Trapdoors, saloons and a hall of mirrors: These unexpected images emerge in The End of Wall Street, Roger Lowenstein's portrait of how the financial system became warped during the housing boom and bust.
A decade after chronicling the hubris of Long-Term Capital Management LP in When Genius Failed, Lowenstein reports on what he calls "the mother of all bubbles." Few emerge from this even-handed account unblemished.
Standard & Poor's, Moody's Investors Service and Fitch Ratings came to resemble saloons that competed by lowering their drinking ages, he writes. Default swaps were a hall of mirrors in which "credit was reflected or distorted at the market's will." As for Lehman Bros. Holdings, its collapse "opened a trapdoor on Wall Street from which poured forth all the hidden demons and excesses."
Here are some excerpts from Bloomberg News' interview with Lowenstein:
The book opens on Bob Rodriguez, a fund manager at First Pacific Advisors who detected signs of a bubble in 2003. Here's a guy in California who races sports cars as a hobby. Why could he see what Ben Bernanke missed?
It's disturbing. Bob Rodriguez is a first-class value investor, a bottom-up guy who looks at balance sheets. When Ben Bernanke and Hank Paulson were saying, "It's just a subprime problem," Rodriguez was looking at Citigroup's balance sheet and saying, "Yeah, it's a subprime problem, but guess who owns subprime?"
Even after the meltdown, Bernanke could barely bring himself to say "bubble," could he?
In January, he again said the Federal Reserve didn't make any mistakes in monetary policy. He admitted they should have been tougher in regulating mortgages but not that the largesse of interest rate policy stimulated the bubble.
His view on bubbles is grounded in the Great Depression.
He firmly believes the Fed was wrong to prick the stock market mania in '29; he drew the wrong lesson of "Don't prick bubbles." It's an Icarus philosophy: Fly as high as you can, crash to Earth and pick up the pieces.
The Fed has just disclosed the assets it bought from Bear Stearns during the rescue. What do they tell us?
We get a sense of the depth and breadth of the bailout when we see the assets include Oklahoma real estate. The entire economy crashed.
You say the Fed induces speculative behavior by holding rates at about zero. Is that what we're seeing now?
If something is free, people won't be disciplined in their use of it. There were more junk bonds issued this year than in any year in history. There's a real danger of reinflating the bubble.
Ratings on mortgage-backed pools got corrupted because banks paid only for ratings that pleased them.
It's like trying on a dress at Bloomingdale's. If you like it, you buy it. If not, you go to Saks. Think of rating companies as suppliers of licenses. Who gives them the right to issue licenses? The government does: The Securities and Exchange Commission has a list of approved agencies. The government should at least withdraw the "approved" designation from anyone paid by issuers.
JPMorgan CEO Jamie Dimon comes across as aggressive. How much collateral did JPMorgan demand from Lehman during the meltdown?
They started demanding more in June; they stepped it up over the summer; in September, they grabbed more. On the weekend when the rescue failed, they were also squeezing Merrill Lynch, though Merrill could ignore them because they had landed into the tender arms of Ken Lewis at Bank of America.
Was JPMorgan rapacious?
JPMorgan was a creditor. Lehman had an obligation to post the collateral its banker demanded. Jamie was no public rescuer. Did he have the obligation to be that? He runs a private bank. Did that make it harder on Lehman? Of course it did. The information that came out recently about what Lehman was doing with its own assets — you know, the manipulation — supports those who said, "We'd better protect our hide, and then some, against these guys."
Should we break up too-big-to-fail banks?
I don't know if we want to set hard lines, but we do need higher capital requirements. The bigger you are, the greater the requirements should be. As you get bigger, there's going to be more of a tax or a drag on profitability. We should also weight FDIC insurance charges toward both asset strength and size.
In many bailouts, bondholders were made whole.
That was a big mistake. If you want to enforce discipline, you need some bonds to fail. The discussion about whether Bear Stearns was sold for $2 a share or $10 missed that. What happened to bondholders? Their credit was enhanced; now they have the credit of JPMorgan instead of Bear. That's where the too-big-to-fail moral hazard lies.