Too Big To Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System – and Themselves. By Andrew Sorkin.
Andrew Sorkin, business writer for the New York Times, provides a wonderful summation of the 2008 financial panic. He brought to life the drama surrounding the government seizure of Fannie Mae and Freddie Mac, Lehman’s collapse, and the last-minute rescue of American International Group. These events contributed to the market pandemonium and, ultimately, the financing of major financial institutions with public funds.
Critics worry that we have fostered zombie institutions. A zombie institution has an economic worth less than zero but it continues to repay its debts, shored up by government credit support.
Sorkin gave good marks to Former Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke, who brought us back from the brink of financial disaster. While not all of their decisions were wise, they acted decisively. Paulson defended the largest financial rescue operation of modern times: “There was only one way that we could reassure the markets and deal with a very significant and broad-based freezing of the credit market. There was no political calculus.” Sorkin felt that this instinctive decision at the height of the crisis stopped the 2008 panic from cascading into a Great Depression.
Bernanke and Paulson changed the role of our government. America historically prided itself on its cut-throat capitalism. Saving companies from their own mistakes was not supposed to be part of the government’s job description.
Sorkin explains why Wall Street executives gambled excessively. Executives became very rich from swinging for the fences. The ability to leverage their balance sheets beyond 30 times their equity promoted an asset bubble. Firms borrowed cheaply and carried inflated inventory, making immense profits on the interest rate spreads. After he struck out and was leaving Merrill Lynch & Co., Stan O’Neal received $161.5 million in securities and retirement benefits, despite promoting policies that effectively bankrupted the firm.
The desire to emulate the profitability of Goldman Sachs motivated Lehman’s boss, Richard Fuld, to make large investments in illiquid securities and commercial property. He overleveraged Lehman’s balance sheet, which was imprudent, given the firm’s heavy dependence on overnight funding. Fuld mistakenly believed that Lehman would be saved in a way similar to Bear Stearns, despite Paulson’s continued warnings that bailouts were politically unacceptable.
AIG allowed an unregulated unit in London to insure trillions of dollars of credit derivatives. Its executives had no idea of the scope of the insurer’s balance-sheet hole. AIG needed liquidity to prevent bankruptcy to meet counter-party commitments. In view of the impending global disaster of an AIG failure, Paulson and Bernanke provided $80 billion of last-minute assistance. In an episode reminiscent of the Keystone Kops, a desperate AIG used bundles of dusty stock certificates from its vaults as collateral for a $14 billion loan from the Federal Reserve.
Sorkin argues that regulators repeatedly failed to demand that government-sponsored enterprises such as Fannie Mae and Freddie Mac obtain appropriate equity capital. Congressional pressure for these institutions to own subprime mortgages added to their woes. Together, they owned or guaranteed nearly half of our nation’s $12 trillion worth of home mortgages.
Sorkin concludes that nobody is comfortable with the present situation of supporting institutions that are “too big to fail.” However, breaking them up is not a viable option in the short term. We can effectively make firms less risky and smaller by requiring more equity and reducing their balance sheets.
Sorkin’s book shows that Bernanke understood the threat of future financial problems and offered helpful suggestions. Bernanke advocated steps such as implementing stronger regulation over nonbanks. He also wants “stronger infrastructure to reduce systematic risk.”
Originally published in the Sarasota Herald-Tribune
