Washington Wednesday: Lessons from the financial crisis

MARY REICHARD, HOST: It’s Wednesday, the 12th day of September, 2018.

Glad to have you along for today’s edition of The World and Everything in It. Good morning, I’m Mary Reichard.

NICK EICHER, HOST: And I’m Nick Eicher. It’s Washington Wednesday.

Ten years ago this month, September 2008. It began with most Americans unaware that the U.S. economy stood on the precipice of disaster.

But disaster is exactly what happened.

By the first weekend of September, the federal government had seized two major companies: Freddie Mac and Fannie Mae. These are the giant public-private hybrid corporations that own or insure most home mortgages in this country. At the time, the two were overexposed to high-risk, so-called subprime mortgages.

When the government took over, it placed the corporations into a conservatorship and that essentially wiped out their stockholders.

Here’s James Lockhart, then-director of the Federal Housing Finance Agency.

LOCKHART: After this exhaustive review, I have determined that the companies cannot continue to operate safely and soundly and fulfill their critical, mission to the public without significant actions to address those concerns.

EICHER: Thus began a chain reaction.

On September 15th, Bank of America buys Merrill Lynch for $50 billion.

Lehman Brothers—holding billions in Fannie Mae stock—files for Chapter 11 bankruptcy. Lehman had nearly $700 billion in assets, making it the largest bankruptcy in U.S. history.

The markets take a nosedive.

CNN: You know what, right now, breaking news: Stocks all around the world are tanking because of the crisis on Wall Street.

EICHER: The Dow Jones Industrial Average is one of the major stock indexes. It measures some of the most stable publicly traded companies. But the Dow fell 4.5 percent in a single day.

The Securities and Exchange Commission announces an emergency ban on short selling stocks of all companies in the financial sector.

Meantime, the world’s largest insurer—American International Group—takes an $85 billion bailout. In exchange, AIG gives the federal government almost 80 percent control of the company.

Goldman Sachs and Morgan Stanley accept greater government oversight.

Then Washington Mutual collapses in the biggest bank failure in U.S. history.

By September 24th, President George W. Bush addresses the nation from the White House.

BUSH: Good evening. This is an extraordinary period for America’s economy. We are in the midst of a serious financial crisis, and the federal government is responding with decisive action.

EICHER: The next week, Congress passes and President Bush signs a $700 billion bailout package that would come to be known by its acronym TARP: The Troubled Asset Relief Program.

And the trouble multiplied: More bad news was to come for other companies and the auto industry, but those represent the lowlights from September 2008: A cataclysmic financial month for a lot of people in the U.S. economy.

Joining me now to discuss all of this is David Bahnsen. He’s a financial adviser and analyst with offices in New York and California. Today, he joins us from California. Good morning, David!

DAVID BAHNSEN, GUEST: Well, good morning. Good to be with you, as always.

EICHER: David, we’ve outlined the events that led up to the financial crisis. But the stage was set long before that. Talk about some of those key factors.

BAHNSEN: From my vantage point it’s really important that we understand what did happen. An excessive amount of debt that had built up in the private sector—you had household debt reach record highs and then household leverage, and those are two different things. There’s an absolute level of debt that you always want to be concerned about, but then the more important factor is the debt divided by the assets. In theory, a level of assets that is growing faster than the level of debt can enable a lot of debt to build up, right? But the problem is when the value of the assets drops, that leverage gives way. That’s what happened in 2008, and it happened in the corporate sector, the banking sector, they had built up so much leverage of these toxic mortgage and real estate related assets. The value of those assets dropped, but the debt, of course, did not. Therefore, the debt divided by assets became unsustainable. An excessive amount of credit that had built up into the financial markets gave way and resulted in the worst recessionary period that we had had as a society since the Great Depression.

EICHER: Well, this is Washington Wednesday, so I want to also talk to you about the political implications here. They would have been big regardless, but this meltdown occurred in the heat of a presidential election. It was just a few weeks away. So looking back, what was the long-term political impact of the financial crisis?

BAHNSEN: Well, they couldn’t look like they weren’t doing anything, and in fact there was something to be done, but they chose to go pass legislation that was riddled either with very token things—like trying to regulate ATM/debit card fees and things like that, which obviously had nothing to do with anyone’s version of the financial crisis—or they tried to do legislation that I argue is actually counter-productive. They didn’t chip away at too big to fail, they officially codified it by setting a kind of standardized process in place for what would happen if one of these too big to fail financial institutions got in trouble again.

So you had a combination of things: The market did a lot of the work for everybody, but then the government added an increase in regulation. The long and short of it was to really hurt a lot of small and regional banks and make them less competitive with the big behemoths. But the big behemoth banks right now have more assets and are a larger share of the U.S. economy than they ever were before the financial crisis.

And all the things I’m saying right now are totally true, I just don’t want it to sound like I’m rhyming with other people’s talking points where they will say, “See, we have more danger than we did before.” That’s not what I’m saying. The leverage is significantly lower in the financial system. But, as a matter of political course, they picked winners and created policies that sort of punished people that had nothing to do with the original financial crisis.

EICHER: The biggest features of the financial crisis were the various bailouts. Under both President George W. Bush in 2008 and President Barack Obama in 2009, we had bailout packages—for AIG, for Fannie Mae, Freddie Mac, the auto industry, and many more. At the time lawmakers—Democrats and Republicans alike—said we’ve got no choice here. We have to keep the economy afloat. So I wonder, David, how is history judging those bailout packages?

BAHNSEN: Well, it’s interesting. The Fannie and Freddie bailouts were done by the Treasury Department, not by Congress. The Treasury Department had, months in advance of the financial crisis, obtained permission from Congress to receive a certain degree of executive authority that gave them the ability to put Fannie and Freddie into conservatorship. The case of AIG. It was the Federal Reserve who ended up taking them under. The U.S. government had big stock in the company, they sold that off through time. They no longer own any shares and the taxpayers made about 20 percent on their money.

Then the real official bailouts came in, what we always call TARP, where Congress passed legislation and the United States government ended up injecting capital directly into nine major banks. All of the money that they gave to these Wall Street firms was paid back at about a 21 percent return to taxpayers. So there are two camps of people, those who swear if they hadn’t done it it would have been armageddon, and that thesis is unprovable. And there are people who say if they hadn’t done anything, nothing would have happened, and we would have been fine and that thesis is most definitely unprovable.

But you brought up the car bailouts and this is, to me, the issue that I can’t let go of…there are a grand total of two entities that received gazillions of dollars from the United States taxpayers that have not paid them back. That is, the car companies of General Motors, Chrysler, and the government subsidized Fannie and Freddie. That’s it. The AIGs and the Wall Street firms all through time ended up having to pay the money back. And at a large return. So, I believe that we forget these details to our own peril and they always seem to be constructed around somebody’s very convenient political narrative.

EICHER: Speaking of political narratives, David, a frequent talking point for politicians like Senators Bernie Sanders and Elizabeth Warren is that no financial executive was ever held criminally accountable for causing the financial crisis—and leaving taxpayers footing the bill. Is it possible that they have a point, in your view?

BAHNSEN: Well, you know, this is the thing: I don’t believe for a second that the Justice Department of President Barack Obama and Attorney General Eric Holder were uninterested in criminally prosecuting and receiving all the political benefit that a headline around such a high-level prosecution would have represented. I believe that it was a pragmatic decision that they did not believe they were going to obtain a successful conviction. They did try to. They arrested two Bear Stearns hedge fund operators – both of whom were acquitted. And I think at the end of the day there was a massive amount of incompetence and incompetence is not yet against the law.

EICHER: David Bahnsen is a financial adviser and analyst based in California. David, thank you.

BAHNSEN: My pleasure.

(AP Photo/Mark Lennihan, File) This Dec. 21, 2016, file photo shows the New York Stock Exchange. 

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