Wolf chuckled, remembering the call. “Obviously, some people were more in the loop than I was, because they’d been engaged earlier by the Fed or by Lehman.”
Citigroup CEO Vikram Pandit was not entirely clear why he had been summoned to the Federal Reserve, but he could feel the buzzing sense of urgency as soon as he arrived. Pandit had joined Citi in 2007 when it acquired his hedge fund, Old Lane Partners, for $800 million, and almost immediately got bumped up to the top position after Chuck Prince was forced to resign. Now, sitting across the table from Paulson and Geithner, surrounded by his peers, he sensed the dread in the room. This wasn’t just about one company, he realized.
Prior to that day, there had been a lot of argument over possible solutions—government assistance, buyouts, and mergers. But on Friday, September 12, it sank in that a Lehman bankruptcy would have ripple effects, and the key players realized they needed to stop bickering and try to figure out answers.
One observer painted a remarkable picture for me of powerful opponents working together. “I looked at Jamie Dimon sitting across from Lloyd Blankfein, and I thought I’d love to write a book called Lloyd Blankfein vs. Jamie Dimon,” he said. “Those two were the giants in the room, and they hated each other so much it was impossible to believe they were sitting there. But you know what? They were very good, very willing to cooperate. And through the whole process I thought Jamie Dimon came off looking better than anybody. He was the guy that always rose above the pettiness with common sense and good ideas.” He was also the one who probably knew more than the others, being the healthiest bank at the table. No surprise later when his competitors railed at him for turning up the screws and demanding more collateral just when it hurt the most.
The men at the Fed working on the Lehman crisis had been divided into three groups. The first group was tasked with examining Lehman’s financials and determining how much capital would be needed. The second group was assigned to figure out a rescue structure. And the third group was assigned to figure out what would happen if Lehman could not be saved. “You’ve got to try harder,” Geithner warned them, his temper frayed. They seethed—no one appreciated being lectured to by Geithner. But they went off to their groups to get started.
TWO
The Bubble Machine
“Although a ‘bubble’ in home prices for the nation as a whole does not appear likely, there do appear to be, at a minimum, signs of froth in some local markets where home prices seem to have risen to unsustainable levels.”
—ALAN GREENSPAN, TESTIFYING BEFORE CONGRESS, JUNE 9, 2005
The most common question people ask me, looking back on the financial meltdown of September 2008 from the perspective of 2010, is, “How did it happen?” How could the financial markets go from such euphoric highs to such desperate lows? And where were the guardians at the gates—those investment banking geniuses with their perfect instincts and fat bonuses who were supposed to predict trouble and make course corrections? Where were the congressional watchdogs on Capitol Hill or the regulators at the SEC? There were some skeptics, hedge funds that resisted the euphoria and bet against the boom and made huge profits. There were some worrisome signs, but only in retrospect did we understand the systemic nature of the crisis. However, there is no question that the tsunami that hit Wall Street started with a trickle of unconventional mortgage loans that nobody imagined could mean such big trouble.
The euphoria of the housing-boom years was intoxicating, and it fueled a sense of urgency with a pulsing mantra: Buy, buy, buy! Home ownership had always been a cornerstone of the American dream, but in the past it was possible only for those who fit certain criteria. Everyone understood that in order to qualify for a home mortgage you had to have a secure job with an income that could comfortably accommodate a monthly mortgage payment, a good credit rating, and a cash down payment of 10 to 20 percent of the purchase price. But fueled by low interest rates and a booming housing market, nonbanks started getting in on the mortgage action. These entities were not as strictly regulated as conventional banks, and soon the mortgage business became tainted as brokers dropped the qualification standards and began writing loans for people with poor credit who couldn’t come up with down payments. They were dubbed “liar loans” because they required practically no verification. You could have claimed to be the Queen of England and walked away with a loan and a “Thank you, Ma’am” without a second look. We all remember the commercials touting the miraculous news: nothing down, no credit check, no requirements, everybody qualifies. It seemed too good to be true, and it was. Usually, subprime mortgages were pumped-up versions of adjustable rate mortgages (ARMs). That is, the interest rates were very low or nonexistent in the early years but then were adjusted to a much higher rate later on. The effect was that monthly mortgage payments shot up; some even doubled. The bitter irony of the setup was that subprime borrowers were the least able to withstand a sudden financial hit.
By 2007 large numbers of borrowers were facing default as the terms of their loans reset, and they were no longer able to afford their monthly payments. Massive defaults put a strain on lenders, but the fallout went far beyond them. By the time the subprime
