The Wall Street money manager diagnoses the ills of America’s political and economic system in a fizzing, irreverent analysis (with promised f-bombs thrown in)
I originally thought we were going to be talking about Wall Street today. But I got the sense from some of your book choices that one of the biggest offenders wasn’t based on Wall Street at all, but on Constitution Avenue in Washington DC.
When you get bit by a dog, you don’t just look at the dog, you have to look at the owner who is holding the leash. To me, a lot of the regulatory changes, and a lot of what the Federal Reserve did, stand on their own as a major factor. But if you’ve read David Hume, if you’ve studied the philosophy of causation, you have to look at what motivated those changes. I have these debates with friends. One group blames everything on big government; the other group blames everything on big corporations. The sad news is that there’s really no difference between the two: Big government and big corporations work hand-in-hand. If you want to know who is the puppet and who is the puppet master, it sure looks like Wall Street has been pulling the strings of Congress for many, many, many years. I remember the Dick Durbin quote, right in the middle of the crisis. He was astonished at all the bankers and bank lobbyists running around the halls of Congress, and said, “I can’t believe these guys – they act as if they own the place.” The fact is, it’s not an act – they do own the place.
But the Federal Reserve itself should be insulated from those kinds of pressures.
They should be, except in the person of Alan Greenspan. He’s just this gnarly mass of contradictions. He’s an acolyte of Ayn Rand – believes that no intervention in free markets is the right approach – and yet he proceeded to spend his entire career, from 1987 through 2005, with his hands on the levers of Federal Reserve policy. He manipulated interest rates and money supply in order to win the love of traders. In 2001 he took rates down to unprecedented levels – below 2% – and kept them there for three years. Rates were at 1% for a full year! That had simply never occurred before in history. If you look at the late 1950s and early 1960s, rates would dip below 2%, but only for weeks at a time. In the “Who is to blame?” game Alan Greenspan is number one with the bullet, he’s top of the list. You can’t blame everything on him, but he’s the one who let all the gas fumes into the enclosed warehouse, knowing that a bunch of smokers were coming in to have a cigarette. Taking rates down to irresponsibly low rates is what set the stage for everything that took place over the next decade.
Are you saying that just as Ben Bernanke admitted the Federal Reserve had caused the first Great Depression, this crisis can also be blamed on our central bank?
The world isn’t black and white. We can’t just say, “The butler did it.” There were many causes, lots of poor judgements. If you look in the centrefold of my book, Bailout Nation, we try to depict everything in a visual form. It’s a great infographic by Jess Bachman that shows all the different factors that came together to cause a big collapse. The Federal Reserve was a significant element. But if you want to do it chronologically, you may want to go back further into the history. The bailout of Chrysler in 1980 set the stage. The rescue of Long Term Capital Management (LTCM) in 1998 encouraged a lot of moral hazard. Then there was all the radical deregulation, the undoing of some of the post-Depression rules that had operated so successfully for 75 years to prevent a major meltdown. The undoing of Glass-Steagall didn’t cause the crisis, but it made it much worse. Then there was the Commodity Futures Monetization Act (CFMA) of 2000, which completely exempted derivatives from any oversight or regulation and removed all reserve requirements. These all built up to set up a situation that was extremely dangerous. So maybe the fumes were already in the warehouse and Greenspan taking rates down to 1% was the spark that ignited the conflagration.
So what are the take-homes? What do we do now?
It’s really simple. Go back through the past 20 years of radical deregulation and overturn all the rules that were changed. You don’t need all this Dodd-Frank legislation. Just reinstate Glass-Steagall, overturn CFMA. Just undo everything that was done in 2003, 2004, 2005 and 2006, remembering that old expression: If it ain’t broke, don’t fix it.
OK, let’s talk about some of the issues in the context of the books. Your first choice goes into the history of the Federal Reserve, and is called Lords of Finance: The Bankers who Broke the World by Liaquat Ahamed.
This book won a Pulitzer – it’s a wonderful narrative covering a 50-year period from before World War I through the Weimar Republic, the Great Depression, and leading up to World War II. It tells that story through the lives of four central bankers – the head of the Federal Reserve in the US, of the Bank of England in the UK, of the German Bundesbank, and the French central bank. It looks at these four players, their professional actions on behalf of their countries as well as their personal relations. It tells the story of the economy, of the global crises that arose, of how people interacted, how governments interacted, what took place with monetary policy. It’s really a fascinating story. Even if you’re not interested in finance, it’s a great read. When I was making my list, I wanted the books to be informative, to fill in the holes in people’s understanding of what happened in the financial crisis. But I also wanted each of these books to be really well written and tell a tale. All five of these books are just masterfully written. I can’t recommend this one enough. It’s a delight to read.
How bad a job did the Fed do in the Great Depression, then?
Let’s put it into a broader context. The US has always had a problem with the concept of a central bank. The initial central bank lasted for 20 years, and was then dissolved. Without a central bank modulating the currency, you tend to have wild swings in money supply, and in the economy you had a series of panics and depressions. So then we had the second Federal Reserve bank. Same thing – it had a 20-year lifespan, and then it died. The result is that by the time we get to the Great Depression the Federal Reserve is a relatively new institution, it’s only 15 years or so old. Its basic approach is rather modest – there’s not a lot of intervention, not a lot of pulling on the levers, there’s very much a recognition that historically, a democratic nation does not like an unelected central bank dictating economic policy. They had a hands-off approach. You really get the concept of that in Lords of Finance, not just within the US, but internationally. How it affected the post-World War I, pre-World War II period, what the central bank shouldhave been doing – now that we have the benefit of hindsight – to moderate the effects of the downturn caused by the market crash and the Great Depression. And yes, it’s fairly obvious that had the central bank been a little looser in its credit policy, we would have had a less severe downturn. They may not have caused the Depression, but they certainly didn’t help it and they probably made it a lot worse.
The Great Depression is, of course, the period Ben Bernanke is an expert on. I got the sense from your book, Bailout Nation, that you don’t think he’s done such a great job, though.
My biggest problem with Bernanke is not so much him as chairman, as him as Fed Governor under Greenspan. He didn’t see the problem coming and he enabled the ongoing reign of error of Alan Greenspan. When the economy is in an utter freefall, when everything is going to hell in a hand-basket, [Walter] Bagehot had the right ideas. The central bank should be the lender of last resort, it should lend on good credit at high rates. What the Federal Reserve did is that, in an attempt to save the banking system, they focused on saving the individual banks. I don’t want to get too wonky, but there are two approaches to respond to a banking crisis. There’s the Japanese way, or the Swedish way. The Swedish approach, which, by the way, is followed by the FDIC, is, “To hell with the banks, save the banking system.” If any given bank is insolvent, you fire the senior management, you wipe out the shareholders, you take the assets, you sell them to the highest bidder and whatever is left over goes to the bondholders. What you’re left with is good assets and preserved accounts. People who ran a bank poorly or invested in bad banks are suitably chastened by the market, and the system is saved.
Japan has its own keiretsu system [whereby banks are owned by companies and vice versa across the economy]. When Japan’s crisis began in 1989, if they had let Bank of Mitsubishi fail, the whole of Mitsubishi would have collapsed. So Japan’s approach was, “To hell with the banking system, save the banks, because if we don’t, everything else is going to go down.” Unfortunately, we took a page from the Japanese approach. Now it’s 30 years later, and Japan is still in a long-term recession.
Do you really believe we should have let those banks go bankrupt then?
Well, the way we let Lehman go down – just take a leap, face down, 50 storeys onto the concrete – no. That’s not the ideal way to do it. What we ended up doing with GM and Chrysler was a pre-packaged bankruptcy: You fire the senior management, wipe out the shareholders, renegotiate all the bad deals, and sell off all the bad assets. GM is having its best year in history! Had we done that with the bigger banks, we would be much healthier today. That tearing off the Band-Aid is much more painful at the time, but it would be healthier today, and more importantly, you don’t set up the [moral hazard] problems going forward. So five to 10 years from now, we don’t have some guy on a trading desk coming up with an idea and saying, “You know, if I take a little more risk, and use a little more leverage, if it works out, it’s a home run for me. But if it crashes and burns, it’s someone else’s problem!”
So how should the banks have been dealt with? You work on Wall Street, give me the specifics.
When Bear Stearns starts to wobble, a few people said, “Hey! We can’t let Bear Stearns go belly-up.” That’s where the mistakes start.
So they should have just been left to go under?
No, no. Here’s what happened. Jamie Dimon [the chief executive of JP Morgan] completely outplayed Ben Bernanke. Dimon went to Bernanke and said, “Look, we’re a counterparty with Bear Stearns, we could probably absorb them – but why should we step up? Normally we wouldn’t do this in a shotgun wedding, it would take a year to negotiate. I have a weekend to make this decision, so you have to guarantee $29bn of losses.” And the Fed did that.
If I had been the Fed chief, I would have said: “Let me explain this to you, Jamie. I know the history of JP Morgan” (Everybody thinks Dimon is this genius who avoided the subprime situation, but that’s actually not true. They just ran into their subprime problem way earlier than everybody else, so when they had to liquidate, there was a bid there.) “I’m looking at the derivative book of Bear Stearns. It’s $8 trillion and you’re the single biggest counterparty. So if they go down, it’s your problem. So here is what I am willing to do. When you go into receivership, I’ll promise not to put you in jail! If you want to buy them, buy them. If you don’t want to buy them, we’re going to put them into a pre-packaged bankruptcy and if it ultimately causes JP Morgan to go bankrupt, well, put it this way, this is your opportunity to avoid it. So take a walk once around the park, and have a good think. As Fed chair, I have no problem testifying that I suggested you buy Bear Stearns because, if you didn’t, it really looked like they were going to blow up JP Morgan – and good luck with the shareholder lawsuits for the rest of your life.”
Instead, Dimon outplayed Bernanke. Bernanke is an academic, he was learning on the job. When the head of one of America’s biggest banks says “I’ll save your bacon, but you’ve got to do this for me…” He didn’t know better. Even at the time, a lot of people, including me, said, “This is outrageous for the Fed to give $29bn to JP Morgan to buy Bear Stearns.”
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