Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession

by Frederick Sheehan

  Commercial and investment banks opened hedge funds; the largest hedge fund in the world was at Goldman Sachs.30 Privateequity firms launched hedge funds. Banks opened privateequity funds. All were buying and selling property—housing developments, ports, power grids, hotel chains, airports, railroads, and highways. All were paying one another: hedge funds borrowing from brokers; investment banks buying mortgages from commercial banks; LBO firms borrowing from commercial banks; LBO firms paying investment banks for underwriting services. Kohlberg Kravis Roberts, Henry Kravis’s firm, paid investment banks $837 million for advice during the first 11 months of 2006.31 The U.S. securities industry paid itself $455 billion between 2003 and 2007.32 This was a much more concentrated form of asset inflation than housing. The casing of the cocoon had to remain solid. The level of credit and profits rose inside the casing.

  Stephen Schwartzman collected billions of dollars from Blackstone’s IPO.33 This was a big media story, although it’s not clear why, since he had been collecting billions for quite a while.34 Time called him one of the “100 most influential people.” His sixtieth birthday party in February 2007 was the place to be. Guests included CNBC’s Maria Bartiromo, perhaps the most familiar face in trading rooms during the boom years other than Alan Greenspan. She was accompanied by her husband, Jonathan Steinberg, son of Saul Steinberg.35

  28 Doug Noland, “Credit Bubble Bulletin,” Prudent Bear Web site, April 20, 2007, p. 10.

  29Goldman Sachs Group Inc. and Subsidiaries, condensed Consolidated Statements of Financial Condition (Unaudited), released April 3 or 4, 2007, for quarter ending February 28, 2007: total assets, $912 billion. Federal Reserve’s total assets on February 28, 2007: $853 billion: Federal Reserve Statistical Release H.4.1, March 1, 2007.

  30 Alistair Barr, “Goldman Is Now World’s Largest Hedge Fund Manager,” MarketWatch, June 21, 2006.

  31Edward Evans, “KKR to Pay Most in Fees in Record Year for Buyouts,” Bloomberg, January 4, 2007.

  32 Christopher Wood, “Greed & Fear,” CLSA Asia-Pacific Markets, August 22, 2008.

  33 Justin Fox, “Blackstone: Too Rich for Congress,” Time, June 28, 2007.

  34 Barbara Kiviat, “The Time 100: Steven Schwarzman,” Time, April 30, 2007.

  Saul’s is a cautionary tale. His insurance company, Reliance Holdings, was forced into bankruptcy; his Old Masters collection was auctioned. He sold his 36-room duplex at 740 Park Avenue—first owned by John D. Rockefeller—to Stephen Schwarzman in 2000.

  By the time of Schwarzman’s party, private equity—a term that was as unfamiliar to the public as IPO was before 1995—attracted wide attention, as well it might, since no company was too big to buy and then dismiss the employees. The Financial Times produced a Special Report with the title: “Barbarians or Emperors?”36 CFO magazine described Goldman Sachs’s $20 billion private equity fund as “Gargantuans at the Gate.”37

  Politicians were foaming and ranting about private equity. This is the moment, as we’ve seen before, when politicians take charge and shut the casino—Saul Steinberg’s attempt to buy Chemical Bank; Kohlberg Kravis Roberts’s gathering of 400 dealmakers to celebrate to celebrate the RJR takeover—the script is clear.

  But it didn’t happen.

  The elected representatives came to their senses. The members of House of Representatives could no longer represent; they were beholden to Fannie Mae, hedge funds, and private equity. It was not only contributions but their own futures that were at stake. The ex-pols used to cross the street and join lobbying firms. Now they hitched onto a hedge fund, privateequity firm, or both (these were growing more difficult to tell apart). Or they joined banks. Phil Gramm, former Republican senator from Texas, was vice chairman of UBS (United Bank of Switzerland); Robert Rubin, secretary of the treasury under President Clinton, served as a director at Citicorp. Leading politicians from the Clinton and two Bush presidencies had joined hedge funds or privateequity firms. A roll call in mid-2007: Lawrence Summers (secretary of the treasury, Clinton administration, and former voting member of the Harvard Corporation’s then-$29 billion endowment) joined D.E. Shaw, a $25 billion hedge fund,38 President George H. W. Bush, James Baker (secretary of the treasury and state, Reagan administration; secretary of state, Bush I), and former British Prime Minister John Major, all served the Carlyle Group in different capacities; Former President Bill Clinton marketed a retail hedge fund in his spare time.39 Former Vice President Al Gore40 and Madeline Albright (secretary of state, Clinton)41 launched their own hedge funds as well.

  35 Dan Ackman, “Forbes Face: Saul Steinberg,” Forbes.com, June 18, 2001. 36 Financial Times, Special Report “Private Equity: Barbarians or Emperors?” April 24, 2007.

  37 Stephen Taub, “Gargantuans at the Gate,” CFO.com, April 23, 2007.

  The Pinnacle

  The tendency for politicians to join hedge funds or LBO firms rather than Wall Street banks was for a good reason: they paid better. Average weekly pay for investment bankers in New York was $16,849 a week. In Fairfield County, Connecticut, where hedge funds are more concentrated, average weekly pay was $23,846 a week.42 In 2006, the top 100 hedge fund managers in the world each earned an average of $241 million.43

  The hedge fund capital is Greenwich, Connecticut, a 40-minute train ride from Manhattan. For decades, it has been home to corporate CEOs, stockbrokers, and investment bankers who boarded the 8:01 to Grand Central Station. The commute was reversing. In 2006, approximately 10 percent of the world’s hedgefund money was managed from offices in Greenwich. Analysts and traders caught the 5:09 (a.m.) from Grand Central to Greenwich. These offices commanded rents nearly 30 percent higher than prime office space in New York.

  38 Marcella Bombardieri, “Ex-Harvard Chief Joins Hedge Fund Company,” Boston Globe, October 20, 2006.

  39 William Hutchings, “Bill Clinton Endorses Quadriga’s Retail U.S. Hedge Funds,” efinancialnews.com, which is: Dow Jones financial news online, March 10, 2005. “Bill Clinton, the former U.S. president, is set to open a New York retail outlet for the products of Quadriga, the Viennese hedge fund manager that was last year stopped from selling its products in Germany by the local regulator because it had no banking licence.[sic]”

  40 www.generationim.com.

  41 Otis Bilodeau, “Madeleine Albright Raises $329 Million for New Fund,” Bloomberg, January 18, 2007.

  42David Cay Johnston, “Pay at Investment Banks Eclipses All Private Jobs,” New York Times, September 1, 2007. This was calculated by the Bureau of Labor Statistics for the first quarter of 2006.

  43“Richest Hedge Fund Managers Get Richer,” CNNMoney, April 9, 2007.

  Hedgefund managers, generally quick to trade, buy, and dispose, demonstrated the same relish in bulldozing houses built in the 1920s for Rockefellers, Havemayers, and Greenways. The teardown, knockup construction turned North Street into a traffic jam of road graders, dump trucks, and wrecking balls. Tudor mansions with 6,000 square feet fell; 15,000-square-foot trophy homes scampered up. (That is the size of an industrial warehouse.) When the 15,000-square-foot pile was deemed inadequate, 20,000-, 25,000-, and 30,000-square-foot havens from humanity rose both east and west. Paul Tudor Jones II built a testament described as “a cross between Tara and a national monument.” Steve Cohen’s house resembled Windsor Castle from the air, and was littered with Gaughins, Van Goghs, Hirsts, and Warhols. Standard features in Greenwich included indoor basketball and squash courts, dishwashers from Asko, windows from Zeluck, basements with wine cellars, waterfalls, hockey rinks, panic rooms, and patios and polo fields surrounded by English country gardens.

  The staffing never stopped—chauffeurs, butlers, maids, Scottish nannies, sommeliers, decorators, lighting-control specialists, stonemasons, carpenters, marble cutters, personal trainers, Zen masters, and fashion assistants. Seven-figure gardening bills require estate superintendents, irrigation specialists, and hedge trimmers.

  The trickle-down effect runs to the busloads of housekeepers, busboys, gardeners, pool boy
s, masseurs, hairdressers, and manicurists who made the reverse commute from New York.44

  The Bottom

  At the other end of the Great Distortion, house prices were out of reach, so terms had been relaxed. The “2 and 28” mortgage—a two-year “teaser” rate that adjusted (“reset”) for the next 28 years—was booming. Since the 2/28 was fairly new to the market, the consequences were not well understood in 2006. (Better put: there were few who let on that they anticipated the inevitable.) The resets would hit hard in 2007.

  44 Nina Munk, “Greenwich’s Outrageous Fortunes,” Vanit y Fair, July 2006; Tom Wolfe, “The Pirate Pose,” Portfolio.com, May 2007; Philip Shishkin, “Out with the Old: Storied Mansions Fall in Greenwich,” Wall Street Journal, April 12, 2008; Greenwich Time newspaper.

  Sam Zell’s observation in 2005 that the “enormous monetization of hard assets has created a massive amount of liquidity” put food on the table, but for how long? More Americans were liquefying their equity and monetizing the proceeds. Since 2001, the GDP had grown by $2.5 trillion; over $800 billion of home equity had been withdrawn in 2005. This was equal to 9 percent of Americans disposable income, in a country where wages were basely rising. ACNielson published a report that described Americans as “among the world’s most cash-strapped people.”45 With 22 percent of Americans having no money left after they paid for essential living expenses, the U.S. ranked number one among 42 countries for “saving futility.”46

  The new Federal Reserve chairman gave a speech in June 2006. He proclaimed: “U.S. households have been managing their personal finances well.”47 It seemed as though Greenspan had never left.

  45 Les Christie, “Americans: World’s Worst Savers,” CNNMoney.com, January 25, 2006.

  46 Ibid.

  47Ben S. Bernanke, “Increasing Economic Opportunity: Challenges and Strategies,” speech at the Fifth Regional Issues Conference of the Fifteenth Congressional District of Texas, Washington, D.C., June 13, 2006.

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  Cheap Talk: Greenspan and the Bernanke Fed

  2007

  New York Times : [T]here are at least 15,000 professional economists in this country, and you’re saying only two or three of them foresaw the mortgage crisis?

  James K. Galbraith: Ten or 12 would be closer than two or three. . . . It’s an enormous blot on the reputation of the profession. There are thousands of economists. Most of them teach. And most of them teach a theoretical framework that has been shown to be fundamentally useless.

  —New York Times Sunday Magazine, November 2, 2008

  In 2007, Greenspan came out talking. Speaking to a Hong Kong audience in late February, he warned of a possible recession in the United States. The Shanghai Stock Exchange fell 9 percent that day, and U.S. stock markets suffered their worst day of trading since they reopened after the September 11, 2001 respite.1 The oracle later clarified his prediction. He thought a 2007 recession was “possible” but not “probable.”2 Still, he was at odds with the Federal Reserve’s position.

  There is no reason that he should have agreed, but given his influence on markets, a better man would have discussed the weather. He could not

  1 Rachel Beck, “Greenspan Rocks Markets,” Associated Press, February 27, 2007.

  2Krishna Guha, “Greenspan Again at Odds with Fed over Recession Risk,” Financial Times, March 6, 2007.

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  restrain himself. The March 2 headline of the Independent (London) said it all: “Greenspan Uses ‘R’ Word Again; Someone Shut Him Up before He Does Serious Damage.”3 But there was no stopping the man. A Financial Times headline on March 6 cited the freelance economist: “Greenspan Again at Odds with Fed over Recession Risk.”4 (He now thought there was a one-third chance of a U.S. recession in 2007.5) Greenspan had more to say that day: “We are in the sixth year of a recovery, imbalances can emerge as a result.”6 This was already the most imbalanced economy since the Emerald City of Oz.

  Greenspan responded to his detractors: “I was beginning to feel quite comfortable that I was fully back to the anonymity I was seeking.” He added: “I try as much as I can to avoid comments relevant to what the Fed is doing. But I have a profession and I’m a private citizen. . . . I adhere to the law.”7 His face was straight as ever, but he sounded like a stand-up comedian.

  By the end of 2006, the Implode-O-Meter Web site listed nine defunct mortgage lenders.8 By the end of March 2007, the list had grown to 49, including some of the largest vacuums that sucked in borrowers: HSBC Mortgage Services, Ameriquest, ACC Wholesale, New Century, and Wachovia Mortgage. Underwriting standards had collapsed and defaults were rising fast. It seems condescending to mention that this combination meant house prices had risen above an affordable level, but that comment was central to a Greenspan speech on March 15 as reported by MSNBC: “Greenspan said . . . subprime woes . . . seemed to result primarily from buyers coming into lofty housing markets late after big price run-ups that had left them vulnerable to hikes in adjustable mortgage rates.”9 This was announced by newswires around the world.

  3 Jeremy Warner, “Greenspan Uses ’R’ Word Again; Someone Shut Him Up before He Does Serious Damage,” Independent (London), March 2, 2007.

  4 Guha, “Greenspan Again at Odds with Fed.”

  5 Craig Torres, “Greenspan Sees One-Third Chance of Recession in 2007,” Bloomberg, March 6, 2007.

  6 Ibid.

  7“Greenspan: Not Trying to Cause Trouble for Ben,” Reuters, March 8, 2007.

  8Implode-O-Meter. These were not necessarily bankrupt, but they had abandoned at least a major segment of their lending activities.

  9“Housing Advocates Warn of Default ‘Tsunami,’” MSNBC.com, March 15, 2007.

  Greenspan was speaking in Boca Raton, Florida, where he was named the American Hero of 2007.10 Greenspan might have made the same observation in 2004; instead, he recommended that Americans take advantage of adjustable-rate mortgages. He might have made the same comment in October 2006, at the time of the National Association of Realtors ad campaign. He made some other elementary observations at Boca Raton. The law-abiding American Hero told his audience that if house prices “would go up 10 percent, the subprime problem would disappear.”11 And if pigs could fly. Greenspan also predicted that subprime mortgage problems would not spread their troubles.12

  Greenspan’s cachet was more ambiguous by now. USA Today, referring to the speech, quoted Hugh Johnson, chairman of Johnson Illington Advisors, an investment advisory firm in Albany, New York: “I wish he’d just go away.”13 This was less likely than house prices rising 10 percent. Greenspan had been talking from the moment he retired. It might be added that the chairman’s retirement party was on a par with Schwartzman’s splurge, the difference being that Greenspan’s farewell was in the Blue Room.

  Subprime Lending

  “Subprime” was soon to join “IPO” and “private equity” as an insider’s financial term that enters the national discussion.14 It was no surprise that defaults were rising. Default rates remained near zero percent as long as houses could be sold at higher prices.

  10 “Greenspan Revels in New Freedom of Speech,” Palm Beach Post, March 15, 2007. Also from the Palm Beach Post: “Stocks, Futures and Options magazine hosted the Boca Raton lunch and gave the 500 attendees money clips and coin-shaped paperweights emblazoned with the market maestro’s image.”

  11“Greenspan: Subprime Spillover Unlikely,” Associated Press, March 15, 2007; http:// tinyurl.com/p8c9mo.

  12“Subprime Spillover Unlikely,” Associated Press, March 15, 2007.

  13“When Alan Greenspan Talks, People Listen,” USA Today, March 21, 2007.

  14 One definition of subprime: “‘Prime’ lending was based on the idea that all three C– questions had to get at least a minimally correct answer before proceeding. . . . If you had, say, two of the three, you might qualify for a near prime (like FHA) or subprime loan. . . .” The 3 Cs are: 1—Credit: “Does the borrower’s hist
ory establish creditworthiness, or the willingness to repay debt?” 2—Capacity: “Does the borrower’s current income and expense situation (and likely future prospects) establish the capacity or ability to repay debt?” 3—Collateral: “Does the house itself, the collateral for the loan, have sufficient value and marketability to protect the lender in the event the debt is not repaid?” From “What Is ‘Subprime’?” Calculated Risk blog, November 25, 2007; calculatedrisk.blogspot.com.

  New Century, one of the largest subprime lenders, depended on house prices to appreciate 4 percent a year. When house prices stopped appreciating in 2005, home buyers defaulted without making a single mortgage payment.15 Separately, the Mortgage Asset Research Institute had already published a study of what were known as “liar’s loans”: those in which the borrower’s stated income is not verified by the lender. The institute found that 60 percent of those who received such mortgages had overstated their income by at least 50 percent.16

  Having run out of solvent home buyers, the percentage of highrisk loans came to dominate the marketplace. During the first nine months of 2006, 22 percent were subprime mortgages.17 By February 2007, 6 percent of mortgages packaged into a security during 2006 were already delinquent.18

  Bernanke had used practically the same data in a November 2006 speech: “In 1994, fewer than 5 percent of mortgage originations were in the subprime market, but by 2005 about 20 percent of new mortgage loans were subprime.” In the same speech, Bernanke went on to discuss other data that should have caused a stir: “[T]he expansion of subprime lending has contributed importantly to the substantial increase in the overall use of mortgage credit. From 1995 to 2004, the share of households with mortgage debt increased 17 percent, and in the lowest income quintile, the share of households with mortgage debt rose 53 percent.” Reading the transcript, it appears Bernanke considered this to be good news. He did advise “greater financial literacy” for “borrowers with lower incomes and education levels.”19 The former South Carolina seventh-grade spelling bee champion often urged self-improvement.