The Alchemists: Three Central Bankers and a World on Fire

by Neil Irwin

  • • •

  In the run-up to the Lehman bankruptcy, the differences in monetary policy on the two sides of the Atlantic had become stark, with the ECB having raised interest rates in July 2008 to tighten the money supply, the Bank of England having left them unchanged for six months, and the Fed having lowered them in early 2008 to loosen the money supply. But in the frantic days of September and October 2008, signs were everywhere that the economic damage from the crisis could become severe—though how severe no one knew yet. There were new reports of mass layoffs seemingly every day, both in the United States and Europe. Global trade was plummeting, according to data from shipping companies. And the inflationary pressures that so worried Trichet and King the previous summers quickly abated—oil, $145 a barrel in July, would drop to about $40 a barrel by the end of the year.

  All signs were pointing to a global economy that was crashing on the rocks of recession or even depression. It was time for the central banks to stop worrying about high inflation and start pumping money into the economy. Bernanke and King, the old officemates at MIT, figured that if all the major central banks acted together, they would have a greater impact than if any one of them acted alone, or even if they all did the same thing separately. And by moving as one, they could eliminate any distortions that might result in currency markets if they moved separately—something Trichet was particularly concerned about. If the ECB cut interest rates, he worried, the euro could decline excessively. By early October, though, he was ready to stand with Bernanke and King. Just three months after raising rates, Trichet prepared to reverse his decision.

  The triumvirate spoke with some of their colleagues at the smaller central banks—Bernanke with Mark Carney at the Bank of Canada, King with Philipp Hildebrand of the Swiss National Bank, and Trichet with Stefan Ingves of Sweden’s Riksbank. Bernanke called a special meeting of the Fed policy committee, via a videoconference system that arrayed the policymakers’ faces across the screen in squares like in the intro to The Brady Bunch.

  The joint announcement released at 7 a.m. New York time on October 8, 2008, of the first globally coordinated monetary easing in history, left little doubt where the Boys of Basel had ended up, whatever their differences had been in the run-up to the crisis. “Throughout the current financial crisis, central banks have engaged in continuous close consultation and have cooperated in unprecedented joint actions such as the provision of liquidity to reduce strains in financial markets,” it read. After noting that inflation pressures had diminished, it continued, “Some easing of global monetary conditions is therefore warranted. Accordingly, the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, Sveriges Riksbank, and the Swiss National Bank are today announcing reductions in policy interest rates. The Bank of Japan expresses its strong support of these policy actions.”

  With the course of action established by that cooperative effort, the banks continued to lower rates individually over the coming weeks. As the Bank of England’s monetary policymakers prepared to gather in November, analysts expected them to cut rates by another half a percentage point. But the economic numbers were even worse than in-house pessimist Danny Blanchflower had imagined. In advance of the meeting, he met with Tim Besley, a Monetary Policy Committee colleague who’d been on the opposite side of the interest rate argument just a few months earlier. Besley had pivoted—the economy had deteriorated farther and faster than he’d thought possible. “What are we going to do?” Besley asked, according to Blanchflower’s recollection.

  “We’ve got to cut 150,” Blanchflower replied. They should, he was arguing, cut interest rates by a percent and a half, three times as much as markets were expecting. Besley went to speak to the more hawkish, inflation-focused members of the committee. Blanchflower went to speak to King. “This has gone completely mad,” he told the governor. “Unless you cut by 150 the second after the decision, I will call a press conference and immediately lay out what you have done.”

  King was quickly coming to the same view; he had a stubborn streak, but was willing to change his views when the world around him offered persuasive evidence that he had been wrong. And the evidence was piling up that the British economy was in free fall due to the global crisis. The committee gathered the afternoon of Wednesday, November 5, to have its initial discussion of the decision it would make the next morning. King started the meeting. “‘I realize where we are,’” Blanchflower recalled him saying. “‘This is a very serious situation. And just to put this on the table, just so we don’t get confused, I have a proposal on the table that we cut by 150 basis points.’”

  After reaching a decision at about 11:30 a.m. on November 6, Blanchflower and his colleagues went to their offices, sworn to silence to ensure there were no leaks before the public announcement at noon. In the moments before the central bank shocked the market with its 150-point cut, Blanchflower was awed by the fact that after months of fighting an unsuccessful battle for the bank to cut rates, he had finally won—though it did take a global financial collapse to make it happen. “I’m shaking. I’m absolutely bloody shaking,” he said. There was a countdown to the announcement, scheduled to happen at precisely noon Greenwich Mean Time, so that all news outlets would get the information at exactly the same time. The media, financial markets, and even other Bank of England staff were stunned by the aggressiveness of the move. Finally, the Bank of England, the most reluctant crisis fighter in the 2007 phase of things, was ready to pull out its big policy guns.

  At the Federal Reserve, Bernanke wasn’t content to quit at the October rate cut either. But given the slashing of rates the Fed had done earlier in the year, there wasn’t much room for more cuts. After the joint rate cut and another by the Fed three weeks later, the federal funds rate on November 1 was only 1 percent, already a historically low level. In other words, the device three generations of Federal Reserve chairmen had used to prop up faltering economies was no longer working. The Fed could lower rates down close to zero, perhaps, but not below that. If interest rates were negative—meaning savers would actually lose instead of make money over time—people would just take their money out of the banks.

  But a decade earlier as an academic, Bernanke had argued that even if short-term interest rates hit the so-called zero lower bound, a central bank wasn’t out of options for fighting a slumping economy. It could always lower longer-term interest rates too. In late 2008, the economy was in free fall—but just how much so wasn’t clear. (Gross domestic product was falling at a 9 percent annual rate, but the first data that became available that winter put the pace of contraction at only 3 percent.) On November 25, the Fed’s Board of Governors announced a plan to buy up to $500 billion in mortgage-backed securities guaranteed by government-sponsored companies like Fannie Mae and Freddie Mac. But in their hurry to try to pump money into the financial system, the Fed’s lawyers made a mistake: It wasn’t within the power of the Board of Governors to have made that decision. This was a form of monetary policy, so it had to be decided by the full Federal Open Market Committee, which includes presidents of reserve banks around the country.

  In the days before the December 16 meeting, Bernanke called his colleagues across the country. All of them agreed that the economy was in terrible shape. Some were angry that they hadn’t been included in the decision on mortgage securities. Others were already antsy about the vast expansion in Fed lending. Bernanke wanted the next policy announcement to be a show of decisiveness and unity. And he wanted not merely to cut rates, but to cut them to zero and pledge to keep them there for some time, as well as to give a formal blessing to the plan to purchase mortgage-backed securities in order to pump money into the economy through alternate means.

  Usually, Bernanke viewed the dissent of one or two policymakers from a decision as the sign of a healthy committee. (“If two people always agree,” he’s said, “one of them is redundant.”) But for this move, he very much wanted unanimity. A
fter all, if the Fed could take such action unanimously, it would create greater confidence that it was truly committed to keeping rates low for a long time. Dallas Fed president Richard Fisher was reluctant to go along with the move, however, viewing it as a risky proposition that wouldn’t help the economy much. He initially voted against the action—then, while his colleagues ate lunch and staffers prepared the announcement, approached Bernanke privately and asked to change his vote. “I felt after going for a walk down the hall that I didn’t want to pull the legs out from under Ben,” Fisher later said. “I didn’t want to be perceived as not being a team player.”

  Bernanke’s years of respectful consensus building had paid off, just when he needed it most.

  • • •

  That fall and winter, the central bankers of the world worked nonstop, in constant touch with each other, the weight of history constantly on their minds. After Liaquat Ahamed’s book Lords of Finance: The Bankers Who Broke the World, an account of how the central bankers of the 1920s and ’30s bungled their way into the Great Depression, was released in January 2009, Geithner tried reading it in the evenings. Over and over, he had to put it down and stop, horrified that even highly intelligent, well-meaning policymakers could mishandle a situation badly enough to create mass human misery.

  But what the world’s most powerful central bankers did in that fall of 2008 was, piece by piece, build a wall of money, attempt to fight the panic on a scale commensurate with its severity. They did it by lending to banks and investment firms and even individual businesses. They did it by swapping dollars and euros and pounds with each other and their counterparts in emerging nations. They did it by trying to influence their governments to bail out insolvent banks. With people in almost every country on earth hoarding their money, the central bankers created more of it, flooding the financial system, substituting their own bottomless resources for those of newly fearful world investors.

  They didn’t prevent a steep decline in the world economy. From May 2008 to March 2009, the global stock market fell in value by almost $27 trillion, a 47 percent drop, wiping out wealth equivalent to the goods and services produced by every human on earth in half a year. If you look at a graph of the U.S. stock market, the period of 1929 to 1931 tracks very closely with that of 2007 to 2009. So do measures of the economy more broadly, such as industrial production. But in the 1930s, the declines continued for years. In the recent episode, they leveled off in the spring and summer of 2009.

  There was far more work to do. But the wall of money built by the global central bankers had held.

  Part III

  AFTERMATH, 2009–2010

  TWELVE

  The Battle for the Fed

  The hallway outside Room 2128 of the Rayburn House Office Building was crowded with dozens of people sitting on the floor. Dressed in lived-in sweats, skintight shorts, and tattered-looking winter coats, they hardly looked like a crowd waiting to view a hearing of the House Committee on Financial Services. They weren’t. The various students, bike messengers, and even homeless people vying for one of the few dozen seats open to the public were members of an unlikely Washington profession: those who earn money by holding a place in line for well-heeled financial lobbyists. And on March 24, 2009, with the unemployment rate rising, economic output plummeting, and the stock market at 1997 levels, they had some even more unlikely competition: a group of middle-aged women in bright pink shirts and life jackets, holding signs that read WHERE’S MY JOB?, WHERE’S MY IRA?, and BAIL US OUT.

  These representatives of Code Pink, a left-wing group that arose to protest the Iraq War and had broadened its interests to include economic issues, had gotten there first, thus claiming the seats right behind the witness table, which would soon be occupied by Fed chairman Ben Bernanke, Treasury Secretary Tim Geithner, and New York Fed president Bill Dudley. American International Group, the giant insurance company that the Fed had bailed out six months before, would be paying out $165 million in bonuses to its employees, honoring earlier contractual commitments made to retain the people responsible for winding down its cash-sapping financial products division. The wrath of an angry Congress was about to descend upon Bernanke and his two colleagues.

  “This is a very important public hearing,” said Massachusetts congressman and committee chair Barney Frank as the proceedings got under way. “It will not be disrupted. There will be no distraction. My own view is that critical conversation, indeed, whole sentences and even paragraphs, advance even a negative view more than bumper stickers, no matter what sort of bumper those stickers are worn on.” The Code Pink protestors held up their signs.

  The committee leaders from both parties started by giving long speeches. Then the three witnesses delivered their opening statements. As Geithner proceeded to talk about “a broad set of regulatory reform proposals, specifically related to systemic risk,” Frank interrupted him.

  “Will you please act your age back there?” said Frank to the demonstrators. “Stop playing with that sign. If you have no greater powers of concentration, then you leave the room.”

  It was Bernanke’s turn. “AIG faced severe liquidity pressures that threatened to force it imminently into bankruptcy—” Frank interrupted again: “The next one that holds a sign will be ejected. I do not know how you think you advance any cause to which you might be attached by this kind of silliness.”

  Once the prepared statements were finally done, Frank told his sixty-some committee members how it would be: They would have five minutes each. No exceptions. “I wish we didn’t have the five-minute rule, and I wish we didn’t have so many members. And I wish I could lose weight without dieting,” he said.

  Michele Bachmann, the firebrand conservative congresswoman from Minnesota who two years later would have a brief turn as a front-runner for the Republican presidential nomination, wondered if the government was in the midst of “a historic shift, jettisoning the free-market capitalism in favor of centralized government economic planning.” She proceeded to question the constitutionality of the Federal Reserve and ask whether there were plans to abandon the dollar and move to an international currency.

  “How do the three of you operate in your own mind?” implored Ron Paul, the Texas congressman who made his own 2012 presidential run and authored the book End the Fed. “Do you operate with the idea that capitalism failed, and they need us more than ever before to solve these problems?”

  Illinois representative Donald Manzullo confronted Bernanke and Geithner over why the government bailout of AIG helped people whose savings were insured by the company to avoid losing out at a time when Americans’ stock portfolios were being hammered. “The American people have lost 40 to 50 percent of their retirement plans,” he said.

  “The purpose of the action we took with AIG,” replied Bernanke, “was not to help any specific counterparty.”

  “But you did,” interrupted Manzullo. “That’s what happened.”

  Americans were paying $40 billion “so that other people don’t lose any of their retirement plans,” Manzullo said. “That’s what happened, isn’t it?”

  “Congressman,” Bernanke said, “those losses the American people would have been—”

  “Give me a yes or no, please,” said Manzullo.

  “. . . would have been far greater—” continued Bernanke.

  “No, did the people who took out—”

  “. . . would have been far greater—” Bernanke tried again.

  “I’m asking the question,” snapped Manzullo. “Did the people who took out insurance with AIG . . . get reimbursed 100 percent so they suffered very little loss? Yes or no?”

  “It depends on the nature of those specific contracts,” said Bernanke.

  Frank interrupted once more: “I would ask the people in that second row to stop the gesturing and the conversations . . . If there’s any further disruption, I would ask the officers . . . to simply e
scort people out.”

  To call it a circus would be unfair to Barnum and Bailey.

  • • •

  In the spring of 2009, people of opposing parties and differing political ideologies could all agree on one thing: The government agency that most clearly deserved to have its wings clipped in response to the economic crisis was the mighty Federal Reserve.

  It was both a convenient and a logical target. To those on the left, the Fed had been blinded by the free-market dogma of its previous chairman, Alan Greenspan, and thus had been unwilling to regulate big banks and protect consumers from taking out irresponsible loans. To those on the right, it had meddled in the free market, pushing too much money into the economy earlier in the decade and then rescuing the banks from their poor decisions when things turned ugly. People in both camps viewed it as a secretive organization with inadequate oversight. A Gallup poll in the summer of 2009 found that 30 percent of Americans approved of the Fed’s performance, a lower rating than even that of the Internal Revenue Service.

  As Bernanke and the Fed made their big decisions during the crisis—the bailouts of Bear Stearns and AIG, the alphabet soup of programs to pump money into the financial system—politics was a second-order concern. Bernanke and his inner circle concluded that they simply had to do what they thought would best support the economy and hope that the politics would work itself out. “If we come out of this with a Hall of Fame batting average, then we’ll be fine,” Bernanke, a baseball fan, told his advisers. Even most of the very best hitters in the Major League Baseball history recorded a hit less than a third of the time. In other words: We’re not going to hit every ball, but we have to keep swinging, doing what we think is best, and as long as the overall results are good, our mistakes will be forgivable.

  Many of the decisions were made quickly and in the middle of the night and involved questions that are supposed to be independent of politics. Plus, it’s hard to brief legislators about anything without it soon leaking to the press, making it problematic to talk about questions that were still undecided. Congress was usually an afterthought, briefed only after a decision had been made and announced—despite the fact that it ultimately controls the existence and authorities of the central bank.