We’ll probably never know how close we came to systemic financial collapse this March, but if anyone had any idea about the scale and scope of the global credit crisis, it was this ragtag collection of Wall Street rainmakers who gathered by phone last Sunday to rescue the world…
By Andrew Ross Sorkin
Just after JPMorgan Chase announced its initial $2-a-share deal to buy Bear Stearns, government officials held an extraordinary impromptu conference call. The participants on the Sunday night call, who got a preview of the deal, were Wall Street’s biggest power brokers: Lloyd Blankfein of Goldman Sachs dialed in from home. John Mack of Morgan Stanley rushed to the office to listen on speakerphone. Richard Fuld of Lehman Brothers, who had been directed to return home from a business trip in New Delhi by none other than Henry Paulson, the Treasury secretary, was patched in, too, among others.
The half-hour call, led by Mr. Paulson and Timothy F. Geithner, the president of the New York Federal Reserve Bank, was a rallying cry for support of Bear Stearns – and more broadly, the financial markets, which, as it was described on the call, were on the verge of a major meltdown if not for the pre-emptive steps that the Fed and JPMorgan took. “It was much worse than anyone realized; the markets were on the precipice of a real crisis,” said one participant. Given that Bear held trading contracts with an outstanding value of $2.5 trillion with firms around the world, “we were talking about the possibility of a global run on the bank.”
In another era, the participants in the phone call would have been an exclusive fraternity of high-powered Manhattanites. But this conversation was also filled with foreign accents – from UBS, Credit Suisse, Deutsche Bank, HSBC and beyond.
In truth, though, the call was still more of a courtesy to our foreign neighbors than it was a genuine effort to gather outside views. Call it speakerphone diplomacy. The “possibility of a global run on the bank” may have been real, but the important decisions had been made long before the folks in London, Dubai and Hong Kong were let in on the code-red secret. The chief executives of Wall Street’s top banks had been taking calls from each other and the Fed all weekend.
So goes the solipsistic world of Wall Street. The Four Seasons crowd may talk a big game about being global – sending lieutenants to start offices halfway around the world – but when it comes to opening up its secret society to foreigners, oddly, doing so is still an afterthought.
It is not just a problem in business. While the Fed and the Treasury Department often check in with their foreign counterparts, they still sometimes take a view that is more local than global. Mr. Paulson, formerly of Goldman Sachs, can propose a radical plan to regulate the financial industry in the United States, as he did this week, but it doesn’t address the larger problem: we’re now so interconnected with the markets abroad, whether it be Japan or even Brazil, that whatever we do on our own is almost beside the point.
“We need much tighter global coordination,” Bruce Wasserstein, the chairman of Lazard, told me this week. “It is myopic to look at things in a narrow box. Where we’ve been moving right, the E.U. is moving left. That doesn’t seem sensible.”
If the United States, for example, were to limit the amount of leverage – or debt – that investment banks or hedge funds could use, that wouldn’t offer any protection from debt-fueled implosions at rival firms abroad. A blowup at a highly leveraged fund in China would still ripple across the system.
Superleveraged funds have been a major culprit in the latest downturn, because their use of debt to juice returns has amplified the effects on the downside. (Just ask investors in two of Bear Stearns’s now-bankrupt hedge funds.) When things go bad, the fallout doesn’t stop at national borders. A fund in London may be connected to another in Thailand and not even know it. Who would have imagined that dentists in Germany owned subprime mortgages in Texas? (They did, or rather, still do – at a huge loss.)
The explosion in the use of derivatives has only tightened the global links – and made a worldwide meltdown easier to imagine. Banks and hedge funds across the world are routinely on opposite sides of contracts tied to debt, interest rates or other, more esoteric benchmarks. The collapse of one party (or sometimes just the possibility of a collapse) can be disastrous for the other. Bear’s downfall will very likely induce new calls to address the unnerving problem of “counterparty risk.” To be more than just a public-relations campaign, any such effort will need to have global reach.
In case there’s a question about how interconnected we really are, just witness the global markets’ near collapse in January when Société Générale, the French bank, blamed what it said was a rogue trader, Jérôme Kerviel, for $7.1 billion in losses. Société Générale’s efforts to unwind its positions – before announcing them publicly – came close to creating a market panic. George Soros, who was attending the World Economic Forum in Davos, declared at the time: “This is not a normal crisis. It is the end of an era.”
The Fed, itself unaware of Société Générale’s ordeal, felt compelled to lower interest rates. But let’s be honest: that didn’t do much, and three months later, we’re in worse shape. As Mr. Soros said then, “I question how far the Fed can go given the reluctance of people to hold dollars.” In the end, he agreed, there will have to be worldwide regulation of some sort. “The financial system needs a global sheriff,” he said.
A global financial cop is an idea that has been raised before, but it has never taken flight. E. Gerald Corrigan, who worked at the Fed for 25 years – as special assistant to the chairman, Paul Volcker, and later as New York Federal Reserve president – reminisced to me about his efforts to create global standards in the mid-1980s.
“I can tell you it was very challenging,” Mr. Corrigan said, referring to his work on the Basel Committee on Banking Supervision, an institution created in 1974 by the central bank governors of 10 of the most developed nations. “How do you get 10 countries to agree on detailed, word-for-word provisions when there are questions about what’s the definition of capital? Just start there.”
Still, he said, “While it is fair to say the cross-border consultation process has gotten much better, there is no question we need a better framework for international coordination of our policies.”
But even the thought of a global oversight committee to develop standards stirs fear in the minds of people who can’t stand the thought of regulation. And the chance that a coalition of countries could ever agree on a set of standards is probably slim. Just look at the debate over climate change, a much direr problem without an agreement on a global solution or even a basic set of standards.
The alternative – a global regulatory patchwork, with havens for leverage junkies – could be just as messy, however.
You might ask, why do we need any regulation? After all, it doesn’t seem to ever help. Every seven years or so, the markets plummet for one reason or another, followed by hand-wringing and calls for new regulations. Laws get passed in haste and the markets improve again. Then we do it all over. We may not repeat the old mistakes, but we have a knack for finding new ones.
All of this is true. But Wall Street, long thought to be the front-runner in globalization, is actually just catching up. Rules have always been lax, or at least inconsistent. The cowboy culture that created Bear Stearns has been exported to far-off corners of the world. The only difference is that the far-off corners aren’t that far off at all.