There have already been a half-dozen or more books published about the global credit crisis of 2007-09, in an age when retrospectives of crises appear at the speed of thought. Of these two, Gasparino's is the far more carefully researched and compiled work. Former Washington Post editor Ben Bradlee famously said journalists write history's first draft; and, as first drafts go, Gasparino's is a fine one. Should anyone have been stranded on Mars while Earth's credit markets imploded, this would be a good catch-up.
Gasparino offers more than facts. Of these two authors, by dint of a longer work history, Gasparino offers much more perspective on our recent times. He also does a better job of cutting through Wall Street rhetoric. His biography highlights his working-class roots, and he is a talking head on CNBC. Imagine Oliver Stone's Wall Street from the perspective of the Martin Sheen character (the father) rather than the Charlie Sheen character (the son).
America's succumbing to its subprime sirens is by now a well covered story, but both books add their share of delicious detail. Zuckerman reports that when a large investor called Countrywide Financial to ask how stated-income mortgage loans work, he was told that lenders were not always allowed to ask for proof of salary--"So we just go to salary.com, look up a job," and put the highest salary found on the loan application. When the same investor later on called Hope Now (a U.S. government program set up to help struggling homeowners), pretending to be a homeowner in trouble, he was advised to stop making payments: "[S]ave your money and just buy another place."
Gasparino reports how, following the departure of CEO Hank Greenberg, AIG's risk-taking mushroomed as the insurer doubled issuance of credit default swap (CDS) protection (selling insurance) against collateralized debt obligations (CDOs), in just the last nine months of 2005 alone. But the more bizarre stage, when observers might say Wall Street drank its own Kool-Aid, came in the first half of 2007, when Merrill Lynch Lynch packaged $34 billion of CDOs, even as other firms held back. By that stage, AIG was no longer willing to insure these products, but lesser insurers stepped up. A year later, late and embarrassed, the rating agency S&P finally admitted that up to 85 percent of the AAA-rated CDOs issued between 2004 and 2006 could default.
If Gasparino set out to write a comprehensive tale, Zuckerman was content to focus on only one slice. His book, as the subtitle indicates, largely focuses on how John Paulson, the hedge fund manager, made so much money betting against U.S. subprime and the banks. As such, the book will be of interest to traders for the impressive way it portrays how Paulson stuck with his convictions when he was very much in the minority. He scaled up his exposure as his convictions grew against U.S. real estate. Then he coolly stuck to his trade even after the first gains came in and extended his trade to include bets against bank counterparties, once his massive profits started rolling in (one man's profit was another bank's loss). Hedge fund luminary George Soros once said it takes courage to be a pig; John Paulson clearly was in hog heaven most of this time.
Zuckerman's book also offers interesting details of how both sides of the madness outlined above were actually structured in financial markets, including how an accounting gimmick allowed traders to invent profits on the "negative basis trade." He explains how both Michael Burry, another bearish hedge fund manager, and Paulson's analyst Paolo Pellegrini anticipated the development of tradable CDS contracts, which would eventually allow both to more fully express their negative views. In addition, he details how Paulson and Pellegrini convinced Bear Stearns, Deutsche Bank and Goldman Sachs to create more CDOs against which they could bet!
However, the main theme Zuckerman tries to make is that somehow a handful of underdogs managed to one-up Wall Street (maybe the biggest one-up of all time). This theme does not quite ring true. It is true that Zuckerman's characterizations of Burry, a social misfit with Asberger's Syndrome who turned from medicine to stock blogging to managing his own hedge fund, and Andrew Lahde, a surfer-dude look-alike who would later drop out a la Timothy Leary after his big wave had come in, are far more interesting than what he was able to tease out of John Paulson (despite spending more than 50 hours interviewing him). But Burry and Lahde were bit players in this drama. Any Harvard Business School-trained hedge fund manager making a few million dollars a year and spending weekends in Southampton (which describes John Paulson before his biggest trade) is not an underdog. To believe otherwise would also be drinking the Wall Street Kool-Aid.
Gasparino documents quite a few human behavior mysteries--e.g., how Merrill Lynch CEO Stanley O'Neal, previously known for risk aversion while CFO, single-handedly pushed Merrill Lynch onto a path of far greater risk after he started running the whole show. Gasparino seems to suggest investor demand for higher profitability and ambitions to match Goldman Sachs lay behind both Merrill Lynch's and Citigroup's march to doom, but he does not delve any further. Meanwhile, in such a world there is the suggestion that Lehman Brothers, under its CEO Dick Fuld, felt it had to swing for the fences if only to survive. There is only a small gloss on "perverse compensation incentives" (p. 310), leading to a final conclusion that the FBI and state attorneys general should prosecute white-collar Wall Street crime in order to correct those misaligned incentives. Economists, of course, know all about incentives, and there is more work to be done.
If personal ambition and corporate keeping-up-with-the-Joneses were all that was behind Wall Street's march over the edge, the question is why there should be any role for government bailout from such behavior? While not central to these markets-focused books, this question looms large.
Gasparino records not only regulatory neglect but active harm done by the relaxation of net capital rules by the SEC, which led to the hoarding of "AAA" mortgage products on bank books. He also notes that regulators have barely uttered a peep about apparently blatant misrepresentations of Wall Street finances during the crisis. One example is the unrealistic marks Bear Stearns had applied to assets held by its former credit hedge fund manager Ralph Cioffi at a time when Merrill Lynch was preparing to seize those assets. Economists will also note a deep resemblance between taxpayer-subsidized speculation by Fannie Mae and Freddie Mac and the behavior of savings-and-loans in the 1980s.
Overall, regulators are presented as, to use Gasparino's word, oblivious. Zuckerman quotes Federal Reserve Chairman Ben Bernanke saying in June 2007: "[T]roubles in the subprime sector seem unlikely to seriously spill over to the broader economy or financial system." Gasparino is harsher: "[Treasury Secretary Hank] Paulson, [Federal Reserve Bank of New York Timothy] Geithner, and [SEC Chairman Chris] Cox had time to react, yet they failed to do so, beyond engaging in a few conference calls with Alan Schwartz and Jimmy Cayne [the final two Bear Stearns CEOs]. Which is why short sellers make so much money." (p. 363)
One possibly mitigating rationale for actions that Hank Paulson and other top policymakers took would be the broader interests of the economy beyond Wall Street. While there is more than a hint that Gasparino would find such a rationale to be questionable, because both books largely ignore the real economy (a glaring omission in each), there is no way to determine if such cynicism is warranted. Zuckerman highlights but one family--the Monteses (who at the end are left saying, "We're one plumbing problem away from default"). Similarly, Gasparino highlights only one family, in the context of mortgage fraud. Zuckerman's title, The Greatest Trade Ever, refers to the single biggest money-making trade of all time, but greatness is in the eyes of the beholder. The newspaper Zuckerman works for, one year after the global credit crisis troughed, published a front-page story about new requests that store mall Santas were hearing from children around the United States: For shoes with no holes and a job for daddy.
Both Hank Paulson and Bernanke declined to be interviewed by Gasparino. One day they may write their own tomes. If so, their facts will need to be checked against sources like Gasparino's.
The policy lessons that remain to be drawn out are vital, because Gasparino makes it clear that such a crisis will all happen again: "[C]ould the great risk taking of the past three decades return and could the country face another implosion of the financial system? The answer is undoubtedly yes." (p. 495) Meanwhile yesterday's strategy of slashing interest rates and ring-fencing a single institution are no longer sufficient to correct severe financial distresses. Already during this crisis Gasparino noted, "the Fed was tapped out" (p. 444). God help us all if the Fed is still tapped out in the next crisis.
Cliff Tan
Stanford Center for International Development, Stanford University, Stanford, CA, USA
By Charles Gasparino, 2009. Harper Business. Pp. 553, $27.99 hardcover.
By Gregory Zuckerman, 2009. Broadway Books. Pp. 295, $26.00 hardcover.
Business Economics (2010) 45,142-144.
doi:10.1057/be.2010.9