Consequences of the Crisis

Assessing the Legacy of the Great Financial Tempest
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Financial Crisis: The Fed

FILE - In this July 22, 2009 file photo, Federal Reserve Chairman Ben Bernanke in Washington before the Senate Banking Committee hearing on the semi-annual monetary policy report. Federal Reserve Chairman Ben Bernanke, widely credited with taking aggressive action to avert an economic catastrophe after the financial meltdown last fall, will be nominated by President Barack Obama for a second term, The Associated Press learned Monday night Aug. 24, 2009. (AP Photo/Gerald Herbert, File)
FILE - In this July 22, 2009 file photo, Federal Reserve Chairman Ben Bernanke in Washington before the Senate Banking Committee hearing on the semi-annual monetary policy report. Federal Reserve Chairman Ben Bernanke, widely credited with taking aggressive action to avert an economic catastrophe after the financial meltdown last fall, will be nominated by President Barack Obama for a second term, The Associated Press learned Monday night Aug. 24, 2009. (AP Photo/Gerald Herbert, File) (Gerald Herbert - AP)

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David Wessel
Wall Street Journal Editor
Thursday, September 17, 2009; 1:00 PM

On Monday, Sept. 15, 2008, investment banking firm Lehman Brothers filed for bankruptcy protection kicking off a week of massive shifts on Wall Street that was the beginning of the largest financial crisis in recent memory.

David Wessel, Wall Street Journal editor and author of In Fed We Trust, will be online Thursday, Sept. 17 at 1 p.m. ET to discuss the steps the Federal Reserve has taken to manage the financial crisis.

A transcript follows.

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David Wessel: Hi. I'm David Wessel, economics editor of The Wall Street Journal, Capital columnist (wsj.com/capital) and author of In Fed We Trust: Ben Bernanke's War on the Great Panic www.infedwetrust.com Please to be with you for an hour to field questions on the Fed ...or anything else economic on your mind.

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Washington, DC: Do people say you look like Ben Bernanke?

David Wessel: You know, that's a good question. I was once mistaken for him on an airplane many many years ago. But he has lost a lot of hair since then, more than I have. I am pleased, however, to see a Fed chairman with a beard.

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Boston: David, first of all love your column and your NPR visits. My question regards a sign I see carried around by Teabaggers asking for an audit of the Federal Reserve. I read the Journal, so I know the Fed has been stuffed full of junk over the past four years, but just how much? What is it that these "Audit the Fed" folks want and what will an audit likely reveal?

David Wessel: First, thanks. Ron Paul has had great success pushing a bill that would expand the Govt Accountability Office's authority to audit the Fed. Today, the GAO can and does audit the Fed but is blocked from auditing the Fed's monetary policy function (moving interest rates, etc.) Paul's bill would change that. He make no secret of his goal. His book is called "End the Fed." The Fed says that if Congress' investigative arm can start prowling around monetary policy decisions, the Fed's ability to move interest rates free of political interference will be compromised. The Fed actually discloses quite a bit of information about its holdings, more now that it has been criticized, and including information on the loans it has made to Bear Stearns and AIG. It won't, however, disclose the banks that come to it for emergency loans. It says that would prompt a run on them.

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New York: Since my city and state have suffered without the tax revenue generated by those outrageous Wall St. salaries and bonuses, I'm kind of on the fence about regulating compensation. Is the idea to cap how much they can make, or the way they make it? Thanks.

David Wessel: Both ideas are floating around -- a cap or a better process for determining compensation. Caps tend to be evaded. The most likely outcome, I think, are some new rules for setting compensation, particularly for reducing the incentives for executives to do things that make a quick buck and then stick others (shareholders, taxpayers, you know who I mean..you and me) with the losses when things go bad. Public anger about compensation is likely to force some significant new rules; whether they accomplish their goal is another matter.

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Washington, DC: Hey David, Stephen Mihm had a great article on Hyman Minsky in the Boston Globe this weekend. He focuses on Minsky's more radical ideas of employer of last resort. If the Government is going to be lender, creditor, asset purchaser and all around backstop of last resort for wealthy corporations why shouldn't it be an employer of last resort for actual people? I am not partial to the means but to the principle. Michael Spence has made some similar recommendations recently suggesting subsidies to employers who hire low wage workers.

David Wessel: Hyman Minsky, about whom my colleague Justin Lahart wrote a few years back in the WSJ, is enjoying a renaissance. He thought a lot about what causes bubbles and recognized that economic models that pretend they don't happen aren't very useful. On govt employment, well, there are people talking about that these days. I sense a great reluctance in Washington -- and outside Washington -- to create massive government bureaucracies to pay people. See the controversy over the fiscal stimulus. More likely, I think, if the labor market continues to sag are some tax breaks to encourage private employers to hire more people

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College Park, Md.: Is an unabridged version of your book out on CD?

David Wessel: There is no CD of my book, alas. But it's available as an MP3 file on audible.com. You can download it and then burn it onto a CD. I did that for my mom. It takes a while.

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Reston, Va.: When the European Banking Authority gets up and running, will the Federal Reserve yield to decisions from the authority in efforts to resolve future global financial problems?

David Wessel: I suspect it will be a very long time before there is a functioning pan-European banking authority so this is very hypothetical. One problem that emerged in this crisis (to quote Mervyn King of the Bank of England) is that banks are global in life and national in death. So their home countries get stuck with the bill when big global banks they fail -- UBS in Switzerland as one example. It's a problem. The current approach is to improve coordination among national bank regulators. It has a long way to go

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Bethesda, Md.: David - a little off tangent here, but do you know if the public can take a tour of the Federal Reserve building? I drive by it every day. Have you ever been, and is it worth seeing?

David Wessel: You can tour the building. It's kinda cool. Has a great art collection. At this web site you can take a virtual tour and see details about arranging a visit. The Federal Reserve Bank of New York is also interesting, especially the gold vault.

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Friendswood, Tex: Some say that commercial real estate is the next shoe to drop. When would we know that the shoe has dropped? And why isn't the market going into panic mode? Is it because banks are better at hiding distressed assets?

David Wessel: Commercial real estate is definitely the next shoe to drop. That seems widely acknowledged. Why no panic? Well, for one thing, it's an anticipated problem, not a surprise. For another, the govt's TARP fund has a lotta money if it needs it. Moreover, these are banks. If banks fail, the FDIC picks up the pieces. Lehman, AIG, Bear Stearns...they weren't organized as banks and that was a big problem.

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Washington, DC: You seem overly sympathetic to Bernanke, is that because he's not Larry Summers?

David Wessel: I have enormous respect for Larry Summers, one of the smartest people I've ever met. Any reporter gets uneasy when he finds himself admiring someone he covers, as I do Bernanke. But I decided to tell the story as best I could, and not try to pose as a cynical, nasty reporter just for the sake of being seen as antagonistic. So I did. I don't think I am "overly sympathetic."

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Arlington, Va.: Mr. Wessel, I'm really looking forward to reading your book. Here is my question: I agree that the Fed actually did a great job of putting a stopper in last September's crisis through big infusions to AIG and other banks to prop them up. But, the basis of the crisis is billions and billions of dollars of bad mortgages, and those have not gone away. How can Mr. Bernanke say that the crisis has passed when there is still all of this junk on the books of major financial companies? Is he expecting TARP to go on forever?

David Wessel: Ben Bernanke has not said that the crisis has passed. He has said that (a) we're no longer on the cusp of another Great Depression and (b) that the economy seems to be, tentatively, growing again, although not fast enough to bring down the unemployment rate.

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Boston: Hey David, did you catch Stephen Roach's case against Bernanke in the FT? 1. Bernanke argued for Central Bank agnosticism for asset bubbles and denied the housing bubble. 2. He was, "the intellectual champion of the "global saving glut" defense that exonerated the US from its bubble-prone tendencies and pinned the blame on surplus savers in Asia." 3. "derivatives' explosion, extreme leverage of regulated and shadow banks and excesses of mortgage lending were all flagrant abuses that both Mr Bernanke and Mr Greenspan could have said no to. But they did not. As a result, a complex and unstable system veered dangerously out of control."

David Wessel: In my book, I talk about the Greenspan years -- and Bernanke's role as an important intellectual ally of Greenspan's. He did argue that central banks shouldn't use monetary policy to prick asset bubbles, siding with Greenspan that instead they should clean up the mess when a bubble burst. He has since said that he is re-thinking that view. The mess that the bursting of the housing and credit bubbles left requires a re-think, he says. (He's right.) Back then, he said that the central bank should be extra vigilant on regulation and supervision if it suspected a bubble, but there's no sign he acted on that while serving on Greeenpsan's board. He did push the global savings glut view, which is still popular in some circles. But I think it widely acknowledged that WITH HINDSIGHT, an impt caveat, the Greenspan Fed kept rates too low for too long -- and the global saving glut argument was used to justify that. Bernanke has shown himself to be significantly more willing to regulate than Greenspan was -- but a lot of that is closing the barn door long after all the horses have fled

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News Hour: It was funny watching you and Krishna Guha on the NewsHour the other night. You two agreed on absolutely everything. I subscribe to the WSJ and FT so it was fun to watch the people I read every morning.

David Wessel: On the News Hour, one is allowed to agree with one's colleagues when they are right. As you know, some other TV shows only want disagreement. I don't agree with Krishna on *everything* but he was reasonable that night.

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New York: What might have happened differently, if anything, if Greenspan had still been Fed chairman during last year's financial crisis? Thanks.

David Wessel: Good question, and I don't know. Greenspan, in his years at the Fed, tended to cooperate with the administration especially at times of crisis. He might have less willing to intervene in the markets than Bernanke was, perhaps would have been less prone to experiment. But we really don't know because he never faced anything like this.

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Richmond, Va.: I know there are many analysts who say it was a mistake to let Lehmann Bros. fail, but what does Bernanke believe?

David Wessel: Bernanke, at least today, says that the Fed did not have the legal power to save Lehman. He says the Fed can lend only on good collateral and Lehman didn't have enough. He says that if he had had the power or if the Congress had given Paulson the $700 billion TARP he would have argued for saving Lehman because the collapse of a big financial institution in a panic is a bad idea.

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Holly Springs, N.C.: The Glass-Steagall Act (1932) was enacted during the Great Depression. It protected bank depositors from the additional risks associated with security transactions. The Act was dismantled in 1999 under the watch of Larry Summers. Consequently, the distinction between commercial banks and brokerage firms has blurred; many banks own brokerage firms and provide investment investment services. Many believe that the action in 1999 maybe one of the key contributing factor of economic meltdown in 2008. Why Larry Summers is invited in Obama administration? Why Congress & Obama administration isn't passing a bill to restore Glass-Steagall Act to avoid future financial meltdown?

David Wessel: Glass Steagall was created during the Depression to separate commercial banking (the Main Street banks that take deposits and make loans) from investment banks (the Wall Street ones that underwrite securities and trade them.) The law had eroded substantially by the time Congress (with the encouragement on Greenspan and Summers) repealed it. I find it hard to blame that repeal for the crisis. After all, Bear Stearns, Lehman and AIG weren't deposit-taking banks and they caused a lot of problems. Rather, the repeal of Glass Steagall is a manifestation of a broader issue -- the general tendency of Washington back then to think that financial markets and the big players in them would do a better job of policing themselves and doing things that made economies grow faster than regulators or rules could ever do. It was a mindset. It has been discredited. Now there is a move -- which Summers now backs -- to make some new rules. We know now that it's not more or less regulation, bigger or smaller government that matters, it's how the govt regulates and how impt it is for government supervision and regulation to evolve as markets do...not to stand by and watch. The reconsideration of the rules by which banks determine how much capital to hold are a good example. There were rules. There were inadequate. Banks didn't have enough capital for the risks they were taking. They will be forced to hold more in the future.

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New York: You don't think there is a huge payoff for Ben after he leaves the Fed? How much in consulting fees will the banks and others he bailed out will he receive? How much will he make in speaking fees? When he promises not to take a dime from any organization he ever had authority over including his entire family, then and only then will I ever believe he acted in the best interests of the American People and not his own.

He was party to ruining the economy and he continues to do so. If all these new tools are untried and untested that he has created out of thin air, what's to say they won't make things thousands of times worse? And will he still get a pension if he fails?

David Wessel: Do people who leave the Fed have the ability to get a lot of money afterwards? Absolutely. Alan Greenspan proves that. (So does Colin Powell, and every other successful high-profile general.) Do I think that is what's motivating him? I don't. He surely would have made more money even just teaching and writing a textbook -- let alone public speaking and consulting -- over the next four years if he had decided not to stand for reappointment.

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Evanston, Ill.: Hey David, How do Bernanke and Paulson justify denying Lehman's request to become a bank holding company and then waiving the waiting period for Goldman and Morgan Stanley to become one after Lehman went bust? The same for Bear Stearns and the discount window?

David Wessel: Very very good question. Here's what they say. (1) Bear Stearns was a shock, and its collapse would have been a shock to the system that Paulson and Bernanke wanted to avoid. (2) Bear had collateral to offer the Fed for a loan. (In fact, the Fed essentially bought $30 billion worth of stuff from Bear that JPMorgan Chase didn't want) (3) Lehman Brothers' problems were more well known than Bears. (4) They tried to do for Lehman what they did for Bear: subsidize a sale. But they couldn't. (5) They had no legal authority to lend to Lehman because it didn't have enough collateral left. (6) After Lehman's collapse, the markets took a very significant turn for the worse. It was, as Bernanke has said, a panic. At that point, as I describe in "In Fed We Trust," he decided to do whatever it took to prevent a collapse of the financial system and a repeat of the Great Depression.

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New York: David, I'm troubled by the fact that the banks still hold all those 'toxic assets,' and that nobody seems to be talking about why this remains so. Whatever happened to the plan for public/private buyers of these assets, and is there more trouble down the road if banks can't unload them? Thanks.

David Wessel: I've wondered (and written) about this. (See The Stench of Toxic Assets Lingers)

The question is whether forcing the banks to raise lots of capital (whether privately or from taxpayers) makes it less important to take the toxic assets off their books. Arithmetically, the answer is yes. The more capital, the more losses a bank can absorb and still keep lending. But some people argue that a bank will never really resume lending readily until the toxic assets are removed. We're still running the experiment.

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Alexandria, Va.: I know this is probably a simple question, but is there a Web site I can use to find out when the Federal Reserve is going to make a rate announcement that may affect my HELOC? I'd like to find out when the announcement is in conjunction with what the experts think about if the rate will be going up, down, or remain the same. Thanks.

David Wessel: The Fed's website is www.federalreserve.gov. I'm not sure what your home-equity line is pegged to. If it's the fed funds rate, then the Fed site helps. If it's the discount rate, the same. If it's banks' prime rate, you have to look at the table we have in The Wall Street Journal or other newspaper. (Sorry, don't know if Wash Post runs it.) If it's a market rate, well, the Fed isn't going be much help in real time there.

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New York: David, thanks for the chat. Are there any reputable economic thinkers who believe the government should not have bailed out the banks? Thanks.

David Wessel: Yes. Allan Meltzer at Carnegie Mellon and Anna Schwartz, who was Milton Friedman's collaborator, both have said as much.

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Washington, DC: RE; Bernanke: You said "a lot of that is closing the barn door long after all the horses have fled " about Bernanke views. Isn't his change of view more like doing a mime of closing the barn door after the barn burnt to the ground with the horses in it. Recognizing that you were wrong about something only gets you out of the bottom quartile, it is a necessary but not sufficient condition for correcting behavior. I guess you can tell I'm not a Big B fan, but then my Masters Thesis, which ripped Greenspan's views, was rejected in 1990, so I got a law degree instead.

David Wessel: Did the Fed blow it? Yes. And so did almost every other institution in our society that was supposed to be watching -- the bank boards and risk managers, the credit rating agencies, the supposedly sophisticated investors who bought securities they couldn't understand, the lender who made mortgages to people who couldn't ever pay them back and the homebuyers who took those mortgages, the elected politicians who didn't respond even to problems that were widely see and the press which didn't yell loud enough even when it did see problems. Did Bernanke make some mistakes? Yes. Did he do a good job of rescuing us from the consequences of mistakes that he, the Fed and others made? Yes to that, too.

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Boston: Beyond the direct TARP funds which purchased equity/warrants in various financial firms, what is the value of the total guarantees that the Fed and other government agencies used to support the financial system? What is the total taxpayer liability? If the government is not disclosing this figure why not and why wouldn't it be able to be pried out by a Freedom of Information Act request? We even got the methods of CIA interrogation techniques via FOIA. Can taxpayers find out what the government has put us on the hook for with these other obligations/liabilities?

David Wessel: This information is public. There are arguments about the best way to count all the guarantees. But, among other places, check the reports posted by the Special Inspector General for TARP (a/k/a SIGTARP.) See also the Fed's monthly reports to Congress at http://www.federalreserve.gov/monetarypolicy/bst_reportsresources.htm Are there still secrets, you bet. But is there a lot of information out there, well, see for yourself

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Laurel, Md.: My own leanings are that most of the bailout stuff is motivated by a government that thinks it can play a positive role, but usually doesn't. I may not have my details right, so perhaps you can correct me:

The one true crisis possibly requiring intervention (that worked) was the TED spread between ultra-short-term commercial paper and T-bills. Whereas it had historically been about 0.25%, it had shot up to 2.5-3.0 a year ago. This effectively froze the kind of lending on which the day-to-day operations of business depends. The Fed intervened by acting as overnight lender of last resort, and the spread went back to almost normal.

Can you tell me if I have factually described this accurately; and if this was actually a crisis into which the Fed intervened productively?

David Wessel: Yes. The TED spread -- or other similar measures, such as the Libor/OIS spread which measures the gap btw the rates banks charge each other and Fed rates -- are a good measure of the stress in the financial system. The Fed (and European Central Bank) intervened when it saw this distress, providing liquidity to the banking system as central banks have always done. They seem to have had some success. But that was really the 2007 early 2008 story. After that, the problems get even worse -- and went beyond liquidity to what economists call solvency. Before Congress okayed $700 billion for TARP, the Fed was the only game in town and it did a lot of lending. After TARP, the Fed (with relief) turned over to TARP much of the task of rebuilding the financial foundations of the banking system, which isn't traditionally the Fed's function.

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David Wessel: All good questions, and there were more I didn't get to. Thanks for your interest. I hope at least some of you found the answers useful. You can read about my book at www.infedwetrust.com and look for my columns in The Wall Street Journal at wsj.com/capital (but you have to pay for them.) Cheers! David

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