And still they come. Books about the global financial crisis continue to proliferate. The early wave was dominated by journalists and politicians writing their first drafts of history. Then retiring central bankers added their two pennies’ worth. Now financial mathematicians and academic lawyers are chipping in. Not all of them have anything new to say; Eric Posner certainly does.
His contribution focuses on the actions taken by the Federal Reserve and the US Treasury in the white heat of the crisis in 2008-09, so it might be thought a little leisurely in gestation. But it was worth the wait.
He begins with one of the most succinct and lucid explanations of the sources and dynamics of the crisis that I have read. As the best lawyers can do, he reduces complex arguments to their essentials. His focus on the expansion of the shadow banking sector is very much to the point, and he cuts through many fashionable arguments about who was to blame in a forensic and dispassionate manner.
Last Resort is not, however, a conventional retelling of a now familiar tale. The core of Posner’s argument concerns the way that the US authorities lent, or did not lend, to distressed firms. He believes that they were right to facilitate the rescue of Bear Stearns, to bail out AIG and to provide massive liquidity support to many banks. By contrast, he thinks that they were wrong to let Lehman Brothers fail, and that the decision to do so can be understood only in political terms. But he nonetheless believes that in doing all these valuable things the Fed and the Treasury were exceeding their powers and, bluntly, “in some cases they disregarded the law”.
His purpose in laying this serious charge, for which he adduces strong arguments, is not to seek jail terms for Ben Bernanke, Hank Paulson and Tim Geithner. Rather, he advances a powerful case for the law to be changed to make an honest woman of the Fed, in retrospect. It needs the explicit authority to do what it did, and that authority needs to be put in place in time for the next crisis.
Posner sees the rhetoric surrounding the 2010 Dodd-Frank Act, to the effect that “never again” should there be a state bailout, as fundamentally misconceived. The moral hazard arguments are in his view overstated. We could encourage fire prevention by abolishing the fire brigade, “but not all fires are caused by carelessness, and not all careless fires should be allowed to burn since, by a process similar to financial contagion, fires may spread from house to house”. So a powerful and robust lender of last resort is needed, with uncontested legal authority to lend to banks and non-banks alike.
The book’s specific legal arguments are particular to the US, and are likely to be tested in the courts before too long. But Posner’s general arguments about the need for robust underpinning of the financial system, and well-defined powers of intervention and rescue, are relevant to any country hosting a complex financial centre.
Howard Davies, a former director of the London School of Economics, is chairman of the Royal Bank of Scotland. He also teaches courses on central banking and the regulation of financial markets at the Paris School of International Affairs.
Last Resort: The Financial Crisis and the Future of Bailouts
By Eric A. Posner
University of Chicago Press 272pp, £20.50
Published 13 May 2018