The Weekend That Changed Wall Street

by Maria Bartiromo

  Back in January, in his final interview with me as Treasury secretary, Hank Paulson had told me during a commercial break, “In six months you will understand why we did what we did.” He meant spending upwards of $1 trillion bailing out major banks without revealing which banks got the money. I thought it was a mysterious remark, but the government secrecy finally became clear: it was hiding Citigroup’s potential insolvency.

  In the wake of the financial crisis, the superstore that was Sandy Weill’s brainchild was in real trouble. Vikram Pandit had been CEO for less than a year, but he had to be thinking his ascension came at the worst possible time. Sources told me that the potential failure of Citigroup was of such concern to government officials that they devised the wall of secrecy for all banks, solely to prevent Citigroup’s weakness from being revealed. But by November 2008, its problems were too great to hide. The $25 billion TARP contribution did not even begin to cover the bank’s asset drain. Was it possible Citigroup could go down? The idea sent a shudder through Wall Street that was felt around the world.

  Observing events with special interest was Prince Alwaleed of Saudi Arabia. The nephew of Saudi Arabia’s King Abdullah, Alwaleed, fifty, could be something of a loose canon, but he was also Citigroup’s largest shareholder. When he first invested in Citigroup, it was seen as a smart move, and his net worth was estimated at more than $21 billion. He was always very opinionated about the company and its management. He loved Weill, and when I spoke to him in 2006, shortly after Weill’s retirement from the board, he didn’t attempt to hide his displeasure with Citigroup’s downward trajectory. He told me of a meeting he’d had with Weill and Chuck Prince in Paris. “We discussed the promise from Chuck that he will deliver good results,” Alwaleed told me. “If I can quote him, he said: ‘We have put the big problems of Citi behind us.’”

  “So, how long a grace period are you giving Chuck Prince?” I asked Alwaleed.

  “The grace period is over,” he said tightly. “You can quote me on that.”

  By November 2008, Chuck Prince was long gone, but Alwaleed was still heaping scorn on his tenure. He recounted a meeting with Sandy Weill, which occurred at some unspecified time in the past. “Immediately when he met me he said, ‘Prince Alwaleed, I’m sorry,’ and I asked him, ‘Sorry for what, Sandy?’ He said, ‘I’m sorry for appointing Chuck Prince.’”

  The blame game was on. Alwaleed said, “Frankly speaking, the destruction of all that took place recently, clearly has to be attributed to the previous management. Now it is the Vikram era, and you have to look at the positive side, at what could take place at Citigroup. Open a new page, put the worst behind us.”

  Of course, that was before the revelations came about Citigroup’s troubles, or before Pandit and the Feds began to lock horns. In June 2009 it was reported that Federal Deposit Insurance Corporation chief Sheila Bair was pushing hard for a shake-up at Citi that would include getting rid of Pandit.

  I asked Pandit, “How much heat are you feeling, and will you step aside?” He replied in his typically even-mannered way, “Given the losses we’ve taken, and until we return to sustainable profitability, we will have speculation. That doesn’t make the speculation correct.” He didn’t say so, but by implication Pandit felt that Bair’s attacks were unwarranted, in light of his aggressive efforts to streamline the company. “We’re a much smaller Citigroup,” he said. “More important, we want to be Citicorp, not Citigroup, going forward. Citicorp is our global bank for consumers and businesses. At the same time, we’ve also decided there are some businesses we need to sell. We closed one of them, the Morgan Stanley Smith Barney joint venture. And we’re methodically selling and rationalizing what we call Citi Holdings.”

  Bair was unsuccessful in forcing an ouster of Pandit; there was an almost deadening silence around her charges. No one else seemed willing to step up and call for Pandit to go. Indeed, many people believed that it was wrong to blame Pandit, a relatively recent arrival, for Citi’s problems. And he seemed to be taking action to make the company more manageable. In fact, Pandit would end up cutting $500 billion from the balance sheet by selling assets and very methodically raising cash.

  Citi was saved, for the time being, but it was still limping along. Amid $45 billion in bailouts and Pandit’s streamlining campaign, Sandy Weill was in the background, trying to get involved—maybe even to come back, although that seemed like wishful thinking on the part of people like Prince Alwaleed and Weill himself. Like Hank Greenberg with AIG, Weill might have thought he could play a role, but his efforts to insinuate himself were rebuffed—as were Greenberg’s. These old fighters, who, one must not forget, were the architects and engineers of enormous global enterprises, could not let go.

  Jim Rogers did not feel much pity for the perpetrators when he talked to me about the collapse of integrity within the system. “They all took huge, huge profits,” he railed. “Who was the head of Citigroup? Chuck Prince? I mean, how many hundreds of millions of dollars did Prince take out of the company? How many hundreds of millions of dollars did other Citibank execs take out of the company? Wall Street has paid something like $40 billion or $50 billion in bonuses in the past decade. Look at Stan O’Neal at Merrill Lynch. He got $150 million for leaving, even though he ruined the company. Look at the guy at Fannie Mae, Franklin Raines. He did worse accounting than Enron. Fannie Mae and Freddie Mac alone did nothing but pure fraudulent accounting year after year, and yet that guy’s walking around with millions of dollars. What the hell kind of system is this?”

  A year after the weekend that changed Wall Street, I broadcast a special on CNBC, called One Year Later: Reflections from the Street. Along with my producers at CNBC, I gathered some of the primary players from that weekend—all older, wiser, and perhaps sobered by the wild run that nearly destroyed our financial system.

  “There’s a calmness back in the market,” John Mack told me, “although people are still shell-shocked. Everyone has gone out of their way—including we at Morgan Stanley—to make sure that we’re in a better position as we go forward in these markets, meaning we’ve raised a lot of capital. We have a new regulator in the Federal Reserve as a bank holding company. That’s a big change from where we were a year ago. It’s huge. And, of course, we’ve looked at our risk management—where did we make mistakes, where do we need to add more resources? So, one year later everyone is feeling better, but everyone is still concerned.”

  This response—relief on one hand, concern on the other—was reflected in the comments of nearly everyone I spoke to during that period. But the attitude was like that of a patient who was on life support a week ago being upgraded to critical. He’s not dying anymore but he’s still very, very sick.

  “It has been like a slow-moving cardiac arrest,” Mohamed El-Erian observed. “As opposed to a sudden stop, you’ve had a number of smaller stops in the system. And we kept the patient, which is the financial system, alive in the ICU, using a tremendous amount of medication. And the patient is better, but he’s still in the hospital and he’s still dependent on medication. But there’s an understanding that over time the medication needs to be reduced and eventually even stopped. But there’s also an understanding that unless the patient changes his behaviors, he’ll end up back in the hospital.”

  Perhaps the patient would like to change his behavior, perhaps not. But it will certainly be hard to do while the fallout from early crises keep invading his well-being. I have always known that it would take years, and maybe even decades, before we fully understood all the factors behind the near collapse of our financial system in 2008.

  When your public and professional actions cause the spotlight to be extended to your family, it’s extremely rough. It is in many cases sad and unfair. Lehman executives, along with many others in the financial industry, found their private lives put on display. The narrative was irresistible: financial fat cats living large while Middle America loses its pension benefits. For a time the cameras were out in force, trolling t
he wealthy communities of Greenwich, Connecticut; Harrison, New York; and other enclaves of privilege.

  Former Lehman trader Larry McDonald, for one, spared no sympathy for the Fulds. “Dick Fuld should publicly apologize,” he told me. “So many people are in pain. Their unemployment has run out, their COBRA [health insurance] has run out. These are back-office people.”

  It is impossible to calculate the scope of the suffering in Middle America that resulted from the crisis, but just among the doomed employees of Lehman Brothers and other failed banks, the pain rose to an intolerable level.

  Meanwhile, umbrellas, ties, duffel bags, coffee cups, and other items bearing the Lehman Brothers logo started making an appearance on eBay. The sales would go toward paying Lehman’s creditors.

  Months later, long after Lehman Brothers had disappeared from the front pages and faded from public interest, the court-appointed examiner who had been quietly studying the events leading up to Lehman’s bankruptcy filed a 2,200-page report. Suddenly, Lehman was back in the spotlight. I suppose the good news, if you were Fuld or Gregory or Callan or anyone else in a critical position, was that there didn’t appear to be criminal charges in the offing—at least, not yet. But that didn’t mean there wouldn’t be lawsuits and legal challenges, because the report made a strong case that Lehman was hiding the truth in the months before it fell.

  Deserving particular scrutiny was its use of a device called Repo 105 in the second quarter of 2008 to move $50 billion off its balance sheet. A repo is a sales and repurchasing agreement that involves transferring assets in exchange for cash, with an agreement to repay the money and take back the assets later. In principle, it’s not much different than a loan, where assets are held as collateral on future payment. The difference in Repo 105 was that Lehman recorded it as a sale and no longer had any record of the assets on its balance sheet. Nor did the firm disclose Repo 105.

  In a daylong hearing before the House Financial Services Committee on April 20, characterized as an “autopsy” of Lehman, Fuld insisted that he was completely unaware of Repo 105. “I have absolutely no recollection whatsoever of seeing documents related to Repo 105 transactions while I was the CEO of Lehman,” he said. Was he credible?

  Such fancy footwork certainly breaks the spirit, if not the letter, of the law. Mary Schapiro, who replaced Christopher Cox as head of the SEC, admitted to Congress that the agency’s oversight was sorely lacking—right up to the moment of Lehman’s bankruptcy. Its investigators only skimmed the surface, looking at obvious trades and statements. They didn’t go deep enough to uncover Repo 105.

  When I caught up with Schapiro in Washington on March 29, 2010, she told me that not only was the SEC looking very carefully at Lehman, but it was examining every major financial institution to see if there were “Repo 105–type issues.” Schapiro was a fresh face and offered new hope that the SEC would no longer be asleep at the wheel. She inspired some confidence in regulatory circles. Even before the latest Lehman revelations, many people had viewed Cox’s tenure as lax, exemplified by Bernie Madoff’s $65 billion swindle, which happened right under the agency’s eyes. There was also an odd item breaking about SEC investigators watching pornography on their office computers at the height of the crisis. One staffer had watched porn for eight hours straight! Could it get any worse?

  When the SEC does not perform its role, and institutions get away with deceptive practices and worse, it tarnishes the credibility of the financial system. This is not just a symbolic black mark. The markets rely on investor confidence, and when that is shaken the results are recorded in tangible declines on balance sheets. Just consider how many millions of people pulled their money out of the stock market between September and December 2008. Their actions were fear driven and may have gone against the best advice of their financial advisers, but it didn’t matter. Once confidence was gone, the stock market couldn’t operate effectively. But one Bush administration source noted to me that “the market is a tough taskmaster and it punishes bad behavior pretty harshly. I don’t think we will ever have a repeat of the kind of crisis that we had in the past.”

  It was a good start. But as the revelations kept coming, and Americans kept bearing the burden, many of them wanted to see bankers going to the woodshed. Tactically, the financial-reform discussions centered on the boogeyman dubbed “too big to fail.” The scares surrounding the potential collapse of institutions like AIG and Citigroup opened a debate about whether any institution should be allowed to grow to the extent that its collapse put the nation—or the global economy, for that matter—in jeopardy. New regulations would become the next change that was to be met on Wall Street. Under the aegis of the Dodd Amendment, sponsored by Senator Chris Dodd of Connecticut, the Senate introduced a wind-down amendment that allowed regulators to break up banks whose failure could pose a “grave threat” to the financial system.

  On two occasions in the space of months I interviewed Treasury secretary Geithner about the government’s response to “too big to fail.” He told me that they had been working hard to find the right way to stop a crisis before it spread. “The key point is, that if big banks ever manage themselves to the edge that they cannot survive without government assistance,” he said, “the government should have the ability to come in and dismember them and unwind them and sell them off in pieces without putting the taxpayers at risk. We don’t want the taxpayers to be at exposure of nearing the costs of the large financial crisis.

  “One way to think about it is to use the firefighting metaphor,” he added. “You want to draw a fire break around the fire, and make sure that the fire can’t jump from the failing firm and threaten the rest of the financial system.” It seemed self-evident to me—so obvious, in fact, that I marveled that such a plan had not been in place at the time of the financial collapse around Lehman. Geithner agreed. “A tragic failure of the country,” he said, nodding vigorously. “We had it in place for small banks, but we didn’t have it in place for large, complex institutions that dominated the world—for Fannie and Freddie, and AIG, and Lehman, and Bear Stearns, and even the major banks in the country. The only authority the president had was to come in and shut down the markets and declare a bank holiday.”

  Geithner and I discussed the matter at some length. I didn’t question his sincerity, or even his incredibly bright mind, which was on full display when he relaxed and opened up one-on-one. At the time of our last interview, in the early spring of 2010, I noted that he looked older and more burdened than he had in September 2008—and no wonder.

  “We are not going back to the system the way it was,” he said firmly, but the new direction was less clear. He spoke of fundamental change, but he couldn’t explain exactly what that would mean.

  NINE

  A Greek Tragedy

  “Our debt is $13 trillion. To give you an idea of what a trillion is, if the day that Jesus Christ was born somebody put a million dollars into a bank account and then added another million dollars every single day for the next two thousand and ten years, you still wouldn’t have a trillion.”

  —DAVID RUBENSTEIN, COFOUNDER AND MANAGING DIRECTOR OF THE CARLYLE GROUP, DISCUSSING THE ENORMITY OF OUR DEBT IN MY PANEL DISCUSSION AT THE ASPEN IDEAS FESTIVAL, JULY 9, 2010

  SPRING 2010

  In a classic Greek tragedy, the protagonist suffers a fall as a result of a fatal flaw. By 2010 this had become an apt metaphor for the sinking fortunes of Greece, which threatened the European Union and the stability of the euro itself. Greece had long been a profligate spender, continuing to pay the bill for an excessive national standard of living, even as it was going broke. Those who might have asked why we should care about what happened to this tiny country across the ocean could find an answer in the dangerous debt load that was building here at home.

  Greece mattered because it was emblematic of what sovereign debt (that is, government-owned debt) could do, and as such was a cautionary tale for the bailout-strapped United States. If debt brought about the cri
sis on Wall Street in 2008, the transformation of private debt to government debt was in many ways the story of the post–September 2008 economy.

  By the time 2010 came around, there was a sense that the panic was dying down, and we were headed toward daylight, even if we were not there yet. But stability seemed to be coming up against some difficult economic and political realities. The crisis on Wall Street in 2008 and the enormous capital spent on bailouts empowered a new administration to push for more stringent financial regulations. No one knew for sure how strict the regulatory environment would become, but many critics felt that the administration should be more focused on the growing debt. A year and a half after the financial crisis, our debt was more than $14 trillion, larger than the U.S. economy, and it was expected to rise to $16.9 trillion by 2015.

  According to the Council on Foreign Relations, foreign ownership of U.S. debt has increased dramatically over the last decade. Foreigners now hold 57 percent of U.S. Treasuries, while foreign holdings of U.S. government agency and government-sponsored-entity debt have increased from 6 to 16 percent. Virtually the entire increase in both has been accounted for by foreign governments, as opposed to private investors. And one government dominates: China. According to the Wall Street Journal, China has accumulated an astounding $850 billion in Treasuries and $430 billion in agency debt over the last decade—almost half the total foreign government accumulation.

  Former Treasury secretary Hank Paulson revealed in his book, On the Brink, that in August 2008 he learned that “Russian officials had [earlier] made a top-level approach to the Chinese suggesting that together they might sell big chunks of their GSE holdings to force the U.S. to use its emergency authorities to prop up these companies,” referring to the debt issued by Fannie Mae and Freddie Mac. Paulson said that the Chinese declined to cooperate but noted that the report was “deeply troubling,” as “heavy selling could create a sudden loss of confidence in the GSEs and shake the capital markets.” With the United States needing to sell another $1.3 trillion in debt this year, should be we worried about these concerns and should the structure of the GSEs be changed?