Infectious Greed (25 page)

As average investors learned about the losses, they became upset with Wall Street, and bankers briefly became pariahs, as they occasionally do. The number of top business-school graduates seeking finance jobs dropped by half. The media portrayed wealthy bankers as villains. And the inevitable cartoons appeared, one picturing a man in a three-piece suit, holding a briefcase and a cup for begging, next to a sign that said “Dabbled in Derivatives.” Another had a caption, “Hey, there's always tomorrow. Well, unless you're in derivatives.” For the 1994 holiday season, Trimedia, a public-relations firm, sent out a card depicting Santa and his reindeer crashing into a building, with the legend, “Don't worry. He's got a derivatives contract from Bankers Trust. Happy Holidays!”

The bankers didn't seem to care about all the fuss. They knew it
would go away soon, as it always did. Instead, they disclaimed any responsibility, and blamed investors for making stupid bets and for failing to supervise their investments. Besides, in December 1994, there was little chance of getting bankers to focus on anything other than the upcoming bonus check.

After several years of being spoiled by skyrocketing bonuses, bankers threw tantrums when they learned overall pay would be down 20 percent for 1994. Many angrily tore up their bonus checks, took unannounced vacations, quit, or otherwise behaved as one might expect of youngsters losing their million-dollar allowances. A trader from Lehman Brothers sent an impostor to perform his jury service while he skipped out on a trip to Milan.
⁴⁷
(Reportedly, when the judge began routinely questioning the surrogate, he said he wasn't the trader, asked to visit the men's room, and never returned.)
New York
magazine reported on other bankers' attempts to “get even” by billing expensive consumer items to their firms, including groceries, home furnishings, Brooks Brothers shirts, and even Chanel suits. One banker said, “Given what they put me through, they owe me.” The greatest abuses involved limousine services, which cost firms millions of dollars in waiting time alone. Bankers called for cars at odd times, made drivers wait, and then billed the fees to their firms, or to clients. One Goldman Sachs banker sent a briefcase—just the briefcase—home to Connecticut in a limo.

As investors learned about these stories, they became angrier, still. This clash between Main Street and Wall Street created the ideal atmosphere for legislators to create new legal rules governing the various new financial instruments and strategies. Investors are typically too diffuse to mount intense lobbying efforts, especially compared to banks, which have well-funded trade organizations and dedicated lobbyists. But in 1994, investors were crying for reforms, and there were signs they were being heard. Congressional staffers began drafting new legislation, judges were hearing lawsuits related to the losses, securities regulators were preparing rules to improve disclosure, and prosecutors were considering bringing criminal cases against various perpetrators. As the year closed, with Orange County filing for bankruptcy, investors found little comfort, except perhaps the hope that governmental officials would punish the wrongdoers and create a new regulatory framework to stop the wave of undisclosed risk-taking of 1994 from spreading even further. Instead, the regulators were about to do precisely the opposite.

T
he two most prominent people managing the regulatory response to the financial fiascos of 1994 were Arthur Levitt Jr. and Mark C. Brickell. Levitt was the chairman of the Securities and Exchange Commission, the primary regulator of financial instruments in the United States—a federal agency that advertised itself as “the investor's advocate.” Brickell was a vice president of J. P. Morgan and the top lobbyist for the derivatives trade group, called ISDA, that had persuaded lawmakers to allow the unregulated derivatives markets to grow unchecked since 1985. It was surprising how much the two men were in sync.

Levitt was an unlikely candidate to be the investor's advocate. During the 1960s and 1970s, he had been a Wall Street broker, eventually rising to become president of the predecessor firm to Lehman Brothers. To the extent he focused on individual investors, he was persuading them to buy stocks. In 1981, he even wrote a book of investment advice called
How to Make Your Money Make Money.
(When Levitt testified before Congress on the collapse of Enron in January 2002, one admirer sitting in the second row of a packed room in the Hart Senate Office Building was clutching a tattered copy of Levitt's book, presumably seeking an autograph.)

After working as a stockbroker, Levitt spent twelve years as chairman of the American Stock Exchange (the smaller sister of the New York Stock Exchange), where he advocated on behalf of major Wall Street
firms and even ran a derivatives-trading business. Levitt had plenty of experience with derivatives, stretching back to as early as 1985, when he chaired a conference on futures and options.
¹

Notwithstanding his Wall Street background, Levitt served the longest term of any SEC chair—nearly eight years—acquiring a reputation as an effective regulator (a reputation that this chapter will show is mostly undeserved). In 2002, after Levitt finally stepped down, some members of Congress even apologized for ignoring some of the proposals Levitt advanced late in his term.

Levitt was a fish in a barrel for Mark Brickell, an aggressive banker who, beginning in 1976, spent more than two decades at J. P. Morgan. J. P. Morgan—like Bankers Trust—was transforming itself from a stodgy commercial bank into a sophisticated risk manager and trader of new financial products. Brickell had studied politics at the University of Chicago and, although he also had attended Harvard Business School and worked in swaps, he only began to thrive at J. P. Morgan when he returned to politics, lobbying on behalf of his bank and other derivatives dealers as chairman of ISDA.

When Brickell's colleagues said he was good at “working” Washington, they vastly understated the case. Many legislators and regulators dreaded Brickell. He was both condescending (saying officials couldn't possibly understand derivatives) and reassuring (saying Wall Street had everything under control). But even Brickell's enemies admitted that he was a success. Brickell and ISDA had kept lawmakers away since the mid-1980s, and in early 1994 over-the-counter derivatives were largely unregulated.

After the Fed raised interest rates in February 1994, Brickell became a pit bull, telling legislators that although recent derivatives losses looked bad, regulators couldn't possibly understand or control the situation any better than market participants. He said new legislation would cause unforeseen damage, potentially imperiling not only Wall Street and the derivatives industry, but—by implication—campaign donations as well. (ISDA's members were major political contributors.)

Throughout 1994 and 1995, Brickell and Levitt worked to protect the finance industry from new legislation. In early 1994, lobbyists waited for investors to calm down from the shock of how much money-fund managers and corporate treasurers had lost gambling on interest rates. When legislation was introduced, Brickell fought it and Levitt gave speeches saying the financial industry should police itself. The issues were complicated, and the public—once so angered by the various scandals—ultimately lost
interest. Instead of new derivatives regulation, Congress, various federal agencies, and even the Supreme Court created new legal rules that insulated Wall Street from liability and enabled financial firms to regulate themselves. Under the influence of Levitt and Brickell, regulators essentially left the abuses of the 1990s to what Justice Cardozo had called the “morals of the marketplace.”
²

As a result, most of the financial dealings described in previous chapters—even obvious malfeasance—went unpunished. Regulators stretched the existing law to bring a questionable case against Bankers Trust, but the result was a relatively small fine for Bankers Trust and no prison time for any bank employee. No one in the Orange County debacle did prison time for any conviction, either. Piper was much the same: Worth Bruntjen continued to manage money, his only punishment being a regulatory slap on the wrist.

The best illustration of this new self-regulatory approach was the response to a $350 million loss incurred by Orlando Joseph Jett, a trader at Kidder Peabody—the investment bank owned by General Electric that sold mortgage derivatives to Worth Bruntjen and David Askin. Prosecutors attempted to bring cases against the key parties at Kidder Peabody, but the facts were too complex, and the law was too unfriendly. (The basic pattern of the “Joseph Jett” story would be repeated several times during the next decade, including by Kent Ahrens of the Common Fund, which lost $138 million on stock-index options and futures at about the same time as Jett's loss,
³
and by Nick Leeson of Barings Bank, which lost a billion dollars trading options and futures in Singapore a few months later—more on Leeson in Chapter 8.)

Where the regulators failed, the markets succeeded in a limited way, by punishing the shareholders of firms that had engaged in questionable schemes. For example, the Joseph Jett scandal destroyed Kidder Peabody and embarrassed Jack Welch, the chairman of General Electric. The message to shareholders was: watch your investments carefully, because without the help of securities regulators—including the supposed “investor's advocate”—you are on your own.

 

 

A
fter almost thirty years working in finance, Arthur Levitt Jr. wanted to cap off his Wall Street career with a Cabinet-level political appointment in the Clinton administration: secretary of commerce or perhaps even treasury. Levitt was an unlikely nominee for chairman of the Securities
and Exchange Commission, a lower-level position requiring substantive knowledge of securities regulation. The typical SEC chairman had been a distinguished lawyer or law professor.

After majoring in English at Williams College, Levitt had ambled through several low-prestige sales jobs in the 1950s, including life insurance and cattle (ironically enough, he had sold cattle to William Casey, who later became chairman of the SEC),
⁴
until Sandy Weill—the later chairman of Citigroup—gave Levitt a job as a stockbroker. Levitt was moderately successful under Weill's tutelage and, although he wasn't always liked or respected, he made a fair amount of money.

But throughout this time, Levitt was unable to satisfy his political ambitions, which stemmed from his father, a respected senior statesman and long-time New York State comptroller. Levitt took on a few minor political appointments, including chairman of President Carter's “White House Conference on Small Business,” but nothing compared to what Arthur Levitt Sr. had accomplished.
⁵

The second Reagan administration considered Levitt for a position, but he still lacked both experience with policy issues and political connections. Besides, he was a Democrat. In 1989, Levitt improved his résumé by taking a quasi-political job as chairman of the American Stock Exchange, where he developed connections with both politicians and Wall Street leaders. He also bought a controlling interest in
Roll Call,
the newspaper that covered insider scoop on Congress.

During the 1992 presidential campaign, Levitt made campaign contributions in the six-figure range, ensuring that several candidates would consider him for an appointment. He gave money to a few unsuccessful presidential candidates, took various politicians on Outward Bound expeditions, and even made a small contribution to Pete Domenici, a Republican on the Senate Banking Committee. But his focus was on William Jefferson Clinton. When Clinton won the Democratic primary, Levitt helped raise $3.5 million for him, and made a personal gift of $40,000 to the Arkansas Democratic party.

When Clinton won the election, the only remaining question for Levitt was whether Clinton would be willing to give a senior appointment to a former stockbroker. During the previous twelve years, Republicans had been cautious about naming Wall Street executives to positions of power, fearing that the public would criticize them for having the fox guard the henhouse. Democrats historically had been even more reluctant to appoint financial executives.

But Bill Clinton had experienced an epiphany about Wall Street during the presidential election. Before 1992, experts had predicted that Clinton would be an unsympathetic president to Wall Street. But Clinton had learned about the power of the financial lobby when he suffered after criticizing Wall Street during the campaign. As president-elect, he famously said, “You mean to tell me that the success of the economic program and my reelection hinges on the Federal Reserve and a bunch of fucking bond traders?” When Clinton discovered that voters cared much more about whether the stock market was going up than other economic issues, he increased support for Wall Street—a then-current and potential future source of substantial campaign contributions—and committed to continue the deregulatory policies of the previous Republican administrations. Clinton appeased the populist anti-corporation forces by making a campaign pledge to halt the allegedly excessive pay of corporate executives.
⁶

Levitt waited to receive a call about a Cabinet position. But there were too many potential nominees with more distinguished backgrounds, including Robert Rubin, who was a much bigger name than Levitt on Wall Street and had been co-chairman of Goldman Sachs, an even bigger campaign contributor. In April 1993, Clinton nominated Levitt to be chairman of the SEC.

Levitt was disappointed. Still, it was an important post and might be a stepping stone to the Cabinet, so Levitt took every measure to ensure the Senate's approval. Numerous securities lawyers objected to Levitt, for numerous reasons, not the least of which was that Levitt didn't have legal experience or even a law degree. (Only two previous SEC chairmen since the 1930s had been non-lawyers.) He tried to assuage their concerns, as he firmed up his Wall Street support, meeting with senior banking officials at the annual dinner for the new governors of the American Stock Exchange, and speaking at a conference held by a major securities lobbying group, the Securities Industry Association.
⁷