(this was published previously in the Macon Telegraph)

Being in the middle of a record economic crisis presents a rare learning opportunity.  Several books are worthwhile for those seeking to understand what just happened.

Too Big to Fail by Andrew Ross Sorkin details the action of the Fed under Benanke and Treasury under Paulson during the crisis period between August and December.  While Geitner as head of the New York Fed was also featured the central player of this crisis was Hank Paulson.

Monumental decisions involving billions of dollars of assets were made in days, sometimes hours.  Both Paulson and Geitner had a sense that the market was due for a correction long before the crisis hit, but they probably did not see it coming as fast and as broad as it did. Bernanke noted that just as there are no atheists in foxholes there are no ideologues in economic crisis either. Neither Republicans or Democrats wanted to bail out Wall Street , but the crisis dictated actions that were against the grain of capitalists of both parties.

Paulson worked tirelessly to find appropriate merger partners for weak players like Merrill Lynch, Wachovia, and Lehman.  He almost had Barclays ready to buy Lehman when the British Financial Services Authority ( FSA) refused to approve the acquisition/merger because of the risk it brought to the British financial system.

Lehman was singular in the fact that it was not acquired or bailed out and thus had to go bankrupt.  Part of this was timing; Congress was just in no mood to bail out a Wall Street player.  Part of the reason was George Bush’s cousin who worked for Lehman and his brother Jeb’s association with the firm. Such close political relations probably worked against the interests of the firm.

In retrospect bailing our Lehman’s may have forestalled the panic that engulfed the rest of the system. With Bear Sterns gone and now Lehman’s gone, depositors wondered who was next and there began a run of the other banks like J.P Morgan and Morgan Stanley.

While Paulson’s association with Goldman was suspect the fact was he had to severe his tie and sell his stock ($485 million worth) in order to take his job at Treasury. Since his actions were so scrutinized he was careful to avoid even conversations that would indicate favoritism toward his old firm.

The most difficult decision was to bail out AIG whose credit default swaps acted as insurance against many of the cdo’s (collateralized debt obligations) that infected the financial markets. As the underlying assets plummeted in value AIG was downgraded and had to put up more capital that it could not provide.

Having to make such massive changes and decision in such short time meant that perfection was not obtainable. Barney Frank justifiably wanted some assurance that compensation to the executives would suffer from their misdeeds, but there simply was not enough time to rule of thousands of contracts during the time period that decisions had to be made.

Wall Street clearly engaged in risks it did not understand, but neither did the regulators such as Greenspan and his successor Bernanke. Complicated risk models gave the CEO’s delusional certainty, but eventually the party came crashing down for the same reason all bubbles burst;  lack of trust and confidence.

But Sorkin spends little space getting into the detail of the causes of the crash and suitably stays focused on the urgency and the actions required in response. 

For more information on the background that caused the crisis I recommend The Housing Boom and Bust by Thomas Sowell,  Financial Fiasco by Johan Norberg, most of all After the Fall: saving Capitalism from Wall Street - and Washington by Nicole Gelinas.

Sowell and Norberg focus more on the misguided Government fiscal and monetary policies that inflated the housing bubble, but Nicole Gelinas also analyzes which good regulations were unfortunately removed (and by who) and which bad ones were inappropriately applied.

A crisis of this nature required the perfect storm of many great errors to all focus their retribution at the same time. Unfortunately the media large engages in partisanship and demonization and few people will take the time to understand what happened and why.  It is complicated but engaging the problem reveals basic principles of sound policy that were violated as they were in previous bubbles.

History repeats itself but never the same way.

In several past postings reviewing the recent financial meltdown, I have noted the pivotal role played by Fannie Mae.

A toxic mix of arrogance and incompetence infected Wall Street.  Bad political, monetary, and tax policy inflated the housing market bubble.  But without the assurances of Fannie Mae, the ratings agencies and market makers would not have  been able to give the mortgage backed securities at the center of the crisis the ratings they clearly did not deserve.

Fannie Mae was exempt from regulation by the FDIC, the SEC and SIPC.  It’ s sole overseer was Congress.  When Congress was presented with evidence that Fannie Mae was taking excessive risks and needed restraint in 2005 and 2006, the bearers of caution were beat down by Barney Frank and many others  and the proposal was unable to even make it out of committee. On almost straight party lines the Democrats refused to restrain the agency. Fannie Mae, with a monopoly granted by the government lobbied hard to prevent any interference by the Congress.

The largest recipients of Fannie Mae campaign funds was Hillary Clinton, Christopher Dodd (Senate Banking Committee Chairman) and Barak Obama.

While understandable outrage was leveled at the Wall Street Firms and AIG for the bailouts the real outrage was the bailout of Fannie Mae.  Now President Obama has pledged unlimited support for the agency.

When private enterprise fails capital exits the enterprise; when a government enterprise fails it attracts additional capital.  Private mistakes go bankrupt, government mistakes get institutionalized.

Are lobbyists that bad?

If the government was about to make sheet-rock illegal because of bad or misguided information and you were in the sheet-rock or home-building business, wouldn’t you seek to persuade the lawmakers than their efforts were wrong? Wouldn’t you seek to give them better information or explain how that law will dramatically increase the costs of homes?

Every business or service sold has unique characteristics that few in Congress understand; they depend on lobbyists to fill in the blanks.  And Congress is not always driven by the highest of motives. They are frequently duped by industries that appear to be fighting to protect the public, but really are just trying to use the law to make life harder for their competitors.

Do we want a health care bill with no inputs from doctors, pharmaceutical companies, or health insurance administrators?  Do we want a trade bill with no input from the producers and consumers who will be harmed? Do we want an energy bill with no input from those who actually produce and distribute …. energy?

Obama and most others have criticized the input of lobbyists and the influence they have yielded. Yet the biggest recipient of campaign funds from the controversial insurance giant AIG, the PAC assembled by  Countrywide Financial, and from Fannie Mae was Barak Obama.  If he was so opposed to lobbyists’ influence why didn’t he reject their campaign contributions?

While critical of the influence of lobbyists, the president’s dramatic growth of government will only increase the activity and influence of lobbyists.  Lobbyists are caused by excess government regulation; a growth in regulation is guaranteed to cause an increase in lobbying activity.

In spite of the rhetoric to the contrary you can expect to see more lobbyists under this president, not less.

I watched this interview with Eliot Spitzer by Fareed Zakaria from March of this Year on Zakaria’s show called GPS.  I was impressed with Spitzer’s view and his depth on the subject of the economic collapse.  (There are two other portions also on YouTube.)  A few salient points he made:

There was not a want for regulators or regulations. Spitzer felt we had more than enough regulators to do the job, but were missing people with the judgment and creativity to do the job.  New regulations and new agencies will not be a substitute for judgment.  We passed new regulations such as Sarbanes Oxeley after the dot com bubble and it did nothing to prevent the housing bubble.

Spitzer referred to a problem with “libertarians masquerading as capitalists” advocating no regulation.  But capitalism in his judgment REQUIRES prudent regulation.  At the same time he warned against “populist legislation” that would strangle the innovations of capitalism and economic growth.  He faulted the firms on Wall Street for selling self regulation and he equally faulted the legislators for buying it.

He also noted how the financial sector lost its bearings and instead of being a mere conduit to those who actually create wealth, became deluded into thinking they themselves could create wealth.

The bonuses paid by AIG at that time were wrong in his opinion, but the dollars were small compared with the bailout money that was passed on to counter party investors such as Goldman Sachs.  With so many people taking a haircut it was just wrong to reimburse their positions 100%.

Spitzer had investigated AIG as Attorney General of New York (before he was governor) for misleading accounting practices and noted that the board had pushed Hank Greenberg out. He was doing his job more aggressively than the federal prosecutors.

It is unfortunate that Spitzer will be remembered for his sexual indiscretions when his investigative work proved to be prescient.