The relationship between the financial industry and Washington started to deteriorate in earnest late January 2010. Two days after the Democrats surprisingly lost an election in Massachusetts for the late Ted Kennedy’s former Senate seat, President Obama, seemingly out of nowhere, announced a sweeping plan to overhaul Wall Street.
“I’m proposing a simple and common-sense reform, which we’re calling the ‘Volcker Rule’—after this tall guy behind me,” Obama announced, referring to Paul Volcker, the former chairman of the Federal Reserve. “Banks will no longer be allowed to own, invest, or sponsor hedge funds, private equity funds, or proprietary trading operations for their own profit, unrelated to serving their customers. If financial firms want to trade for profit, that’s something they’re free to do. Indeed, doing so—responsibly—is a good thing for the markets and the economy. But these firms should not be allowed to run these hedge funds and private equities funds while running a bank backed by the American people.”
The proposal, which would have a profound effect on the way the industry worked, was greeted with cheers from critics of the financial sector, but with dismay from those within it. “For a lot of Wall Street people, it was like, ‘Okay, first you slap us in the face, now you kick us in the balls. Enough is enough. I mean, we’re done,’” one banking CEO complained.
The choice was especially surprising because for many months Volcker, whom Obama had asked to chair the President’s Economic Recovery Advisory Board, had effectively been ignored by other members of the administration, like Timothy Geithner, the Treasury secretary.
Volcker had been the most outspoken member of Obama’s inner circle about the need for reform. To him, Wall Street had grown far too complicated with fancy new products like collateralized debt obligations and had veered away from its core purpose of helping the economy through responsible lending.
At a gathering of bank CEOs in late 2009, he famously chided its leaders.
“Wake up, gentlemen,” he declared. “I wish that somebody would give me some shred of neutral evidence about the relationship between financial innovation recently and the growth of the economy, just one shred of information.” He added, “The most important financial innovation that I have seen the past twenty years is the automatic teller machine. That really helps people.”
In early June 2010 Warren Buffett was subpoenaed to testify before the Financial Crisis Inquiry Commission. The commission, which had been appointed by the president, had been mandated “to examine the causes of the financial crisis that has gripped the country and to report our findings to the Congress, the President, and the American people.”
As part of its investigation, it summoned Buffett to a hearing about the role of rating agencies, including Moody’s, of which his Berkshire Hathaway was the largest shareholder.
But the commission wasn’t strictly interested in Buffett’s views on the agencies. What the panelists, like much of the public, really wanted to know was who exactly was to blame for the crisis.
Buffett’s response spoke to the essential truth of both the boom—which was fueled by speculation in the housing market—and the bust:
When there’s a delusion, a mass delusion, you can say everybody is to blame. I mean, you can say I should have spotted it, you can say the Feds should have spotted it, you can say the mortgage brokers should have, Wall Street should have spotted it and blown the whistle.
I’m not sure if they had blown the whistle how much good it would have done. People were having so much fun.
And it’s a little bit like Cinderella at the ball. People may have some feeling that at midnight it’s going to turn to pumpkin and mice, but it’s so darn much fun, you know, when the wine is flowing and the guys get better looking all the time and the music sounds better and you think you’ll leave at five of twelve and all of a sudden you look up and you see there are no clocks on the wall and—bingo, you know? It does turn to pumpkins and mice. It’s hard to blame the band. It’s hard to blame the guy you’re dancing with.
There’s plenty of blame to go around. There’s no villain.
However accurate his assessment, Buffett’s answer was hardly satisfying to those still eager for the sight of some executive—any executive—being hauled away in handcuffs.
Despite months of effort, however, a viable culprit had yet to be identified.
In March 2010, a court-appointed examiner in the bankruptcy of Lehman Brothers, Anton R. Valukas, issued a report that, at over 2,200 pages and a cost of more than $36 million, was the closest thing to an autopsy of Lehman. The report had been highly anticipated by the Justice Department and Securities and Exchange Commission, whose own probes had stalled. Despite the voluminous amount of information it had gathered, however, it did not appear to have produced a smoking gun, for while it raised questions about the firm’s behavior, it also appeared to exonerate its board.
Mr. Valukas stated that, while Lehman’s directors should have exercised greater caution, they did not cross the line into “gross negligence.” Instead, he concluded, “Lehman was more the consequence than the cause of a deteriorating economic climate.”
The report did, however, include some new revelations that could still lead to government action. Its most interesting and controversial discovery concerned an accounting practice called Repo 105, which the public was learning about for the first time. As the report explained it, “Lehman did not disclose … that it had been using an accounting device (known within Lehman as ‘Repo 105’) to manage its balance sheet—by temporarily removing approximately $50 billion of assets from the balance sheet at the end of the first and second quarters of 2008… .Lehman’s own accounting personnel described Repo 105 transactions as an ‘accounting gimmick’ and a ‘lazy way of managing the balance sheet as opposed to legitimately meeting balance sheet targets at quarter end.’”
The report found that there were “colorable claims” (a legalism for a civil case) against certain members of Lehman’s management—Richard Fuld, Chris O’Meara, Erin Callan, and Ian Lowitt—for breaching “their fiduciary duties by exposing Lehman to potential liability for filing materially misleading periodic reports” and against Lehman’s auditor, Ernst & Young, for “ being professionally negligent in allowing those reports to go unchallenged.”
In particular, the report said of Fuld that, “There is sufficient credible evidence to support a determination that Fuld’s failure to make a deliberate decision about Lehman’s disclosure obligations was grossly negligent or demonstrated a conscious disregard of his duties.”
For his part, Fuld (who has since returned to work by setting up a small advisory firm several blocks from Lehman’s old headquarters) insisted he was unaware of Repo 105. “I have absolutely no recollection whatsoever of
