Exile on Wall Street E-Book

Mike Mayo

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 354

Veröffentlichungsjahr: 2011

Beschreibung

An insider points out the holes that still exist on Wall Street and in the banking system Exile on Wall Street is a gripping read for anyone with an interest in business and finance, U.S. capitalism, the future of banking, and the root causes of the financial meltdown. Award winning, veteran sell side Wall Street analyst Mike Mayo writes about one of the biggest financial and political issues of our time - the role of finance and banks in the US. He has worked at six Wall Street firms, analyzing banks and protesting against bad practices for two decades. In Exile on Wall Street, Mayo: * Lays out practices that have diminished capitalism and the banking sector * Shares his battle scars from calling truth to power at some of the largest banks in the world and how he survived challenging the status quo to be credited as one of the few who saw the crisis coming * Blows the lid off the true inner workings of the big banks and shows the ways in which Wall Street is just as bad today as it was pre-crash. * Analyzes the fallout stemming from the market crash, pointing out the numerous holes that still exist in the system, and offers practical solutions. While it provides an education, this is no textbook. It is also an invaluable resource for finance practitioners and citizens alike.

Leseprobe

Contents

Introduction: Watering Down the Wine

Chapter 1: “God’s Work” at the Fed

Chapter 2: The Big Time—or Something Like It

Chapter 3: Exile . . . and Redemption

Chapter 4: The Professional Gets Personal

Chapter 5: The Crisis

Chapter 6: The Vortex

Chapter 7: Citi, Part I: A Long, Sad Saga

Chapter 8: Citi, Part II: The Plot Sickens

Chapter 9: A Better Version of Capitalism

Accounting

Bankruptcy

Clout

Chapter 10: The Meaning of Life

Acknowledgments

About the Author

Index

Copyright © 2012 by Mike Mayo. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

ISBN 978-1-118-11546-6; ISBN 978-1-118-20364-4 (ebk); ISBN 978-1-118-20365-1 (ebk); ISBN 978-1-118-20366-8 (ebk)

Introduction

Watering Down the Wine

I had an epiphany not long ago. It took place during a dinner conversation at a massive investors’ conference in Hong Kong. Over the course of five days, some 1,300 investors showed up, along with another 500 top corporate executives. The former president of Pakistan, Pervez Musharraf, spoke about his country’s role in the global economy. Historian Simon Schama discussed the United States’ current position in the world, and film director Francis Ford Coppola flew in to talk about the importance of narrative. Asia’s economy was sizzling, with a growth rate three times than that of the United States, creating a billion more middle-class citizens—and this event was at the epicenter of that growth. Evidence as to why China would likely overtake the United States as the largest economy within a decade was on full display. Perhaps this was why my daughter was being offered the chance to learn Mandarin in her New York City school.

But what really stood out for me was something someone said over dinner on the first night I arrived. I had just come off a sixteen-hour flight from New York to Hong Kong, one of the longest nonstop flights in the world, and was dining with about a dozen bank analysts from major Asian countries. We were at the Dynasty restaurant, which has a Michelin star and spectacular views of Victoria Harbour, though I was too jet-lagged to appreciate the scenery.

Over the ten-course meal, we went around the table and discussed the current prospects for banks in our specific markets. This was the real point of the meal—to share information—and in this way, we were acting as unofficial ambassadors for our home countries.

The Japanese bank analyst talked about how that government’s policies had allowed banks to continue lending to corporate borrowers even though those companies, and many of the banks themselves, should have folded years ago. They were zombies, the walking dead. The Chinese analyst talked about how his country still had tremendous room for growth. Consumer credit in China, as a percentage of the overall economy, was only about one-fifth the level in the United States. The ride would be bumpy for investors in Chinese bank stocks, but the long-term prospects were very promising. Next, the bank analyst from Korea spoke, then Thailand, Indonesia, and so on.

I knew my turn was approaching, and I started thinking about what I would say. At the time, I was in the middle of a very public dispute with Citigroup over some of its accounting practices. Citi didn’t like what I had been saying and had adopted a shoot-the-messenger approach. For the past several months, I had been airing my concerns in the media, through outlets like CNBC and the Wall Street Journal, and the company either ignored the issues I raised or sniped back at me in the press. It would all come to a head a few weeks after that conference, but in the meantime, the financial community had been following it closely.

This kind of fight was not new to me. I’ve worked as a bank analyst for the past twenty years, where my job is to study publicly traded financial firms and decide which ones would make the best investments. My research goes out to institutional investors: mutual fund companies, university endowments, public-employee retirement funds, hedge funds, private pensions, and other organizations with large amounts of money. Some individuals I meet with manage $10 billion or more, which they invest in banks and other stocks. If they believe what I say, they invest accordingly, trading through my firm.

Here’s the difficult part, though. For about half of my career, especially the last five years or so, most big banks hadn’t been good investments. They’d been terrible investments, down 50, 60, 70 percent or more. In fact, if you didn’t even do any analysis and just assumed the worst about bank stocks—that is, that they weren’t good places to invest your money, that they weren’t well-run companies—you’d have done OK lately. Not much analysis required.

Over the years, I’ve been saying this loudly and repeatedly. As far back as 1999, I pointed out certain problems in the banking sector—things like excessive risks, outsized compensation for bankers, more aggressive lending. Those same problems would build throughout the 2000s and ultimately erupt during the financial crisis of 2007–2008, taking down Lehman Brothers, Bear Stearns, and dozens of smaller banks and thrifts. However, taking a negative position doesn’t win you many friends in the banking sector. I’ve been yelled at, conspicuously ignored, threatened with legal action, and mocked by executives at the companies I’ve covered, all with the intent of persuading me to soften my stance.

The response from some places where I’ve worked has not been much better—I’ve seen the banks from all sides, not only as an analyst covering them but also as an employee working for them. At times, colleagues were trying to drum up business from the same banks that I was critiquing, and when I said things they didn’t like, I faced a backlash. I’ve bet my career on my convictions, and at times that stance has forced me to find a new job—and has even led to my being fired.

Almost every step of my career has been a struggle. When I first tried to get a job on Wall Street, I applied to two dozen firms over five years before landing my first interview. Since then I’ve worked at UBS, Lehman, Credit Suisse, Prudential Securities, and Deutsche Bank, among others.

Yet my experience has been worth the struggle. I’m still in the game and I still love my work. I was the only Wall Street analyst to testify to the Senate Banking Committee in 2002 about conflicts of interest on Wall Street, even as other analysts were sanctioned for pumping up tech stocks and not spotting debacles like Enron—at the time, the biggest bankruptcy in history. In 2010, I again testified, this time for the commission investigating the causes of the recent financial crisis. In part, that invitation came because I was named by Fortune magazine as one of eight people who saw the crisis coming. Over the decade leading up to the crisis, I produced about 10,000 pages of cautionary research on the banking sector.

I fundamentally believe in the U.S. banking system. It’s the best in the world, and throughout our history, it’s done the most good for the most people. Our banks are excellent at their primary function of allocating capital to the most promising opportunities, which leads to the creation and expansion of companies, innovative products, better job prospects, and an overall increase in the standard of living. Because the U.S. economic system allows individuals to be rewarded on merit, people are motivated to work harder, move to new locations with better employment prospects, take risks, and retrain when they have a shot within a fair system.

Look at the results: Even with the recent crisis, we have the world’s largest economy, leading worker productivity and mobility, more innovation in fast-growing sectors like technology and health care, and the world’s top universities. Over the past generation, the number of people worldwide living in a capitalist society has more than tripled. When it comes to exports, France has wine; we have capitalism.

So at the dinner conversation that Sunday night in Hong Kong, when my turn came to speak, I talked about how the U.S. banking sector was still climbing out of the holes it had dug for itself during the financial crisis.

“Our banks have repaired their balance sheets, with a reduction in problem loans and new capital,” I said. “So the safety of the system is better, and that’s good. The issue is one of ‘all dressed up and nowhere to go.’ That is, the chance of big failures has dramatically declined, so the U.S. banks look better, but I’m not sure where the banks will get their growth.”

Another analyst asked me to clarify.

“U.S. banks are a lighter version of what’s taken place in Japan,” I said. “We’re in year two of what has been a twenty-year cycle in Japan. I’m not saying that it’ll take U.S. banks and the economy that long to fully recover, but the real question is how much longer—one, three, five years—will it take to get back to normal. That’s the question. There are still big headwinds.”

“What about Citi?” one of the other analysts interrupted me. “It’s a dog, right, Mike?”

I hesitated. Citigroup encapsulated all of my views on the current problems of the banking sector—the wasted potential, the fact that so few at the company seemed embarrassed or upset with its performance, the way that many of its problems were reconstituted versions of the problems that had plagued it over the past two decades: excess risk, aggressive accounting, and outsized compensation, among others.

Before I could formulate a diplomatic answer, one of the other analysts spoke up, and this is what would linger in my mind. “All U.S. banks are like that,” he said with a laugh.

I froze, feeling myself growing defensive. It was a little like the situation where you’re allowed to criticize people in your own family but instantly defend them as soon as anyone else does. My reflexive answer was that all U.S. banks aren’t like that. There are hundreds of smaller regional banks that had little to do with the financial crisis and even a few large banks that performed better than the rest. But you don’t hear much about them, because on the whole the bad operators have been bad enough to overshadow the good, and they’ve helped foster a poor reputation for U.S. banks, a kind of negative brand for our financial system. It’s as if the French had decided to water down their wine before shipping it out.

In fact, the root causes of the crisis are still in place. Large banks have enough clout to beat the living daylights out of anybody who gets in the way—politicians, the press, or analysts like me. They can effectively send you into exile, and they get their way more often than not. Look no further than CEO compensation. I have no problem with individuals getting paid a lot of money if they deliver sustainable results. Yet bank CEO pay has already climbed back near precrisis levels, even though twelve of the thirteen largest U.S. banks would have failed if not for government intervention. The CEOs of two banks, SunTrust and KeyCorp, each made more than $20 million over the period from 2008 through 2010, even while their companies lost hundreds of millions of dollars. That’s not capitalism; that’s entitlement.

Here’s a starkly contrasting scenario: In the middle of the Japanese financial crisis in the late 1990s, the CEO of one of Japan’s big four investment firms—Yamaichi Securities—appeared on television to apologize for the actions of his company, and he broke down in tears. That’s unusual for any executive, but especially by the reserved cultural standards of Japan. I don’t need to see tears from the executives of U.S. banks, but at least some recognition that the real owners of these companies—the shareholders—matter.

BloombergBusinessweek ran a March 2011 profile of the chairman of Citigroup, Dick Parsons, which included some quotes about the events of the financial crisis. As Parsons described it, “Timmy Geithner would say, ‘Call me directly because this is too important an institution to go down.’” You read that right: Parsons called the Secretary of the Treasury “Timmy” in an interview, which does not exactly acknowledge the authority of the Secretary, a post once occupied by Alexander Hamilton. He also talked about why the government had to bail Citi out, by describing the likely consequences if the company had been allowed to go under: “You wouldn’t be able to buy a loaf of bread or clear a check,” Parsons said. “It would be like Egypt. People would be out on the streets.” Can that really be true? Citigroup’s continued existence is the only thing separating the United States and Egypt? What comes across in the profile is a sense of arrogance and insider access. It was the equivalent of flipping the bird at shareholders, the Treasury, and the country at the same time.

I get frustrated with banks—I get furious at times—because they should hold themselves to a higher standard. Irresponsible actions by these institutions have put our economy and our entire capitalist system at risk, and the rest of the world has noticed. In August 2011, the Russian prime minister, Vladimir Putin, said that the United States is “living like parasites” off the global economy. This statement felt like a particularly stinging rebuke to me, since both of my grandfathers escaped a socially and economically unjust Russia and made tremendous sacrifices to create a successful life for my family in the United States. I have a kinship to that legacy to ensure a better world for my three children—it’s literally in my blood. But I also have an urgent worry that the successes of the past generations are beginning to run out of steam, in part because of systemic problems in our financial sector. Banks are integral to how our system functions. We can and should do better.

That means bank executives, particularly CEOs, need to operate as stewards of something larger than themselves and not just grab the fast buck and run. Bankers, like all people, respond to incentives, and these days the incentives on Wall Street are set up to reward short-term behavior. It’s simply too easy to jump in and grab all the money you can rather than adopting a broader view that considers whether certain deals or mergers or trades are in the long-term interest of the firm or the country.

As I write this in the late summer of 2011, the market is showing volatility that would have been extreme before the financial crisis but now is more a permanent part of the market. Investor sentiment seems to change from unusually positive to forcefully negative in a matter of days. This stems from a fundamental lack of trust and confidence in the financial system, and how can it not?

Even after the shortcomings exposed during the crisis, banks still show aggressive accounting and opaque disclosures. Even after CEOs of failed companies walked away with eight-figure paychecks, compensation is still rigged in favor of senior management. Even after big banks used their power to get rules changed that helped their companies—or, really, their senior managers (after all, most of the rank and file at banks are more like Main Street than Wall Street)—the companies use their power to block actions that would allow for better checks and balances. Lumped together, all of these actions lead you to wonder: “How did they get away with it? And how is it still happening?”

This is not a book solely about the latest financial crisis. Instead, it is about the larger historical arc of the banking industry and how I have spent my career trying to warn investors and banks about the problems I’ve seen. Most of the behaviors that caused the crisis were in place long before the downturn, and—even worse—most have not changed since then. Some people want to look at the crisis as an isolated event, a single discrete occurrence that can be sealed off and looked back on in the past tense. But that’s not accurate. The crisis didn’t occur because of something that banks did. No, it was the natural consequence of the way banks are, even today.

That was my epiphany—the analyst in Hong Kong was dead right. Not all U.S. banks are poor operators, but as a group, the biggest ones are. Because of this ongoing pattern of bad behavior, we’re tainting an important global export of this country—capitalism—and showing that while it has the potential to raise people’s standard of living and reallocate capital more effectively than any other economic system, it also has a lot of room for improvement. We are watering down the wine.

Notes

Fortune magazine: “8 Who Saw the Crisis Coming—and 8 Who Didn’t,” August 6, 2008. http://money.cnn.com/galleries/2008/fortune/0808/gallery.whosawitcoming.fortune/index.html.

Dick Parsons: Devin Leonard, “Dick Parsons, Captain Emergency,” BloombergBusinessweek, March 24, 2011. www.businessweek.com/magazine/content/11_14/b4222084044889.htm.

Putin: Maria Tsvetkova, “Putin Says U.S. Is ‘Parasite’ on Global Economy,” Reuters, August 1, 2011. www.reuters.com/article/2011/08/01/us-russia-putin-usa-idUSTRE77052R20110801.

Chapter 1

“God’s Work” at the Fed

Unlike a lot of people on Wall Street, I have no pedigree. No Ivy League degree, no prep schools, no internships arranged by a well-placed uncle. In fact, my whole family is a collection of immigrants and outsiders. On my father’s side, my great-grandfather came from Odessa, Russia. In 1905, during the pogroms in that city, his brother was killed by a Cossack guard. My great-grandfather ended up strangling the guard before sneaking out of the country. He arrived in the United States at age thirty-seven, and his last name, Koretzky, was cut down to Kerr. A year later, he was able to arrange for several other family members to get out of Russia, as well, including his son, my grandfather. They entered the United States through Ellis Island in 1906, and for a while the family was so poor that the oldest son had to leave school at age twelve to sell flypaper on the street corners of South Philly.

My mom was raised in an Orthodox Jewish immigrant family in Baltimore, with very traditional values. Her father emigrated from Gomel, then part of Russia, in 1907, also via Ellis Island. Her mother died of cancer when she was just three, and she grew up in her aunt’s house. My mom was an original thinker, into sushi and yoga before either one became fashionable. I often came home to find her upside down, doing a headstand in a corner of the house. My parents split up when I was three years old, and although most people in her family never left the Baltimore area, she settled in Washington, DC. It’s only forty miles away, but it might as well have been a different planet to her family. She worked at the local TV station to support her life as a single mom with three kids. She remarried when I was five, in 1968, to the person she considered her soul mate. My mother and stepdad met at a bridge tournament where they discovered that they both enjoyed the same brand of cheap Scotch.

My stepdad—who raised me along with my mom—also immigrated to the United States, and his story is also that of an outsider. He grew up in Romania in the 1930s, and during his childhood, he watched his country go from a Romanian monarchy, to dysfunctional democracy, to dictatorship, to a Nazi takeover, and then to Communist rule after World War II. When he was seventeen, my stepdad tried to escape from the country, because of violent threats against Romanian Jews.

His goal was to get to Palestine, which was then controlled by the British. He had the equivalent of $350, money he had made by selling cigarettes, gum, and candy on the black market. His first escape attempt failed—he made it across the border to Hungary but was captured by the secret police and sent back to Romania. On his second attempt, he was again caught. On the third attempt, as with my great-grandfather, he had to kill someone in self-defense (in this case, a Romanian guard) in order to finally make it out.

In 1948, he went to Palestine to fight for the Jews’ new homeland. When I was a child, I remember him telling me that he would gladly have given his life if he knew it would have resulted in a Jewish state. That willingness to trade personal sacrifice for patriotic goals really resonated with me. It wasn’t just about getting ahead and taking care of yourself—there were larger principles at work.

Not that this got in the way of his willingness to hustle a little bit. He was street smart and spoke eight languages, in part from his dealings on the black market. For a while, he smuggled watches across the border from Switzerland into Italy. When he later wrote a memoir of this time in his life, he remembered having hundreds of them strapped to his body under his clothes, so many that he ticked like a time bomb.

He served in the Israeli navy and later the merchant marine, and he got into the United States by jumping ship in Florida, later becoming a citizen. By the mid-1960s, he landed in the Washington, DC, area, where he started and ran an aluminum-siding business. He had changed his last name after his escape from Romania; at the time of his move to Florida, he was known as “May’ami,” which was an anglicized version of the Hebrew phrase “to my nation.” In Florida, people called him “Mike Miami,” so he changed his name to Mayo. When I was growing up, every year on the first day of school I had to explain that the last name that I used wasn’t Kerr but Mayo.

My stepdad told me constantly as a kid that World War III with Russia was an absolute certainty. He slept with a handgun by his bed his entire life. I would wake up to hear him screaming profanities at his sales rep, every curse word in the book, demanding that the rep bring in more leads. I was astonished one day to find out that this salesperson was a woman, Vickie, who was good at her job and continued to work for my stepdad for years despite the daily shouting matches.

When he opened a Romanian restaurant with my mother in 1981 called the Vagabond in Bethesda, Maryland, he was comfortable speaking Spanish to the busboys and English to the customers and could hold his own in political discussions with the diplomats who came in. As my mom put it to a restaurant reviewer once, “He can speak, read, sing, and cook fluently in eight languages.” My stepdad did all the cooking at this restaurant, including recipes his mother used to make, and the place once won “Best Duck” in the restaurant section of Washingtonian Magazine. He loved vodka and cigars, and, really, he just loved life. He used to say that he didn’t want to wait to be an alter kocker, which is Yiddish and translates roughly to “old fart,” before he could enjoy himself. Once when he was traveling in France, some people said to him in French—thinking that he couldn’t understand—that his giant cigar looked like a prick. “Yes,” he shot back in perfect French, “but it doesn’t taste like one.”

When it came time for me to pick a college, I went with the University of Maryland for my bachelor’s degree, because the couple of people in my family who had attended college went there. Later I got an MBA at George Washington University at night while working full time. Both schools were good experiences—Maryland’s math department was in the top twenty in the country when I was there; GWU had a respectable business program—but neither one makes the doors fly open on Wall Street.

I know this because my early attempts to get a job there fell flat. I still have the rejection letters, every one of them. Prudential: “We have considered your background and, although it is impressive, we find that our current staffing requirements are not consistent with your objectives and abilities.” Goldman Sachs: “If we do not contact you directly, you can assume that there are no appropriate openings available.” I like looking through this folder of initial rejections, because some of the firms in there don’t exist anymore—Drexel Burnham, Kidder Peabody, Bankers Trust. But at the time I was crushed. I didn’t get one interview.

During this time, I was working at IBM, where I stayed for only a few years, just long enough to realize that a corporate culture like that wasn’t for me. I remember the old-timers wearing lapel pins that showed the number of years they’d been at the company—twenty-five years, thirty years. My friends and I would keep our IBM ID tags on when we went to the bars at night, thinking (incorrectly) that they would impress the ladies.

As the Wall Street rejections continued to pile up, I took a job at the Federal Reserve in Washington, DC, where I first learned to analyze bank deals. The salary represented a pay cut from IBM. I’d be a “GSer,” referring to the government service pay scale, something that everyone in my family had always regarded suspiciously, given their natural mistrust of bureaucrats. I tried explaining that staffers at the Fed aren’t technically in the GS system, but that didn’t cut it. Still, I wouldn’t trade my time there for anything. It was at the Fed that my thoughts on the banking industry took shape and where I learned about the crucial role that objective analysis plays as a check and balance on the sector.

I worked there in the late 1980s and early 1990s. Alan Greenspan was the Fed chairman, but this was before he became a cult figure in the financial markets, and at the time his predecessor, Paul Volcker, had left a lasting impression at the agency. To this day, Paul Volcker is my hero—the six-foot-seven iconoclast who was willing to raise interest rates in the early 1980s in order to stop inflation. That measure led to a necessary but painful slowdown in the economy, with temporarily higher unemployment and interest rates as high as 20 percent. It drew fierce protests—farmers drove their tractors in front of the Fed’s headquarters in the Eccles building on C Street in Washington, and one congressman wanted Volcker impeached—but it successfully ended the stagflation of the prior decade. Volcker was willing to take hard, necessary steps, a rarity for many public figures at that level. When his term ended in 1987, President Reagan would replace him and bring in Greenspan.

Since the financial crisis, history has come back to Volcker. Greenspan’s legacy became tarnished by the 1998 bailout of hedge fund Long-Term Capital Management, which represented a shift in the Fed’s strategy. It signaled to the market that if conditions got bad enough, the Fed would step in to save floundering banks. This strategy carried through to the Internet bubble and post-Greenspan to the crisis in 2007 and 2008, when unusual policy actions protected the banks and others from their own mistakes.

After the latest financial crisis and the real estate debacle, Volcker looks increasingly correct about the need for effective regulation. I respect him most because he never bought into the line—invariably offered by bankers—that regulators should do what’s best for the banks because that will do the most good for the country.

Volcker always took the opposite approach: The goal of the Federal Reserve, and of all outsiders with any kind of oversight role on the financial system, isn’t just to help the banking industry. It’s not to strip away any regulation or constraint and turn Wall Street into a casino. Instead, it’s to ensure that the banking industry remains stable and helps our economy thrive. Volcker was an outsider, and he argued for a big, bold line between the public sector and the private sector that it regulates. Investor and philanthropist George Soros, a friend of Volcker’s, once called him “the exemplary public servant—he embodies that old idea of civic virtue.”

That was his legacy at the Fed when I was there, and we believed that. Civic virtue. Detachment from the companies we were overseeing. Lloyd Blankfein, the CEO of Goldman Sachs, said in a notorious 2009 interview that he thought the firm was doing “God’s work,” and he was promptly ripped to shreds in the press for it. But during my time at the Fed, we genuinely believed that we were performing a valuable public service: protecting the banking system for the benefit of our country. We weren’t getting rich—administrative assistants on Wall Street at the time made more than the average Fed employee—but we were performing a crucial function in the economy and helping the country advance. This was partly a reflection of the times. It was the tail end of the Cold War, when, after all my stepdad’s warnings, World War III had never happened. America had won, and we proved that capitalism was the better economic system. America had a meritocracy that allowed people to rise up through their own talents and efforts. And by harnessing that desire, capitalism could do amazing things. It could direct money to the most productive avenues in order to create wealth and raise living standards. It could transform nations and defeat tyrants. But it needed some checks and balances to function optimally.

My first few months at the Fed were like Marine Corps boot camp. I was part of a class of two dozen wide-eyed junior regulators, meeting daily in a classroom in nearby Foggy Bottom. I learned to write reports that made a clear argument for whether a deal should be approved or not. Don’t hedge, don’t waste anyone’s time. Clarify your argument and substantiate it. In our early training, we got lectures from FBI investigators about fraud—I remember one story about what it was like to nab embezzlers or people running other long-term scams. When you finally arrest them, the FBI investigator told us, they’re almost relieved. “It’s like pulling a knife out of their back,” he said. Another finance expert talked to us about the typical growth rate of banks and how some exceptionally rapid growth in the industry shouldn’t be celebrated but questioned. “If something grows like a weed, maybe it is a weed,” he said. That quote would come back to me when I watched home loans at big banks grow through the roof from the late 1990s to the late 2000s.

More than anything, we were grounded in the basics of bank finance, specifically bank financial statements, which show items differently than the rest of the corporate world. Money is the product that banks sell—loans, deposits, and securities—as opposed to goods and services. Instead of millions of iPods in inventory, you see millions of loans to companies and individuals. In other industries, loans are typically liabilities because as a borrower you’re on the hook to pay that money back. But banks are lenders, meaning that loans are assets. The more loans a bank makes—assuming it has done its homework and reasonably believes that the loans went to reliable, upstanding people who are going to pay them back—the better off that bank is.

As complicated as high-level finance has become in the past decade, at its core, banking is a simple business. Bankers borrow money at a certain interest rate, mostly as customer deposits, then lend it out at a higher rate, and they get to keep the difference. For a long time banks operated on the 3-6-3 rule: Borrow at 3 percent, lend at 6 percent, and be on the golf course by 3 P.M. From the 1940s through the late 1960s, this was the guiding principle. Banks were closer to utilities—very reliable and without big boom-and-bust scenarios. There were some laws in place, like Glass-Steagall, which came about after the 1929 crash and prevented consumer banks and investment banks from being owned and operated by the same company. This ensured that traditional banks, which took relatively limited amounts of risk with customer deposits by making loans, were separate from investment banks, which were using their own capital to take greater risks. Those rules were like governors on a car engine—they helped prevent banks from growing too fast, and they kept the overall industry reasonably safe. They also limited bank returns, which is why bankers wanted them overturned.

When I arrived at the Fed, the country had just gone through the savings and loan (S&L) crisis of the late 1980s—the first financial problem I understood as an adult, though it wouldn’t be the last. In fact, it shows how many banking crises boil down to the same fundamental problems. S&Ls, also known as thrifts, are a narrower form of traditional banks that mostly take deposits from individuals and make loans for people to buy homes. The crisis happened because small local thrifts got too big, too fast, by expanding outside these core areas. The S&L failures cost the taxpayers since their deposits were insured like ordinary bank deposits, meaning that the government paid back depositors when the S&Ls couldn’t.

Ineffective changes in regulation were at the heart of the problem. Thrifts, which were not under direct Fed supervision, were always less regulated than conventional banks, and the rules became even more lax after Congress passed several pieces of legislation in the early 1980s. These greatly expanded the types of loans that thrifts could make and the interest rates they could pay depositors above prior tight interest rate ceilings. If a bank or thrift wanted more deposits, it could offer more interest and watch the deposits flow in. This is exactly what happened, but the deposits were of the volatile type, “hot money,” because these deposits tend to chase the highest rates and can’t be relied on in tough times.

Similarly, banks can always make more loans if they find less stable borrowers or offer unusually attractive terms. In this case, S&Ls made more loans for risky construction projects, things like fast-food franchises, wind farms, and casinos. The safer loans of the time, residential mortgages, declined from 80 percent of the total in 1982 to 56 percent by 1986, and banks replaced them with riskier loans funded by hot-money deposits. Over the next four years, from 1982 to 1986, the thrift industry posted ridiculous growth, with loans and other assets doubling to $1.2 billion, a potential recipe for disaster.

For a while, real estate boomed, and everyone in banking—not just the thrifts—wanted a piece of that growth. The economy was humming. Demand for office space went up, rents were pushed higher, construction flourished, and banks actively looked for builders that they could lend to, creating a virtuous cycle. Yet expansion like that isn’t sustainable, because it’s driven by an excess supply of financing that outpaced the underlying growth in the economy and population. By the late 1980s, as it became clear that actual demand for office space was much lower than supply, real estate developers started having problems paying back the loans. When credit started to turn bad, thrifts and many banks were unprepared for the losses. The problems started in the United States and then spread around the world. (If this all sounds familiar, it should.) About 1,000 S&Ls went out of business, and the final cost of the crisis was $160 billion, including $132 billion from federal taxpayers. From that point on, the mistakes the banks and thrifts made were variations of the same theme—some combination of regulatory changes and overheated growth—and would have even bigger consequences.

The S&L crisis was the dark side of capitalism, and it showed that without some checks and balances on the system, the potential for excesses could weaken it from within. Capital could be misdirected—frittered away or destroyed—and not only would an opportunity be lost, but people’s lives would be devastated. That was our function at the Fed: to monitor the financial system and prevent similar catastrophes from happening again. We didn’t have the money of Wall Street, but we had power.

This balance was the subject of discussions that my friend and Fed colleague Hank and I used to have during our early-morning runs. Making our way down Constitution Avenue to the Lincoln Memorial, we would debate who was more powerful: Fed chairman Alan Greenspan or Citicorp CEO John Reed. I would stress that the Fed chairman held more power, since his control of monetary policy would determine the strength of the economy and could even swing national elections. As we ran up the steps of the Lincoln Memorial to touch the wall and then back down again, Hank would say that John Reed could move billions of dollars with a phone call and do so without all of the second-guessing by government underlings.

Around the Reflecting Pool we would press on, past the Jefferson Memorial. I told him that I had once seen a fax in the office that laid out the money Citicorp needed to raise to meet the government’s capital requirements. “See?” I said. “Greenspan calls the shots for John Reed!” Hank huffed something about the strength of the CEO during periods when banks were healthier as we slowed to a jog in front of the Grecian columns of the Fed headquarters at the Eccles building, one of Washington’s Beaux Arts landmarks. Little did I know that this concept—the relative clout between regulators and the private sector—would continue to play out for the next two decades, particularly in periods of crisis.

During my time at the Fed, I worked in the merger-approval division or, as we answered the phone, “Applications.” Two banks that wanted to merge had to get clearance from the Fed. Usually that happened at one of the twelve Fed regional banks around the country, but if there were any unusual circumstances—for example, if one of the banks was foreign owned, or particularly large—it would be handled in Washington.

I looked at hundreds of deals in my time there. In one twelve-month period, I analyzed 119 deals. If we thought a merger might be more risky than we were comfortable with, we would go back to the bank and say that management had to make some changes to the deal terms. Often the banks had to set aside more capital—meaning they needed a bigger fund of reserves in case something should go wrong down the road. As we saw it, we were defending the country, in a way. As the banking industry became more integrated, we were establishing international capital standards, and this was going to make the system safer. In the end, it would be just a little bit better for everybody.

The Fed had extremely high standards, so every report had to be perfect, down to the last word and statistic. Literally, my boss would read my reports and move the word “however” to another part of the sentence, perhaps simply to send a signal to me about the scrutiny of our work. The logic needed to be perfect, too, laid out as concisely as possible so as not to waste the time of anybody reading it and also to uphold legal scrutiny in the unlikely but still possible scenario that the Fed was sued over one of these decisions. It was as if I were required to write an A+ paper every time.

Most of my work would be reviewed by my bosses and then filed away with a stamp TO RECORDS, where it was likely never read again. I imagined the warehouse scene at the end of Raiders of the Lost Ark, with crates of old reports piled to the ceiling. I was one of about ten people in DC reviewing merger applications, and the job involved some tedium and little visibility. I was conscious that we didn’t have many resources. There’s a daily trade newspaper in the industry, called American Banker, and because it’s expensive, we weren’t allowed to get individual subscriptions at the Fed. Instead, a single copy would get circulated around, with a distribution list ranking names in order of seniority. By the time it got to me, it was three and a half weeks old.

But the money, or lack of it, was less important than working with those who had responsibility, authority, and power—the people who set policy for the national economy. We ate breakfast in the Fed cafeteria, with wall-to-wall windows looking toward Constitution Avenue, one block south, and to the monuments of the Mall beyond. In the distance were the Washington Monument and the Lincoln Memorial, symbols that inspired and reminded us about the importance of the work we were doing. A regular group of people met for breakfast most mornings. I used to run to work from my apartment in the Adams Morgan neighborhood of Washington, where I had pinned up a photo of Alan Greenspan torn from a cover story about him in The Economist magazine. I often left home early so that I’d have time to use the gym at the Fed and then get a giant plate of eggs and pancakes, smothered in butter and syrup. (I ate terribly in those days.)