All The Devils Are Here: Unmasking the Men Who Bankrupted the World (72 page)

By March, the fury had found a new outlet: AIG. In March 2009, the news broke that AIG-FP was going to pay $165 million in bonuses to its traders and executives. Although most of them had had nothing to do with the destruction, the payments became a huge scandal. The House wasted no time in passing a bill taxing all bonuses—at 90 cents on the dollar—for any household that made more than $250,000. Republicans and Democrats vied to outdo each other. “This is absolutely appalling,” said Senate Minority Leader Mitch McConnell. “It’s like taking the American people’s hard-earned tax dollars and slapping them in the face with it,” said Elijah Cummings, a Democratic congressman from Maryland. “There are a lot of terrible things that have happened in the last eighteen months, but what’s happened at AIG is the most outrageous,” said Larry Summers, who had become one of Obama’s top economic advisers. AIG executives received death threats. Some even had to have private security guards stationed in front of their homes. The Connecticut Working Families Party held a bus tour of AIG executives’ homes.

Finally, there was Goldman Sachs. As part of the AIG bailout, the New York Fed made the decision to pay AIG’s counterparties in its multisector CDO business 100 cents on the dollar. In mid-March, a day after the AIG bonus news broke, AIG disclosed that Goldman Sachs had received
$12.9 billion, more than any other firm. Goldman had claimed all along that its exposure to AIG was hedged.
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Didn’t this show that Goldman was lying? “This needless cover-up is one reason Americans are getting angrier as they wonder if Washington is lying to them about these bailouts,” opined the
Wall Street Journal
editorial page. Wasn’t this proof that Hank Paulson had protected his old firm by steering billions in cash Goldman’s way? And what about all those ex-Goldman guys in positions of power everywhere?

By the middle of the summer, Goldman Sachs was producing blowout profits, had repaid its $10 billion in TARP funds, and had already set aside $11.4 billion—a record sum—with which to pay bonuses to employees. And Goldman executives began to say that maybe they’d never needed any help anyway. Although Lloyd Blankfein in particular was careful to express gratitude to taxpayers, the bonuses sent a signal that Goldman considered itself somehow divorced from the actions that had led to the crisis, when, in fact, Goldman had been right there in the thick of it. It was maddening. They may have been smarter than everyone else, but they weren’t better. Not anymore.

By the following spring, Goldman’s arrogance had landed it a solo hearing in front of the Senate Permanent Subcommittee on Investigations, in which the firm was lambasted for the way it had duped clients and furthered the crisis. Thus it was that Goldman Sachs, a firm whose Manhattan headquarters bears no name, which has no storefronts anywhere in the country, and which has never sold its financial products directly to run-of-the-mill consumers, became the public’s favorite villain.

At the heart of the anger was a powerful sense that something terribly unfair had taken place. The government had bailed out companies—companies whose loans and capital raising are supposed to help the country grow—that had turned out to be making gargantuan side bets that served no purpose other than lining their own pockets. Homeowners, whose mortgages had served as the raw material for those side bets, got no such help. “I’m not even against a bailout,” says Prentiss Cox. “We had to do it. But
regulators are always concerned that we don’t send a message to future homeowners that they can get away with this. They should have made it clear to lenders that there are consequences. Instead, it’s all the money to the lenders and all the shame to the homeowners.”

People also felt that a great crime had been committed, yet there was not going to be a great punishment. Ralph Cioffi and Matt Tannin, the only two people so far to have been indicted as a result of the financial crisis, were acquitted. The government decided not to bring charges against Joe Cassano. The SEC has charged Countrywide’s Angelo Mozilo, David Sambol, and Eric Sieracki civilly; that case is set to go to trial in the fall of 2010. And the SEC got a $550 million settlement with Goldman Sachs that many people felt let the firm off easy. But as the case involving Cioffi and Tannin shows, it is very hard to find the line between delusion, venality, and outright corruption. Much of what took place during the crisis was immoral, unjust, craven, delusional behavior—but it wasn’t criminal. The most clear-cut cases of corruption—the brokers who tricked people into bad mortgages, the Wall Street bankers who knowingly packaged bad mortgages—are in the shadows, cogs inside the wheels of firms like Ameriquest, New Century, Merrill Lynch, and Goldman Sachs. We’ll probably never even learn most of those people’s names.

What was the point of it all? In spring of 2007, even before the crisis hit, the Center for Responsible Lending published numbers showing that between 1998 and 2006 only about 1.4 million first-time home buyers purchased their homes using subprime loans. That represented about 9 percent of all subprime lending. The rest were refinancings or second home purchases. The Center also estimated that more than 2.4 million borrowers who’d gotten subprime loans would lose or already had lost their homes to foreclosure. By the second quarter of 2010, the homeownership rate had fallen to 66.9 percent, right where it had been before the housing bubble. Ever so swiftly, the wave of foreclosures in the aftermath of the crisis wiped out the increase in homeownership that had occurred over the past decade. In other words, subprime lending was a net drain on homeownership. A lot of needless pain was created in the process.

Financial innovation? Collateralized debt obligations? Synthetic securities? What had been the point of
that
? “The financial industry is central to our nation’s ability to grow, to prosper, to compete, and to innovate,” President Obama said when he signed the new legislation. During the bubble it had
been nothing of the sort. As Paul Volcker said at a
Wall Street Journal
conference in late 2009, “I have found very little evidence that vast amounts of innovation in financial markets in recent years have had a visible effect on the productivity of the economy.”

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.

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.