The Weekend That Changed Wall Street

by Maria Bartiromo

  Some people were grumbling that the SEC’s suit smacked of political motivations. Later I asked SEC chairman Mary Schapiro if there was any basis to that suspicion. She denied it vigorously. “Let me just say point-blank that there was nothing political about this case. We bring hundreds of cases, every year. We’ve brought many cases coming out of the financial crisis, in fact. And we bring cases when we’re ready to bring them, not based on really any predetermined calendar or predetermined perspective.”

  Still, I questioned the timing. And amazingly, when I Googled “Goldman fraud” one day, I came up with an ad for the Obama administration’s financial regulation reform, asking for a political donation. Huh? Just as the SEC was coming out with the charges, there were e-mails being sent from President Obama to his constituents saying that America needed to get moving on financial reform. As I searched “Goldman Sachs SEC” on Google, two sponsored results popped up: one from Goldman titled “Goldman Sachs Website” and one from www.BarackObama.com titled “Help Change Wall Street.”

  One fact was undeniable: the charges represented a more aggressive SEC than we’d seen in a long time. That wasn’t a bad thing. But when I spoke to a number of top-notch corporate attorneys, they were unanimous in the belief that it would be very difficult for the SEC to prove such a complicated case, involving sophisticated instruments and seasoned, high-stakes investors. There wasn’t even unanimity within the SEC; the vote to bring the charges was 3 to 2.

  Having said that, there was certainly an important issue of corporate ethics underlying the charges. A few days after the announcement, I was speaking to an audience of around two hundred people in New Canaan, Connecticut. The audience wanted to know if there was anything new on the Goldman Sachs story. I said quite honestly that it was too soon to know whether fraud had actually occurred. One man asked me, “If you had only one question you could ask Lloyd Blankfein right now, what would it be?”

  It was an excellent question. Looking out into the sea of faces, I could tell that these ordinary Americans, many of whom had suffered tremendous losses during the financial crisis, were in no mood to give Goldman the benefit of the doubt. I answered, “I’d ask if he thought what he allowed the firm to do was appropriate behavior toward his investment clients, and was it morally ethical.” The room exploded in cheers, and that, I thought, was the heart of the matter. People wanted accountability. They felt that investment banks skirted ethics all the time, whenever it was lucrative to do so. They felt that these guys moving vast amounts of money just didn’t care. It didn’t matter whether it was true or not. Reputation is everything to an investment bank. It relies on trust, and if that trust is undermined, it can be brought down. So the SEC suit was deadly serious for Goldman Sachs.

  It didn’t help that one of the vice presidents named in the fraud charge, Fabrice Tourre, sent an embarrassing, self-congratulatory e-mail to a colleague: “Only potential survivor, the fabulous Fab…standing in the middle of all these complex, highly leveraged exotic trades…” In another e-mail, he described an investment vehicle that “has no purpose, which is absolutely conceptual and highly technical,” thus confirming a public perception that high-stakes investing does nothing to support the fundamental health of the economy. Tourre became the poster boy for the arrogant, cutthroat culture of investment banking. It was not the image that Goldman Sachs needed at that moment.

  On April 27, the Senate Permanent Subcommittee on Investigations, chaired by Senator Carl Levin, performed the familiar ritual of public accountability, calling a group of current and former Goldman Sachs executives, including Blankfein, to explain themselves. Such hearings are notorious opportunities for grandstanding, and those looking for illumination could hardly expect to receive any. True to form, the senators tried for eleven long hours to score points, using colorful metaphors, while the bankers ducked and weaved and labored to bury the issues in heavy layers of investment-speak.

  In particular, Senator Claire McCaskell, reiterated a gambling metaphor: “You are the bookie; you are the house. You had less oversight than a pit boss in Las Vegas,” she charged. The men at the table were hard-pressed to defend themselves and were mostly unresponsive. They clearly believed that the senators had little understanding of the complexities of their business, and in some respects that was true.

  A source at Goldman Sachs, who was frustrated by the tone of the hearings, told me with a note of bitterness in his voice, “These hearings are never about clarity. The senators want to tar and feather our guys. They’re looking for a scapegoat, and we’re it. It’s a public spectacle.”

  If anyone expected the tone to change once Blankfein took his seat late in the day, they were mistaken. During hours of questioning, he struggled to explain Goldman’s position to the stony-faced senators, once acknowledging with frustration, “I’m trying to explain it and I wish I were better.”

  Reporting on the hearings throughout the day, I couldn’t imagine how the average viewer—even one knowledgeable about investment banking—could draw any firm conclusions. At times it felt as if it were a large cleansing ritual, and what the senators were really saying was, “America almost crashed in 2008. Explain yourselves!” But while it would be impossible for anyone to determine, based on the hearings, whether Goldman was guilty of fraud, I did notice a striking stance, taken over and over, that may explain some of the dismay felt by American citizens. The executives became downright tongue-tied any time they were asked the simple question, “Do you have an obligation to represent the best interests of your clients?” The obvious answer, straight out of Client Services 101, is, “Yes, of course.” But the Goldman executives seemed to have a hard time giving a straight answer. They were afraid to say the wrong thing after being lawyered up in preparation of the hearing.

  In the end it didn’t matter if the senators had scored any hits. In fact, I did not see any major body blows against Goldman during the hearings, and I believed fraud would be very hard to prove. However, the jury of public opinion voiced its upset. The gold-plated firm took a hit for sure. Goldman paid $550 million to settle with the SEC, putting an end to the potential tarnish of a legal fight.

  TEN

  Capitalism in the Balance

  “The historical debate is over. The answer is free-market capitalism.”

  —THOMAS FRIEDMAN

  In the fall of 2009 I was invited to do an honorary teaching fellowship at Stanford University’s Hoover Institution. It was exhilarating to be in the company of extremely bright MBA students who were preparing to enter the workforce. It was also quite a wake-up call.

  I was taken aback when one after another of the students challenged me to defend capitalism. They asked, “Does this system really work? What’s the value of the free market?” I could see in their eyes and in their words that they just didn’t believe it anymore. My response sounded hollow, even to me, because although I had no doubt that capitalism is the most freedom-promoting and personally fulfilling economic system ever devised, I also knew that the financial collapse of 2008 and the bailouts of 2009 had failed so many people who believed in its basic tenet: hard work is rewarded. The students were unwilling to blindly trust a system that had failed so miserably. Once again, the questions of “too big to fail” and why Americans had to rescue companies whose poor decisions had gotten them into trouble kept haunting the conversations I was having with students.

  As I returned to New York City, I contemplated what the students had told me, in light of the events that had transpired since that crucial weekend in September 2008. Had we learned a valuable lesson and changed our ways, or were the changes merely the equivalent of shuffling deck chairs on the Titanic?

  There is no question that easy money, too much liquidity, and way too much debt, along with greed and recklessness inside financial institutions and among individuals, had left the country damaged. For many decades the world had followed “the American way” and admired the United States. Now, after the crisis, that was changing. Unde
r Secretary of State Bob Hormats told me, “For so long China looked to America for know-how. Now the Chinese have left the class.” Europe and the Mideast—particularly in places like Dubai, whose fortunes had been undone by reckless and grandiose overbuilding—were contemplating how they would get out of the stranglehold of leverage and grow once again.

  As the Stanford students suggested, capitalism itself had been damaged and was in the grip of a crisis of confidence. For the system to work, people have to trust that it will work for them. Instead, the public saw too many other people making a lot of money doing questionable deals, with countless lives turned upside down as a result. They saw the supposed guardians of the economy being careless with their money. For the first time in my memory, students were asking, “Is capitalism a force for good?”

  The classic assumption that of course it is—an assumption under which I have operated throughout my life—had been upended. Embedded in the bedrock of the financial system is the presumption that the markets are always right, that they’re self-correcting, and that the cream will ultimately rise to the top. Now people were questioning whether this is still true.

  The students at Stanford challenged me, and others, to question the conscience of Wall Street. For them it was urgent. They were among the best and the brightest, trained and conditioned to enter a system that no longer seemed capable of supporting their dreams.

  The Lehman weekend changed Wall Street, not because the failure of a single investment bank, or even the failure of several banks, was enough to implode an infrastructure that was centuries in the making. It changed Wall Street because it was a stunning moment when the confidence of a nation and the world was blown. Capitalism is not a tangible entity with inherent value, like a precious jewel. Its value is wholly dependent on public trust. When we say that capitalism is the best system in the world, that belief is based on the understanding that by and large the people involved will play fair.

  Nor are investors merely abstract dealers or superrich fat cats. The most traumatic consequences of the financial crisis were felt by ordinary people, who lost their jobs, their homes, and their retirement savings through circumstances entirely beyond their control. They believed a basic tenet of capitalism, that everyone can get a shot at the brass ring, and the ring snapped in their fingers.

  The famed free-market economist Milton Friedman spent his life arguing that capitalism was necessary for freedom. He fought against government intrusion in the markets, stating that it impeded that freedom—not to mention that it screwed things up. He once noted that if the federal government were put in charge of the Sahara Desert, within five years there would be a shortage of sand. Friedman died in 2006 at age ninety-three, during the height of the financial boom that preceded the fall. I wonder what he would say today about what occurred and what corrective measures should be taken. I am fairly certain that the advent of TARP and other government bailouts had Friedman spinning in his grave. And I doubt he’d agree to more stringent regulation.

  The debate continues: what is the nature of capitalism, and what is the government’s proper role?

  One evening in early 2010, I had dinner with my friend Garry Kasparov. The world champion chess player has become a political activist and commentator. He told me he was writing a book about the financial system. Conversations with Kasparov are always thought-provoking, and this one was no different.

  “Do you believe that Paulson did the right thing in pushing for TARP?” he asked me.

  “I do,” I replied. “It was a moment in time when government intervention was necessary.”

  He shook his head in disapproval. “Then you are not a free-market capitalist,” he said. “Don’t tell me you are. If you believe in bailouts, that flies in the face of free-market capitalism, which requires you to allow firms to fail. They made mistakes, they took on untenable risks, and they should have failed, so new companies could emerge.”

  Kasparov’s position is one side of a vigorous discussion that is taking place across the country. But the systemic failure that necessitated TARP really was a remarkable situation—one that called for a flexible response. Emergency exceptions exist everywhere in our lives. We don’t, for example, say that if a person can’t earn money he should be allowed to starve. Our free-market principles make broad allowances for people in need. So, too, with a damaged system. Imagine what would have occurred in September 2008 if the federal government had said to all the banks and companies, “Sink or swim on your own.” Perhaps the lights would have gone out on our economy.

  Having said that, there is no question that TARP had problems in the way it was structured. I discussed this with Elizabeth Warren, the chair of the Congressional Oversight Panel, charged with reviewing TARP. Warren is well cast as the voice of oversight. A no-nonsense consumer advocate and professor at Harvard Law School, the fifty-year-old Warren speaks in the calm voice of a parent, but the impact of her words is knife sharp. When I asked her, “Where has the TARP money gone?” I was taken aback by her answer: “We not only do not know. We’re never going to know.”

  I was briefly speechless. How could we not know?

  Warren described how Paulson had failed to establish even minimal reporting procedures. “Secretary Paulson put this money into the largest institutions, and he didn’t ask, ‘How is this money going to be used?’ He put it in and covered his eyes and said, ‘I don’t care how you spend it.’ So we lost the ability to track it.”

  There will be arguments for a long time about whether TARP and the stimulus saved the economy. Alan Greenspan told me that it wasn’t the stimulus that brought us back from the brink. It was a renewal of confidence in the stock market in early 2009. The markets bottomed on March 10 and rose for most of the year, making people feel richer and more optimistic. This, Greenspan said, was critical to the recovery, even if later in the year and into 2010, new worries emerged.

  As the financial markets barreled into 2010, Congress was praying that the recovery would stick, while trying to respond to the anxiety people were feeling about their futures. The purpose of the financial-reform proposals that were making their way through the Senate and House was full of merit: protect consumers, rein in the speculative frenzy, stabilize the system, encourage legitimate growth, and prevent another financial crisis. But while most people agreed on the goals, the question of how to structure reform was more contentious.

  In March I traveled to Washington and met with Barney Frank, the chairman of the House Financial Services Committee, about the elements he believed should be a part of financial reform. For Frank there were five essentials:

  1. A systemic regulator to assure that no companies would be “too big to fail.”

  2. A resolution authority, giving the government the power to decide whom to pay and whom not to pay. Frank told me, “Hank Paulson said that his biggest problem when faced with Lehman Brothers was ‘I either pay everyone or I pay no one. I paid no one because I didn’t have the authority to shut parts down and save the rest. When AIG happened, I had to pay everyone.’”

  3. A consumer financial protection agency to make certain that nothing fell through the cracks. Frank acknowledged that there were regulations on the books—credit card protections, etc.—but the banks managed to get around them, and this legislation would strengthen the protections.

  4. Risk retention. “Thirty years ago,” said Frank, “when you lent someone money, they paid you back and that was it. Today, you lend someone money, and then they sell the loan to someone else and someone else, spreading the risk. Under this legislation they would have to retain the risk for a period of time.”

  5. Transparency on derivatives, so we’d know where the derivatives were and who had exposure.

  Frank was also interested in a proposal by former Federal Reserve chairman Volcker, dubbed the “Volcker Rule,” that would allow regulators to restrict proprietary trading at specific banks if it was deemed to be a risk to the entire financial system or threaten the bank’s sa
fety. Volcker’s position seemed logical: don’t allow banks to use consumer deposit bases as their own checkbooks to trade. Separate so-called proprietary trading from deposit bases. It appeared simple enough, but precisely defining proprietary trading would pose yet another challenge. In Washington I spoke with several high-level sources who strongly believed that the Volcker Rule, as initially proposed, would never make it into law. For one thing, formulating a precise enough definition of what does and does not constitute proprietary trading “unrelated to serving their customers” would be difficult at best and probably impossible.

  Notably, a discussion of the future of Fannie Mae and Freddie Mac was completely absent from financial-reform proposals, because, bluntly put, no one knew how to fix the mammoth mess. It was astounding, considering that the agencies held $5.3 trillion in mortgages. A frustrated insider complained to me, “How the government let Fannie and Freddie operate for the twenty-five years before 2008 was scandalous, and how the government now can fail to deal with them is even more scandalous.” I couldn’t find one person, on or off the record, who felt that a solution could be found while the economy was still fragile. “If the government were to stop supporting Fannie and Freddie as they are right now, that would cause a run on the government debt, as Fannie and Freddie debt is owned all over the world,” said an analyst. In an interview with Senator Dodd he admitted that he would have liked to have seen Fannie and Freddie be a part of financial reform, but it just wasn’t possible. “Nobody knows what to do with it,” he told me candidly. “It’s so big. Clearly you’ve got to replace Fannie and Freddie with some alternate idea. Frankly, no one knew exactly what they’d like to replace it with.”