Too Big to Fail… Or Save

Too Big to Fail… Or Save B Y PAUL ATKINS A review of uation on a mid-September Sunday when Lehman Brothers Too Big to Fail: The Inside Story of was sinking before its management’s—and the govern- How Wall Street and Washington Fought to Save the ment’s—eyes. He tells how Henry Paulson, then U.S. Financial System—And Themselves, Secretary of the Treasury, vomited after one excruciating by Andrew Ross Sorkin, Viking, 2009, and meeting. He even recounts what John Mack, chairman of Morgan Stanley, told his wife just before they went to bed Too Big to Save? How to Fix the one night. Meanwhile, the reader must somehow hope to U.S. Financial System, by Robert Pozen, discern, from among all of the beguilingly precise details Wiley, 2009. and quotations, truth from embellishment in Sorkin is a newspaper the storytelling. uring the past eighteen months, dozens of In focusing on reporter and has authors have produced books about the details and actions of written a book in the 2007–09 financial crisis. Two of these specific people, Sorkin books illustrate well the broad choices a implicitly subscribes to same vein: he does reader has: You can spend your time being the “Great Man” theory not consider the Dentertained, picking up some color about the people play- of history—studying ing important roles and how they influenced events, or history by examining institutional and you can learn something about the underlying causes and the particular personali- effects in an interesting, approachable way. ties involved. It is structural pressures. In Too Big To Fail, author Andrew Ross Sorkin, a New undoubtedly true that York Times reporter, supplies a rollicking, well-woven, at individual foibles and prejudices help determine the out- times profane “insider account” of daily events before and come of events, whether they be military battles or bailing during the financial crisis. In Too Big To Save?, author out banks. Would the course and outcome of the financial Robert Pozen, senior lecturer at Harvard and chairman of crisis have been different if, for example, instead of the an investment firm, methodically examines and evaluates intervention-oriented Henry Paulson, President Bush had the U.S. government’s response to the crisis, explains con- still been served by Paulson’s reflective predecessor, cepts, and suggests reforms to prevent another one. Treasury Secretary John Snow, who had sounded the alarm It is clear that Sorkin interviewed nearly every signif- in 2004 about the housing market bubble and advocated icant figure in the financial crisis and had access to calen- action against the excesses of Fannie Mae and Freddie dars and correspondence. At times clearly one-sided in his characterization of the players, he describes in detail (with Paul Atkins served as a commissioner for the U.S. full, multi-party quotations) events such as the chaotic sit- Securities and Exchange Commission from 2002 to 2008. 56 THE INTERNATIONAL ECONOMY SPRING 2010 ATKINS THE MAGAZINE OF INTERNATIONAL ECONOMIC POLICY 888 16th Street, N.W., Suite 740 Washington, D.C. 20006 Phone: 202-861-0791 • Fax: 202-861-0790 www.international-economy.com Mac? Sorkin does not address this sort of question, so one carries this argument too far is left wondering. when he suggests that Sorkin is a newspaper reporter and has written a book Treasury should have bought in the same vein: he does not consider the institutional and common, rather than pre- structural pressures that existed and contributed to the ferred, stock in troubled insti- crisis. Only in his epilogue does he briefly touch larger tutions. In our dynamic issues for the future, without delving into policy issues of marketplace, politicians and regulatory reform. bureaucrats cannot run com- Where to turn for explanations and analysis? A superb, panies very well, nor would thorough, and approachable treatment of policy issues and we want them to try. So, a pre- suggestions for solutions, Pozen’s book is an essential tool ferred shareholding would bet- for understanding the financial crisis. He carefully assesses ter reflect the true nature of each governmental response and suggests many ways to this relationship. Too Big to Fail by improve the design of financial regulation. For example, Pozen writes like the Andrew Ross Sorkin in his first hundred Harvard teacher he is— Pozen could come pages, Pozen deals with patiently leading readers the housing finance mar- through the important aspects down harder on the ket—how the housing of the financial system that moral hazard bubble grew and the contributed to the financial policies that contributed crisis. Each chapter ends with created by to it, including the secu- a summary and several dia- “too big to fail.” ritization of mortgages grams to illustrate how com- through Fannie Mae and plex concepts actually work. Freddie Mac. He also His review is not just focused explains in easy-to-understand terms how credit deriva- on the United States, but is tives work and identifies nine characteristic mistakes in also international in scope, using financial models. including the global implica- In the course of the crisis, the U.S. Treasury injected tions of the financial crisis taxpayer funds into more than six hundred financial insti- such as the dangers of trade tutions, a number so incredibly high that it cannot possibly protectionism and the organi- Too Big to Save? by support a coherent theory of “too big to fail.” Pozen argues zation of the International Robert Pozen persuasively that Congress should establish narrow crite- Monetary Fund. Pozen ria for bailing out banks and then apply the criteria (if at explains how international all) in a disciplined and transparent process. Here, Pozen capital requirements for large banks ironically encouraged could come down harder on the moral hazard created by banks to invest in riskier assets and that the Basel II “too big to fail,” which is ultimately a flawed policy that reforms relied too much on models and on credit rating should be avoided. agencies’ opinions. Pozen assesses the crisis through his compelling con- Sorkin’s book is entertaining as a tabloid version of cept of one-way capitalism. In his view, U.S. taxpayers the crisis, filled with juicy stories and well-drawn portraits shouldered most of the risk of loss in rescuing financial of big personalities. Pozen’s instruction is more substan- institutions, but did not bargain for enough of the poten- tive. He recognizes that institutions are more than just the tial benefit. For example, in late September 2008 Warren men and women who run them. Whether you agree with Buffett received 100 percent warrant coverage when he Pozen or not on his specific recommendations, you have purchased Goldman Sachs’ preferred stock. Two weeks to concede that he has made a great contribution to the later, the Treasury received only 15 percent warrant cov- debate about where we go in the aftermath of such a pro- erage for its purchase of Goldman’s preferred stock. Pozen found crisis. ◆ SPRING 2010 THE INTERNATIONAL ECONOMY 57.

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