Even as Federal Reserve Chair Paul Bernanke and Treasure Secretary Henry Paulson were testifying on Capitol Hill about the proposed $700 billion+ bail-out of our financial industry, New York Times financial reporter Gretchen Morgenson was giving an interview on NPR which was hard-edged and scary in its analysis of what could happen if the proposed rescue effort were to go into effect without oversight. She used the word "lie" more than once. The interview, hosted by Terry Gross, is excerpted and edited to make it possible to get it transcribed quickly.
NPR: We've been told by Henry Paulson that unless Congress agrees to a $700 billion bail-out package, we will face disaster. Give us a sense of what he means. What would likely happen if we didn't do this big bail-out?
Gretchen Morgenson: Probably everyone who's listening knows that we already face disaster, regardless of whether this plan goes through or doesn't go through. That's the very reason why they're scrambling to put together a plan. We are facing financial disaster -- or armageddon, or whatever word you want to use -- because of a combination of very lax lending, extremely large uses of borrowed money (also known as leverage), and a deregulatory viewpoint that really took a handsoff approach to the financial system. Those three things together have led us to the edge of the cliff.
NPR: What is the cliff? What happens at the other end if you fall off?
GM: As you know, several firms have falled off the cliff. Other firms have been driven into the arms of larger financial entities that can possibly absorb them and not cause them to fail outright. We've had the failure of Bear Sterns. We've had the failure and bankruptcy filing of Lehmann Brothers. Two venerable names on Wall Street. What has happened here is that these firms took outsized risks with their own money -- and then borrowed more money to take those risks. When you have that kind of a set-up, when you have borrowed money, and your assets that you've borrowed money to buy decline in value, you are then asked for more money. What happens is that the underlying assets that you've purchased are the collateral that support the loan that you have taken out. It's like a mortgage on your house. Your house declines in value and your loan then exceeds the amount of the house value and you're under water. It's essentially the same thing that these brokerage firms were doing. They were borrowing money. They made bets. The bets went bad. And then they had to put up more collateral. Which they didn't have.
NPR: What does that mean for everybody else?
GM: You need to have some certainty in the population that such things as money market funds, for example, are not going to fail as a result of this. Money market funds have become a real choice of most people as a place to stash their cash when they're not investing it or when they might need it. It's a very kind of liquid form of safekeeping for your money. There were some situations earlier this week and last week where money market funds did start to go below one dollar which is their net asset value they like to stay at. People just had no concept that you could actually lose money in a money market fund. People were thinking that that was the same as having a bank account that was insured. So this has a spillover effect. These problems at, say, Lehmann Brothers have a spillover effect. It was the fact that the money market fund owned the debt at Lehmann Brothers, that was then in bankruptcy, that caused it to go below one dollar a share. We're all very connected in this world. So when one company fails the potential for having a kind of domino effect of spreading failure into, as I explained, such areas as money market funds that seem to be completely unrelated.
NPR: You said that even with this $700 billion bail-out plan, we could still be facing disaster.
GM: First of all, a $700 billion bail-out plan that does not describe to me with certainty how they're going to value these assets that the taxpayer is going to be backing -- that's a disaster right there. How do I know that they're not going to pay too much for these assets -- that you and me and my son and everyone else's children ad infinitum are going to be paying too much for troubled assets to get bankers out of trouble! And bankers got us into this mess! Why should we be rescuing them? I understand that we're in a very, very difficult position and a frightening position. But I want to be absolutely certain and every taxpayer should want to be certain that we are not going to be asked to spend more money than we ought to simply to bail out people who made very big mistakes and took very big risks!
NPR: How did this situation go so quickly from the secretary of the Treasury telling us that the crisis was being controlled to -- suddenly -- you have to pay this bill immediately or else the whole system is going to crash. There's no time to think about it. There's no time to debate. Stop asking for changes. You've got to do it right now!
GM: That's a good question and one that I don't know the answer to. I'll tell you this: it really makes me suspicious.
NPR: Tell me what your suspicions are!
GM: My suspicions are that we were not told the truth in the beginning. Secretary Paulson, Ben Bernanke -- a whole cast of characters -- were rolled out all during 2007, really up until September 2007, saying that it was "contained!" This problem would be "contained!" to subprime. Anybody with a brain, anybody with eyes in their head knew that it was not going to be contained because nothing ever is nowadays because we're all so interrelated. So that was a lie. You have very little integrity among these people, it seems to me. Why should I now believe what they're saying? That I should hurry up and pass this bill or agree to its terms (which are not detailed) when these people weren't telling me the truth five minutes ago?
NPR: Well, there's also the question that if these people weren't able to rescue the financial situation before, why do we think they can do it now with $700 billion?
GM: And why do we think $700 billion is going to be the number? Could it be more?
NPR: Let's go through what the basics of the bill say and look at what the lobbyists are trying to do behind the scenes. What is Henry Paulson asking for?
GM: They're asking for approval to have a fund, a taxpayer funded pool of money to buy troubled assets from banks' balance sheets. They hope that this will then allow the banks to recapitalize themselves, get healthy, and start lending again. One of the unintended consequences of the period we're in, where banks are hobbled by these bad loans, is that they retrench on lending. They rein in their lending to even the most credit-worthy customers, whether a company or an individual who's trying to buy a home. So we need the wheels of commerce to be greased and lending is that grease. As long as those wheels are not turning, it's threatening the overall economy. So they want to get these loans off the books so the banks can feel confident about lending again.
NPR: What are the troubled loans that this fund would attempt to buy back?
GM: Mostly they are mortgages, mortage securities, pools of mortgages that have been sold to investors. These are some of the loans that were made at the tail-end of the housing boom -- 2005, 2006, 2007 -- when you really didn't even have to be ambulatory or have a pulse to get a mortgage. There was so much free money floating around that my cat could have gotten a mortgage on a house. So these were very, very iffy loans. They were made with the kind of aspects where they would increase the interest rate dramatically after two or three years, really putting the borrower in a difficult position if they couldn't pay that increase. So these are really at the heart of the problem. There were so many of these loans made that the banks are really troubled by them. There are also other loans that by association have gotten hurt as well. Corporate loans that are also feeling the same effects of bank problems that we're seeing. Heavy leveraged. Too much leverage, say, on a commercial real estate property. You really do see mostly mortgages here, but you also see corporate loans and other items as well.