The new law can’t and won’t fix the unfairness. Nor will it bestow on Wall Street a sense of moral purpose. It can’t. The best it can do is protect against the worst of the abuses that took place during the bubble. It is difficult to know whether it will do even that. It is all well and good to have a systemic risk regulator, to cite one important example, but will that agency or person actually know how to look for systemic risk? It was often said in the aftermath of the crisis that agencies like the Fed and the SEC and the OCC had plenty of tools to curb the abuses that were taking place in the banking system. They just lacked the will. And that was true. These new regulations will also only be as good as the regulators themselves.
Perhaps the most glaring omission in the new law was any mention of Fannie Mae and Freddie Mac. With everything that happened in the two years since the crisis, neither the administration nor Congress has done anything to change the status of Fannie Mae and Freddie Mac. Right now, at least, they don’t dare: by 2010, Fannie and Freddie (along with the Federal Housing Administration) were backing more than 95 percent of mortgages. Right now, you simply cannot buy a house in America without a government stamp of approval. Once upon a time, the private market wanted nothing so much as to marginalize the GSEs. Today, it’s the private market that has been marginalized, afraid to make a loan that the government doesn’t guarantee.
Fannie and Freddie have continued to lose money—the government has put $150 billion into them to keep them solvent on an accounting basis. (It is worth noting, though, that most of this doesn’t yet represent actual cash losses on mortgages. The real number could be much bigger or smaller depending on where home prices go.) They have continued to be controversial. The same people who were GSE haters back when they were at the peak of their power now claim that Fannie and Freddie caused the crisis—by leading the charge into subprime mortgages to meet their housing goals. This is completely upside down; Fannie and Freddie raced to get into subprime mortgages because they feared being left behind by their nongovernment competitors. But never mind. They remain in a kind of limbo state, wards of the government, while underpinning a housing market that still can’t function without them.
The reason that the legislation makes no mention of the GSEs is that nobody can figure out what to do. Can we ever have a truly private sector market for mortgage securitization, or will it always require the government? Can Fannie’s and Freddie’s roles eventually grow smaller as the financial system regains its confidence? Can they be privatized? Abolished? Turned into government agencies? None of these answers satisfy. In the spring, the Treasury Department requested public input on the reengineering of the mortgage system and the reform of the GSEs. In response, Treasury got more than 570 comment letters. There is no consensus.
All those years ago, Lew Ranieri captured the essence of today’s debate when he asked, at the very dawn of mortgage-backed securities, “What should the government do? What should it be allowed to win at?” When the government held an invitation-only conference on the future of housing finance in the late summer of 2010, Lew Ranieri was asked to participate. He—and we—have had three decades to watch the mortgage market evolve in ways that turned out to be terribly destructive. Maybe, thirty-plus years after the creation of mortgage-backed securities, we can get it right this time.
ACKNOWLEDGMENTS
First, a note on sourcing: In the course of researching this book, we spoke to several hundred people, including former and current Wall Street executives—from CEOs to risk managers in the trenches—as well as bankers, former and current employees of AIG, Fannie Mae and Freddie Mac, rating agency employees, executives at mortgage companies, loan officers, appraisers and fraud investigators, community activists, legislators, lobbyists, academics, and former and current officials at Treasury, the FDIC, the OCC, the OTS, and the Federal Reserve. Where possible, we have acknowledged our sources in the text of the book. But given the sensitivity, not to mention the ongoing investigations and lawsuits, the majority of people we spoke with did not want their names used. We are grateful for both their time and honesty, and for readers’ understanding.
We were also fortunate to be able to draw on the mountains (literally) of fine newspaper stories, magazine articles, books, and academic papers on subjects related to the financial crisis. We owe a particular debt to reporters who wrote about the problems in the subprime world before they were revealed by the financial crisis; one article that stands out is the exposé of Ameriquest published in the Los Angeles Times in 2005. In the text, we’ve cited articles from which we drew specific facts and incidents. More broadly, in writing about the three decades of financial change documented in this book, we relied on the great contemporaneous work by the New York Times, the Wall Street Journal, the Washington Post, and the American Banker, which we found particularly helpful in its in-depth coverage of regulatory skirmishes over capital requirements, as well as the political infighting that affected the financial industry during years when most people weren’t paying attention to such things.
There have been, of course, numerous books written about the financial crisis since the fall of Bear Stearns in the spring of 2008. We’ve cited a number of them in the text, but we would be remiss if we did not single out a handful that were particularly helpful to us. They include Gillian Tett’s Fool’s Gold, an account of the creation of credit default swaps; Liar’s Poker, Michael Lewis’s rollicking tale of Lew Ranieri and the rise of mortgage-backed securities; The Partnership, Charles Ellis’s history of Goldman Sachs; The Greatest Trade Ever, by Gregory Zuckerman, about John Paulson’s audacious decision to short the housing market; Panic, by Andrew Redleaf and Richard Vigilante, which persuasively argues that efficient market theory was at the root of the crisis; and Chain of Blame, by Paul Muolo and Mathew Padilla, a great source of insight about the birth and inner workings of the subprime mortgage machine. Janet Tavakoli’s Dear Mr. Buffett is a scathing exposé of the seamy underbelly of the derivatives and CDO businesses. Memoirs we relied on include The Age of Turbulence, by Alan Greenspan (and Peter Petre), In an Uncertain World, by Robert Rubin (and Jacob Weisberg), The Rise and Fall of Bear Stearns, by Alan “Ace” Greenberg (and Mark Singer), and most especially On the Brink, by Henry Paulson, a fount of insight about what key players were doing and thinking during key moments of 2007 and 2008.
We also drew heavily from the work that Congress has done in untangling the financial crisis. In particular, we relied on testimony that has been elicited, and documents unearthed, by the Senate Permanent Subcommittee on Investigations, the Financial Crisis Inquiry Commission, and the Congressional Oversight Panel.
There are a handful of people we returned to again and again for insight. In particular, we owe a debt to Jason Thomas, John Hempton, and Andrew Feldstein, who were too gracious to call our questions dumb, even when they were. There is a long list of other people who can’t be named to whom we also owe our gratitude. They know who they are. Thank you.
We owe a huge debt to our good friend and agent Liz Darhansoff, who (once again!) talked us off the ledge more times than we can count. Ditto to our good friend and editor Adrian Zackheim, who, at several key points along the way, deftly pointed us in the right direction when we were getting lost in the thicket. At Portfolio we would also like to thank Will Weisser, Allison McLean, Jeff Miller, Alex Gigante, and especially Emily Angell and Courtney Young, who went above and beyond in getting us from sprawling manuscript to published book. In the early stages of our research, we were aided by our old friend Maggie Boitano. In the latter stages, we were ably assisted by two newer friends, Dan Slater and Zachery Kouwe, who chased down people, facts, and documents, often at the last minute.
Since there are two of us, we have two separate groups of friends and colleagues who helped us get through life as we were getting through this book. We would like to thank them now. Bethany first:
I’d like to thank Vanity Fair—in particular, Graydon Carter and Doug Stumpf—who have given me the fr
eedom to explore the financial crisis and to take the time to write this book. I’d also like to thank Fortune, my longtime home, for teaching me the ropes of business journalism and allowing me to take months to write in-depth stories about, among other subjects, Fannie Mae. In addition, a special thanks to Ken Scigulinsky and Joe Ferrara, who served as unpaid research assistants and sources of ideas, debate, and inspiration.
On a personal note, I wouldn’t have survived the process of reporting and writing this book without the love and support—and great sense of humor—of my wonderful husband, Sean Berkowitz. I also owe a big thanks to my circle of extended family and friends who have put up with my general grumpiness and lack of time during this project. In particular, my love and gratitude go to my mother-in-law, Naomi Berkowitz, who has made sure that Laine was fed, clothed, and diapered while I panicked at my computer, and to Lyle and Dana Berkowitz. Thanks also to Bob and Karen Ranquist, the team at Ranquist Development, and Jennifer Lissner for friendship, professionalism well beyond the ordinary, and a marvelous place to live and work. I’d also like to thank Karen Muirhead, Indira Jusic Zisko, and Sara Rodriguez for the loving care they’ve provided my daughter, and the peace of mind they’ve provided me. Of course, a thank-you to Laine for being as accommodating as an infant can be. My parents, Robert and Helaine McLean, and my sister, Claire McLean, have always helped me keep book writing in perspective. I would be lost without Steve Baerson’s encyclopedic knowledge of history and extraordinary bookkeeping skills. And a final thank-you to my beloved Beast, who has now weathered two books and the corresponding loss of Frisbee time with as much grace as a bulldog can muster.
Joe’s thank-you’s:
The New York Times has been a wonderful home for me these last five years. Winnie O’Kelley took me aside not long before the crisis erupted in 2008 and told me in no uncertain terms that I would be well served to start focusing my column on the mounting problems on Wall Street. That was great advice, to say the least. Larry Ingrassia, my boss in the business section, involved me in several big projects in the immediate aftermath of the crisis that whetted my appetite for writing this book. He, along with executive editor Bill Keller and Gerry Marzorati, who until recently edited the New York Times Magazine, were extremely generous in granting me the extended leave that allowed me to write this book. Gerry also assigned me a story on risk management for the magazine; that story became the basis for Chapter 4. Vera Titunik edited that story beautifully, as she always does. My colleagues Louise Story and Eric Dash helped me in numerous ways. Andrew Ross Sorkin was especially generous with insight and advice, especially once he’d finished his book about the financial crisis, Too Big to Fail.
Books consume writers; inevitably, that obsession winds up roping in their friends and families. Among the friends I’d like to thank are Steve Klein, Ken Auletta and Amanda Urban, Sam Waksal and Andrea Rabney, Bill Burd and Jane Noble, Charlie Borgognoni, Adam Bryant, Tim and Jennifer Smith, Paul and Jennifer Argenti, Greg Frank and Lauren Foster, Jimmy Smyth, Meg Rhodus, Roger and Claudine Parloff, Dan and Becky Okrent, and David and Lyn Grogan.
My three older children, Kate, Amato, and Nick, watched with bemusement and a touch of pride as I worked to complete the book; they’ve seen this act before. My future mother-in-law, Louise Schneider, arrived in the nick of time, just as Bethany and I were racing to the finish line, and offered a great deal of help and comfort.
As I was beginning to write this book, I acquired a puppy, a German shepherd named Lanka. I was always surprised and happy at the way he could lift my spirits, offering stretches of simple pleasure. About a month before this book was finished, a new member of the family arrived: Macklin Joseph. Baby Mack is a wonder, and a source of immense joy. I can’t wait to dedicate my next book to him.
As for this book, it is dedicated to Dawn, the love of my life, who saw me through this project, as she has seen me through every part of our life together these past years. She makes it all worthwhile.
INDEX
Aames
Abacus CDOs
Abbamonto, Paul
ABX subprime index
ACA Management
ACORN
Adelson, Mark
Adjustable-rate mortgages
defaults
operation of
pay option ARMs
Advani, Deepali
AIG. See American International Group (AIG)
AIG Financial Products (AIG FP)
BISTRO
bonuses (2009)
under Cassano
CDOs, multisector
CDO tranches
collapse of
collateral calls
collateral triggers
credit default swaps
Edper losses
Geenberg control of
incentive compensation
profitability of
risk-taking, beginning of
under Savage
SEC investigation of
under Sosin
swaps, developing
Alberto, Patricia
Alternative Mortgage Transaction Parity Act (1982)
American Home Mortgage Investment Corporation
American International Group (AIG)
antiquated infrastructure of
bonuses, post-bailout
CEOs. See Greenberg, Maurice R. “Hank”; Sullivan, Martin; Willumstad, Robert
derivatives division. See AIG Financial Products
founding of
fraudulent activities
government bailout
profitability of
ratings cut
restatement of earnings
risk-taking by
stock, decline of
subprime portfolio of
subsidiaries
Ameriquest
collapse of
consumer complaints/lawsuits
dangerous products of
fraudulent activities
loan fees
portfolio retention branches
profitability of
prohibited in Georgia
state attorneys’ investigation of
See also Arnall, Roland
Amresco
Anderson, Jenny
Anderson, Josh
Anderson Mezzanine Funding CDO
Andrukonis, David
ARCS Commercial Mortgage Company
Armey, Richard
Arnall, Roland
as ambassador to Netherlands
biographical information
style/personality of
wealth of
See also Ameriquest; Long Beach Mortgage
Arthur Anderson
Ashley, Stephen
Askin, David
Asset-backed commercial paper (ABCP)
Asset-backed securities (ABS)
Associates
Athan, Tom
Baby boomers, and homeownership
Bailouts. See Federal bailouts
Bair, Sheila
Baker, Richard
Bankers Trust, swap deal lawsuit
Bank of America
Countrywide acquired by
Merrill Lynch acquired by
subprime branches, closing
Barnes, Roy
Bartiromo, Maria
Basel Committee on Banking Supervision, capital reserves rule
Basis Yield Alpha Fund
Bear Stearns
ABS index
Bank of America lawsuit
CDOs
foreclosures, plan to prevent
hedge funds, collapse of
High-Grade Structured Credit Fund
High-Grade Structured Credit Strategies Enhanced Leverage Limited Partnership
J.P. Morgan acquisition of
Beattie, Richard
Behavioral economics
Beneficial
Bensinger, Steve
Bernanke, Ben
Berson, David
Birnbaum, Josh
BlackRock
Black-Scholes formula
Black swans
Blankfein, Lloyd
during collapse
compensation from Goldman
Goldman Sachs under
Blue sky laws, MBSs exemption from
Blum, Michael
Blumenthal Stephen
BNC Mortgage
BNP Paribas
Bolten, Joshua
Bomchill, Mark
Bond, Kit
Bond ratings
CDOs
and credit enhancements
failures, examples of
public trust in
ratings shopping
system of
for tranches
Value at Risk (VaR) applied to
See also Moody’s; Standard & Poor’s
Bonuses, post-TARP
Born, Brooksley
biographical information
derivatives, regulatory efforts
style/personality of
Bothwell, James
Bowsher, Charles
Bradbury, Darcy
Brandt, Amy
Breit, John
Brennan, Mary Elizabeth
Brickell, Mark
Brightpoint fraud
Broad Index Secured Trust Offering (BISTRO)
AIG FP credit protection
features of
Broderick, Craig
Bronfman, Edward and Peter
Bruce, Kenneth
Buffett, Warren
Burry, Michael
Bush, George W.
homeownership initiatives
Paulson appointment
war with Fannie/Freddie
Buxton, George
Callan, Erin
Calomiris, Chris
Calyon
Canfield, Anne
Capital reserves
Basel I loophole
Basel I rules
and bond ratings
credit default swap as substitute
Fannie Mae
Fed requirements
risk-based capital requirements
and subprimes, FDIC recommendations
Cassano, Joe
and AIG-FP collapse
All the Devils Are Here Page 49