The Alchemists: Three Central Bankers and a World on Fire

by Neil Irwin

  Every major financial crisis spurs a rethinking of financial regulation, and as the Panic of 2008 raged, there was little doubt that the pattern would hold. After President Barack Obama was inaugurated in January 2009, he made overhauling the financial system a priority. “You never want a serious crisis to go to waste,” Obama’s first chief of staff, Rahm Emanuel, said in November 2008. Initially, the new administration was hoping Congress would pass some form of financial reform in time to take to an international summit in April 2009. That proved unrealistic given the sluggishness of the legislative process, but the White House was still eager to move. When Neal Wolin, the deputy treasury secretary, told Emanuel that it could take weeks to draft a bill, given the hundreds of pages of complex details to work through, Emanuel, who wanted a bill written in days, pointed at Wolin’s computer and said, “Sit down and start fucking typing.”

  Christopher J. Dodd, a veteran senator from Connecticut, was chairman of the Senate Committee on Banking, Housing, and Urban Affairs, and he would be the one to try to craft a financial reform bill that could make it through the procedural gauntlet that was the United States Senate in 2009. A single senator out of the one hundred could slow activity on the Senate floor to a crawl on nearly anything, from the confirmation of a midlevel bureaucrat to passing Obama’s signature initiative of overhauling the health care system. In earlier times, there had been an unwritten agreement against using that power except in really important cases, but by 2009 minority parties routinely filibustered anything controversial, requiring a sixty-vote supermajority and days or weeks to overcome objections.

  Dodd, the son of a senator and a three-decade veteran of the institution, envisioned financial reform being done the old-fashioned way: with the two parties contributing their best ideas and hammering out a deal across the negotiating table that eighty or ninety senators from both sides of the aisle could happily support. “I don’t want to be sitting on the floor of the Senate begging for a sixtieth vote with sixty guns pointed at my head,” Dodd told an aide in the spring of 2009. “This is different, and it shouldn’t be ideological.”

  The key to his strategy was going after the Federal Reserve.

  Dodd himself was irritated that the Fed, under Greenspan, had done little to use its regulatory powers to rein in bad mortgage lending during the housing bubble. He didn’t have the deep-seated populist objections to the central bank that some of his colleagues did, but Dodd did see the extraordinary actions the Fed had taken during the crisis as evidence of an organization with too much concentrated power. In one hearing, he compared giving the Fed more power after its failings during the crisis to a parent “giving his son a bigger, faster car right after he crashed the family station wagon.”

  Dodd also believed that a fundamental reason for the crisis was that the United States had so many different bank regulators—five of them at the federal level alone, plus separate banking authorities in each state. Banks had the ability to choose what type of charter—and hence what regulator—they would have. That in turn gave regulators some incentive to take a hands-off approach, lest banks switch to different charters and a regulator lose relevance and funding.

  Dodd viewed cutting back the power of the Fed as an important way to build bipartisan consensus. The Republican leader on the Banking Committee was Senator Richard Shelby of Alabama, a particularly vehement opponent of the central bank. Shelby had refused to negotiate on behalf of Republicans on the Wall Street bailout legislation because he was opposed to passing it in any form, and he believed the Fed’s low-interest-rate policies in the early 2000s were the main cause of the housing bubble. Dodd’s plan was to replace the complex system of overlapping bank regulators with a single, newly created one—that is, to take away one of the core powers that the Fed had long held dear, the ability to supervise banks all over the country. It was, in Dodd’s view, reining in an agency that had grown too powerful. Shelby’s staff described the approach more colorfully: “Fuck the Fed.”

  That was in the rarefied confines of the U.S. Senate. As Dodd and Shelby moved in their own way to unmake the modern Federal Reserve, another political threat was emerging from different quarters.

  Texas representative Ron Paul was officially a Republican in 2009, though he disagreed with the party on nearly as much as he agreed. He opposed both the Iraq War and high defense spending, for example, and he favored the legalization of narcotics. Paul had previously run for president as the nominee of the Libertarian Party; in 1988 he won 0.5 percent of the national vote, which was good enough for third place. His presidential ambitions found more success in 2008 and, especially, 2012, when his strongly antigovernment stance resonated among Republican primary voters more than party leaders would have liked. So opposed was he to government action of all stripes that when there was a vote in the House on some inoffensive measure such as naming a rural post office after a deceased local official or designating May as Mental Health Month, Paul was very likely to be the one dissenter in a 434–1 vote.

  Unsurprisingly, Paul hated the Fed. He was in favor of a strict gold standard and ending the government’s monopoly on issuing money. The idea of paper money issued and guaranteed by the government is, after all, anathema to someone who deeply distrusts government. Paul also had a penchant for conspiracy theories, and he used his position as a member of the House Financial Services Committee to ask questions of Bernanke (and Greenspan before him) that no one else in the Congress would think to pose. At one hearing in 2010, Paul suggested that the Fed had some involvement with the Watergate break-in and funding Saddam Hussein in the 1980s, which Bernanke described as “absolutely bizarre.”

  But in 2009 Paul’s long-running crusade against the Fed became a cause that seemingly everyone wanted to join. One of his criticisms was that the Fed kept too much information secret from Congress and the public. His answer was legislation that would allow Congress a freer rein to look into the Fed’s business. Under existing law, political authorities didn’t have the ability to demand details of the inner workings of Fed decisions on monetary policy or its dealings with foreign central banks. Central bankers view secrecy as a key to their ability to operate—it gives them the freedom to deliberate away from the pressures of politicians or the public. But this merely magnified the impression held by Paul—and by more and more of his colleagues—that the Fed was up to something nefarious.

  Paul’s name for his legislation was particularly inspired: “Audit the Fed.” After all, every corporation gets audited; any institution of the Fed’s size should be held to such routine accountability. In fact, on financial matters the Fed was already audited, with an independent inspector general in house, oversight by Congress’s investigative arm, and reserve bank audits carried out by the same major accounting companies that audit every major corporation in America.

  Paul wanted something more than the prevention of fraud and theft, though: He wanted Congress to be able to stick its nose into the decisions the Fed made on interest rate policies, foreign currency swaps, and emergency lending to banks. To Fed officials, Paul was asking for a tool with which Congress could bring political influence to bear on monetary policy. It’s one thing to make an unpopular move knowing you’ll have to explain yourself in a congressional hearing a few months later, quite another to know that investigators will soon subpoena every document that was created in the course of reaching that decision. To Paul, Audit the Fed was just a way to add a bit more democracy to an antidemocratic body.

  Three hundred twenty of 435 representatives—nearly three quarters of the House—eventually signed on as cosponsors of the Federal Reserve Transparency Act. Vermont’s Bernie Sanders, the lone socialist in the U.S. Congress, took up the cause in the Senate, and by the spring of 2009 the effort to audit the Fed was picking up momentum.

  • • •

  With the Fed under attack, the man at its helm was called to become a politician himself. It wasn’t a natural fit.


  Ben Bernanke wasn’t born to be a Washington operator. He had little inclination—or skill—for glad-handing and backslapping. Unlike Greenspan, who frequented the Georgetown social circuit with his wife, NBC newscaster Andrea Mitchell, Bernanke preferred a quiet evening at home with his Kindle or a trip to the theater with his wife. Bernanke took the Fed chairmanship hoping to add greater anonymity to the role—to be less the all-powerful deity that Greenspan sometimes seemed, more the quiet functionary.

  The financial crisis ruled out that possibility. In a crisis, people want someone to step up and be in charge, and Bernanke did exactly that. But his newness to Washington and discomfort with the trappings of power were obvious, particularly early on. When dealing with members of Congress, Bernanke simply acted like himself, addressing questions as forthrightly as the confines of his office would allow, explaining economics and the Fed’s decisions with the same simple language he once used to teach Princeton undergraduates. Before a congressional hearing, he would sit for “murder boards”—prehearing sessions lasting hours during which advisers fired off questions on the full range of subjects he might encounter, occasionally imitating the style of one of the more distinctive members of Congress. He developed a style of detached reserve that was effective in sometimes hostile hearings, responding calmly and deliberately even when his questioner was in a blind rage. Only on the rarest of occasions did he become testy or combative himself. But for the legislative battle in the offing, mere politeness wouldn’t be enough.

  The Fed wasn’t set up for a legislative war. Its legislative affairs office comprised only five people—compared with about three thousand lobbyists employed by the financial industry as a whole—and the Fed did not play the hardball game of using press leaks and veiled threats to get its way on Capitol Hill. The Fed style was more to state its case as directly and repetitively as it needed to and hope that its technical competence and straightforward arguments would win the day. In preparation for political combat, in the summer of 2009 Bernanke hired a new chief lobbyist, Clinton treasury department veteran Linda Robertson. He also paid particular attention to maintaining a personal touch with key lawmakers. When Tennessee senator Bob Corker wanted to personally review hundreds of pages of confidential documents about the Fed’s bailout of AIG, Bernanke welcomed him to the Fed’s headquarters, joined him for breakfast, and prepared a room in which Corker could comfortably spend hour upon hour going through pages.

  Bernanke readily admitted that the Fed had made mistakes, in particular not using its regulatory powers to reduce bad mortgage lending and otherwise protect consumers in the years just before the crisis. He agreed that the bailout actions the Fed had taken during the crisis were unpalatable, even as he defended them as having been absolutely necessary to prevent an even worse economic situation. But he viewed the approaches being dreamed up by Dodd and Shelby as potentially disastrous. He’d seen how other bank regulators, in the run-up to the crisis and then during it, had suffered from tunnel vision, focusing on the individual banks they regulated rather than thinking about more important economic interconnections.

  “Mr. Chairman, I understand your objectives here—but I do believe it’s a very, very serious matter to take the Fed essentially out of financial-stability management,” Bernanke told Dodd in one hearing. “I do think that taking the Federal Reserve out of active bank supervision would be a mistake for the country.”

  But with the politics of the moment what they were, Bernanke and the Fed seemed ready to lose big. “If the Fed were running for reelection,” a congressional aide told the Washington Post, “it would go home to spend more time with its family.”

  Bernanke wasn’t the only one opposed to Dodd’s plan to use Fed bashing as a means to financial reform. Geithner viewed the Federal Reserve as key to making the financial system less prone to crises than it had been in the past. In his view, whatever the mistakes of the preceding years, the Fed had been nimble in addressing the crisis while other financial regulators had been sluggish. Its people were smarter, and its abilities to print money and serve as lender of last resort provided the ultimate backstops to economic disaster. He saw a stronger Fed as a fundamental goal of financial reform and brought in two Fed staffers as detailees to the Treasury Department to help make his case.

  On May 19, 2009, the treasury secretary brought the Democratic senators from the Banking Committee, along with key staffers who would be drafting financial reform legislation, to breakfast in a dining room on the second floor of the Treasury Department. Over coffee and eggs, Geithner laid down his three nonnegotiable goals: First, the Federal Reserve must keep the authority to oversee any bank big enough to bring down the financial system if it failed—$50 billion in assets was the number he had in mind. “If that were not the case,” Geithner told his fellow Democrats, pointing to the White House next door, “I would recommend that the president veto this bill.” Second, the government must retain the power to offer an emergency backstop of the banking system, which had proved crucial during the crisis. Third, the treasury secretary, rather than the appointee to a newly created job, must be put in charge of a new council of regulators meant to identify risks in the financial system and designate which firms needed an extra measure of oversight from the Fed.

  Of course, the banks themselves had a few ideas about who ought to regulate them. From giants like J.P. Morgan and Citigroup to tiny, state-chartered institutions with a single branch, the banks wanted to stay under the purview of the Fed. “The Fed examiners always came in as bankers and understood the banker’s experience of risk,” said Camden R. Fine, president of the Independent Community Bankers of America. “Each regulator has its own cultural bias, and the Fed’s bias is, ‘We’re a bank, too.’” Dodd’s idea of some unknown new über-regulator alarmed the banks.

  The giant banks were politically toxic in the wake of the Wall Street bailout, so they had to approach Congress carefully. If they advertised their position too loudly, it could be counterproductive. But they had Geithner making their case forcefully—even threatening a presidential veto. The thousands of smaller banks were on their own, with Geithner willing to take them out from under the Fed umbrella, if that’s what was needed for a deal. But that didn’t mean they were powerless. One of the best tools for gaining influence in Washington is simple geography: The more members of Congress view you as representing their hometown interests, the more they’ll fight for you. There’s an old joke about the perfect military aircraft having parts made in all 435 congressional districts, to ensure it will never be defunded.

  America’s small banks are the closest real thing to that mythical aircraft. In every town across the country there are community banks. Their executives and boards of directors tend to be pillar-of-the-community types—the ones who fund local charities and, especially, give money to congressional campaigns. That made the Independent Community Bankers of America—with its five thousand members operating twenty-three thousand bank branches and controlling $1 trillion in assets—a formidable lobbying power in Washington.

  In meetings with Barney Frank and Dodd’s senior staffers, Fine made an offer: The community bankers could never actively support legislation that would increase bank regulation. But so long as Congress left his members alone—and left the Fed in place as their regulator—they wouldn’t try to fight the financial reform bill. “I told them we would come out swinging against Dodd’s bill if it included a single regulator,” said Fine. “They threatened to gut the Fed, and I told them they’d have a hell of a fight.”

  There was another group with plenty to lose if the responsibility for regulating banks across the United States was taken away from the Fed. For the far-flung reserve banks that comprise the Federal Reserve system, the approach that Dodd’s staff was developing was something approaching an existential threat. Fed officials in cities like Kansas City and Dallas and Philadelphia had been out of the loop as officials in Washington and New York made thei
r series of bailout decisions. The presidents of the other reserve banks had high regard for Bernanke personally; more so than Greenspan, they believed, he respected them, engaged with them, and listened to their thoughts and concerns. But many of them also felt that the Bernanke Fed had taken actions that endangered the credibility of the whole institution without informing many of its component parts.

  Some of the crisis-era decisions had been made in such a hurry that, aside from New York, the reserve banks didn’t even find out about them until they were announced publicly. At least one reserve bank president had been reduced to dialing in to one of the briefing calls that the Fed conducted for journalists to learn about the latest decision by his colleagues in Washington.

  Perhaps the closest ally in the Federal Reserve System for the country’s smaller banks was Thomas M. Hoenig, president of the Kansas City Fed since 1991. A veteran of supervising banks, he had been manning the discount-window desk when an Oklahoma bank called Penn Square failed in 1982, in turn causing the failure of Continental Illinois National Bank and Trust, the biggest in U.S. history until the 2008 crisis.

  Hoenig loathed the too-big-to-fail banks, which he saw as benefiting from a public safety net that the smaller banks lacked. He also saw the ultra-low-interest-rate policies embraced by Bernanke as a major cause of the financial crisis. And from attending events around his Federal Reserve district, which encompasses parts of seven states in the center of the nation and contains no giant banks but hundreds of smaller ones, Hoenig had picked up early on the depth of public rage at the Fed. At one luncheon in Santa Fe, New Mexico, he gave a speech and then opened up the room for questions. “It was the most hostile crowd I’ve ever seen,” he said later. “People were angry.”