[This review was published in the Summer 2016 issue of The Journal of Social, Political and Economic Studies, pp. 95-105.]

 

Book Review

 

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

Ben S. Bernanke

W. W. Norton & Company, 2015

 

Alan Greenspan.[1]

Henry M. Paulson, Jr.[2]

Timothy Geithner.[3]

Sheila Bair.[4] 

Neil Barofsky.[5] 

Elizabeth Warren.[6] 

Each these leading figures during the Great Recession has published a memoir reviewed in this journal (i.e., The Journal of Social, Political and Economic Studies).[7]  With Ben Bernanke’s The Courage to Act, we are now able to review the one memoir that has been needed to complete the circle.  Bernanke served as Federal Reserve chairman from February 2006 to January 2014, a period that spanned the year and a half preceding the crisis and approximately six and a half years after it started.

A caution: our criticisms should not be taken to obscure the fact that Bernanke is a brilliant and accomplished man.  Born in 1953, he achieved academic excellence at Harvard University and the Massachusetts Institute of Technology (MIT).  He served six years as the chair of the economics department at Princeton University, and was editor of the American Economic Review.  His appointment to the Federal Reserve Board in 2002 was followed by his eight-year service as its chairman.  To recite these things is merely to give the highlights of an impressive record. 

His memoirs provide a chronological narrative of his life, with emphasis on his and the Federal Reserve’s role during the tumultuous years of the financial crisis.  The narrative contains much discussion of policy issues, although a serious student of those issues will wish there were more.  In War and Peace, Leo Tolstoy took off from his story-telling to include long essays on the philosophy of history.  Something akin to that, placed perhaps in appendices, would be most welcome here. Just the same, an editor would not be unreasonable in thinking it best to make two books out of it: the present personal narrative, and a follow-up book for that deeper analysis. 

 We will give a chronology of the financial crisis and of the steps taken to combat it.  Although that is valuable in itself, as well as illustrating the book’s vast information-content, we will give a more prominent place to a critical examination of Bernanke’s thinking by placing it near the beginning of this review.

Some important observations 

            While at MIT, Bernanke found Milton Friedman and Anna Schwartz’s A Monetary History of the United States fascinating, and “became a Great Depression buff,” believing with Friedman and Schwartz that “the collapse of the money supply in the early 1930s, rather than the Great [stock market] Crash, was the more important cause of the Depression.”  Bernanke explains that until the Friedman/Schwartz book “the prevailing view – based on John Kenneth Galbraith’s 1954 book The Great Crash, 1929 – was that the Depression was triggered by the speculative excesses of the 1920s and the ensuing stock market crash.”  A section in the memoir tells about the developments in economic theory from the 1930s to the present, and Bernanke indicates that he is a party to the “new Keynesian synthesis” that “undergirds the thinking of most mainstream economists today.”  This is a viewpoint that differs from an idealization of a market economy as a perfectly tuned instrument and from the position that in a financial crisis it is best to “let the bottom fall out” so that the economy can more quickly start its rebound.  Instead, it holds that market failures make an active monetary and fiscal response imperative “to restore full employment and normal levels of inflation,” along with “financial stability and normal flows of credit.”

This emphasis on monetary and fiscal policy seems to this reviewer to leave Bernanke, and indeed the “main body of economic thinking” of which he speaks, to have been seriously “behind the curve” in understanding the more important issues facing the American economy.  Monetary and fiscal policies have no doubt been important, but they are by no means sufficient, as a number of authors both before and after the Great Recession have made clear.  (Those commentators have not, however, been within that “mainstream.”)

Using the hindsight that is now available to us all, Bernanke describes the viruses that came to infect the financial system and led to the crash.  He says “we were not entirely unaware of or unconcerned about the risks….” (our emphasis).  In fact, he says “I argued for more systematic monitoring of threats to the financial system.”  But it is impossible to read The Courage to Act without sensing that the rot (of perilous risk-taking, incredible leverage, abandoned home mortgage loan standards, short-sighted profit-seeking, credit reporting agencies’ conflicts of interest, and opaque securitization that facilitated the sale of bad and barely understood investments throughout the world) occupied a rather small niche in his thinking.  “Not entirely unaware” is an apt description of the failure to grasp the situation within the financial world.  Bernanke says Galbraith pointed to “speculative excesses in the 1920s,” but that this concern was overridden by insights into the collapse of the money supply.  It is too bad that in the lead-up to 2007 both could not have been taken seriously together.

Bernanke agrees with Alan Greenspan in thinking that it is very difficult for the Fed to discern whether a “bubble” is occurring, such as in the housing market.  We can’t help but think that this is a place where greater awareness of what is actually going on in the financial industry will help.  When the price of homes becomes far out of proportion to the earnings of the buyers, when the prices have been on a continual rise, when large numbers of home loans are being made in total disregard of prudent lending standards, when hundreds of millions of dollars of foreign money are flooding the housing market through the worldwide sale of mortgage-backed-securities – all of these (and perhaps more) are visible indicia of a bubble.  Were they not visible to the Fed? 

The rot went even further than we have suggested by the list of the abuses.  What had happened was that the financial system had become an integral part of what today is called “crony capitalism.”  The literature makes much mention of the “moral hazard”[8] that is created when financial firms become convinced that any amount of (incredibly profitable) risk can be taken on because, after all, the government will bail out the risk-takers when things go to smash.  Even after all the uproar over the bailouts during the crisis and after the Dodd-Frank financial reforms, passed in mid-2010, barred future bailouts and provided a mechanism for the orderly “resolution” of failing financial institutions, a commentator for the New York Times reports that “there are many people who remain convinced that the government will never have the nerve to let an important institution actually fail.”[9]  Writing in 2011, he cited as evidence the fact that “the big banks currently have a much lower cost of capital than their smaller brethren precisely because the bond market doesn’t believe they will ever be allowed to fail.”  Timothy Geithner, Ben Bernanke and the other principals in the frantic effort to save one institution after another in 2008 were, whether they could avoid it or not, caught up as instruments in the “crony capitalist” marriage of big money and government.  As readers of their memoirs we agonize with them as they narrate their day-to-day struggles during those months.  If we detach ourselves from the intimacy of that involvement, however, we see that the whole system was profoundly deviant.  The responsibility for that falls not on any single individual, but on a long-term intellectual, political, institutional and cultural failure.

As the United States went through yet another “jobless recovery,” with corporate profits increasing rapidly at the same time there was stagnation in employment, another reason for thinking the  monetary and fiscal policy makers such as Bernanke are “behind the curve” is that they virtually ignore the non-monetary factors such as technology, globalization, imports, off-shoring and immigration.  As this reviewer studied The Courage to Act, he noted, over and over again, the places where Bernanke’s discussion ignored the tidal wave of those real forces.[10]  An example is where he speaks of “our means of combating high unemployment – stimulating demand by pushing down… interest rates….”  Another is where he joins the conventional call for more “education and skills training.”  He hardly notices that the United States has lost much of its productive economy, and that that has a bearing on the job market; that workers at all skill levels are being supplanted by computer-driven automation; and that millions of immigrants, many in the United States illegally, have competed at low wages for work as roofers, taxicab drivers, lawn care providers,  motel cleaning women, and the like, all asserted sophistically to be “jobs Americans won’t do.”  Instead, the mantra is to juice up the economy with easier credit and tons of new money, and that that will take care of it.     

This failure to take into account the forces that are eating away at employment has its roots in long-standing economic thinking.  The premise that employment is a function of monetary policy was written into the “dual mandate” assigned to the Federal Reserve by law in 1977.  Bernanke tells us the Fed was “directed to pursue both ‘maximum employment’ and ‘price stability.’”  This was without giving the Federal Reserve any power over technology, immigration and the other factors (which the Fed could not control, of course, even if Congress had been fanciful enough to lay them in its lap).  The suggestion has been made that it is time to drop the employment side of the mandate.  To do so would help focus attention on the non-monetary forces eating away at employment.

It isn’t our intention to be unkind to a brilliant man who gave of himself so devotedly in the service of his country as he faced the long agonies of the financial crisis, but our critique of his role calls for at least one additional point.  The tension between those who led the bailouts of the “too big to fail” institutions and thought it necessary to treat the financial titans with kid gloves, on the one hand, and the overseers of the bailouts (Neil Barofsky as special inspector general, Elizabeth Warren as chair of Congressional oversight, and Sheila Bair at the FDIC), on the other, is accurately thought of as a tension between those who identified with “the banking elite” and the “populists” whose sympathies were with “Main Street.”  Bernanke‘s memoir shows that he was clearly among the first of these.

Secretary of the Treasury Timothy Geithner argued in his own memoir that great care had to be taken not to threaten the interests of the big banks and their executives, because to do otherwise was likely to cause “panic” or “contagion” or their “non-cooperation.”  Bernanke discusses this, pointing out that “many in Congress wanted to cap pay at financial institutions that benefited from taxpayer dollars… Even before the crisis, many people saw financial executives’ big paychecks as unfair.”  Although he recognizes that point of view, he joins Geithner when he writes that “as a practical matter, if the conditions for participation in TARP [the bailout] were too onerous, firms would do what they could to stay away”[i.e., stay away from the billions of dollars about to be bestowed upon them].    When AIG was bailed out, “we essentially allowed AIG’s counterparties – most of them large financial institutions, some of them foreign – to receive the full benefit of the insurance [AIG had sold them to cover their mortgage-backed-securities].”  The question was asked, “Why had we not insisted that those counterparties, which included companies like Goldman Sachs, bear some losses?”  Bernanke’s response:   “We had no legal means to force reductions.”  The lack of will apparent in this explanation stands out too  starkly to be ignored.  We are to believe the Fed and Treasury had no negotiating leverage, or even power of persuasion, with people who were on the taking-end of several billion dollars.  There were people and firms profiting magnificently from the debacle, as we see when we are told that after a “package to stabilize Citigroup” went into effect, “Citi’s stock price soared nearly 60 percent.”  Many of those profiting had been parties to the malfeasance that produced the crisis.  To argue that there was no way they could be brought to share in the misery is to show the “affinity for the banking elite” that set Geithner, Bernanke, et. al., apart from their “populist” critics.

The elitism is also apparent in Bernanke’s semantics.  There are a number of places where Bernanke writes disparagingly of “populists.”  Although he acknowledges that “a dose of populism is healthy for any democracy [because] it reminds us that the government is supposed to serve the people,” his emphasis is always negative, even when speaking not of ignoramuses but of the likes of Sheila Bair and Elizabeth Warren.  “In extreme forms, populism can lead to cynical manipulation” – and the apparent presumption is that appeals to the common citizens’ interests are almost inevitably of that nature.  That presumption is rooted, of course, in a low opinion of the ordinary citizen’s mentality, which is considered easy prey for “manipulation.” 

This is the way an elite perceives the bulk of humanity.  It may be well-founded in many historical circumstances.  Indeed, we agree with John Stuart Mill’s thinking that a free society, as much as any other, needs a leadership strata.  But not just any elite will do; to satisfy the need Mill had in mind, it must be one that identifies with and bolsters the society at large.  For an elite to look down condescendingly on the American “Main Street” disparages a principal tenet of a free society – that the people, even with all their foibles, are capable. 

We do not mean to overstate Bernanke’s “elitism.”  He comes through clearly as a man of good will.  But, as we said when we discussed “crony capitalism” above, a central fact about the United States in recent decades has been the two-party “duopoly” in which the two main political parties, the Congress and the executive branch of government have been married to lobbyists, major corporations, and the enormous financial firms.  It is in the context of that fact that the elitism must be duly noted, even at the cost of appearing ungracious.

Chronology of the crisis and of the responses to it

            The day-to-day narrative in The Courage to Act conveys much information.  We have distilled the following chronology for the value it may have to readers.  It is, of course, far from exhaustive.

            The housing crash is said to have started on August 9, 2007, when France’s largest bank, BNP Paribas, “barred investors from withdrawing money from three of its investment funds that held securities backed by U.S. subprime mortgages.”  The event spread panic among investors around the world as they came to realize they held securities of unknowable value.  There was an immediate impact on the short-term funding market in the United States.

            The definitional criterion for a “recession” is well established as being when the country’s gross domestic product is negative for two consecutive quarters.   The National Bureau of Economic Research is looked to to establish the dating for a recession’s beginning and end.  The “Great Recession” is said to have started in December 2007 and ended in mid-2009.

            In March 2008, the Fed bailed out Bear Stearns, the fifth-largest American investment company, with a $30 billion loan. Sheila Bair has suggested that this had the effect of increasing the moral hazard within the financial community, since the large firms didn’t take heed of the Bear Stearns plight but instead continued their high-risk leverage, lurching toward the crisis that came to a head for them that fall.

            Indeed, the bottom did fall out in September 2008.  The U. S. government seized and placed in conservatorship Fannie Mae and Freddie Mac, the two huge “government-sponsored enterprises” that together either “owned or guaranteed about $5.3 trillion in U.S. mortgages.”  The fourth-largest investment bank, Lehman Brothers, took bankruptcy, with devastating effects.  [Bernanke takes pains to counter the general impression, which at one time he encouraged, that he “let it happen”; he explains that he didn’t have the legal authority to act, because Lehman lacked the “adequate collateral” that the Fed would lawfully have needed.]  The Treasury used the Exchange Stabilization Fund (created in the 1930s)  to provide guarantees to stop a run on the money market funds.

            It was during the fall of 2008 that frantic day-to-day arrangements were made to keep one large financial firm after another from failing.  A major development, which Bernanke refers to as “a decisive turning point,” was the administration of “stress tests” on the banks.  When the results were made public and showed that most banks had enough capital, “the private sector became willing once again to invest in U.S. banks.” 

            The bailout bill known as TARP, for “Troubled Asset Relief Program,” was voted down in Congress on September 29, but then passed by both houses within less than a week.  Although it was presented to Congress as being for the purchase of billions of dollars’ worth of “toxic assets,” there was an almost immediate change of direction, with the money being used for “capital injection” into the banks by the government’s purchase of newly-created non-voting preferred stock, which would not give the government control, but would allow the taxpayers to benefit from any later rise in the stocks’ value.

            TALF (the Term Asset-Backed Securities Loan Facility) was created in late November.  It featured government loans to investors to buy any of a variety of AAA-rated securities (such as student loans, credit card loans, and commercial mortgages).

            In December, TARP funds were used for the bailouts of the automotive companies General Motors and Chrysler, and their financing arms.

            The “stimulus package” known as ARRA (American Recovery and Reinvestment Act of 2009), amounting to $787 billion, became law on February 17, 2009.  $288 billion was used for tax reductions, including the Social Security payroll tax; $144 billion went to help state and local governments; and the remaining $355 billion funded “diverse federal spending programs.”          

            The home mortgage relief programs HARP and HAMP (Home Affordable Refinance Program and Home Affordable Modification Program) were set up on February 18.  HARP was to benefit homeowners whose homes were worth less than their Fannie Mae or Freddie Mac mortgages, but who were still current on their payments.   HAMP applied to all mortgages, and was to help homeowners who were behind on payments.  We are told the results of both programs were disappointing. The FDIC started its own mortgage modification program in July 2008.

            Among the other programs created early in the recession were: TSLF (Term Securities Lending Facility), to lend Treasury securities to primary dealers;[11] TAF (Term Auction Facility), to help with longer-than-overnight borrowing from the Fed; PDCF (Primary Dealer Credit Facility), for primary dealers to borrow from the Fed; TLGP (Temporary Loan Guarantee Program), under which the FDIC insured new senior debt and extended its deposit insurance broadly to cover business, government and non-profit accounts; and the CPFF (Commercial Paper Funding Facility), for loans by the Fed to firms by buying the firms’ commercial paper, which the firms would later repurchase.  [Readers will be glad to know we are just kidding when we say they will be tested on all this in the next issue.]

            The Federal Reserve had started its “quantitative easing” (LSAPs, or “large-scale asset purchases”) in August 2007 when the housing crisis became apparent.   A little more than a year later, the program pumped $70 billion into the economy in response to the Lehman failure.  It was expanded in March 2009, and Bernanke says it eventually led to the purchase of “hundreds of billions of dollars of securities.”  Various phases of quantitative easing continued over several years, and for many months lowered the interest rate on deposits to virtually zero.

            The monetary-policy aspects of all this, and much more besides, fell within the four main response elements listed by Bernanke: lower interest rates, emergency liquidity, rescues, and stress test disclosures.

The aftermath and reforms

            The Dodd-Frank Wall Street Reform and Consumer Protection Act was signed on July 21, 2010.  It established a framework for reform, but Bernanke agreed with Senator Dodd that “much work remains to be done,” because it needed to be fleshed out with hundreds of new regulations and studies.  Bernanke speaks well of the reforms, expecting them to “create a financial system that is significantly safer.”  He devotes five pages to summarizing its provisions:

            .  “The Fed would become the regulator of systemically important financial institutions, including non-banks “such as the Wall Street investment firms and huge insurance companies like AIG.”

            .  “Tougher capital and other standards” would be devised for firms designated as systemically important by the newly-created Financial Stability Oversight Council.  These standards would even apply to “foreign-owned banks operating in the United States.”

            .  The Office of Thrift Supervision was dropped and a new Consumer Financial Protection Bureau created, assigned responsibility for protecting those who use financial services.  Elizabeth Warren, later elected U.S. Senator from Massachusetts, was put in charge of getting the CFPB started.

            .  “One of the most important reforms,” Bernanke says, “was the new authority to unwind failing, systemically important financial firms.”  This “resolution” process is assigned to the FDIC, which can run the firm, honor the obligations to secured creditors while imposing losses on those who are unsecured, repudiate contracts (such as bonus contracts), and fire the top executives.  If the FDIC suffers losses, it can recoup by an assessment against large firms.  The big firms are required to produce “living wills” with plans about how they can be resolved without hurting the financial system. 

            .  The “Volcker rule,” named after the earlier Fed chairman Paul Volcker, was enacted   With exceptions, the rule bans “banking companies from short-term trading of many securities, derivatives, and commodity futures and options.”

            .  Bernanke says the business left unfinished by the Act includes “the status of Fannie Mae and Freddie Mac,” and “the vulnerability of money market funds and the repo market to runs.”  In a serious omission, he makes no mention of the problem of “lack of insurable interest” in the insuring of derivatives by the likes of AIG.  In the lead-up to the crash, firms that had no ownership or other interest in a security could nevertheless take out insurance on it – a form of pure gambling that is strictly prohibited in property and life insurance. 

 

The literature that has grown up about the Great Recession, including the memoirs of all the principal “first responders” in government and the commentaries of many knowledgeable observers, is massive.  The crisis is one of the most thoroughly reported events in economic history.  The Courage to Act and other memoirs take their place as not just readable, engrossing accounts, but as first-person historical documents.

 

Dwight D. Murphey

 

Endnotes

                         

1  Greenspan was chairman of the United States’ central bank, the Federal Reserve, from 1987 1to 2006.

2  Paulson was U. S. Secretary of the Treasury, July 2006-January 2009.

3  Geithner was president of the New York Federal Reserve Bank before serving as the U. S. Treasury Secretary from January 2009 to January 2013.

4  Bair was head of the Federal Deposit Insurance Corp. (FDIC) from June 2006 to July 2011.

5  Barofsky was the special inspector general for oversight of the Troubled Asset Relief Program (TARP; the “financial bailout”) from December 2008 to March 2011.

6  Warren was chair of the Congressional Oversight Panel regarding TARP from early 2009 to September 2010.  She is now a U. S. Senator.

7  Here are the respective reviews, with information about when we published them and where they may be found (for access free of charge) on www.dwightmurphey-collectedwritings.info :

Henry M. Paulson, Jr.’s  On the Brink: Inside the Race to Stop the Collapse of the Global Financial System, our Fall 2010 issue, website Book Review 141;  

Alan Greenspan’s The Age of Turbulence, reviewed in our Winter 2010 issue and accessible on the website as Book Review 142;  

Neil Barofsky’s Bailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street, our Fall 2012 issue, website Book Review 154; 

Elizabeth Warren’s A Fighting Chance, our Fall 2014 issue, website Book Review 177;

Book review article, “Sheila Bair on ‘The Great Recession,’” our Winter 2012 issue, website Article 108.

Book review article, “A Preeminent Book on the Financial Crisis: Timothy F. Geithner’s Memoir as Secretuary of the Treasury,” our Winter 2014 issue, website Article 114.

8  “Moral hazard” is a term that comes out of the insurance industry, and refers to a person’s propensity toward taking greater risks if he knows his insurance company, and not himself, will be paying for any loss. 

9 See op-ed columnist Joe Nocera’s New York Times Magazine interview with FDIC chair Sheila Bair in the July 9, 2011, issue of that magazine.

10 In Martin Ford’s Rise of the Robots: Technology and the Threat of a Jobless Future (Basic Books, 2015, p. 37), Ford refers to the 2007 edition of a textbook on economics co-authored by Bernanke, and says the book “suggests that slow wage growth from 2000 on may have resulted from ‘the weak labor market that followed the recession of 2001’ and that wages ought to ‘catch up to productivity growth as the labor market returns to normal’ – a view that seems to ignore the fact that the tight correlation between wage and productivity growth began to deteriorate long before today’s college students were born.”

11  A “primary dealer” is a firm that serves as a middleman for government securities by buying them from the government and reselling them.

 

 

 

 

           

 

 

 



[1]  Greenspan was chairman of the United States’ central bank, the Federal Reserve, from 1987 to 2006.

[2]  Paulson was U. S. Secretary of the Treasury, July 2006-January 2009.

[3]  Geithner was president of the New York Federal Reserve Bank before serving as the U. S. Treasury Secretary from January 2009 to January 2013.

[4]  Bair was head of the Federal Deposit Insurance Corp. (FDIC) from June 2006 to July 2011.

[5]  Barofsky was the special inspector general for oversight of the Troubled Asset Relief Program (TARP; the “financial bailout”) from December 2008 to March 2011.

[6]  Warren was chair of the Congressional Oversight Panel regarding TARP from early 2009 to September 2010.  She is now a U. S. Senator.

[7]  Here are the respective reviews, with information about when we published them and where they may be found (for access free of charge) on www.dwightmurphey-collectedwritings.info :

Henry M. Paulson, Jr.’s  On the Brink: Inside the Race to Stop the Collapse of the Global Financial System, our Fall 2010 issue, website Book Review 141;  

Alan Greenspan’s The Age of Turbulence, reviewed in our Winter 2010 issue and accessible on the website as Book Review 142;  

Neil Barofsky’s Bailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street, our Fall 2012 issue, website Book Review 154; 

Elizabeth Warren’s A Fighting Chance, our Fall 2014 issue, website Book Review 177;

Book review article, “Sheila Bair on ‘The Great Recession,’” our Winter 2012 issue, website Article 108.

Book review article, “A Preeminent Book on the Financial Crisis: Timothy F. Geithner’s Memoir as Secretuary of the Treasury,” our Winter 2014 issue, website Article 114.

 

 

 

 

 

[8]  “Moral hazard” is a term that comes out of the insurance industry, and refers to a person’s propensity toward taking greater risks if he knows his insurance company, and not himself, will be paying for any loss. 

[9] See op-ed columnist Joe Nocera’s New York Times Magazine interview with FDIC chair Sheila Bair in the July 9, 2011, issue of that magazine.

[10] In Martin Ford’s Rise of the Robots: Technology and the Threat of a Jobless Future (Basic Books, 2015, p. 37), Ford refers to the 2007 edition of a textbook on economics co-authored by Bernanke, and says the book “suggests that slow wage growth from 2000 on may have resulted from ‘the weak labor market that followed the recession of 2001’ and that wages ought to ‘catch up to productivity growth as the labor market returns to normal’ – a view that seems to ignore the fact that the tight correlation between wage and productivity growth began to deteriorate long before today’s college students were born.”

[11]  A “primary dealer” is a firm that serves as a middleman for government securities by buying them from the government and reselling them.