When Wall Street was shaken
Reviewed by Nirmal Sandhu

House of Cards: How Wall Streetís Gamblers Broke Capitalism
by William D. Cohan.
Allen Lane.
Pages 468. £25. 

THIS book, which reads like a financial thriller, is for those keen to understand what caused the Wall Street turmoil, how top investment banksódriven by greed, easy credit, lack of supervision and even government encouragementódiscarded caution and allowed themselves to be blown away. It also helps one appreciate how the RBI closely regulates Indian banks.

The 2008 financial meltdown will be long debated: What caused it and why no one could stop its global spread. Cohan holds the following responsible: the US government, rating agencies, Wall Street, commercial agencies, regulators and investors.

An investigative journalist-turned-investment banker at Wall Street, Cohan has captured the historic financial drama in detail. Avoiding jargon, he simplifies the chaotic world of finance, even for dummies, while focusing on Bear Stearns blunders that brought this 85-year-old investment firm down like a house of cards.

This pioneer of securities trading was driven by the philosophy: make money from money and it had to be other peopleís money. A sign that hung outside the firmís trading room read: "Letís make nothing but money".

The Bear management took pride in promoting an opportunistic culture. It took risks and made a lot of money, and in the process accumulated hard-to-sell and hard-to-value mortgages. On its balance sheets gathered prime mortgages and still riskier ALT-A mortgages, which offered very high yields.

When a firm consistently makes money, its shares zoom and the media too gets carried away. In March 2003, Fortune declared Bear Stearns "the most admired securities firm" of 2002, ahead of Goldman Sachs and Morgan Stanley.

On March 28, 2003, The New York Times published a laudatory article, Distinct Culture at Bear Stearns Helps it Surmount a Grim Market. The same day Wall Street Journal carried an article titled A Contrary Bear Stearns Thrives.

Bill Clinton and George W. Bush, supported by the Congress, encouraged loans to low-income, high-risk borrowers. The Federal Reserve, the US central bank, kept interest rates too low for too long.

Banks extended "credit to the less-than creditworthy, allowing them to buy homes, cars, and other goods and services they could not afford but thought they needed". A lot of people bought homes with no down payment. So, the people who lost homes later never had them in the first place.

The other factors that shook the countryís economic foundation included "a historic and ongoing increase in real-estate values, a rapid Ďinnovationí of Wall Street that made credit risk easier to manufacture, to trade, and in theory, to hedge".

What brought the immediate catastrophe was the tendency of Wall Street securities firms like Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers and Bear Stearns to resort to overnight borrowings to carry out their day-to-day business. As a result, "each was just twenty-four hours away from a funding crisis". Wall Street executives were skilled in the art of day-to-day survival.

Blinded by soaring profits from by the mortgage mania, Bear and Lehman accumulated $6 billion and $15 billion unsalable Alt-A mortgages, respectively, on their balance sheets.

As the sub-prime crisis spread, the lenders kept asking for more capital backup from Bear, which soon ran out of cash. In the deteriorating financial environment, confidence evaporated fast and no one trusted the other with money.

To save Bear from bankruptcy, the Fed intervened and ensured its capitulation to JP Morgan. That gave the first jolt to financially systems across the world. Why a bailout for Bear? So many in the US and outside asked the question. Tim Geithner of the Fed explained: "`85 an abrupt and disorderly unwinding of Bear Stearns would have posed systemic risks to the financial system and magnified the downside risks to economic growth in the United States."

Americans generally hate a firmís bailout with the taxpayerís money and would rather like its collapse. Noted columnist Paul Krugman summed up the prevailing sentiment thus: " Bear `85 deserved to be allowed to failóboth on the merits and to teach Wall Street not to expect someone else to clean up its messes. But the Fed rose to Bearís rescue anyway, fearing that the collapse of a major bank would cause panic in the markets and wreak havoc with the wider economy. Fed official knew that they were doing a bad thing, but believed the alternative would be even worse."

The US government was very selective and even discriminatory in saving some while letting others fail. Bear Stearns, Fannie Mae and Freddie Mac as also AIG got the bailout, but the same was denied to Lehman Brothers. The Ferderal Reserve deserves the flak it got. Looking back, Stephen Roach of Morgan Stanley says: "In retrospective, we did not have a global savings glut. We had an American consumption glut. In both of these cases, Bernanke was complicit in massive policy blunders on the part of the Fed."





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