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Yves here. The 15th anniversary of the Lehman bankruptcy, which kicked off the fourth acute phase of the 2007-2008 global financial crisis and came close to destroying the financial system, is almost upon us. In America, the old convention of remembering seminal events, such as the Pearl Harbor bombing or the assassination of Martin Luther King, appears to have gone out of fashion. While some events are perhaps best not turned into fetishes, like the anniversary of 9/11, memory-holing these traumas minimizes the harms suffered, such as in 9/11, not just to the immediate victims, but also to first responders who wound up with lung damage from working in the toxic fumes coming from the smoldering rubble.
For the financial crisis and the runup to the Lehman meltdown, many many books have been written, including our own ECONNED.
Here, INET president Rob Johnson and the INET head of research take up the Lehman anniversary, and cover a lot of ground in the hour-long talk. A key point they make is Lehman could have been bailed out, but Treasury Secretary Hank Paulson nixed that idea, and it was clear at the time that the Administration would not salvage Lehman. The reason at the time was that there had been too much criticism of the Bear Stearns rescue that March; some argued that the ex-Goldman CEO wanted to do in a former commercial rival. Regardless, even up to the collapse, Lehman was trying to arrange a rescue. Andrew Ross Sorkin’s Too Big to Fail reported the Lehman #2 as close to having cinched a “good bank/bad bank” deal with the Korean Development Bank, only to have CEO Dick Fuld himself scupper it by bursting into the room (he’d been frozen out for good reason) and insisting Korean Development Bank buy the whole firm.
Johnson and Ferguson point out that whether or not to salvage Lehman was the Fed’s, not the Treasury’s call. They argue that a bailout would not be a bad thing if the top execs and board were turfed out, something both the Bush and Obama Administrations were simply not willing to do (recall that early in the Obama Administration, even Serious Economists like Paul Krugman were pumping for a nationalization of Citigroup).
Johnson and Ferguson discuss a recent book by Lawrence Ball on the Lehman failure which includes a detailed chapter in which he analyzes Lehman and concludes it was probably solvent. I have difficulty with this argument, having followed the Lehman condition in gory detail in 2008, but I haven’t read the chapter and thus can’t opine. I am told that Ball’s analysis persuaded some who had though Lehman was hopelessly underwater….but (not to be too snarky) Ball is an economist and I suspect may even with his careful work does not have a sufficient appreciation of the finer, as in nastier, points of financial asset valuations. A counterpoint to Ball’s view is that the Lehman brokerage operation was finally wound up after over 14 years, at a loss. SEC broker dealers famously are ever and always solvent even the security firms around them fail. For the Lehman broker-dealer to have been wound up at a loss says there was fraud, big time, which makes me question any claim about the rest of Lehman having been solvent in a “normal” market.
But I do agree with the conclusion in this talk, that Lehman could have been stabilized and then split into a smaller, surviving entity and the rest liquidated or sold in pieces at a loss.
Although Ferguson and Johnson blame a lot of the failure to get adequate reforms on Congressional lobbying against Dodd Frank, the real blame lies with Obama. As we wrote in 2010:
Recall how we got here. Early in 2009, the banking industry was on the ropes..
The case for bold action was sound. The history of financial crises showed that the least costly approach is to resolve mortally wounded organizations, install new management, set strict guidelines, and separate out the bad loans and investments in order to restructure and sell them….
This juncture was a crucial window of opportunity. The financial services industry had become systematically predatory. Its victims now extended well beyond precarious, clueless, and sometimes undisciplined consumers who took on too much debt via credit cards with gotcha features that successfully enticed into a treadmill of chronic debt, or now infamous subprime and option-ARM mortgages….
But incoming president Obama failed to act. Whether he failed to see the opportunity, didn’t understand it, or was simply not interested is moot. Rather than bring vested banking interests to heel, the Obama administration instead chose to reconstitute, as much as possible, the very same industry whose reckless pursuit of profit had thrown the world economy off the cliff.
The talk is lively with a lot of pithy phrase-making and mordant humor. Both Ferguson and Johnson are having a good time despite the seriousness of the topic.
Originally published at the Institute for New Economic Thinking website
In the days following the Lehman Brothers collapse, one financial behemoth after another, including American International Group (AIG), Washington Mutual, and Wachovia collapsed. The crown jewels of Wall Street – Morgan Stanley and Goldman Sachs – slid toward the abyss. The Federal Reserve, the Treasury, and other regulators were forced to step in, sometimes in conjunction with famous private investors, to rescue the system. The government in effect nationalized AIG and, after two cliffhanging votes in Congress, it directly injected capital into leading private banks.
Ever since then, debates have raged about why the authorities – the Fed and the Treasury — allowed Lehman to go broke, after earlier helping to salvage a series of other institutions.
INET President Robert Johnson and INET Research Director Thomas Ferguson review those dramatic events. They also draw disquieting parallels between the Lehman debacle and more recent episodes of financial deregulation, including recent controversies over crypto and private equity.
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Transcript
Rob Johnson:
This is Rob Johnson, President of the Institute for New Economic Thinking. I’m here today with our research director, Tom Ferguson, as we approach the 15th anniversary of the Lehman Crisis. The Lehman Crisis was a very profound event. It was like a wake-up call on the relationship between economy and governance. Tom, thanks for joining me.
Thomas Ferguson:
Well, I’m glad to be here. Although I have to confess, the last few decades have been somewhat traumatic and in no small part because of things we’re going to talk about. It’s almost like talking about a Halloween party that went just terribly wrong.
I mean, the striking thing about the Lehman to me is it’s like the paradigm case for lots of stuff that has happened since, but it’s also like the granddaddy of them all. It’s very rare that one single event just collapses the whole financial world, but it did it and they had a lot of aiding and abetting and helpers, a lot of regulators, a lot of bankers, lots of other folks, politicians. But yeah, it’s a completely traumatic event, and like most traumatic events, I have to tell you, Rob, I’m not overwhelmed by modern press coverage of this or even most modern scholarship. In that sense, I could say I’m actually glad to be here because this subject still needs a good airing.
Rob Johnson:
Well, how would I say? Whenever a stressful experience takes place that creates what you might call some shameful awareness of actions, it breeds ostriches and there are a lot of people who want to keep their heads in the sand, particularly in the aftermath of the failure of SVB Bank and other issues. But as we’ll talk about today, it goes into other things, the avoidance of climate change given its urgency. What does governance, what does media, what does expertise do right now? All the polls, whether Richard Edelman or Gallup or what have you, show that the faith in governance and expertise in the United States and in many other countries is in tatters.
Thomas Ferguson:
Which just tells us I think that the world’s not crazy at some fundamental level. Yeah, there’s a lot to be suspicious about. Maybe we should go back though and retrace the sort of formative events in Lehman remembering that the anniversary here, we’re not celebrating, we’re commemorating. It’s September the 15th, 2008. That’s when they filed for bankruptcy in the early morning hours of that, but Lehman was an investment bank. It’s like the disappearance of dinosaurs actually. I mean all those dinosaurs turned into commercial banks, so they weren’t in business a few days later, the old investment banks. But fundamentally, this is a story about – surprise – financial deregulation. Financial deregulation that starts 20 years or more before. It is a constantly… I mean, if this sounds familiar, because it is. It’s going on right now in Congress in regard to both private equity regulation where the Securities and Exchange Commission and Gary Gensler have been pushing for regulation and large numbers of congressmen and women on both sides of the aisle are pushing back.
And then of course the crypto regulation craze, where… I mean, crypto is amazing – it’s like the little koala bear parent of Lehman. In this sense, it’s that crypto was a case where you could see this was going to end in disaster. The notion that you could just let all these folks do whatever they wanted and sell whenever they wanted under very poor information conditions would end in tears, it’s obvious. Then it did. People have lost billions on crypto, but this thing like the koala bear is still walking around Congress and a lot of people are very happy to pick it up and embrace it, but we better come back.
Rob Johnson:
I was going to say the siren songs of temptation ask you to create earmuffs and we didn’t create the earmuffs with regard to crypto and we experienced calamity. But like you said, these are echoes that we’ll come back to towards the end of this conversation. Let’s go back. I’ll just say about the precursors that led to Lehman, the deregulation that was taking place in the financial sector, faith in unfettered markets, lack of faith in the state as an architect or enforcer and you might call warning signs that came a little bit earlier within the same year when Bear Stearns was taken over by JPMorgan and many politicians at that time – because I had worked as the chief economist of Senate Banking Committee – said to me, “Oh, okay, is that over?”
And I said, “No, there’s a whole lot on the horizon.” I didn’t name Lehman to them at the time, but I said, “There’s a lot of turmoil on Wall Street.” And they were saying to me, “We’re doing lots of fundraising on Wall Street. We can’t start to repair this.” And I said, “When are you going to? Because it’s got to be repaired after the election.” I said, “You may not get to the election.” Lehman came to our, how would I say, focal point and vividly affected society before any election took place. So in that respect, I was-
Thomas Ferguson:
Yeah, I know they made Hollywood movies out of this, but in fact, it was like a Hollywood movie because they all thought they could get past the election and they couldn’t. They were caught dead right in the middle, right after the Republican convention had just occurred, which was a giant free market celebration with everybody saying we had to end bailouts, and by then, yes, we had just bailed out Bear Stearns and then we had also bailed out Freddie and Fannie [Freddie Mac – Federal Home Loan Mortgage Corporation; Fannie Mae – Federal National Mortgage Association] in the sort of mixed enterprises, sort of.
Rob Johnson:
But let’s zoom in on Lehman itself. You’ve been through a book recently by Laurence Ball.[1] That is a very good deep dive into many of the, one might say the context, the circumstances, and the activities. Why don’t you describe Lehman itself?
Thomas Ferguson:
I like the Ball book a lot actually, though there’s some other stuff, including those two papers we wrote for the International Journal of Political Economy, that reached exactly the right conclusion, that this was basically a political call, that there wasn’t any clear reason it couldn’t have been bailed out.[2]
What Ball’s book shows you is that Lehman was maybe even arguably solvent right in the short run, but for sure was probably solvent if you took not mark-to-market stories, but over the somewhat longer run, which might get back to a normal market. You could have bridged loaned it, if you like, and saved it. They chose not to and Ball does a good job of showing that, I think. It does really say pretty much what we said and it leaves out the political party stuff. The fact that the Republican convention had just happened, that the Republican nominee was saying no more bailouts, and that it clearly got to Hank Paulson who was the Treasury secretary.
It’s clear, and Ball does a very good job on this. He shows you that decisions basically made in Washington, that the legal relationship between, if you like, the presidency and the Federal Reserve… It was a Federal Reserve’s call on whether to bail it out there. In fact, Paulson, as the Treasury Secretary, just told them, no bailout. And that’s what the Fed and, both Bernanke as head of the Fed and Geithner as head of the New York Fed fell in line with that. I’d say Ball makes the case on that. It’s absolutely right. It’s a political story. Now let’s-
Rob Johnson:
Let me just interrupt for a second because there’s, how do I say, for people who aren’t immersed in finance, I’ll use an analogy. There’s a game called musical chairs. There are more people than there are chairs, and you know when the music stops, somebody’s going to get thrown out of the game.
Thomas Ferguson:
Chuck Prince, who was at Citibank, actually used that analogy about how they had to keep dancing as long as the music was playing. In other words, just keep buying this junk.
Rob Johnson:
And what you knew when Lehman came into the crosshairs of concern was that if you made them alone, it was analogous to putting another chair in the room temporarily, but without a loan to Lehman and them crashing, it might wreck some of the other chairs in the room and take more people out of the game, and that was the environment in which people were, how would I say, anxious because the propagation from Lehman’s losses to others were being envisioned in scenarios at places like Citibank or JPMorgan or Morgan Stanley or whatever. Everybody’s looking at their, what I’ll say, cross-exposures with other large entities.
Thomas Ferguson:
It is interesting – a point Ball makes in his book too – is that the Fed almost surely underestimated the effects of Lehman. He’s very compelling on that point, despite testimony like Bernanke keeps saying, he always knew it would be a disaster. That’s not consistent with either his behavior or what he was saying in the immediate aftermath, but I think the big story here that one wants to focus on is the regulators. They had tons of detailed information about all kinds of things, really detailed stuff. The New York Fed [had] studies of this and that, but they couldn’t draw conclusions from it. They weren’t able to extract significant generalizations. Instead, what everybody did is they sat there and repeated the basic mantras about how deregulation’s basically okay. I mean what Bernanke actually said in the immediate aftermath of the collapse, which is what he said just before, was, “We’ve given the markets time to prepare, so this shouldn’t be so bad.”
Then the whole world collapsed. And so you put these two things together, a tendency to underestimate, to take comfort in received wisdom and shibboleths, the stuff that is endlessly echoed in the press by politicians and its giant echo chamber that this is really fundamentally a good thing. Then you underestimate the consequences of that and then finally you have to step in to save it. It’s a catastrophic sequence in which you first have a disaster build, then you can step in to save it. That in turn just creates huge numbers of additional problems. I mean, obviously, you had a world depression for a while… I mean, we won’t even get into how the consequences of… You know that if you’re trying to go out into a job market during a depression, it’s not great and people went hungry, starved, died in the developing world.
I mean there’s just no end of catastrophes here, but they also haven’t dealt with the giant problem of moral hazard. That is to say, almost everybody had intimations of mortality in this. That is to say, the lightning would flash and they could say, “We have to be really a little bit careful.” People were – though not everybody, Lehman was late to do this though it started to do it too – trying to sell off some of their more dangerous assets and they would sit there and know that this could lead to disaster and they just kept going anyway, as you suggest.
And the problem is then when the thing goes to pieces, we, the taxpayers, have to pick them up. In effect what Lehman showed you – it’s the absolute paradigm case of modern, meaning contemporary – financial structures that are fragile and can’t exist without it for a whole day. They found that out it was one day. I’m not a Barney Frank fan, but Frank got off one great line. He said that was a free market day, September the 15th, we had one day of the really free market.
Rob Johnson:
It was an avalanche.
Thomas Ferguson:
The whole world went down.
Rob Johnson:
So the dilemma that you face, you’re a policy maker and you’re saying, “We have faith in markets.” Markets decide value. Markets help us be efficient in the use of resources. Markets foment innovation, rising tide to raise all boats. But in the case of a financial market, if people think there are, what I’ll quote, “conjectural guarantees” around the moral hazard, means they may be called, be more aggressive in riskier areas until they realize it isn’t going to work. Then they create a stampede when they’re coming back out. And when the stampede occurs, it doesn’t just affect the balance sheets or the companies for having made a wrong decision, it has ramifications for the health of the entire economy.
Thomas Ferguson:
And when we bail them, people know they can take big loss, they can take big risks. Some of them will lose. Occasionally somebody goes down like Lehman went down. Those folks didn’t enjoy that experience, but almost everybody else got bailed out and they got to keep bonuses. They didn’t get fired. They just… Stuff that should have been retired wasn’t and most bank officials just lived happily ever after, literally happily ever after. Even some of the Lehman senior folks, I think probably existed in a just fine condition by comparison with most of the population.
Rob Johnson:
As Joe Stiglitz said the polluters got paid and the rest of us paid the bill.
Thomas Ferguson:
That’s exactly the condition of the financial system today. I mean, people know that if the thing collapsed, they still take risks, they’re pushing forever more deregulation. Within a year or two after the Dodd-Frank legislation, which passed, which was passed a year or so after Lehman went down to try to reform some stuff of it, some parts of that, it was watered down with no small help from people like Barney Frank. That’s well-documented in some Newsweek articles and things. The Dodd-Frank [bill] was an improvement over what you had in most things. So we probably should come back to the one really big thing about bailouts that needs some discussion there, but the point on that stuff is they never solved the moral hazard problem. And so the music, you’re still dancing with the music and people want less capital within the next two or three years.
INET has a pretty decent paper on this, I think because I helped co-author it, on showing you how even the Democrats in Congress that initially voted for Dodd-Frank changed their mind under an influx of money from banks and other financial groups that wanted in on that.[3] And so that continuous noise about let’s have less capital, don’t make us report our holdings, don’t make us reveal them, and let’s do crypto, which could be thought of as let’s put everything in a paper bag that no one can trace and then hope everything turns out for the better and let’s give the paper bag to everybody who wants one to go push it out there. I mean, it’s like how crazy is this?
Rob Johnson:
Yeah. Well, we had a number of scholars we’ve worked with, Ed Kane. He showed that once the notion of what I’ve called the mother of all moral hazards, that too-big-to-fail banks will be bailed out. What it did is it took the default risk premium off their funding costs, gave them a competitive advantage against smaller banks, facilitated concentration, and facilitated them taking bigger and riskier positions themselves.
Thomas Ferguson:
Nobody’s work has been more important than Ed Kane’s and Ed used to talk to me. Ed Kane and I were quite good friends and we would talk a lot, and we still have an unfinished manuscript of his and I’m trying to figure out quite how we deal with that. But Ed expressed to me his exasperation with other groups that did not want to necessarily publish all his papers that sometimes would refuse to do it, and I mean there was nobody probably more widely respected. He was a significant member of that Shadow Open Market Committee for many years, which was impeccably orthodox in most of its thinking and reading, except that they were actually serious on trying to regulate banks.
And so Ed’s work is fundamental and you can judge, in my opinion, the seriousness of most modern writing on finance by how seriously they engage with Kane’s findings, especially the papers that show you how the big banks’ stock market premiums reflect that advantage that they’re too big to fail. A very interesting question for me – it was something that Ed and I talked a lot about in the last few years of his life – was after the sort of all the current disasters, the rounds of COVID where we had financial markets go down then riotously up, {the question] was how much bigger was that moral hazard, bubble blowing, if you like?
Were other types of entities, say private equity, at least the large ones because there’s lots of small private equity too, were they becoming too big to fail? And on an international basis, how does this work? Ed was perfectly clear that the Americans were, in some fundamental sense, the guarantors of the European financial system through the swaps agreements. But this stuff, it’s not sufficiently studied and amazingly apart from a few places, BIS occasionally or once in a while, the IMF, you’re not seeing much preoccupation with this continuous web of derivatives that just expands. Although INET published some very good papers on how that was insufficiently regulated even now really.[4]
Rob Johnson:
And a number of scholars at the BIS, the Bank for International Settlements in Switzerland, have continued to pursue and illuminate, which you want to call the flaws or inadequacy of reporting or restriction or whatever, that leaves the world system at risk. I know our friend Michael Greenberger, he used to be at the CFTC and he’s often talked to me about the competition between reserve centers around the world. You have these places like London, like New York, Berlin, Paris, Shanghai, Hong Kong, what have you, they all want the business to go there. They all want the executives to be there. They want wealthy people and wealthy companies to enhance the value of the real estate in their cities.
One of the ways they achieve that is by guaranteeing the executives at financial firms that if you do your business with us, the reporting examination and other requirements will be lessened relative to the other financial centers. And he, Michael Greenberger, studied how all kinds of positions that were held by the United States’ so-called special purpose vehicles, things that I would call the Enron problem. Jim Chanos illuminated it very, very beautifully. And these guys keep their losses out from your awareness until such time that they’re imploding and then the size and scale of the bailout they need, which was not apparent or understood by the regulators, explodes.
Thomas Ferguson:
Yeah. Maybe we just quickly unpack that for folks. I mean it’s what might be called the financial reporting footnote problem. That is to say, there’s more in the footnotes than there is in the 200 pages of report, if you can actually unpack it, and it’s highly coded. I mean it’s become as crazy as the tax code and for roughly similar reasons. It’s how extremely big investors get out of regulation and this process is endemic and we’re not making a whole lot of progress on it there. I did just see the first articles appearing on what are essentially various proposed rules for European banks, and people are coming, “Well, you know what? Those are a lot weaker than the American rules.” Now that’s saying a lot considering that we just had a run on regional banks and the crypto meltdown, which was just astonishing.
They’re proposing weaker stuff and they said, well… The one thing I actually saw, this is remarkable for journalism because I almost never see this, yeah, it’s exactly what you just said that, well, these people want big banks to come over there. I mean, this should have been a G7 or a G20 problem that should have been worked on better than it has come out.
Rob Johnson:
Yes. I remember you and I worked at the Roosevelt Institute for a period of time and they created a report that we all participated in called “Let Markets Be Markets,” and there was a gentleman named Portnoy who created a picture. I remember watching this when he presented it, of what did it look like at Citigroup? Well, if you looked at the headquarters, the holding company, everything looked fine and all the earnings looked fine except all the special purpose vehicles contained all of their vulnerability that required them to participate in the bailout. And he was saying that essentially we have created a system that’s tolerating, masking where our vulnerability is. Our friend Michael Greenberger said it was related to the desire of financial centers to grow or seek volume. But there were many dimensions to it.
Thomas Ferguson:
I think I can declassify this. We actually had a researcher come to us and asked for a grant, which we did support in that particular [case], and he talked to regulators. Then they were telling them exactly that. When I got the paper back from him, none of that was in there. And I said, “What the heck?” And it was perfectly obvious why he wasn’t doing it and we didn’t publish the paper, but this is the type of problem that if you’re trying to do financial research, you face all the time and folks who think that somehow you can just leave this around to the regulators and everything is really under control. It’s not.
Rob Johnson:
Yeah. Well, let’s talk a little bit about an area that you’ve done a tremendous amount of work in, which is the role of money in politics. The idea that experts at universities, where the endowment depends upon wealthy and powerful people supporting them, media, which depends upon their advertisers, or politicians, which depend upon contributions to assure their reelection. When you embed the market system in that media, that system of expertise, and that system of governance that’s so dependent on money, there’s a tremendous, what I’ll call, structural sense that people will be hiding from what they should do for the common good in order to ensure their own profitability and survival.
Thomas Ferguson:
I, of course, am shocked, just shocked to hear that-
Rob Johnson:
You were my teacher.
Thomas Ferguson:
No, I know.
Rob Johnson:
I did it.
Thomas Ferguson:
I mean, it is not a secret that Ithiel de Sola Pool took me out to lunch at MIT, I mean Chomsky wrote it up years ago and it was on the web for ages, so there’s no point in even trying to deny it. And he said, “Look, kid.” He was actually trying to be nice to me, actually. He was a former chair and you paid attention to what he said. He said, “Look, just do your historical stuff. Don’t write about contemporary politics.” I said, “Thank you.” And then wrote a bunch of articles about, well, both actually. But yeah, you run into that problem all the time. I am now seeing academic articles in political science where people are trying to say, “Well, you know all this money in politics, it’s really signaling. You have to find a way to signal a Congress.” Well, if you want to go find a way to signal a congress, all right, throw one reception for them because they’ll come and you’ll get your signal.
This is not what money in politics is doing. It’s not a signal system and that’s like a satire on the human race for people at Yale. This was a Yale guy who was pushing this line recently. And the collapse of professional standards for criticism and critical evaluation here is really pretty grotesque. I mean it’s bad. Well, all right, this problem does really need, though, to be addressed and it’s getting worse and at the same time, the money and politics problem is partly one on the press because the press won’t cover this stuff either.
I mean the fact that Chuck Schumer’s kid is a leading lobbyist for private equity, well, that you should probably read about from time to time. We’re not reading about it, even though we’re in the middle of a huge fight with private equity trying to avoid regulation by the SEC now. And this is not a party story, this is a… I mean there’s large chunks of the Democratic Party and as far as I can tell, virtually the whole of the Republican Party are in private equity’s corner on this stuff there, but the press has gotten a lot worse on this.
I have to tell you, there’s days that I wake up and I think, would it be so terrible if all these guys are replaced by ChatGPT? Because what you have now, I just give you a real example. I’ll disguise the names. I met a guy who was covering a presidential race from a major American magazine. You’d all recognize it. And this guy, he was a perfectly sensible being. He said, “Well, I’m an English major,” and he said, “I don’t know anything about this stuff.” And I thought to myself, oh boy, what does that do? It leaves his editors free to rewrite the copy. When you actually study reporters, there’s several excellent papers on this, some of the best by Daniel Chomsky on actually The New York Times. Turner Catledge, the papers are in Mississippi. He wrote a great paper on the rewrites if you like. Folks are now under enormous time pressure in the internet age to write fast. They can’t do research.
Research consists of calling up a few folks, getting some views. It’s often the case, the list of phone numbers, and I’m not making this up, I have seen it, will come from folks they treat as their trusted folks, who turn out to be strong ties to either [party]. I mean there’s a rule, a kind of informal rule, you should have some Republicans and some Democrats with ties to the national parties. And nowadays, you have… Money is so pervasive in the national party system that they’re subsidizing bloggers and various other stuff and they just all fall in line here. It’s not just however monkey see, monkey do, it’s monkey see, monkey do, and occasionally bananas get passed. And so what you’re seeing here is a silence machine that sometimes there’ll be only a highly stylized discussion and you can pursue almost nothing in detail.
And so what you see, [for example] Bill White, actually, in a paper we published not too long ago, just noted just how strongly correlated the market enthusiasm and the press is in all of these various cases of financial disaster. It’s a very sharp observation and it’s exactly right. You’re really dealing with an interrelated system here and you got to treat it as such. So the key point, just to reiterate one more time, is, all right, what happens on that is you go and tell there is at least one catastrophe and then you hope you can repair it, especially if you misjudge it. You go to climate change where it seems clear to me that people have way underestimated what that they didn’t take a cut, people knew the world was going to warm.
Now it’s perfectly fair to say that, yeah, this is not just a question of global warming. You also have that Pacific Ocean current out there that happens to be in a bad place. So maybe in a couple of years it might not be so terrible, but you know what? It seems pretty obviously getting worse as a trend and people are way underestimating the kinds of investments you’ll have to make. In Boston and other cities today, they’re opening schools without air conditioning and small details like that. And it turned out there was a federal program for assistance that would allow you to help people who couldn’t pay their, well, mostly heating bills. You got air conditioning, which is turning into as important as heat and program budgeting doesn’t really cover that. I mean technically you can do it, but if you drop the money on people in October, guess where most of the money is going to go for? It’s in heating.
This type of stuff is recurring everywhere together with local weather problems, which are actually bigger deals overall than probably big hurricanes because you get the violence of storms everywhere. The piece, I wrote it, it’s actually on climate change and on INET, that made a big point of this.[5] So people are way underestimating the problems and you can hope that as you get to a disaster that enough will change that it changes, but maybe it {won’t]. Now that brings us back to Lehman. Let’s just walk through the key points here, which is I think Laurence Ball-
Rob Johnson:
So you’re saying just so for clarification, there is an analogy about the neglect of what we should do for people in climate that we can learn from the neglect or refraction of what we did do relative to what we should have done in the experience of Lehman Brothers?
Thomas Ferguson:
And the same with crypto and with the other issues in financial regulation right now, yeah. Now let’s just walk through. I agree with Ball and we agree then with ourselves in the sense that we did write this and we wrote it back six or seven years ago, there that this was basically a political call to let Lehman go as to paraphrase a famous line of Hank Paulson’s, he didn’t want to be Mr. Bailout anymore and right on the heels of the Republican convention, which was a free market jamboree with McCain and everybody denouncing bailouts of Fannie and Freddie and everything else there. Okay, so Bush and Paulson, just then as Ball shows you, they basically just say, “We’re not going to save it,” and Bernanke and Geithner fall in line. Let me repeat that. The president and the Treasury Secretary make that call and Geithner and Bernanke fall in line.
Rob Johnson:
Whereas Geithner is not yet the treasury secretary-
Thomas Ferguson:
He’s head of the New York Fed.
Rob Johnson:
And Bernanke’s the-
Thomas Ferguson:
And Bernanke’s the head of the Fed. And the legal, it’s precisely the upside-down quality of the legal relationship because the Fed should have been the only people to decide on whether they could apply their 13-3 rule for a special bailout or not. Instead, politics is overruling the Fed there. Now the question is then again in climate and such like that, are you going to have that type of situation or not? Now, in the financial system, we have this problem that a lot of folks who had, I think, good intentions were trying hard to limit bailouts, I thought they thought, and I think you agree with me, we all shared this view then and now, that you’ve got to prevent bank failures, but you shouldn’t rescue bankers. And so they rather got a little overenthusiastic-
Rob Johnson:
Bankers or even bank creditors entirely. You can restructure the bonds.
Thomas Ferguson:
There’s no reason to save the stockholders. There just should not be the equivalent of Medicare for all for banks. That’s insane, but that’s what we’ve got. It’s like we have in one sector socialism. That’s just the long and the short of it. What they did in the revision of the legislation on emergency bailouts in Dodd-Frank was to actually further complicate the legal rules for getting the bailout, which was essentially now they require not just the Fed but the Treasury Secretary to sign off.
Now the Treasury Secretary is a political animal from the word go, whatever they may think or say, and you could see that the politics of this got pretty squirrely just a few months ago, when the runs on the regional banks occurred, effectively what the authorities, meaning the Fed and the treasury principally, but all the other folks who are now in these various councils, they were all in effect… They had to steer around the fact that Republicans controlled the House, that they were nominally opposing bailouts, so they couldn’t be exactly sure of what would happen if they actually tried to do the equivalent of a Lehman bailout for any of these banks.
So what they ended up doing was waiting for the emergency, declaring it an emergency, and then saying we’re dealing with it on a case-by-case basis. That creates enormous uncertainty. And then you saw these runs, which, as far as I can tell, still happen in small places where people pulled the money out of the regional banks. Some of them dumped it quite stupidly. This is like lemmings running down the wrong end of the cliff into money market funds and everybody else rolled into big banks like, no secret, JPMorgan-Chase.
Now, the striking thing about this is here we are in the middle of a movement where we’re trying to restore some antitrust powers and where the emphasis has been on the potential baleful systemic influence of large banks. Now you’re in setting up a situation where the only place you could be sure your money is secure, for the Ed Kane reason, that the system banks are the solution, the big ones, is put them in there. This is crazy, this doesn’t work, and it’s sitting out there now. This problem is not solved. The Europeans have a version of this problem too in that they just haven’t been able to get a single resolution authority through… I mean, they wrote legislation – didn’t go through the European Parliament. They basically sit there with one big special fund that they could use, but basically their lender of last resort is midnight meetings of finance ministers after the fact.
What could go wrong? It’s just the long and the short of it. It’s just like in climate, what can go wrong if you all sit there and ignore all the danger signs and everybody says you’re okay to do this and you’re getting paid by folks as you run for congress president and whatever? This is a mess.
Rob Johnson:
You’re getting paid by people who benefit from the continued use of fossil fuels.
Thomas Ferguson:
Big stake in the existing system, big stake in the existing system. Yes.
Rob Johnson:
I mean that’s where it’s a little bit different in the financial system. You’re protecting institutions where they become what you might call ultra-risky. In the case of climate change, you’re protecting institutions so they don’t have to change to evolve to the challenges Mother Nature presents.
Thomas Ferguson:
That’s right. Yeah.
Rob Johnson:
Both are about the money-politics, but they are different…
Thomas Ferguson:
And then the mass politics of all of this is it’s a little different in each case. A lot of folks see the bailout of the super-rich and the banking system, and they just quite legitimately go crazy. As somebody said, they want Dirty Harry for president, they don’t want… Well, we’ll let that tennis ball go by there. And the climate system, you’re throwing lots of costs on ordinary people and you’re not addressing the sort of local daily needs with nearly enough money and interest.
Rob Johnson:
I’ve had a couple of episodes with regard to climate change where I’ve been involved in panels and somebody once raised their hand and they said, “We know a little bit about your history. You’re from Detroit. Well, with globalization, automation, and so forth, Detroit got destroyed and we’re sitting here in West Virginia and we agree with you that we got to stop with coal and climate change, but we’re not going to join the party if we’re just going to get crushed. You got to create adjustment assistance and then we’ll become allies.” Until that time, they’re part of the resistance. And so I can see people not having faith that unless you’re a big powerful concentrated interest, you’re not going to be taken care of in the transformation.
Thomas Ferguson:
Yeah. I mean I’d give the Biden administration credit as I think you would for some of its initiatives. Many of its other initiatives are not so wonderful.
Rob Johnson:
But I think with regard to finance, you had mentioned a little bit earlier in our conversation about the Republican House. The Republican House is recognizing something that my friends Alex Gibney and David Sirota created in an audible audiobook podcast. It’s free. It was called Meltdown, and they didn’t mean the meltdown of the financial markets. They meant the meltdown in trust, in faith, in governance because we paid the polluters, because we bailed out the power, and all of a sudden you had Occupy Wall Street, the Tea Party, then a Republican House, then a Republican Senate, and then Donald Trump was president. And so the despondency about taking care of the big guys is the music that the Republican House was dancing to in this last year saying we’re not going to be part of those bailouts because they know how much the general public feels hurt by the concentrated power. On the other hand, what they do behind their mask might be entirely different.
Thomas Ferguson:
And some of the energy on keeping down the deficit also taps into that sentiment. That for sure is what sits there. Now, I think this is a very unstable disequilibrium. I mean, you’re just moving slowly down toward probably some new dramatic changes. Again, the cycle of catastrophe where Lehman becomes a kind of almost Aztec sacrifice before you can just take the rest of the elders and really bail them out. That stuff, you’re likely to see more of this. I mean, I refer to the Schlock and Shock syndrome. I mean, you read ChatGPT journalism by live humans or ChatGPT, it just doesn’t matter. It hasn’t got research. It doesn’t have anything to say, and it just repeats what they’re all reading on the internet until you have a disaster. Then they have to go interview people and then depending on how the population’s taking it, something might or might not happen. It’s a mess. If you want a happy ending, you know the answer to this, see a Disney movie, don’t contemplate finance, climate change, medical care, or any of the other big problems that you can name.
Rob Johnson:
Let’s go back and say, here’s the Lehman episode. If we had done it right, what would we have done at that time?
Thomas Ferguson:
Okay. What I think we would’ve done is precisely what I think you and I talked about at the time, actually. I mean, we would not simply have just tided the bank over. That would’ve solved the problem of bankruptcy and kept up national income. But it didn’t solve the moral hazard problem. All the bankers who were participants in that situation should have been told to leave. I mean, not just those folks, but the price for bailouts of all those other firms of AIG, of Lehman, of Goldman, sorry.
Rob Johnson:
Wells Fargo.
Thomas Ferguson:
Goldman and Morgan Stanley, yeah, Wells, everybody, all the folks should have been told to leave. They should not have had their bonuses paid to them. It’s not like we’re condemning them to a life of penury. I’m not suggesting this is not Michelangelo’s Last Judgment, where, over there, and as you face them, it’s on the right.
They’re all descending into hell. This is not what we’re suggesting, but you haven’t got a financial system that can run without periodic bailouts. It’s so fragile that its fragility hits the Fed every time. Even now as they raise rates, you see all these folks talking, “Oh my God, are our portfolios going down in value and the bonds that we did there?” And this question is being asked not just in the United States, but in Europe, all over Asia. Everybody was into this stuff and you have a super fragile financial system and if you need to address that and it can’t be they play and we pay. And so structurally, that’s what should have happened in 2008. It didn’t.
Rob Johnson:
Structurally what should have happened is a change in the rules about examination, regulation, boundaries on what you can invest in and not invest in.
Thomas Ferguson:
And the mass. Look, these guys, these are folks who usually say, well, it’s creative destruction for the ordinary person when they lose their jobs and whatever. They should have lost theirs and they would’ve found reemployment. They got lots of talents. They could be gainfully employed. This is not a bill of attainder. Again, we’re not at Michelangelo here, but you have a financial system that now works deliberately on as little capital as possible. The mere thought of making them hold more capital attracts such protests right now in Congress, this is a fight that’s going on. And I mean the Trump people rolled back some of the capital rules. They just did it and they took back a lot of the other Dodd-Frank stuff earlier even with acquiescence from significant pieces of the Democratic Party and to the cheers of a lot of economists connected with that. This is a financial fragility that works by effectively… When you do this in monetary policy, it results often in just blowing bubbles, is the only way you get prosperity.
Rob Johnson:
But for instance, we might say you could focus on how the Reserve District Bank in San Francisco handled SVB in the three years leading up to it.
Thomas Ferguson:
Meaning it didn’t, yeah.
Rob Johnson:
But the errors they made as an example which leads to the reform of how supervision and regulation takes place.
Thomas Ferguson:
Of course there’s been, to my knowledge, no reform. I mean the guy from SVB who was I think actually on the bank board I believe was he had some supervisor-
Rob Johnson:
Was on the board of the-
Thomas Ferguson:
Board of director. He got off. That’s not exactly what we’re talking about as a reform.
Rob Johnson:
But I guess in finishing this conversation, there is a basis for despondency, but we’ve got to find the way forward. We’ve got to find a way forward so that people regain their trust in faith in the society which they live. They feel their children’s future will be better. And there I think is plentiful evidence, whether it’s climate or whether it’s finance that we’re not there.
Thomas Ferguson:
They needed a revision of Dodd-Frank on finance that actually is serious about addressing the defects in supervision and accounting. This situation has got to end where the footnote is more important than the entire arrest of the financial report. That’s crazy. And there if you want, how about that for a happy use of artificial intelligence? Just write decent financial reports and I hope to live to see that day. But yeah, we need a revision of Dodd-Frank and you need a revision of political money rules and the question of the public commons and the news media is so big, we’ll have to do it some other time. But there are clearly you’re dealing here with a system that is now an advanced disrepair. We can’t keep going with Schlock and Shock.
Rob Johnson:
Let me add one other dimension, which I think is important right now. We’re talking as though repair within the nation state can take care of the problem, but one of the problems of globalization and what I’ll call nanosecond redeployable capital, is that the state sometimes doesn’t have power because people can avoid taxation or people can avoid anything by redeploying to a place where-
Thomas Ferguson:
Offshore.
Rob Johnson:
Offshore where there’s less scrutiny or less pressure.
Thomas Ferguson:
No scrutiny at all unless somebody leaks it.
Rob Johnson:
Exactly. So when I look at the studies, the BIS, they seem to show big, big markets. I’m talking about $60 trillion and more of things that are, how you say, immersed in the intertwined shadow banking system, but haven’t-
Thomas Ferguson:
Effectively global shadow banking.
Rob Johnson:
Right. And we haven’t knocked on the door of a global governance or of national governance so that the ex-ante awareness of the risks that are building is completely understood. So I think there’s one thing which is improving the nation’s state in its relation to money, politics, scrutiny, and working for the common good. But I also think we have a global architecture challenge right now vis-a-vis finance that is enormous.
Thomas Ferguson:
Yes. It’s actually a valuable clarification. It’s also true, unfortunately, in this increasingly acrimonious multipolar international economic system and just multipolar international relations system. This is becoming a good deal harder.
Rob Johnson:
To achieving agreement, whether it be on climate or finance regulation is getting much more difficult.
Thomas Ferguson:
We’re getting close to a situation of the League of Nations in the early 1930s. This is not a wonderful situation to be in.
Rob Johnson:
But I wanted to point that out before we quit because I think that internationalist dimension, I mean, there are some people who we might call look for glimmers of good news, seeing how technology could be deployed to create a much more strong and resilient low-cost system for monitoring all of the financial positions. That this isn’t something that’s in the mystery hidden under the pillows on the couch anymore.
Thomas Ferguson:
I entirely agree. The AI should make it easier in theory.
Rob Johnson:
But we have to deploy these technologies for the common good, and that’s again related to your money politics question of whether we will make those kinds of investments.
Thomas Ferguson:
Oh, exactly.
Rob Johnson:
Good.
Thomas Ferguson:
All right. Not surprisingly we agree.
Rob Johnson:
Any last thoughts? I think Lehman’s wake-up call sets in motion many things, including the founding of INET, but I think there are, what do I call, parallels or analogies in other types and other sectors, and there’s a lot of work to do.
Thomas Ferguson:
Yeah. It’s not like INET’s work is done.
Notes
[1] The Fed and Lehman Brothers (Cambridge University Press, 2018)
[2] Thomas Ferguson and Robert Johnson, “Too Big to Bail: The ‘Paulson Put,’ Presidential Politics, and the Global Financial Meltdown: Part I: From Shadow Financial System to Shadow Bailout,” Intl. J. of Pol Economy, Vol. 38, No. 1 (Spring, 2009), pp. 3-34; Ferguson and Johnson, “Too Big to Bail: The ‘Paulson Put,’ Presidential Politics, and the Global Financial Meltdown – Part II: Fatal Reversal—Single Payer and Back,” Intl. J. of Pol Econ, Volume 38, No. 2 (2009), pp. 5-45
[3] Thomas Ferguson, Paul Jorgensen, and Jie Chen, “How Much Can the U.S. Congress Resist Political Money? A Quantitative Assessment,” Institute for New Economic Thinking Working Paper No. 109
[4] Michael Greenberger, “Too Big to Fail U.S. Banks’ Regulatory Alchemy: Converting an Obscure Agency Footnote into an ‘At Will’ Nullification of Dodd-Frank’s Regulation of the Multi-Trillion Dollar Financial Swaps Market,”Institute for New Economic Thinking Working Paper No. 74
[5] Thomas Ferguson, “Central Banks, Green Finance, and the Climate Crisis.”