What Really Happened in the 2008 Market Meltdown: A book review and analysis of Ben Bernanke’s book, The Courage to Act: A Memoir of a Crisis and Its Aftermath

Douglas Goldstein, CFP®

As a financial professional who worked with clients throughout the 2008 market meltdown, I was particularly interested in understanding the Chairman of Federal Reserve Bank’s perspective of that period. Ben Bernanke’s book The Courage to Act: A Memoir of a Crisis and Its Aftermath is an exceptionally well-written autobiography that explains the background of the banking crisis, the crisis itself, and its aftermath. The perspective that Bernanke shares, however, does more than put another page in the history textbook of the world economy; it raises a number of fundamental questions about how the mess began, why many innocent bystanders were injured, and whether we have made appropriate structural changes to avoid such catastrophes in the future.

Who’s in Charge?
By learning about the inner workings of the Fed’s decision-making system, I couldn’t help but wonder: Is it smart to have the largest and most influential economy in the free world dependent on one man? The Chairperson of the Fed wields incredible influence over money supply and employment levels that even if it’s run by the sharpest mind, it might be better to have the free market control the level of interest rates and employment. The central bank and other government offices should enforce transparency and encourage better financial education, but ultimately the combined interests and wisdom of the millions of market participants would ultimately dictate the rate at which money is lent as well as the regulations that could promote full employment. Why should the law of supply and demand that governs all other commerce be suspended for money supply?

Although Bernanke credits his Fed comrades and Treasury associates for their involvement, it’s clear that he, much like his predecessor Alan Greenspan, figured out the required policy and then usually succeeded in persuading others to join him.

Is the Fed a Giant Investment Company?
When describing the AIG bailout, which put $182 billion of taxpayer money at risk, Bernanke notes that the Fed demanded an 80% ownership stake in the insurance company’s core business “to ensure that taxpayers shared in the gains if the company recovered.” Though the Fed’s goal to protect the investment interests of those who had entrusted their tax money to the Federal Government may seem noble, I can’t understand what gives the government the right to act as a mutual fund. We, the people, don’t give our money to Washington so it can make investment decisions for us. Congress is a legislative body, not an investment company. If we want risky investments, we can pick our own funds and investment managers. Frankly, if I had to invest $182 billion, I would prefer to diversify it among several money managers rather than to politicians and their appointees. It’s not the government’s job to confiscate funds of private citizens, which are what taxes really are (“Give us your money or go to jail.”), and then select stocks to buy. Ultimately, the theme of the Fed’s conversation in dealing with the crisis was, “Let’s make a huge bet on AIG, even though the private markets are unwilling to make that bet because they think it’s a bad idea and don’t want to risk their own money. Luckily, we have taxpayer money to throw at this idea.”

Compare the amount of time that private investment companies spend researching and making investment decisions to the fast pace at which the Fed invested our money, and under great pressure to do so. Interestingly, Bernanke notes that when Congressman Barney Frank asked where the Fed would get the money, Bernanke said that the Fed had $800 billion, so this was only around 11% of its balance sheet. It’s incredible that anyone would put such a huge percentage of a portfolio into a deal with “little time for careful reflection.” It’s as if your investment advisor told you, “Look, I am really busy now and I don’t have time to research the details, but I’ve decided to take ten percent of your portfolio and invest it all in one company that is on the verge of bankruptcy. And even if you don’t make money on the deal, at least your investment will help the country… so it’s a patriotic investment if nothing else.” Would you still want to invest with him if he did?

Just Because it Worked, It Doesn’t Make it Right
Ultimately, it’s true that the bet paid off. But should we be happy? Even Bernanke himself wasn’t sure the deal would work, and he continues to question the wisdom of the move. But the worst part of the whole situation is that rather than saying, “Phew, we really dodged a bullet that time. Now we have to make fundamental changes in the way the government, the economy, and these banks are so intertwined,” it’s back to business as usual. The lack of transparency and inability to understand the depth of the financial complications that Wall Street players create under the permissive oversight of the regulators should frighten everyone. This risk cannot be solved by more regulation, since writing thousands of more pages of law will not contain the peril. Indeed, the crisis surfaced even though there already were thousands of pages of rules and regulations. Those with large profit incentives will always be more creative and wily than the government workers tasked with reining them in. Instead, the government should announce that it absolutely will not backstop the firms, and it should demand transparency of the financial tools that are created and traded. Then the risk will fall back where it belongs – on the owners of the companies (the shareholders) and anyone who lends them money. Complexity is the enemy of the consumer, and without better transparency, consumers are at a distinct disadvantage.

The Government Had Encouraged Toxic Loans
When describing the TARP program, wherein Congress authorized taxpayer money to be lent to banks and possibly other companies too, at the Fed’s discretion, Bernanke says, “…while we wanted banks to lend [to consumers and businesses], we didn’t want them to make bad loans. Bad loans had gotten us into this mess in the first place.” What he should have stressed was that the banks had made all of those bad loans at the behest of a Congress that made legislation that forced the banks to originate loans that had a poor chance of success, with the alleged goal of helping low-income families fulfill the American Dream of home ownership.

Is it the government’s obligation to fund its citizens to build the white picket fence, or should it only create a favorable opportunity and environment?

The Truth about a Government for the People
Bernanke explains a great deal about the political machinations of Washington. He admits the depressing reality that he had to contort his ideas in order to fit into the political restrictions that stopped him from pursuing more responsible plans. For example, he talks about the importance of regulatory reform. He notes any significant reform would not make it through Congress because, “The congressional oversight committees jealously guarded their turf because the market players regulated by the two agencies could be counted on to provide lucrative campaign contributions.”

Could there be a more clear admission that good policy is trumped by campaign contributions? Regardless of whether Bernanke’s massive overhauls would make sense, the big money interests are the ones who come out winning. So much for free markets and protecting consumers!

More and More and More Government
In order to fend off future bubbles and crashes, Bernanke established yet another taxpayer-funded office, the Office of Financial Stability, Policy, and Research. This multi-disciplinary team unites great minds in an attempt to monitor and oversee financial institutions and create programs whenever it looks like trouble is brewing. Though I respect the brilliance of the team members of the new Office of Financial Stability, I wonder how the public can continue to put so much trust in more banking bureaucracy. What steps were taken to allow the public to clearly see the inner workings of their banks so that folks could make up their own minds about whether to trust the institutions?

Worse, however, was the backstopping by the FDIC that allowed, and continues to allow, banks to take inappropriate risks with their deposits since they know the FDIC will bail them out if necessary. I am all for having some insurance on bank deposits, but not if it means greater risk-taking by the banks themselves. Why not have the banks actually pay a market-level premium to buy FDIC coverage? Maybe allow other governments to sell bank deposit insurance to the banks, too?

During the 2008 crash, Main Streeters questioned the ongoing ability of the FDIC to deliver on its guarantees. When clients were running scared and I told them they could put their money into the FDIC-backed CDs, they said they weren’t sure that this was a safe option. Regardless of the fact that not a single penny of FDIC-insured money was ever lost, the fact of the matter is that the public didn’t have faith in the agency. That makes sense. The government’s coffers are limited and should not be used to bail out the excesses and unreasonable risks that banks take. If no private insurance company would cover those risks, then the government should realize that there is a problem with putting taxpayers’ money at risk.

The Fed’s and the Taxpayer’s Interests Aren’t Aligned
Bernanke helps financial advisors like me recognize an inherent conflict of interest between the Fed and the people. Many regular folks got a wake-up call in 2008 and decided to slow their borrowing and spending, and increase their savings. That was a responsible choice for them. The Fed, on the other hand, wanted them to pull out their credit cards and spend. Using debt to buy things allows people to spend more than they really have, which can supercharge the economy. But responsible advisors encouraged their clients not to spend what they don’t have. Bernanke notes that lack of consumer spending made the downturn “deeper and more protracted,” which caused the Fed a problem. However, the spending slowdown helped those individuals who chose to pay down their debt rather than dig themselves deeper into a hole. This was a particularly prudent move since no one knew what financial surprise was lurking in the shadows.

Retirees Took a Beating
During Bernanke’s battle to save the economy, he and his team leveraged their main tool, control of interest rates. They did this by lowering the Federal Funds rate and also by buying longer term bonds in order to push rates down further, a practice called “quantitative easing.” One of the goals of this strategy was to assist people to keep or buy homes by lowering mortgage rates. But a consequence of low rates is the income destruction of people living on fixed income, mainly the elderly. Ordinary folks who had saved responsibly for decades, and deposited their hard-earned money into savings accounts were not getting the 4% or more that they had expected. Instead, they found themselves praying to get half of that. Bernanke, in fact, points out even more extreme figures, noting that bank CDs paid only half a percent, one-tenth of what savers expected. Pensioners and others living on fixed income had to radically cut their lifestyle or else invest in riskier securities with the hope of higher returns.

In effect, the Fed’s policies injured the financial prospects of retirees in order to rescue people who had voluntarily chosen to take out mortgages that they could not maintain. Nothing like giving a slap in the face to those who loyally paid their taxes for decades! Though I feel sorry for the people who lost their homes, as a financial planner who has had to explain to retirees with battered returns and shattered dreams, I am not too sympathetic to the decisions of the Fed that led to the older generation’s suffering.

Bernanke justifies his decision by saying that low rates were necessary to stimulate the economy, and that this would help the retirees because it would “prevent their twenty- and thirty-something children from moving back home.” In my decades of advising retirees, I haven’t met any who feared their adult children would move back with them. What I did hear, though, was their worry that they wouldn’t have enough to pay the cost of a retirement home and they could not count on their kids to help them. I’ve heard retirees worry about the cost of health care and finding competent help. I’ve heard retirees worry about low interest rates and having to adjust their lifestyle accordingly. But, the fear of adult children moving back in is not at the top of their concerns. Bernanke seems a little out of touch with the reality of the low interest rate environment.

Low Taxes and Buying Decisions in the Hands of the People
Several mentions throughout the book of encouraging lending to small businesses and lowering taxes reminded me of the importance of getting cash into the hands of the consumers and business owners so that they can make their own spending and savings decisions.

Having government puppeteers pull the strings of the economy requires god-like omniscience, which is impossible. Even the former Fed Chairman, Alan Greenspan, known as “The Maestro,” could not control all aspects of the economy to avoid every pitfall. After all, it was under his watch that the real estate market expanded until he passed the reins of the ready-to-pop bubble to his successor, Ben Bernanke. The reality is that no centralized government can take into account all aspects of the economy, nor make truly objective decisions. Rather than letting special interests dictate the government’s monetary and fiscal policies, the marketplace is a much more effective tool for stabilizing the economy than the government. Bernanke’s own comments about getting cash into the hands of the people seem to support this theory. This proposal doesn’t mean supporting a system of financial anarchy. The government certainly has a role to play in overseeing the economy. Specifically the regulators and lawmakers need to ensure a level playing field with a solid judiciary to back it up, extreme transparency, and quality education for people to make them capable to make their own decisions. In order to create a nation that can handle that level of self-responsibility, however, the education system needs reform so that high school graduates understand how the world of money works. Reforming the education system? That’s for a different essay (I recommend reading Seth Godin’s book, Stop Stealing Dreams: What is school for?, which you can download for free .)

Finally, although I am a financial advisor associated with a broker/dealer, the opinions in this piece are mine alone.

Take the time to read Bernanke’s book and judge for yourself if you think the system is better now than it was eight years ago.