Bought and Paid For (17 page)

The CDO was supposed to lessen risk while at the same time allow banks to sell mortgages to riskier borrowers. The more mortgage bonds were packed into a CDO, the more diversified the risk would be, thus the less likely the entire bond would fall into default. That was the theory, at least. Because after all, what would possibly cause mortgages to simultaneously go into default in Denver, Miami, and Las Vegas? The buyers of these CDOs were safe because even if a few of the mortgages that lay behind these financial concoctions went belly up, the majority would still be earning their nice, fat payments, and the CDO would continue to generate cash for its owners. (This was because technically the firms made sure the CDOs were “overcollateralized,” i.e., had some extra cash packed into them to account for a few defaults.)

Investors flocked to these instruments because they produced such large returns. Liberals who advocated housing as a right, as opposed to something that must be earned, saw the CDO as a savior because it allowed banks to keep making risky mortgage loans. Everyone seemed fat and happy. The housing bureaucrats in the Clinton administration achieved their goal of raising the number of people in homes from 60 percent of the population to 70 percent. Wall Street's profits soared, and Bob Rubin eventually started earning as much as $15 million per year at Citigroup, one of the biggest players in the CDO markets, even though he would later concede he hadn't the foggiest idea how one of these supreme examples of financial magic worked.

The partnership between government and Wall Street was working, until it wasn't.

“H
ello, this is Warren Spector and I'mcalling to see if you havevoted yet.”

It was the twentieth call Spector had made that hour, and yet none of the people on the other end recognized his name or the role he played as the number two executive at Bear Stearns during the burgeoning financial crisis, which ironically was now propelling
his
candidate, Senator Barack Obama, closer and closer to the presidency.

It was the week before the 2008 presidential election, and Spector was canvassing for voters in Palm Beach, a key battleground district in the all-important war to win Florida, a state that had trended Republican in recent years but was clearly now up for grabs. Spector was seated in a large room with other volunteers, mostly college kids, a key force behind Obama's surging campaign. Like the people on the other end of the telephone, no one in the room seemed to have a clue that just a year earlier, their fellow volunteer, Warren Spector, now sitting with them in this drab room, had been among the most powerful people on Wall Street.

Those days seemed so far away. Not long after Wall Street's meeting with Obama at Johnny's Half Shell in Washington DC, Spector had gotten the ax. The Bear Stearns hedge funds he was supposed to be overseeing had failed, giving his boss and longtime nemesis, Jimmy Cayne, the reason he was waiting for to fire his number two. Cayne, of course, would have done it sooner if he had thought the board and investors would have allowed it.

Still, not all of the animosity between Cayne and Spector had to do with business. Spector was acknowledged by all, including Cayne, as an expert in the bond market, particularly the highly lucrative mortgage-bond market, and with him running that part of the business, Bear had become one of the most profitable firms on the Street. That business was now the root cause of the firm's demise.

Instead, the rift can be traced, at least in part, to politics. Spector wanted Cayne's job, and Cayne was doing everything he could to block him, including at one point a few years earlier telling Bear's thirteen thousand employees in a memo that his number two had basically violated company policy when he overtly supported Democratic presidential candidate John Kerry.

“Free speech should not be confused with directly or indirectly using the company to endorse personal political views or agendas,” wrote Cayne, whose staunchly conservative views are well known on Wall Street.

Once the hedge funds—some of the riskiest investments in the market, packed full of toxic CDOs and even CDOs squared (CDOs of CDOs
,
believe it or not)—blew up, Cayne had his excuse to fire Spector, which he did, announcing that a new team would be put in charge to get the firm on the right track. Whatever Spector's faults, Bear could have used him and his expertise in the bond market in the months ahead: A contagion spread throughout Wall Street, and the result of thirty years of risk taking in esoteric securities aided and abetted by both large and small government bailouts began to set in. The big firms were gambling just as the Bear Stearns hedge fund managers had, and they had all loaded up their books with billions of dollars in toxic mortgage debt.

Bear Stearns itself was hit particularly hard, in no small part, Cayne and others believed, thanks to Spector. After all, Spector had been in charge not just of the hedge funds but of the entire bond division. Spector would point out that he wasn't the only executive in charge of monitoring the firm's enormous risk taking (legendary trader Alan “Ace” Greenberg often ran the risk committee meetings). Either way, Bear was the first domino to fall during the great financial crisis that began to unfold in March 2008. But it wasn't the only one. The giant mortgage lenders Fannie Mae and Freddie Mac—which the government used as vehicles to carry out its policy of homeownership as a civil right—would go next, as would hundreds of billions of dollars of taxpayers' funds that would be appropriated to bail them out. The bailouts of Fannie and Freddie, by the way, would only work for a while—as I write this book the
New York Times
was reporting that the cost of bailing out Fannie and Freddie could exceed the cost of all the rest of the bailouts combined. With the bill standing at $145.9 billion in June 2010, the Congressional Budget Office is predicting that the final tab could reach a mind-boggling
$389 billion—
more than a third of a trillion dollars to bail out just these two troubled firms. Later in the fall of 2009, Lehman Brothers would collapse too, though unlike Bear and Fannie and Freddie it would not receive a bailout. Instead it would be forced to declare bankruptcy, a rare show of government restraint when Wall Street had bet wrong.

But as Spector sat in Obama's Palm Beach campaign headquarters, the outgoing Bush administration had come to the conclusion that letting Lehman fail had been a mistake. Following its collapse, a financial panic had set in, threatening to plunge the nation into economic chaos. At least that's what the public was told, and while Federal Reserve chairman Ben Bernanke and Treasury secretary Hank Paulson were predicting unimaginable disaster without unprecedented government support, they were still grappling with how best to save the remaining big investment firms and banks—Citigroup, Bank of America, Merrill Lynch, JPMorgan Chase, Morgan Stanley, and even the great Goldman Sachs.

Over the next six months, they would all receive hundreds of billions in direct and indirect aid from the government to stay afloat as policy makers embarked on a messy, and ultimately successful, rescue effort. Of course, success in this case entailed keeping in business a failed behemoth like Citigroup, which ignored repeated demands from investors to downsize its bloated operations until it was far too late.

But this afternoon, as he dialed one call after another, Spector seemed like he had not a care in the world. And why should he? He had been forced out of Bear in August 2007, nearly a year before the firm's crash and forced sale to JPMorgan Chase for a measly $10 a share. Many of the executives had lost their life savings, which had been tied up in company stock, but not Spector. As soon as he was fired, while Bear's stock price remained at a healthy $100 a share, Spector sold everything and almost instantaneously became $300 million richer.

Spector was known inside Bear for his lack of emotion. Some, like Cayne, considered him moody and arrogant, a by-product of a privileged life (an upper-middle-class upbringing, a fancy MBA, and so on). Cayne was so disdainful of Spector's attitude he used to refer to Spector as “Lord Fauntleroy.” Others who took a more nuanced view of Spector pegged his attitude as an indifference to his job; even while he was gambling billions of dollars of company money in esoteric bond markets, Spector acted as if he had better things to do, like read the
Sunday Times
book review.

But Spector was now legitimately excited to be working for the man he believed was going to be president, even if his post-Bear lifestyle was being mocked by Cayne, now Bear's disgraced ex-CEO (in addition to allowing the firm's risk taking to expand to dangerous levels under his watch as CEO, Cayne had been playing bridge while the firm was imploding in March 2008, when he still held the title of company chairman). Cayne, who had always incessantly questioned Spector's manliness, was now having a field day as he received a report from a former Bear Stearns executive who said he had spotted Spector at a local country club in “tight, tight shorts with a poodle under his arm.”

Others who know Spector say he was just trying to fit in with the campaign staff, many of them college students who didn't even own a business suit. Originally a Hillary Clinton supporter, Spector had slowly but surely become a convert along with the rest of his good friends on Wall Street who had attended that initial secret meeting in Washington a year earlier. During the nomination process, Obama had initially seemed like a long shot. But even as the Wall Street elite bet wrong on their investments in toxic mortgage debt, they soon bet right on Obama, who would go on to beat Clinton thanks to his strong Wall Street support.

They also bet, as we saw earlier, that they were getting the Obama who had displayed himself so elegantly that night in Washington and dismissed his reputation as a Marxist with ties to terrorists. “Obama's a moderate,” another early Obama supporter, Larry Fink, would assure his friends and colleagues as they dined at his favorite Upper East Side restaurant, Sistina, and discussed his impressions of the man who would be president.

Fink wasn't alone. Tom Nides, the Morgan Stanley executive and überlobbyist who had convinced his friend and boss former Republican John Mack to vote for Hillary, now sealed the deal for him to vote for Obama. Jamie Dimon had steered JPMorgan Chase more or less unscathed through the financial crisis, even if the government had forced the bank to take $25 billion in capital as a precautionary measure, but as Election Day approached, the press officials at JPMorgan were giddy over their boss's support for Obama and the pending wave of Democrats to take office that year. And with good reason: JPMorgan supported Democratic candidates and committees at a much higher rate than it did Republicans while Dimon's personal donations show a significant preference for Democrats. Between 1989 and 2009, he and his wife donated more than $500,000 to Democrats and their committees, twelve times more than he gave to Republicans, according to a study conducted by the Center for Responsive Politics, which tracks political contributions.

While most of Spector's Wall Street colleagues showed their support by giving money, Spector gave his time and energy as well. At first, Spector, who splits his days between his luxurious homes in New York and Martha's Vineyard and a palatial estate in Palm Springs, Florida, got involved in the campaign because he was bored. In the midst of the ongoing turmoil he certainly wasn't going back to Wall Street; in fact, given his enormous wealth, he didn't have to.

But it wasn't long before working for Obama became something more fulfilling. Being part of an effort to bring “change” to the country was filling a void in Spector's life. While many men, like Dimon and Nides, loved Obama because they believed he was a moderate—someone Wall Street could do business with and, of course, make money from—Spector, now out of the securities business and someone who had always been involved in Democratic Party politics, was personally satisfied for the first time in years. He was part of something that was “good” and would “make a difference”—clichés, to be sure, but Spector didn't mind. After decades of making money on Wall Street, Spector found purpose in helping elect not only the first African American president of the United States, but also a man with the wisdom to change the direction of the country, to make it more appealing abroad and better for the masses here at home.

Spector and Obama first met in the spring of 2004. It was a lunch meeting arranged through a mutual friend and held at Bear Stearns's private dining room in New York City. At the time, Obama wasn't that far removed from his days as a community organizer who would look at Wall Street as the enemy of the poor and middle class. He was a local state senator vying for a seat in the U.S
.
Senate. Spector didn't really know who he was, and he didn't really have time to waste on political neophytes, but he took the meeting anyway because his friend assured him that he would just “fall in love with this guy.”