The famed free-market economist Milton Friedman spent his life arguing that capitalism was necessary for freedom. He fought against government intrusion in the markets, stating that it impeded that freedom—not to mention that it screwed things up. He once noted that if the federal government were put in charge of the Sahara Desert, within five years there would be a shortage of sand. Friedman died in 2006 at age ninety-three, during the height of the financial boom that preceded the fall. I wonder what he would say today about what occurred and what corrective measures should be taken. I am fairly certain that the advent of TARP and other government bailouts had Friedman spinning in his grave. And I doubt he’d agree to more stringent regulation.
The debate continues: what is the nature of capitalism, and what is the government’s proper role?
One evening in early 2010, I had dinner with my friend Garry Kasparov. The world champion chess player has become a political activist and commentator. He told me he was writing a book about the financial system. Conversations with Kasparov are always thought-provoking, and this one was no different.
“Do you believe that Paulson did the right thing in pushing for TARP?” he asked me.
“I do,” I replied. “It was a moment in time when government intervention was necessary.”
He shook his head in disapproval. “Then you are not a free-market capitalist,” he said. “Don’t tell me you are. If you believe in bailouts, that flies in the face of free-market capitalism, which requires you to allow firms to fail. They made mistakes, they took on untenable risks, and they should have failed, so new companies could emerge.”
Kasparov’s position is one side of a vigorous discussion that is taking place across the country. But the systemic failure that necessitated TARP really was a remarkable situation—one that called for a flexible response. Emergency exceptions exist everywhere in our lives. We don’t, for example, say that if a person can’t earn money he should be allowed to starve. Our free-market principles make broad allowances for people in need. So, too, with a damaged system. Imagine what would have occurred in September 2008 if the federal government had said to all the banks and companies, “Sink or swim on your own.” Perhaps the lights would have gone out on our economy.
Having said that, there is no question that TARP had problems in the way it was structured. I discussed this with Elizabeth Warren, the chair of the Congressional Oversight Panel, charged with reviewing TARP. Warren is well cast as the voice of oversight. A no-nonsense consumer advocate and professor at Harvard Law School, the fifty-year-old Warren speaks in the calm voice of a parent, but the impact of her words is knife sharp. When I asked her, “Where has the TARP money gone?” I was taken aback by her answer: “We not only do not know. We’re never going to know.”
I was briefly speechless. How could we not know?
Warren described how Paulson had failed to establish even minimal reporting procedures. “Secretary Paulson put this money into the largest institutions, and he didn’t ask, ‘How is this money going to be used?’ He put it in and covered his eyes and said, ‘I don’t care how you spend it.’ So we lost the ability to track it.”
There will be arguments for a long time about whether TARP and the stimulus saved the economy. Alan Greenspan told me that it wasn’t the stimulus that brought us back from the brink. It was a renewal of confidence in the stock market in early 2009. The markets bottomed on March 10 and rose for most of the year, making people feel richer and more optimistic. This, Greenspan said, was critical to the recovery, even if later in the year and into 2010, new worries emerged.
As the financial markets barreled into 2010, Congress was praying that the recovery would stick, while trying to respond to the anxiety people were feeling about their futures. The purpose of the financial-reform proposals that were making their way through the Senate and House was full of merit: protect consumers, rein in the speculative frenzy, stabilize the system, encourage legitimate growth, and prevent another financial crisis. But while most people agreed on the goals, the question of how to structure reform was more contentious.
In March I traveled to Washington and met with Barney Frank, the chairman of the House Financial Services Committee, about the elements he believed should be a part of financial reform. For Frank there were five essentials:
1. A systemic regulator to assure that no companies would be “too big to fail.”
2. A resolution authority, giving the government the power to decide whom to pay and whom not to pay. Frank told me, “Hank Paulson said that his biggest problem when faced with Lehman Brothers was ‘I either pay everyone or I pay no one. I paid no one because I didn’t have the authority to shut parts down and save the rest. When AIG happened, I had to pay everyone.’”
3. A consumer financial protection agency to make certain that nothing fell through the cracks. Frank acknowledged that there were regulations on the books—credit card protections, etc.—but the banks managed to get around them, and this legislation would strengthen the protections.
4. Risk retention. “Thirty years ago,” said Frank, “when you lent someone money, they paid you back and that was it. Today, you lend someone money, and then they sell the loan to someone else and someone else, spreading the risk. Under this legislation they would have to retain the risk for a period of time.”
5. Transparency on derivatives, so we’d know where the derivatives were and who had exposure.
Frank was also interested in a proposal by former Federal Reserve chairman Volcker, dubbed the “Volcker Rule,” that would allow regulators to restrict proprietary trading at specific banks if it was deemed to be a risk
