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When the Crisis Was at Crescendo

Alan S. Blinder is said to be a potential successor to Federal Reserve Chairman Ben S. Bernanke, whose term expires in January. Blinder’s “After the Music Stopped: The Financial Crisis, The Response, and the Work Ahead” reads like a blueprint to avoid commitments at any confirmation hearing.

Keeping one’s options open might be useful at the Fed, and the country might benefit in the end. But going into the fifth year of Fed deployment of tools and power that few knew the central bank had (and some wish it didn’t), a reader would like a former Fed vice chairman and a Princeton economics professor to be more direct about the choices the next Fed chairman will face, many of them the result of decisions made by the current chairman.

Blinder gives the Fed and other government agents high marks for dealing with the past crisis but isn’t helpful about how a future Fed would cope with the next one now that Congress has curtailed its powers, as well as the Treasury’s. Blinder is right that bubbles are hard to recognize as they build, but aren’t university professors supposed to look back and identify some markers that will help next time? “Greedy bankers” — Blinder’s term — deserve only a share of the blame for the crisis, he says, and then lists seven causes with a common ingredient most readers will spot: bankers.

Hindsight is 20-20, but Blinder seems to think it’s therefore unsporting to use it. That’s a shame because “After the Music Stopped” is gripping reading, quite an achievement for a recap of events that are starting to recede from memory. Some members of Congress are already showing signs they have forgotten the chain of events set off by the collapse of Lehman Brothers, the dangers posed by a barely noticed foreign office of a barely regulated U.S. insurance company, and a run on money market funds.

They should read Blinder’s Chapter 6 about September 2008, especially the week beginning Sept. 15: Lehman fell. The Fed effectively nationalized insurance company AIG because the unsupervised activities of the company’s London financial products business created a massive risk for its counterparties. Investors fled from money market funds. Morgan Stanley and Goldman Sachs applied to become banks under the Fed’s regulatory scrutiny and, more important, its rescue operation.

What’s striking is the speed at which things were unfolding and forcing the Fed, the Treasury and other regulatory agencies to make momentous decisions. Any one of a series of events posed a grave danger to the system. Coming at a rapid-fire pace, they collectively could have overwhelmed the ability to respond. But even as they were dodging the systemic bullets, officials by and large worked purposefully toward the right outcome. Bernanke has earned his retirement.

Blinder’s clarity about the choices faced and the risks — legal, political and economic — of action or inaction is what make his book compelling. He slows down the thinking, giving it a coherence that wasn’t always apparent at the time. If there is a “eureka” moment in the response to the crisis, it’s when officials make the transition from dealing with troubled institutions to dealing with troubled markets.

The Fed undoubtedly expanded its power to do its work. But with the Bush administration unwilling to act when action was most needed and Congress — or many members — either blissfully unaware of the economic danger or willing to risk it, the Fed opted for staving off disaster.

Given that the central bank’s mandate does include the pursuit of maximum employment, its steps to avert a much deeper economic contraction fell within the spirit of its mandate, if not the letter of the law.

Former Fed Vice Chairman Blinder puts the clearest thinking in the central bank, making that institution look better than others. But he’s not especially harsh on anybody else. Saying that Lawrence H. Summers was “acerbic, domineering and argumentative” has long since stopped counting as a revelation. Henry M. Paulson Jr., the Treasury secretary apparently abandoned by President George W. Bush in the final months of 2008, comes off less like a bull in a china shop than a puppy in a stack of clean towels. He didn’t always help, but didn’t do any damage that couldn’t quickly be fixed.

They all got it pretty much right.

“On balance, the years 2008-2010 were marked by extraordinary policy activism, not passivity, by the Federal Reserve and two presidential administrations. The scope and volume of these policies were enough to keep heads spinning and policy makers exhausted ... Perhaps the biggest surprise of the entire episode is that they succeeded as well as they did.”

Getting it right, however, won’t make the next chairman’s job easier. Congress, which was for a massive injection of rescue funds before it was against them only to be for them again after the markets plunged, has reined in the power of the rescuers. Members say they don’t want banks that are too big to fail, but the regulators face banks bigger than ever with fewer powers if failure comes. The Dodd-Frank financial overhaul enacted in 2010 to reduce the risk of crisis is already being chipped away.

His subtitle notwithstanding, Blinder’s not much help on the work ahead. He closes weakly with a financial 10 commandments and a seven-step rehabilitation program for policymakers. His first four commandments? Thou shalt remember that people forget. Thou shalt not rely on self-regulation. Thou shalt honor thy shareholders. Thou shalt elevate the importance of risk management. Ignoring those commandments caused the last problem. They’re starting to be ignored again.

Randolph Walerius is an analyst for the CQ Roll Call Washington Securities Briefing.

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