In a book called Firefighting – The Financial Crisis and its Lessons written by Ben S Bernanke, Timothy F Geithner and Henry S Paulson published by Penguin Books, NY, 2019. The book offers lessons from a crisis. The 3 authors were the lead news daily in 2008 through 2010 as the financial industry went through losses, destabilization, recession and recovery. The 3 people had to come up with a variety of tools to fight the fires and to allow for recovery. In all industries including finance, regulations are there for the last crisis not the current one. If the crisis is worse this time, the regulations are less effective because all industry change from the last crisis. Finance is always a little different because much of finance is about confidence. Banks lend money, they have to have a level of confidence the counterparty will repay. When the confidence falls, investors run will their money to something safer. When money goes to something safer, it effects regulatory levels.

Not surprisingly, the 3 authors noted the system is more complex than ever and when they tried to do something, they quickly realized the tools in the toolbox were not sufficient for the job and needed to persuade politicians to give them better tools.

The story of Lehman was a nightmare because it was loosely regulated, heavily overleveraged, deeply interconnected nonbank, with too much exposure to the real estate market and running on short-term financing. It was not the start of the crisis, because Fannie Mae, Freddie Mac, AIG and Merrill Lynch were bigger and near collapse.

The reason why Lehman collapsed was because the policymakers could not save it, they had no powers. However after Lehman collapsed, the policymakers were given the power to end the fire. Lehman was highly profitable on subprime mortgages, commercial real estate and other highly leverage investments. If Lehman had been a commercial bank, the FDIC could have seized it, guaranteed its liabilities, and resolved it to avoid a messy bankruptcy. Lehman is a nonbank, no one had the power to help. Lehman needed a buyer, Bank of America (BoA) was considering then it bought Merrill. Barclays was considering but it needed a shareholder vote and there was no time for it, so the regulators in the UK said no.

AIG, the global insurer, had fallen through the cracks of our broken regulatory system. The 3 policymakers had not paid attention to the company, as Office of Thrift Supervision was its regulatory body. AIG insured the lives of 76 million people, 180,000 businesses that employed 2/3’s of America’s workforce and had $2.7 trillion derivative contracts through the Financial Products division. The insurance aspects were the reason the Fed gave a $85 billion credit line in exchange for 79.9% of the firm.

Some critics were outraged the Fed did not insist on haircuts that would reduce payments. Haircuts are a common feature during the normal bankruptcy process, but they a sure way to make the panic worse and the Fed did not have the power to insist on haircuts. The goal of a crisis response should be to alleviate fears, not to confirm and amplify them.

Eventually AIG paid back its guarantee and when the government sold its position made $23 billion.

The next step was the AMLF (Asset Backed Commercial Paper Money Market Mutual Fund Liquid Facility) This was designed to stop the run of money market funds with invested $3.5 trillion for 30 million Americans and the commercial paper market which is the lifeblood of many companies. The idea was to guarantee money market funds just as the FDIC guaranteed bank deposits. Within 2 weeks the program was up to $150 billion.

For months, the policymakers had been working on stronger emergency authorities, but Congress had not given anything. President Bush said the time had come to go to Congress and the TARP or Troubled Assets Relief Program came into being. It was designed to buy up to $700 billion of toxic mortgage-backed securities.

The process was for the House of Representatives to vote for it, then the Senate and the President signs the bills. The first vote in the House lost with Republicans voting against, then the stock market fell 9% or $1 trillion and some Republicans came to their senses. The bill passed the second time in the House and Congress and the President signed off.

For crisis managers, it is vital to have the tools you need before a crisis, so that they do not need to rely on political leaders to take political risks in real time under the public microscope.

Now that the policymakers had the tool of TARP the issue was hope to use it. Do they make assets, equity because the system needed more capital and buying assets was an indirect and inefficient way to boot capital levels. There was no easy way to determine which assets should be bought. Eventually Hank’s team decided to buy nonvoting preferred stock rather than common equity. This would calm fears of a government takeover, and do so on relatively attractive terms so that strong and weak banks would accept the capital and restore confidence in the system.

The 9 biggest banks were summoned to Treasury and were told to accept the equivalent of 3% of their risk-weighted assets for a total of $125 billion in TARP investments. If they did not take it, then the other government guarantees would be taken away from them. For the rest of the banking system $125 billion was available to smaller banks and eventually nearly 700 banks took financing. This was a critical step toward stabilizing and recapitalizing the banking system.

In Europe, banks were nationalized but not giving capital and were undercapitalized for years. This lead to a slower recovery.

The policymakers wrote about incoming President Obama and President Bush working together and then Obama doing a very good job both in understanding and continuing the regulations in his term.

In May, the Fed released the results of its stress test, and they were much better than many in the markets has expected. The Fed determined 9 of the 19 largest financial firms were already adequately capitalized to withstand the test’s worst case scenario and the other 10 needed $75 billion in additional capital which was given.

The economy was helped by the American Recovery and Reinvestment Act of 2009, $300 billion in temporary tax cuts along with $500 billion worth of new federal spending. By 2015 the economy had recovered to precrisis levels.

Linking to dividend paying stocks, when parts of the economy or the economy goes into crisis, it will take time to come back to precrisis levels. If you have invested in dividend paying stocks, you will have dividends that could go into some of the better companies that were affected by the crisis. Cash is king during a crisis, but patience is a virtue, because if you have done your homework in advance, you can pick up great assets for less money and continue with healthy dividends.

There are more questions than answers, till next time – to raising questions.