Deciding What the Scandal Actually Is

In a free and open and highly competitive culture like ours, where you’re a winner with all the goodies or a pathetic joke, the very worst thing is to realize big things have been happening and you had no idea they were. You were out of the loop. You were not attentive enough, or were just too dumb to see what was happening, or worse yet, those in the know decided you didn’t need to know – you were unimportant, or they decided that they could jerk you around and laugh at you behind your back. It would be idle fun for them, until you bored them. And thus all of life is like junior high – there are the cool kids and you’re not one of them.

It’s maddening. And you can whine and say it’s just not fair. And you can say there ought to be rules, so everyone knows what’s going on. That’s only fair. But it doesn’t work that way, and no one likes a whiner. So there’s always this awful feeling – everyone gets the joke, or knows the real story – everyone except you. And they don’t even pity you – you’d have to matter at least just a little to be worth the trouble. You’re not. And the worst thing is that there are severely limited ways to fight back. You can fake being so cool you don’t really care, and pretend that maybe you’re so cool you know something everyone else doesn’t know – sort of James Bond meets Steve McQueen. But that’s a pose. The important things in the world are done by the important people, who talk to each other about such things, not to you. You’re not even a pawn in the game of life.

Anyone who has worked in a large organization knows all this. All the real decisions are made by two guys, two cool guys, who stayed late on a Thursday evening and decided what would happen next – who would get promoted and who would be shown the door, and who would find themselves at a desk doing nothing. You were home with the wife and kids. But it’s a competitive world. What did you expect?

But if the important things in the world are done by the very few important people, who talk to each other about such things, not to you, an alternative is to get angry. There are very few of them – maybe one percent of us all – and the other ninety-nine percent can decide to rise up and say enough is enough. That seems to be what all this Occupy Wall Street stuff is about. Life isn’t junior high, where the cool kids rule and everyone else isn’t even worth the bother of noticing – or it shouldn’t be junior high. But of course it is. The folks at Goldman Sachs in Lower Manhattan – West Street between Vesey and Murray – have not been looking out their windows. Why would they?

But sometimes matters do get out of hand, and late on Sunday night at the end of the Thanksgiving weekend, Bloomberg reported this:

The Federal Reserve and the big banks fought for more than two years to keep details of the largest bailout in U.S. history a secret. Now, the rest of the world can see what it was missing.

The Fed didn’t tell anyone which banks were in trouble so deep they required a combined $1.2 trillion on Dec. 5, 2008, their single neediest day. Bankers didn’t mention that they took tens of billions of dollars in emergency loans at the same time they were assuring investors their firms were healthy. And no one calculated until now that banks reaped an estimated $13 billion of income by taking advantage of the Fed’s below-market rates, Bloomberg Markets magazine reports in its January issue.

No one knew about this, and Digby comments:

The good news is that the government refused to compound the problems by helping out average Americans with their foreclosures, thus avoiding moral hazard.

She is a bit bitter, but Bloomberg reports that this was a damned big deal:

The size of the bailout came to light after Bloomberg LP, the parent of Bloomberg News, won a court case against the Fed and a group of the biggest U.S. banks called Clearing House Association LLC to force lending details into the open.

The Fed, headed by Chairman Ben S. Bernanke, argued that revealing borrower details would create a stigma – investors and counterparties would shun firms that used the central bank as lender of last resort – and that needy institutions would be reluctant to borrow in the next crisis. Clearing House Association fought Bloomberg’s lawsuit up to the U.S. Supreme Court, which declined to hear the banks’ appeal in March 2011.

The amount of money the central bank parceled out was surprising even to Gary H. Stern, president of the Federal Reserve Bank of Minneapolis from 1985 to 2009, who says he “wasn’t aware of the magnitude.” It dwarfed the Treasury Department’s better-known $700 billion Troubled Asset Relief Program, or TARP. Add up guarantees and lending limits – and the Fed had committed $7.77 trillion as of March 2009 to rescuing the financial system, more than half the value of everything produced in the U.S. that year.

More than half the value of everything produced in the country? And no one knew? It seems so.

And MSNBC’s Bottom Line adds more detail:

Those borrowed trillions were a deeply-buried secret. It appears that even high-ranking Fed officials didn’t know about the scale of the handouts. According to Bloomberg… unnamed sources say that even top aides to Treasury Department head Henry Paulson were kept in the dark.

The six biggest banks in the country received a total $160 billion in TARP funds, but as much as $460 billion from the Fed, raising the question as to how and why this nearly $8 trillion in loans, guarantees and limits remained under wraps for so long. According to the Fed, the massive scale of banks’ borrowing - and the red ink that prompted it – had to be kept secret to avoid spooking investors and prompting a panic or bank runs that would have had even more devastating consequences on the shaken economy.

But there are the cool kids, or in this case, the really important kids:

The Fed defended its actions back then by contending that the biggest financial institutions in the country were too big to fail – a phrase that has become a bone of contention among lawmakers, some of whom argue that a “too big to fail” bank is one that’s too big to exist.

Ohio Senator Sherrod Brown sponsored a bill last year that would cap a bank’s non-deposit liabilities at 2 percent of gross domestic product, and crack down on workarounds banks currently use to bypass a 1994 law that prohibits any one bank from holding more than 10 percent of all deposits in the country.

It’s not fair. There ought to rules. But no one likes a whiner, and Massimo Calabresi at Time’s Swampland, says everyone ought to calm down here. Calabresi says the story seems to be in search of outrage, Sherrod Brown may be saying that this is an issue that can unite the Tea Party and Occupy Wall Street, but in this case the Fed saved the world:

The Fed saved the world economy through all this lending without losing a penny in the process. And after its initial heavy breathing, the article does give the Fed an opportunity to explain itself.


“Supporting financial-market stability in times of extreme market stress is a core function of central banks,” says William B. English, director of the Fed’s Division of Monetary Affairs. “Our lending programs served to prevent a collapse of the financial system and to keep credit flowing to American families and businesses.”


In other words, lending money to banks in a crisis is the whole point of the Fed: saving the world economy by flooding the system with money when it is about to freeze up is exactly what the central bank was created to do. If you don’t like it, then vote for Ron Paul and see what a world without the Fed looks like.

And Calabresi sees another agenda at work here:

Buried beneath the attempts to tap public outrage is a larger point, which is that reforming Wall Street to avoid a similarly catastrophic crisis in the future would have been easier if all the information obtained, compiled and explained by Bloomberg’s reporters had been out there sooner.

Dodd-Frank mandates that borrowers at the Fed’s discount window be identified two years after they borrow, whereas they never needed to be identified before. The story’s authors, however, suggest that Dodd-Frank would have been tougher on banks if people had known the extent of the borrowing earlier.

But Calabresi isn’t convinced:

Remember the $13 billion of extra earnings touted in the headline? If you make it all the way to the third to last of 22 sections, the article states that the number is actually a guess by Bloomberg based on estimates of how much the banks saved by using the Fed money “to avoid selling assets to pay investors and depositors who pulled their money. So the assets stayed on the banks’ books, earning interest.” Does anyone think forcing the banks to sell assets in the middle of a crisis would have stemmed the panic the Fed lending was designed to stop better than just letting them use the borrowed money?

But there is all the liquidity the Fed pumped into the banking system during the height of the financial crisis in 2008, but then Felix Salmon explains what that really means:

Ladies and Gentlemen, this is what a lender of last resort looks like…. On September 16, 2008, Morgan Stanley owed $21.5 billion to the Fed. The next day that number doubled, to $40.5 billion. And eight working days later, on the 29th, the bank’s total borrowings from the Fed reached $107 billion. The Fed didn’t blink: it kept on lending, as much as it could, to any bank which needed the money, because, in a crisis, that’s its job.

So there may be no scandal here. Or maybe there is, as Matthew Yglesias breaks this down into a number of specific issues, starting off by contending that lending vast sums in a banking panic is simply not scandalous:

Serving as a “lender of last resort” is historically one of the main roles of a central bank. When everyone decides they want more liquidity simultaneously, everyone will end up going bust. But a central bank can’t “run out of money” so it never needs to worry about liquidity. What it’s supposed to do in a panic is ensure that liquidity problems don’t cripple banks and create new liquidity problems. Bagehot’s Rule, named after Walter Bagehot, says that in a crisis central banks should “lend freely, but at a penalty rate.” Nobody should run out of cash.

But then that’s the problem, as these weren’t penalty rates:

It was always clear that massive emergency lending of some kind was going on and also that some people would regard this lending as a dastardly “bailout” that kept banks in business. But what’s really coming into view now is that this lending was not at a penalty rate. It was ultra-cheap money that allowed banks to earn profits designed to help resolve fundamental solvency problems. As Bloomberg puts it “the Fed says it typically makes emergency loans more expensive than those available in the marketplace” to ensure that it’s strictly addressing liquidity issues rather than solvency ones, but “during the crisis, Fed loans were among the cheapest around, with funding available for as low as 0.01 percent in December 2008.”

So that sweetheart deal is a bit of a scandal, but erring on the side of activism, as happened here, is defensible:

The presumption of the “lend freely, but at a penalty rate” strategy is that this will suffice to save most of your banks and keep the economy going. But what if your banks actually are insolvent and can’t pay the penalty rate? Then is your greater duty to save the banking system, or to save the fussy distinction between a bailout and an emergency loan? I can easily see the case for erring on the side of activism rather than risking economic chaos. In principle what you’re supposed to do in this situation is take an equity stake in the insolvent institutions, fully or partially nationalizing. Maybe Fed officials felt this was somehow impossible to do on the needed timeframe and a massive secret low-interest lending policy was the least of all possible evils.

But that leads to the real scandal, which Yglesias identifies as abandoning activism for the rest of us:

If I had fully understood what the Fed was doing in the fall of 2008 and the winter of 2008-2009, the truth is that I would have defended it all. Things were falling apart, and the important thing was for monetary policymakers to be engaged in an all hands on deck effort to prevent demand from collapsing and a years-long spell of mass unemployment.

So, if what Yglesias calls the operational aspects of that gets messy and a bit “unfair” then “so much the worse for fairness and cleanliness.”

But the real scandal has only emerged with clarity in the subsequent years. Having ensured the basic stability of the banking system, monetary policymakers in America proceeded to forget all about their go-getter attitude and ability to reach deep into the practical and legal toolkit in order to get what they want. We’re heading into the winter of 2011, with three years of mass unemployment under our belt and no end in sight. That’s not happening because the Fed was too generous with the free money for banks at the height of the crisis. It’s because once the acute phase of the banking crisis ended, suddenly we returned to small thinking and small-c conservatism. But it can’t be both. If in a time of crisis, the right thing to do is to get “crazy” then there’s plenty more crazy stuff the Fed could be doing to boost overall spending in the American economy. Or if the right thing to do is to stay orthodox and ignore the human consequences, then there was no reason not to stay orthodox three years ago and refuse to lend at anything other than a penalty rate.

Still, this nearly eight trillion dollar effort should be put in context:

The government didn’t actually lose any money on these deals. There was no loss of funds or transfer of real economic resources. But as Bloomberg writes “details suggest taxpayers paid a price beyond dollars as the secret funding helped preserve a broken status quo and enabled the biggest banks to grow even bigger.”

Capitalism is supposed to have an evolutionary dynamic. Firms with sound business strategies survive and expand. Firms with unsound business strategies shrink and go bust. Consequently, over time the average quality of business strategies is improving. This evolution toward better firms over time is one of the key pillars of our prosperity. If ill-managed firms nonetheless survive, the system is broken in a fundamental way.

And Kevin Drum sees it this way:

Yes, we aimed a big bazooka full of money at the banksters in 2008. That’s galling, and there’s a good case to be made that we should have done it differently. Maybe more executives should have been fired, maybe the Department of Justice should have tossed more Wall Street traders in jail, and maybe a couple of big money center banks should have been placed in temporary receivership. But even conceding all that, the Fed and Congress (kicking and screaming, but eventually doing the right thing) saved the banking system, and that had to be done. There’s a certain amount of unfairness that’s inherent in any banking rescue, and I can live with that when the alternative is a second Great Depression.

But hoo boy, what a contrast with how the rest of us were treated. Things like principal write-downs, second waves of stimulus, aid to states, and mortgage cramdown all got a bit of idle chatter but were then left to die. For some reason, it would have been unfair to hand out money to profligate homeowners, state and local workers, and the millions who have been unemployed for more than a year.

And yes, in some cosmic sense, perhaps it would have been unfair. Massive financial crashes always produce some inherent unfairness. For some reason, though, we were willing to overlook that unfairness when it was Wall Street that came begging, but became obsessed with it when all the rest of us came begging.

And Drum says that this is how 2008 radicalized him:

It’s one thing to know that the rich and powerful basically control things. That’s the nature of being rich and powerful, after all. But in 2008 and the years since, they’ve really rubbed our noses in it. It’s frankly hard to think of America as much of a true democracy these days.

And there’s Paul Krugman:

When spring rolls around, we’ll reach the third anniversary of Ben Bernanke’s declaration that “green shoots” were making an appearance – and there will still be 4 million Americans who have been out of work for more than a year. Yet there has been no sense of urgency about dealing with unemployment; indeed, most of the elite conversation has been about stuff like cutting Social Security payments a decade or two from now.

That’s what the cool kids do. They take care of themselves, and each other. And we live in a free and open and highly competitive culture, where you’re a winner with all the goodies or a pathetic joke, or not even worth pitying. It may be like junior high, but it is what it is. Why should the cool kids even care?

But the economist Joseph Stiglitz says they should care:

Alexis de Tocqueville once described what he saw as a chief part of the peculiar genius of American society – something he called “self-interest properly understood.” The last two words were the key. Everyone possesses self-interest in a narrow sense: I want what’s good for me right now! Self-interest “properly understood” is different. It means appreciating that paying attention to everyone else’s self-interest – in other words, the common welfare – is in fact a precondition for one’s own ultimate well-being. Tocqueville was not suggesting that there was anything noble or idealistic about this outlook – in fact, he was suggesting the opposite. It was a mark of American pragmatism. Those canny Americans understood a basic fact: looking out for the other guy isn’t just good for the soul – it’s good for business.

The top 1 percent has the best houses, the best educations, the best doctors, and the best lifestyles, but there is one thing that money doesn’t seem to have bought: an understanding that their fate is bound up with how the other 99 percent live. Throughout history, this is something that the top 1 percent eventually does learn. Too late.

That’s fine, but that’s the future. What about now? The important things in the world are done by the important people, who talk to each other about such things, not to the rest of us. What shall we do about that?

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About Alan

The editor is a former systems manager for a large California-based HMO, and a former senior systems manager for Northrop, Hughes-Raytheon, Computer Sciences Corporation, Perot Systems and other such organizations. One position was managing the financial and payroll systems for a large hospital chain. And somewhere in there was a two-year stint in Canada running the systems shop at a General Motors locomotive factory - in London, Ontario. That explains Canadian matters scattered through these pages. Otherwise, think large-scale HR, payroll, financial and manufacturing systems. A résumé is available if you wish. The editor has a graduate degree in Eighteenth-Century British Literature from Duke University where he was a National Woodrow Wilson Fellow, and taught English and music in upstate New York in the seventies, and then in the early eighties moved to California and left teaching. The editor currently resides in Hollywood California, a block north of the Sunset Strip.
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3 Responses to Deciding What the Scandal Actually Is

  1. Katherine says:

    interesting post

    i live in a small town where a small number of not so ordinary residents strive to take care of our small number of homeless by providing free meals, health care, and promoting the establishment of an ongoing shelter / i am proud to report that due to those of us who are concerned with the common welfare of our citizens a local and very successful businessman is now kicking in a rather substantial donation / he got the message, so to speak, that you write about !


  2. Steven Feig says:

    What is frustrating about this whole scenario is that after such a mind-blowing bailout, banksters appear to have learned NOTHING from the experience. They are still reluctant to cut defaulting homeowners any slack, have resumed HUGE bonuses, and still cry for less regulation! They don’t seem to have been given ANY pause by these events — haven’t realized that maybe credit default swaps, derivatives, and other creative ways of slicing and dicing sub-prime loans into AAA-rated securities MAYBE, JUST MAYBE — wasn’t such a good idea after all. Nope! Let the good times roll — again!

  3. David C. says:

    This article misses one huge point. Notice it acknowledges that the Fed does provide a necessary function in times of financial crisis. But immediately says “See! They did nothing for me.”

    Typical. Without the banks and a stable banking system, you have no “me.” Really isn’t the real scandal two-fold. First we don’t teach economics or finance in schools ( motive there?). Second we are full-out a generation that is all about me. This author can’t see past his nose. The concept of the Macro benefit, or the for the good of all, isn’t even a consideration.

    Do you think after all the inevitable huge spending cuts and impending riots, that as a nation we will finally see that we have been the most selfish generation to ever live in America. Our children and grandchildren will daily bear the burden of our vile one focused lives.

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