Because these demands put the banks in an unusually risky situation, government regulators stepped in to help their cooperative colleagues. They allowed banks to shed the risk through questionable financial devices. One, “credit default swaps,” allowed insurers to sell indemnification insurance to lenders against the risk that a borrower would default. The authorities also allowed these arrangements to stand outside normal insurance regulations and, consequently, also outside the usual security protocols. To further spread the risk of these sub-prime loans, Washington also encouraged “securitization,” by which banks created a bond backed by a bundle of individual mortgages. The banks could then rid themselves of the sub-par risks by selling those bonds on the open market to individuals, foundations, pension funds, and even foreign governments. Washington promoted this effort by also willfully ignoring the credit rating agencies that were giving undeservedly high safety ratings to these bonds, even though they included a large proportion of risky sub-prime debt.
Despite all this maneuvering, by 2007, this house of cards began to collapse. The always-risky sub-prime borrowers began to fail on their mortgage obligations. In the face of such widespread default, the firms that had so actively cooperated with Washington’s guidance faced insolvency, as did those who bought that questionable debt. Washington’s response? It sprang into action, to save, it claimed, the financial system. But, as it turned out, Washington did so also to protect its corporate partners.
The fate of Bear Stearns is instructive. When, in 2008, this New York-based global investment bank first showed signs of having trouble, it was in complete compliance with all federal and international regulations. It was solvent. What it did face was a temporary shortage of liquidity. It was well within Washington’s power and experience to simply advance an emergency loan to protect the firm and those parts of the financial system that depended on Bear’s ability to meet its obligations. That is what Washington did later for several firms, using the more than $430 billion of tax money it put at risk through the Troubled Asset Relief Program (TARP). But Bear Stearns it treated differently. It surely was no coincidence that this broker-dealer had always been a disruptive and uncooperative agent in financial markets. Perhaps because the people who ran Bear had less social pedigree than those who ran Goldman Sachs and the other established financial firms, the company never had much inclination to cooperate with Washington or other companies. It is notable how Bear Stearns some years earlier had refused to join a Federal Reserve effort to arrange loans for the failing Long-Term Capital Management, whose top executives, not coincidentally, had exceptionally good Wall Street, Washington, and academic connections. So instead of smoothing over Bear Stearns’ troubled moment, Washington forced the company to sell itself at a bargain price to J.P. Morgan, a firm notably cooperative with Washington.
It was only after the forced sale of Bear Stearns that Washington passed the TARP legislation and the consequent huge flow of money that assisted Citibank, Chase, and other banks with less obstreperous reputations than Bear Stearns, and who could boast of their cooperation with Washington’s subprime push. TARP also assisted Goldman Sachs—so renowned for its links to Washington that one standing Wall Street joke holds that Goldman’s url has a “.gov suffix,” while another joke, playing on the firm’s name, refers to it as “Government Sachs.” Because TARP funds could only go to banks, and because Goldman at the time lacked a commercial banking license, the authorities rushed a license through for it. But they made no such effort for Lehman Brothers, a firm that, despite its long pedigree, was well outside the collusive establishment. Washington simply let it go bankrupt. Then the government, in a remarkably novel move, effectively nationalized the insurer AIG. This firm, too, had a less-than-cooperative reputation. It was also disputing the value of credit default swaps it had sold to Goldman Sachs. Goldman insisted that the loans in question had become riskier and demanded that AIG put up more assets to ensure that it could pay should the loans fail. AIG resisted. Once the federal government took over, it forced AIG to pay the full amount Goldman had demanded—in excess of $4 billion. These particular default swaps were one of the few assets that paid in full during the crisis of 2008–09.
This elaborate cherry-picking of winners and losers is all the more revealing, because Washington all along had at its disposal a more egalitarian and coherent approach. In the early 1990s, when a similar crisis developed among savings and loan associations (s&ls), the government had a very different plan. Because most of these institutions were too small to “qualify” for government-business collusion, the authorities had little need to protect some and not others. Unlike in 2008–09, Washington treated all the s&ls equally. To oversee the orderly bankruptcy of many of them, it established and funded the so-called Resolution Trust Cooperation (RTC), which sold off their good assets to meet their obligations to creditors and which, for the sake of financial stability, took their questionable assets onto its own books for resolution over time. Over the long-term, the government actually made a profit on the taxpayers’ monies involved. That a solution like the RTC was never considered in 2008–09 suggests that either everyone in Washington had suffered memory loss or that their desire to pick winners and losers impelled them to a less consistent approach than would have been possible with a revival of the RTC.
EARLIER EVIDENCE of collusive behavior appeared in the 1990 destruction of Drexel Burnham. Washington worked hard to put down this aggressive investment bank, not so much because it was resisting the government’s agenda but because it was attacking established firms that were cooperating with Washington. Drexel Burnham’s “sin” was its invention of what became known as the “leveraged buyout,” which enabled relatively small players to take over large, established firms. A group of investors would identify a company with an ineffective management and attempt to take over the firm by buying out its shareholders. To pay for these purchases, the takeover group would issue bonds through Drexel Burnham, which would promote these bonds by offering the assets of the targeted company as a form of repayment guarantee. If the targeted firm had a good competitive position in its market but was saddled with an inefficient management (as is usually the case with monopolies or companies otherwise protected by government), Drexel Burnham’s promise was compelling.
Such “hostile takeovers” were long considered taboo among established firms because they disrupted the accepted business practices and ordered hierarchies with which managements were comfortable and on which Washington depended for cooperation. Mutually agreed-upon mergers were fine (especially those blessed by Washington), but usurpations such as those orchestrated by Drexel Burnham were deemed simply too disruptive. Drexel, for instance, backed T. Boone Pickens’ attempt to take over Gulf Oil in 1983 and Unocal in 1985, as well as Carl Icahn’s 1985 bid for Phillips 66. These efforts failed, but came close enough to succeeding to unsettle managers, as did Ted Turner’s success in 1985 using Drexel’s leveraged buyout techniques to take over MGM/UA and Kohlberg Kravis Robert’s famously successful 1988 takeover of RJR Nabisco.
The consequent widespread disruption attracted Washington’s attention. Its partners in economic management were suffering. Before the authorities made any accusation of wrongdoing, the Securities Exchange Commission investigated Drexel intensively. Eventually, it uncovered illegalities on the part of one Drexel Burnham employee. Instead of an individual prosecution, the discovery generated a deeper examination of Drexel. Such investigations were common enough—one illegality often leads to another. What was unusual is that the U.S. Attorney used the RICO (Racketeer Influenced and Corrupt Organization) statute to freeze Drexel’s assets during the investigation, even before uncovering any major wrongdoing. The asset freeze effectively made it impossible for Drexel Burnham to meet its obligations. It was a death sentence for the firm, as it would have been for any financial institution, and Drexel closed its doors in early 1990. The firm never admitted to guilt but it did accept the judgment of the authorities. It had little choice. Only later did it emerge that Drexel Burnham had indeed broken laws, also common enough because the rules are so extensive that few firms can remain entirely compliant all the time. Something other than common compliance failures, however, must explain the zeal with which the authorities attacked Drexel, even before they discovered any wrongdoing. It had less to do with law than with stopping Drexel’s disruption of the cooperative-collusive system.
Imagine the action in Silicon Valley today had Washington not crushed Drexel Burnham, and with it, its practices. Tesla, for instance, has management difficulties, enjoys a leading competitive position, has missed several self-imposed production deadlines, and what is most important, enjoys considerable public subsidy. If leveraged buyouts were still the order of the day, Tesla would present a ripe takeover target for an aggressive outside management. Apple, Microsoft, Google, and other technology giants have enormous—and enormously attractive—pools of cash on their balance sheets. These liquid assets earn little and support no project to improve their companies’ technologies or expand their businesses. Were a takeover as feasible as it was in the past, a management team would view these hoards of cash as an easy way to promise repayment to bond buyers in a leveraged buyout. But having crushed Drexel Burnham, Washington has warned off any such behavior, and in doing so has assured Tesla, Apple, Google, and others that no such threat exists, that they face neither competition nor pressure to use these idle funds—to further research, for example, or to increase employment. Washington has these and other cooperative, comfortable managements under its protective wing. Nor do recent privacy hearings alter this protective posture. Regulation could serve these firms as the earlier description made clear it could serve Facebook.