Ten Years Ago

Ten years after the Panic of 2008 began, the hardest thing is dealing with the might-have-been in its immediate aftermath.  What if President Barack Obama had better understood the situation he inherited?

He might have emulated Franklin Delano Roosevelt and begun his term as explainer-in-chief. He might have devised some modern equivalent of FDR’s “fireside chats” – the thirty-one radio broadcasts the president made in 1933 and 1934.

Obama then could have proceeded to explain what had happened in the last few months, what the Federal Reserve Board, the Bush administration, and the US Congress had done about it and why, and what steps his administration would take next.

He would have said that, in the days after September 15, when Lehman Brothers filed for bankruptcy, the US had suffered an uncontrolled banking panic, the first such since the Panic of 1907 – not just the United States, but the entire global banking system.

He would have explained how the 1907 panic, halted the old-fashioned way by a syndicate of wealthy bankers led by J.P. Morgan, was so severe that it led Congress to create the Federal Reserve System as lender of last resort in such emergencies.

He would have explained that an incipient panic after 1929 had paralyzed the inexperienced Fed in the early 1930s, and that Roosevelt had been able to ease the fears with that first chat. He might have told, as an aside, how Roosevelt’s Fed chairman Marriner Eccles had diagnosed the paralysis, and, drafting the Banking Act of 1935,  centralized lending decisionswith the seven-member Board.

Obama would have explained that only after the Panic had commenced did Federal Reserve chairman Ben Bernanke, Treasury Secretary Henry Paulson, and New York Fed chief Timothy Geithner understand the intricacy with which the shadow banking system (as it would become known) was connected to the familiar banking system.  He might have commended the Paulson eventual valor (if not his foresight) and explained that he was asking Tim Geithner to lead his Treasury Department, that he would nominate Bernanke to a second term  as well.

He could have explained that, while a decline in home prices was the proximate cause of the crisis, it was better understood as an increasingly frenzied search for safe assets coming near the end of a thirty-year global boom that had begun in the late 1970s.

Therefore, he might have said, there was no reason to take the crisis out on homeowners.  His administration, he would have told listeners, had begun an urgent search for a way of freezing subprime mortgages at their teaser rate for however long was required to avoid mass foreclosures.

Only then would he have moved on to the difficult topic of stimulus – the deficit spending he was asking Congress  to authorize to counteract the rapidly deepening recession, which has been aggravated by a breathtaking if quickly reversed decline in world trade. And he would have warned that similar difficult choices lay ahead for members of the European Union.

True, the leaders who halted the stampede — Bernanke, Geithner, Paulson, and their respective teams—didn’t understand themselves at first what they were up against. No one had seen a banking panic in the US for seventy-five years. They were thought to have become impossible.  Four days were required to get government departments on the same page; another two weeks to persuade Congress it had no choice but to act.

But by Inauguration Day, those who had battled the panic had a pretty good idea OF what had happened and why.  Bernanke, Paulson and Geithner told their stories last week at the Brookings Institution in a remarkable two-day conference on the tenth anniversary of the panic.

Obama, on the other hand, either did not have a good grasp of the situation, or he did and chose to ignore it. Obama had hired Hillary Clinton’s campaign economic advisor, Jason Furman, after he defeated her in the spring; he signed former Treasury Secretary Lawrence Summers as his chief advisor on the Friday after Lehman.

That’s not to say that Summers is a bad economist.  But he clearly does not share the Bernanke-Paulson-Geithner view of what was distinctive about the crisis.  Summers helped persuade Obama to support the gauzy Troubled Asset Relief Program appropriation known as TARP that President Bush requested that Friday morning. And Obama never reversed himself on the campaign trail. But he had little or nothing to say about the rescue of the financial system

Instead, “stimulus” had become the mantra of the Obama team even before the election. The only question was how much could Congress be expected to approve?  The Congressional Republicans, who had no better version of what had happened to take to voters than did the Obama team, hit the warpath.

Much has been said about the utter failure of “new classical” economics to give an account. But “new Keynesian” thinking was not much better (though it was better). Read Larry Summer’s first major speech, in March 2009.

How should we think about this crisis?…  [I]t was the central insight of Keynes’s General Theory that two or three times each century, and now is one of those times, the self-equilibrating properties of markets break down as stabilizing mechanisms are overwhelmed by vicious cycles, as the right economic metaphor becomes not a thermostat but an avalanche, and that is what we are confronting today.

To see what Summers thinks today, check out “The financial crisis and the foundations for macroeconomics,” his op-ed article in The Washington Post last week.  Or wait, if you like, for A Crisis Wasted: Barack Obama’s Defining Decisions, by Reed Hundt. (Rosetta, February 2019). Hundt, another star of the Clinton administration (think Internet) and a veteran policy entrepreneur, was one of the would-be advisors who was cast aside after the election, along with campaign economist Austan Goolsbee, FDIC chief Sheila Bair, and Fannie Mae receiver Herbert Allison. His is the best account yet of what went on behind the scenes in those first six months.

Perhaps Obama would have done better to stick with Goolsbee, the economist who had come with him to the dance, rather than rely on Summers. With his University of Chicago connections, and his modest professional ways, Goolsbee would have brought fewer preconceptions to the job. He might have negotiated a more genuinely bi-partisan economic stance with which to begin the Obama administration – one that put the panic at the center of his account and acknowledged that the main event had been boldly and satisfactorily resolved by Bush administration appointees four months before Obama’s term began.

Hindsight is twenty/twenty. We’ll never know. The meeting at Brookings last week, a joint undertaking of the Hutchins Center on Fiscal and Monetary Policy and the Program on Financial Stability at the Yale School of Management, was terrific. It took ten years to happen, instead of ten weeks in the autumn of 2008. But, even now, we may hope for a better understanding of the crisis than the one we have today.

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