Crashed
Page 24
On Monday, October 13, 2008, the UK nationalized Lloyds-HBOS and RBS. That same day Germany announced that it was putting up 400 billion euros in guarantees and 100 billion euros for recapitalization. France guaranteed 320 billion euros in medium-term bank debt and set up a 40 billion euro capitalization fund. Italy budgeted 40 billion euros for capitalization and “as much as necessary” in guarantees. In the Netherlands the guarantees came to 200 billion euros. Spain and Austria each put up 100 billion euros.93 In proportion to GDP, the largest program was that in Ireland. But Belgium and the Netherlands also made huge commitments.
Europe’s national programs were defined by the circumstances of the banks and local politics. France’s large banks were in relatively good shape. Société Générale was fortunate that the so-called “Kerviel scandal” involving 50 billion euros in unauthorized positions and losses of almost 5 billion euros, unwound in January 2008, rather than six months later at the height of the crisis.94 Société Générale managed to recapitalize and avoid a takeover, which might have ended as badly as the other shotgun weddings of the period. In addition, the French bank, which acted as a close partner of Goldman Sachs, was a particular beneficiary of the generous terms of the AIG bailout. But even if the other major French banks were robust, no one was exempt from the loss of confidence in the fall of 2008. On October 16 an emergency recapitalization and refinancing program was ramrodded through the French parliament. The urgency was commonplace. What was different in France was the response of the private sector. All of the major banks, led by BNP Paribas, agreed to take capital from the Société de Prise de Participation de l’État (SPPE). A second tranche followed in January 2009. Again, all the banks took the capital. Even more unusual was the refinancing scheme headed by the Société de Financement de l’Économie Française (SFEF). This entity was legally entitled to issue state-guaranteed bonds on behalf of banks up to a total of 265 billion euros, but 66 percent of its shares were subscribed by the six major French banks. Even HSBC France signed on. It was an elegant construction. With the French state holding only a minority stake, the SFEF’s liabilities were not counted toward the French public debt. At the same time, thanks to a special arrangement with the banking regulators, the SFEF was not required to meet Basel II capital rules, so the actual financial call on the banks was minimal. It was an efficient mechanism for restoring confidence made possible both by the relative lack of pressure on France’s biggest banks and close cooperation within France’s extraordinarily tight-knit elite.95 Though they work in very different ways, business and government are every bit as interconnected in Paris as they are in New York and Washington, DC, enabling that rarest of things under conditions of market competition—an uncoerced agreement on collective action.
For sheer scale, only Germany’s program rivaled that in Britain. On October 17 the legislation establishing the Sonderfonds Finanzmarktstabilisierung was bounced through the Bundestag.96 But as in Britain, any possibility of a general solution was spoiled by the power of the dominant player. With the regional Landesbanken ailing and Commerzbank struggling with the ill-advised takeover of Dresdner, Deutsche Bank saw the opportunity to put distance between itself and the rest. In an internal discussion, which was clearly intended to be leaked, CEO Josef Ackermann stigmatized the national bailout package. He would be ashamed, he let it be known, to see his bank requesting help from Berlin. As Barclays was to do in the UK, Deutsche preferred to rely on accounting tricks and investments from gulf state sovereign wealth funds to see it through the crisis. It too would later face legal action over its makeshift crisis management, but in the United States, not in Germany.97 Meanwhile, Steinbrück was livid. Ackermann, he said, had paved the way “for a two-class society in the banking sector: into those that don’t need help and those that are at risk of relegation. This is dangerous, because the markets respond to it.”98 It was the same problem that at the same moment was preoccupying Washington.
IV
After the setback in Congress on September 29 there was never any option but for the Treasury to make a second attempt to get the TARP legislation on the books. To get TARP passed, Paulson abandoned his demand for a blank check. The $700 billion in bailout funds were split into three tranches, a first of $250 billion, a second of $100 billion and $350 billion conditional on presidential request and congressional approval. Support for the banks would be balanced by tax breaks for the middle class and support for home owners. Section 109 of the act specifically empowered the Treasury secretary to “facilitate loan modifications to prevent avoidable foreclosures.”99 Rather than immunity for the Treasury secretary, the law now provided for multiple overlapping layers of oversight. On October 3 TARP passed into law, carried by 74 percent of the Democratic votes in the House, but only 46 percent of the Republicans.
But by the first week of October, with events in the US markets and in Europe moving at a rapid pace, it was clear that TARP as originally conceived would not work. The Treasury faced the sheer impracticality of making markets for hundreds of billions of dollars’ worth of dubious assets at a time of market terror. Either it overpaid and sacrificed the taxpayer interest, or it drove a hard bargain and risked ruining the banks it was trying to help. Meanwhile, the British had tipped the discussion in favor of recapitalization. Rather than buying bad assets or guaranteeing more borrowing by the banks, government should inject share capital. Having obtained the funds from Congress for asset purchases, TARP would now be repurposed as a vehicle for injecting capital. At the same time, events in Ireland, Germany and the UK had changed the conversation about deposit insurance. According to Paulson, it was the risk of a shift in funds from the United States to Europe that led him and Bernanke to converge on the FDIC and to demand that its head, Sheila Bair, should offer even more comprehensive guarantees.100
The new package was worked out between the Treasury, the Fed and the FDIC over the weekend of October 11–12, in the shadow of the G7/G20 meetings. It was presented to the stunned CEOs of America’s nine largest banks on the afternoon of Monday, October 13, just as the Europeans were rolling out their guarantees.101 It was a take it or leave it offer. In rations fixed by Tim Geithner as president of the New York Fed, all nine major banks would be required to take slices of government capital. The shares would be preferred shares. The guaranteed dividends that the federal government would require were low, but would escalate after five years to give the banks an incentive to repay early. In exchange for accepting the capital injection, the banks would receive an FDIC guarantee on all business checking accounts and a guarantee on any new debt issued by the summer of 2009, up to a total of 125 percent of the debt maturing by the end of that year. The two were linked. No FDIC guarantee without government capital injection. Characteristically, Ben Bernanke sought to calm the fraying nerves in the room by appealing to everyone to consider their common interests. They were all in it together. “I don’t really understand why this needs to be confrontational,” he said soothingly.102 The bankers stared at him in disbelief. The core of American financial capitalism was about to be partially nationalized.
Beyond the general sense of shock, the reactions came down to business logic. For the weakest in the group it was evidently a great deal, and Vikram Pandit of Citigroup said so. Given the state of his balance sheet, he couldn’t afford to be fussy. As he blurted out: “This is cheap capital.” Indeed, it was. The yield on Citigroup bonds that day was 22 percent. Paulson was asking for 5 percent.103 A better-placed bank, like J.P. Morgan, could have got by without the TARP money. But Dimon understood the systemic logic and was among the first to sign, though he made his signature conditional on the rest of the group agreeing. It was California’s Wells Fargo that forced the government side to show its hand. When Wells objected to bailing out New York banks, Paulson coolly pointed out that Wells Fargo was sitting opposite its regulator. If they did not take the capital on offer that afternoon, they would be notified the following morning that they were undercapi
talized. They would find themselves locked out of capital markets. When they came back to Paulson for help, the terms would be less attractive than those available that afternoon. The CEOs were then dismissed to call their boards. Within a matter of hours they had all agreed. Under the Capital Purchase Program facility, America’s nine largest banks took $125 billion in preferred stock from the government.
By comparison with the less encompassing effort in Europe, America’s recapitalization would come to look very impressive. And this judgment was reinforced by hindsight. America’s banks recovered from the crisis more quickly and comprehensively than their European counterparts. The meeting of October 13, 2008, it seems, is when the great transatlantic divergence began.104 Advocates of strong executive branch prerogatives would later celebrate these actions as an essential assertion of sovereign authority. As it had done after 9/11, the American state had declared a state of exception and it had risen to the occasion.105 But comforting as it may be to invoke sovereign power at moments of great uncertainty, this is a mystification of the events in September and October of 2008. The path from Lehman to TARP was less one of a sovereign state rising to a crisis than of a dysfunctional power struggle within the social and political network that tied Washington, DC, to Wall Street and to the European financial system beyond. In September political and commercial considerations had prevented a deal to save Lehman. It took a month of panic, political confusion and unprecedented financial turmoil to reach the point in mid-October when the barons of Wall Street would listen when Paulson thumped the table and declared that everyone must take the Treasury’s money. Even then, the executive branch had the power that it appeared to do in large part because J.P. Morgan swung behind the Treasury proposal. If this was an act of sovereignty, whose sovereignty was it? The American state’s, or that of the “new Wall Street”—the network personified by figures like Paulson and Geithner who tied the Treasury and the Fed to America’s globalized financial sector?106
The Treasury’s act of power would have been more impressive if the injection of capital had been on onerous terms. But the opposite was the case. Vikram Pandit was right. The capital the Treasury was “forcing” on the banks was cheap, in every respect. As Phillip Swagel, assistant secretary for economic policy at the Treasury and a key architect of Paulson’s bailout, has described it: “[T]o ensure that the capital injection was widely and rapidly accepted, the terms had to be attractive, not punitive. . . . [T]his had to be the opposite of the ‘Sopranos’ or the ‘Godfather’—not an attempt to intimidate banks, but instead a deal so attractive that banks would be unwise to refuse it.”107 The Treasury was far from being a difficult shareholder. Designating itself a “reluctant shareholder,” the US government abstained from claiming any voting rights.108 Whereas in the UK and Germany the nationalization of Lloyds-HBOS, RBS, Hypo and Commerzbank was akin to bankruptcy restructuring and led to wholesale changes in management, America’s more comprehensive approach was necessarily light touch.109 If robust J.P. Morgan was to participate in the scheme alongside ailing Citigroup, the terms could not be too onerous. The participants in TARP were allowed to go on paying dividends. The dividend to be paid on the capital provided from TARP was no more than 5 percent, half of what Goldman Sachs paid to Warren Buffett when he “rescued” them. The Treasury’s aim was to persuade all banks to participate en masse so as to ensure that state support was not taken as a signal of weakness that would attract the attention of short sellers. As Steinbrück had spelled out in his furious reaction to Deutsche Bank, at a moment of crisis, defense of the system involved both treating everyone as though they were healthy and the healthier banks being willing to play along. They had to recognize that in the event of a truly comprehensive crisis their cherished margin of superiority would not save them from disaster.
The result of the Treasury’s “sovereign” intervention was to extend a huge subsidy to the banks, increasing the value of their businesses by perhaps as much as $131 billion.110 The biggest beneficiaries were the fragile investment banks and the sprawling colossus of Citigroup. Citigroup received $25 billion from the Treasury in exchange for securities valued at $15.5 billion and soon to be worth much less. In contrast, Wells Fargo, widely regarded as one of the banking industry’s stronger players, gave approximately $23.2 billion worth of securities for its $25 billion in government capital.111 J.P. Morgan did not need the money, and by agreeing to go along with the government’s efforts to stop the run, Dimon passed up the opportunity to predate any more of his weaker competitors. For critics of the bailout, like Sheila Bair of the FDIC, it seemed that the entire process was a smoke screen put up to hide a bailout of Citigroup.112 The Clinton-era network was still at work. Citi was not just too big to fail. It was too well connected. Whatever one thinks of this interpretation, it is undeniable that as soon as the extreme panic of early October had passed, the pretense of equal treatment was dropped.
The October stabilization was not enough for Citigroup. In November it disclosed huge losses and announced fifty-two thousand layoffs. By Friday, November 21, 2008, Citi’s market valuation was $20.5 billion, down from $250 billion in 2006. As fear spread, the death knell sounded. Citi was losing access to repo markets. The end, it seemed, was nigh. Given Citi’s immense size and entanglement in global markets, the consequences did not bear contemplating. In an urgent series of negotiations culminating with “Citi weekend” on November 22–23, another deal was patched together. A second capital injection of $20 billion reinforced Citi’s balance sheet while a so-called loss protection plan protected it against losses on $306 billion in toxic assets. In exchange the government received $7 billion in preferred shares paying 8 percent.113 Bank of America was struggling too and that put Merrill Lynch in jeopardy. As the takeover proceeded, the full scale of Merrill’s mortgage losses was becoming apparent and CEO Ken Lewis and his team at Bank of America were desperate to pull out of the deal that had saved the investment bank on September 14. No one wanted to go back to Lehman weekend. Under heavy pressure from Paulson and Bernanke, Lewis pressed on with the deal, withholding crucial information from Bank of America’s shareholders, but taking another $20 billion in government capital and a “loss-protection arrangement” on $118 billion of Merrill’s troubled assets.114
The financial crisis was not yet contained. But at least in political terms, Wall Street was reassured. On November 4 Barack Obama won the presidency and the Democrats consolidated their grip on both the House and the Senate. American progressives celebrated a historic victory. Obama appeared as an almost messianic figure and he occupied not just the White House. He had the congressional majority necessary to actually change America. And in a remarkable historical twist, the election of the first African American president on the Democratic Party ticket was good news for Wall Street too. It was Obama and the Democrats who had provided the Bush administration with the political backing they needed for the extraordinary crisis-fighting measures of 2008. And they clearly intended to continue that line. On November 23, the same day that the Treasury announced the latest round of support for Citi, Obama’s team made public their nomination for Treasury secretary. The rumor mill had been churning for weeks. Perhaps not surprisingly given his long-standing connections to Obama, Rubin was on the short list, as was Larry Summers, his coarchitect of Clinton-era deregulation. Paul Volcker, Greenspan’s predecessor as Fed chair, godfather of disinflation in the Carter-Reagan era, was an Obama favorite. But he was too old. The others were too politically toxic. The man picked for the Treasury was none other than the hard-driving head of the New York Fed, Tim Geithner, a protégé of Summers and Rubin. Summers was made head of the National Economic Council while he waited to replace Bernanke as Fed chair. Rubin would serve as an éminence grise behind the scenes—a “Harry Hopkins” role, Rubin liked to call it—while another of his protégés and partners in the Hamilton Project, Peter Orszag, would take the role as director of the budget. The keeper of the lists in the transition team
was Michael Froman, Rubin’s former chief of staff at the Treasury. Froman continued to draw a salary as Citigroup’s head of emerging markets strategy while he moonlighted for the Obama campaign.115 In 2009 he joined the Obama administration as deputy assistant to the president and deputy national security adviser for international economic affairs. The only figure on the Obama economics team who did not belong to the Clinton-era “old boys” networks was Christina Romer, a “new Keynesian” economist from Berkeley and noted expert on the history of the Great Depression, who was appointed to be chair of the Council of Economic Advisers.116 The market liked the news. As one investment adviser noted, “Geithner assures a smooth transition between the Bush administration and that of Obama, because he’s already co-managing what’s happening now.”117
Indeed, even to talk in terms of a transition from the Bush administration to Obama is to exaggerate the break. Well before November 4, the baton had already passed. The political party that had demonstrated its willingness to mobilize the full resources of the US government to fight the financial crisis was the Democratic Party. The Republicans weren’t so much a partner in managing the crisis as a symptom of it. In the course of the crisis the GOP had shown itself to be less a party of government than a political vehicle through which conservative, white Americans expressed their alarm at the earthquakes shaking their world.
Chapter 8
“THE BIG THING”: GLOBAL LIQUIDITY
In retrospect it can seem as though it was the decisions taken in the first weeks of October 2008 that decided the future course of events. The United States moved concertedly toward recapitalizing its banks. In Europe, proposals for a common approach were vetoed by Berlin. From there the crisis unfolded as a series of national struggles that after 2010 became once again entwined in the form of the eurozone crisis. In the end Europe could not escape a common solution, but it would take years of economic uncertainty and distress before it arrived at that point. As the eurozone crisis would reveal, the national approach insisted on by Berlin was fundamentally unfit for purpose. But by focusing attention on the European dimension of interdependence, that judgment in fact understates the case. The banks and the borrowers of Europe were indeed interdependent. But even more basic and far more pressing in the fall of 2008 was their dependence on the United States. The closure of interbank and wholesale funding markets created huge pressures in the dollar-funding markets all over the world, and it was in Europe that the pressure was most acute. This was a shortfall that even the strongest European states were powerless to address. That it did not result in a spectacular transatlantic crisis was decided not in Europe but in the United States, where the Fed, acting in the enlightened self-interest of the US financial system, acknowledged the compelling force of financial interconnectedness and acted on it. At a moment when Paulson and the Treasury were struggling with Congress to mobilize political support for a backstop for the American financial system, the Fed, without public consultation of any kind, made itself into a lender of last resort for the world. When the music in the private money markets stopped, the Fed took up the tune, providing a stopgap of liquidity that, all told, ran into trillions of dollars and was tailored to the needs of banks in the United States, Europe and Asia. It was historically unprecedented, spectacular in scale and almost entirely unheralded. It transformed what we imagine to be the relationship between financial systems and national currencies.