The Great Read-cession, Part IX

Confidence MenWe’re wrapping up the financial crisis book reviews with today’s look at two books on the reform efforts that followed the crash of 2008.

Confidence Men: Wall Street, Washington, and the Education of a President

by Ron Suskind, 2011

 

The last two books I read focused mainly on the government’s response to the crisis, as opposed to the crisis itself. Confidence Men, which got a lot of attention when it came out for its revelations of in-fighting in the Obama Administration, showcases Obama’s response to the financial crisis, both as a candidate and as a new president.

As a candidate, of course, the financial crisis and the housing bubble were a boon to Obama. The sluggish economy of President Bush’s last few years helped Obama’s message of change resonate with the electorate, and John McCain’s incoherent response to the crisis—including his assertion that “the fundamentals of our economy are strong” on the day Lehman failed—helped doom his campaign.

But once Obama was elected, the crisis became a tremendous albatross. One problem was that while many within the campaign anticipated a crisis of some kind, nobody really expected it to come so fast and be so severe. Suskind details a scene from early in Obama’s campaign—August of 2007—in which Obama’s economic advisers warn him that, as president, he will need to respond to a housing crisis. But they estimated that the crisis would hit in “year two” of an Obama presidency, and it would cost about two million jobs. In reality, of course, it came before Election Day, and ultimately cost about eight million jobs.

Plus, President Obama had other items on his agenda. Much of Suskind’s book is, predictably, devoted to health care reform. This is its own interesting story—about how the Obama Administration moved from health care reform to health insurance reform—but its main relevance to the financial crisis is to show how quickly Obama wanted to move on. He was eager for the economy to pick up and for reforms to be implemented, mainly so that he could devote his Administration to the things he had campaigned on—ending foreign wars, health care, etc.

Suskind’s thesis, then, is that Obama wasn’t prepared for the challenges of the moment, and thus was unsuccessful in responding to them. There is certainly something to this argument. For one, Suskind makes a compelling case that Obama’s original sin was simply surrounding himself with the wrong people.

During Obama’s transition, his choices for economic posts came down to two distinct teams. One team mainly comprised Obama’s advisers during the campaign, people like Austan Goolsbee, Robert Wolf, and the former Fed chairman, Paul Volcker. But this group was relatively unknown in Washington or, in the case of Volcker, not beloved by Wall Street.

The other team was comprised mainly of former Clinton Administration officials, people like Larry Summers and Tim Geithner. Ultimately, of course, Obama went with the latter team, though his reasoning—experience—was strange. It was true that Summers and Geithner did have the most experience with the current crisis, but that had largely been to enact the policies that helped cause it: Summers had been instrumental in repealing Glass-Steagall, and had helped deregulate futures contracts and swaps; Geithner had been an architect of the Bear Stearns bailout as the head of the New York Federal Reserve, and he famously oversaw the AIG bonuses, which became a huge scandal.

It wasn’t just their questionable economic judgment that made Summers and Geithner bad choices—they also weren’t effective managers. Summers, in fact, is almost villainous in Suskind’s telling. He is arrogant and rude, dismissive of competing viewpoints, and bad at working with others, particularly women.* Summers is quoted in the book as saying that, in the Obama White House, there was “no adult in charge,” but of course he himself was largely responsible for this lack of oversight. Obama entrusted things to Summers, who would shut people out of meetings, make decisions without input from his team, and yell at people for not consulting with him.

*Problems working with women were, in fact, rampant in the Obama White House, and Suskind documents how women often felt marginalized and unheard. Some of this was due to Summers and Rahm Emanuel, who both had abrasive personalities, but it also seems to have been largely Obama’s fault. The President does not come off as particularly friendly, and he helped enable a poor work environment. The book is actually a great illustration of current problems facing women in the workplace, where outright sexism is less of a problem than the insularity of male bonding.

Geithner may have been an even worse choice. From a simple public relations standpoint, Geithner was not an effective communicator, in a time when there was unprecedented attention being paid the Treasury Secretary. Geithner, in public, would stumble over words, misspeak, and come off as unsure and indecisive. Plus, his confirmation raised a mini-scandal when problems arose with his taxes.*

*Suskind also points out that, though Geithner was confirmed, the tax issue likely cost Obama his appointment of Tom Daschle, who had a similar, though less serious, tax problem of his own. Daschle had been a leading advocate for health care reform for years, and losing him was a serious blow to the Obama’s Administration work on Obamacare.

On a more substantive level, Geithner was the leading proponent of the view that stabilizing Wall Street was the government’s top priority. Paulson, Summers, Bernanke, and others had all operated on this thinking to some degree, but nobody seemed to embody it like Geithner. To him, Washington had to make sure that banks stopped failing and stopped losing money. The government thus shouldn’t take any step that might hurt the banks, or contribute to more losses. Only later, once the financial industry was stable, should serious reforms be considered.

Of course, this thinking is totally backwards. There is no political appetite for reform when a system is stable—it is only in times of crisis that real change can occur. As Suskind quotes one banker, “The president had us at a moment of real vulnerability. At that point, he could have ordered us to do just about anything…But he didn’t—he mostly wanted to help us out, to quell the mob. And the guy we figured we had to thank for that was Tim. He was our man in Washington.”

Everything Geithner did was done with the express or implicit purpose of boosting the banks. His “stress tests” on the banks were largely for show, a way of tamping a federal stamp of approval on the banks, and most of the TARP-related plans, like PPIP (Public Private Investment Program) and TALF (Term Asset-Backed Securities Loan Facility), were basically just programs of cheap government loans to banks and funds to buy toxic assets from each other, and effectively drive up their rock-bottom prices. In the one case when Geithner was actually tasked with doing something that might hurt Wall Street—the government organized restructuring of the failing Citigroup—Geithner just didn’t do it despite direct orders from the President; so it never happened.

And once the banks returned to stability and profitability, efforts at reform stalled. Suskind shows how the most important provisions of the Dodd-Frank Act—like ones that limited the size of banks, or attempted to reform the ratings agencies—were ultimately stripped from the bill or made toothless. By then, the government had lost its leverage, and Wall Street could effectively fight back against any reforms.

In examples like these, Suskind’s book makes a persuasive case that a president is only as good as those he surrounds himself with. Obama’s choice of Emanuel as his chief of staff was similarly ill-advised.* But Obama himself deserves a fair share of blame. He underestimated the severity of the crisis and didn’t ask for a big enough stimulus, despite the warnings of several economists that the stimulus needed to be at least $1 trillion.** More importantly, though, he didn’t fashion a real response to the problem, perpetuating Treasury’s ad hoc approach, and never allowing for serious debate from all views.

*Suskind’s book has one scene that includes probably the most fateful haircut in American history. In an early discussion with Obama’s economic advisers, they were debating whether or not to temporarily nationalize some of the banks. Though many, like Summers and Christina Romer, argued that it was the only way to rid some banks of the toxic assets, there was some resistance. Eventually, after several hours, Obama announced that he was going to “get a haircut and have dinner with my family… When I come back I want this issue resolved.” As soon as he left, Emanuel summarily dismissed (with lots of swearing) Summers and Romer’s plan. When Obama came back, they agreed to Geithner’s phony stress tests.

**The reason for a smaller stimulus shows the peculiar logic of Washington. Obama and Emanuel didn’t want a trillion dollar stimulus because they thought deficit hawks and the public at large would balk at such a large price tag. Of course, the American Recovery and Reinvestment Act ended up costing $787 billion, so it’s not like the Obama Administration got any points for being frugal.

Ultimately, the smaller stimulus led to a slow recovery, and by 2010, Obama and Democrats in Congress were pretending the stimulus never happened. In fact, many Republicans were able to argue that the stimulus HURT the economy, and the idea of any more stimulus money was dead on arrival. In trying to save $200 billion—at a time the government was offering trillions to Wall Street—the Obama Administration did substantive harm to the economy, and political harm to itself.

Having said all that, Suskind’s book sometimes strains too hard to support his thesis that Obama “wasn’t ready.” It’s true that Obama’s handling of the crisis was not great, but a lot of the steps were already in place before he was sworn in. They don’t seem to have been caused by Obama himself as much as the culture of Washington. Even Obama’s mistakes don’t really seem to be of the “not ready” variety, though Suskind always portrays them that way. Some were just quirks of his personality, or his decision to trust former Clinton Administration officials, or his focus on health care at the expense of financial reform.

So much of Suskind’s book, though, is clearly written to conform to a narrative. His writing is often heavy-handed, to manufacture suspense—“One buyer, two banks. The question: Who would get there first?”—or to create the illusion of meaning—“What is it like to stand inside a collapsing world? Things that seem so solid—solid like the earth, as regular as sunrise—and then nothing?”

And his reporting is sometimes shoddy. He calls John Thain “the former number two at Goldman, who after Paulson left was beaten out for the top job by Blankfein,” but Thain left Goldman to run the NYSE two years before Paulson left and Blankfein took over. Suskind’s breakdown of the financial crisis itself is oversimplified, and relies too heavily on just a few Wall Street sources.

All this, of course, hurts Suskind’s credibility. Although his reporting on many issues is certainly excellent, some of it must be taken with a grain of salt. Too often it seems like Suskind is more intent on writing a political thriller than with breaking down the issues at hand. To be fair, though, Suskind’s book contains two of the most important quotes in all the books I read. But I’ll get to those later…

 

BailoutBailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street

by Neil Barofsky 2012

 

Neil Barofsky’s book on Treasury’s handling of the bailouts was a perfect palate-cleanser to this buffet of financial books, both stylistically and substantively. Barofsky, who was the Special Inspector General in charge of oversight of TARP from December of 2008 to March of 2011, personally witnessed the cleanup after the disaster of 2008, so he is able to trace the aftermath of the events. Perhaps just as important, though, is that Barofsky is one of the few authors who was not previously enmeshed in the worlds of finance and government. Most of the previous books were written either by people who had worked on Wall Street (Paulson, Ritholz, McDonald), or reporters who had covered Wall Street for a long time (McLean/Nocera, Sorkin, Cohan). Barofsky, however, was a true outsider.

Barofsky was a prosecutor for the U.S. Attorney’s Southern District of New York, and his work on mortgage fraud cases served as his main qualification for the post of SIGTARP, which was designed to provide oversight for the bailout money.* Of course, by the time Barofsky was sworn in, Treasury had already begun changing the terms of the bailout.

*The world of Inspectors General, or IGs, is itself somewhat scandalous, as Barofsky tells it. IGs are there to provide oversight for various departments and agencies—there are about 65 in total—but they tend to be overly deferential to those agencies. For example, Treasury has its own IG—Eric Thorson—who could have reviewed the bailouts in his own office, but Barofsky implies that Congress made sure to include provisions for a special SIGTARP since Thorson had a reputation of being essentially a Yes-Man (as Barofsky convincingly portrays him).

TARP had been sold to Congress as a program to buy toxic mortgages from the banks (hence the name, Troubled Asset Relief Program), and many members of Congress only voted for it with the understanding that, once the government owned some of these mortgages, it could provide mortgage relief to the homeowners. But just 11 days after the law was passed, Hank Paulson, having decided that would take too long, announced the Capital Purchase Program (as outlined in Sorkin’s book) that handed $250 billion to the banks with no strings attached.

Though that money had been sent out weeks before Barofsky was sworn in, he made a relatively simple recommendation—he asked that the banks explain what they did with the money. This seems like an eminently reasonable request. After all, the stated goal of CPP was to encourage the banks to lend more, so why not ask to see if they were actually lending the TARP money? But Neel Kashkari, the Treasury official who oversaw TARP, resisted, insisting that “all money is green,” so it would be impossible for banks to separate TARP funds from other funds.

Of course, this is specious logic. While it may be true that all money looks the same, there are obviously some tells. If someone hands me a check for $100,000, and the next day I go out and buy a boat, it’s not hard to connect those events, even if the check for the boat was written from my savings account. And even if the requirements would be easy for banks to cheat, why not at least make them report something?

But Barofsky explains that, “Treasury didn’t really view the initial CPP recipients as ‘healthy and viable’ and that the stated core policy goal of increasing lending was apparently more of a public relations move than an executable policy.” In other words, the bailout was just designed to keep the banks afloat—not increase lending—despite what Treasury said publicly.

This pattern repeats itself throughout Barofsky’s story: Treasury announces a program; Barofsky investigates and makes recommendations for the program to achieve its goal; it’s revealed that the real goal is actually just to help banks. The most disgusting example is the Home Affordable Modification Program, or HAMP. HAMP was started by Geithner, and its stated goal was to address mortgage modifications that many Congressmen wanted but which had gone unaddressed in CPP. When President Obama announced the plan, he said it was to help between 3 and 4 million homeowners. In reality, the program did tremendous harm to homeowners.

Barofsky points out that Treasury not only left the modification details to mortgage servicers (usually subsidiaries of bigger banks) who were not prepared to handle them—it also structured the incentives so that servicers benefited from not granting modifications. What tended to happen was that servicers would offer homeowners “trial” modifications, which would often drag on indefinitely. All that time, unbeknownst to the borrowers, they were accruing late fees for paying the new “trial” rate.

If servicers made the trial modifications permanent, those late fees would go away, so they generally just dragged out the trials for months and even years, or ultimately rejected the modifications (of the stated goal of 4 million, there have been only 600,000 or so permanent modifications so far, and many of those have redefaulted), at which point homeowners faced immense bills for late fees they couldn’t afford and hadn’t realized they accrued. As Barofsky says, it was “more profitable for a servicer to drag out trial modifications and eventually foreclose than to award the borrowers quick permanent modifications.”

But when he pointed this out, Treasury made no changes. Barofsky realized that the real goal of HAMP was to “foam the runway” for banks. If all the foreclosures hit the banks at once, then the losses would be devastating for those who held bonds and CDOs backed by those homes, but if you could spread the defaults out over several years, then the banks could cushion those losses with other earnings. In other words, even HAMP was designed to help the banks.

Aside from the policy specifics—of which Barofsky packs a lot into his short book—Barofsky dwells on the culture inside Treasury. Some of this takes the form of amusing anecdotes about petty offenses and SIGTARP’s lousy office, but more substantively, Barofsky documents Treasury’s culture of deference to Wall Street. Many of the books highlighted the incestuous relationship between Washington and Wall Street, but Barofsky, as an outsider who was granted insider status, is able to see it and document it most clearly.

Barofsky refrains from calling anyone corrupt—indeed, he goes out of his way to say that even people he argued with, like Kashkari, Paulson, Geithner, and Herb Allison, were all patriotic, honest people. It’s simply that their experience working on Wall Street and with banks shaped their perception of the economy as a whole. As a result, they seemed to think whatever was good for the banks needed to be done.

If the banks needed money, Treasury would give them money; if banks needed AIG bonds to be paid off in full, then Treasury would pay them off in full; if banks needed foreclosures drawn out, then Treasury would start a program for that.* When it came to regular people, though, Treasury would get very principled. When Barofsky pointed out that only by reducing the principal owed on mortgages could Treasury really stem the tide of foreclosures, Treasury pointed out the moral hazard of bailing out delinquent homeowners.** How Geithner, et. al., kept a straight face when invoking “moral hazard” after trillions of dollars of bailouts, Barofsky doesn’t say…

*It’s also worth pointing out that the banks rarely ASKED for these things, and in some cases actively fought against them, which is another respect in which “corruption” fails to really capture the problem. Treasury would simply decide what was in the best interests of the banks.

**Of course, it’s also possible that even this was just more doublespeak to protect the banks. Presumably reducing the principal on the mortgages would have affected the securities backed by those mortgages in the same way that a wave of simultaneous foreclosures would have. 

Even more disconcerting, there was a presumption among those who came from Wall Street that people on Wall Street were naturally good. The reason incentives in these programs were often so poor was that Treasury officials simply assumed banks would do the right thing. When Barofsky pointed out potential for fraud in TARP, Kashkari insisted that no bank would risk its reputation by defrauding the government. Of course, this was the same logic that helped cause the crisis in the first place.

Indeed, Barofsky points out how closely the recovery programs mirrored the practices that led to the crisis. Excessive leverage, reliance on credit-ratings agencies, and devious accounting practices were all featured heavily in Treasury’s plans. Even the Dodd-Frank bill helped solidify the Too Big To Fail problems it was meant to address. In general, the book shows how little has actually changed since the crisis of 2008.

Thankfully, Barofsky manages to distill a lot of rather complicated details of these policies in relatively clear language. He is intelligent, but plainspoken and direct in his writing. This served him well in his job and in his book, but presumably made him an outsider in Washington.

Towards the end of Bailout, he tells the story of a hearing in early 2011. Representative Darrell Issa, new to his position as chairman, made a procedural error that Barofsky perceived as a personal slight, and he got incensed. When he told his wife, though, she pointed out that such petty, procedural issues were exactly what he had hated about Washington, and Barofsky started working on his letter of resignation. He quit before he got fully infected. Which is a shame, because his reasons for quitting are exactly what made him so good at his job.

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