The greatest fear during that time was that there would be a run on the investment banks triggered by rumors. True or not, fear would set in and cause people to run for cover and withdraw their money. There was also worry about short-sellers. The concern was so serious that Andrew Cuomo, New York’s attorney general, announced that he was launching an investigation into short-sellers. “Short-selling in and of itself is not illegal,” he explained to me, “and many people argue that it’s a productive part of the marketplace. There can be behavior that is illegal, however, if you’ve spread false information and are trying to drive down prices for your own economic benefit.” A type of short-selling, called naked short-selling, was being investigated by the SEC, and Cox announced a temporary ban on this practice.
Still, Morgan Stanley’s stock fell precipitously. In a single week after Lehman declared bankruptcy, the stock price dropped from the low thirties to the low teens. Mack had predicted a “run” on his bank, and now it was happening. In a memo to employees, he warned them to beware of short-sellers and to hold steady in a market controlled by fear and rumors.
During the week he called me to share his frustration. “Maria, when people turn on CNBC and see the headline scrolling across the screen, ‘Will Morgan Stanley make it?’ what do you think that does to us?” A normally calm guy, Mack was edgy and on the verge of anger.
Mack was constantly on the phone with Paulson and Geithner, as well as with Blankfein. The experience was one of humility, of recognizing that there were no real gods of finance. Everyone was vulnerable. It was one thing to point fingers at individual companies and say, “You did a bad job and you’re paying the price.” It was quite another to watch stable companies experiencing the aftershocks. There was no time for blame or regrets—only action.
“I don’t know if I got four or five calls a day from Hank Paulson, or ten calls,” Mack told me, “but he called me a number of times every day, as did Tim Geithner.” As the weekend neared, those calls took on greater urgency.
“What is plan B?” Geithner asked Mack. “You’ve got to find a partner.”
Mack and his people were working overtime to do just that. They were talking to the Chinese, to the Japanese, to Warren Buffett. They were talking to Pandit at Citigroup and Dimon at JPMorgan. As they headed into another weekend of all-nighters, Mack was running out of time.
Paulson called Saturday morning. “John,” he said, “we cannot have Monday morning open without a solution. It’s not just about Morgan Stanley; it’s about a financial meltdown on a global basis.”
Mack assured Paulson that he understood and that he was in serious discussions with the Japanese about a sizeable investment in Morgan. He and his team spent another night at Morgan Stanley’s midtown office.
Sunday morning Mack received a call from the big guns: Paulson, Geithner, and Bernanke. “We see things you don’t see,” Bernanke said. “This is much bigger than one firm.”
“What are you trying to say?” Mack asked cautiously.
“Call Jamie,” Geithner said. “He’ll buy your bank.”
“I’ve called Jamie. He doesn’t want it,” Mack replied.
“He wants it now,” Geithner said testily. “Call him. He’ll buy it.”
Mack was running out of patience. “Yeah, he’ll buy it for a dollar,” he said heatedly. Then he took a deep breath and made his voice very calm. “I have the utmost respect for the three of you,” he said. “What you do for this country makes you patriots. But I won’t do it.” And he put down the phone.
At Goldman Sachs, Blankfein was worried, although the wolves were not yet at his door. He’d told Mack earlier in the week, “You’ve got to hold on. I’m twenty seconds behind you.” He floated the idea to Mack, “Do you think if we were bank holding companies it would help us?” In the end, it turned out to be the solution Mack was looking for, and a way to stop the bleeding that Blankfein knew would ultimately bring him down as well.
On September 21, a mere week after Lehman’s fall, a new announcement shook the financial world. The last remaining investment banks, Goldman Sachs and Morgan Stanley, were changing their status to become bank holding companies. On the downside, they would be more strictly regulated, but on the upside they would have access to credit from the Federal Reserve Bank, along with consumer deposits to boost their capital balances.
It was the end of investment banking as it had operated. Goldman Sachs and Morgan Stanley were now more like conventional banks, limited in their ability to make high-risk (and highly lucrative) deals. They were humbled and brought to their knees. Just imagine: in March 2008 there were five great investment banks. Six months later there were none.
Mack wanted to get Morgan Stanley back to basics. He felt that the boom years had led to a loss of discipline in his firm and others. He told me that in the midst of the giddiness of success, “You need to have the discipline to look inward and ask whether this fits with our balance sheet, our capital, and our risk management. Are we stepping out of our comfort zone in investing and trading? The leadership needs to have the discipline to forego the business in the interests of stability—to say, ‘I know we may not be as profitable as some of our competitors, but we have a strategy and we’re going to stick with that strategy.’”
In the Roosevelt Room, a windowless workroom in the West Wing of the White House, dominated by a long, sleek table and high-back chairs, President George W. Bush sat with his top economic team and listened to the bad news. Paulson, Bernanke, and the president’s economic advisers sat around the table, taking turns explaining what was happening and offering recommendations. A sense of looming catastrophe was in the air, and it took a great deal of discipline to stay focused.
“I’ll tell you, the calmest person in the room was always the president,” one of the men in the meetings told me. In spite of the public perception that everyone’s hair was on fire in the days following Lehman’s collapse, that is not the picture he and others presented of that early period after the weekend that would change Wall Street. “Hank could be an excitable guy, and he wasn’t the only one, but the president kept trying to impress on us that we had to keep it on an even keel, think things through, not pull the trigger before we’d taken careful aim. It was an important message, because everything was happening so fast. The president’s attitude helped avoid a panic mode.
“This was not like the television show The West Wing,” he added, “where people are running through the corridors and yelling a lot. We didn’t yell. The meetings were very calm, very respectful. I can’t remember one meeting ever, even in the height of the crisis when it was very emotional, when there were shouting matches.
“Of course we were nervous. We literally thought we were on the verge of the Great Depression. But never, never in those meetings did you ever see emotion or anger or hysteria. Just didn’t happen. I think President Bush did a good job of keeping us steady, and saying, ‘Look, you guys, I want you to think this through, and before we do anything, you’re going to tell me what you’re doing and what it is you think we should be doing, and I want to hear the rationale.’”
One person in the room during many of these critical meetings was Ed Lazear, the president’s chief economic adviser. I asked him to give me a sense of what it was like during those days. “There was no average day,” he said. “We never knew what each day would bring. The volatility in the system was enormous—especially the market swings. It wasn’t crazy to have a five-hundred-point day, and there were even a couple of seven-hundred-point days. I knew when I woke up that every day was going to be at a minimum weird, and at a maximum horrible. What it wouldn’t be was a great day.”
Lazear’s mornings started around 5:15, and while he was still in bed he’d click on CNBC to see what was happening in the international markets. He’d sit in bed and start scribbling notes on the pad he kept on his nightstand. By 6:45 a.m. he was at the office briefing his colleagues and senior staff and making a plan for the day. “We always had a
plan,” he told me, “even though we had no idea what new crises we’d have to face. We all agreed that we had to take whatever action was necessary to make sure that the market had confidence and that we could ensure that the firms that were so essential to credit and economic growth would survive.”
Lazear, an intense guy with a lively face and a shiny bald head, had been plucked from academia to serve the president. He was known as a brilliant economist and an unconventional thinker. When it came to the current financial crisis, he had a theory that was quite unique. He called it the popcorn theory, and he later explained it to me this way: “There were two ways of looking at the crisis. One was the domino view—and it was the most common. Everyone knows the domino theory. One domino topples, it knocks over the next one, knocks over the next one, and the whole thing crashes. Most people thought that was what was going on, and I even thought it myself for a while. When we were back trying to figure out how to prop up Bear Stearns, we actually thought if we kept that domino standing, others wouldn’t fall.
“But by May of 2008, I had switched my view to what I call the popcorn theory. Here’s how it works. When you’re making popcorn, you pour oil in the pan, add the kernels, and then, as the oil gets hot, the kernels start to pop. Now, suppose you take the first kernel out of the pan. It would not stop the other kernels from popping, because the oil is hot. They’re going to keep popping as long as the fire is going. Apply this theory to Lehman Brothers. We were all in favor of trying to save Lehman, but even if we’d succeeded, other kernels would keep popping—AIG, Washington Mutual, Wachovia, and so on. I’m not sure it would have prevented stock market damage because it wasn’t just Lehman; it was panic in the entire financial system. There was a fundamental problem in the system, and what you had to do was turn the heat off. Or alternatively, you could strengthen the pan—essentially capitalize the financial sector—to withstand all the popping going on inside.”
That, according to Lazear, was the reasoning behind the Troubled Asset Relief Program (TARP), an unprecedented effort to turn down the heat on a systemic crisis. “AIG was a big deal, but remember, there were lots of big deals going on right then,” Lazear recalled. “Merrill was a big deal; Lehman was a big deal; Fannie and Freddie were a big deal; AIG was a big deal; Washington Mutual and Wachovia were big deals. We had a lot of stuff on our plate at that point, and initially the strategy was to take them one at a time and try to deal with them and prevent any one of them from causing a collapse of the system. But we realized that the piecemeal approach was not an effective strategy.
“I’m an academic by training,” he said, “and the historical precedent for this was absent. We’d never seen anything like it. Even in the Great Depression, which people always refer back to, the parallels weren’t the same. The Great Depression, in many respects, was worse, but it was worse because it was prolonged. It wasn’t worse because of the one initial event. The stock market crash was terrible, but the stuff that happened in those weeks in September 2008 was terrible as well. This was a pretty scary event.”
Back in New York, on the floor of the Stock Exchange, I was hearing a lot of frustration over the piecemeal solutions. People were ready for a comprehensive answer. They didn’t want to sit there week after week and watch the next bank fail, and the next bank fail. Everyone was looking to Washington to show leadership.
“Even though we said we needed an overall strategy, the truth is, we were not of one mind on what that overall strategy should be,” Lazear acknowledged. “It took some time for that to evolve. In retrospect, it would have been better if we’d handled it in a smoother fashion, but it was a war, and like all wars, things don’t always go exactly as you plan them. There was an enemy out there. In the end, fortunately, we got it right, and I think TARP was an important component in getting things back on track.”
There was no real controversy about TARP at the White House, but the prospect of TARP kicked up some dust on the campaign trail. The administration tried not to be distracted by the presidential race, but there was some concern that politics would sideline their efforts. When McCain appeared on the Today show, taking an antibailout position, Paulson got on the phone and talked him down. Barack Obama was more publicly supportive of Paulson’s efforts, but there was still a lot of confusion in the country about the meaning and necessity of TARP. The first time it came up for a vote in Congress, it fell short.
“I remember having a meeting with the president right after it failed,” a White House source told me. “We all got together in the Roosevelt Room, and the president said, ‘Look, we’ve got to take another shot at it. We can’t have this happen. We got to go for it.’ So that was the week where we worked the stuff out.”
The president’s economic team fought back hard against the skeptics. They believed it was time to take a bold chance, and they knew that if they didn’t do it, they might end up regretting it later. “It might have been unnecessary,” Lazear said with the benefit of hindsight, “but we’ll never know. In my view, it was necessary, and it didn’t cost the taxpayers very much. Most of the money was repaid. Meanwhile, it was extremely important to get capital into the financial sector to make sure that the pan was strong enough to withstand all the popping going on inside.”
The pushback from some free-market capitalists was essentially this: if you believe in free markets, companies should be able to thrive and fail as a result of their own actions. If a firm takes on too much debt and is on its knees, it is appropriate for that firm to go down, with the assets being acquired by another firm. The difference here was that so many firms—AIG in particular—were not so much too big to fail as they were too connected to fail. White House economic adviser Keith Hennessey told me that the “intent was to get at the root of the problem. The president’s instinct was not to intervene in the markets unless it was absolutely necessary.” But the opinion was growing that it was, indeed, just that.
Testifying before the House Financial Services Committee, Paulson stressed that it was essential that the federal government have the power to intervene to save the nation from financial collapse. He added that it was not just a national issue anymore; it was global. In a two-day period at the end of September, the governments of Ireland, the UK, Belgium, France, and Iceland were forced to step in and prevent the failure of financial institutions.
Even with the government plan, Ken Rogoff, the Thomas D. Cabot Professor of Public Policy and professor of economics at Harvard University, predicted many bank failures. “Unless the Treasury decides to buy out every bank, we’re going to see more consolidation,” he told me on Closing Bell. “The industry is coming from a very bloated place—not just bad debt, but the business model itself. I anticipate we’ll change the whole way of doing business.”
The well-respected economist and author Amar Bhidé also thought TARP was a terrible idea. “I have enormous confidence in the institutions of America,” he told me, “and I hope they will override the mistakes individuals make. But this whole business of TARP reminds me a lot of the WMD business in Iraq: ‘Oh my God, just trust us. There are these WMDs, and unless you give us the authority now and right now to bomb them, disaster will befall us all.’ Giving Wall Street or Detroit or the banks money with virtually no personal accountability erodes the legitimacy of the system. Ultimately, the great strength of this economy is the belief that the game is not rigged, that we can all get ahead if only we try harder. The destruction of that belief could be an awful consequence of this desperate shoveling of money.”
There was tremendous relief at the Treasury Department and the White House when TARP passed on October 3, and the government immediately injected $250 billion into the system to stabilize banks. But the relief was extremely short lived. One White House official shuddered recalling what happened next. “After TARP passed, the market fell five hundred points in an hour—which was totally bizarre because this was supposed to be good news. When that happened it was the closest we came to—not panic, but feeling
the situation was quite desperate.”
In the blame game, one factor kept coming up over and over again—the repeal of the Glass-Steagall Act, a major move toward bank deregulation. Glass-Steagall—named for the two men who wrote the bill, Senator Cantor Glass, Democrat of Virginia, and Representative Henry Bascom Steagall, Democrat of Alabama—became law in 1933, during the height of the Great Depression. At the time there was a strong belief that the collapse of Wall Street was largely due to reckless investing by commercial banks. Glass-Steagall created a barrier between investment and commercial banks that would make such recklessness impossible. However, the law was viewed as a thorn in the side of banking, and the industry had been lobbying for its repeal for many years. Finally, in 1999, the campaign, spearheaded by Senator Phil Gramm of Texas, was successful, and Congress repealed Glass-Steagall. Gramm’s efforts had the full support of Federal Reserve chairman Alan Greenspan, Treasury secretary Robert Rubin, and President Bill Clinton. Indeed, Rubin told Congress as early as 1995, “The banking industry is fundamentally different from what it was two decades ago—let alone in 1933.” Rubin believed that the rise of globalization demanded a more open and flexible investing environment, and he viewed Glass-Steagall as a roadblock. Later, when Larry Summers replaced Rubin at Treasury in the final years of the Clinton administration, he got on board as well. Many Monday-morning quarterbacks blamed the events of 2008 on this critical piece of deregulation—something I asked Clinton about the week after Lehman’s failure. Clinton vehemently denied that the repeal of Glass-Steagall was to blame for Wall Street’s collapse, and he defended his administration’s decision to repeal the act. “We still have heavy regulations and insurance on bank deposits, requirements on banks for capital and for disclosure,” he said. “I thought at the time that repealing Glass-Steagall might lead to more stable investments and a reduced pressure on Wall Street to produce quarterly profits that were always bigger than the previous quarter. But I have really thought about this a lot. I don’t see that signing that bill had anything to do with the current crisis.”
The Weekend That Changed Wall Street Page 12
