After the French Revolution it was famously said that the surviving Bourbon aristocrats had “learned nothing and forgotten nothing.” Judging by their recent op-ed piece in The New York Times, “What We Need to Fight the Next Financial Crisis,” the same could be said of Ben Bernanke, Tim Geithner, and Hank Paulson.
As treasury secretaries and chair of the Federal Reserve, these three were the most powerful regulators of the financial system during the disastrous crisis of a decade ago. Yet they devote only a few words to their own failures to predict or prevent the last crisis (“Although we and other regulators did not foresee the crisis…”) and the lessons that might hold for today. Just a brief paragraph is devoted to the state of post-crisis regulations.
Instead, the thrust of the editorial is that the country needs to be prepared to fight the next financial crisis with another colossal, multitrillion-dollar bailout of Wall Street—the same kind of bailout that in 2008 failed to avert the loss of nine million jobs in the worst downturn since the Great Depression. What’s more, according to the authors, the central problem with post-crisis regulatory reforms isn’t that new rules are too weak, or that the reforms that did take place are being rolled back under the Trump administration. It’s that post-crisis changes reduce the ability of unelected regulators to deploy trillions of dollars in public assistance to Wall Street.
What might be most disturbing here is the authors’ seeming indifference to the costs of the kind of bailouts we saw in 2008. Such programs are not simply neutral “fire-fighting tools.” They change incentives for the financial institutions they benefit, both by encouraging irresponsible risk-taking in advance and by delaying adjustment to new market realities during a crisis. (The respected economist Viral Acharya has documented exactly this negative impact during the 2008 crisis.) And they change incentives for regulators. Having an unlimited firehose of public money in case of a crisis means less incentive to fight the hard political battles to make financial institutions take precautions in advance.
Bailouts also have opportunity costs for the vast majority of us who aren’t financial insiders. When the government uses its emergency money creation powers exclusively to assist financial institutions, leaving others victimized by a downturn to struggle for funding through the ordinary budget process, a pernicious double standard is created. That double standard is harmful both to ordinary citizens dealing with unemployment or foreclosure, and to public faith in the legitimacy of our political and economic system. The authors’ perspective is apparently that this double standard may have “seemed” unjust but was “necessary” to save the economy. Given the lengthy period of depressed economic performance following the bailouts—the longest recession in the post-World War II era—that’s questionable to say the least.
The details of their arguments are also flawed. They portray the 2008 bailout programs as ordinary “firefighting tools” which will be routinely needed by “future generations of financial firefighters,” rather than a radical and unprecedented expansion of Federal bailout powers. Yet the 2008 interventions clearly went far beyond traditional lender of last resort interventions. The 2008 crisis marked the first time since the 1930s that the Federal Reserve provided direct lending to non-bank institutions, and it did so on a scale that dwarfed any prior example.
The previously obscure Section 13(3) that the Federal Reserve relied on to authorize its non-bank lending had last been used in 1936, and in its entire history had been used to make 123 loans for just $1.5 million in total. During the financial crisis this authority was used countless times to extend tens of trillions of dollars of revolving credit. Professors Lawrence Jacobs and Desmond King have estimated that during 2009 the Federal Reserve gave loans and guarantees to the financial sector equal to over half of the total value of everything produced in the United States during that year. The Federal Reserve’s own records show from $500 billion to $1.6 trillion in credit support extended to Wall Street institutions every single week for 47 consecutive weeks, from mid-September 2008 to mid-August 2009. That figure that doesn’t even include TARP assistance or various credit guarantees. Two other forms of emergency assistance discussed in the piece—large-scale FDIC guarantees of bank debt and Treasury guarantees of investment funds—are tools that had never been used before the 2008 crisis. If these kinds of large-scale financial sector interventions are all routine “firefighting tools,” then why had the Federal government never come close to using them at any point before 2008?
Bernanke, Geithner, and Paulson also fault post-crisis legal changes for sharply limiting the ability of regulators to provide needed emergency assistance to the financial sector. That’s also deeply misleading. Despite the unprecedented scale of crisis lending programs, Congress only made relatively minor changes to the Federal Reserve’s authority after the crisis.
Specifically, in the Dodd-Frank Act, Congress required that to prevent favoritism, future lending to non-bank financial institutions must be part of a “broad-based” program of assistance to Wall Street, rather than limited to an individual institution. More information also needs to be provided to the public when lending. Such limited changes in lending authority effectively ratifies most of what the Federal Reserve did in the crisis. And contrary to the claims in the op-ed, the FDIC can continue to issue broad guarantees of bank debt, just as it did during the crisis—except that Congress must pass a resolution approving the program. The implicit assumption that a requirement for congressional approval is equivalent to getting rid of the program shows a deeply anti-democratic bias.
After the crisis Congress also approved a major new channel of emergency assistance, a new line of Federal credit for resolving a failed financial institution. This credit line allows regulators to deploy up to 10 percent of the value of a failed financial institution—potentially hundreds of billions of dollars—if it is needed to buffer the impact of a bankruptcy. This new tool also illuminates why Congress chose to ban emergency assistance limited to a single institution. The large new credit line, combined with new resolution procedures authorized in the Dodd-Frank Act, means that regulators should now have the resources and authority to close down and resolve any single institution rather than bail it out.
Rather than rethink what happened in 2008 so that we can create a fairer and more effective outcome the next time, these powerful former regulators seem to want to repeat the 2008 playbook in the future. The lasting costs of the 2008 crisis for most Americans should make it obvious that this is the wrong approach. Instead, we need to reconsider what a more effective approach would look like next time. If giant “too big to fail” institutions remain so large and so complex that their financial distress cannot be managed through traditional means, then we need to consider breaking up and restructuring these institutions, including by separating ordinary commercial banking and the payment system from the riskiest Wall Street activities. Government support provided in response to a crisis needs to be reconsidered as well. The full financial muscle of the Federal government should not be reserved for financial system insiders, but should also ensure that the Main Street Americans directly harmed by the economic fallout from a financial collapse receive assistance as well. Otherwise, the next crisis will be even more damaging than the last one.