Federal Reserve

Our film starts as Bear Stearns is stumbling, and a rumor is going, and the housing bubble has burst, and it's all going to go down in about a week. From Dallas you must have watched some of this happen. What did you think about the idea of pumping that $30 billion into Bear Stearns? …

Well, first of all Tim Geithner then is head of the Federal Reserve Bank in New York, and he was on the front line. The way Ben Bernanke has chaired the Federal Reserve is all of us are consulted in the process. … We had countless video telephone conferences and other conferences, as well as meetings, to go over what was happening.

We did not supervise Bear Stearns. We did not have supervisory power over Lehman Brothers. We did not have supervisory power over AIG. But the role of a central bank in a crisis, in a panic -- and this goes back to the panic of 1825 and basically the handbook that was written by a man named [Walter] Bagehot with the Bank of England -- we, in essence, pulled out that playbook in a modern context, and we opened the floodgates. We were the lender of last resort. That's what a central bank does.

I take no issue with that urgent need for what we called "exigent action." The real thing is to prevent it from ... happening again. And one thing that Dodd-Frank does do is it puts these other kinds of large institutions under a body of supervision. There is an oversight committee. It is now chaired by the secretary of the Treasury. The chairman of the Federal Reserve is involved in all of the other agencies.

But at the time, it was seemingly just an extraordinary failure, or potential failure of the system that could bring the system down. And then there were others that follow, as you know, in consequence.

You felt that way, though? You really felt like when those phone calls and those video conferences were happening, you were at the edge of the abyss?

Well, you could see -- and this is the parlance of our business -- but you could see the credit default swap spreads widening. What that means is that the cost of insurance against risk was becoming more expensive and more expensive, and the market was telling you that something was wrong. And so it's one thing, when you're in a battle, you react tactically.

In terms of developing a strategy, being prepared for this, remember we had gone through almost 25 years of what they call the Great Moderation. Interest rates were low; we had new people coming into the competitive system, new populations like China bringing prices down, and very little volatility in the marketplace, with some exception of 1987, but they didn't last for very long. And I thing people became complacent. And with complacency, people take greater risk.

Again I want to remind you, Bear Stearns was not on our supervisory duty, but we had the job of stepping in to make sure that a panic didn't ensue that would end up compressing the entire global economy and leading to deflation. …

Talk about being on the hot seat.

I do believe the Fed not only did the right thing under the circumstances at the time. I want to remind your viewers, we did something that is very unusual in the government of the United States or any government anywhere in the world. We did what we said we would do, because the system stopped. All forms of payment froze when we got to the depth of the panic. Banks wouldn't lend money to each other.

The first money market mutual fund in the United States quote "broke the buck." Commercial paper, one of the most basic instruments in finance, that market failed. Someone had to step in and remake those markets, and we did it.

That's point number one. We actually did what we said we were going to do. Secondly, they worked. Thirdly, we made money for the United States taxpayer. And this is the most unusual part of all: When we were done, we closed them all down.

I'm very proud to be part of a team that actually did something that's almost never done in government: (a) create something and then close it down, and (b) have it be profitable for the taxpayer. But I certainly don't want to ever be part of any team that ever has to go through this again. … This was incredible decision-making under incredible duress.

But, you know, you could argue almost any single case is exceptional and has to be acted on. It's sort of a perverse Lake Wobegon. All our children are exceptional and everything is exigent and has to be acted on, and it's unusual and unique. And this is one of the traps you fall into when you have these large institutions that you don't really understand, are poorly regulated, which Bear Stearns, and Lehman, and AIG were. …

When you have that kind of concentration where you don't understand really where the risks are -- they're gigantic in size, they have global scope -- that's where you have a huge risk of an error infecting the rest of the system, what they call "contagion" in finance. …

The new president comes in. … What was the state of play on inauguration day?

You had a system that was in the midst of crisis. We had an economy that was rapidly submerged in increasing amounts of debt. On top of that, we were in an economic recession. And regardless of whether he's a Democrat or Republican, he stepped right in the middle of it immediately.

And so I think the good thing that the Fed was allowed to do is what the central bank should do at the time. And again, it is a unique body with its capacity to do what it does. It has to be careful. Obviously we've ended up with a much-bloated balance sheet compared to what we had before the crisis.

Just to give you some numbers to put things in perspective: Before the crisis, what we call the "footings" of the central bank, that is the assets balance sheet, was about $800 billion. Now it's close to almost $3 trillion. Well, why is that? It's not because of the special programs we put together the patchwork to solve the insolvency of these various markets. Those worked, as I said before. They've been closed down. They made money for the taxpayer. They restored liquidity in the system.

The question really is what do we do in a postoperative sense? And this is now running into the last year of a first, or ultimate presidential administration for this president. We have kept rates very low. We've re-liquified the system. This is very, very important. We provide the gasoline for the engine of our economy. We have very full gas tanks right now. We have sitting on deposit at the 12 Federal Reserve Banks, where private banks put their excess reserves, almost $1.7 trillion in excess reserves, for which we pay them 25/100ths of 1 percent per annum. No banker wants to just sit with that. They'd like to make more money of it.

Corporate America, separate from that, we estimate has over $2 trillion in excess cash sitting on their balance sheets that they don't need under the current cash flow design and needs and their capital expansion necessities or plans. And then the non-depository financial institutions, the buyer groups and others, have copious amounts of cash.

So we've gone from what happened at the beginning of this presidency, which was no liquidity and a crisis, to now a re-liquified system. … Now we are flush with capital, and we're beginning to see it, but how do you accelerate the economy? How do you incentivize? And so it's a different set of problems now that this president came in with, or the last president had to confront at the end of his term.

... What you're saying in the case of credit default swaps is they were in an unregulated space, so nobody was checking [whether] the buyers or sellers of these things would be solvent in the event of a calamity?

Exactly, and was a real dereliction of responsibility of the Federal Reserve, particularly Federal Reserve in New York, which is where a lot of this was going on.

How do you account for the fact that a lot of smart people made this miscalculation?

I think it has to be self-interest. They were captured by the financial market.

And making a lot of money?

Those in the financial sector were making a lot of money.

The regulators don't make any more money.

The regulators were what we call "cognitively captured." They spent all the time with the bankers. The bankers said: There's a wonderful party going on. Don't spoil it. We're smart people. Trust us.

You see that mentality reflected so strongly in the testimony that Alan Greenspan gave to Congress where he said: "There was a flaw in my reasoning. I thought that the banks would manage their risk better, and obviously they didn't."

But I think actually that that position was untenable and irresponsible, because you don't, as a regulator, just trust. Your job is to make sure that if they don't do their job, the consequences for our banking system, for our whole economy, aren't a disaster. ...

... The Bloomberg article that came out a few weeks ago, about forget the TARP [Troubled Asset Relief Program], the reality is that there was $7.7 trillion that was lent or opened up to the banks in one way or another, low interest rate loans and everything else. Tell me what the conversation was, what the reaction of the administration was. ...

... Remember the bank bailout stretched out over a very long period of time. Data that's only become available more recently has revealed how deep the problems were.

The first clear symptom was the Bear Stearns bailout in March 2008. A lot of people were very worried after the breaking of the housing bubble. They were aware that banks had exposure. Many economists thought the likelihood that there would be severe consequences was very high.

[Federal Reserve Chairman Ben] Bernanke made a speech: Don't worry, the risks are contained. Those of us who listened to that really got even more worried, because it was clear that they didn't understand or that they were covering up.

The data that has come out since about lending in 2007 and '08 by the Fed shows that it was massive, that the financial system was going through tremors, and they must have known it. The Fed was lending not just to American banks but to banks all over the world, and in amounts that were really astonishing. ...

... Bloomberg made a big to-do a month ago when they reported that $7.7 trillion had been open to the banks and financial institutions through the Fed. Not that they were given that money, but over a period of time that amount of money flowed out. There's of course a lot of debate over the figures, but the bottom line that people eventually say is that trillions were certainly opened up and given at different points to different banks at different periods of time, all in secret. ... So put that into perspective for us.

What I was referring to a moment ago was essentially the TARP money, money that the Treasury controlled. The Congress appropriated $700 billion for the TARP program, most of which never got used.

From the time that President Obama took office, the money that we used from the TARP program didn't go into the big banks; it actually went into the smaller banks. It went into the other programs we've discussed, which were designed to open up the credit markets and to deal with the legacy asset problem. We allocated some of the money for housing programs and for the auto resolution, but not into the big banks. ...

The Fed was tremendously effective in what they do. I think Ben Bernanke and his team deserve a ton of credit for keeping us out of the second Great Depression, and I think it's unfortunate and unfair for people in hindsight to be attacking them.

This lending program was a very important component of what helped turn around the system. The figures I think were grossly distorted. If I lend you a dollar today for 24 hours, you repay it tomorrow, and I lend you another dollar, and you repay it, and I lend you another dollar. That's not $3; it's $1.

But if these loans were overnight loans, you're double, triple, quadruple counting. I don't know what the multiple is, but you're greatly exaggerating the numbers is the first thing.

The second thing is these were loans made against collateral. One of the Fed's roles is a lender of last resort, and they lent against good collateral; they didn't lose any money. They made a tremendous profit for the taxpayer.

I think I read a couple weeks ago they just sent a check to the Treasury Department for $74 billion, a lot of which was as a result of programs that they put in place to try and prevent the economy from going into the abyss. ...

The issue ... still remains that it was done behind closed doors. People didn't know the programs were that extensive and the number of loans that needed to keep on going out. What's your take on that?

I actually think the information was out there. I haven't gone back and looked at the website and things like that, but these programs I thought were public. The Fed's balance sheet is public, so the amount of loans that they have outstanding in any given time is freely available. ...