After the Music Stopped
The Financial Crisis, the Response, and the Work Ahead
Named one of the Ten Best Books of 2013 by Michiko Kakutani and the New York Times Book Review
“Blinder is a master storyteller . . . one of the best books yet about the financial crisis.” —The Wall Street Journal
Alan S. Blinder—esteemed Princeton professor, Wall Street Journal columnist, and former vice chairman of the Federal Reserve Board under Alan Greenspan—is one of our wisest and most clear-eyed economic thinkers. In After the Music Stopped, he delivers a masterful narrative of how the worst economic crisis in postwar American history happened, what the government did to fight it, and what we must do to recover from it. With bracing clarity, Blinder chronicles the perfect storm of events beginning in 2007, from the bursting of the housing bubble to the implosion of the bond bubble, and how events in the U.S. spread throughout the interconnected global economy. Truly comprehensive and eminently readable, After the Music Stopped is the essential book about the financial crisis.
From AFTER THE MUSIC STOPPED by Alan Blinder. Reprinted by arrangement of The Penguin Press, a member of Penguin Group (USA), Inc. Copyright (c) 2013 by Alan Blinder.
WHAT’S A NICE ECONOMY LIKE YOU DOING IN A PLACE LIKE THIS?
We came very, very close to a global financial meltdown.
—Federal Reserve Chairman Ben S. Bernanke
Did anyone get the license plate of that truck?
That’s how many Americans felt after our financial system spun out of control and ran over all of us—almost literally—in 2008. The U.S. economy was crawling along that summer, with employment drifting down, spending weakening, and the financial markets suffering through a gutwrenching series of ups and downs—mostly downs. The economy was hardly in great shape but neither was it a disaster area. It wasn’t even clear that we were headed for a recession, never mind the worst recession since the 1930s. Then came the failure of Lehman Brothers, the now-notorious Wall Street investment bank, on September 15, 2008, and everything fell apart. Yes, the license plate of that truck read: L-E-H-M-A-N.
Most Americans were innocent bystanders who didn’t know where the truck came from, why it was driven so recklessly, or why the financial traffic cops didn’t protect us better. As time went by, shell shock gave way to anger, and with good reason. A host of financial manipulations that ordinary people did not understand, and in which they played no part, cost millions of them their livelihoods and their homes, bankrupted many businesses, destroyed trillions of dollars’ of wealth, brought the once-mighty U.S. economy to its knees, and left all levels of government gasping for tax revenue. If people felt as though they were mugged, it’s because they were.
The financial “accidents” that took place between the summer of 2007 and the spring of 2009 had severe consequences, which Americans experienced firsthand. But most citizens are baffled, and many are extremely displeased, by what their government did in response to the crisis. They question the justice of the seemingly large costs taxpayers had to bear, and they wonder why so many reckless truck drivers are still on the road, prospering while other Americans suffer. Perhaps most of all, they are anxious about what the future may bring. As late as the 2012 election, a strong majority of Americans were telling pollsters that the country was still “on the wrong track” or “heading in the wrong direction.” No wonder we heard populist political thunder from both the Right (the Tea Party movement) and the Left (the Occupy movement).
The United States recently completed the quadrennial spectacle we call a presidential election with a plainly angry electorate. While President Obama won reelection, no one yet knows what the 2012 election will bring in its wake. But we do know that the last chapters of the story that began in 2007 are yet to be written. So let’s start by looking back. What hit us—and why?
A VERY BRIEF HISTORY OF THE FINANCIAL CRISIS AND THE GREAT RECESSION
Historical perspective accrues only with the passage of time, and we are still living through the aftermath of the frightening financial crisis and the Great Recession that followed closely on its heels. (Economists date the end of a recession as when the economy stops contracting, which came in June 2009. But the public seems to consider “recession” an approximate synonym for “hard times,” which are clearly still in progress.)
But enough time has now elapsed, and enough dust has now settled, that some preliminary judgments can be made. Consider this book a second draft of history. There will doubtless be thirds and fourths.
It is vital that we reach some preliminary verdicts relatively quickly because Americans’ well-justified anger is affecting—some would say, poisoning—our political discourse. This book concentrates on the what and especially the why of the financial crisis and its aftermath. It’s a long and complicated story, but some understanding is essential for the better functioning of our democracy. So before getting enmeshed in the details, here is a very brief history of the financial crisis, the Great Recession, and the U.S. government’s responses to each. It will take only four paragraphs. The fourth may surprise you.
The Supershort Version
The U.S. financial system, which had grown far too complex and far too fragile for its own good—and had far too little regulation for the public good—experienced a perfect storm during the years 2007–2009. Things started unraveling when the much-chronicled housing bubble burst, but the ensuing implosion of what I call the “bond bubble” was probably larger and more devastating. The stock market also collapsed under the strain, turning many 401(k)s into—in the dark humor of the day—“201(k)s.” When America’s financial structure crumbled, the damage proved to be not only deep but wide. Ruin spread to every part of the bloated financial sector. Few institutions or markets were spared, and the worst-affected ones either perished (as in the case of Lehman Brothers) or went on life support (as in the case of Citigroup). We came perilously close to what Federal Reserve Chairman Ben Bernanke called “a global financial meltdown.”
Some people think of the financial markets as a kind of glorified casino with little relevance to the real economy—where the jobs, factories, and shops are. But that’s wrong. Finance is more like the circulatory system of the economic body. And if the blood stops flowing . . . well, you don’t want to think about it. All modern economies rely on a variety of credit-granting mechanisms to circulate nutrients to the rest of the system, and the U.S. economy is more credit-dependent and “financialized” than most. So when the once-copious flows of credit diminished to mere trickles, the economy nearly experienced cardiac arrest. What had been far too much liquidity and credit during the boom years quickly turned into vastly too little. The abrupt drying-up of credit, from both banks and the so-called shadow banking system, coupled with the massive destruction of wealth in the forms of houses, stocks, and securities, produced what you might expect: less credit, less buying, and a whopping recession.
The U.S. government mobilized enormous resources to alleviate the financial distress and, more important, to fight the recession. Congress expanded the social safety net and enacted large-scale fiscal stimulus programs. The Federal Reserve dropped interest rates to the floor, created incredible amounts of liquidity, and expanded its own balance sheet by making loans, purchasing assets, and issuing guarantees the likes of which it had never done before. Many of the Fed’s actions were previously unimaginable. I remember coming into class one morning in September 2008, scratching my head in disbelief and saying, “Last night the Federal Reserve, which has never regulated an insurance company, nationalized one!” The company was the infamous AIG.
Now the surprise: It worked! Not perfectly, of course. But for the most part, the financial system healed faster than most observers expected. (Remember, healing in this context does not mean returning to the status quo ante. We don’t want to do that.) And the economy’s contraction, though deep and horribly costly, turned out to be both less severe and shorter than many people had feared. Only the homebuilding sector, a small share of our economy, experienced anything close to Great Depression 2.0. For the rest, unemployment never quite reached 1983 levels, never mind 1933 levels. That doesn’t mean everything was hunky-dory by, say, 2012. Far from it. But the worst, most assuredly, did not happen. So that’s my capsule history, and it suggests a modestly happy ending—or at least a sigh of relief. That said, we are grading on a pretty lenient curve when the good news is that the United States avoided a complete meltdown of its allegedly best-in-class financial system and a second Great Depression. In truth, U.S. macroeconomic performance since the fall of 2008 doesn’t merit even the proverbial gentleman’s C. It has been the worst in post–World War II American history. Give it an F instead.
Congress rewrote the rulebook of finance in 2010, trying to ensure that nothing like this will ever happen again. But the financial reforms are so new—most not yet even in effect—that no one knows how the redesigned regulatory system will work in practice, especially once it comes under stress. And bank lobbyists are fighting the reforms tooth and nail. To turn Rahm Emanuel’s famous principle into a question: Did we waste this crisis or use it as a catalyst for much-needed change? Only time will tell.
List of Acronyms and Abbreviations
PART I. IT HAPPENED HERE
1. What’s a Nice Economy Like You Doing in a Place Like This?
PART II. IT HAPPENED HERE
2. In the Beginning…
3. The House of Cards
4. When the Music Stopped
5. From Bear to Lehman: Inconsistency Was the Hobgoblin
6. The Panic of 2008
PART III. PICKING UP THE PIECES
7. Stretching Out the TARP
8. Stimulus, Stimulus, Wherefore Art Thou Stimulus?
9. The Attack on the Spreads
PART IV. THE ROAD TO REFORM
10. It’s Broke, Let’s Fix It: The Need for Financial Reform
11. Watching a Sausage Being Made
12. The Great Foreclosure Train Wreck
13. The Backlash
PART V. LOOKING AHEAD
14. No Exit? Getting the Fed Back to Normal
15. The Search for a Fiscal Exit
16. The Big Aftershock: The European Debt Crisis
17. Never Again: Legacies of the Crisis
The Wall Street Journal:
"[Blinder] is a master storyteller... [After the Music Stopped] is one of the best books yet about the financial crisis."
Michiko Kakutani, The New York Times:
"Highly readable... Mr. Blinder draws on the work of many... reporters in his account. But if large portions of After the Music Stopped feel familiar, the book nonetheless benefits from its wide-angle perspective, as well as from its vantage point in time, now that it's possible to assess the fallout of decisions that were being made on the run by White House and Treasury officials under extraordinary pressures. It also benefits from Mr. Blinder's clear-eyed prose and nimble gifts as an explainer — gifts that sometimes approach those of Bill Clinton, when it comes to making complicated economic issues and policies understandable to the lay reader. Direct and concise, Mr. Blinder tells it as he sees it."
"Blinder's book deserves its likely place near the top of reading lists about the crisis. It is the best comprehensive history of the episode... A riveting tale."
The New Republic:
"For a reader wondering how we got here, and why the people in charge have seemed, often, to be so chary of stringing up the culprits, or tearing down the system, Blinder's book - not least because his fair-minded approach and pragmatic mindset evokes that of America's current regulators - gives us an invaluable insight."
"What does all the knowledge mean to generalist readers? A lot, actually. Blinder is no defender of his economist colleagues or other former and current insiders who caused so much damage - or, at minimum, failed to see the collapse on the horizon. He writes clearly - as well as lots of journalists. That combination makes the book a worthy addition to the literature."
“If you want to get between the covers with your favorite econ nerd this season, I recommend Alan Blinder’s After the Music Stopped: The Financial Crisis, the Response and the Work Ahead. Written by the former vice chairman of the Federal Reserve, this deserves a place among the top reads on the Great Panic and its aftermath.”
Cleveland Plain Dealer:
"A prodigiously detailed yet generally accessible investigation of the roots of the meltdown, its multiple and continuing reverberations in the United States and globally, and the short-term fixes and long-term remedies required to treat, and then heal, the patient."
President William J. Clinton:
"If you want to understand every aspect of our economic crisis—how we got into it, how we escaped a depression, why we haven't fully recovered, and what we have to do now—read this book. It's a masterpiece—simple, straightforward and wise."
Paul A. Volcker:
"True to his scholarly roots and informed by his practical insights, Alan Blinder has produced in After the Music Stopped both a comprehensive and, mirabile dictu, engagingly readable analysis of the great financial crisis. Whether or not one agrees with every particular judgment, the force of the argument is clear: here we are, four years later, still short of reforms that are needed."
"Alan Blinder is one of the world's best informed and most balanced, sensible economists. His credentials include years as a senior adviser in the Clinton White House, then as vice chairman of the Federal Reserve and as regular op-ed contributor to the Wall Street Journal. After the Music Stopped is the best account available of what really happened in the 2008 financial crisis, why and what it now means for the future."
Mohamed A. El-Erian:
"Of all the books that I have read on the topic—and I have read quite a few—After the Music Stopped provides the most authoritative account of the why, how and what of the global financial crisis. This highly readable analysis takes you brilliantly through the construction of America's fragile house of financial cards, its sudden and dramatic collapse and, as important, the difficult reconstruction and rehabilitation work that must still be done. Whether you are interested in current affairs or in history, read this book if you want an expert and well-written analysis of how economics and politics interacted to create one big mess, not just for America but also for the global economy."
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