By Howard Davies
EDINBURGH – Journalists, the adage goes, write “the first rough draft of history.” It’s a grand claim, but perhaps the best of them achieve something close to that. In the case of the Great Financial Crisis of 2008, Andrew Ross Sorkin of The New York Times did so in his book Too Big to Fail, which remains a useful description of how it felt on Wall Street when the markets began to collapse. Sorkin had good access to the key people involved.
The second draft of history is often written by the key people themselves. After World War II, Winston Churchill confidently asserted that history would treat him kindly because “I propose to write that history.” When the financial crisis erupted, the same thought may have crossed the minds of Hank Paulson, Ben Bernanke, and Tim Geithner, who were US Treasury Secretary, Chairman of the Federal Reserve Bank, and President of the New York Fed, respectively. All three published lengthy memoirs explaining why they did, and didn’t, do what they did and didn’t do – inevitably, with a degree of self-justification in each case.
Now, a decade later, the three of them have co-authored what might be described as version 2.1 of that episode’s history. At the cost of far fewer trees, Firefighting: The Financial Crisis and Its Lessons briefly summarizes the conclusions they now draw.
William Wordsworth described the origin of poetry as “emotion recollected in tranquility.” That might overstate the case for this book a little, but they have made a stab at pulling away from the day-to-day narratives of their earlier work to offer calmer judgments, now that the dust has settled and we can see the longer-term impact of the decisions they made in haste.
The style is a little curious at times. It is full of observations like: “Ben did this…. Tim thought that… Hank took a different view,” and so on, as if the Three Musketeers had been interviewed by an oral historian. There is also some routine praise for the two presidents they worked with, George W. Bush and Barack Obama, and a reprise of their frustration with people who did not see the world their way, and obstructed their solutions, like Sheila Bair of the Federal Deposit Insurance Corporation (FDIC) and various pesky members of congress.
The main interest lies not so much in the narrative chapters, which cover the same ground as their earlier books, as in their policy recommendations for the future. It is noteworthy that they have been able to reach consensus on quite a radical program. Three proposals in particular should cause policymakers in the United States and elsewhere to think hard.
First, Bernanke, Geithner, and Paulson point out that imposing higher capital requirements on banks caused much credit creation to migrate to the non-bank sector, where US authorities still lack authority to intervene, whether preventively, by requiring higher capital reserves, or by providing financial support to stabilize markets if necessary. They argue for an FDIC-style insurance model for the broader financial system. Quite how that would work is left unclear, but the idea is worth further thought.
Second, they note that the US system of financial regulation has barely been reformed, despite the many weaknesses revealed by the crisis. In their view, “the balkanized financial regulatory system could use reform, to reduce turf battles among redundant agencies with overlapping responsibilities.” They tried to promote change, but only one small agency, the ineffective Office of Thrift Supervision, has been abolished. Even after the Dodd-Frank overhaul, they lament, “there is no single regulator responsible for safeguarding the system as a whole.” That is a damning commentary on the Financial Stability Oversight Council, which was supposed to fulfill that function.
They are a little coy about the identity of those “redundant agencies,” but the Commodity Futures Trading Commission must be on their list. No other country has separate regulators for cash equities on the one hand, and derivatives on the other. Only defensive congressional fiefdoms prevent rational reform in that area.
The third proposal is targeted principally at the Trump administration, though Congress is again also implicated. Bernanke, Geithner, and Paulson believe that current US fiscal policy is deeply misguided. The deficit is too high, at a time when the economy is growing healthily. That is bad economics today, and, more important, the authorities could, as a result, find it difficult to relax fiscal policy to combat a future recession. As they put it, “the use of fiscal adrenaline could be limited just when it is needed most.” There is an urgent need to “restock the emergency arsenal,” particularly when there is relatively little scope to relax monetary policy. The Fed began a process of normalizing monetary policy, but has not completed the job, and President Donald Trump is doing what he can to prevent them from doing so, by heckling from the sidelines.
The Three Musketeers remain positive about some elements of the post-crisis program. Bank capital has been greatly strengthened, and the transparency of the derivatives markets materially enhanced. Those changes make the financial system safer. But their agenda for further reform is substantial, and fundamental. And, next time, we may not be as fortunate in the quality and resourcefulness of our crisis managers – or in the wisdom of their political masters.
Davies is Chairman of the Royal Bank of Scotland.