In Fed We Trust

In his non-fiction book In Fed We Trust: Ben Bernanke's War on the Great Panic (2009), American journalist and author David Wessel details the steps taken by Chair of the U.S. Federal Reserve Ben Bernanke in the wake of the 2007 financial crisis. Though Wessel concludes that Bernanke and his colleagues ultimately made good decisions to correct the nation's economic collapse, he also writes that American regulators and politicians were woefully unprepared to handle such a catastrophe; this lack of preparation nearly led to a financial meltdown on par with the Great Depression of the 1930s.

Before discussing Bernanke's response to the financial crisis, Wessel details how the crisis came about in the first place. Most economists agree that the most immediate and direct cause of the financial crisis was the collapse of the housing market. Over the previous decade leading up to 2007, housing prices soared by an average of 124 percent. With housing prices showing little signs of slowing, and with home construction booming thanks to an influx of foreign wealth from Russia and Asia, banks took on extra risk in offering mortgage loans to homebuyers who in previous years would not have qualified for home loans. By 2004, these loans, known as "subprime mortgages," made up 20 percent of all home loans in America, up from 10 percent in previous years. Government-run affordable housing policies were also a factor in contributing to the overall atmosphere surrounding subprime lending, but a bipartisan Financial Crisis Inquiry Commission later contended that loans offered by government-sponsored mortgage corporations like Fannie Mae and Freddie Mac were not a chief cause of the crisis and performed better than subprime mortgages offered by private banks during this period.

Exacerbating the problem was Wall Street's invention of new, incredibly risky investment instruments such as "mortgage-backed securities" and "collateralized debt obligations." Through these instruments, mortgages were bundled into single assets and then sold to investors. Despite the fact that an increasing number of these mortgages were subprime loans on which homeowners were likely to default, financial institutions were able to secure relatively high credit ratings for these investments, making them seem safer than they really were. This, Wessel argues, was largely due to the inability of government credit rating boards to properly understand the banks' increasingly complex financial offerings.



In addition, investors and financial institutions began to participate in a practice known as credit default swaps. Ideally, this instrument allows investors to purchase insurance against risky investments in case they fail. However, due to the increasing complexity of financial derivatives markets at this time, along with the failure of government officials to properly regulate these evolving markets, hedge funds were enabled to purchase credit default swaps against an investment even if they held no risk in the assets in question. This allowed certain institutions to essentially bet against their own mortgages, thus creating even more incentive to offer subprime mortgages at increasingly reckless rates.

Amid all the bad actors operating during the lead-up to the financial crisis, Wessel casts one man in particular as the calamity's chief villain: Alan Greenspan, who served as the Chair of the U.S. Federal Reserve between 1987 and 2006, when Bernanke took the reins. A die-hard libertarian and proponent of laissez-faire free market economics, Greenspan oversaw a period during which numerous financial regulations dating back to the Great Depression were either relaxed or eliminated altogether. Wessel asserts that in 2008, Greenspan admitted that his approach was deeply flawed, testifying to a House committee, "I made a mistake in presuming that the self-interest of organizations, specifically banks and others, were such that they were best capable of protecting their own shareholders."

Wessel cites numerous individuals who characterize a lack of engagement and interest from then-President George W. Bush in response to the financial crisis. A lame duck president with only a few months remaining in his term, Bush deferred most of the major decisions to people like Bernanke and Treasury Secretary Hank Paulson. That included the controversial $180 billion bailout of American International Group (AIG) which had sold tens of billions of dollars worth of credit default swaps without properly reinsuring them or securing collateral to back them. Though the bailout was officially finalized by the Obama administration, Bush sanctioned the move, telling Bernanke and Paulson, "If you are comfortable with this, then I am comfortable with this," without any further debate on the topic. While this decision came under enormous scrutiny after AIG paid out obscene bonuses to its executives with bailout money, Wessel contends the bailout was ultimately the correct choice because it staved off a potential chain reaction that threatened the solvency of other major financial institutions, including Merrill Lynch, Bank of America, and Goldman Sachs, which would, in turn, deepen the crisis.



But the most unorthodox—though arguably effective, at least in Wessel's telling—move from Bernanke was his decision to lower interest rates from more than 5 percent to zero in less than a year's time. When this failed to inject the necessary liquidity into the U.S. economy to stave off further damage, Bernanke's Federal Reserve bought up unprecedented amounts of financial assets from banks, particularly the mortgage-backed securities that helped sink the economy in the first place. This controversial practice is known as "Quantitative Easing," and by 2010, the Federal Reserve had used it to purchase $2.1 trillion, most of which was outstanding bank debt and mortgage-backed securities.

Wessel is cautiously admiring of Bernanke's willingness to break the rules to do "whatever it takes" to save the U.S. economy from further ruin, stating that his actions as Fed Chair staved off the very worst outcomes of the financial crisis, at least for now. Nevertheless, the book's most compelling argument is that such extreme measures should never have been necessary in the first place. Moreover, if current politicians, regulators, and appointees don't learn from the mistakes of men like Alan Greenspan, the United States is poised to suffer financial crises in the future that are just as ruinous as the one in 2007, if not worse.