The Social Structure of Financial Crisis Governance, 1974 and 2008
Pierre-Christian Fink Columbia University
Running head: Financial Crisis Governance
Word count: 7,100
* Pierre-Christian Fink, Department of Sociology, Columbia University, 606 West 122nd Street, MC 9649, New York, NY 10027. E-mail: [email protected]. FINANCIAL CRISIS GOVERNANCE 2
The Social Structure of Financial Crisis Governance, 1974 and 2008
Abstract: Crises are moments of uncertainty in which existing routines no longer apply.
Yet across some crises, patterns of governance repeat themselves. This article defines the conditions under which crisis governance is partially predictable, and identifies mechanisms operative in such cases. The argument is developed through a comparison of governance during the financial crises of 1974 and 2008, drawing on original archival research. In both cases, the institutional set-up led to the Federal Reserve becoming the leading institution in crisis governance. The Federal Reserve recombined forms of expertise from its two main departments (monetary policy and financial regulation) that are separate during normal times. As a consequence, it conceived of both crises as runs not on banks but on the money market, through which banks and other institutions increasingly fund themselves. Because the framing of the crisis as a money-market run implied even more risk—a disaster for the entire economy—than that of a bank run, the Federal Reserve hid its framing from Congress and the public. To solve the crisis, the Federal Reserve and its allies from banks and executive agencies sought to stabilize the money market by repurposing old tools to create so-called funding facilities. Only as a complement to this effort did bail-outs of banks take place.
Key words: Disaster, Financial Sociology, Political Sociology, Archival Research
FINANCIAL CRISIS GOVERNANCE 3
The Social Structure of Financial Crisis Governance, 1974 and 2008
In the wake of 2008, sociologists have increasingly sought to explain crisis governance. A line of research focused on the micro level identifies “unplanned, trial-and- error [action by] a policy apparatus reaching its limits” (Thiemann 2018:195). Existing regulations had failed to prevent the crisis and existing tools such as the Federal Reserve’s discount window proved insufficient to resolve the acute problems in the financial system.
Confronted with uncertainty, actors were forced to improvise and wound up bailing out banks (Jacobs 2012; Swedberg 2010). Scholars working in this line of research stress that crisis governance happens “in the heat of the moment” (Lazar 2006:268) and strive to
“recover a sense of the contingency that surrounds all decisions” during crises (Lamoreaux
2001:632). They claim that “[c]risis is resistant to epistemologies of causal uniform regularities” (Steinmetz 2018:n.p.; similarly Gibson 2011; Sewell 2005).
Yet scholars taking a macro approach highlight that the outcome of crisis governance is remarkably consistent: the financial system is being rescued (Roitman 2014).
These scholars argue that contingency is restricted to the surface, while further down there is “a determinate direction to history” (Konings 2018b:208). The details of bailouts differ
(Culpepper and Reinke 2014; Woll 2014) but their existence is one of the “systematic features of [the contemporary] financial regime” (Konings 2018a:18). “Never do we have more certainty about the need to maintain capitalism’s key institutions than at times when the banks seem about to fail and we face genuine uncertainty” (Konings 2017:n.p.).
However, this line of research is still grappling with “a residual teleology or functionalism” FINANCIAL CRISIS GOVERNANCE 4
(Konings 2018b:207). If uncertainty exists, i.e., if pre-crisis routines no longer work, how can actors accomplish a financial rescue again and again?
This paper takes a comparative approach to answer this question. Original archival research into the crisis of 1974—at the time the most severe one since the Great Depression
(Grossman 2010:266–69; Spero 1980)—is combined with a synthesis of revisionist scholarship on the crisis of 2008 (Judge 2017; Mehrling 2017; Ricks 2016; Tooze 2018).
In both crises, the Federal Reserve communicated to the public that the crisis was one of banks but internally understood the crisis as one of the money market. The money market had emerged during the 1950s and 1960s as a major source of funding for financial and other corporations (Battilossi 2010; Stigum and Crescenzi 2007). In 1974 and 2008, the
Federal Reserve was most concerned with the freezing of this market and tried to render it liquid through new tools, so-called funding facilities. Only as a complement to this strategy did it engage in bailouts of banks.
Based on this empirical finding, it becomes possible to explain why crisis governance under certain conditions exhibits chaos on the surface and order below. Faced with uncertainty, actors at the core of crisis governance develop a new frame, but they strategically conceal the new frame from the periphery. This pattern is predictable because it is shaped during normal times. First, whether the core of crisis governance is one government institution or a government-wide initiative depends on the institutional set-up for dealing with a conventional problem below the threshold of crisis. In the case of financial regulation, that set-up isolates institutions, blocks cooperation, and makes the
Federal Reserve the first mover. Second, a new framing of a crisis does not arise de novo FINANCIAL CRISIS GOVERNANCE 5
but as a recombination of existing concepts and data sources. The Federal Reserve, which is not only a financial regulator but also implements monetary policy, is uniquely well- positioned to develop a framing of financial stability that is centered on the money market.
The concealment of a frame is particularly likely in the governance of financial crises because they are endogenous (Block 1977; Merton 1948; Swedberg 2012). In other crises, such as a drug scandal, regulatory action cannot worsen the problem. A drug does not become more dangerous because the Food and Drug Administration shares information about its toxicity. In finance, however, regulators may deepen the crisis if they disseminate an understanding of the problem that is more pessimistic than that of the audience.
This paper makes the double talk of central actors visible by drawing on data that was confidential during the crises. For the events of 1974, the papers of Federal Reserve governor Andrew F. Brimmer contain important information not found in other government archives. The postwar archive of the New York Clearing House provides the first inside perspective on private actions during the crisis. After 2008, the size and shape of the Fed’s funding facilities was disclosed as the result of a lawsuit under the Freedom of Information Act over the protest of the Federal Reserve and the New York Clearing
House.
The paper is organized as follows. The next section discusses existing sociological approaches to crises and develops a framework that can account for predictability in crisis governance. The discussion of the cases then begins with a section that provides empirical background on bank runs and money market runs. The following four sections trace crisis FINANCIAL CRISIS GOVERNANCE 6
governance in 1974 from the center (the Federal Reserve) to the periphery (Congress and the public). The discussion brings in the 2008 case for comparison.
CRISIS GOVERNANCE
Sociologists studying crises typically posit a discontinuity from normalcy. Crises are painted as periods of uncertainty in which the usual routines no longer apply. This paper argues that such contingency exists only in some crisis. In other crises, routines from normalcy are recombined in predictable ways. Whether crisis governance will be predictable and if so, which shape it will take, depends on decisions taken before the crisis.
Knowledge
In a crisis, reality overflows existing frames in such a way that action is no longer effective. Actors may or may not become aware of this discrepancy. If they do, they may or may not succeed in developing a new frame.
A new frame does not arise de novo but as a recombination of existing types of expertise (Padgett and Powell 2012). This recombination may take the form of the adoption of a different conceptual framework at the highest level of an organization (Fligstein, Stuart
Brundage, and Schultz 2017). But it may also entail the re-arrangement of data by “research assistants, junior economists, midlevel officials, and also mainframe computers with their glitches and bugs” (Elyachar 2013:147). As regulatory institutions generate much of their data through the implementation of administrative programs, a promising way for such re- FINANCIAL CRISIS GOVERNANCE 7
arrangement is to exploit linkages between parts of the institution that implement different programs and are separate from one another during normal times (Carrigan 2014).
Among financial regulators, the Fed is uniquely well-positioned to create such linkages during crises. It not only regulates banks but implements monetary policy and hence continuously acts in the money market, collecting information that the other regulators do not have access to.
Institutions
This erasure of institutional barriers during crises needs to be institutionally prepared during normal times. In his study of the Cuban missile crisis, Gibson paints a picture of crisis governance by the U.S. government as “fluid and contingent processes at the very bottom of the (sociological) micro-macro continuum” (Gibson 2011:408). High- ranking officials deliberated as a group in which “protocol, status differences, and bureaucratic loyalties were suspended” (2012:7). But this form of decision-making did not arise spontaneously. The group, known as ExComm, had been set up as a new bureaucratic entity after the Bay of Pigs invasion. It was designed for situations in which “incomplete information […] and bureaucratic interests threatened to lead [the President] astray”
(Gibson 2012:51).
For a financial crisis, the famously disjointed U.S. government (Clemens 2006;
Laumann and Knoke 1987) has no corresponding institution that would give rise to fluid discussion. Instead, institutions are set up in such a way that sense-making will tend to take place in each institution individually. Financial problems involve the different institutions in such a way as to bring them into conflict. A financial firm experiencing problems will FINANCIAL CRISIS GOVERNANCE 8
first turn to the Federal Reserve, which is lender of last resort and hence can provide immediate financial support. As soon as the Federal Reserve has extended credit (and wants its money back), it is in conflict with the FDIC (which does not want to pay out money from its insurance fund). The OCC has no tools to intervene during a crisis but every reason to hide its shortcomings as a regulator leading up to the crisis.
The differences in institutional set-up shape the uses to which frames are brought.
In an institutional set-up such as the ExComm, “actors struggle to make sense of that which is occurring [and] to have their interpretations provide the ground for other actors’ actions”
(Reed 2016:38). These are framing contests in which actors try to convince others (Boin et al. 2016:78–101; Kaplan 2008, 2015). In contrast, an institutional set-up such as in financial regulation renders not only the dissemination but also the hiding of a frame potentially effective (Gibson 2014).
EMPIRICAL BACKGROUND: BANK RUNS AND MONEY-MARKET RUNS
A classic run happens when banks fund themselves through deposits from retail customers. A bank takes a $200 demand deposit from a teacher or a $1,000 time deposit from a dentist at an interest rate posted in the bank. In that system, a run happens when depositors fear that a specific bank is making losses and withdraw their deposits. In a self- fulfilling prophecy, such a run can bring down even a solvent bank (Merton 1948).
To preempt bank runs, the U.S. government in 1913 set up the Federal Reserve as a lender of last resort and in 1933 the FDIC as a provider of deposit insurance. The lender of last resort will provide liquidity to a bank that is experiencing a run. The deposit FINANCIAL CRISIS GOVERNANCE 9
insurance will make a run superfluous because depositors know that they will get their money back even if their bank fails.
Beginning around 1950, major U.S. banks shifted their funding away from retail deposits and to the money market, which is not protected by deposit insurance. In that emergent market, the managers of giant pools of money (e.g., the treasurer of General
Motors) would compare the rates of several banks and lend their funds to the bank that provided the best return given risk tolerance, often shifting their deposits every day. Unlike the local retail depositors, the managers of money pools moved funds around nationally and, beginning in the 1960s, internationally, as dollar money markets in London were created and soon rivaled those in New York in size.
A run on the money market happens when the managers of the giant pools of money fear that a bank will not repay them and withdraw their money. While a retail depositor can have her deposit paid out in cash and put that cash under the mattress at home, the treasurers of large firms cannot do so because of the sheer size of their funds. In a so-called flight to safety, they shift their deposits to the U.S. government (short-term Treasury securities) and maybe the highest-status banks, leaving all other money-market borrowers unable to fund themselves. Those other borrowers have to turn to the Fed as lender of last resort.
FEDERAL RESERVE: RECOMBINING FRAMES AND REPURPOSING TOOLS
The top officials at the Federal Reserve became aware of the 1974 crisis almost simultaneously through the central bank’s two main departments: monetary policy and FINANCIAL CRISIS GOVERNANCE 10
banking regulation. In normal times, these departments worked separately. During the crisis, the Federal Reserve combined concepts, data, and tools from both arms.
As monetary-policy maker, the Fed acted through the money markets. Members of its market desk met every morning with traders from major money market participants to learn about their respective views of the market and plans for the day (Lindow 1972:81,
141). The Fed governors in Washington received an update from the market desk about money-market conditions at least daily.1 As new money markets developed in the 1950s and 1960s, the Fed was typically a step behind but with a short delay did learn of the major changes, e.g., by dispatching Fed of New York officials in the early 1960s to London to ferret out information about the emerging eurodollar market (Burn 2006:140–45).
During the crisis, the Fed collected more detailed information about the money market than in normal times. For a “Special Financial Markets Briefing,” a Fed staffer gathered “information from two major dealers.”2 The briefing measured the differential stress in the money market by calculating risk premiums, e.g., for certificates of deposits with a maturity between 60 to 89 days over a 3-month Treasury bill, and of medium-grade over high-grade commercial paper. It also reported where the money market had frozen:
“virtually no sales of [lowest grade paper] are taking place.”3 On the London dollar market, investors no longer lent to any but the best names.4
These money-market conditions put banks under stress. In July, a confidential Fed survey found that regional banks had problems rolling over their certificates of deposit.
Between May and August, the Fed was approached by several regional banks that had trouble funding themselves on the money market.5 FINANCIAL CRISIS GOVERNANCE 11
The Fed did not interpret these issues primarily as problems of individual banks but as signs of the “general uneasiness in the Eurodollar market” and other money markets.6
Already on Sunday, May 12, in the earliest days of the crisis, a report alarmed the Board that a run was happening in the money markets. The report discussed conditions in four money markets (certificates of deposit (CDs), commercial paper, eurodollars, and discount notes):
If such an atmosphere prevails on Monday, it seems distinctly possible that corporate treasurers and other investors in large CDs and bank holding company commercial paper will shift their investment preferences radically. This would probably be manifested in a move toward Treasury bills, a shortening of CD and commercial paper maturities, and increased selectivity (rational or not) in placement of funds with banks and bank holding companies. Eurodollar deposit availability would become very shaky in such an atmosphere. The nonbank commercial paper market, and particularly the market for documented discount notes, would almost surely be dragged along were such a chain of events to be set in motion.7
The Fed combined this knowledge about the money market with its understanding of systemic risk, which grew out of its role as a bank regulator. During the 1960s, the Fed developed models to predict the consequences of the failure of one institution on others
(Özgöde 2015). The 1970 bankruptcy of Penn Central, the largest bankruptcy in U.S. history, reinforced this framing.8 A Fed staff member wrote in a memo for the Committee for Contingency Planning: “our economy cannot function without a viable financial mechanism and the financial mechanism would be destroyed by a confidence crisis […] A confidence crisis would be so disastrous that, if there is danger of one, the Government should be prepared to prevent it.”9 Faced with the situation of 1974, Fed chairman Arthur
F. Burns said in a private conversation: “I […] think I am sitting on a volcano that could blow up at any time and blow this economy apart in the process!” (Barr 1975:308). FINANCIAL CRISIS GOVERNANCE 12
Banks that could no longer fund themselves in 1974 turned to the Federal Reserve as lender of last resort. Under existing law, the Fed lent to a bank that fulfilled two requirements: it had to be solvent and possess good collateral. On May 8, two days before its problems became public, FNB asked for an emergency loan from the Fed of New York and received it. As that initial decision was made, concerning the first requirement, there was maybe not certainty that FNB was solvent, but there was no certainty that it was insolvent. On the second requirement, FNB had good collateral. But very soon—as the crisis deepened and the size of the LOLR loan grew—, both assumptions seemed more and more in doubt. As early as May 14, the Fed Board’s head supervisor drew FNB’s solvency into doubt: “This situation makes even more imperative the formulation of a plan to indicate the condition under which funds are being advanced, and stating plans for repayment.”10 As the emergency loan from the Fed grew, FNB ran out of high-quality collateral and posted lower-quality collateral.11 The Fed soon had “a queasy feeling about the collateral coverage.”12 FNB was robbing Peter to post collateral to Paul: “Some of the securities pledged to us as collateral are withdrawn from time to time to use under rp
[repurchase] arrangements or to substitute for other collateral.”13
Under existing law, the Fed should have stopped the emergency loan. But it did not do so. Fed governor Andrew Brimmer would later explain that “in financing Franklin’s needs for the five months when the Federal Reserve knew that Franklin would ultimately fail, the System had its eyes on a range of considerations extending well beyond Franklin”
(Brimmer 1976:109–10). The credit from the Federal Reserve allowed Franklin to pay out all its money-market creditors. Burns held that making borrowers whole in one transaction FINANCIAL CRISIS GOVERNANCE 13
would reassure all borrowers engaged in that kind of transaction.14 The risk of a failure of
FNB was increasingly borne by the Fed. In this way, the repurposed tool of lender of last resort indirectly stabilized the money market.
NEW YORK CLEARING HOUSE: SHARING THE NEW FRAME BUT AVOIDING THE ENSUING RESPONSIBILITY
The Federal Reserved turned to the New York Clearing House as it attempted to stabilize the money market in a more direct and effective way than was possible with existing tools. Within days of the beginning of the crisis, Fed officials discussed the idea
“[t]hat we essentially back stop or guarantee Fed Funds purchases.”15 The idea was that money market participants should start trading with FNB again. Governor Bucher expected
“that the resumption of federal funds trading would have a very positive psychological effect upon the financial community.”16
It was not clear how the Fed could enroll the money market in such a maneuver.
The General Committee of the New York Money Market was no longer operating, and it had in any case only represented the domestic money market. To speak with the increasingly important eurodollar money market in London, the best option was to place a guest article in Eurodollar magazine, but it appeared only once a month and was semi- public. Under time pressure, the Fed turned to the NYCH. It represented at least a sizable chunk of the dollar and eurodollar money markets, had a formal process to arrive at a decision, and its daily operation as a clearing house for checks meant that there was a practice of collective action. FINANCIAL CRISIS GOVERNANCE 14
The Fed asked the NYCH member banks to resume money-market trading with
FNB. On June 5, the NYCH Committee was called into a special meeting at the building of the Fed of New York. Two Fed governors had come up from Washington. Governor
Holland said that “there was an urgent need to devise an interim federal funds support program for [FNB]. The urgency stemmed from the fact that […] the bank required a psychological lift in the marketplace.”17
The NYCH member banks were not willing to take any risk. They required that the
Fed guarantee the entire federal-funds package and cut the size of the package in half. Even though the NYCH could draw on an ongoing practice that encompassed a formula by which costs were split among its member, two banks initially disagreed with contributing their share to the federal-funds package.18 Finally, the NYCH agreed to the innovation proposed by the Fed: “on motion duly made, seconded and unanimously approved the […]
Resolution was adopted.”19 But the package in its final form did not leave enough impression with the financial community to change the dynamics in the money market
(Zweig 1995:452).
The inaction of the NYCH was the result not of an inability to act collectively but of the structure of the money market. The NYCH member banks actually profited from
FNB’s problems. As a financial journalist observed: “Paradoxically, the Franklin situation has helped the Chase as well as other large banks.”20 In contrast to bank runs of the traditional type, with retail depositors running, wholesale investors could not withdraw their investment and store it as cash. Because of the size of their holdings, the treasurers of large companies who moved their funds out of FNB had to invest them somewhere else. FINANCIAL CRISIS GOVERNANCE 15
Their prime choices were short-running government debt and the money-market instruments of the largest banks. Hence the NYCH member banks had access to ample funds at low interest rates.
A counterfactual case that took place simultaneously shows that the NYCH members did take risks to stabilize a system when they did not benefit from the crisis.
CHIPS (Clearing House Interbank Payment System) was a computer system owned and run by the NYCH that undergirded many transactions in the money market and in the foreign exchange market. It came under stress after a disruption in the settling of foreign exchange contracts. On June 26, 1974, German banking regulators declared a major player in the foreign exchange market, Herstatt bank of Cologne, bankrupt (Mourlon-Druol 2015;
Schenk 2014). The decision was made at 2:40 p.m. Central European Time. At that moment, many foreign exchange deals of Herstatt due that day had been settled in half:
Herstatt had already received the payment in one direction, but its contractors had not received the opposite payment. In New York, the settling partner for Herstatt was Chase
Manhattan bank. After learning of Herstatt’s closure, Chase Manhattan did not carry out payments (Becker 1976). Because major New York City banks did not receive payments from Chase, they in turn did not make payments. CHIPS was frozen.21 Citibank boss Walter
Wriston orchestrated the restart of payments and took on his own bank the risk of making the first payment (Zweig 1995:455–60).22 FINANCIAL CRISIS GOVERNANCE 16
FEDERAL DEPOSIT INSURANCE CORPORATION: RESISTING ATTEMPTS TO BE CONVINCED OF THE NEW FRAME
After the tools available to the Fed had proved insufficient to stabilize the money market and the NYCH had rebuffed the Fed’s effort to become enrolled in stabilization, the Fed decided to engineer a bailout of Franklin in such a way that no money-market investor would lose money. Under existing law this required the Federal Deposit Insurance
Corporation to make an exception. Usually, the law called for the FDIC to liquidate an insolvent bank and to pay out the insured depositors from the FDIC’s insurance fund. In this case money-market investors would lose their funds, as they were not insured. Money- market investors would only receive their money back if the FDIC decided that it would be cheaper for the insurance fund to merge the insolvent bank with a healthy one. The Fed called for a merger in “the larger issue of the stability of the financial markets.”23 The Fed’s deputy general counsel provided a legal analysis of how much flexibility could be read into the FDIC Act in order to avoid a liquidation of FNB.24
The Fed received support from the Treasury. The deputy secretary of the Treasury,
Gardner, had managed a bank in Philadelphia and expanded its money-market operations.
He framed the crisis as one of the money market: “the FDIC insurance in a simple liquidation applies only to the extent of $20,000 of depositors’ funds. The regulators, to protect all depositors, are developing a plan that will pay out the full amount of deposit liability or assure its safety. A premature disclosure and an aborted plan could have enormously disruptive effects on the financial markets.”25 Gardner had an impact on his boss. In a meeting with Wille, “Secretary Simon said that in his view it was unthinkable FINANCIAL CRISIS GOVERNANCE 17
that we would permit the bank to be liquidated.”26 For their claim that a default on the uninsured deposits would let the sky fall down, the Fed and the Treasury found willing collaborators in the banks. In conversations with the regulators, bankers repeatedly used the word “disastrous” to describe the consequences of such a default.27
The FDIC—an institution independent from the Federal Reserve and the
Treasury—did not frame the crisis as one of the money market but rather traditionally. Its chairman Frank Wille put FNB in a line of bank failures that were caused by problems at the level of the individual bank.28 He was “an almost obsessively methodical and scrupulous attorney.”29 The law did not call for the FDIC to take into account larger concerns about financial stability and so, in a conversation with the CEO of a major bank, he “noted that an option was liquidation of FNB.”30 By early June, he had his staff work on a contingency plan to take control of FNB and requested from the OCC, according to a memo, “information about insured and noninsured deposits.”31 In his copy, Fed governor
Brimmer underlined the words “insured and noninsured deposits.” For the Fed, this was distinction was fatal: the FDIC should not only make retail depositors but also money- market investors whole. The FDIC pushed back against the Fed, arguing that it was bound by law to look at one bank at a time and not to take into account possible repercussions for the entire financial system (Horvitz 1975:597). The FDIC’s head of research argued that
“it is irresponsible to argue that the FDIC can simply ignore existing law […] If the payoff of a large bank is really unthinkable, as many observers feel, then that fact should be reflected in the law” (Horvitz 1975:600). FINANCIAL CRISIS GOVERNANCE 18
And yet the FDIC went along with avoiding a liquidation of FNB for a different reason. According to Wille, if the FDIC had paid out FNB’s creditors, the FDIC’s fund would have been depleted to the point of being almost empty. It was doubtful whether the remaining small fund would still create confidence should another bank get into trouble.32
As one FDIC official admitted: “Given the finite size of the deposit insurance fund, payoff of the largest banks in the country is impossible” (Horvitz 1975:595). And so the FDIC finally arranged for a merger of Franklin that it assisted. It took over the worst assets from
FNB and allowed banks to bid for the better assets. On October 8, they were bought by
European-American Bank, a consortium of European banks interested in increasing their presence in the U.S. market.
CONGRESS AND THE PUBLIC: BEING KEPT UNAWARE OF THE NEW FRAME
The crisis of 1974 came to the attention of the public as a potential failure of the
Franklin National Bank of New York. In one of the first stories on the crisis, a New York
Times reporter—expecting a traditional bank run—visited a branch of FNB in the Financial
District and counted the people who withdraw cash at the teller window.33 He reported little activity. What the reporter missed was that in the same building but in its back offices,
FNB’s traders were on the phones, frantically trying to find money-market funding to keep the bank afloat until the next day.
During the crisis summer of 1974, the Fed and its allies kept many actions out of the public’s eye. In a letter to the head of the German central bank, Burns called the FINANCIAL CRISIS GOVERNANCE 19
possibility that details of the crisis management could “be drawn into the political arena at a high level […] a development that I am sure would be of as deep concern to you as it would be to me.”34 Discussions between the Fed and its private collaborators closed with the sentence: “There will be no distribution made to the Congress or to the press.”35
This line of action had been planned. A “strictly confidential” contingency plan for a future financial crisis drawn up by Fed staff in 1970 laid out that the public should be kept out whenever possible. “The mood of Congress in this situation, it seems safe to surmise, would […] not be dissimilar from the reactions of a beehive split open with the sudden blow of a heavy stick: violently roused from familiar behavior patterns, uncertain where to turn, but worked up and looking for something to sit on and sting.”36
The most prominent legislator on banking, House Banking Committee chairman
Wright Patman, accused the Fed right after its first actions in the crisis of acting “in secret.”37 He expressed his fear that “[t]he American public and the Congress will never know” enough about the regulators’ actions to judge them.38 Over the course of the crisis,
Patman repeatedly demanded information from the regulators. His attempts were blocked.39
In addition to outright secrecy, the Fed employed a strategy of communicating some of its actions but framed in as traditional a way as possible. In instances where the Fed judged it impossible to keep the beehive undisturbed, the effort was to not split it open but to carefully blow smoke into it. The Fed gave particular attention to its first public statement, a press release. Written over the first weekend of the crisis, the draft was circulated among Board members with a rare “Special” label alerting them to its FINANCIAL CRISIS GOVERNANCE 20
importance. The Fed predicted correctly how much attention the press release would get.
The New York Times printed it verbatim. It would shape the future terms of public debate.
The press release spoke only of Franklin National Bank. The Fed painted the image not of a crisis outrunning existing laws but rather of a problem at one bank, easily understood with existing categories and taken care of with existing tools.40 This effort to quarantine the problem was carried through as the crisis went on. A speech delivered by the Fed chairman in the summer of 1974 was summarized as follows by a business journalist: “Chairman Burns’ assessment of the financial structure […] was, in effect, yes, there are problems, but Franklin National was an isolated situation brought on by inadequate management. The financial structure of the country is sound.”41 This was the opposite of the Fed’s internal framing of the crisis, which saw Franklin as the pivot of the problem but that problem as encompassing the entire financial system, whose structure had changed so markedly with the rise of money-market funding.
Very few actors were in a position to inform the public about the framing that dominated on the inside. One candidate was Patman. His team of staffers had, with mixed success, for years tried to get as much information as possible about the money market out of the Fed and the banks. In his first press release after the crisis began, he mentioned the rise of the money market as one cause of the crisis: “Franklin National is one of the big banks which took advantage of the Federal Reserve’s promotion of high interest certificates of deposit. These misguided policies helped push many large banks into CD’s in heavy amounts and I am sure this is one of the problems which the Federal Reserve is attempting to bail out at Franklin National now. So we are seeing not only a bail-out of Franklin FINANCIAL CRISIS GOVERNANCE 21
National, but a bail-out of misguided monetary and banking policies pursued by the Federal
Reserve System.”42 But Patman could not pry the information that he would have needed to substantiate that hunch in the crisis from the Fed and its collaborators. Patman also had a difficult reception. Even while many newspapers cited liberally from Patman’s press release, the left out the passage about the money market.43
The difficulty to introduce the structure of the financial run as a topic of political debate among the public can be seen clearly in the reception of the book The Bankers
(1974) by the financial journalist Martin Mayer. It was published in December 1974 and, in early 1975, became a bestseller and book-of-month club choice. Mayer explained the rise of the money market as a “silent revolution in banking.” Mayer’s insistence on the importance of the structural changes in finance was criticized across the political spectrum.
From the right, Erich Heinemann, an analyst for Morgan Stanley, dismissed Mayer’s diagnosis of “structural faults in the industry” by arguing that these changes had been made by rational actors and hence could not be bad.44 From the left, the journalist David
Hapgood, author of the book The Screwing of the Average Man, criticized Mayer for overlooking what he saw as the main culprit: crony capitalism. “There is something drastically wrong with the focus of a 545-page book on The Bankers which does not include
Nelson A. Rockefeller in its index.”45
DISCUSSION: COMPARISON WITH THE 2008 CRISIS
Comparison of the two cases establishes similarities in both the creation of funding facilities and in the secrecy about them. Ten years after the crisis of 2018, a burgeoning FINANCIAL CRISIS GOVERNANCE 22
interdisciplinary literature proposes a new account of how the U.S. government managed the crisis (Judge 2017; Mehrling 2017; Ricks 2016; Tooze 2018). While attention has previously focused on bailouts (Culpepper and Reinke 2014; Woll 2014), the emphasis is now on funding facilities. They are described as the “decisive innovation of the crisis,” an action of “historic and lasting significance” (Tooze 2018:11). Through them, the American government entered into transactions with private traders who were no longer willing to trade with one another. It did so primarily in the money markets that financial and non- financial firms use to fund themselves over the short term (as short as one day). The bank bailout had a volume of 700 billion dollars, whereas that of the funding facilities was as high as 29 trillion dollars (Tooze 2018:202–19).
In 2008, just as in 1974, insiders and outsiders spoke about one crisis but meant different things, and insiders tried to keep it that way. There were frontpage stories,
Congressional debates, and bestseller books (Sorkin 2009). But these all focused on the bailout part of crisis management.
On Capitol Hill, while controversy swirled around TARP [the bailout program], there was silence about the Fed’s gigantic global liquidity effort. As one senior New York Fed official remarked, it was as if a “guardian angel was watching over us.” If some members of Congress understood what was going on, they thought better of discussing the Fed’s actions openly. The reality of global financial policy disappeared in a “spiral of silence,” in which it suited both the Fed and its collaborators to bury the reality of massive and explicitly hierarchical interdependence. (Tooze 2018:219)
CONCLUSION
This paper has developed a theory that accounts for the partial predictability of governance in crises under certain conditions. It has shown that the degree of such predictability is predetermined during normal times. When the institutional set-up for FINANCIAL CRISIS GOVERNANCE 23
handling normal problems below the crisis threshold isolates institutions from one another, action during crises will be mainly determined by the features of existing institutions. In a crisis, an institution can improvise in predictable ways by recombining its usually separate functions.
Archival research into the financial crisis of 1974 and a synthesis of recent scholarship on the 2008 crisis has shown that crisis governance was similar and to a large degree predictable. In both cases, the institutional set-up led to the Federal Reserve becoming the leading institution in crisis governance. The Federal Reserve recombined knowledge and tools from its two main departments (monetary policy and banking regulation), which are separate in normal times. As a consequence, the Fed conceived of both crises as runs on the money market. To govern this crisis, the Fed sought to enroll some actors and kept others in the dark.
This finding helps to explain why reforms after the 2008 crisis have been shallow
(Coombs 2017; Helleiner 2014; Münnich 2016). The Federal Reserve and its allies covered the tracks of the money market crisis. Unaware of the insiders’ framing, Congress and the public only had a severely restricted range of policy proposals available for debate.
FINANCIAL CRISIS GOVERNANCE 24
ENDNOTES
1 Daily interest-rate reports, Gerald R. Ford Library, Arthur F. Burns Papers (AFB), Box
B34, Folder “Exchange Rates, 1971–1975.”
2 James L. Kichline, “Special Financial Markets Briefing,” June 3, 1974, p. 4, Brimmer
Papers, Box 173, Folder 5.
3 ibid., p. 2.
4 Edward C. Etting to J. Charles Partee, July 11, 1974, AFB, Box B89, Folder “President
– Meetings with, 7/11/74 and 8/20/74.”
5 American Bankshares Corporation: John E. Ryan to Board of Governors, May 24, 1974,
Brimmer Papers, Box 173, Folder 7; Fidelity: Brenton C. Leavitt to Board of Governors,
July 5, 1974; Brimmer Papers, Box 173, Folder 6; First Maryland: Brenton C. Leavitt to
Board of Governors, June 11, 1974, Brimmer Papers, Box 173, Folder 5; National Bank of Detroit: J. E. Ryan to Board of Governors, August 9, 1974, Brimmer Papers, Box 173,
Folder 6.
6 J. E. Ryan to Board of Governors, August 9, 1974, Brimmer Papers, Box 173, Folder 6.
7 Samuel B. Chase, Jr. and Edwin M. Wess to Board of Governors, May 12, 1974,
Harvard University, Baker Library, Andrew F. Brimmer Papers, Box 173, Folder 7.
8 Peter Keir to Arthur F. Burns, June 30, 1970, https://fraser.stlouisfed.org/archival/1193/item/3508, accessed on December 16, 2017.
FINANCIAL CRISIS GOVERNANCE 25
9 Eleanor J. Stockwell to Committee for Contingency Planning, June 4, 1970, pp. 8, 2,
AFB, Box B37, Folder “Federal Emergency Loan Programs, 1970-1971”; see also
Anonymous (Federal Reserve Bank of New York?), “Consequence of a Shutdown of the
Penn Central Railroad”, October 1, 1970, AFB, Box B88, Folder “Penn Central, August–
November 23, 1970.”
10 Brenton C. Leavitt to Board of Governors, May 15, 1974, Brimmer Papers, Box 173,
Folder 9.
11 Steven M. Roberts to Andrew F. Brimmer, July 24, 1974, Brimmer Papers, Box 173,
Folder 6.
12 Brenton C. Leavitt to Board of Governors, June 7, Brimmer Papers, Box 173, Folder 5; see also Brenton C. Leavitt to Board of Governors, June 21, 1974, Brimmer Papers, Box
173, Folder 5; and Brenton C. Leavitt to Board of Governors, July 1 and 2, Brimmer
Papers, Box 173, Folder 6.
13 Brenton C. Leavitt to Board of Governors, June 7, 1974, Brimmer Papers, Box 173,
Folder 5.
14 Arthur F. Burns to Karl Klasen, August 8, 1974, AFB, Box B56, Folder “Herstatt
Bank.”
15 Brenton C. Leavitt to Board of Governors, May 16, 1974, Brimmer Papers, Box 173,
Folder 9.
FINANCIAL CRISIS GOVERNANCE 26
16 Minutes, June 5, 1974, p. 72, Columbia University, Rare Book and Manuscript Library,
New York Clearing House Archive (NYCH), Committee Minutes, vol. 14.
17 Minutes, June 5, 1974, p. 72, NYCH, Committee Minutes, vol. 14.
18 Minutes, June 7, 1974, p. 75, NYCH, Committee Minutes, vol. 14.
19 ibid.
20 Albert L. Kraus, “Observation posts: New York.” Euromoney, November 1974, p. 62.
21 John F. Lee to Gordon T. Wallis, July 18, 1974, NYCH, Committee Files, Box 12,
Folder “July 24, 1974.”
22 Minutes, July 1, 1974, pp. 76–77, NYCH, Committee Minutes, vol. 14.
23 Task Force for Reforming the Structure of Regulatory Agencies Supervising Banking
Organizations and Related Depository Institutions to Committee on Regulations, Bank
Supervision and Legislation, September 25, 1974, AFB, Box B7, Folder “Bank
Regulatory Reform, October 1974.”
24 Baldwin B. Tuttle to Board of Governors, July 10, 1974, Brimmer Papers, Box 173,
Folder 6.
25 Stephen S. Gardner to William E. Simon, October 8, 1974, WES, Drawer 22, Folder
57.
26 Brenton C. Leavitt to Board of Governors, June 21, 1974, Brimmer Papers, Box 173,
Folder 5.
FINANCIAL CRISIS GOVERNANCE 27
27 Brenton C. Leavitt to Board of Governors, July 11 and 12, Brimmer Papers, Box 173,
Folder 6.
28 Albert L. Kraus, “What happens after Franklin?”, Euromoney, June 1974, pp. 68–69.
29 Chris Welles, “The Needlessly High Cost of Folding Franklin National”, New York,
November 18, 1974, pp. 71–81, here p. 75.
30 Brenton C. Leavitt to Board of Governors, July 8, 1974, Brimmer Papers, Box 173,
Folder 6.
31 Brenton C. Leavitt to Board of Governors, June 3, 1974, Brimmer Papers, Box 173,
Folder 5.
32 Frank Wille, “The FDIC and Franklin National Bank: A Report to the Congress and all
FDIC-Insured Banks.” Speech before the Annual Convention of the Savings Banks
Association of New York State, Boca Raton, Florida, November 23, 1974. Printed in
Bank failures, regulatory reform, financial privacy: hearings before the Subcommittee on
Financial Institutions Supervision, Regulation and Insurance of the Committee on
Banking, Currency and Housing, House of Representatives, Ninety-fourth Congress, first session, on H.R. 8024, Part 2, 1975, pp. 1038–1089, here p. 1052.
33 George Vecsey, “Bank Branch Gets Patrons’ Loyalty”, New York Times, May 14,
1974.
34 Arthur F. Burns to Karl Klasen, August 8, 1974, AFB, Box B56, Folder “Herstatt
Bank.”
FINANCIAL CRISIS GOVERNANCE 28
35 Joseph W. Barr to Frank Wille, September 26, 1974, WES, Drawer 22, Folder 57.
36 Robert Solomon to Arthur F. Burns, December 10, 1970, p. 5, AFB, Box B34, Folder
“Eurodollars, November–December 1970.” The press was seen as worse: “Apart from a handful of the more sophisticated papers with able financial staffs, the press in this country will have still less of a grip than Congress on why the crisis has arisen and what should be done about it.” (ibid, p. 6)
37 Press release, Patman Papers, Box 504A, Folder “5/13 Statement on Franklin
National.”
38 Press release, Patman Papers, Box 504A, Folder “5/13 Statement on Franklin
National.”
39 Press release, Patman Papers, Box 504A, Folder “7/10 Statement on Franklin
National.”
40 The press release also contained more generic language to play down the crisis. It noted that “Chairman Burns, who is in Europe, has been kept informed of developments. Since this matter does not require his personal attention, he has no intention of changing his travel plans.”
41 Albert L. Kraus, “Capital market questions after Nixon,” Euromoney, September 1974, pp. 56–57, here p. 56.
42 Press release, Patman Papers, Box 504A, Folder “5/13 Statement on Franklin
National.”
FINANCIAL CRISIS GOVERNANCE 29
43 Articles in the May 14, 1974 issues of Jersey Journal, Dayton Journal Herald, and
Cincinatt Inquirer.
44 Erich Heinemann, “A Flawed Analysis of Banking,” New York Times, February 9,
1975.
45 David Hapgood, “The Bankers,” New York Times, January 26, 1975.
FINANCIAL CRISIS GOVERNANCE 30
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