Most outside observers had difficulty keeping up with the momentous events of the weekend of September 14-15, 2008 with all of the twists and turns that finally led to Lehman Brothers’ historic bankruptcy filing, Bank of America’s purchase of Merrill Lynch, and AIG’s bailout only a few days later. Ever since that tumultuous period, there has been a need for a comprehensive book covering the behind the scenes events. Andrew Ross Sorkin’s Too Big To Fail has succeeded in delivering exactly what is needed to gain a better understanding of these historic events.
If newspapers are the “first draft of history”, Andrew Ross Sorkin played a major role with his New York Times coverage of the financial crisis in 2008. Although Mr. Sorkin is only 32 years old, he has obviously been able to build up a massive network of contacts on Wall Street and in Washington. Mr. Sorkin’s coverage spans the timeframe from the failure of Bear Stearns up to the passage of the TARP legislation, but the narrative really shines when it comes to the events of a September weekend when the financial system came much closer to total collapse than anyone on the outside could have realized at the time.
Mr. Sorkin’s book has received a great deal of media attention and book reviews, but there is also a need to step back and think about the lessons that must be learned if future crises are to be avoided. The inability of Washington to come to any agreements on financial system reform was a significant failure in 2009, but one that received little attention outside the financial press. With each passing week of relative “calm”, chances grow greater than another crisis may be required to prompt reforms.
Greed and Fear
The old adage that a balance between greed and fear creates equilibrium on Wall Street seems hopelessly out of date in light of the revelations in this book. In the “text book world”, investors and other players in a market system need to be driven by the profit motive (“greed”) but decisions are tempered by a desire for safety (“fear”). For many decades on Wall Street, the partnership model in investment banking seemed to keep the level of risk aversion high enough to prevent overreaching (for a great book on the old model at Goldman Sachs, for example, see Charles D. Ellis’ The Partnership).
One can argue that many leading Wall Street players lost huge sums of money in the 2008 crash, so the absence of more “fear” in the system cannot be explained merely by a change in the ownership models of the investment banks. Indeed, an absence of adequate levels of risk aversion extended to Main Street and Washington as well. Rep. Barney Frank’s famous declaration in favor of “rolling the dice” with softer underwriting standards for mortgage lending as well as the reckless disregard of financial prudence by many subprime borrowers cannot be ignored.
False Illusions and Egos
From the outside looking in, Wall Street and Washington are populated by highly confident, assertive, and competent individuals who seem equipped to carry out their responsibilities in a capable manner. While there are many individuals who fit this description well, some of whom appear in Mr. Sorkin’s book, many others appear to suffer from the human defects that affect everyone else. At several points in the book, we can see cases where ego prevented otherwise intelligent actions from being taken.
For example, why did Lehman Brothers’ CEO Dick Fuld, shocking even his own team, attempt to abruptly change the terms of a nearly sealed deal with Korea Development Bank in early August that would have valued Lehman at a premium and likely saved the firm? Was it a matter of seeking better terms for his shareholders, a question of ego, or confidence that a government bailout would be a backstop if all else failed?
There are countless other situations in the book where the reader, with the benefit of hindsight, asks: Why?
Government players hardly come out of the story looking like heroes either, with the possible exception of Treasury Secretary Hank Paulson who had the unenviable task of coming up with solutions for the crisis without appearing to favor a bailout of his former colleagues at Goldman Sachs. Throughout Mr. Sorkin’s account of the events, it becomes quite apparent that helping Goldman was probably the last thing on Mr. Paulson’s mind.
Timothy Geithner, the current Treasury Secretary, was President of the Federal Reserve Bank of New York during the crisis. Mr. Geithner comes across as the main deal maker for the Fed while Chairman Ben Bernanke takes a much lower profile role. While there is no doubt that Mr. Geithner played a critical role, he often comes across as authoritarian in terms of his tactics. For example, at several points, he makes threats or orders bank CEOs to take action during meetings and simply leaves the room asking to be notified when a solution is in place. Whether this was necessary or not during these remarkable times is an open question, but this is not how we should want government officials to behave in normal times.
President Bush hardly appears in the narrative and seems quite detached in the few occasions where he is being briefed on the crisis. For all practical purposes, Secretary Paulson was calling the shots for the Executive branch of the Federal Government throughout this process. Sen. Barack Obama made a few appearances in the book (as well as on Secretary Paulson’s calendar) but Sen. John McCain hardly appears at all which is surprising given that he famously suspended his campaign in order to return to Washington and work on a solution for the crisis.
Financial Regulatory Reform
One of the interesting aspects of the book is the degree to which government officials pushed to “marry” commercial banks and investment banks during the height of the crisis in September. It seems like every possible permutation was considered, to the point where Mr. Geithner was referred to mockingly as “E Harmony” in a reference to the online dating site. At the same time, many in government blame the 1999 repeal of the Glass-Steagall Act, which prohibited the union of commercial and investment banks, for precipitating the crisis.
While the idea of giving investment banks access to stable deposits through commercial banks had a great deal of merit during the crisis, such mergers also created ever larger institutions, many of which are considered “too big to fail”. It seems that society must decide which is the lesser of two evils: Government regulations that seek to keep financial institutions small such that none can become “too big to fail” or heavy handed regulations that properly govern mammoth institutions that are obviously “too big to fail”.
Wall Street: Pick Your Regulatory “Poison”
Wall Street cannot have it both ways: If regulations are repealed that then allow financial institutions to grow so large that a failure would have systemic impacts, then regulations governing the conduct of these institutions is essential to avoid future crises from developing. On the other hand, if we accept regulations that prohibit mergers that will result in massive institutions, Wall Street firms should have more flexibility to conduct their ongoing affairs without as much regulatory scrutiny since the failure of any one institution will not be systemically important.
It seems preferable to have “blocking” regulations such as Glass-Steagall rather than “operational” regulations required to govern massive financial institutions that are of systemic importance. A “blocking” regulation is not as intrusive into the day to day operation of firms and is less likely to throw sand in the gears of capitalism. In contrast, the regulatory regime required to monitor massive systemically important institutions will, of necessity, be intrusive and bureaucratic.
“Too Big To Fail: The Sequel”?
There are many potential solutions that should lead to a more stable financial system going forward, but each passing week makes it less likely that reforms will be made. As the economy recovers and “business as usual” returns to Wall Street, the seeds are now being planted for the next crisis. While no doubt capable of the task, we should hope that Mr. Sorkin does not have the opportunity to write a sequel to Too Big To Fail. The consequences could be even more severe.