Securities and Exchange Commission: Created in the wake of the crash of 1929, the SEC is the Street’s top cop. It regulates the exchanges and its member firms, in addition to stamping out corporate abuse. However, over the last couple of years, the agency’s reputation has suffered as it not only missed a number of high-profile frauds (most famously that of Ponzi schemer Bernie Madoff) but also failed to prevent the financial meltdown of 2008.
Weather Underground: A radical sixties left-wing group whose membership included Obama confidant William Ayers. The group was responsible for a number of planned bombings of government buildings, including one on the Pentagon in protest of the Vietnam War.
APPENDIX III
A Few Key Financial Terms and Concepts
Bailout: The act of saving an institution from imminent failure through an injection of funds. During the financial crisis, the government had to bail out many financial firms that were on the cusp of bankruptcy to prevent a total collapse of the financial system. (Contrast this with other forms of government support, such as the discount window.)
Bond: A debt investment where investors lend money to either a corporation or a government for a set period of time at a fixed interest rate. A bond’s “coupon” is the interest-rate payment that is made over the life of the bond. The “principal” is the face value of the bond and the amount on which the creditor receives interest. Fixed income is an extremely lucrative business for Wall Street, as both federal and local governments need to tap the credit markets to fund their fiscal obligations.
Carry trade: An investment strategy where investors borrow at a low short-term rate and then proceed to invest in higher-yielding longer-term debt. Investors make money by pocketing the difference between the short-term rate at which they borrow and the long-term rate at which they invest. The carry trade was at the heart of the investment banks’ strategy to generate profits during the mortgage boom. Following the bailouts, the remaining big firms were designated “commercial banks” instead of investment banks; the implicit support this gave them from the U.S. Treasury allowed them to make unprecedented profits following the bailouts by borrowing money cheaply from the U.S. government and then investing it in bonds that paid higher rates of interest.
CDO (collateralized debt obligation): A security backed by a pool of other debt securities, such as, but not limited to, mortgages. Car loans and credit card debt are examples of other types of debt that might be packed into a CDO. A CDO is typically divided into various risk categories, or tranches, which are then sold to investors. The higher-rated (more senior) tranches are considered less risky, while the lower-rated, or junior, ones pay higher interest. A CDO squared is a CDO that is backed by other CDOs. The big banks’ purchases of tens of billions of dollars’ worth of CDOs that went bad lay at the heart of the crisis.
Commercial bank: A financial institution that accepts customer deposits and makes commercial loans. Commercial banks are regulated by the Federal Reserve and, in exchange for being able to access their customers’ deposits, are required to take less risk than investment banks. Since the repeal of the Glass-Steagall Act, however, the difference between a commercial and investment bank has decreased.
Credit-default swap: A credit-default swap is a form of a swap, or derivative, whose underlying value is determined by another security. In its simplest form, a CDS is an insurance contract against the default of a bond. While CDSs are often used for hedging purposes, many investors use them to speculate on the health of a company or even a country.
Derivative: A financial instrument whose value is derived from the price of another financial asset. Derivatives are contracts that can refer to a vast array of financial products, from standard equity options like puts or calls to much more complex instruments like credit-default swaps (see entry above), which are linked to the value of an underlying debt instrument. Derivatives are typically used for hedging or speculative purposes. Investors like them for their leverage, but as Orange County found out, leverage can work well on the way up and wipe institutions out on the way down.
Discount window: The discount window is the primary lending mechanism by which financial institutions can borrow from the Federal Reserve. The rate they pay on the loan is called the discount rate. The discount window exists to ease liquidity concerns that may arise in times of trouble. When Goldman Sachs was reclassified a commercial bank, it had the same access to funding as regular banks that take and hold deposits.
Fannie Mae and Freddie Mac: The most prominent of the government-sponsored enterprises, Fannie Mae and its smaller sibling, Freddie Mac, played a crucial role in the expansion of the housing bubble. Fannie Mae, or the Federal National Mortgage Association, was created during the Depression to increase the availability of mortgage lending. It was charted as a public company in 1968. Freddie Mac, the Federal Home Loan Mortgage Corporation, was created two years later. Fannie and Freddie buy mortgages from various lenders and then either hold those mortgages in their portfolios as investments or repackage them with other loans to create mortgage-backed securities, which are then sold to various investors. At one point these two companies owned or insured half of America’s $12 trillion in mortgages. Both the Clinton and Bush administrations were unsuccessful in their attempts to rein in the influence of the GSEs. In September 2008, both companies were taken over by the government due to massive losses from risky loans.
Glass-Steagall Act: Enacted in response to the collapse of the banking system during the Great Depression, the Glass-Steagall Act, or Banking Act of 1933, prohibited commercial banks from engaging in investment-banking activities, such as the trading or underwriting of securities. It established the FDIC, which insured commercial bank deposits, but it also divided the banking industry into two distinct houses: the banks, which took in deposits and made loans, and the brokers, which engaged in the riskier parts of the capital markets. Glass-Steagall was changed in 1999 by the Gramm-Leach-Bliley Act, which relaxed many of the restrictions on commercial banking activities. Many have pointed to the watering down of Glass-Steagall as the starting point of the financial crisis that ensued a decade later.
Government-sponsored enterprises (GSE): A group of government-chartered companies whose purpose is to increase the availability of credit for everything from home borrowing to student loans. These corporations include Freddie Mae, Fannie Mac, Sallie Mae, and Ginnie Mae.
Hedge fund: A lightly regulated investment fund that is typically only available to wealthy investors. Unlike mutual funds, which must follow investment mandates, hedge funds can use a wider range of investment and trading techniques to generate profits. Contrary to their name, often-times they are most exposed to risk due to their heavy use of leverage.
Hedging: Any investment strategy designed to hedge, or offset, risk against an existing position or investment.
Investment bank: A financial institution that is primarily engaged in the riskier aspects of the capital markets, such as the underwriting and trading and selling of securities. Investment banks offer an array of financial services, from merger advice to back-office services for other financial institutions. The key distinction between commercial and investment banks is that an investment bank does not handle customer deposits. Investment banks are regulated by the Securities and Exchange Commission.
Leverage: The use of borrowed money to enhance investment returns. Leverage was at the heart of the financial crisis, as many firms borrowed at enormous levels, in some cases $30 or more for every dollar they owned, to make speculative bets on the markets. Leverage can work both ways. On the way up it increases returns, but on the way down it can magnify losses. For example, if a trader has $10 and leverages at ten to one, he now has $100 to invest. If his bet goes up 50 percent, he’s made $50—or 500 percent of his initial stake of $10. But if his bet goes down 50 percent, he’s now in the hole $40—four times the amount of money he has on hand.
Moral hazard: The fear that insulating a person or party from the results of ri
sk taking will encourage more risky behavior. This was the primary argument against bailing out the financial institutions, who all made risky bets only to be saved in the end through taxpayer-financed bailouts.
Mortgage-backed security: A type of bond that is backed by the underlying cash flow of various mortgages.
Municipal bond: A type of bond that is issued by a state or local government. The interest is tax free, making it an attractive investment for wealthy people looking to shelter their income. “Muni” bonds are considered among the safest of all investments, but as Orange County illustrated, there is no such thing as a sure bet when it comes to investing.
Run on the bank: The unexpected and rapid exit of deposits or cash balances from a financial institution. Bank runs occur when individuals lose confidence in the solvency of a particular financial institution. The most historically famous instances of runs on the bank occurred during the Great Depression, when rumors of insolvency at a bank would lead to long lines of customers waiting to withdraw their deposits—leading to just such an insolvency. Runs on investment banks are similar, except that the creditors are hedge funds and other large investors as opposed to ordinary individuals.
Savings and loan (S&L): Savings and loans are commonly called thrifts and are federally insured financial institutions that take in deposits for the purpose of making real estate or other consumer loans. In the eighties and early nineties, lax lending standards and a slowdown in real estate cause the failure of a number of federally insured S&Ls.
Securitization: The process of structuring and redirecting the cash flow of an asset to create multiple securities. Securitization is at the heart of the credit industry, as bankers look to capture the cash flow of any type of receivable, be it a mortgage, credit card loan, or something else, and structure it into a separate security that can be bought or sold by investors.
Systemic risk: The threat of a collapse of the entire financial system, as opposed to the failure of a single company or financial entity. It was the threat of systemic risk that drove the Fed and Treasury to take extraordinary steps in the midst of the financial crisis.
“Too big to fail”: The notion that some institutions are so vital to the overall health of the economy that their failure would lead to a collapse of the entire financial system. Some would argue that “too big to fail” coddles banks and tacitly endorses risk taking. Others feel that following this approach saved the U.S. financial system from a complete meltdown. Few argue that, as things stand, in the event of a new crisis the U.S. government would still consider most of the major financial firms too big to fail.
Underwriting: The process by which Wall Street firms bring to market either a debt or an equity security. Underwriters allow companies and governments to access public capital, either in the form of direct ownership or through structuring loans. Underwriting fees used to be the lifeblood of the securities industry, but they have since taken a distant back seat to trading revenues.
NOTES
Introduction
3 “$13.4” billion figure for Goldman Sach’s annual earnings report.
5 “God’s Work” from “Meet Mr. Goldman Sachs,” Times (London), November 8, 2009.
5 “10 percent unemployment” from the Bureau of Labor Statistics.
5 “vampire squid” from “The Great American Bubble Machine,” Rolling Stone, July 9, 2009.
6 “Fat Cats” from “Obama Slams Wall Street Bankers,” Wall Street Journal, December 14, 2009.
6 Description of Blankfein’s upbringing from “Lloyd Blankfein, A Profile,” Forbes, December 16, 2009.
7 ShoreBank’s ties to members of the Obama administration from “Wall Street Scrambles to Save ShoreBank,” Wall Street Journal, May 17, 2010.
7 “Valerie Jarrett sat on the board of Chicago Metropolis 2020” from chicagometropolis2020.org.
8 Eugene Ludwig’s role in saving ShoreBank from “Goldman Joins Race to Save Chicago Bank,” Wall Street Journal, May 13, 2010.
8 “Greg Craig” from “Goldman Taps ex-White House Counsel,” Politico, April 19, 2010.
8 Various contributions to ShoreBank from “ShoreBank Close to Raising $125 Million in Private Capital,” Wall Street Journal, May 19, 2010.
9 Rahm Emanuel’s ties to Goldman Sachs from “Goldman Will Be Sitting Pretty with Emanuel in the Obama White House,” Washington Examiner, April 21, 2010.
Chapter 1: A Secretive Meeting
17 Description of meeting between Wall Street bankers and Obama from author’s interviews with people who were present and confirmed by members who were there.
18 Description of Wall Street’s financial support on Bush/Kerry election from OpenSecrets.org.
19 “Dimon’s own 2009 compensation of more than $17 million” from “JPMorgan’s Dimon Gets $17 Million Bonus,” New York Times, February 5, 2010.
20 Description of McCain’s relationship with Wall Street from author’s interviews with people close to the matter.
20 McCain’s description of Wall Street as a “villain” and pledge to “change the way Washington and Wall Street” do business from McCain campaign statement, September 17, 2008.
21 Lawrence Summers’s description of females’ aptitude for math from “Summers’s Remarks on Women Draws Fire,” Boston Globe, January 17, 2005.
23 Description of Obama’s activities as a community organizer from “What Did Obama Do as a Community Organizer,” National Review, September 8, 2008.
23 “Other states vote; New York invests” from “How Barack Obama Struck Fund-Raising Gold,” New York magazine, April 15, 2007.
24 Gallogly’s relationship with Obama from author’s interviews with people close to the matter.
27 Number of meetings between Gallogly and Obama from POTUS Tracker, Washington Post, July 14, 2010.
27 Gallogly fund-raising totals from Opensecrets.org.
32 “Exceeded $300 million” from “As Bear Stearns Implodes, Warren Spector Keeps $382 Million,” Bloomberg, March 19, 2008.
33 “Impressed immediately” from author’s interviews with people familiar with Spector’s meeting with Obama.
34 Description of Gallogly’s relationship with Volcker from author’s interviews with people close to the matter.
34 “Rezko became literally” from “Obama and His Rezko Ties,” Chicago Sun Times, April 23, 2007.
37 “Cayne had publicly chastised” from “A Top Official at Bear Ousted Over Funds Implosion,” New York Times, August 6, 2008.
37 “Current scourge of Wall Street” from author’s interviews with people in the meeting.
38 “Paid an ACORN Affiliate $800,000” from “Obama and ACORN,” Wall Street Journal, October 14, 2008.
38 “Mickey Mouse” from “ACORN Charged in Voter Fraud,” MSNBC, May 4, 2009.
38 “Most liberal U.S. Senator” from “Why Obama Was the Most Liberal,” National Journal, August 25, 2008.
38 “Obama had voted against” from “Obama’s Record Shows Caution, Nuance in Iraq,” Boston Globe, March 20, 2007.
39 Reverend Wright’s phrase “God damn America” from “Obama’s Pastor Disaster,” Orange County Register, March 15, 2008.
39 “Jewish vote” from The Daily Press of Newport News, June 10, 2009.
39 Wright’s comments on 9/11 from “Obama’s Pastor: God Damn America, U.S. to Blame for 9/11,” ABC News, March 13, 2008.
39 Greg Fleming’s recollection of Obama’s dinner from author’s interviews with people familiar with the meeting.
40 Obama and McCain campaign totals from Opensecrets.org.
41 Cavanaugh’s contributions to Obama from author’s interviews with executives at JPMorgan.
41 Description of Tom Nides’s Democratic fund-raisers from author’s interviews with people close to the matter.
Chapter 2: The Left Side of Wall Street
44 “Obama rewarded these generous” from “How Barack Obama Struck Fund-raising Gold,” New York magazine, April 15, 2007.
45
Goldman, JPMorgan, and Bank of America not experiencing a single negative day of trading losses from “ ‘ Perfect Quarter’ at Four U.S. Banks Shows Fed-Fueled Revival,” Bloomberg Businessweek, July 19, 2010.
46 Steve Schwarzman’s comments on McCain’s lack of interest in hearing from Wall Street executives from author’s interviews with people close to the matter.
46 Description of McCain’s dislike of Wall Street from author’s interviews with people familiar with the matter.
47 Account of former Merrill Lynch CEO John Thain’s support of McCain from “Thain Is Good for McCain,” Politico, November 14, 2007.
48 Description of McCain screaming at former Treasury secretary Hank Paulson from author’s interviews with people close to the matter.
50 Dimon’s directing his senior staff to contribute to Obama from author’s interviews with people close to the matter.
50 Goldman and JPMorgan Chase’s campaign contributions for September 2008 from Opensecrets.org.
52 John Mack’s endorsement of Hillary Clinton from “John Mack Backs Clinton,” Bloomberg Businessweek, April 27, 2007.
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