The Courage to Act: A Memoir of a Crisis and Its Aftermath

694 Pages·2015·8.47 MB·English

by  Ben S. Bernanke

CONTENTS
AUTHOR’S NOTE
PROLOGUE I Can Still Stop This . . .
PART I. PRELUDE
CHAPTER 1. Main Street
CHAPTER 2. In the Groves of Academe
CHAPTER 3. Governor
CHAPTER 4. In the Maestro’s Orchestra
CHAPTER 5. The Subprime Spark
CHAPTER 6. Rookie Season
PART II. THE CRISIS
CHAPTER 7. First Tremors, First Response
CHAPTER 8. One Step Forward
CHAPTER 9. The End of the Beginning
CHAPTER 10. Bear Stearns: Before Asia Opens
CHAPTER 11. Fannie and Freddie: A Long, Hot Summer
CHAPTER 12. Lehman: The Dam Breaks
CHAPTER 13. AIG: “It Makes Me Angry”
CHAPTER 14. We Turn to Congress
CHAPTER 15. “Fifty Percent Hell No”
CHAPTER 16. A Cold Wind
CHAPTER 17. Transition
CHAPTER 18. From Financial Crisis to Economic Crisis
PART III. AFTERMATH
CHAPTER 19. Quantitative Easing: The End of Orthodoxy
CHAPTER 20. Building a New Financial System
CHAPTER 21. QE2: False Dawn
CHAPTER 22. Headwinds
CHAPTER 23. Taper Capers
EPILOGUE: LOOKING BACK, LOOKING FORWARD
ILLUSTRATIONS
ACKNOWLEDGMENTS
A NOTE ON SOURCES
SELECTED BIBLIOGRAPHY
INDEX
AUTHOR'S NOTE
In all crises, there are those who act and those who fear to act. The Federal
Reserve, born of the now little-known Panic of 1907, failed its first major test in
the 1930s. Its leaders and the leaders of other central banks around the world
remained passive in the face of ruinous deflation and financial collapse. The
result was a global Great Depression, breadlines, and 25 percent unemployment
in the United States, and the rise of fascist dictatorships abroad. Seventy-five
years later, the Federal Reserve—the institution that I have dedicated the better
part of my adult life to studying and serving—confronted similar challenges in
the crisis of 2007–2009 and its aftermath. This time, we acted.
The title of this book was inspired by my colleagues at the Federal Reserve,
policymakers and staff alike. When the economic well-being of their nation
demanded a strong and creative response, they mustered the moral courage to do
what was necessary, often in the face of bitter criticism and condemnation. We
were joined in the fight by others in government—the leaders and staff of the
Treasury Department under two administrations deserve special note—as well as
many of our counterparts at central banks and finance ministries around the
world. I am grateful to all of them and proud to have been part of the global
effort to contain the most dangerous economic crisis of our time.
I am most grateful, however, to my wife, Anna, the love of my life, for
suggesting the book’s title—and for so much more, as will become clear.
PROLOGUE
I Can Still Stop This . . .
I
t was 8:00 p.m. Tuesday, September 16, 2008. I was exhausted, mentally and
emotionally drained, but I could not sit. Through the windows of my office in
the Federal Reserve’s Eccles Building, I could see the lights of the traffic on
Constitution Avenue and the shadowy outlines of American elms lining the
National Mall. Dozens of staff members remained at work, but the corridor
immediately outside my door was hushed and empty. Michelle Smith, the head
of our communications office and my chief of staff, sat quietly, the only other
person in the room. She was waiting for me to say something.
FOUR HOURS EARLIER, Treasury secretary Hank Paulson and I had sat side by side
in tan leather armchairs in the windowless Roosevelt Room of the White House,
steps from the Oval Office. A portrait of Teddy Roosevelt as Rough Rider on a
rearing horse hung above a fireplace. Facing Hank and me across the room’s
polished wood table sat the current occupant of the White House, a somber
George W. Bush, with Vice President Dick Cheney at his side. The president’s
advisers, Hank’s senior aides, and representatives of other financial regulatory
agencies filled the remaining dozen seats around the table.
Usually, the president liked to keep things light at meetings, by opening with
a wisecrack or good-naturedly teasing a close adviser. Not that afternoon. He
asked bluntly, “How did we get to this point?”
The question was rhetorical. We had been fighting an out-of-control financial
crisis for more than a year. In March, the Fed had lent $30 billion to help
JPMorgan Chase save the Wall Street investment bank Bear Stearns from failure.
In early September, the Bush administration had taken over Fannie Mae and
Freddie Mac to prevent the collapse of the two companies responsible for
financing roughly half of all residential mortgages in the United States. And just
the day before, at 1:45 a.m., Lehman Brothers—the nation’s fourth-largest
investment bank—had filed for bankruptcy, following a frantic and ultimately
futile search for a merger partner led by Hank and New York Fed president Tim
Geithner.
Now I found myself explaining to the president why the Federal Reserve was
planning to lend $85 billion to American International Group (AIG), the world’s
largest insurance company. The company had gambled recklessly, using exotic
financial instruments to insure securities backed by subprime mortgages. Now
that those mortgages were going bad at record rates, the financial firms that had
bought the insurance, together with other AIG counterparties, were demanding
payment. Without the cash, AIG would go bankrupt within days, perhaps hours.
We weren’t motivated by any desire to help AIG, its employees, or its
shareholders, I told the president. Rather, we didn’t think that the financial
system—and, more importantly, the economy—could withstand its bankruptcy.
Reacting to the Lehman failure, markets already were in the grip of a full-
blown panic of an intensity not seen since the Depression. The Dow Jones
industrial average had plunged 504 points on Monday—its steepest one-day
point decline since September 17, 2001, the first day of trading after the
September 11 terrorist attacks—and the selling wave had spread to markets
worldwide. As confidence in financial institutions disappeared, interest rates on
loans between banks had shot skyward. Ominously, we were receiving reports of
both large and small investors pulling their cash out of money market mutual
funds after a large fund suffered losses stemming from Lehman’s collapse.
Everyone in the room knew that rescuing AIG would be terrible politics in a
presidential election year. Just two weeks earlier, the president’s own party had
declared flatly in its 2008 convention platform, “We do not support government
bailouts of private institutions.” The Federal Reserve’s proposed intervention
would violate the basic principle that companies should be subject to the
discipline of the market and that the government should not shield them from the
consequences of their mistakes. Still, I knew that, as chaotic as financial
conditions were now, they could become unimaginably worse if AIG defaulted
—with unknowable but assuredly catastrophic consequences for the U.S. and
global economies.
With more than $1 trillion in assets, AIG was more than 50 percent larger
than Lehman. It operated in more than 130 countries and had more than 74
million individual and corporate customers worldwide. It provided commercial
insurance to 180,000 small businesses and other corporate entities employing
106 million people—two-thirds of American workers. Its insurance products
protected municipalities, pension funds, and participants in 401(k) retirement
plans. AIG’s collapse could well trigger the failures of yet more financial giants,
both in the United States and abroad.
The president, grim-faced, listened carefully. Paulson had warned him earlier
in the day that action on AIG might be necessary, and he knew that our options
were severely limited. No private investors were interested in buying or lending
to AIG. The administration had no money and no authority to rescue it. But the
Fed could lend to AIG to keep it afloat if the company’s many subsidiaries
retained enough value to serve as collateral for the loan.
Bush responded as he had consistently during the financial crisis, by
reiterating his trust in Hank’s and my judgment. He said that we should do what
was necessary, and that he would do what he could to provide political cover. I
was grateful for his confidence, and for his willingness to do the right thing
regardless of the likely political consequences for himself and his party. Having
the president’s support was crucial. At the same time, essentially, the president
was telling Paulson and me that the fate of the U.S. and global economies was in
our hands.
OUR NEXT MEETING, at half past six that evening at the Capitol, had been even
tougher. Hank and I gathered with congressional leaders in a cramped
conference room. House Speaker Nancy Pelosi wasn’t able to attend the hastily
arranged gathering, but Senate majority leader Harry Reid and House minority
leader John Boehner were there, along with Senate Banking Committee
chairman Chris Dodd, House Financial Services Committee chairman Barney
Frank, and several others.
Hank and I again explained AIG’s situation and our proposed response. We
were besieged with questions. The lawmakers asked about the Fed’s authority to
lend to an insurance company. Normally, the Fed is empowered to lend only to
banks and savings institutions. I explained a Depression-era provision of the
Federal Reserve Act—Section 13(3)—that gave us authority in “unusual and
exigent circumstances” to lend to any individual, partnership, or corporation.
The lawmakers wanted to understand the consequences of letting AIG fail and
how the loan would be paid back. We answered as best we could. Yes, we
believed this step was necessary. No, we could make no guarantees.
As the questions began to die down, I looked over and saw Senator Reid
wearily rubbing his face with both hands. Finally he spoke. “Mr. Chairman. Mr.
Secretary,” he said. “I thank you for coming here tonight to tell us about this and
to answer our questions. It was helpful. You have heard some comments and
reactions. But don’t mistake anything anyone has said here as constituting
congressional approval of this action. I want to be completely clear. This is your