A couple of recent pieces on the late financial debacle have me puzzling over this stuff again—mostly because I still understand little of it (the big boys, naturally, like it that way). But here goes.
Too Big to Fail is a 2009 book by reporter Andrew Sorkin treating the agonizing days in September 2008 when the system almost collapsed. It’s a fascinating read, if for nothing else than the fact that it familiarizes us with the major mandarins of finance and government. We become chummy with then-Treasury Secretary Hank Paulson and NY Fed chairman Tim Geithner, the latter now Obama’s Treasury Secretary. Of the two, Paulson comes off as the better man—more capable, more sensitive to the personalities he had to deal with (and therefore more respected by them), more concerned to save the system. Geithner strikes us as a bit of a tyrant, jealous of his perks, prone to order his bankers to jump through the hoops he has set for them. Paulson, by contrast, always solicits the ideas of those he tries to persuade. We also get the feeling that the entire ordeal—having to bail out the free-market system he was and is so much a part of—was one Paulson would have avoided if he could. He was perfectly happy as CEO of Goldman Sachs. As Treasury Secretary, on the other hand, he has to persuade, cajole, and take crap from Congress; at various points, we are told that he actually vomits from the political tension he is under. No wonder. If all reports are to be believed, the financial system was on the very brink of collapse. The way Sorkin tells the story also indicates that the renowned TARP bailout of major financial institutions was actually a political/psychological ploy meant to calm markets and the American people—a plan that forced nine major banks to accept an infusion of billions of dollars each, whether they needed it or not. Many did: Citibank, Morgan Stanley, and AIG. Others, especially Goldman Sachs and Wells Fargo, did not. But in order to create the illusion of equality and stability, Paulson’s plan required all banks to accept the money.
The story begins with the impending collapse of Lehman Brothers. We feel almost sorry for the CEO, Dick Fuld, who had spent his life building the firm, and who, until the very end, thinks he can work a deal to get another bank to rescue his. Such a buyout is what Geithner and Paulson spend most of their time trying to arrange. But Lehman’s problems, coming after the bailout of Bear Stearns, suffered from bad timing: the public was already alarmed by the first bailout and it was clear another would ignite a firestorm of protest. So Lehman’s failure was political as much as financial. Indeed, one of the failings of this book is that we never really get a clear explanation of why any of these financial giants was hemorrhaging so badly. We learn about the fall in their stock prices; we hear that the “short sellers” are driving their price down; but we don’t really quite understand what the root problems or mistakes are. What we get mostly are vignettes dramatizing little episodes in the long series of near-mergers and deal collapses. Some of these vignettes are telling: Bob Diamond, CEO of Barclay’s Bank, approached by Geithner to buy Lehman, wants the Federal Reserve to guarantee the deal (it is amazing to realize how alergic these financial “geniuses” are to the free market economics they’re always preaching).
“We need to be seen, to be invited by you and shepherded by you,” Diamond insisted. “You guys asked me if there was a price at which we’d be interested and you asked me, if so, ‘What do you need?’ That doesn’t mean I’m gonna call Fuld. That’s completely different.”
Giethner, growing frustrated with his equivocation, asked again, “Why can’t you just call Fuld? Why can’t you do it?”
“I’m not going to ask a guy if I can buy him, you know, at a distressed price,” Diamond said. “It only works if you guys are looking to arrange a deal. If you’re not, fine, no hard feelings, we’re okay.”
Then comes Sorkin’s comment:
However much Barclays may have wished to avoid giving the impression that they might be taking advantage of someone else’s misfortune, it was, of course, precisely what they were seeking to do. (p. 262)
This is really the key to the entire skein of deals and deal-making that Sorkin portrays. All these pooh bahs knew each other, played golf with each other, sat on boards together, had dinners together (at the finest restaurants on the planet, of course). They wanted to appear to be friends; but, in fact, they were sharks, circling each other, keen always to detect the smell of blood from a wounded competitor.
Unfortunately, during those terrible days of September, there was a lot of blood in the water. Once Lehman was allowed to fail, fear ruled Wall Street and Washington as well. No one knew who would be next because all the firms were interrelated financially. AIG had written enormous amounts of insurance—credit default swaps—for Goldman Sachs and others. If banks tried to collect on these insurance policies, which many did, AIG was going down. It was this domino of collapses that Paulson and Geithner, in Sorkin’s telling, were so desperate to prevent. At one point, before Paulson promoted his TARP program, we listen in on one of his conversations with Steve Schwarzman, chair of private-equity giant, the Blackstone Group. Schwarzman says:
“I have to tell you, the system’s going to collapse in the next few days. I doubt you’re going to be able to open the banks on Monday….People are shorting financial institutions, they’re withdrawing money from brokerage firms because they don’t want to be the last people in—like in Lehman—which is going to lead to the collapse of Goldman and Morgan Stanley. Everybody is just pursuing his self-interest,” Schwarzman told him. “You have to do something.” (emphasis mine).
What strikes me here is the language: Everybody is pursuing his self-interest. Well now, isn’t that a damn shame! These are the people who have raised the individual pursuit of self-interest to the level of holy dogma: this is what makes capitalism, free markets great. But when it happens within the club, when the dogs turn on each other, then they cry foul! You have to do something! And of course, Paulson did do something, for it was right after this that he put together, and rammed through Congress, the TARP bailout program.
This is fascinating stuff. We actually find ourselves rooting for the Treasury Department, for financial leaders like Dick Fuld, to succeed. I liken this feeling to the similar feeling one gets when watching mafia movies: no matter how heinous their behavior, we root for the characters who are portrayed from the inside as protagonists. Their cause becomes our cause. Sadly, what Too Big to Fail leaves out are the series of fraudulent, near-criminal activities that led these Wall Street powerhouses to run aground: the sub-prime mortgages, the collateralized debt obligations, the credit default swaps, all the exotic instruments whereby they and their executives enriched themselves to obscene levels, and brought the entire financial system and the economy it supports to near ruin. A recent article, “Banks Self-Dealing Super-Charged Financial Crisis,” indicates just how culpable these guys were. What the analysis by ProPublica reveals is that when these Wall Street banks saw how the market for the mortgage-backed securities they’d been packaging at great profit was faltering, they “created fake demand.” They simply bought their own products—the worst of the mortgages in their CDOs—and put them together in new CDOs, which they then proceeded to sell. They knew these new CDOs were junk, because that’s why they’d separated them out in the first place. And when the new ones proved hard to sell in full, they created yet more CDOs to buy those. ProPublica calls this a “daisy chain that solved one problem but created another.” And when the daisy chain could no longer be hidden, when, as we learn in Too Big to Fail, the banks could no longer get away with valuing these toxic assets at the inflated levels they claimed for them, the banks started to collapse.
That’s when we American taxpayers came to the rescue: TARP, Toxic Asset Relief, means that the U.S. government was forced to buy the worst of these bank “assets” to get them off their books—because with them, the big banks would fail.
I don’t know about you, but this just gives me a warm feeling all over.