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Into the Maw

How Obama-era economics failed us.

By Ryan Cooper

April 6, 2020

From left: Larry Summers, Christina Romer, Timothy Geithner, Barack Obama, Ben Bernanke, and Sheila Bair at the white House in 2009.(Mandel Ngan / Getty)

When Barack Obama took office, he faced the biggest combination of crisis and opportunity that any incoming president had since Franklin Delano Roosevelt. In 1932 the Great Depression had ravaged the country and was only getting worse. Even as he prepared to move into the White House, a fresh wave of banking panic swept through the nation, and it was clear that if Roosevelt was to save American democracy, he needed to put forward a sweeping set of reforms, which is exactly what he did via two major rounds of policy initiatives in 1933 and 1935.

In 2008, Obama faced a similar crisis: The economy was in free fall, and the financial system was gripped by panic. Unemployment had not yet come anywhere close to Depression levels, but like FDR, Obama had the opportunity—even the mandate—to enact far-reaching reforms. Unfortunately, he did not use this opportunity. Faced with a shattering economic breakdown, Obama and his key advisers largely sought to restore the wobbly precrisis status quo, inaugurating a decade of economic stagnation and dislocation that culminated in the election of Donald Trump.

The story of Obama’s missed opportunity to fix the rot in the American economy is frequently noted by the left, but it is also the subject of two recent books written mainly by Obama administration insiders—A Crisis Wasted: Barack Obama’s Defining Decisions, by Reed Hundt, who worked on Obama’s transition team, and Firefighting: The Financial Crisis and Its Lessons, by Ben Bernanke, Tim Geithner, and Henry Paulson (the former Goldman Sachs chairman and CEO who served as George W. Bush’s treasury secretary). The former is a brutal and devastating indictment of Obama’s strategic missteps as he confronted the crisis, while the latter attempts an apologia for the Bush-Obama crisis management strategy that inadvertently confirms Hundt’s key points. What both books show is that Obama and his administration burned up most of their political capital rescuing the banks from a crisis caused by their own mistakes, and they offer us a warning about doing the same thing again as we face yet another potentially disastrous recession.

As the winds of financial crisis gathered strength in late 2007, the key question faced by both policy-makers and those in the banking industry was what should be done about the supposedly too-big-to-fail firms. Several keystone institutions—the gigantic insurer AIG, the megabank Citigroup, the investment banks Bear Stearns and Lehman Brothers, and many of the other big Wall Street players—were heavily invested in mortgage-backed securities that turned out to be stuffed with the financial equivalent of toxic waste, and it was clear that, left to their own fate, they would implode.

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Worse, the wholesale funding market—the unregulated “shadow banking” system that provided the daily credit flows on which the whole global financial system depended—was experiencing a kind of bank run, and financiers could no longer get the loans necessary for their daily operations. Savvier firms like Goldman Sachs and JPMorgan Chase had already shorted (or made bets against) the housing market and so were able to defend themselves against a disaster centered there—but if any of the other big players went down, they were all too aware that they would likely go, too. After all, the counterparty for many of those shorts was the now-ailing AIG. If it failed, it would take down Goldman and probably most of the rest of Wall Street as well, since they were all so intertwined. Thus, without some kind of government rescue, the entire financial system would collapse.

Yet even if everyone agreed on the necessity of a rescue, there was much less agreement on the form it should take. This was the question that the economic advisers for both the president and the president-elect were grappling with in the last months of 2008. One option, which Paulson favored, was simply to buy up toxic mortgages in order to get them off the banks’ balance sheets. A more compelling option was the one favored by Timothy Geithner, then head of the New York Federal Reserve Bank and soon to be Obama’s treasury secretary: He recommended “capital injections,” in which the government bought a whole bunch of bank stock—in other words, a partial nationalization—that would help strengthen the banks’ balance sheets and thus stabilize the financial system. The banks could then lend against the government’s fresh capital and further fortify themselves with more good assets to offset the bad ones.

For those financial companies in dire straits, the government would also have the option to simply buy them outright should their collapse threaten financial stability. The Federal Reserve had broad powers to buy up failing firms by declaring an emergency under Section 13(3) of the Federal Reserve Act. In “unusual and exigent circumstances,” the Fed could use its money-creating authority to simply purchase a failing company. Once owned by the government, a problem firm could be prevented from going bankrupt, and there would be time to examine its books and either fix it up or isolate it from the rest of the market and let it collapse.

Paulson opposed Geithner’s plan on ideological grounds, saying that it was “socialistic” and “sounded un-American.” But as the crisis gathered strength and it became clear that asset purchases would not be enough to save the system, the “socialistic” options won out. In early September, Paulson directed the Treasury Department to take control of the mortgage giants Fannie Mae and Freddie Mac (already partly backed by the state anyway), which were then teetering on the brink of collapse. A worried Bush informed Paulson that “we have to make it clear that what we are doing now is transitory, because otherwise it looks like nationalization.” But this caveat never came to pass; to this day, Fannie and Freddie are still owned by the government (and incidentally have turned a steady profit since 2012).

But Paulson refused to do the same thing for Lehman Brothers, which was nearing collapse a couple of weeks later. As Hundt writes, he maneuvered to prevent a Fed rescue and instructed the company to declare bankruptcy, thereby setting the stage for the largest bankruptcy in American history. This instantly caused market panic and put AIG on the brink of failure as well. As the markets tanked, Federal Reserve chairman Ben Bernanke threw caution to the wind, declared a Section 13(3) emergency, and rushed in with an $85 billion loan in return for almost 80 percent of AIG’s stock—making good old Uncle Sam the owner of the world’s largest insurance company.

Bernanke and Paulson insist that the law allowed the Federal Reserve to rescue AIG but not Lehman: The latter “did not have enough solid collateral the Fed could lend against to keep it afloat in a structure the market would accept, as AIG did with its insurance businesses,” they and Geithner explain in Firefighting. But this distinction was extremely dubious from the start. “Bush did not question this hair-splitting legalism from two non-lawyers,” Hundt dryly notes, while the then-chairman of the House Financial Services Committee, Representative Barney Frank, encouraged Bernanke and Paulson to interpret their powers broadly.

Regardless of whether the government should have purchased Lehman Brothers too, the issue with the bailouts of AIG, Fannie Mae, and Freddie Mac was that they were wildly unpopular—but not because people were worried about the government becoming “socialistic.” What infuriated them was the unfairness: AIG blew itself up making stupid bets, and now the government was leaping to its rescue with $85 billion (later increased to $180 billion). And yet the Bush administration did little about the company’s executives, who had played such a crucial role in wrecking the American economy in the first place. Meanwhile, the people suffering from their atrocious decisions were not similarly bailed out; they continued to see their jobs disappear, their homes foreclosed on, and their pension funds devastated.

Paulson recognized this growing outrage, and so he turned to the Democratic-controlled Congress for additional powers and money—$700 billion in all—thereby pinning “the tail of responsibility on the Democratic donkey,” as Hundt puts it. The bill, to create something called the Troubled Asset Relief Program (TARP), was voted down by Congress the first time, but with Obama’s support as president-elect and more oversight and structural controls built into it, TARP passed the House and Senate the second time around, thus making it “the first and most significant decision” of Obama’s presidency, Hundt writes: one in which he “let Paulson pick his presidential priority” and “chose bank bailouts—euphemistically, stabilizing finance—as his top strategic goal.”

Money now in hand, Paulson set to work. However, he did not even consider the plight of ordinary people, who had suffered terribly as a result of the banking industry’s choices. Instead, he offered the banks one of the sweetest deals in the history of American finance. Gathering together the heads of the nine biggest banks, he, Geithner, and Bernanke informed them that they had to accept partial nationalization. But in exchange, their balance sheets would be strengthened with US government cash, and in addition the Federal Deposit Insurance Corporation (FDIC) would guarantee their business checking accounts and their debt issued through mid-2009. Everyone present agreed to the terms and divvied up the $125 billion in government capital as Geithner had split it. They may not have had much say in the matter, but the terms they were offered were exceedingly generous. As a shareholder, the government would not exercise its right to vote on the management of their companies, its required dividends were low, and it would seek no changes of management or limits on bonus payments, except for CEOs. In effect, the government was giving the banks an enormous pile of money and asking for almost nothing in return.

In Firefighting, Paulson, Bernanke, and Geithner insist that they were simply reacting pragmatically to extraordinarily difficult circumstances. “The only way to contain the economic damage of a financial fire,” they argue, “is to put it out, even though it’s almost impossible to do that without helping some of the people who caused it.” They could not have nationalized the banks outright, they continue, because that would only have led to more panic; even “nationalizing one or two major firms seemed likely to trigger panics that could lead to additional government takeovers,” which they wanted to avoid. As far as the three men are concerned, they did what they needed to do to save the financial engines of the American economy—though the rest of that economy remains distinctly unsaved.

Of course, the pragmatic pose that Paulson, Bernanke, and Geithner strike in their book conceals a political agenda and also hides many of the errors they made along the way. The Bush-Obama bailouts reflected a highly political and ideological choice on their part to preserve the financial status quo at any cost—including the enormous share of the country’s economic output gobbled up by Wall Street—and to do so while directing incomprehensible amounts of money to the banks instead of to the American people. With the Bush and the Obama administrations’ backing, they moved heaven and earth to save the banks, while doing almost nothing to rein in Wall Street or address the crash’s devastating effects on employment or mortgage holders. In stark contrast with their radical generosity toward the banks, any steps that either administration took to fix the broader economy were limited and hesitant. Obama’s bailout of the Detroit automakers, for instance, included requirements for drastic restructuring, while the economic stimulus provided under the Recovery Act was smaller than the administration’s own experts knew was necessary. Obama’s advisers rejected ideas for boosting the stimulus’s effects, such as creating a government infrastructure bank and gaming the Congressional Budget Office analysis window with time-limited tax cuts.

Perhaps the most egregious malpractice was the administration’s supposed effort to assist mortgage holders who had gone underwater on their loans—in reality, a backdoor bank bailout that made the foreclosure crisis worse. The Obama administration not only accepted Paulson’s priority of saving Wall Street but also chose to sacrifice those ordinary Americans whose problems were caused by the banks but who now threatened their future stability. The real estate bubble had drastically inflated home prices across the nation, and people who had bought at the top of the market saw their net worth devastated as values fell but their mortgages remained at the same high balances and interest rates. Those mortgages had been packaged into exotic assets traded and owned by Wall Street banks. Somebody was going to have to eat those losses—and Paulson, Bernanke, Geithner, and the Obama economic team were committed to making sure it wasn’t the banks.

Once in office, Obama only doubled down on Paulson’s agenda, nominating Geithner as his treasury secretary and turning the foreclosure policy over to him. The TARP bill included a sweeping grant of authority and an unspecified appropriation to pursue foreclosure relief—meaning interest rate reductions, payment reschedulings, principal reductions, and “other similar modifications.” Obama previously promised to pursue “cramdown,” a policy that would have allowed homeowners to write down their mortgage to the home’s assessed value during bankruptcy proceedings. But since real homeowner relief would have harmed the banks (by reducing the value of their mortgage assets), Geithner refused to include principal reductions in his foreclosure plan and made the program such a Kafkaesque nightmare that few participated in it. Those who did found themselves at the mercy of mortgage servicers who had direct financial incentives to foreclose, and that is exactly what they did: They proceeded to trick thousands of homeowners into foreclosure. While more and more Americans lost their homes, Geithner quietly and successfully lobbied Congress to stop cramdown altogether. Through it all, Obama did nothing—just as he did nothing when Geithner disobeyed a direct order to draw up plans to wind down Citigroup.

In Hundt’s interviews with administration officials, the logic of this choice is discussed explicitly. “The only problem was that there was $750 billion of negative equity in housing—the amount that mortgages exceeded the value of the houses,” says Obama economic adviser Austan Goolsbee. “For sure the banks couldn’t take $750 billion of losses and for sure the government wasn’t willing to give $750 billion in subsidies to underwater homeowners, to say nothing of the anger it would engender among non-underwater homeowners.” Christina Romer, the head of Obama’s Council of Economic Advisers, puts that figure higher but comes to a similar conclusion. “There was about $1 trillion of negative equity,” she tells Hundt, “and getting rid of it would have helped increase consumer spending and heal the economy. But for the government to just absorb it would have been very expensive.”

Thus, since the banks couldn’t handle these losses and the government was unwilling to do so, the Obama team decided to quietly shove them onto homeowners. This choice would result in about 10 million families being forced out of their homes through foreclosure or some other process—roughly one out of every six homeowners. These foreclosed properties would then become economic time bombs, since abandoned houses damage neighborhoods and the value of adjacent homes. The political side effects were also disastrous. As Hundt writes, “In swing states affected severely by the housing market downturn, the reduction of mortgage credit supply had five times the negative effect on votes for the presidential candidate of the incumbent party than the increase in the unemployment rate.” Eventually, Rust Belt states were the hardest hit. “Chicago had the highest rate of negative equity among large markets,” he writes. “The surrounding states proved fertile territory for Donald Trump’s campaign.”

With rare exceptions, the Obama administration didn’t even bother to prosecute the major bankers who had gone on a veritable financial crime spree during the go-go years that led to the crisis—something that would have won it easy plaudits. And when it turned out the banks (which owned most of the mortgage servicers) were foreclosing with documents forged on an industrial scale, all the administration did was to step in and arrange a slap-on-the-wrist settlement with minor restitution. Indeed, in some states, banks were allowed to claim credit for relieving mortgage debt that it was legally impermissible to go after in the first place. In all of these cases, administration officials feared the financial instability that would result if they stopped Wall Street from committing crimes.

Some might argue that Obama and his economic team did the best they could under the circumstances. But if he had looked back at Roosevelt’s moves as president-elect and then in his first two years in office, he would have clearly seen an alternative path. After Herbert Hoover lost the presidential election in 1932, he attempted to persuade Roosevelt to embrace his disastrous status quo policies, which had only deepened the Depression. As historian Eric Rauchway writes in his book Winter War, Hoover took the galloping banking panic that gathered strength in the winter of 1932–33 as an opportunity to inveigle Roosevelt into continuing his conservative program of austerity, the gold standard, and fewer regulations of the market.

Roosevelt politely declined, stating that he had a democratic responsibility to carry out what he had promised. He noted further that he had no formal power until assuming office, and it would be improper to accept responsibility without authority. He suggested that Hoover should do as he saw fit until March, after which Roosevelt would chart his own course.

Hoover spun this incident into a big lie about the history of the transition, insisting that the incoming president had deliberately allowed the Depression to get worse so he could get his New Deal passed. Hoover then pushed this narrative for decades in dozens of articles and books until it became dogma in right-wing circles.

What is surprising is that Obama and his economic team accepted Hoover’s version of events. “We didn’t actually, I think, do what Franklin Delano Roosevelt did, which was basically wait for six months until the thing had gotten so bad that it became an easier sell politically, because we thought that was irresponsible,” Obama told a group of liberal writers in 2010. Letting things go to pot so as to blame the other side “was in many ways FDR’s approach in 1932,” Goolsbee tells Hundt.

The Obama administration’s embrace of Hoover’s fake history has demonstrated why Roosevelt was right to stick to his guns. In the 12 years since Obama and his team pursued their bank-friendly agenda, it has become abundantly clear that what was needed was precisely what they did not do and were unwilling to do: to drastically cut down the size of the too-big-to-fail banks, impose new regulations to make Wall Street both safer and less of a drain on the economy, and help out the many underwater homeowners they left to drown instead, as FDR did with the Home Owners Loan Corporation.

Obama’s advisers often explained many of his choices by invoking legal constraints, but there was no technical or legal reason that a more just and thoroughgoing overhaul of the financial sector, coupled with support for homeowners and the rest of the American people, couldn’t be done. The administration could have insisted that any financial company receiving government support must fire its top management, ban all bonus payments, end dividends and share buybacks, and break itself up into smaller pieces—and that any company that refused would be left to fend for itself. The Fed could also have nationalized any company whose failure posed the risk of taking down too many others with it, as it did with AIG. Directly owned companies could then have been restructured, their bad debts written off, and sold once they were sound again. This would have purged the bad debt from the system, allowed the Obama administration to actually help underwater homeowners, and reduced the power of the banking lobby, which hamstrung the administration in Congress at every turn. Hell, the government could have even hung on to some of the banks to give to the US Postal Service to set up a public option for banking.

Politics would have been an obstacle to this plan but not an insurmountable one. Obama could have insisted on stringent conditions for the TARP bill, given the fact that Democrats were providing most of the votes for its passage. “We could have forced more mortgage relief. We could have imposed tighter conditions on dividends or executive compensation,” Goolsbee admits to Hundt. Failing that, Obama could have simply bided his time until he took office. Bernanke at the Fed was a bigger obstacle, given that his term was to last until 2010, but Fed chairs are still susceptible to political pressure. For example, Obama could have threatened to publicly attack Bernanke’s policy if he didn’t go along—especially his backdoor lending programs, which he was very keen on keeping quiet. Obama could have driven the big banks into bankruptcy and forced the Fed to take action. Most obviously, he could have appointed reformers to the Federal Reserve’s governing board. Instead, he left two Fed seats open for the critical first year of his administration and renominated Bernanke when his term was up.

In all likelihood, the government would have ended up owning a good portion of the American financial system for a time, though it’s worth noting that then-FDIC head Sheila Bair dismisses the fears of a nationalization-induced panic. “I didn’t believe in a domino effect,” she tells Hundt. “If you have a controlled failure, the markets will adjust.” Whatever the case, while the Republican right would have howled bloody murder—just as it did over every Obama policy—the rest of the US electorate almost certainly would have been satisfied, so long as the bankers were made to pay and regular folks got a cut of the bailout money. And the financial system would have been much more stable and far safer in the end. What happened instead was a hideously unfair and economically disastrous mess. Obama spent most of his considerable political capital on defending a cabal of corrupt, rotten financiers who very nearly ruined the world economy. His party alienated millions of voters, who felt abandoned and betrayed by the Democrats, which ended up costing them thousands of seats in state and local government. Thus, when the 2016 presidential election rolled around, Obama’s successor could not even beat a tawdry game-show demagogue.

In the end, Obama made off well, personally at least; he is now collecting $400,000 fees giving speeches to the big banks while he works on producing Netflix shows. Meanwhile, Geithner is president of the private equity firm Warburg Pincus (which, incidentally, rakes in cash by tricking poor people into accepting high-interest loans), and Bernanke works for the bond firm PIMCO. Only Paulson, ironically, is working outside finance.

The rest of us, however, are still living with the consequences. Right now, an even worse financial crisis and recession appear to be in the offing because of the coronavirus outbreak, which Trump has catastrophically mismanaged. Let’s hope the next person to enter the Oval Office while the financial sector is obliterating itself isn’t someone willing to feed the American people once again into Wall Street’s maw.

Ryan CooperRyan Cooper is a national correspondent for The Week and the author of the forthcoming book How Are You Going to Pay for That?


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