But in this case, there was no meaningful federal rule. “[N]either of these federal agencies replaced the preempted state laws with comparable, binding consumer protection regulations of their own,” wrote Patricia McCoy, the director of the University of Connecticut’s Insurance Law Center, in 2008. And the preemption doctrine was never intended to give banks free rein to make abusive loans to people who had no chance of being able to pay them back. But perhaps the most important thing was the message it sent. “It gave lenders a sense that they had a protector in the government,” says Prentiss Cox, who ran the consumer enforcement division in the Minnesota attorney general’s office until 2005.
Preemption also became a recruiting tool for the regulators trying to expand their own empires. Incredibly, American financial institutions had the ability, under certain circumstances, to switch regulators—an idea that had long been promoted by Alan Greenspan. His essential belief was that having multiple, overlapping regulators was good for the system because, as he once put it in testimony before the Senate banking committee, it served as a “valuable restraint on any one regulator conducting inflexible, excessively rigid policies.” (“The present structure,” he added, “provides banks with a method … of shifting their regulator, an effective test that provides a limit on the arbitrary position or excessive rigid posture of any one regulator.”) Jerry Hawke, the comptroller of the currency, took that idea a step further—rather than sit back and wait for institutions to come to the OCC, he actively talked up the “advantages” of being regulated by the agency he headed. In early 2002, for instance, the OCC issued a press release with this startling headline: “Comptroller Calls Preemption a Major Advantage of National Bank Charter.” A former regulator says that he viewed his job as “a salesman for the national charter. He would make sales calls. The OCC used preemption as its advertising.”
Just about a year after the OCC first began trumpeting the virtues of preemption, the OTS joined in, announcing that the thrifts it oversaw were exempt from the key provisions of Georgia’s new law. The OTS’s move helped make the state’s law moot. “Either we will have an unlevel playing field and a rush of people to go get OTS charters or we will see a leveling out of the playing field by having the state legislature” change the law, said a spokesman for the mortgage lobby. Sure enough, by the spring of 2003, the law had been replaced by a much weaker one.
The OTS had long asserted preemption when states passed laws that it didn’t think its thrifts should have to follow. But in early 2004, the OCC went all in, decreeing that all institutions under its watch would be exempt from all state and local laws aimed at predatory lending.
After Wachovia moved its mortgage company into its federally chartered bank in order to take advantage of the OCC’s preemption policy, the state of Michigan argued that it should still be able to regulate Wachovia’s local lending unit. Wachovia sued. The OCC filed a supporting brief. The fight went all the way to the Supreme Court, which in 2007 sided with Wachovia.
And so it went. New Jersey, which passed a predatory lending law in the fall of 2003, repealed it a year later after the lending community, along with the rating agencies, followed the Georgia playbook. In New York, the OCC asserted preemption when then attorney general Eliot Spitzer simply tried to get data from national banks in order to see if they were complying with fair-lending laws. “I think the reality is that the refusal to permit our inquiry, and the assistance of the OCC in helping the banks stop it, was symptomatic of a world where nobody wanted to look at anything,” Spitzer later said.
John Dugan, who replaced Hawke in 2004 as comptroller of the currency, would later argue that national banks were only a small part of the problem. He wasn’t completely wrong; by the OCC’s calculation, national banks originated 12.1 percent of nonprime loans between 2005 and 2007. But his argument missed the larger point. Preemption created competition between the OCC and the OTS—and the OTS, which regulated institutions like IndyMac and WaMu, was indisputably a weaker regulator. Secondly, preemption meant that even the state-chartered lenders didn’t have to curb their abuses, because states were reluctant to pass or enforce strict rules for their institutions that federally regulated institutions were allowed to duck. Says Kevin Stein, the associate director of the California Reinvestment Coalition: “Banks said, ‘We don’t have to comply.’ The OCC said, ‘They don’t have to comply.’ The state legislatures said, ‘If we can’t pass a law that regulates federally chartered banks operating in our state, then we’re not going to regulate state-chartered lenders, because then they can’t compete.’ It was a legislative and regulatory race to the bottom.”
Finally, subprime loans continued to make their way, unchecked, into the national banking system, thanks to securitization. It really didn’t matter who originated them. States had no way of cutting off that all-important funding source. And the national regulators, with their energy focused on making sure that “their” institutions were free from pesky state laws, idly stood by.
What none of the regulators could see was the most obvious fact of all: if cities and states all over the country felt the need to enact their own laws—as twenty-five states, eleven localities, and the District of Columbia had by 2004, according to a GAO report—didn’t that suggest there was a problem that needed fixing? Even the FBI seemed to think so. In October 2004, Chris Swecker, the assistant director of the criminal investigative unit of the FBI, told Congress that “mortgage fraud is pervasive and growing.” He explained, “The potential impact of mortgage fraud on financial institutions and the stock market is clear. If fraudulent practices become systemic within the mortgage industry and mortgage fraud is allowed to become unrestrained, it will ultimately place financial institutions at risk and have adverse effects on the stock market. Investors may lose faith and require higher returns from mortgage-backed securities.” And still the regulators remained unconcerned.
There was one halfhearted effort to enact a national law to curb some of the subprime lending abuses. But while some lenders, including Ameriquest and New Century, did want national legislation to avoid the constant need to beat back state and local laws, the powerful Mortgage Bankers Association didn’t put its weight behind a law. One former lobbyist says that the deciding factor was Angelo Mozilo, who told him, “No regulator is going to tell me what kind of products I can offer.” According to the Wall Street Journal, Countrywide spent $8.7 million between 2002 and 2006 on political donations, campaign contributions, and lobbying to defeat antipredatory lending legislation. Old-school Republicans always felt, here’s the channel of commerce and here are the curbs, says Chris Hoyer, who runs the plaintiffs’ firm James Hoyer in Tampa, Florida. “Go over them, and we’ll kill you. As soon as someone starts to cheat to get market share, and their market share gets bigger, well, guys are gonna cheat to keep and get market share. That’s why you have old-school rules. Bad shit happens if you let the curbs down.”
For the few who remember the old world of mortgages, and the concept of risk, those were surreal days. Dave Zitting, an old-fashioned mortgage banker with a homespun style, runs the Arizona-based Primary Residential, which makes mortgages across the country. Zitting started in mortgage banking in 1988, when he was eighteen, and aside from one year spent bagging groceries, he’s never done anything else. He grew up in a world where making a loan was all about the four Cs—credit, collateral, capacity, and character. “We thought of a loan like an airplane,” he says. “It couldn’t fly unless it had all four parts.” As he watched the growing insanity, he says he went from feeling scared to leave a C out to thinking, “What good am I? Have I just been fooling myself that I’m doing a job? Holy shit, maybe these guys are on to something—maybe paying for a home has nothing to do with the four Cs.” When he started in business, there were three loan products. By 2005, there were six hundred. The rule, Zitting says, was “Breathe on a mirror, and if there’s fog, you got the loan.”
In 2005, Zitting began to dip his toe into the subp
rime market, although he insisted on tight controls. Every subprime loan that was offered at a branch was underwritten again at headquarters. He still remembers the day in June 2005 he got a call from a wholesaler who bought his company’s loans. This wholesaler was “one of the largest organizations on the planet.” (Zitting, who is still in the business, won’t name the company, other than to say, “They’re not around anymore.”) They flew him to their headquarters because they wanted to talk to him. Around a conference table sat a dozen men in suits. “They said, ‘Dave, what’s going on? Your company sells us the lowest amount of approved loans of anyone we do business with,’” Zitting recalls. Because Zitting used this company’s software, they could see that their system was approving loans that Zitting was then rejecting at headquarters.
“Oh, it’s simple,” Zitting told them. “We check the credit at corporate, and not a lot make it through.”
“That’s why we flew you out,” one of the suits responded. “We don’t like that. You need to trust our system, and if you do, your volume will go up by leaps and bounds.”
“How do I know the borrower will pay?” Zitting asked.
“You don’t need to worry about that,” they responded.
The next day, Zitting says, he got the “trade tapes” for the subprime loans he was selling, which showed the prices various buyers were willing to pay. June had been a big month for him: Primary Residential had underwritten $9 million of subprime loans. Usually, the offer was close to what the buyer had been promising verbally, but this day, the offer was surprisingly low. So Zitting called up the guy he dealt with. “I said, ‘Something is screwed up in the secondary market,’” he recalls. “He said, ‘I’ve been fielding those calls all day.’” It was a moment when the subprime market was tightening up, almost as if the bubble was coming to an end. Although the moment didn’t last very long, it was enough for Zitting.
“Dave,” the man said. “I like you. Get out.”
“Excuse me?” Zitting replied. He thought to himself, “I just came from a meeting where people were telling me not to turn down loans.”
The man said, “If you ever say I said this, I’ll deny it, but if you want your company to be around, you will not fund another subprime loan. There is going to be a bloodbath.”
And so, Zitting says, he called an emergency board meeting and he shut down his tiny subprime business, even though his firm had just spent $400,000 buying some necessary software. “All my friends in the business were laughing all the way to the bank,” he says. Over the next two years, he watched his business pals make millions and buy private jets and mansions. He remembers thinking to himself, “What the crap?”
11
Goldman Envy
Goldman Sachs went public on May 4, 1999, ending a 130-year partnership and ushering in a new era, with shareholders to answer to, a board of directors to provide oversight, and a chief executive officer instead of a senior partner. Even at a time when Internet IPOs were all the rage, Goldman’s public offering stood out. The stock was priced at $53 a share, but it opened at $76—the opening was delayed an hour because the demand was so strong. By day’s end, it stood at $70 a share, giving it a market valuation of $33 billion. The $3.6 billion the company raised in the offering made it the second largest IPO ever. The average take for the 350 former and current partners who owned most of Goldman’s stock was $63.6 million. Senior partner-turned-CEO Jon Corzine held shares that were suddenly worth $305 million. Hank Paulson, who would become CEO within days of the IPO, had a stake worth $289 million. One Wall Street competitor told Business Week, “To have priced this much paper—as a nontechnology stock—is incredible.”
To an outsider, the Goldman IPO must have seemed like a no-brainer. But people connected to the firm knew that the act of going public had been the culmination of a long struggle that had left many scars. As early as 1986 Bob Rubin and Steve Friedman, who were still co-heads of the fixed-income department—but were already pushing hard to reshape the Goldman culture—floated the idea of an IPO. It got nowhere. Over the next five or six years, the subject would occasionally bubble up, sometimes in small discussions, sometimes at firm-wide meetings, but the resistance to an IPO from the majority of the partners (and former partners, who retained an ownership stake in the firm even after they retired) remained strong. Some feared it would destroy what made Goldman special; some worried that they would be disadvantaged compared to other partners who had larger stakes; some didn’t want to see Goldman’s financials—and their compensation—printed in the newspapers.
In truth, however, Goldman badly needed to go public. Merrill Lynch, Lehman, and Morgan Stanley were already public companies, as were most other big Wall Street firms. Big, publicly held banks like Citibank and J.P. Morgan were Goldman competitors. Transformational deals were taking place that were reshaping Wall Street, and those deals used stock as currency. Wall Street firms that went public suddenly had what Charles Ellis, the Goldman historian, calls “substantial permanent capital.” They could take more risk. They could grow more rapidly. They were no longer reliant on the partners’ capital. Firms that didn’t go public would, in all likelihood, be left behind.
When Corzine became senior partner in 1994, he made it his mission to persuade his partners about the necessity of an IPO. In this he succeeded. The deal was originally supposed to happen in the fall of 1998, but had to be postponed, embarrassingly, when Goldman got caught up in the Russian crisis and the collapse of Long-Term Capital Management. Even when the IPO finally took place the following spring, it was not without internal turmoil. Shortly before it finally went off, Corzine was ousted in a palace coup, replaced by Paulson. (Although the change in leadership was announced prior to the offering, Corzine stayed on until the IPO was completed.) And John Whitehead, he of the famous fourteen business principles, wrote an anguished letter to all the Goldman partners: “I don’t find anyone who denies that the decision of many of the partners, particularly the younger men, was based more on the dazzling amounts to be deposited in their capital accounts than on what they felt would be good for the future of Goldman Sachs.”
The IPO was a critical turning point for Goldman Sachs. Over time, its culture did change, as the company—you couldn’t really call it a firm anymore—became focused on such measures as return on capital, stock performance, and growth. A firm where senior partners used to say “Trees don’t grow to the sky” began instead to talk about aggressive goals for return on equity. The trading side of the firm—for which “substantial permanent capital” was its lifeblood—eventually overwhelmed the investment banking side, in terms of profits, stature, and ethos.
And starting in the early 2000s, Goldman, having adjusted to life as a public company and having transformed itself into a money machine, went on a run the likes of which has rarely been seen in the annals of corporate America. Its 2003 revenues were $16 billion. They rose to $21 billion in 2004, $25 billion in 2005, and nearly $38 billion in 2006—more than double what it had been just three years before. Its market cap that year topped $88 billion. Somehow, Goldman always seemed to be in the sweet spot of every market. Somehow, Goldman always seemed to react to big market shifts faster than anyone else. Somehow, Goldman never seemed to make a wrong move.
But nobody could quite say how. As Goldman began generating most of its revenue from trading, it became impossible for outsiders to see how Goldman was making its money. Trading can mean a lot of things. It can mean acting as a market maker or trading for one’s own account—or both. It can mean treating clients fairly or “ripping their faces off,” as traders sometimes put it. It can mean trading plain vanilla bonds or peddling complex derivatives deals. Competitors began to whisper that Goldman had become increasingly ruthless, increasingly cutthroat, and increasingly concerned only about its own bottom line—and its bonuses. “They’d cut your ear off for a nickel, rip your throat out for a quarter, sell their grandmother for a penny, and sell two grandmothers for two pennies!” groused on
e private equity executive.
The rest of Wall Street watched Goldman’s metamorphosis with a mixture of envy, frustration, and resentment. But even as Goldman’s peers questioned and criticized its transformation, they also tried to copy it. The money—both the profits the firm produced and the paychecks its partners got—made Goldman the firm that everyone else had to keep up with. And to the outside world, it looked like they had become like Goldman. They all embraced risk taking and they all began to produce outsized profits. And yet the crisis would show that they weren’t like Goldman at all.
In his memoir, On the Brink, Paulson recalls the moment when he went to talk to Corzine after the coup had been completed. Corzine had just learned his fate; he’d been informed by John Thain, Goldman’s CFO and Corzine’s close friend. (In 2007, Thain was named chief executive of Merrill Lynch; during the worst weekend of the financial crisis, he negotiated its merger with Bank of America.) “Hank, I underestimated you,” said Corzine, according to Paulson. “I didn’t know you were such a tough guy.”
In fact, there was a lot about Hank Paulson that was surprising. He was a devout Christian Scientist, whose worst vice was too many Diet Cokes. Despite a nine-figure net worth, he inveighed against conspicuous consumption. He was almost absurdly frugal, a trait he inherited from his father, an Illinois jeweler. He and his wife, Wendy, whom he married during his second year at Harvard Business School, were avid conservationists and fanatical bird-watchers. Though they obviously lived in New York, the Paulsons’ homestead was in the Midwestern prairie, on a farm in Barrington, Illinois. It was where Paulson had grown up.
As a leader, Paulson was cut from a very different cloth than, say, Bob Rubin. He once told his alumni magazine that “I’m not an inspirational leader. I’m just not.” He didn’t lead by charm, or by leading people to his way of thinking by asking, “What do you think?” Rather, he was a force of nature, and his management style was marked by a kind of brutal pragmatism. His preferred mode was revving into action rather than sitting back, waiting, and patiently strategizing. He was direct to a fault, utterly lacking the verbal slickness that dissembling requires. At about six foot two with a build that still mildly resembled the Dartmouth football player he’d once been, and a gravelly voice to boot, Paulson had an aggressiveness about him that made people think he was much bigger than he was, and which could intimidate people into silence. These qualities also led some people to underestimate Paulson, as Corzine had. But doing so was a mistake: he had a mind that was surprisingly detail-oriented, nuanced—and clever.
All the Devils Are Here Page 21
