Inside Job (17 page)

You could also
buy
junk, and ignore its risks, as long as you could buy CDS protection on it. One major additional reason that Wall Street was able to sell so many toxic mortgage
securities was that they could point to CDS sellers, especially AIG, and say: Look, this stuff is great. But if you’re worried about it, no problem; all you need to do is walk over to those
great folks at AIG, pay them a small fraction of your annual returns, and you’ll be completely protected.

Moreover, the total amount of risk created in the market was potentially limitless. Consider real insurance again. In the event of a disaster—an earthquake, a hurricane, or a
tornado—the total liability of a real insurance company is limited to the actual damage caused by the disaster. But in the case of CDSs, as long as someone was willing to sell them, there was
no limit to the size of the liabilities and risks that could be created.

Of course, selling gigantic amounts of such “insurance” on risky, even fraudulent, securities would be unwise. But AIG did it, for three reasons. The first was the complexity and
opacity of the market, even—a cynical person might say
especially
—to AIG senior management. The second reason was that AIG’s senior management and board of directors were
out to lunch. I invite readers to compare AIG’s investor presentations from the late bubble era—late 2007 and early 2008 especially—to the post-crisis congressional testimony of
AIG’s ex-CEO Martin Sullivan. The investor presentations are absurdly optimistic and
misleading, but they are also incredibly complex, whereas Mr Sullivan appears to be
. . . not a complex man. He was the handpicked successor to Maurice (Hank) Greenberg, who seems to have chosen him for his pliability when Greenberg was forced out as CEO by Eliot Spitzer’s
fraud investigations in 2005. AIG’s board, which had also been largely handpicked by Greenberg, was as pliable as Mr Sullivan.

But the third reason is that AIG used the same toxic bonus system that destroyed everyone else. The company’s CDS business was insanely profitable—until it wasn’t—with
profit margins of over 80 percent in its “best” years. It was run by a highly autonomous 375-person London-based unit, AIG Financial Products (AIGFP), which was the personal fiefdom of
a man named Joseph Cassano. AIGFP kept 30 percent of each year’s profits as cash bonuses, passing the rest to the parent company. During the bubble, AIGFP paid itself over $3.5 billion in
cash bonuses (Cassano personally made over $200 million) and handed $8 billion to AIG, by 2005 accounting for 17 percent of AIG’s total corporate profits.

In 2007, when the bubble started to deflate, the CDS buyers started to come knocking, demanding their money. Cassano resisted, while publicly telling investors in late 2007 that he could not see
AIG losing “even one dollar” on the CDSs. Cassano blocked both external and internal auditors from reviewing AIGFP’s books. In 2007 AIGFP’s vice president for accounting
policy, Joseph St. Denis, grew concerned about the CDSs and how they were being valued. Cassano angrily and obscenely denied him access to the information, telling St. Denis that he would
“pollute the process”. St. Denis eventually resigned in protest, telling AIG’s chief auditor in late 2007 that he could not support AIGFP’s CDS accounting. Cassano stayed in
place until AIG collapsed in September 2008. In response to public pressure, AIG terminated him, but then immediately rehired him as a consultant at the rate of $1 million per month, until that
arrangement too was ended after being publicized in congressional hearings.

As of this writing (early 2012), credit default swaps have resurfaced
as a factor in the sovereign debt crisis of Europe, and the potential spread of that crisis
throughout the US and European banking sector. Some people never learn. . . .

HAVING CONSIDERED THE
investment banking industry’s behaviour, let us return to the question of how and why CEOs and boards of directors could
have tolerated this, and in particular why they could have allowed it to destroy their own companies. In part, the same financial incentives operated for them, and made them indifferent to the fate
of their firms, employees, and customers. In some other cases, however, destroying their firms was clearly contrary to their self-interest, at least to some extent. Why did they let it happen? For
there is no question that to some extent, the senior management of some of the banks did indeed behave irrationally.

Here, we must leave pure economics and ponder the toxic effects of too much wealth, too much power, the new culture of American investment banking, and a life conducted within the cocoon of
America’s new oligarchy. Let us consider, for example, Jimmy Cayne. For those who might find what follows just slightly difficult to believe, I invite you to Google a phrase along the lines
of “Jimmy Cayne helicopter Plaza Hotel bridge golf megalomaniac marijuana.”

Jimmy Cayne became CEO of Bear Stearns in 1993, and assumed the additional role of chairman in 2001, remaining in both positions until he was finally forced out as CEO in January 2008, by which
point it was too late to save the company.

Mr Cayne, who appears to have been very widely disliked, was not someone you were likely to feel comfortable telling that he was destroying his firm and the world economy. Former employees have
told me a variety of stories. He would convene early morning meetings in the office,
order a nice hot breakfast from a waiter, and consume it during the meeting, offering
nothing to his subordinates, who waited for him to finish. He would invite someone into his office, make a show of taking out two cigars, light one up, and then put the other one in his pocket. He
insulted subordinates in public, using extreme profanity. His predecessor as CEO of Bear Stearns, Ace Greenberg, described him as “a dope-smoking megalomaniac.”

But that’s his good side. As Bear Stearns’s profits and share price soared as a result of the bubble, Mr Cayne became a billionaire, and he went from being arguably obnoxious to
being seriously disconnected. He routinely took three- and four-day weekends, as well as extended holidays. For his long weekends, he frequently commuted from Bear Stearns headquarters by
helicopter to his New Jersey golf club, where he had permission to land his helicopter on the grounds, and where he kept a house. At Bear Stearns, he reserved a lift for his sole use. A serious
bridge player, he paid two Italian professionals $500,000 per year to play with him. He travelled to many bridge tournaments and also spent a great deal of time playing bridge on his computer.
Despite being a staunch Republican, he also reportedly smoked a lot of marijuana, with bridge partners, fellow hotel guests, and others frequently seeing and smelling it.

When the bubble started to implode in 2007 and Bear Stearns started to come under pressure, Mr Cayne was frequently AWOL at critical times. Even on weekdays, and even when his company was
collapsing in 2007 and 2008, he never carried a phone or pager when he was playing golf or bridge. He travelled repeatedly to bridge tournaments during this period, sometimes remaining away from
the office a week or more. He would not participate in conference calls or meetings if they conflicted with his bridge schedule.

Bear Stearns’s troubles started for real in mid-2007, with the collapse of two of its investment funds that had been heavily concentrated in properties. On Thursday, 14 June 2007, when
Bear Stearns publicly reported its first worrisome financial results, Cayne was playing golf
in New Jersey; he played the following day as well. One month later, on 17 July
2007, Bear Stearns told investors that the two property investment funds were now worthless. The next day, 18 July, Mr Cayne flew to Nashville, Tennessee, for a bridge tournament, joined by Bear
Stearns’s head of fixed-income products, Allen Spector, and stayed there for most of the following ten days, playing bridge. Mr Cayne was in the office for only eleven days that month. Even
when he participated in conference calls, he would sometimes drop off without warning.

This did not seem to disturb the board of directors. Indeed, the impetus for Cayne’s removal as CEO seems not to have been his performance, but the increasing publicity, particularly a
Wall Street Journal
article in November 2007 that described his golf and marijuana habits, and his being unreachable while indulging them. Even after being forced out as CEO in January 2008,
Cayne remained chairman of the board. In early March 2008, about a week before his firm collapsed and was sold to JPMorgan Chase, Mr Cayne closed on his purchase of two adjoining apartments in the
Plaza Hotel for $24 million. On 13 March, when Bear Stearns entered its final death spiral, he was in Detroit, Michigan, playing bridge again; he joined the board’s conference call late so
that he could finish his game first.

On 10 May, two months after his firm’s collapse, Mr Cayne attended a party held at the Plaza for new residents. The party included caviar and cognac bars, as well as a buffet that
replicated an exhibit from the Metropolitan Museum of New York entitled “The Age of Rembrandt”.

Mr Cayne did suffer, of course. He lost his job; but when Bear Stearns collapsed he was seventy-four years old, near retirement age anyway, and it seems likely that in his head, he had already
been retired for quite some time. The value of his Bear Stearns stock declined from about $1 billion at its peak to a mere $65 million when JPMorgan Chase bought the shares. But Mr Cayne had
thoughtfully taken out lots of cash over the previous years, so his estimated net worth remains about $600 million, probably sufficient to support his myriad habits.
He still
lives at the Plaza (at least when he’s in Manhattan—he has several other homes, including the one next to his golf club).

Certainly extreme, I hear you say, but could such behaviour possibly be common, much less representative?

Well, yes, actually.

So, yes, it is true that some of the destruction caused by the bubble and crisis cannot be attributed entirely to rational self-interest and fraud. But that doesn’t mean that the rest was
caused by innocent, well-intentioned error. Rather, it was symptomatic of a culture, and a governance system, that was seriously out of control.

During the bubble, many Wall Street executives constructed surreal little universes around themselves. The essential components of these worlds were physical isolation via private environments
off-limits to their employees (limousines, lifts, planes, helicopters, restaurants), sycophantic employees and servants both at work and at home, and a compliant, clueless board of directors. Often
their worlds also included trophy wives, mistresses, prostitutes, and/or drugs. Leisure activities were divided generationally. Young traders and salesmen focused on nightclubs, strip clubs,
parties, gambling, cocaine, and escorts; New York investment bankers certainly spend over $1 billion a year in nightclubs and strip clubs, much of it charged to their firms as reimbursable, and
tax-deductible, business entertainment. The older generation of senior executives, most of them married, tend to favour golf, bridge, expensive restaurants, charity events, art auctions, country
clubs, and Hamptons estates.

Jimmy Cayne wasn’t the only one with a private elevator and a taste for helicopter commuting; in fact he was comparatively reasonable. After complaints, he eventually agreed to reserve the
lift for his private use only between 8 a.m. and 9 a.m. every day. Richard Fuld, Lehman’s CEO, had a different system. Whenever Fuld’s limousine approached Lehman headquarters, his
chauffeur would call in; a specially programmed elevator would descend to the car park, held there by a guard until he arrived. Then the lift took Fuld straight to the thirty-first
floor, with no stops, so he didn’t have to see any of his employees. Here’s how a former Lehman employee described it (part of this is in my film):

Stan O’Neal at Merrill Lynch had a private lift too—namely, any lift that happened to be around when he arrived. A security guard would hold the next lift that appeared, preventing
anyone else from entering and, if necessary, ordering others already in the elevator to leave.

Lehman and most of the other banks also had corporate art collections, which sometimes absorbed considerable executive energy. All of the banks maintained chefs for their elegant private dining
rooms, usually several of them, with access strictly controlled for executives and guests of differing levels of seniority and wealth. I’ve eaten in a few of them (Morgan Stanley, JPMorgan
Chase); they’re
very
nice.

Everyone had limousines and drivers, of course, but there were serious toys, too. When Lehman went bankrupt, it owned a helicopter and six corporate jets. Two of the jets were 767s, which
normally seat over 150 people when used by airlines, and cost more than $150 million when purchased new. In addition, however, Joe Gregory, Lehman’s president (the number two position under
Fuld, the CEO), had
his own
personal helicopter, in which he commuted daily to Lehman from his mansion in the Hamptons. (In bad weather, he sometimes used a seaplane.) Gregory had a
household staff of twenty-nine people. Citigroup owned two jets, and tried to take delivery on a new $50 million plane
after
it had collapsed and been rescued by the US government.

Okay, so they had toys. But what were their financial incentives, how did their boards of directors compensate them, examine their conduct,
reward and discipline them?
Were others as bad as Bear Stearns and Jimmy Cayne?

Yes, they were. Professor Lucian Bebchuk of Harvard Law School examined the conduct of the most senior executives of Bear Stearns and Lehman Brothers in the years prior to their collapse. In
both cases the top five employees had collectively taken out over $1 billion in cash (that is, a billion from
each firm
) in the several years immediately preceding the collapse. This does
not suggest that these men (and all ten were men) had unlimited faith in the future of their firms, nor powerful incentives to avoid risk.