Monday, November 30, 2009

Phil Swagel Advises Ben Bernanke

I am continuing to work my way through Andrew Ross Sorkin's Too Big To Fail. One section had me rolling on the floor laughing. I'm sure it wasn't written to come off that way, but if you know a little background, it's the tale of a slapstick routine if I ever heard one.

Sorkin details a visit to Fed chairman Ben Bernanke, at the height of the financial crisis in 2008, by Neel Kashkari, then-Interim Assistant Secretary of the Treasury for Financial Stability, and Phillip Swagel, then-Assistant Secretary for Economic Policy under Paulson at the Treasury. Sorkin goes into their jumping into the car to get to the Fed and their seeming awe at making a presentation to Bernanke,a "break the glass" solution to the crisis.

Now what is totally absurd about this is that in my view Swagel (and probably Kashkari) were in brain freeze. They are both smart guys, but they were at the Treasury to carry water for Treasury Secretary Paulson and that was it. Like Geithner, these are the types Paulson seemed to surround himself with. Generally smart guys who Paulson could intimidate into not thinking for themselves and working as technocrats to carry out whatever he wanted.

When I questioned Swagel earlier this year about the summer of 2008, he admitted to me that he had no idea there was no money growth that summer. Money growth dropped from a 12% annualized rate early in the year to 1.4% during the summer,in the midst of a housing crisis.

Got that? The Treasury's top economist had no clue that Bernanke had stopped printing money in the summer of '08. Brain freeze. Thus, time for a mad cap caper over to the Fed.

Their recommendation to Bernanke was to auction off the mortgages and get the Treasury to buy them (It's not exactly clear from the book how this contradiction was to take place). But, as part of the plan, the Treasury wouldn't pay cash for the mortgages at the discounted price, but a newly created special Treasury security.

Of course, when you realize that the problem was a liquidity crisis for the banks, a newly created Treasury security was the last thing banks needed. They needed cash. Secondly, a markdown of the mortgages to market prices would have bankrupted most of them.(Something I would have been in favor of, but certainly not Kashkari/Swagel)

One can only imagine what Bernanke was thinking when this presentation was made. He did ask Kashkari/Swagel where they came up with the figure of $500 million as the amount of this new Treasury security that would be required. The answer they gave seemed to suggest they picked the number out of a hat, which was probably what Bernanke suspected.

Last we read about the plan from Sorkin is that Bernanke put it on a shelf in his office. Maybe after he has a tough grilling from Congress, he heads back to the office, grabs the plan, reads an excerpt and has a little chuckle to himself.

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