Firefighting: The Financial Crisis and Its Lessons
Ben Bernanke, Henry Paulson, and Timothy Geithner
Penguin Books, $16 (paper)

The Great Crash of 2007–2009 stripped American middleclass families of wealth. It gave rise to nativist politics on the right and socialism on the left, killing credence in neoliberal market capitalism in both the United States and Europe. It buried the Washington consensus that had energized bipartisan support for U.S. leadership around the world. Indeed, China has replaced the United States as the leading country whose investment drives the global economy.

In his 2018 letter to shareholders, Jamie Dimon, CEO of JPMorgan Chase, described the state of the union as follows: “Middle class incomes have been stagnant for years. Income inequality has gotten worse. Forty percent of American workers earn less than $15 an hour, and about 5% of full-time American workers earn the minimum wage or less, which is certainly not a living wage. In addition, 40% of Americans don’t have $400 to deal with unexpected expenses, such as medical bills or car repairs.”

Given the ample volume of hindsight, it takes conviction verging on stubbornness to insist that the United States government did all it reasonably could have done in response.

According to Dimon, cumulative economic growth over the last decade has been half of what it would have been in a normal recovery. As a result the economy is $4 trillion smaller than it should be. In his words, that growth “certainly would have driven wages higher and given us the wherewithal to broadly build a better country.”

It is widely recognized that the economic disappointments of the last decade made it extremely difficult for the Democratic presidential nominee in 2016 to run on her predecessor’s record, even though unemployment was at last reaching satisfactorily low levels and wages had begun to increase. Conversely, Donald Trump’s successful campaign is often seen as reflecting voter dissatisfaction with the government’s response to the financial crisis of 2008.

Given the ample volume of hindsight, it takes conviction verging on stubbornness to insist that the United States government under the Bush administration did all it could to prevent the crisis and that both the Bush and Obama administrations did all they reasonably could have done in response. Yet in their three separate memoirs, numerous public statements, and now in their jointly written book, Firefighting: The Financial Crisis and Its Lessons, the trio of President Bush’s Treasury Secretary Hank Paulson, President Obama’s Treasury Secretary Tim Geithner, and both presidents’ Fed Chairman Ben Bernanke have made these claims.

Historians will debate the events of 2007–2009 for decades, and the leading actors, namely the trio of Bernanke, Geithner, and Paulson, should be complimented for their many good steps as well as their willingness to account for their decisions. But they were wrong in 2008, and they are especially wrong now to promote the wrong lessons from their experience. In Firefighting, for instance, they look to the next crisis and correctly assert that the Federal Deposit Insurance Corporation (FDIC) should be able to “fully stand behind” the obligations “of large complicated banks on the brink of failure . . . while winding them down in an orderly fashion.” But in an FDIC resolution shareholders and creditors take some loss. The firefighters rejected that approach in 2008, and they continue now to argue that in a crisis it is wrong “to ensure that risk takers pay a price for their risk taking” such as by “imposing haircuts on creditors.” By arguing that risk takers should be held harmless in the next crisis, they are restating the position that tied President Obama to one of the most unpopular government actions in history—namely, the bail-out. No future president should, or would want, to take this advice.

Notwithstanding many actions by the trio in emergency conditions, their reaction to the recession was not what the country deserved. Indeed, it had at least three serious flaws that we should be revisiting and learning from for next time.

When a fire seems poised to break out again in the financial sector, government leaders should throw water on the sparks instead of waiting for a full-fledged conflagration.

First, they bailed out Bear Stearns in March 2008, let Lehman Brothers go bankrupt on September 15, 2008, and bailed out AIG on September 16, 2008. In the first of these moves, they had another firm buy the failing firm. In the middle decision, they magnified the losses for everyone by implementing no plan in advance. And in the last of these moves, the government took control and fired management.

This unpredictable signaling intensified the dreadful reaction to the Lehman bankruptcy. The government’s sinuous path of decision-making inspired a lack of confidence. That in turn contributed to the over-reaction of the real economy to the financial crisis, leading to excessive reductions in investment and employment.

Second, at all times, the trio’s top priority should have been helping the real economy recover from the economic calamities of the Great Crash. At the time, it was no secret that domestic construction jobs were evaporating and consumer consumption was falling. Housing prices had also plummeted: ultimately, homeowners’ equity fell from nearly $14 trillion to about $6 trillion. But instead of taking actions to help Americans, the trio (and the presidents they advised) chose strengthening the financial sector as their primary objective. The misguided belief was that by instilling confidence in the balance sheets of big financial firms, they could cause benefits to flow through to Main Street.

This error in strategic goals led to a series of bad policies. First, instead of passing what the trio refer to as a “small” fiscal stimulus composed of tax cuts in February 2008, the Republican White House could have joined with the Democratic Congress to jumpstart more spending. Second, instead of protecting firms from having to take write downs on the debt and mortgage securities they held on their balance sheets, the trio could have used the authority of the Housing and Economic Recovery Act (HERA) to re-finance or restructure troubled mortgage loans or constrain foreclosures in a meaningful way. Third, instead of the modest recovery program enacted in February 2009, the trio could have championed a significantly larger recovery program. Geithner, in a memorandum he co-wrote with Larry Summers (likely with Bernanke’s input too) for President-elect Obama on December 15, 2008, recommended that the second economic stimulus to create Main Street jobs not be greater than approximately $800 billion because an “excessive recovery package could spook markets or the public and be counterproductive.” And fourth, instead of returning the $200 billion in unspent bailout money to Congress after the big banks had passed the stress tests in 2009, the trio could have spent the unused bailout money to protect homeowners and jumpstart job creation.  

Leaders have to trust that the United States can recover from the worst of financial shocks but know that it cannot long survive an ethic of saving the well-off at the cost of the rest of the country.

The third serious flaw in the recovery effort was that the Troubled Asset Relief Program was not a good law. Its principal defect was that Paulson could act with no supervision: he could buy whatever he wanted (including the most spurious assets traded). Moreover, no bank benefitting from the one-sided sale would suffer any limitation on bonuses much less replacement of management, and the actual amount of government funding would prove more than twice what the banking system actually needed for recapitalization.

In Firefighting, the trio acknowledge that the post-Lehman crisis compelled TARP’s passage—indeed, the trio have argued for a decade that Congress would not pass a useful bill without a crisis. But it is more accurate to conclude that the trio’s approach invited an avoidable crisis in order to pass a bad law. Indeed, the smoke of the Lehman explosion was the only reason a bill that awful could be pushed through Congress.

The timing, too, in retrospect is suspect. In September of 2008, for example, the trio had told Congress that the emergency required weekend action. This proved untrue. Moreover, by the time TARP was enacted in October 2008, some of the biggest Wall Street firms in which Paulson insisted on investing did not even need or want the money. The TARP legislation is not a model of what was then or is now desirable. Instead, in 2010, Dodd-Frank Wall Street Reform and Consumer Protection Act wisely used the FDIC to guarantee troubled firms’ obligations while meting out haircuts to equity and debt holders as the method for recovery.

None of this is to argue that drastic times do not call for drastic measures. But when a fire seems poised to break out again in the financial sector, government leaders should throw water on the sparks instead of waiting for a full-fledged conflagration. And if the fire rages anyhow, government should not rebuild the burnt towers of Wall Street while leaving Main Street to dig out from the rubble. The real economy is more important than the financial sector. Indeed, in the next crisis or before, the financial sector should help fund, through taxes or mandated investment, the recovery of the real economy. Perhaps then the financial sector might not grow as dangerously large as it has.

Exactly what needs to be done when the next crisis hits cannot be precisely predicted, but whoever fights that fire must remember that transparent, equitable, and justice-delivering government is not expendable. When the going gets tough, tough-minded government leaders have to trust that the United States can recover from the worst of financial shocks but know that it cannot long survive an ethic of saving the well-off at the cost of the rest of the country. What Theodore Roosevelt called the “malefactors of great wealth” should at least lose some of that wealth as their just deserts are served.