A Tsunami of Excuses
IT’S been a year since Bear Stearns collapsed, kicking off Wall Street’s meltdown, and it’s more than time to debunk the myths that many Wall Street executives have perpetrated about what has happened and why. These tall tales — which tend to take the form of how their firms were the “victims” of a “once-in-a-lifetime tsunami” that nothing could have prevented — not only insult our collective intelligence but also do nothing to restore the confidence in the banking system that these executives’ actions helped to destroy.
Take, for example, the myth that Alan Schwartz, the former chief executive of Bear Stearns, unleashed on the Senate Banking Committee last April after he was asked about what he could have done differently. “I can guarantee you it’s a subject I’ve thought about a lot,” he replied. “Looking backwards and with hindsight, saying, ‘If I’d have known exactly the forces that were coming, what actions could we have taken beforehand to have avoided this situation?’ And I just simply have not been able to come up with anything ... that would have made a difference to the situation that we faced.”
Jimmy Cayne, Mr. Schwartz’s predecessor, never had to testify before Congress. But he told me, with some rare humility, that before he resigned, “there was a period of not seeing the light at the end of the tunnel .... I wasn’t good enough to tell you what was going to happen.”
Yet Dick Fuld, the longtime chief executive of Lehman Brothers, was squarely in the Schwartz camp last October when he told Congress: “I wake up every single night thinking, ‘What could I have done differently?’ What could I have said? What should I have done?’ And I have searched myself every single night. And I come back to this: at the time I made those decisions, I made those decisions with the information I had.”
Harvey Miller, the bankruptcy lawyer who is representing what remains of Lehman, has been working hard to absolve Mr. Fuld. In a brief responding to a motion made by lawyers for the New York State comptroller, who has joined a class-action suit against the company, he wrote, “The comptroller fails to recognize that Lehman was a victim of a financial tsunami that was beyond its control.”
Now, wait just a minute here. Can it possibly be true that veteran Wall Street executives like Messrs. Cayne, Schwartz and Fuld — who were paid an estimated $128 million, $117 million and at least $350 million, respectively, in the five years before their businesses imploded — got all that money but were clueless about the risks they had exposed their firms to in the process?
In fact, although they have not chosen to admit it, many of these top bankers, as well as Stan O’Neal, the former chief executive of Merrill Lynch (who was handed $161.5 million when he “retired” in late 2007) made decision after decision, year after year, that turned their firms into houses of cards.
For instance, even though he had many opportunities to do so, Mr. Cayne never steered Bear Stearns away from an extremely heavy concentration on its hugely profitable fixed-income business. The firm starved its asset management business, its brokerage business and its investment banking business, which were not as profitable as fixed income but would have spread Bear’s risk.
In 2003 Mr. Cayne passed on chances to diversify his firm by buying Pershing, the back office and clearing unit of Credit Suisse First Boston, and Neuberger Berman, a midsize money manager. “Acquisitions were not my forte,” Mr. Cayne told me. As a result, by the end, his top lieutenants stopped even trying to persuade him to diversify.
Mr. Cayne never seriously considered raising the firm’s equity, which we now know was perilously low, nor did he seriously consider selling or merging it. Rather, he deliberately chose to take Bear deeper into the manufacture and sale of all those risky mortgage-backed securities, as well as into the business of doing trades with hedge funds. Why? Simply put, Bear’s board paid him and the other four members of Bear’s executive committee — including Mr. Schwartz and another former chief executive, Alan C. Greenberg — to maximize the firm’s “return on equity” calculation, which is Wall Street lingo for figuring out how much money one can make using as little capital as possible.
This directive encouraged Mr. Cayne to make the firm as profitable as possible — a worthy goal, no doubt — but without raising any more cash or issuing any new stock, as doing either would increase the denominator of the return-on-equity calculation, and thereby lower the bonus pool Mr. Cayne and his executives could split among themselves.
When viewed through this simple prism, it is not the least bit surprising that when Bear Stearns ran into trouble soon after its two hedge funds blew up in June 2007, Mr. Cayne — and later Mr. Schwartz — chose not to raise new equity, even though they could easily have done so back then. So Bear’s balance sheet remained larded with extremely risky assets that the firm had leveraged to the hilt by borrowing cheaply in the overnight financing markets. The lenders of such money have the right to decide each day whether to continue to provide the financing or to cut the borrower off.
At Lehman, the facts and circumstances were somewhat different than those at Bear Stearns — for instance, after Mr. Cayne passed on it, Lehman bought Neuberger Berman, and Lehman had built a bigger investment-banking business over the years than Bear. Yet the outcome was similar.
Like Mr. Cayne, Mr. Fuld had made huge and risky bets on the manufacture and sale of mortgage-backed securities — by underwriting tens of billions of mortgage securities in 2006 alone — and on the acquisition of highly leveraged commercial real estate. Five days before the firm imploded, Mr. Fuld proposed spinning off some $30 billion of these toxic assets still on the firm’s balance sheet into a separate company. But the market hated the idea, and the death spiral began.
Even Goldman Sachs, which appears to have fared better in this crisis than any other large Wall Street firm, was no saint. The firm underwrote some $100 billion of commercial mortgage obligations — putting it among the top 10 underwriters — before it got out of the game in 2006 and then cleaned up by selling these securities short. Basically, Goldman got lucky.
When in the summer of 2007 questions began to be raised about the value of such mortgage-related assets, the overnight lenders began getting increasingly nervous. Eventually, they decided the risks of lending to these firms far outweighed the rewards, and they pulled the plug.
The firms then simply ran out of cash, as everyone lost confidence in them at once and wanted their money back at the same time. Bear Stearns, Lehman and Merrill Lynch all made the classic mistake of borrowing short and lending long and, as one Bear executive told me, that was “game, set, match.”
Could these Wall Street executives have made other, less risky choices? Of course they could have, if they had been motivated by something other than absolute greed. Many smaller firms — including Evercore Partners, Greenhill and Lazard — took one look at those risky securities and decided to steer clear. When I worked at Lazard in the 1990s, people tried to convince the firm’s patriarchs — André Meyer, Michel David-Weill and Felix Rohatyn — that they must expand into riskier lines of business to keep pace with the big boys. The answer was always a firm no.
Even the venerable if obscure Brown Brothers Harriman — the private partnership where Prescott Bush, the father and grandfather of two presidents, made his fortune — has remained consistently profitable since 1818. None of these smaller firms manufactured a single mortgage-backed security — and none has taken a penny of taxpayer money during this crisis.
So enough already with the charade of Wall Street executives pretending not to know what really happened and why. They know precisely why their banks either crashed or are alive only thanks to taxpayer-provided life support. And at least one of them — John Mack, the chief executive of Morgan Stanley — seems willing to admit it. He appears to have undergone a religious conversion of sorts after his firm’s near-death experience.
“The events of the past months have shaken the foundation of our global financial system,” Mr. Mack told Congress in February. “And they’ve made clear the need for profound change to that system. At Morgan Stanley, we’ve dramatically brought down our leverage, increased transparency, reduced our level of risk and made changes to how we pay people.” He continued: “We didn’t do everything right. Far from it. And make no mistake: as the head of this firm, I take responsibility for our performance.”
Well, it’s a start. But there can be no restoration of confidence in the banking system — and therefore no hope for an economic recovery — until Wall Street comes clean. If the executives responsible for what happened won’t step forward on their own, perhaps a subpoena-wielding panel along the lines of the 9/11 commission can be created to administer a little truth serum.
William D. Cohan is the author of “House of Cards: A Tale of Hubris and Wretched Excess on Wall Street.”