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ECONOMY
Updated September 8, 2013, 9:04 p.m. ET
Financial Crisis: Lessons of the Rescue, A
Drama in Five Acts
By
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DAVID WESSEL
CONNECT
Five years after the near-collapse of the global financial system, Americans could
justifiably celebrate victory.
After all, the U.S. economy is growing, and, measured per capita, is back to where it was
before the crisis. Unemployment is falling. Banks have regained their vigor and paid back
nearly all the $245 billion taxpayers pumped into them. The stock market has recovered
all the ground it lost. So has household net worth.
A Crisis That Reshaped the U.S. Economy
U.S. markets have taken a well-documented ride since the financial crisis bloomed in
2008. Less well understood are changes in segments within some of those critical markets
— housing, jobs, stocks and the federal government's investments. Track some of these
shifts over time.
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Timeline: The Events That Shook the System
Quiz: Do You Remember Crisis Fundamentals?
From the Archives: 2008 Coverage
Bios: Cast of the 2008 Financial Crisis
Bios: Cast of the 2008 Crisis
Several bankers, policy makers and financiers were thrust into the spotlight. Review the
cast of characters.
Protesters held signs behind Richard Fuld, chairman and chief executive of Lehman
Brothers, as he took his seat to testify at a House Oversight and Government Reform
Committee hearing on the causes and effects of the Lehman Brothers bankruptcy, in
Washington, on Oct. 6, 2008.
Or Americans could rightly wonder why things are still so bad and ask if anything could
be been done differently—some policy pursued, some step avoided—to have eased the
prolonged economic pain.
Even after four years of economic growth, there are still 11.3
million people unemployed. Employment is up but there are
still 1.9 million fewer jobs than at the peak in 2008.
Five years after the bankruptcy of Lehman Brothers, where does the U.S. economy stand
now? Looking at the latest data on GDP, jobs, and housing, WSJ's Jason Bellini has
#TheShortAnswer.
Housing prices are rising, but one in six mortgage holders still has a loan larger than the
value of the house. The income of the typical household, the one in the statistical middle
of the middle, is 5% lower, adjusted for inflation, than in September 2008, according to
the latest estimates.
More From Real Time Economics
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Interview: Chris Dodd on the Financial Crisis
And the public is largely disgusted by the whole spectacle, much of it convinced that
Wall Street got bailed out and Main Street didn't. "To save the economy, we had to
violate a core American principle: You bear a risk, you suffer the consequences," says
Neel Kashkari, who ran the Treasury's Troubled Asset Relief Program, the TARP, that
funneled taxpayer money into the banks.
Enough time has passed to identify key moments in the war to save the world economy,
enough time to second-guess the generals. They did prevent Great Depression 2.0 and,
yes, it could have been worse. But could it have been better? Did missteps worsen the
crisis, or sow seeds of the next one?
More
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Graphic: A Reshaped Economy
Timeline: Events That Shook the System
Quiz: Do You Remember the Crisis?
Photos: What a Financial Crisis Looks Like
Bios: Cast of the 2008 Financial Crisis
MIT economist Andrew Lo points out there is still significant debate over both the causes
and the cures for the crisis. "We haven't decided as a country, as a society, to study these
failures like the National Transportation Safety Board studies an airline crash to make air
travel safer," he says.
How Big Is Too Big
The first Wall Street domino to fall was Bear Stearns. J.P. Morgan Chase caught it, with
government help, and many investors concluded that the government wouldn't let any
major institution fail—an assumption that would prove catastrophically wrong a few
months later.
To save Bear, the Federal Reserve in March 2008 put $29 billion
of taxpayer money at risk to grease the deal. Fed Chairman Ben
Bernanke has called that "the toughest choice." That's because it
was "the first one," he has said, the first extension of the Fed safety
net to an institution that wasn't a Fed-supervised bank.
Mr. Bernanke and his fellow financial generals— Henry Paulson,
then Treasury secretary, and Tim Geithner, then president of the
Federal Reserve Bank of New York—say the Bear Stearns rescue
was necessary because the firm was so interconnected with the rest
of the system. And, they point out, taxpayers got back all the
money they put up.
Critics counter that had they let Bear go under, investors wouldn't have lent so
readily to other Wall Street firms afterward, worsening the eventual implosion.
Vincent Reinhart, a former top Fed staffer, has called the decision to not let Bear
Stearns fail "the worst policy mistake in a generation."
The big domino was Lehman Brothers, the investment bank dragged
down by bad real-estate loans. Standing by as it went into bankruptcy
in September 2008 is the most second-guessed decision of the entire
crisis. "In hindsight, it is very hard to argue that it wasn't a mistake,"
says Frederic Mishkin, a Columbia University economist who left the
Fed board in August 2008.
At the time, though, he says, there was a case for letting Lehman fail to
teach Wall Street a lesson: "Everyone knew Lehman was exploiting the
fact that everyone thought the Fed would bail them out," he says.
The mantra of central bankers and other regulators, Mr. Mishkin says,
is that "you want to be tough, as long as you don't blow up the system."
The hard part, of course, is to know when to be tough and when
intervene to prevent the system from blowing up.
Richard Fuld, Lehman's CEO, told the Financial Crisis Inquiry Commission that he
believed to the very end that his company could be saved with government help. He said
he told Mr. Paulson, "If you would give us a bridge [loan], let's put Lehman back
together. We can wind down these positions, and we can make a lot of this ugliness go
away."
The government, of course, refused.
"We knew we were very sure the collapse of Lehman would be catastrophic," Mr.
Bernanke told the Financial Crisis Inquiry Commission a year after the event. The
Treasury and the Fed tried to sell Lehman, but couldn't. And though they offered
different explanations at the time, Messrs. Bernanke, Geithner and Paulson today all say
that they had no choice but to let it go.
"I will maintain to my deathbed that we made every effort to save Lehman, but we were
just unable to do so because of a lack of legal authority," Mr. Bernanke has said.
Mr. Paulson says that if the government's financial overseers had in 2008 the powers that
Congress granted them in 2010, they would have taken over Lehman. "It would have
been messy, but it would have been better," he says.
The next day, with global markets in full panic, the Fed, reluctantly, bailed out American
International Group, a huge insurer that had made big, losing bets on complex financial
transactions known as derivative investments.
All in all, the Fed and Treasury committed $182 billion to AIG. In exchange, taxpayers
got the bulk of the shares in the company. Those shares have all been sold now, and by
Treasury calculations, taxpayers got all their money plus another $23 billion. AIG is half
the size it was before the crisis.
But the takeover provoked political backlash, especially after it was revealed that
Goldman Sachs and other firms AIG made transactions with had been made whole and
some AIG executives and traders who had been at the scene of the crash got big bonuses
to clean it up.
Surprise Under TARP
The collapse of Lehman and all that followed led Congress, with substantial hesitation, to
approve President George W. Bush's request for $700 billion of taxpayer money for
TARP to rescue the banks. The game plan Mr. Paulson outlined to Congress changed
before a nickel was spent, but it did largely accomplish the government's aims and at less
ultimate cost to taxpayers than even optimists expected back in 2008
Mr. Paulson told Congress that the TARP program would be used to buy "toxic assets"—
mortgages that would never be paid back in full—from the banks. It wasn't. Instead, the
Treasury bought shares in the banks to shore up their capital footings.
"The severity and constantly expanding nature of the crisis meant we frequently operated
on the fly," Mr. Paulson says today. "We got TARP to do one thing that didn't work," he
said later, "but it succeeded brilliantly in doing another."
The terms remain controversial: the willingness to let bailed-out banks continue to pay
dividends, the subsequent rescues of Citigroup and Bank of America, the strings on
executive compensation (criticized both as too tight and too loose), the link (or lack
thereof) between getting TARP money and lending more.
A congressionally mandated oversight panel said later that TARP "provided critical
support to markets at a moment of profound uncertainty," but it left behind a
"troublesome legacy" of "continuing distortions in the market, public anger toward policy
makers, and a lack of full transparency and accountability."
Of the original $700 billion, about $428 billion was or will be disbursed, the
Congressional Budget Office estimates. Much of that has been repaid. CBO puts the
eventual tab to taxpayers at $21 billion.
One of the biggest successes in the government's campaign to save the banks were the
much-maligned "stress tests," initiated in early 2009 to assess the strength of 19 big
banks and, crucially, to force those that flunked to raise capital.
Though Europe later went through the stress-test motions, its version was neither as
aggressive or demanding as the U.S. Today, Europe's hobbled banks continue to restrain
euro zone economic growth.
U.S. at the Wheel
The rescue of the U.S. auto industry, in hindsight, looks like a roaring success. Both
President Bush and President Barack Obama deemed the industry too big to fail, at least
at a time of financial panic. In all, taxpayers put up about $80 billion. The Treasury says
they have recouped about $51 billion of that, so far. Chrysler has paid back its loans.
Taxpayers almost surely will take a loss on their remaining stake in General Motors Co.
Detroit auto makers are now solidly back in the black, thanks in part to the governmentled restructuring that eliminated much of the U.S. industry's excess production capacity,
lightened their debt loads and, in many instances, enabled lower wages and more flexible
work rules. That helped the auto makers raise prices and invest profits in more efficient
cars and trucks.
The motor vehicle and parts industry has added 190,000 jobs since June 2009, though its
workforce is much smaller than before the crisis.
The bailouts left an aftertaste. As the TARP oversight panel put it, the rescue left the
impression "that any company in American can receive a government backstop, so long
as its collapse would cost enough jobs or deal enough economic damage."
Housing Hangover
The 30% decline in housing prices confronted the Bush and Obama administrations and
Congress with vexing choices that were never resolved to anyone's satisfaction. And
housing, until recently, has been a significant weight on the economy.
At the worst, nearly one of every four Americans with a mortgage had a loan bigger than
the size of the value of the house. In the past five years, lenders have completed
foreclosures on 4.5 million homes, according to real estate data firm CoreLogic .
A parade of government programs, each with its own acronym, was crafted to cushion
some homeowners. A lot were helped: Under one program, nearly 900,000 mortgages
were modified to reduce the monthly payments. About 2.7 million got help refinancing
loans at lower rates.
But many more didn't get help.
"In a sense, all these programs failed because they were designed to help people who
needed only a moderate amount of assistance, a very narrow segment of the distressed
homeowners," says Mr. Kashkari, who oversaw TARP.
Bigger efforts were discussed. "There were much more muscular steps we could have
taken," says Sheila Bair, former chief of the Federal Deposit Insurance Corp. "Yes, they
would have been difficult to implement, but not impossible."
But the various schemes would have been costly—which meant either nicking
bondholders, or taxing some Americans who didn't buy more house than they could
afford, in order to help some Americans who did. Neither the Bush nor Obama
administrations thought they would work.
Housing was "where we had the biggest gap between people's expectations of what was
possible and what was realistic," Mr. Geithner said in an interview this year. "We didn't
have half- or three-quarters of a trillion dollars to provide principal reduction," he said.
And "doing so would have been a very inefficient way to help the economy, and really
unfair in many ways."
Economy: Still Healing
Five years later, the financial system has healed enough that there are now occasional
worries that some of the borrowing excesses of the past are returning. But the economy
hasn't fully healed despite an extraordinary display of fiscal and monetary firepower.
The fundamental unresolved policy question is this: Were the fiscal and monetary
stimulus the wrong medicine, or were they just too small to do the job?
Beginning in 2008, policy makers dusted off the works of John Maynard Keynes, the
mid-20th century British economist who prescribed spending increases and tax cuts to
cure the Great Depression, and revisited advice they had given Japan as it confronted
deflation, or falling prices, in the late 20th century.
Mr. Obama won congressional approval of tax cuts and spending increases that, by
CBO's latest reckoning, added up to $830 billion over 10 years. The Fed cut short-term
interest rates to zero in December 2008 and, nearly five years later, is promising to leave
them there for another few years. Figuring that wouldn't be sufficient, it printed,
electronically, about $2.8 trillion to buy bonds to push long-term rates down, an
unprecedented show of monetary force.
Yet each year for the past few has opened with forecasts that this will be the one that the
U.S. economy grows at 3% or better; each year so far has disappointed. CBO estimates
that U.S. output of goods and services will be below its potential until 2017.
Unemployment remains at levels once seen only in recessions.
In this light, the fiscal and monetary stimulus efforts look like failures, as Republicans
frequently observe. Mr. Geithner points to unremitting bad luck: the European sovereigndebt crisis; the disruption following Japan's tsunami and nuclear meltdown.
Top Obama administration and Federal Reserve officials say today they would have
preferred more government spending to make up for the shortfall in demand from the
private sector.
"We brought the deficit down faster than would have been optimal, and as a
consequence, we've suffered slower growth than we needed to suffer," says Lawrence
Summers, who was among Mr. Obama's advisers and is now a leading contender to
succeed Mr. Bernanke at the Fed.
The policy makers who led the response to the crisis argue that the economy would have
been even worse if not for the stimulus. And there is substantial support for that view
among private-sector economists.
Not everyone is convinced. "Government policy has been the cause of the problem," says
Stanford economist John Taylor. He prescribes less federal spending and "unwinding
monetary excesses" while returning to a predictable monetary policy based more on rules
and less on the discretion of Fed officials.
There also is a lingering sense that uncertainty and anxiety are holding things in check,
too.
"You get moments where people seem to feel a little better, and then they pull back,
again," says former Sen. Christopher Dodd (D., Conn.,) who gave his name to the DoddFrank bill crafted after the crisis to strengthen financial regulation. "That lack of that
sense of security that things are going to be OK" is a major reason "we haven't taken off."
Write to David Wessel at [email protected]
A version of this article appeared September 8, 2013, on page A1 in the U.S. edition of
The Wall Street Journal, with the headline: Lessons of the Rescue: A Drama in Five Acts.
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