Goldman Sachs and Morgan Stanley both applied to change their status from brokers into banks, bringing them more firmly under the Fed umbrella and ending the era of independent investment banks. A few days later, Washington Mutual, a former icon of America’s mortgage market and retail financial world, collapsed. The FDIC, the American insurance group, took control of the group, to avert a Northern Rock–style bank run, and quickly sold it to JPMorgan Chase for a knockdown price. Jamie Dimon had always wanted to expand the bank’s retail operations in the American Midwest and was thrilled to grab WaMu. Then Citigroup announced a move to purchase the ailing Wachovia group, with US government support, only to be trumped by a rival bid from Wells Fargo. Consolidation was intensifying day by day, and so was state intervention.
In London, on September 29, the UK government nationalized Bradford & Bingley, a British lender. The next day the German, Luxembourg, and Belgian governments poured money into Dexia, a European financial giant, to avert its collapse, and the Irish government guaranteed the deposits of all its banks. A few days later, Germany unveiled plans to save Hypo Real Estate, another vast property giant, and the Dutch government nationalized Fortis. Then Iceland nationalized all its large banks in a frantic—and ultimately futile—effort to prevent a full-blown crisis from engulfing the tiny island. One of the most remarkable announcements came from the British government on October 8, when the Chancellor of the Exchequer announced that the government would inject £25 billion of capital into UK banks in the form of direct equity stakes. The UK was using taxpayer money to directly recapitalize the banks, taking government involvement to a whole new level of activism unimaginable even a month before.
On Sunday, October 13, 2008, Jamie Dimon received an urgent phone call from the Treasury Department. “We need you in Washington tomorrow at 3:00 p.m.” Paulson was summoning the heads of the nine biggest American banks for yet another meeting. He refused to give a clue about the agenda.
As Dimon and the other CEOs traveled to Washington, they had reason to feel apprehensive. In the previous few weeks, a financial hurricane had hit them, inflicting a brutality on the financial system that none of them had seen in their lifetimes.
As the nine American CEOs trooped into a gilded room of the US Treasury, few were expecting what they were told. Never before in its history, even during the 1930s Depression, had the US government nationalized large swaths of the banking system. When Paulson had first unveiled his proposal for the TARP, he had stressed that the money was intended to help the government to buy assets from the banks, not banks themselves, but now he was taking a page from the UK’s playbook.
When Dimon and the others sat down at the table in the Treasury conference room, they were presented with pieces of paper that stated they would sell shares of their banks to the government and were forcefully told to sign. The deal, Paulson added, was a “take it or leave it” scenario: either the banks accepted this “voluntary” infusion of federal money or they would be left out on a limb, ineligible for support if any future crisis broke. It was clear that the US Treasury wanted the banks to act as a pack.
As the men sat around the table, Richard Kovacevich, head of Wells Fargo, pointed out that his San Francisco–based bank had escaped the worst of the mortgage-linked woes and thus did not need help. Kenneth Lewis, head of Bank of America, pointed out that his bank had just raised $10 billion of fresh capital—and thus did not need more funds. Some CEOs expressed concern that the measure would lead to unwelcome curbs on banking pay.
Then Dimon chipped in. While he was adamant that JPMorgan Chase did not need the infusion of capital to survive, he recognized that Paulson’s plan might be a good deal. Dimon knew that some of his competitors would not survive without more funds. “It sounds good,” he said. Around the table, the other eight bankers slowly agreed to get on board. Paulson got his deal.
As the CEOs left the room, some comforted themselves that the deals didn’t quite add up to actual nationalization. The government was acquiring just a small stake in their banks, and it did not plan to exercise management control. Yet a rubicon had been crossed. For five long decades, American finance had worshiped at the altar of free-market ideals. A new era of finance had dawned.
EPILOGUE
On January 29, 2009, JPMorgan Chase hosted a cocktail party for two hundred of its key clients and contacts in the elegant surroundings of the Piano Bar, in the smart Swiss ski resort of Davos. The occasion was the much-buzzed-about annual gathering of the World Economic Forum, which for the first seven years of the decade had been dominated by the investment banking elite. Goldman Sachs, Barclays, Lehman Brothers, and others threw lavish dinners for favored guests, and bank executives strutted on the conference room stages, extolling the virtues of free markets, globalization, and financial innovation. Sleek black limousines whisked them between meetings at hotels in close proximity; they were too grand to trudge through snowy slush.
This year a funereal mood hung in the crisp mountain air. Almost no banking CEOs attended. John Thain, the former CEO of Merrill Lynch, had been scheduled to host a breakfast but had just been sacked. Bob Diamond, head of Barclays Capital, canceled his dinner appearance at short notice because his bank’s share price was collapsing. Lloyd Blankfein, head of Goldman Sachs, stayed away as a demonstration of cost cutting. As the American and European public realized the scale of the banks’ woes over the winter, and the level of government—read taxpayer—money being used to prop them up, outrage was escalating. The numbers were staggering. By the winter of 2009, economists estimated that mark-to-market credit losses had reached almost $3 trillion. Banks and insurance companies had already written down more than $1 trillion and received more than $300 billion of government funds. The carnage on CDO of ABS products was particularly stunning. By early 2009, two thirds of mortgage CDOs issued in 2006 and 2007 (or some $300 billion) were in a state of default, and a quarter had already been liquidated. Investors holding supposed triple-A super-senior notes had lost most of their money. That was just one blow. More widely, in the US and Europe, central bank balance sheets and national debt burdens had ballooned as governments tried to bail out the banks. Yet the banks themselves were still slashing lending to companies and consumers, because the securitization machine had all but broken down. Voters were livid. On both sides of the Atlantic, politicians were imposing radical curbs on bankers’ pay. Some wanted financiers to be put in jail. The US Treasury had demanded that Citi cancel an order for an executive jet. “We are moving into a world of socialist banking, where the government can meddle wherever it wants,” lamented one senior European bank executive. “No one wants to appear in public.”
Jamie Dimon was the exception. He had never been one to stay in the shadows; outspoken speech was part of his brand. By early 2009, Dimon was trying to speak with more gravitas than he had in his youth. He was keenly aware of the increasingly heavy weight of responsibility falling on his shoulders. Yet he reckoned that somebody on Wall Street needed to have the courage to speak up—and stand out, if for no other reason than that he was getting fed up with all the procrastination among the Western governments on how to fix the mess. “This stuff is getting old! I just wish they would get on with it. Politicians are playing catch as catch can,” Dimon said at one Davos event, triggering spontaneous applause. “I haven’t yet seen people get all the right people into the room and close the door and put a solution up on the wall. God knows, some really stupid things were done by American banks and American investment bankers…. Some stupid things were done…but it wasn’t just the bankers. Where were the regulators in all this?”
Dimon had the luxury of being able to speak as a survivor. Just before flying to Switzerland, he unveiled JPMorgan Chase’s fourth-quarter results, which showed the bank’s profits were just $702 million, 76 percent down on the previous year, due to a $1.8 billion write-down on its leveraged loans and $1.1 billion in losses on mortgage assets. “It’s very disappointing,” Dimon curtly declared, warning
that the bank could suffer further significant losses on its mortgage book if house prices kept falling. The bank’s share price tumbled as some analysts warned that credit card and student loan losses could also emerge. “Jamie Dimon is set for a fall,” observed Charlie Gasparino, a prominent financial commentator, suggesting that it “would put in question his current status as the king of Wall Street.” Compared to the bank’s rivals’, though, the figures looked dazzling. By January 2009, the US government had dramatically increased its stake in Citi, after new credit losses threatened to trigger its collapse. Bank of America had also been bailed out again when it discovered new rotten assets on the books of Merrill Lynch. As its rivals’ share prices collapsed, JPMorgan Chase had become the biggest bank in the world in terms of market capitalization. When an industry dinner was held in London in January to hand out banking prizes, JPMorgan Chase won more categories than any bank had ever done before.
The bank’s party in the Piano Bar on the night of Thursday, January 29, spoke volumes about how the bank’s status had changed. The invitations to the event had been designed to carry the ghostly signature of J. Pierpont Morgan, the bank’s founder and former Wall Street guru. In the autumn of 2008, the JPMorgan investment bank had rebranded itself as “J.P. Morgan,” in honor of the traditional link with their founder. In a world where investors had lost faith in cyberfinance, J.P. Morgan realized that it was a huge advantage to have such an illustrious history and an actual legend to promote. The bank had also revived the old motto of J. Pierpont’s son (J. P. “Jack” Morgan), which called for chasing after “first-class business…in a first-class way.” It was now being stamped onto internal memos. The Heritage Morgan bankers were utterly thrilled.
J.P. Morgan had big plans. During the early years of the twenty-first century it had watched with envy and awe as Goldman Sachs extended its tentacles into politics and government, often via its powerful network of alumni. J.P. Morgan now planned to emulate that strategy. It started an “alumni” society, at the suggestion of Andrew Feldstein and other former J.P. Morgan bankers, and began cultivating political allies. As J.P. Morgan’s guests nibbled on canapés in the Piano Bar, Al Gore, an adviser to the bank, could be seen mingling in the crowds. So could Tony Blair, another well-paid new adviser.
As Bill Winters surveyed the crowds in the Piano Bar, he harbored mixed emotions about the strange journey he had traveled with the bank. Almost fifteen years had passed since he had gone down to Boca Raton for that wild weekend of drinking and brainstorming. In some respects, he seemed little changed from the young derivatives trader who had been thrown into the swimming pool. His hair was now flecked with gray, and dark circles ringed his eyes—a testament to months of financial crisis. Yet he still had a fun-loving streak; given a chance, he laughed, he would be happy to slip out of the formal reception, grab a toboggan, and hurtle down the slopes of Davos.
Winters also remained convinced that financial innovation could be a thoroughly good thing. He had seen at first hand the utterly disastrous consequences when innovation was used in an unwise manner; but not all the innovations had turned so sour, Winters insisted. In spite of the New York Federal Reserve’s fears, the credit derivatives world had continued to function during the crisis, even when trading had stopped in almost every other part of the market. Credit derivatives contracts linked to Lehman had settled smoothly too. J.P. Morgan’s own history showed that innovation need not lead to crises. “I mean, we have made plenty of mistakes,” Winters hastily added. As ever, he was wary of sounding upbeat. “But we made deliberate choices not to do things like CDO of ABS…people are sitting around now and saying innovation is bad, that derivatives are this terrible thing, that credit derivatives should be banned. But really this crisis is not to do with derivatives. It is about bad mortgage lending, bad risk management practices, how the innovation was used.”
It was a message, though, that was hard to get across. As Winters circulated at Davos, he repeatedly tried to explain to people that he still believed that innovation—used correctly—could be a good thing. Almost nobody wanted to listen. What bankers said no longer received much respect. Time and again in Davos, delegates had lashed out against “derivatives,” and credit derivatives in particular. Wen Jiabao, the Chinese premier, pointedly berated the Western financial world for its lack of self-discipline. Vladimir Putin, his Russian counterpart, scoffed at bankers’ use of “virtual money,” noting that “the pride of Wall Street banks have now ceased to exist.” The optimistic side of Winters liked to hope that the backlash would prove temporary. The realist, though, was dismayed. It looked as if it could take years before the anger died away—perhaps longer than any of the original team in Boca Raton would remain in their banking careers.
And what of the other members of the old J.P. Morgan group? In late 2008, Winters’s former boss Peter Hancock moved to Ohio, to take a job as a vice chairman of KeyCorp, a respected regional bank. When he told his former colleagues about the move, some were astounded that such a cerebral, international man would head to Ohio. After Hancock left J.P. Morgan in 2000, though, his career never resumed its former brilliant trajectory. For a few years, he ran a consultancy with Roberto Mendoza, another former J.P. Morgan banker, and Robert Merton, the Nobel Prize–winning economist, offering advice on financial innovation. But the venture never truly flourished. Hancock sometimes found it hard to convince clients to adopt his creative and innovative ideas or even to understand how valuable derivatives could be when used wisely. He found that lack of comprehension painfully frustrating. He hoped Ohio would offer a new chance to implement his ideas. “Watching the financial crisis unfold, I felt that I could be of greater use as a bank executive accountable for ideas and execution, as opposed to being on the sidelines as an adviser,” he explained.
Over in Pittsburgh, Bill Demchak was thriving in the world of regional banking. PNC was one of the winners in the crisis, its losses being dramatically smaller than those of its competitors, due partly to Demchak’s canny management of the credit portfolio. From time to time, rumors circulated that Demchak was about to be hired back to Wall Street, to help fill in for the dire shortage of experienced executives who both understood how complex finance and derivatives work and had emerged from the crisis with clean hands. Demchak, though, was in no hurry to jump.
In New York, Demchak’s good friend Andrew Feldstein continued to run his fund and chase his dream of building a better credit derivatives world. The climate, though, was proving extremely challenging. By the end of 2008, BlueMountain had $4.8 billion under management and had outperformed most of its peers. But when the crisis erupted at Lehman Brothers, the entire hedge fund sector witnessed a dramatic outflow of funds. BlueMountain was hit by that trend, ironically, because it had produced such good relative returns in 2008 that investors wanted to realize their gains. Eventually, the drainage was so bad that BlueMountain was forced to impose a partial “lockup,” whereby investors are prohibited from withdrawing their funds.
Feldstein remained determined to fight back. “What we think of as the traditional hedge fund will shrink—that is, hedge funds operating with high degrees of leverage and with expectations of quarterly redemption,” he observed in early 2009. “[But] I think it is too soon to say whether the alternative investment industry will shrink. Over time, it would be untenable for investors to keep their money in zero-yielding government bonds.” But Feldstein wasn’t expecting a recovery anytime soon. Back in the 1990s, he was at law school with Barack Obama. “I was not a close friend of Obama in law school,” he reflected, “but I did interact with him frequently, especially on the basketball court. You can tell a lot about people by the way they play pickup basketball—what was very easily recognized about Obama was that he was a leader.” He feared that Obama faced a monumental challenge in repairing the financial sector.
Feldstein was facing his own daunting challenge—to create a more rational credit derivatives world. By early 2009, the banking industry had fina
lly started “tearing up”—or offsetting—derivatives contracts on a large scale, reducing the volume of outstanding deals in the market by more than half. The industry was also adopting a more standardized system for structuring credit derivatives, to enable it to place activity on a clearing platform. But the reform efforts were moving slowly—more slowly than Feldstein wanted—due to internal industry bickering. Jerry Corrigan and Feldstein blamed the problem on a dire lack of “financial statesmanship,” or the inability of banks to think about the public good.
A block away from BlueMountain’s offices, at JPMorgan Chase’s headquarters at 270 Park Avenue, Blythe Masters was embroiled in her own fights. She was no longer directly involved in the world of structured credit or derivatives, but instead running the commodities division of J.P. Morgan. Alongside that job, though, she held the post of chair of the Securities Industry and Financial Markets Association, the main industry body representing the arena of complex finance. Technically, that made her the most senior Western banker to hold the thankless task of championing the area of finance that was the center of a virulent backlash. It was a tough role. In late 2008, after the Lehman disaster, Masters started receiving hate mail. One British newspaper dubbed her the woman who had created the “weapons of financial mass destruction.” Angry postings on the internet blamed her for wreaking disaster on the system. “If the financial world crashes, you’ll know who to blame!” shrieked one hysterical blog. Another suggested that the Hollywood actress Tilda Swinton could play Masters in a film about the crash, since they looked similar. When Masters moved house in early 2009, the gossip column of the New York Post gleefully reported that she had “slashed the price of the Reade Street residence to $11.9 million, down from $14 million.”
Fool's Gold: How the Bold Dream of a Small Tribe at J.P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe Page 28