The New York Times earlier this month contributed a memorable anecdote to the lore of this crisis when it reported on the emergency session that took place in the Roosevelt Room of the White House on the day after the credit markets shut down.
It was Thursday, September 18, when Federal Reserve Board Chairman Ben Bernanke and Treasury Secretary Henry Paulson explained to President Bush that, in the wake of government’s decision to let Lehman Brothers fail a few days earlier, banks in Europe and the United States had ceased lending to one another, each for fear their counterparty might be in similar jeopardy.
The previous January Bush had pushed through a $150 billion stimulus package designed to stave off recession, delivered mostly in the form of income tax rebates, to no apparent macroeconomic effect. Only two days before, he had agreed to lend $85 billion of taxpayer money to insurance giant American International Group to keep it solvent. Now a commitment to other institutions in the neighborhood of $700 billion would be required if the gridlock were not to continue.
The world economy had, for the moment, come to a halt.
Mr. Bush, according to several people in the room, paused for a single, stunned moment. “How,” he wondered aloud, “did we get here?”
The Times reporters used the anecdote as a jumping-off point for an account of home-ownership policy and bank regulation (“White House Philosophy Stoked Mortgage Bonfire”) that was riveting, despite its failure to mention monetary policy, world trade imbalances, oil prices or the rest of the macroeconomic setting. (“There are plenty of culprits, like lenders who peddled easy credit, consumers who took on mortgages they could not afford and Wall Street chieftains who loaded up on mortgage-backed securities without regard to the risk. But the story of how we got here is partly one of Mr. Bush’s own making…. From his earliest days in office, Mr. Bush paired his belief that Americans do best when they own their own home with his conviction that markets do best when let alone.”)
The thing about that dramatic session that we’d really like to know is, What came next? Who responded to the president’s question? How? Or did it simply hang in the air? It will take much longer to find how George W. Bush’s understanding evolved that day of the markets’ desperate situation. These things leak out a little bit at a time.
But even a persuasive and reliable account of the view from the Roosevelt Room that morning won’t shed much light on the situation that obtained in capital markets on September 18.
There the state of affairs was little different from the way that former Treasury Secretary Paul O’Neill described it in March this way. “If you have 10 bottles of water, and one bottle had poison in it, and you didn’t know which one, you probably wouldn’t drink out of any of the 10 bottles; that’s basically what we’ve got there.” Segregating those famous “toxic assets” is still the central problem today, somewhere ner the top of President-elect Barack Obama’s list of things to do as soon as he takes office.
O’Neill, you will remember, is the corporate executive who Vice President Dick Cheney persuaded to take the job as Treasury Secretary after the Supreme Court declared George Bush the winner of the tie election. The two had met during the presidency of Richard Nixon, when O’Neill, then a career civil servant, was assistant director of the newly-created Office of Management and Budget, and Cheney was an assistant to an ambitious ex-congressman named Donald Rumsfeld in the Office of Economic Opportunity. Even then, O’Neill had a reputation for fiscal prudence; Cheney would occasionally introduce him as “the smartest guy I know.”
All three men moved up to senior jobs in the administration of Gerald Ford: Rumsfeld, ultimately, as Secretary of Defense; Cheney, to replace him White House Chief of Staff; and O’Neill to deputy director of OMB. Alan Greenspan was chairman of the Council of Economic Advisers. When Ford was defeated, O’Neill left government for the private sector, first at International Paper Co, then to thirteen highly successful years at Alcoa, Inc., blazing a path that both Rumsfeld and Cheney would follow, at G. D. Searle & Co. and Halliburton Energy Services, respectively. O’Neill had his doubts, but took the Treasury job anyway. The opportunity to be among his old comrades was too tempting to pass up – especially since, as the administration’s senior economic official, he could hope to counsel the president in a pragmatic approach to taxing and spending.
That was the beginning of one thing after another. The first Bush tax cuts. The decision to back away from the Kyoto Protocol on greenhouse gas emissions. The 9/11 attacks and the war in Afghanistan. The Enron scandal. The running battles with National Economic Adviser Lawrence Lindsey and political counselor Karl Rove. The drive to war in Iraq and, on its eve, the second tax cut.
O’Neill became isolated in his dissents from the administration’s increasingly ideological stance. In the summer before the midterm elections, Bush welcomed the Treasury Secretary back from a well-publicized tour of Africa with these words: “Hey, there, Big O. You know something? You’re getting quite a reputation as a truth-teller. You’ve got yourself a real cult following, don’t ya?” A month after the Republican victory in the elections, Bush fired him.
All of this is described in detail The Price of Loyalty: George W. Bush, the White House, and the Education of Paul O’Neill, an account of O’Neill’s two years at Treasury by former Wall Street Journal reporter Ron Suskind that was published in 2004. Based on extensive access to O’Neill and to the written record, as well as interviews with many other participants, the book is even more readable than it was when it first appeared. Then it was washed out by news of the war in Iraq and the American election. The presumption of competence was still in favor of Bush. Not even the dismissal of Lt. Gen Jay Garner after just two months as US administrator in Iraq had made headlines the year before.
All the details of O’Neill’s dissent are lovingly recorded in Suskind’s book, including the climactic exchange with Vice President Dick Cheney that produced what is, at least with respect to its economic policy, probably the single best-known quotation of the Bush presidency.
The package of tax proposals, led by the 50 percent cut in the individual tax on dividends, had been all but buried before the midterm elections; it came up infrequently and always in the past tense – what George Bush wanted to do but couldn’t afford.
But after the Republicans won the midterms, O’Neill could sense a change in the White House, a smugness, a sureness. Now Cheney brought up the tax proposals again, how they would provide stimulus….
O’Neill jumped in, arguing sharply how the government was ‘”moving towards fiscal crisis,” and “what rising deficits would mean to our economic soundness.”
Cheney cut him off.
“Reagan proved deficits don’t matter,” Cheney said. (Emphasis added.)
O’Neill shook his head, hardly believing that Cheney – whom he and Greenspan had known since Dick was a kid – could say such a thing.
He was speechless. Cheney moved to fill the void. “We won the midterms,” he said. “This is our due.”
Two months ago, after the White House went public with its $700 billion bailout plan, O’Neill tried in vain to attract interest in an alternative, one that would apply government guarantees to troubled assets based on sober analyses of their discounted cash flow, and offer twenty-year loans to banks wishing to increase their capital at two points above the government’s cost of funds. His calls to congressional leaders went unreturned, he told Brendan Murray of Bloomberg News. “We have no capacity in the federal government and it’s not possible to create a capacity to manage a $700 billion property portfolio. It’s crazy. It’s like we’ve lost out moorings.”
For all of these reasons, Paul O’Neill is my candidate for Man of the Year. The hunt is on for various seers who saw trouble coming and sounded timely and well-reasoned alarms. William White, former chief economist of the Bank for International Settlements; Kenneth Rogoff, former chief economist of the International Monetary Fund, and Maurice Obstfeld of the University of California at Berkeley; Robert Shiller, of Yale University; investment analysts Jeremy Grantham, Andrew Smithers and George Cooper; Nouriel Roubini of New York University and his RGE Monitor consulting firm – each has earned some right to say “I told you so.”
But none was more prescient or braver than O’Neill, who first put his reputation on the line and then described the problem with unprecedented candor to anyone willing to listen. The White House was lavish in its contempt when The Price of Loyalty appeared in 2004. Maybe now those avid readers, Karl Rove and George Bush, will have time to peruse it.
I went to the library in early November to get Robert Shaplen’s 1960 book on Ivar Kreuger, the “Swedish match king,” whose 1932 suicide in Paris deprived “an astonishing number of the very best people” of the wealth they had invested in the holding company that controlled his far-flung operations (as John Kenneth Galbraith puts it in his introduction). I intended to write a column predicting that the financial crisis would soon unmask a memorable fraud.
As an admirer of Charles P. Kindleberger’s Manias, Panics and Crashes: a History of Financial Crises, I knew that cheaters are inevitably part of the story of any crash, because, as Kindleberger wrote, “The propensities to swindle and be swindled run parallel to the propensity to speculate during a boom.”
Too late for that column now! But not too late for you to try to find a copy of Shaplen’s book, Kreuger: Genius and Swindler, preferably at your library, for used copies are pretty dear – or, perhaps, for some enterprising publisher to get in touch with Shaplen’s heirs. The long-time New Yorker writer was one of the finest journalists of the second half of the twentieth century; Kreuger is as interesting today as when John Maynard Keynes eulogized him as “maybe the greatest financial intelligence of his time.”
Much of Shaplen’s book appeared in three articles in September and October 1959, for those who have access to the New Yorker’s digitital archive. Law professor Frank Partnoy (F.I.A.S.C.O: Blood in the Water on Wall Street; and Infectious Greed: How Deceit and Risk Corrupted the Financial Markets) is said to be finishing a new book on Kreuger. More power to him. But it’s going to take quite a while to produce as satisfying an account of Bernard Madoff affair as deeply satisfying at that Shaplen book.