A Lonely Success

Don’t forget: the bailouts worked.

People working inside Lehman Brothers’ New York headquarters on Sept. 16, 2008, two days after the firm collapsed. September is the month for anniversaries from hell. Last week we remembered 9/11, and this week it’s time to recall the collapse of Lehman Brothers. Most of the discussion about the financial crisis has focused on a question that won’t go away: could the fall of Lehman have been prevented? For many this was the cardinal error that sparked the crisis. Others believe that Lehman was the precipitating factor, but that the financial system was so highly leveraged that something or other would eventually have broken its back.

We will never know what would have happened if Lehman had not failed. But we can be fairly sure that without its collapse, it would have been impossible to shock the political system into action. In the month after the fall, the U.S. government made a series of massive moves to restore stability to the financial system. And it’s clear that those actions saved the American—and thus the global—economy from total collapse.

Consider the facts. After the fall of Lehman, credit froze in the U.S. economy. Banks stopped lending to anyone, even Fortune 500 companies with gold-plated credit. People couldn’t get consumer and car loans at any price, businesses couldn’t get short-term loans to meet payroll. Private-sector borrowing—the lifeblood of modern economies—fell from 15 percent of GDP in late 2007 to minus 1 percent of GDP in late 2008.

The effects on the broader economy were immediate. GDP shrank by 6 percent in one quarter. Some 1.7 million people lost their jobs, the biggest drop in employment in 65 years, which was then exceeded in the next quarter when 2.1 million jobs evaporated. The net worth of American households decreased by $5 trillion, falling at the unprecedented rate of 30 percent a year. The worldwide numbers did not look much better. The contraction in global trade in late 2008 and early 2009 was worse than in 1929 and 1930. In other words, we were surely headed for something that looked like a Great Depression.

The U.S. government’s actions stopped the fall. Between the passage of the Troubled Asset Relief Program (TARP) and the massive quantitative easing of the Federal Reserve, markets realized that the government was backstopping the financial system, that credit was beginning to flow again, and that if no one else was going to inject capital into the system, the U.S. government would do so. Part substance, part symbolism, the effect was to restore confidence and stability to the system. In fact, the financial system bounced back so fast that the government will likely recover almost 90 percent of the funds it committed during those months, making this one of the cheapest financial bailouts in history.

The best evidence that TARP worked is that now, most people think it was unnecessary. In fact, about 60 percent of the country thinks it was a bad idea. Congressmen and senators who supported it now distance themselves; the most powerful line of attack against any of them tends to be that they voted for the bailouts. JFK said that victory has 100 fathers, and defeat is an orphan. But this is the strange case of a success that no one wants to claim.

Bank bailouts have always been unpopular. People hate to pay the bills for other people’s improvidence, and they detest having to do so for rich people. Viewed in moral terms, TARP is unconscionable. Financial institutions created the mess, and yet they were the ones being bailed out. But governance is sometimes about practical realities. Had the financial system gone under, the American economy would have come to a standstill. It very nearly did. We had to save the banks to save the economy.

The remarkable aspect of TARP, in retrospect, was the bipartisanship that made it possible. Hank Paulson and Barney Frank became comrades in arms. George W. Bush cooperated with Nancy Pelosi. Conservative Republicans endorsed a vast government appropriation. Liberal Democrats supported a bank bailout. The fact that people of wildly differing political persuasions all came to the conclusion that this was the right policy should be some proof that it was not ideologically motivated. For a moment in September 2008, Washington worked.

Alas, it won’t happen again. It took a crisis to concentrate the minds of politicians. The American system had a heart attack and we responded fast and well. Unfortunately, the problems we face in the future are less like heart attacks and more like cancer—problems that if unattended will grow and metastasize. In the long run, though, they’ll have the same effect on the patient.