Determining when to analyze any historical event often rests upon subjective judgment. For example, it’s likely too early to dissect the Madoff affair because all the details have not yet to emerge. Two recent books, however, each of which examined the tumultuous events culminating in the financial crisis of 2008, have convinced me that it’s now time to seriously study this controversy.
The books really need to be read in tandem – kind of a yin and yang. The Big Short, by famed author Michael Lewis, looks at the events from the eyes of the outsiders who questioned the establishment. Hank Paulson’s book, On the Brink, is the ultimate insider’s book as Paulson was the Treasury Secretary during this period and at the core of key financial and policy decisions. As long as you understand that Lewis has a disdain for Wall Street and Paulson’s account is less than detached, reading the two back-to-back provides a balanced perspective of what caused these events and the people involved.
First, neither book spends any time focusing on the governmental policies that led to the financial upheaval. Second, it still is difficult to come to grips with the fact that this worldwide crisis was caused by astonishingly weak practices on single-family residence loans. Whether prodded by government or not, some very sharp people on Wall Street not only participated in this charade, but encouraged it – and ultimately ended up holding large portfolios of flimsy loans. Third, we should be thankful that Hank Paulson, a Wall Street insider, was Treasury Secretary at the time because of his great knowledge of the financial companies involved and his long-time relationship with their leaders. If Paul O’Neill or John Snow, President Bush’s first two Treasury Secretaries, had still been in office, we might all be standing in soup lines today.
The striking difference between the two books concentrates on Wall Street’s leadership. Lewis’s book centers largely around two eccentric geniuses who bet against the system – Michael Burry, a hedge fund administrator with one eye and Asperger syndrome, and Steve Eisman, with FrontPoint Partners, who may be the most anti-social person in Manhattan. They both perceived correctly that many of the nation’s top investment bankers were completely unaware of the levels of risk and exposure they had assumed. Conversely, however, Paulson rarely expresses anything other than confidence and admiration for Wall Street’s top echelon.
Which begs the question how these leaders could be so capable when most of them were leading their companies toward the cliff. Richard “Dick” Fuld, the head of now-defunct Lehman Brothers, was a perfect example of cluelessness. At one point he complained to Paulson that the hedge funds were causing his problems, when the real issue was Lehman’s incompetence and greed, ultimately leading to the destruction of his 158-year-old company. It was reminiscent of the 1980s, when enterprises like Unocal appealed to Congress for protection from investors like Michael Milken instead of operating their companies better. The only big bank/investment house that came out truly clean in the whole process was Wells Fargo, who assiduously avoided all the toxic assets.
One of the more bothersome events was the treatment of Ken Lewis, the now former head of Bank of America. BofA was perceived to be one of the companies that helped clean up the mess and was pushed into a deal attempting to save Lehman Brothers. They backed off that deal to acquire Merrill Lynch, whose impending collapse would have certainly thrown the financial system into a tizzy. The deal with Merrill Lynch was premature, as only afterwards did Lewis discover that Merrill would lose $18 billion in the quarter. Lewis was then was forced by the Obama administration to resign because of bonuses paid to keep key Merrill personnel in place.
In the meantime, Fannie Mae raised $7.4 billion in common stock, all of which was quickly wiped out when the government took over the GSEs (government sponsored enterprises). Yet no one has ever held a hearing to accuse the (obviously incompetent) executives of Fannie Mae of criminal malfeasance for taking people’s money while they were on the verge of collapse. Unfortunately, too many politicians had their hands in Fannie and refused to expose themselves to the truth of failure of their wards. The GSEs continue to lose mountains of money every month with no end in sight; their cumulative losses are now headed toward $150 billion and rising faster than the water that hit New Orleans. And unlike most of the financial institutions that accepted TARP funds, there is no repayment on the horizon.
The raging debate continues regarding credit default swaps (CDS) and derivatives. Paul Volcker recently warned Congress about limiting them, and, as we know, Congress usually goes overboard on whatever it does. Several people in the industry argue that while derivatives should be more scrupulously regulated, they ultimately have their place and should not be totally banned. That being said, Michael Lewis pointed out that most of the people in the CDS market did not understand what they were buying or selling, and could not clearly explain it to the parties. All they knew was there was a market and they were making commissions. It was legalized gambling – pure and simple.
Another part of the problem rests with the industry and all of its fancy names. Paulson had an index in his book with 50 acronyms, most of which only insiders would know. My suspicion is that this financial industry jargon is used mainly to make the insiders feel self-important, akin to a tax lawyer or CPA quoting tax code sections in an attempt to mesmerize their clientele when they really are unclear about what they are doing.
The future is now in the hands of the politicians, who largely come out well in Paulson’s book. He praises and criticizes Democrats and Republicans equally. He did, however, single out John McCain for occasional silliness, which was perhaps an indication of why he lost the presidency. The elected official who came out looking the best was President Bush. He was head of state when a major market upheaval was caused by the convergence of many bad decisions from the Federal Reserve and prior government policies combined with some greedy Wall Street types.
From Paulson’s account, Bush never flinched and never wavered, and above all never made self-serving political decisions. Working closely with Paulson, Geithner and Bernanke, he did what he thought was right. The question now is whether Obama will do the same while facing the new financial storm caused by the Greek upheaval and the pending challenges coming from Spain, Ireland, Portugal, and Italy. Hopefully, he will follow Bush’s example and lead responsibly – instead of listening to Rahm Emanuel and trying to take advantage of any crisis.