Question: Who is most culpable for the crisis, Washington or Wall Street?

David Wessel: I think one of the extraordinary things about this crisis is the list of culprits. Almost no check on the financial system worked. The Bank Risk Management Committees didn't manage risk, the credit rating agencies stamped triple A, Gold Plated status on things that weren't, people made mortgages to people who couldn't pay them back, people got mortgages that couldn't pay them, the regulators were asleep, the financial press did a lousy job even though they tried to call attention to some of the excesses. But while some aspects of the crisis were made in Washington, I think this one really falls more squarely on Wall Street.

This crisis had its roots in an attitude that Washington should get out of Wall Street's way and just let Wall Street do its thing: innovate, and make the world better for us while making a lot of money for them, and that turned out to be a mistake.

Question: Who was responsible for the asset bubble that formed?

David Wessel: As you know, there’s a big argument there. What was the root cause of the bubble? Was it that the Asian economies were saving so much money that they flooded the world with liquidity and as a result everybody that wanted to borrow could borrow whether or not they had something good to do with the money? Or was it the monetary policy of the United States, the Federal Reserve, and some of the other central banks that kept rates artificially low, and that triggered the asset bubble and the borrowing binge?

I think clearly, both played a role. Ben Bernanke, when he was a member of the Federal Reserve Board, blamed very much the savings glut, and I think that underplays the role that the Fed actually played. So, I don’t think that the Fed was wrong, that the savings glut didn’t exist, but I don’t think the that the Fed did everything it could, particularly with its regulatory arm, to prevent the savings glut from turning into a credit bubble.

I think what we’ve learned is quite clear. The Federal Reserve used to believe, and they were explicit about it, that they could not and should not do anything to prick an asset bubble, stock prices, housing prices you name it. Instead, they should wait until a stock or asset bubble of some kind burst and only after it burst should they get into the act and that would be the mop up strategy. The only caveat was that if asset prices were somehow spilling over into the prices of goods and services, then maybe there was a case for the Fed to raise interest rates.

But Ben Bernanke himself had said that that view needs to be re-examined as a result of this devastating recession caused by the bursting of the housing and credit bubble. So I think, right now, there’s a lot of ferment inside the Federal Reserve and there will be continued ferment until they are faced with this choice again, what to do about something that looks to a lot of people like an asset bubble, they will be more inclined to act than they would have ten years ago because of this crisis. It may not be an increase in interest rates. It may be using the regulatory or supervisory power to kind of lean on the bankers to stop lending so much. It may be actually forbidding certain practices. They could have been much more aggressive in forbidding sub-prime mortgages, for instance. But the world will never be the same as it was in 1999.

Question: How should officials address Chinese currency interventions?

David Wessel: Well, the world economy is unbalanced, and this imbalance is both partly responsible for the crisis and is hurting the recovery from the crisis. The fundamental problem is that the United States saves too little, and borrows too much; most of it from Asia, and Asia, particularly China, saves too much and relies too much on sending that savings to the United States instead of using that money to buy stuff from us.

So, this imbalance, they save too much and we don’t save enough, has to end for the world to get on with the business of widely shared prosperity. One way in our system that that happens is through exchange rates because when the dollar falls and another currency rises, that makes imports more expensive to Americans and it makes our exports more attractive to foreigners. In almost every country in the world now of any size, the currencies are moving around with the markets. The Chinese are a notable exception. The may be something that they think is in their interest, but from what I sit, it’s slowing the process of readjustment and rebalancing the world economy and is not doing the world any favors even though it may be very popular with the Chinese exporters.

Question: Is there anything that American policymakers ought to be asking the Chinese?

David Wessel: The problem is that the Chinese are not going to do things because America wants them to. They are going to do things because they are convinced they are in their self-interest and the Chinese learned a lesson from Asian financial crisis, which is when exchange rates are very flexible they can move down very fast and cause a calamity. And had learned a big thing from the recent crisis, which is the Americans don’t know quite so much about finances they pretended. “The teacher has become the pupil,” one of the Chinese officials said to an American official.

As a result, the U.S. doesn’t have much credibility with the Chinese and we can trot out 50 economists who tell them this is in their interest and they’ll look back and see that none of those economists predicted the great panic that we just lived through. I think in the end, what will happen is, that other Asian countries whose currencies float against the Dollar will pressure the Chinese because it makes it difficult for them to export if the Chinese currency is not rising against the Dollar and the Thai Baht, and the Indonesian Rupiah are rising that gives the Chinese an unfair advantage, these countries say. And eventually the Chinese will realize that they are creating a lot of strains in their own system by holding the Chinese wheel arm low and they’ll adjust. They’re getting a lot of pressure from the IMF, from the World Bank. So, I think it will only happen when they are convinced it’s in their interest and one way that is likely to happen is not through pressure from the United States, but more from pressure from other people.

Question: Did Bernanke’s mantra of “whatever it takes” lead us astray?

David Wessel: I think that a “whatever it takes” approach got us through this crisis but has a number of enormous risks. One of them is that it can justify almost anything. If you don’t have a set of principles that you can explain for what you are doing, then how can anybody know what you’re going to do next? In fact, one of the problems in this crisis was that the rules kept changing. If you were a preferred shareholder at Fannie Mae and Freddie Mac, you got wiped out. But if you were a preferred shareholder at Bear Stearns, you didn’t. If you were a bond holder at Washington Mutual, you got largely wiped out, but if you were a bondholder of AIG you didn’t get wiped out. If you were a bondholder of Lehman Brothers though, you got devastated. And so this kind of shifting the rules of the game makes life kind of difficult.

I think that, in my view, one of the things that Bernanke and Hank Paulson, and Tim Giethner did that, in retrospect was a mistake, was wasting the time after Bear Stearns, which occurred in March, 2008, and not coming up with a more articulated game plan for what they would do if they had to cope with a collapse with another financial institution. Of course one of the biggest criticisms of Mr. Bernanke is that he didn’t do whatever it takes and he let Lehman Brothers fail. He says he didn’t have any other choice under law. We at the Wall Street Journal surveyed four dozen economists on Wall Street and by 3 to 1; they said they didn’t believe him. That had there been a will to save Lehman Brothers, there would have been a way.

I do think that the AIG bailout is one that is getting a lot of scrutiny for exactly the right reasons. And the question really is, was it necessary to pay the counterparties of AIG, Goldman Sachs, Deutsche Bank, UBS, the big names of global finance, 100 cents on the dollar in order to protect the financial system? Admittedly, the Fed and the Treasurer were making decisions under a lot of pressure. That was a very busy week in September, 2008. But with the benefit of hindsight, it looks like they did themselves a lot of damage, politically, and it hurt their credibility when it looked like only the big guys, Goldman Sachs and Deutsche Bank and so forth got 100 cents on the Dollar and everybody else has to take a haircut. So, one can understand why they did it, and it’s clear that they did not have enough tools to deal with a collapse of an institution other than a bank. That’s why Bernanke, and Geithner, Paulson, George Bush, and Barack Obama, have all asked Congress to change the rules so that when something like Lehman Brothers, or Bear Stearns, or AIG gets into trouble in the future, the Federal Government will be able to treat them the way it treats a bank. Say, “Okay, you screwed up, you’re mine now, we’ll decide who gets paid and who doesn’t, and we have a system for doing that.” There is no system. There was no system then, there is no system today, a year later, for dealing with an AIG or a Lehman Brothers. So, the tools that the authorities had were unfortunately limited. They weren’t up to the task.

Question: DEAN BAKER, BEAT THE PRESS: How did the Fed fail to see a trillion dollar housing bubble?

David Wessel: I think that when you go back and look at what was going on inside the Fed, there were people who warned that this was a housing bubble. But, they were not convincing and the reigning view at the Fed was, even if it is a bubble, we shouldn’t interfere with it. We should let the markets do their thing and if it bursts, it will be as Bernanke and Paulson said in late 2007 even, it’ll be contained. And they were comforted by the fact that when the tech stock bubble had burst earlier in the 2000’s, it had done a lot of damage to people who had bought a lot of internet stocks, but it hadn’t really done a lot of damage, lasting damage, to the economy. And so they looked at it as they looked at that. So, it was not only a failure of analysis, it was failure of ideology in the best sense, a world view that led them to believe that even if there was a housing bubble, they shouldn’t do anything.

Now, Greenspan went around saying, “You can’t have a national housing bubble. Real estate is local, housing prices are local, you can have froth,” he said, “in some markets.” And it’s very late in the rise in house prices where he kind of throws in the towel and says, “I think we have a big problem.” So, he was just wrong, and because he had been right so often, people kind of believed him.

Question: DEAN BAKER, BEAT THE PRESS: Does this raise questions about the Fed’s competency?

David Wessel: Sure. But who was more competent? The rest of the bank regulators were just as bad. I think as a result of this, we have every right to expect the Fed to be much more thoughtful about asset markets and to be more open and to think about how it can use it’s weaponry to let a little air out of any bubble before it bursts. I think they are not yet convinced they can or should do that, but I think that’s the right debate to have.

I think some of it had to do with the fact that the financial system had evolved and a lot of the mortgages were being made in institutions that were not under the Fed’s jurisdiction. And the Fed, like a lot of bank agencies said, “We’re responsible for this set of people and someone else is responsible for other people and it’s their problem.” But some of these mortgages were made by affiliates of banks, and the Fed could have pushed harder into those affiliates to see what they were doing, but Greenspan didn’t think it was a good idea.

Greenspan says that he was caught by surprise by the surge in sub-prime lending in 2006 and 2007, that when he first saw reports in trade publications that there had been this big increase in sub-prime lending that he didn’t believe the number because he didn’t believe that the situation could change so rapidly and that was something where he just made a bad judgment. When the official numbers came in, it turned out that these earlier reports from mortgage trade publications were right. But in 2005 and early 2006, there wasn’t yet as big a sub-prime problem. It’s really 2006 and 2007 when sub-prime mortgages take off and where everybody begins to say, “Whoa. There’s a problem here.” And then, of course, people didn’t think that housing prices could fall as much as they did, so they assumed that a lot of these mortgages would be okay because the people could refinance, or the bank could take the house and it would be worth what people had borrowed against, and that turned out just to be wrong.

To put it another way, some of these mortgages were bad in any circumstance. Some of them were only bad because house prices fell so much and people misunderstood how far house prices could fall.

Question: Do you see any real impetus for financial regulatory reform?

David Wessel: Well, I think it’s kind of obvious that the financial regulatory system is broken and there is a push by the President and the Treasury Secretary, and the Fed Chairman, and Barney Frank, the Chairman of the House Financial Services Committee, to change the rules. But they’re running into a lot of resistance and I think they are running into resistance for a number of reasons. One is, that this is kind of hard, and Congress doesn’t like to do hard things and some people want to do a lot and some people want to do nothing, and as a result the status quo sometime prevails. The memory of the crisis is fading enormously quickly and that means that the urgency of doing a financial regulatory reform is fading as well.

But the other problem is that the financial reform has not good constituency. There are a lot of individual constituencies, a lot of businesses and each one of them is attacking one piece of the bill or another, and as a result, that’s slowing it down. The President’s strategy clearly had been to put a new consumer regulatory agency on the bill as a kind of locomotive, to pull it through Congress. But that hasn’t worked very well. So, we’re talking here in November, 2009, looks to me like the House of Representatives will manage to get a bill out before the end of the year, but it will be next year before we learn whether the Senate can do the same and then they’ll have to be compromised and by then the memory of the crisis will have faded so much, or the bitterness over high unemployment may be so severe that it’s difficult to get a coherent bill out of Congress.

You know, I should say that the reason we have a Federal Reserve was because we had a financial panic in 1907, and that panic ended because of the intervention of one man, J. P. Morgan. Everybody agreed after that, that we needed to have a better system. But the Federal Reserve Act didn’t pass until 1913. There were six years of arguments between debtors and creditors, farmers, and bankers, and populace. It wasn’t until Woodrow Wilson became President and kind of showed some leadership and Louis Brandeis helped him form a compromise that got this clunky bill through Congress. So, that was six years, it could take six years this time too.

Jamie Dimon did not do exactly what J. P. Morgan did, the man whose name is on the bank that Jamie Dimon runs. But in the crisis, in March, 2008, someone had to step up and take over Bear Stearns, get some money from the Feds, $30 Billion to help do it, but Jamie Dimon was that man. And J. P. Morgan in that episode saved the day. And they also ended up buying Washington Mutual and they play, now an important role because some banks are bust and other banks are weak and J. P. Morgan and Goldman Sachs are among the strong. So, it is very much history repeating itself. It’s kind of ironic, the rules are different, the circumstances are different, but the J. P. Morgan empire is once again at the center of the whole system.

Question: Who is to blame for the housing crisis?

David Wessel: Fact 1 is that the Federal Reserve was given by Congress substantial power to oversee the mortgage industry. Not all of it, but some of it. Fact 2, the Federal Reserve had the power to ban unfair and deceptive practices in mortgage lending and other lending and didn’t use that power in the case of mortgages because Greenspan thought it was very difficult to make a rule; it was really something that should be done case by case. Fact 3, Greenspan was not a big fan of regulations. Greenspan in his own book says that he didn’t agree with a lot of the laws that govern regulation in the United States. Laws that he was pledged to enforce, but he would obey the law of course, and he did what was required by the law, but he was not a regulatory enthusiast, to say the least. And so, he was never pressing his staff to say, how can we come up with a law that will do something here? Fact 4, Ned Gramlich had a different view of the world. Ned Gramlich is not a prophet, or the late Ned Gramlich was not a prophet. He didn’t see the entire collapse of the housing bubble, or anything like that. All he said was, there were some consumers out there who were getting some kind of lousy products and he thought it was the role of government, in this case the Federal Reserve on whose board he sat, to regulate that so that the people who were getting the mortgages would be protected. He was a simple consumer protection argument and he and Greenspan disagreed. Greenspan said subsequently, and Gramlich didn’t push very hard. Gramlich and others say, give me a break; it was hard to get anything trough the Fed unless Greenspan wanted it to happen and Greenspan was not a fan of this.

I don’t think that had Ned Gramlich been 100% successful we would have avoided the housing bubble. I think the housing bubble was caused by a number of factors and one of them is the supply and demand question that Ed Glazer talks about, although Glazer is much more focused on what makes housing prices go up in some communities and down in other, or up less than others. And that really isn’t what we’re talking about here. We’re talking about a massive generalized cross the country surge in home prices, and I don’t think that Glazer pretends to explain that. This is more like the financial bubbles that financial economists study. So, what would have happened if Gramlich had been more aggressive, or more successful in tightening the Feds regulation of sub-prime mortgages, as in fact, the Fed has done subsequently after all the horses left the barn, they closed the door. They’ve outlawed all the mortgages that nobody is making any more now.

Well, I don’t think we would have avoided the housing bubble, but maybe it would have been more – I don’t think we would have avoided the housing bubble because there was so much going on, but it might have been less widespread and there might have been fewer victims. And I think that’s all that you can say. Obviously mortgage regulation can stop mortgage brokers, or banks, from making mortgages to people that have no income, no job, and no hope of paying back the loan. In fact, the financial community frequently yelps that regulation will stop them from making these sorts of loans. And Barney Frank, among others, has said, “Yeah. That’s the point.” So, for instance, the Congress passed a new law on credit cards. The Fed has written rules to enforce it and that will make it harder for some people to get credit cards who probably shouldn’t get them. Well, the same thing could have happened with sub-prime mortgages should the Fed had acted differently.

Question: The fact that we couldn’t see this crisis coming, does this signal anything for the future?

David Wessel: In many respects, this crisis was a failure of imagination. The authorities, Bernanke, Geithner, and Paulson, even though they had this gut sense the we might have a financial crisis, never imagined that so much could ride on the value of houses in the U.S. And if the value of houses in the U.S. fell, which was a surprise, that that could pull down the entire financial system.

So, one thing that tells us is that we are going to have crisis in the future, human foresight is limited, we will go through periods of lots of boom in financial markets and then lots of angst and depression in financial markets and we should not be thinking that we are going to come up with a system that prevents every crisis. What we need to do is come up with a system that makes them less frequent, makes them less severe when they happen and somehow cushions the blow so that when they happen, they don’t have such widespread effects as this one did.

I think that having a systemic regulator, someone who’s charged with looking across the entire financial system, makes a lot of sense. It’s certainly better than not having one. One of the reasons this crisis was so severe is there was a whole bunch of people going around looking at just the institutions they regulated. In some cases there were huge institutions that nobody was looking at and in other cases, they just weren’t looking for the connections between Bank A, and Investment Firm B, and Mortgage Broker C, and Insurance Company D. Well we can surely do a better job of that. Whether the Fed is the right agency or not is kind of a political debate right now. The Fed is certainly better equipped than any existing agency to do that, but one could set up a new agency to do that. The British tried that, it didn’t work very well, but the British have done that. So, I think that all you can say is, we should do it, but we shouldn’t be naïve. It’s not going to cure us from any repeat of a crisis.

Question: Can we build a system less prone to human error?

David Wessel: One can always hope, but I don’t think so. Look, it is striking how few people were involved in the big decisions in this crisis. And it might have been better if at some times the circle of people who participated was larger. I was struck, for instance, for how little intervention there was from the White House in some of the key decision. Like, should Lehman Brothers be bailed out or not? The peculiarity of the law limits the number of Fed Governors who can sit in a room and talk about something that matters to three without calling it a meeting and having a formal notice under the Freedom of Information Act. As a result, Michigan as often not included in the deliberations even though he was one of the financial experts who was a member of the seven-member Federal Reserve Board at the time.

But, I mean, this is a little bit like thinking about World War II. In the end, there were some key generals, Patton, and Montgomery, and Eisenhower, and there were lots of people involved in the decisions, but in any war, there’s going to be a handful of generals who come up with a strategy and then a lot of people who execute it and advise them. And I’m not sure if we can hope for much more in a circumstance like this.

You know, there are two ways to look at what just happened. One was, it was an enormous failure of our system, our governance, and of the people we charge with protecting us from a financial calamity. And I think all of those things are true. But one can also say that, at a moment of great peril to the United States economy, and in deed to the global economy, somehow this small band of people managed to pull the U.S. economy, the global economy back from the abyss of depression. So, we don’t know how the story is going to end. We might have a decade of stagnation, and that would be horrible of course, but for the moment, I don’t think you want to complete condemn the system that put these people in place and gave them the authority to do what they did so that today, in November, 2009, the odds of another Great Depression, or back to close to zero, whereas a year ago, they were more like 30%.

Question: Some people say our lack of understanding for basic economics got us into this mess. How should economics be taught in school?

David Wessel: That question has a number of pieces that don't touch each other. One thing is there was a failure of academic economics here. Too many macro-economists underplayed the importance of finance and of financial institutions and their understanding of the world. The relatively small number who were working in this field, Bernanke being one of them, could have used a lot more help. So there are a lot of practicing economists who had a model view of the world that didn't turn out to be quite rich enough to cover what was happening.

I don't think that we're going to convince a whole lot of people that they shouldn't take a loan that they can't pay by giving them a high school economics course. So do I believe that more people need sound financial education, a sense of if it looks too good to be true it probably is, a way to understand that if borrow something, some money and you're paying 12 percent interest that that could add up over time. The answer to that is yes and we should do a better job of that and there's been endless efforts to do it and it's going to be kind of hard if you have kids who can't add and subtract but if you get past the add and subtracting thing we should be able to do that better and websites and calculators can help.

But I think that some people look at the teaching of consumer economics as a panacea and it isn't. We are always going to have people who don't get it and it's important to think of a way to give them choices that help steer them away from really bad decisions. I think there's a lot of new thinking in economics called behavioral economics that gives us a guide here.

We would not build a grade school cafeteria where the kids had 12 feet of dessert and then six inches of fruit, vegetables and protein. But that's what we do in finance. You go into a bank and there's a hundred ways that they can lend you money that you can't afford to pay back. So one of my disappointments in the financial regulatory bill that's working through Congress is they rejected some of the proposals that the President had made that would structure these decisions so that if you went to get a mortgage you would be required to be shown if you got a regular ‘ole 30 year fixed year mortgage, this is what your payments would be and this is how much interest you would pay over time. If you take this new fangled mortgage, this is how it's different.

So you can still get the new fangled one but you should be shown that choice. In the credit card bill that passed, I believe there are rules that say to people -- rules that say that the credit card company has to put on the bill if you make the minimum payment -- the $29 you have to pay, the minimum -- how many months or years will it take you to pay off your balance. That's a way to help people make decisions in real-time when they're faced with them and it's not something you can teach them in 8th grade and hope they'll remember when they're 37.

Question: ARNOLD KLING, ECONLOG: To what extent was this a liquidity crisis and to what extent was it a solvency crisis?

David Wessel: A liquidity crisis is when you have a lot of financial institutions that are in good shape, but they’re just kind of short of cash and they need somebody like the Federal Reserve to tide them over until they can get back on their feet, but they basically have made good loans. A solvency crisis is when the loans at a bank are made is so lousy that even if it could collect them all on the day of the crisis, they wouldn’t get enough money to pay off their depositors.

Clearly this crisis began as a liquidity crisis, and that’s how the Fed treated it. But eventually it became a solvency crisis. That’s when, in the end, the Federal Government put a lot of tax payer capital into the banks. That’s how you rebuild the foundations. The problem is that, it’s not always clear when you’re crossing the line from liquidity to solvency and it’s certainly not always clear at the moment you have to make a judgment.

Question: ARNOLD KLING, ECONLOG: What do you say to those who think it’s a liquidity crisis?

David Wessel: Well, I don’t agree with the premise. I mean, the reason that Bernanke joined Paulson in going to Congress to ask for $700 billion of taxpayer money was that he knew it was a solvency crisis. The reason Lehman Brothers went down was not liquidity, it was solvency. So, I think there was a political tactic decision about, at what point do you go to the ramparts and shout, “We need taxpayer money. The banks are bust.” And how do you do that so you get the money, but you don’t frighten people into cowering under their dining room tables?” But I don’t think there was a problem of analysis here.

Now, I do think there is a problem of sometimes the people in the room look at their clients as the financial institutions and that’s particularly true of people who have spent their life in the financial industry, Hank Paulson at the Treasury. Bernanke has tried to explain this when he went on 60-Minutes, he said, “I did not set out to save Wall Street. I set out to save Main Street. In order to save Main Street I had to save Wall Street.” I think that’s a coherent view. He believes that finance is crucial to the well functioning of the economy where most of us live and work. But it turns out to be such a complicated sentence that most Americans can’t follow it.

Question: DAN INDIVIGLIO, THE ATLANTIC BUSINESS CHANNEL: Would reducing the power of the Fed, or increasing its transparency have helped?

David Wessel: This is one that really requires hitting the rewind button and then changing the plot and then hitting the fast forward button and seeing what the ending is. It’s kind of an impossible question to answer. Surely it would have been better if somebody in the government was charged with having an overarching responsibility for this financial system and had both the mandate and the capacity to say, “You know, there’s just an awful lot of bad mortgage loans being made and we should make less of them.” Or to say that, securitization, turning loans into securities, is causing problems because the people who make the loans just pass the hot potato to the security holder who buys them and they don’t have any skin in the game, so as a result they are making a lot of lousy loans. So, surely they would have made a lot of difference.

I don’t think that the stuff about Fed transparency, the Fed providing more information really would have made much difference before the crisis. Most of what people are upset about is not what happened before the crisis, but the lending that the Fed did during the crisis. And so, I think that’s an issue. And I think that also having a system where there are so many bank regulators and there’s so much turf battle going on was clearly not helpful, and it’s unfortunately that it doesn’t look like the pending legislation will consolidate that very much.

The government could have been much clearer about what it was doing. There was a lot of confusion about what the Paulson, Bernanke, Geithner program was. I think that you can never set out a perfect set of principles that say this is how to respond in this circumstance, but they should have done more of that. It would have been better if the government had more authority going into the crisis to deal with the collapse of a financial institution other than a bank so that they would have had a choice in September 2008, that was better than bankruptcy, Lehman Brothers, or bailed out AIG. It would have been better if there were some fund that the Treasury Secretary and the Fed Chairman and the head of the FDIC could tap in an emergency that didn’t require going to congress. Something that had maybe a lot of locks on it, but at least some body would have the key so that the government could fire back when the country was attacked by a financial virus instead of twiddling its thumbs and doing all of these jury-rigged programs until Congress got around to giving them the money. So, I think those are a few things.

Question: FELIX SALMON, REUTERS FINANCE: Do you believe the Fed’s claim that it tried to impose a haircut on AIG’s creditors?

David Wessel: I think this is a question that we don’t yet know enough to answer. But clearly, they did not impose a haircut on the counterparties to AIG. Clearly those counterparties, the big banks, Goldman Sachs, Deutsche Bank, the rest of them, had a strong interest in the system and it would have been – I would have liked know just how hard did the Fed try to tell them, look, everybody’s got to take 98 cents on the dollar, or 87 cents on the dollar. We’re not bailing anybody out 100%. But there were a lot of problems, one was, this was an international company and it’s one thing for the Fed and the Treasury to lean on J. P. Morgan and Goldman Sachs and Morgan Stanley. The French banks might be a lot less susceptible to the charms of Ben Bernanke and Hank Paulson, and you could have a really bad international dispute over this. But most importantly, this was happening with a lot of other things going on. It was kind of a busy week there. First they marry Bank of America and Merrill Lynch. Then they had this problem with Lehman Brothers, and then right behind, literally hours later, they’re dealing with AIG. So, I don’t think you can look at any one of these things in isolations. Sure, it they had six months to think about it, they probably would have done a better job. In retrospect, should they have done something more to force a haircut on the counterparties of AIG, I think the answer to that is, yes. Could they have done it with the power they had in the circumstances they were confronting, I honestly don’t know.

Question: RYAN AVENT, FREE EXCHANGE/THE BELLOWS: Is the Fed’s focus on regulatory reform distracting from its primary mission?

David Wessel: I don’t. Because I don’t think that you can have full employment and price stability and ignore the financial system and ignore asset bubbles. My gosh, if there’s anything we’ve learned in the last five years is that employment has a lot to do with what goes on in asset bubbles. We have 10.2% unemployment today and it’s not because of conventional monetary policy, raising interest rates because there was an increase in the consumer price index. It’s the result of a finance bubble. So, I don’t think the Fed can do its job without looking at that stuff. That doesn’t mean that the Fed has to have the authority to supervise every bank in America and there’s an honest debate that goes on among people. Many of them allies of the Fed about whether the Fed should or shouldn’t have that direct authority. But I don’t think asset bubbles are a distraction, I think asset bubbles are a key part of their mission.

Question: RYAN AVENT, FREE EXCHANGE, THE BELLOWS: Should the Fed be expanding or contracting its credit using operations?

David Wessel: Well, Ben Bernanke has a really hard task. He has to decide when is the right moment to contract credit and raise interest rates. If he does it too soon, we’ll get a relapse in to recession. That’s what happened in 1937 when the Great Depression was extended because the Fed was too tight at the wrong time.

On the other hand, if he waits too long, we'll get an outbreak of inflation greater than he thinks is prudent. So I don't think anybody thinks the moment is to tighten is today. The argument is over how soon should the Fed do that; some of that depends on how the economy performs and I think that it's a tricky balance. It takes a great deal of technical skill. This is not like any recession we've seen in our lifetime and that means that we can't be sure the economy is going to react in the same ways. It takes a great deal of luck because you just got to get it right and sometimes you have to make a guess. You don't have the luxury of waiting for to see how the play's going to end before you decide what role you're going to play in the third act.

Finally, it's going to take a lot of political courage on Bernanke's part. The Fed is under attack by the public, by the Congress, and he is undoubtedly going to have to raise interest rates and drain credit for the system before everybody thinks the economy's back to normal and he's going to have to do that at a moment when the Congress is looking at the powers of the Fed and the law that governs it. So it's not going to be popular and it's going to be tricky. So we all can only hope that he has the technical skill, the luck, and the political guts to do it at the right time because if it does it at the wrong time we'll have a much worse economy than if he does it at the right time.

Question: What personalities does Bernanke have to contend with in order to achieve this in Washington and Wall Street?

David Wessel: His first constituency is his own colleagues at the Fed. I think he's got them pretty much in line; although, there are some people who are outspokenly critical of him inside the Fed. The second constituency is the American people because Congress is hostile to the Fed because they sense that the people are hostile. The Gallup Poll did a survey in the summer of 2009 and they found that fewer people think the Fed is doing a good than any other federal agency that they mentioned including the IRS. The Fed has become a lightning rod for all the anger about the sense that Wall Street got bailed out and Main Street didn't. Like Greenspan and like Volcker before him, the Congress is an important constituency for the Fed and its Chairman.

I call the Fed the fourth branch of government in the subtitle of my book and that's a way to express just how much clout and independence they had during this crisis but the fact is it's not enshrined in the Constitution and Congress could change the law and it could change the law in ways that would make it harder for the Fed to do its job, particularly harder to raise interest rates or lower them when they think it's appropriate. So that means courting a lot of members of Congress. Not only the powerful ones like Barney Frank and Chris Dodd the Chairman of the two relevant committees in the House and Senate but also the rank in file members who have to vote on things A lot of them think the Fed is a bunch of bank protecting nitwits and they're hostile.

Then finally, they do have a constituency on Wall Street in markets. We, in this country, rely on the willingness of lots of people with money around the world to lend it to us at very cheap rates. That's the only reason why we could have this big stimulus package, it's the only reason why the Federal government could be running such a big deficit, and to some extent Ben Bernanke and his colleagues at the Fed are the custodians of the US dollar and if people think we're going to have a lot of inflation here or a lot of bank failures or a lot of other problems, they're not going to be willing to hold so many dollars. That means that we'll have to pay more to borrow. So he can't ignore the markets but they are not his only constituency.

Question: MARK THOMA, ECONOMIST’S VIEW: How do the editorial and news divisions of the Wall Street Journal influence coverage?

David Wessel: Most newspapers have a wall between the news side and the editorial side. What makes the Wall Street Journal different is that our wall is very high and it has barbed wire on the top. I long ago came to terms with the fact that the edit page has its views and sometimes its own facts, and they’re different from the facts that I see. I don’t worry about it. I do my best to explain to our sources in Washington that we do our thing and they do theirs and the fact that we’ve been successful in covering Presidents with views as different as Ronald Reagan and Bill Clinton suggest to me that here in Washington, people get it. It’s a bigger problem overseas because the editorial views of newspapers tend to affect their news sides more; papers are more partisan, so sometimes that is hard to explain to foreigners. One thing I will say is that a lot has changed at the Wall Street Journal since Rupert Murdock bought the company, but that thing hasn’t. I don’t care what the edit page says, and I don’t think they care what I say and there’s very little interchange of ideas between us. We see each other in the men’s room or on the basketball court, sometimes we sit down with the same policy maker to have a conversation, but I just don’t worry about it and I think the readers are lucky. They get two newspapers for the price of one.

The Wall Street Journal has many constituencies. There are a set of people who buy the Wall Street Journal because they like the editorial page and they like to read what the editorial page has to say about the issues of the day. There’s a constituency of people who are in business and who want to know what’s happening to their competition, what’s happening to their economy, the dry cleaner in Peoria who wants a sense of how’s business. But I think more, and more, there are people who read the Wall Street Journal because they want a good well-rounded newspaper and other newspapers have been forced to shrink more than we have so that we always had strong political coverage. We covered the civil rights crisis in the ‘60’s, with unusual vigor. And in the years since then, the paper has become broader, not narrower.

The first section of the paper now is largely general news, not business and finance. So, I think like any successful newspaper, we have to accept that we have many constituencies, some of them reading us only online or on their Blackberry’s, and our only way to survive as a viable institution is to do enough for each of them so they buy the paper and then they get the rest of the stuff that they don’t want.

Question: What are some of the really important economic blogs?

David Wessel: I look at Calculated Risk. I look at Greg Mankiw's blog. I look at Brad DeLong's blog. I look at Paul Krugman's blog for the stuff that's not in the New York Times when he puts online. Simon Johnson and his friend do one called Baseline Scenario that's good. I've learned a lot to rely on Twitter in a way because what Twitter does is someone notices something interesting on a blog that I don't normally read but it's on the subject that I like to know something about. So I don't have an RSS feed so I don't like look at 50 things a day but those are the ones that I do and then we have our own, Realtime Economics, and I spend substantial time making sure that we have some interesting stuff up there.

I think the danger here is very real though, that blogs and cable TV become a way for people to get their prejudices confirmed. If you believe that John Kerry really won the presidential election, you can find some blog that says oh yeah that's what happened and it had to do with faulty voting machines. And if you believe that Barack Obama was really born in Kenya you can find a blog to say that. What I worry about is if people go to the Internet and get their prejudices confirmed that the role of people like reporters at the Wall Street Journal who are trying to check out the rumor before they print it or post it gets diminished and in the worst case the profits go to people at the extremes, to MSNBC on one side and Fox on the other and there are fewer profits for people in the middle who are trying to do what used to be called fair and balance journalism.

I don't think it so much restrains a better part of valor, it's that if you put something on your website or in your newspaper you ought to have reason to believe it's true. And it's very hard for us when people complain, "You didn't report this thing that I read on XYZ Website." We can say, "Actually we did look into it. We found out it wasn't true, so we didn't put it on our site." In the old days, that would meant that no one heard about it except the people who are on the inside. Today, it's like everybody knows it. Everybody knows things that are not true because they can read it on the Internet.

I hope that what will happen is that there will be so much information overload that people will once again realize that some sites are more credible than others and they will turn to those to be mediators between themselves and the whole flood of news. I mean, most of us do not need the news media to tell us about the things that we do every day; I don't need to read my local newspaper to discover that a tree fell in front of my house, but what I rely on the media to do is to tell me the things that I need to know that I didn't see myself. People tend to be very critical when there's a story written in the newspaper about a meeting they were at or a subject they know well and they say, "I was at that meeting..." or "I know that subject and this reporter doesn't get it." That then challenges the credibility of everything else they read in that publication.

Well I'm hoping that works in reverse. That when they read for the fifteenth time on some website something about Barack Obama that isn't true, that they'll begin to think, "Well this is entertaining but it's not true and I'd rather go to some mainstream media site or some credible new stream media site to give me the truth." But we're not at that point yet, so it's a little bit frightening.

Question: To what degree did economics bloggers influence coverage of the crisis?

David Wessel: I think there’s a long term trend here that people who work for traditional media, like the Wall Street Journal, are both blogging themselves and reading blogs to get new and different ideas, or net and different takes, or smart analysis on what’s going on. I think actually, that became more important during the crisis than to the run up. But it does provide an important monitor and check on the mainstream press willing to go with the flow.

I think one of the lessons I learned is that if things are going fine and 9 out of 10 experts say that everything’s going to be okay, and one says that we’re cruising for a bruising that our coverage should not be 90% positive and 10% negative. We really have to listen harder to that 10%. And sometimes the way you find those 10%, the way you get a critical read on their views, is to read what they’re blogging and what other bloggers say on them. So, I think it played a role and I think it well play a much bigger role in the future.

Recorded on November 20, 2009