Alan Blinder is the Gordon S. Rentschler Memorial Professor of Economics and Public Affairs at the Princeton Department of Economics, and served both on President Clinton's Council of Economic Advisors (1993-94) and as vice chairman of the Federal Reserve Board of Governors (1994-96). His new book, a history of the financial crisis called After the Music Stopped, is out tomorrow. We talked on the phone Friday; a lightly edited transcript follows.
Dylan Matthews: I was somewhat surprised that you decided to write a history of the crisis. That genre has mostly been dominated by journalists thus far.
Alan Blinder: I wanted to write a book that was very different from what you get from journalists, and rather different from what you get from historians. It’s an analytical history. It’s vastly more about the "why?" of the crisis than the "who?" of the crisis. The ultimate motivation is my belief, which I’m absolutely convinced of, that people really don’t understand what in the world happened and what motivated some of the government’s response.
DM: All right, so what should they understand that they're missing?
AB: They need to understand a lot of things. They need to understand something about the crazy house of cards that was built before, but they especially need to understand the pros and cons of some of the things the government did in response, many of which have been absolutely vilified.
A good example of that was TARP, which could have been done better, but has to go down in history as a phenomenal success. If you poll people, they think TARP was a total failure. One of the ways to kill something in Washington these days is to say it’s like TARP. Among other things this makes me worried about what will happen the next time we have a financial crisis.
The second example of that is the stimulus bill, which has been vilified by Republicans. It’s said it didn’t create any jobs, which if you think about it for 30 seconds, it’d be impossible to spend that much money without creating any jobs.
DM: How much of this do you think has to do with people's difficulty with reasoning counterfactually? So you see the economy, which isn't that great, and conclude "Well TARP and the stimulus must not have worked."
AB: I think that’s a very major part of it. In his book, Thinking, Fast and Slow, my colleague Daniel Kahneman has this concept he called WYSIATI – "what you see is all there is." If you believe the only thing there is is what you see, what you see is that all these things were done and the economy went pretty poorly anyway. What you don’t see is how poorly it would have done without any of these actions being taken. A principal objective of this narrative [in the book] is to combat WYSIATI.
DM: You mentioned you had some criticisms of TARP. What could have been done better?
AB: If you remember what the acronym stands for, it's the Troubled Assets Relief Program. It was sold to Congress as a government program that was going to buy up these toxic assets and then sell them back at a profit. Instead Hank Paulson, who was then the secretary of the Treasury, decided to use it only for injecting capital into banks, largely by buying preferred stocks. I didn’t agree with the choice, we could have done both, and it kind of gave it a bait and switch aura. He never purchased any troubled assets with it.
At the level of details, when Paulson proposed the terms to the banks, I think he made them vastly too favorable: no additional lending, not even a cessation of paying dividends; very minimal, extremely minimal, restrictions on executive compensation, very little upside for taxpayer if it all worked out. All those features added to the public anger at being fleeced.
People think that we spent all this money shoveling cash into the pockets of undeserving banks. And they were undeserving. That’s the only part of that statement that’s true. The only losses are going to come from the automobile bailout, which certainly didn’t have anything to do with troubled assets relief, but people think we just handed this money over to bankers.
DM: A lot of people, including your colleague Paul Krugman, were calling for the Treasury to nationalize the big banks in 2009. How do you think that proposal has held up since?
AB: In my view, poorly. I was on the other side of the argument at the time. It was argued in many, many places, including in front of the president of the United States. Temporary nationalization made sense. It was a judgment call, I judged that it wasn’t necessary. Tim Geithner’s judgment was more important and he judged that it wasn’t necessary.
There were downsides to nationalization that I think got short shrift by some people. If you had in mind subsequently, or even in real time right then, getting people to invest in banks, having nationalized them was not the best way to do that. Once the bank is nationalized, the shareholders were skunked. Threatening to nationalize them is not a good idea. If there’s no way to get more capital into the banks and they have such big losses that they’re irretrievable, then you nationalize them. But I don’t think either one of those was the case for U.S. banks.
Let’s put it this way. None of the U.S. banks failed violently. Wachovia was a very big bank that did more or less fail but that was handled by FDIC, not perfectly but pretty well. By 2009, people were talking about nationalizing Bank of America, Citibank, Wells Fargo ... JPMorgan Chase, none of which really needed to be nationalized and weren’t. I give Geithner credit for that, since I think that if he had come down on the other side it would have happened.
DM: Was there a way to respond effectively to the crisis without contributing to the moral hazard problem by bailing out irresponsible banks?
AB: No. [laughs] Moral hazard is a serious issue, and I don’t dispute that. The problem with the people who only care about this, the moral hazard ayatollahs, is that when you hear it you think it’s the only issue. The things they say about the moral hazard are correct and we did create moral hazard problems then. If we had been completely hard-nosed then and said, "I’m not going to do it," there’s a very good chance the whole system would have gone down the tubes, and that’s a pretty big problem. I’m willing to tolerate some moral hazard to save the system.
DM: What would you like to see done to prevent another crisis and recession like this one?
AB: That was what Dodd-Frank is designed to do. Is it a perfect piece of legislation? No. What anything, including a great novel, that’s 2,300 pages long is perfect? Nothing.
I think it’s a good bill. There are places I’d like to see it push harder, like on the regulation of derivatives. There still is a big political fight about implementing it. It gives us what’s called an "orderly liquidation procedure," which of course has not been tried yet and Lord knows we hope it doesn’t have to be tried anytime soon.
Back then, the judgment of Paulson, Bernanke and Geithner was they had two choices: find someone to buy Lehman [Brothers] or put it into bankruptcy. When the last buyer disappeared, that led to the decision to put it into bankruptcy. They knew it was going to be bad, but they didn’t have another mechanism. Now we have this orderly liquidation procedure to allow a company like Lehman to perish, but not to do so as quickly or with such a terrible mess. Instead it would be put in the charge of the government and liquidated in an orderly manner, as the FDIC does with banks when it needs to do that. It tries not to have to do that, but when it does it lays them to rest.
There are things in Dodd Frank that guard against the amazingly disgraceful underwriting practices that many banks followed during the boom years, making mortgage loans that can only be called crazy. My favorite examples were the so-called "NINJA" loans, which stands for "No Income, No Job, no Assets." The number of NINJA loans should be zero. It is zero under Dodd Frank.
What would I have done differently? Derivatives. This is totally hypothetical, but have fewer banking agencies at the end than we had at the beginning. We went in with four bank regulators and came out with three, but of course added CFPB (Consumer Financial Protection Bureau), which is another good aspect, somebody to look after the interests of ordinary people. Politics made it impossible to do more regulatory consolidation than was done in Dodd-Frank. Another example of that was there were proposals to merge CFTC (Commodity Futures Trading Commission) with SEC (Securities and Exchange Commission), and that wasn’t done. If you can cast politics aside, if you could, I think we could have come up with a better version. But you can’t do that. Once you allow for the political constraints, it's a good bill.
DM: You once proposed having an independent Fed-like agency take charge of tax policy, to allow for better pivoting between budget balancing and stimulus. Given Congress' gridlock of late, do you think the case for an agency like that is stronger?
AB: It has, in fact not only the crisis, but the incredible gamesmanship and partisanship has strengthened my view. I think it’s probably made it less likely that anything like that could happen. For something like that to happen, the politicians and the public need to put some trust in this independent agency, and one of the bad legacies of the crisis is that the Federal Reserve is less trusted than it was in '06 and '07, which is a shame because I think it performed admirably. There was a poll in summer 2009 in which people were asked for their appraisal in terms of quality of nine federal agencies and the Fed came out last, dead last, which to me was incredible but emblematic of how tarnished the Fed’s reputation became.
In that piece I was posing the question of whether we’d model a fiscal agency with responsibility for taxes on the Fed. This is not going to happen, the way the Fed is viewed now.
DM: Do you think setting firmer pro-growth rules for the Fed, like a nominal GDP target, would help speed up recovery from future recessions?
AB: I think only modestly. The Federal Reserve has a restricted purview for the monetary system. It can’t control taxes, government spending. I don’t think it should. Within that restricted purview, Bernanke has proven that they can be pretty expansive. I mean, the Fed has done a lot of things that, if you’d asked me or anybody six years ago, could or would the Fed do something like that, most of us would have said no, the Fed wouldn’t do anything like that. It’s a real stretch of its operating procedures, but he did that.
The hard truth which we learned is that once the short-term interest rate hit zero, a lot of these other things the Fed can do, while not powerless, are just not nearly as potent an instrument as the short-term interest rate. The simple explanation of the Fed's powers, which got rendered obsolete by the crisis, is saying it only has one instrument, which is the short-term interest rate. It turns out it has much more but they’re not nearly as good.
DM: Do you think the Fed could have done more to prevent the crisis, or perhaps to pop the housing bubble as it grew?
AB: I half agree with that. The half I very much agree with is, not so much pop the housing bubble, but one of the enablers was the abandonment of sanity in underwriting. Banks were making many, many irresponsible if not downright foolish loans. The Fed could have cracked down on that and it didn’t. When I said the Fed has performed admirably, I’m talking about from post-Lehman Brothers on. I don’t agree with what they did on Lehman, I didn’t at the time and I don’t know. But that’s a long time now, when they've been absolutely terrific.
DM: Do you have any sympathy for the view that Fannie Mae and Freddie Mac, driven by the Community Reinvestment Act, drove down loan quality and contributed to the crisis?
AB: I have very little. If you make a long list, that belongs on it, that Congress pushed Fannie and Freddie into this subprime or alt-A market, less quality loans, more than it should have. But the facts of the matter are that they were not the major players in the mortgage craziness. They came in later because they were getting their market share decimated by the less responsible lenders. What's more, they started getting out before the crisis, their portfolios were shrinking, not rising, and thirdly, within the universe of subprime and alt-A mortgages, it was clear that the workout has been going on for so long that Fannie and Freddie had the better stuff, not the worse stuff.
If you look at the performance of the loans in Fannie/Freddie’s portfolio, I’m willing to put them on the list of people or institutions that made mistakes, but they belong pretty far down the list. CRA, I mean man oh man, this was passed in 1977! It sure took a long time! When I hear things like that, I used to joke sometimes that if everything good in the 90s was because of Reagan’s tax cuts, why don’t they go back to Andrew Mellon's from the 1920s? At some point you have to inject a little common sense.