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 THE PENGUIN PRESS Published by the Penguin Group Penguin Group (USA) Inc., 375 Hudson Street, New York, New York 10014, U.S.A • Penguin Group (Canada), 90 Eglinton Avenue East, Suite 700, Toronto, Ontario, Canada M4P 2Y3 (a division of Pearson Penguin Canada Inc.) • Penguin Books Ltd, 80 Strand, London WC2R 0RL, England • Penguin Ireland, 25 St Stephen’s Green, Dublin 2, Ireland (a division of Penguin Books Ltd) • Penguin Group (Australia), 707 Collins Street, Melbourne, Victoria 3008, Australia (a division of Pearson Australia Group Pty Ltd) • Penguin Books India Pvt Ltd, 11 Community Centre, Panchsheel Park, New Delhi – 110 017, India • Penguin Group (NZ), 67 Apollo Drive, Rosedale, Auckland 0632, New Zealand (a division of Pearson New Zealand Ltd) • Penguin Books (South Africa), Rosebank Office Park, 181 Jan Smuts Avenue, Parktown North 2193, South Africa • Penguin China, B7 Jiaming Center, 27 East Third Ring Road North, Chaoyang District, Beijing 100020, China Penguin Books Ltd, Registered Offices: 80 Strand, London WC2R 0RL, England First published in 2013 by The Penguin Press, a member of Penguin Group (USA) Inc Copyright © Alan S Blinder, 2013 All rights reserved Diagram on page 77 from The Deal, issue of October 6, 2008 By permission of The Deal LLC Quote from “Hey Jude” by John Lennon and Paul McCartney, published by Sony/ATV Music Publishing All rights reserved LIBRARY OF CONGRESS CATALOGING IN PUBLICATION DATA Blinder, Alan S After the music stopped : the financial crisis, the response, and the work ahead / Alan S Blinder p cm Includes bibliographical references and index ISBN 978-1-101-60587-5 Global Financial Crisis, 2008–2009 Financial crises—United States Finance—United States United States—Economic conditions—2009– United States–Economic policy—2009– I Title HB37172008 B55 2013 330.973—dc23 2012031025 While the author has made every effort to provide accurate telephone numbers, Internet addresses, and other contact information at the time of publication, neither the publisher nor the author assumes any responsibility for errors, or for changes that occur after publication Further, publisher does not have any control over and does not assume any responsibility for author or third-party Web sites or their content No part of this book may be reproduced, scanned, or distributed in any printed or electronic form without permission Please not participate in or encourage piracy of copyrighted materials in violation of the author’s rights Purchase only authorized editions To Madeline CONTENTS Title Page Copyright Dedication List of Acronyms and Abbreviations Preface PART I IT HAPPENED HERE What’s a Nice Economy Like You Doing in a Place Like This? PART II FINANCE GOES MAD In the Beginning The House of Cards When the Music Stopped From Bear to Lehman: Inconsistency Was the Hobgoblin The Panic of 2008 PART III PICKING UP THE PIECES Stretching Out the TARP Stimulus, Stimulus, Wherefore Art Thou, Stimulus? The Attack on the Spreads PART IV THE ROAD TO REFORM 10 It’s Broke, Let’s Fix It: The Need for Financial Reform 11 Watching a Sausage Being Made 12 The Great Foreclosure Train Wreck 13 The Backlash PART V LOOKING AHEAD 14 No Exit? Getting the Fed Back to Normal 15 The Search for a Fiscal Exit 16 The Big Aftershock: The European Debt Crisis 17 Never Again: Legacies of the Crisis Notes Sources Index 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 people’s 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 Poor’s 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 *The Fed and the FDIC are immune to such budgetary constraints because they fund themselves *Full disclosure: I now write a regular op-ed column for the Wall Street Journal The statement stands nonetheless *IndyMac was a nickname for Independent National Mortgage Corporation Do you think they named it to sound like Fannie Mae and Freddie Mac? *DTI is a common measure of affordability But it’s a bad acronym DTI is not the ratio of debt to income, but rather the ratio of what is (close to) debt service to income—specifically, the sum of principal and interest payments, property taxes, and insurance to household income Only the first two of these constitute debt service *Legally, Bair’s term as FDIC chair ran well into 2010, so President Obama could not have removed her But agency heads often depart voluntarily if they are no longer wanted *Actually, $75 billion was allocated, since another $25 billion was kicked in from Fannie Mae and Freddie Mac, which were by then really government agencies In March 2012, CBO estimated that only $16 billion of the $50 billion from TARP would ever be utilized *Vice President Dick Cheney famously told then Treasury secretary Paul O’Neill in 2002 that “Reagan proved that deficits don’t matter.” *Maybe not quite to zero By paying a higher interest rate on reserves, the Fed may be able to induce banks to hold more of them More on this later *Headline inflation occasionally does, but that’s almost always because of either rapidly rising or falling oil prices *Spain and Italy would get in the crosshairs later More on the European sovereign debt crisis in chapter 16 *From 2000 to 2011, the two inflation rates were percent and 2.4 percent, respectively *When Ryan redid his budget a year later, the cuts of two thirds were reduced to about one half *For example, Senator Barack Obama had voted against President Bush’s request to raise the national debt ceiling in 2006 But that was a “free vote” because everyone knew the request would pass *This famous quote seems to come in an almost infinite number of variants Kissinger is not even sure he said it! *Much the same is true of Spain ... S After the music stopped : the financial crisis, the response, and the work ahead / Alan S Blinder p cm Includes bibliographical references and index ISBN 97 8-1 -1 0 1-6 058 7-5 Global Financial Crisis,. .. 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 THE PENGUIN PRESS Published by the Penguin Group... OF THE FINANCIAL CRISIS AND THE GREAT RECESSION Historical perspective accrues only with the passage of time, and we are still living through the aftermath of the frightening financial crisis and