Day 2: Responding to the Global Financial Crisis

my name is John Allen and I'm the president of the of Brookings and I'd like to welcome each of you here today for a very important event hosted by our Hutchins Center for fiscal and monetary policy the Hutchins Center's mission of improving quality fiscal and monetary policies as well as educating the public on the same because one we're deeply proud of here at Brookings I want to thank you all for joining us today and to welcome those who are coming in by webcast and of course to offer a very warm Brookings welcome to the media as the upcoming discussion with the guidance of Tim Geithner and Hank Paulson and our own distinguished fellow Ben Bernanke the Hutchins Center has teamed with the Yale program on financial stability to undertake an important task the aim of this project which we highlighted in an all-day conference yesterday is to ask key individuals who were in the government responding to the 2007 to 2009 financial crisis to record important decisions the decisions that they made at the time in essence to find out what they did what they didn't do what they couldn't do and why the goal is to create a reference for future generations if you will of financial crisis fighters who would want to know and who would wonder what did they do way back in 2008 today we have the exciting opportunity to hear from three of the most consequential participants in this crisis outstanding leaders all who deserve a substantial amount of credit for preventing the second Great Depression first Ben Bernanke of course who was the chair of the Federal Reserve and Hank Paulson who was the secretary of the Treasury and the Bush administration and Tim Geithner who was president of the Federal Reserve Bank of New York and then Secretary of the Treasury in the Obama administration and they will be interviewed by Andrew Ross Sorkin of the New York Times and CNBC who will be soliciting questions from the audience following his conversation also ladies and gentlemen just a reminder we are on the record and we're live but before we begin I'd like to welcome to the stage Andrew metric the Janet Yellen professor of finance and management at the Yale School of Management and the director of their financial stability program thank you very much good morning you're here to see what is the main event what is a multi-year project to catalogue explain and analyze the actions that were taken during the financial crisis by the official sector in the United States these actions were taken by these as leaders these three individuals here and I think while we can argue and discuss and we will whether or not any of the specific things that they did were good or bad or worked or didn't work what is not in dispute is the extraordinary partnership that was forged by the three of them the cooperation across two different administrations of different parties and perhaps even more surprising in official Washington across multiple agencies of one government the federal government this cooperation has extended to the project that that we're hearing about today where they have brought from the private sector from government service from academia the people who worked with them as their key lieutenants in 2007 through 2009 back to do the work to explain what they did and to make a record of those decisions this is a unique thing for financial crises I'm a scholar of financial crises we don't have a record like this from anywhere else which is in part why we're often condemned to make the same kinds of mistakes over and over again so this will be a very valuable service what they have done to bring their teams back together again for scholars for future crisis fighters and for anybody who wants a financial crisis not to have devastating effects as somebody from all three of those groups I want to say thank you and I look forward to hearing what you have to say today thank you and thank you for being here thank you to the Hodgkinson center here at Brookings it is a privilege to have this conversation ten years later and we hope to make this an interactive conversation so please do ask your questions ask them early and and and write down there the cards going around I want to start this morning by trying to bring us all back to 2008 we're gonna have a conversation and debate about the policies of what took place but this was as much a story to some degree about policy as I would argue it was about people and it was personal and I want to start by trying to bring all of you all three of you back to what I imagine may have been some of your own worst personal moments we've had some conversation over the years about this but I'm genuinely curious when you when you lie in bed at night ten years later Hank what you think of as as as as the worst moment for you personally well 10 years later I haven't been doing a lot of thinking back so I but by going through this process I think about it I hope basically we were too busy during the day we were just working around the clock so when we were playing offense there wasn't a lot of time to you know be fearful but to me by and large the worst moments were waking up because I would invariably put my head on the pillow it goes sound asleep immediately and but wake up around midnight you know at night little problem seeing big and big problem seeing insurmountable and so I would into the abyss and and in just you know seafood lines see a second Great Depression wondering if one more institution went down how would we ever put it all back together again but the the the events during the day when you know when you know there were a good number of events we all lived through the one that comes immediately to mind was the Sunday Lehman Brothers weekend when we had gone to bed on Saturday night thinking that a deal was done come in Sunday morning you know talked with the team talked with Tim they everything looked good and when we learned that afternoon after trying everything that it wasn't going to be Lehman was going to go down and I remember then just being overcome by a sense of fear everyone was looking to me what was I how was I going to deal with it and then I did something was very uncharacteristic I I stepped out called my wife Wendy told her you know I'm scared and she she immediately brought me back to one of our favorite verses from second Timothy you know that the Lord had given us the spirit of fear but power and love and a sound mind and I immediately snapped back you know and and and and was fine and and then the related event was about ten days later it hit me I had a brother it was a just my best friend a senior vice president of Lehman and I had not talked to him about this it just hit you it just hit me I mean we're the reason it just hit me is that week you know after we it was just stunning the number of things we were dealing with you know we had to focus on you know I'm Morgan Stanley and Goldman Sachs needed to go to Congress for the tarp you know IG the money markets so I called him and when I called him he was just terrific you know he he just said listen I knew you did everything you could I was worried about you don't worry about me but but it was but it was but there are plenty of those as I think back on and I don't want to think back on all of different moments but they're up there playin Tim your moment I don't know I just remember that mix of crushing burden responsibilities of fear about whether we were gonna be able to get our arms around it just tired it was easier when we decided whatever the next stage of escalation when you could choose to act but I think the hardest thing was you know sitting at the table with my wife in the morning with her reading about what we were doing and just seeing on her face that mix of despair and doubt and I believe that she felt we were you know ethical people trying to do the right thing but but she looked at what we did and said and you know her she was like really I think that was our thing and of course that was mirrored by you know what we faced across the country and that gap between what we thought was right what we thought was the best of the available options the gap between what we thought was gonna provide the broadest benefit right we fastest as quickly as possible and what people thought was fair and just I think that was in some ways the hardest thing I want to get back to that and the questions your wife had in just a moment because I think those questions maybe the questions of the country is still grappling with but then real briefly your moment cuz I know you had one Tuesday I think markets and chaos we organized an 85 billion dollar loan to make sure the world's largest insurance company would not collapse Hank and I went to Bush got his support but he said go talk to Congress so hanket I went to talk to a group of congressional leaders and explained what we were doing why we were doing it you know will it work it could work will you get your money back we hope so yeah so the questions went on for a while and then it died down and then Harry Reid was leading the discussion he said remember Hank remembers this oh gosh he said he said mr. secretary mr. chairman he says I want to thank you for coming down here and explaining this situation to us he says but I want you to understand one thing nothing you've heard here tonight constitutes congressional support or approval for what you're about to do this is your decision and your responsibility and I remember feeling so alone looking over at Hank and saying this is the kind of thing that we're going to have to do where do you get the 85 billion dollars so mr. chairman you're the professor on this panel yeah you grade people for a living no you don't understand how it works at these Ivy League university grade or measure if you will your own performance and the performance of these gentlemen I don't think about it now how should we all think about it how would you grade it you know it's not really a fair question obviously because you know we didn't let the students grade themselves usually right I mean I think I think generally I mean my general a sense you know we didn't anticipate the fool when we ended all of us had various concerns about the financial system about the economy none of us anticipated the full ramifications and extent of the crisis and so in that respect we were late we then responded very aggressively I think overall we were successful in stabilizing the financial system and there was a paper given here yesterday about comparing how quickly it happened at what cost how quickly the economy recovered and generally we look good compared to other advanced economies to other countries and that have had crises in the past I think we're you know we didn't succeed obviously and and and Tim already alluded to that is that you know we didn't persuade the country generally speaking that what we were doing was necessary although we firmly believed it was and so that communication issue I think is is still out there but we did respond aggressively to the crisis itself and did bring it under control pretty quickly so Tim what do you think you missed what do you think was the the big miss in all this if we just go to the central issue of how we got here you know it's you could just a common thing it happens across lots of parts of economic policy which is it's the it's the general failure of people to appreciate the damage that might come from the remote implausible low probability event it seemed it seemed to most people living in this country that the type of financial panic are run on the banking system that was part of the Great Depression they could proximate cause the Great Depression was not something that could happen in modern times and you know you could say that was a failure of imagination our as a country we were living with the financial system with it had looked more stable over time that made people believe it was more stable in the future but we ran into a dangerous moment in the world with a system that would dramatically outgrown the protection of the Great Depression without the tools to prevent panics to break panics and that but you know in a simple way it's the it's the failure to anticipate act early enough to reduce the risk of the existentially damaging event that seems remote and implausible so when you look at the numbers that you guys have all put together and your teams and put together 10 years later is there data that you wish you had focused on more and they today you'd focus on instead Hank is there any piece of data that you think I don't think this is about data because my strong belief is that these crises are unpredictable in terms of cause or timing or the severity when they hit and sure there will always be someone at that time that can say look I called it but that person won't get it I'll get it right the next time and so to me the huge takeaway was that we were dealing with an epoch once every 75 year a financial crisis a severe crisis and to me the biggest takeaway was you we weren't able to put out the fire without getting the fiscal authorities we needed from Congress without getting the tools we needed and so the there was nothing more frustrating then because by early 2008 we we we knew we needed more and to know you needed more and can't get it is is a tough situation to be in and so to me I knew when we got there we knew how flawed the regulatory system was a Treasury we started working on a study looking at the limitations but it was just missing missing the the magnitude of the event okay this is you Hank Paulson on the debate you said I was never able to this is what you actually said was one of the things you wished you had could have done better you said I was never able to convince the American people that what we did wasn't for Wall Street but was for them I'm going to ask all three of you about this because this to me is central issue if you look at where we are today and described it as a success economically there are still many in this country who don't believe it and the question is from a policy perspective both in the policy itself and in the communication of the policy was there another way to do it well I will start because what you're looking at me but I would begin by saying I think one of the issues was that we were early relative to do the work some other countries have stepped in to deal with these things and so we stepped in before the banks had collapsed and we did some things to to fix the financial system which are very hard to explain because there are objectionable things I mean a you know in the United States of America you know there's a fundamental sense of fairness that the American people have that if you take risk and you succeed that's great but if you take risk the government shouldn't be there that you don't want to reward the arsonist and and so but we were forced to do things to protect the American people which are by definition going to be hard to defend and then the second thing is how did we how could we explain what we were doing was for Wall Street and not you know it did that it wasn't for Wall Street and that it was for the for the American people and it is very very hard to explain that that the system was so complex so interconnected that we had to go to the source and Wall Street was it was like the heart and we had to stop we had to go to the heart we had to go to the source to stop the bleeding otherwise it was going to kill economy and what we were doing as we were putting the tarp the things we did we did was like putting a tourniquet on it but it's very hard to explain that finance is the lifeblood of the economy and we tried it all of us do it up there then did something at 60 minutes Tim talked about all the time I tried to explain that you know that if you want to take money out of your ATM if you want a loan to send your kids to college whatever you need finance but it's a hard case to make and we are unable to make it German I think the premise of your question is somehow that the current dissatisfaction populism the remaining obvious economic problems that there are are all traceable back to the financial crisis I think that's a wrong premise financial crisis didn't help obviously we know historically of financial crises do tend to precede increases in populist politics but people have been saying that the country's been going in the wrong direction for 40 years there's been a long period of very slow gains in real wages increasing inequality slow upward mobility social mobility we've had rising concerns about trade China's entry to the WTO in 2002 immigration cultural issues so the whole gamut of things that are feeding into the popular mood I think the financial crisis obviously exacerbated that but it was not I don't think the primary source of the politics that we're seeing today now in the communication it was tough I mean none of us has experts in communication I did go on 60 minutes and I spoke at military bases and colleges and things like that but we had some very gifted people like Tim's boss President Obama and others who really couldn't turn around that that narrative and I think that's just very hard to do let me ask about some of the policy issues themselves though in terms of the development of tarp in terms of questions about whether you'd want to help homeowners more directly I know that's something Tim you've thought a lot about principal reduction things like that do you look at that today and say had we gone in that direction both from a policy perspective we'd be better off economically or politically I think that um in general the country would have been a better served if we'd had a stronger program of you might call him fiscal stimulus tax cuts support for states and local governments a whole range of things like that larger sustained longer and so there was less burden on the Fed to carry the burden of trying to get the economy growing again after we put out the financial fires and you know we did put in place a you know quite large sustained program of tax cuts of things like that they were ultimately overwhelmed by the cutbacks of the state level and that put a big drag on the recovery which was always gonna be weak and damaged coming out of the financial crisis I think that would have made a big difference and we were successful in relaxing some of the political constraints on that but not not successful enough housing is you know tragically complicated and the broad thrust of the programs we did were not large enough to offset a substantial part of the damage from a recession of which millions and millions people lost their jobs the approach we adopted and we were trying to do the best with the available tools we had was to try to make sure we brought mortgage rates down we keep the housing mortgage market open and functioning so that house prices would start rising again people wouldn't suffer you know massive additional loss of wealth those of those programs which are done by as a result of GSE conservatorship witch Hank oversaw and what the Fed was done in monetary policy they were very powerful the programs we did to directly limit the risk people would lose their home unnecessarily they helped nine million people benefit for lower payments on their mortgages and millions of people refinanced who were underwater but they were not large enough and they came late in the process that came too late and it would have been better if they if the stuff we learned in the process of trying to make those things work we learned that more quickly and delivered it better I know one of the issues that you think about a lot is Fannie and Freddie and how that you think ultimately did help homeowners imagine imagine how far housing prices would have fallen if we didn't have mortgage funding during the financial crisis and Fannie and Freddie were the were the only source of of mortgage financing so that made a a very significant difference so I just can't imagine what would happen if they end Glenda well what led you to the conservatorship I mean what what was the spark for that for well the inflection point well the spark was these were these huge entities you know that you know they they had like five point four trillion dollars and and securities outstanding that were we're getting ready to implode and and so and you know their securities were the three point seven trillion in the u.s. at one point seven trillion outside of the US you know just sort of flowed like water throughout the financial system we had been treated as if they were you know had this implicit government guarantee but these were entities that auctioned off sometimes twenty billion of debt and a week they'd even had an auction that had gone wrong so so I started working you know in the fall of 2006 with Barney Frank got permission from the Bush White House did to compromise and to the president encouraged it encouraged me to to to work out a compromise that we were working you know for a long time but it took it took them at the end just getting ready to go down to have to go and get those emergency authorities one of those I ask you the questions I think about the geopolitical issues we deal with today and I remember in your book you write a sequence about a phone call you got about the Chinese and the Russians memory so that that was you know we were talking all the time I mean Ben and Tim and I were talking with foreign counterparts the Chinese were actually quite responsible during the financial crisis and the relationship we'd built with this batik economic dialogue was very helpful so the anecdote you talk about illustrates how global these entities were because what had happened was it wasn't a phone call it was we've gone to Congress we've gotten these emergency authorities we did not yet know how bad it was when you looked under the hood and it was terrible much worse than anybody had expected but so I wasn't sure of the extent of the of the problem or what we were going to do to address it and I was in China on a short trip and a Chinese of someone I was very close to a very senior Chinese official took me aside and said the Russian said approached them and said let's start selling together and this will force the Treasury secretary to use the emergency authorities the so-called bazooka and I'm thinking to myself you know I don't even know the extent of the problem we haven't come up with a solution to address it you know that just put more pressure and we are already rushing because we knew that there were a number of very unstable financial institutions four or five of them and we really wanted to stabilize Fannie or Freddie before before they came unglued so that it really was an added incentive but that was you talk about scary moments that was another one because here I was in China so I couldn't pick up the phone and call back to the US because my calls back to the US and I couldn't say to bend then had a team of people in Fannie Freddie and I couldn't say how bad has it been because I didn't want the Chinese I'm saying oh yeah I think everything's gonna be okay and they would listen to the phone so I but my phone call would be it would all be positive things and I couldn't talk about that call I had from the Russians but when as soon as I got back well you know that really gave me a an incentive to get moving policy question on Fannie and Freddie for both of you when Fannie and Freddie were put in a conservatorship I can't imagine that anyone on this panel thought ten years later that it still would be did you know I guess I would have thought that by now they would have been some restructuring but we also see that Congress is having difficulty making bipartisan you know policy decisions and so there I guess the job painted was so good that you know it's been sustainable you know the housing market is functioning and the and the GSEs are functioning so I think there'd be good arguments to to do some reforms but it's not an emergency and Congress is not working in that effectively you know outside of emergency situations and the you know the like many things in policy the solutions are divisive and our system it's it's sort of easy to inertia as like overwhelming when the solutions are divisive but the system as it as it works a day it doesn't work it's a manageable problem it's not the optimal solution to be better to transition at some point in the future to a housing system where the government's playing such a not playing such a large role but the government will have to play a meaningful role in the housing market in any recession and your whatever you think about the long-term future of the GSEs whatever you think about the design structures before the crisis they're less fragile today the incentives are better and you will need them in the future to mitigate the risks of a future recession you talked about things that are divisive and as we said there's continues to be a conversation about rescuing banks and tarp and and what that looks like one of the things we didn't talk about we were talking about tarp before is the accountability of executives and I think that Barney Frank may still be here I know one of the dates that you had early on that he had with you was around executive compensation if you're gonna hand over the money to the banks you need to restrict the executive compensation how should people think about that today I was the one and you need to start with what our plan was what we wanted to do was get out quickly and recapitalize the system and we had no power to force banks to take capital and you know in the world we were living when a healthy bank could very quickly become a shaky Bank if the economy continued to deteriorate or for certain banks if some banks went down so what we did was we when we and I negotiated this with Congress we agreed to certain restrictions on CEO compensation and golden parachutes but we didn't accept restrictions on bankers bonuses because otherwise that banks wouldn't have taken capital and so what we did we had is something that worked extraordinarily well but was extraordinarily unpopular so we we had something that let us go out with lightning speed put capital into 700 banks and it turns out that that money that went into the banks and insurance companies all came back plus a fifty billion dollar profit but more importantly it it averted catastrophe it kept the system from going down I would argue that that it stands it was very novel so it stands in stark contrast with what has historically done what is historically done is you put capital into banks yeah punitive terms and so the only banks that take it are those that have failed or about to fail that's what the Europeans did the Brits would capital into to bang the only ones are willing to take it just as you're going down and so their banking system remained under capitalized long after ours and you know and our recovery worked much better but the this made what we did more unpopular and then what really hurt really really hurt was after this was all done in 2009 when the banks are earning big money they turned around and paid big bonuses and that was more more than I could stomach you know it it was I just thought it was I thought it was beyond bad but it was showed a stunning lack of self-awareness and I think that through a fuel on the fire but so I'm saying we did we had to make we knew what the public wanted to hear right we may not be politicians we may not be great communicators but it didn't take much to know what the public wanted to hear they want to be tough on bankers they didn't want to you know they didn't want to reward the arsonists etc but we were trying to protect the public and if we were dealing with the banking system after it collapsed okay it would have been a lot easier to do the kinds of things they did is there is there any room either between everybody on this panel or even just in your own heads to have done it any differently today on this question on this question we're facing some very tough constraints which is we wanted to keep the banking system alive and to put capital in the strong banks and unless Congress is willing to give us the authority to force in capital which they were not going to do we had it had to be all voluntary programs that did put some constraints on you know how punitive the terms could be including things like interest payments and so on so that was the constraint that that Hank was facing in a very tough one now the Fed and the other regulators did try to make some changes for example changing the structure of compensation so that it you you you you could get clawbacks where if you after two or three years if you're did a trade you got paid for that but it when bad then you had to pay back you know those kinds of things to make it a more longer-term type of relationship between performance and reward so we're some changes made in terms of how conversation is paid but there was this always this problem that if you wanted to keep the banking system open and healthy it had to be voluntary in the part of the stronger banks and that puts some constraints on what let me also say something here I think fundamentally what we did was even if we had constraints was fundamentally unpopular across the red line putting capital into institutions in the US has never been popular and I look what other people did around the world I don't think what the Europeans did the Europeans did all kinds of tough measures on compensation and I don't think what they did was any more popular the fact is people don't like banks and during a financial crisis they really don't like banks and yet if if you if you destroy if you're too tough on the banking system then you make it very hard on the general of the public were you gonna say I think it's the central dilemma it's it's why it's why financial crises are typically so damaging is because most countries most governments faced with the base with the politics of trying to prevent the system from collapsing wait and they let it burn and they they get utter to close the edges that's where they've got a collapsed so their only options are the nationalize and that's fundamentally what turns financial that creates the risk of panics and what what makes panics so damaging to the economy as a whole and you know we adopted a different strategy you know we we'd spent a lot of time looking at what countries had done and across financial area and we adopted a different strategy and our strategy was to say so try to act earlier a little more preemptively not early enough because we didn't have the authority but a little more preemptively and to recognize that what makes sense in a normal messy recession with respect to some individual bank failures doesn't work in a panic where the risk of collapse is great and that that fundamental thing that what you need to do in a panic is sort of the opposite of what seems fair normal normal times is the fundamental dilemma and design of strategy and it's why the gap between what is the most effective strategy to protect the broadest interest of the average person is so in conflict with the natural politics of the time or the with the general sense what people think is moral injustice but but again the question even embedded in there is yes it yes it worked and there was an efficiency to it would it have been as efficient or even putting efficiency aside was there an opportunity to do any any part of it differently I mean not I think for the reasons Hank you may have said you know if you if you decided to wait until the government owned every bank they'd all collapsed or half of them classic government or any bank you would have vast degrees of freedom to try to figure out what he wanted to do that would have been the I think the irresponsible immoral choice so the the paradox of this and the central dilemma and I think the central lesson from natural crisis because again you've seen all the alternative choices countries made is that it's better for the broader interest Act early but it makes the politics harder to manage you know where we nationalized institutions where the government took the predominant ownership of the institutions we did the classic sensible things we fired the management and the board we limited dramatically future compensation we did that where we had the option for doing it but by just choosing a strategy was designed to leave the system in private hands and get it back to function as quickly as possible we left ourselves with limited choices to try to find a better balance between the let me ask you a policy question and there's there is no counterfactual list so we will never know and I imagine it's a confluence of all of these things but from a priority perspective if you were to talk about the importance of things that took place after the crisis tarp is one of them clearly the stress test would be another and I on everybody the stock market continued to fall after tarp was enacted and then there was what the Fed was doing how do you how do you rank those in priority order in terms of Delta fiscal at and and and and the fiscal peace which is more important heartbeat or respiration I tell you though I want to say one thing I think what when I think about what I am really really grateful for you know in terms of working with with these two guys who were just I could not have had better partners when I look at Ben Bernanke the chairman of the Fed and you normally don't think of academic you talk about academia you don't think at least I don't think of courage right you know then just just to show you my bias but to me the courage people forget how extraordinary things they did and the withering criticism he was subjected to and so I would say when I look at overall when I look at the recovery and the fact that we were growing it at 2% from you know the third quarter of 2009 I think that's extraordinary and so I don't think you can you know I think Ben gave the right answer but in terms how do you you know you needed all of them and without any one of those pieces I think we would have been a lot worse but but I think then at the Fed to me was it was critically important I want to talk about one of the big issues we have not mentioned yet and is probably one of the big mysteries if not debates that continues to linger ten years later and that is around Lehman Brothers I want to read you that this is the editorial page op-eds the morning after Lehman Brothers failed and I should tell you The Wall Street Journal op-ed page was almost identical to this this is what the paper said it is oddly reassuring that the Treasury Department a Federal Reserve let Lehman Brothers fail did not subsidize the distress sale of Merrill Lynch to Bank of American tried to line up loans for AIG rather than make alone themselves government intervention would have been seen either as a sign of extreme peril in the global financial system or of extreme weakness on the part of federal regulators and it's an interesting op-ed because going into that weekend's the conventional wisdom I imagine even in the room was that if Lehman Brothers failed the market was prepared for it there's no you say no I mean let's just go back a little dicks is important go back in in March Bear Stearns you know came to the edge of the abyss and we made the judgment then very important judgment we made then which is that the system was so fragile that we were not confident it could sustain the effects of default by a substantial financial institution in that moment and we decided it was in the interest of the country to do what we could to reduce that risk but we also decided that for a weak investment bank that lost the credibility of the market undergoing a run business is bleeding away that the Fed alone had no option to save it by lending that what we could do is try to find a willing buyer large enough to provide the mix of capital and guarantees necessary for them to get through this to be absorbed into the larger hands in the Lehman case we made the same judgment we thought it would be although the system had a lot of time to adjust to the possibility of Lehman failing the system was much more fragile Lehman was larger we thought it was necessary again to try to do everything we could to reduce the risk that they failed but we thought our only option was to try to find a willing buyer and ultimately we failed in that why did we fail in that because we were willing to make it to incent a willing buyer to acquire it it failed because Lehman was much weaker and the system was much more fragile so the universe of plausible buyers was much more and there was nobody really strong enough to be willing to step in even with the prospect of some assistance and that left us with with no choice but we thought it was gonna be bad and it was it was it was bad it was much worse than we thought when we envisioned and you know it's a good lesson I think that's good you begin to remember if people thought it was a deep mistake for us to intervene to prevent bear stearns failing and the predominant view prevailing even September with this system much closer the edge of panic was that it would be a mistake to prevent Lehman from failing and there was a relief when we were sure they thought we chose not to then and they were they were mistaken in their belief because I was our view that we should try to save them our problem was that our means at that point I remember we had taken we had stretched the feds authority well beyond what most normal humans were comfortable with and that had proved deeply inadequate to save the system from the risk of a panic from tipping in the panic because we learned something that most countries learned over time which is that in the end you need a more powerful mix of guarantees in capital to stop a run and to get a broken system going again and you know ultimately Congress in its wisdom largely to the credit of Hank and Ben gave us a sufficient set of tools that we could avert the risk of bridge oppression but not soon enough to give us the authority to prevent all the damage mr. chairman notes speak to this all three of you have has said that this wasn't really a choice when it came to the failure of Lehman that you didn't have the ability that you didn't have the authority to effectively save the company because you didn't believe that there was enough collateral that is a comment that was made several weeks after the failure of Lehman Brothers in the moment it was not something that people in the room even remember being talked about speak to that issue because I think that there are still many people who don't believe and may never believe that this was not a choice well Tim has put out a very useful Q&A with Andrew metric on the details of the Lehman decision we had only one tool which was lending against collateral we were unable to put capital in that would only come later with tarp we were unable to give guarantees you've had a situation where you had an investment this was not a commercial bank with a large amount of loans to use as collateral and with a sustainable level of funding deposit insurance and in life this was an investment bank that was funded largely by short-term wholesale funding that had mostly encumbered collateral its assets were a mix of market assets whose businesses depended very heavily on instantaneous confidence because its customers its counterparties were bleeding away very quickly and so it was not the thing I want to say is this was not some kind of narrow legal judgment it was not like saying oh we can do it but it's just on the other side of legality that wasn't the way we were thinking about it we were thinking about it in terms of is it feasible Canada is it viable and our fear was and I and and I have to say that I was having conversations continues I was in Washington preparing for the FOMC meeting I was talking continuously to Hank in to Tim our belief was that the making a loan against the collateral that was available would at best sustain the company for a few days that it was not a viable business that all we would do is end up bringing a lot of bad assets under the Fed's balance sheet and maybe protect a few a few creditors but we would not be it would not be sufficient to keep the company alive and that was the the critical element and so it would again it not a narrow legal judgment it was a judgment about feasibility and that is something on which we have never wavered I mean I think that is and that is you know despite some contradictory opinions I think that's also the overwhelming view of academics and and judges and others who have looked at the looked at when you and your people like like Warren Buffett say you know what the Fed is the lender of last resort maybe it would have been legal maybe it wouldn't have I would have just done it and I would have let them sue me afterwards no I he's a wonderful man but he didn't have the information that we had this is a really important thing because we live with this in the future there's just a lot of magical thinking about what central banks can do and what protections they can provide and can they provide some artificial support to asset prices can they levitate them can they say these things and that that magical thinking persists throughout this was certainly true in the crisis but these tools the Fed were given were designed to be limited and I don't I have never I had not seen the credible case that lending up to the value even generously determined of available collateral for a bleeding business with its assets underwater would have been effective in preventing its failure remember we did exhausted the universe of possible buyers so I you know people think it was a different decision that we made in the bursts it was the same decision it was just a different outcome is the same decision because the judgment we made was the only choice was to try to find a stronger pair of hands that provide a mix of capital guarantees the government could not provide that because Tarpon not hate you should have you said that the day afterwards because I will say you left the impression for some period that there was a choice he made yeah sure did you know communication is a very tricky thing during a financial crisis and I was always looking toward saying something that would increase the market stability and that night you know Morgan Stanley's liquidity had been breed bleeding away John Mack was on the phone with me Sunday night I was in my hotel room I got on the plane and flow back to - to Washington and and and John Mack was saying I don't know how long we can live the shorts are gonna be all around us so I flew back and I got you know I found myself standing up on the White House press room and I felt like if I said guess what there's not a single power the United States of America that will save a disintegrating investment bank we did not have the authority to do it I think Morgan Stanley would have gone down immediately and that was my judgment so I I tried to put his go-to face on it as I possibly could and the other thing I say now and it's pretty clear to me now looking back at it you know ten years later that you know at the time we were desperately trying to get this done and we came quite close and if we'd had a buyer with all of the banks that we're gonna take the bad assets I think we would have been in a situation where a Fed could have made a Bear Stearns type loan and all of us would have rejoiced at that but as I look at it back and look at it now and get back to something that then says about about the tools the system was fragile we had Merrill Lynch AIG Lehman going down in the same weekend you know we had wah wah Co via Citigroup sitting out there that there was so much dry tinder that regardless of what had happened you know if B of a had bought Lehman then Merrill Lynch would have gone down it would have been worse we were ultimately it was going to take capital guarantee authority fiscal authorities we are ultimately going to have to go to Congress so if it hadn't been Lehman it would have been it would have been something else so it was it was a terrible outcome but one thing it did do was it it shocked the political system and we were able to go get tarp and even then Congress voted down the the Republicans voted it down the first time so it was a you know it was a nightmarish that one thing I can say with a hundred percent certainty is that all three of us really we might not have known how bad it was going to be but we we knew it was going to be bad and we wanted to avoid it let me ask you about some of the politics of this at that time because there was pressure on everybody we were in the middle of a presidential election which people often seem to forget as you said the house did not pass tarp the first time it was your own party that was making it difficult that when you look at the politics of today if this crisis happened today what do you think would happen what do you think what do you think would happen I'm asking anyone who wants to take it but I would say there's a lot of dysfunction in Washington today no doubt about it but I don't want I know what people expect me and want me to say but I don't ever want a bet against the United States of America and our political system during a crisis a crisis can bring people together and I was thinking back you know that when I came to Washington in July of 2006 a lot of things hadn't been going right for for President Bush and people talk about you know low approval rating like 40% well he was in the high 20s and this was a poisonous atmosphere and I remember going up to Congress and how poisonous it was early on it I'm just saying I'm very grateful that we had a year before the crisis hit I had a chance to get to know and get some things done with members of Congress we were very lucky in terms of some of people that were in leadership positions there like Barney Frank and Chris Dodd and Judd Gregg and and we had I had a you know president that was really really encouraging us to work on a bipartisan basis so there's a lot of things that that worked but a crisis can bring out the best so again you're not going to get me to say we couldn't do it today because if we couldn't do it it would be just catastrophic I can't imagine what would happen to our country if we hadn't got the tarp can I get either of you to say I mean I think it's good to point out that the the core of the financial system mean the basic defenses of capital and leverage restrictions and liquidity funding is really dramatically more conservative than it was no seven and that will buy us a margin of safety for some period of time and you want to make sure you preserve those defenses they don't let them a road over time through changes in regulation or just falling behind the curve of innovation but those are much stronger much more broadly applied and you know we do have some tools we didn't have an O 7 for dealing with a failing complicated institution but you know we the the Congress also took away and limited some of the tools that were essential in this crisis and will be probably essential in a future crisis and what that what the consequence of that means independent of the politics of the moment is that it has to get really terrible for Congress to be willing to provide the tools that you ultimately need and that means that as a country we're choosing to run a system that creates the risk again at some point in the future that things have to get really terrible again before there's the freedom to act and that's a consequential choice I don't think it's a choice made with you know intelligent design and great wisdom and but even in a well-functioning political system with a bipartisan spirit of cooperation with people focused on country about party which I think largely was the case in the fall of a wave you know you you choose to you choose to run a system without the degrees of freedom in in a to fight a panic it'll have to get terror you have got too close to the risk of a Great Depression before Congress ultimately authorized the authority and I think that's a choice no serious country makes around the world today and I don't think it's the right choice for us as a country mr. chairman all three of you wrote an op-ed that ran in the New York Times over the weekend speaking to this issue about the next crisis and what tools we have and what tools we don't have to deal with this if in fact a large major financial institution in this country had a significant problem think of one of the top three or four banks in this country do you think that we would actually follow through on using the tools and methods that are laid out for us or do you think that there would be a political will at that point to say we can't roll the dice and see if this works we're gonna actually have to step in all over again well there be some improvements and and Tim mentioned you know stronger banks and higher capital so and I think an important improvement is this orderly orderly liquidation Authority which gives a more systematic pre-programmed way to deal with a failing financial firm now people have different views about about how successful it would be particularly it in practice right directly it sounds great yeah I know but but I can tell you as as a former bureaucrat that if you have a procedure that is in place and Congress has approved you're certainly gonna try it you are gonna try it and I think we have somewhat different I think a little more I'm a little more optimistic maybe then Tim and Hank they could speak for themselves about about this olá process because I've talked to the FDIC about it and gotten some sense about how it would be put in practice but at a minimum even just with just we're talking about Lehman I think if we had had that olá procedure it would not have eliminated the problem it would not have solved the problem but I think it would have created more orderly and you know less destructive resolution than what the uncontrolled bankruptcy that in fact we had so so I think yes it will be tried and in if you have a single firm that's in trouble and the rest of the system is broadly okay I think it could very well work I mean this is very elegantly designed a set of tools with new authority that Congress made possible but I think even the in the wildest dreams of the architects of that authority it wasn't designed to save us from the risk of a panic and you know I when the FDIC first came to me when I was in the in the Treasury and walked me through how it would work and I asked them well how would it work if we applied it in a wait the fall of wait would have worked and they said I thought they were right about it they said well yeah of course you did it for one the risk is you have to do it for four more and the only way to offset the damage is for the Fed to lend freely to the financial system and ultimately for Congress make it possible to guarantee liabilities of the system so I think even at that point they were modest in their ambitions for it but it's a well-designed thing and as Ben said if you face the situation where the world is otherwise relatively stable and you have a single institution who's managed themselves to the edge of the edge of failure yeah you should let that process work one of the issues we have not really talked about it all is QE one two three and more one of the great critiques of all of the programs post the crisis but particularly QE is this idea that it exacerbated and created an even greater sense of inequality in this country and I'd hope you could speak to that I know it's something you've fought a lot about and you've written about yeah I think there's some folks who don't like QE and as each argument fails they move down the ladder and so now you have hedge fund managers writing The Wall Street Journal how QE is creating inequality as if they cared QE QE there's no evident ever seen an academic paper that that asserts the QE creates inequality yes it supports asset prices as does any successful economic program would cause stock prices to help recover but it also has contributed to 1617 million new jobs what is more important for the middle class than job creation it also supports house price increases it lowers interest rates that the borrowers including mortgage borrowers have to pay so I think the evidence for that is very very limited if in fact there are concerns about inequality which of course there are I think the right way to approach that is through fiscal policy the Fed has a single tool basically interest rate policy its job is to stabilize employment and to keep inflation close to target again I don't think it's as first-order effects on inequality I think if in their transitory probably in any case if there are concerns which there are then fiscal policies the right way to deal with it but I really think this is a really an on a non-issue for QE this is a follow-up question from someone in the audience who wrote on a card this is for been directly how did you think about political pressure to undertake or not to undertake rather qe2 how did you factor that into policymaking did you consult congressional leadership no we did we were unwillingly consulting congressional leadership because they sent us they sent us a letter saying not to do qe2 which we know which we ignored because our mandate was to try to achieve full employment and price stability and we felt that in order to do that we needed to take further steps we no longer could could cut interest rates further so QE was to at that point was the only option we saw so we we did as the Fed as as opposed to do which is we made policy based on our mandate and our tools and we ignored the political advice I want to talk to you all about potentially how you might see a future crisis we have a question that just come in that says will well an increase in electronic trading and a decrease in market making make the next crisis works and I'd add that earlier this week JP Morgan wrote a report called what they are predicting as the great liquidity crisis they say will hit financial markets it'll be marked by flash crashes and stock prices and social unrest and that the trillion dollar shift to passive investments computerized trading strategies electronic trading desks will exacerbate sudden severe drops they go on to predict that central banks will be forced to make unprecedented moves including direct purchases of equities or could even b-negative income taxes what do you guys think of that I think that on the right way to think about the risks in the system is that um there's no way to anticipate the full range of things that cause a system to break down there's no there's not no capacity to anticipate preempt where you can't run the system confident you'll be able to anticipate there's a huge diversity of things that go bad and you should design the system so it's robust enough and resilient enough to withstand as broader range of tests or shocks whatever their source as possible and and that's what the reforms post-crisis have tried to do but as I think we learned in the crisis that requires not just a strong set of defenses in terms of capital and funding stability but it requires a strong emergency arsenal when those defenses fail so I good to worry about all the potential sources of shocks but you should be humble and skeptical about the ability of people to identify and and therefore preemptively defuse those things you should work at it it's a forever war but recognize that in the end what you want to do is to make the system more resilient against the natural failures of people to be able to anticipate and preempt are there any areas that you think about Hanks business specific specific groups and what do you think about this passive investment move that's really changed the face of the way the markets work sorry I make too first of all I ascribe to everything that Tim said this is difficult to predict I do believe we tend to fight the last war and I'm when I'm concerned I'm more concerned about I'm not concerned about a problem in our banking system where all the focuses so you know sure could some of those risks materialize I am concerned about liquidity with there's not banks aren't precluded from doing their traditional market making rule I was never a big believer in the Volcker role I thought that was you know was not the right way to go I I'm more concerned about risks outside of the US but basically I come back to it well my Tim says and so in addition to having the arsenal I think it's important the way I look at it and say we've got the strongest deepest most competitive economy in the world fewer than problems in other economies but we've got problems and so I tend to think about it and say now when our economy is strong we should be moving to fix those problems and what I think about the problems that really concern and why and and I would say basically the best defense we have against a financial crisis is having a strong economy we're going to be less susceptible to the problem and we're going to be better able to respond and so I'm much more concerned with things like the fiscal deficit dealing with that because I think that debt bomb is a big concern and then I come back to some of the things that been talked about because I looking at some serious structural economic issues that predated the the the crisis that contributed to the crisis and you know continued unabated and you know this income disparity issue and with wages having been flat for so long and as I look at their crisis I mean household said and doubled their borrowing in the 10 years before the crisis because people were were you know were repressed they were borrowing to live beyond their means so as I look at it I think our economic system and our democracy have a hard time working with that level of disparity and so to me fixing some of those problems and some of the issues like immigration that divide us politically and economically are the things where my focus is so rather than staying up at night trying to it was like I remember after the financial crisis we're getting Goldman Sachs that the financial crisis after 9/11 and we were getting Goldman Sachs up and going again and I remember sitting around a room and people started brainstorming all the different ways that terrorists could kill us you know could they get in the water what about the vents what about whatever and I finally said enough is enough I mean we you're gonna go nuts thinking about all this we've got to get Goldman Sachs up and going again and and so on and I think here we could dream about all the different ways the next crisis could hit us but the key thing is fixing our economy making it as strong and resilient as possible making sure we have the right to fences and that's you know the the right tools and that's the best you can hope for Hank talked about a debt bomb then what do you think how do you feel about that and how does that manifest itself ultimately well I don't think that I'm not not dead Hawk in a sense I think there's some imminent crisis or some kind of run on the dollar or anything like that likely or however we are on a track whereby the share of GDP devoted to paying interest is going to be rising and rising and rising and it's going to begin to swallow up the rest of the fiscal budget which is already beginning to do and reduce our flexibility for whatever emergency we face whether it's a war or a financial crisis or whatever it might be in the future so it is concerning in a long-term sense that we're not planning how to use our national resources for an aging Society for defense for all the other things that you know we need to prepare for so I think it's more like an allocation of resources problem to me rather than a near-term financial crisis risk do you worry about it if every financial crisis ultimately is about dead is about leverage in the system where is it today well the household sector you know has brought overall debt down and pretty substantially relative income its modestly higher in the corporate sector is dramatically lower in the financial sector and the sovereign the government's balance sheet its eroded somewhat but you know we're we're still a tremendously strong country in terms of the things that matter to overall fiscal sustainability so you know I think I think I would say that you know we're pretty fortunate and in our mix of challenges relative to those many countries face and if you worry about the financial imbalances that typically you know create the dry tinder for a financial crisis I would say you'd want to look largely outside the US and we won't be complete can't be indifferent to could be affected by those but I think we have partly because of the progress was made in this countries I think we have a luxury as a country now to focus our resources and political capital on the whole range of other economic challenges that preceded the crisis and the the crisis could not solve two more questions that one from the audience I don't know if there any work you have just more as well and just it's really a follow-up to the question we had talked about earlier this op-ed that you folks had written in the New York Times over the weekend this question says in the op-ed related to the op-ed what tools has Congress taken from the public specifically and why should we worry them so what are the actual tools and and and if they're lobbyists in this room we should go lobby to have to make sure of those tools don't get taken away what should they which they be lobbying for a lot of the emergency Authority like the capital programs and tarp expired but what Congress did is limit the FDIC's ability to provide broad guarantees to the banking system without congressional approval limited the feds ability uses emergency authorities to land the individual non-bank financial institutions like like AIG or Bear Stearns and put some other limitations on the on the effectiveness of those emergency tools and limited the Treasury's ability to use the exchange Stabilization Fund to guarantee money markets all things that were very valuable essential in the crisis they could be restored quickly but you know as you learned it's hard in the crisis even when things feel terrible to get the politics to work in favor of mustering the will to legislate and it seems implausible now that this is a moment you could find the will to restore the strength in the Arsenal to what's typical across most countries it seems implausible to say that but I suspect the politics of that it easier in the moment today than they might be as you're slipping towards the the abyss an international question specifically this one related to China we could broaden out to more broadly as well I'll ask it to our China file expert here Hank Paulson is one of the intentions of this project to develop lessons for the perhaps inevitable financial crisis that may happen in China at some point in the future or as the Chinese system to different and I'd also brought it out to say what kind of lessons do we think that other foreign governments should be thinking about well you know first of all I would say that the world is becoming a smaller place and we're very interconnected so when you look if if China were to have a serious economic issue it would affect us and in a number of ways because they they're responsible for driving a good percentage of global economic growth and so it's not just the us-china relationship number one number two and I think it's been well written about I that there's a lot of leverage at the sub-national level in China so that you know there there are plenty of risks these things are unpredictable but China has advantage that most of its that is in women be it's in their currency they have a financial system that's relatively closed they've got a strong fiscal situation at the national government and and their population doesn't have a lot of leverage so I would be you know more focused on volatility there and and what would happen you know China has not discovered a better economic model and they've got plenty of problems so I I often tell people when they're looking at China that I think we're really right - you know forgetting about tactics to be you know because I might argue about tactics but you know it is unacceptable for them not to to continue to open their markets to to competition but the but the the I don't you know I I don't discount the role the China plays in terms of the global economic system it's a significant it's a significant one but I'm not predicting a financial crisis in China Tim and Ben how much of what took place here is applicable in other countries I think a lot of it is applicable and I would mention again the EO program on financial stability which is trying to develop lessons not just from our crisis but from dozens of other crises I mean one of the things that was so interesting in some sense about our crisis was that it was a old fashioned banking panic at some level except it took place in a very different institutional setup with electronic deposits as opposed to depositors running you know on the bank in the street so many of the same principles the same issues were there but just in a different institutional setup and so I think it is actually very useful what neo program is doing to try to look at policy responses and and what in a variety of contexts both emerging market and advanced economies and one things that comes out of that effort is that there are a lot of commonality so the basic economics is kind of the same across panics it's just that the institutional setups and the details different but we can learn and and during the crisis we looked at the experiences of Sweden and and Japan and many other examples trying to see what we can learn from from their experiences is this not to be unfair the generals you know we people talk about generals and Wars and the risk of just fighting the last war if only I mean you know these things they repeat they have the same basic dynamics they ultimately require the same basic solutions they happened to countries around the world at a pretty tragic pace with tragic consequences but they happen to the same country kind of rarely long intervals or relative stability before you have them so memory fades of what you need to do and one thing we're trying to do is to you know have been likes to say the enemy is forgetting is to try to preserve the body of knowledge that was created from the experience we had other countries having this crisis about what works what doesn't so that our successors and those in other countries have a better set of tools and they can narrow the gap between you know diagnosis and action in the future that that's our hope but I think that I think it's a it's a it's a these are more commonly you would like in their basic dynamics okay so final question for me we've talked a lot about the policy stuff and you guys clearly and maybe it was the crisis itself but you guys actually became genuinely good friends over over all of these years but I would argue even before that all three are you unique with unique distinctions and differences in terms of the kinds of people you might want in a perfect scenario in the midst of a crisis how much do you think this is really not about the policies that we're talking about at all but is about the people that are gonna do it you know you look today at an administration where there's leaks everywhere and everybody is back fighting in this and that maybe crises bring people together so that doesn't happen but how much you put this at the very individual level let's say you know I would just simply say the tools and authorities are important people sitting in the seats are also important I think that I would just say looking at it personally I couldn't have asked for two partners sort of the extraordinary and complementary skills and backgrounds that you know Ben and Tim have and as I you know so I asked myself sometimes why did it work as well as it did with the three of us and we had right we had a year beforehand we we communicated all the time and they know I'm assigned the phone probably too much so we communicated all the time I think all three of us are by definition team players I mean that was all three of us are our team players I think the fact as I thought about it that our backgrounds and experiences and personalities or so different made it work because we in many ways we weren't competitive we we each had different things we brought to the party and we appreciated what each other had we we also were in a crisis it helped also that we we started with big time that we started with the common philosophy that it was a risk we didn't want to take to have a major financial institution go down so we never we never debated that and then so we were able to pool or Minh we needed each other because in the middle of a crisis and we pooled our skills and our authorities and the tool we use and then each person you know partnerships don't work if you don't think everyone's pulling their weight and so we we each understood what the other was doing and we built the sort of trust and confidence in each other but I look at it and I just can't tell you how much admiration I have for those two but but it it is and it was institutional we talked last night with our I mean then lay down the law to fed him at the New York Fed and then at Treasury Tim always said I don't like peacocks you know I want people people they got to be members of a team and so when I say this really important thing which is you know in our system of government we're in the executive branch we were placed the top four levels of government every time there's a change administration the system depends a lot on the quality of people that occupy the civil service of particular the Treasury the talent at the FDIC and the depth of talent experience at the Fed and in new york fed and i think that one of the great advantages we had i think and of course we admire each other and very lucky in in in our partnership and in the support of the two presidents we were for you know obviously the huge advantage we had is that we had a team of people exceptional integrity smart creative people who were you know just overwhelmingly focused on trying to figure out what was the best of the bad choices what was it be the most effective thing and that's something you have to sustain and preserve and nurture it you have to create the incentives that make it attractive and a possible of people to come and spend a meaningful part of their lives in these institutions and we're more depend on that as a country because we replace a larger swath of the government at these regular intervals important thing to recognize you know again we're reporting out front of the the costs of letting the defense's weaken a road over time the importance of a broader arsenal the importance of knowledge about what works but you know a lot of this is about the the depth and of talent in the institutions that ultimately would be necessary in a crisis mr. chairman this is your house you're the last word what was a pleasure an honor to work with these two men I think one of the things I was important is the avoidance of turf battles if you look at military histories you see even in a world war that the different services and the different groups are sometimes pushing against each other you know trying to protect their their turf we early on had a sufficient agreement about what the challenge was and what the risk was and had that we had common goals and we were willing to work for those common goals even sometimes at the expense of our individual bureaucracies or or departments so that was that was really critical and I want to I was going to say and I want to reiterate what Jim said about the quality of the bench and the quality of the people who are doing the analysis because all of these we talk about all these programs and these complicated capital injections and stress tests these require dozens if not hundreds of you know people who understood the technicalities of banking and regulation and supervision who were able to implement these programs successfully with no as far as I can recall no scandals no you know no favoritism no error is nothing it was just done extremely well and the quality of that execution was actually a very important part of this okay and and they worked for no bonuses we're gonna leave it there Chairman Bernanke secretary Paulson secretary geithner thank you thanks for watching be sure to LIKE and subscribe for more videos from Brookings [Music]

Channel: Brookings Institution

Views: 20,094

Keywords: Brookings Institution, Federal Reserve Chairman Ben Bernanke, financial crisis, great recession, finance, 2008 financial crisis, banks, banking sector, Ben Bernanke, Tim Geithner and Hank Paulson, U.S. economy, John R. Allen, Andrew Metrick, Andrew Ross Sorkin, Ben S. Bernanke, Tim Geithner, Hank Paulson

Id: je8IaqRcixM

Length: 85min 46sec (5146 seconds)

Published: Wed Sep 12 2018