by Nomi Prins
Paulson and Wilson had met while they were students at Dartmouth College. It was Paulson who helped recruit Wilson to Goldman, and the pair had been annual bone fishing buddies in the Bahamas.90 But Wilson was tied to even bigger fish than Paulson: he had gone to Harvard Business School with George W. Bush. While Wilson was standing in line at an airport north of New York City, he got the call from the Oval Office. Bush urged, “Kenny, your country needs you.”
Wilson was considered the banker to the banks. “Anyone who is anybody in financial services knows Ken Wilson,” said Citigroup’s chief financial officer Gary Crittenden at the time.91 Wilson also received quite a gift for his help to the Bush administration: he got to advise on major Treasury plans for the burgeoning crisis as a “contractor.”
But because Wilson wasn’t on the regular government payroll, he didn’t have to publicly disclose his financial records, including his total stock holdings in Goldman Sachs. Because his holdings are private, it is likely, but not totally clear, that since his stock had lost a lot of value at the time, he kept it in the hopes it would rebound.92 Even Hank Paulson didn’t get that benefit, although in hindsight, Paulson was forced to sell his Goldman stock and options at a much better comparative level. And because he was exempt from paying capital gains tax on the sale, he did okay.93
Another man who moved around between the big banks and Washington was Bob Steel, who had retired as vice chairman from Goldman in February 1, 2004.94 But that was before his old boss needed his help to save the banking system. See, there might be competition between men during their time in the same firm, but once they’re on the outside, they know they can trust one another more than anyone else. It just works that way. So when Paulson called on Steel to take the post of Undersecretary of the Treasury for Domestic Finance, there was one answer. Steel was there. He was sworn in on October 10, 2006.95
Once in the Beltway, Steel was known as Paulson’s closest confidant and was heavily involved in creating the agreement behind JPMorgan Chase’s purchase of Bear Stearns in March 2008. Steel was the man who briefed President Bush on the deal and played a crucial role in constructing the Bush administration’s policy regarding the mortgage market crisis in early 2008, which included plans to attend to the mounting problems at government sponsored entities such as Fannie Mae and Freddie Mac.96
As it was for Rubin, though, Washington turned out to be an interim career move between two bank positions. On July 9, 2008, Steel resigned from his position, and on the same day he went to run Wachovia Bank, at the time the fourth largest bank in America.97 The whole arrangement raised the ire of ethics watchdogs. “It’s not technically a conflict of interest as long as he didn’t work on issues that impact only Wachovia,” said Melanie Sloan, executive director of Citizens for Responsibility and Ethics in Washington. “But it smells bad. If one day you’re regulating banks and the next day you’re at the bank, one has to wonder if the decisions you made at Treasury were in view of future employment options.”98
When Steel was hired to run Wachovia, the Goldman investment banker relationship came into play once again. At the time, Wilson was advising Wachovia on the strategy and management of the troubled loans in its portfolio. Not surprisingly, that advisory role would be much easier if a former Goldmanite was in charge over there.99
On taking over the bank, Steel had pledged to keep Wachovia an independent entity.100 A few months later, he vowed to sell the bank’s noncore assets to raise $5 billion in capital during 2009.101 Less than two weeks later, the bank posted close to $9 billion in losses for its second quarter.102 By the time of Steel’s hiring, Wachovia stock had already dropped 62 percent from the beginning of 2008.103
By early September 2008, it was down nearly 80 percent, and federal officials were pressuring it to cut a deal or face collapse.104 But there was a glitch. On September 15, financial stocks were in the toilet, Lehman Brothers went bust, and Bank of America got stuck with Merrill Lynch.105 Yet, Steel told Jim Cramer on Mad Money that Wachovia had a “great future as an independent company. . . . But we’re also focused on the very exciting prospects when we get things right going forward.” Wachovia shares fell 25 percent that day.106
With his company’s stock in free fall, Steel swung into action the next day. He held a conference call regarding the possibility of selling a chunk of Wachovia or merging with another company. On September 17, 2008, Steel called Morgan Stanley’s CEO John Mack to talk about a potential merger.107 Mack and Steel had both attended Duke University and were on its board of trustees.108
Amid all of the chaos, customers were extracting billions of dollars of deposits from Wachovia.109 This happened during the period that Steel was in merger talks with Citigroup and Wells Fargo.110 Then things got tricky. First, Wachovia agreed to sell its banking operations to Citigroup, then on October 2, 2008, Wachovia’s board said it would sell the full company to Wells Fargo in a $15.4 billion deal.111 Wachovia shareholders would get $7 a share for their stock, 35 percent lower than the closing stock price on the day Steel was on Cramer’s show.112 No matter, though. Wachovia was headed by Steel. It was also a client of Goldman Sachs, which pocketed a cool $25 million fee for its services in advising the merger.113
In late January 2009, a few months after the Wells Fargo deal, it emerged that the SEC was investigating Steel for his Mad Money remarks, though no charges have been filed as of this writing.114 The investigation continues. But it remains to be seen whether Goldman Sachs will take any responsibility for anything negative, despite the firm’s fingers being all over the deal—and whether it will be deemed misleading or merely hopelessly optimistic to tout your company’s rosy future right before that future changes dramatically.
The End Game
As with any important historical period, hindsight will provide clarity and be subject to interpretation. Each period has its key characters and events. There are only a few choice slots from which you can dominate domestic and global finance. And as it turns out, Goldman occupied many of them leading up to the Second Great Bank Depression. No doubt its imprint will remain, if not increase, going forward. Even if there are fewer Goldmanites in positions of power, the influence they wielded during their tenures at senior banking and political roles will have an impact that will last for decades.
It is human nature to protect what’s yours. In the case of the banking world, whatever may have been going on in the minds of the elite Goldman alums, through their words and their actions they protected their individual pots of gold and philosophies at the expense of the general population and the public good. And that’s simply not right.
We should ponder another question. Maybe checks and balances for corporate and political leaders are in order to reduce the risk that a small group with a single philosophy or power base has too much control over our financial world and lives.
5
We Already Have a Bad Bank: It’s Called the Federal Reserve
Let me issue and control a nation’s money, and I care not who writes the laws.
—Mayer Amschel Rothschild, founder of the House of Rothschild
In 1941, the investment banker Cyrus Eaton wrote in the University of Chicago Law Review, “The doctrine that finance must be the servant rather than the master has been proclaimed before, although it has been increasingly neglected in practice in the United States.”1 Sixty-eight years later, finance was still the master, and the Federal Reserve, the Treasury, and Congress were the servants and coconspirators.
The Fed was the first agency to flex its muscles and open its books, and ultimately on a substantially grander scale than the Treasury ever did, under the auspice of averting a full fledged financial crisis. In August 2007 the Fed purchased $19 billion of mortgage backed securities and $19 billion of repurchase agreements, and added $62 billion of temporary reserves.2 A month later, the Fed injected another $31 billion into the U.S. money markets in three separate operations, later following it with one more round of $20 billion in December. These a
re all fairly large amounts, but still within the realm of the Fed’s normal responsibility to grease the wheels of credit.3
(A note on use of the word injection—the word conjures medical or druglike images for a reason. The intent of a cash injection into the markets is to stimulate the flow of money, similar to how an adrenaline shot stimulates the oxygen and blood flow in a person. If the injection is strong enough, one may suffice. In the case of the Second Great Bank Depression, multiple injections of cash were required to resuscitate a system that was a willing participant in its own attempted suicide. Call that “a cry for help.”)
The last time the Fed had to combat freezing credit was after 9/11. Then, it acted in a more subdued way by lowering discount rates and providing loans to the banks affected by the attacks. The idea was to help the system, not to be its mother.4
Before the Fed unleashed Operation Print Money for the Banks, it maintained $770 billion of nonrisky Treasury bonds on its books.5 As the national lender of last resort, the Fed could give financial institutions cash in the form of short-term loans and, in return, these firms would post secure assets, such as Treasury bonds, as collateral. The reason was simple: the sounder the collateral, the better the loan terms for the borrowing bank. It behooved banks to post these highest quality bonds, so they did.
The Fed would receive interest payments on those Treasury bonds and hand a portion of them back to the Treasury Department as they came in. It was a symbiotic relationship in which the Fed was effectively paying interest on the Treasury’s public debt, so that the Treasury didn’t have to do it.
That low-risk practice went out the window during the Second Great Banking Depression. As the great bailout unfolded, the complexity of the Fed’s books increased in tandem with its appetite for risky, unquantifiable asset and mortgage backed securities. The new trend was coupled with an appreciable move toward secrecy. Banks began to post all sorts of junk to the Fed just to get it off their books, and in return they received low cost loans.
The consolidation of America’s money into fewer and fewer banks over the last three decades made the Fed’s trashy asset books even worse.
“In 1977 commercial banks held 56 percent of all financial assets. By 2007 the banking share had fallen to 24 percent. The shrinkage meant the Fed was trying to control credit through a much smaller base of lending institutions. It failed utterly—witness the soaring debt burden and subsequent defaults,” William Greider wrote in the Nation on March 11, 2009.6 Yet way before anyone could have fathomed the immense scope of the bailout, the Fed had begun to quietly blow up the loan balloon it hoped would quickly sail off with the subprime crisis.
During the winter of 2007, the Fed transformed itself into a sort of pawnshop for banks that needed quick cash; as long as the banks were in decent condition and could collateralize their loans, they could get money at a discount rate, at auction, through the Term Auction Facility (TAF) program—sort of in the same way you can get a $100 loan from a pawnshop by putting up your grandmother’s old jewelry.7 Competition for the money was fierce. Although there were $119 billion worth of requests from 166 bidders, the Fed only gave out $40 billion in its first two December 2007 auctions.8 Come the spring of 2008, the Fed was blazing through uncharted territory. It had gone above and beyond its official mandate to keep credit flowing through the economy. Again in a very secretive way, the Fed became not only a bank of last resort for the banks, but the biggest hedge fund manager in the world.
A standard hedge fund takes in money or assets and promises to use them to provide a handsome return for the investor through various bets—on housing, oil, weather, whatever. Hedge fund managers make fees, typically 2 percent management fees, based on these returns and the volume of assets they have under management, plus 20 percent performance fees.9 Hedge funds borrow money against these assets from commercial and investment banks to make even bigger speculative wagers. The thinking goes: the more you bet right, the more money you make. The operative word here is more.
So, during a time when banks couldn’t give away their nonperforming (banktalk for “toxic”) assets at any price, the Fed inhaled trillions of dollars’ worth of them and in return issued them debt at interest rates that no normal American would ever get (really low ones).
Because risky assets were sitting on the Fed’s books as collateral for loans, the Fed was put in the passive role of hoping the assets’ value would turn around someday or that the banks that pawned them off would be able to retrieve them and pay back their loans. A good hedge fund would never allow itself to operate in such a submissive manner. But the Fed doesn’t have to worry about positive returns; its supply of money is endless.
Chase Hunts a Bear with the Fed’s Rifle
On March 11, 2008, the Fed created the Term Securities Lending Facility (TSLF). The TSLF allowed the Fed to lend banks as much as $200 billion for up to 28 days, rather than the quick-shot overnight loans that had been the standard in the past. Collateral could come in the form of anything with a AAA rating, even though many AAA securities should have been rated as junk.10 The Fed’s evolution into a quasi-hedge fund manager gained steam when it backed a quasi- hedge fund, Bear Stearns, the former investment bank and my former employer. Stepping outside the normal bounds of its authority, the Fed provided the financial backing that allowed JPMorgan Chase to take over Bear Stearns. This move was part of an almost militaristic coup.11 The Fed’s allies in this operation were the Federal Reserve Bank of New York, run by Timothy Geithner; the Treasury Department, run by Henry Paulson; and the Securities and Exchange Commission (SEC), run by Christopher Cox.
The entire process took about two weeks. Stage one began on the evening of Thursday, March 13, 2008, when, according to Tim Geithner’s congressional testimony, he took part in a conference call with “representatives from the Securities and Exchange Commission, the Board of Governors of the Federal Reserve, and the Treasury Department.”12
On that call the SEC staff informed him that “Bear Stearns’ funding resources were inadequate to meet its obligations and the firm had concluded that it would have to file for bankruptcy protection the next morning.”13 In other words, the investors had already headed for shore, and the loan sharks, the firms that had lent Bear money backed by tanking collateral, wanted blood.
This situation unleashed a sleepless night of consideration, culminating in a call at the crack of dawn the next day. Geithner, leading the strike, had spent the night poring over options with the Fed and the Treasury. Ben Bernanke, with insistence from Paulson and Geithner, concluded that the Fed would come up with the money to ensure that the deal went through.
JPM Chase head Jamie Dimon was no idiot. If he was going to take Bear on, he didn’t want to take on its potential losses, too. He needed government guarantees, and he got them. But later that day, it dawned on JPM Chase and the Fed just how much junk they were dealing with: among other things, securities stuffed with subprime mortgages, credit default swaps, and loans from and to other banks. There was a regulatory catch, too. The Fed couldn’t directly lend to Bear because it was an investment bank and was outside the Fed’s jurisdiction.
But this problem, too, had a workaround. The New York Fed would extend an overnight loan to JPM Chase from its discount lending window, and JPM Chase could then lend that money to Bear Stearns. This operation would keep the firm afloat while it was prepped for the hand-off to JPM Chase and would help ensure that the deal went through.
Stage two came two days later, but not without some second thoughts. Early in the morning on Sunday, March 16, JPM Chase rescinded its offer to take Bear Stearns. Bernanke leapt into action, boosted by fear that the Asian markets would catch wind of the percolating catastrophe before they opened that night. So he did the unprecedented. He agreed to back Bear Stearns’s dying assets if JPM Chase would take the firm. Treasury Secretary Paulson jumped in and advised JPM Chase to offer $2 per Bear share, rather than the $4 it was prepared to offer. He and Geithner also called Bear
Stearns chair Alan Schwartz, telling him he had to accept JPM Chase’s offer.14
Later that evening, Geithner informed James Dimon that the New York Fed would assist the acquisition with $29 billion in financing, backed by Bear Stearns assets.15 It would also fast track the necessary regulatory approvals to move the merger forward.
Stage three unveiled the Primary Dealer Credit Facility (PDCF), which was announced the same day that Geithner agreed to put up the cash to back the Bear Stearns deal.16 Citing a familiar refrain, the Fed created this facility due to the “unusual and exigent circumstances” that “existed in financial markets, including a severe lack of liquidity.”17 The PDCF allowed investment banks to borrow from the Fed for the first time.18 It was meant to be a temporary program to provide quick loans that would mature the day after they settled with an interest rate equal to that of the New York Fed primary credit rate.19 As of this writing, that interest rate is .5 percent.20 In conjunction with the opening of this facility, as requested by the SEC, New York Fed examiners were supposedly sent to all the major investment banks to report back to the Federal Reserve on the banks’ financial conditions. If this in fact happened, it wasn’t very effective, given that by the end of 2008, several major banks were on life support (make that public bailout-support).