
,” a congressional aide told the
Washington Post,
“it would go home to spend more time with its family.”

Bernanke wasn’t the only one opposed to Dodd’s plan to use Fed bashing as a means to financial reform. Geithner viewed the Federal Reserve as key to making the financial system less prone to crises than it had been in the past. In his view, whatever the mistakes of the preceding years, the Fed had been nimble in addressing the crisis while other financial regulators had been sluggish. Its people were smarter, and its abilities to print money and serve as lender of last resort provided the ultimate backstops to economic disaster. He saw a stronger Fed as a fundamental goal of financial reform and brought in two Fed staffers as detailees to the Treasury Department to help make his case.

On May 19, 2009, the treasury secretary brought the Democratic senators from the Banking Committee, along with key staffers who would be drafting financial reform legislation, to breakfast in a dining room on the second floor of the Treasury Department. Over coffee and eggs, Geithner laid down his three nonnegotiable goals: First, the Federal Reserve must keep the authority to oversee any bank big enough to bring down the financial system if it failed—$50 billion in assets was the number he had in mind. “If that were not the case,” Geithner told his fellow Democrats, pointing to the White House next door, “I would recommend that the president veto this bill.” Second, the government must retain the power to offer an emergency backstop of the banking system, which had proved crucial during the crisis. Third, the treasury secretary, rather than the appointee to a newly created job, must be put in charge of a new council of regulators meant to identify risks in the financial system and designate which firms needed an extra measure of oversight from the Fed.

Of course, the banks themselves had a few ideas about who ought to regulate them. From giants like J.P. Morgan and Citigroup to tiny, state-chartered institutions with a single branch, the banks wanted to stay under the purview of the Fed. “The Fed examiners always came in as bankers and understood the banker’s experience of risk,” said Camden R. Fine, president of the Independent Community Bankers of America. “Each regulator has its own cultural bias, and the Fed’s bias is, ‘We’re a bank, too.’” Dodd’s idea of some unknown new über-regulator alarmed the banks.

The giant banks were politically toxic in the wake of the Wall Street bailout, so they had to approach Congress carefully. If they advertised their position too loudly, it could be counterproductive. But they had Geithner making their case forcefully—even threatening a presidential veto. The thousands of smaller banks were on their own, with Geithner willing to take them out from under the Fed umbrella, if that’s what was needed for a deal. But that didn’t mean they were powerless. One of the best tools for gaining influence in Washington is simple geography: The more members of Congress view you as representing their hometown interests, the more they’ll fight for you. There’s an old joke about the perfect military aircraft having parts made in all 435 congressional districts, to ensure it will never be defunded.

America’s small banks are the closest real thing to that mythical aircraft. In every town across the country there are community banks. Their executives and boards of directors tend to be pillar-of-the-community types—the ones who fund local charities and, especially, give money to congressional campaigns. That made the Independent Community Bankers of America—with its five thousand members operating twenty-three thousand bank branches and controlling $1 trillion in assets—a formidable lobbying power in Washington.

In meetings with Barney Frank and Dodd’s senior staffers, Fine made an offer: The community bankers could never actively support legislation that would increase bank regulation. But so long as Congress left his members alone—and left the Fed in place as their regulator—they wouldn’t try to fight the financial reform bill. “I told them we would come out swinging against Dodd’s bill if it included a single regulator,” said Fine. “They threatened to gut the Fed, and I told them they’d have a hell of a fight.”

There was another group with plenty to lose if the responsibility for regulating banks across the United States was taken away from the Fed. For the far-flung reserve banks that comprise the Federal Reserve system, the approach that Dodd’s staff was developing was something approaching an existential threat. Fed officials in cities like Kansas City and Dallas and Philadelphia had been out of the loop as officials in Washington and New York made their series of bailout decisions. The presidents of the other reserve banks had high regard for Bernanke personally; more so than Greenspan, they believed, he respected them, engaged with them, and listened to their thoughts and concerns. But many of them also felt that the Bernanke Fed had taken actions that endangered the credibility of the whole institution without informing many of its component parts.

Some of the crisis-era decisions had been made in such a hurry that, aside from New York, the reserve banks didn’t even find out about them until they were announced publicly. At least one reserve bank president had been reduced to dialing in to one of the briefing calls that the Fed conducted for journalists to learn about the latest decision by his colleagues in Washington.

Perhaps the closest ally in the Federal Reserve System for the country’s smaller banks was Thomas M. Hoenig, president of the Kansas City Fed since 1991. A veteran of supervising banks, he had been manning the discount-window desk when an Oklahoma bank called Penn Square failed in 1982, in turn causing the failure of Continental Illinois National Bank and Trust, the biggest in U.S. history until the 2008 crisis.

Hoenig loathed the too-big-to-fail banks, which he saw as benefiting from a public safety net that the smaller banks lacked. He also saw the ultra-low-interest-rate policies embraced by Bernanke as a major cause of the financial crisis. And from attending events around his Federal Reserve district, which encompasses parts of seven states in the center of the nation and contains no giant banks but hundreds of smaller ones, Hoenig had picked up early on the depth of public rage at the Fed. At one luncheon in Santa Fe, New Mexico, he gave a speech and then opened up the room for questions. “It was the most hostile crowd I’ve ever seen,” he said later. “People were
angry.
”

Even though the regional reserve banks had nothing to do with the Wall Street bailouts, they had the most to lose if anti-Fed sentiment led to stripping the institution of its oversight power. Regulating banks was what Federal Reserve branches spent most of their days doing. Without that responsibility, they would have little to do besides the nuts-and-bolts work of providing cash to commercial banks in their districts. The reserve bank presidents always couched their arguments in terms of what was best for the financial system overall, but the politically savvy could see that the presidents had a great deal at risk.

The Fed’s point man on bank regulation in Washington was Daniel Tarullo, an acerbic law professor appointed to the Fed Board of Governors by Obama. If Hoenig’s world was one of small-town banks lending to their local farmers and factory owners, Tarullo’s was one of trips to Basel to negotiate capital standards for the likes of Goldman Sachs. Hoenig feared that Tarullo and the Board of Governors would happily throw the smaller banks overboard if that was what it took to keep oversight of the giant banks. “I got the sense that they weren’t going to interfere, but also that this wasn’t their issue,” said Hoenig, referring to his colleagues in Washington. “Everyone is influenced by their environment, and theirs is international and Wall Street, so that’s where their focus is.” Hoenig and a handful of the other reserve bank presidents were eager to make their way to Washington to make sure Bernanke, Geithner, and Tarullo didn’t sell them down the river in order to strike a deal with Dodd.

The forces fighting on behalf of the Fed amounted to a powerful set of interests, though not all precisely aligned: Bernanke and his colleagues at the Fed Board of Governors; Geithner and the Obama administration; the private banks large and small; and the reserve banks around the country with their own business and political connections. The question, entering the financial reform debate in 2009, is whether that would be enough to conquer the deep-seated animosity to an institution that was so deeply unpopular on Capitol Hill.

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W
hen President Obama took office in early 2009, the conventional wisdom was that Bernanke would be a one-term Fed chair. Not only had he failed to prevent the worst recession in modern times, but he was a Republican working in a Democrat-led Washington. There was frustration among Democrats that Republican appointees had held the Fed chairmanship continuously since 1987, and there was even an obvious Democratic candidate for the job.