by James Mann
Those hopes were soon shattered. Between Labor Day of 2008 and Inauguration Day in January 2009, the American economy went through the most wrenching series of upheavals since the Great Depression. The Bush administration suddenly found itself lurching from one daily crisis to the next as the financial system froze up; America’s leading banks tottered; its auto industry neared collapse; and its largest insurance company had to be rescued by the government. In the fourth quarter of 2008, the American economy declined at an annualized rate of 8.9 percent, and 651,000 Americans lost their jobs.
Bush’s approach to the financial crisis stood in pronounced contrast to the way he had run the economy in the first years of his presidency. In 2001, he had been the driving force on behalf of his own policies, barnstorming around the country and seizing the airwaves to win congressional support for his tax cuts. When his first treasury secretary, Paul O’Neill, had raised objections, Bush had marginalized him and then forced him out. Conversely, by 2008, Bush was reacting to events rather than making them happen. He allowed a different treasury secretary, Henry Paulson, to take charge of handling the response to the financial crisis, giving him extraordinary leeway and authority, while Bush largely confined himself to approving Paulson’s recommendations. In his last year in office, Bush possessed little if any clout on Capitol Hill. Most notably, in the throes of the financial crisis, Congress voted down the Troubled Asset Relief Program, his administration’s principal legislative response, with Bush’s own Republican Party leading the opposition.
Nevertheless, the role Bush played during the financial crisis was crucial, in the sense that without strong action by his administration, the banking and credit upheavals and ensuing recession could well have been far worse than they were. In approving strong governmental intervention, including massive bailouts of some of America’s leading companies, Bush had to overcome his own conservative instincts and free-market principles. Simply put, he was determined to be on the right side of history. “If we’re really looking at another Great Depression,” he told his aides that fall, “you can be damn sure I’m going to be Roosevelt, not Hoover.”
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When it came to America’s leading banks and securities firms, Bush saw himself as something of a populist, although his policies did not reflect that view. Paulson, who met with Bush often during the financial crisis, described the president’s attitude toward Wall Street as a blend of “heart-of-the-country disdain” and “genuine contempt.” Bush’s grandfather had prospered on Wall Street, but both George H. W. Bush and George W. Bush had forsaken careers in finance for the oil industry. In the case of George W., his identity as a Texan ran deep, and with it came a skepticism toward Eastern elites, whether at Yale or on Wall Street.
Still, Bush did not give voice to these views during his two presidential campaigns as he raised unprecedented sums of money, with significant support from Wall Street. Bush’s two tax cuts—especially the second, which cut levies on capital gains and dividends—benefited the financial industry more than any other sector of the economy, opening the way for those in the highest income brackets or with investment income to keep millions more each year.
In 2004, Bush nominated Alan Greenspan to a fifth term as chairman of the Federal Reserve, where for nearly two decades he had consistently opposed stronger regulatory control of financial markets. With Greenspan’s term on the Fed set to expire in 2006, Bush appointed Ben Bernanke his successor, mostly because Bernanke was seen as likely to perpetuate existing policies. The following year, Bush appointed a new treasury secretary from the heart of Wall Street: Henry Paulson, the chief executive officer of Goldman Sachs. Paulson won from Bush a series of assurances that he would possess greater authority within the administration than had his predecessors. When he took the job, one newspaper profile predicted that with only two and a half years left in the administration, Paulson “may have little chance to make a mark on many economic issues.”
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The blame for the financial crisis cannot be laid entirely at the doorstep of Bush or his administration. The policies that gave rise to the crisis had their origins well before he became president. There had been a trend toward deregulation of the financial system since the 1970s, and it had accelerated in the 1990s under the Clinton administration, with Treasury Secretaries Robert Rubin and Lawrence Summers playing leading roles alongside Greenspan. Together, they defeated an effort to regulate trading of financial instruments used to hedge risk, called derivatives, that were, a decade later, at the heart of the financial crisis. The Clinton administration also won passage of changes to the Glass-Steagall Act of 1933, so that, for the first time since the Great Depression, commercial banks could deal in securities transactions. Separately, Clinton also pushed to increase home ownership throughout the nation, with a special focus on lower-income families.
Bush did nothing to reverse any of these policies; instead, he further accelerated the trend toward deregulation and expanded home ownership. Opposition to “big government” and to government regulation were prominent themes in his campaigns, and as president his appointments to federal regulatory agencies such as the Securities and Exchange Commission and the Commodity Futures Trading Commission reflected these beliefs. He also gave further fuel to the boom in housing. If extending home ownership was for Clinton a means of helping minority groups and the poor, for Bush it became a component of his idea of an “ownership society,” the slogan he used as part of his unsuccessful drive to privatize Social Security.
By Bush’s second term, real estate brokers and originators were extending subprime mortgages to more and more buyers with a questionable ability to repay even the interest on the loans, let alone the principal. The mortgages were then sold to firms that “bundled” them together into packages of securities that were sold and resold in such a way that the weakness of the original mortgages was not apparent. There was little if any regulatory scrutiny of any of these transactions. The process was made all the more risky by the sale of derivatives and credit-default swaps, which amounted to large bets on the viability of these securities. Meanwhile, as the number of buyers for homes increased, housing prices spiraled ever higher. As they did, some home owners took out new home-equity loans based on the increased paper value of their houses.
Housing prices rose to the point where, by 2004, there was speculation about whether they represented a classic bubble. Greenspan dismissed the claims as “most unlikely” and continued to keep interest rates low. The following year he told the nation that while housing prices might not continue to increase, the market would simply “simmer down.”
Soon after he was appointed treasury secretary, Paulson told Bush that the flood of unregulated capital into hedge funds, derivatives, and credit-default swaps “has allowed an enormous amount of leverage—and risk—to creep into the financial system.” He warned that America’s financial system had been suffering some major shock every four to eight years and that he was convinced another “disruption” was coming. By his own admission, however, Paulson had no idea when or how that disruption would come or how severe it would be. Significantly, he did not focus on housing or even mention the subject in his warning to Bush.
Housing prices peaked in late 2006, then leveled off and started to decline, leaving growing numbers of buyers “underwater” with homes worth less than the outstanding balance on their mortgages. Foreclosures steadily increased. In the spring of 2007, Paulson and Bernanke sought to dampen concern. Paulson told the public repeatedly that the problems that had been caused by subprime mortgages were “largely contained.” He later acknowledged that he had failed to recognize how many bad mortgages had been written or how increasing amounts of leverage had amplified the negative consequences for the financial system of a housing decline.
The first tremors were felt in the summer of 2007, when the large French bank BNP Paribas stopped withdrawals from three hedge funds dealing in subprime mortgages. Although Bush announced a program to he
lp home owners avoid foreclosures and the Federal Reserve cut interest rates, the economy slid downward toward recession. In early 2008, with Democratic support, Bush won passage of a onetime tax rebate aimed at stimulating the economy. At the time, Paulson and others thought the nation faced a short, V-shaped recession and would begin to turn upward by the middle of the year.
The falling home prices were causing the value of mortgage securities to drop rapidly, along with the stock prices of the banks that held them. In early March 2008, as Bush was preparing to give a speech in New York the next day to reassure the markets, he and Paulson argued over a few words in the draft. Paulson objected to a line that said there would be no government bailouts. “We’re not going to do a bailout, are we?” Bush asked. Paulson told him the financial system was so fragile that he wanted to leave the door open for that possibility.
That same afternoon, Paulson learned that Bear Stearns, one of Wall Street’s most prominent investment banks, which had a large exposure to mortgage securities, was on the brink of failure. In his speech the following day, Bush avoided talking about bailouts, saying merely that the government needed to be careful about intervening in markets. He was upbeat. “I’m coming to you as an optimistic fellow.… Fortunately, we recognized the slowdown early and took action,” he said.
Paulson was concerned that Bear Stearns was so interconnected to other investment banks and institutions, including large hedge funds, that its failure would jeopardize some of them as well. Over that weekend, with Bush’s approval, he engineered a resolution under which another bank, JPMorgan Chase, bought Bear Stearns for a low share price while the Federal Reserve provided a $30 billion loan for a separate entity to buy Bear Stearns’s worst mortgage securities, thus effectively taking those more risky assets off JPMorgan’s hands.
Bush struggled to find a justification for this deal that would be in accord with his long-stated opposition to government intervention in the economy. “You’ll have to explain why it was necessary,” he told his treasury secretary. Paulson repeatedly argued in public that the failure of Bear Stearns would have been a disaster because it was so interrelated with other financial firms. This rationale, however, had an important consequence of its own: it gave the impression that the Bush administration and the Federal Reserve were unwilling to let a major financial institution go bankrupt. “After Bear Stearns, potential buyers of any failing financial institution … would ask the Fed not whether it would lend, but how much it was willing to kick in,” wrote the financial journalist David Wessel.
Over the following months, the stock prices of America’s two leading institutions for housing finance, the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) tumbled downward as investors sold shares in fear that the companies would be brought down by their holdings of subprime mortgages. The two companies were privately owned but had been created and supported by the federal government; as a result, they were generally considered safe enough that foreign governments, including Japan, China, and Russia, held large stakes. In July, Paulson informed Bush that Fannie Mae and Freddie Mac were at risk, and he sought congressional approval to help rescue them, including the power to put taxpayer money into the institutions.
The housing institutions, which had their origins in the New Deal, had been a subject of recurrent Republican criticisms for decades. Bush himself had been calling for changes in Fannie Mae and Freddie Mac since 2003, making, by his own count, seventeen proposals for reform and for stronger regulation. Nevertheless, when faced with a potential collapse of Fannie Mae and Freddie Mac, Bush told Paulson that the first order of business was to “save their ass.” By that point, foreign governments were weighing in with the administration to register concern about the safety of their bond holdings, and Bush wanted to stave off any action that could cause a decline in the dollar and damage to America’s standing overseas. As a result, with Bush’s approval, Paulson sought and obtained standby authority from Congress to put money into the firms and to seize control of them. In early September, the Bush administration put Fannie Mae and Freddie Mac into conservatorship, firing and replacing their top executives. The details were different, but once again the Bush administration had intervened to prevent financial firms from failing.
These actions were beginning to attract considerable criticism. On the political left, Bush and Paulson were accused of bailing out Wall Street, while on the right, critics complained that they were interfering in the markets. Just after the federal government took control of Fannie Mae and Freddie Mac, McCain and his running mate, Governor Sarah Palin of Alaska, wrote an opinion article for the Wall Street Journal under the headline “We’ll Protect Taxpayers from More Bailouts.”
Such criticism had an impact. By early September, Bush and Paulson were on the defensive about any further rescues of financial institutions. “All of us were well aware that after Fannie and Freddie, the country, Congress, and both parties were fed up with bailouts,” Paulson wrote in his memoir.
That was the political climate as the financial crisis neared its apex. The week after the takeover of Fannie Mae and Freddie Mac, Bush and Paulson were informed that another Wall Street investment bank, Lehman Brothers, was on the brink of bankruptcy. Lehman, which was even larger than Bear Stearns, had run into liquidity problems stemming from its heavy purchases of mortgage securities, and its stock price was dropping rapidly.
This time, Paulson was determined to avoid using taxpayer money for another rescue. “I’m being called Mr. Bailout. I can’t do it again,” he told colleagues. With Bush’s support, Paulson searched to find a last-minute buyer for Lehman Brothers, but other banks had little interest without the prospect of federal money to buy off the firm’s toxic mortgage securities. For a time, Bush’s hopes were focused on Barclays, the British bank, which seemed interested, but the chancellor of the exchequer threw cold water on the idea. The British did not want to import America’s financial panic.
“What the hell is going on?” Bush asked Paulson. “I thought we were going to get a deal.” But this time, there was no deal and no rescue. Bush and Paulson made the decision to let Lehman Brothers fail. On Monday, September 15, 2008, the firm declared bankruptcy.
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On the morning Lehman failed, Bush told Paulson he consoled himself that the bankruptcy would send the message that his administration was not going to keep bailing out failing companies. In short order, however, Bush would find himself unable to abide by this precept.
Paulson had believed that the consequences of a Lehman failure would not be so severe, because the near-bankruptcy of Bear Stearns six months earlier had put investors and other Wall Street firms on notice, giving them plenty of time to protect themselves from the collapse of a major company. This analysis turned out to be faulty: Bear Stearns had taught the opposite message, that the government would not allow a collapse.
After Lehman’s bankruptcy, as Bush put it, “all hell broke loose.” Credit immediately froze up as Wall Street firms refused to lend to one another or to Main Street businesses. Other major financial institutions were thrown into jeopardy as short-sellers drove stock prices down. On the day the bankruptcy was announced, the Dow Jones Industrial Average sank 500 points.
That same day, the ratings firms downgraded the debt for the mammoth insurance company American International Group (AIG), which had written large insurance contracts against defaults on risky mortgage securities. That action required AIG to put up more collateral to its lenders, and the firm, already in trouble, quickly veered toward bankruptcy. It was even more interconnected to financial institutions around the world than Bear Stearns or Lehman Brothers; the German and French finance ministers both urged the Bush administration not to let AIG go bankrupt. Moreover, AIG’s failure would have affected municipalities and the life insurance, annuities, pension benefits, and retirement plans for ordinary Americans. Within forty-eight hours, with the Federal Reserve in the lead, the adm
inistration worked out the rescue of AIG, taking an 80 percent equity interest and effectively nationalizing it. Wielding the authority the government had just acquired, Paulson personally chose a new CEO for the company.
However reluctantly, Bush went along. Late in his presidency, he had become a hands-off president in dealing with economic policy, the opposite of his approach to foreign policy, where he had become increasingly a hands-on president. “If you are comfortable with this, then I am comfortable with it,” he told Paulson and Bernanke. He thus found himself reversing after only two days the “no-more-bailouts” message he had hoped to send with the Lehman bankruptcy. By this juncture, he was irritated and baffled by what his economic advisers were telling him he needed to do. He questioned Paulson closely about why they could not let AIG fail without devastating the broader economy, wanting to know how the financial system had become so disastrously entangled.
The result of having to save AIG so soon after letting Lehman go down was to leave Bush without any guiding principles or rationale for his actions. His administration was against bailouts, until it was for them; it would rescue failing companies in some instances but not others. Investors and Wall Street were uncertain what to expect. Bush gave up on trying to be consistent. “Saving AIG would look like a glaring contradiction. But that was a hell of a lot better than a financial collapse,” he later explained. These words epitomized his approach to everything else that happened in the following months. The only rationale that could serve to explain the administration’s policies was one of necessity: Bush set principles aside and did whatever he had to do to keep the economy afloat.
