Blinder - After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead

ALSO BY ALAN S. BLINDER

Hard Heads, Soft Hearts

Offshoring of American Jobs

The Quiet Revolution

Downsizing in America

Asking About Prices

Central Banking in Theory and Practice

Economics: Principles and Policy

ALSO BY ALAN S. BLINDER

Hard Heads, Soft Hearts

Offshoring of American Jobs

The Quiet Revolution

Downsizing in America

Asking About Prices

Central Banking in Theory and Practice

Economics: Principles and Policy

AFTER THE MUSIC STOPPED

THE FINANCIAL CRISIS, THE RESPONSE, AND THE WORK AHEAD

ALAN S. BLINDER

THE PENGUIN PRESS

New York

2013

CONTENTS

LIST OF ACRONYMS AND ABBREVIATIONS

ABCP: asset-backed commercial paper

ABS: asset-backed securities

AIG: American International Group

AIG FP: AIG Financial Products

AMLF: Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility

ANPR: Advance Notice of Proposed Rulemaking

ARM: adjustable-rate mortgage

ARRA: American Reinvestment and Recovery Act (2009)

BofA: Bank of America

CBO: Congressional Budget Office

CDO: collateralized debt obligation

CDS: credit default swaps

CEA: Council of Economic Advisers

CEO: Chief Executive Officer

CFMA: Commodity Futures Modernization Act (2000)

CFPA: Consumer Financial Protection Agency

CFPB: Consumer Financial Protection Bureau

CFTC: Commodity Futures Trading Commission

CME: Chicago Mercantile Exchange

CP: commercial paper

CPFF: Commercial Paper Funding Facility

CPI: Consumer Price Index

CPP: Capital Purchase Program

DTI: debt (service)-to-income ratio

ECB: European Central Bank

EMH: efficient markets hypothesis

ESF: Exchange Stabilization Fund

FCIC: Financial Crisis Inquiry Commission

FDIC: Federal Deposit Insurance Corporation

FHA: Federal Housing Administration

FHFA: Federal Housing Finance Agency

FICO: Fair Isaac Company

FOMC: Federal Open Market Committee

FSA: Financial Services Authority (UK)

FSLIC: Federal Savings and Loan Insurance Corporation

FSOC: Financial Stability Oversight Council

G7: Group of Seven (nations)

GAAP: generally accepted accounting principles

GAO: Government Accountability Office

GDP: gross domestic product

GLB: Gramm-Leach-Bliley Act (1999)

GSE: government-sponsored enterprise

H4H: Hope for Homeowners

HAFA: Home Affordable Foreclosure Alternatives Program

HAMP: Home Affordable Modification Program

HARP: Home Affordable Refinancing Program

HAUP: Home Affordable Unemployment Program

HHF: Hardest Hit Fund

HOLC: Home Owners Loan Corporation

HUD: Department of Housing and Urban Development

IMF: International Monetary Fund

ISDA: International Swaps and Derivatives Association

LIBOR: London Interbank Offer Rate

LTCM: Long-Term Capital Management

LTRO: Longer-Term Refinancing Operations

LTV: loan-to-value (ratio)

MBS: mortgage-backed securities

MOM: my own money

NBER: National Bureau of Economic Research

NEC: National Economic Council

NINJA (loans): no income, no jobs, and no assets

NJTC: new jobs tax credit

OCC: Office of the Comptroller of the Currency

OFHEO: Office of Federal Housing Enterprise Oversight

OMB: Office of Management and Budget

OMT: Outright Monetary Transactions

OPM: other peoples money

OTC: over the counter

OTS: Office of Thrift Supervision

PDCF: Primary Dealer Credit Facility

PIIGS: Portugal, Ireland, Italy, Greece, and Spain

QE: quantitative easing

Repo: repurchase agreement

S&L: savings and loan association

S&P: Standard and Poors

SEC: Securities and Exchange Commission

Section 13(3): of Federal Reserve Act

SIFI: systemically important financial institution

SIV: structured investment vehicle

SPV: special purpose vehicle

TAF: Term Auction Facility

TALF: Term Asset-Backed Securities Loan Facility

TARP: Troubled Assets Relief Program

TBTF: too big to fail

TED (spread): spread between LIBOR and Treasuries

TIPS: Treasury Inflation-Protected Securities

TLGP: Temporary Liquidity Guarantee Program

TSLF: Term Securities Lending Facility

UMP: unconventional monetary policy

WaMu: Washington Mutual

PREFACE

When the music stops... things will be complicated. But as long as the music is playing, youve got to get up and dance. Were still dancing.

T hose were the immortal words on July 8, 2007, of Chuck Prince, then the CEO of Citigroup. It may be the most famous, or infamous, quotation of the entire financial crisis. Almost exactly a month later, the music stopped abruptlyand so did the dancing.

True to Princes prophecy, things got quite complicated and very uglynot only for Citigroup but for the entire world. The high-stakes game of musical chairs turned out to be remarkably short on seats, and large swaths of the financial industry fell rudely to the floor. The U.S. economy subsequently sank into its worst recession since the 1930s. The U.S. government, which was led at the time by a bunch of alleged free-marketeers, was called upon to ride to the rescue multiple timesnot because the financial firms deserved it, but because the chaos threatened to pull all of us down into the abyss with them. They were incredible events.

A NOTHER B OOK ON THE C RISIS ?

But the story of the financial crisis of 20072009, or at least parts of it, has been told many times, in many different ways, in a wide variety of books and articles. So why yet another work about the crisis and its aftermath?

One reason is simply that the American people still dont quite know what hit them, how and why it happened, or what the authorities did about itespecially why government officials took so many unusual and controversial actions. Misconceptions about the governments role are rife to this day, and they are poisoning our politics. Was government part of the problem, or part of the solution? This book attempts to answer these and related questions. The version of the story I tell focuses more on the why than on the what of the crisis and response. No one else has done that to date.

Doing so is important for several reasons. One is that a comprehensive history of this episode has yet to be written. A number of fine books, mostly by journalists, have examined pieces of the puzzle, sometimes in excruciating detail. The book you hold in your hands is different. Its not a work of journalism, so if you want to learn about who said what to whom when, you are best advised to look elsewhere. My purpose, instead, is to give the big picture rather than focus on just one or two pieces. One day, some ambitious historian will put everything together in a two-thousand-page tome. My version of the story is comprehensive but shorter. It is also less of a whodunit and more of a why-did-they-do-it?

An even more important reason for writing this book is that the events recounted here are still reverberating, both in the United States and around the world. You read about them every day, and they will pose major public policy challenges for years. The U.S. economy has not yet climbed out of the ditch into which the financial crisis and the Great Recession drove it. Unemployment remains high, the budget deficit is still huge, and the mortgage foreclosure problem festers. In Europe, the crisis is still unfolding. Some of the remedies put (or not put) into place in response to the crisis remain under vociferous, and often highly partisan, debate. That includes the Dodd-Frank financial reform act of 2010, the continuing foreclosure mess, the monstrous federal budget deficit, the Federal Reserves ongoing efforts to boost the economy, and more. Unlike most books on the crisis, this one zeroes in more on public policy than on the mysteries of modern finance.