Mixed Messages

David Wessel seems to be doing the impossible: his book, In Fed We Trust, is getting mentions from all over the Internet, even before its publication, despite competition from what seem like dozens of other crisis books. That’s what a good PR campaign (and a good review from Michiko Kakutani) will do for you.

I obviously haven’t read the book yet, but I was interested in this description in Bloomberg:

None of the senior government policy makers anticipated the credit-market collapse that followed Lehman’s bankruptcy filing in the early hours of Sept. 15, according to Wessel’s book. . . .

On a conference call the previous week, Paulson, Bernanke, Securities and Exchange Commission Chairman Christopher Cox, and senior staff members from those agencies had agreed that companies and investors who did business with Lehman had learned from Bear Stearns and would have acted to protect themselves from a Lehman failure, Wessel wrote.

What were they supposed to learn from Bear Stearns? That they should be very, very afraid of a major bank failure and take steps to protect themselves? Or that the government would step in, so that even if shareholders were largely wiped out, counterparties would be protected? It seems like more of them drew the latter conclusion, even though Paulson, Bernanke, et al. wanted them to draw the former conclusion.

This seems to me an illustration of the fact that you can never be sure what message you are sending. Perversely, even letting Lehman fail ultimately convinced market participants that the government would step in the next time – because the damage done by Lehman’s collapse was so great. One-off intervention are a crude and risky way of communicating policy and creating incentives.

By James Kwak

8 responses to “Mixed Messages

  1. This is news? I mean, does anybody think they let Lehman fail expecting the result they got?

    I have a more basic question. Should they have rescued Lehman Brothers, or not? Is one-off intervention worse than simply rescuing everybody on the taxpayer’s dime?

  2. If I remember correctly, the government stepped in the very next day with a full guarantee – 100 percent on the dollar payment – of all of AIG’s instruments (whatever they sold – have no idea how to even define their products!)

    Still want to know what Lloyd Blankfein was doing in the meeting with Paulson and AIG peeps when determining the outcome for AIG. Seems very unusual. But perhaps unusual only outside of Wall Street.

    And yes, the lessons learned from this crisis is that too-big-to-fail is the very best way to socialize your losses while privatizing your profits.

    Companies outside of the interconnected web of finance or under $100 billion in assets – too bad – you are on your own….

  3. donthelibertariandemocrat

    ” None of the senior government policy makers anticipated the credit-market collapse that followed Lehman’s bankruptcy filing in the early hours of Sept. 15, according to Wessel’s book. . . .

    On a conference call the previous week, Paulson, Bernanke, Securities and Exchange Commission Chairman Christopher Cox, and senior staff members from those agencies had agreed that companies and investors who did business with Lehman had learned from Bear Stearns and would have acted to protect themselves from a Lehman failure, Wessel wrote.”

    I can’t accept this for the following reasons:
    1) The economic conditions after Bear had worsened. If we needed to save Bear to stave off Debt-Deflation, surely the situation was worse in Sept. Why tempt fate?
    2) Fannie/Freddie had been saved. That makes two precedents of govt intervention in six months.
    3) Unless I am mistaken, there was already a flight from agencies to treasuries beginning by the point of Lehman.
    4) William Gross was betting on inflation staying the same or going up, I believe. Surely they must of known that many big-time investors were investing based on implicit govt guarantees.
    5) There was a special emergency derivatives trading session on the Sunday before Lehman, at which the discussion included the view that if Lehman fell, Merrill would do so immediately as well.
    6) They acted immediately after Monday, telling me that they had at least considered the possibility that there could be dire consequences to Lehman falling.
    7) They’d been working hard with the B of A and Barclays, I believe, to save Lehman.
    8) There was no Plan B for investors. Investors made that clear after the fact, but, being investors, I can’t believe that they hadn’t let the govt know that there was no Plan B.
    9) We didn’t know, but they did, that the govt couldn’t simply seize some of these faltering businesses, including large banks. In other words, their only tool was to merge major financial concerns. They proved that during that week with the B of A and Merrill. Surely they knew that, absent such a merger, Lehman could blow up. After all, wasn’t it an enormous bankruptcy to consider? Who thought that it would go well? Fuld didn’t.

    I’m sorry, but, whatever Paulson thought, I can’t believe that Bernanke thought that this was a good decision. The craziest thing is that the leaders of our country appear to be saying that they didn’t understand that, since the S & L Cris, the financial system was operating under the assumption that the govt would intervene quickly and effectively, I suppose, in response to a major financial crisis. How could they not know that? The reaction to Lehman shows that’s what everybody else thought.

  4. I do not quite understand what point the author is making here. Is the author suggesting that the Fed and Treasury knew nothing about how banks had prepared for that event? That the Fed and Treasury did not even bother to ask the banks if or how they prepared?

  5. There aren’t going to be any “smoking guns” in this book we haven’t already heard about. What is Paulson or anyone else going to tell Wessel they didn’t tell Congress if they thought it had a real relationship to the cause of the crisis?? In the NYT Kakutani says that Wessel says that the Greenspan Fed “kept interest rates too low for too long,” Uuuuhh, ya, no shit Sherlock.

    Alan Blinder could tell us many interesting things about the Fed I think. Unfortunately he’s too classy of a gentleman to tell tales on former colleagues.

  6. Nobody could have anticipated…

  7. “This seems to me an illustration of the fact that you can never be sure what message you are sending.”

    It also is an illustration of the fact that these people don’t have nearly as much clue as we give them credit for. “The best and the brightest,” is an illusion “in act”.

    That is, these people may be extremely bright (though I suspect much of it simply “self-promotion”), but no level of intelligence can chart mob psychology. These aren’t matters of numbers and formulas, these are matters of unpredictable human behavior that verge on “chaos theory”. It’s the old “butterfly effect”.

    In that case intuition and wisdom, which are curiously oft the flip side of intelligence, are probably more applicable if anything. And to that end, I know many people who are way smarter than me, who do way stupider things and unable to find their way out of paper bags at times.

    Ultimately I ascribe the positions and wealth of these “masters of the universe”, which includes the Fed and Treasury, more to hubris, machismo, and ruthlessness than to strict intelligence. For given the complexity of systems in which they are employed, the former is ultimately probably more valuable than the later.

  8. D. Christopher Leonard

    I don’t find it all that odd that Treasury and Fed officials (amongst myriad others) miscalculated (if in fact they did) by permitting Lehman bros to fail. I concur with some of the other commentators that arrogance and hubris are important characteristics of most of the protagonists. Remember that the phrase, “best and brightest” coined by Halberstam, referred to the arrogance and hubris, the lack of historical consciousness (an American trait) of those running the Indochina war both as policy and its military strategy. The late McNamera exemplified this blending of supreme arrogance. ‘rationality’ and purported ‘realism”. The Wall St barons and those transported to government service share these traits. It ought to be remembered that “IQ” (or intelligence) is not the same as the capacity to judge, nor does it imply wisdom. All of the protagonists were smitten with the religious belief in markets, market efficiency, and the fool’s belief that uncertainty could be transmogrified into risk – like straw into gold.