All the Presidents' Bankers (76 page)

Then, on July 9, he unveiled his plan to “curb” corporate crime in a speech given in the heart of New York’s financial district. Barely a swipe at his Wall Street friends, he urged bankers to provide honest information to investors. With that kind of tepidity, bankers knew they had nothing to fear from their commander in chief. The fact that Merrill Lynch was embroiled with the Enron scandal was not something Bush would confront. Merrill’s alliances with the Bush family stretched back many years.
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Three weeks later, Bush signed the Sarbanes-Oxley Act of 2002.
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It purportedly ensured that CFOs and CEOs would confirm that the information in their SEC filings was presented truthfully, kept accounting and auditing firms from servicing the same client (as Arthur Andersen had done for Enron), and required analysts (such as Jack Grubman) to disclose any conflicts of interest their employers might have with the companies whose stocks they touted. Republicans complained that the act created unnecessary paperwork—as they still do today. And Democrats refused to understand that the act was essentially useless as a fraud deterrent—as it remains today.

To do his part, Alan Greenspan cut interest rates, ultimately down to 1.5 percent, to help banks remain liquid during the scandal-induced credit crunch. Still, by September 2002, half a million telecom jobs had been eliminated as the result of fraud-induced bankruptcies, and $2 trillion of $7 trillion in stock market value had been erased. Twenty-three telecoms went bust, including WorldCom on July 21, 2002.
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The combination of corporate crime and bankers’ coyness dragged down the market, the overall economy, and citizens’ pension accounts, as Washington continued to waffle on the notion of corporate reform amid a series of after-the-fact hearings.
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Tepid Reform amid the March to War

Bush’s primary concerns transcended issues of corporate honesty and banker collusion. On March 19, 2003, he launched the Iraq War with a shower of cruise missiles into the Iraqi night sky.
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Two days later, by a vote of 215 to 212, the House approved Bush’s $2.2 trillion budget, including $726 billion of tax cuts. Shortly afterward, Bush appointed former Goldman Sachs co-CEO Stephen Friedman director of the National Economic Council, the same role Robert Rubin had played for Clinton.
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Amid the “shock and awe” that launched the Iraqi invasion, notions of banker culpability and reform took a back seat in the media and for the population at large. But a month later, a $1.4 billion Wall Street settlement spearheaded by New York attorney general Eliot Spitzer, with input from the SEC, was finalized. For his efforts, Spitzer was dubbed “the Enforcer” on a September 2002
Fortune
cover.
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On April 28, 2003, ten major banks agreed to pay $875 million in various penalties, in addition to $432.5 million to fund independent research and $80 million to promote investor education, a paltry sum compared to their pre-scandal profits.
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According to Spitzer’s official statement, the settlement implemented “far-reaching reforms that will radically change behavior on Wall Street.”
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But it did nothing of the kind. Not a single item in the settlement was a serious threat to bankers’ status quo.
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Off-balance-sheet vehicles and unregulated derivatives would resurface a few years later, causing far greater damage—this time to the global population.

On October 15, 2003, Democrat Timothy Geithner was chosen to succeed William McDonough as president and CEO of the Federal Reserve Bank of New York. Geithner was serving as director of policy development at the IMF, following a stint at the Council on Foreign Relations.
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Prior to that, he had served as undersecretary of the Treasury for international affairs from 1998 to 2001, during the Asian currency and Russian debt crises. Geithner had powerful friends, having served under both Rubin and Summers.
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The two former Treasury secretaries advised the search committee that supported Geithner.
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It was their deregulatory ideas that led to the economic crumbling of the early 2000s (and to the later crisis beginning in 2007, after which Summers became Obama’s economic adviser). But now they ensured another like-minded compatriot would take the helm of the New York Fed and fortify the big bankers.

Bush’s Reelection Campaign and Capital Limits

By the end of 2003, in the wake of the Wall Street settlement and Sarbanes-Oxley Act—over which bankers grumbled publicly but weren’t particularly concerned about privately—bankers began amassing funds for Bush’s 2004 reelection campaign.
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A bevy of Wall Street Republicans, including Hank Paulson, Bear Stearns CEO James Cayne, and Goldman Sachs executive George Herbert Walker (the president’s second cousin) fell under the category of Bush’s “Pioneers,” raising at least $100,000 each.
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The top seven financial firms raised nearly $3 million for his campaign. Merrill Lynch emerged as his second biggest corporate contributor (after Morgan Stanley), providing more than $586,254.
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The firm’s enthusiasm wasn’t surprising. Reagan’s Treasury secretary, Donald Regan, had been its chairman. Way before that, in 1900, George Herbert Walker had founded the investment bank G. H. Walker and Company, which employed various members of the Bush family over the following decades, until becoming part of Merrill in 1978.
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Merrill Lynch CEO Earnest “Stanley” O’Neal received the distinguished moniker of “Ranger,” having raised more than $200,000 for Bush’s campaign.
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O’Neal and Cayne had hosted Bush’s first New York City reelection fundraiser in July 2003.
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Campaign support from bankers appeared to have its benefits. Paulson, for one, was still beating the drum for more leverage for investment banks. On April 28, 2004, five SEC commissioners convened to consider the issue.
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Four years had lapsed since Paulson had first made his request to raise leverage parameters before Congress.
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This time, under the leadership of William Donaldson (who began his career at G. H. Walker and Company), the SEC approved the request.
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Whether leverage parameters were officially raised or not remains a matter of debate, but official language provided bigger banks (with more than $5 billion in assets) more latitude with capital requirements.
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The largest investment banks, all of which were part of Bush’s top ten fundraisers, were permitted to use their own systems to determine leverage, which amounted to the same thing as parameters being raised. Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers, and Bear Stearns applied for “consolidated supervised entities” status, which enabled them to use in-house models to determine how much capital they should set aside to back risky bets.
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At the time, SEC commissioner Harvey Goldschmid warned, “If anything goes wrong, it’s going to be an awfully big mess.”
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Within a few years, leverage had risen from 12 percent to 30–40 percent, depending on the firm, and that figure didn’t even begin to account for the leverage that could be embedded in any one security or the risk associated with codependent securities.
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Whereas in the 1980s Wall Street created corporate junk bonds and in the 1990s enabled companies like Enron to hide off-book losses and gains, now Wall Street began minting toxic securities lined with subprime loans and wrapped up in derivatives. And the more loans a bank could get, the more toxic securities and derivatives linked to those securities could be spawned and sold.

Meanwhile, another merger that would alter the trajectory of Wall Street was brewing. In July 2004, William Harrison announced that JPMorgan
Chase would acquire Chicago-based Bank One for $59 billion.
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By December 31, 2005, Bank One CEO Jamie Dimon assumed the helm of the conglomerate. From there, he eventually rose to take his former boss’s mantle of King of Wall Street.

Government by the Goldman, for the Goldman

The bankers’ help might have tipped the scales in Bush’s favor. On November 3, 2004, Bush won his second term in a tight election, capturing 51 percent of the popular vote and 274 electoral votes against Democrat John Kerry’s 252.
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From an alignment perspective, Goldman Sachs bankers now saturated Washington. New Jersey Democrat Jon Corzine, a former Goldman CEO, was on the Senate Banking Committee. Joshua Bolten, a former executive director at the Goldman Sachs office in London, was director of the Office of Management and Budget. And Stephen Friedman was Bush’s economic adviser.
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None of them expressed concern about the housing market or the growing leverage at the nation’s investment banks. Under Geithner, the New York Fed issued a report examining the risks of a potential housing bubble. It concluded there was no such thing on the horizon.
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Yet from 2002 to 2007, the biggest US banks created nearly 80 percent of the approximately $14 trillion worth of global mortgage-backed securities (MBS), asset-backed securities (ABS), collateralized debt obligations (CDOs), and other concoctions of packaged assets fashioned during those years. International banks created the other 20 percent.
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Subprime loan packages were the fastest-growing segment of the MBS market. This meant that the financial products exhibiting the most growth were the ones containing the most risk.

In that interim, Bush picked Ben Bernanke to replace Alan Greenspan as chairman of the Federal Reserve. The bankers needed to keep their party going. Bernanke made it immediately clear where his loyalties lay, stating, “My first priority will be to maintain continuity with the policies and policy strategies during the Greenspan years.”
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On February 1, 2006, after telling his nomination hearing committee he thought “derivatives, for the most part, are traded among very sophisticated financial institutions and individuals who have considerable incentive to understand them and to use them properly,”
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Bernanke was appointed Fed chair.
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Bankers could keep manufacturing derivatives with their new chief regulator’s approval. Commercial and investment banks entered overdrive, packaging and repackaging the subprime and commercial real estate loans
they had extended when rates were so low, pumping money into subprime lenders and developers building in “growth” areas throughout the United States, and selling the related securities and derivatives within the United States and around the world.

Two years after persuading the SEC to adopt rules that enabled many of those assets to be undercapitalized and underscrutinized, President Bush selected Paulson to be his third Treasury secretary. Josh Bolton had arranged the pivotal White House visit between the two men that sealed the deal. As Bush wrote in his memoir,
Decision Points,
“Hank was slow to warm to the idea of joining my cabinet. Josh eventually persuaded Hank to visit with me in the White House. Hank radiated energy and confidence. Hank understood the globalization of finance, and his name commanded respect at home and abroad.”
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On May 30, 2006, when Bush officially announced Paulson’s nomination, he, like Clinton had with Rubin, equated Paulson to Alexander Hamilton. Robert Rubin remarked that the choice was “well done.”
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When Paulson assumed the Treasury post on July 10, 2006, Lloyd Blankfein took the reins of Goldman. Paulson’s free-market ideas aligned with those of Bush. In response to a question from Idaho Republican Mike Crapo at his Senate confirmation hearing, Paulson echoed Bernanke’s stance regarding derivatives regulation. He said he was “wary” of proposals to strengthen regulation of derivatives because of their importance in managing risk.

Under Bush, Paulson, and Bernanke, the banking sector would buckle and take the global economy down with it. Its nearly $14 trillion pyramid of superleveraged toxic assets was built on the back of $1.4 trillion of US subprime loans, and dispersed throughout the world.
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European buyers, in particular, as well as pension funds, small municipalities, and local banks became fertile dumping ground for toxic assets, precipitating years of widespread economic collapse.
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Housing Problems Brewing

On March 9, 2007, Paulson cohosted a conference on US capital market competitiveness along with his undersecretary of domestic finance, Bob Steel, another Goldman veteran.
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The conference was announced the day after China’s stock market plunged more than 9 percent and the Dow fell 3.3 percent. Its central report warned “a regulatory race to the bottom will serve no useful competitive purpose.”
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It implied that tighter regulations will restrain competition, not enforce stability.

Six weeks later, Paulson delivered an upbeat assessment of the economy to a business group gathering in New York. Despite evidence that 2006 foreclosures had topped 1.2 million, rising 42 percent from 2005, he declared that the US economy was “very healthy” and “robust.”
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The following month, in a speech before the Federal Reserve Bank of Atlanta, Geithner said innovations like derivatives had “improved the capacity to measure and manage risk” and declared that “the larger global financial institutions are generally stronger in terms of capital relative to risk.”
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