Bought and Paid For (22 page)

The CEOs of the two major firms that went down in 2008, Bear Stearns and Lehman Brothers, were making positive statements about their firms' condition on financial TV and in the newspapers right up until the end. In the case of Lehman Brothers, this was especially dramatic: On September 10, 2008, then CFO Ian Lowitt boasted to analysts of the strength of the firm's liquidity; i.e., its abilities to meet its financial obligation with available funds. Five days later, on September 15, the firm collapsed and filed for bankruptcy. And as we've seen, Lloyd Blankfein of Goldman Sachs
still to this day
proclaims that his firm didn't need the government money during the financial crisis, that it was “forced” on Goldman, and that the firm had been doing just fine through the entire debacle.

So Miller remained unconvinced, particularly because the guy making the statement was Vikram Pandit.

Pandit had survived as Citigroup's CEO into the spring of 2009—but just barely. His bank, of course, was one of the largest recipients of government bailout money. In order to survive, Citigroup had needed not just one but two bailouts in the form of fresh capital from the federal government, and that doesn't count billions of dollars in government guarantees on its holdings of toxic assets. Pandit, to be fair, had inherited much of Citigroup's mess from his predecessors, Chuck Prince and Sandy Weill, the men who had created the Citigroup “empire” with the assistance of Bob Rubin.

“Vikram is the best person for the job, and we had several potential CEOs to chose from,” Rubin nervously explained in early 2009, just before he was forced out of Citigroup, when asked whether his support for Pandit as CEO could be counted among the myriad mistakes that he made during his decade at the company, when it went from the most powerful bank in the world to a virtual ward of the U.S
.
government.

Rubin was defending himself as Citigroup was forced to take another dose of bailout money, one that made the U.S. taxpayer the largest single shareholder of the big bank. Shares of Citigroup, which had traded near $60 during its glory days, were now hovering around $1. Outraged investors had pushed for Rubin's ouster (he would leave in early January 2009), and they weren't crazy about Pandit sticking around, either.

And with good reason: When Pandit replaced Prince in early 2008, he had refused to sell off vast pieces of the unwieldy bank, despite pressure from his investors, who saw nothing but losses for the next year and had begun selling Citigroup shares. And now he was conducting a fire sale of assets to drum up much-needed cash as regulators like FDIC chief Sheila Bair began threatening to end his short-lived career as CEO once and for all.

It was an odd decision for someone who had made it to the very upper echelon of Wall Street, not because of his personality (he's considered among the least inspiring and charismatic of Wall Street executives) but because he was considered one of the smartest. He came to Wall Street with a PhD from Columbia University, and during his many years at Morgan Stanley earned a reputation for understanding incredibly complex financial products, particularly details that eluded more senior executives. And he knew how to make money. In order to get him to join the company, Citigroup purchased his hedge fund for nearly $800 million, even though a year later Citigroup closed the fund due to its poor performance.

That's why it was so confounding that he started out by listening to Bob Rubin, one of the architects of Citi's massive and bloated infrastructure and, in many ways, of the financial crisis itself. Rubin's defense of Citigroup's absurd business model was unyielding. Now Citigroup had created a massive dilemma for the federal government: If it let Citi fail, the taxpayer would have to cover part, if not all, of the $800 billion in customer deposits (because of deposit insurance), not to mention the systemic damage to the financial system when traders had to unwind a balance sheet of nearly $3 trillion.

Rubin's miscalculation was based, of course, on the time-tested Big Government-Wall Street bailout recipe, where the government helps Wall Street by lowering interest rates, thus pumping massive amounts of liquidity into the system and reviving profits. Maybe a bank or two would fail; one immediately did, as Bear Stearns ended up imploding just a few months after Pandit was named CEO of Citigroup. But Citigroup would survive and eventually thrive in this difficult environment because it had a base of customer deposits to draw on if money got tight (a benefit that not even the mighty Goldman Sachs possessed).

By the time the financial crisis reached full force, neither Pandit nor Rubin seemed as smart as his advanced degrees and their reputation had suggested. Citigroup had so many stashes of toxic assets that even top company officials had no idea how much crap it had on its balance sheet. It held some profitable businesses that could have been sold off at a profit—like its brokerage business, Smith Barney—but the time had already passed for Pandit to get top dollar if he tried to sell them.

So, stuck losing money and with nothing to sell, Pandit came crawling to the federal government (Rubin would deny playing any role in the negotiations) for as much bailout money as possible. He nearly lost his job over it, and yet he survived because no one else wanted to run a bank whose symbol on the NYSE is the letter C for “Citi,” but whose symbol among investors had become
S
for “shitty.”

Then something happened—Citi was back in the black just like in the good old days, at least if you believed Vikram Pandit. He claimed that the first quarter of 2009 was Citi's best since before the financial crisis began to pick up steam. If Miller was skeptical, the market wasn't. Shares of Citigroup, which had been trading below $2 (less than the price of a copy of the
New York Times
), were now moving higher—close to $5. That's after the beleaguered banking behemoth logged five straight lousy quarters that produced a staggering $40
billion
in losses.

And Pandit and Citi weren't alone. Two days after Pandit announced his results, JPMorgan Chase's Jamie Dimon, not to be outdone by his old bank, went on television and told CNBC's Melissa Francis that he was optimistic that his bank, also one of the biggest recipients of TARP bailout money, would be profitable in the quarter as well. The remarks sent shares up over 4 percent to just over $20.

Ken Lewis, the soon-to-be-ex-CEO of Bank of America, was under investigation by former Housing and Urban Development (HUD) secretary and current New York attorney general Andrew Cuomo for his role in the bank's controversial purchase of Merrill Lynch. I won't dwell on Lewis's legal problems here, but I will point out what he told the markets about the bank's postbailout progress: Bank of America, with hundreds of billions in bad loans, which inherited Merrill's portfolio of bad debt, made a profit in both January and February 2009, and it would continue to make money for most of the rest of the year.

How can all of this be possible?
Miller thought. He considered the three banks in question: Citigroup was drowning in a sea of subprime loans. A few months ago it had been basically insolvent, and it was now a virtual ward of the state (the government took a 30 percent ownership in Citi in return for its bailouts). Bank of America, based on its holdings of toxic assets, wasn't far behind Citi in terms of the state of its balance sheet, and the government owned a piece of it as well. Jamie Dimon and JPMorgan Chase had escaped the worst of the subprime crisis, but even they weren't without their problem loans and issues. And then there was the fact that the future, at least on paper, didn't look too bright. Wall Street had gotten itself into the mess in the first place by holding onto bonds tied to the real estate market. And as Miller's tour of Fort Myers real estate revealed, housing prices showed little sign of recovering or even stabilizing.

Paul Miller is a good analyst, but like most analysts, he was rarely allowed to explore the inner workings of “the machine,” as the trading operations of Wall Street are known. Among the reasons why the burgeoning financial crisis had escaped the notice of most Wall Street researchers (and of most journalists, as well) is that the trading desks are considered off limits to all but a chosen few. The reason for this is simple: The trading desks are the Fort Knox of Wall Street. Over the past thirty years, the trading desk, particularly the bond trading desk, was where the big money had been made.

The profit margins for creating and trading a mortgage-backed security dwarfed those of any other business on Wall Street. Why offer stodgy merger advice to a corporation or tell a small investor where to put his retirement savings when you can create a mortgage bond and basically print money? The result was that traders like Lloyd Blankfein were picked ahead of the bankers to fill the management ranks.

One of the big ironies of the financial collapse was that while the likes of Blankfein were making so much money for Goldman, they were also creating the situation that led to its demise. Bankers used to love to brag that the mortgage-backed security did so much social good, allowing people who couldn't afford homes access to loans so they could achieve the American dream. Maybe so, but consider the following: All the trading and risk taking with mortgage bonds, particularly bonds for which there was no public market and no way to truly gauge their value, had led to the financial collapse of 2008. Under Blankfein, Goldman had made a decidedly left-hand turn with its support of political liberals like the president and the Democrats who ran Congress, and Goldman was one of the top underwriters of mortgage debt. But that didn't stop the firm, when it saw the crisis coming, from shorting (betting against) the very bonds that Big Government fans touted as vehicles toward universal homeownership. The “big short,” as it was known inside Goldman, had made the firm billions in profits. But Goldman wasn't the only bank that benefited. Indeed, another large benefactor of this process was Fortress Capital, the giant hedge fund that had hired former liberal presidential candidate John Edwards in 2006. It should be noted that Edwards, for all his lofty rhetoric as a U.S
.
senator from North Carolina, a vice presidential candidate, and later a presidential candidate, had something in common with his liberal soul mate Lloyd Blankfein: Both apparently saw nothing wrong with profiting off the demise of the American economy as Fortress, too, was making money betting against the subprime market.

And now, in another irony, it was that same trading that was returning Wall Street to the profitability that even informed skeptics like Paul Miller couldn't believe was happening.

The reason was simple: Miller and his colleagues weren't allowed anywhere inside the Fort Knox-like secrecy that surrounded the trading desks, because if they had been, they would have seen that the Wall Street money machine wasn't a function of brilliant bets on the bond markets (as the firms would later try to spin their return to profitability) but rather another, less publicized bailout engineered yet again by Wall Street's friend, Big Government.

The program was billed as a way to revive mortgage lending to consumers, which had virtually dried up. By purchasing an unbelievable
$1.2 trillion
in mortgage bonds and Treasury bonds (that's almost $4,000 worth of bonds, many of them near-worthless toxic assets, for every single person in the United States), the Federal Reserve would stimulate the lending markets by lowering interest rates, thus reviving the mortgage bond market that allowed banks to make loans to consumers. Forget the fact that the mortgage bond market itself was the reason why so many lousy loans had been made in the first place; it was fairly clear from the beginning that it would be Wall Street rather than consumers that would see the immediate benefits from the program.

“The government stepping in and buying mortgage securities accomplished two things for the banks,” Miller later reflected, as he began making sense of the situation. “It not only gave them a trading partner for all these illiquid assets, but it essentially allowed them to reprice their balance sheet.”