[This book review was published in the Summer 2013 issue of The Journal of Social, Political and Economic Studies, pp. 210-220.]
After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead
Alan S. Blinder
The Penguin Press, 2013
Books about the Great Recession have come along in a natural progression. A first wave consisted of those written during the early months of the crisis, and gave much detail about the debacle and its causes. The second wave came after passage of the bailout bill (TARP) in late 2008 and the “stimulus package” (ARRA) in early 2009. The authors of those books were able to tell much about the immediate responses to the crisis, though they necessarily felt the need to precede this by retelling what the first books had covered. Now, as the years pass and the monetary and fiscal responses to the calamity give way to longer-term efforts at “reform,” a third wave of books will appear dealing with those later developments. But because each author sees his own contribution as not simply part of the flow, but as a “stand alone” explication that needs to be at least somewhat complete in itself, the books in this third wave will again go back over much of the ground covered by those in the first two and will thus devote only part of their attention to the reform phase.
Alan Blinder’s After the Music Stopped follows this pattern. It recapitulates the events of the crisis and its aftermath, but then goes into the later efforts at reform. A reader will find it significant that it is one of the early books in the third wave, and that for that reason it isn’t able to spell out the reforms as accomplished fact. This is because most of the reforms are still on the drawing boards. The writing was finished in late 2012, and as of that time Blinder found it necessary to report that the Dodd-Frank Act, the U.S. Congress’s massive financial reform statute in 2010, was “virtually never more than a skeleton” because “the sketchy… content… must be translated into concrete, detailed regulations by the agencies involved.” Nonetheless, what the author is able to do is valuable. He provides nuanced discussion of a good many reform proposals, and provides excellent quick-reference Tables which identify several issues, “key aspects of the debate” about each issue, what the U.S. Treasury Department’s reform proposal contained, and what was (and was not) included in the Act itself. As the third wave continues, there will no doubt be a vast future literature analyzing the financial regulations that emerge from the agencies that Dodd-Frank put in place.
In these pages, we have reviewed a number of books about the recent financial crisis written by eminent economists of various persuasions. Alan S. Blinder fits in well with that company. He served on President William Clinton’s Council of Economic Advisers, and from 1994 to 1996 was the vice chairman of the U.S. Federal Reserve’s Board of Governors. In addition to writing a monthly column for the Wall Street Journal, appearing in a variety of television discussions, and serving as vice chairman of a financial services firm, Blinder is the “Gordon S. Rentschler Memorial Professor of Economics and Public Affairs” at Princeton University. As a number of things he says reveal, his political persuasion aligns him strongly with the Obama administration and the Democratic Party, although this doesn’t prevent him from voicing independent, critical views when he thinks they are called for.
A reader who has not studied one or more books about the crisis will find After the Music Stopped an instructive place to start. Blinder is evidently quite a good teacher. This shows in his especially good explanation of several things, including, say, the SIVs (structured investment vehicles) which banks used as auxiliaries to allow them to build up much greater leverage (borrowing) than ordinary banking would allow. Other items of particular benefit include his account of the European debt crisis, and his explanation of Greece’s long financial plight. The book is not a textbook per se, and certainly avoids giving any dry-as-dust impression, but is clearly meant to be instructive.
His account of the causes of the Great Recession suffers, as do so many of the earlier books, from important omissions we will note later, but otherwise comports with the standard narrative, which points to abuses and failures of many kinds. We won’t survey all of that again here, but have noticed some specifics mentioned by Blinder that our readers will find valuable. * In the context of the criticisms that have been made of the computer models used by the financial institutions, Blinder tells us something quite surprising, that “many fancy mathematical models of risk were based on only three years’ worth of data or less.” * Severe problems with the American accounting system come to the fore when he reports the rather outrageous fact that “many CEOs were only dimly aware of all the SIVs, conduits, and other off-balance-sheet entities their companies had.” He says that “Lehman [i.e., Lehman Brothers, whose bankruptcy in September 2008 triggered so much panic] was using accounting subterfuges to conceal some of its debt.” * Blinder gives detail about the “hundreds of billions of dollars’ worth of embarrassingly bad subprime mortgages” when he recounts the total volume, as of 2005, as being $1.25 trillion. Most of these were originated, he says, by mortgage brokers “beyond the purview of the federal regulatory system,” since the brokerage houses weren’t banks. * He directs our attention to the fact that Congress explicitly mandated the non-regulation of derivatives in 2000, leaving a gaping hole in the regulatory system that, in various other connections also, proved a failure. * “Credit default swaps” (actually, insurance against the default of bonds or other securities) grew in volume from less than $1 trillion in 2001 to $62 trillion in 2007. Eighty percent of the CDS, Blinder says, were “naked CDS” – pure gambling contracts where the party insured didn’t have any sort of “insurable interest” (ownership or other connection) in the item being insured. Not only were these a blatant form of gambling on the buyers’ part; the firm providing the insurance wasn’t subject to insurance regulation and was free to sell its guarantees without having more than the flimsiest of capital to assure that it could perform as promised. AIG was the main culprit here, and in the midst of the crisis had to be “essentially nationalized,” with a $182 billion loan commitment from the U.S. government. (The government was eventually repaid this money, but only after the financial system had suffered through the equivalent of an epileptic fit.)
The tidbits just mentioned about the causes make the book well worth reading. Blinder goes on to give similar information about the Federal Reserve and Treasury Department’s responses. * He tells us, for example, about how the creditors of AIG, Bear Stearns, and the federal mortgage agencies Fannie Mae and Freddie Mac, were all paid 100% on the dollar, even though Sheila Bair, the head of the Federal Deposit Insurance Corporation, “argued vociferously” that the creditors should “take a haircut” (i.e., share in the losses). An odd thing that emerges from the narrative is that the very people whose wild risk-taking caused the crisis held the government hostage with regard to the form the response would take. Secretary of the Treasury Timothy Geithner told Congress that “if we had sought to force counterparties to accept less than they were legally entitled to, market participants would have lost confidence….” * This “tail wagging the dog” phenomenon appeared again as it kept the government from putting limits on executive compensation. Blinder says Geithner, wanting the big banks to “participate willingly” in their own bailout, “knew it wouldn’t happen if bank executives were forced to take pay cuts.” Accordingly, despite howls of protest from the American public, the huge bonuses kept coming to the people at the top of the failing financial institutions even as they failed.
Blinder explains that the Federal Reserve’s pumping of ever-more money into the economic system through years of “quantitative easing,” accomplished by the Fed’s massive purchases of securities, has been having the effect of building up the reserves held by banks. The “easing” has been done with the hope that the banks will use the money to make loans, thereby facilitating economic recovery. Instead, the banks have been sitting on the reserves, which constitute a vast source of potential inflation when finally the reserves are multiplied by loans made based on them. Fortunately, according to Blinder, the Federal Reserve has tools by which it should be able, when the time comes, to prevent inflation. It is reassuring, of course, to know that we can count on the perspicacity and timely action of the Federal Reserve.
He writes of “the half-hearted attack on the home mortgage foreclosure problem,” which is predicted eventually to see 10 million or more homes in foreclosure. If the federal government had lent what was needed (with perhaps claw-back provisions to recoup from the borrowers who were saved from foreclosure), “the net cost of avoiding millions of foreclosures might have been zero – or less.” A model for action could have been the Home Owners’ Loan Corporation, which in the 1930s bought up troubled mortgages and issued new loans to homeowners (in an amount that in present-day dollars would come to $800 billion). Blinder says that during the recent crisis Sheila Bair (who we remember was head of the FDIC) repeatedly questioned “why the government was so willing to bail out banks but so unwilling to bail out distressed homeowners.” He says “it was a good question that never got a satisfactory answer.”
It is surprising that, having reported the question, Blinder wimps out on it. Even though it is a question that goes to the heart of the response to the crisis, he leaves the subject without telling us whether a “rescue at the bottom,” so to speak, would not have kept the mortgage-backed securities from being “toxic.” It was a combination of the toxicity of the securities and the inability of the financial world to know which were toxic that so greatly undercut the financial position of investors and banks worldwide. By not discussing this, Blinder leaves a void of immense significance. If a systemic solution of Bair’s preferred sort could have been effected, did it make sense to do a “rescue at the top” rather than one that went to the heart of the problem and, by doing so, would have protected the “real economy” and have prevented financial losses to millions of people? It isn’t as though no one thought of this in the fall of 2008.
A final item we will mention about Blinder’s review of the responses to the crisis casts some light on how much the American political system and both of the major political parties and their presidential administrations are held captive, as so many commentators maintain, by “big money.” The “rescue at the top” exemplifies that. It is even more apparent in the lack of criminal prosecutions against those who committed the near-ubiquitous frauds that permeated the financial world. Blinder says that “while many of the victims were innocent, the perpetrators of the numerous frauds and near frauds were not.” And yet he tells us that, as of the time of his writing, there had been only one prosecution (which was of a relatively small case). “Can it really be true,” he asks, “that the U.S. Department of Justice could find no bigger cases to prosecute?”
As previously mentioned, Blinder includes a Table listing the key reform issues, with the principal questions that have been raised about each, and spelling out what the Treasury Department’s 2009 proposal contained and what was done by the Dodd-Frank Act in 2010.
On such a thing, for example, as financial institutions that are “too big [or interconnected] to fail,” debate has centered on whether the firms should be broken up, or if that is not done, how troubled firms should be handled, whether by ordinary bankruptcy proceedings or by a more streamlined administrative “resolution” process. We are shown that neither the Treasury nor the Dodd-Frank Act favored breaking them up, and opted instead for a newly-created resolution authority.
Neither of them calls for a reinstatement of the 1933 Glass-Steagall Act, repealed in 1999, which had kept commercial banks out of investment banking. Blinder supports this decision, arguing that commercial banks’ involvement in investment banking contributed rather little to the causes of the financial crisis. He sees proprietary trading by banks the same way, as “not what got us into trouble.” The Treasury proposal didn’t advocate reinstating the Volcker Rule against such trading, but Dodd-Frank does.
As to whether those who are involved in creating asset-backed securities should be required to have some money of their own at stake, Blinder reports that “intense lobbying by community banks got the 5 percent skin-in-the-game requirement… shifted from the originating banks, where Treasury had put it, to the securitizers, namely the banking giants and Wall Street firms.”
Some of the other reforms have to do with which agency should be assigned the task of being a “systemic risk regulator” to keep an eye on the overall health of the financial system (Dodd-Frank calls for the Federal Reserve to work with a newly-formed Financial Stability Oversight Council to this end); the creation of a separate Consumer Financial Protection Bureau located within, but independent of, the Federal Reserve; the regulation of derivatives; raising capital and liquidity requirements, with an application of them to off-balance-sheet entities, which we recall took on such extremes of leverage during the lead-in to the crisis. All of these require further fleshing-out, but some issues were more explicitly “kicked down the road”: for example, Dodd-Frank calls for “study” of the conflict-of-interest-creating incentives under which rating agencies have operated; little has been resolved about the “obscene levels” of executive compensation or the nature of executive incentives; and the restructuring of the system of mortgage finance awaits future action.
Blinder’s text discusses, of course, each of the issues. It is interesting that he does not attempt to point in the direction of a clear-cut solution for each; rather, we are told on several of them just how difficult the matter is, since there are complex interactions with lots of trade-offs. Much of the substance of reform awaits the enactment of new regulations (through a time-consuming and tedious process) pursuant to the rule-making powers granted by the Act to a variety of governmental agencies. Thus, as we indicated earlier, readers will find When the Music Stopped quite helpful in identifying the issues that are “on the plate,” but will have to wait for later books to say what eventually is done. It’s worth mentioning, as Blinder does, that bank lobbyists are actively fighting several of the proposed reforms. Blinder doesn’t dwell on it, but we know, too, that the American Right is currently imbued with a rather ardent opposition to “more regulation.” Given the forces at work, there is a not-inconsiderable possibility that little effectual will be accomplished to deconstruct the syndrome of short-sightedness and venality that led the United States, and with it much of the world, into the recent debacle.
Intellectual insufficiencies: little thinking “outside the box”
After the Music Stopped is characteristic of almost all of the literature about the financial crisis by staying within the invisible intellectual constraints that confine the discussion to conventional categories. No thought is given to whether the recent calamity should force a profound rethinking of the entire financial scaffolding of the global economy. In the 1930s, approximately 250 economists, led by some of considerable prominence at the University of Chicago, proposed “the Chicago Plan” to completely revamp the monetary and banking system, very much changing the nature of each. This was the subject of an article by this reviewer in our Fall 2011 issue. The proposal was lost sight of as the United States became engulfed by the war clouds that heralded World War II. It is surprising that “business as usual,” with of course considerable tweaking, remains the preoccupation of American economic thinkers.
Blinder is by no means unique in staying with the standardly-accepted nostrums. * In common with most others, he talks in terms of “jobs,” but without considering the on-rush of non-labor-intensive technology, the outsourcing and off-shoring that is concomitant with the United States’ role in the global market, or the impact of immigration, much of it illegal and indiscriminate, on the labor market. * He uses economic statistics without the myriad qualifications that are needed to understand the real meaning of almost any of them. * He discusses “bubbles,” but without expanding his view to take into account the herd phenomenon that can create a tidal wave out of the trillions of dollars sloshing around in the ocean of global finance, something that is taken very seriously by such authors as William Greider in his 1997 One World, Ready or Not and David Smick in his 2008 The World is Curved. * He devotes a chapter to the American national debt, speaking of the debt as “unspeakable” and “untenable,” but this doesn’t prompt him to discuss the tremendous inefficiencies of, and leakages from, the income tax system, and whether the substitution of a Value Added Tax (VAT), as advocated by a number of economists, would provide a vastly improved source of revenue.
Some of Blinder’s omissions may result from his political orientation. * He conforms to the usual “political correctness” that so assiduously ignores the role that American racial policies played in bringing about the subprime mortgage fiasco, which involved home loans granted with little documentation, or no documentation, or based on false information about the borrower’s income (so-called “liar loans”), or even on a NINJA basis (which, as Blinder explains, is an acronym for loans to “people with no income, no jobs, and no assets”). * His discussion of the Obama administration’s mortgage modification program falls far short of candor. He says little about the program’s snail’s pace and paltry augmentation, its administrative complexity, the severe problems with the “mortgage servicers” to whom the job was assigned and who were incentivized to serve themselves rather than the homeowners, the Treasury’s effort to warp the statistics to make the program look more successful than it was, or about the meager results that benefitted relatively few distressed borrowers. * He praises the “stimulus program,” enacted in the first weeks of the Obama administration, as having “scored pretty well,” and says the $830 billion went mostly to tax cuts, infrastructure spending, and aid to state and local governments. One would imagine that an economic stimulus program would be spent rather rapidly, since its purpose was to kick-start the economy into action; but Blinder takes little account of the program’s having been spread out over as much as ten years. Nor does he pay close attention to what the sponsored projects were. As we said in our review of a David Wessel book, “the projects included a medley of (1) spending to satisfy a long-preexisting wish-list favored by the American Left; (2) pork-barrel spending to benefit local constituencies and the electoral interests of congressmen who represent them; (3) items pressed for by powerful lobbies; and (4) the initiation of what can best be seen as a ‘national industrial policy’ along environmentalist lines.”
Thus, we end our review as we have with so many others relating to the financial crisis, by pointing to the book’s weaknesses and omissions and then reminding readers of all the good things we have said about the book earlier in the review. Alan Blinder’s After the Music Stopped is in many ways instructive, and well deserves a place among the many excellent books on the crisis. We haven’t mentioned, but should, that it is written to be easily understood by the average intelligent reader.
Dwight D. Murphey
 TARP is the acronym for “The Troubled Assets Relief Program,” which was first presented as a vehicle for the government’s purchase of toxic securities but was soon changed into a means to inject capital into the troubled banks. $700 billion was authorized, but Blinder points out that (only) about $430 billion was actually disbursed. Most of the money was eventually repaid to the government, so that Blinder reports that a March 2012 estimate was that “the TARP’s ultimate net cost to the taxpayers was just $32 billion.”
 ARRA was the “American Reinvestment and Recovery Act,” also known as “the stimulus package.” It started as a $787 billion package, but wound up costing $830 billion.
 The Dodd-Frank Act became law in the U.S. on July 21, 2010.
 These reviews may all be found in the issues of this Journal since 2008, and may also be accessed, free of charge, at www.dwightmurphey-collectedwritings.info either in the Articles section as Book Review Articles or in the Book Review section.
 Blinder says “in total, the wealth of U.S. households fell by something on the order of $18 trillion” [his emphasis].
 The economist Paul Craig Roberts was one who did. See our review of his book How the Economy Was Lost, in the Fall 2010 issue of this Journal. It appears as BR140 (i.e., Book Review 140) on the web site referred to in Footnote 4 here.
 In comparison to the inaction of the Obama administration in this regard, we recall that economist Pat Choate urged strong measures which he believed are important to restoring the world’s confidence in the American financial system: he went so far as to suggest that the executives of all firms that failed, or that had to take bailout money, because of “overexposure to subprime mortgages” be banned for life from “working in the securities and financial industry.” See the review of his book Saving Capitalism in our Spring 2010 issue. The review appears as BR134 on the web site identified in Footnote 4.
 Entitled “Capitalism’s Deepening Crisis: The Imperative of Monetary Reconstruction,” it can be accessed as A105 (i.e., Article 105) on the web site previously referred to. The American Monetary Institute also promotes the Chicago Plan, although in a significantly different form (as explained in the article) than this reviewer advocates.
 See this reviewer’s article “Today’s Economic Statistics: Poorly Suited When Put Forward as Measures of Well-Being” in our Fall 1997 issue. It is found as A72 on the web site (see Footnote 4 here).
 See this reviewer’s book review article (A102 on the web site we’ve referred to) entitled “Responses to the Great Panic – and Some Questions They Raise,” published in our Spring 2010 issue.