Read 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown Online
Authors: Simon Johnson
Can it?
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All nine banks were also represented at the March 27, 2009, meeting discussed in the Introduction, except for Merrill Lynch, which was acquired by Bank of America in the interim.
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Only if the bank failed to pay its dividends six times would the government have the right to elect directors.
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The discount rate is the rate at which banks may borrow money directly from the Federal Reserve; the federal funds rate is the rate at which banks borrow money from each other overnight.
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The junior tranches of a CDO bore the first losses from the entire pool of mortgages or mortgage-backed securities that went into the CDO, so a default rate of only 6 percent could render an entire tranche of CDO securities worthless. Although securitization spread risk among many investors, it also concentrated risk into the junior tranches.
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A bank’s balance sheet is supposed to record what its assets are worth; a write-down is a reduction in the recorded value of an asset. In practice, the rules on what values to use for assets can vary depending on many factors. Only some assets need to be “marked to market,” meaning that their values should be adjusted to current market prices.
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AIG’s derivatives contracts gave its counterparties the right to demand collateral to protect them against the possibility that AIG might not be able to honor those contracts. The amount of collateral the counterparties could demand went up as AIG’s credit rating went down.
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In the case of General Motors, the government used its power as the only source of financing to force out CEO Rick Wagoner and to dictate “haircuts” for creditors—steps it did not take with any major commercial or investment bank.
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Commercial banks could record some assets on their balance sheets at high “book values” even if they could not actually sell them at those prices. So on paper, banks remained solvent—their assets exceeded their liabilities, whether or not they could actually sell the assets for enough to cover the liabilities. Selling assets would force banks to recognize their losses; not selling them allowed them to pretend that the assets had not deteriorated in value.
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Goldman Sachs insisted that it received no net benefit from the money it received from AIG, because it was fully hedged, primarily via credit default swaps on AIG itself; this claim has been disputed.
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Maiden Lane II was the vehicle for a separate component of the AIG bailout.
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The purpose of the transaction was to limit AIG’s potential losses. With the credit default swaps outstanding, it could have been liable for the full face value of the CDOs. After the credit default swaps were retired, the remaining risk in the CDOs was held by Maiden Lane III; AIG’s losses on Maiden Lane III were limited to its contribution of $5 billion, with any further losses being taken by the New York Fed.
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The stress tests included eleven of the thirteen banks present at the March 27, 2009, meeting at the White House: American Express, Bank of America, Bank of New York Mellon, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, PNC, State Street, US Bank, and Wells Fargo (Freddie Mac and Northern Trust were omitted). The other eight institutions subjected to the tests were BB&T, Capital One, Fifth Third, GMAC, KeyCorp, MetLife, Regions Bank, and SunTrust.
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If a trader wants to exit a large position quickly, he is at the mercy of the people he is trading with, who can essentially name their price. An e-mail from one trader, published by the blog
Zero Hedge,
included this excerpt: “During Jan/Feb AIG would call up and just ask for complete unwind prices from the credit desk in the relevant jurisdiction. These were not single deal unwinds as are typically more price transparent—these were whole portfolio unwinds. The size of these unwinds were [
sic
] enormous, the quotes I have heard were ‘we have never done as big or as profitable trades—ever.’ ”
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THE AMERICAN OLIGARCHY
Six Banks
What all this amounts to is an unintended and unanticipated extension of the official “safety net.” … The obvious danger is that with the passage of time, risk-taking will be encouraged and efforts at prudential restraint will be resisted. Ultimately, the possibility of further crises—even greater crises—will increase.
—Paul Volcker, September 24, 2009
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If they’re too big to fail, they’re too big.
—Alan Greenspan, October 15, 2009
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Between 1985 and 1992, over 2,000 banks failed in the savings and loan crisis, a consequence of deregulation, mismanagement, and fraud. Those S&Ls had been largely overseen by the Federal Home Loan Bank Board, which had failed to shut down struggling thrifts early in the 1980s, instead hoping that they could grow into solvency by expanding into more profitable (and riskier) businesses.
3
In response, Congress passed the Financial Institutions Reform, Recovery, and Enhancement Act of 1989. Among other things, it abolished the Federal Home Loan Bank Board and replaced it with the Office of Thrift Supervision (OTS). On August 9, 1989, President George H. W. Bush signed the bill, saying, “This legislation will safeguard and stabilize America’s financial system and put in place permanent reforms so these problems will never happen again.”
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NPR correspondent Chana Joffe-Walt tells the story:
I talked to several people who worked for that predecessor agency, the Bank Board, and they describe that on that day, the day the OTS was created, they left the office, these agency employees, and they walked across the street to a hotel. They turned on the TV, and they sat and watched the first President Bush stand up at a podium and declare, “Never again will America allow any insured institution [to] operate without enough money.” And then the agency employees watched as the President trashed their agency. The press conference ended, they turned off the TV, left the hotel, crossed the street, and went back to work. Pretty soon someone came by and changed the sign: The Office of Thrift Supervision.
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This, of course, is the same Office of Thrift Supervision that would be responsible for American International Group, Countrywide, and Washington Mutual in the 2000s.
At this crucial juncture in our history, as America emerges from a deep recession into an uncertain economic future, and in the wake of an epochal bailout of our largest banks, we must reform the financial system that made possible the financial and economic crisis that cost millions of people their jobs and added trillions of dollars to the national debt. The last few years have proven that our financial sector and its political influence are a serious risk to our economic well-being, and without significant change there is no reason to believe we will not soon experience the next boom, the next bust, and the next president explaining to the American people that he must rescue Wall Street in order to save Main Street. And significant change will require addressing the disproportionate wealth and power of a handful of large banks at the pinnacle of the financial sector.
Simply asking bankers to behave differently will not work; the solution can only come by changing the rules of the financial system, which requires government action. Five days after President Obama’s election, his chief of staff, Rahm Emanuel, said, “Rule one: Never allow a crisis to go to waste. They are opportunities to do big things.”
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But more than a year after the collapse of Lehman Brothers, even relatively moderate legislation to reform the financial sector was still stuck in Congress.
The Obama administration attempted to show that it was serious about change. “The industry needs to show that they get it on the compensation issue,” Obama said at the March 27, 2009, White House meeting discussed in the Introduction. “Excess is out of fashion.” (According to
The New York Times,
“The bankers nodded, but made no firm commitments.”)
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On June 17, 2009, President Obama unveiled what he called “a sweeping overhaul of the financial regulatory system, a transformation on a scale not seen since the reforms that followed the Great Depression.”
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He proposed stricter oversight of financial institutions, new regulations for securitization and over-the-counter derivatives, increased consumer protections, and new government powers to cope with a crisis.
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Three months later, standing in the heart of the Manhattan financial district, Obama promised:
We will not go back to the days of reckless behavior and unchecked excess that was at the heart of this crisis, where too many were motivated only by the appetite for quick kills and bloated bonuses.… [T]he old ways that led to this crisis cannot stand. And the extent that some have so readily returned to them underscores the need for change and change now. History cannot be allowed to repeat itself.
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But despite the president’s lofty language, many of his proposals represented only incremental reform. They did little to address the problem at the heart of the financial system: the enormous growth of top-tier financial institutions and the corresponding increase in their economic and political power. In place of bold measures, the administration preferred technical solutions (increased capital and liquidity requirements for large banks), regulatory deck-chair-shuffling (merging the oversight functions of the OCC and the OTS in a new National Bank Supervisor), or marginally strengthened corporate governance (nonbinding shareholder votes on executive compensation packages).
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The New York Times
’ Joe Nocera called the Obama plan “little more than an attempt to stick some new regulatory fingers into a very leaky financial dam rather than rebuild the dam itself.”
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Nonetheless, Wall Street fought tooth and nail to block new regulation and preserve the favorable environment that emerged after the government rescue of 2008–2009, with less competition, a strengthened government guarantee, and no new restrictions on the pursuit of profits. As of October 2009, 1,537 lobbyists representing financial institutions, other businesses, and industry groups had registered to work on financial regulation proposals before Congress—outnumbering by twenty-five to one the lobbyists representing consumer groups, unions, and other supporters of stronger regulation. Even Citigroup, 34 percent owned by the government, hired forty-six lobbyists of its own. In the first nine months of 2009, the industry spent $344 million on lobbying. Senior Obama adviser David Axelrod observed, “You would hope after American taxpayers stepped in to save these companies from a disaster of their own making they would be deploying their army of lobbyists to strengthen and not thwart financial reform,” but that was far from the case.
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Instead, in the words of one congressional staffer, the industry launched “an orchestrated, well-funded effort by the banks to manipulate our legislation and leave no fingerprints.”
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For example, the regulatory bill introduced in the House Financial Services Committee initially exempted a wide range of derivatives trades by nonfinancial companies from the new requirements proposed by the administration.
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Michael Greenberger, a veteran of the Commodity Futures Trading Commission, claimed that the draft legislation “had to be written by someone inside the banks, because buried every few pages is a tricky and devilish ‘exception.’ It would greatly surprise me if these poison pills originated from anyone on Capitol Hill or the Treasury.” Journalist William Greider reached the same conclusion after talking to a congressional insider.
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Although the exemption was subsequently narrowed, this example demonstrates the ability of Wall Street to take advantage of technical complexity to advance its interests.
Wall Street also benefited from the administration’s decision to defer actual reform until after the crisis had ebbed—despite Emanuel’s “rule one.” In part because of the debate over health insurance reform, financial regulation did not receive serious public consideration until fall 2009—after the economy had started growing again, the banking sector had returned to profitability, and months of Republican attacks had reduced Obama’s approval ratings and increased skepticism about government action of any kind. By the time battle was joined, both Wall Street and Washington were back to business as usual.