The Big Squeeze - 1. Introduction

Introductions

(Mike’s perspective)

For confidentiality, I don’t want anyone to know me, my twin brother, or my boyfriend’s full names. No, I am not worried about being out, the federal government has a pretty good non-discrimination policy in place now with President Obama in the hot seat and my boss is open-minded. My brother is basically a millionaire and doesn’t give a rat’s ass what anyone thinks. My partner is a corporate lawyer, who would sue you for every cent you have if you even mentioned “fruit” in a high pitched tone near him. I don’t want our names to get out, because there’s just too much crap and reputation risk to ever reveal that kind of detail, especially with what we knew happened between September 10, 2008-January 15, 2009.

Let’s start off with some simple introductions, my name is Mike. My friends call me Mikey and unless you’re my boyfriend, Brad, don’t ever insinuate my name is Michelle even if you’re speaking with a French accent. I worked as a GS-12 Manager level Actuary for US Treasury Department. I am their guy for reading the tea leaves and entrails, then I write the doom and gloom reports. For an example right now in 2012, if Warren Buffet turns a few shades paler, someone like me would calculate in the chance that his cancer is intensifying, thus increasing the risk to markets based on emotional and economic indicators at any given point in time. Yes, actuarial science is one part psychology, but it is mainly advanced math. In 2008, I was working for a few years out of the Goldman Sachs’ risk department before switching over to government work. I liked working out VaR projections, but a friend of mine sold me on joining him in Treasury. It would be a good stint to learn how the other side of things worked, so I thought why not? The pay cut was a bit more dramatic than I thought it would be from $150,000 before bonuses to $68,000, but I had saved more than enough and bought three homes, one in New York, one in Washington, and one in New Hampshire for tax purposes, so I wouldn’t be eating McDonald’s fish fillets instead of le Cirque sea bass. By the way, I want to emphasize this point to all you haters out there, there is no such thing as a “Goldman conspiracy” to take over the world. Normal readers won’t get that point, but talk to someone in finance and you will hear the rumors of the evil empire. We make “the Illuminati” seem like a proven scientific fact compared to what they think Goldman and ex-Goldman guys are responsible for creating.

My twin brother, Matt, who does look exactly like me, was a Senior Manager of Financial Operations at Morgan Stanley. Matt is combative, confrontational, aggressive, and has an attitude on top of all that. Matt loves to use gambling metaphors in everything; I think he did the World Series of Poker in Las Vegas, a few years ago, too. Yeah, he’s a born New Yorker as our parents liked to describe him to friends. With that combination, he probably chose the right profession and firm. Morgan Stanley, once the mightiest Wall Street investment bank in the country, was number #2 after Goldman’s ascent. Morgan Stanley was spun off from JP Morgan back in 1935, when word came that Glass-Steagall made it illegal for Commercial and investment banking to be tied into each other. Matt applied to many firms of course like any undergrad, but I think he chose Morgan out of his personal desire to prove himself and his abilities. Back in 2003, we had both been interns with Goldman and I took their offer, but he chose to strike out to seek their competition. Part of me thinks that he did it, because he wanted to split himself off from me. Twins are unique in that way, we were one person at some point and I think people still think we’re that same person despite being totally different. He’s also gay as well, which is not surprising as twins have a higher rate of homosexual prevalence if one is gay. However, despite all his bluster and anger management issues, he’s a big soft bottom in reality. He’s made a pretty good name for himself up to this point as he had somewhere between $30-40 million worth in investments, securities, and money market accounts.

Brad is a lawyer. Diplomatic, when he needs to be. Threatening, if he thinks you are pushing him around. Whether you were working as a regulator or an investment banker, you hated lawyers. They tell you the most inconvenient truths about the laws protecting both sides from each other. It is why there is turnover for outside legal consultants. Unless, you’re smart and capable of walking that thin line between good sense and better judgment; neither side wants to hear the truth about what they’re doing or what they want to do being realistic or not in the legal framework. However, they needed a splash of cold water, so Brad had his work cut out for him. At this point, Brad and I had started dating infrequently. I liked his dispassionate and passionate sides in his formal arguments; I think he liked my natural inclination towards drawing logical lines of reasoning. We met during the Bear Stearns intervention back in March.

Here’s a little history lesson prior to the what happened around September 10^th, Brad’s firm was providing outside consultation and a legal concept for the government to intervene in what Wall Street at that point would call the first “Jamie” deal. The deal was named after Jamie Dimon, CEO of JP Morgan, who took over Bear Stearns with a subsidized bid of $2 per share, later raised to $10 per share by urging of Henry Paulson, US Secretary of Treasury and my boss just below President Bush. I didn’t meet Mr. Paulson, when he was my boss at Goldman, but based on what I knew about him, he was a good operator and fair dealer. The deal was ingenious actually and unlike what later transpired was not really direct government intervention as some people had claimed at first, like Senator Bunning of Kentucky, who called everyone at Treasury “Socialists” for providing financial support in the deal.

The “non-political” facts are more complicated, the value of mortgage backed securities or MBS products could not be determined effectively at that point in time and unwinding it would take more than a year, which made Bear Stearns’ true value difficult to pin down. This put pressure on their stock price, creditors, and their investors. Cash was running out due to pullouts from investors and soaring borrowing costs. They could not raise more due to valuation concerns and the unknown liabilities of the securities kept the other banks from buying them outright. The solution was that the government would cover the losses after the first billion for the JP Morgan buyout at a distressed price. The liberals screamed bailout and conservatives screamed socialism.

Then, Fannie Mae and Freddie Mac were taken over by the government on September 7^th 2008 as they were also losing value fast. In their case, it wasn’t the subprime mortgages that killed their valuation, but their modeling set up was based on an eternally appreciating real estate market. I don’t know who the risk managers were over there, but if Americans really wanted a sacrificial lamb with real meat, they should have dragged them out and had them shot for advocating such an unrealistic risk model.

After the intervention with Fannie Mae and Freddie Mac, rumors started coming out of the woodwork that President Bush was under pressure from Republican leaders on Capitol Hill to remove Henry Paulson from his post as Secretary of Treasury. It didn’t matter that he took over in late in 2006, when housing markets had already started souring. It didn’t matter that he was genuinely trying to come up with market based solutions in the spirit of American Capitalism and free markets based on his understanding of business as CEO of Goldman Sachs. He had done the most unthinkable thing to the laymen conservative politician; he sold one company by giving government money and took over publicly traded companies by forcing government control.

Ironically, neither company, Fannie Mae or Freddie Mac, was fully public as they were founded and held in minority stake by the United States Government directly for decades. In other circumstances, if another company’s internal investor tried to take over that company after it had lost almost 90% of its value and fired its incompetent management, people would call it a “White Knight” takeover and praise the conquering hero as they have left them with some value rather than no value at all. Paulson just did what he would have done, if he were still CEO of Goldman Sachs, but to the public, it’s a bailout or socialism. Sadly no one understood this fact at the time. It’s just the principle of how business works to maximize what you have and can get, not the impossible Washington rhetoric of “helping Main Street instead of Wall Street” or “Evil big government spending”. This is my opinion, but if Washington were not applying so much pressure after Fannie and Freddie takeovers, Lehman would have been saved. Quite frankly, most of Congress is still clueless.

(Matt’s Perspective)

Half of that is bullshit about me, Mikey! I’m not a soft bottom damn it. I can fuck my share of tight asses. Jesus Christ, you let a few guys fuck you a few times and everyone thinks you’re Brent Corrigan. I have tastes and pick my guys, too. If Brad weren’t attached to Mikey, I’d be going down on that stud.

Anyway, beyond my sex life, another thing I hate about Mikey is the way that he psychoanalyzes me. I am not some set of numbers and variables; I’m his twin brother. You don’t need to make sense of everything I do. I just do it.

Does a roulette player need to justify putting everything on 12? No, he just has the feeling that it’s the right move. He either loses all his money or makes about 35 times his initial investment. I don’t know about you, but the investment is worth the risk to me. Mikey would be betting on the outsides and waiting for the probabilities to reach an acceptable level of “risk” before he placed down his bets. It might be true that his way is safer and will eventually generate more money than mine if it never falls on 00, but it will take him at least 5-6 successive doubling attempts before he can make the same amount of money.

Don’t get me wrong, Mikey is doing a good job and the world needs more people like him and fewer guys like me. What happened during the 2000’s was pretty stupid from a financial standpoint as it was from a risk standpoint. How the hell could we have become so leveraged up during that period?

Look, I am not some wishy washy Democrat or liberal economist, but someone should have told us to stop. You don’t hand a gambler a loan and tell him “Go enjoy yourself”, if you are realistically looking for returns. You’re going to basically destroy capitalism at its core, when you are using $1 dollar to borrow $30 dollars. We were making a lot of our bets with other people’s money.

Now with that said, I want to correct a bad assumption among the average American. Over the years, I keep hearing this from people outside finance, “why the fuck did my stockbroker tell me to invest in Alcoa, they just lost 30% of their stock value”. I can tell you based on earnings, ratios, and moving averages, where to invest your money, but all that value is based on human assumptions.

Is Apple really worth $700 a share? Hell if I know, but people believe it, so I put premiums on it hitting a target of $800 in the future. If someone says the stock is worth $0.01, most people will just say they’re idiots. However, if bad news comes around like Apple losing their copyright battle to Samsung, the new iPhone explodes after a few hours of use, or other crap, the crazy outlier bidding at $0.01 a share doesn’t seem so crazy after all. The value of a company falls as confidence is lost due to bad news or events that might impact future earnings.

With the fall in stock value, you’re also seeing a fall in general corporate valuation and an increase in lending costs from bankers using corporate stock as a means to gauge corporate value. Every major corporation in the world operates on some type of lending and credit to pay for their operations. Few in reality have $100 million dollars lying around in their bank accounts all the time to pay for everything from payroll, health insurance, an order of pens, or even a new fax machine. To be honest, stocks don’t even matter to how a company records earnings or losses, but it does affect lending and financing, which is where cash poor companies go bankrupt. You’re forcing a company to have higher costs in borrowing for operations and other issues if it falls to a certain point where banks think you’re going under due to public perception. That’s what screwed most of our firms over in 2008. Then, there’s the thing about how we’re really each other’s bitches due to our counterparty contract commitments, but I’ll tell you guys later how we royally fucked that idea.

(Brad's perspective)

Well, both of them covered their general views and perspectives. I love Michelle by the way, LOL! The first time that I met Mikey, he was such a bitch to deal with. You think lawyers are bad; well you haven’t met actuaries; they scare you to death with every scenario that they propose until you are forced to pick the best of the worst cases. Yeah, he really forced me to think on my feet and I nearly threw a few punches at him during the Bear Stearns consultation.

Four years later, we’re married. At various points from September 2008 to January 2009, I thought the world was going to end. Banks were falling apart, the money market funds had bucked the trend, and I personally had lost probably close to $3 million on paper. Although compared to what some of my friends lost, I should be counting my blessings.

I am a lawyer, a junior partner at a prestigious New York law firm, which I don’t want to name as we still have to keep many matters confidential. I just want to give a fresh legal perspective on what was happening as I think everyone had focused heavily on the financial disaster without really looking at the law and the problems inherent before the financial crisis.

Legally, the biggest problem facing the country around that time was the concept of government intervention and length of intervention. For instance, the conservatorship of Fannie and Freddie was technically impressive. The government did not throw everyone under the bus; they actually tried to secure the institution through technical concepts, i.e. control over ownership. It is technically less stressful in practice than the capital injections and rules that had to be created, when TARP (Troubled Asset Relief Program) was executed.

There were also roles of government agencies in what they can do and cannot do based on market focus. Former SEC chairman, Christopher Cox, was cautious about his oversight into the realm of private regulations. The SEC had no power to regulate investment banks; they also could not order one to file chapter 11 bankruptcy protection. It’s a very messy question about regulatory controls and if no one is really driving, then where is this industry going except for a crash with no survivors. The case for government regulations is very clear, but no one at that point had oversight.