Decision Points

by George W. Bush

I worked closely with Congress to meet my spending targets—or, as I called it, the overall size of the pie. I didn’t always agree with how Congress divvied up the pieces. I objected to wasteful earmarks inserted into spending bills. But I had no line-item veto to excise pork barrel spending projects. I had to either accept or reject the bills in full. So long as Congress met my bottom line, which it did year after year, I felt that I should hold up my end of the deal and sign the bills.

  The results have been a subject of heated debate. Some on the left complain that tax cuts increased the deficits. Some on the right argue that I should not have signed the expensive Medicare prescription drug benefit. It is fair to debate those policy choices, but here are the facts: The combination of tight budgets and the rising tax revenues resulting from economic growth helped drive down the deficit from 3.5 percent of the GDP in 2004, to 2.6 percent in 2005, to 1.9 percent in 2006, to 1.2 percent in 2007.

  The average deficit-to-GDP ratio during my administration was 2.0 percent, below the fifty-year average of 3.0 percent. My administration’s ratios of spending-to-GDP, taxes-to-GDP, deficit-to-GDP, and debt-to-GDP are all lower than the averages of the past three decades—and, in most cases, below the averages of my recent predecessors. Despite the costs of two recessions, the costliest natural disaster in history, and a two-front war, our fiscal record was strong.

  BUDGET COMPARISON TABLE***

  * * *

  At the same time, I knew I was leaving behind a serious long-term fiscal problem: the unsustainable growth in entitlement spending, which accounts for the vast majority of the future federal debt. I pushed hard to reform the funding formulas for Social Security and Medicare, but Democrats opposed my efforts and support in my own party was lukewarm.

  Part of the problem was that the fiscal crisis seemed a long way off to the legislative branch while I was in office. In early 2008, the Congressional Budget Office estimated that the debt would not exceed 60 percent of GDP until 2023. But because of the financial crisis—and spending choices made after I left office—debt will exceed that level by the end of 2010. A fiscal crisis that many saw as distant is now upon us.

  “Wall Street got drunk, and we got the hangover.”

  That was an admittedly simplistic way of describing the origins of the greatest financial panic since the Great Depression. A more sophisticated explanation dates back to the boom of the 1990s. While the U.S. economy grew at an annual rate of 3.8 percent, developing Asian countries such as China, India, and South Korea averaged almost twice that. Many of these economies stockpiled large cash reserves. So did energy-producing nations, which benefited from a tenfold rise in oil prices between 1993 and 2008. Ben Bernanke called this phenomenon a “global saving glut.” Others deemed it a giant pool of money.

  A great deal of this foreign capital flowed back to the United States. America was viewed as an attractive place to invest, thanks to our strong capital markets, reliable legal system, and productive workforce. Foreign investors bought large numbers of U.S. Treasury bonds, which drove down their yield. Naturally, investors started looking for higher returns.

  One prospect was the booming U.S. housing market. Between 1993 and 2007, the average American home price roughly doubled. Builders constructed homes at a rapid pace. Interest rates were low. Credit was easy. Lenders wrote mortgages for almost anyone—including “subprime” borrowers, whose low credit scores made them a higher risk.

  Wall Street spotted an opportunity. Investment banks purchased large numbers of mortgages from lenders, sliced them up, repackaged them, and converted them into complex financial securities. Credit rating agencies, which received lucrative fees from investment banks, blessed many of these assets with AAA ratings. Financial firms sold huge numbers of credit default swaps, bets on whether the mortgages underlying the securities would default. Trading under fancy names such as collateralized debt obligations, the new mortgage-based products yielded the returns investors were seeking. Wall Street sold them aggressively.

  Fannie Mae and Freddie Mac, private companies with congressional charters and lax regulation, fueled the market for mortgage-backed securities. The two government-sponsored enterprises bought up half the mortgages in the United States, securitized many of the loans, and sold them around the world. Investors bought voraciously because they believed Fannie and Freddie paper carried a U.S. government guarantee.

  It wasn’t just overseas investors who were attracted by higher returns. American banks borrowed large sums of money against their capital, a practice known as leverage, and loaded up on the mortgage-backed securities. Some of the most aggressive investors were giant new financial service companies. Many had taken advantage of the 1999 repeal of the Glass-Steagall Act of 1932, which prohibited commercial banks from engaging in the investment business.

  At the height of the housing boom, homeownership hit an all-time high of almost 70 percent. I had supported policies to expand homeownership, including down-payment assistance for low-income and first-time buyers. I was pleased to see the ownership society grow. But the exuberance of the moment masked the underlying risk. Together, the global pool of cash, easy monetary policy, booming housing market, insatiable appetite for mortgage-backed assets, complexity of Wall Street financial engineering, and leverage of financial institutions created a house of cards. This precarious structure was fated to collapse as soon as the underlying card—the nonstop growth of housing prices—was pulled out. That was clear in retrospect. But very few saw it at the time, including me.

  In May 2006, Josh Bolten walked into the Treaty Room with a guest he was trying to recruit to the administration, Goldman Sachs CEO Henry Paulson. I hoped to persuade Hank to succeed Secretary of the Treasury John Snow. John had been an effective advocate of my economic agenda, from tax cuts to Social Security reform to free trade. He had done a good job of managing the department and left it in better shape than he’d found it. He had been on the job for more than three years and both John and I felt it was time for a fresh face.

  With John Snow. White House/Eric Draper

  Josh told me Hank was a hard-charger—smart, energetic, and credible with the financial markets. Hank was slow to warm to the idea of joining my Cabinet. He had an exciting job on Wall Street and doubted he could accomplish much in the final years of my administration. He had a fine reputation and did not want his name dragged through the political mud. He was an avid conservationist who loved to fly-fish for tarpon and watch birds with his wife, Wendy—interests he might not be able to pursue. While Hank was a lifelong Republican, he was a party of one within his family. Wendy was a college friend and supporter of Hillary Clinton’s. Their two children were disillusioned with the Republican Party. I later learned that Hank’s mother cried when she first heard he was joining my Cabinet.

  In his steady, low-key way, Josh eventually persuaded Hank to visit with me in the White House. Hank radiated energy and confidence. His hands moved as if he were conducting his own orchestra. He had a distinct way of speaking that could be hard to follow. Some said his brain was moving too fast for his mouth to keep up. That didn’t bother me. People accused me of having the same problem.

  Hank understood the globalization of finance, and his name commanded respect at home and abroad. When I assured him he would be my primary economic adviser and have unlimited access, he accepted the offer. I was grateful to Wendy and Hank’s family for supporting him. At the time, none of us realized his tests as treasury secretary would rival those of Henry Morgenthau under FDR or Alexander Hamilton at the founding of the country.

  When I took office, I became the fourth president to serve with Federal Reserve Chairman Alan Greenspan. Created under President Woodrow Wilson in 1913, the Fed sets America’s monetary policy and coordinates with other central banks around the world. Its decisions have a wide-ranging impact, from the strength of the dollar to the interest rate on a local loan. While its chairman and board of governors are appointed by the president and confirmed by the Senate, the Fed
sets monetary policy independently from the White House and Congress. That’s the way it should be. An independent Fed is a crucial sign of stability to financial markets and investors around the globe.

  I invited Greenspan to the White House for regular lunches. Dick Cheney, Andy Card, and I would eat. Alan would not. He spent all his time answering our questions. His grasp of data was astounding. I would ask him where he saw the economy headed over the next few months. He would quote oil inventories, changes in freight miles in the railroad industry, and other interesting statistics. As he rattled off the figures, he slapped his left hand against his right fist, as if to jar more information loose. When his position came up for renewal in 2004, I never considered appointing anyone else.

  With Alan Greenspan. White House/Eric Draper

  When Alan sent word that he would retire in early 2006, we started the search for a successor. One name kept coming up: Ben Bernanke. Ben had served three years on the Fed board and joined my administration as chairman of the Council of Economic Advisers in June 2005. He was well respected by the staff and by me. Raised in a small South Carolina town, he was humble, down-to-earth, and plainspoken. Like me, he loved baseball. Unlike me, his team was the Boston Red Sox. He was able to distill complex topics into understandable terms. In contrast to some in Washington, the salt-and-pepper-bearded professor was not addicted to the sound of his own voice.

  I liked to needle Ben, a sign of affection. “You’re an economist, so every sentence starts with, ‘On one hand … on the other hand,’ ” I said. “Thank goodness you don’t have a third hand.” One day in the Oval Office, I ribbed Ben for wearing tan socks with a dark suit. At our next meeting, the entire economic team showed up wearing tan socks in solidarity. “Look at what they’ve done,” I said to Dick Cheney. The vice president slowly lifted the cuff of his pants. “Oh, no, not you, too!” I said.

  What stood out most about Ben was his sense of history. He was a renowned academic expert on the Great Depression. Beneath his gentle demeanor was a fierce determination to avoid the mistakes of the 1930s. I hoped America would never face a scenario like that again. But if we did, I wanted Ben at the helm of the Federal Reserve.

  As Fed chairman, Ben developed a close relationship with the other members of my economic team, especially Hank Paulson. Ben and Hank were like the characters in The Odd Couple. Hank was intense; Ben was calm. Hank was a decisive business leader; Ben was a thoughtful analyst who had spent much of his life in universities. Hank was a natural talker; Ben was comfortable listening.

  Their opposing personalities could have produced tension. But Hank and Ben became perfect complements. In hindsight, putting a world-class investment banker and an expert on the Great Depression in the nation’s top two economic positions were among the most important decisions of my presidency.

  With Ben Bernanke (left) and Hank Paulson. White House/Eric Draper

  I began my final year in office the same way I had started my first, concerned about a bursting bubble and pushing for tax relief.

  In mid-2007, home values had declined for the first time in thirteen years. Homeowners defaulted on their mortgages in increasing numbers, and financial companies wrote down billions of dollars in mortgage-related assets. Council of Economic Advisers Chairman Eddie Lazear, a brainy and respected Stanford professor, reported that the economy was slowing down. He and the economic team believed we might be able to mitigate the effects with well-timed tax relief.

  In January 2008, I sent Hank Paulson to negotiate a bill with Speaker Nancy Pelosi and House Minority Leader John Boehner. They hammered out a plan to provide temporary tax incentives for businesses to create jobs and immediate tax rebates for families to boost consumer spending. Within a month, the legislation had passed by a broad bipartisan majority. By May, checks of up to $1,200 per family were in the mail.

  The economy showed some signs of resilience. Economic growth reports were positive, unemployment was 4.9 percent, exports had reached record highs, and inflation was under control. I was hopeful we could dodge a recession.

  I was wrong. The foundation was weakening, and the house of cards was about to come tumbling down.

  Early in the afternoon of Thursday, March 13, we learned that Bear Stearns, one of America’s largest investment banks, was facing a liquidity crisis. Like other Wall Street institutions, Bear was heavily leveraged. For every dollar it held in capital, the firm had borrowed thirty-three dollars to invest, much of it in mortgage-backed securities. When the housing bubble popped, Bear was overexposed, and investors moved their accounts. Unlike the run on First National Bank in Midland, there were no paper sacks.

  I was surprised by the sudden crisis. My focus had been kitchen-table economic issues like jobs and inflation. I assumed any major credit troubles would have been flagged by the regulators or rating agencies. After all, I had strengthened financial regulation by signing the Sarbanes-Oxley Act in response to the Enron accounting fraud and other corporate scandals. Nevertheless, Bear Stearns’s poor investment decisions left it on the brink of collapse. In this case, the problem was not a lack of regulation by government; it was a lack of judgment by Bear executives.

  My first instinct was not to save Bear. In a free market economy, firms that fail should go out of business. If the government stepped in, we would create a problem known as moral hazard: Other firms would assume they would be bailed out, too, which would embolden them to take more risks.

  Hank shared my strong inclination against government intervention. But he explained that a collapse of Bear Stearns would have widespread repercussions for a world financial system that had been under great stress since the housing crisis began in 2007. Bear had financial relationships with hundreds of other banks, investors, and governments. If the firm suddenly failed, confidence in other financial institutions would diminish. Bear could be the first domino in a series of failing firms. While I was concerned about creating moral hazard, I worried more about a financial collapse.

  “Is there a buyer for Bear?” I asked Hank.

  Early the next morning, we received our answer. Executives at JPMorgan Chase were interested in acquiring Bear Stearns, but were concerned about inheriting Bear’s portfolio of risky mortgage-backed securities. With Ben’s approval, Hank and Tim Geithner, the president of the New York Fed, devised a plan to address JPMorgan’s concerns. The Fed would lend $30 billion against Bear’s undesirable mortgage holdings, which cleared the way for JPMorgan to purchase Bear Stearns for two dollars per share.****

  Many in Washington denounced the move as a bailout. It probably didn’t feel that way to the Bear employees who lost their jobs or the shareholders who saw their stock drop 97 percent in less than two weeks. Our objective was not to reward the bad decisions of Bear Stearns. It was to safeguard the American people from a severe economic hit. For five months, it looked like we had.

  “Do they know it’s coming, Hank?”

  “Mr. President,” he replied, “we’re going to move quickly and take them by surprise. The first sound they’ll hear is their heads hitting the floor.”

  It was the first week of September 2008, and Hank Paulson had just laid out a plan to place Fannie Mae and Freddie Mac, the two giant government-sponsored enterprises, into government conservatorship.

  Of all the emergency actions the government had to take in 2008, none was more frustrating than the rescue of Fannie and Freddie. The problems at the two GSEs had been visible for years. Fannie and Freddie had expanded beyond their mission of promoting homeownership. They had behaved like a hedge fund that raised huge amounts of money and took significant risks. In my first budget, I warned that Fannie and Freddie had grown so big that they presented “a potential problem” that could “cause strong repercussions in financial markets.”

  In 2003, I proposed a bill that would strengthen the GSEs’ regulation. But it was blocked by their well-connected friends in Washington. Many Fannie and Freddie executives were former government officials. They had close
ties in Congress, especially to influential Democrats like Congressman Barney Frank of Massachusetts and Senator Chris Dodd of Connecticut. “Fannie Mae and Freddie Mac are not facing any kind of financial crisis,” Barney Frank said at the time.

  That claim seemed more implausible as the years passed. In my 2005 budget, I issued a more dire warning. “The GSEs are highly leveraged, holding much less capital in relation to their assets than similarly sized financial institutions,” the budget read. “… Given the very large size of each enterprise, even a small mistake by a GSE could have consequences throughout the economy.”

  That summer, we made another run at legislation. John Snow worked closely with Senate Banking Committee Chairman Richard Shelby on a reform bill that would create a new regulator authorized to reduce the size of the GSEs’ investment portfolios. Senator Shelby, a smart, tough legislator from Alabama, pushed the bill through his committee despite unanimous Democratic opposition. But Democrats blocked a vote on the Senate floor. I am always amazed when I hear Democrats say the financial crisis happened because Republicans pushed deregulation.

  By the summer of 2008, I had publicly called for GSE reform seventeen times. It turned out the eighteenth was the charm. All it took was the prospect of a global financial meltdown. In July, Congress passed a reform bill granting a key element of what we had first proposed five years earlier: a strong regulator for the GSEs. The bill also gave the treasury secretary temporary authority to inject equity into Fannie and Freddie if their solvency came into question.

  Shortly after the legislation passed, the new regulatory agency, led by friend and businessman Jim Lockhart, took a fresh look at Fannie’s and Freddie’s books. With help from the Treasury Department, the examiners concluded the GSEs had nowhere near enough capital. In early August, both Freddie and Fannie announced huge quarterly losses.