The five-member COP, chaired by Harvard professor Elizabeth Warren, has produced the most devastating and comprehensive account so far. Unanimously adopted by its bipartisan members, it provides alarming insights that should be fodder for the larger debate many citizens long to hear—why Washington rushed to forgive the very interests that produced this mess, while innocent others were made to suffer the consequences. The Congressional panel’s critique helps explain why bankers and their Washington allies do not want Elizabeth Warren to chair the new Consumer Financial Protection Bureau.
The report concludes that the Federal Reserve Board’s intimate relations with the leading powers of Wall Street—the same banks that benefited most from the government’s massive bailout—influenced its strategic decisions on AIG. The panel accuses the Fed and the Treasury Department of brushing aside alternative approaches that would have saved tens of billions in public funds by making these same banks “share the pain.”
Bailing out AIG effectively meant rescuing Goldman Sachs, Morgan Stanley, Bank of America and Merrill Lynch (as well as a dozens of European banks) from huge losses. Those financial institutions played the derivatives game with AIG, the esoteric practice of placing financial bets on future events. AIG lost its bets, which led to its collapse. But other gamblers—the counterparties in AIG’s derivative deals—were made whole on their bets, paid off 100 cents on the dollar. Taxpayers got stuck with the bill.
“The AIG rescue demonstrated that Treasury and the Federal Reserve would commit taxpayers to pay any price and bear any burden to prevent the collapse of America’s largest financial institutions,” the COP report said. This could have been avoided, the report argues, if the Fed had listened to disinterested advisers with a less parochial understanding of the public interest.
Fed and Treasury officials dismiss this critique as second-guessing of tough decisions they had to make in the fall of 2008, amid the fast-moving global crisis. Yet two years later, those controversial decisions remain highly relevant. Public anger has not abated. It fuels the election turmoil that this year threatens to bring down incumbents in both parties who voted for bank bailouts.
[…] The AIG rescue was done in ways that had “poisonous effects” on the financial marketplace and public opinion, the report concluded. Cynical expectations were confirmed, both for citizens and financial players. Some financial firms are simply “too big to fail,” it seems; Washington will not let them collapse, no matter what the president claims.
The most troubling revelation in this story is the astonishing weakness of the Federal Reserve and its incompetence as a faithful defender of the public interest. In the lore of central banking, the Fed is awesomely powerful and intimidating. As regulator of the banking system, it has life-and-death influence over banks. As manager of the economy, it has open-ended authority to intervene in the financial system to restore stability, as the central bank did massively during the crisis.
Yet the Fed was strangely passive and compliant when it came to demanding cooperation and sacrifice from the largest financial institutions. Timothy Geithner was then president of the New York Federal Reserve Bank, the lead regulator of Wall Street’s largest banks. He briefly insisted they must accept the burden of rescuing AIG. But the bankers called his bluff and blew him off—and Geithner deferred to their wishes. The taxpayer bailout followed. The episode is relevant to the future, because Geithner is now Obama’s Treasury Secretary and in charge of preventing the next taxpayer bailout.