For being right about the financial crisis, Volcker was offered what was thought to be an easy job with the Obama administration, something that was more or less a “thank you” for his early support for the young and economically inexperienced candidate. The president’s economic inner circle of Geithner and Summers and their senior staff regarded Volcker as someone who had to be tolerated but not taken seriously.
There was only one problem: Paul Volcker didn’t see it that way.
“I hear about these wonderful innovations in the financial markets, and they sure as hell need a lot of innovation,” Volcker said in his trademark no-nonsense, almost monotonic style of speech, “and I can tell you of two—credit-default swaps and collateralized debt obligations—which took us right to the brink of disaster. Were they wonderful innovations that we want to create more of?”
Volcker was speaking at a December 2009 Wall Street Journal conference that focused on the banking crisis and Wall Street’s role in creating the massive risk that upended the financial system. During his speech and in answering questions, Volcker attacked Wall Street on everything from its massive compensation packages based on short-term trades to its corporate governance system, where boards of directors barely understood the business of risk that the banks had adopted.
Despite the creation of all those funky derivatives, CDOs, and the like, Wall Street actually lacked innovation, Volcker claimed. The massive amounts of derivatives designed to limit risk only caused more of it. Many of the high-tech companies the firms brought public paid them massive investment-banking fees to downplay their shortcomings in research to investors and ultimately became insolvent. In fact, the greatest innovation that he could come up with from the banks over the past two decades was the ATM—the automatic teller machine, because it “really helps people and prevents visits to the bank and is a real convenience.”
“More of the same,” was how one banking executive who heard of the speech described it to me. That’s because for years Volcker had attacked big banks like Citigroup and JPMorgan Chase as “bundles of conflicts,” in other words, for being so big that they often served the interests of corporations at the expense of depositors and people who bought stock through their brokerage channels.
What made Volcker’s commentary so searing and accurate was that he couldn’t be bought, and wouldn’t be. His post-Fed job was with a small but prestigious investment advisory firm rather than a large bank. He didn’t engage in the corrupt and conflicted banking practices that were so lucrative and evil at the big firms. As a result, he was free to opine on Wall Street’s aberrant behavior, particularly when it came to the business model du jour, the large universal bank where millions of small investors, many of them buying stocks for the first time to save for retirement as 401(k) plans replaced old pension funds, constantly got the shaft because they were prodded by the firms’ brokers to buy shares of companies that the banks had underwritten. The stocks of these companies were further enhanced by conflicted analyst research reports issued by people like Henry Blodget of Merrill Lynch and Jack Grubman of Citigroup. Critics charge that these analysts promoted the shares of the companies they analyzed because they weren’t necessarily paid to steer clients to the best investment but rather to help their firms get more underwriting business from those same companies. Paul Volcker was one of those critics.
Now Volcker wanted to rein in what he saw as Wall Street’s other sin, namely its addiction to risk. But for a guy who wasn’t supposed to have much sway inside the Obama administration, Volcker worked as if he had a lot of it. I ran into more than a few former top executives at Wall Street firms who told me in mid- to late 2009 that they had spoken to Volcker, who was planning something big to reduce Wall Street risk taking once and for all. For a time Volcker toyed with the idea of bringing back Glass-Steagall, which would have forced a separation of JPMorgan, Citigroup, and Bank of America into separate investment and commerical banks. Based on what I know about these meetings, I believe he decided against that measure because putting the genie back in the bottle was much more difficult than it appeared. Moreover, not even the great Paul Volcker was prepared to tell Jamie Dimon that he had to spin off his commercial banking business.
So in the end, Volcker called for some pretty inconsequential reforms—soon to be collectively dubbed the Volcker rule—which would prevent all banks, from Goldman Sachs to those that handle customer deposits and are thus protected by the FDIC, from risking it all by speculating in the markets with company capital. No more so-called proprietary trading, no more hedge funds or private-equity funds for banks, if the federal government was to back up their deposits in the event of massive losses.
And now, as the public outrage over Wall Street profits grew louder amid burgeoning unemployment, the president began to listen to his most anti-Wall Street economist. Had Obama come to understand that the massive protections he continued to offer the banks while they gambled should finally come to an end? Probably not. Did he understand that the public was beginning to associate him and his administration with the fat-cat bankers? More likely.
The wake-up call for Obama was when Republican Scott Brown, a little-known state legislator, won the Senate seat held by liberal icon Teddy Kennedy, even after Obama spent time in Massachusetts campaigning for the Democrat, Martha Coakley. Obama, the man who made women swoon when he ran for president and packed stadiums filled with admirers to hear his pearls of wisdom, was getting a taste of reality. Americans loved his personal story but had begun to hate his policies. His poll numbers were now cruising lower, mostly the result of the struggling economy but also because the public was fully digesting the inequity of Obamanomics: Bankers make bundles while everyone else suffers.
Amid this tailspin, Obama began to embrace the original anti-Wall Street economist, Paul Volcker, and the Volcker rule got a new lease on life in a new financial reform law Obama promised to get done before the end of 2010. As Obama began to unveil his plan to reform the financial markets, which included new proposals to limit risk Volcker had advocated, there was the six-foot-six-inch Volcker standing right to his side, hovering over the president like a giant tower while the diminutive Geithner stood meekly in the background.
The spectacle sent a chill through Wall Street. The consequences for JPMorgan Chase of the “new Volcker rule,” as it became known on Wall Street, were not life threatening though they were still pretty stark and they made Jamie Dimon seethe: Depending on the final language, the firm might have to spin off its massive hedge fund, known as Highbridge Capital, which had $21 billion in assets under management. Goldman Sachs not only owned a bank in Utah (not the biggest part of its operations but a nice moneymaker) but the firm was officially designated as a bank, meaning the rule would squeeze its lucrative business of “proprietary trading.” (It turned out not to be that easy for Goldman, since the firm had been deemed a bank after the 2008 financial collapse.) Who knew how Citigroup would be affected, as the bank traded commodities all across the world even in its current shape as a near basket case.
Blankfein, of course, never saw it coming. The Volcker proposal appeared on its face to hit the banks hard, but Citigroup and JPMorgan had somewhat curtailed their proprietary trading activities. Goldman, on the other hand, was in essence one large hedge fund that was only technically a bank; it didn’t matter whether or not it offered checking deposits; the Fed still regulated the firm as it did Citi and JPMorgan.
As one JPMorgan executive put it, “Goldman is now in the roach motel with the rest of us, and the poison will be worse for them than anyone else.”
When news hit that the rule was being strongly considered as part of the legislation, Goldman’s lobbyists, many of them former legislative staffers who had worked for key Democratic lawmakers like Barney Frank, fanned out across Capitol Hill. David Viniar, the firm’s CFO, scheduled a conference call and assured analysts that the rule was no biggie; proprietary trading accounted for just 10 percent of the firm’s revenues, he sa
id. Dimon’s flacks offered the same spin—the rule would get modified down to almost nothing, they told reporters, even as Dimon privately worried that JPMorgan might have to spin off its massive private equity holdings and hedge funds when he read the fine print of the Volcker rule.
One of the ironies of the rule is that neither proprietary (“prop”) trading nor hedge fund investing was the major cause of the 2008 financial collapse. Wall Street’s massive losses largely stemmed from the firms’ creating mortgage bonds and other complex investments for clients, so in essence the Volcker rule was meaningless. It did nothing to prevent the possibility of another financial collapse and it still allowed the banks to be “too big to fail.”
“Volcker has no idea how the financial crisis began,” Larry Fink remarked after he heard that the president was beginning to take Volcker seriously. Fink, as we’ve seen, had made a killing from the various bailouts and mechanisms offered during the postbailout months. And yet by early 2010 he had begun telling friends that he was no longer a fan of the president. Obama, Fink complained, had lost his way. Not only was the president listening more to Volcker, whom he considered misguided, but the Wall Street-loving guy he knew on the campaign trail had morphed into a class warrior. Fink told people he had voted for Obama as a change toward moderation—change from the big-spending ways of George W. Bush and the nation’s cowboy image overseas, particularly in the Middle East, where BlackRock managed money for wealthy Arabs—and because he couldn’t bear to vote for a ticket that included the superconservative and, in his eyes, incompetent Sarah Palin.
What he got instead was a doubling down of Bush in terms of spending and a heaping dose of class warfare to boot. The guy he had thought was a moderate turned out to be a lefty.
And he also received a doubling down of abuse. Ken Langone, who had supported Rudy Giuliani’s failed presidential run, never let Fink forget that the man he had helped elect had turned out to be a disaster, according to people who overheard their conversation over lunch at San Pietro.
Lloyd Blankfein had initially supported Hillary Clinton for president, but had gravitated toward Obama with the rest of Wall Street. Now, like Fink, he wished he hadn’t. The pressure on Goldman mounted through the spring of 2010 at an unrelenting pace, with verbal attacks and more congressional hearings. Despite estimates of a $100 million bonus, Blankfein ended up taking just $9 million. Goldman presented the award—all of it in company stock—as a sign that Blankfein was doing the right thing, walking away from money he had rightfully earned but couldn’t take because of the public’s distaste for the firm’s success.
The PR victory, such as it was, barely registered with the general public, which believed that even $9 million to a banker that feasted off the taxpayer was far too much. Private polling done by the financial firms showed Wall Street’s standing sinking even lower, with Goldman leading the downward trend.
The prickly Blankfein, it should be noted, isn’t a beloved figure inside Goldman as, say, the charismatic John Mack is within Morgan Stanley. But oddly enough, his plight—and now the plight of the firm—brought Goldman’s many warring factions (the bankers never really got along with the traders) together for the first time in years.
The consensus inside the firm, even among bankers who hated both Blankfein and Gary Cohn, was that the firm was the victim of a witch hunt. Many even believed that Goldman’s woes could be traced to latent anti-Semitism in the public, ironically inflamed by the relentless coverage of the firm by the New York Times.
Goldman, of course, traced its roots to German Jews who after the Civil War couldn’t work at the WASP-owned banks, and that identity remained part of the firm’s cultural fabric for years. After the firm’s being run for the past fifteen years by WASPs (Jon Corzine and Hank Paulson), Blankfein was a throwback to the early days, and according to people at Goldman, several top executives believed the critical press coverage, particularly some of the most stinging rebukes published in the New York Times by acclaimed investigative reporter Gretchen Morgenson, carried anti-Semitic overtones and as absurd as such a charge might be, the firm should register the complaint with Times management.
But it’s hard to play the victim when you’re making so much money (Goldman earned $3.5 billion during the first quarter of 2010), and the firm’s war-weary flack Lucas van Praag cautioned that such a press strategy would ultimately backfire.
For a change, Blankfein and company listened to him.
Meanwhile, Wall Street’s best friends in the administration, Treasury secretary Tim Geithner and chief economic adviser Larry Summers, had continued to signal to Blankfein, Dimon, and the rest of the Wall Street ruling commission that they shouldn’t worry too much about Obama’s financial reform rhetoric, assuring their friends on Wall Street that they had all but killed the most pernicious parts of the Volcker proposal, namely the call to end proprietary trading and the provisions to limit how much the firms can place of their own capital in hedge funds and private equity.
It had been a hard-fought battle, they said. Obama, after all, was actually beginning to listen to Volcker after about a year of ignoring the most experienced economist in his administration, and Volcker hated Wall Street. But a sharp drop in the stock market had made Obama think twice, and the Volcker rule, in its current form, was dead, at least until the next financial crisis.
With that, the firms began feeling good about themselves as they partied on more than $140 billion in bonus money for 2009, doled out during the early part of 2010. It was as if 2008 had never happened, and in the minds of most of Wall Street, it hadn’t.
But it did happen, of course, and just about as soon as word leaked that the Volcker rule was out, it was back in.
“Volcker is crazy” was the assessment of just about every banker on Wall Street when they heard the latest: The old man somehow reclaimed the president’s attention.
Volcker, as it turned out, might be crazy, but he wasn’t stupid. For all the push-back from Geithner and company on Volcker’s proposal (Geithner through a spokesman denies that be opposed the final product), the plan somehow received a second life when Wall Street started buzzing as to how Volcker made his plea directly to the president. Soon his political aides, particularly David Axelrod, who was credited with devising Obama’s successful campaign strategy, began to support the measure as well. The public, Volcker argued, wanted something done about the risk taking that had proved so dangerous. More than that, by doing nothing to rein in the banks, Obama, the candidate of hope and change, was being associated with the most hated entities in America.
For all the rule’s faults, its political value couldn’t be underestimated. Obama’s association with the big banks, combined with his far-left agenda, had begun to crush his once-lofty poll numbers and threatened Democratic control of the House and Senate. Among the most vulnerable was Senate majority leader Harry Reid, the same Harry Reid who had gone begging to Goldman for campaign cash and gotten screamed at by Blankfein’s enforcer, Gary Cohn. Many in Obama’s own party would have supported a breakup of the banks, something the public probably would have supported as well. But that would have assured a war with the likes of Jamie Dimon, and all the Wall Street cash would have begun to flow to the Republicans.
So Obama settled for the next best thing, a compromise: the Volcker rule. Thanks to Summers and Geithner, Volcker and his rule languished inside the Obama White House for months, Wall Street executives with direct knowledge of the matter say—that is, until it became clear that Obama’s presidency depended on doing something that took on the banking system that he had protected for so long and that had allowed the hated Goldman Sachs to boast record-breaking profits, which were on track to beat bonuses earned in 2009.
With that, Paul Volcker, eighty-three, who was for most of his time in the Obama White House considered nothing more than an ornament, a rare antique to be marveled at for a brief moment before going about your business, became a star once again. The man who had raised interest rates i
n the late 1970s and early 1980s and argued that high unemployment for a time would be good for the country had now found relevance in the populist anger that was sweeping the country and in Obama’s decision to tap into it by attacking his old friends on Wall Street.
Geithner, people at the firms tell me, was livid and so scared about his own relevancy that he began cutting ties with many of his closest contacts on Wall Street. Summers, for his part, kept those contacts but told them he was so frustrated by his diminished status that he might leave the administration at the end of the year. Emanuel, meanwhile, explained to his Wall Street friends that given the anti-Wall Street mood of the nation, the hatred that was palpable from the lefties who read the Huffington Post blog and the right-wingers attending Tea Party rallies, the banks should be glad they had friends in high places.
The Volcker rule, despite assurances from Emanuel, Geithner, and Summers to the contrary, wasn’t merely in the new financial reform bill; it had become the centerpiece of the entire package being adopted by Chris Dodd, the Democratic senator from Connecticut, not just to rein in Wall Street but also to curry favor with the public as the 2010 midterms drew closer.
Despite funneling substantial sums of campaign cash his way because of his senior position on the Senate Banking Committee, Wall Street had always considered Chris Dodd a fair-weather friend. Since he was from Connecticut, his base of support wasn’t Wall Street but the giant hedge-fund industry, which had its offices in the swanky areas of Greenwich and Stamford and competed with the New York-based banks for talent.
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