Page 1 of 3 The Treasury's moral black hole
By Julian Delasantellis
In The Spy Who Came in From the Cold, Martin Ritt's 1965 film adaptation
of John Le Carre's 1963 cold war espionage novel, career British spy Alec
Leamus (Richard Burton, in one of his finest roles) finally lets the blinkers
fall from his eyes to see the true moral ambiguity of his lifelong profession.
In response to his lover, who posits that spies should have a better sense of
right and wrong, he describes his world, his profession and his colleagues,
exactly as he now sees it.
"What the hell do you think spies are? Moral philosophers measuring everything
they do against the word of God or Karl Marx? They're not! They're just a bunch
of seedy, squalid bastards like me: little men, drunkards, queers, hen-pecked
husbands, civil servants playing cowboys and Indians to brighten
their rotten little lives. Do you think they sit like monks in a cell,
balancing right against wrong?"
The first of the economic operatives of George W Bush's economic team, Philip
Swagel, has just come in from the cold, and, Leamus-like, he doesn't have a lot
of kind words for his former comrades in arms.
Norman Mailer wrote about the protesters who marched on the Pentagon during the
Vietnam War as being "the armies of the night", but the 25,000 Americans
marching last week with their little boxes of store-brand tea bags to protest
Barack Obama's economic policies deserve a new moniker all for themselves. In
calling for more tax cuts and less deficit spending from an administration that
just expanded the deficit in order to allow for US$270 billion of tax cuts,
maybe these present-day protesters are the armies of the not too bright.
But another thing, along with the centrality of the issue of faith, namely,
faith in possession of guns, as the solution to all of society's problems, that
seems to have upset so many people is what has become known as "bailout
nation", a one-size-fits-all derogatory appellation for the numerous recent
government rescue initiatives to save parts of the financial services and
automotive industries threatened in the ongoing economic downturn.
This is somewhat ironic, for, with the exception of the $800 billion economic
stimulus package containing the tax cuts that was passed in February, most of
the bailouts originated from out of the last, frantic days of Bush's Republican
administration. As the American masses stream out onto the street to protest
against policies from the rescue of Bear Stearns to the Troubled Assets Relief
Program (TARP), advocated and implemented by the Republican Bush, the current
opposition to President Barack Obama realizes that, while you can't fool all
the people all the time, maybe, with all of US talk radio along with Fox News
on your side, you can keep the public fooled up until the midterm Congressional
elections of 2010, when the Republicans hope to take back control of the US
Congress.
Present at the creation of the bailout nation was one Phillip Swagel, assistant
secretary of the Treasury for economic policy from December 2006 to January
2009. With a bachelor's degree magna cum laude from Princeton and a masters'
and PhD from Harvard in economics, Swagel sounds more qualified to be in the
Obama administration than its predecessor. Perhaps the publication by the
Brookings Institution of his 55-page account, "The Financial Crisis: An Inside
View" [1], of how decision-making worked in Henry Paulson's Treasury Department
during the early parts of the current financial crisis, is an attempt to seek
atonement with the truth, a penance rarely employed during these past eight
years.
Paulson was Bush's third Treasury secretary, taking over in the summer of 2006
after leaving the post of chief executive of Goldman Sachs. Bush's first
Treasury secretary, Paul O'Neil, was pressured out of the job at the end of
2002 when he raised too much concern about the president's profligate spending.
Bush's second Treasury secretary, John W Snow, was shown the door when Bush's
political staff came to the conclusion that the media and American public were
spending too much time fixated on the administration's failures in Iraq and not
enough on the supposedly strong US economy.
Swagel's description of Paulson's early days at the Treasury is instructive, in
that, one can see what officials there, in choosing what contingencies to
prepare for, felt they needed to work on and what was essentially working just
fine.
"Secretary Paulson on his arrival in summer 2006 told Treasury staff that it
was time to prepare for a financial system challenge. As he put it, credit
market conditions had been so easy for so long that many market participants
were not prepared for a financial shock with systemic implications. His frame
of reference was the market dislocations that had taken place in 1998 with the
Russia and LTCM [Long-Term Capital Management] crises.
"From summer 2006, Treasury staff had worked to identify potential financial
market challenges and possible policy approaches, both near term and over the
horizon. The longer-range policy discussions eventually turned into the March
2008 Treasury Blueprint for Financial Markets Regulatory Reform that provided a
high-level approach to financial markets reform.
"Consideration of near-term situations included sudden crises such as terror
attacks, natural disasters, or massive power blackouts; market-driven events
such as the failure of a major financial institution, a large sovereign
government default, or huge losses at hedge funds; or slower-moving
macroeconomic developments such as energy price shocks, a prolonged economic
downturn that sparked wholesale corporate bankruptcies, or a large and
disorderly movement in the exchange value of the dollar that led to financial
market difficulties. None of these were seen as imminent in mid-to-late 2006,
and particularly not with the magnitude that would eventually occur in terms of
the impact on output and employment."
It's illustrative that the first dangers thought to be facing the markets,
"terror attacks, natural disasters, or massive power blackouts", must have
originated from the contagious anti-terror paranoia that oozed out of vice
president Dick Cheney's office across the entire executive branch following
September 11, 2001. As Swagel notes, threats generated by the markets
themselves were not "seen as imminent in mid-to-late 2006, and particularly not
with the magnitude that would eventually occur in terms of the impact on output
and employment."
But even though 2006 was just about the apogee of the flat out, red-zone
revving of the US financial system that had been going on since the April 28,
2004, ruling by the Securities and Exchange Commission that allowed much higher
leverage for investment banks (a ruling handed out when Paulson was chief
executive of investment bank Goldman Sachs), the free-market idolatry of the
Bush era failed to see the possibility that much very wrong could possibly come
from it.
Even with the leverage firehose still drenching the system with liquidity, by
2006 real estate prices were beginning to top out and roll over as Swagel
arrived to advise the newly installed Paulson. Yet the US Treasury was not yet
interested in any potential threats from the markets. They were still up there
on the widow's walk with binoculars, scanning the skies for hijacked airliners.
Later in 2006, a Treasury initiative that might have cushioned the blow of what
was to come was blocked by White House ideologues. In response to accounting
standards scandals that had occurred earlier in the decade at the Fannie Mae
and Freddie Mac government-sponsored enterprises (GSEs), the Treasury proposed
new oversight regulations for the GSEs. These were opposed by the White House
and died at the end of the Republican Congress. No matter what it said, the
White House did not want the GSEs to thrive with modern regulation; it wanted
them, symbols of the hated activist, New Deal philosophy of Franklin Delano
Roosevelt, to wither on the vine and die.
With George W Bush pre-occupied with the rise, and by 2006 it was mostly the
fall, of his reputation in Iraq, until the financial crisis broke hard the next
year, the bureaucracy both in the White House and at Treasury was mostly left
alone to fight their own battles, Swagel reports.
"Other aspects of the decision-making were self-imposed hurdles rather than
external constraints. Notable among these hurdles was chronic disorganization
within the Treasury itself, and a broadly haphazard policy process within the
administration (and sometimes strained relations between Treasury and White
House staff) that made it difficult to harness the full energies of the
administration in a common direction. To many observers, Treasury also lacked
an appreciation that the rationales behind actions and decisions were not being
explained in sufficient detail; without understanding the motivation for each
decision, outside observers found it difficult to figure out what further steps
would be taken as events unfolded. Part of this was simply the difficulty of
providing adequate explanation in real time as decisions were taken rapidly,
while another part was the simple lack of trust in Treasury and the
administration - many journalists and observers at times did not believe simple
(and truthful) explanations for actions."
Like the old story of the boy who cried wolf one too many times, it seems that
even the bureaucrats at Treasury were forced to pay a price for the sins of the
foreign policy team of defense secretary Donald Rumsfeld (2001-2006) and vice
president Cheney. They seem to have lied so much that, eventually, no one in
the Bush administration was believed when they said much of anything about
anything.
Thus, the less-than-functional policy team was in place as the crisis gained
steam in early 2007. Swagel himself knew that something was wrong when he gave
a talk "to a group of financial industry participants in commercial real estate
- the firms that build, fund, and invest in office buildings, factories,
shopping centers, apartments, and so on. Participants explained to me that
there was such incredible liquidity that any deal could be done and any
building financed."
But still, according to Swagel, the economic picture was just so bright he had
to wear shades.
"While this talk was alarming, economic indicators seemed to back it up, [gross
domestic product] growth had slowed in the second half of 2006 but looked to be
strong again in 2007 (as it was in the middle two quarters) and the labor
market upswing that had taken hold in mid-2003 remained in force. Indeed,
Secretary Paulson's public rhetoric was that growth was unsustainably strong
and that it would be no surprise to have a period of slower growth as the US
economy settled into a more normal pattern."
Were they all like amateur meteorologists who, seeing that today is sunny,
extrapolate endless sunny days ahead? Or was it that, especially after the
Republican defeats in the 2006 mid-term Congressional elections, the message
being broadcast very clearly from 1600 Pennsylvania Avenue was that never was
to be heard a discouraging word?
At first, the rise in foreclosures were thought to be nothing all that
dangerous to the economy, and that it would soon peak out. Then Sheila Barr and
her Federal Deposit Insurance Commission (FDIC) came around, told the boys that
something funny had been going on in the mortgage market these past few years.
"What we missed was that the regressions did not use information on the quality
of the underwriting of subprime mortgages in 2005, 2006, and 2007. This was
something pointed out by staff from the [FDIC], who had already (correctly)
pointed
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