those that didn't predict the financial crisis were asked to solve it -- 4/23/18

Today's selection -- from The Big Short by Michael Lewis. In the 2008 global financial crisis, the financial leaders who were asked to solve the crisis were the very ones who failed to predict it, and in many cases helped to cause it:

"[In 2008 and 2009], the people in a position to resolve the financial crisis were, of course, the very same people who had failed to foresee it: Treasury Sec­retary Henry Paulson, future Treasury Secretary Timothy Geithner, Fed Chairman Ben Bernanke, Goldman Sachs CEO Lloyd Blankfein, Morgan Stanley CEO John Mack, Citigroup CEO Vikram Pandit, and so on. A few Wall Street CEOs had been fired for their roles in the subprime mortgage catastrophe, but most remained in their jobs, and they, of all people, became important characters operating behind the closed doors, trying to figure out what to do next. With them were a handful of government officials -- the same government offi­cials who should have known a lot more about what Wall Street firms were doing, back when they were doing it. All shared a distinction: They had proven far less capable of grasping basic truths in the heart of the U.S. financial system than a one-eyed money manager with Asperger's syndrome [Michael Burry of Scion Capital].

"By late September 2008 the nation's highest financial official, U.S. Treasury Secretary Henry Paulson, persuaded the U.S. Congress that he needed $700 billion to buy subprime mortgage assets from banks. Thus was born TARP, which stood for Troubled Asset Relief Program. Once handed the money, Paulson abandoned his promised strategy and instead essentially began giving away billions of dollars to Citi­group, Morgan Stanley, Goldman Sachs, and a few others unnatu­rally selected for survival. For instance, the $13 billion AIG owed to Goldman Sachs, as a result of its bet on subprime mortgage loans, was paid off in full by the U.S. government: 100 cents on the dollar.

"These fantastic handouts -- plus the implicit government guarantee that came with them -- not only prevented Wall Street firms from fail­ing but spared them from recognizing the losses in their subprime mortgage portfolios. Even so, just weeks after receiving its first $25 billion taxpayer investment, Citigroup returned to the Treasury to confess that -- lo! -- the markets still didn't trust Citigroup to survive. In response, on November 24, the Treasury granted another $20 bil­lion from TARP and simply guaranteed $306 billion of Citigroup's assets. Treasury didn't ask for a piece of the action, or management changes, or for that matter anything at all except for a teaspoon of out-of-the-money warrants and preferred stock. The $306 billion guarantee -- nearly 2 percent of U.S. gross domestic product, and roughly the combined budgets of the departments of Agriculture, Education, Energy, Homeland Security, Housing and Urban Develop­ment, and Transportation -- was presented undisguised, as a gift. The Treasury didn't ever actually get around to explaining what the crisis was, just that the action was taken in response to Citigroup's 'declin­ing stock price.'

Lehman Brothers headquarters in New
York City, one year prior to bankruptcy

"By then it was clear that $700 billion was a sum insufficient to grap­ple with the troubled assets acquired over the previous few years by Wall Street bond traders. That's when the U.S. Federal Reserve took the shocking and unprecedented step of buying bad subprime mort­gage bonds directly from the banks. By early 2009 the risks and losses associated with more than a trillion dollars' worth of bad investments were transferred from big Wall Street firms to the U.S. taxpayer. Henry Paulson and Timothy Geithner both claimed that the chaos and panic caused by the failure of Lehman Brothers proved to them that the system could not tolerate the chaotic failure of another big financial firm. They further claimed, albeit not until months after the fact, that they had lacked the legal authority to wind down giant financial firms in an orderly manner -- that is, to put a bankrupt bank out of busi­ness. Yet even a year later they would have done very little to acquire that power. This was curious, as they obviously weren't shy about asking for power.

"The events on Wall Street in 2008 were soon reframed, not just by Wall Street leaders but also by both the U.S. Treasury and the Federal Reserve, as a 'crisis in confidence.' A simple, old-fashioned financial panic, triggered by the failure of Lehman Brothers. By August 2009 the president of Goldman Sachs, Gary Cohn, even claimed, publicly, that Goldman Sachs had never actually needed government help, as Goldman had been strong enough to withstand any temporary panic. But there's a difference between an old-fashioned financial panic and what had happened on Wall Street in 2008. In an old-fashioned panic, perception creates its own reality: Someone shouts 'Fire!' in a crowded theater and the audience crushes each other to death in its rush for the exits. On Wall Street in 2008 the reality finally over­whelmed perceptions: A crowded theater burned down with a lot of people still in their seats. Every major firm on Wall Street was either bankrupt or fatally intertwined with a bankrupt system. The problem wasn't that Lehman Brothers had been allowed to fail. The problem was that Lehman Brothers had been allowed to succeed."



Michael Lewis


The Big Short: Inside the Doomsday Machine


W.W. Norton & Company


Copyright 2011, 2010 by Michael Lewis


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