All the Presidents' Bankers (65 page)

Clausen believed the third world needed funds to avoid defaults, but he also thought that it would have to give up resources and control to private companies in return for the financial aid. He criticized commercial banks for
slowing their lending at this critical juncture and blamed them for taking “a narrow view of their own interests.”

Clausen knew well that private bankers would only help in ways that suited them. They did not want defaults, nor did they want to forgive debt or put more of their money at risk if there were other avenues through which to deal with the situation.

During his speech, Baker also urged banks “to boost their lending to the fifteen major debtor nations by $20 billion over the next three years.” He demanded debtor countries “adopt policies favoring economic growth, modeled on the tax-slashing and private-sector-oriented ideas of the Reagan administration” as well as for “continued tough scrutiny by the IMF.” In practice, Baker was calling for struggling countries to sink further into debt, plus give up more of their economic sovereignty and resources to external financial forces.

Though in essence the plan differed little from Clausen’s, Clausen was not consulted regarding Baker’s speech.
⁸⁵
He informed Baker that he would not be seeking a second term.
⁸⁶
The feeling of the administration was mutual.

CHAPTER 16

T
HE
L
ATE
1980
S
: T
HIRD
W
ORLD
S
TAGGERS
,
S&LS
I
MPLODE

“Greed is good.”

—Gordon Gekko, Oliver Stone’s leveraged buyout king in
Wall Street

A
S THE BIG BANKERS WORRIED ABOUT THE THIRD WORLD, THEY CONTINUED TO
press the Reagan administration to back their related bets. Domestically they worried about the attempts of the S&Ls to encroach upon their depositor territory. On the one hand, deregulated S&Ls meant the larger banks could use the smaller firms as dumping grounds for questionable real estate deals. On the other, big banks had their own deregulation agenda to push in Washington.

Meanwhile, flailing S&Ls were angling for more deregulation, too. John Rousselot, president of the National Council of Savings Institutions, complained directly to Reagan that “efforts to regulate the savings industry in the name of protecting the deposit insurance funds are misguided. The key
to helping the industry regain its financial health is to free it up to compete.”
¹
The competition argument was everywhere.

To back his argument, Rousselot presented a twenty-one-page analysis of all 202 S&L failures between January 1981 and September 1985. The report was created by George Bentson, a University of Rochester professor who had found “no connection between those failures and the sector’s use of the new powers that had been granted by Congress and the states.”
²
The Cato Institute and similar entities undertook their own studies with equivalent results.
³

That conclusion ignored the codependent and carnivorous nature of banking, and the increasing intermingling of security creators and distributors and traders who needed to be regulated properly to protect the public from reckless practices within that chain. The Garn–St. Germain Depository Institutions Act of 1982 had removed the last restrictions on the level of interest rates that S&Ls could pay for deposits. That meant they could entice hoards of new consumers to open money market accounts with checking privileges at rates that matched inflation. The floodgates of depositors seeking higher returns were opened, and the S&Ls eagerly invited them into their firms.

As Martin Mayer wrote in
The Greatest-Ever Bank Robbery,
“The owners of what had just become decapitalized S&L’s could raise endless money and take it to whatever gambling table was most convenient. If they won, they kept it . . . if they lost, the government would pay.”
⁴

It was no coincidence that securities backed by packages of risky mortgages simultaneously became vogue at Wall Street investment banks that converted questionable loans into more questionable securities and sold these for a hefty price. The business was so profitable that Wall Street took to sourcing deposits for the S&Ls, just so the S&Ls had more assets as collateral to buy more lucrative (to the investment banks) but risky securities from them.

The thrifts did, in turn, use those deposits (through arrangements called repurchase agreements) as collateral to buy additional securities (like faulty mortgage-backed securities).
⁵
Those securities were also subsequently repurposed as collateral against additional loans with which to buy even more of them. The entire process resembled a casino wherein the house enabled even the most deadbeat players to keep making bets in a winner-take-all situation for the house. Wall Street houses used the S&Ls as a commission-producing dumping ground on all of the above-mentioned fronts. And they often traded against the positions they sold the S&Ls, hastening their demise.

Wall Street bankers were occupied with other forms of shady deals in the mid-1980s as well. In 1986, $50 billion of fresh junk bonds hit the market
(compared to $3 billion in 1976).
⁶
In an elaborate web of fraudulent corporate deals to augment the real estate deals plaguing the S&L industry, Drexel Burnham Lambert’s “Master of the Universe” banker Michael Milken fused together a network of junk bonds and investors, earning billions of dollars in the process. His boss, Ivan Boesky, complemented his efforts by breaking insider-trading rules.
⁷
(Milken later pled guilty to six counts of securities fraud and served twenty-two months of a ten-year prison sentence.
⁸
)

Clausen after the World Bank, Armacost in Trouble

As the casino mentality minted millionaires on Wall Street, the tone in Washington turned more nationalist with respect to protecting US bankers against the world. In February 1986, the Senate Banking Committee heard another round of testimony from major bankers regarding the need for “competitive” deregulation.

“In order to assure continued leadership of our capital markets and of American financial institutions our laws must be updated,” Dennis Weatherstone, chairman of Morgan Guaranty Trust’s executive committee (later JPMorgan Chase), declared before the committee. “American banks must be freed to compete with foreign banks in the US securities markets.”
⁹
The matter to him was of fundamental liberty and national power.

Part of the fervent push for deregulation was a reaction to the epic failure of banking decisions regarding international lending, especially to the developing Latin American countries. These failures had to be supplanted by other means. The industry as a whole was buckling under the failure of the late-1970s loans it had extended, but BankAmerica was showing the worst record of the top five US banks. Clausen’s former exploits and Armacost’s subsequent leadership at the bank were suddenly under media scrutiny.

According to a
Fortune
magazine article, under Clausen’s leadership, “From 1976 to 1980, the bank’s rating had been sliding at an alarming pace.”
¹⁰
During his five-year tenure as the president and CEO, Armacost regularly had to dodge bullets about the bank’s problems.
¹¹
For years, the board continued to believe Armacost when he promised that the sour loans, made so liberally under Clausen, were in fact solid.
¹²

In the ongoing flare-up of Latin American debt problems, Armacost was forced to resign. In a bizarre déjà vu, this made room for Clausen’s return to the helm of BankAmerica on October 12, 1986.
¹³
BankAmerica’s board reinstated the man who had so zealously pushed for those loan extensions
to begin with rather than choose someone, anyone, with a more restrained notion of risk taking. The move even surprised an industry predicated on revolving public-private doors. The
LA Times
noted, “Clausen’s expected return to the bank . . . is a shock.”
¹⁴

As the World Bank described Clausen, “He felt more comfortable with the private sector than with government bureaucracies and [took] his cues from the financial markets rather than the demands of the developing countries.”
¹⁵
Shortly after he rejoined BankAmerica, the firm posted a $1 billion first-quarter loss.
¹⁶
But that was nothing.

BankAmerica stood to lose more than $7 billion if the larger Latin American countries (including Mexico, Brazil, and Venezuela) defaulted.
¹⁷
Once back on the private side, Clausen needed the multinational cavalry to save his bank. So he proposed that the IMF and other agencies provide guarantees to the banks to enable them to lend more.

On the surface this seemed like a way to subsidize bank lending and provide support for existing loans while staving off a larger crisis. But the idea didn’t sit well with all the other bankers. Citicorp chairman John Reed adopted his predecessor’s philosophy that banks, not bureaucratic political institutions like the IMF, should make decisions about loans. His feeling on the matter would soon translate into bold action.

At a financial meeting in Washington in May 1987, Paul Volcker told a group of New York bankers that keeping Mexico afloat would be cheaper than rescuing BankAmerica.
¹⁸
But either strategy amounted to rescuing the bank.

Reed’s Gambit and the Rise of Greenspan

In May 1987, J. P. Morgan became the first commercial bank to receive Fed approval to underwrite commercial paper for its own account.
¹⁹
In June 1989, the Fed would grant Morgan another key perk—authorization to underwrite corporate debt, making it the first commercial bank to be able to do so since 1933.
²⁰
Reed later described the move as “the beginning of the crack in the door.”
²¹

But in mid-1987, Reed was more focused on his mammoth exposure to third world debt. While other bankers prevaricated, Reed played a crafty game to instigate more government aid for the situation.
²²
On May 21, 1987, having decided the government wasn’t moving fast enough to help private banks contain the growing crisis, Reed announced that Citicorp would add $3 billion to its loan-loss reserves against third world loans, racking up a $2.5 billion quarterly loss.
²³

Treasury Secretary Baker hadn’t even formally acknowledged that there was a problem at that point. By setting aside $3 billion in reserves, Reed knew he would cause a reaction in Washington.
²⁴

Morgan chairman Lewis Preston was caught off guard by the aggressiveness and noncollaborative nature of Reed’s move, not to mention the positive acclaim Reed was receiving for “admitting the obvious about Third World Debt.” Hence, he promptly followed Reed’s lead by presenting Mexico with his own plan “to recapture the initiative.”
²⁵

With the potential for serious foreign loan losses mounting while the White House considered the details and nature of government bailouts, bankers still needed cheap money to cover the holes in their income. They decided that Volcker wasn’t lowering rates quickly enough or pushing for the kind of deregulation that would enable them to grow by buying banks or financial services companies. According to Bob Woodward, before Volcker’s second term was due to expire, Baker advised Reagan, “It’s time to have your own Fed chairman . . . in my mind, there is only one person to turn to.”
²⁶
The person he was referring to was Alan Greenspan.

In addition to having been called upon to educate Reagan on the economy during his campaign, and laughing at his jokes on the road, Greenspan had served for ten years on J. P. Morgan’s board of directors as the firm waged its fight to repeal Glass-Steagall.
²⁷
He later wrote that as a board member in 1977, he “would sit in the same conference room at 23 Wall Street where much of the financial chaos of 1907 had been resolved.”
²⁸
He marveled at J. P. Morgan’s character and personal influence during that panic.

Charles Geisst, a historian and professor of finance at Manhattan College, recounted Greenspan’s attempts to dismantle the Glass-Steagall Act from within the J. P. Morgan fold in a PBS
Frontline
interview: “Morgan produced a pamphlet called ‘Rethinking Glass-Steagall’ in 1984, which he [Greenspan] obviously . . . had contributed to. . . . The pamphlet was advocating getting rid of the Glass-Steagall Act so that commercial bankers particularly could begin to underwrite corporate securities again, as they hadn’t done since before 1933.”
²⁹