Instead of reading any more of the Financial Crisis Inquiry Report, I went home Friday night and watched American Madness, Frank Capra’s 1932 thriller about a banking panic. The friend who recommended it borrowed it for me from the library.
A faster 75 minutes I’ve seldom spent. Like the Congressional Commission’s report, the film reinforced my conviction that the really interesting thing that happened in September 2008 was the worldwide panic in the banking system – financial institutions running on each other behind the scenes.
Director Capra made Madness in 1931, fifteen years before his far-better-known It’s a Wonderful Life appeared. That film also depicts a bank run that tests the character of its hero — he uses his honeymoon cash to halt it. The earlier film, made at a time when banks were failing by the hundreds, is much the darker story.
The thoroughly likeable Walter Huston (fresh from having starred as D.W. Griffith’s Abraham Lincoln) plays a populist banker who lends on character, he says, not collateral. He has devoted twenty-five years to building Union National Bank. It is a prosperous institution.
But his head cashier, a rogue, has lost $50,000 gambling. Threatened by a mobster, the cashier arranges for the vault to be left open at midnight, and for the blame to be pinned on a subordinate. A night watchman is killed in the burglary.
That it was an inside job is manifest. The run starts the next morning, when the habitually-bored bank telephone operator rings a friend to report that the bank was robbed and a certain sum of money is gone. Confusion mounts throughout the day. So does the amount said to be missing. Rumors quickly spread.
By afternoon the panic is full-throated. Lines are forming on the sidewalks outside the bank. Its directors, investors whose capital is at risk, want to sell Union National to New York Trust, which will call many of its loans. Its good-hearted president threatens to close its doors instead (and wipe out the directors’ investments). It’s a terrifying moment – complicated by the presumed infidelity of the president’s wife. The details – telephone conversations, crowd scenes, teller tactics, the machinery of the vault itself – are vivid.
The panic is stemmed only when the little guys who have benefitted over the years from the bank’s lending policies begin to show up to deposit their hard-earned cash in a show of faith, just as in Wonderful Life. The run subsides, as quickly it began. The crime is solved, the marriage repaired. By the end of the film, the telephone operator is bored again.
Everything is here that you need to understand the broad outlines of the recent financial crisis – at least the panic that precipitated what has become a long slump. The subprime mortgage industry is the counterpart of the gangsters and the crooked cashier (though its motives are, of course, not so malign). Those who shorted the housing sector so successfully, using credit default swaps, were the equivalent of the telephone operator; it was they who forcefully called attention to the problem (while the slicing-and-dicing techniques known as the securitization business made it much harder to know whom to trust).
The panic, though, only began when the losses were publicly recognized – that is, when Lehman Brothers was permitted to fail (unlike Bear Stearns, a few months before), triggering fears about the solvency of nearly everyone else in the system, and touching off an intricate month-long series of events.
And it wasn’t the little guy who resolved the situation in 2008, but rather the US Congress and the Federal Reserve Board, by indicating a willingness to lend (at a penalty rate) to anyone who wanted assistance (and even some who didn’t) until the panic subsided. There were, of course, many more subplots in the real-world crisis than in the movie. But the key events map pretty well from the one to the other.
The Financial Crisis Inquiry Report never achieves a high degree of clarity, especially with its minority dissents, but it does get the architecture right. It begins by describing the shadow banking system. It decomposes many and various elements that contributed to the crisis (all but the global imbalances that were was the mainspring of the thing!). And the chapter on the panic itself makes pretty good reading.
Nor does the FCIR get to the bottom of things: particularly the simmering year-long struggle between the Treasury Department and the Fed over measures that might have mitigated the panic, contained the housing crash somewhat, and engineered a softer landing for the real economy. But in the highly partisan atmosphere that produced the two Republican dissenting opinions, that is clearly asking too much.
In fact, the 27-page minority report by Commissioners Keith Hennessey, Douglas Holtz-Eakin and vice chairman Bill Thomas does a generally better job of stating clearly and succinctly what they call the ten causes that were essential to the crisis than the 400-page majority report. (Never mind the short further dissent by commissioner Peter Wallison, who blames the whole thing on government housing policy.)
Still, I suspect the Commission’s majority report, and the testimony that was elicited in the course of its preparation, eventually will prove useful in structuring our understanding of what happened. We haven’t heard the last of the financial crisis. In due course the mechanisms that caused it will become clearer.
Meanwhile, if you curious to know something about the emotional intensity that was, for a time, at the heart of the financial crisis, never mind the ominous helicopter camera of Charles Ferguson’s documentary Inside Job. Have a look at the masterful crowd scenes of American Madness instead.
Various readers have written to warn against the dangers of espousing a “pure panic” theory of the financial crisis.
It is true that I have a very high opinion Slapped by the Invisible Hand: The Panic of 2007 , by Gary Gorton, of Yale University’s School of Management. I’ve written about Gorton twice in EP, here and here. In a December article in Strategy+Business, I called Slapped the best book of the year. And in a lengthy contribution to the TIFF Education Foundation, a forum for longer-form journalism for which I have high hopes, I compared the essays collected in Gorton’s book to the more extensive narrative tradition of Peter Bernstein, author of Capital Ideas: The Improbable Origins of Modern Wall Street and many other works.
The great virtue of Gorton’s key paper is that it was presented at Jackson Hole in August 2008. It explained, in plain English,that a situation that was at the time being called a “credit crisis” was in fact a nascent panic in the in the non-bank or “shadow” banking system – a new world of commercial paper and or repurchase agreements (“repo”), all but invisible in the monetary aggregates, but otherwise little different from the world of the epic Panic of 1907.
Within three weeks, what Ben Bernanke has described as “the worst financial crisis in global history, including the Great Depression” had begun. “If you look at the firms that came under pressure in that period…,” Bernanke told the Financial Crisis Inquiry Commission, “only one… was not at serious risk of failure… So out of maybe the 13, 13 of the most important financial institutions in the United States, 12 were at risk of failure within a period of week or two.”
Understanding what happened in those few weeks in September and October 2008 is hardly the end of explaining what has happened to financial intermediation in the last forty years or so, and what might be done to render it safer and less prone to crisis. It is, however, the indispensable beginning.