At that moment, upon finally learning how deep Fannie and Freddie’s problems were, Paulson decided the government had to take over the companies. “I started to race against the clock,” Paulson later recounted. He knew that Lehman Brothers’ third-quarter results were going to be disastrous. He was worried that Lehman’s problems would spread to the GSEs and trigger a run. He met with Bernanke, who agreed. For the sake of the housing market, the government needed to step in and nationalize the companies. “We had no choice,” Paulson would later say. Simply injecting capital—the original heart of the bazooka plan—would be a political disaster for the Treasury, given the Republicans’ feelings. Nor, Paulson believed, would it bring back investor confidence. “Why would any sane investor put money into these companies without knowing what the ultimate disposition would be?” Paulson would ask.
On August 26, from the Situation Room on the ground floor of the West Wing, Paulson briefed President Bush, who was at his ranch in Crawford, Texas. He briefed the president a second time on September 4. “Do they know it’s coming, Hank?” Bush asked.
“Mr. President,” Paulson replied, according to his memoir, “we’re going to move quickly and take them by surprise. The first sound they’ll hear is their heads hitting the floor.”
Even at this late date, Fannie and Freddie had powerful friends on Capitol Hill. Had they gotten advance word, they would surely have pulled every string they had to prevent what was coming. “We had to take them by surprise,” Paulson later said. “We just did.”
On the Thursday before Labor Day weekend, in a meeting with shareholders, Fannie gave reassurances that the government didn’t have anything up its sleeve. The following Friday, September 5, Mudd was summoned to a meeting at the Federal Housing Finance Agency—formerly known as OFHEO—at three p.m. When the Fannie contingent arrived, nobody came to meet them, so they wandered around the lobby. They saw Bernanke come in the front door. They also spotted a Wall Street Journal reporter who had been given a heads-up about the meeting. It would have been “almost comical if it weren’t tragic,” Mudd later said.
In a conference room just off his office, Lockhart was seated between Bernanke and Paulson. Lockhart read what appeared to be a script citing one regulatory infraction after another before he got to the real point. Although his team, admittedly, had given Fannie a clean bill of health recently, its capital was sorely deficient and the company couldn’t fulfill its mission. The message, explains one person who was there, was “If you oppose us, we will fight publicly and fight hard, and do not think that your share price will do well with all of the forces of the government arrayed against you.”
Then the government laid out its takeover terms. Existing shareholders of both common and preferred stock in both companies would be largely wiped out. The government would provide no up-front cash, but would put in preferred stock up to a combined $200 billion as equity fell below zero. Fannie and Freddie would be allowed to grow their portfolios through 2009 in order to support the mortgage market, but then they were supposed to begin shrinking them to $250 billion. Freddie, in a separate meeting, agreed immediately. The Fannie contingent at first objected, but eventually realized they had no choice. A government takeover was not easily resisted, not even by Fannie Mae—especially since the government had done one last thing to ensure it would get its way. The GSEs immediately had to fire all their lobbyists, so there could be no running to their friends on the Hill. “Cutting off the head of the snake,” people involved called it.
When Paulson was asked on CNBC about how much money the GSEs would really require, he said, “[W]e didn’t sit there and figure this out with a calculator.”
Paulson would later say that putting Fannie and Freddie in conservatorship was the thing he was most proud of in the crisis. “I knew with great certainty that we were not going to get through this thing without them,” he said.
Paulson had also hoped that the takeover of the GSEs would help calm the growing storm. “I hoped that we’d bring the hammer down and it would be the cathartic act that we needed to get through this,” he later said.
But it didn’t work out that way. If anything, the takeover of Fannie and Freddie only further damaged investor confidence. “The U.S. government, with access to information no private investor could summon, had lured investors into a trap,” Redleaf later complained. “Had the CEO of a private company gone about telling investors that his company had ‘more than adequate capital’ and was in a ‘sound situation’ knowing that the company might be in bankruptcy within weeks, he would have gone to jail for securities fraud.”
The real problem was a little different. The government’s information hadn’t been that much better than anyone else’s, and the government’s optimism was as naive as everyone else’s. And the scale of the losses was simply beyond anything that Paulson had imagined. The takeover of the GSEs shredded some of the last lingering bits of delusion about how bad things really were.
It started all over again on Monday, September 8. Just as Paulson had sensed, Lehman Brothers was the domino. The market that day rose 2.6 percent, but Lehman Brothers dropped $2.05, to $14.15. On Tuesday, the news broke that a last-ditch deal Fuld had been negotiating with the Korea Development Bank had broken off. The stock dropped again. John Thain, Paulson’s old colleague at Goldman who had replaced Stan O’Neal as the CEO of Merrill Lynch, called. “Hank,” he said, “I hope you’re watching Lehman. If they go down, it won’t be good for anybody.” On Wednesday, Lehman preannounced its third-quarter results. It lost $3.9 billion, thanks to a $5.6 billion write-down on its real estate holdings.
That Thursday, September 11, John Gapper, the financial columnist for the Financial Times, wrote a column, only half tongue in cheek, with the headline “Take This Weekend Off, Hank.” Noting Lehman Brothers’ mounting troubles, and the likelihood of another long weekend for the Treasury secretary, he wrote, “[W]hen he has worked on weekends recently, the taxpayers have paid dearly.”
Paulson, of course, did work that weekend. Lehman, Merrill, WaMu, AIG—the vultures were circling all of them. Late Friday afternoon, Paulson flew to New York and spent the weekend at the New York Fed, in nonstop meetings with Fed officials and Wall Street CEOs, and they tried to stop what they all saw coming. By Monday morning, Lehman Brothers, unable to find a buyer—or to persuade the government to save it—was bankrupt. Merrill Lynch had been bought by Bank of America. Right behind them came AIG, which would be rescued by the government a few days later at an initial cost of $85 billion.
There was nothing the government, or anyone else, could do to hold it back any longer. Some thirty years in the making, the financial crisis had finally arrived. The volcano had erupted.
Epilogue: Rage at the Machine
On July 21, 2010, President Obama signed into law the Wall Street Reform and Consumer Protection Act, a 2,300-page, 383,000-word piece of legislation that marked, unquestionably, the biggest change in the regulation of the financial industry since the aftermath of the Great Depression. The law had been two years in the making, and most of it, in one way or another, was a reaction to the excesses that had led to the financial crisis.
The Federal Reserve would get new powers to look broadly across the financial system. A council of federal regulators led by the Treasury secretary would help ferret out systemic risk. A new consumer agency was created to help end the lending abuses and keep people from getting loans they could never hope to pay back. Under this new law, most derivatives will supposedly be traded on an exchange—meaning in the clear light of day, where prices and profits are transparent. The bill creates a process to liquidate failing companies, so that there is a reasonable alternative to bailouts. It outlaws proprietary trading at financial institutions that accept insured deposits—the so-called Volcker Rule. “Because of this law, the American people will never again be asked to foot the bill for Wall Street’s mistakes,” President Obama said. Well, maybe.
Footing the bill for Wall Street’s
mistakes was precisely what the American taxpayer had been doing since September of 2008, in a hundred different ways. And Americans were angry about it. It wasn’t just the obvious examples—like the $182 billion in federal help that AIG required before it was over. The Federal Reserve guaranteed money market funds. It bought tens of billions of dollars of “toxic assets”—that was the culture’s shorthand for securitized subprime mortgages after the crisis—to help the banks get back on their feet. The FDIC, meanwhile, guaranteed all new debt issued by bank holding companies, without which they could not have funded themselves in the debt markets. Let’s face it: they were all now government-sponsored enterprises. And so they would remain, despite protestations to the contrary. Because as everyone learned with Fannie and Freddie, implicit government guarantees, whether they arise from a congressional charter or from the market’s belief that the government will stand behind a failing company, are awfully hard to take away.
It took a while after Lehman weekend for the panic to quell. It is easy to forget now, but Morgan Stanley and Goldman Sachs both found themselves caught in the contagion, and could well have gone under. Morgan was saved only when it managed, at the last moment, to make a deal with Mitsubishi UFJ, a big Japanese bank. Goldman, along with Morgan Stanley, was allowed to become a bank holding company, thus receiving a government imprimatur that Dick Fuld could never get for Lehman Brothers. Washington Mutual was sold in a fire sale to J.P. Morgan. Wachovia was on the verge of collapse when Wells Fargo bought it in December 2008. Citigroup needed multiple infusions of federal cash.
So long as there was that deep uncertainty of how big the black hole was—that paralyzing fear that nobody knew anymore what anything was worth—the crisis didn’t abate. “The way I think about the crisis is that it occurred because of the systemic abuse of trust in capital markets,” says Australian financial analyst and historian John Hempton. “The blowups of subprime, then of Bear Stearns, and then of Fannie exposed massive lies. Then we went from a collective belief in soundness to a collective belief in insolvency.”
It took the absolute certainty that the United States government would use its financial might to prevent that insolvency to stanch the bleeding. That was Paulson’s most famous act during the crisis: along with Bernanke, he pleaded with Congress to give Treasury $700 billion that he could use to shore up the system. The money was called the Troubled Asset Relief Program, or TARP. On October 13, his $700 billion in hand, Paulson met the CEOs of the eight biggest banks in a Treasury conference room. He told them that they would all be taking money from the government, like it or not. Although several came to regret taking it, none had the nerve to say no to Hank Paulson.
The passage of the TARP marked the first outpouring of populist fury. Despite all the apocalyptic talk that the financial system was at stake, you had to feel that in your gut to believe it, because the only way anyone could prove it would have been to not pass the bill and see if the financial system went under. It was hard to make the connection between a big bank in New York that traded credit derivatives and a family in Ohio that couldn’t get a loan if that faraway bank went under. All people could really know for sure was that taxpayers’ money was going to prop up the very firms whose greed and mistakes helped cause the crisis.
The anger didn’t subside after the danger had passed. If anything, it grew stronger. It would build in waves, crest, and then take aim at a different target.
People raged at the Bank of America-Merrill Lynch deal—at the way John Thain had accelerated the payment of $3.6 billion in bonuses to Merrill traders days before the deal was completed; at the way Ken Lewis had averted his eyes; at the way Bernanke and Paulson had pushed and prodded and bludgeoned Lewis into completing the deal when the CEO got cold feet at the last minute. The deal almost certainly averted Merrill’s bankruptcy. It didn’t matter; people wanted blood. Congress held three hearings on the Bank of America-Merrill Lynch deal, mainly so that members of Congress could vent on behalf of their constituents.
By March, the fury had found a new outlet: AIG. In March 2009, the news broke that AIG-FP was going to pay $165 million in bonuses to its traders and executives. Although most of them had had nothing to do with the destruction, the payments became a huge scandal. The House wasted no time in passing a bill taxing all bonuses—at 90 cents on the dollar—for any household that made more than $250,000. Republicans and Democrats vied to outdo each other. “This is absolutely appalling,” said Senate Minority Leader Mitch McConnell. “It’s like taking the American people’s hard-earned tax dollars and slapping them in the face with it,” said Elijah Cummings, a Democratic congressman from Maryland. “There are a lot of terrible things that have happened in the last eighteen months, but what’s happened at AIG is the most outrageous,” said Larry Summers, who had become one of Obama’s top economic advisers. AIG executives received death threats. Some even had to have private security guards stationed in front of their homes. The Connecticut Working Families Party held a bus tour of AIG executives’ homes.
Finally, there was Goldman Sachs. As part of the AIG bailout, the New York Fed made the decision to pay AIG’s counterparties in its multisector CDO business 100 cents on the dollar. In mid-March, a day after the AIG bonus news broke, AIG disclosed that Goldman Sachs had received $12.9 billion, more than any other firm. Goldman had claimed all along that its exposure to AIG was hedged.25 Didn’t this show that Goldman was lying? “This needless cover-up is one reason Americans are getting angrier as they wonder if Washington is lying to them about these bailouts,” opined the Wall Street Journal editorial page. Wasn’t this proof that Hank Paulson had protected his old firm by steering billions in cash Goldman’s way? And what about all those ex-Goldman guys in positions of power everywhere?
By the middle of the summer, Goldman Sachs was producing blowout profits, had repaid its $10 billion in TARP funds, and had already set aside $11.4 billion—a record sum—with which to pay bonuses to employees. And Goldman executives began to say that maybe they’d never needed any help anyway. Although Lloyd Blankfein in particular was careful to express gratitude to taxpayers, the bonuses sent a signal that Goldman considered itself somehow divorced from the actions that had led to the crisis, when, in fact, Goldman had been right there in the thick of it. It was maddening. They may have been smarter than everyone else, but they weren’t better. Not anymore.
By the following spring, Goldman’s arrogance had landed it a solo hearing in front of the Senate Permanent Subcommittee on Investigations, in which the firm was lambasted for the way it had duped clients and furthered the crisis. Thus it was that Goldman Sachs, a firm whose Manhattan headquarters bears no name, which has no storefronts anywhere in the country, and which has never sold its financial products directly to run-of-the-mill consumers, became the public’s favorite villain.
At the heart of the anger was a powerful sense that something terribly unfair had taken place. The government had bailed out companies—companies whose loans and capital raising are supposed to help the country grow—that had turned out to be making gargantuan side bets that served no purpose other than lining their own pockets. Homeowners, whose mortgages had served as the raw material for those side bets, got no such help. “I’m not even against a bailout,” says Prentiss Cox. “We had to do it. But regulators are always concerned that we don’t send a message to future homeowners that they can get away with this. They should have made it clear to lenders that there are consequences. Instead, it’s all the money to the lenders and all the shame to the homeowners.”
People also felt that a great crime had been committed, yet there was not going to be a great punishment. Ralph Cioffi and Matt Tannin, the only two people so far to have been indicted as a result of the financial crisis, were acquitted. The government decided not to bring charges against Joe Cassano. The SEC has charged Countrywide’s Angelo Mozilo, David Sambol, and Eric Sieracki civilly; that case is set to go to trial in the fall of 2010. And the SEC got a $550 million settlement
with Goldman Sachs that many people felt let the firm off easy. But as the case involving Cioffi and Tannin shows, it is very hard to find the line between delusion, venality, and outright corruption. Much of what took place during the crisis was immoral, unjust, craven, delusional behavior—but it wasn’t criminal. The most clear-cut cases of corruption—the brokers who tricked people into bad mortgages, the Wall Street bankers who knowingly packaged bad mortgages—are in the shadows, cogs inside the wheels of firms like Ameriquest, New Century, Merrill Lynch, and Goldman Sachs. We’ll probably never even learn most of those people’s names.
What was the point of it all? In spring of 2007, even before the crisis hit, the Center for Responsible Lending published numbers showing that between 1998 and 2006 only about 1.4 million first-time home buyers purchased their homes using subprime loans. That represented about 9 percent of all subprime lending. The rest were refinancings or second home purchases. The Center also estimated that more than 2.4 million borrowers who’d gotten subprime loans would lose or already had lost their homes to foreclosure. By the second quarter of 2010, the homeownership rate had fallen to 66.9 percent, right where it had been before the housing bubble. Ever so swiftly, the wave of foreclosures in the aftermath of the crisis wiped out the increase in homeownership that had occurred over the past decade. In other words, subprime lending was a net drain on homeownership. A lot of needless pain was created in the process.
Financial innovation? Collateralized debt obligations? Synthetic securities? What had been the point of that? “The financial industry is central to our nation’s ability to grow, to prosper, to compete, and to innovate,” President Obama said when he signed the new legislation. During the bubble it had been nothing of the sort. As Paul Volcker said at a Wall Street Journal conference in late 2009, “I have found very little evidence that vast amounts of innovation in financial markets in recent years have had a visible effect on the productivity of the economy.”
All the Devils Are Here Page 48
