What would the Fed have been looking at that would have worried them? ...Part of its traditional role is lender of last resort, which you're always afraid of. The Fed was essentially created as a firebreak against banking crises. One bank fails, and that starts a run on the next bank, and that bank fails, and you know what happened in the 1930s, but also in fact was a regular feature of the U.S. economy.
Basically the panic of 1907, (investment banker and financier) J.P. Morgan stepped into the rescue. And people said: "Hey, there won't always be J.P. Morgan to do this. We probably should have an official institution that does it." And they had trouble with that role until the New Deal added a bunch of extra firebreaks. That is the Fed's central role and always has been. Fed and LTCM, 1998 -- the collapse of liquidity because you have a financial panic is what the Fed is there to stop.
The Fed had, by the time of Lehman, understood that there are a lot of things that aren't -- commercial banks aren't the Fed's traditional responsibility -- that can nonetheless have the same systemic effects as a bank failure. And in fact, when people ask me, "What can I read to understand the nature of this crisis?," I actually point to a
(then-head of the New York Fed Timothy) Geithner speech from June 2008, before Lehman, about the parallel banking system and how it has become vulnerable to the modern equivalent of bank runs. And that's the source of our extreme fragility financially right now.
Presumably people at the Fed, presumably Geithner as well, were saying: "This is effectively maybe an investment bank, not a commercial bank. But it's got short-term debt and illiquid assets and CDS, credit default swaps, and a lot of counterparty risk. And if this thing goes under, (there) could be cascading effects through the system." That would be the view you'd expect them to have. You'd expect them to be very afraid of letting an institution like that fail.
Tell me what you know about Tim Geithner. ...Geithner is a Larry Summers protégé from Treasury. He worked his way up during the Summers years at Treasury and did a lot of international stuff, very involved with the Asian financial crisis of the late '90s, which is, in some respects, a dry run for what we're having now, universally regarded. I spent time in meetings with him. Extremely smart, extremely aware of the stuff, very discreet, controlled, a good central banker, even though that's not where he comes from originally. But he's got the central banker ability to talk knowledgeably about a subject without actually saying something that is going to cause the Dow to move by 500 points, and the kind of person that you really need.
I don't know if he has the political skills, but the closest parallel, he reminds me of Bob Rubin, even though it's a different career path. But he comes across that way -- very calm, intellectual guy with a good grasp of the markets.
And of course New York Fed, you have to understand -- in normal times, when you're just doing ordinary monetary policy, all the action is in Washington. When you're in this kind of financial thing, the New York Fed becomes, in some ways, a co-equal partner of the Board of Governors in Washington. So he's been in the middle of the maelstrom all along. ...
link The interview was posted February 2009, but it appears to be from November 2008.
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