The End of Wall St. by Roger Lowenstein

Intro
1. Late Summer 2008, Lehman Brothers fails as the largest bankruptcy ever in the US
2. AIG rescued, Fannie & Freddie go into conservatorship. " the forces of evil unleashed on American Society"
3. Home foreclosures broke every record. Socialization of lending and mortgage risk
4. How did Finance become a growth industry?
5. shadow system- solvency assured not by capital in vault, but agreements w/ 3rd parties-derivatives
Suprime
1. Savings plummeted from 4% GDP under Clinton to negative 4% GDP by end o Bush's first term
2. Bernanke " my own preferred explanation focuses on what I see as the emergence of a global saving glut..."
3. The risk involved in any particular mortgage came to matter less than the average risk assigned to the group
4. Conti Mortgage
  1. bottom 15% absorbed all prospective losses before the next class lost a cent
  2. assertion was losses on the pool would not be greater than 15%...rated Triple A so pensions, mutual funds, corporate treasurers dipped toes
5. CDOs- legal fictions organized for the purpose of buying and selling bonds
6. removed ultimate investor from scrutinizing mortages
Rating Agencies
1. Originally working for subscribers, not issuers
2. SEC decided to penalize brokers for holding bonds less than investment grade
3. S&P, Moody's, Fitch grandfathered,effectively govt. outsourced its regulatory function
4. Corportations forced to pay for "opinions"
  1. created conflict of interest
5. Role as gatekeeper opened subprime flood gates to institutional world
6. "high ratings replaced independent judgment"
Lehman
1. "The banking system was metamorphosing into an off-balance sheet +derivatives world - shadow banking system
2. 1850, scrappy, tribal culture, insular, suspicious of outsiders
3. Dick Fuld-insecure, U of CO, former bond trader
4. consistently on brink every market cycle
5. not in "storage biz, but moving biz"
6. stock up 16 times since public in 94-05'
7. $40B in mortgages yr. subprime loans, sliced into bonds,assembled into CDOs, then sold to clients, used for collateral on commercial property
8. financed w/ short term capital, buying 30 yr mortgages up o 30 yrs
Lenders
1. Countrywide- Mozillo
  1. 02' to 04' subprimes vaulted from 4% to 11%
  2. adjustable loans from 1/7th to half
  3. option ARM, piggy back loans, no cash down
  4. teaser rates, no money down incentivized speculation
2. Washington Mutual
3. Employees grilled on failed loans to close
  1. "thin file is a good file
4. risk department would play "customer service role and avoid imposing burden on loan officers
5. hip salespeople, more retail than banking
6. prime borrowers, more than half were reaching for second mortgages
Desperate Surge
1. Brokers thought not bubble because low interest rates, housing shortage..based on logic at onset
2. Phoenix up 42% in 05'
  1. Citi CDOs $6B in 03', to $20B in 05'
  2. Bob Rubin of Citi believed CDOs "risk free"
  3. int rates raised to 5%, "Ben pricked bubble"
  4. Bulk of new loans option ARMS,untested in stress
    1. Wachovia buys Golden West
    2. ML buys New Century Mortgage "Maseratis in lot"
3. ML in 06' underwrote $54B of CDOs, $44B subprime, 3 fold leap from 05'
  1. most went to inventory as investors "cooled"
4. Lehman 26-1, Bear 29-1, Morgan Stanley 32-1
5. Commercial banks exposure to RE historically 15%, ballooned to 50%
6. Mozillo,March 06'"100% mortgages, most dangerous product in existence"
Absence of Fear
1. Bernanke"..problems in subprime mkts seem likely to be contained,3-18-07
2. Bear hedge funds collapse, file for bankruptcy
3. since 00', $1.8 trillion securities floated by subprime
4. FPA's Bob Rodriguez speech-"We believe this liquidity, safety net, can be withdrawn without notice,Summer 07'
5. Cramer" We have Armageddon!"
6. Chuck Prince-CEO Citi- didn't know CDO vs a grocery list
AIG
1. Credit default swaps-insurance on CDOs
2. guarantor for bulk of US mortgages
3. AAA balance sheet-screwed by small derivatives trading desk
4. insured for 7 to 15 cents on each $100 of CDO value
5. 20% mortgages subprime..CDO prices went up-synthetic CDOs created"clones"
6. models "all win- no loss biz"
7. Cassano- $34m bonus, $280 mil over 8yrs
8. JP Morgan to AIG "You're so screwed"
Trouble for all
1. SIVS start blowing up,experiments in pure leverage
  1. Citi $49B in SIVS
2. money markets breaking buck?
3. O'Neal fired @ML, Prince @ Citi 5days later
4. Goldman margin calls on AIG
5. Fed lowers rates 5.25 to .25
6. "don't borrow short and lend long"
7. insurers reach out to Fed, "not able to pay claims"
8. Fannie/Freddie forced to buy $200B more in housing by Paulson
9. Discount window open to inv. banks & Wall St.
10. $3/4 T Wall St paper matures in 15 months
  1. discount window opened to Wall St. & Investment banks
"confidence & credit are mutually reinforcing"
Lehman Teeters
1. stability vs moral hazard- Paulson+Geithner
  1. Fannie+Freddie nationalized
  2. IndyMac seized by FDIC-depression era lines for getting $
2. credit system shriveling away, down 9% annualized
  1. commercial paper from 40days to 15
3. Wall St. CEOs summoned to Fed over weekend
  1. Chess game of "who's looking at who?"
  2. Merril to BofA
  3. AIG, Lehman, Merrill- dissected as pieces of meat
    1. speed dating"should we be talking?"
  4. Barclays blocked from acquiring Lehman by UK govt.
    1. Brits had no interest in importing American contagion
  5. Scramble to contain Lehman
    1. $600B borrowed
    2. viral effects,money markets, CDS
  6. AIG $60B hole
Aftershocks
1. 30 day Tbill 1.3% to .22% following Mon.
2. companies drew on credit lines to preserve liquidity
  1. hedge funds liquidity frozen by British Law
3. Primary Reserve Fund $785m Lehman paper,breaks buck
4. AIG Rescue
  1. Goldman a counterparty +part of syndicate lender
  2. no private capital stepped up to fill $85B hole
  3. 79.9% AIG warrants for $85B in equity by US govt.
  4. Willemsted(AIG CEO),renounce you $22mil +"you're fired"
5. Bernanke "there are no ideologues in financial crisis"
  1. Sept. 16,2008-Fed declines to lower interest rates,"didn't see economic slowdown as paramount risk"
    1. worst recession in 7 decades
Hedge Fund War
1. Morgan Stanley-down 24% Sept. 17,2008
  1. MS shorted by 40mil shares, clients betting against them and leaving to JP Morgan
2. Goldman & Morgan Stanley plead for curbs on shorts + petition to become commercial banks
3. Fidelity,PIMCO,BlackRock pulling commercial paper/repo loans even against collateral, upset every principal of banking
  1. money market runs
4. "America's market system failed"
  1. Investment banks= too many mortgage securities
  2. commercial banks=too many mortgages
  3. investors failed,regulate economies,appropriate capital+limit risks?
    1. Deregulation Failed
5. TARP
  1. Fed became sole credit supplier of substance
    1. "hoarding mentality"
  2. "liquidity not the answer...capital is needed"
  3. invests in all banks $125B
    1. Nadir of crisis
  4. "capitalism requires capital"
  5. Fed became dominant provider of mortgages,car loans,student loans, ST commercial credit, loans to banks
6. WAMU seized and given to JP Morgan
7. Buffet $5B to Goldman, 10%preferred dividend
8. 1 of 5 mortgages underwater
9. Wachovia negotiated w/Citi for week, Wells came in w/ bid +consumated over night
  1. Topic
10. Germany rescues banks $40B
  1. Ireland guarantees every deposit=2X GDP
11. Moody's downgraded 4,221 tranches of CDOs worth $450B, more than 80% were AAA originally + 50% defaulted!
12. Fed lowers rates and buys multitudes of assets- nationalization
13. Dow down 42% from peak, 26% over month, 22% over 7 trading days
14. $9B paper check hand delivered for Mitsubishi for Morgan Stanley
15. 22% high yield debt yields
16. Tbill yield turns Negative
The End of Wall St.
1. Govt. spending accounted for 26% of economy -fall 09'
2. Hyman Minsky "success breeds a disregard of the possibility of failure"
3. The new finance was flawed because its conception of risk was flawed
4. "An End of an Era"