inside the meltdown

Chris Dodd

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As chairman of the Senate Banking Committee, Dodd (D-Conn.) had a direct hand in crafting the Troubled Asset Relief Program (TARP). This is the edited transcript of an interview conducted on Dec. 3, 2008.

“This is the chairman of the most important central bank in the world, announcing to the leadership of Congress, 'Unless we act within days, the financial system will melt down.'”

… What are you worried about [during the week of Bear Stearns' collapse]?

To [Federal Reserve Chairman] Ben Bernanke and [Treasury Secretary] Hank Paulson's credit, they called me all weekend, not that I was involved in negotiations, but to let me know what they were trying to do.

I had actually met about six or eight months before with a new head of Bear Stearns. I heard there were problems there, but I had no idea the magnitude of them. And he had made a suggestion at the time. ... He wondered why the Federal Reserve Bank did not open the discount window to investment banks, subject them to the same regulatory requirements that member banks would be subjected to. That might be some way to sort of right this problem for investment banks at that hour. ...

We raised the issue with the Federal Reserve, asked them what they thought about that idea. They rejected it out of hand. The reason I tell you that is, of course, on that weekend coming up, you may recall that on that Thursday night before the Friday, when they went into this deal, they announced that they were going to open the discount window just to Bear Stearns, which was, in effect, a death sentence for them.

By Friday morning, of course, there was just a run on Bear Stearns. The thing collapsed -- the only one to get that treatment. Obviously the Fed was sending a message: This is an institution that's about to fail.

Because people could get their money out, they ran on it.

No other investment bank was getting the discount window open for them. So to single them out, in a sense, was to virtually assign them to a death sentence. And of course, that's what happened over that week. That Sunday night, of course, they announced they were opening the discount window for everybody, at least the other investment banks.

And my reaction at the time was, well, I hope this is the end of it. We put, I think, around $29 or $30 billion as a backstop to the federal government, that if this was the kind of message, this was going to send a shock wave through Wall Street, through Lehman Brothers and others: Get your act together; this is what can happen to you if you don't clean up your act and deal with your toxic instruments and the like.

And so like many at the time, I thought, well, I hope this is the end of it. I candidly felt we could have done a better deal. It seemed to me that in the $30 billion, what did we get for it? It's going to take a long time for these instruments to get healthy. In terms of us getting any kind of profitability out of them, the taxpayers would be in-lined with warrants, if that were the case.

The question I've asked myself since then, of course, a lot is, what were these people thinking about? ... Do you honestly believe only one of these investment banks are in trouble, the rest are not?

When you say "these people," who do you mean?

The Treasury. These are the people who we charge with the responsibility of monitoring. This is the Fed. These are the wizards. These are the guys who have the Ph.D.s and spent their lives looking at this, spent every working day, have huge staffs that monitor this. They're the ones who are supposed to keep [an eye] out for systemic risk in our country. That's their job every day. Why didn't someone -- maybe they did, but certainly not principals -- stand up and say, "Wait a minute; this is a lot bigger than Bear Stearns"? ...

... Bernanke knows in the summer of '07 that the banks are in trouble, not to mention the big five on Wall Street. They don't come up to you and say: "Hey, we've got some trouble. We think we've got a real systemic problem."

No. In fact, August '07, I asked them to come to my office, both Hank Paulson and Ben Bernanke. And Secretary Paulson, who I like very much, a decent man, obviously bright, ran Goldman Sachs. All he wants to talk to me about that day -- by the way, the markets were cascading in August '07 -- and all he wants to talk to me about is the debt ceiling.

Now, to Ben Bernanke's credit, he got it. ... He said, "I'm going to use all the tools available to me to deal with this." Now, he never did, but he seemed to understand -- much more so than Hank Paulson did -- what was lurking on the horizon in terms of the foreclosure issues and obviously the related problems.

Did you see a lot of daylight between those two guys on more than just that?

Yeah, and looking back on it probably much more now that I've come to know them better. Ben Bernanke wrote his doctoral dissertation -- he's an expert on Depression-era economics and politics. So he has an historical knowledge, an awareness of what can happen when you end up in moments like this. ... He seemed to have a deeper appreciation of the importance of acting. But because he was new at it, I think he was unsure of himself politically on how to move and whether or not to be more aggressive. ...

I was accused of grandstanding by inviting them up here to tell me what they were going to do about it on Aug. 2, 2007, when we had the problems with the markets, and wondering why they weren't doing more and what steps were they going to take.

In fact, on Dec. 7, 2006, I wrote a letter to the Federal Reserve Bank wondering why they weren't doing more to mitigate subprime mortgage problems. ... I didn't become chairman until January 2007 of the [Senate Banking] Committee. ... When we met with the staff of the Federal Reserve, they actually told us, in January '07, that they were aware of this problem in the housing issue three years earlier and had indications of this bubble being created. And so the very first hearings we held in January and February 2007 were on the subprime mortgage crisis, and we've been talking about it ever since. Had 80 hearings and meetings on the subject matter. This very room, in March and April '07, had all of the stakeholders in the mortgage area promise me ... that they would do everything in their power to do workouts with mortgages that were difficult. Of course, they never did. ...

So you're not at all surprised in August '07 the economy is in some deep trouble.

No, no. ... Anyone who spent five minutes looking at this issue will tell you the underlying cause of all of it was the residential mortgage crisis, the subprime, the predatory lending that went on, obviously, where you're getting to this day 9,000 foreclosures a day.

And it's been a mantra of mine ... since late '06, when the problem first began to emerge, that you had to mitigate the foreclosure problem. Until you put a tourniquet on the hemorrhaging in residential mortgages, this problem will not be solved. So it's been highly frustrating.

You talked about Bernanke and his personality and his lack of political acumen or whatever from the very beginning. What about Paulson?

Well, Hank is new to it, too. He's never been in this culture before. And the Wall Street culture is obviously different than a Washington culture. So you end up with things like sending up a three-and-a-half-page bill asking for $700 billion on Sept. 20. Who gave them that brilliant advice, without even calling ahead of time?

We met, of course, the night of Sept. 18 in that famous meeting in the speaker's office.

Take me to that meeting.

It's the economic equivalent of 9/11 in my view, having been here for both events, ... sitting in that room with Hank Paulson saying to us, in very measured tones, no hyperbole, no excessive adjectives, that unless you act, the financial system of this country and the world will melt down in a matter of days. There was literally a pause in that room where the oxygen left.

Literally -- I know I'm drawing too close of an analogy here given the lives lost on 9/11, but it's that kind of a moment. This is not some analyst. This is not some functionary at the Treasury. This is the chairman of the Federal Reserve Bank, the most important central bank in the world, announcing to the leadership, Republicans and Democrats of Congress, "Unless we act within days, the financial system will melt down." And so the next 13 days were historic here.

Who's in the room?

There are about 12 or 13 of us. It's the leadership, the Speaker [of the House Nancy Pelosi (D-Calif.)], the Democratic leadership of the House, the Senate -- [Senate Majority Leader] Harry Reid [D-Nev.], of course; Dick Durbin [D-Ill.]; Chuck Schumer [D-N.Y.]; myself; Dick Shelby [R-Ala.], my ranking member here; [Rep.] John Boehner [R-Ohio]. …

... When you go over there to Pelosi's office, do you know what it's about?

... It was obviously a big meeting. I had no idea I was going to hear what I heard at the time. We'd had a lot of meetings already. Going back to March, obviously, over the last year and a half, all I've been doing is having meetings and hearings in this room and elsewhere about the subject matter. I didn't know whether it was another AIG or whether or not we were going to be talking about a GSE [government-sponsored enterprise] problem, Fannie [Mae (Federal National Mortgage Association)], Freddie [Mac (Federal Home Mortgage Corp.)], whatever else it was. I did not anticipate what I heard. ...

We turned it right over to Ben Bernanke and Hank Paulson to describe. And then, of course, it's a lot of questions and what was going to be included and what were they asking for and how much. They didn't want to give us a number that night.

I remember it distinctly, because some said: "Well, you've got to do something. You've got to say something about mortgages. And that's because obviously symbolically that's important." I remember very clearly saying: "No, it's not symbolic. It's the heart of the problem."

I understand they wanted to talk about just buying-up-the-toxic-instruments approach. I've always thought from that night on that the most important thing to do was to make the equity investments in institutions. You get much more bang for the buck for doing so. It's not unprecedented; we did it in March '33 to June '33 under Jesse Jones and the New Deal. That's exactly what they did: They injected capital into 5,000 banks. ...

Was there a difference in the room -- Republican, Democrat, Bernanke, Paulson -- about injection versus buying?

Not at that point. And again, the bill that Secretary Paulson set up only allowed him to do the purchasing of the toxic instruments, that three-page bill, which was an outrage.

Within 36 hours, I had crafted an 82-page bill with a lot of accountability standards -- warrants, protect[ions for] taxpayers, excessive executive compensation provisions, mortgage mitigation, foreclosure mitigation issues -- which became sort of the basis of the bill that was ultimately adopted about 12 days later, adding a lot more conditionality.

The important point here is expanding the authority. If we're going to give you the money, you ought to have the authority to do more than just one thing. And as we've seen, of course, they have changed their tune substantially from the purchasing of the instruments now to making the equity investments.

I even gave them the authority -- and they're not arguing with me today -- of doing something about the automobile industry if they needed to. And of course, they don't want to use the authority. There's no requirement in the bill they'd be mandated in doing it. But I kept on asking Paulson, "I want to make sure you have all the authority you need to have in order to act on this matter, along with the Federal Reserve." ...

When you walked out of that meeting at Nancy Pelosi's office that night, what did you think, Senator?

I thought it was going to be a very tough road. I had no idea what I was going to see delivered on Saturday morning, a three-page bill. Again, I assumed what would happen is that Paulson's shop, the Treasury and the Fed and others, would come up and say to Nancy Pelosi and Harry Reid and those of us who are charged with working on these issues: "What do we need to do? What are the things you should have in this bill? What are the conditionalities members in your constituents will insist upon before we get this resource?" And we might have spent that weekend actually crafting a piece of legislation that would come forward.

So it was mind-boggling to me that I woke up Saturday morning and discovered this three-page bill that had been submitted at 1:30 in the morning without any consultation whatsoever. ...

Did he seem to know what he actually wanted and what he was going to do?

He was very certain about what he wanted early on. He kept on arguing. I remember I called him one night -- woke him up, he claimed -- and talked to him about purchasing the equity, investing into the equity of these financial institutions. And again, I'm listening to others who are very knowledgeable -- I must have a stack of e-mails and letters from people all over the country who are ... knowledgeable about this, work in this industry -- who almost unanimously were wondering why the Federal Reserve, and particularly the Treasury, were not making the direct equity investments. Why was he hung up on this idea of only purchasing the toxic instruments?

You buy a toxic instrument for a dollar, that's all you get is a dollar's worth, whereas you make an equity investment of public monies, you can leverage private capital, maybe 10-, 12-, 15-to-1. ...

So when you call him, what does he say?

He says: "It takes too long. You have to do it institution by institution. There are too many institutions I have to deal with." That was the argument at the time. And again, I'm not arguing with a guy who spent his lifetime on Wall Street and running one of the most successful, if not the most successful, investment bank on Wall Street.

That's a hell of a journey for a free-market guy like Hank Paulson, too. ... Sitting with a bunch of senators and congressmen saying, "Give me a blank slate, and I'll go solve this problem."

And again, that was the arrogance of it, in a way. And I think it's also naivete. The idea that you send up at 1:30 in the morning, on Saturday morning, a three-page bill saying, "Give me $700 billion, and by the way, no agency can intervene, and no court can intervene," that's rather remarkable. You know, a subprime mortgage is four pages long. Here he was asking for $700 billion, [it was] twice the cost of the Iraq war, and nobody can ask any questions.

I don't know who advised him about that at the time, but it was a disaster. And of course, over that weekend, the media's reacting to it. So by Monday, when you start to respond to this, there already is a mountain of opposition. We're 30-some-odd days away from a national election, with the entire House of Representatives up for re-election and one-third of the Senate, and we're asking them to stand up and vote for a $700 billion bailout, as it's called, for financial institutions on Wall Street, with little or no explanation of why that relates to Main Street.

At one point, the Treasury Department was asked to explain what this meant to Main Street. I'll never forget the meeting, which happened to occur some days later. And they literally could not answer the question. A member got up and said: "I'm going home to my state tomorrow. I'm speaking to my Chamber of Commerce at 9:00 tomorrow morning, and they're going to ask me why I'm helping out Wall Street and how does that help them in this small town in my state. And can you tell me the answer?" And there was silence.

I mean, it's not a hard answer. The question, obviously, if the bank's credit markets are seized up, that automobile dealership in that small town, that small business that doesn't have access to capital and credit, that needs to operate its business, is going to die, and you're going to have a heart attack. And so connecting the dots is not all that difficult.

Couldn't do it?

Couldn't do it.

When they're sitting in that meeting on the 18th, and they say, "We need this money; the economy is going to melt down by Monday," ... what did they attribute the meltdown to?

Again, there was an understanding that the residential mortgage market was the problem. And obviously, the securitization -- it isn't just holding a mortgage. When I had my first mortgage, I could have gone down to my local bank for 30 years and looked at it every day. And it never left town, my mortgage. And all of a sudden, a number of years ago, the brilliant idea of securitizing, which was actually not a bad idea because it created capital to allow more people to be able to afford to buy a home, under good underwriting standards -- I'm not opposed to securitization.

It was the branding of these securitized bundles as being AAA. It was luring people into mortgages they knew they couldn't afford. But the broker was out of the deal within five to six weeks; the bank was out of the deal in eight to 10. And the rating agency was out of it quickly, as soon as they put a label on it as being a highly reliable and conservative investment. And, of course, others who are looking at these things did not know what they were getting, being sold off into the marketplace globally. And obviously all of that [led to this] cascading effect, as these mortgages failed, and the markets, the capital markets seize up. ...

I speak at a high school almost every week in my state, and I always say if I could explain this to high school students, they'll understand: ... You're all taking biology. Our economic system is like our circulatory system. That capital has to flow and move around from banks. Almost every business borrows money to survive -- to pay their employees, to buy their goods or their raw materials -- and then they pay it back. And then they put people to work; they produce products or provide a service. And when the circulatory system gets clogged up, obviously you could have a stroke or a heart attack. And that's, in effect, what our economy is doing, a stroke or a heart attack. ...

When you turned three pages into 80 pages, how did Paulson take that?

I didn't care at that point. My theory around here -- and this isn't just this administration; it's anyone -- I find I get the most success [when we] do our work up here. ... See if you can't put something together, and then invite the White House. You invite the White House early in this process, it never ends. They never stop negotiating, or they never negotiate with you.

At that point I was so angry about the three and a half pages -- it was insulting. Not a phone call, nothing at all. I had gone through a weekend of people screaming across the country, rightfully so, [about] the arrogance of this, taking $700 billion of taxpayer money on a three-page bill and saying, "No court, no agency can intervene." So frankly, I had little interest at that point of what Treasury thought.

Now, they were up negotiating with people, but my goal was to find out where my fellow senators were, Democrats and Republicans, where [Chairman of the House Financial Services Committee] Barney [Frank (D-Mass.)] was in the House. We didn't have the luxury of going through the normal process where the Senate acts and the House acts and weeks go by, and you sometimes get together and sometimes don't, and ultimately work something out. We had 13 days. Congress was leading. They had an election coming up, and we'd been told we have days to act or we're going to melt down. ...

Sept. 25, meeting at the White House. ... Tell me about it.

Well, it's bizarre. We could do a show on this one alone. At the request of my colleague [Sen.] John McCain [R-Ariz.] -- he's postponed or put his [presidential] campaign on hold. In fact, the more interesting meeting, in fact the more substantive meeting occurred that morning, I met with my key Republicans and Democrats in the House and the Senate on this issue to finalize that 80-page bill we had talked about and to do what else had to be done. ... We held a press conference at 1:30 that Thursday, saying we've agreed in principle. We need to work out the details of it, but here's what we believe we can support, Democrats and Republicans.

Four o'clock is the meeting at the White House. It's sort of anticlimactic; we're already now agreed up here. And that meeting was strange in that Barack Obama was there, of course John McCain, the two presidential candidates, and the leadership of the House and the Senate. And you almost, at the end of the meeting, [thought], why did we have this? No clarity came out of it, and it was frankly a bit mortifying in a way.

And I recall Hank Paulson being very worried that the Democrats -- and rightly so -- were very angry at being drawn into this, dragging the presidential politics into this, as if somehow they were going to magically jump ahead of all of this and solve the problem. And again, I have great respect for John McCain -- he's a good friend -- and I understand why. He understood politically if he didn't get in front of this issue, campaign over. So he was flying into, all of a sudden, an area that he had little or no knowledge or background in -- or interest in, for that matter -- and was trying to insert himself into the debate.

In fact, the people up here, that I talk with every single day, who I rely on, Democrats and Republicans, were already hard at work on this, and, in fact, the irony, that very morning had sort of come to an agreement. So the White House meeting was a strange occurrence that sort of floats in and floats out and has no bearing or significance at all on the outcome. ...

What happens with the legislation? Why did it just crash and burn? ...

I was on the floor of the Senate. I was in the cloakroom of the Senate watching that vote, and I didn't have a good feeling about it.

And again, people initially say: "Look, we have to do whatever we have to do here. This is a patriotic moment for our country. It's not going to be popular. We've got to stand up and do the right thing." ... And then I think over the following days, as there was tremendous criticism as a result of what the Treasury sent up on Saturday morning --

So given that, and candidates running with opponents saying, "This is a dreadful thing to be doing," so the pressures are mounting. People are going back to their constituencies screaming at them over "How did this happen? Who's to blame? How did we get in this mess?" And you could just feel it slipping away.

It then took, of course, several days to regroup and to come back and for people to realize, I think from others, that doing nothing, walking away from this -- I would indict a Congress. I'm now looking back. I wish we had done more. But having a limited amount of time to do things, I think we did the best we could under the circumstances. But had we done nothing, had we walked away, I think we could be indicted by history for this.

One of the great other historic moments that happen[s] is the Oct. 19 meeting with the banks lined up in alphabetical order across the desk from Paulson and Bernanke. ...

I sent Hank Paulson a speech that this guy Jesse Jones, who's one of the architects of Franklin Roosevelt's New Deal, ... gave in 1951 about what they did [in their first 100 days]. Jesse Jones convinced Roosevelt that they needed to inject capital into these lending institutions.

On March 4, Inauguration Day 1933, as many as 5,000 banks were closing their doors as Franklin Roosevelt was giving his inaugural address; 26 percent of the people were unemployed in the country. I mean, you talk about 8 percent today here, so the magnitude is significantly greater in those days. But it's a great speech ... and it reminded me very much of the Oct. 19 meeting at the Treasury -- although I was not there, but just reading about it.

The banks in 1933 did not want the money. Now, the numbers are quaint -- it is a million dollars, a million and a half. One bank in Detroit got $12 million, which was an outrageous sum in those days. And they didn't want it; they didn't want to be stigmatized in 1933. It was looking as though they needed federal help or had to get bailed out in some way; that they felt their shareholders, their investors might leave them, very much like, I'm told, the meeting at the Treasury. That "We don't want this; we don't need this" -- at least some of them were saying that. So history repeats itself.

Obviously in '33 it worked, and ultimately all the banks did think it worked. And they also lent money; that was the big difference. They got the money, they lent the money back out to consumers and began to get things moving.

In this instance, of course, what's been so frustrating for me, as the chairman of this committee and the one who gave the Treasury the authority to do this, is I still see them cutting deals that allow preferred shareholders to get dividends to buy healthy institutions. ...

And I don't mind them buying failing banks. That would make some sense to me in order to stem this stroke or heart attack that our economy's having. But the idea that you'd go out and provide bonuses to people, and you're providing dividends to people and buying healthy banks, this is not at all anyone's intention when we crafted the legislation in September. ... They know this. This is no mystery to them. Don't ever suggest to me that somehow I gave them the authority to do it. ...

How did injection become the solution?

As I said earlier, it was the suggestion being made by many that there was a far greater chance that your dollars would have a greater impact on the problem. Both proposals were designed to produce the same result. Hank Paulson's notion about buying the toxic instruments ... how much are you going to pay for them? ... There [were] all of those questions about valuation.

But the goal was to get private capital to come back in and get the circulatory system operating. Those who argued for the direct investment I think made the better argument, and that is, this is not an unlimited amount of money, and by putting this in, and then you leverage private capital, the more likely you're going to get more private capital to come as a result of making those investments. And that's what history had proven to be correct. That's why I sent him the Jesse Jones speech from 1951 about why that worked.

Where are we now?

We're still in trouble. And it's now in the real economy. This is what is so frustrating. This is not Katrina. This is not a natural disaster. This was a manmade one. This was avoidable. This was preventable. What began with a problem with subprime mortgages, which could have been corrected with some pain, clearly, but could have been corrected, has now cascaded into a problem that is affecting virtually millions of people's lives, their homes, their jobs, their retirements. So that is the great sadness in all of this, despite the efforts of many, including ourselves. And we're not without culpability. ...

I believe that these injections of capital, the confidence coming back, we'll slowly see credit begin to move. LIBOR [London Interbank Offered] Rates -- that is, the lending rates that banks charge each other to borrow money -- [are] coming down, and that's very good news.

Credit is beginning to flow, but it's going to take time for us to get on our feet. And it's global. It isn't just confined to our own country. So we're still in trouble. But I have a tremendous amount of confidence in the flexibility, the creativity, the imagination of Americans generally. And I think with this new administration making tough decisions, which they have to, that we're going to get out of this.

This is not the Great Depression. I realize people use the analogy all the time, and there are comparisons very legitimately, but we ought to be careful. That was a very different time, and we had none of the safeguards in place today, or the capacity of resources. It's more dangerous, in a way, because it is global. ...

posted february 17, 2009

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