The Weekend That Changed Wall Street

by Maria Bartiromo

  Ben Bernanke tried to calm such fears back in 2006. “It would be very much against their own interest to do so,” said the Fed chief. “Heavy selling would precipitate precisely the fall in the dollar’s local and global purchasing power that the Chinese fear. So the Chinese would not cut off their noses to spite their faces.” Still, there is no question that foreign ownership of U.S. debt has put us in a less secure position internationally.

  In January, when I was covering the World Economic Forum in Davos, Switzerland, the alarm bells were sounding about sovereign debt. When discussing the next global crisis, Ken Rogoff, a professor of economics at Harvard, gave an impassioned warning. “Government money brought us back,” he acknowledged, “but it morphed into a long-term debt crisis—an illusion of normalcy. The crisis is over because governments guaranteed everything and spent like drunken sailors.” Rogoff gave the bailout its due, noting that it was a good thing that we didn’t have a second Great Depression. “The problem is,” he added, “if one looks at history, banking crises are too often followed by a wave of sovereign debt crises a few years later. No surprise, [today] debt is exploding. In countries like the U.S., we may see painful political consequences—belt tightening, higher taxes, slower growth. In emerging Europe, we could see worse, including outright default. We may tell ourselves we’re better; we’ve figured things out; we won’t have the political problems other countries have faced; we’re different. But I submit to you, we’re not.”

  Not everyone agreed with Rogoff’s position, but almost like clockwork, when I arrived back in New York from Davos, the focus turned to Europe and a staggeringly slow recovery. CEOs from Hewlett-Packard to Coach told me Europe was stuck in the mud, unable to break out of the grips of recession. And now the new focus was government debt, particularly in Greece and its impact on the rest of Europe.

  Since Greece was part of the eurozone, consisting of sixteen states that use the euro as their sole currency, there was deep concern over the possibility that the entire region could be on the hook to bail them out. Once again, we were dealing with “too big to fail,” only this time it was on a national level. How many American companies would be exposed, and how deep would the contagion run? These worries gripped the markets.

  When the euro was formed back in 1992, there were several critics who argued that it was folly. They asked, how could you combine a large group of nations with very different economic landscapes and financial sensibilities under one umbrella, one currency, and one central bank? For example, as the strongest player, should Germany’s central bank be governed the same way as a weak player like Greece? Now it seemed that the worst fears were coming to pass. With Greece’s sinking fortunes tied to Europe’s financial stability, the stronger nations were facing popular unrest. I saw that people in Germany were angry the way many Americans were angry in the face of bailouts a year earlier. They were asking, “Why should Germans, who have practiced fiscal responsibility, have to bail out the people of Greece for their bad spending habits?” The situation was reminiscent of the weekend on Wall Street when Hank Paulson and Tim Geithner tried to persuade big firms like Goldman Sachs, Citigroup, Morgan Stanley, JPMorgan, and others to create a fund to help Lehman or face the risk of going down themselves. A year and a half later, European leaders were trying to convince Germany, Italy, Ireland, and, to a lesser degree, Portugal and Spain to do the same for Greece. When the European Union and the International Monetary Fund came up with a bailout of $1 trillion, it was stunning. This was an extraordinary amount of money, and yet in the days following the announcement, the global markets plummeted. Investors were not convinced it would work.

  It wasn’t only European fortunes that were tied to Greece’s crisis. There were implications for America as well. According to Moody’s, Greece’s debt was an untenable 115 percent of the country’s economic output. No one I talked to saw U.S. debt escalating to levels as high as Greece’s, but one investor I spoke with off the record—a leading investor in China—shared with me important information about one possible consequence that could have a major impact on the economy here. This investor was very concerned about U.S. debt because he said that 50 percent of China’s wealth was invested in our debt. If our situation did not improve, he told me that China would scale back its buying of debt. The outcome: we’d probably have to raise interest rates to make the debt more attractive to investors, and that would likely have ripple effects on interest rates domestically, affecting everything from bonds to the housing market.

  Again, it was a sobering picture of the consequences of too much debt. As we watched riots break out in Athens over the prospect of skyrocketing taxes and the brutal sacrifices being imposed on a nation on the brink of failure, I couldn’t help thinking that we should be taking a lesson from the crisis abroad. Imagine a scenario where the U.S. government would announce simultaneously a huge tax hike, a wage freeze, a spike in the price of oil, delayed retirement, higher interest rates, higher unemployment, and a generally depressed standard of living across the board. While such a scenario was not likely, it was not the stuff of science fiction, either. The sovereign debt crisis could place the American dream at risk.

  In May 2010 I spoke to former president Clinton, and he cautioned against the mentality that we could spend our way into prosperity. “The American people have to take responsibility,” he said. “You just can’t keep saying you want more government than you want to pay for. And borrowing money from overseas, it’s just not right. It’s bad for our kids and grandkids, and it puts us in a very vulnerable position going forward. I simply don’t think we can afford to keep exploding this debt.”

  It was questionable if even in the midst of failure Greece was getting the message. When I interviewed Greek finance minister Giorgos Papaconstantinou at the peak of the crisis, he seemed to want to blame not Greece’s notorious overspending but the nature of investment activity. He criticized the lack of transparency in the financial system, particularly around collateralized debt obligations (CDOs), derivatives, and other instruments that “basically corner countries” that are trying to do the right thing and get their financial houses in order. That was one way of looking at it, but most experts were clear that Greece’s problems were of its own making, and the solutions were going to cause a great deal of pain to the population. One observer compared Greece to a subprime homeowner who owed more than he could afford but who might find the cost of a rescue—rising taxes and spending cuts—intolerable.

  I spoke with Nassim Taleb, a former Wall Street trader and author of The Black Swan, a critical view of the deception inherent in financial solutions. He emphasized that there was “massive fragility” in the markets that would not be alleviated by an infusion of cash. Granted, he told me, the rescue package for Greece by the European Central Bank and the International Monetary Fund briefly made things better. But, he said, “It’s like putting a lot of Novocain on a decaying jaw. The infection is still spreading. You’ve got to do surgery, and people are afraid of surgery.”

  One person who was relatively sanguine about the perceived crisis was the former Bear Stearns chairman Ace Greenberg. He’d seen nearly six decades worth of market fluctuations. He was there when the Dow fell 45 percent in 1973. He was there on Black Monday in October 1987, and he famously said after a huge market drop, “Markets fluctuate. Next question.” So when I asked him in June 2010 about concerns with the stability of the euro, he brushed them off. “I’m sorry Greece is having a problem,” he said. “But Greece is a tiny country, even by the standards of Europe. And, you know, sometimes, Maria, markets go up and down for no reason. In 1987 the market went down 32 percent in two days, and that was the blue chips. The other stocks you couldn’t even sell, so you didn’t know how far down they went. They couldn’t find a reason for why it went down. There was no reason. There were no changes. Over a short spell we made it all back; and it was just a question of, like in the West, enough thunder starts a stampede and everybody runs for the exit.”


  Greenberg’s point wasn’t exactly confidence inspiring. Nor did I believe that market activity was entirely random. The stock market was responding to real concerns on a global level. Greece might have been tiny, but it was the canary in the coal mine.

  Professor Axel Weber, a European Central Bank Governing Counsel member and Germany’s Bundesbank president, was among the small group putting together the bailout for Greece. He told me that Greece’s problems were not a result of the global financial crisis, but its own failure to control spending over the years. “One thing that is clear is Greece had a fiscal deficit even in the good times of 2004, 2005, 2006,” he said. “So the situation was that fiscal space was stretched at the starting condition, before this crisis. Greece is a special problem, and the Union is dealing with this problem going forward.”

  Weber’s caution going forward demonstrated parallels with the efforts of our own Treasury Department to stabilize the economy and protect banks by footing the huge bill. But his primary message was one of fiscal responsibility. “It will be key to use the proceeds of this recovery that we’re about to see in order to get to a sustainable starting position,” he said. “That will be the lesson that has to be drawn. We need more fiscal responsibility in each and every member country. And the crisis told us that this is much more key to the Union than it has been perceived up till now.” Weber’s point was one that we needed to take to heart in America: Don’t just relax into the recovery. Use it as a moment to get our house in order. Greece did nothing to pay down its debt during prosperous times. We are in danger of following the same path.

  There was little question that Greece’s main problem—spending money it did not have—was enabled by the same kind of financial maneuvering that nearly brought down Wall Street. When Papaconstantinou was blaming investment banking activities for Greece’s debt, he failed to mention that his country had welcomed the involvement on the part of Goldman Sachs that had allowed Greece to join the Union in the first place. According to a Bloomberg report, Goldman Sachs managed $15 billion of bond sales for Greece after arranging a currency swap that allowed the government to hide the extent of its deficit. These complicated swaps were perfectly legal, and Goldman earned a fat fee of around $300 million for arranging the deal. But like the broke homeowner living in a mansion, Greece was in over its head and didn’t show it. And its grand facade was enabled by an investment banking system that was already breaking down.

  Axel Weber turned a hard eye on the banking system as a whole. “Taxpayers around the world have put roughly twenty-five percent of global GDP on the table to deal with bank rescues,” he pointed out. “They have a right to know whether this was a lack of risk management, whether it was simply some flaws in the system, where it was related to some unfortunate market developments, or whether deliberate attempts of fraud were on the line.”

  The drumbeat against the investment banking culture was growing louder, and Goldman was bearing much of the brunt, probably because the firm had been so successful for so long.

  Lloyd Blankfein had long ago perfected an inscrutable demeanor. The Goldman Sachs chief was seldom in the news, and he rarely spoke to the media. He didn’t really need to. Goldman was at the top of the pile, not scrambling for credibility or attention. It was a gold chip firm in a gold chip industry. Likewise, Blankfein was friendly but opaque when it came to sharing his views. Although he was known to be quick witted, he mostly kept his humor and his analysis to his inner circle.

  In many respects, Goldman’s reputation was impeccable; its success the envy of its peers. However, with the financial industry under the microscope, the media—egged on by a sometimes hysterical, conspiracy-theory-driven blogosphere—was intent on uncovering alleged special treatment afforded Goldman by the Feds. The implication was that there were old-boy ties between the 140-year-old firm and its alumni, many of whom went into government and public service. Some said that there was a revolving door between the halls of power at Goldman and the halls of power in Washington. An October 17, 2008, New York Times article, titled “The Guys From ‘Government Sachs,’” created some discomfort in the ranks.

  Even a partial alumni list of the firm was striking. Robert Rubin and Hank Paulson were both chairmen of Goldman before becoming secretary of the Treasury, as was Jon Corzine, prior to serving in the U.S. Senate and as governor of New Jersey. Stephen Friedman was a Goldman chief before becoming chairman of the New York Fed—a position he was forced to resign over purchase of Goldman stock. Bob Steel was at Goldman when he was recruited by Paulson to the Treasury. Paulson also called on other Goldman alumni at important moments during the financial crisis. He put Neel Kashkari, a thirty-five-year-old up-and-comer at the firm, in charge of managing TARP, and he pulled in Goldman director Ed Liddy to replace Bob Willumstad at AIG. Paulson himself had been recommended for the Treasury by White House chief of staff and Goldman alumnus Josh Bolten.

  The Obama administration continued the trend. Goldman Sachs alumni include Bob Hormats, Hillary Clinton’s economic adviser; Gary Gensler, head of the Commodities Futures Trading Commission; and Mark Patterson, Geithner’s deputy in charge of overseeing TARP. In addition, the head of the NYSE, Duncan Niederauer, and the head of the New York Federal Reserve, William Dudley, both came from Goldman.

  Finding Goldman alumni was like playing a game of Six Degrees of Separation. The links were amazing, although many critics questioned whether they were proper. Should so many alumni of Goldman be making decisions about whom to save and whom to bail out at the height of the financial crisis? Much of the grumbling about Goldman centered on the bailout of AIG. Goldman was a major counterparty of AIG’s, and had the Feds not rushed to the rescue, Goldman would have taken a major hit. Instead, it would end up being paid 100 cents on the dollar for its AIG holdings.

  The story of Goldman Sachs’ connections went beyond who was in its family tree. There was also a question of family values. Granted, powerful companies often take extra heat from the eternal critics who contend that power always corrupts. But speak to certain Goldmanites and you hear a lot of chutzpah—including Blankfein’s unfortunate comment to a reporter that he was just a banker “doing God’s work.” If so, God’s pay scale was among the highest on earth. Hundreds of Goldman executives and traders received bonuses topping $1 million during the height of the crisis in 2008, and working there made Blankfein one of the richest men in the world. He quipped to the Times of London in 2009, “I know I could slit my wrists and people would cheer.”

  Yet in many ways Blankfein represented the very best of the American dream. Raised in New York City, the son of a postal clerk, he was a lower-middle-class kid whose hard work and ambition landed him at Harvard and then at Harvard Law School. He joined Goldman Sachs in 1981, rising steadily up the ranks. When Paulson left the firm to become Treasury secretary, Blankfein stepped into the position of chairman and CEO.

  Blankfein was a devoted husband and father of three, who shunned the limelight and the New York party circuit. He was poorly cast as a capitalist villain, and people close to him reported that he was stunned and angry when the SEC filed civil fraud charges against the firm on April 16, 2010, alleging that Goldman misled investors on a particular deal. The incident in question occurred some time before the height of the financial crisis, back in early 2007, when there were just beginning to be signs of stress. Goldman allowed John Paulson’s firm—the hedge fund known for shorting the housing market—structure a deal called Abacus 2007-ACI, without notifying the primary investor that Paulson was involved in the selection. Would the buyer have invested in Abacus had it known the person on the other side of the trade actually selected the securities to bet against?

  The last time Goldman Sachs made such a splash in the gossip columns was back in 1999, when Corzine, who had made Paulson his co-CEO, was dispatched in a bloodless coup spearheaded by Paulson and Chief Financial Officer John Thain. Paulson and Corzine had different styles and different visions for the white-shoe firm. In t
he decade to come, Goldman Sachs would reap phenomenal rewards and accumulate assets of more than $1 trillion. Now it was in the spotlight with an ugly word attached to its name—fraud. People may have envied Goldman, but truth be told, its reputation was solid, which helped it continue to thrive even during the financial crisis. The charges were coming against a firm that many people would say was the least likely to find itself in this position.

  The news about Goldman Sachs came just as I was in the final stages of completing this book. Breaking news always vies with the longer-term analysis of a book project, but I felt the situation gave me a perfect opportunity to bring some deeper issues of the crisis to the forefront. More than any other firm, Goldman Sachs epitomized who we are as a capitalist society, and where we are headed. In the wake of the weekend that changed Wall Street, I found that Washington and the Street were connected as strongly as I’d ever seen them in my twenty years covering financial news, due in large measure to the cries for financial reform.

  I felt that the timing of the SEC’s announcement against Goldman was very curious. I couldn’t recall a similar situation in which charges against a publicly traded company were announced during the trading day. In addition, the fact that the announcement came on the Friday before financial reform was going to be debated in Congress raised the question of whether politics, not alleged wrongdoing, was driving the charges. The SEC had missed a lot—the worst financial crisis of the era, Bernie Madoff’s Ponzi scheme, and more. Was this just a way to show that there was a new sheriff in town? Was it fair? Was it even provable?