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Crisis Turned Federal Reserve Into Fourth Branch of Government, Author Says

August 12, 2009 at 12:00 AM EDT
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"In Fed We Trust" author David Wessel discusses how the central bank reacted to the financial crisis and its changing role in setting U.S. and global financial policy.
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JIM LEHRER: And next, the power of the Federal Reserve at the height of the financial crisis. Once again to Jeffrey Brown. A note: This conversation was recorded before today’s developments.

JEFFREY BROWN: Even amid some recent positive economic signs, the fallout from the financial meltdown continues. And the lasting impact on individuals, communities and institutions is still being assessed.

A new book, “In Fed We Trust: Ben Bernanke’s War on the Great Panic,” goes behind the scenes to look at what happened and why. Author David Wessel has helped us understand events along the way this past year. He’s economics editor for the Wall Street Journal and joins me now.

And welcome back.

DAVID WESSEL, Wall Street Journal: Thank you. Good to be here.

JEFFREY BROWN: You have covered this every day, the daily news that we’re both part of. When you step back from all those little pieces and take a look at the big picture, what struck you most?

DAVID WESSEL: I think two things strike me. One is just how enormous the threat was to the financial system and the whole economy.

You know, when you write about this one company, one day of the market at a time, it’s hard to realize just how big a threat it was. And when I talked to Bernanke a few weeks after the Lehman Brothers thing, and he says to me, “We came very close to Depression 2.0,” it sort of took my breath away.

And the second thing is that…

JEFFREY BROWN: That will take your breath away, when…

DAVID WESSEL: Yes. Yes. And it wasn’t clear then we’d avoided it. The other thing was that these people seem larger than life on TV and in the papers, but they’re — you know, they’re smart people, but they’re ordinary people, and the number of decisions they had to make under fire, with no owner’s manual, with very little precedent to go on, I mean, it was exhausting. And it’s kind of amazing how much we depended on a very small group of people to basically save us from that economic calamity.

JEFFREY BROWN: So one of the key moments that you write about, of course, is Lehman Brothers…

DAVID WESSEL: Right.

JEFFREY BROWN: … the decision-making there about what to do about it, and that’s a perfect moment to talk about some of these things you just talked about. You have key players. You have Ben Bernanke, Henry Paulson, Tim Geithner. Personalities come into play, a sense of not certainty about exactly what to do.

The collapse of Lehman Brothers

DAVID WESSEL: That's absolutely right. So during that Lehman weekend in September 2008, Bernanke, who is the economist, economic historian from Princeton, who has very little experience directly in the markets and very little experience in government, he stays behind in Washington.

Geithner, Tim Geithner, then the president of the Federal Reserve Bank in New York, an accomplished behind-the-scenes technocrat, who has lived through a lot of crises before and kind of has maybe a bit of hubris or arrogance in that he's never met a crisis he couldn't fix, and fix today's problem, and worry about tomorrow's tomorrow.

And then you have Hank Paulson, who is this former Dartmouth football player, which comes up in every profile of him because he feels like a football player. He's very physically restless, a guy who's done 100 deals on Wall Street, very impatient, very gruff, gives orders, expects people to comply, has seen -- considers himself the equal or maybe the superior of all the CEOs who are involved in this thing.

And, basically, they come to that weekend hoping to sell Lehman Brothers to a British bank, just as they had sold Bear Stearns to JPMorgan Chase earlier. They don't have a Plan B, and the rest is history.

JEFFREY BROWN: But there is that sense of sort of making -- and it's an interesting mix of making it up as you go, but based on some experience...

DAVID WESSEL: Oh, absolutely.

JEFFREY BROWN: ... even though this is all new.

DAVID WESSEL: Yes, well, I think in a way the most interesting of that is Bernanke, since the man spends his entire previous adult life studying the mistakes that the Fed made that caused the Great Depression. Once he figures out that this is like that again, he looks at the whole world through that lens.

Some people think he's overreacting or just sticking to the paradigm he knows, but it becomes clear that it is the right paradigm, it is the right metaphor. And because he saw how serious it was when financial institutions collapsed during the Depression, the collapse of Lehman is actually quite painful to him.

JEFFREY BROWN: But, you know, it's also interesting that you write about is, is the fact that he didn't catch on right away, right? I mean, he was part of the Fed -- Alan Greenspan's Fed. In spite of all this experience, Ben Bernanke was, sounds like, slow to catch on, slow to understand the magnitude of the potential problem.

DAVID WESSEL: I think that's right. I think both Ben Bernanke at the Fed and Hank Paulson at the Treasury used the word "contained" a lot in 2007, by which they meant they knew housing was a problem, but they thought the damage would be contained to housing and somehow other parts of the economy would do well.

After all, oil prices were rising, and that suggested there was a lot of demand for oil, so there was growth somewhere, and they didn't understand how much the house price problem had infected the entire financial system. It really isn't until late 2007, early 2008 when they realized the whole world economy is infected, it's not contained at all to housing.

Greenspan's legacy

JEFFREY BROWN: And the other person looking back is Alan Greenspan, lionized for much of his term, and yet you look back now and it looks as though he -- and he has said some of this -- was sort of controlled by a kind of mindset that in the end didn't apply to what was happening.

DAVID WESSEL: Well, that's right. I think Alan Greenspan probably got too much credit for the good times and too much blame for what followed, but there's no doubt that, when you make the list of all the people and institutions who let us down, he has to be on the list.

And you make a good point. I think one of the things that Greenspan believed -- and he has said it -- is that, if you have a lot of rich, sophisticated investors playing poker, that they will do a better job of policing the poker table than any regulator ever could, because they have so much money at stake.

JEFFREY BROWN: That was his thinking.

DAVID WESSEL: That was his thinking. It was wrong, and he's admitted as much. He testified before Henry Waxman and said, "My worldview is wrong."

So it wasn't only that he didn't use his regulatory power, but he influenced the entire Washington community to think that we should leave the markets alone because regulation usually doesn't do any good.

'A fourth branch of government'

JEFFREY BROWN: So, in the end, when Ben Bernanke acted, the Fed has taken on this huge new role, what has been a mostly secret, even mysterious institution for so many people, now is a bigger player. He's taken a much more public role. You know about the event he did with us recently and other news organizations. You refer to the Fed now as even a fourth branch of government.

DAVID WESSEL: Right. I think that it exposed itself as almost a fourth branch of government during this crisis. No one else had the power or the money to act to save us from calamity, except the Fed.

The president had more authority to launch a nuclear missile to defend the country than he did to spend trillions of -- billions of dollars to defend the banking system. So the only institution in our government that had the ability to do this was the Fed, and they came in with all guns blazing.

JEFFREY BROWN: But that leads us to where we are now, which is a debate over this unelected...

DAVID WESSEL: Right.

JEFFREY BROWN: ... this unelected officer, this unelected agency, with so much power in a democratic society.

DAVID WESSEL: Right. And it's caused a lot of concern. You know, there was a Gallup poll recently that found fewer people think the Fed is doing a good job than think the IRS is doing a good job.

Part of this is a long history in America of people being suspicious of concentrations of political power. It's why Alexander Hamilton's First Bank of the United States, a forerunner of the Fed, was blown up and the Second Bank of the United States was blown up, as well.

I think people are a little alarmed that the Fed exposed itself as having so much power, and they fear that the Fed has bailed out Wall Street at the expense of Main Street.

And the reason Bernanke went on TV is, he's trying to make the opposite case. He's trying to say, "I had to save Wall Street because it was the only way to protect Main Street."

JEFFREY BROWN: And let me ask you briefly before I let you go, when you go back, you look -- you write this book, do you now sitting here today feel more sanguine about our ability to prevent something like this in the future?

DAVID WESSEL: I think we've learned some lessons, but I think one of the lessons is, it's very hard to predict the ups and downs of the markets. And, to a large extent, this was a failure of imagination. People didn't imagine that so much of the financial system could be built on such a fragile foundation, and it's made me a lot less confident that we can control the markets or see the future clearly.

JEFFREY BROWN: All right. The book is "In Fed We Trust." David Wessel, thanks very much.

DAVID WESSEL: You're welcome.