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With the mortgage market deteriorating, I had wanted to announce the MBS purchases as soon as possible. We discussed what we needed to do to authorize the program. An existing FOMC directive allowed the New York Fed to purchase MBS guaranteed by Fannie, Freddie, or Ginnie, so long as the purchases were consistent with the Committee’s monetary policy decisions. No further FOMC approval was needed, argued Brian Madigan, the Board’s Monetary Affairs Division director, so long as we took other steps to keep the federal funds rate at the target level. But the Board’s general counsel, Scott

Alvarez, argued, and Brian and I were persuaded, that a program of this size and importance should be undertaken with FOMC approval, if only to maintain good relations. I had not forgotten the Reserve Bank presidents’ concerns about insufficient consultation.

We briefed the FOMC in a video conference about the proposal and its rationale. Afterward, Don and I worked the phones to see if FOMC participants would support it and, if so, whether they would be okay with an announcement before the next meeting. Confident that we had the Committee’s support, we announced the plan to purchase MBS. The Committee formally ratified the program at its December meeting, with actual MBS purchases to begin about a month later.

Despite Don’s and my calls before the announcement, several presidents remained unhappy. They believed that, given the significance of the decision, I should not have announced the program before the FOMC formally voted. I had been motivated by the need to act quickly, but, on reflection, I decided that they had a point. At the January 2009 FOMC meeting I acknowledged that I had made a mistake in making the announcement with only informal approval and promised I would follow a more deliberative process in the future. We agreed that asset purchases would be subject to the same degree of FOMC oversight as changes in short-term interest rates had been.

WHEN BANK OF AMERICA CEO Ken Lewis had declined to buy Lehman in September, the silver lining was that he agreed to acquire Merrill Lynch, which well might have been the next domino to fall. Lewis sealed the deal, without government assistance, with Merrill CEO John Thain. The Fed Board approved the merger on November 26 and the shareholders of both companies approved on December 5.

Paulson and I had been relieved at Merrill’s apparent stabilization, so we were shaken to learn in mid-December that the deal was threatening to come undone. Lewis asked for a meeting, and, on December 17, we heard for the first time that Bank of America was thinking about walking away. Lewis told us that Bank of America had only recently determined that Merrill was likely to suffer much greater than anticipated losses in the fourth quarter (it would eventually announce a $15.3 billion loss). Lewis said he was considering invoking a clause in the contract with Merrill—known as the material adverse change clause, or MAC clause. It permitted Bank of America to rescind the agreement if Merrill’s condition proved materially worse than had been represented at the time the contract was signed.

Lewis’s news meant that we were potentially facing yet another massive blow in our battle to control the crisis. If the merger did not go through, Merrill would certainly face an immediate run by funders, customers, and other counterparties, a run that could easily spread to Bank of America as well. As we had just seen, the funding pressure on Citi could be attributed in part to its failure to merge with Wachovia. I also felt certain that, if Lewis walked away from the deal, the wider panic would escalate, which could not be good for Bank of America. I wondered what he could be thinking.

After consulting with Scott Alvarez and our bank supervisors, I became even more convinced that Lewis’s plan to invoke the MAC clause made no sense. From both a business and a legal perspective, the

case for using the clause seemed exceptionally weak. Bank of America had been afforded ample opportunity to analyze Merrill’s assets before the shareholder vote—no one had claimed that Merrill had misrepresented its holdings—and changes in market conditions were explicitly excluded as a basis for invoking the MAC clause. If Lewis tried to use the clause, he likely would provoke extended litigation that Bank of America would ultimately lose. During the litigation, both companies would no doubt be under intense market pressure, and in the end Bank of America would likely be forced to acquire a much weakened or even insolvent Merrill Lynch.

The Fed supervised Bank of America’s holding company, but we had no authority to compel the company to go through with the merger. When Lewis asked me to send a letter to his board instructing them to consummate it, I declined. Legally, the decision had to be Bank of America’s. We were also careful not to advise Lewis on the disclosures to his shareholders about Merrill’s losses, the merger plans, or his negotiations with the government. Hank and I did make clear that we thought that invoking the MAC clause was a terrible idea for both Bank of America and the financial system. We also told him what we had already said publicly: We would do what was necessary to prevent any more failures of systemically important financial institutions. With that general assurance, Lewis persuaded his board to go through with the merger, which was completed on New Year’s Day.

During the month that followed Lewis’s visit to Washington, we worked to determine what the merged company would need to remain viable. I suspected that securing government help was probably one of Lewis’s objectives when he threatened to invoke the MAC clause. That aside, Merrill’s losses were large and Lewis had reason to be concerned about the stability of the combined companies, particularly because Bank of America had substantial losses of its own. We had shored up AIG and Citi. Investors likely would next probe Bank of America for weakness. We wanted to act before we were forced to do so by a run.

With advice from Kevin Warsh and numerous supervisory and legal staff—including staff from the Richmond Fed, Bank of America’s immediate supervisor—we and the Treasury put together a package modeled on the Citi transaction. Hank put in $20 billion more TARP capital into the merged company, charging the same 8 percent dividend rate that Citi and AIG were paying. As in the Citi deal, the Treasury, Fed, and FDIC invoked the systemic risk exception. We ring-fenced a $118 billion portfolio, made up mostly of assets from the former Merrill Lynch. Similar to Citi, Bank of America was responsible for the first $10 billion of losses and 10 percent of any beyond that. Treasury would cover subsequent losses, up to a maximum of $7.5 billion. The FDIC took the next $2.5 billion. The Fed promised to make a loan equal to 90 percent of any assets remaining after all other funds had been exhausted. For this protection, Bank of America would give the government $4 billion in preferred stock upon implementation of the ring fence. We announced the package on January 16, 2009. Kevin Warsh ended an email to me, “Happy inauguration day, Mr. President!” The incoming administration faced plenty of problems, but it looked like Bank of America would not be one of them.

Both the Citi and Bank of America ring fences reassured the market but would never cost the Treasury, the FDIC, or the Fed any money. Indeed, in May, Bank of America would ask the government not to implement the ring fence agreement, saying it did not expect losses to exceed the $10 billion it was obliged to cover. We would allow Bank of America to cancel the deal, but only after it agreed to pay the government a $425 million termination fee as compensation for bearing some of the bank’s risk over the period since the announcement.

Controversy would dog the Bank of America episode, however. Bank of America shareholders criticized Lewis for not disclosing Merrill’s losses earlier. Hank and I were accused of abusing our authority by allegedly forcing Bank of America to go through with the deal. The House Committee on Oversight and Government Reform, chaired by Democrat Edolphus Towns of New York, with Darrell Issa of California the senior Republican, would air the issues in a fraught hearing on June 25. In a meeting just before the hearing, Ohio Democrat Dennis Kucinich told me that they “hadn’t been able to pin any securities law violations” on me but that I should expect a tough hearing anyway. Hank and I were sworn in, as if we were witnesses in a criminal trial. I explained that we had sought to persuade Lewis to go through with the merger but that the decision remained in his hands, and his board’s, as did the responsibility for disclosing Merrill Lynch’s losses to shareholders. The hearing ended after three and a half hours of bombast and insinuation. The committee’s accusations gained no traction, and it did not pursue the matter further. However, in September 2012, Bank of America would agree to pay nearly $2.5 billion to settle claims that it had misled shareholders about the acquisition.

DURING DECEMBER 2008, executives of the Big Three automakers in Detroit, and others on their behalf, had asked Congress for help. The Fed also received calls from auto executives, who clearly were very worried about whether their firms could survive the next few months. The companies were suffering the combined effects of the recession and their poor strategic choices, including the failure to adapt their cars and trucks to the high gas prices of the previous few years. But they were also experiencing something like a slow run. Suppliers and other creditors were demanding cash in advance for fear that one or more companies would fail. Congress had considered various ways to help, but no solution had emerged.

After initial congressional attempts to provide help failed, Senate majority leader Harry Reid, House Speaker Nancy Pelosi, Senator Chris Dodd, and other members of Congress called on the Fed to lend to the auto companies. We were extremely reluctant. We believed that, consistent with the Fed’s original purpose, we should focus our efforts on the financial panic. We were hardly the right agency to oversee the restructuring of a sprawling manufacturing industry, an area in which we had little or no expertise. And, unlike the financial emergencies that required quick responses, the threats to the auto industry were unfolding more slowly, giving Congress time to debate options. If Congress decided not to act, it didn’t seem legitimate for the Fed to effectively overrule its decision.

Fortunately, the issue became moot when Paulson and President Bush agreed to use TARP funds for

GM and Chrysler (Ford decided not to participate), as well as for their financing arms. President Bush announced the investments from the Roosevelt Room on December 19, and the Obama administration would follow through. The commitment of funds to the auto companies left little doubt that the second $350 billion tranche of the TARP would be needed. Four days before we announced the Bank of America package, on January 12, President Bush had requested the second tranche, relieving the incoming president of that politically distasteful responsibility, and Congress did not block it.

THE DECEMBER 16 FOMC meeting was pivotal, so I extended it to two days, beginning on Monday, December 15. Unemployment had risen to 6.7 percent in November and payrolls had declined by more than half a million that month, an enormous drop. And it looked like we were hurtling into an abyss. On December 1, the National Bureau of Economic Research had officially confirmed that the U.S. economy had entered a recession a year earlier, helping to trigger a 680-point drop in the Dow. Board economists forecast the economy would shrink rapidly in the fourth quarter and the first quarter of 2009—pushing the unemployment rate to 7-3/4 percent by March and above 8 percent by the end of 2009. Even that dire forecast would turn out to be considerably optimistic.

We were ready to cut the federal funds rate target further, from 1 percent. In 2003, we had been reluctant to cut much below that level, in part because of concerns that money market funds and other institutions would not be able to function normally at such low rates. Nevertheless, at this meeting we ended up specifying a target range for the funds rate between zero and 1/4 percent. It was a tough call for some of the hawks, who had resisted rate cuts since the beginning of the crisis, and the discussion ran long. Charles Plosser noted that he was voting yes “with some reluctance.” Richard Fisher voted no initially, but during a break for lunch, with only minutes left before the vote was publicly announced, he told me that he wanted to change his vote. I announced the vote change when the Committee reassembled, explaining that Richard had switched “in order to maintain a united front.”

The decision was historic. It meant that the FOMC had accepted that economic conditions required a funds rate near zero. In that respect, the United States had become Japan, where short-term rates had been pinned near zero for years.

Now that the funds rate was essentially zero, we could no longer ease monetary policy by simply cutting the funds rate target. We’d have to find another way. We discussed possible options at length at the December meeting, echoing our debates in the last years of Green-span’s chairmanship, when the funds rate had reached 1 percent and we were worried about deflation. The discussion also reflected the themes I had raised in my 2002 Helicopter Ben speech about deflation and unconventional monetary tools. Even though the overnight interest rate was essentially at zero, longer-term rates were higher. If we could push down longer-term interest rates, we could stimulate the demand for housing, autos, and capital investment. Increased spending in turn should put more people to work and help stave off deflation.

We focused on two tools. The first—large-scale asset purchases, or LSAPs, as the staff dubbed them

—could involve buying hundreds of billions of dollars’ worth of securities to hold on our balance sheet. We were already entering that business with the Committee’s formal approval of the $600 billion in GSE mortgage-backed securities and debt announced three weeks earlier. Besides buying these securities, we could also step up our purchases of Treasury securities, which we already routinely bought and sold in smaller amounts as part of normal monetary policy operations. I had broached the possibility of systematically buying large quantities of Treasuries in a speech a few weeks earlier in Austin, Texas, and we said in our December FOMC statement that we would evaluate the possibility—a fairly strong hint to the market. Our goal in buying longer-term securities, like Treasury bonds, would be to lower the interest rates on them and put downward pressure on other longer-term rates, providing additional stimulus to the economy.

The second tool we discussed was communications strategy, or “open-mouth operations.” With short-term interest rates essentially at zero, we could hope to convince the public and the markets that we would keep short-term rates low for a long time. That, in turn, should help push down longer-term rates, because expectations about future short-term rates influence investors’ decisions on what yields to accept on longer-term securities. We also talked once again about an explicit numerical inflation target, something that I had been advocating since I arrived at the Fed in 2002. In the current circumstances— with inflation likely to drop very low during the recession—setting an explicit objective could help convince markets that policy would remain easy for as long as needed to return inflation to our target. We knew, though, that setting a numerical target would be a big step, both economically and politically, and we agreed only to further discussions. For this meeting’s statement, we embraced qualitative language. In an echo of the Greenspan-era phrases “considerable period” and “likely to be measured,” we said we anticipated that weak economic conditions likely would warrant exceptionally low levels of the federal funds rate “for some time.”

TIM GEITHNER, HAVING recused himself after the incoming administration announced its intention to nominate him as Treasury secretary, did not attend the FOMC meeting. As was customary for any departing member of the FOMC, however, we roasted and honored him at a postmeeting dinner. I teased Tim about his inclusion in a New York Daily News article headlined “Hotties of the Obama Cabinet” but concluded by thanking him for his work over the past year and a half. “You have been just the sort of person anyone would want alongside them in the financial crisis foxhole,” I said. Jeff Lacker, a frequent intellectual sparring partner of Tim’s, speaking on behalf of the Reserve Bank presidents, ribbed him about his apparent willingness to bail out anybody at any time. Tim replied in kind, characterizing Jeff’s frequently expressed view that the various bailouts were themselves a cause of market disruptions as the theory that “firefighters cause fires.” It was mostly good-humored, but tinged by the underlying tensions in the Committee during a very difficult period.

Tim’s departure would be a significant loss to the Fed. I would miss the profanity-laced intensity that

he brought to our deliberations and his distinctive aphorisms: “plan beats no plan,” “foam on the runway,” “Old Testament thinking,” and more. I was nevertheless pleased that I would be gaining an able partner in the new administration. In choosing Tim, the president-elect showed that he was willing to take some political heat to get the adviser he wanted. Tim had patiently explained to Obama why he would be a bad choice for the Treasury, most importantly because of the baggage he would bring as an architect of unpopular bailouts. He had recommended Larry Summers, one of his mentors, instead. But Obama had made up his mind and pressed Tim to accept, which he eventually did.

Anna and I had gotten to know Tim’s gentle and down-to-earth wife, Carole, a social worker and the author of a young-adult novel. Carole’s reaction to Tim’s nomination was about the same as Anna’s to my Fed chair nomination—deep unhappiness born of knowing what the job was likely to entail for both her husband and the family. Like Anna, Carole had no interest whatsoever in the putative glamor of being the spouse of a national policymaker. By this time I understood Carole and Anna’s concerns well. When Tim’s nomination was announced and the stock market jumped, I jokingly congratulated him on the “Geithner rally.” He and I both knew how fickle market (and media) judgments can be.

Tim’s troubles would start early, when some errors he had made in calculating his taxes during a stint at the International Monetary Fund became a centerpiece of his confirmation hearing. Despite the bumps, and there would be more, Tim would remain cool in the face of adversity. His great strength, cultivated over his years in government, was his focus on getting the policy right, whatever the obstacles. He attracted smart and dedicated people, and he emphasized a team approach—his standard for hiring staff was “no jerks, no peacocks, no whiners.” I also appreciated Tim’s limited patience for Washington bloviating and spin doctoring, although I knew that it would sometimes hamper his effectiveness in his new, more political role as Treasury secretary.

I was pleased with Obama’s other choices for economic policy appointees as well. I had known Larry Summers for decades. While I had stumbled into economics in college, it seemed that Larry had been groomed from childhood to be a star in the field. Both his parents were economists, and two uncles— Kenneth Arrow and Paul Samuelson—had won Nobel Prizes. As National Economic Council director, Larry seemed likely to stake out and defend his own views rather than play the role of policy traffic cop that Al Hubbard had performed so well in the Bush White House. But his analytical skills, particularly his ability to detect weaknesses in an argument, would make everyone around him better and lead to better policy.

For my old position as chair of the Council of Economic Advisers, Obama would nominate Christina Romer, my former colleague at Princeton and neighbor in Rocky Hill, New Jersey. A talented economic historian, now at Berkeley, she had, like me, published papers on the Great Depression. She knew that passive, orthodox policymaking greatly worsened the Great Depression, and, like me, she tended to favor aggressive, unconventional policies in the face of dire threats to financial and economic stability.

The president-elect also would nominate a new member of our Board, Dan Tarullo. He would fill the

seat occupied by Randy Krosz-ner, which would force Randy—who never won Senate confirmation to a second term—to leave in January 2009. Dan, a Georgetown University law professor who specialized in financial regulation, had served in various roles in the Clinton administration and had led the transition team’s economic issues working group. I had not worked with Dan before, so I invited him to meet with me. I was impressed by his knowledge of the Fed and his interest in our work. I thought he would be a natural to take over the bank supervision committee after Randy’s departure. I was less sure of how well Dan, a lawyer among economists, would fit into the FOMC, but he would more than hold his own in monetary policy debates, digging particularly deeply into labor market issues. After his confirmation on January 27—by a vote of 96 to 1, with only Senator Bunning voting no—the Board would consist of Betsy Duke, Kevin Warsh, Dan, Don Kohn, and me, with two seats still empty. (During the week between Randy’s departure and Dan’s swearing-in, the Board would be left with only four members for the first time in its history.)

The transition from one administration to another involved departures as well as new faces, of course. On Monday, January 5, I hosted a small dinner at the Fed in honor of Hank Paulson. Two past Treasury secretaries (Bob Rubin and Larry Summers), the incoming secretary (Tim Geithner), the two living past Fed chairmen (Paul Volcker and Alan Greenspan), and Board vice chairman Don Kohn attended. Hank was reflective. A lot had happened during his watch, and he seemed relieved it was ending. He had worked closely with the incoming administration and believed he had given Tim and his colleagues the means to continue the fight against the crisis—especially the money provided by the release of the second tranche of the TARP.

When he returned to his home near Chicago, Hank would be free to pursue his passions—China and environmental preservation. He would found an institute at the University of Chicago dedicated to building business and cultural ties between the United States and China. He would continue his frequent visits to that country and would publish a book about the economic opportunities there. On the ecological side, Hank and his wife, Wendy, continued both their hobbies (they are avid birdwatchers) and their philanthropy. They funded a foundation to preserve Little St. Simons Island off the coast of Georgia.

On January 20, 2009, Anna and I attended the inauguration of the new president on the steps of the Capitol. It was the first inauguration for both of us. My security detail escorted us through ranks of police officers into a small, ornate room in the Capitol where we waited with FBI director Robert Mueller and his wife, Ann, until it was time to take our seats behind the speaker’s podium. In front of us, as far as we could see, an enormous crowd covered the Mall. We waited, shivering in the gusty wind and 28-degree cold. Finally the ceremony began. Aretha Franklin sang “My Country, ’Tis of Thee,” Chief Justice John Roberts administered the oath of office, and the new president began his first inaugural address.

The president had campaigned on hope, even as the nation faced economic calamity, and he sounded that theme again. “We remain the most prosperous, powerful nation on earth,” he said. “Our workers are no less productive than when this crisis began. Our minds are no less inventive, our goods and services

no less needed than they were last week, or last month, or last year. Our capacity remains undiminished. .

. . Starting today, we must pick ourselves up, dust ourselves off, and begin again the work of remaking America.”

Sitting with Anna on the dais, listening to those words, I hoped that the inauguration would mark an opportunity to regather our collective strength and determination to help restore the prosperity of the United States and the world.

CHAPTER 18

From Financial Crisis to Economic Crisis

The frenetic autumn of 2008 had tested the mettle and skills of the staff and leadership throughout the Federal Reserve System. As the pressure rose and it seemed the bad news would never end, I saw exhaustion in everyone’s face. Senior staff stayed on call pretty much 24/7, and employees at all levels were prepared to work as many hours as needed. Brian Madigan, at the office all hours of the day and night, grew so pale that colleagues worried about his health. Family and personal lives took a backseat. One weekend, Michelle Smith’s six-year-old son, Henry, hid her continually buzzing BlackBerry and was crestfallen when she found it. Yet morale remained high—people knew that they were doing essential work, and they took pride in their professionalism and expertise. As often as possible, we engaged in free-flowing, problem-solving meetings—blue-sky thinking. These sessions produced some of our best ideas, and even when they led nowhere they kept us focused. A group of economists took to calling themselves, proudly, I think, “the nine schmucks” when, after one lengthy blue-sky session, as memo writing and research assignments were doled out, I joked, “How come the same nine schmucks get stuck with all the work each time?” I worried, though, about how long we could sustain our efforts.

I tried to appear, and in fact be, calm and deliberate, though my insides often churned. (Geithner once called me “the Buddha of central banking,” which I took to be a compliment, although with Tim you were never quite sure.) As I told Michelle, a frequent sounding board, financial panics have a substantial psychological component. Projecting calm, rationality, and reassurance is half the battle. It was overwhelming, even paralyzing, to think too much about the high stakes involved, so I focused as much as I could on the specific task at hand—preparing for a speech or planning a meeting.

Anna made our home life an oasis, and she pushed me to take care of myself and to take time off. At

her suggestion and after consulting a doctor, I eliminated gluten from my diet, and digestive issues that bothered me early in the crisis eased. She was far from an avid baseball fan but was always willing to go to Nationals games with me. In exchange, I went with her to dance performances at the Kennedy Center. She did small things like buying an aromatherapy diffuser to scent our house with rosemary, lavender, and other fragrances. (Typically, I might not have noticed if she hadn’t pointed it out.) And she always kept me grounded: At dinner, I would tell her about some multi-billion-dollar action that the Fed had taken, and she would say, “That’s nice,” and remind me to take out the garbage and the recyclables. We also shopped for groceries together on weekends, trying unsuccessfully to be inconspicuous as our security agents trailed behind.

Our two dogs, Scamper (an ancient beagle-basset) and Tinker (a small, friendly dog of indeterminate breed), provided some diversion. They would see me to the door in the morning, then return to their perches by the living room window, overlooking a courtyard. During the crisis I wished more than once that I could skip the office and sit with them for the day.

In 2008, Anna fulfilled a longtime dream, starting an educational program for urban kids in Washington, which she named Chance Academy. As the number of children in the program grew over the next few years, she would add part-time teachers, and parents would volunteer their time in lieu of paying the small tuition. We covered most of the costs ourselves, with occasional help from friends and foundations. Anna spent sixty hours a week or more on the project at no pay and loved what she was doing. It was a relief to hear about her daily experiences when I came home. I believed the Federal Reserve was helping people, but Anna could see the benefits of her efforts much more concretely and immediately in the progress and joy of her students.

Date: 2016-04-22; view: 667