On Wall Street, greed is still a good thing: Andrew Ross Sorkin

The date: September 19, 2008

The players: Henry Merritt Hank
Paulson Jr — The 74th treasury secretary of the US, Neel T Kashkari — assistant treasury secretary for financial stability, Kevin I Fromer — assistant treasury secretary for legislative affairs.
The motive: To decide on the amount of money to ask the US Congress for the bailout of the collapsing American financial system. 

The dialogue:
“What about $1 trillion?” Kashkari said.
“We’ll get killed,” Paulson said grimly.
“Okay,” Kashkari said. “How about
$700 billion?”
“I don’t know,” Fromer said. “That’s better than $1 trillion.”
“There’s around $11 trillion of residential mortgages, there’s around $3 trillion of commercial mortgages, that leads to $14 trillion, roughly 5% of that is $700 billion,” said Kashkari. 

And that, ladies and gentlemen, is how the big round number, for the biggest financial bailout in history of mankind was decided.

“The number was made up out of thin air. It was literally Hank Paulson and his team sitting around in a room trying to figure out how much money they could possibly get the Congress to give them,” says Andrew Ross Sorkin, reporter and columnist from The New York Times and most recently, the author of the best selling, fly in the wall account of the initial days of the financial crisis: Too Big To Fail - Inside the Battle to Save Wall Street (The dialogue above has been reproduced from the book). In this interview, Sorkin speaks to DNA on the days leading to the start of the financial crisis and why Wall Street still hasn’t learnt its lessons. Excerpts:

Why did Paulson and Geithner let Lehman Brothers go under? They saved just about everything before and after that...
There were a couple of reasons. The first piece of it was that frankly, they had run out of time and that there was enormous amount of political pressure that Paulson, in particular, was under to not be Mr Bailout. On the fateful Sunday (September 14, 2008) what happened was once Barclays (which was trying to buy out Lehman Brothers) was gone, Paulson thought he had run out of options. Also they (Paulson and Timothy Geither, then president of the Federal Reserve Bank of New York, now Paulson’s successor at the treasury) determined that there was no collateral Lehman had, so they felt that they couldn’t lend.

I also think there was an element of frustration with Dick Fuld (the CEO of Lehman Brothers) and with Lehman Brothers. Paulson had been pushing on them for months and months and months to do something and he felt that they hadn’t. In the final pieces, the regulators let Lehman fail because the CEOs involved in the rescue effort who were around the table that weekend at the Federal Reserve, all were telling the regulators that they had lowered their exposure, and that it would be okay, and that the world would survive without Lehman Brothers.

Why was Lehman unable to do a deal on its own with Warren Buffett, or Barclays Bank, which was interested in buying them or for that matter even Bank of America, which ultimately bought Merrill Lynch?
The problem for Lehman was that they started looking for a buyer way too late. And they didn’t want to accept a low price. There were probably opportunities to have sold the firm or got in a major equity investment much earlier in the year 2008, and would have been even better if they had been looking in late 2007, when some of the other banks raised money. But they didn’t. So by the time they really started looking, the market had turned sour and there were many questions about the way they valued their books.

And what about Warren Buffett?
There was this secret conversation back in March 2008, where Warren had spoken about trying to buy a stake in Lehman Brothers and Fuld did not want to do it and frankly, Buffett did not want to do it either because the terms weren’t going to be good enough, but he was also worried about the business. Everybody was worried about what was on the books of Lehman Brothers. Nobody knew how bad it really it could be.

Would the crisis have panned out differently if Lehman had been rescued?
There is no question in my mind that the greatest mistake that the government made in all of this was letting Lehman Brothers go. Had they not let Lehman go under, the crisis would not have been as nearly as deep. That is not to say that there would have been no crisis at all, because remember, AIG was going to be next and that they would have had to deal with one of these. And by the way, it’s possible that if they had bailed out Lehman Brothers, they would have felt that they couldn’t have bailed out AIG. So it is all very difficult to judge what would have happened, because it is hypothetical. But letting Lehman go on its own was by miles the biggest mistake.

How did the government come around to rescuing AIG a few days after they let Lehman go under?
The reasons for saving AIG were much clear than the reasons for saving Lehman Brothers. AIG had so many counterparties there was a feeling that if you let AIG go, you were going to put a dozen other banks and institutions out of business and really put pressure on economies not just in the US, but around the world.

Remember, BNP Paribas and many other French banks and other global banks were exposed to AIG. The other issue was that the Federal Reserve had determined — wrongly, but determined, none the less — that AIG had enough collateral to lend them money. The calculation was wrong because AIG didn’t have the collateral and at that time, the Federal Reserve thought it did and so the Fed lent the money. Interestingly, if you think who was around the table when they were discussing AIG: Goldman Sachs and JP Morgan.

Everybody at that table had as much incentive to say that AIG had as much collateral as humanly possible, whereas all the people who were around the table talking about Lehman Brothers during that weekend had every incentive to say that there was no collateral, because everybody wanted to buy Lehman for nothing.

Do you think AIG had overextended itself by going beyond its core business of insurance into exotic derivative products such as credit default swaps?
Oh, absolutely! My favourite part of the whole book by the way, is when President Bush says to Paulson and Ben Bernanke: “An insurance company does all this?” Well, this one did. If you had asked 99% of the world ‘What does AIG do’, they would have told you it’s an insurance company. But it really was so much more. And that was a big part of the problem.

How did something like that happen?
It was never regulated by the Federal Reserve or the Securities Exchange Commission (the stock market regulator). The way it works in the US is that there are statewide regulators. So let’s say if you run an insurance company in the state of New York, you will be regulated by the New York state insurance regulator. So the regulator was always looking into the subsidiaries of AIG. Nobody was looking at the parent company nor were they looking at AIG Financial Products, which was a separate unit, which ended up not being regulated. Most of the derivative trading that they did was so opaque that it was difficult for regulators to appreciate or comprehend how deep they were in these markets.

How did Paulson go from being “I can’t be Mr Bailout” to someone who rescued almost everybody?
It was very difficult for him getting his head around to the idea of rescuing everybody. But that Wednesday after the authorities had let Lehman go (September 17, 2008) and after they had saved AIG, when they saw that Morgan Stanley was next, and that Goldman Sachs was after that and that General Electric, the global conglomerate, could be in jeopardy…

We were at a moment were big and small companies potentially were not be going to able to make payroll the next week. And that’s why it was quite an extraordinary problem. And that was the awakening, a realisation that the only way to fix this would be to truly step into the bridge. He hated it and I mean literally, it was something that bothered him very much. But he felt that it was the thing they needed to do. And frankly, in the end, it was the right thing to do though we would be living with the repercussions of those decisions for years to come.

Do you think the Wall Street CEOs involved in the initial stages of the rescue had an idea that they were a part of history as it was being made?
I spent a lot of time with many of those participants and I think they did realise it. There were some of them who actually ended up taking notes at the meetings. And I asked them why they took notes, because most of these CEOs never take notes. At least one of them said to me that this was history in the making.

People at the helm of things at Wall Street are the best of the breed. Why do you think they didn’t see the crisis coming?
Great question! This generation of leaders on Wall Street had never experienced failure like this before. The idea that the entire system could fall apart was beyond their comprehension. I would say it is like the failure of imagination. I am a journalist, you are a journalist and I would say that we are professional sceptics. If you are on Wall Street, a part of your job is to be a professional optimist. Really. Jamie Dimon a couple of weeks ago was on Capitol Hill and he was saying that when they built their models, they did not include the assumption of real estate prices falling. And it was just remarkable. It was just a lack of control, lack of oversight and a lack of imagination on what really could happen.

Did the Federal Reserve and Treasury officials realise the magnitude of the crisis when they initially started to deal with it?
Oh, they missed it completely. The regulators missed it. Alan Greenspan missed it. Ben Bernanke missed it. Hank Paulson missed it. Tim Geithner missed it. Throughout the entire process, they were always behind, they could never catch a break. Everyday was worse than the day before. It was very difficult for them, but there is no question that like the people on Wall Street, they missed it too. And I always say one of the reasons for that is this sort of ‘groupthink’, where all of them come from the same background, and they think the same way.

The feeling that one gets from your book is that the entire rescue process in September was extremely haphazard. As Ben Bernanke put it and you quote in the book, “There are no atheists in foxholes and no ideologues in financial crises.”
Zero. You are absolutely right. There was no plan. They had thought about different contingency plans, but they never really, really, had a plan on how to deal with any of these things. Again, because they never really, truly comprehended that they were going to be in this place. And it is worrying for a lot of people when you realise that your elected officials didn’t have a plan. It’s nerve wracking.

How did the $700 billion bailout number happen?
That they made up. And that’s what I find so comical about it because the number was made out of thin air. It was literally Hank Paulson and his team sitting around in a room trying to figure out how much money they could possibly scare the Congress to give them. So the number had very little to do with what they thought they needed and everything to do with how much they thought they could get.

What was the most audacious rescue proposal you heard about during those days?
The most audacious or surprising proposal in my mind was the effort to put Goldman Sachs and Citigroup together. When Tim Geithner had called up Llyod Blankfein and suggested that he call Vikram Pandit. To think now what would have happened had Goldman Sachs and Citigroup been merged is quite a thought. Citigroup, as you know, required a massive government bailout only months later.  So if you had merged it with Goldman, the situation frankly might have been worse.

Most of Paulson’s team at the Treasury were ex-Goldman employees. Did that have an impact on the decisions they made?
Yes and no. I do believe that the number of former Goldman employees clearly created as I said before, what I call the ‘groupthink’ about how they approached all these issues. And by the time Goldman was in trouble, clearly there was an effort to make sure that firm did not go under. But I don’t think that they did anything to try to advantage Goldman at the disadvantage of everybody else, despite all the conspiracy theories.

Would you say Wall Street was a victim of “a strategy that worked extraordinarily well right up until the moment it didn’t?”
Oh, 100%. On Wall Street, everything works until it doesn’t, and that’s what happened.

One of the things you say towards the end of the book is “the sad reality is that Washington typically tends not to notice much until an actual crisis is in hand.” Do you think things have changed since the crisis broke out?
It’s funny, [but] if you had asked me that question only a couple of weeks ago, I would have told you that things seem to be the same and sadly so.

Over the past couple of weeks here in the US, there has been a real popular outrage around the country on what’s going on in Wall Street. And President Obama has made a number of proposals to reign in Wall Street. It’s the first time we are seeing some of these things. I wish that they were more comprehensive, meaning he is kind of announcing one plan one week. It would be much better if there was a comprehensive plan. But I do think that Wall Street, as a result of these things, is going to change and you are already seeing a little bit with the incentives. The bonuses are coming down. They are being put more in stock. There is less leverage. But I will tell you that the ethos, the culture of Wall Street hasn’t changed. Greed, as Gordon Gecko said in the movie Wall Street, is still good.

What about the likes of Goldman and Morgan Stanley which survived the crisis. Are they still taking on the kind of risk as they did in the past?
Morgan Stanley is clearly not taking the same kind of risk. They have changed their model quite substantially, in part, because they were not very good at taking risk. Goldman Sachs is still taking an enormous amount of risk, probably more so than just about any firm on Wall Street. It will be interesting to see whether the government really puts pressure on them to stop taking such risk.

Could you elaborate on this?
If you were to look at Goldman’s earnings, a disproportionate amount of their earnings comes from proprietary trading, trading for their clients. So they are taking on risks to do that whereas at the other firms, most of their revenues are coming either from advisory services or other types of businesses that don’t require enormous amount of risk. Goldman is still, at some level, operating with more risk on a day-to-day basis. In fact for Goldman, the value at risk, the kind of money at risk everyday, was actually higher last year than it was a year before the crisis.

How do you see this crisis playing out?
Oh boy! If I knew that, I wouldn’t be a journalist. (laughs)

But that is a question one needs to ask...
’Know it is. I suspect that we are going to see more and more efforts at regulation over the next 12 months. I don’t know if they are going to have any teeth. I don’t know if the regulations are going to be significant or if they get watered down, but I do think it’s going to be a part of a national and global conversation about Wall Street and risk, for months, if not years to come. In the US especially, it does not look like that the economy is going to be coming back in a major way anytime quickly. I imagine that we are going to be bumping along the bottom for a very long time.