by Ron Suskind
The bottom line was that the budgetary issues had been pushed along, Kick the Can style, as the need for stimulus and the attempts to push through sweeping reforms took priority. The administration’s pitch was always the same: We’ll build a brick wall down the road. It’ll be solid and credible and unbudgeable. Until then, the administration will spend freely, as is needed in a recession.
Biden had been brilliant in December, negotiating a raised debt ceiling in exchange for the creation of a bipartisan National Commission on Fiscal Responsibility, headed by retired Wyoming Republican senator Alan Simpson and Erskine Bowles, Clinton’s former chief of staff, an all-around responsible appointee, to shape a plan for a sustainable fiscal future.
But Orszag knew that the plan’s nonbinding recommendations, due out in December 2010, wouldn’t be embraced unless there was a sufficient political rationale at that moment. Brick wall? More like a discussion of where such a wall might be placed, if that.
Orszag decided he wouldn’t stick around to fight that battle. Soon, he was sitting in the Oval Office.
Obama said he didn’t want him to leave. Orszag stuck with substance. He discussed his concerns that they’d left themselves in a budgetary vise—that delaying the pain of real fiscal rigor, the setting of nonbinding placeholders such as the Simpson-Bowles commission, and Orszag’s sense that they’d be ducking the tough choices again—meant he’d “have trouble selling” the coming year’s budget. The president looked at him skeptically. He knew Orszag was displeased where things were going on the budget, but, Obama said, “we can work those things out—it’s still early.”
Then Orszag took it down one more step. “I come in every day with a lump in my chest,” he told the president. The tension, the chaos, the infighting, especially the battles with Summers—it had all made life hard to tolerate in the White House, Orszag said. It wasn’t that he was unfamiliar with a high-pressure, high-stakes effort, after six years in the Clinton administration. But this was different. “I think there are going to be some changes coming in terms of personnel that’ll be helpful with all that,” Obama said.
The president had received a few more memos from Rouse. Without giving Orszag the specifics, he wanted to let his OMB director know that there might be some departures among the senior staff that might provide relief. “I don’t want you to feel that way, Peter,” Obama said, genuinely concerned. “I really don’t.”
Sitting with Obama, Orszag couldn’t help but think of what the president might have accomplished if, as Orszag said, he had a “proper process to fill his needs.”
And thinking of the president’s fortunes brought him back to Summers’s assessment—expressed in many ways until this spring—that they were “home alone.”
He’d thought about it, and turned it over in his head countless times, in the tumultuous year and a half since joining the administration.
Orszag felt the president had great “raw ability,” but was stymied by a process that Summers, for the most part, oversaw, like “someone stealing gas from your gas tank and then criticizing you for not being able to drive your car.”
In economic policy meetings without the president, Summers would joke that they were all caught in “relitigation roulette,” where the outcomes of important policies—like a spinning roulette wheel—were left to blind chance.
But Orszag and others said that the quip was something of a misdirection on Summers’s part, as Larry stood in a central role in determining those outcomes.
How did he do it? “By willfully ignoring the president’s wishes and relitigating again and again decisions the president had made because Larry didn’t think they were well informed or this or that. And instead of actually coming back to him with more information, he came back to him with the same information, just repackaged a little.”
What issues? Orszag, like others—including many of the women who thought Summers’s “debate society” had hijacked their policies—can tick off a long list. Obama wanted to move forward on tough climate change legislation; Summers was opposed, telling Orszag, at one point, “we have to derail this!” It was derailed. A financial transactions tax on banks and financial institutions, to try to tame the trading emphasis that has swept those industries and, along the way, raise money: Obama said, in one meeting, “we are going to do this!” Summers disagreed; it never materialized. The list goes on.
“Larry just didn’t think the president knew what he was deciding,” said Orszag. Sometimes, the result was just long delay. The president was, from early in the administration, pushing for discretionary freeze on spending. Orszag favored that as well and wanted to make a presentation on the matter. Summers said to him, “You can’t just march in and make that argument and then have him make a decision because he doesn’t know what he’s deciding.” In that instance, after long delays, the president did champion the discretionary freeze. But either delay or defeat of the president’s wishes generally defined the course of events.
“The fundamental question is did the president want a check on his decisions ex post facto? Did he actually want the relitigation roulette, because he recognized that his instincts weren’t correct? Or was this outright and willful” on Summers’s part, that “I know more than the president, flat-out. That strikes me as more likely.”
Even as Orszag sat with the president on that spring day in the Oval Office, he was perplexed, and all but exhausted with frustration. Word had circulated for months through the West Wing of Rouse’s reorganization, with a special focus on an economic team which—with so many domestic crises—was the core operation of the Obama presidency.
“The question is why didn’t [Obama] stop it. People knew. People realized the process wasn’t working, and they kept saying it. By spring of 2010, when I was saying I just don’t want to do this anymore, they kept saying they would fix it. And they set deadlines that were, of course, missed . . . but, the president didn’t say, ‘Goddammit!’
“He didn’t demand that it be changed,” Orszag said, reflecting, a year later, on his tenure in the White House. “And that can’t be healthy.”
Which is why sitting with Obama, in this exit meeting, Orszag felt a kind of sadness. The promise of Grant Park, of the inauguration, of all those grand plans. It now seemed so far away.
“Peter, thanks for your hard work,” the president said. “I want you to stay in touch with me.”
“Of course, Mr. President.”
16
Mind the Gap
The cost of not “using the crisis” in the early days of his presidency to retool the financial services industry—the power plant of the U.S. economy and, in large measure, of the American way of life—was being acutely felt by the spring of 2010.
After his interest in restructuring the industry, beginning with Citibank, was sidetracked, Obama fell back to the stance that meaningful reform would arrive as soon as the financial system was stabilized.
The industry managed to play to this conditionality to its fullest—saying it remained “fragile” across nearly a year, even as the largest banks were hauling in record profits.
This drew some angry words from the president, especially after another harvest of year-end bonuses was reported in January 2010. But whereas his opprobrium of the year before, when he called such bonuses “shameful,” struck fear into the mercantile hearts of Wall Street, his words now had little effect.
The princes of New York had sized him up. He’d already been shorted by the Street.
While he was able to regain his footing to salvage health reform, winning a measurable victory—albeit far less grand than his Inaugural ambitions—financial reform was different. It always was. An individual’s options for health insurance, sticker shock from a hospital bill, or fear of being left sick and not covered in old age always carried visceral relevance to daily life that was missing in regard to reforms of the way money and risk were managed.
Advantage Wall Street. The effects of its actions were pervasive, but
felt secondhand, where the distressed party was often made to feel that a bad outcome was his fault.
The only things that carried health care’s kind of day-to-day, kitchen-table relevance were low interest rates and the ups and downs of the stock market.
As long as those two, linked issues were in the plus column, people would feel a sense of some forward motion. Bernanke kept rates low. The Dow had rebounded from 6,200, its low in early March 2009, to 10,000 by the early spring of 2010.
The Street still focused on the profitable trading of debt securities. Even with the market’s rebound, debt remained king, roaring back with a variety of successful arbitrages.
But, if nothing else, the public at large was beginning to better understand the meaning of the word “arbitrage,” long at the center of the Wall Street lexicon. The famous phrase “mind the gap”—long heard on the London Underground system to alert riders to the treacherous little space between train and platform, and now widely used—was particularly instructive. Arbitraging, in its many forms, is about minding the gaps—gaps between the way things are and the way they should be, or soon will be—all over the global economy, and then having the speed and flexibility to profit from them. These gaps, mishaps, irregularities, or, in economic parlance, “inefficiencies,” are often small and ephemeral, which makes volume the key. A hundred basis points are nothing much on $1,000. Just 10 bucks. On a $100 million, it’s real money; on $1 billion, that much more.
And that’s the game, the goal of the relentless hustle: to snatch those few hundred basis points by swiftly pushing lots of capital into tiny cracks in the global markets, and then pulling it out just as fast. This doesn’t create much of anything—such as new jobs, the way a company might with a fresh invention or a product launch, or even a service that fills a tangible need. It just profits the customer of the arbitrager, and the arb himself—most, still, are men—who’s committed, with every available corpuscle, to find “risk-free profit at zero cost.” That’s the standard definition of arbitrage: it’s also called something for nothing; or something gained from something else going terribly wrong.
The great arbitrage of the Great Panic and crash involved interest rates. The Fed’s policy, from 2007 onward, was to depress interest rates, pushing them to the lowest levels on record. This was intended, of course, to spur lending and consumer spending as the country slipped into its deep recession. With household debt at a stunning 130 percent of GDP, low rates were seen as the best way to keep cash in people’s pockets, as opposed to paying debt service, so they could spend it. They could refinance their existing debts at a lower rate, maybe pay some of them down, or get new credit at attractive rates to help stave off financial collapse, to keep their balls rolling. All these things happened, but only very modestly. While the cost of funds for banks—something directly controlled by the Fed—dropped to less than 1 percent, the rates for mortgages, consumer credit, and small business loans didn’t drop quite as much, and profit margins for the purveyors of debt, of all kinds, grew. But by early 2010 it was indisputable that this had not spurred fresh lending. Banks, both shadow and traditional, asserted that individuals and companies, especially small businesses, were already carrying unsustainable levels of debt, and that quality customers were scarce. Mortgages, the lodestar of risk and reward in the debt world, were defaulting at record rates; car loans and credit card defaults were not far behind. The heightened risk of default meant there was little downward pressure on consumer credit rates, just better spreads on any loans that were being made.
Nonetheless, the Fed kept the spigot open, hoping for a change. It had become history’s lowest-cost lender, sending off, between the fall of 2007 and the end of 2009, nearly $3.5 trillion in essentially interest-free money to banks, nonbanks, finance companies, state governments, investment trusts, foreign governments, or anyone hanging out a financial services shingle, many of whom would sign on to an arrangement where recipients could keep any profits gained from putting that money “to work,” while the Fed ate any losses. Of course, for Bernanke there was a secondary, and largely unspoken, purpose of unleashing this river of free money: to help anyone in the management of money and risk earn his way out of trouble, and then some. This particularly troubled Paul Volcker. In an Oval Office meeting back in the spring of 2009, he saw this bank-support program launched and complained that government was doing too much to restore the existing, flawed system, and that banks were certain to use all that free money to churn up huge profits. “Does it have to be so frothy?” he queried the room, with evident frustration.
Geithner’s position was: to be safe, yes, it does. On that score, the Fed’s program, complemented by various grants and guarantees from Treasury, succeeded wildly.
By early 2010 the banks had, in fact, notched their easiest victory in years by simply lending that fresh Fed money back to the planet’s largest, safest, and still hungriest customer for debt: the U.S. government itself.
Being handed free money and then, by buying Treasury bonds, lending it back to the U.S. government at 3 percent, generated enormous profits. So, while the Fed waited for the gap to close between its intention, getting credit to the hardest hit parts of the economy, and the hard realities of the debt cycle, the banks hit the arbitrager’s mark, each day, notching “risk-free profits at zero cost.”
For financial institutions who’d spent decades trying, and so often succeeding, in engineering ways to make something from nothing, this particular arbitrage was helpful in restoring them to the form they’d enjoyed before the crash, only more so.
Lending that free money back to the government was just the largest of the advantages available from a negligible cost of funds. The spread between what banks paid depositors and what they received from all borrowers, and extensions of credit, grew admirably.
How much did this federal support of the banks cost taxpayers? By 2010, credible calculations had started to emerge. With debt of approximately $14 trillion issued by the Fed, Treasury, federal agencies, and municipalities, which was scooped up by banks and other investors worldwide, the distinction between a near-zero rate at present (on short-term Treasury bonds) and the long-standing average of about 3 percent amounts to roughly $350 billion a year.
At the same time, that enormous taxpayer subsidy skewed the market for a key commodity, money, in ways that impelled investors to search for yields in higher-risk instruments than they normally would have sought.
That meant the great trading machine was running fast and clean.
Trading in derivatives booked its strongest year ever, with JPMorgan and Goldman leading the way.
As it was in the early 2000s, when interest rates were lowered by Greenspan to spur the consumer activity following the tech boom’s crash, the world’s aggregated wealth, in funds of all stripes, was again hungry for yield. The fact that 40 percent of the world’s assets had vanished in the crash—that those funds had dropped from the 2007 peak of $70 trillion down to $40 trillion—seemed not to have changed behavior. Those assets moved forcefully into whatever exotic arbitrages (gap plays), derivatives (bets on the future), and swaps (noninsurance insurance) the financial engineers could gin up.
Just as banks had used their lowered cost of funds to increase profit margins, companies, especially large ones, used the downturn to cut costs even more than the sluggish demand merited. Their profit margins widened as well. And by early 2010 they had built up large cash reserves, estimated at more than $1 trillion. They weren’t hiring, or expanding. This money, building like a lake above a dam, returned corporate treasurers to their lead roles, reuniting them with the large banks to help move huge sums to and fro in arbitrages of all kinds. The repo market got up and running again. Credit default swaps were bustling as well, with $35 trillion in outstanding swaps in early 2011.
People did make money from the rise in equities, but like the stock fluctuations of the late 1990s, it was largely recouping value that had always been on paper. Even with this surge bring
ing the stock market back to roughly the precrash level—albeit the same level as in 2000—Ranieri’s prediction three decades back seemed to hold. Once the debt securities market takes off, it’ll dwarf equities.
It wasn’t until the spring of 2010—more than two years after the collapse of Bear Stearns—that the SEC finally made a first move. There had been no significant prosecution or disciplinary action, at that point, by any federal entity. With its first salvo, though, the SEC shot high: in mid-April it accused Goldman Sachs of securities fraud in a civil lawsuit. The SEC charged that the bank created and sold a mortgage security secretly built to explode in the laps of unwitting investors, and then bet against it.
The mortgage-backed security in question, called Abacus 2007-AC1, was among two dozen CDOs that Goldman constructed so the bank and several of its most prized clients could bet against the housing market. The meat of the SEC charge was willful misrepresentation by Goldman, which said that the mortgage securities bundled into Abacus had been chosen by an independent firm, with no ongoing interest in the deal, to perform well under a variety of market circumstances. In fact, they had been selected by John Paulson, the hedge fund manager who built expertise in the mispricing of mortgage risk that resulted in one of the largest hauls in Wall Street history—$3.7 billion in 2007—his early and sizable short positions in the mortgage market. Paulson, in fact, had selected some of the most egregiously mischaracterized mortgage securities he could find: CDOs with triple-A ratings, which were all but certain to default. Two European banks and an array of investors lost more than $1 billion on the Abacus. Goldman and Paulson shorted the securities shortly after they were sold and made out handsomely.
