Too Big to Fail [6]
“The sudden failure or abrupt withdrawal from trading of any of these large U.S. dealers could cause liquidity problems in the markets and could also pose risks to others, including federally insured banks and the financial system as a whole,” Charles A. Bowsher, the comptroller general, told a congressional committee after being tasked with studying a developing market known as derivatives. “In some cases intervention has and could result in a financial bailout paid for or guaranteed by taxpayers.”
But when cracks did start to emerge in 2007, many argued even then that subprime loans posed little risk to anyone beyond a few mortgage firms. “The impact on the broader economy and the financial markets of the problems in the subprime markets seems likely to be contained,” Ben S. Bernanke, the chairman of the Federal Reserve, said in testimony before Congress’s Joint Economic Committee in March 2007.
By August 2007, however, the $2 trillion subprime market had collapsed, unleashing a global contagion. Two Bear Stearns hedge funds that made major subprime bets failed, losing $1.6 billion of their investors’ money. BNP Paribas, France’s largest listed bank, briefly suspended customer withdrawals, citing an inability to properly price its book of subprime-related bonds. That was another way of saying they couldn’t find a buyer at any reasonable price.
In some ways Wall Street was undone by its own smarts, as the very complexity of mortgage-backed securities meant that almost no one was able to figure out how to price them in a declining market. (As of this writing, the experts are still struggling to figure out exactly what these assets are worth.) Without a price the market was paralyzed. And without access to capital, Wall Street simply could not function.
Bear Stearns, the weakest and most highly leveraged of the Big Five, was the first to fall. But everyone knew that even the strongest of banks could not withstand a full-blown investor panic, which meant that no one felt safe and no one was sure who else on the Street could be next.
It was this sense of utter uncertainty—the feeling Dimon expressed in his shocking list of potential casualties during his conference call—that made the crisis a once-in-a-lifetime experience for the men who ran these firms and the bureaucrats who regulated them. Until that autumn in 2008, they had only experienced contained crises. Firms and investors took their lumps and moved on. In fact, the ones who maintained their equilibrium and bet that things would soon improve were those who generally profited the most. This credit crisis was different. Wall Street and Washington had to improvise.
In retrospect, this bubble, like all bubbles, was an example of what, in his classic 1841 book, Scottish author Charles Mackay called “Extraordinary Popular Delusions and the Madness of Crowds.” Instead of giving birth to a brave new world of riskless investments, the banks actually created a risk to the entire financial system.
But this book isn’t so much about the theoretical as it is about real people, the reality behind the scenes, in New York, Washington, and overseas—in the offices, homes, and minds of the handful of people who controlled the economy’s fate—during the critical months after Monday, March 17, 2008, when JP Morgan agreed to absorb Bear Stearns and when the United States government officials eventually determined that it was necessary to undertake the largest public intervention in the nation’s economic history.
For the past decade I have covered Wall Street and deal making for the New York Times and have been fortunate to do so during a period that has seen any number of remarkable developments in the American economy. But never have I witnessed such fundamental and dramatic changes in business paradigms and the spectacular self-destruction of storied institutions.
This extraordinary time has left us with a giant puzzle—a mystery, really—that still needs