courage to act

8/20/2019 Courage to Act

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P R O L O G U E

I Can Still Stop This . . .

It was 8:00 p.m. Tuesday, September 16, 2008. I was exhausted,

mentally and emotionally drained, but I could not sit. Through the win-dows of my office in the Federal Reserve’s Eccles Building, I could seethe lights of the traffic on Constitution Avenue and the shadowy outlines

of American elms lining the National Mall. Dozens of staff membersremained at work, but the corridor immediately outside my door washushed and empty. Michelle Smith, the head of our communications

office and my chief of staff, sat quietly, the only other person

in the room. She was waiting for me to say something.

Four hours earlier, Treasury secretary Hank Paulson and I had sat side

by side in tan leather armchairs in the windowless Roosevelt Room of

the White House, steps from the Oval Office. A portrait of Teddy

Roosevelt as Rough Rider on a rearing horse hung above a fire-place.

Facing Hank and me across the room’s polished wood table sat thecurrent occupant of the White House, a somber George W. Bush, with

Vice President Dick Cheney at his side. The president’s advisers,

Hank’s senior aides, and representatives of other financial regulatory

agencies filled the remaining dozen seats around the table.

Usually, the president liked to keep things light at meetings, by

opening with a wisecrack or good-naturedly teasing a close adviser.

Not that afternoon. He asked bluntly, “How did we get to this point?”

The question was rhetorical. We had been fighting an out-of-con-trol

financial crisis for more than a year. In March, the Fed had lent


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$30 billion to help JPMorgan Chase save the Wall Street investment

bank Bear Stearns from failure. In early September, the Bush admin-

istration had taken over Fannie Mae and Freddie Mac to prevent thecollapse of the two companies responsible for financing roughly half

of all residential mortgages in the United States. And just the day

before, at 1:45 a.m., Lehman Brothers —the nation’s fourth-largest

investment bank — had filed for bankruptcy, following a frantic and

ultimately futile search for a merger partner led by Hank and New

York Fed pres-ident Tim Geithner.

Now I found myself explaining to the president why the Federal

Reserve was planning to lend $85 billion to American International

Group (AIG), the world’s largest insurance company. The company

had gambled recklessly, using exotic financial instruments to insure

securi-ties backed by subprime mortgages. Now that those mortgages

were going bad at record rates, the financial firms that had bought the

insur-ance, together with other AIG counterparties, were demanding

pay-ment. Without the cash, AIG would go bankrupt within days,

perhaps hours. We weren’t motivated by any desire to help AIG, its

employees, or its shareholders, I told the president. Rather, we didn’t

think that the financial system — and, more importantly, the

economy — could with-stand its bankruptcy.

Reacting to the Lehman failure, markets already were in the grip

of a full-blown panic of an intensity not seen since the Depression.

The Dow Jones industrial average had plunged 504 points on

Monday — its steepest one-day point decline since September 17,2001, the first day of trading after the September 11 terrorist

attacks — and the selling wave had spread to markets worldwide. As

confidence in financial institutions disappeared, interest rates on

loans between banks had shot skyward. Ominously, we were

receiving reports of both large and small investors pulling their cash

out of money market mutual funds after a large fund suffered losses

stemming from Lehman’s collapse.

Everyone in the room knew that rescuing AIG would be terrible


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P r O L O G U E xi

politics in a presidential election year. Just two weeks earlier, the presi-

dent’s own party had declared flatly in its 2008 convention platform,

“We do not support government bailouts of private institutions.” TheFederal Reserve’s proposed intervention would violate the basic prin-

ciple that companies should be subject to the discipline of the market

and that the government should not shield them from the conse-quences

of their mistakes. Still, I knew that, as chaotic as financial conditions

were now, they could become unimaginably worse if AIG defaulted —

with unknowable but assuredly catastrophic consequences for the U.S.

and global economies.

With more than $1 trillion in assets, AIG was more than 50

percent larger than Lehman. It operated in more than 130 countries

and had more than 74 million individual and corporate customers

worldwide. It provided commercial insurance to 180,000 small

businesses and other corporate entities employing 106 million

people — two-thirds of American workers. Its insurance products

protected municipalities, pension funds, and participants in 401(k)

retirement plans. AIG’s col-lapse could well trigger the failures of

yet more financial giants, both in the United States and abroad.

The president, grim-faced, listened carefully. Paulson had warned

him earlier in the day that action on AIG might be necessary, and he

knew that our options were severely limited. No private investors

were interested in buying or lending to AIG. The administration had

no money and no authority to rescue it. But the Fed could lend to

AIG to keep it afloat if the company’s many subsidiaries retainedenough value to serve as collateral for the loan.

Bush responded as he had consistently during the financial crisis,

by reiterating his trust in Hank’s and my judgment. He said that we

should do what was necessary, and that he would do what he could to

provide political cover. I was grateful for his confidence, and for his

willingness to do the right thing regardless of the likely political

consequences for himself and his party. Having the president’s support was crucial. At the same time, essentially, the president was tell-


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ing Paulson and me that the fate of the U.S. and global economies

was in our hands.

Our next meeting, at half past six that evening at the Capitol, had

been even tougher. Hank and I gathered with congressional leaders in

a cramped conference room. House Speaker Nancy Pelosi wasn’t

able to attend the hastily arranged gathering, but Senate majority

leader Harry Reid and House minority leader John Boehner were

there, along with Senate Banking Committee chairman Chris Dodd,

House Financial Services Committee chairman Barney Frank, and

several others.

Hank and I again explained AIG’s situation and our proposed

response. We were besieged with questions. The lawmakers asked

about the Fed’s authority to lend to an insurance company. Normally,

the Fed is empowered to lend only to banks and savings institutions.

I explained a Depression-era provision of the Federal Reserve Act —

Section 13(3) —that gave us authority in “unusual and exigent

circum-stances” to lend to any individual, partnership, or corporation.

The lawmakers wanted to understand the consequences of letting

AIG fail and how the loan would be paid back. We answered as best

we could. Yes, we believed this step was necessary. No, we could

make no guarantees.

As the questions began to die down, I looked over and saw Sena-

tor Reid wearily rubbing his face with both hands. Finally he spoke.

“Mr. Chairman. Mr. Secretary,” he said. “I thank you for cominghere tonight to tell us about this and to answer our questions. It was

help-ful. You have heard some comments and reactions. But don’t

mistake anything anyone has said here as constituting congressional

approval of this action. I want to be completely clear. This is your

decision and your responsibility.”

I returned to my office. Tim Geithner, who had negotiated the bailout

deal, called with the news that AIG’s board had agreed to our


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proposed terms. The terms were tough, for good reason. We didn’t

want to reward failure or to provide other companies with an incen-

tive to take the types of risks that had brought AIG to the brink. Wewould charge a high interest rate on the loan and take an ownership

stake in the company of nearly 80 percent, so taxpayers could benefit

if the rescue worked. The Federal Reserve’s own Board had

approved the deal earlier that day. All we needed to do now was put

out the press release.

But I needed a few moments to think about it all. I believed we

were doing the right thing. I believed we had no other reasonable

choice. But I also knew that sometimes the decision-making process

acquires a momentum of its own. It was important to be sure.

Without doubt, the risks we would be taking were huge. Though

$85 billion was an enormous sum, much more was at stake than

money. If AIG failed even with the loan, the financial panic would

intensify, and market confidence in the Fed’s ability to control the

crisis could be destroyed. Moreover, the future of the Fed itself could

be at risk. Sena-tor Reid had made clear that Congress would accept

no responsibility. The president would defend us, but in a few

months he would be out of office. If we failed, an angry Congress

might eviscerate the Fed. I did not want to be remembered as the

person whose decisions had led to the Fed’s destruction.

I can still stop this, I thought, as I looked out at Constitution Ave-

nue. The loan required unanimous Board approval, so all I would

have to do would be to change my own vote. I said as much toMichelle and added, “We haven’t announced anything.”

If we acted, nobody would thank us. But if we did not act, who

would? Making politically unpopular decisions for the long-run ben-

efit of the country is the reason the Fed exists as a politically

indepen-dent central bank. It was created for precisely this purpose:

to do what must be done — what others cannot or will not do.

Michelle interrupted my thoughts. “We have to put something

out,” she said softly.


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“Okay,” I said. “It’s got to be done. Let’s look at the press release

one last time.”

It began, “For release at 9:00 p.m. EDT: The Federal ReserveBoard on Tuesday, with the full support of the Treasury Department,

autho-rized the Federal Reserve Bank of New York to lend up to $85

billion to the American International Group . . . ”

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