Appreciation: Wessel on Bernanke

There's a delicious moment of unintended hilarity in the midst of In Fed We Trust, David Wessel's absorbing account of life at the epicenter of the non-meltdown last fall---together with a cautionary moral. The subject is Sheila Bair. Recall that Bair is the "strong-willed" Wessell's phrase and somewhat fortuitous (by Wessell's account) chairman of the Federal Deposit Insurance Commission.

Coming from Mars, you might expect to find the FDIC in charge of any effort to deal with banks in crisis. After all it is the FDIC that nationalizes liquidates failing banks. They are the guys in polyester who swoop in on a Friday night and open the doors next Monday morning after a transfer which one hopes will prove entirely invisible to the attending public. And pretty good at it, too: by my count, they've done their schtick 81 times so far this year.

Bank regulation has long proven way more complicated than that, and Wessel provides a thrilling account of how Ben Bernanke, et al., by a mix of bluff, guile and improvisation tortured the statute books and the bank ledgers in their campaign to fend off Armageddon.

Until they needed Bair's consent, and Bair said "no." By Wessel's account, this happened more than once, and evidently it made some of the salvationists just crazy. You get the impression that she put the whole operation at risk by stubbornly (my word) refusing to extend FDIC protection beyond a fairly restrictive letter of the law. Evidently she just didn't understand, Wessel seems to suggest, just how narrow-minded and obstructionist her concerns had come to be, and how much she put at risk by her skepticism and hesitation.

Okay, let's grant that from other accounts we can affirm that Bair was something of a loose cannon in the bailout operation and wasn't afraid of bandying about her power to make known her views. But there is a perfectly obvious (though invisible to Wessel) reason why she proved so obstructionist. That is: they treated her like a girl. Unintentionally but unambiguously, Wessel makes it clear that the pooh-bahs at Treasury and the Fed scarcely gave a thought to Bair's role in the great enterprise until they needed her signature or he bankroll. Even then, they seem to have perceived her as more or less of a speed bump and couldn't understand why she didn't just flatten when they rolled over.

In fairness, the real problem here doesn't seem to be Bernanke himself, who comes across in Wessel's account as one of the least ego-driven politicians alive: Wessel says that early in the crisis Bernanke "courted" (Wessel's word) Bair, "once going to her office and sitting next to her to a computer keyboard to fashion a compromise" (wouldn't you like to see Alan Greenspan do that, huh?). But Wessel says that later Bernanke and Treasury Secretary Hank Paulson and New York Fed Chairman (later Paulson's successor)Tim Geithner all came to see her as "stubborn and myopic." Tellingly, he says they also came to envy "the political agility that made her a hero on Capitol Hill."

Okay folks, time for the moral. In two words, "Stockholm Syndrom"--Wessel is just way too close to his story. He'a a diligent reporter with a pretty good knack for untangling abstruse money maneuvers, and a delicate touch for nuance as he tries to understand at least some of the personal issues involved. But his critical detachment is just about zero. So what we get here is the Bernanke version, told not with any insidious ulterior motive, but in a straightforward manner by a serious reporter who simply believes that Bernanke and his allies were right.

The Bair example is dramatic and amusing, but it is not the most important. Of much greater urgency: Wessel simply takes it for granted that Bernanke was essentially right: save us all from drowning by turning on all the spigots. Now, as a matter of fact, I tend to think Bernanke was right. But how can I know? More, how can anyone know? How do you test the rightness of a decision like this, when you can never have anything even remotely like a counterfactual?

Wessel gives you none of this. And while this kind of critical inquiry might be a lot to expect from a piece of quasi-journalism, still there were ways of approaching the issue. Specifically, as Wessel does have the courtesy to note, there are plenty of people who thought that Bernanke's strategy was fundamentally wrong. I mean in particular the several other Fed officials who voiced doubts and reservations (albeit almost always out of earshot from the daily press). Or John B.Taylor from Stanford who has positioned himself as the loudest nay-sayer in recent monetary debates (and who does get passing mention in Wessel's account). I'm pretty sure any one or more of them would have been happy to take some time on the record with Wessel to add dimension the main line of the narrative.

A related problem may be book-structual at least as much as (or more than) Stockholm Syndrome. That is the focus on Bernanke and the Fed. Bernanke certainly is a central figure--perhaps the central figure. But just about every page of Wessel's book makes clear that the rescue effort was a full court press, involving not just Bernanke but also Paulson and Geithner and others. The trouble with the focus on Bernanke is that he leaves Wessel unable to spell out the relationship between the three players. Certainly they understood the importance of cooperative/coordinated effort. But did they truly think alike? This ias implausible. A better and more thorough book would have spent more time trying to suss out the relationship between them.

But a better and more thorough book probably couldn't have been ready for publication so soon after the events it chronicles, not even (or especially not) if it was written a beat reporter whose objective was to grind out a good piece of second-generation journalism. That's a limitation, but granting the limitation, I'd say that Wessel has done quite a good job. I wouldn't be surprised but the authors of later and more leisured accounts will be peeking at their copies of Wessel's before they undertake to write their own.

The Paulson Catalog

This will be everywhere this morning but I might as well join the fray--James Pethokoukis (channeling Ed Yardeni) on "The 11 Blunders of Hank Paulson" (link):

Strategist Ed Yardeni says that "everything that [Hank] Paulson has done or endorsed has worsened the credit crisis and sent stocks reeling." Like what, for instance? Like these, and I quote:

(1) Paulson's Super-SIV proposal was a distraction that went nowhere. It was the first clue that he likes half-backed schemes that are hard to implement.

(2) The vaunted "Teaser Freezer" hasn't worked. Neither has the Hope Now Alliance. Indeed, many borrowers who've been foreclosed never even heard about these new outreach programs to keep them in their homes.

(3) Letting investment banks borrow from the Fed's discount window just after Bear Stearns failed suggests that letting the firm go was done as a risky gesture to the principle of avoiding moral hazard, which has subsequently been thrown out the window.

(4) The government's unwillingness to provide transparent rescue plans started with the mysterious $29bn Bear Stearns portfolio acquired by the Fed.

(5) After multiple assurances that Fannie and Freddie were solvent, they were seized and put into conservatorship. Stiffing owners of their preferreds opened an estimated $25bn black hole in the capital of regional banks that owned these securities. It also seized up the one market that financial firms had for raising capital.

(6) Refusing to support the suspension of mark-to-market accounting was Paulson's second biggest mistake.

(7) His biggest mistake was letting Lehman go under. Dick Fuld should have been forced out, and Lehman should have been rescued. A guy who ran GS and all the MS advisors around him should have known that letting Lehman go under would blow up money market funds and the commercial paper market. It also blew up the prime brokerage business and massacred the hedge fund industry, which sent stock prices into a free fall.

(8) When AIG was seized, the terms of the government's rescue package were punitive. They've been recently eased, but the firm can't raise funds by selling only 49% of its various non-core assets, as required by its "bailout" deal.

(9) TARP was a really bad idea that was sold to Congress and the public by inciting a panic, and sending the global economy into a tailspin. Claiming that the Treasury could purchase one-of-a-kind troubled assets in reverse auctions made no sense. The RTC solution to the S&L crisis of the early 1990s won't work to end this crisis.

(10) The Capital Purchase Program of TARP, started on October 14, is providing capital to banks that probably should be forced to fail and to those that don't even need it. Hopefully, Congress won't give the second $350bn installment of TARP to the Treasury.

(11) Paulson has been aiming to kill "bad" hedge funds. The result of his disjointed fixes has been a massacre of innocent bystanders, including long-only investors getting killed in all the stocks that hedge funds are being forced to sell.

My take: I think Paulson's credibility with the financial markets has been exhausted. Now I am not sure what the magic solution was. Maybe some recapitalization of key players plus an Uncle Sam-led home refinancing plan. Or maybe a) suspending mark to market, b) a zero capital gains tax for the next five years, and a corporate income tax holiday. But I will give this to Paulson: He does strike me as a guy who is working himself near death to deal with an amazingly tough problem.

Comment: Some of these are above my paygrade, and not all are of equal dignity. Most important, surely: (9) and (4). I don't agree with (6) although maybe some tinkering with mark-to-market would be possible, and useful. The real point, though, is that the list is so long. As (I believe) John Stewart so wisely put it, we have the impression that Paulson is "flailing wildly at the keyboard." Oddly enough, the focus appears to fall entirely on Paulson. I should think we would give equal billing to the man who is supposed to know more than anyone else in the world about financial crisis--Fed Chairman Ben Bernanke.

Matt Yglesias and the Great Depantsing

Matt Yglesias has an uncharacteristically (for Matt) unsophisticated post up about the mortgage meltdown and the practice of banking (link). Matt puzzles over why the mortgage meltdown is creating such a pervasive problem. He discovers that the mortgage enterprises are, in some sense, like banks, and finds this insight, on the whole, comforting.

For most non-economist commentators, this probably draws a passing grade. But you might have expected ominicompetent Matt to realize that (a) there is no good, workable definition of what is a bank; and (b) correspondingly, everything is a bank, actually or potentially.

What’s a bank? The conventional old-style definition is that a bank is an entity that (a) takes deposits and (b) makes loans. Fair enough, but consider a life insurance company. It “takes deposits,” in the sense that we leave money on account with it for years at a time. It “makes loans,” in the sense that it tries to turn a profit with the money on account. And you could say that anyone “makes a loan” any time he extends credit. I read somewhere that Toyota isn’t a car company, it’s just a bank that happens to sell cars. At first blush, I assumed the quip meant only that Toyota was so choked with money it had to cook up ways in which to invest it. On second blush, it sank in on me that for Toyota—indeed for any car company, maybe for any big-ticket inventory seller—the installment credit side of the business may come to dominate, leaving the “inventory” side as some kind of a loss leader.

This is the kind of pitch banks make when they argue that they play on an unfair playing field—they are constrained by regulation, but others are not.

I’ve got a lot of sympathy with this argument, but there is an unsettling mirror image. That is: at the end of the day, still banks really are different from any other kind of enterprise. Banks are party of a system that runs on trust, and once trust ends, the whole system unravels. So banking is the only system in which one does not gain from the failure of one’s competitor. I’ve heard people describe it as the situation you get in a rugby scrum when somebody loses his pants: all the players mill around and make a racket while the unfortunate recovers his dignity. Then they give high fives all round and charge off again down field. I must say, I don’t envy Ben Bernanke tonight, as he tries to play “lender of last resort” (cf. Charles Kindleberger, passim (link)) for an entire galaxy. Is anyone strong enough to rectify the great depantsing. Anyone? Anyone?