The new HBO film of the book Too Big To Fail by Andrew Ross Sorkin omitted several key factors in an otherwise suspenseful true-life drama depicting the near collapse of the American financial system. By now, most people who care about the crisis know the cast of characters: US Treasury Secretary Hank Paulson; Fed chief Ben Bernanke; Lehman Brothers chairman Dick Fuld; and the honchos who led Citibank, Merrill Lynch, JP Morgan Chase, Morgan Stanley, and a handful of others among the national banks outside New York.
The crisis began when the government agreed to finance a shotgun marriage of failing investment banker Bear Stearns to JP Morgan Chase, but stopped short of funding a merger when Lehman showed signs of distress. Despite herculean efforts to find a buyer for Lehman -- including an emergency weekend meeting called by Paulson to railroad other relatively solvent banks to put up a billion apiece to take out Lehman's "toxic" real estate assets. This scheme was a prelude to a deal in the works for UK's Barclay's to purchase Lehman's remaining safer assets. But in the end that last ditch effort failed due to British regulators requiring more time for shareholder approval. Time, however, was not available, which dramatizes the Perils of Pauline precipice confronting Paulson and gang. Monday's opening bell on the New York Stock Exchange would toll the collapse of Lehman, and possibly the beginning of the end for the economy.
Paulson did end up seeking approval from Congress to use public funding to rescue Fannie Mae and Freddie Mac, the giant semi-governmental agencies that provide underwriting for mortgage loan packages. Then the other foot fell as AIG, the insurance behemoth that needed funding to cover the hedge bets purchased by banks to protect their exposure to risky mortgage instruments. The Congress once again ponied up funds. Even GE was near ruin as capital markets dried up. Finally, Paulson went back to Congress to ask for $790 billion more to create the Toxic Asset Relief Program (TARP) while working with Timothy Geithner, then chief of the New York Fed that oversaw national banks in New York City, to force mergers of banks and investment banks before they failed.
TARP was a capitulation by Paulson. The idea of pumping money directly into banks smacked of socialism, but there was not time to wait out buying toxic assets; the system had to have liquidity immediately to survive. The key to TARP was agreement by healthy banks to accept loans to avoid staining needy banks -- and for all recipients to loan the new funds out to leverage the economic engine. But most banks used TARP money to shore up their balance sheets, and today banks are not lending except to blue chip customers. The underlying problem of lingering toxic real estate holdings has not been solved, prolonging the recession. And small businesses, the backbone of the economy -- the segment that creates nearly all new jobs -- are left with no liquidity. Thus unemployment marches on.
Had Paulson saved Lehman, the financial collapse could have been far less severe, as he must know now looking back over the crisis. He was wrong in his prediction that markets would welcome Lehman's demise as tough love, agreeing that government should not intervene every time a private firm imploded -- in other words avoiding "moral hazard" whereby banks were assured they would be bailed out no matter their transgressions. The markets, unresponsive at first, reacted negatively and the stock market took another dive in reaction to the news about Lehman's forced demise. This bad decision was followed by contradiction after contradiction to the moral hazard basis of the Lehman decision: the government takeover of Fannie and Freddie and AIG; public investment in forced mergers; and finally TARP, the mother of all government intervention in the banking system.
And why didn't Paulson reactivate the Resolution Trust Corporation created during the 1989-1994 real estate scandal to absorb toxic assets? Under TARP, today's bad loans are still spread across the financial system and not gathered in one pool where they can be sold at a discount or written off. It may be a decade before they are finally finished off. Until then banks are reluctant to lend and home values will remain deflated as a steady stream of foreclosed properties continue to come on stream.
It is now understood that lack of regulation caused the crisis, beginning with legislation that tore down the wall between commercial banks and investment banks in Bill Clinton's administration. Under the delusional leadership of Alan Greenspan at the Federal Reserve, free markets were supposed to regulate themselves. When Brooksie Born of the Commodities Futures Trading Commission pointed out as early as 1993 that trillions of dollars were traded without the scrutiny of regulators, she was humiliated by Greenspan and the Treasury. Instead, the belief that real estate values could never crash generated new unregulated investment vehicles based on mortgage tranches. They were so popular the demand grew, causing mortgage underwriters to throw away qualification requirements for homeowners in order to produce even more dicey home loans for investors to slice and dice. The bubble was also fueled by pressure on Fannie and Freddie by members of Congress who insisted on home ownership for everyone. These factors allowed for the creation of more mortgage investment instruments, and more insurance swaps to hedge against the collapse that few thought would ever happen.
But there is one more deregulation scandal that the new film skated over: the termination of the "uptick rule," the requirement that "short sellers," investors who bet a stock will decline in price, cannot short a stock unless it ticks up in value. Beginning in 1999 they began to target stocks they wanted to short, in effect spelling the demise of selected companies and financial institutions. It can be argued the "shorties" began the meltdown in 2008 by attacking Bear Stearns, even though the investment banker was solvent and able to raise capital. They then turned to Lehman. David Einhorn, chief of Greenlight Capital, used the bully pulpit of an annual meeting of Wall Street traders and executives to pounce on Lehman in his keynote address. Blood was spilled in the water and the sharks swarmed to short Lehman out of existence.
New legislation to rein in investment and banks does not include reinstating the uptick rule. And the swindlers on Wall Street who brought down the American economy are back to business as usual. But on Main Street, where the real business of the economy occurs, credit is non-existent, unemployment hovers near 10% and the value of the assets of middle Americans has not recovered. Home values remain 40% below pre-2008 levels, investment portfolios and IRA accounts remain weak -- despite spikes in the stock markets -- home building, the ignition switch of local economies, is reaching new lows and small businesses continue to struggle to survive.
Too Big To Fail, the book and the movie, at least recounts the greed and corruption of the culprits who ruined the lives of millions. But where is the remorse? And where is the punishment?