Excerpted from The Courage to Act: A Memoir of A Crisis and Its Aftermath by Ben S. Bernanke. Copyright © 2015 by Ben S. Bernanke. With permission of the publisher, W. W. Norton & Company, Inc. All rights reserved.
I Can Still Stop This . . .
It was 8:00 p.m. Tuesday, September 16, 2008. I was exhausted, mentally and emotionally drained, but I could not sit. Through the windows of my office in the Federal Reserve’s Eccles Building, I could see the lights of the traffic on Constitution Avenue and the shadowy outlines of American elms lining the National Mall. Dozens of staff members remained at work, but the corridor immediately outside my door was hushed and empty. Michelle Smith, the head of our communications office and my chief of staff, sat quietly, the only other person in the room. She was waiting for me to say something.
Four hours earlier, Treasury secretary Hank Paulson and I had sat side by side in tan leather armchairs in the windowless Roosevelt Room of the White House, steps from the Oval Office. A portrait of Teddy Roosevelt as Rough Rider on a rearing horse hung above a fireplace. Facing Hank and me across the room’s polished wood table sat the current occupant of the White House, a somber George W. Bush, with Vice President Dick Cheney at his side. The president’s advisers, Hank’s senior aides, and representatives of other financial regulatory agencies filled the remaining dozen seats around the table.
Usually, the president liked to keep things light at meetings, by opening with a wisecrack or good-naturedly teasing a close adviser. Not that afternoon. He asked bluntly, “How did we get to this point?”
The question was rhetorical. We had been fighting an out-of-control financial crisis for more than a year. In March, the Fed had lent $30 billion to help JPMorgan Chase save the Wall Street investment bank Bear Stearns from failure. In early September, the Bush administration had taken over Fannie Mae and Freddie Mac to prevent the collapse of the two companies responsible for financing roughly half of all residential mortgages in the United States. And just the day before, at 1:45 a.m., Lehman Brothers—the nation’s fourth-largest investment bank—had filed for bankruptcy, following a frantic and ultimately futile search for a merger partner led by Hank and New York Fed president Tim Geithner.
Now I found myself explaining to the president why the Federal Reserve was planning to lend $85 billion to American International Group (AIG), the world’s largest insurance company. The company had gambled recklessly, using exotic financial instruments to insure securities backed by subprime mortgages. Now that those mortgages were going bad at record rates, the financial firms that had bought the insurance, together with other AIG counterparties, were demanding payment. Without the cash, AIG would go bankrupt within days, perhaps hours. We weren’t motivated by any desire to help AIG, its employees, or its shareholders, I told the president. Rather, we didn’t think that the financial system—and, more importantly, the economy—could withstand its bankruptcy.
Reacting to the Lehman failure, markets already were in the grip of a full-blown panic of an intensity not seen since the Depression. The Dow Jones industrial average had plunged 504 points on Monday—its steepest one-day point decline since September 17, 2001, the first day of trading after the September 11 terrorist attacks—and the selling wave had spread to markets worldwide. As confidence in financial institutions disappeared, interest rates on loans between banks had shot skyward. Ominously, we were receiving reports of both large and small investors pulling their cash out of money market mutual funds after a large fund suffered losses stemming from Lehman’s collapse.
Everyone in the room knew that rescuing AIG would be terrible politics in a presidential election year. Just two weeks earlier, the president’s own party had declared flatly in its 2008 convention platform, “We do not support government bailouts of private institutions.” The Federal Reserve’s proposed intervention would violate the basic principle that companies should be subject to the discipline of the market and that the government should not shield them from the consequences of their mistakes. Still, I knew that, as chaotic as financial conditions were now, they could become unimaginably worse if AIG defaulted—with unknowable but assuredly catastrophic consequences for the U.S. and global economies.
With more than $1 trillion in assets, AIG was more than 50 percent larger than Lehman. It operated in more than 130 countries and had more than 74 million individual and corporate customers worldwide. It provided commercial insurance to 180,000 small businesses and other corporate entities employing 106 million people—two-thirds of American workers. Its insurance products protected municipalities, pension funds, and participants in 401(k) retirement plans. AIG’s collapse could well trigger the failures of yet more financial giants, both in the United States and abroad.
The president, grim-faced, listened carefully. Paulson had warned him earlier in the day that action on AIG might be necessary, and he knew that our options were severely limited. No private investors were interested in buying or lending to AIG. The administration had no money and no authority to rescue it. But the Fed could lend to AIG to keep it afloat if the company’s many subsidiaries retained enough value to serve as collateral for the loan.
Bush responded as he had consistently during the financial crisis, by reiterating his trust in Hank’s and my judgment. He said that we should do what was necessary, and that he would do what he could to provide political cover. I was grateful for his confidence, and for his willingness to do the right thing regardless of the likely political consequences for himself and his party. Having the president’s support was crucial. At the same time, essentially, the president was telling Paulson and me that the fate of the U.S. and global economies was in our hands.
Our next meeting, at half past six that evening at the Capitol, had been even tougher. Hank and I gathered with congressional leaders in a cramped conference room. House Speaker Nancy Pelosi wasn’t able to attend the hastily arranged gathering, but Senate majority leader Harry Reid and House minority leader John Boehner were there, along with Senate Banking Committee chairman Chris Dodd, House Financial Services Committee chairman Barney Frank, and several others.
Hank and I again explained AIG’s situation and our proposed response. We were besieged with questions. The lawmakers asked about the Fed’s authority to lend to an insurance company. Normally, the Fed is empowered to lend only to banks and savings institutions. I explained a Depression-era provision of the Federal Reserve Act—Section 13(3)—that gave us authority in “unusual and exigent circumstances” to lend to any individual, partnership, or corporation. The lawmakers wanted to understand the consequences of letting AIG fail and how the loan would be paid back. We answered as best we could. Yes, we believed this step was necessary. No, we could make no guarantees.
As the questions began to die down, I looked over and saw Senator Reid wearily rubbing his face with both hands. Finally he spoke. “Mr. Chairman. Mr. Secretary,” he said. “I thank you for coming here tonight to tell us about this and to answer our questions. It was helpful. You have heard some comments and reactions. But don’t mistake anything anyone has said here as constituting congressional approval of this action. I want to be completely clear. This is your decision and your responsibility.”
I returned to my office. Tim Geithner, who had negotiated the bailout deal, called with the news that AIG’s board had agreed to our proposed terms. The terms were tough, for good reason. We didn’t want to reward failure or to provide other companies with an incentive to take the types of risks that had brought AIG to the brink. We would charge a high interest rate on the loan and take an ownership stake in the company of nearly 80 percent, so taxpayers could benefit if the rescue worked. The Federal Reserve’s own Board had approved the deal earlier that day. All we needed to do now was put out the press release.
But I needed a few moments to think about it all. I believed we were doing the right thing. I believed we had no other reasonable choice. But I also knew that sometimes the decision-making process acquires a momentum of its own. It was important to be sure. Without doubt, the risks we would be taking were huge. Though $85 billion was an enormous sum, much more was at stake than money. If AIG failed even with the loan, the financial panic would intensify, and market confidence in the Fed’s ability to control the crisis could be destroyed. Moreover, the future of the Fed itself could be at risk. Senator Reid had made clear that Congress would accept no responsibility. The president would defend us, but in a few months he would be out of office. If we failed, an angry Congress might eviscerate the Fed. I did not want to be remembered as the person whose decisions had led to the Fed’s destruction.
I can still stop this, I thought, as I looked out at Constitution Avenue. The loan required unanimous Board approval, so all I would have to do would be to change my own vote. I said as much to Michelle and added, “We haven’t announced anything.”
If we acted, nobody would thank us. But if we did not act, who would? Making politically unpopular decisions for the long-run benefit of the country is the reason the Fed exists as a politically independent central bank. It was created for precisely this purpose: to do what must be done—what others cannot or will not do.
Michelle interrupted my thoughts. “We have to put something out,” she said softly.
“Okay,” I said. “It’s got to be done. Let’s look at the press release one last time.” It began, “For release at 9:00 p.m. EDT: The Federal Reserve Board on Tuesday, with the full support of the Treasury Department, authorized the Federal Reserve Bank of New York to lend up to $85 billion to the American International Group . . . ”