by Nomi Prins
The Cruelest Lie of All
There are those who blame lending, and certainly subprime lending was terribly predatory. Conservatives, however, toward the end of 2008, began to blame the people getting the subprime loans and the Democrats for pushing through the Community Reinvestment Act (CRA) in 1977, which sought to end discriminatory home lending practices.
CRA “led to tremendous pressure on Fannie Mae and Freddie Mac—which in turn pressured banks and other lenders—to extend mortgages to people who were borrowing over their heads. That’s called subprime lending. It lies at the root of our current calamity,” the conservative columnist Charles Krauthammer wrote on September 26, 2008, in his nationally syndicated column. Translation: the Democrats allowed Poor People to do this. And innocent Wall Street paid the price.
Krauthammer continued, “Were there some predatory lenders? Of course. But only a fool or a demagogue—i.e., a presidential candidate—would suggest that this is a major part of the problem.”95 (Of course, maybe Krauthammer is just always reactionary. At the beginning of the Iraq War, he wrote, “Hans Blix had five months to find weapons. He found nothing. We’ve had five weeks. Come back to me in five months. If we haven’t found any, we will have a credibility problem.” 96 Credibility problem indeed.)
Since late 2008, plenty of fools and demagogues have argued and, in fact, proved Krauthammer wrong. But for a while, conservative stalwarts such as Fox News’s Neil Cavuto and newspaper columnist George Will echoed the idea that it wasn’t greed but a 1977 regulatory law that brought down the economy.97 Given that the value of subprime loans in the market is overwhelmed by the amount of the full federal bailout by a factor of ten to one, that’s not anywhere near reality.
The finance community’s theory is one of selective Darwinism: Little people who take bad risks deserve the consequences. Companies that take bad risks are a welcome addition to the fallen competitor list. Banks that survive the chaos can reposition themselves at the top of the financial piles, and deserve all the federal bailout money, and assistance in growing even bigger, that they can get.
Indeed, after the Bear Stearns bailout, then treasury secretary Paulson said of his former competitor, “When we talk about moral hazard, I would say, ‘Look at the Bear Stearns shareholder.’”98 Blaming the bad apple and delivering some well chosen words about America’s destiny will usually mute the need for regulation. That’s why current congressional packages tend to offer cosmetic financial solutions to long-term regulatory dilemmas.
No matter where the blame lies, as housing prices kept dropping and foreclosures kept rising, the feds jumped into gear late and indicted several hundred mortgage players, including former Bear Stearns credit hedge fund stars and current scapegoats Ralph Cioffe and Matt Tannin, and many lesser known characters. The FBI and the Department of Justice targeted a slew of small and big firms after the fact, from Puerto Rico-based Doral Financial Corporation, unknown to most households, to more prominent names: AIG, Countrywide Financial, Washington Mutual, Bear Stearns, Lehman Brothers, UBS AG, New Century Financial, Freddie Mac, and Fannie Mae.
When all is forgotten and we’ve moved on to our next financial crisis, there will be certain fingers frozen in time pointing at the subprime loans as the cause of the calamity. Big Finance would prefer that. But the truth is that the subprime loan tragedy was merely the catalyst that exposed the mega tiered securitizations of securitizations, the massive leverage chain derivatives attached to nothing concrete, and the ineffective regulatory restraints. All of which led us down the rabbit hole of the Second Great Bank Depression.
3
Everybody Wants to Be a Bank
When money speaks, the truth is silent.
—Russian proverb
An air of impending disaster pervaded Wall Street late on Sunday night, September 21, 2008. Goldman Sachs and Morgan Stanley each faced a severe capital shortage, having borrowed well beyond their means, thanks to the massive leverage ratios allowed by the Securities and Exchange Commission (SEC). The only thing these old dogs of the investment world could do at that particular moment—and it was brilliant—was flip onto their backs, muster up their cutest puppy dog smiles (even though they should have known better than to knock over all the houseplants), and beg the federal government for a good, long scratch. Perhaps even to their own surprise, the old dogs were scratched like never before.
When we look back at that moment decades from now, it will surely seem that the very smart people at Goldman Sachs and Morgan Stanley were able to make the government’s most powerful financial arbiters look foolish. How did this happen? Easy. Goldman Sachs and Morgan Stanley told the Federal Reserve exactly what it wanted to hear: We need you.
Two of the country’s most powerful investment banks, accustomed to making huge profits and having limited government regulation, came to the Fed’s doorstep, hat in hand, and asked—nay, begged!— for government help. They wanted the Fed to make them bank holding companies (BHCs). The proposal seemed to defy everything that Goldman Sachs and Morgan Stanley stood for. They seemed willing to relinquish their ability to speculate and leverage excessively. On the surface, anyway.
The Fed determined that emergency conditions existed because of the prevailing market chaos and because the sky had fallen on Lehman Brothers, the banks’ competitor. Under “unusual and exigent circumstances,” as defined in a 1932 provision in the Federal Reserve Act, the Fed could grant the changeover and allow the investment banks access to its discount lending window, effectively ensuring Morgan Stanley and Goldman Sachs easy access to massive lines of credit.1 For those of you keeping score at home: change of status equaled river of free money. No one questioned the Fed’s actions.
Morgan Stanley also applied to become a financial holding company (FHC); Goldman Sachs gave notice of its intent to do the same.2 The BHC and FHC designations provided the best of both worlds—the investment banks got guarantees and cheap loans from the government as BHCs, plus freedom from many commercial bank regulations as FHCs. A BHC can only engage in classic commercial banking activities (such as taking deposits and extending loans), whereas an FHC has a broader mandate, in fact, one nearly identical to everything both investment banks were already doing.3
The Fed approved the investment banks’ BHC filings that September 21 night, bypassing the regular five day antitrust waiting period and without time or apparent inclination for any meaningful debate.4
So the two remaining investment bank giants, in their new BHC incarnation, craftily got access to further taxpayer backing, and they could still operate as they had before. What’s more, the name change provided other avenues for the banks to bogart easy money. On October 14, 2008, the FDIC created the Temporary Liquidity Guarantee Program (TLGP), which I’ll talk about more in the next chapter.5 The TLGP allowed Goldman Sachs, Morgan Stanley, and others to mooch off money that should have been reserved for banks dealing with average consumers. With the FDIC’s backing, the banks could raise capital by issuing debt with really low interest rates, as opposed to the corporate rates they would have had to pay had they not taken on the new titles. That little trick allowed Goldman Sachs to raise more than $29 billion of cheap debt and Morgan Stanley to raise nearly $24 billion.6 Previously, neither bank had taken a dime in deposits from anyone beneath a seven figure income bracket, and they had never acted like or had any intention of acting like consumer banks—yet they had no shame lining up at the government’s vast money till. Hey, what could be better than money that was practically free? The conversion to BHCs also presented a way for Goldman Sachs and Morgan Stanley to dodge transparency. By becoming BHCs, they got around disclosing how much their assets were worth, based on market values. They could instead reclassify their assets as “held for investment,” just as the big banks did.7 In other words, don’t tell, and we, the Fed, won’t ask. We have yet to see how much each bank got from the Fed’s loan facilities, but we’ll see exactly how secretive the Fed is later.
Will They Really
Be More Regulated Now?
In the aftermath of the reclassification, the Fed itself took on even more responsibility and power. It became the regulator for more U.S. financial institutions, because they were all becoming BHCs, which are under the Fed’s regulatory purview. But even with their new names, Goldman Sachs and Morgan Stanley are still investment banks, just as horse manure by any other name still smells as rank. Under the rules of the Bank Holding Company Act, these newly named firms have a two year conversion period, with the possibility of extending that grace period even further. (That’s plenty of time to lobby for changes to the act, which they probably will.) See, if the Fed was serious about using this Second Great Bank Depression period to become a stricter regulator, it would not have provided this leniency. That it did shows us that the Fed will not be able to prevent a Third Depression. Indeed, it will shoulder part of the responsibility for that event.
Economist and codirector of the D.C. based Center for Economic and Policy Research Dean Baker was skeptical from the beginning of Goldman Sachs’s and Morgan Stanley’s bait, switch, and get bailed out strategy. “On principle it’s a big deal that they will be regulated as commercial banks. Over the longer term, I don’t know if they’ve thought it through and if the Fed has thought it through.”8
I called Baker a few months after Goldman Sachs and Morgan Stanley became BHCs, and he told me, “They are going to get by as much as they can. They are first looking at survival, but they will always try to slip out of regulations. Goldman Sachs and Morgan Stanley are powerful. They are trying to make a virtue out of a necessity and will try to squirrel out of whatever they can. If they get through this, they will fight again later.”9
Of course, public spin on the move was important. Both firms went out of their way to extol its virtues, mostly in an effort to keep nervous investors calm. “This fundamentally alters the landscape,” a Goldman Sachs spokesman said. “By becoming a bank holding company and being regulated by the Federal Reserve, we have directly addressed issues that have become of mounting concern to market participants in recent weeks.”10 (Note that this “mounting concern” referred to the people who bought their stock, not to people losing their homes.)
In its SEC filing dated September 21, 2008, Goldman Sachs was equally optimistic: “In recent weeks, particularly in view of market developments, Goldman Sachs has discussed with the Federal Reserve our intention to be regulated as a bank holding company. We understand that the market views oversight by the Federal Reserve and the ability to source insured bank deposits as providing a greater degree of safety and soundness. We view regulation by the Federal Reserve Board as appropriate and in the best interests of protecting and growing our franchise across our diverse range of businesses.”11
John J. Mack, the chairman and chief executive of Morgan Stanley, echoed his company’s competitor, saying, “This new bank holding structure will ensure that Morgan Stanley is in the strongest possible position—to seize opportunities in the rapidly changing financial marketplace.” 12 Don’t you just love it? Not the rapidly imploding one, the rapidly changing one. Not to contain risk, but to seize opportunities.
Yet somehow the media pitied Goldman Sachs and Morgan Stanley, as if these once valiant warriors were forced to succumb to powers greater than themselves, only to be rendered mere commoners.
Indeed, it was unsettling that the Wall Street Journal bought Goldman Sachs’s and Morgan Stanley’s line about regulation being a necessity, with the paper concluding that Wall Street’s image of investment bank gods was a thing of the past. It conjured images of dying roses, their parched stems on vines scorched by an unnatural summer heat. The financial media’s empathy served to mask the true dangers behind the move these investment banks were making, one that would have lasting repercussions.
Let me just break down the first few paragraphs in the Fed’s initial article on the BHC move so that you can hear the violins:
The Federal Reserve, in an attempt to prevent the crisis on Wall Street from infecting its two premier institutions, took the extraordinary measure on Sunday night of agreeing to convert investment banks Morgan Stanley and Goldman Sachs Group Inc. into traditional bank holding companies.
In other words, the Federal Reserve is Batman and it rushed in to save Morgan Stanley and Goldman Sachs, the two most important firms in Gotham City.
With the move, Wall Street as it has long been known—a coterie of independent brokerage firms that buy and sell securities, advise clients and are less regulated than old fashioned banks—will cease to exist.
So, we’re supposed to believe the difference between Goldman Sachs and the West Main Street Bank of Hicksville has now been erased.
Wall Street’s two most prestigious institutions will come under the close supervision of national bank regulators, subjecting them to new capital requirements, additional oversight, and far less profitability than they have historically enjoyed.13
So, Goldman Sachs and Morgan Stanley were not only premier, they walked on water. And now these bastions of superior finance will have to be monitored and might make less money. If you believe that it’ll work out that way, I have some credit default swaps I’d like to sell you.
The Fed might not have questioned the lasting impact of its decisions to turn every capital starved institution into a BHC, but there were other external voices of concern regarding the banks’ true intentions going forward. “These are strong competitors who take advantage of loopholes,” said economist Gary Dymski. “Companies may approach risk cautiously during the current economic crisis, but how is it going to be ten years from now?”14
Nouriel Roubini, the chairman of the RGE Monitor and a professor of economics at New York University, told the Financial Times that the financial supervisory system “relied on self regulation that, in effect, meant no regulation; on market discipline that does not exist when there is euphoria and irrational exuberance; on internal risk management models that fail because—as a former chief executive of Citigroup put it—when the music is playing you gotta stand up and dance.”15
Proof of the investment banks’ slyness came six months after their BHC approvals, when Goldman Sachs announced on February 4, 2009, that it wanted to repay its $10 billion government bailout as soon as possible, because the government was cramping its style.16
As David Viniar, chief financial officer at Goldman Sachs, put it at a Credit Suisse Group conference in Naples, Florida, “Operating our business without the government capital would be an easier thing to do. . . . We’d be under less scrutiny and under less pressure.”17
Investors and traders were gleeful when they heard that news. Goldman shares jumped more than 6 percent that day, which just goes to show that “the market” (meaning its speculative stock traders) will never learn from its screwups. No matter how expensive the consequences, risky practices will be rewarded more than government regulations are. It defies logic.
Indeed, as Goldman Sachs CEO Lloyd Blankfein wrote in a February 8, 2009, op ed article for the Financial Times: “Taking risk completely out of the system will be at the cost of economic growth. Similarly, if we abandon, as opposed to regulate, market mechanisms created decades ago, such as securitization and derivatives, we may end up constraining access to capital and the efficient hedging and distribution of risk, when we ultimately do come through this crisis.”18 But then, no one expects Blankfein to constrain future profit potential. If you control the system, you assume you can sidestep its risks or squeeze the public to pay for the damage. It was up to the same Fed that said Goldman Sachs could step under the cheap federal assistance tent to do some regulation. But, in opening its books to extend mega-loans to these new quasi-BHCs, it demonstrated—loud and clear—that it would not.
Not Only Investment Banks Can Be Banks
The reaction of most citizens to the barrage of news about bailout bucks flying to various banks like paper clips to a desk magnet is usually, “Hey, can I get my own bailout?” No. Not a dollar, a di
me or even a cent. But if you’re a corporation with a good legal team, you can get an affirmative answer—as we’ve seen, it merely takes a little name change.
American Express was one of the first companies to follow Goldman Sachs’s and Morgan Stanley’s lead. On November 10, 2008, it, too, jumped on the Bank Holding Company Bailout Bandwagon.19 Chairman and CEO Kenneth Chenault spelled out the reason for the name change in a prepared statement. “Given the continued volatility in the financial markets,” he said, “we want to be best positioned to take advantage of the various programs the U.S. government has introduced or may introduce.”20
He said this without a trace of self consciousness, even as American Express reported a 23 percent drop in third quarter profits and announced it would chop 10 percent of its workforce.21 Even worse, its fourth quarter earnings were down 72 percent versus the same quarter in 2007.22 The move also didn’t immediately help American Express’s share price, which dropped a few days after the BHC announcement to its lowest value since April 1997.23
