Goldi Sachs and the Leh Bears
A look back at the 2008 financial crisis
Tale as Old as Time…
2018 marked the 10 year anniversary of one of the greatest financial collapses in the history of the world (how’s that for hyperbole?).
Surprisingly, with the exception of Vice / HBO’s 'Panic: The Untold Story of the 2008 Financial Crisis' the anniversary went by without much acknowledgment, analysis, or reflection.
I strongly suggest watching the Vice documentary. It is a great look back at the financial crisis featuring one of a kind interviews with the key players, including Presidents Bush and Obama.
The story of the events surrounding the crash have been well documented over the past decade. Here’s a short list of movies I recommend on the subject:
The Last Days of Lehman Brothers – 2009 – (BBC)
The Love of Money – 2009 – (BBC)
Inside Job – 2010 – (Film, Academy Award Winner for Best Documentary)
Wall Street: Money Never Sleeps – 2010 – (Film by Oliver Stone)
Too Big to Fail – 2011 – based on the Andrew Ross Sorkin book – (HBO)
Margin Call – 2011 – (Film, Nominated for Academy Award for Best Original Screenplay)
The Big Short – 2015 – based on the book by Michael Lewis – (Film, Academy Award Winner for Best Adapted Screenplay)
Panic: The Untold Story of the 2008 Financial Crisis – 2018 – (Vice, HBO)
However, none of the aforementioned (and I do mean none) touch on the most significant aspect (in my opinion) of the crisis. While most of the aforementioned films touch on the housing bubble and even on the government bailout of the banks, none talk about how the individual taxpayer and mortgage holders were hung out to dry while the banks were double, triple, and quadruple dipping in the billions.
Somehow the financial crisis devastated the average American investor, but left the banks that perpetrated and perpetuated this bubble flush with funds. The solution to prop up the market in the days after the financial collapse essentially boiled down to bailing out the banks but doing nothing to bail out the borrowers.
TARP, in part, stole decades of prosperity from multiple generations of people, and in my opinion, planted the seeds of division and dissent that has allowed the current toxic political atmosphere around the globe to take hold and fester. It was a transfer of wealth from Main Street to Wall Street unlike any other.
In 2012 the Treasury Department estimated the total household wealth losses caused by the crisis at $19.2 trillion. The Census Bureau’s 2010 estimate of 46.2 million people in poverty is the “largest number in the 52 years for which poverty estimates have been published.” Meanwhile Goldman Sachs is trading at a higher market cap today than it was ten years ago.
According to the Washington Post retail investors have pulled nearly $1.2 trillion from the market since the crash while institutional investors have by and large recovered their 2008 losses. In the immediate aftermath institutional investors added $43 billion into the market while retail investors pulled $78 billion from the market, largely at the bottom of the crash.
Yes, the market has long since recovered, but 84% of all stock market wealth is owned by 10% of the population and over 80% of the market gains since 2008 went to institutional investors, so the recovery has not really trickled its way down to the average american.
Too Small to Succeed…
By now you’ve all heard the term ‘too big to fail,’ but the reason we ended up in such a scenario is because the investment banks weren’t happy with just making a ‘modest’ bit of money on the housing market investment products known as CDOs. They wanted more. They needed more. They were the big bad wolf and they needed to be fed. One little red riding hood wouldn’t do…they wanted to consume the entire population of the enchanted forest.
See, originally banks were giving mortgages to borrowers with good credit scores for homes they could afford. Investment banks were then buying up those mortgages and bundling them and selling them as investment products. Those investment products were then given good (AAA) credit ratings so low risk investors ended up having the bulk of their pensions and retirement plans filled with these products.
Now as long as the borrowers could pay their mortgage, and the housing market remained stable the investment products would maintain their value and pensions were secure. However if the housing market collapsed and if the properties that comprised the bundled debts went into default, then the investment products themselves would begin to tank and average Joes would lose their pensions.
All of this was relatively stable so long as the borrowers could afford the mortgages on their reasonably appraised homes. However, once the investment banks saw how much money they could make on these investment products they began to pressure the mortgage underwriters and mortgage brokers to issue more loans. To do that, the loan officers had to lower the bar on the type of borrowers they could approve, which ultimately led us to stated income and NINJA (No Income No Job No Asset) loans.
This ultimately led to anyone and everyone being able to get a mortgage on a property they actually couldn’t afford which artificially appreciated the housing market and expanded the “bubble” as we’ve all come to know it. It corrupted the whole system from bank appraisers to the credit rating agencies and so on and so forth.
Huff and Puff and Blow…
Soon everyone was knowingly or unknowingly tied into this system. Whether you had multiple properties for investment reasons, or bought a house that was more expensive than you could afford, or had your pension / retirement funds managed by companies like State Street that invested your funds in CDOs, you were a part of this massive juggernaut of a system and you could not escape it.
Soon, the investment banks realized that too many of these loans were risky… toxic even and they began to buy insurance against their investment products ('The Big Short' does a great job focusing on this aspect). So they were selling the investment products on the one hand, and betting against the very same products on the other without ever disclosing their insurance hedges to their unsuspecting investors.
This is where you meet characters such as the infamous “fabulous fab” Fabrice Tourre who famously documented that “the whole building is about to collapse” as a result of the two faced game played by the investment banks upon their consumers. Tourre was indicative of the double dealing that made Michael Lewis’ 'Liars Poker' view of Wall Street look like it was written about saints compared to the modern day sinners.
The Leh Bears…
Bear Stearns was the first little piggy to have its house blown down as a result of the housing crash. News of its toxic exposure sent the stock reeling from a high of $133.20 to a purchase price of $2 from Chase. Ultimately, Bear did fetch $10 a share, but still a dollar store price compared to its once glorious value as Wall Street icon and titan.
The film 'Margin Call' gives some insight into how a firm leveraged to the hilt might suddenly come to the realization that the music has stopped playing and all the chairs have already been taken. Luckily for Bear Stearns, they found a buyer in Chase and a willing partner in the Federal Reserve Bank of NY to backstop the Bear books.
Lehman Brothers wasn’t quite so lucky. When Lehman Brothers found its books upside down with no liquidity and a bottomless pit of funds invested in toxic assets, they were not backstopped by the Fed. Their 'Hail Mary' sale to Barclays of London was quashed by British regulators forcing a Lehman Bankruptcy. Lehman’s assets were eventually purchased in bankruptcy but not before the fall of Lehman decimated the financial global markets. The primary difference between Lehman and Bear Stearns being the Fed’s decision to prop up one and leave the other for dead.
The Lehman bankruptcy did strike fear into the hearts of the other banks resulting in deals for Merrill Lynch (Bank of America), Morgan Stanley (Mitsubishi UFJ Financial Group), and others, not the least of which was Warren Buffett’s investment in Goldman Sachs. It also resulted in Morgan Stanley and Goldman Sachs becoming commercial banks.
Every fairy tale has a hero. The character with the golden touch that comes out unscathed despite going through the worst of circumstances. Often those characters somehow even end up better off than they were before the conflict arose.
In 2008, the company with the Midas touch, was arguably, Goldman Sachs (a far cry from the hero of this story). Goldman was days away from complete obliteration as were the rest of the investment banks in the wake of the Lehman bankruptcy. But Goldman had an ace in the hole…Treasury Secretary Hank Paulsen, who was the former CEO of Goldman.
Goldman had been famously pushing CDO products on the one hand and betting against the market they were creating on the other through Credit Default Swaps, primarily backed by AIG. So when the housing and financial market collapsed, Goldman’s hedge was to cover its losses to keep the company afloat. However, AIG owed so much on the Swaps to banks across the board that they could not pay it all out…..AIG was insolvent.
Their insolvency would domino through the markets resulting in the insolvency of every major bank including Goldman Sachs. AIG's failure would crash the entire global financial system.
Enter Paulsen, who had the government backstop AIG so that AIG could pay Goldman Sachs one hundred cents on the dollar owed. That coupled with a timely cash infusion by Warren Buffet and a $10 billion bailout by the government through TARP and Goldman emerged from the crisis in fine form.
In fact, though Goldman was key in crashing the market through the CDOs, Goldman got money from investors, AIG, Warren Buffet, and TARP….while the investors lost everything. Not to mention that Goldman watched its competitors, Bear Stearns, Lehman Brothers, and Merrill Lynch all but perish so it even ended up with greater market share than before and also was given commercial banking status. What a haul?!
The triple dippers vs the double defaulters
Goldman clearly won on all sides. But what about the investors? Well, they ran the risk of defaulting on their mortgage, having their houses foreclosed on, being sued on their personal guarantees of their mortgage, losing retirement funds invested in the market, losing their jobs, and destroying their credit score all a result of the financial crisis.
Where was the bailout for them? Where were the government backstops and the mortgage forgiveness programs that allowed them to stay in the house, write down the value of the mortgage, forgive the personal guarantees, refund the lost retirement packages, guaranty their job / wages, and freeze their credit scores?
AIG was backstopped to pay Goldman Sachs one hundred cents on the dollar. But John Q. Public was hung out to dry and that is the story that isn’t nearly told enough.
Police Departments, unknowingly, had their retirement funds invested in CDOs because the credit agencies rated them as AAA investments. Where was their TARP funding?
This is the real story of the 2008 financial collapse…not merely the recklessness that caused the collapse, but the fact that the powers that be felt the need to prop up the market by bailing out the businesses without bailing out the people.
For years there has been a debate about whether corporations are people. What the 2008 collapse taught us is that corporations are far more valuable than people. And if you watch the 'Inside Job,' you’ll see the government was warned about the risks of the crash years prior to it occurring. They were warned about the implications of deregulation and derivative mortgage investment products, but they did nothing. They screwed the pooch on the front and back end of the situation creating such desperation amongst the electorate, which bred division, and made the nation ripe for a nationalistic populistic political movement more toxic than the assets that nearly bankrupted the world.
When children hear a bedtime story they enjoy, they often shout…“again!” Well, this story is not one we want to repeat but it is one that appears to be playing on a loop.
The 2008 crash was in part caused by deregulation, loose lending practices, derivative financial products in an economy with an already rising national debt and rising rates. Does that sound famililar?
For those of you that saw 'The Big Short' you saw the closing tag line of the film that warned viewers about Bespoke Tranche Opportunities. In the wake of the film’s warnings economists pointed to the existence of Dodd Frank and the Consumer Protection Act as reasons why BTOs won’t be the same as the 2008 CDOs. Unfortunately in May of 2018 congress began the process to roll back the Dodd Frank regulations and President Trump has vowed to repeal Dodd Frank in its entirety.
Lending is also getting loose again. In August of 2018 New York investment bank executives reported that the banks are under pressure again to generate loans.
The current economic policy of the US has already generated a $2 trillion increase in the national debt.
Financial deregulation + mounting pressure to loosen loan requirements + a rise in national debt + the reemergence of CDO type products + rising rates = red flags.
And if you don’t think the market is already hyper sensitive to a possible repeat of 2008 remember that on February 5, 2018 (exactly one year ago today), the DOW experienced the single largest drop in history – as a reaction to rising interest rates.
Goldilocks spent time trying to find the bed that was just right for her. One was too big, one was too small, and one was just right.
Unfortunately, our economy doesn’t seem to be looking for the right bed….it seems to be looking for a way to sleep in all the beds ever made all at once till we’ve broken every single one of them. Let’s just hope when the next bubble bursts, we’re not the one left looking for a place to sleep.