In David Wessel's book, In Fed We Trust, he delivers a riveting play-by-play account of the worst financial crisis since the Great Depression by narrating the actions of the key persons tasked with managing it – Federal Reserve Chairman Ben Bernanke and Treasury Secretaries Hank Paulson and Tim Geithner. In the Great Panic, as Wessel has termed it, the role of the Federal Reserve was pushed into prominence as it acted as first, and often times, only responder to the financial crisis. Calling upon its broad powers in new and unorthodox ways, the Fed was able to avert a complete and utter meltdown of the global financial system – a situation that would have shaken the very foundations of capitalism.
Overview of Contents
To summarize the contents of Wessel's brilliant narration, he immediately takes readers into the fire with a look at the most pivotal moment of the Great Panic – September 14th through 18th when Lehman Brothers was left to fail and the crisis took a dramatic turn. Following this is a brief account of panics past, the Federal Reserve's history, Greenspan's role, and Bernanke's rise to become Fed Chairman. Once the stage is set and main character identified, Wessel moves through the events of the Great Panic chronologically as it began in August of 2007 and continues until it showed signs of abating twenty-two months later.
Three men played critical roles in managing the Great Panic and Wessel takes readers beyond a simple recounting of their actions; he details each man's personality characteristics and how this shaped outcomes. This adds a great deal of depth to the work, as the key players' personalities made a significant impact on the effects their decisions had on the financial system, and more importantly, the psyche of the markets. With Bernanke's calm demeanor contrasted with Paulson's more boisterous and, at times, impetuous personality, Wessel is able to show how well each performed in what he termed the 'theater' aspect of the job.
In a financial crisis, not only do the key figures need to get the substance – changes to interest rates, the money supply, etc. - right, but they must also convey these actions to the markets on a very public stage. If the right policy decision is made but is poorly conveyed to the markets, it can negate its effectiveness. As Wessel points out, this happened on more than one occasion with Paulson and Geithner more prone to gaffs in the public eye than Bernanke. The results of these missteps were added financial pain and a deepening of the crisis.
Perhaps the greatest problem on stage for the three men was in the seemingly always changing game plan on how to handle the Great Panic. They acted to save Bear Stearns, but left Lehman Brothers to fail. Wachovia found shelter, but Washington Mutual was left to its demise. As Wessel explains, there were good reasons for this, but the net effect of their performance was to temporarily erode market confidence as it appeared there was little consistency in their decisions.
However, even with these issues, the three were able to get more right than wrong. Once the Great Panic was in full swing, they adopted the mantra of 'whatever it takes'. This meant they would do what was necessary to stop the unhinging of the financial system, using a variety of tools and powers that were previously either never used or hadn't been seen in a very long time. On balance, the key players did enough right to get the job done.
The Federal Reserve's Role
Traditionally, the Federal Reserve has the function of controlling the money supply and thereby setting key interest rates – on the surface, a boring endeavor. During normal market conditions, the Fed is primarily charged with keeping inflation under control and promoting policies that will help the U.S. economy grow at reasonable and sustained rates. This is generally accomplished through targeted interest rates that signal to the market what can be expected in the near term.
A critically important aspect of the Federal Reserve is that it operates independently of the political process. This is by design, because when the Fed was established nearly a century ago, legislators wanted to be sure that it could act swiftly and decisively to stabilize the financial system whenever a panic arose (panics were common prior to the Fed's creation). This would prove to be invaluable over the course of the Great Panic, as Wessel shines a bright light on the stark contrast of the Fed's ability to act versus that of Treasury and Congress.
Expanded Powers, Creativity
Though the Fed's role during normal circumstances can appear relatively mundane, when a financial emergency arises, it can become the most dynamic organization in the world of finance. During the crisis, the Fed acted as first responder to the panic that was laying waste to the markets. This was the quick and decisive action that legislators had planned for when the Fed was created and its powers expanded over the following decades.
However, the Great Panic demanded far more from the Fed than could previously have been imagined. As Wessel points out, the Fed had to push the limits of its powers and become increasingly creative in the formulation of its response to the greatest threat to the American financial system since the 1930s. The chief problem facing the Fed was a rapid decline in the flow of credit among financial institutions.
To get credit flowing again, the Fed assumed its role as “lender of last resort” and created new lending facilities on the fly. After cutting interest rates by a total of 5.25% over a short span, the Fed continued to face seizing credit markets. As a result, much more needed to be done.
This resulted in the creation of a number of new lending facilities with varying acronyms to help the Fed fulfill its role in fighting the crisis. Among these newly created facilities were the Term Auction Facility (TAF), the Term Securities Lending Facility (TSLF), and Primary Dealer Credit Facility (PDCF). Through these lending facilities, hundreds of billions of dollars were pumped into the markets in an effort to get the flow of credit moving.
The Fourth Branch of Government
The fact that the Fed could unilaterally create hundreds of billions of dollars in money with no oversight or Congressional review demonstrates that it is the fourth branch of government. Though this may appear to be a frightening proposition, the Fed's unique role in the economy demands this to be so. Without this level of independence, it is clear that its response time in an emergency would be slowed and this would be disastrous to the financial system.
This truth may be easily understood by those familiar with history or economics, but it appeared to be lost on the general public. There was a loud and growing sentiment on Main Street that the Fed and Treasury were pawns of Wall Street. This could not be further from the truth. What happens on Wall Street was, is, and always will be inextricably linked to Main Street as would be demonstrated in the months following the height of the Great Panic.
An important note should be made here. While the Fed certainly pushed the boundaries of its power, it also recognized its limits. When the Fed and Treasury went to Congress to ask for help to the tune of $700 billion in taxpayer funds, the Fed knew that it had reached the edge. This respect for the boundaries of the Fed's power is important to understand as many are now calling for closer oversight of the Fed – a grave mistake should these actions be taken.
As the process of passing the Troubled Asset Relief Program (TARP) clearly demonstrated, politics should never be inserted into the emergency response to financial crises. The House of Representatives voted down the measure on Monday, September 29th and the consequence was a loss of $1.2 trillion in wealth in a single day. Though TARP would eventually be signed into law, this delay at the hands of politics remains the loudest endorsement of protecting the Federal Reserve's independence.
Decision-making Under Pressure
When the subprime crisis escalated and was transmitted to other parts of the financial system, it became clear that unusual action would need to be taken. With frozen credit markets that were proving difficult to thaw, financial institutions were buckling under the strain. The first major institution to receive a 'bailout' was Bear Stearns, a large investment bank that was under attack because of its exposure to complicated financial instruments related to subprime mortgages. Unable to obtain credit to finance its portfolio, the company was in serious trouble.
This was crunch time for the Fed, as a Bear Stearns failure would dramatically accelerate the financial panic that was underway. With only a few days to make a decision, Bernanke and Paulson determined that Bear must be saved. To make this happen, the Fed had to find a buyer – a process that would normally take months – in just four short days. JP Morgan-Chase was the only candidate that was willing to absorb Bear, but the Fed had to do it at a price.
As Wessel walks through the litany of major financial institutions that were either saved or lost, he makes the assertion that the Fed was forced into the business of picking winners and losers. Who would be saved and who would be allowed to fail was not always at the discretion of the Fed. On at least one occasion, Washington Mutual, Bernanke and Paulson were overridden by FDIC head Sheila Bair. On another occasion, Lehman Brothers, a buyer could not be found. Regardless of the outcome, Bernanke, Paulson, and later, Geithner would have to make snap decisions with enormous impact to the financial system.
While it is still too early to give an authoritative response, Wessel is generally positive in his assessment of the Fed's handling of the Great Panic. He acknowledges that its initial response was timid and that the Fed greatly underestimated the scope of the problems facing the financial system. However, his overriding belief is that the Fed's “whatever it takes” attitude and its bold actions ultimately saved the financial system from certain failure. In the closing pages, he asks (paraphrasing), “If the Fed had not acted so boldly and decisively, what would the world look like today?” Just a guess, but the world would likely be a far, far worse place.Our Rating: 4 Stars - a must read for financiers and politicians.