Bought and Paid For (12 page)

But Dimon and Blankfein continued to press: The system was better, they assured the administration, and their firms were better—they spun a tale of a Wall Street that had learned its lessons from the past. They claimed they no longer used massive leverage and wild trading strategies to make money.

More than that, in order to survive in the long term they needed to retain talent, people like that young Goldman trader I spoke with, who could make serious money trading at hedge fund if Goldman was no longer able to pay him the big bucks.

Dimon, notorious for his quick temper and lack of patience, was about to explode as the paper pushers in Washington kept dragging their feet through the late winter and early spring of 2009 on the firm's repaying its TARP money. During a town hall meeting with his employees, he explained his frustration when he was sitting before one of the numerous congressional committees investigating the banking crisis. “While I was sitting there, I was thinking I should raise my hand and say, ‘I will wire you back the (TARP) money if you let me leave right now,' ” Dimon quipped to massive laughter and applause.

By the spring of 2009, the administration, for all its misgivings and concerns about the safety of the banking system, finally succumbed to the relentless pressure. JPMorgan Chase, Goldman, and Morgan Stanley would be allowed to repay their TARP money by the summer; Citigroup and Bank of America, given their mammoth size and equally mammoth problems, would do so later in the year.

And so, of course, the bonuses began to flow again.

There is a theory, promoted for years by the banks and accepted as gospel by their defenders in government, that helping Wall Street profit is good for the country: As the banking system improves and strengthens, small businesses will have access to credit, while entrepreneurs will be able to find more capital to expand. This is, of course, the argument Bob Rubin, both inside the White House and later as a Wall Street executive, has made for years, first to Bill Clinton and now to Barack Obama. But small-business lending has fallen significantly despite the improving profits of the banks.

Look no further than Citigroup. In the first quarter of 2009, the company made $1.5 billion in profit. The next quarter, it earned $4.2 billion. But the bank's consumer lending fell. In the first quarter of 2009, Citigroup had a little more than $301 billion in outstanding consumer loans. But in the next quarter, that number fell to $292 billion. By the end of the year, it fell to $270 billion, a 10 percent decline. While the bankers were getting rich trading with the government, the average Joe was having trouble getting a loan. Same story for Bank of America. It earned $4.2 billion in the first quarter of 2009 and another $3.2 billion in the next quarter. Like other firms, these profits were driven not by taking risks on businesses and people but simply by trading some stocks but mostly bonds. In the first quarter of 2009, the bank generated $7.5 billion in trading profits. In the second quarter, the bank's traders made even more money: $7.7 billion. But in those same two quarters, outstanding consumer loans fell to $543 billion from $564 billion, a decline of more than 3 percent. By the end of the year, Bank of America's outstanding consumer loans fell to $531 billion, a decline of more than 5 percent. In fact, it seems that the big banks have plowed most of their profits into massive new bonus pools to reward their employees as the benefits of Big Government continue to flow to Wall Street through Obama's second year in office.

It is Wall Street, after all, that gets to profitably underwrite the trillions of dollars in state, local, and federal debt that will be sold in the coming years to support Obama's Big Government agenda—government-run health care, the $800 billion economic stimulus program, expensive climate control legislation, and any of the countless other programs that the new administration plans to unleash that will grow the national debt to historic proportions.

With that in mind, now is the time to take a closer look at just how the Wall Street firms benefit from the expansion of government and what the consequences can be for the rest of us.

For decades Wall Street has been doing wonders to keep Big Government at as big a level as it can, almost always at the expense of the average American taxpayer. When Rudy Giuliani was mayor of New York City, his staff members reached out to their friends on Wall Street and cooked up an idea to plug the city's massive budget deficit: They would create a dummy corporation that would sell bonds for the purchase of the city's water system. Water taxes would pay off the debt over time, the city was assured, and the proceeds of the bond sale would flow right into the mayor's hemorrhaging budget.

Everyone seemed to benefit, except the taxpayer. The Giuliani administration wouldn't have to make politically painful budget cuts, and the firms underwriting the city's bonds would make a fortune—their bonus checks coming right out of the pockets of taxpayers. In Giuliani's defense, he inherited a massive and unwieldy bureaucracy from his predecessor, David Dinkins, and by the end of his eight years in office had cut the size of New York City's government more than any of his predecessors or, for that matter, the man who succeeded him, billionaire businessman Michael Bloomberg.

But the fact remains that a big reason New York City and, for that matter, New York State, have some of the highest taxes in the country, crippling business development and forcing the middle class to move elsewhere, is because all that tax money is needed to pay off loads of debt piled up as politicians balance the books with Wall Street chicanery. By the time Giuliani left office, the city was shelling out a little more than $2.5 billion a year in debt-service payments; today the city is paying closer to $5 billion annually—that's more than $7,000 for every citizen in the city, according to the
New York Daily News
.

Wall Street firms are supposed to have their own research arms to analyze the safety and the security of these bonds. But like the rating agencies that are paid by the city to rate its bonds and have given the big spenders a free pass, the big firms have barely raised an eyebrow about New York's massive indebtedness (approaching a combined $200 billion), and when they do, it is usually in hushed tones.

Meanwhile, New York City chugs along, with mayor after mayor praying that those Wall Street bonuses keep on flowing so their tax revenues keep growing. But other municipalities, where budgets aren't supported by people making millions a year in salary, face a very different reality.

Just ask the citizens of Orange County, California.

Orange County, a sunny suburban oasis south of Los Angeles, is known for its political conservatism (an airport named for conservative icon John Wayne is located there) and its beautiful beaches. It is the last place you would have thought would engage in shady and dangerous fiscal practices. But back in the early 1990s, facing a burgeoning budget deficit and a public that didn't want to pay for it (and didn't want to cut spending, either), the county's treasurer, Robert Citron, turned to Wall Street for help.

He found a partner at Merrill Lynch in Michael Stamenson, a top salesman of bonds and other financial products, mostly to state and local governments. If you were a young broker who wanted to be a player at Merrill Lynch back in the 1990s, Michael Stamenson had simple advice for you: Possess the “tenacity of a rattlesnake, the heart of a black widow spider, and the hide of an alligator.”

This philosophy had paid off for Stamenson, who, while at Merrill, had amassed a small fortune—one much larger than that of any of the government bureaucrats who were his clients. That fortune bought him three homes in which he threw lavish parties, featuring valet parking; a seven-figure income; a beautiful young second wife; and, most of all, the admiration of his colleagues. “I would say that Stamenson is exceptional as far as understanding the investment philosophies and goals of the clients he works with,” former Merrill CEO David Komansky once told the
New York Times
.

It's fair to say that Stamenson was at ground zero of Wall Street's love affair with Big Government. He built his business by catering to local municipalities, which had huge investment pools that needed to be put to work—meaning they needed to be invested in securities that would produce higher-than-average returns so those returns could be directed back into the budgets of states, counties, and cities (if there's one thing I've learned in decades of reporting on politics, it's that no government bureaucrat
ever
wanted a smaller budget).

In the early 1990s, Stamenson's expertise was in high demand. The economic downturn that had begun with the implosion of the junk bond market in late 1989 hit the real estate market hard and fast, and tax revenues began to plummet. State and local budgets in California and New York were hit particularly hard. Both were among the highest-taxed states in the country, with all that money going to support massive spending plans: lavish deals with unions, generous welfare benefits, and more. Politicians in both states refused to cut services—fearing a backlash from unions and other interest groups—and they could raise taxes only so much.

So they turned to Wall Street, and in large part to Stamenson, for help.

Robert Citron seemed like a typical client of Stamenson's in that he was Orange County's longtime treasurer (for twenty-four years) and he knew his way around Wall Street—he had been dealing with the big firms for years to underwrite his county's debt and, more important, to help him manage the county's various investment pools. The way the county's budgeting worked, tax money from local governments and school districts in the county were funneled into the countywide pools, and Citron was in charge of investing the money.

Citron appeared to be a modest man. A Democrat in a largely affluent Republican county, he ate regularly at the local Santa Ana Elks Club, a dingy local hangout that offered unlimited soup and salad for $4.50. He bought his clothes at local outlets and favored bright polyester pants and pastel blazers. He liked turquoise jewelry and often spoke of his fondness for USC, his alma mater.

But those quirks aside, it was his supposed financial acumen and, as it turns out, zeal for successful risk taking that had made him a local legend. Under his watch, Orange County's investment pools produced the type of returns that would make any fancy hedge fund manager green with envy. As a result, tax increases remained a distant reality despite massive government spending on everything from roads to new schools. During much of Citron's tenure as treasurer, spending grew a whopping
10 percent
annually.

That's why the massive returns from his hedge fund (for that's what the investment pool he ran really was) were so important; despite Orange County's reputation for staunch conservatism, Big Government was flourishing in the warm California sun, and it was being paid for by Citron's investment strategy, which was no different from that of a typical hedge fund investing in exotic securities that could blow up at any moment.

Helping Orange County pay for this largesse was Wall Street—or, to be more precise, a consortium of Wall Street lenders that included Credit Suisse but was led by Merrill Lynch, thanks to Stamenson's relationship with Citron.

Needing to drum up revenues to finance the county's big spending, like the finance ministers would do in Greece years later (thus leading to their national economic collapse in 2010), Citron frequently bet on derivatives known as swaps, or instruments whose value would fluctuate widely depending on the direction of interest rates. In one case, he purchased $100 million worth of securities whose value would increase if interest rates fell but would plunge if interest rates rose.

The strategy worked for years, and Citron was a local-government superstar, the Oracle of Anaheim, so to speak. But in 1994, the Federal Reserve began raising interest rates and Citron stopped looking so omniscient as losses in his investment pools began to mount. Under the deal he had cut with Merrill, the county had to post “collateral,” or make payments to the Wall Street firms on the other side of its swaps, as its losses mounted. Citron couldn't just walk away from these deals; to do that would be a financial death sentence, a black mark as far as Wall Street was concerned, making it difficult to sell bonds and finance the county's operations in the future.