The following is an excellent excerpt from the book “BUSH” by Jean Edward Smith from Chapter Twenty-Four: “Financial Armageddon” on page 615 and I quote:
“Bush did not answer the question. He said, “Thank you,” and walked away. His initial response to the subprime mortgage meltdown was similar to his initial response to Hurricane Katrina. He watched it happen.
That same day, Ameriquest, which had been the nation’s largest subprime lender in 2005, went out of business. With $45 billion in mortgage loans outstanding, most of which were subprime, Ameriquest was no longer viable. Its assets were sold to Citigroup for an undisclosed price. Ironically Ameriquest was for many years the name of the stadium in which the Texas Rangers, Bush’s old team, played baseball.
In his memoirs, Bush notes that “the global pool of cash, easy monetary policy, booming housing market, insatiable appetite for mortgage-backed assets, complexity of Wall Street financial engineering, and leverage of financial institutions created a house of cards. This precarious structure was fated to collapse as soon as the underlying card–the nonstop growth in housing prices–was pulled out. But few saw it at the time–including me.”
By the end of 2007, the housing market was in a nosedive. The median price had fallen to $217,800, and new construction was down 24.8 percent from its peak–the second largest decline on record. Perhaps more revealing, over 2.2 million foreclosures–default notices, auction sale notices, and bank repossessions–had been filed on 1,285,873 residential properties, an increase of 75 percent over 2006. Bush responded on December 6, by announcing a voluntary plan–the HOPE NOW Alliance–to freeze interest rates on subprime mortgages for five years. The plan would be funded by private industry. “HOPE NOW is an example of Government bringing together members of the private sector to voluntarily address a national challenge, without taxpayer subsidies or without Government mandates,” said Bush. The effect was minimal. “This is a Band-Aid when the patient needs major surgery,” noted a leading financial publication.
Two weeks later, Bush restated his views on the housing downturn in Fredericksburg, Virginia. “People are concerned around this country about housing,” said the president. “Here’s my attitude on housing. One, the Government should never bail out lenders; two, some people bought a house that they shouldn’t have been in the market to buy; three, there are speculators who thought they could get one of these reset mortgages, and flip it, make some money.” Bush went on to say that the mortgage market had changed. Mortgages had been bundled. “So the savings and loan doesn’t own the mortgage anymore, or the bank doesn’t own the mortgage anymore. It’s owned by some international group, perhaps, or it’s bundled into an asset. And so there is hardly anyone to negotiate with. And so lenders aren’t sure where to turn. They have creditworthiness; they may get pinched as their interest rates reset.”
As if to confirm Bush’s assessment, in early March of 2008 the venerable firm of Bear Stearns, one of Wall Street’s big five investment banks, [FOOTNOTE: “Bear Stearns was the smallest of the five, which included Goldman Sachs, Morgan Stanley, Merrill Lynch, and Lehman Brothers. Under the Glass-Steagall Act that had been enacted during the first one hundred days of FDR’s New Deal, the investment banks were divorced from commercial banking. This separation was repealed by passage of the Gramm-Leach-Bliley Act of 1999, creating a giant supermarket that was largely unregulated, somewhat analogous to that which existed in 1929.”] faced a severe liquidity crisis. Bear Stearns was a major underwriter of subprime securities, and was heavily leveraged. With the market in precipitous decline, many of the firm’s clients began to withdraw their money, and many of its creditors demanded more collateral for their loans. To accommodate the requests, Bear Stearns used its cash reserves, and by the afternoon of Thursday, May 15, had just $2 billion in cash left, not nearly enough to meet its obligations when the market opened Friday morning.
“This is the real thing,” Paulson told Bush. “We’re in danger of having a firm go down.”
Bush was initially reluctant to assist Bear Stearns. “In a free market economy, firms that fail should go out of business.” Bush believed that if the government stepped in, it would set a precedent. “Other firms would assume they would be bailed out, which would embolden them to take more risks.”
Paulson and Bernanke at the Federal Reserve initially agreed with Bush that Bear Stearns should be allowed to fail, but a quick inspection of Bear Stearns’s books by federal officials in New York convinced them otherwise. Bear Stearns was far too interconnected. As Paulson put it, “Bear had hundreds, maybe thousands, of counterparties–firms that lent it money or with which it traded stocks, bonds, mortgages, and other securities. These firms. . . all had myriad counterparties of their own. If Bear fell, all these counterparties would be scrambling to collect their loans and collateral.” It would be a domino effect. Paulson believed that if Bear Stearns went down, it would take many other firms with it.
Bush reluctantly agreed. “While I was concerned about creating a moral hazard, I worried more about a financial collapse.” Working through the night of May 15, Paulson and Bernanke made an arrangement with Jamie Dimon, the CEO of JPMorgan Chase, which was Bear Stearns’s clearing bank. Utilizing a never before used portion of the Federal Reserve Act of 1932 that empowered the Fed to extend credit to financial institutions other than banks “in unusual and exigent circumstances,” the Federal Reserve loaned money to JPMorgan, who would pass it along to Bear Stearns. [FOOTNOTE: “Section 13 (3) of the Federal Reserve Act of 1932 states, “In unusual and exigent circumstances, the Board of Governors of the Federal Reserve System by the affirmative vote of not less than five members, may authorize any Federal Reserve bank. . . to discount for any individual, partnership or corporation, notes, drafts, and bills of exchange when such notes, drafts, and bills of exchange are endorsed or otherwise secured to the satisfaction of the Federal reserve bank.” Act of July 21; 1932, 47 Stat. 715.] That would provide Bear with sufficient liquidity to get through trading on Friday.
A more serious problem was to find a permanent solution for Bear’s lack of liquidity before the Asian financial markets opened Sunday evening. Working through the weekend, Paulson and Bernanke hammered out an agreement with Jamie Dimon whereby JPMorgan would buy Bear Stearns for a knockdown price of $2 a share, a total of $236 million. (At the height of the housing market in January 2007, Bear Stearns stock sold for $173 a share–a capitalization of almost $20 billion.) In addition, the Federal Reserve would provide $30 billion and assume ownership of Bear Stearn’s mortgage portfolio. [FOOTNOTE: “The Federal Reserve established a free-standing entity, Maiden Lane, LLC, and Maiden Lane took control of Bear Stearns’s mortgage assets. (Maiden Lane is the name of a small street alongside the New York Federal Reserve.) The Fed actually provided $28.8 billion and JPMorgan put up $1.5 billion to buy the mortgages. These were considered “loans” that would be repaid to the Fed and JPMorgan as Maiden Lane sold off the mortgages. Final Report of the National Commission on the Causes of the financial and Economic Crisis in the United States, the Financial Crisis: Inquiry Report (New York: PublicAffairs, 2011), 290.”] Dimon later sweetened the offer to $10 a share, and the Bear Stearns board accepted.
Bush was relieved that a financial crisis had been avoided. “Can we say we are going to get our money back?” he asked Paulson.
“We might, but that will depend on the market,” Paulson replied.
Bush said a lot of people were going to object to what they had just done. “You’ll have to explain it,” he told Paulson. “You’ve got credibility.”
Throughout the spring of 2008 the housing market continued to decline. Prices were down 21 percent from their highs two years before and many homeowners were “underwater”–the amount of their mortgage exceeded the value of their property. Mortgage foreclosures were also rising rapidly. The Sun Belt was particularly hard hit. In Stockton, California, 9.5 percent of all houses were in foreclosure; in Las Vegas, 8.9 percent, and in San Bernardino, California, 8.1 percent. On July 11, 2008, IndyMac Bank, one of the largest financial institutions in the Los Angeles area and the seventh largest mortgage originator in the United States, went bankrupt. With $32 billion in assets, it was the fourth largest bank failure in American history.
A much more serious problem pertained to the two real estate giants that operated under government sponsorship: the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). As the nation’s largest mortgage lenders funding roughly two thirds of the home loans in America, they had suffered enormous losses and many believed they were on the verge of going under. Officially, Fannie and Freddie were private companies. They were chartered by the government to encourage home ownership and to provide a profit for their shareholders. Their debt, estimated at $5.2 trillion, traded on global financial markets as though the United States government had guaranteed it (which it had not). If Fannie and Freddie went under, it would not only create enormous havoc in financial markets, but would seriously undermine the creditworthiness of the American government.
To meet the emergency, Bush asked Congress for authority to invest federal funds in Fannie and Freddie to provide them with sufficient liquidity to meet the crisis. That was what Paulson recommended, and Bush agreed. “We’ve got to get this done,” said the president. The Democratic Congress was supportive, and even raised the debt ceiling to accommodate the president’s request. On July 23, 2008, the Housing and Economic Recovery Act (HERA) passed the House 272-152, and three days later cleared the Senate 72-13. Under the legislation, the federal government was given a free hand to support Fannie and Freddie, the secretary of the treasury was given oversight responsibility, and the two firms would remain private corporations.
The enactment of HERA did not stop the bleeding. Both Fannie and Freddie continued to suffer heavy losses, and by September it was evident that they could not survive on their own. Paulson recommended to Bush that the two firms be placed under government “conservatorship.” The government would assume an 80 percent ownership stake in each firm, a new management team would be installed, and they would be provided access to $200 billion in ready cash. Once again, Bush agreed. “It won’t look good, but we are going to do what we need to do to save the economy.”
On Sunday, September 7, 2008, Paulson announced the takeover. It was the largest government intervention in private financial markets since the Great Depression. The public response was overwhelmingly favorable. When the markets opened on Monday, the Dow closed up 300 points. Billionaire Warren Buffett was quoted as saying that the takeover was “exactly the right decision for the country.” Even the Wall Street Journal, ever critical of government intervention, endorsed the plan. For a brief moment, it appeared as though the financial panic had been contained. [FOOTNOTE: “Fannie and Freddie returned to profitability in May 2012, with $4.5 billion that month. They have remained profitable, and by the end of 2014 had provided the Treasury with $225.4 billion. Gretchen Morgenson, “After Crisis: A Cash Flood and Silence,” New York Times, February 15, 2015.”]
That was not the case. As soon as the pressure on Fannie and Freddie was relieved, investors turned their attention to Lehman Brothers, one of Wall Street’s most hallowed institutions. Lehman had $600 billion in assets, but like Bear Stearns, was heavily leveraged and highly exposed to the mortgage market. In 2007, Lehman Brothers had made the greatest profit in its 158-year history, but with the mortgage meltdown it now faced a severe liquidity crisis. As stock markets around the world resumed their tumble, Lehman’s shares were hit by waves of selling. On Tuesday, September 9, 2008, Lehman’s stock dropped by 45 points. On Wednesday it dropped another 7 percent. By the end of the week, Lehman’s shares were selling for $3.65, a small fraction of their earlier value. The decline in its stock price placed a severe strain on Lehman’s liquidity. Without an immediate infusion of cash, the firm could not meet its obligations when the markets reopened on Monday.
The solution was to find a buyer for Lehman similar to JP Morgan Chase’s emergency takeover of Bear Stearns in March. Paulson went to New York on Friday to oversee the negotiations. Two banks were interested–Bank of America and Barclays–but both made it clear that any deal would be contingent upon the government’s agreement to absorb Lehman’s toxic mortgage assets. The Federal Reserve had provided $30 billion in the case of Bear Stearns, and just last weekend had put up $200 billion to rescue Fannie and Freddie. It seemed a reasonable expectation.
For whatever reason, Paulson declined to do so. He recognized the need to remove Lehman’s mortgage assets, but insisted that the financial industry, not the government, should provide the funds to do so. Negotiations went nowhere. Without government support the banks were uninterested, and Lehman filed for bankruptcy early Monday morning. [FOOTNOTE: “After Lehman Brothers declared bankruptcy, Barclays bought Lehman’s North American investment banking operations and its presence on Wall Street for $250 million. It also paid $1.5 billion for Lehman’s headquarters building and other real estate. Several months later, when the market had stabilized, Barclays showed a profit of $3.5 billion on the transaction.” James B. Stewart, “Eight Days: The Battle to Save the American Financial System” The New Yorker, September 21, 2009.”]
Bush followed Paulson’s lead throughout the Lehman crisis, and so the question arises why Paulson was unwilling to provide government support for Lehman as it had for Bear Stearns, Fannie, and Freddie. Sometime later Paulson and Bernanke made the argument that they lacked legal authority to bail out Lehman, but that was not true. Section 13(3) of the Federal Reserve Act, which was used to rescue Bear Stearns, is a virtual carte blanche for the Fed “in unusual and exigent circumstances.” The answer is perhaps more personal. Paulson told Bernanke and New York Fed president Timothy Geithner that he did not want to be known as Mr. Bailout. I’m being called ‘Mr. Bailout.’ I can’t do it again.”
“This was one of the few times,” said Geithner,
“when there was any distance between Hank and me. There was even some distance between Ben and me. I sensed their advisers pulling them toward political expedience. . . . The natural human instinct in a financial crisis, and especially the political instinct, is to avoid unpopular intervention, to let the market work its will, to show the world you’re punishing the perpetrators. But letting the fire burn out of control in much more economically damaging, and ultimately more politically damaging, than taking the decisive actions necessary to prevent it from spreading. . . into the core of the system. By pledging not to take any more risk, I thought we risked fanning the flames.”
Another reason, rarely mentioned, may have been the age-old animosity between Goldman Sachs, Paulson’s old firm, and Lehman Brothers. This was not simply a commercial rivalry, but often personal and very bitter. Whatever the reason, the failure to rescue Lehman Brothers launched the financial meltdown that followed. Christine Lagarde, then France’s finance minister (and now managing director of the International Monetary Fund), said Paulson’s decision was horrendous. “For the equilibrium of the world’s financial system, this was a genuine error.” Peter Wallison, a member of the congressional established Financial Crisis Inquiry Commission, called Paulson’s refusal “perhaps the greatest financial blunder ever.”
Bush accepted Paulson’s decision. When his cousin George Walker IV, a direct descendant of their common great-grandfather the renowned financier George Herbert Walker, and a member of Lehman’s executive committee, called the White House that evening and attempted to speak with Bush, he declined to take the call. “I’m sorry, Mr. Walker. The president is not able to take your call at this time,” said the operator. But he took Paulson’s call. “Will we be able to explain why Lehman is different from Bear Stearns?”
“Without JP Morgan as a buyer for Bear, it would have failed,” Paulson replied. ‘We just couldn’t find a buyer for Lehman.” Paulson was partially right. No banks wanted to buy. But if the Fed had bought Lehman’s toxic assets, as they did for Bear, there is little doubt that a buyer could have been found.
Paulson’s error in not bailing out Lehman Brothers was immediately evident when world stock markets opened Monday. A tsunami of selling hit stocks, driving prices to new lows. In New York, the Dow was down almost 5 percent. Financial stocks were hit even harder. Hedge funds withdrew money from investment banks and credit markets dried up. The most extreme flight of capital was from the American Insurance Group (AIG), an insurance giant that had become heavily involved in insuring mortgage-backed securities. With the housing market in free fall, and with liquidity drying up, AIG faced bankruptcy. Its stock plummeted 60 percent on Monday, and without major assistance it clearly could not survive. If AIG went down, the entire financial system would be imperiled, given the extent to which the insurance conglomerate was intertwined with the world’s major financial institutions.
How did we get to this point?” Bush asked Paulson at a White House meeting Monday afternoon. Paulson did his best to explain the interconnectedness of the financial system to the president. “If we don’t shore up AIG, we will likely lose several more financial institutions. Morgan Stanley, for one.”
Bush found it harder to believe that an insurance company could be so interconnected but Paulson persisted. Eventually, the president surrendered. “Somebody you guys are going to have to tell me how we ended up with a system like this and what we need to do to fix it.” With Bush’s approval and Treasury support, the Federal Reserve provided AIG with $85 billion that day in return for 80 percent control of the company. The money was technically a loan that AIG would repay when the market recovered.
“There was nothing appealing about the deal,” said Bush. “It was basically a nationalization of America’s largest insurance company. Less than forty-eight hours after Lehman filed for bankruptcy, saving AIG would look like a glaring contradiction. But that was a hell of a lot better than a financial collapse.”
Why did Bush agree to bail out AIG but not Lehman Brothers? Because that is what Paulson and Bernanke recommended. Throughout the financial crisis Bush relied on the judgment of his secretary of the treasury and the chairman of the Federal Reserve, and did not insert his personal opinion. That practice differed fundamentally from his approach to diplomatic and military issues. As commander in chief, Bush relished both the responsibility and the authority that went with the position. He did not hesitate to overrule diplomats and generals, and did not shy from initiating policy himself. The decision to bring democracy to Iraq in 2003, and the surge in 2007, are good examples of the president’s determination to take charge. But in the economic meltdown of 2008, Bush recognized that the issues were exceedingly complex, and their ramifications even more so. They were beyond his expertise. As president, he continued to make the final decisions. But he trusted the judgment of Paulson and Bernanke, and relied on their advice even when it ran counter to many of his cherished beliefs. Bush was aware of that and had no regrets. “Putting a world class investment banker and an expert on the Great Depression in the nation’s top two economic positions were among the most important decisions of my presidency,” Bush wrote in his memoirs.
Bush was tired. This was the eighth year of his presidency, most of his original staff had departed, his approval ratings had dropped to the high 20s, he was consumed with the fighting in Iraq and Afghanistan, and both presidential candidates–John McCain and Barack Obama–were pointedly ignoring him. “I felt like the captain of a sinking ship,” said Bush.”
(THE FOLLOWING IS FROM THE INSIDE FRONT JACKET COVER AND I QUOTE:
“Bush calls himself “the decider,” and Smith says that it was an apt description. Others have insisted that Vice President Dick Cheney made key foreign policy decisions in the Bush White House, but Smith shows that it was the president who was in charge, often acting without or even against the counsel of his advisers. No other president in modern times acted with such self-assured autonomy.
Smith credits Bush with leading the global fight against AIDS, improving relations with China, reducing nuclear arsenals with the Russians, and insisting on higher educational standards with “No Child Left Behind.” But he led the country into the disastrous war in Iraq in response to the 9/11 terror attacks even though Iraq has nothing to do with the attacks. The war in Iraq dominated his presidency, and by toppling Saddam he paved the way for the rise of ISIS. He had to violate his own political philosophy to save the economy from collapse in 2008, but he still left his successor with the worst recession in seventy years. Not surprisingly, he exited the White House with the lowest approval ratings of any president in decades.”
LaVern Isely, Progressive, Overtaxed, Independent Middle Class Taxpayer and Public Citizen Member and USAF Veteran