It seems almost achingly quaint to recall those warm and hazy days when "banker" was a synonym for sobriety and propriety -- a time when those who worked in finance, as well as those who reported on it, believed that a pinstriped suit connoted one thing and a chalk stripe something else entirely.
Anyone who still retains such antique illusions will lose them in fewer than 10 pages into "House of Cards: A Tale of Hubris and Wretched Excess on Wall Street," William D. Cohan's masterfully reported account of the collapse of Bear Stearns, the investment banking house whose implosion a year ago this month signaled the beginning of the worst global financial crisis since the Great Depression.
Cohan, a former senior investment banker who has turned into one of our most able financial journalists, is the author of 2007's "The Last Tycoons," a highly regarded history of Lazard Freres & Co., Wall Street's most storied investment bank. In this new book, he deploys not only his hands-on experience of this exotic corner of the financial industry but also a remarkable gift for plain-spoken explanation. That's essential, because it may be that only quantum physics defies the descriptive powers of ordinary language quite so completely as the derivatives markets whose meltdowns have devastated Wall Street.
The other great strength of this important book is the breadth and skill of the author's interviews. Essentially, with pauses for needed explanation, he has used them to construct a staccato narrative of the frantic 10 days in March of 2008 that began with the first doubts about Bear Stearns' liquidity and ended when the Federal Reserve and U.S. Treasury forced the firm to sell itself at a fire-sale price to JP Morgan Chase. That and the subsequent bankruptcy of Lehman Brothers, the sale of Merrill Lynch, the collapse of insurance giant AIG and the virtual incapacitation of much of the banking sector, including behemoths Bank of America and Citibank, marked the end of Wall Street's second Gilded Age and the onset of the current global financial crisis.
Essentially, then, what Cohan has given us is a day-by-day, conversation-by-conversation account of a financial debacle equivalent to the failure of Credit Anstalt, the Vienna bank whose default signaled the globalization of the Great Depression.
At the time of its collapse, Bear Stearns was one of the world's largest and most aggressive investment banks, securities traders and brokerage firms. It employed more than 15,000 people in offices around the world and, just a year earlier, Fortune had recognized it as "America's most admired securities firm." It also was the company most heavily invested in various forms of mortgage-backed securities, the novel financial instruments that subsequently sucked the world financial system down into a whirlpool of illiquidity, as American real estate inflation slowed and, then, declined.
That was Bear Stearns' undoing because, as Cohan explains, "Unlike a bank, which is able to use the cash from its depositors to fund most of its operations . . . pure investment banks such as Lehman Brothers and Bear Stearns had no depositors' money to use. Instead they funded their operations in a few ways: either by occasionally issuing long-term securities, such as debt or preferred stock, or most often by obtaining short-term, often overnight, borrowings in the unsecured commercial paper market or in the overnight 'repo' market, where the borrowings are secured by the various securities and other assets on their balance sheets. These fairly routine borrowings have been repeated day after day for some 30 years and worked splendidly -- until there was perceived to be a problem with either the securities or the institutions backing them up, and then the funding evaporated like rain in the Sahara. The dirty little secret of what used to be known as Wall Street securities firms -- Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers and Bear Stearns -- was that every one of them funded their business in this way to varying degrees, and every one of them was always just 24 hours away from a funding crisis."
That crisis came to Bear Stearns when analysts and other Wall Street players began to raise questions about the liquidity implications of the huge positions in mortgage-backed securities -- particularly subprime mortgages -- that it was carrying on its books. One of the things Cohan points out is that numerous analysts, including the respected Meredith Whitney, had for some years warned that the trade in credit default swaps and various mortgage-backed instruments was setting the stage for "a credit implosion" that "could begin a domino effect of corporate insolvencies." Welcome to our pain, circa 2009.
Cohan does a brilliant job of sketching in the eccentric, vulgar, greedy, profane and coarse individuals who ignored all these warnings to their own profit and the ruin of so many others. It's impossible to do justice to his reportorial detail in a brief review, but suffice to say it's slightly horrifying to learn the importance bridge played in Bear Stearns' internal culture.
The firm's last chief executive, Alan Schwartz, is philosophical about the collapse of his company. He can afford to be; he was paid $35,734,220 in cash less than a year before Bear Stearns' forced sale. As he sees it, he could have done a better job of running his business, but -- in the end -- "it was a team effort. We all [messed] up. Government. Rating agencies. Wall Street. Commercial banks. Regulators. Investors. Everybody."
In the midst of all this devastating heedlessness and wanton venality we confront the mentality of looters rather than that of financiers, let alone captains of industry as we traditionally understand them. Schwartz's airy dispersal of responsibility into the rhetorical ether notwithstanding, it's hard not to feel nostalgic for those stodgy-sober old guys in the pinstripes and to hunger for their advice on where to go from here.
Former Federal Reserve Chairman Paul Volcker, now 81 and an economic advisor to President Obama, certainly is one of those. Recently, he candidly admitted to a gathering of Nobel laureates and high-level investors that "even the experts don't quite know what's going on" in the global economy. The financial meltdown that began on Wall Street, he said, spread through the rest of the world with "shocking" speed, adding, "I don't remember any time, maybe even the Great Depression, when things went down quite so fast."
While the precise structural causes of the current catastrophe still may be obscure, Volcker said he was confident that we won't "revert to the kind of financial system we had before the crisis." The future, he predicted, will hold not only more stringent regulation of the entire banking system -- particularly with regard to risk management -- but also of hedge and equity funds. To the remaining Wall Street smart guys who argue that re-regulation will stifle the "creativity" of the American financial sector, the sober old central banker had a dismissive rejoinder: The most heralded of these financial "innovations" -- like credit default swaps and asset backed securities of the sort that brought Bear Stearns and so many others down -- have created little but fees for their originators.
The only banking "innovation" that has been of real importance to the vast majority of people over the last three decades, Volcker pointed out, is the automatic teller machine.
As Cohan's remarkable new work of financial journalism shows, the current mess began when the investment bankers began to treat everyone else's finances like their private ATM.