“And Then The Roof Caved In” by CNBC reporter David Faber details what really happened to cause the greatest economic collapse since the Great Depression. An excerpt.
Prologue: ‘On the Verge’
It’s September 14, 2008, the second week of the NFL season. After being out for the day, I’ve returned home with my family and am hoping to settle into the couch to enjoy the day’s late game. But I know that’s probably not going to happen. Try as I might to convince myself otherwise, this Sunday is far from typical. Ever since I left the office on Friday, I had been nervously awaiting this moment, when I could begin to make phone calls to try to find out whether the financial world that I have covered for the last 22 years is a thing of the past.
When I left my office at CNBC’s headquarters on Friday, it was clear the storied investment bank Lehman Brothers was in deep trouble. I had been reporting on its worsening plight for months. Lehman had been battling a crisis of confidence that began in the earliest days of the credit meltdown. A financial company such as Lehman, which is exchanging vast sums of money every minute with other financial companies, must maintain the trust of those with whom it does business. The minute that trust disappears, as it did earlier in the year with Lehman’s competitor Bear Stearns, the firm is unable to meet its obligations. In other words, it’s lights out. The concern among investors and, most importantly, the firms with whom it did business, was that Lehman was not being honest about the value of the assets on its balance sheet.
The firm had played big in the mortgage industry and many did not believe Lehman’s endless claims that it was marking its real estate-related assets at their appropriate value.
There had been plenty of days over the last year when Lehman was free of the rumors and doubt that would color its future. But, like a cancer that retreats into submission, yet still lurks within, Lehman had never been able to fully shake the concerns about its balance sheet. For Lehman, the last few weeks had seen the cancer return with a vengeance, and, as I left work late on Friday, it seemed certain the 114-year old investment bank would be sold. If a sale couldn’t be arranged, it was far from clear that Lehman could keep operating. That would mean only one thing: bankruptcy.
I pulled the phone to my lap, but still kept the football game on, somehow hoping it would all blow over. As I began to review my list of contacts to determine whom to call, my mind went back to a meeting I had with Lehman’s chairman and CEO Richard Fuld only three months earlier. I had not seen Fuld for years and we both agreed it might be a good time to get reacquainted. And so, late one June afternoon, I headed to Fuld’s office in midtown Manhattan to try to get a better understanding of what was truly going on at the firm he had led for the previous 14 years. A day earlier, the firm had reported a second-quarter loss of $ 2.8 billion and said it was raising $6 billion in new capital. Lehman was certainly not in good shape, but it seemed poised to survive.
Fuld did most of the talking. He seemed to be testing out a new approach to explaining why his firm was going to thrive in the years ahead. I sat respectfully as he droned on, talking about Lehman’s global franchise and all the ways it could make money beyond the financing of real estate. Fuld is a tough guy. But as I sat back and listened to him pontificate on the merits of the firm he had shaped, he seemed out of touch, as though he were not fully entrenched in the new reality of the financial world: a reality in which every firm had become suspect.
Toward the end of our meeting I asked Fuld why he went ahead with a $22 billion deal to finance and buy the giant real estate investment trust Archstone, a deal that compounded its holdings of real estate. It was a deal Lehman could have exited. Whereas doing so would have hurt the firm’s reputation, it would have saved it billions in potential losses in what was already an uncertain real estate market. Exiting the Archstone deal would have also saved Lehman from endless conjecture on just how much money it was losing from the deal — conjecture that contributed to a lack of confidence in the firm’ s solvency. Fuld seemed surprised at the question. “It was a good deal,” he told me. “We still think it’s a good deal.” I really thought the question might prompt a bit of self-reflection or even self-criticism. But that was Dick Fuld. He believed. Two days after our meeting, Fuld would fire his longtime number two, Joe Gregory, and his chief financial officer, Erin Callan.
A few quick calls had me now somewhat up to speed with what was developing. Lehman had been having conversations with both Bank of America and Barclay’s about an acquisition, but as the weekend came to a close there was no deal. The key reason was that the U.S. government was making it clear it would not step in to take on any of Lehman’s bad assets. Without a government assist, would-be buyers were leery. What had seemed improbable on Friday and inconceivable during my meeting with Fuld only a few months earlier, was now likely: Lehman Brothers was about to go bankrupt.
It was only the start of the longest night of my career.
For weeks prior to that Sunday evening, I had also been following the startling decline of another company that was far less visible than Lehman Brothers, but far more important to the health of the world’s financial system. American International Group (AIG) was the world’s largest insurance company. It was built by a man named Maurice Greenberg into the greatest single powerhouse the insurance industry had ever known. In many countries around the world, Greenberg had written the laws that would govern the sale and use of insurance. AIG was for many years among the most valuable financial companies in the country. Its market value was routinely above $150 billion. But in 2006, the then 81-year-old Greenberg had been forced from the company after New York’s Attorney General Eliot Spitzer accused him of wrongdoing. AIG would never be the same. Many of the risks the company took on during Greenberg’s reign were risks that he alone may have fully understood. Still, there were few who had any true concern about its financial health.
As a reporter, you tend to follow your sources. While the world was chasing the rapid decline of Lehman, I found myself far more interested in what was going on at AIG. That was because a handful of people I have known for years were involved with the company’s travails. AIG had suffered from a series of quarterly losses. Its stock had sunk dramatically. And in the weeks leading up to that Sunday night, it had lost $50 billion in market value. Still, while the idea that Lehman Brothers could go bankrupt had been contemplated by the many investors and trading counterparties that relied on it, few if any of those same constituencies would ever have thought about such a fate befalling the massive AIG.
It was a call that same night that I’ll never forget. The voice on the other end of the phone was calm. I was calling to get some insight into any of the night’s developing stories and hoped this source might be able to provide it. I remembered this person had done work for AIG and asked whether there was any concern at the insurer about what might happen with a Lehman bankruptcy.
“That’s not their concern,” was the reply.
“Why not?” I asked.
“Because they are on the verge themselves.”
I thought I must have misheard. “On the verge of what?”
“What do you think?”
Yep, it was going to be a very long night.
AIG, which ran a group of highly regulated insurance businesses, was connected to virtually every financial instrument known to the modern financial system through a separate group of unregulated businesses. For many years, the company had the highest credit rating a company could obtain (AAA) and was able to borrow at costs that were not much higher than the federal government. With what was an almost-unlimited supply of cheap money, AIG had done a lot of stupid things. The stupidest of all was its decision to move aggressively into the market for credit default swaps (CDSs).
In AIG’s defense, a credit default swap is a form of insurance. It gives the buyer of the CDS insurance against the risk of default on any given debt instrument, whether it be a corporate bond, an auto loan, or, to AIG’s lasting regret, a subprime mortgage. Credit default swaps trade based on the likelihood that whatever it is they are insuring will default. The greater the chance investors believe there is that a default will occur, the higher the price of the credit default swap. Like so many other businesses on Wall Street, the CDS market made a great deal of sense before it spun out of control. We’ll talk more about this phenomenon in Chapter 7, but suffice to say that AIG did not appropriately gauge the risk of all the credit default swaps it was writing.
I made more calls. I spoke to another longtime source who knew what was going on at the company. He told me that on Friday, AIG had been unable to roll its commercial paper. It was an off-the-record comment, meaning that I could not use it in my reporting, but it helped me understand just how bad the situation at the company had become. The commercial paper market is used by what are typically high-credit-quality corporations for their short-term borrowing needs. In that market, corporations can borrow billions of dollars for 30, 60, or 90 days, and, when those debts come due; most corporations simply roll them over for another 30-, 60-, or 90-day term. The problem comes when no one wants to buy a corporation’s commercial paper and it is unable to roll. Now I understood how AIG could be “on the verge.” Unable to borrow in the commercial paper markets, the company was rapidly running out of money.
It seemed like a good time to call the office. The typical Sunday at CNBC is pretty quiet, given the network does not feature live programming on the weekends. While we have a handful of people on the assignment desk and a few producers working on the next morning’s shows, our cavernous headquarters is a lonely place on a Sunday night. Not on this night; it was all hands on deck, and, having not checked in thus far, I was only now made aware that we were going live beginning at 8 p.m. Reporting from my couch with the football game on in the background was no longer an option. I showered, put on a suit, and headed for work.
By 6 p.m., news was starting to pour in on a variety of fronts. The Wall Street Journal and New York Times were reporting the stunning news that Lehman would be filing bankruptcy, having been unable to convince the Federal Reserve or Treasury to come to its aid. And in a story I had completely missed, it seemed Bank of America had quickly moved on from its brief courtship with Lehman and was very close to buying the nation’ s largest and most important brokerage house, Merrill Lynch. Merrill, I would subsequently learn, was fearful that a Lehman bankruptcy would assure it the same fate and chose to save itself with a hastily crafted deal at a mystifyingly high price.
The Lehman and Merrill stories were being well covered by our own reporters and our competitors, so I focused on AIG. I leaned back at my desk and took a deep breath before embarking on another round of phone calls. I had been a financial reporter for two decades. I had covered the fall of Drexel Burnham Lambert in 1989. I had reported on the collapse of the savings and loan industry in 1990. I’d been lucky enough to break the news of the fall of the hedge fund Long Term Capital Management in 1998 and the massive fraud at WorldCom in 2002. I had reported on the tech bubble’s inflation in the late 1990s and its bursting in the early 2000s. And here I was, watching three events happening in the same night that taken separately might have been typical of the biggest financial stories of a decade. It was disorienting, to say the least.
In the intricate dance between reporter and source, persistence is the one constant. After speaking with four or five people who each add an insight or level of detail to a report, I usually find it wise to go back to my initial source and try to cajole a bit more information from the person by convincing him or her of how much more I’ve learned since we first spoke: “I already know this, but could you tell me that one again?” And so, having learned that AIG was desperately trying to raise cash and was talking to private equity firms and Warren Buffett (who controls a huge insurance company), I went back to my original source.
Yes, he told me, AIG was talking to private equity firms and anyone else it thought might be able to lend it money. Its intention was to use certain of its businesses as collateral for a short-term “bridge” loan that it would repay when those businesses were sold. But those talks were not looking promising. AIG needed the money immediately and the firms wanted time to understand its true financial health before committing capital. As a result, my source told me, the company was casting its eyes toward the Federal Reserve. AIG wanted the nation’s central bank to give it a bridge loan of $20 billion. But just then, the Federal Reserve and Treasury, which had evidently decided to let Lehman Brothers go bankrupt, were also turning a deaf ear to AIG’s pleas. CNBC broadcast live that evening until midnight. A few moments after we went off air, Merrill Lynch announced it was being acquired by Bank of America. A few hours later, Lehman Brothers filed for bankruptcy. But AIG did not. It wasn’t quite out of money yet.
That Monday, a throng of executives from AIG and their many advisors descended on the office of the Federal Reserve Bank of New York. AIG’s financial position was getting worse by the minute.
Its counterparties reacted to the scary news about its future by pulling their business from the company. That left AIG with even less cash. What was worse, the company’s credit rating was going to be downgraded as soon as Monday night, forcing AIG to post more collateral for various transactions. The $20 billion it needed on Sunday night had doubled in less than a day. AIG was now asking for $40 billion.
AIG had a trillion dollars in assets. It did business in every part of the world and it had written credit default swaps on $2.7 trillion worth of debt instruments. While there was debate about whether a bankruptcy filing by Lehman Brothers would devastate the financial system, there were no such arguments about the effect of a bankruptcy for AIG. Among the people whose opinion I have come to trust over my career, the conclusion was unanimous: AIG’s failure would cause a systemic breakdown of the financial system given its deep and broad ties into every part of that system. As that Monday evening’s telecast came to a close, it looked like the Fed was going to test that conclusion.
Strange things were happening in the credit markets. Confidence, already sorely tested the past 13 months, was all but gone. Financial institutions were severely cutting back on lending to one another in a disturbing pattern that would crest three days later. But still the Fed was not ready to lend AIG money. I had reported on Monday that the investment bank Morgan Stanley and law firm of Wachtel, Lipton had been hired by the Fed to advise it on AIG. It seemed a promising sign for those who were hoping the company would be saved. But as Tuesday began there was no sign that a loan would be forthcoming. That Tuesday morning I reported definitively, based on my conversations with numerous sources who knew, that if AIG did not receive money from the Federal Reserve it would file for bankruptcy the next day.
The Fed blinked. Reluctant as Treasury Secretary Henry Paulson may have been to take the unprecedented step of lending billions of taxpayer dollars to a publicly traded insurance company, the risk of not doing so was too large to take. The Fed’s initial recalcitrance had proved costly. What was $20 billion on Sunday and $40 billion on Monday had amazingly become $85 billion by Tuesday night. AIG ’s business had deteriorated that quickly. The downgrade of its credit rating on Monday night had forced it to post billions in additional collateral. I reported the news that night in what had become our customary breaking news programming. AIG would receive an $85 billion bridge loan from the federal government with a term of two years and an interest rate of LIBOR (London Inter-Bank Offer Rate) plus 8.5 percent. In return for that loan, the federal government would take control of the giant insurer by obtaining 79.9 percent of the company’s public shares. The American taxpayer had just bought itself the biggest, most troubled insurance company in the world.
When the credit crisis began in the late summer of 2007, I turned to a group of people I had been speaking with for 20 years to get insight about its significance. I started as a banking reporter in the mid-1980s, and one of the few benefits of growing older is that your sources do, too. The midlevel executives I had spoken with in the 1980s were now running many of our nation’s banks. Even in the earliest days of the crisis, when financial institutions were only beginning to show trepidation about extending credit and the stock market was about to hit new all-time highs, my sources were certain that we were in for deep trouble. The investors in the stock market seemed to have no idea what was going on in the credit markets — no idea of how hard it had become to get a loan, even if it was of extremely short duration, and no idea, it seemed to me, of what that fact would mean for our financial markets or our economy.
On Wednesday, after another late night of broadcasting, many people believed that while there was more bad news to come, the worst of the financial tsunami had passed. But those people weren’t paying attention to the credit markets. In those markets, panic was setting in.
The credit markets are similar to a sewer system. When they are working well, no one thinks about them. In the same way that we don’t question where that clean water that comes out of our tap is actually coming from, most professionals on Wall Street or Main Street don’t give much thought to the free flow of credit. It is something we accept as a constant. But when that credit gets backed up, it is reminiscent of a malfunctioning sewage system. People start to notice. And to take the simile one step farther, if a broken sewage system does not get quickly repaired, a host of malicious diseases is not far behind.
A year after my sources had first warned of the deep trouble toward which we were heading, we had found it. Banks that had not been making loans to corporations or consumers were now leery of making loans to each other. The commercial paper market, which had been slowly drying up for a year, was now closed to almost every borrower. And most terrifying of all, fear was starting to spread throughout the system. Every debt security, other than the debt issued by our government, was suspect. People were pulling money out of every conceivable form of debt and pulling their money out of their bank accounts for fear their bank would soon fail.
Panic is not typically rational. But the threat of panic made rational people prepare for the worst, which meant doing the very same things those who were panicking were doing. Money was coming out of everything, including heretofore-safe money market accounts and heading into Treasury bills and bonds. In a reflection of the panic, people were buying three-month Treasury bills that offered no interest rate. They were giving the U.S. government their money and only asking that it be returned to them three months later.
The conversations I began having with my longtime friends and sources (often one and the same) took on a surreal quality. Can you really put money in a mattress? Can I bury gold bullion in my backyard?
Should I buy a safe and a gun? What happens when people lose all faith in the currency and it simply becomes a piece of paper? What happens when everyone loses confidence in the creditworthiness of everyone else?
And then, on Thursday morning, September 18, we were face to face with it. Over the past few days, a handful of money market funds had seen vast redemptions that were forcing them to liquidate their holdings. The panic had started when one such fund lost value after it suffered losses from its holdings of debt of the now-bankrupt Lehman Brothers. Some funds were forced to stop their own investors from withdrawing their money immediately, which showed more panic. The money market funds, typically large buyers of commercial paper, had completely withdrawn from that market. In the same way that AIG had been shut out of the commercial paper market six days earlier, now even corporations without any connection to the financial services business were finding it impossible to borrow. And even banks that had always been happy to lend to each other were no longer willing to do so.
Thirteen months after our crisis in credit began, the United States and the rest of the world were about to watch the financial system implode. Countless corporations would be forced to file bankruptcy.
Commercial banks and investment banks, watching their depositors and trading partners exit en masse, would quickly become insolvent.
The word credit is derived from the Latin credere, which means “to believe.” When the belief that you will be paid back disappears, there is no credit. Belief is the lifeblood of a healthy financial system and its disappearance brought the very real possibility that the United States and much of the Western world would be thrown into a financial cataclysm the likes of which we had never seen.
How did we come to this point? How did we lose Bear Stearns in March and Lehman Brothers six months later? How could Merrill Lynch have been forced to sell itself? How did the American taxpayer end up owning AIG? And after all that, how was it that our system itself was still teetering on the edge of collapse? That story begins seven years earlier, in the rubble of the World Trade Center.
Excerpted from "And Then The Roof Caved In" by David Faber. Copyright (c) 2009, reprinted with permission from John Wiley & Sons, Inc.