The Magazine

The Credit Crisis of 2008

As was the case a century ago, it's good to have a J.P. Morgan when you need one.

Mar 31, 2008, Vol. 13, No. 28 • By IRWIN M. STELZER
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The really bad news about the debt crisis is that it is sowing the seeds from which will bloom, if that is the right word, hundreds of doctoral dissertations five or so years hence. Economic model builders, unchastened by the fact that their predecessors' models failed to anticipate, indeed, contributed to the great crisis of 2008, will concoct elaborate equations designed to reveal whether it was the Fed's interest rate cuts, or its pumping of hundreds of billions into the credit markets, or the JPMorgan Chase-led takeover of Bear Stearns, or Hank Paulson doing whatever it is Treasury secretaries do in these circumstances, or the calming words of George W. Bush that brought the credit crunch to an end.

Given the political bent of most university economic departments, it is a safe bet that President Bush will be found to be on the cause-side of the balance sheet, not the cure-side. So, too, will former Fed chairman Alan Greenspan, whose fondness for free markets will prompt the academics to blame much of the problem of 2007-2008 on his 18-year tenure as manager-in-chief of U.S. monetary policy. Other than those certainties, we can expect an inconclusive duel to the death of bored audiences by competing econometric models.

Not that we have not already learned a great deal about crisis containment. For one thing, it is good to have a J.P. Morgan around. Students of history will remember that almost exactly 100 years ago, in 1907 to be exact, one J.P. Morgan rode to the rescue of a financial system on the verge of collapse--if one can imagine someone with the girth of the great 70-year-old banker riding to anything. It seems that the Knickerbocker Trust Company had backed speculators seeking to corner the market in shares of a copper company. They failed and so did the bank. Stuck with unmarketable securities it had accepted as collateral (cf.today's subprime mortgages and other securitized paper), it had insufficient cash to meet depositors' demands. Other banks grew nervous, refused to clear with Knickerbocker, and tightened credit to the point where credit-worthy borrowers such as New York City, Boston, and Westinghouse could not sell their IOUs.

Enter J.P. Morgan. He cobbled together a consortium including John D. Rockefeller and other elite members of the rich-and-famous club to put up tens of millions, the Treasury added $25 million of taxpayer money (a half billion in today's dollars), and trust-busting President Theodore Roosevelt told his attorney general, "I felt it no public duty of mine to interpose any objection" to the complicated rescue scheme.

The rescue took about two weeks. Bernanke and the current head of JPMorgan Chase, Jamie Dimon, managed a similar feat in two days. Bear Stearns is no more. In a mere 100 hours, shares in the 75-year-old investment bank, trading, and brokerage firm fell from $70 to $2, the price at which it was picked up by Morgan. Factor in the $1.2 billion at which Bear Stearns's Midtown Manhattan headquarters office building is valued, and Dimon got Bear for nothing. In this drama, Dimon played old J.P., and Hank Paulson played George Cortelyou, Roosevelt's Treasury secretary. Bernanke came on stage to show that Woodrow Wilson's decision to establish the Fed half a decade later was a good idea.

Which tells us something more about what future researchers will find: The era of free-market, no-government-intervention purists is over, if indeed it ever existed. Bush and Paulson have been leading the "no bailout" contingent, at least when it comes to poor, overextended home-owners trying to cope with suddenly higher payments as the teaser rates on their mortgages are reset. But to clear the way for Dimon to swallow Bear, the president and the Treasury secretary agreed to have the taxpayers guarantee $30 billion of Bear's difficult-to-value assets. That puts taxpayers at risk; the precise nature of Bear's assets and liabilities is unknown to the Fed, which had no time to do anything resembling due diligence if it was to complete the deal before Asian markets opened on Monday morning. If the assets prove dicey, taxpayers will have to cover the loss. The risk-takers are us. Paulson might insist that he allowed the government to take on billions in risk only to save the system, rather than any one company, but if it looks like a bailout, and smells like a bailout, it probably is a bailout, certainly of the Bear Stearns bondholders, although employees, many of whom have been partly paid in shares in recent years, will prefer the term "wipe-out."