?As long as I am alive, this firm will never be sold. And if it is sold after I die, I will reach back from the grave and prevent it.?
?Richard Fuld, chairman, Lehman Brothers, in end-2007.
The chairman?s wish was granted less than a year later, though his wish had changed by then. Out of cash and his shares in free fall, Fuld, who earned $22 million the previous year, was out on Wall Street, hat in hand, desperately seeking a buyer in Korea Development Bank and Barclays. No one glanced in his direction. The Fed and treasury did not return calls. In the pre-dawn hours of September 15, before Asian markets opened, the 158-year-old investment bank that witnessed the Civil War, two world wars, the Depression and the bubble years, filed for bankruptcy.
Such was the hubris of Wall Street bluechips brought down by the market they helped build, that even when it was sinking, Merrill Lynch refused to sell to Bank of America and fired the CEO who attempted it. The largest mortgage financier, Countrywide, sold loans like popcorn, while the largest thrift, Washington Mutual, stocked up on subprime. Citi packed $135 billion of inscrutable securities in its special investment vehicles. Rating agencies, which were supposed to guard borrowers? interests, signed up with the debtors instead. AIG, the world?s largest insurer, became a hedge fund grafted to an insurance company, while regulators peacefully slept. No one saw the clouds overhead. When lightning struck, few were left standing.
In The End of Wall Street, Roger Lowenstein tells the story of how the lights went out for Wall Street. At the beginning of The End…, Lowenstein introduces the reader to Fannie Mae and Freddie Mac, two government-sponsored, but private entities, which supported US housing by purchasing mortgage bonds. Armed with an implicit government guarantee and excellent political links, the ?mortgage twins? went about their housing mission with gay abandon, buying up dubious mortgage securities. Credit rating agencies helped too, reducing rating standards to suit Wall Street?s wishes. When Lehman and Merrill Lynch took mortgage bonds to Moody?s, S&P and Fitch, they ?helpfully? penciled in the expected credit rating, notes Lowenstein. And if the investment bank didn?t like the rating, the agency received no payment; the bank would simply try its luck with another agency.
The author dedicates considerable space for Lehman and AIG, the investment bank that failed and the insurer that US seized. Lehman was to suspect mortgage securities as Countrywide was to liar loans, both masters in their dubious specialisations. AIG, meanwhile, issued reckless credit default swaps, guaranteeing them from issuer default without knowing their risk.
Lowenstein recounts the desperate surge of Wall Street in the final months before it went over the cliff. Wachovia rushed a merger with subprime lender Golden West because it wanted a foothold in California?which later turned out to be the Ground Zero of mortgage defaults. Merrill accelerated its CDO assembly line, acquired First Franklin, a subprime lender, and targeted New Century, another subprime lender. Bonuses boomed and investment bankers got themselves golden parachutes even as the industry rushed headlong towards the abyss.
Treasury secretary Henry Paulson and Federal Reserve chairman Ben Bernanke debut in chapter 7. Both were ?fundamentally decent?. While Bernanke was ?steeped in econometrics?, Paulson ?believed reflexively in unrestricted markets?. While ex-Goldman Paulson cautioned Bush to ?expect some stress in financial markets?, Bernanke seemed blissfully unaware of the gathering storm even in 2007, when he testified that the ?impact of the broader economy and financial markets of the problems in the subprime market seems likely to be contained?. As it turned out, subprime poison brought the world to its knees.
However, by early 2007, alarm bells had started ringing. The rating agencies were getting concerned about defaults in securities they had rated AAA. The fixed-income chief at Lehman warned of rising risks, but was forced to leave the company instead. Countrywide noticed the refinance market drying up and discontinued no-downpayment loans. Washington Mutual, the country?s largest thrift, came out with huge loan loss provisions.
It?s from here on that Lowenstein?s book becomes a gripping read. Citi starts reporting trouble with CDOs, while Merrill Lynch sacks its chief Stan O?Neal. With values of mortgage securities falling, AIG starts getting collateral calls. Countrywide?s delinquencies surge and a wave of foreclosures sets in, dragging home prices and driving mortgages underwater, which spark even more defaults. Lehman goes belly-up, while the mortgage twins and AIG find refuge in the Treasury?s embrace. The government shoves billions down the throats of nine leading but tottering banks and takes a big chunk of Citi. The automobile industry too would see feds at their doors soon.
Wall Street?s travails of 2008 are largely in the public domain, but Lowenstein?s narrative from the battlefield is engaging and lavish on details, especially when it comes to the specifics of the Bear bailout, the Lehman bankruptcy, the Merrill fire sale and the forced capital injections. The author paints a vivid picture of a treasury secretary agonising over moral hazard and financial stability, a Fed chief stunned to see his theories failing and bluechip bankers huddled in the Fed?s conference rooms through the night, worried of making ends meet the next day, even as a financial hurricane howled outside.