When he looks back over his tumultuous two years inside the epicenter of America’s financial crisis, the one moment that really stands out for Robert Hoyt, L’89, G’89 — the top lawyer in the U.S. Treasury Department at the end of the Bush administration — is the moment that it almost all fell apart.
It was the afternoon of Sept. 29, 2008. After a long string of 14-hour days, Hoyt and his key Treasury colleagues were up on Capitol Hill to answer last-minute questions from lawmakers on an emergency $700 billion rescue package aimed at resolving a credit crunch that was crippling the U.S. capital markets.
With that task completed, they wandered over to the gallery of the House of Representatives to witness the final vote, which was expected to result in narrow passage because leaders of both parties were on board. Instead, the measure was defeated by a 228-205 margin, as the Bush administration aides watched in stunned silence.
“It was almost an out-of-body experience,” says Hoyt, reliving the ordeal in a January interview as he was preparing to clear out his office for the incoming Obama administration. “Our legislative folks who were there expected that the floor manager would do something to bring it back — and slowly it dawned on us that they couldn’t fix it. Finally, I came back to my office — to watch the stock market plummet. It was disheartening.”
That unhappy ending didn’t stick. The House came back later that week to approve the revised Troubled Asset Relief Program, or TARP, the Bush administration’s response to the near-collapse of the economic system brought on by U.S. financial institutions making massive bad investments in mortgage-backed securities. But the real last chapter of the saga — of whether Bush’s massive intervention in the U.S. economy was able to avert an economic slowdown on the scale of the Great Depression — hasn’t been written.
Two Penn Law alumni found themselves at the heart of the story, in key fiscal policy positions as the presidency of George W. Bush wound down. In fact, Hoyt found he was working closely with Heath Tarbert, L’01, GRL ’02, who went to work in the White House legal counsel’s office in the summer of 2008 and, in a twist of fate, was assigned the portfolio for economic policy. For both Hoyt and Tarbert, their final days in an outgoing GOP administration were a blur of overlapping crises, from the fall of the Lehman Brothers investment firm to stabilizing the banking system to averting the bankruptcy of major automakers.
The irony of all this is that massive interventions seemed to be almost a complete reversal of the first seven years of Bush administration policy, in which the overriding philosophy was to cut taxes and promote a free market economy with minimum government regulation. But both Hoyt and Tarbert, in separate interviews, defended the intervention in the financial markets as the only possible answer, because doing nothing would have guaranteed a wide-reaching collapse of the U.S. economy.
“People were hesitant in a Republican administration to intervene,” notes Tarbert, who had just wrapped up a prestigious law clerkship with Supreme Court Justice Clarence Thomas when he took the White House job. “But economists on both sides of the aisle also agreed that if there was ever a time to act, that time was now.”
One of the scariest times for the administration officials came on Sept. 18, after news reports that the collapse of Lehman Brothers meant potential losses for investors in a money-market account that was heavily invested in Lehman commercial paper. The report led to a speedy withdrawal of $550 billion from similar accounts in just an hour or two, and government officials at Treasury and elsewhere worried that some $5.5 trillion could be pulled out by day’s end, which could crash the entire financial system.
“That was an important day — it was like there was something in the system that could have slipped beyond the point of no return,” Tarbert recalled months later. He said the main players — Treasury, the White House, and later the Federal Reserve — determined there was authority under a fairly obscure piece of Depression-era legislation, which created the Exchange Stabilization Fund, to act quickly to pump $50 billion into the system and stabilize it while guaranteeing deposits up to $250,000. It was that crisis, Tarbert explained, that really brought home the need for the larger bailout, or TARP, legislation.
From the beginning, the complexity of the global financial crisis created considerable legal work for the likes of Hoyt, who became the top attorney at Treasury in December 2006 after a stint in the White House counsel’s office. Hoyt oversaw a team of some 2,000 lawyers that advised the department on everything from tax policies to tracing the financing of terrorists. But it would be the crisis in the credit markets that took up the bulk of his time after the summer of 2007, when the market for sub-prime mortgages began to collapse.
“From the beginning, Treasury shifted gears immediately, to start using its tools to devise solutions to the problems in the credit market,” Hoyt says. “One big area was determining what authorities and powers that we had — both as a general matter and to handle the different crises as they came up.” The result was that the Bush administration developed different responses to the complex events. In March 2008, the Federal Reserve, with Treasury’s backing, engineered a $29 billion loan that prevented the collapse of brokerage house Bear Stearns, but the government did not intervene as rival Lehman Brothers went under that September.
“We just didn’t have the tools to fix everything,” Hoyt says of the consequential decision to allow Lehman to fail. “There was a big difference between Lehman Brothers and Bear Stearns in that we had a buyer for Bear (JP Morgan Chase). The government needed to support that transaction with lending, because essentially they needed a bridge, while with Lehman there was no transaction to bridge. No one was willing to buy the company.”
Nevertheless, Lehman was the most serious in a row of cascading dominoes — including federal help for the quasipublic mortgage giants Fannie Mae and Freddie Mac. Then, in November, Hoyt’s team had to pull an all-nighter to finalize a $306 billion asset guarantee for Citigroup.
By then, Hoyt found that he was working at times with Tarbert, who knew that his job as an associate White House counsel would be a short-term position but had no idea he’d find himself at the cutting edge of American financial history. Tarbert said in a January interview that every incoming White House lawyer is assigned a policy area, and because he had worked for a time for the Wall Street-based law firm Sullivan and Cromwell he was assigned the financial-sector portfolio. Colleagues told him that portfolio was “relatively quiet.”
Instead, Tarbert found himself involved in the drafting of critical legislation, especially the bailout package that became known as TARP. “We knew that the economic financial sector was in great turmoil and we were very much concerned about banks failing and causing a catastrophic effect that could have had the entire banking system collapse.” Like Hoyt, he said that worry overrode whatever concerns a conservative administration might have felt over a massive economic intervention. “Nobody knew what was in the black box” of bad loans that were held by the major banks, and he says everyone wanted to avoid the worst possible outcome.
Tarbert notes that Treasury and the Federal Reserve managed to administer the initial rescues of banks and insurance giant AIG. But administration officials realized that they would need congressional approval for a more sweeping plan. However, it proved difficult to develop a program that would stabilize banks and lay the necessary foundation for them to resume lending money to businesses and consumers.
Did it make more sense for Treasury to actually purchase the toxic mortgage-backed assets of the banks and take them off of their books, or should the government quickly inject new capital by buying equity stakes in the troubled institutions? Ultimately, the administration spent most of the initial $350 billion of the program on the second idea, and the results have been controversial. Critics say that the cash flow didn’t convince the banks it was safe to make risky loans during a deep recession even as some banks continued to pay large bonuses to their top executives. Hoyt counters that the rapid infusion of capital stabilized a banking system that was on the verge of collapse — a necessary precondition to programs that would follow, aimed at unfreezing the credit markets.
Hoyt says he believes that while the root causes of the economic crisis will be debated for years to come, history will agree that the Bush administration was correct to intervene on the scale and at the time that it did. He also says he was disappointed by the widespread criticism that the TARP program lacks transparency. Hoyt notes that Treasury has publicly documented every dollar spent, and that the real problem is that banks are unable to trace accurately how they spent the government’s money, as opposed to money they have from other sources.
The transition to the Obama administration complicated matters. On some key issues, including the near-bankruptcy threat of automakers General Motors and Chrysler, Bush officials decided, after consulting with the Obama transition team, to offer short-term aid that handed off to the incoming president the more difficult longer-term political decisions about the government’s role in the car business.
Now, a new Obama administration is in office with a dual focus. It must figure out how to better use the remaining $350 million in bailout money for the financial sector and also administer the $787 billion economic stimulus program that aims to stanch job loss.
Penn’s Michael Knoll, the Theodore K. Warner Professor of Law & Professor of Real Estate, said Obama faces an additional challenge in reversing Bush economic policy: how to address calls for increased government regulation of banks and other financial institutions. “It’s easy to be ideologically opposed to regulation and say you don’t like it, whatever it looks like, but it’s harder to describe a one-size fits all philosophy of imposing regulations, so the politics are a little unclear here,” he says.
But David Abrams, assistant professor of Law, Business, and Public Policy at Penn Law, worries about the impact of bailout decisions already made. He says officials were too quick to eliminate moral hazard in order to prevent investors who make bad decisions from losing their money. “If the feds rescue every bank that screws up,” he adds, “there’s no incentive not to screw up.”
He says he does not envy the mission facing Obama’s economic team. “These are very difficult problems.” His colleague Knoll said the severity of the recession has placed worries about the deficit on the back burner. He said the important thing about stimulus money “is getting folks to spend it.”
“In the Keynes model, it didn’t really matter what the money is for, ‘bridges to nowhere’ are fine... Getting people to work, even if they’re doing nothing, will get things moving again.”