Inside Job (22 page)

THE BUSH ADMINISTRATION’S
handling of the emerging crisis was bizarre and frightening even when it was competent, which was rarely. On the one
hand, the year 2008 was marked by unquestionably deep, sincere concern for financial stability on the part of Henry Paulson and Ben Bernanke, who both worked inhumanly hard to forestall global
collapse. Yet the administration’s response was also marked by a stunning obliviousness to the causes, severity, and consequences of the crisis on the part of the very same Henry Paulson and
Ben Bernanke; a completely clueless president who made Jimmy Cayne on the golf course look like an obsessively detail-oriented micromanager; total disregard on the part of the Bush administration
for the effects of financial sector and government conduct on the bottom 99.9 percent of the population; and financial sector elites oscillating between fear and greed.

But we must pause for a moment of gratitude that the crisis did not come under the tenure of Alan Greenspan or, worse, that of John Snow, who was Treasury secretary from
2003 until mid-2006. Mr Snow isn’t stupid in the narrow academic sense; he has a PhD in economics and a law degree. But he had zero working experience in finance. After his academic work he
became a lawyer, then an assistant secretary of transportation, then CEO of CSX, a railroad company, from which position George W. Bush plucked him to run Treasury.

There is no evidence that Snow had the faintest clue about a bubble. He resigned in 2006 only because it was revealed that he had not paid any taxes on $24 million in income from CSX, which had
forgiven Snow’s repayment of a gigantic loan that the company had made to him. Upon leaving Treasury, Snow became chairman of Cerberus Capital Management, a huge private equity fund. Cerberus
also employs former vice president Dan Quayle, and several of its portfolio companies have benefited from US government contracts dependent upon political influence. The principal hallmark of
Cerberus’s first major new investments under Mr Snow was not corruption, as that might seem to imply; it was breathtaking stupidity. Cerberus purchased half of GMAC, General Motors’
financing division, and 80 percent of Chrysler. Both collapsed immediately after the crisis erupted, wiping out most of Cerberus’s investment by mid-2009 and requiring over $20 billion in
emergency government assistance.

But even under Bernanke and Paulson, it still wasn’t good. They continued to deny the existence of a bubble or potential crisis until the bitter end, and for two years Bernanke continued
Greenspan’s refusal to regulate the mortgage industry. Only in late 2007 did the US Federal Reserve create draft regulations under the 1994 HOEPA law, and the regulations were not issued
until mid-2008, which was just a teeny bit late. By early 2008 warnings of impending crisis were coming from almost everywhere. In addition to Bill Ackman’s mid-2007 presentation and Allan
Sloan’s October 2007 article in
Fortune
, there were warnings by New York University economist Nouriel Roubini; Charles Morris’s book
The Trillion Dollar Meltdown
,
published in February 2008; verbal
warnings by the leadership of the IIMF, including its then managing director, Dominique Strauss-Kahn; and warnings by Christine Lagarde
(then France’s minister of economics and finance, and later StraussKahn’s successor at the IMF) at the G8 meetings in February 2008.

In a recent private conversation, a senior financial executive observed to me that Goldman Sachs executives have a decidedly mixed record when operating outside of Goldman Sachs. Referencing Jon
Corzine at MF Global, Robert Rubin at Citigroup, and John Thain at Merrill Lynch as well as Mr Paulson, this executive commented that these men were trained to be traders and managers in a tightly
structured universe, but not to think about large-scale structural and conceptual issues, or to deal with organizations far messier than Goldman. Whether this accounts for Paulson’s
complacency, I do not know. But even in private meetings with his counterparts, and as late as mid-2008, Paulson was stunningly complacent about the oncoming crisis.

Paulson and Bernanke have thus far largely escaped the condemnation they deserve, perhaps out of gratitude for their unquestioned nerve and commitment once the acute crisis period began in
September 2008. For the most part, I would not presume to second-guess the majority of their actions during those chaotic, psychotic, terrifying weeks of September and October 2008. But their prior
and subsequent conduct is another matter. And even some of the decisions taken during the crisis period reveal an ability to be cool and careful when investment bankers’ interests, or their
own, were at stake.

Bernanke was a lifelong academic who had never done anything else until appointed to the Federal Reserve Board in 2002. He clearly has excellent diplomatic and political skills, but he had never
had any experience either as a banker or as a regulator prior to joining the Fed. He became chairman of the Federal Reserve Board only in early 2006, just as the bubble was peaking. During the
crisis, Bernanke appears to have deferred to Paulson, and obeyed his orders, almost without exception.

Paulson certainly had very impressive experience, but also a slightly peculiar and somewhat unsavory career. He had a wholesome, all-American youth in small-town Illinois; he was an Eagle Scout,
a
football player, and a devout Christian Scientist. (In his frequently selective and self-serving memoir
On the Brink
, Paulson goes out of his way to defend his
religion’s attitude towards medical care.) But in 1972–73, Paulson served as the personal assistant of White House counsel and domestic affairs assistant John Ehrlichman, another devout
Christian Scientist, during the period when Erhlichman was working intensively to cover up his highly criminal activities in the Watergate affair. We don’t know what Paulson saw or heard at
the office, but by early 1973 there was already clear public evidence that Ehrlichman had done some very nasty things, including running covert burglary and political sabotage operations and
assisting in the Watergate coverup. Yet Paulson stayed in Ehrlichman’s employ. Under mounting pressure, Nixon forced his aide to resign in April 1973, and Ehrlichman was convicted of
conspiracy, obstruction of justice, and perjury in 1975.

Paulson joined Goldman Sachs in 1974, worked very hard, and rose fast, becoming chief operating officer and then CEO in 1999, mounting a coup that forced out his predecessor Jon Corzine. Given
Paulson’s background, it seems very difficult to believe that he had no sense of the increasingly dishonest, unsound nature of Goldman’s mortgage CDOs in 2004–2006, the height of
the bubble. By the time Paulson left Goldman in May 2006, it had issued tens of billions of dollars of increasingly toxic mortgage securities, and had extensive dealings with several of the worst
originators. It was only seven months after Paulson’s departure that Goldman started its Big Short.

Paulson also appears to have fully supported and in several cases championed Goldman’s, and his industry’s, many deregulatory efforts throughout the 1990s and the 2000s. These
included repealing Glass-Steagall, banning the regulation of OTC derivatives, relaxing disclosure requirements for mortgage CDOs (via a joint letter to the SEC signed by Goldman and Morgan Stanley
executives in 2004), relaxing the SEC’s leverage restrictions on investment banks in 2004, and continuing the Federal Reserve’s long-standing refusal to regulate the mortgage industry.
As Treasury secretary, Paulson also lobbied to reduce the power and funding of the SEC.

As darkness gathered in 2007 and 2008, there was no serious attempt by Paulson or Bernanke to create a systematic monitoring process for the financial system—which,
of course, would have been fiercely resisted by Mr Paulson’s former employer and others in the industry. In fairness to Paulson and Bernanke, they inherited a badly outdated and weakened
regulatory system. But in significant measure, this was the result of their own deliberate actions to cripple it—Bernanke while on the Federal Reserve Board, then the Bush White House staff,
and then finally as chairman of the Fed, and Paulson when he was running Goldman Sachs, which lobbied fiercely and continuously for ever more deregulation.

The combination of the industry’s incentives for secrecy or even disinformation, weak disclosure requirements, the progressive crippling of the regulatory system, and Bernanke’s and
Paulson’s own ignorance and/or dishonesty was an extremely destructive cocktail. Indeed, one clear lesson from the crisis is that almost nobody in the financial sector had incentives to be
honest or to warn the regulators—not those gaming the system, not most of those betting on its collapse, not even those who were about to collapse themselves. As 2008 progressed Paulson,
Bernanke, and the whole world were repeatedly blindsided by developments that could have been predicted, and which in some cases (e.g., the collapse of the CDO market and of AIG) actually
were
predicted—especially by Goldman Sachs, the hedge funds betting against the mortgage market, and various economists. But precise assessment and management of these developments
depended upon facts that Paulson and Bernanke never seemed to have. As the various narratives of the crisis make clear, Paulson and Bernanke generally had no more than two to three days’
advance notice of the impending collapse of major financial institutions including Bear Stearns, Lehman Brothers, Merrill Lynch, AIG, Washington Mutual, and Citigroup. The same was true of
upheavals in the commercial paper market and money market funds. In most cases, these events could have been foreseen substantially earlier.

The further consequence of Paulson and Bernanke’s willful
information vacuum was that they did virtually no planning for, or analysis of, what would happen if major
firms did fail. For example, when Lehman Brothers went bankrupt, neither Paulson nor Bernanke was aware that British and Japanese law required that the assets of Lehman’s local subsidiaries
be frozen, preventing Lehman’s clients from retrieving their money. Nor did they understand that Lehman’s bankruptcy would have immediate, major effects on commercial paper markets and
money market funds that held large amounts of Lehman’s short-term debt.

Their lack of preparedness was worsened by the utter incompetence or inexperience of many senior administration personnel. Christopher Cox, the chairman of the SEC, was a former corporate
attorney and Republican congressman with no previous experience either in financial services or as a regulator. He also had significant health problems during the late bubble period, having
undergone cancer surgery in January 2006. Cox had gutted the SEC’s risk monitoring and enforcement organizations, which did not file a single lawsuit related to the mortgage bubble under his
chairmanship. But he was far from alone.

In my film I show selections from my interview with Frederic Mishkin, who was one of the seven members of the Federal Reserve Board from September 2006 through August 2008. (Or rather, one of
the few members of the board; during much of the crisis period, two and sometimes three of the Fed Board seats remained vacant.) Mishkin resigned effective 31 August 2008, two weeks before the
collapse of Lehman, Merrill Lynch, and AIG, and one doesn’t know whether to be outraged or grateful. His record is a stunning litany of judgement errors and occasional hocus-pocus, ranging
from his paid boosting of Icelandic banks in 2006 to his being unaware of the high credit ratings still enjoyed by major banks on the brink of their collapse in September 2008.

In July 2007 Paulson recruited David McCormick, whom I also interviewed for my film, from the White House staff to become the Treasury Department’s undersecretary for international
affairs. It was a very odd choice, perhaps designed to ensure that Paulson faced no competition in the international arena. I have known David
McCormick, slightly, for a long
time, although we haven’t talked since the release of my film
Inside Job
(which doubtless made him quite unhappy). David is an intelligent, accomplished man who studied engineering at
West Point, served in the first Persian Gulf War, and then had a very successful business career, first in consulting and then in the software industry. In the Bush administration he likely spent
too much energy averting his eyes from everything in front of him, but I think that David is basically a decent, thoughtful guy.

But was David McCormick the right guy to be the Treasury Department’s undersecretary for international affairs during the worst financial crisis since the Great Depression? No way. David
had no experience with international finance, very little international experience of
any
kind (outside of the Persian Gulf), and had never worked either in a financial institution or at a
financial regulator. Here are some excerpts from our exchanges about Lehman and various international issues related to the crisis.