by Prins, Nomi
Technically, the banks should write off some of the debt, and they could also lend new money to the struggling countries. But that didn’t happen. The banks still didn’t lend and wouldn’t lend for another nine months or so, and then only after additional incentives were added.67
Bank of America, Clausen, and Third World Debt
Three years after Clausen returned to the top slot at Bank of America, the firm with the largest US bank exposure to Mexico was still reeling. Thus, Clausen was particularly keen on the Brady plan.68 In July 1989, he helped bang out its details alongside Alan Greenspan; Gerald Corrigan; Pedro Aspe, Mexico’s finance minister; and Citibank chairman John Reed, who led the fifteen-bank advisory committee on behalf of no less than three hundred creditor banks.69
As leader of the negotiations and head of the bank with the second biggest exposure to Mexico, Reed had already officially lent Brady his support after a visit to the White House in late March.70 Unofficially, US banks were mired in private negotiations. They refused to fully embrace the proposed Brady plan or comply with the US government’s request that they forgive a portion of loans, despite Brady’s incentives or “additional financial support” from the IMF and World Bank that was designed to get the banks on board.71 Former Citibank chairman George Moore had strong thoughts of his own regarding the crisis, which he had penned in his 1987 book, The Banker’s Life, and augmented in a March 1989 paper that circulated around the White House.72
Moore admitted that the banking system had gone “too far” in recycling oil profits when OPEC quadrupled the price of oil. But rather than blame banks for overzealous lending (that far exceeded the reasonable country limits set in the 1930s), he put the onus on the IMF and the Bank for International Settlements, who, he said, had “to know of the extreme heights to which these debts had rapidly risen.”73 It was not unlike bankers and politicians blaming the Fed for the late 1920s speculation that led to the Crash of 1929, as opposed to the banker culprits who had stood to gain more personally from their speculative practices.
As Moore summarized the situation: “It was a wonderful party—before the check came. It was a trillion dollar binge. The banks thought they were making a lot of money, the borrowers never had it so good. All ordered more drinks, as long as the bar was open. Meanwhile, responsible international institutions like the IMF and World Bank were looking out the window when they should have stopped the party!”74
On June 2, 1989, the World Bank unveiled its three-year program for Least Developed Countries (LDC) debt relief, as per Brady’s proposals.75 Three months later, J. P. Morgan added $2 billion in loss reserves anyway, to indicate the program was insufficient. Chairman Lewis Preston stated, “The action we’ve taken should give us greater flexibility to work with these countries advising government and private sector clients.”76 It was a version of Reed’s what’s-in-it-for-us doctrine, which entailed banks soliciting the government to buoy their positions but not helping in return to alleviate the problems—and as such, placing the burden of their actions on the taxpaying population. It also opened avenues for bankers to further extend themselves into the region for merger and acquisition business.
Reed Slams Regulation
Meanwhile, Reed still had national policies to change. He was called before the Senate Banking Committee on July 13, 1989, to provide testimony on domestic financial policy.77 This time, he stressed his opposition to deposit insurance premiums.
Reed proposed that the level of deposit insurance be gradually cut back.78 He wanted depositors to judge for themselves whether banks and savings institutions were taking undue risks. His logic was similar to that of Chase chairman Winthrop Aldrich during the Depression; the big banks that were better at managing their risk should not have to pay the same premium for insurance as the banks that weren’t, or any if possible. Customers could decide if their deposits were safe or not.
Reed also united with Corrigan before the Senate Banking Committee to argue that the US banking system was falling behind that of other countries.79 Reed demanded no less than a “major restructuring of our financial system” to keep up with a rapidly changing “competitive environment.”80
As the latest torch carrier for that global competitiveness argument, Reed paved the path for Robert Rubin, Larry Summers, and the man who would be his partner in finally breaking Glass-Steagall, Sandy Weill. Now deregulation was presented as even more critical in the fight against potential European banking supremacy, and thus to America’s position as a global financial power.
The S&L Blowout and Greenspan’s Game
The deregulation of the S&L industry between 1980 and 1982 had enabled thrifts to compete with commercial banks for depositors, and to invest that money (and money borrowed against it) in more speculative real estate ventures and junk bond securities. When those bets soured, the industry tanked. Between 1986 and 1989, 296 thrifts failed. An additional 747 would shut down between 1989 and 1995.81
Among those, Silverado Banking, Savings and Loan Association went bankrupt in December 1988, costing taxpayers $1.3 billion.82 Neil Bush, George H. W. Bush’s son, was on the board of directors of Silverado at the time. He was accused of giving himself a loan from Silverado, but denied all wrongdoing. Records in the Bush archives show seven pages of redacted communication related to Neil Bush in early 1990.83 Another son, Jeb Bush, had already been dragged through headlines in late 1988 for his real estate relationship with Miguel Recarey Jr., a Cuban American mogul who had been indicted on one charge of fraud and suspected of up to $100 million of Medicare fraud charges.84
But the most expensive S&L failure was Lincoln Savings, a debacle that cost taxpayers $3 billion.85 The flameout also led to the Keating Five political scandal, in which five US senators were implicated in accepting campaign contribution bribes from Charles Keating.86 Keating had secured a study from Alan Greenspan, then a private sector economist, concluding that direct speculative investments were not harmful.87
It took several months of internal political battles before the Bush S&L plan headed to the House floor for consideration, but finally, on June 14, 1989, it was ready.88 On the same day that the Bush team was presenting its S&L package, Greenspan was swiping at Glass-Steagall, retreading the well-worn theme of global competition before the Senate banking subcommittee. He claimed that current regulation put US banks at a competitive disadvantage and thus inhibited the US financial system’s growth globally, and by extension the very stability of the country (using the angle Reagan had mentioned at his swearing-in ceremony).
“There is no question we are being significantly suppressed by the Glass-Steagall restriction,” said Greenspan. “My concern is that as we continue to internationalize . . . we are in effect inhibiting our institutions from fully participating in that.”89
With Greenspan on deck advocating the repeal of Glass-Steagall, New York bankers reinvigorated their drive to expand across state lines and to circumvent New Deal limitations on the financial services they could hold under one roof, such as the inability to purchase insurance companies. Their argument was that insurance restrictions should not apply to subsidiaries of bank holding companies. In other words, just because banks couldn’t own insurance companies, why couldn’t their subsidiaries?
In practice, this was a minor but important distinction. As Philip Corwin, senior legislative counsel for the American Bankers Association, put it, the issue had gone from a “turf fight (between insurance and banks) to a consumer issue.” In a rather odd alliance, the Consumer Federation of America supported the big banks’ campaign for insurance powers.90 The CFA subscribed to the notion that the more firms were involved in insurance, the more it would increase competition and thus decrease rates for individual consumers, an argument disproven time and time again. For when big firms expand their reach, consolidation, and power, the actual result is higher prices.
Bush’s S&L bailout plan became the Financial Institution Reform, Recovery and Enforcement Act, signed on August 9, 1989.91
The FIRREA abolished the Federal Savings and Loan Insurance Corporation (FSLIC) and allowed the Federal Deposit Insurance Corporation (FDIC) to insure S&L deposits.92
The centerpiece of the act was the establishment of the Resolution Trust Corporation (RTC) to handle savings and loan failures.93 The first president of its oversight board was Daniel Kearney, a banker who had spent a decade in Salomon’s real estate financing department creating the very securities that had combusted on the books of the S&Ls.94 The RTC would be funded via a new privately owned corporation, the Resolution Funding Corporation (REFCORP), which would issue $30 billion in long-term bonds to raise the needed capital beginning in 1990.95
This proved another boon for the big commercial banks. They could profit by virtue of their intermediary position selling those bonds into the market, while the government was subsidizing the entire project.96
Within six years, the RTC and the FSLIC sold $519 billion worth of assets for 1,043 thrifts that had gone belly up. Key Wall Street banks were involved in distributing those assets, making money on financial destruction once again. Washington left the public on the hook for $124 billion in losses; the thrift industry lost another $29 billion.97
Bankers vs. Senators: Venezuela
Willard Butcher, CEO of the Chase Manhattan Bank, succeeded Dennis Weatherstone in 1989 on the Fed’s advisory council.98 He, too, had a wide range of concerns about the restrictive nature of current regulation and the LDC debt problem for US banks. While his compatriots wrestled with the Treasury Department and Congress on the issue of LDC debt, he took up the issue with the media.
On July 25, 1989, Butcher wrote a letter excoriating a New York Times editor over his assumption that banks rejected a proposal for Venezuela’s debt reduction because “it did not offer them the option of lending Venezuela new money to use for repaying its existing debt.” Butcher claimed, “The banks rejected the proposal because that country’s request for debt reduction was excessive and not based on needs.”99
But his harshest criticism centered on the piece’s suggestion that the United States “announce that there will be no international guarantees on Third World debt for any bank unless all the banks jointly approve sizable debt reduction.”100
He declared the idea “naive and illogical” on the basis that US banks accounted for only 31 percent of Venezuela’s bank debt versus that extended by foreign institutions, and thus, it was unlikely anyway that “all the banks will ever jointly agree.”101 Butcher warned, “The progress of these negotiations cannot be helped by editorials that are illogical and wrong.”102
More broadly, he was using the globalization of excessive debt as an argument against US banks doing their part to alleviate a situation they had created, while his brethren in Washington were arguing that US banks had to be deregulated in order to compete with these international firms for more such opportunities.
Two months later, a team of five senators sent letters to eight top bankers including Preston, Clausen, Butcher, and Reed.103 They implored the bankers to support the government’s plan for Venezuela debt restructuring. They even played hardball, promising to support funding to the IMF and World Bank for “market-oriented economic reforms” only if banks reduced debt or began lending again.104
The bankers battened down their hatches and refused to respond to federal threats or promises of rewards for “good behavior.” As the World Bank said in its annual report, “the hard reality is that less debt has been forgiven in 1989 than in 1988, and that the amount of resources marshaled to finance debt relief is pitifully small.”105
Economic Suffering
As the 1980s drew to a close, unemployment soared and the economy limped, just as they had when the decade began. The Brady plan turned out to be a bust; the bankers ignored the senators’ pleas, as Reed, Preston, and Weatherstone effectively forced the government to back them. The glut of debt that the banking sector had spewed into the world absent full repayment left them in the position of needing to find another “game.” While pundits and economists debated the impact of deficits and tax policy on the general economy, it remained the bankers’ actions that had driven an immense bubble of bad debt domestically and internationally, with sizes that far overshadowed the US deficit.
As former undersecretary of the Treasury Paul Craig Roberts had warned Don Regan in August 1986, and later wrote in a Wall Street Journal piece on October 28, 1986, “A stronger force than tax cuts was operating on U.S. Capital outflows.”106
Roberts noted that “a fundamental change in the lending practices of U.S. banks” was the critical factor. “Money-center banks were heavy lenders to the Third World, expecting rising commodity prices such as oil and copper to service and repay loans. When [price] inflation collapsed, the bankers realized that they had overexposed their capital and stopped lending.”107
The deluge of bank debt combined with recessionary economies inevitably accelerated economic suffering throughout the world. In the United States, 614 out of 3,200 thrifts had collapsed by the end of the 1980s (the most since the Great Depression), costing the US government more than $85 billion, as larger banks swept in to pick up their remains and enhance their own customer base in the process. Another 429 would fail during the first half of the 1990s, bringing the total to 1,043 failures.108
Moreover, the federal government and Fed response to the third world debt crisis, S&L bailout, and 1987 stock market crash was to subsidize the banking system with federal and multinational money. The bankers had succeeded in pushing the presidency to back losses domestically and from a foreign lending perspective in ways that would have been embarrassing to the bankers of an earlier era. They had succeeded in privatizing their profits and socializing the costs of failure. This financial policy had officially become US domestic and foreign policy.
Bank leverage ratios and risk-taking decisions, already growing, increased exponentially as a result, only to be later compounded by derivatives and other complex financial instruments. Bankers now wielded enormous power to alter the economic and financial nature of the world in more extreme ways, and with more money at stake, than ever before. No longer was there even a pretense of alignment with domestic concerns or collaboration with the White House, except as fodder for arguments about why the biggest banks should be allowed to increase in size. If anything, it was the other way around. Financial voracity and the bankers’ quest for power, enabled by an increasingly subordinated Washington, had trumped reason and would continue to do so in the 1990s.
CHAPTER 17
THE EARLY TO MID-1990S: KILLER INSTINCT, BANK WARS, AND THE RISE OF GOLDMAN SACHS
“Some men know the price of everything and the value of nothing.”
—Oscar Wilde
THE 1990S WERE A DECADE THAT RAN ON TECHNOLOGICAL STEROIDS, FROM THE sheer speed at which financial transactions took place to the dot-com mania that Federal Reserve Board chairman Alan Greenspan dubbed “irrational exuberance.”1
With the Cold War over, America lacked a great external enemy. There was no major national distraction to divert the tide of the global dispersion of US financial power, no public interest to protect against outside enemies in reality or in rhetoric. There were no restraints on the drive for self-interested accumulation or the final dismantling of banking rules in the name of American competitiveness. The moneyed elites were now full-fledged gladiators with no business need for a social compass but every need for a warrior spirit. The men running Wall Street didn’t come from families with famous names on the high-society circuit; they were men who fought for power in their firms and around the world without such attachment to lineage.
The conundrum for these bankers was that Europe’s banks had reemerged as true challengers thanks to the global expansion of firms like UBS in Switzerland, Deutsche Bank in Germany, and Barclays in Britain. Fearful of losing their position in the hierarchy of financial influence, US bankers demanded domestic deregulation with increasing intensity—while embracing far riskier practices.
It was America versus the world, only now financial products and more substantive mergers and derivatives trading augmented the spread of political doctrines. The assumption was that “democratic capitalism,” the ideology that merged US political goals with financial ones, had successfully defeated more “socialistic” international commerce, trade, and business doctrines. The proof was increasingly evident in the extreme divergence of US CEO pay versus that of average American workers and their global counterparts. Big balance sheets bolstering the most powerful US banks were as important as large weapons arsenals. In this war of international opportunism, the American government remained keen to aid and invest. As President Bush’s policies gave way to Clinton’s, the White House yielded to more bankers’ demands—just as they had in the 1980s but with a much greater degree of completion and higher global stakes.
The Continuing S&L Crisis
In May 1990, Chase chairman and CEO Willard Butcher met with President Bush to discuss his views about America’s global competitive position. Butcher and his international advisory committee saw real opportunity to finance reconstruction efforts in post-Communist Eastern Europe, which would augment their other international business. Butcher wanted to ensure that Bush was on board with the foreign policy initiatives that would be necessary to complement his plan, which entailed supplementing standard lending with more complex deals across borders, including the use of derivatives markets.
Bush was receptive. As Butcher later wrote him, “You are just as we think of you: warm, articulate, committed and concerned not only about the American people but about the state of the world.”2
President Bush didn’t respond personally. With lobbyists and lawyers inserting themselves into the political-financial complex, the personal connections characterized by gestures like Johnson’s thank-you phone calls and Eisenhower’s carefully crafted letters had become relics of another time.
