Antiplanner’s Library: Too Big to Fail

The Antiplanner finished reading Too Big to Fail, a 539-page tome describing the events of the financial crisis from the Bear Stearns collapse in March, 2008 to the Treasury’s forced purchase of billions of dollars worth of shares in nine major banks in October, 2008. New York Times reporter Sorkin says the book is based on “more than five hundred hours of interviews with more than two hundred individuals who participated directly in the events surrounding the financial crisis.”

With the exception of an eleven-page epilogue, the author makes no apparent attempt to interject his own opinions about what happened. As such, the book represents the best and worst of modern journalism: the best because it appears to be a frank recitation of events on Wall Street, in the Fed, and the U.S. Treasury; and the worst because the accuracy of that recitation depends on who the author interviewed (whose names he doesn’t specifically reveal).

In one curious scene, New York Fed general counsel Thomas Baxter tells Lehman executives that the Fed has decided to force Lehman’s to file for bankruptcy. Although Lehman President Bart McDade was among those in the meeting, as told in the book the meeting turned into an eyeball-to-eyeball confrontation between Baxter and bankruptcy attorney Harvey Miller. “Why is bankruptcy necessary?” Miller yells. “There’s going to be Armageddon” (357-358). It seems peculiar that Miller, who stood to make hundreds of thousands of dollars in the bankruptcy and almost nothing if the company didn’t go bankrupt, would take such a strong stand while Lehman officials whose jobs and fortunes were on the line sat on the sidelines. it seems likely that Sorkin learned the story of this meeting from Miller.

More serious examples of such bias are evident throughout the book. Some people such as J.P. Morgan CEO Jamie Dimon, come off as heroes, while others, such as SEC Chair Christopher Cox, FDIC Chair Sheila Bair, and Lehman Brothers CEO Richard Fuld appear incompetent or even villainous. The Antiplanner can’t help but wonder if the people who get the most positive treatment are the ones who gave the best interviews.

For example, Fortune magazine ranks Bair as the second-most powerful woman in the world, yet Sorkin paints her as a “media grandstander” who obstructed important policy changes because her “only concern was to protect the FDIC” (496). To stabilize markets, Treasury Secretary Henry Paulson proposed that FDIC should guarantee all bank deposits, not just the first $100,000 (increased to $250,000 by the TARP bill). Bair opposed this, the book suggests, only because of “the extraordinary strain such a guarantee could put on the FDIC” (511). Yet it isn’t hard to think of legitimate reasons why this is a bad idea. Can you spell “moral hazard”? Such guarantees, when not countered by some other regulation or incentive, are what led to the savings & loan scandal.

The book paints Richard Fuld, who was CEO of Lehman Brothers for longer than the heads of any other major bank, as the biggest villain. In A Colossal Failure of Common Sense, former Lehman employee Larry McDonald says Fuld was so out of touch with his company that–until a few months before the bankruptcy, when an internal revolt forced him to make changes–no more than a handful of employees had ever seen, much less met him. Sorkin ignores Fuld’s employee relationships and focuses on his seemingly effortless ability to sabotage every effort to save the company.

For example, when Lehman executives are desperately seeking help from Morgan Stanley, Fuld accused Morgan Stanley of trying to poach Lehman’s top people (192). After Lehman’s President McDade reaches an agreement to have a Korean bank buy out Lehman for 125 percent of book value, Fuld antagonizes the Koreans by demanding 150 percent (214-216). Sorkin calls Fuld “naive” but, in the epilogue, apologetically suggests he was “driven less by greed than by an overpowering desire to preserve the firm he loved” (535).

To the Antiplanner, the real incompetents are Treasury Secretary Paulson and New York Fed President (and current Treasury Secretary) Timothy Geithner. The book portrays them as working tirelessly to preserve the financial system. Yet they misread the problem in the first place, and then tried to impose half-baked solutions on banks without any detailed consideration of the consequences or input from the banks themselves.

The misreading had to do with focusing on Lehman’s while ignoring AIG. Right up to the day Lehman’s filed for bankruptcy, Paulson and Geithner spent all their time trying to deal with Lehman’s. Yet AIG turned out to be far bigger and far more interconnected with other banks around the world. Lehman’s, for example, was a record-setting $600 billion bankruptcy. But AIG had $2.7 trillion of derivative contracts with 12,000 other companies–and that was just a fraction of AIG’s total operation (236).

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When Bear Stearns collapsed in March 2008, Paulson and Geithner persuaded J.P. Morgan to take over the company by offering $29 billion in federal loan guarantees. But they caught so much flack for violating free-market principles that, when Lehman’s collapsed in September, they refused to offer similar guarantees. Lehman’s, in their estimate, wasn’t “too big to fail.” Within hours of Lehman’s bankruptcy, however, it quickly became clear that AIG was too big to fail, so Paulson decided the taxpayers should bail it out by buying 80 percent of the company at an eventual cost of more than $180 billion, much of which will never be repaid (532, 537).

AIG’s CEO Robert Willumstad had been in his job for only three months, having inherited a mess from his predecessor. But as soon as Paulson agreed to bail out the company, he decided to replace Willumstad so it wouldn’t “seem as if the government was backing the same inept management that had created this mess” (396). WIth almost no thought at all, Paulson picked Ed Liddy, the former CEO of Allstate (397). When notified of this decision, an AIG board member said, “If we were looking for a CEO of this company, not only wouldn’t he have been on the short list, he wouldn’t have been on the long list” (404). Liddy lasted only eleven months (532).

In the meantime, the rest of the banking and investment industry was falling apart, which Paulson and Geithner tried to fix by ordering banks to merge with one another–as if banks that were too big to fail could be saved by making them even bigger. One minute, they told Morgan Stanley to merge with Citigroup. The next minute, they told it to merge with Wachovia. Then they told it to merge with J.P. Morgan.

The executives of these companies would dutifully call their counterparts to start merger talks, but none of them could take it seriously when they were almost immediately told to merge with someone else. When Morgan Stanley asked Mitsubishi to buy a share of the bank for $9 billion, Paulson told Morgan Stanley’s CEO to drop the talks because “they’ll never do it” (474). Yet Mitsubishi’s investment ultimately saved Morgan Stanley. “So unpopular was Geithner’s single-mindedness about merging banks,” says Sorkin, “that some CEOs began referring to him as ‘eHarmony,’ after the on-line dating service” (480).

As the depths of the crisis became clear, Paulson’s team proposed to Congress that the federal government buy up to $700 billion of subprime mortgage bonds and other “toxic assets.” After Congress passed the bill, Paulson suddenly decided instead to simply “invest” in the banks by giving them billions of dollars and taking proportionate shares of the banks.

At the time, Paulson and Geithner were so clueless that they thought Citigroup was one of the sounder banks. So they decided to force Citigroup to accept $25 billion so as to not stigmatize other banks that truly needed the money (514-515). On October 13, they ordered the CEOs of Citigroup, J.P. Morgan, and seven other banks to Washington for a meeting at which they announced that the federal government was going to use TARP funds to “invest” in the banks (524). Vikram Pandit, the CEO of Citigroup–which was in much more serious trouble than anyone outside the bank knew–got a “huge grin” on his face “as if he had just won the Powerball lottery” (527) The government wound up giving Citigroup tens of billions more, much of which it will probably never get back (530, 537).

Meanwhile J.P. Morgan CEO Dimon, whose company didn’t need a bailout, told his staff that this “was bad for J.P. Morgan [because it would help their competitors], but we can’t be selfish. We shouldn’t stand in the way.” When Wells Fargo CEO Richard Kovacevich tried to resist taking the money, Paulson told him that if he didn’t, “you’re going to get a call tomorrow telling you you’re undercapitalized and that you won’t be able to raise money in the private markets” (525). He took the money, but both Wells Fargo and J.P. Morgan paid it back as soon as the government would let them. (A complete list of TARP fund recipients and repayments is available here and here.)

Sorkin’s epilogue makes it clear that TARP really didn’t work: the Dow would fall another 37 percent before markets stabilized (529). What did work was letting the banks work things out with one another. When Lehman’s went bankrupt, “the Fed wisely decided to permit Lehman’s broker-dealer to remain open after the parent company filed for bankruptcy, which allowed for a fairly orderly unwinding of trades in the United States.” European and Asian countries, however, forced Lehman’s branches in those regions to completely shut down, leading to “pandemonium” in foreign markets (536).

Sorkin accepts the conventional wisdom that the roots of the crisis lay in “the deregulation of the banks in the late 1990s; the push to increase homeownership, which encouraged lax mortgage standards; historically low interest rates, which created a liquidity bubble; and the system of Wall Street compensation that rewarded short-term risk taking.” Yet his own book disproves the latter point, at least. One third of Lehman’s, for example, was owned by its employees, who received half their annual bonuses in the form of company stock that they were not allowed to sell for five years. This should have forced them to take a long-term view. Fuld alone owned 2 million shares that at one time were worth $1 billion but after the bankruptcy were worth only $65,000.

HBO is turning Sorkin’s book into a movie with an all-star cast featuring Billy Crudup as Geithner, William Hurt as Paulson, James Woods as Fuld, and Paul Giametti as Bernanke (who is only a bit player in the book). While the book has dramatic appeal, it misleadingly focuses on personalities rather than incentives and institutions. The good news is that there is little danger that the movie will be “Hollywoodized” as the book itself already has been.