Economy

Former Wall Street Player Reveals the Inside World Behind Shady Bailouts to Bankers

An interview with Prins, former managing director at Goldman Sachs, now a razor-sharp financial muckraker and author of the new book, "It Takes a Pillage."

A former managing director at Goldman Sachs and now a razor-sharp financial muckraker (and regular AlterNet contributor), Nomi Prins understands the labyrinthine world of Wall Street finance, with all its warts, as well as anyone.

In her new book, It Takes a Pillage: Behind the Bailouts, Bonuses and Backroom Deals From Washington to Wall Street, Prins lays bare the whole fetid corpse of the burst mortgage bubble.

It wasn't reckless borrowers and their subprime loans that built the house of cards that has come crashing down around us over the past two years, but an out-of-control finance sector running on a perverse set of incentives that made it incredibly profitable to essentially throw caution to the wind and take on incomprehensible amounts of risk.

Prins exposes the revolving door between Wall Street and Washington and shows how it led to a Wild West mentality on "the Street" that allowed the whole casino to flourish for a time.

And she follows the trillions in direct bailouts, subsidized loans and guarantees shelled out by the taxpayers when the whole thing went belly up, shining a bright light on the shadowy deals that decided which institutions would crash and burn and which others would receive the support needed to stay afloat, feast on the corpses of the fallen and then go on to the record profits and fat bonuses Wall Street's survivors enjoy today.

AlterNet recently asked Prins about the book, where we are in the financial crisis and her views of where we're going.

Joshua Holland: Nomi, throughout the book you refer to the economic meltdown of 2007-09 as the "second Great Bank Depression." What do you mean by that -- give us a sense of the historic connective tissue that exists between these two periods of really intense economic upheaval?

Nomi Prins: I struggled with the appropriate term for this current crisis period but wanted to give credit to the banks that drove us into this whole period, hence the name. Both the Great Depression and the second Great Bank Depression were caused by the exact same thing -- underrestricted financial firms manufacturing products that were fabricated from fancy numbers, inflated with tons of debt on the back of little to substantiate it and sold to investors and each other by crafty salespeople and short-term-oriented greed-induced bankers.

Both are ultimately a result of a plethora of risky bank-led esoteric products and practices going bust on the American public.

Although, we don't have a 25 percent unemployment rate and bread lines today, we do have double-digit unemployment in 139 different metropolis areas (compared to 15 before last fall's bank crisis), the national unemployment rate is close to 10 percent (from 5.8 percent before last fall's crisis) and foreclosure figures are comparatively high for both historical periods.

The Great Depression was catalyzed by the 1929 stock market crash 80 years ago. The Second Great Bank Depression was catalyzed by an industrywide credit crunch, ignited by subprime-loan losses sitting beneath mounds of toxic assets.

So for both periods, it was an overzealous, overleveraged, underregulated banking system that brought the rest of the economy down.

JH: You do a great job detailing the regulatory changes that allowed the bankers to game the system -- the forks in the road that were and weren't taken by previous administrations. Tell me a little bit about that: What was your reaction when all these guys -- the [Ben] Bernankes and [Henry] Paulsons -- argued that nobody could have predicted the outcome of, for example, Congress passing Phil Gramm's Commodity Futures Modernization Act instead of the Predatory Lending Consumer Protection Act.

NP: Well, I wrote a whole chapter in my first book, Other People's Money, right after I left Goldman Sachs, predicting what would happen if you don't regulate credit derivatives, and from what I heard from through the Goldman grumblings at the time, Paulson wasn't thrilled with the book, but had he read it, it might have helped him.

Many people had warned of the ramifications of the Commodity Futures Modernization Act, it's just that no one running the Fed, Treasury Department or certainly any major financial institution cared. The risks were not discussed in the general tidal wave of free-market, megalobbied euphoria of the time.

The government, like any other collection of people, listens to its own. As I wrote in It Takes Pillage, with a revolving door into the government from companies like Goldman Sachs, and the lion's share of its economic advisers spouting the same free-market, deregulatory philosophy, the government is either getting exceptionally bad advice (or anti-citizen advice) by design or sheer willful neglect.

Either way, neither is good. Goldman Sachs, in particular has produced two Treasury secretaries, Robert Rubin under Clinton, and Paulson under [George W.] Bush, proving that partisanship is no match for Wall Street power and influence.

Stephen Friedman, former CEO of Goldman was also chairman of the New York Federal Reserve, while [current Treasury Secretary] Tim Geithner was president there, and they both presided over substantial Wall Street subsidies during the fall of 2008.

The smaller players from Goldman also had irrevocable influence over the financial system. Paulson's protégé, former Goldman Co-President John Thain took one of the biggest pay packages in Wall Street history to run Merrill Lynch into the arms of Bank of America in a federal-brokered and -backed merger. The list goes on and on.

But it should also be noted that the most successful banks, or the ones that used their federal capital for trading profits, including JPM Chase enjoy terribly cozy relationship with Washington.

Aside from that, between June 2006 and June 2007, foreclosures had increased by more than 50 percent. This was public information leading up to the crisis. Paulson, of all people, having just jumped into his position from having been the CEO of Goldman Sachs should have known that when foreclosures and defaults rise to that kind of extent, it means that securities created on the notion that this wouldn't happen were going to be doomed, and therefore all trading and borrowing that used those securities, now called toxic assets, as collateral were going to hit a tremendous speed bump.

So, either he was being a complete idiot and learned nothing during the 12 years he ran Goldman, or he hoped that the problems would go away, or he figured the government, at least the treasury department he ran, could figure out a way to help his old friends.

Indeed, in the summer of 2007, as the Fed was quietly dumping billions of dollars into the financial markets to keep them running, Paulson was saying things like, "I've been through periods of stress, turbulence in the market for over the course of my career various times, and never in any of those other periods have we had the advantage of a strong economy underpinning the markets."

JH: Now, we hear a lot about the little people's irresponsibility in all this -- in the collapse. They took on more debt than they could sustain, they thought the good times would roll forever. You argue this was never about the little guy, right?

NP: Neither the crisis, nor the bailout was about the little guy. Former Treasury Secretary Henry Paulson was explicit in stating several times, and in several ways, that the government should not be bailing out homeowners who got in over their heads. And true to those sentiments, it didn't. Instead, amidst trillions of dollars of subsidies to the industry were made available in the most original and creative of ways, and no heed was paid the jointly humane and economical solution which would have been to find ways to restructure personal mortgages and loans, as opposed to dumping buckets of money over the top layers of the financial community and promising it would somehow trickle down and loosen credit for the "little guy."

The people that blame the Community Reinvestment Act for the avalanche of predatory lending are missing the true numbers that represent the situation. Only $1.4 trillion worth of subprime loans were extended between 2002 and 2007. On the back of those loans, the industry created $14 trillion worth of various types of assets and borrowed up to 10 times that amount using those new assets as collateral.

If the government had wanted to help homeowners and contain the costs of the bailout, it could have subsidized underwater mortgages directly at the loan level, or made it mandatory for banks to renegotiate credit terms or mortgage balances with individuals, as opposed to making it a mild suggestion that the banks have no incentive to follow.

For the money spent on subsidizing the industry, the government could have bought out every single outstanding mortgage in the country. Plus, every student loan and everyone's health insurance. And on top of that, still have trillions of dollars left over.

That's why I get so enraged at the bizarre notion that a 10-year, $900 billion health care option is somehow egregious and government interfering with our lives. We should all take $90 billion a year to sustain our health and access to health care over lavishing trillions on the banking system any day, no matter what our political party affiliation is.

JH: Sticking on that line, you write in the book that "The finance community's theory is Darwinian: Little people who take bad risks deserve the consequences. Companies that take bad risks are a welcome addition to the fallen-competitor list." But not all those who took bad risks did fall -- in fact some of the financial firms that are raking in healthy profits and whose execs are cashing out huge bonuses took some risk as well. Can you tell us who ended up getting all those billions in bailout money?

NP: At one point, a total of $19.3 trillion comprised of $17.5 trillion deployed in some capacity for subsidizing or bailing out banks (including $3.7 trillion to back money market funds, which has now been taken off the table) compared to $1.8 trillion for citizen-related assistance, including some homeowner initiatives. I keep track of the changes to these figures on a monthly basis on my Web site: http://www.nomiprins.com/bailout.html (also on that page are regularly updated compensation figures for all the banksters). Today, the total bailout figure is (still) over $14 trillion, which is an immense private-sector subsidy by any historical standard.

Of the top three main recipients of the bailout: Bank of America still owes the government $63.1 billion, AIG sits on top of a $181.8 billion pile of federal help, and Citigroup has a $368.7 billion public cushion.

Other recipients of government aid include Goldman Sachs, who is on track to pay out $22.1 billion in total compensation compared to $10.9 billion in 2008 and $20.2 billion in 2007. Additionally, JPM Chase is on track to pay $29.1 billion, nearly what it would have paid out in compensation in the year before the crisis, had it owned Bear Stearns and Washington Mutual then. Goldman Sachs still floats on $54 billion of federal support, and JPM Chase $73 billion – even after repaying their TARP obligations. (Remember, the $700 billion TARP fund is but a fraction of the entire bailout and subsidization of the banking industry, despite Goldman, JPM Chase and the government wanting us to believe otherwise.)

JH: But it didn't have to be that way. You argue that the "too big too fail" argument in the context of the Wall Street bailout wasn't so clear-cut. What might the Fed have done -- could it have just said 'No!'? Wouldn't it have devastated the whole economy if it had?

NP: The Fed could have said, no – or even said yes with a whole bunch of caveats, but instead chose to shout a big old YES -- with no strings attached.

I don't believe the economy would have tanked if AIG went bankrupt. Nor would individual insurance policy holders with AIG have lost their policies, which was a popular scare tactic at the time. In some sort of receivership situation, parts of AIG would have kept functioning, while others would be examined and possibly wound down. If that had occurred, we wouldn't be out the $182 billion we're still publicly out of/stuck with, because of AIG subsidies and guarantees, and we certainly wouldn't have written a $12.9 billion check to Goldman Sachs to cover its losses to AIG, which were predicated on contractual arrangements that would have been worthless had AIG gone bankrupt.

The government saved Goldman and others by backing AIG, and that simply wasn't necessary.

The Fed didn't have to allow Goldman and Morgan Stanley to become bank holding companies in a Sunday night fear feast on Sept. 21, 2008, and thereby solidifying the ability of those two firms to access federal subsidies and FDIC backing for new debt they issued.

The Fed definitely didn't have to allow, or better yet, encourage Bank of America to acquire Merrill Lynch, JPM Chase to acquire Bear Stearns and Washington Mutual, or Wells Fargo to merge with Wachovia. All of these megamergers are resulting in greater risk-taking than before the crisis.

What the Fed should have done, most importantly, is give the same, or greater, subsidies to individual or small businesses facing their own credit problems or home foreclosures. If that had happened, it would have been both cheaper and more humane, and it would have stabilized the general economy so that we wouldn't be seeing greater unemployment, record foreclosures and rampant credit deterioration a year after this massive bank bailout that was allegedly supposed to trickle down to help everyone else.

There's an item in the Federal Reserve Act, Item 33, that allows the Fed to use its powers in any way it sees fit (basically) in an emergency. It decided to use those powers to consolidate the bank landscape and bail out Wall Street. Instead, it should have used them to help individuals who are the true foundation of our national economy.

JH: The bailout was of course begun under Bush, but the new administration hasn't pursued a very different course in terms of staving off the next Great Bank Depression. In the book, you say, "Instead of instituting actual sweeping reform, Obama and Co. merely call their ideas reform." Why do you think that is -- is it just a testament to the power of the financial services industry, or the ideologies of the team Obama put together, one heavy with Wall Street vets?

NP: It is sadly, both. Obama never should have chosen Tim Geithner as his Treasury Secretary (incidentally he did so the day after the government handed a massive bailout guarantee to Citigroup, a firm Geithner had once argued didn't have to keep up the same risk-reporting level it had started post Enron anymore), nor have Larry Summers as a key economic adviser.

Geithner, in particular was one of the key architects of the Wall Street bailout and subsidization. In a recent analysis I did of Paulson's phone records, he had 375 direct phone calls with Geithner, compared to just 212 with Ben Bernanke, chairman of the Federal Reserve. Geithner was central to the formation of this bailout, and the N.Y. Fed extended 85 percent of the entire (now) $4.4 trillion of loan facilities that the Fed put on tap to aid for the banking sector (not including GSE's and system injections) under his leadership.

The top guy on Geithner's speed dial today is Goldman Sachs CEO Lloyd Blankfein. There's no scenario under which Geithner would ever say that what he did during the bailout and crisis period was wrong. Bill Clinton still doesn't see how repealing Glass-Steagall was at all involved in this crisis. Summers of course, was treasury secretary that day, a decade ago, when the Glass-Steagall Act was repealed, in fact, he introduced the ceremony.

The big lie about bank consolidation and deregulation was that it was necessary for America to compete in the global markets. Well, American banks lead the crisis, and other nations are right angry with that. So, with the same crew, and with the exceedingly powerful bank lobby pushing for status quo (or worse) every single day, it's hard to see where the appropriate lightbulb of reason and logic will flash.

Paul Volcker, is the one guy on the Obama team calling for a separation of commercial and investment banks and rightly warning that if we don't do that, we have set ourselves up for a greater fall.

JH: So if you were Queen for a day, you'd do things very differently. In the book, you lay out "6 steps to real reform," and I want to focus on one of them. The fourth of your steps is to "fix the entire banking foundation." What does that mean, Nomi? What would it look like?

NP: We need to deconstruct the banking landscape by reinstating the Glass-Steagall Act of 1933 that was repealed in 1999. What the government now considers "too big to fail" I consider "too big to succeed."

Last year's bank crisis devolved into the fastest government consolidation of an industry ever. For their near-failure, the surviving megabanks were rewarded with name changes to allow easier access to government capital and government (i.e. taxpayer) backed mergers.

Today, some are posting record earnings and are on track to record bonuses because of federal subsidies and renewed risk-taking. That means an inherently risky environment, only now with our money on the table, not just the capital banks were lending to each other before the crisis.

A bipartisan Congress, Republican treasury secretary and Democratic president -- FDR, established the Glass-Steagall Act. It was enacted to segment the financial industry into two parts -- commercial banks dealing with the public, and thus taking less risk, and receiving more government backing, and investment banks dealing with speculations and not getting government capital for their self-made problems.

In 1999, a bipartisan Congress repealed Glass-Steagall in a 90-8 vote ([Arizona's Sen.] John McCain didn't vote). Two senators in particular, Byron Dorgan, D-N.D., and the late Paul Wellstone, D-Minn., warned of the impending cost to the American people of recombining the banking system and allowing any commercial bank to merge with any investment bank and insurance company. They were right.

Yet, in a flourishing deregulatory speech condemning the old Depression-era act in the fall of 1999, President Bill Clinton signed our fate -- a gift that would keep taking a decade later. As banks merged with a vengeance across once-defined lines, they needed more and more capital to buy each other and in order to compete with each other -- it didn't matter how they got it or concocted it in shady assets. The result was poorer reporting standards on risk, greater speculative appetite and a multitrillion bailout.

Yet, to this day, there are very few voices in Washington talking about bringing back Glass-Steagall. Sure, they worry about banks being too big to fail or "systemically important" as Treasury Secretary Geithner and Federal Reserve Chairman Bernanke put it.

Still, is anyone mentioning the most logical way to take care of the pending disaster: chopping them up, making them smaller, more transparent and more easily backable and regulatable? No. It boggles the mind.

JH: Finally, a question I often ask of authors: What is the one thing you hope your readers will take away from the book?

NP: I hope they will know that this banking crisis wasn't about subprime loans gone wrong but by a banking system, still intact, that leverages, or borrows, too much on the back of consumers mortgages, loans and deposits, and that anyone who says otherwise is lying.

That subsidizing the private banking sector with a tremendous bailout package, does not, and can not trickle down to the wider economy, because there is absolutely no profit or legislative incentive for that to happen. That we need to be as vocal as people were in the 1930s, because our individual economic states continue to deteriorate, even as the biggest banks are back to bigger profits, risk and bonuses.

We need to get out to more "showdowns in Chicago" to make it clear we won't stand for this, and we need to make it absolutely clear to our Congresspeople and President Obama that cosmetic regulations don't cut it -- that keeping the power players on Wall Street as they are, on our dime, is ethically, morally and economically wrong!

I hope readers will come away with more information and a renewed fighting spirit.

Joshua Holland is an editor and senior writer at AlterNet. Nomi Prins is a senior fellow at the public policy center Demos and author of It Takes a Pillage: Behind the Bailouts, Bonuses, and Backroom Deals from Washington to Wall Street.