- including Goldman Sachs, Morgan Stanley, JPMorgan Chase, Bank of America, Citigroup, Deutsche Bank, UBS, and Barclay’s - so that they were awash in cash and had no incentive to hire or lend. They laid off people en masse, yet hoarded the money at the top. Over half of the industry was left scrambling for jobs. Many were left to create their own businesses and soon found there was little to no capital to be had. No one was lending or investing—least of all the biggest firms on the Street. Many believed that if the Street had not received these funds, the big firms would have been forced to hire and rebuild. Or if the distribution had been more equitable and circulated through the system, it would have created new business and jobs. The defaulting debt would not have landed on the Federal Reserve balance sheet, but would have been decomposed and reissued at fire sale prices. This would have created a whole new market of distressed investors, sellers and buyers, similar to the Resolution Trust Corporation (RTC) created after the Savings and Loan industry crashed in the 1980s.
Instead, this process was further interfered with when the Securities and Exchange Commission (SEC) and Federal Accounting Standards Board (FASB) suspended “mark-to-market” rules in April 2009. Mark-to-market meant that you valued assets according to what these were worth on the current market. With the elimination of this rule, firms could evaluate their assets, including defaulting loans and securities, at pre-crisis phantom values. Bloomberg News reported in April 2009: “Companies could use ‘significant’ judgment gauging prices of some investments on their books, including mortgage-backed securities.” This enabled banks to “boost net income” and “reduce writedowns,” meaning they would not have to account for market losses. For example, if your house was worth $500,000 before the crash and $250,000 after, your net worth would have been cut in half. The new FASB rules allowed the largest financial institutions to pad their values in ways that no ordinary debtholder could. Additionally, it allowed these institutions to “sell” assets to the government at inflated self-determined values. Janet Tavakoli, president of Tavakoli Structured Finance and an expert on credit risk stated the FASB plan “destroys capitalism …and violates the spirit of democracy established by the founding fathers of the United States.” She explained that, “U.S. taxpayers can be told they are making money on their $700bn investment when in reality they are losing money.”
In true capitalism, the challenge is “bear the risk” and remake and rebuild yourself. The industry and those in it are very good at adapting to changing conditions. But following the Fed bailouts and the changes in accounting rules, this could no longer be done. The free market had been eliminated with the scales tipped in the direction of these oversized and over-capitalized institutions. It was as if two Wall Streets had been created: one that operated on traditional capitalism, the other propped up with government support. The biggest banks became bloated as they feasted on taxpayer cash with no strings attached. They were allowed to grow larger and larger, gobbling up smaller institutions along the way. It only added to their hubris and sent the second and third tier firms begging them for capital. The smaller firms and institutions could not compete with federally subsidized coffers. The level playing field, which could have revitalized the market, was swept away. Thousands of highly educated, talented and formerly expensive professionals hit the unemployment lines. Hundreds of solid and established New York area businesses, from Wall Street consulting firms to mom and pop stores dependent on a vibrant economy, shuttered their doors. The domino-like fallout affected millions of small businesses across the country. Our firm struggled for survival, slashing overhead, shrinking our offices, reducing employee hours and pay, eliminating consultants, and cutting every possible expense. We did everything we could to avoid laying off long-term employees, even paying them from our own diminished resources. It was shared suffering; as a team we might get through this, and our skeleton staff remained loyal despite the hardships. In small business, unlike many larger corporations, people are not expendable.
In the months after Lehman Brothers fell, things grew personal for many in the investment community. The entire financial industry was in a state of deep shock. How could this have happened? That Treasury Secretary and former Goldman CEO Hank Paulson allowed Lehman to fail, yet saved every other firm on the Street, is a mystery that may never be solved. It caused great pain to many of the old Lehman guard that I knew well. Many industry professionals who had nothing to do with the mortgage markets lost everything in a single day. There was something Shakespearean in its magnitude. The crash was heard around the world. It was like a neutron bomb had fallen on the industry. The fact that over the next few days the Feds saved AIG, Goldman, Merrill Lynch and Morgan Stanley was astonishing. Why had Lehman taken the fall for the industry? This is something many of us wanted to know. Word was that Lehman CEO Dick Fuld would not negotiate, refusing two offers to save his firm. Others told me that the offers never materialized because Lehman’s commercial real estate balance sheet was highly toxic. In the end, Barclay’s was the only victor of Lehman’s demise when they bought the financial giant for a song and absorbed some of the firm’s best talent.
After the bank went belly up, “Chet,” a Lehman asset manager, was looking for another job. He had spent ten years in the commercial real-estate (CRE) division at Lehman and nine years before that at another investment bank. He managed the assets (loans, bonds and properties) Lehman owned for their own account. At forty-four years old, he looked much younger than his years and was the father of middle school twins. The markets were in turmoil, and the Street was flooded with talented people looking for another home. Chet and I both knew it would not be easy landing another job like the one at Lehman. I asked him how he thought the industry chaos was able to get so far out of control. He explained: “People forgot about liquidity. They were too caught up in the profit frenzy. In 2007 deals started to break and things started slowing down. They should not have done much that year. Instead they [the senior executives] did some of the biggest deals in the market.” As he thought about this, he became increasingly agitated remembering his losses. I told him, “Everything happens for a reason. Sometimes we don’t know the reason until a long time afterward.” He started to choke up: “We used to be nicer to each other. I don’t know what happened. I don’t know why that wears off.” We sat for a couple of minutes in silence not knowing what to say. Then I asked, “Do you think this will change the way the industry does business?” He replied slowly, “I don’t know. I hope it does.” Months later, he and a few Lehman colleagues started their own commercial-real estate investment firm, but were having a tough time getting it off the ground.
As these conversations continued, I began to recognize I was in the middle of something far greater than me or my immediate purpose. Because of the magnitude of the moment, the conversations changed. I could not just talk about P&L’s (profits and losses) anymore. I had to go deeper and try to make sense of this industry tragedy. The Lehman guys were hurting—even the most senior among them. Some wept in my office; some raged; some spoke of God. It was an extraordinary experience as we shared our thoughts on how the industry had self-destructed. As the discussions developed, I began to ask the hard questions of those who were front and center in the devastation. What did you do? Why did you do it? Did you try to stop it? If not, why? What were you thinking? I wanted to know the answers as much as they wanted to explain them.
Easy Money
At the same time, I was reading in the paper about the outrageous actions of many firms in the markets. The industry recklessness was well-documented; contempt for Wall Street exploded to new levels. Additionally, there were those on Main Street who had behaved similarly: the mortgage broker in a one-room office on Main Street who had given out loans like others give out lollipops; individual investors who had bought homes with no money down and walked away without a second thought; borrowers who had “bought” homes with loans at 120% of value; the real estate agents who had worked with lenders to churn out as many poor quality deals as possible. The industry had somehow cannibalized itself. “Sign here” for a fast profit was the repeated call. Housing values will keep going up—no problem. Simple folks were caught in the frenzy of Wall Street easy money. They wanted a piece of their own get-rich-quick scheme too. If Wall Street can do it, why can’t I? Behind it all were the industry market makers whom I spoke with every day. Unlike the mortgage broker or lender, the people on the other side of the securities trade were distant from Main Street. One of the top producers in the mortgage market explained, “The human factor is too far removed