Iceland’s de facto bankruptcy—its currency (the krona) is kaput, its debt is 850 percent of G.D.P., its people are hoarding food and cash and blowing up their new Range Rovers for the insurance— resulted from a stunning collective madness. What led a tiny fishing nation, population 300,000, to decide, around 2003, to re-invent itself as a global financial power? In Reykjavík, where men are men, and the women seem to have completely given up on them, the author follows the peculiarly Icelandic logic behind the meltdown.
by
Michael Lewis
April 2009
Just after October 6, 2008, when Iceland effectively went bust, I spoke to a man at the International Monetary Fund who had been flown in to Reykjavík to determine if money might responsibly be lent to such a spectacularly bankrupt nation. He’d never been to Iceland, knew nothing about the place, and said he needed a map to find it. He has spent his life dealing with famously distressed countries, usually in Africa, perpetually in one kind of financial trouble or another. Iceland was entirely new to his experience: a nation of extremely well-to-do (No. 1 in the United Nations’ 2008 Human Development Index), well-educated, historically rational human beings who had organized themselves to commit one of the single greatest acts of madness in financial history. “You have to understand,” he told me, “Iceland is no longer a country. It is a hedge fund.”
How did the economy get into this mess? Visit our archive “Charting the Road to Ruin.” Plus: A Q&A with Michael Lewis. Illustration by Brad Holland.
An entire nation without immediate experience or even distant memory of high finance had gazed upon the example of Wall Street and said, “We can do that.” For a brief moment it appeared that they could. In 2003, Iceland’s three biggest banks had assets of only a few billion dollars, about 100 percent of its gross domestic product. Over the next three and a half years they grew to over $140 billion and were so much greater than Iceland’s G.D.P. that it made no sense to calculate the percentage of it they accounted for. It was, as one economist put it to me, “the most rapid expansion of a banking system in the history of mankind.”
At the same time, in part because the banks were also lending Icelanders money to buy stocks and real estate, the value of Icelandic stocks and real estate went through the roof. From 2003 to 2007, while the U.S. stock market was doubling, the Icelandic stock market multiplied by nine times. Reykjavík real-estate prices tripled. By 2006 the average Icelandic family was three times as wealthy as it had been in 2003, and virtually all of this new wealth was one way or another tied to the new investment-banking industry. “Everyone was learning Black-Scholes” (the option-pricing model), says Ragnar Arnason, a professor of fishing economics at the University of Iceland, who watched students flee the economics of fishing for the economics of money. “The schools of engineering and math were offering courses on financial engineering. We had hundreds and hundreds of people studying finance.” This in a country the size of Kentucky, but with fewer citizens than greater Peoria, Illinois. Peoria, Illinois, doesn’t have global financial institutions, or a university devoting itself to training many hundreds of financiers, or its own currency. And yet the world was taking Iceland seriously. (March 2006 Bloomberg News headline: iceland’s billionaire tycoon “thor” braves u.s. with hedge fund.)
Global financial ambition turned out to have a downside. When their three brand-new global-size banks collapsed, last October, Iceland’s 300,000 citizens found that they bore some kind of responsibility for $100 billion of banking losses—which works out to roughly $330,000 for every Icelandic man, woman, and child. On top of that they had tens of billions of dollars in personal losses from their own bizarre private foreign-currency speculations, and even more from the 85 percent collapse in the Icelandic stock market. The exact dollar amount of Iceland’s financial hole was essentially unknowable, as it depended on the value of the generally stable Icelandic krona, which had also crashed and was removed from the market by the Icelandic government. But it was a lot.
Iceland instantly became the only nation on earth that Americans could point to and say, “Well, at least we didn’t do that.” In the end, Icelanders amassed debts amounting to 850 percent of their G.D.P. (The debt-drowned United States has reached just 350 percent.) As absurdly big and important as Wall Street became in the U.S. economy, it never grew so large that the rest of the population could not, in a pinch, bail it out. Any one of the three Icelandic banks suffered losses too large for the nation to bear; taken together they were so ridiculously out of proportion that, within weeks of the collapse, a third of the population told pollsters that they were considering emigration.
In just three or four years an entirely new way of economic life had been grafted onto the side of this stable, collectivist society, and the graft had overwhelmed the host. “It was just a group of young kids,” said the man from the I.M.F. “In this egalitarian society, they came in, dressed in black, and started doing business.”
F
ive hundred miles northwest of Scotland the Icelandair flight lands and taxis to a terminal still painted with Landsbanki logos—Landsbanki being one of Iceland’s three bankrupt banks, along with Kaupthing and Glitnir. I try to think up a metaphor for the world’s expanding reservoir of defunct financial corporate sponsorships—water left in the garden hose after you’ve switched off the pressure?—but before I can finish, the man in the seat behind me reaches for his bag in the overhead bin and knocks the crap out of me. I will soon learn that Icelandic males, like moose, rams, and other horned mammals, see these collisions as necessary in their struggle for survival. I will also learn that this particular Icelandic male is a senior official at the Icelandic stock exchange. At this moment, however, all I know is that a middle-aged man in an expensive suit has gone out of his way to bash bodies without apology or explanation. I stew on this apparently wanton act of hostility all the way to passport control.
You can tell a lot about a country by how much better they treat themselves than foreigners at the point of entry. Let it be known that Icelanders make no distinction at all. Over the control booth they’ve hung a charming sign that reads simply, all citizens, and what they mean by that is not “All Icelandic Citizens” but “All Citizens of Anywhere.” Everyone is from somewhere, and so we all wind up in the same line, leading to the guy behind the glass. Before you can say, “Land of contradictions,” he has pretended to examine your passport and waved you on through.
Next, through a dark landscape of snow-spackled black volcanic rock that may or may not be lunar, but that looks so much as you would expect the moon to look that nasa scientists used it to acclimate the astronauts before the first moon mission. An hour later we arrive at the 101 Hotel, owned by the wife of one of Iceland’s most famous failed bankers. It’s cryptically named (101 is the city’s richest postal code), but instantly recognizable: hip Manhattan hotel. Staff dressed in black, incomprehensible art on the walls, unread books about fashion on unused coffee tables—everything to heighten the social anxiety of a rube from the sticks but the latest edition of The New York Observer. It’s the sort of place bankers stay because they think it’s where the artists stay. Bear Stearns convened a meeting of British and American hedge-fund managers here, in January 2008, to figure out how much money there was to be made betting on Iceland’s collapse. (A lot.) The hotel, once jammed, is now empty, with only 6 of its 38 rooms occupied. The restaurant is empty, too, and so are the small tables and little nooks that once led the people who weren’t in them to marvel at those who were. A bankrupt Holiday Inn is just depressing; a bankrupt Ian Schrager hotel is tragic.
With the financiers who once paid a lot to stay here gone for good, I’m given a big room on the top floor with a view of the old city for half-price. I curl up in silky white sheets and reach for a book about the Icelandic economy—written in 1995, before the banking craze, when the country had little to sell to the outside world but fresh fish—and read this remarkable sentence: “Icelanders are rather suspicious of the market system as a cornerstone of economic organization, especially its distributive implications.”
That’s when the strange noises commence.
Stefan Alfsson: A fisherman turned banker, who was laid off from his trading job in October and now might return to fishing.
First comes a screeching from the far side of the room. I leave the bed to examine the situation. It’s the heat, sounding like a teakettle left on the stove for too long, straining to control itself. Iceland’s heat isn’t heat as we know it, but heat drawn directly from the earth. The default temperature of the water is scalding. Every year workers engaged in street repairs shut down the cold-water intake used to temper the hot water and some poor Icelander is essentially boiled alive in his shower. So powerful is the heat being released from the earth into my room that some great grinding, wheezing engine must be employed to prevent it from cooking me.
Then, from outside, comes an explosion.
Boom!
Then another.
Boom!
A
s it is mid-December, the sun rises, barely, at 10:50 a.m. and sets with enthusiasm at 3:44 p.m. This is obviously better than no sun at all, but subtly worse, as it tempts you to believe you can simulate a normal life. And whatever else this place is, it isn’t normal. The point is reinforced by a 26-year-old Icelander I’ll call Magnus Olafsson, who, just a few weeks earlier, had been earning close to a million dollars a year trading currencies for one of the banks. Tall, white-blond, and handsome, Olafsson looks exactly as you’d expect an Icelander to look—which is to say that he looks not at all like most Icelanders, who are mousy-haired and lumpy. “My mother has enough food hoarded to open a grocery store,” he says, then adds that ever since the crash Reykjavík has felt tense and uneasy.
Two months earlier, in early October, as the market for Icelandic kronur dried up, he’d sneaked away from his trading desk and gone down to the teller, where he’d extracted as much foreign cash as they’d give him and stuffed it into a sack. “All over downtown that day you saw people walking around with bags,” he says. “No one ever carries bags around downtown.” After work he’d gone home with his sack of cash and hidden roughly 30 grand in yen, dollars, euros, and pounds sterling inside a board game.
Before October the big-name bankers were heroes; now they are abroad, or laying low. Before October Magnus thought of Iceland as essentially free of danger; now he imagines hordes of muggers en route from foreign nations to pillage his board-game safe—and thus refuses to allow me to use his real name. “You’d figure New York would hear about this and send over planeloads of muggers,” he theorizes. “Most everyone has their savings at home.” As he is already unsettled, I tell him about the unsettling explosions outside my hotel room. “Yes,” he says with a smile, “there’s been a lot of Range Rovers catching fire lately.” Then he explains.
For the past few years, some large number of Icelanders engaged in the same disastrous speculation. With local interest rates at 15.5 percent and the krona rising, they decided the smart thing to do, when they wanted to buy something they couldn’t afford, was to borrow not kronur but yen and Swiss francs. They paid 3 percent interest on the yen and in the bargain made a bundle on the currency trade, as the krona kept rising. “The fishing guys pretty much discovered the trade and made it huge,” says Magnus. “But they made so much money on it that the financial stuff eventually overwhelmed the fish.” They made so much money on it that the trade spread from the fishing guys to their friends.
It must have seemed like a no-brainer: buy these ever more valuable houses and cars with money you are, in effect, paid to borrow. But, in October, after the krona collapsed, the yen and Swiss francs they must repay are many times more expensive. Now many Icelanders—especially young Icelanders—own $500,000 houses with $1.5 million mortgages, and $35,000 Range Rovers with $100,000 in loans against them. To the Range Rover problem there are two immediate solutions. One is to put it on a boat, ship it to Europe, and try to sell it for a currency that still has value. The other is set it on fire and collect the insurance: Boom!
The rocks beneath Reykjavík may be igneous, but the city feels sedimentary: on top of several thick strata of architecture that should be called Nordic Pragmatic lies a thin layer that will almost certainly one day be known as Asshole Capitalist. The hobbit-size buildings that house the Icelandic government are charming and scaled to the city. The half-built oceanfront glass towers meant to house newly rich financiers and, in the bargain, block everyone else’s view of the white bluffs across the harbor are not.
T
he best way to see any city is to walk it, but everywhere I walk Icelandic men plow into me without so much as a by-your-leave. Just for fun I march up and down the main shopping drag, playing chicken, to see if any Icelandic male would rather divert his stride than bang shoulders. Nope. On party nights—Thursday, Friday, and Saturday—when half the country appears to take it as a professional obligation to drink themselves into oblivion and wander the streets until what should be sunrise, the problem is especially acute. The bars stay open until five a.m., and the frantic energy with which the people hit them seems more like work than work. Within minutes of entering a nightclub called Boston I get walloped, first by a bearded troll who, I’m told, ran an Icelandic hedge fund. Just as I’m recovering I get plowed over by a drunken senior staffer at the Central Bank. Perhaps because he is drunk, or perhaps because we had actually met a few hours earlier, he stops to tell me, “Vee try to tell them dat our problem was not a solfency problem but a likvitity problem, but they did not agree,” then stumbles off. It’s exactly what Lehman Brothers and Citigroup said: If only you’d give us the money to tide us over, we’ll survive this little hiccup.
A nation so tiny and homogeneous that everyone in it knows pretty much everyone else is so fundamentally different from what one thinks of when one hears the word “nation” that it almost requires a new classification. Really, it’s less a nation than one big extended family. For instance, most Icelanders are by default members of the Lutheran Church. If they want to stop being Lutherans they must write to the government and quit; on the other hand, if they fill out a form, they can start their own cult and receive a subsidy. Another example: the Reykjavík phone book lists everyone by his first name, as there are only about nine surnames in Iceland, and they are derived by prefixing the father’s name to “son” or “dottir.” It’s hard to see how this clarifies matters, as there seem to be only about nine first names in Iceland, too. But if you wish to reveal how little you know about Iceland, you need merely refer to someone named Siggor Sigfusson as “Mr. Sigfusson,” or Kristin Petursdottir as “Ms. Petursdottir.” At any rate, everyone in a conversation is just meant to know whomever you’re talking about, so you never hear anyone ask, “Which Siggor do you mean?”
Because Iceland is really just one big family, it’s simply annoying to go around asking Icelanders if they’ve met Björk. Of course they’ve met Björk; who hasn’t met Björk? Who, for that matter, didn’t know Björk when she was two? “Yes, I know Björk,” a professor of finance at the University of Iceland says in reply to my question, in a weary tone. “She can’t sing, and I know her mother from childhood, and they were both crazy. That she is so well known outside of Iceland tells me more about the world than it does about Björk.”
One benefit of life inside a nation masking an extended family is that nothing needs to be explained; everyone already knows everything that needs to be known. I quickly find that it is an even greater than usual waste of time to ask directions, for instance. Just as you are meant to know which Bjornjolfer is being spoken of at any particular moment, you are meant to know where you are on the map. Two grown-ups—one a banker whose office is three blocks away—cannot tell me where to find the prime minister’s office. Three more grown-ups, all within three blocks of the National Gallery of Iceland, have no idea where to find the place. When I tell the sweet middle-aged lady behind the counter at the National Museum that no Icelander seems to know how to find it, she says, “No one actually knows anything about our country. Last week we had Icelandic high-school students here and their teacher asked them to name an Icelandic 19th-century painter. None of them could. Not a single one! One said, ‘Halldor Laxness?’!” (Laxness won the 1955 Nobel Prize in Literature, the greatest global honor for an Icelander until the 1980s, when two Icelandic women captured Miss World titles in rapid succession.)
T
he world is now pocked with cities that feel as if they are perched on top of bombs. The bombs have yet to explode, but the fuses have been lit, and there’s nothing anyone can do to extinguish them. Walk around Manhattan and you see empty stores, empty streets, and, even when it’s raining, empty taxis: people have fled before the bomb explodes. When I was there Reykjavík had the same feel of incipient doom, but the fuse burned strangely. The government mandates three months’ severance pay, and so the many laid-off bankers were paid until early February, when the government promptly fell. Against a basket of foreign currencies the krona is worth less than a third of its boom-time value. As Iceland imports everything but heat and fish, the price of just about everything is, in mid-December, about to skyrocket. A new friend who works for the government tells me that she went into a store to buy a lamp. The clerk told her he had sold the last of the lamps she was after, but offered to order it for her, from Sweden—at nearly three times the old price.
Bjarni Brynjolfsson: A fishing guide, who is back to hosting fly-fishermen instead of bankers.
Still, a society that has been ruined overnight doesn’t look much different from how it did the day before, when it believed itself to be richer than ever. The Central Bank of Iceland is a case in point. Almost certainly Iceland will adopt the euro as its currency, and the krona will cease to exist. Without it there is no need for a central bank to maintain the stability of the local currency and control interest rates. Inside the place stews David Oddsson, the architect of Iceland’s rise and fall. Back in the 1980s, Oddsson had fallen under the spell of Milton Friedman, the brilliant economist who was able to persuade even those who spent their lives working for the government that government was a waste of life. So Oddsson went on a quest to give Icelandic people their freedom—by which he meant freedom from government controls of any sort. As prime minister he lowered taxes, privatized industry, freed up trade, and, finally, in 2002, privatized the banks. At length, weary of prime-ministering, he got himself appointed governor of the Central Bank—even though he was a poet without banking experience.
After the collapse he holed up in his office inside the bank, declining all requests for interviews. Senior government officials tell me, seriously, that they assume he spends most of his time writing poetry. (In February he would be asked by a new government to leave.) On the outside, however, the Central Bank of Iceland is still an elegant black temple set against the snowy bluffs across the harbor. Sober-looking men still enter and exit. Small boys on sleds rocket down the slope beside it, giving not a rat’s ass that they are playing at ground zero of the global calamity. It all looks the same as it did before the crash, even though it couldn’t be more different. The fuse is burning its way toward the bomb.
When Neil Armstrong took his small step from Apollo 11 and looked around, he probably thought, Wow, sort of like Iceland—even though the moon was nothing like Iceland. But then, he was a tourist, and a tourist can’t help but have a distorted opinion of a place: he meets unrepresentative people, has unrepresentative experiences, and runs around imposing upon the place the fantastic mental pictures he had in his head when he got there. When Iceland became a tourist in global high finance it had the same problem as Neil Armstrong. Icelanders are among the most inbred human beings on earth—geneticists often use them for research. They inhabited their remote island for 1,100 years without so much as dabbling in leveraged buyouts, hostile takeovers, derivatives trading, or even small-scale financial fraud. When, in 2003, they sat down at the same table with Goldman Sachs and Morgan Stanley, they had only the roughest idea of what an investment banker did and how he behaved—most of it gleaned from young Icelanders’ experiences at various American business schools. And so what they did with money probably says as much about the American soul, circa 2003, as it does about Icelanders. They understood instantly, for instance, that finance had less to do with productive enterprise than trading bits of paper among themselves. And when they lent money they didn’t simply facilitate enterprise but bankrolled friends and family, so that they might buy and own things, like real investment bankers: Beverly Hills condos, British soccer teams and department stores, Danish airlines and media companies, Norwegian banks, Indian power plants.
That was the biggest American financial lesson the Icelanders took to heart: the importance of buying as many assets as possible with borrowed money, as asset prices only rose. By 2007, Icelanders owned roughly 50 times more foreign assets than they had in 2002. They bought private jets and third homes in London and Copenhagen. They paid vast sums of money for services no one in Iceland had theretofore ever imagined wanting. “A guy had a birthday party, and he flew in Elton John for a million dollars to sing two songs,” the head of the Left-Green Movement, Steingrimur Sigfusson, tells me with fresh incredulity. “And apparently not very well.” They bought stakes in businesses they knew nothing about and told the people running them what to do—just like real American investment bankers! For instance, an investment company called FL Group—a major shareholder in Glitnir bank—bought an 8.25 percent stake in American Airlines’ parent corporation. No one inside FL Group had ever actually run an airline; no one in FL Group even had meaningful work experience at an airline. That didn’t stop FL Group from telling American Airlines how to run an airline. “After taking a close look at the company over an extended period of time,” FL Group C.E.O. Hannes Smarason, graduate of M.I.T.’s Sloan School, got himself quoted saying, in his press release, not long after he bought his shares, “our suggestions include monetizing assets … that can be used to reduce debt or return capital to shareholders.”
Nor were the Icelanders particularly choosy about what they bought. I spoke with a hedge fund in New York that, in late 2006, spotted what it took to be an easy mark: a weak Scandinavian bank getting weaker. It established a short position, and then, out of nowhere, came Kaupthing to take a 10 percent stake in this soon-to-be defunct enterprise—driving up the share price to absurd levels. I spoke to another hedge fund in London so perplexed by the many bad LBOs Icelandic banks were financing that it hired private investigators to figure out what was going on in the Icelandic financial system. The investigators produced a chart detailing a byzantine web of interlinked entities that boiled down to this: A handful of guys in Iceland, who had no experience of finance, were taking out tens of billions of dollars in short-term loans from abroad. They were then re-lending this money to themselves and their friends to buy assets—the banks, soccer teams, etc. Since the entire world’s assets were rising—thanks in part to people like these Icelandic lunatics paying crazy prices for them—they appeared to be making money. Yet another hedge-fund manager explained Icelandic banking to me this way: You have a dog, and I have a cat. We agree that they are each worth a billion dollars. You sell me the dog for a billion, and I sell you the cat for a billion. Now we are no longer pet owners, but Icelandic banks, with a billion dollars in new assets. “They created fake capital by trading assets amongst themselves at inflated values,” says a London hedge-fund manager. “This was how the banks and investment companies grew and grew. But they were lightweights in the international markets.”
O
n February 3, Tony Shearer, the former C.E.O. of a British merchant bank called Singer and Friedlander, offered a glimpse of the inside, when he appeared before a House of Commons committee to describe his bizarre experience of being acquired by an Icelandic bank.
Singer and Friedlander had been around since 1907 and was famous for, among other things, giving George Soros his start. In November 2003, Shearer learned that Kaupthing, of whose existence he was totally unaware, had just taken a 9.5 percent stake in his bank. Normally, when a bank tries to buy another bank, it seeks to learn something about it. Shearer offered to meet with Kaupthing’s chairman, Sigurdur Einarsson; Einarsson had no interest. (Einarsson declined to be interviewed by Vanity Fair.) When Kaupthing raised its stake to 19.5 percent, Shearer finally flew to Reykjavík to see who on earth these Icelanders were. “They were very different,” he told the House of Commons committee. “They ran their business in a very strange way. Everyone there was incredibly young. They were all from the same community in Reykjavík. And they had no idea what they were doing.”
Hordur Torfason: An activist and a protest organizer.
He examined Kaupthing’s annual reports and discovered some amazing facts: This giant international bank had only one board member who was not Icelandic, for instance. Its directors all had four-year contracts, and the bank had lent them £19 million to buy shares in Kaupthing, along with options to sell those shares back to the bank at a guaranteed profit. Virtually the entire bank’s stated profits were caused by its marking up assets it had bought at inflated prices. “The actual amount of profits that were coming from what I’d call banking was less than 10 percent,” said Shearer.
In a sane world the British regulators would have stopped the new Icelandic financiers from devouring the ancient British merchant bank. Instead, the regulators ignored a letter Shearer wrote to them. A year later, in January 2005, he received a phone call from the British takeover panel. “They wanted to know,” says Shearer, “why our share price had risen so rapidly over the past couple of days. So I laughed and said, ‘I think you’ll find the reason is that Mr. Einarsson, the chairman of Kaupthing, said two days ago, like an idiot, that he was going to make a bid for Singer and Friedlander.’” In August 2005, Singer and Friedlander became Kaupthing Singer and Friedlander, and Shearer quit, he said, out of fear of what might happen to his reputation if he stayed. In October 2008, Kaupthing Singer and Friedlander went bust.
In spite of all this, when Tony Shearer was pressed by the House of Commons to characterize the Icelanders as mere street hustlers, he refused. “They were all highly educated people,” he said in a tone of amazement.
H
ere is yet another way in which Iceland echoed the American model: all sorts of people, none of them Icelandic, tried to tell them they had a problem. In early 2006, for instance, an analyst named Lars Christensen and three of his colleagues at Denmark’s biggest bank, Danske Bank, wrote a report that said Iceland’s financial system was growing at a mad pace, and was on a collision course with disaster. “We actually wrote the report because we were worried our clients were getting too interested in Iceland,” he tells me. “Iceland was the most extreme of everything.” Christensen then flew to Iceland and gave a speech to reinforce his point, only to be greeted with anger. “The Icelandic banks took it personally,” he says. “We were being threatened with lawsuits. I was told, ‘You’re Danish, and you are angry with Iceland because Iceland is doing so well.’ Basically it all had to do with what happened in 1944,” when Iceland declared its independence from Denmark. “The reaction wasn’t ‘These guys might be right.’ It was ‘No! It’s a conspiracy. They have bad motives.’” The Danish were just jealous!
The Danske Bank report alerted hedge funds in London to an opportunity: shorting Iceland. They investigated and found this incredible web of cronyism: bankers buying stuff from one another at inflated prices, borrowing tens of billions of dollars and re-lending it to the members of their little Icelandic tribe, who then used it to buy up a messy pile of foreign assets. “Like any new kid on the block,” says Theo Phanos of Trafalgar Funds in London, “they were picked off by various people who sold them the lowest-quality assets—second-tier airlines, sub-scale retailers. They were in all the worst LBOs.”
But from the prime minister on down, Iceland’s leaders attacked the messenger. “The attacks … give off an unpleasant odor of unscrupulous dealers who have decided to make a last stab at breaking down the Icelandic financial system,” said Central Bank chairman Oddsson in March of last year. The chairman of Kaupthing publicly fingered four hedge funds that he said were deliberately seeking to undermine Iceland’s financial miracle. “I don’t know where the Icelanders get this notion,” says Paul Ruddock, of Lansdowne Partners, one of those fingered. “We only once traded in an Icelandic stock and it was a very short-term trade. We started to take legal action against the chairman of Kaupthing after he made public accusations against us that had no truth, and then he withdrew them.”
One of the hidden causes of the current global financial crisis is that the people who saw it coming had more to gain from it by taking short positions than they did by trying to publicize the problem. Plus, most of the people who could credibly charge Iceland—or, for that matter, Lehman Brothers—with financial crimes could be dismissed as crass profiteers, talking their own book. Back in April 2006, however, an emeritus professor of economics at the University of Chicago named Bob Aliber took an interest in Iceland. Aliber found himself at the London Business School, listening to a talk on Iceland, about which he knew nothing. He recognized instantly the signs. Digging into the data, he found in Iceland the outlines of what was so clearly a historic act of financial madness that it belonged in a textbook. “The Perfect Bubble,” Aliber calls Iceland’s financial rise, and he has the textbook in the works: an updated version of Charles Kindleberger’s 1978 classic, Manias, Panics, and Crashes, a new edition of which he’s currently editing. In it, Iceland, he decided back in 2006, would now have its own little box, along with the South Sea Bubble and the Tulip Craze—even though Iceland had yet to crash. For him the actual crash was a mere formality.
W
ord spread in Icelandic economic circles that this distinguished professor at Chicago had taken a special interest in Iceland. In May 2008, Aliber was invited by the University of Iceland’s economics department to give a speech. To an audience of students, bankers, and journalists, he explained that Iceland, far from having an innate talent for high finance, had all the markings of a giant bubble, but he spoke the technical language of academic economists. (“Monetary Turbulence and the Icelandic Economy,” he called his speech.) In the following Q&A session someone asked him to predict the future, and he lapsed into plain English. As an audience member recalls, Aliber said, “I give you nine months. Your banks are dead. Your bankers are either stupid or greedy. And I’ll bet they are on planes trying to sell their assets right now.”
The Icelandic bankers in the audience sought to prevent newspapers from reporting the speech. Several academics suggested that Aliber deliver his alarming analysis to Iceland’s Central Bank. Somehow that never happened. “The Central Bank said they were too busy to see him,” says one of the professors who tried to arrange the meeting, “because they were preparing the Report on Financial Stability.” For his part Aliber left Iceland thinking that he’d caused such a stir he might not be allowed back into the country. “I got the feeling,” he told me, “that the only reason they brought me in was that they needed an outsider to say these things—that an insider wouldn’t say these things, because he’d be afraid of getting into trouble.” And yet he remains extremely fond of his hosts. “They are a very curious people,” he says, laughing. “I guess that’s the point, isn’t it?”
Icelanders—or at any rate Icelandic men—had their own explanations for why, when they leapt into global finance, they broke world records: the natural superiority of Icelanders. Because they were small and isolated it had taken 1,100 years for them—and the world—to understand and exploit their natural gifts, but now that the world was flat and money flowed freely, unfair disadvantages had vanished. Iceland’s president, Olafur Ragnar Grimsson, gave speeches abroad in which he explained why Icelanders were banking prodigies. “Our heritage and training, our culture and home market, have provided a valuable advantage,” he said, then went on to list nine of these advantages, ending with how unthreatening to others Icelanders are. (“Some people even see us as fascinating eccentrics who can do no harm.”) There were many, many expressions of this same sentiment, most of them in Icelandic. “There were research projects at the university to explain why the Icelandic business model was superior,” says Gylfi Zoega, chairman of the economics department. “It was all about our informal channels of communication and ability to make quick decisions and so forth.”
“We were always told that the Icelandic businessmen were so clever,” says university finance professor and former banker Vilhjalmur Bjarnason. “They were very quick. And when they bought something they did it very quickly. Why was that? That is usually because the seller is very satisfied with the price.”
You didn’t need to be Icelandic to join the cult of the Icelandic banker. German banks put $21 billion into Icelandic banks. The Netherlands gave them $305 million, and Sweden kicked in $400 million. U.K. investors, lured by the eye-popping 14 percent annual returns, forked over $30 billion—$28 billion from companies and individuals and the rest from pension funds, hospitals, universities, and other public institutions. Oxford University alone lost $50 million.
Geir Haarde: The former prime minister, on January 28, one of his last days in office.
Maybe because there are so few Icelanders in the world, we know next to nothing about them. We assume they are more or less Scandinavian—a gentle people who just want everyone to have the same amount of everything. They are not. They have a feral streak in them, like a horse that’s just pretending to be broken.
A
fter three days in Reykjavík, I receive, more or less out of the blue, two phone calls. The first is from a producer of a leading current-events TV show. All of Iceland watches her show, she says, then asks if I’d come on and be interviewed. “About what?” I ask. “We’d like you to explain our financial crisis,” she says. “I’ve only been here three days!” I say. It doesn’t matter, she says, as no one in Iceland understands what’s happened. They’d enjoy hearing someone try to explain it, even if that person didn’t have any idea what he was talking about—which goes to show, I suppose, that not everything in Iceland is different from other places. As I demur, another call comes, from the prime minister’s office.
Iceland’s then prime minister, Geir Haarde, is also the head of the Independence Party, which has governed the country since 1991. It ruled in loose coalition with the Social Democrats and the Progressive Party. (Iceland’s fourth major party is the Left-Green Movement.) That a nation of 300,000 people, all of whom are related by blood, needs four major political parties suggests either a talent for disagreement or an unwillingness to listen to one another. In any case, of the four parties, the Independents express the greatest faith in free markets. The Independence Party is the party of the fishermen. It is also, as an old schoolmate of the prime minister’s puts it to me, “all men, men, men. Not a woman in it.”
Walking into the P.M.’s minute headquarters, I expect to be stopped and searched, or at least asked for photo identification. Instead I find a single policeman sitting behind a reception desk, feet up on the table, reading a newspaper. He glances up, bored. “I’m here to see the prime minister,” I say for the first time in my life. He’s unimpressed. Anyone here can see the prime minister. Half a dozen people will tell me that one of the reasons Icelanders thought they would be taken seriously as global financiers is that all Icelanders feel important. One reason they all feel important is that they all can go see the prime minister anytime they like.
What he might say to them about their collapse is an open question. There’s a charming lack of financial experience in Icelandic financial-policymaking circles. The minister for business affairs is a philosopher. The finance minister is a veterinarian. The Central Bank governor is a poet. Haarde, though, is a trained economist—just not a very good one. The economics department at the University of Iceland has him pegged as a B-minus student. As a group, the Independence Party’s leaders have a reputation for not knowing much about finance and for refusing to avail themselves of experts who do. An Icelandic professor at the London School of Economics named Jon Danielsson, who specializes in financial panics, has had his offer to help spurned; so have several well-known financial economists at the University of Iceland. Even the advice of really smart central bankers from seriously big countries went ignored. It’s not hard to see why the Independence Party and its prime minister fail to appeal to Icelandic women: they are the guy driving his family around in search of some familiar landmark and refusing, over his wife’s complaints, to stop and ask directions.
“Why is Vanity Fair interested in Iceland?” he asks as he strides into the room, with the force and authority of the leader of a much larger nation. And it’s a good question.
As it turns out, he’s not actually stupid, but political leaders seldom are, no matter how much the people who elected them insist that it must be so. He does indeed say things that could not possibly be true, but they are only the sorts of fibs that prime ministers are hired to tell. He claims that the krona is once again an essentially stable currency, for instance, when the truth is it doesn’t currently trade in international markets—it is assigned an arbitrary value by the government for select purposes. Icelanders abroad have already figured out not to use their Visa cards, for fear of being charged the real exchange rate, whatever that might be.
The prime minister would like me to believe that he saw Iceland’s financial crisis taking shape but could do little about it. (“We could not say publicly our fears about the banks, because you create the very thing you are seeking to avoid: a panic.”) By implication it was not politicians like him but financiers who were to blame. On some level the people agree: the guy who ran the Baugur investment group had snowballs chucked at him as he dashed from the 101 Hotel, which his wife owns, to his limo; the guy who ran Kaupthing Bank turned up at the National Theater and, as he took his seat, was booed. But, for the most part, the big shots have fled Iceland for London, or are lying low, leaving the poor prime minister to shoulder the blame and face the angry demonstrators, led by folksinging activist Hordur Torfason, who assemble every weekend outside Parliament. Haarde has his story, and he’s sticking to it: foreigners entrusted their capital to Iceland, and Iceland put it to good use, but then, last September 15, Lehman Brothers failed and foreigners panicked and demanded their capital back. Iceland was ruined not by its own recklessness but by a global tsunami. The problem with this story is that it fails to explain why the tsunami struck Iceland, as opposed to, say, Tonga.
But I didn’t come to Iceland to argue. I came to understand. “There’s something I really want to ask you,” I say.
“Yes?”
“Is it true that you’ve been telling people that it’s time to stop banking and go fishing?”
A great line, I thought. Succinct, true, and to the point. But I’d heard about it thirdhand, from a New York hedge-fund manager. The prime minister fixes me with a self-consciously stern gaze. “That’s a gross exaggeration,” he says.
“I thought it made sense,” I say uneasily.
“I never said that!”
Obviously, I’ve hit some kind of nerve, but which kind I cannot tell. Is he worried that to have said such a thing would make him seem a fool? Or does he still think that fishing, as a profession, is somehow less dignified than banking?
A
t length, I return to the hotel to find, for the first time in four nights, no empty champagne bottles outside my neighbors’ door. The Icelandic couple whom I had envisioned as being on one last blowout have packed and gone home. For four nights I have endured their Orc shrieks from the other side of the hotel wall; now all is silent. It’s now possible to curl up in bed with “The Economic Theory of a Common-Property Resource: The Fishery.” One way or another, the wealth in Iceland comes from the fish, and if you want to understand what Icelanders did with their money you had better understand how they came into it in the first place.
The brilliant paper was written back in 1954 by H. Scott Gordon, a University of Indiana economist. It describes the plight of the fisherman—and seeks to explain “why fishermen are not wealthy, despite the fact that fishery resources of the sea are the richest and most indestructible available to man.” The problem is that, because the fish are everybody’s property, they are nobody’s property. Anyone can catch as many fish as they like, so they fish right up to the point where fishing becomes unprofitable—for everybody. “There is in the spirit of every fisherman the hope of the ‘lucky catch,’” wrote Gordon. “As those who know fishermen well have often testified, they are gamblers and incurably optimistic.”
Fishermen, in other words, are a lot like American investment bankers. Their overconfidence leads them to impoverish not just themselves but also their fishing grounds. Simply limiting the number of fish caught won’t solve the problem; it will just heighten the competition for the fish and drive down profits. The goal isn’t to get fishermen to overspend on more nets or bigger boats. The goal is to catch the maximum number of fish with minimum effort. To attain it, you need government intervention.
Johanna Sigurdardottir: The new prime minister, the modern world’s first openly gay head of state.
This insight is what led Iceland to go from being one of the poorest countries in Europe circa 1900 to being one of the richest circa 2000. Iceland’s big change began in the early 1970s, after a couple of years when the fish catch was terrible. The best fishermen returned for a second year in a row without their usual haul of cod and haddock, so the Icelandic government took radical action: they privatized the fish. Each fisherman was assigned a quota, based roughly on his historical catches. If you were a big-time Icelandic fisherman you got this piece of paper that entitled you to, say, 1 percent of the total catch allowed to be pulled from Iceland’s waters that season. Before each season the scientists at the Marine Research Institute would determine the total number of cod or haddock that could be caught without damaging the long-term health of the fish population; from year to year, the numbers of fish you could catch changed. But your percentage of the annual haul was fixed, and this piece of paper entitled you to it in perpetuity.
Even better, if you didn’t want to fish you could sell your quota to someone who did. The quotas thus drifted into the hands of the people to whom they were of the greatest value, the best fishermen, who could extract the fish from the sea with maximum efficiency. You could also take your quota to the bank and borrow against it, and the bank had no trouble assigning a dollar value to your share of the cod pulled, without competition, from the richest cod-fishing grounds on earth. The fish had not only been privatized, they had been securitized.
I
t was horribly unfair: a public resource—all the fish in the Icelandic sea—was simply turned over to a handful of lucky Icelanders. Overnight, Iceland had its first billionaires, and they were all fishermen. But as social policy it was ingenious: in a single stroke the fish became a source of real, sustainable wealth rather than shaky sustenance. Fewer people were spending less effort catching more or less precisely the right number of fish to maximize the long-term value of Iceland’s fishing grounds. The new wealth transformed Iceland—and turned it from the backwater it had been for 1,100 years to the place that spawned Björk. If Iceland has become famous for its musicians it’s because Icelanders now have time to play music, and much else. Iceland’s youth are paid to study abroad, for instance, and encouraged to cultivate themselves in all sorts of interesting ways. Since its fishing policy transformed Iceland, the place has become, in effect, a machine for turning cod into Ph.D.’s.
But this, of course, creates a new problem: people with Ph.D.’s don’t want to fish for a living. They need something else to do.
And that something is probably not working in the industry that exploits Iceland’s other main natural resource: energy. The waterfalls and boiling lava generate vast amounts of cheap power, but, unlike oil, it cannot be profitably exported. Iceland’s power is trapped in Iceland, and if there is something poetic about the idea of trapped power, there is also something prosaic in how the Icelanders have come to terms with the problem. They asked themselves: What can we do that other people will pay money for that requires huge amounts of power? The answer was: smelt aluminum.
Notice that no one asked, What might Icelanders want to do? Or even: What might Icelanders be especially suited to do? No one thought that Icelanders might have some natural gift for smelting aluminum, and, if anything, the opposite proved true. Alcoa, the biggest aluminum company in the country, encountered two problems peculiar to Iceland when, in 2004, it set about erecting its giant smelting plant. The first was the so-called “hidden people”—or, to put it more plainly, elves—in whom some large number of Icelanders, steeped long and thoroughly in their rich folkloric culture, sincerely believe. Before Alcoa could build its smelter it had to defer to a government expert to scour the enclosed plant site and certify that no elves were on or under it. It was a delicate corporate situation, an Alcoa spokesman told me, because they had to pay hard cash to declare the site elf-free but, as he put it, “we couldn’t as a company be in a position of acknowledging the existence of hidden people.” The other, more serious problem was the Icelandic male: he took more safety risks than aluminum workers in other nations did. “In manufacturing,” says the spokesman, “you want people who follow the rules and fall in line. You don’t want them to be heroes. You don’t want them to try to fix something it’s not their job to fix, because they might blow up the place.” The Icelandic male had a propensity to try to fix something it wasn’t his job to fix.
Back away from the Icelandic economy and you can’t help but notice something really strange about it: the people have cultivated themselves to the point where they are unsuited for the work available to them. All these exquisitely schooled, sophisticated people, each and every one of whom feels special, are presented with two mainly horrible ways to earn a living: trawler fishing and aluminum smelting. There are, of course, a few jobs in Iceland that any refined, educated person might like to do. Certifying the nonexistence of elves, for instance. (“This will take at least six months—it can be very tricky.”) But not nearly so many as the place needs, given its talent for turning cod into Ph.D.’s. At the dawn of the 21st century, Icelanders were still waiting for some task more suited to their filigreed minds to turn up inside their economy so they might do it.
Enter investment banking.
F
or the fifth time in as many days I note a slight tension at any table where Icelandic men and Icelandic women are both present. The male exhibits the global male tendency not to talk to the females—or, rather, not to include them in the conversation—unless there is some obvious sexual motive. But that’s not the problem, exactly. Watching Icelandic men and women together is like watching toddlers. They don’t play together but in parallel; they overlap even less organically than men and women in other developed countries, which is really saying something. It isn’t that the women are oppressed, exactly. On paper, by historical global standards, they have it about as good as women anywhere: good public health care, high participation in the workforce, equal rights. What Icelandic women appear to lack—at least to a tourist who has watched them for all of 10 days—is a genuine connection to Icelandic men. The Independence Party is mostly male; the Social Democrats, mostly female. (On February 1, when the reviled Geir Haarde finally stepped aside, he was replaced by Johanna Sigurdardottir, a Social Democrat, and Iceland got not just a lady prime minister but the modern world’s first openly gay head of state—she lives with another woman.) Everyone knows everyone else, but when I ask Icelanders for leads, the men always refer me to other men, and the women to other women. It was a man, for instance, who suggested I speak to Stefan Alfsson.
Lean and hungry-looking, wearing genuine rather than designer stubble, Alfsson still looks more like a trawler captain than a financier. He went to sea at 16, and, in the off-season, to school to study fishing. He was made captain of an Icelandic fishing trawler at the shockingly young age of 23 and was regarded, I learned from other men, as something of a fishing prodigy—which is to say he had a gift for catching his quota of cod and haddock in the least amount of time. And yet, in January 2005, at 30, he up and quit fishing to join the currency-trading department of Landsbanki. He speculated in the financial markets for nearly two years, until the great bloodbath of October 2008, when he was sacked, along with every other Icelander who called himself a “trader.” His job, he says, was to sell people, mainly his fellow fishermen, on what he took to be a can’t-miss speculation: borrow yen at 3 percent, use them to buy Icelandic kronur, and then invest those kronur at 16 percent. “I think it is easier to take someone in the fishing industry and teach him about currency trading,” he says, “than to take someone from the banking industry and teach them how to fish.”
He then explained why fishing wasn’t as simple as I thought. It’s risky, for a start, especially as practiced by the Icelandic male. “You don’t want to have some sissy boys on your crew,” he says, especially as Icelandic captains are famously manic in their fishing styles. “I had a crew of Russians once,” he says, “and it wasn’t that they were lazy, but the Russians are always at the same pace.” When a storm struck, the Russians would stop fishing, because it was too dangerous. “The Icelanders would fish in all conditions,” says Stefan, “fish until it is impossible to fish. They like to take the risks. If you go overboard, the probabilities are not in your favor. I’m 33, and I already have two friends who have died at sea.”
It took years of training for him to become a captain, and even then it happened only by a stroke of luck. When he was 23 and a first mate, the captain of his fishing boat up and quit. The boat owner went looking for a replacement and found an older fellow, retired, who was something of an Icelandic fishing legend, the wonderfully named Snorri Snorrasson. “I took two trips with this guy,” Stefan says. “I have never in my life slept so little, because I was so eager to learn. I slept two or three hours a night because I was sitting beside him, talking to him. I gave him all the respect in the world—it’s difficult to describe all he taught me. The reach of the trawler. The most efficient angle of the net. How do you act on the sea. If you have a bad day, what do you do? If you’re fishing at this depth, what do you do? If it’s not working, do you move in depth or space? In the end it’s just so much feel. In this time I learned infinitely more than I learned in school. Because how do you learn to fish in school?”
This marvelous training was as fresh in his mind as if he’d received it yesterday, and the thought of it makes his eyes mist.
“You spent seven years learning every little nuance of the fishing trade before you were granted the gift of learning from this great captain?” I ask.
“Yes.”
“And even then you had to sit at the feet of this great master for many months before you felt as if you knew what you were doing?”
“Yes.”
“Then why did you think you could become a banker and speculate in financial markets, without a day of training?”
“That’s a very good question,” he says. He thinks for a minute. “For the first time this evening I lack a word.” As I often think I know exactly what I am doing even when I don’t, I find myself oddly sympathetic.
“What, exactly, was your job?” I ask, to let him off the hook, catch and release being the current humane policy in Iceland.
“I started as a … “—now he begins to laugh—“an adviser to companies on currency risk hedging. But given my aggressive nature I went more and more into plain speculative trading.” Many of his clients were other fishermen, and fishing companies, and they, like him, had learned that if you don’t take risks you don’t catch the fish. “The clients were only interested in ‘hedging’ if it meant making money,” he says.
I
n retrospect, there are some obvious questions an Icelander living through the past five years might have asked himself. For example: Why should Iceland suddenly be so seemingly essential to global finance? Or: Why do giant countries that invented modern banking suddenly need Icelandic banks to stand between their depositors and their borrowers—to decide who gets capital and who does not? And: If Icelanders have this incredible natural gift for finance, how did they keep it so well hidden for 1,100 years? At the very least, in a place where everyone knows everyone else, or his sister, you might have thought that the moment Stefan Alfsson walked into Landsbanki 10 people would have said, “Stefan, you’re a fisherman!” But they didn’t. To a shocking degree, they still don’t. “If I went back to banking,” he says, with an entirely straight face, “I would be a private-banking guy.”
B
ack in 2001, as the Internet boom turned into a bust, M.I.T.’s Quarterly Journal of Economics published an intriguing paper called “Boys Will Be Boys: Gender, Overconfidence, and Common Stock Investment.” The authors, Brad Barber and Terrance Odean, gained access to the trading activity in over 35,000 households, and used it to compare the habits of men and women. What they found, in a nutshell, is that men not only trade more often than women but do so from a false faith in their own financial judgment. Single men traded less sensibly than married men, and married men traded less sensibly than single women: the less the female presence, the less rational the approach to trading in the markets.
One of the distinctive traits about Iceland’s disaster, and Wall Street’s, is how little women had to do with it. Women worked in the banks, but not in the risktaking jobs. As far as I can tell, during Iceland’s boom, there was just one woman in a senior position inside an Icelandic bank. Her name is Kristin Petursdottir, and by 2005 she had risen to become deputy C.E.O. for Kaupthing in London. “The financial culture is very male-dominated,” she says. “The culture is quite extreme. It is a pool of sharks. Women just despise the culture.” Petursdottir still enjoyed finance. She just didn’t like the way Icelandic men did it, and so, in 2006, she quit her job. “People said I was crazy,” she says, but she wanted to create a financial-services business run entirely by women. To bring, as she puts it, “more feminine values to the world of finance.”
Today her firm is, among other things, one of the very few profitable financial businesses left in Iceland. After the stock exchange collapsed, the money flooded in. A few days before we met, for instance, she heard banging on the front door early one morning and opened it to discover a little old man. “I’m so fed up with this whole system,” he said. “I just want some women to take care of my money.”
It was with that in mind that I walked, on my last afternoon in Iceland, into the Saga Museum. Its goal is to glorify the Sagas, the great 12th- and 13th-century Icelandic prose epics, but the effect of its life-size dioramas is more like modern reality TV. Not statues carved from silicon but actual ancient Icelanders, or actors posing as ancient Icelanders, as shrieks and bloodcurdling screams issue from the P.A. system: a Catholic bishop named Jon Arason having his head chopped off; a heretic named Sister Katrin being burned at the stake; a battle scene in which a blood-drenched Viking plunges his sword toward the heart of a prone enemy. The goal was verisimilitude, and to achieve it no expense was spared. Passing one tableau of blood and guts and moving on to the next, I caught myself glancing over my shoulder to make sure some Viking wasn’t following me with a battle-ax. The effect was so disorienting that when I reached the end and found a Japanese woman immobile and reading on a bench, I had to poke her on the shoulder to make sure she was real. This is the past Icelanders supposedly cherish: a history of conflict and heroism. Of seeing who is willing to bump into whom with the most force. There are plenty of women, but this is a men’s history.
When you borrow a lot of money to create a false prosperity, you import the future into the present. It isn’t the actual future so much as some grotesque silicon version of it. Leverage buys you a glimpse of a prosperity you haven’t really earned. The striking thing about the future the Icelandic male briefly imported was how much it resembled the past that he celebrates. I’m betting now they’ve seen their false future the Icelandic female will have a great deal more to say about the actual one.
Author Michael Lewis is a contributor to The New York Times Magazine.
Showing posts with label vanity fair. Show all posts
Showing posts with label vanity fair. Show all posts
1 April 2009
30 January 2009
The Gaza Bombshell ~ Vanity Fair
In the light of the article following, go back and re-examine supposed stupid errors - two wars, refusal to sign-on for preservation of the biosphere, corruption of the monetary system, corruption of the justice system. . . a consistent pattern of destruction of social structures [The US, Iraq, Afghanistan, Columbia] that might have contained and controlled damage.
You will find only the monomania called "Use of Weapons" - bombs, land-mines, missiles, bullets - but not more orderly or open societies.
Lets face it, the Bush years have been characterised by a rush to chaos and endlessly rising entropy.
On to Vanity Fair.
"After failing to anticipate Hamas’s victory over Fatah in the 2006 Palestinian election, the White House cooked up yet another scandalously covert and self-defeating Middle East debacle: part Iran-contra, part Bay of Pigs. With confidential documents, corroborated by outraged former and current U.S. officials, the author reveals how President Bush, Condoleezza Rice, and Deputy National-Security Adviser Elliott Abrams backed an armed force under Fatah strongman Muhammad Dahlan, touching off a bloody civil war in Gaza and leaving Hamas stronger than ever.
The Al Deira Hotel, in Gaza City, is a haven of calm in a land beset by poverty, fear, and violence. In the middle of December 2007, I sit in the hotel’s airy restaurant, its windows open to the Mediterranean, and listen to a slight, bearded man named Mazen Asad abu Dan describe the suffering he endured 11 months before at the hands of his fellow Palestinians. Abu Dan, 28, is a member of Hamas, the Iranian-backed Islamist organization that has been designated a terrorist group by the United States, but I have a good reason for taking him at his word: I’ve seen the video.
To hear an interview with David Rose and to see documents he uncovered, click here.
It shows abu Dan kneeling, his hands bound behind his back, and screaming as his captors pummel him with a black iron rod. “I lost all the skin on my back from the beatings,” he says. “Instead of medicine, they poured perfume on my wounds. It felt as if they had taken a sword to my injuries.”
On January 26, 2007, abu Dan, a student at the Islamic University of Gaza, had gone to a local cemetery with his father and five others to erect a headstone for his grandmother. When they arrived, however, they found themselves surrounded by 30 armed men from Hamas’s rival, Fatah, the party of Palestinian president Mahmoud Abbas. “They took us to a house in north Gaza,” abu Dan says. “They covered our eyes and took us to a room on the sixth floor.”
The video reveals a bare room with white walls and a black-and-white tiled floor, where abu Dan’s father is forced to sit and listen to his son’s shrieks of pain. Afterward, abu Dan says, he and two of the others were driven to a market square. “They told us they were going to kill us. They made us sit on the ground.” He rolls up the legs of his trousers to display the circular scars that are evidence of what happened next: “They shot our knees and feet—five bullets each. I spent four months in a wheelchair.”
Abu Dan had no way of knowing it, but his tormentors had a secret ally: the administration of President George W. Bush.
A clue comes toward the end of the video, which was found in a Fatah security building by Hamas fighters last June. Still bound and blindfolded, the prisoners are made to echo a rhythmic chant yelled by one of their captors: “By blood, by soul, we sacrifice ourselves for Muhammad Dahlan! Long live Muhammad Dahlan!”
There is no one more hated among Hamas members than Muhammad Dahlan, long Fatah’s resident strongman in Gaza. Dahlan, who most recently served as Abbas’s national-security adviser, has spent more than a decade battling Hamas. Dahlan insists that abu Dan was tortured without his knowledge, but the video is proof that his followers’ methods can be brutal.
Bush has met Dahlan on at least three occasions. After talks at the White House in July 2003, Bush publicly praised Dahlan as “a good, solid leader.” In private, say multiple Israeli and American officials, the U.S. president described him as “our guy.”
T
he United States has been involved in the affairs of the Palestinian territories since the Six-Day War of 1967, when Israel captured Gaza from Egypt and the West Bank from Jordan. With the 1993 Oslo accords, the territories acquired limited autonomy, under a president, who has executive powers, and an elected parliament. Israel retains a large military presence in the West Bank, but it withdrew from Gaza in 2005.
In recent months, President Bush has repeatedly stated that the last great ambition of his presidency is to broker a deal that would create a viable Palestinian state and bring peace to the Holy Land. “People say, ‘Do you think it’s possible, during your presidency?’ ” he told an audience in Jerusalem on January 9. “And the answer is: I’m very hopeful.”
The next day, in the West Bank capital of Ramallah, Bush acknowledged that there was a rather large obstacle standing in the way of this goal: Hamas’s complete control of Gaza, home to some 1.5 million Palestinians, where it seized power in a bloody coup d’état in June 2007. Almost every day, militants fire rockets from Gaza into neighboring Israeli towns, and President Abbas is powerless to stop them. His authority is limited to the West Bank.
It’s “a tough situation,” Bush admitted. “I don’t know whether you can solve it in a year or not.” What Bush neglected to mention was his own role in creating this mess.
According to Dahlan, it was Bush who had pushed legislative elections in the Palestinian territories in January 2006, despite warnings that Fatah was not ready. After Hamas—whose 1988 charter committed it to the goal of driving Israel into the sea—won control of the parliament, Bush made another, deadlier miscalculation.
Vanity Fair has obtained confidential documents, since corroborated by sources in the U.S. and Palestine, which lay bare a covert initiative, approved by Bush and implemented by Secretary of State Condoleezza Rice and Deputy National Security Adviser Elliott Abrams, to provoke a Palestinian civil war. The plan was for forces led by Dahlan, and armed with new weapons supplied at America’s behest, to give Fatah the muscle it needed to remove the democratically elected Hamas-led government from power. (The State Department declined to comment.)
But the secret plan backfired, resulting in a further setback for American foreign policy under Bush. Instead of driving its enemies out of power, the U.S.-backed Fatah fighters inadvertently provoked Hamas to seize total control of Gaza.
Some sources call the scheme “Iran-contra 2.0,” recalling that Abrams was convicted (and later pardoned) for withholding information from Congress during the original Iran-contra scandal under President Reagan. There are echoes of other past misadventures as well: the C.I.A.’s 1953 ouster of an elected prime minister in Iran, which set the stage for the 1979 Islamic revolution there; the aborted 1961 Bay of Pigs invasion, which gave Fidel Castro an excuse to solidify his hold on Cuba; and the contemporary tragedy in Iraq.
Within the Bush administration, the Palestinian policy set off a furious debate. One of its critics is David Wurmser, the avowed neoconservative, who resigned as Vice President Dick Cheney’s chief Middle East adviser in July 2007, a month after the Gaza coup.
Wurmser accuses the Bush administration of “engaging in a dirty war in an effort to provide a corrupt dictatorship [led by Abbas] with victory.” He believes that Hamas had no intention of taking Gaza until Fatah forced its hand. “It looks to me that what happened wasn’t so much a coup by Hamas but an attempted coup by Fatah that was pre-empted before it could happen,” Wurmser says.
The botched plan has rendered the dream of Middle East peace more remote than ever, but what really galls neocons such as Wurmser is the hypocrisy it exposed. “There is a stunning disconnect between the president’s call for Middle East democracy and this policy,” he says. “It directly contradicts it.”
Its here
You will find only the monomania called "Use of Weapons" - bombs, land-mines, missiles, bullets - but not more orderly or open societies.
Lets face it, the Bush years have been characterised by a rush to chaos and endlessly rising entropy.
On to Vanity Fair.
"After failing to anticipate Hamas’s victory over Fatah in the 2006 Palestinian election, the White House cooked up yet another scandalously covert and self-defeating Middle East debacle: part Iran-contra, part Bay of Pigs. With confidential documents, corroborated by outraged former and current U.S. officials, the author reveals how President Bush, Condoleezza Rice, and Deputy National-Security Adviser Elliott Abrams backed an armed force under Fatah strongman Muhammad Dahlan, touching off a bloody civil war in Gaza and leaving Hamas stronger than ever.
The Al Deira Hotel, in Gaza City, is a haven of calm in a land beset by poverty, fear, and violence. In the middle of December 2007, I sit in the hotel’s airy restaurant, its windows open to the Mediterranean, and listen to a slight, bearded man named Mazen Asad abu Dan describe the suffering he endured 11 months before at the hands of his fellow Palestinians. Abu Dan, 28, is a member of Hamas, the Iranian-backed Islamist organization that has been designated a terrorist group by the United States, but I have a good reason for taking him at his word: I’ve seen the video.
To hear an interview with David Rose and to see documents he uncovered, click here.
It shows abu Dan kneeling, his hands bound behind his back, and screaming as his captors pummel him with a black iron rod. “I lost all the skin on my back from the beatings,” he says. “Instead of medicine, they poured perfume on my wounds. It felt as if they had taken a sword to my injuries.”
On January 26, 2007, abu Dan, a student at the Islamic University of Gaza, had gone to a local cemetery with his father and five others to erect a headstone for his grandmother. When they arrived, however, they found themselves surrounded by 30 armed men from Hamas’s rival, Fatah, the party of Palestinian president Mahmoud Abbas. “They took us to a house in north Gaza,” abu Dan says. “They covered our eyes and took us to a room on the sixth floor.”
The video reveals a bare room with white walls and a black-and-white tiled floor, where abu Dan’s father is forced to sit and listen to his son’s shrieks of pain. Afterward, abu Dan says, he and two of the others were driven to a market square. “They told us they were going to kill us. They made us sit on the ground.” He rolls up the legs of his trousers to display the circular scars that are evidence of what happened next: “They shot our knees and feet—five bullets each. I spent four months in a wheelchair.”
Abu Dan had no way of knowing it, but his tormentors had a secret ally: the administration of President George W. Bush.
A clue comes toward the end of the video, which was found in a Fatah security building by Hamas fighters last June. Still bound and blindfolded, the prisoners are made to echo a rhythmic chant yelled by one of their captors: “By blood, by soul, we sacrifice ourselves for Muhammad Dahlan! Long live Muhammad Dahlan!”
There is no one more hated among Hamas members than Muhammad Dahlan, long Fatah’s resident strongman in Gaza. Dahlan, who most recently served as Abbas’s national-security adviser, has spent more than a decade battling Hamas. Dahlan insists that abu Dan was tortured without his knowledge, but the video is proof that his followers’ methods can be brutal.
Bush has met Dahlan on at least three occasions. After talks at the White House in July 2003, Bush publicly praised Dahlan as “a good, solid leader.” In private, say multiple Israeli and American officials, the U.S. president described him as “our guy.”
T
he United States has been involved in the affairs of the Palestinian territories since the Six-Day War of 1967, when Israel captured Gaza from Egypt and the West Bank from Jordan. With the 1993 Oslo accords, the territories acquired limited autonomy, under a president, who has executive powers, and an elected parliament. Israel retains a large military presence in the West Bank, but it withdrew from Gaza in 2005.
In recent months, President Bush has repeatedly stated that the last great ambition of his presidency is to broker a deal that would create a viable Palestinian state and bring peace to the Holy Land. “People say, ‘Do you think it’s possible, during your presidency?’ ” he told an audience in Jerusalem on January 9. “And the answer is: I’m very hopeful.”
The next day, in the West Bank capital of Ramallah, Bush acknowledged that there was a rather large obstacle standing in the way of this goal: Hamas’s complete control of Gaza, home to some 1.5 million Palestinians, where it seized power in a bloody coup d’état in June 2007. Almost every day, militants fire rockets from Gaza into neighboring Israeli towns, and President Abbas is powerless to stop them. His authority is limited to the West Bank.
It’s “a tough situation,” Bush admitted. “I don’t know whether you can solve it in a year or not.” What Bush neglected to mention was his own role in creating this mess.
According to Dahlan, it was Bush who had pushed legislative elections in the Palestinian territories in January 2006, despite warnings that Fatah was not ready. After Hamas—whose 1988 charter committed it to the goal of driving Israel into the sea—won control of the parliament, Bush made another, deadlier miscalculation.
Vanity Fair has obtained confidential documents, since corroborated by sources in the U.S. and Palestine, which lay bare a covert initiative, approved by Bush and implemented by Secretary of State Condoleezza Rice and Deputy National Security Adviser Elliott Abrams, to provoke a Palestinian civil war. The plan was for forces led by Dahlan, and armed with new weapons supplied at America’s behest, to give Fatah the muscle it needed to remove the democratically elected Hamas-led government from power. (The State Department declined to comment.)
But the secret plan backfired, resulting in a further setback for American foreign policy under Bush. Instead of driving its enemies out of power, the U.S.-backed Fatah fighters inadvertently provoked Hamas to seize total control of Gaza.
Some sources call the scheme “Iran-contra 2.0,” recalling that Abrams was convicted (and later pardoned) for withholding information from Congress during the original Iran-contra scandal under President Reagan. There are echoes of other past misadventures as well: the C.I.A.’s 1953 ouster of an elected prime minister in Iran, which set the stage for the 1979 Islamic revolution there; the aborted 1961 Bay of Pigs invasion, which gave Fidel Castro an excuse to solidify his hold on Cuba; and the contemporary tragedy in Iraq.
Within the Bush administration, the Palestinian policy set off a furious debate. One of its critics is David Wurmser, the avowed neoconservative, who resigned as Vice President Dick Cheney’s chief Middle East adviser in July 2007, a month after the Gaza coup.
Wurmser accuses the Bush administration of “engaging in a dirty war in an effort to provide a corrupt dictatorship [led by Abbas] with victory.” He believes that Hamas had no intention of taking Gaza until Fatah forced its hand. “It looks to me that what happened wasn’t so much a coup by Hamas but an attempted coup by Fatah that was pre-empted before it could happen,” Wurmser says.
The botched plan has rendered the dream of Middle East peace more remote than ever, but what really galls neocons such as Wurmser is the hypocrisy it exposed. “There is a stunning disconnect between the president’s call for Middle East democracy and this policy,” he says. “It directly contradicts it.”
Its here
11 December 2008
Capitalist Fools
Behind the debate over remaking U.S. financial policy will be a debate over who’s to blame. It’s crucial to get the history right, writes a Nobel-laureate economist, identifying five key mistakes—under Reagan, Clinton, and Bush II—and one national delusion.
by
Joseph E. Stiglitz
January 2009
Treasury Secretary Henry Paulson and former Federal Reserve Board chairman Alan Greenspan bookend two decades of economic missteps. Photo illustration by Darrow.
T
here will come a moment when the most urgent threats posed by the credit crisis have eased and the larger task before us will be to chart a direction for the economic steps ahead. This will be a dangerous moment. Behind the debates over future policy is a debate over history—a debate over the causes of our current situation. The battle for the past will determine the battle for the present. So it’s crucial to get the history straight.
What were the critical decisions that led to the crisis? Mistakes were made at every fork in the road—we had what engineers call a “system failure,” when not a single decision but a cascade of decisions produce a tragic result. Let’s look at five key moments.
No. 1: Firing the Chairman
In 1987 the Reagan administration decided to remove Paul Volcker as chairman of the Federal Reserve Board and appoint Alan Greenspan in his place. Volcker had done what central bankers are supposed to do. On his watch, inflation had been brought down from more than 11 percent to under 4 percent. In the world of central banking, that should have earned him a grade of A+++ and assured his re-appointment. But Volcker also understood that financial markets need to be regulated. Reagan wanted someone who did not believe any such thing, and he found him in a devotee of the objectivist philosopher and free-market zealot Ayn Rand.
Greenspan played a double role. The Fed controls the money spigot, and in the early years of this decade, he turned it on full force. But the Fed is also a regulator. If you appoint an anti-regulator as your enforcer, you know what kind of enforcement you’ll get. A flood of liquidity combined with the failed levees of regulation proved disastrous.
How did we land in a recession? Visit our archive, “Charting the Road to Ruin.” Illustration by Edward Sorel.
Greenspan presided over not one but two financial bubbles. After the high-tech bubble popped, in 2000–2001, he helped inflate the housing bubble. The first responsibility of a central bank should be to maintain the stability of the financial system. If banks lend on the basis of artificially high asset prices, the result can be a meltdown—as we are seeing now, and as Greenspan should have known. He had many of the tools he needed to cope with the situation. To deal with the high-tech bubble, he could have increased margin requirements (the amount of cash people need to put down to buy stock). To deflate the housing bubble, he could have curbed predatory lending to low-income households and prohibited other insidious practices (the no-documentation—or “liar”—loans, the interest-only loans, and so on). This would have gone a long way toward protecting us. If he didn’t have the tools, he could have gone to Congress and asked for them.
Of course, the current problems with our financial system are not solely the result of bad lending. The banks have made mega-bets with one another through complicated instruments such as derivatives, credit-default swaps, and so forth. With these, one party pays another if certain events happen—for instance, if Bear Stearns goes bankrupt, or if the dollar soars. These instruments were originally created to help manage risk—but they can also be used to gamble. Thus, if you felt confident that the dollar was going to fall, you could make a big bet accordingly, and if the dollar indeed fell, your profits would soar. The problem is that, with this complicated intertwining of bets of great magnitude, no one could be sure of the financial position of anyone else—or even of one’s own position. Not surprisingly, the credit markets froze.
Here too Greenspan played a role. When I was chairman of the Council of Economic Advisers, during the Clinton administration, I served on a committee of all the major federal financial regulators, a group that included Greenspan and Treasury Secretary Robert Rubin. Even then, it was clear that derivatives posed a danger. We didn’t put it as memorably as Warren Buffett—who saw derivatives as “financial weapons of mass destruction”—but we took his point. And yet, for all the risk, the deregulators in charge of the financial system—at the Fed, at the Securities and Exchange Commission, and elsewhere—decided to do nothing, worried that any action might interfere with “innovation” in the financial system. But innovation, like “change,” has no inherent value. It can be bad (the “liar” loans are a good example) as well as good.
No. 2: Tearing Down the Walls
The deregulation philosophy would pay unwelcome dividends for years to come. In November 1999, Congress repealed the Glass-Steagall Act—the culmination of a $300 million lobbying effort by the banking and financial-services industries, and spearheaded in Congress by Senator Phil Gramm. Glass-Steagall had long separated commercial banks (which lend money) and investment banks (which organize the sale of bonds and equities); it had been enacted in the aftermath of the Great Depression and was meant to curb the excesses of that era, including grave conflicts of interest. For instance, without separation, if a company whose shares had been issued by an investment bank, with its strong endorsement, got into trouble, wouldn’t its commercial arm, if it had one, feel pressure to lend it money, perhaps unwisely? An ensuing spiral of bad judgment is not hard to foresee. I had opposed repeal of Glass-Steagall. The proponents said, in effect, Trust us: we will create Chinese walls to make sure that the problems of the past do not recur. As an economist, I certainly possessed a healthy degree of trust, trust in the power of economic incentives to bend human behavior toward self-interest—toward short-term self-interest, at any rate, rather than Tocqueville’s “self interest rightly understood.”
The most important consequence of the repeal of Glass-Steagall was indirect—it lay in the way repeal changed an entire culture. Commercial banks are not supposed to be high-risk ventures; they are supposed to manage other people’s money very conservatively. It is with this understanding that the government agrees to pick up the tab should they fail. Investment banks, on the other hand, have traditionally managed rich people’s money—people who can take bigger risks in order to get bigger returns. When repeal of Glass-Steagall brought investment and commercial banks together, the investment-bank culture came out on top. There was a demand for the kind of high returns that could be obtained only through high leverage and big risktaking.
There were other important steps down the deregulatory path. One was the decision in April 2004 by the Securities and Exchange Commission, at a meeting attended by virtually no one and largely overlooked at the time, to allow big investment banks to increase their debt-to-capital ratio (from 12:1 to 30:1, or higher) so that they could buy more mortgage-backed securities, inflating the housing bubble in the process. In agreeing to this measure, the S.E.C. argued for the virtues of self-regulation: the peculiar notion that banks can effectively police themselves. Self-regulation is preposterous, as even Alan Greenspan now concedes, and as a practical matter it can’t, in any case, identify systemic risks—the kinds of risks that arise when, for instance, the models used by each of the banks to manage their portfolios tell all the banks to sell some security all at once.
As we stripped back the old regulations, we did nothing to address the new challenges posed by 21st-century markets. The most important challenge was that posed by derivatives. In 1998 the head of the Commodity Futures Trading Commission, Brooksley Born, had called for such regulation—a concern that took on urgency after the Fed, in that same year, engineered the bailout of Long-Term Capital Management, a hedge fund whose trillion-dollar-plus failure threatened global financial markets. But Secretary of the Treasury Robert Rubin, his deputy, Larry Summers, and Greenspan were adamant—and successful—in their opposition. Nothing was done.
No. 3: Applying the Leeches
Then along came the Bush tax cuts, enacted first on June 7, 2001, with a follow-on installment two years later. The president and his advisers seemed to believe that tax cuts, especially for upper-income Americans and corporations, were a cure-all for any economic disease—the modern-day equivalent of leeches. The tax cuts played a pivotal role in shaping the background conditions of the current crisis. Because they did very little to stimulate the economy, real stimulation was left to the Fed, which took up the task with unprecedented low-interest rates and liquidity. The war in Iraq made matters worse, because it led to soaring oil prices. With America so dependent on oil imports, we had to spend several hundred billion more to purchase oil—money that otherwise would have been spent on American goods. Normally this would have led to an economic slowdown, as it had in the 1970s. But the Fed met the challenge in the most myopic way imaginable. The flood of liquidity made money readily available in mortgage markets, even to those who would normally not be able to borrow. And, yes, this succeeded in forestalling an economic downturn; America’s household saving rate plummeted to zero. But it should have been clear that we were living on borrowed money and borrowed time.
The cut in the tax rate on capital gains contributed to the crisis in another way. It was a decision that turned on values: those who speculated (read: gambled) and won were taxed more lightly than wage earners who simply worked hard. But more than that, the decision encouraged leveraging, because interest was tax-deductible. If, for instance, you borrowed a million to buy a home or took a $100,000 home-equity loan to buy stock, the interest would be fully deductible every year. Any capital gains you made were taxed lightly—and at some possibly remote day in the future. The Bush administration was providing an open invitation to excessive borrowing and lending—not that American consumers needed any more encouragement.
No. 4: Faking the Numbers
Meanwhile, on July 30, 2002, in the wake of a series of major scandals—notably the collapse of WorldCom and Enron—Congress passed the Sarbanes-Oxley Act. The scandals had involved every major American accounting firm, most of our banks, and some of our premier companies, and made it clear that we had serious problems with our accounting system. Accounting is a sleep-inducing topic for most people, but if you can’t have faith in a company’s numbers, then you can’t have faith in anything about a company at all. Unfortunately, in the negotiations over what became Sarbanes-Oxley a decision was made not to deal with what many, including the respected former head of the S.E.C. Arthur Levitt, believed to be a fundamental underlying problem: stock options. Stock options have been defended as providing healthy incentives toward good management, but in fact they are “incentive pay” in name only. If a company does well, the C.E.O. gets great rewards in the form of stock options; if a company does poorly, the compensation is almost as substantial but is bestowed in other ways. This is bad enough. But a collateral problem with stock options is that they provide incentives for bad accounting: top management has every incentive to provide distorted information in order to pump up share prices.
The incentive structure of the rating agencies also proved perverse. Agencies such as Moody’s and Standard & Poor’s are paid by the very people they are supposed to grade. As a result, they’ve had every reason to give companies high ratings, in a financial version of what college professors know as grade inflation. The rating agencies, like the investment banks that were paying them, believed in financial alchemy—that F-rated toxic mortgages could be converted into products that were safe enough to be held by commercial banks and pension funds. We had seen this same failure of the rating agencies during the East Asia crisis of the 1990s: high ratings facilitated a rush of money into the region, and then a sudden reversal in the ratings brought devastation. But the financial overseers paid no attention.
No. 5: Letting It Bleed
The final turning point came with the passage of a bailout package on October 3, 2008—that is, with the administration’s response to the crisis itself. We will be feeling the consequences for years to come. Both the administration and the Fed had long been driven by wishful thinking, hoping that the bad news was just a blip, and that a return to growth was just around the corner. As America’s banks faced collapse, the administration veered from one course of action to another. Some institutions (Bear Stearns, A.I.G., Fannie Mae, Freddie Mac) were bailed out. Lehman Brothers was not. Some shareholders got something back. Others did not.
The original proposal by Treasury Secretary Henry Paulson, a three-page document that would have provided $700 billion for the secretary to spend at his sole discretion, without oversight or judicial review, was an act of extraordinary arrogance. He sold the program as necessary to restore confidence. But it didn’t address the underlying reasons for the loss of confidence. The banks had made too many bad loans. There were big holes in their balance sheets. No one knew what was truth and what was fiction. The bailout package was like a massive transfusion to a patient suffering from internal bleeding—and nothing was being done about the source of the problem, namely all those foreclosures. Valuable time was wasted as Paulson pushed his own plan, “cash for trash,” buying up the bad assets and putting the risk onto American taxpayers. When he finally abandoned it, providing banks with money they needed, he did it in a way that not only cheated America’s taxpayers but failed to ensure that the banks would use the money to re-start lending. He even allowed the banks to pour out money to their shareholders as taxpayers were pouring money into the banks.
The other problem not addressed involved the looming weaknesses in the economy. The economy had been sustained by excessive borrowing. That game was up. As consumption contracted, exports kept the economy going, but with the dollar strengthening and Europe and the rest of the world declining, it was hard to see how that could continue. Meanwhile, states faced massive drop-offs in revenues—they would have to cut back on expenditures. Without quick action by government, the economy faced a downturn. And even if banks had lent wisely—which they hadn’t—the downturn was sure to mean an increase in bad debts, further weakening the struggling financial sector.
The administration talked about confidence building, but what it delivered was actually a confidence trick. If the administration had really wanted to restore confidence in the financial system, it would have begun by addressing the underlying problems—the flawed incentive structures and the inadequate regulatory system.
W
as there any single decision which, had it been reversed, would have changed the course of history? Every decision—including decisions not to do something, as many of our bad economic decisions have been—is a consequence of prior decisions, an interlinked web stretching from the distant past into the future. You’ll hear some on the right point to certain actions by the government itself—such as the Community Reinvestment Act, which requires banks to make mortgage money available in low-income neighborhoods. (Defaults on C.R.A. lending were actually much lower than on other lending.) There has been much finger-pointing at Fannie Mae and Freddie Mac, the two huge mortgage lenders, which were originally government-owned. But in fact they came late to the subprime game, and their problem was similar to that of the private sector: their C.E.O.’s had the same perverse incentive to indulge in gambling.
The truth is most of the individual mistakes boil down to just one: a belief that markets are self-adjusting and that the role of government should be minimal. Looking back at that belief during hearings this fall on Capitol Hill, Alan Greenspan said out loud, “I have found a flaw.” Congressman Henry Waxman pushed him, responding, “In other words, you found that your view of the world, your ideology, was not right; it was not working.” “Absolutely, precisely,” Greenspan said. The embrace by America—and much of the rest of the world—of this flawed economic philosophy made it inevitable that we would eventually arrive at the place we are today.
by
Joseph E. Stiglitz
January 2009
Treasury Secretary Henry Paulson and former Federal Reserve Board chairman Alan Greenspan bookend two decades of economic missteps. Photo illustration by Darrow.
T
here will come a moment when the most urgent threats posed by the credit crisis have eased and the larger task before us will be to chart a direction for the economic steps ahead. This will be a dangerous moment. Behind the debates over future policy is a debate over history—a debate over the causes of our current situation. The battle for the past will determine the battle for the present. So it’s crucial to get the history straight.
What were the critical decisions that led to the crisis? Mistakes were made at every fork in the road—we had what engineers call a “system failure,” when not a single decision but a cascade of decisions produce a tragic result. Let’s look at five key moments.
No. 1: Firing the Chairman
In 1987 the Reagan administration decided to remove Paul Volcker as chairman of the Federal Reserve Board and appoint Alan Greenspan in his place. Volcker had done what central bankers are supposed to do. On his watch, inflation had been brought down from more than 11 percent to under 4 percent. In the world of central banking, that should have earned him a grade of A+++ and assured his re-appointment. But Volcker also understood that financial markets need to be regulated. Reagan wanted someone who did not believe any such thing, and he found him in a devotee of the objectivist philosopher and free-market zealot Ayn Rand.
Greenspan played a double role. The Fed controls the money spigot, and in the early years of this decade, he turned it on full force. But the Fed is also a regulator. If you appoint an anti-regulator as your enforcer, you know what kind of enforcement you’ll get. A flood of liquidity combined with the failed levees of regulation proved disastrous.
How did we land in a recession? Visit our archive, “Charting the Road to Ruin.” Illustration by Edward Sorel.
Greenspan presided over not one but two financial bubbles. After the high-tech bubble popped, in 2000–2001, he helped inflate the housing bubble. The first responsibility of a central bank should be to maintain the stability of the financial system. If banks lend on the basis of artificially high asset prices, the result can be a meltdown—as we are seeing now, and as Greenspan should have known. He had many of the tools he needed to cope with the situation. To deal with the high-tech bubble, he could have increased margin requirements (the amount of cash people need to put down to buy stock). To deflate the housing bubble, he could have curbed predatory lending to low-income households and prohibited other insidious practices (the no-documentation—or “liar”—loans, the interest-only loans, and so on). This would have gone a long way toward protecting us. If he didn’t have the tools, he could have gone to Congress and asked for them.
Of course, the current problems with our financial system are not solely the result of bad lending. The banks have made mega-bets with one another through complicated instruments such as derivatives, credit-default swaps, and so forth. With these, one party pays another if certain events happen—for instance, if Bear Stearns goes bankrupt, or if the dollar soars. These instruments were originally created to help manage risk—but they can also be used to gamble. Thus, if you felt confident that the dollar was going to fall, you could make a big bet accordingly, and if the dollar indeed fell, your profits would soar. The problem is that, with this complicated intertwining of bets of great magnitude, no one could be sure of the financial position of anyone else—or even of one’s own position. Not surprisingly, the credit markets froze.
Here too Greenspan played a role. When I was chairman of the Council of Economic Advisers, during the Clinton administration, I served on a committee of all the major federal financial regulators, a group that included Greenspan and Treasury Secretary Robert Rubin. Even then, it was clear that derivatives posed a danger. We didn’t put it as memorably as Warren Buffett—who saw derivatives as “financial weapons of mass destruction”—but we took his point. And yet, for all the risk, the deregulators in charge of the financial system—at the Fed, at the Securities and Exchange Commission, and elsewhere—decided to do nothing, worried that any action might interfere with “innovation” in the financial system. But innovation, like “change,” has no inherent value. It can be bad (the “liar” loans are a good example) as well as good.
No. 2: Tearing Down the Walls
The deregulation philosophy would pay unwelcome dividends for years to come. In November 1999, Congress repealed the Glass-Steagall Act—the culmination of a $300 million lobbying effort by the banking and financial-services industries, and spearheaded in Congress by Senator Phil Gramm. Glass-Steagall had long separated commercial banks (which lend money) and investment banks (which organize the sale of bonds and equities); it had been enacted in the aftermath of the Great Depression and was meant to curb the excesses of that era, including grave conflicts of interest. For instance, without separation, if a company whose shares had been issued by an investment bank, with its strong endorsement, got into trouble, wouldn’t its commercial arm, if it had one, feel pressure to lend it money, perhaps unwisely? An ensuing spiral of bad judgment is not hard to foresee. I had opposed repeal of Glass-Steagall. The proponents said, in effect, Trust us: we will create Chinese walls to make sure that the problems of the past do not recur. As an economist, I certainly possessed a healthy degree of trust, trust in the power of economic incentives to bend human behavior toward self-interest—toward short-term self-interest, at any rate, rather than Tocqueville’s “self interest rightly understood.”
The most important consequence of the repeal of Glass-Steagall was indirect—it lay in the way repeal changed an entire culture. Commercial banks are not supposed to be high-risk ventures; they are supposed to manage other people’s money very conservatively. It is with this understanding that the government agrees to pick up the tab should they fail. Investment banks, on the other hand, have traditionally managed rich people’s money—people who can take bigger risks in order to get bigger returns. When repeal of Glass-Steagall brought investment and commercial banks together, the investment-bank culture came out on top. There was a demand for the kind of high returns that could be obtained only through high leverage and big risktaking.
There were other important steps down the deregulatory path. One was the decision in April 2004 by the Securities and Exchange Commission, at a meeting attended by virtually no one and largely overlooked at the time, to allow big investment banks to increase their debt-to-capital ratio (from 12:1 to 30:1, or higher) so that they could buy more mortgage-backed securities, inflating the housing bubble in the process. In agreeing to this measure, the S.E.C. argued for the virtues of self-regulation: the peculiar notion that banks can effectively police themselves. Self-regulation is preposterous, as even Alan Greenspan now concedes, and as a practical matter it can’t, in any case, identify systemic risks—the kinds of risks that arise when, for instance, the models used by each of the banks to manage their portfolios tell all the banks to sell some security all at once.
As we stripped back the old regulations, we did nothing to address the new challenges posed by 21st-century markets. The most important challenge was that posed by derivatives. In 1998 the head of the Commodity Futures Trading Commission, Brooksley Born, had called for such regulation—a concern that took on urgency after the Fed, in that same year, engineered the bailout of Long-Term Capital Management, a hedge fund whose trillion-dollar-plus failure threatened global financial markets. But Secretary of the Treasury Robert Rubin, his deputy, Larry Summers, and Greenspan were adamant—and successful—in their opposition. Nothing was done.
No. 3: Applying the Leeches
Then along came the Bush tax cuts, enacted first on June 7, 2001, with a follow-on installment two years later. The president and his advisers seemed to believe that tax cuts, especially for upper-income Americans and corporations, were a cure-all for any economic disease—the modern-day equivalent of leeches. The tax cuts played a pivotal role in shaping the background conditions of the current crisis. Because they did very little to stimulate the economy, real stimulation was left to the Fed, which took up the task with unprecedented low-interest rates and liquidity. The war in Iraq made matters worse, because it led to soaring oil prices. With America so dependent on oil imports, we had to spend several hundred billion more to purchase oil—money that otherwise would have been spent on American goods. Normally this would have led to an economic slowdown, as it had in the 1970s. But the Fed met the challenge in the most myopic way imaginable. The flood of liquidity made money readily available in mortgage markets, even to those who would normally not be able to borrow. And, yes, this succeeded in forestalling an economic downturn; America’s household saving rate plummeted to zero. But it should have been clear that we were living on borrowed money and borrowed time.
The cut in the tax rate on capital gains contributed to the crisis in another way. It was a decision that turned on values: those who speculated (read: gambled) and won were taxed more lightly than wage earners who simply worked hard. But more than that, the decision encouraged leveraging, because interest was tax-deductible. If, for instance, you borrowed a million to buy a home or took a $100,000 home-equity loan to buy stock, the interest would be fully deductible every year. Any capital gains you made were taxed lightly—and at some possibly remote day in the future. The Bush administration was providing an open invitation to excessive borrowing and lending—not that American consumers needed any more encouragement.
No. 4: Faking the Numbers
Meanwhile, on July 30, 2002, in the wake of a series of major scandals—notably the collapse of WorldCom and Enron—Congress passed the Sarbanes-Oxley Act. The scandals had involved every major American accounting firm, most of our banks, and some of our premier companies, and made it clear that we had serious problems with our accounting system. Accounting is a sleep-inducing topic for most people, but if you can’t have faith in a company’s numbers, then you can’t have faith in anything about a company at all. Unfortunately, in the negotiations over what became Sarbanes-Oxley a decision was made not to deal with what many, including the respected former head of the S.E.C. Arthur Levitt, believed to be a fundamental underlying problem: stock options. Stock options have been defended as providing healthy incentives toward good management, but in fact they are “incentive pay” in name only. If a company does well, the C.E.O. gets great rewards in the form of stock options; if a company does poorly, the compensation is almost as substantial but is bestowed in other ways. This is bad enough. But a collateral problem with stock options is that they provide incentives for bad accounting: top management has every incentive to provide distorted information in order to pump up share prices.
The incentive structure of the rating agencies also proved perverse. Agencies such as Moody’s and Standard & Poor’s are paid by the very people they are supposed to grade. As a result, they’ve had every reason to give companies high ratings, in a financial version of what college professors know as grade inflation. The rating agencies, like the investment banks that were paying them, believed in financial alchemy—that F-rated toxic mortgages could be converted into products that were safe enough to be held by commercial banks and pension funds. We had seen this same failure of the rating agencies during the East Asia crisis of the 1990s: high ratings facilitated a rush of money into the region, and then a sudden reversal in the ratings brought devastation. But the financial overseers paid no attention.
No. 5: Letting It Bleed
The final turning point came with the passage of a bailout package on October 3, 2008—that is, with the administration’s response to the crisis itself. We will be feeling the consequences for years to come. Both the administration and the Fed had long been driven by wishful thinking, hoping that the bad news was just a blip, and that a return to growth was just around the corner. As America’s banks faced collapse, the administration veered from one course of action to another. Some institutions (Bear Stearns, A.I.G., Fannie Mae, Freddie Mac) were bailed out. Lehman Brothers was not. Some shareholders got something back. Others did not.
The original proposal by Treasury Secretary Henry Paulson, a three-page document that would have provided $700 billion for the secretary to spend at his sole discretion, without oversight or judicial review, was an act of extraordinary arrogance. He sold the program as necessary to restore confidence. But it didn’t address the underlying reasons for the loss of confidence. The banks had made too many bad loans. There were big holes in their balance sheets. No one knew what was truth and what was fiction. The bailout package was like a massive transfusion to a patient suffering from internal bleeding—and nothing was being done about the source of the problem, namely all those foreclosures. Valuable time was wasted as Paulson pushed his own plan, “cash for trash,” buying up the bad assets and putting the risk onto American taxpayers. When he finally abandoned it, providing banks with money they needed, he did it in a way that not only cheated America’s taxpayers but failed to ensure that the banks would use the money to re-start lending. He even allowed the banks to pour out money to their shareholders as taxpayers were pouring money into the banks.
The other problem not addressed involved the looming weaknesses in the economy. The economy had been sustained by excessive borrowing. That game was up. As consumption contracted, exports kept the economy going, but with the dollar strengthening and Europe and the rest of the world declining, it was hard to see how that could continue. Meanwhile, states faced massive drop-offs in revenues—they would have to cut back on expenditures. Without quick action by government, the economy faced a downturn. And even if banks had lent wisely—which they hadn’t—the downturn was sure to mean an increase in bad debts, further weakening the struggling financial sector.
The administration talked about confidence building, but what it delivered was actually a confidence trick. If the administration had really wanted to restore confidence in the financial system, it would have begun by addressing the underlying problems—the flawed incentive structures and the inadequate regulatory system.
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as there any single decision which, had it been reversed, would have changed the course of history? Every decision—including decisions not to do something, as many of our bad economic decisions have been—is a consequence of prior decisions, an interlinked web stretching from the distant past into the future. You’ll hear some on the right point to certain actions by the government itself—such as the Community Reinvestment Act, which requires banks to make mortgage money available in low-income neighborhoods. (Defaults on C.R.A. lending were actually much lower than on other lending.) There has been much finger-pointing at Fannie Mae and Freddie Mac, the two huge mortgage lenders, which were originally government-owned. But in fact they came late to the subprime game, and their problem was similar to that of the private sector: their C.E.O.’s had the same perverse incentive to indulge in gambling.
The truth is most of the individual mistakes boil down to just one: a belief that markets are self-adjusting and that the role of government should be minimal. Looking back at that belief during hearings this fall on Capitol Hill, Alan Greenspan said out loud, “I have found a flaw.” Congressman Henry Waxman pushed him, responding, “In other words, you found that your view of the world, your ideology, was not right; it was not working.” “Absolutely, precisely,” Greenspan said. The embrace by America—and much of the rest of the world—of this flawed economic philosophy made it inevitable that we would eventually arrive at the place we are today.
9 December 2008
Vanity Fair sees broke rich people ~ Profiles in Panic
Profiles in Panic
With Wall Street hemorrhaging jobs and assets, even many of the wealthiest players are retrenching. Others, like the Lehman Brothers bankers who borrowed against their millions in stock, have lost everything. Hedge-fund managers try to sell their luxury homes, while trophy wives are hocking their jewelry. The pain is being felt on St. Barth’s and at Sotheby’s, on benefit-gala committees and at the East Hampton Airport, as the world of the Big Rich collapses, its culture in shock and its values in question.
by
Michael Shnayerson
January 2009
A snapshot: East Hampton, late summer, a lawn party at a house on the ocean overlooking the dunes. The host is a prince of private equity known for dressing well. One of his guests is Steven Cohen, the publicity-shy billionaire whose SAC Capital, with $16 billion under management, is perhaps the most revered of the 10,000 or so hedge funds spawned by this giddily rich time. Nearby is Daniel Loeb, of Third Point, one of the better-known “activist” hedge funds, who hopes to move soon into a 10,700-square-foot, $45 million penthouse at l5 Central Park West, a Manhattan monument to the new gilded age. Gliding easily between them is art dealer Larry Gagosian, so successful at selling Bacons and Serras to Wall Street’s new titans—including to Cohen—that he now travels in his own private jet and has his own helicopter to take him to it.
How did we land in a recession? Visit our archive, “Charting the Road to Ruin.” Illustration by Edward Sorel.
But here’s the odd thing: despite the beauty of the ocean view, nearly all the guests have their backs to it. Cohen is deep in conversation with a colleague who seems to be pitching him a deal. Loeb hovers close to his wife, a former yoga teacher. Gagosian is near his stunning young girlfriend. No one notices the clouds that are, quite literally, on the horizon. Snap.
Six weeks later, the photograph is cracked and sepia-toned, curling at the edges, a historic print. In just that short time, the storm has hit and nothing looks the same.
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t may be premature to say our gilded age has ended. Third Point dropped 10 percent in October, bringing it down 27 percent for the year, but Daniel Loeb is still moving into his extravagant new apartment. Steven Cohen’s SAC was down 11 percent in October and 18 percent for the year to date, but that still leaves him plenty of money to add a second ice-skating rink to his Greenwich, Connecticut, estate. And Larry Gagosian is still selling plenty of art.
What’s definitely gone—along with Lehman Brothers and Bear Stearns—is leverage, at least to the dizzying degree it was recently used by Wall Street’s investment banks, hedge funds, and private-equity firms to parlay each dollar of their assets into $10, $20, even $30 or more of credit to make gargantuan deals and profits. The credit crunch has made such leverage as quaint as the market in Dutch tulips. Without it, Wall Street salaries have already started drifting gently back to earth like so many limp balloons.
Gone, too, are jobs—lots and lots of them. Along with a sizable portion of Lehman’s 26,000 worldwide, and Bear Stearns’s 14,000, Wall Street firms across the board—even Goldman Sachs—are cutting back, and that pain radiates out to the limousine drivers and caterers and lawyers and personal trainers and restaurant owners and real-estate brokers who rely on Wall Street clients, not to mention to the many nonprofits and charities that have grown accustomed to Wall Street money. The latest estimate of jobs New York will lose, both on and off Wall Street, is l60,000. Governor David Paterson says the state’s budget deficit has already reached $12.5 billion. In New York City, where Wall Street accounts for more than a quarter of the tax revenues, Mayor Michael Bloomberg thinks the financial-sector crisis will leave a $2 billion hole in the next fiscal year’s budget.
Almost everyone has lost something—if not their jobs, then 25 to 50 percent of their retirement savings—and nearly everyone is glum, anxious, hung over. Prudence is the watchword now: sackcloth after the brilliant silks and brocades of the gilded age. The day after Lehman Brothers went down, a high-end Manhattan department store reportedly had the biggest day of returns in its history. “Because the wives didn’t want the husbands to get the credit-card bills,” says a fashion-world insider. A prominent designer says ruefully, “People really aren’t shopping at all unless there’s a deal or sale. It’s pretty dramatic—they have the stores at their mercy.”
Even those who have plenty left to spend aren’t spending it. “I ran into a couple I always see at the antiques show,” one Upper East Side woman recounts of her visit to the Armory show on Park Avenue. “They always buy something fairly grand. ‘What have you bought this time?’ I asked. ‘Oh, nothing!’ they said. ‘We’d feel … ashamed.’” Another Upper East Side woman often goes from lunch at Michael’s restaurant on West 55th Street to Manolo Blahnik a block away to pick up a $600 or $700 pair of shoes as “retail therapy.” No more. “I was at Michael’s yesterday and was thinking, Oh, Manolo’s … But then I thought, Why? Why do that? It just doesn’t feel good.”
A Penny Saved
Only months ago, ordering that $1,950 bottle of 2003 Screaming Eagle Cabernet Sauvignon at Craft restaurant or the $26-per-ounce Wagyu beef at Nobu, or sliding into Masa for the $600 prix fixe dinner (not including tax, tip, or drinks), was a way of life for many Wall Street investment bankers. “The culture was that if you didn’t spend extravagantly you’d be ridiculed at work,” says a former Lehmanite. But that was when there were investment banks. Now many bankers, along with discovering $15 bottles of wine, are finding other ways to cut back—if not out of necessity, then from collective guilt and fear: the fitness trainer from three times a week to once a week; the haircut and highlights every eight weeks instead of every five. One prominent “hedgie” recently flew to China for business—but not on a private plane, as before. “Why should I pay $250,000 for a private plane,” he said to a friend, “when I can pay $20,000 to fly commercial first class?”
The new thriftiness takes a bit of getting used to. “I was at the Food Emporium in Bedford [in Westchester County] yesterday, using my Food Emporium discount card,” recounts one Greenwich woman. “The well-dressed wife of a Wall Street guy was standing behind me. She asked me how to get one. Then she said, ‘Have you ever used coupons?’ I said, ‘Sure, maybe not lately, but sure.’ She said, ‘It’s all the rage now—where do you get them?’”
One former Lehman executive in her 40s stood in her vast clothes closet not long ago, talking to her personal stylist. On shelves around her were at least 10 designer handbags that had cost her anywhere from $6,000 to $10,000 each.
“I don’t know what to do,” she said. “I guess I’ll have to get rid of the maid.”
Why not sell a few of those bags?, the stylist thought, but didn’t say so.
“Well,” the executive said after a moment, “I guess I’ll cut her from five days a week to four.”
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here were, to be sure, some big-name “blowups” as the market began to implode. Here was Sumner Redstone, chairman of Viacom and CBS, who had to sell $233 million worth of Viacom and CBS stock in order to pay down part of an $800 million loan. T. Boone Pickens, legendary Texas oilman, was another blowup, and so was Chesapeake Energy’s Aubrey McClendon, forced by a margin call to sell 94 percent of his 32 million company shares into the bear market. (Worth $2.2 billion last July, the shares were sold in October for $569 million.) Kirk Kerkorian, 91, has lost about $12 billion on his 54 percent ownership stake in MGM Mirage, the casino and hotel operator that owns almost half the hotel rooms on the Las Vegas Strip, including those in the Bellagio, the MGM Grand, the Mirage, and Mandalay Bay. The company’s stock is down 86 percent this year, and its bonds were downgraded deeper into junk status in October. Kerkorian has reportedly told friends that he “lived one year too long.” (He now claims he never said it.) Nevertheless, he and the other three men are all still billionaires.
These were the stories known because they involved large chunks of publicly traded stock. But as October turned into one of the worst market months since October l929, rumors ran rampant about which high-flying hedge funds would crash as they tried in vain to unwind their investments in derivatives and other unregulated securities, many of them entwined with subprime mortgages. With their lenders forcing them to sell assets at new lows, and their investors trying to pull their money out, the hedge funds were caught in the middle: the gilded age’s biggest winners were now among its biggest losers. Would Ken Griffin’s Citadel be the first big hedge fund to go? Or Fortress—whose clients are trying to redeem $4.5 billion? In fact, the first big tree down following that dreadful month was Tontine Associates, which managed $11 billion through its four hedge funds and whose activist founder, Jeffrey Gendell, had become a billionaire by generating more than 100 percent returns in 2003 and 2005. After two of his funds had lost two-thirds of their value, Gendell bowed to the inevitable and is expected to close them. Days later came word that Steven Rattner was closing his small but high-profile media hedge fund, Quadrangle Equity Investors, after approximately 25 percent year-to-date losses.
Of those 10,000 hedge funds, as many as half may join the casualty list in the next few years. Not that many hedge-fund managers, though, will be reduced to selling apples. Take Remy Trafelet, 38, a handsome, smooth-faced preppy whose fund faces steep year-end losses and dwindling capital—from $6 billion to $3 billion—as investors depart. In a good year, such as 2005, when Trafelet racked up 42 percent returns, he and his partners pocketed hundreds of millions of dollars.
Still, he may have to trim his lifestyle a bit.
Sandcastles in the Sky
Tellingly, no fewer than 50 high-end New York apartments have been put on the market since late September, most by Wall Streeters. Usually, the fall listings for apartments between $10 and $20 million are all teed up by Labor Day. Not this year, as The New York Times’s Josh Barbanel notes. At the Majestic, on Central Park West, two Wall Streeters listed their three-bedroom units within hours of each other. Robert Long, a managing director of hard-hit Allied Capital, listed 8C for $13.8 million as “the most magnificently renovated grand apartment to become available on Central Park West in years.” James Kern, a former senior managing director of Bear Stearns, listed 17D—the “ultimate renovation”—for $12 million.
Ten blocks away, at the Park Laurel tower, on 63rd Street, Charles Michaels, of the hedge fund Sierra Global Management, listed his 2,800-square-foot, four-bedroom apartment with terrace for $l4.9 million. In early October, Steven F. Stuart, of the Garrison Investment hedge fund, listed the apartment directly above Michaels’s—no terrace—for $10.8 million. Ten days later, real-estate developer Ira Resnick put his own, similar apartment at the Park Laurel up for sale—for $10 million.
Nowhere is the downturn more dramatic, though, than downtown, where new condominium towers by cutting-edge architects vie for a market that’s almost vanished overnight: young Wall Streeters with bonuses to throw at sleek, overpriced apartments in Richard Meier–knockoff buildings. For the developers, it’s proved a game of high-stakes musical chairs. Those who got their buildings up by early 2007 have sold many of their units by now. Those who started selling after Bear Stearns’s collapse, last March, are struggling, as the Web site StreetEasy confirms. And for those just getting started, good luck.
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n the financial district itself, hotel impresario André Balazs embarked on the 47-story William Beaver House in 2006. StreetEasy’s Sofia Kim suggests the name was meant—or at least interpreted—as a naughty wink to hard-partying bachelor traders. With the Tsao & McKown–designed building due to open this month, 209 of its 320 mostly one- and two-bedroom units have sold at top-of-the-market prices—from $900,000 to $6 million. But the rest are either for sale or being held in reserve. That’s a lot of unsold units.
Still, Balazs has done better with the Beaver House than Kent Swig has with his condominium tower at 25 Broad Street, designed by Cetra/Ruddy. Swig closed its sales office until further notice, citing liquidity problems due to Lehman Brothers’ demise. At One York Street, the soaring glass tower designed by Enrique Norten overlooking busy Canal Street, developer Stan Perelman says 28 of his 40 units have closed, though he admits that his 6,096-square-foot penthouse, with an asking price of $34 million, has yet to find a taker. The raw space, entirely glass-walled, is both exhilarating and somewhat vertiginous; as for the small ventilation windows at ankle height, they’re probably not a good idea for an owner with cats. “When the hardwood floors are in, the slabs, the home theater—press a remote and all the shades go up automatically and the music begins—someone will say, ‘Where do I sign?,’” Perelman suggests. Next month, that is, or the month or the year after …
River views—and the cachet of a world-class architect—do help. The Superior Ink building, a former factory on West 12th Street overlooking the Hudson, was given a Robert A. M. Stern makeover, and most of its 68 apartments and seven adjoining town houses have sold. So, then, how about partial river views and a famous artist, just one block away?
On West 11th Street, painter and filmmaker Julian Schnabel has lived for years in a wide former stable he calls Palazzo Chupi. In keeping with the gilded age, he added nine lavish floors of his own design. Richard Gere bought the fourth floor, but now it’s back on the market. A “private individual” took the fifth, and Schnabel himself lives on the sixth and seventh. Still for sale above are a duplex and a triplex penthouse.
From across the street, the addition’s dusty-rose stucco and Italianate arches look striking enough. Inside, Palazzo Chupi is nothing less than a brilliant artist’s interpretation of a gilded age—only not this one. More like the Italian Renaissance.
A bronze-domed elevator with Italian-tile floor opens into the penthouse’s furnished living room, with nearly 15-foot ceilings of hand-hewn wood beams, a colorful Venetian-glass chandelier, and a massive, 8-foot-high fireplace. Giant Schnabel canvases fill the walls. They aren’t included in the $24 million price, but as Corcoran broker James Lansill puts it, “You could try … ” Schnabel is, he says, a seller. In fact, the triplex started at $32 million—before the market meltdown.
The triplex has 3,713 square feet of interior space, but also 2,304 square feet of balconies and terraces (seven in all). It has arched windows throughout, baronial bathrooms with vintage fixtures, and the most romantic master bedroom in New York. The interior of the duplex is even larger, and features a living room—25 feet by 41.6 feet—with wood-beamed ceilings nearly 20 feet high. Only three terraces, though, hence the bargain price of $23 million. Among its many splendors is a huge square bathroom with a sunken tub in the middle, a fireplace, and French doors that open out through red velvet drapes to an Italian-tiled balcony. “His idea is for you to be able to sit in the bath with a roaring fire, the doors wide open, and snow on the balcony,” Lansill says.
Either of Schnabel’s gilded-age fantasies is well worth the price for anyone with $20 to $30 million to spare. The question is: Does anyone have $20 to $30 million to spare on a gilded-age fantasy these days? Perhaps. In the black-and-white-tiled lobby, as Lansill leads the way out, a trim, elegantly dressed Russian fellow with blond hair and wraparound sunglasses sweeps in. “I have an appointment,” he says to the guard in a thick Russian accent, “with Mr. Schnabel.”
Going, Going, Gone
Fall’s auctions, in both London and New York, have tracked the deepening gloom as surely as real estate and stocks have. Literally on the heels of Lehman’s bankruptcy, in mid-September, Damien Hirst held a two-day sale of animals in formaldehyde and other nature-based art at Sotheby’s in London and raised $200 million, apparently from Russian, Middle Eastern, and Asian buyers for the most part, thus panicking the private-art-dealer world, which he’d circumvented by using the auction house. For perfect end-of-an-age timing, his “Beautiful Inside My Head Forever” auction ranked right up there with Blackstone’s June 2007 I.P.O., at private equity’s high-water mark. Then came the sickening slide in the stock market. By early November London’s Evening Standard was reporting rumors that some buyers had reneged on their bids and that a lot that had purportedly sold was being offered to a collector. (A Sotheby’s spokesman denied the rumors.)
By mid-November, Sotheby’s was reporting a $52 million loss in guarantees from the season’s first auctions—sums the auction house had guaranteed sellers before the market meltdown and had to make good on when their art fetched prices below those figures. That included the $40-million-plus guarantee reportedly promised to private-equity titan Henry Kravis and his wife, Marie-Josée, for Edgar Degas’s Dancer in Repose. On November 3, the circa 1879 pastel and gouache sold over the phone, with a bid placed in Tokyo for only $33 million, leaving Sotheby’s on the hook for millions. William Ruprecht, Sotheby’s chief executive, later announced, “We’re out of the guarantee business, at least for a while.”
Christie’s had its own problems. One in particular involved auctioning 16 postwar drawings owned by former Lehman chairman Richard Fuld and his wife, Kathy, in New York on November 12. Christie’s had given them a $20 million guarantee, but the group fetched only $13.5 million. The entire auction, of contemporary works by such noted artists as Barnett Newman, Willem de Kooning, and Roy Lichtenstein, achieved only half its pre-sale low estimate.
As auctions go, so, soon enough, will museums, accustomed to Wall Street largesse. People are wondering: Will Kathy Fuld, who has donated or helped acquire 42 artworks for the Museum of Modern Art, stay on the board as a vice-chairman? For that matter, will private-equity billionaire Leon Black, another MoMA vice-chairman? In early October a company owned by Black’s Apollo Management lost a legal battle in Delaware chancery court over its efforts to back out of a $6.5 billion deal. The judge ruled that a deal was a deal and must go forward, but Apollo’s lenders, Credit Suisse and Deutsche Bank, now seem unlikely to participate, and Black and his Apollo co-founder, Joshua Harris, may face having to pay billions in damages. That may not put Black in a mood to buy art for MoMA.
Other museums face similar funding threats, as do all philanthropies. When the meltdown deepened, talk inevitably turned to the Robin Hood Foundation, started by hedge-fund legend Paul Tudor Jones II and underwritten largely by hedge-fund money. Citadel Investment’s Ken Griffin has been a generous donor, but with his largest fund down nearly 40 percent for the year, how likely is Citadel to pony up a major gift in 2009? Or Glenn Dubin, of Highbridge Capital Management? (Two of its funds are down 32 and 37 percent for the year.) Or Alan D. Schwartz, on whose watch as C.E.O. Bear Stearns went down? In the case of Richard Fuld, the answer seems already clear: as of late October, his name was no longer listed on Robin Hood’s board of directors.
The fate of the Lehman Brothers Foundation tells the larger story of post-meltdown Wall Street philanthropy all too well. In the halcyon days, before the downturn, when one year Lehman Brothers was racking up a record $4 billion net income, its employee-funded foundation pledged $3 million to Lincoln Center’s redevelopment campaign, $1 million to the Apollo Theater’s education and outreach programs, and $50,000 to the Orchestra of St. Luke’s, among other New York causes. The good news is that the foundation, as a non-profit entity, wasn’t linked to Lehman’s bankruptcy filing. The bad news is that Lehman’s ex-employees, their jobs gone and their stock all but worthless, probably won’t be kicking in any more money to the foundation. (A spokesman for the Lehman foundation did not respond to a call from Vanity Fair.)
The Huntington Mafia
If the gilded age has come to an end this fall, surely Lehman’s demise—with its bankruptcy filing on that Monday morning of September l5, 2008—was the tipping point. It panicked the money markets, froze global credit, and sent stock prices spiraling down.
Lehman’s 31st floor—where Fuld and his top executives worked—was by all accounts a quiet place, especially by midafternoon, one managing director recalls dryly. Among Fuld’s loyalists, no one was more loyal than his number two, chief operating officer Joe Gregory, whose story, even more than Fuld’s, seems emblematic of the age now past. If Tom Wolfe were writing a sequel to The Bonfire of the Vanities, Gregory would be his man.
Gregory, 56, was a legend at Lehman—less for his business exploits than for his lifestyle. He had several homes: a principal residence in Lloyd Harbor, on Long Island’s North Shore; an oceanfront McMansion in Bridgehampton; a ski home in Manchester, Vermont; an apartment at 610 Park Avenue; and reportedly a house in Pennsylvania. “He had a kid who went to a small school in Pennsylvania,” a former senior colleague recalls. “Joe didn’t like the hotel, so he bought [a] house in town. It was probably only $500,000, but he paid for it so that, on the maybe two trips a year he took there, he’d have a nice place to stay. And then he had it redecorated!” The colleague says he heard it on good authority that Gregory’s after-tax expenses approached $15 million per year. That, he heard, was exclusive of mortgages. (Gregory’s lawyer declined to comment on e-mails from Vanity Fair.)
Gregory came from a modest background, an ex-colleague recalls; at one time he had aspired to be a high-school history teacher. One summer while attending Long Island’s Hofstra University, though, he worked as an intern at Lehman and got hooked. Both he and Fuld joined the firm soon after college; as the two men rose in the ranks, they became close friends.
Like Fuld, Gregory started on the commercial-paper trading desk. By the 1980s he’d become a top executive in fixed income and was known as one of Lehman’s Huntington Mafia, because all four executives in it lived in or near that North Shore town and often commuted together. “It was said that the four of them decided the fate of the floor every day on their drives back and forth,” recalls one ex-colleague. “And you had to be in their good graces to survive on the fixed-income floor.”
Gregory’s rise was strongly linked to Fuld’s: loyalty was his strong suit. “Joe never had clients,” says a lawyer who worked with the firm. “So he wasn’t on 31 because he was a rainmaker. And he never really had a business he was responsible for. He was Fuld’s full-time loyal lieutenant. And Fuld did have a yes-man mentality, where if people didn’t agree with him they’d get shot. And Gregory was sort of the hatchet man, who fired them or tried to enforce rules.”
Gregory played the sidekick role well, two ex-colleagues suggest. The problem, says one, is that as president and chief operating officer, beginning in 2004, he came to oversee all departments, including the derivatives that would get so tricky. The commercial paper (i.e., short-term loans solicited by creditworthy companies and banks) he’d traded in his early days was lower-risk. “If you bought it wrong, you could hold the position,” one ex-colleague explains, “till it rolled off—30 or 60 days. So it would cost you a few basis points, that’s all.” The longer end of the market involved bonds you might get stuck with if the market changed. “I don’t know if Gregory knew how much risk he was taking,” the ex-colleague says. “The other thing, which Joe had never seen, was how a market could go highly illiquid. Joe had observed this but not lived it.”
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s the real-estate bubble swelled, and with it the $55 trillion market in unregulated, collateralized debt obligations and credit-default swaps, so did Gregory’s compensation—and lifestyle. He and his current wife, Niki, provided generously for their five children—three of them hers, two his. They gave to medical charities—Huntington Hospital, Weill Cornell Medical Center, and the Maurer Foundation for Breast Health Education, among others. When their daughter became a serious soccer player, the Gregorys underwrote a new local soccer field. “Joe had a huge heart—he gave a ton of money away,” says one ex-colleague. At Lehman, the ex-colleague adds, “he drove all the diversity and philanthropic initiatives.”
But the Gregorys rewarded themselves too. Tired of the 90-minute commute, Joe bought a helicopter for the ride. When he realized the chopper couldn’t fly to Manhattan in inclement weather, he got a seaplane. Niki was known as the best customer at the high-end boutique where all the wealthy North Shore wives shopped; the store’s personal buyers came to the house, their arms filled with couture and cashmere. The Gregorys undertook a renovation of the Lloyd Harbor home that would cost, by one report, $3.5 million. They bought the Bridgehampton home for about $19 million in 2006 and hired a top local designer to do it up. One day Gregory called his staff out to admire the new Bentley he’d just bought for his wife. “Look at the dashboard,” he allegedly said. “It’s one piece of burled wood.”
“They weren’t society people,” says an acquaintance of the Gregorys. “They didn’t buy art the way the Fulds did; they didn’t really entertain.” The Lloyd Harbor renovation included a new state-of-the-art kitchen, but the Gregorys ate cold cuts on their fine china. (One guest espied a $4,600 price sticker on one of the plates. She chose not to ask whether the price was for one plate or the set.) At a local restaurant he frequented, Gregory once left an $1,800 tip for a $200 tab, says a Lehman colleague.
The problem was that roughly 75 percent of Gregory’s compensation—which reached $26 million in 2007—was in Lehman stock. Some of the stock could be sold only after a five-year waiting period, but most Lehman employees kept the bulk of their holdings long after that—not only out of loyalty but because its rise from $6 a share in 1998 to $85 in early 2007 had made them very, very rich. At least on paper. Fuld had by far the largest in-house holding: at the high-water mark, he owned stock worth almost $1 billion—not counting his stock options. Gregory had the second-largest stake: an estimated $574 million.
Most Lehman bankers saw little risk in borrowing against their stock to fund the lifestyle to which they were, on paper, entitled. “Say you have $8 million of Lehman stock,” suggests a senior investment adviser, using hypothetical numbers but a true-life case about a good friend who worked at Lehman. “You want to build a $2 million house. You pledge your stock and you borrow the money and you say to yourself, ‘Let’s say the worst happens: we have a terrible drop in the market. My $8 million will still be worth $4 million, and I’ve only borrowed half of that. So I’m being very conservative.’ But that doesn’t allow for $8 million down to zero.”
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t Lehman, Gregory set a new goal in 2007, according to a former colleague: he wanted Lehman to overtake Goldman Sachs, which was raking in huge profits by leveraging as much as 40 to 1. And he wanted Lehman’s share price to reach $100. He imposed ambitious targets on all of Lehman’s capital departments, targets that required taking big risks on deals that would become increasingly shaky.
As the real-estate market collapsed, so did those investments. For Gregory, the end came in June 2008, with the release of Lehman’s shockingly bad second-quarter numbers: $2.8 billion in losses, after months of confident pronouncements from the firm.
When the numbers came out, the outcry was fierce. Lehman was accused of misleading the market by attaching wildly over-optimistic values to its portfolio of commercial real estate and mortgage-backed securities. Class-action suits by pension funds hard-hit by Lehman’s losses were filed. Groups like the Operative Plasterers and Cement Masons International Association Local 262 and the Fire & Police Pension Association of Colorado—these were among the plaintiffs who hadn’t even known they were part of the gilded age. Only they were: Lehman’s bankers had used their retirement money to make those 40-to-1 bets and live like princes. Now that money was gone.
Fuld seemed reluctant to fire his old friend, so Gregory made the decision for him. “Wall Street wants a head,” he said sadly, The Wall Street Journal reported. At some point, Gregory apparently turned to Lehman for a loan, according to New York magazine, borrowing money against his stock.
He did not sell any of his Lehman stock in the first half of 2008, company records show. How much of it he was able to sell over the summer—if any—remains an open question, since upon his departure from the firm his transactions were no longer publicly posted. Ben Silverman, of InsiderScore.com, which tracks corporate compensation and insiders’ transactions, says that regulatory filings indicate that Gregory was bound by a lockup agreement preventing him from selling his stock for 90 days. By the time that period was up, it was Friday, September 12; the following Monday, Lehman announced its bankruptcy and the stock closed at 15 cents a share. Unless Lehman had agreed to release Gregory from the lockup after he resigned, he would barely have had a chance to act before his paper millions vanished into thin air.
What Gregory could do—and did—was put property up for sale. The apartment at 610 Park Avenue found a buyer in October for $4.4 million. The Bridgehampton house is still on the market for what local brokers diplomatically call an “aggressive” price: $32.5 million.
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utside, the Gregory house on Surfside Drive looks like a thousand other Hamptons McMansions—an architectural hodgepodge built on spec—though it sits somewhat oddly next to a public parking lot, separated only by a hedge of tall firs.
Inside, the house is decorated not just exquisitely but relentlessly. The long foyer has a high, arched ceiling, raised-panel walls, and a curved papal balcony from which the owners might look down from the second floor to greet arriving guests. One guest recalls that when the Gregorys bought the house it was already fully decorated, but the couple hired Winn Cullen, a decorator based in nearby Locust Valley, to rip everything out and make it perfect again—in an entirely new way. No expense was spared.
In the main living room—all creams and beiges—the built-in bookcases hold not one but two large flat-screen TVs: one on either side of the fireplace, like big black bookends. Why two? The broker is stumped. Perhaps because the bookcases would be almost empty without them. Or perhaps it’s a theme: in the kitchen are two Sub-Zero refrigerators flanking the large butcher-block island. And upstairs are two master bedrooms, each with a grand view of the Atlantic.
Sometime over the summer, before the market meltdown, the house on Surfside was nearly sold. Unfortunately, the would-be buyer was perturbed to learn that the large back lawn, with its gunite pool and walkway over the dunes to the beach, would have to be drastically reduced before the house could be sold. That’s because Gregory’s property is in violation of a Southampton town ordinance requiring preservation of natural beachfront vegetation. Before a sale can close, the broker explains, a broad swath of the lawn will need to be ripped up and the natural flora restored. The potential buyer may also have balked at the carrying costs: $66,000 annually for full insurance, including extra flood coverage for hurricane damage, and $34,000 in taxes—$100,000 a year before walking in the door. Plus the grounds crew.
Gregory never used the Bridgehampton house much; these days, he spends his time dealing with his lawyers. He’s one of a dozen top Lehman officers federal prosecutors have subpoenaed for one of three grand-jury investigations probing whether Lehman painted too rosy a picture of its finances—including that portfolio of commercial real estate. If they knowingly misled investors, some of those officers may go to jail.
The New Math
Most 60-year-old ex–Lehman Brothers bankers likely squirreled away enough to at least scrape by on a couple of million a year. As for the 25-year-olds, they never earned enough to have much to lose. But the mid-30s or mid-40s Lehman banker who lived up to his high compensation—or beyond it—is reeling, hurting, and possibly bankrupt.
One Sunday evening in October, a former Lehmanite in his mid-30s settles into a velvet banquette at the Gramercy Park Hotel’s elegant Rose Bar. At first he’s circumspect. But after a couple of Johnnie Walker Blacks on the rocks, he opens up.
“Let’s take a guy who makes $5 million a year,” the banker suggests. “He’s paid two and a half million dollars of that in equity compensation”—Lehman Brothers stock. Plus he gets to buy that stock at a 30 percent discount, so he’s really getting $3.25 million in stock. “Plus appreciation? Over five years? That’s $25 to $30 million!
“Then let’s say a guy in that position borrowed $5 million against the $30 million in stock. It would seem a very conservative loan, right? Until the $30 million goes down to zero, which is what happened. So now he’s negative $5 million.”
True, that same Lehman banker got the other half of his compensation in cash. The banker nods. “For five years, he made two and a half million dollars a year in cash. So that’s twelve and a half million dollars. But of course he’s had to pay more or less 50 percent in taxes, so divide that and he’s got six and a quarter million. He’s probably spent that money over those five years—$1 million a year, it’s not so hard to do, right? So he has nothing—and he has to repay that $5 million loan.”
A month before the bankruptcy, the banker muses, his peers were complaining about the $10,000 or $20,000 they had to pay for lifetime dibs on the best season tickets in the New York Giants’ new stadium. But they were paying. They were complaining about private-school tuitions. “But it was actually a way of saying, ‘I’m rich—rich enough to afford it.’
“The day Lehman went bankrupt, people realized they were going to get no bonuses, no severance, and no equity. Oh—and no health care. And no salary.”
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o far, many seem more stunned than angry, or even timidly hopeful now that Barclays, the English bank, has bought much of the firm and offered shell-shocked Lehmanites their jobs—for now. Peter J. Solomon, 70, a former vice-chairman of Lehman Brothers who runs his own investment-banking firm, says, “What I see in the Lehman people is not enough bitterness. They’re still there, they have three months, Barclays is offering them jobs for a while. But that won’t last for most of them. You’re going to see the biggest impact in the first quarter of next year.”
At least the thirtysomething banker in the Rose Bar isn’t married with kids.
Alexandra Lebenthal, a New York–based wealth manager for investors with between $2 million and $20 million in assets—the modest to mid-level rich—offers a keenly authoritative portrait of a thirtysomething Lehman banker, married with kids, in a guest column called “What It Costs” on the Web site NewYorkSocialDiary. Blake and Grigsby Somerset are fictional, their finances all too plausible.
Before Lehman’s stock began to plummet, Lebenthal suggests, Blake’s annual compensation was $9.5 million—much of that in company stock. He was carrying a $2 million loan used for a house in the Hamptons, but felt perfectly able to afford his annual expenses: the Park Avenue apartment maintenance ($120,000); the Hamptons house mortgage ($75,000); the nanny and driver ($100,000); his wife’s clothing ($100,000); the personal trainer three times a week ($18,000); food, including restaurants ($30,000); charitable benefits and other nonprofit causes ($200,000); private school for three children ($78,000); Christmas in Palm Beach ($15,000); spring in Aspen ($15,000); and a wedding-anniversary diamond necklace for Grigsby ($50,000).
At least Blake has been hired on by Barclays. But his Lehman stock portfolio is now worthless. He and Grigsby have to cut their annual living expenses from about $1 million to a fraction of that, and do it in ways that don’t show, for the worst—the worst—would be the public disgrace of falling out of their social class.
First to go: vacations, the trainer, the driver, and entertaining. No restaurants, no shopping excursions, no new ball clothes for Grigsby (last year’s will have to do). But, for now—for appearances—the Somersets will scrimp to keep the kids in their schools, and the nanny, and the Hamptons house. For now.
Bears at the Hedgerow
What, indeed, of the Hamptons, where the Somersets still go, though they can’t afford to anymore? On high-hedged roads everywhere, for-sale signs are nearly as prevalent as in southern Florida. A broker in Bridgehampton says she’s often the only one in her storefront office, the neat rows of little white desks as desolate as tombstones. Some brokers are rumored to have even taken jobs in East Hampton Main Street stores.
All over the Hamptons, overstretched owners hope to rent next summer to cover the bills. But even if supply doesn’t overwhelm demand, fear and greed may roil the market. One East Hampton broker tells a story of clients who wanted to renovate their house and asked her—before the meltdown—to find them a rental to live in for a year while the work was being done. The broker called an owner on Further Lane, who agreed to rent for $425,000. Then came Lehman’s demise. The owner decided she’d need more money: $500,000. One week later, the market had fallen again. Now the owner panicked: “I’ll take $400,000,” she declared. Six days later, she was down to $300,000. Then … $250,000. “The $500,000 was all about greed,” says the broker, “and the $250,000 was all about fear.”
At East Hampton airport, so recently the scene of Gulfstream gridlock, an eerie silence has settled in. The private-jet parade diminishes, of course, right after Labor Day, but this fall, says one airport employee, “it was like turning off a light.” September traffic was down 35 percent from the previous year. The stalwarts still come, sources say: Revlon’s Ronald Perelman, industrialist Ira Rennert, Michael Bloomberg, and Starbucks chairman Howard Schultz. But there’s a lot of time for staff to read.
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p in Greenwich, Connecticut, unofficial hedge-fund capital of the world, the real-estate market is, if anything, worse. Jean Ruggiero, one of the town’s leading brokers, at William Raveis, still sells houses—the good brokers know how to play a down market—but currently there are 55 available for $9 million and up. That’s a lot for Greenwich. “The owners are having a hard time just getting the brokers to come,” says Ruggiero. “The broker thinks, Why bother? I don’t have any clients—why waste the gas?”
Ruggiero offers a white-elephant tour. Here’s a Georgian mansion that sold not long ago, she says, to a Russian oligarch for more than $10 million, with a 10 percent down payment. Unfortunately, says Ruggiero, the Russian was unable to close on the deal. “So he lost the deposit, and the house is still on the market.”
Here’s the infamous “Lake Carrington Estate,” an unfinished stone mansion of 35,000 square feet that sits seemingly abandoned in an overgrown field surrounded by a chain-link fence. When the spec mansion was listed at $28 million in mid-2007, it was declared “couture-ready.” Ready, that is, for a proud hedge-fund buyer to make his own design decisions about the interior, since the house was raw inside, with unfinished floors and no kitchen or bathroom fixtures. Those flourishes would probably cost another $10 million, not counting the grounds, which are couture-ready too. Is its recent sale for $13.7 million to an unnamed buyer a good market sign … or a bad one?
Here’s one more: a $19.9 million mansion that just sold—after 763 days on the market—for $11 million. Good or bad? “Oh, that’s a good one,” Ruggiero says.
Greenwich estate manager Jacqueline de Bar describes how wealthy locals are cutting back: letting the pastures grow, canceling the leaf blowers, doing the storm windows themselves. At Betteridge Jewelers—known as Wall Street’s jeweler—third-generation owner Terry Betteridge says a lot more customers are coming in since the meltdown, to sell, not buy. “I’ve seen some bad ones in the last two months,” he says. “I know a Wall Street guy who’s literally been selling jewelry to make the mortgage payments. He and his wife came in together, bringing things to sell.… Just this morning, we took in a $2.7 million lot. An amazing collection, some of the best jewelry in the world, everything signed—extraordinary things I couldn’t buy before. No matter what I bid wasn’t enough. Now I can.”
Down the street is Consigned Couture, where Wall Street wives come to unload last year’s designer clothes and accessories. Some send their housekeepers, others their daughters. “My calendar is booked a month ahead, up to eight appointments a day,” says owner Dolly Ledingham. That’s sellers. Buyers? Not so much. “They used to come in to spend $1,000. Now they spend $100.”
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n this global economy, the age’s excesses and aftermath are spread wide, nowhere as vividly as in London. Notting Hill was the epicenter of London’s gilded age, where every driveway, it seemed, had a Maserati, every mansion a makeover, often including an underground pool. Now, says Sunday Times columnist Rachel Johnson, who chronicled the invasion of the financiers in her 2006 novel, Notting Hell, bankers are staggering around like lost souls, while their wives gather at 202, the stylish Westbourne Grove restaurant in Nicole Farhi’s boutique, to share their fears. “What they’re crying about is they’ve lost all their stock, and their houses are worth less than they were,” says Johnson of the wives, “but they’re really upset that on January 31 they have to pay huge tax bills. Even though they don’t have the cash anymore, the liability remains on what they earned before.”
In London as in New York, Lehman bankers are among those hardest hit. One in his mid-30s says that for two weeks after the bankruptcy the New York office was cloaked in ominous silence—no communication from the 31st floor to London’s Canary Wharf. After the filing, the banker and his colleagues were all told to keep coming to work, or else possibly not get paid. So they came in and played Pac-Man and Tetris. Finally, he says, the whole London-based fixed-income group was called into an auditorium and “made redundant” by a representative from the accounting firm PricewaterhouseCoopers. That was it for the banker’s Lehman career—and the $1 million in company stock that a friend says he lost.
On a higher level, major figures on the London financial scene have lost billions—tens of billions, in some cases. Only last May, Indian tycoon Lakshmi Mittal, who owns the world’s largest steel company, paid $230 million for Israeli-American hedge-fund tycoon Noam Gottesman’s Georgian mansion, in Kensington Palace Gardens—a London record. Now, amid the commodities plunge, Mittal is said to have lost some $50 billion, and to be down to his last $16 billion. Michael Spencer, founder of icap, the interdealer broker, watched roughly $700 million of his stake in the firm go up in smoke as the market came down.
Another name bandied about is that of Nat Rothschild. The 37-year-old son of Lord (Jacob) Rothschild, he some years ago weaned himself from a dissolute life, gave up alcohol (even his family’s Château Lafite Rothschild wine), and turned to the serious work of making money, eventually becoming co-chairman and rainmaker of the New York–based hedge fund Atticus Capital. Rothschild continued to live well—very well, with homes in London, Manhattan, Moscow, Greece, and Klosters, Switzerland, where he established his principal residence, where there are no English taxes. He went from home to home, the London Daily Mail reports, in an elaborately equipped Gulfstream jet, supposedly always with two uniformed butlers, rarely staying more than four days in any locale. But the rainmaking worked: Atticus pulled in eye-popping returns, and Rothschild probably made more than $800 million—all in advance of the $750 million or so he’d one day inherit. “He has a very difficult relationship with his father,” suggests London-based columnist Taki Theodoracopulos. “I think his father would have liked him to be more interested in houses and furniture. This guy just cares about making money.”
Now Atticus has racked up staggering losses of $7.5 billion. Its Atticus European fund, once worth $8 billion alone, was down 43 percent by early October.
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sually, December is the year’s most festive time in New York. Wall Street bankers either have their bonuses or know what they will be. Their wives have bought new gowns for the season’s charity balls—the Metropolitan Museum’s acquisition-fund benefit and the New York Botanical Garden’s Winter Wonderland Ball, and more, at ticket prices ranging from $400 to $15,000. Then it’s off to St. Barth’s for sun worshippers, Aspen for skiers.
But not this year.
How did we land in a recession? Visit our archive, “Charting the Road to Ruin.” Illustration by Edward Sorel.
Privately, some New York benefit organizers wonder if even half the stalwarts will show up. On St. Barth’s, rental villas are usually booked by early fall; this year, many were available as of early November. At Aspen’s St. Regis hotel, Christmas week was still available, at $13,920 for two.
For bankers and hedgies, the fear this holiday season is not of bonuses reduced or denied—that’s expected. The real fear is of massive layoffs and massive redemptions by hedge-fund investors, of another Wall Street bloodbath in early ’09.
Soon, says wealth manager Alexandra Lebenthal, the Blake and Grigsby Somersets will find out what they’re really made of. “Were their lifestyle, friends, and even marriage based on living a certain way, without limits, or do they have the values to make it through the tough times?”
Philip K. Howard, a New York lawyer and social critic whose new book is Life Without Lawyers, sees a sea change which was overdue. Every 30 years or so, he notes, the country has to redefine its social values. We’ve just reached the next time. “So this end of the new gilded era—it’s like a bucket that spilled, and finally the money spilled out, and we were left with a culture whose sense of purpose and responsibility were lacking. And now there’s a real need for people, and society as a whole, to rethink and re-structure their values.”
“I may be the only one who’s thrilled by this recession,” says the wife of one London private-equity manager who took his lumps this fall. “It just means we’ll have to get possibly another job. But the bottom line is that it is just money. When you realize that you have enough—your health and a roof and good food and your family—you have to just feel lucky.”
Happy New Year.
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With Wall Street hemorrhaging jobs and assets, even many of the wealthiest players are retrenching. Others, like the Lehman Brothers bankers who borrowed against their millions in stock, have lost everything. Hedge-fund managers try to sell their luxury homes, while trophy wives are hocking their jewelry. The pain is being felt on St. Barth’s and at Sotheby’s, on benefit-gala committees and at the East Hampton Airport, as the world of the Big Rich collapses, its culture in shock and its values in question.
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Michael Shnayerson
January 2009
A snapshot: East Hampton, late summer, a lawn party at a house on the ocean overlooking the dunes. The host is a prince of private equity known for dressing well. One of his guests is Steven Cohen, the publicity-shy billionaire whose SAC Capital, with $16 billion under management, is perhaps the most revered of the 10,000 or so hedge funds spawned by this giddily rich time. Nearby is Daniel Loeb, of Third Point, one of the better-known “activist” hedge funds, who hopes to move soon into a 10,700-square-foot, $45 million penthouse at l5 Central Park West, a Manhattan monument to the new gilded age. Gliding easily between them is art dealer Larry Gagosian, so successful at selling Bacons and Serras to Wall Street’s new titans—including to Cohen—that he now travels in his own private jet and has his own helicopter to take him to it.
How did we land in a recession? Visit our archive, “Charting the Road to Ruin.” Illustration by Edward Sorel.
But here’s the odd thing: despite the beauty of the ocean view, nearly all the guests have their backs to it. Cohen is deep in conversation with a colleague who seems to be pitching him a deal. Loeb hovers close to his wife, a former yoga teacher. Gagosian is near his stunning young girlfriend. No one notices the clouds that are, quite literally, on the horizon. Snap.
Six weeks later, the photograph is cracked and sepia-toned, curling at the edges, a historic print. In just that short time, the storm has hit and nothing looks the same.
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t may be premature to say our gilded age has ended. Third Point dropped 10 percent in October, bringing it down 27 percent for the year, but Daniel Loeb is still moving into his extravagant new apartment. Steven Cohen’s SAC was down 11 percent in October and 18 percent for the year to date, but that still leaves him plenty of money to add a second ice-skating rink to his Greenwich, Connecticut, estate. And Larry Gagosian is still selling plenty of art.
What’s definitely gone—along with Lehman Brothers and Bear Stearns—is leverage, at least to the dizzying degree it was recently used by Wall Street’s investment banks, hedge funds, and private-equity firms to parlay each dollar of their assets into $10, $20, even $30 or more of credit to make gargantuan deals and profits. The credit crunch has made such leverage as quaint as the market in Dutch tulips. Without it, Wall Street salaries have already started drifting gently back to earth like so many limp balloons.
Gone, too, are jobs—lots and lots of them. Along with a sizable portion of Lehman’s 26,000 worldwide, and Bear Stearns’s 14,000, Wall Street firms across the board—even Goldman Sachs—are cutting back, and that pain radiates out to the limousine drivers and caterers and lawyers and personal trainers and restaurant owners and real-estate brokers who rely on Wall Street clients, not to mention to the many nonprofits and charities that have grown accustomed to Wall Street money. The latest estimate of jobs New York will lose, both on and off Wall Street, is l60,000. Governor David Paterson says the state’s budget deficit has already reached $12.5 billion. In New York City, where Wall Street accounts for more than a quarter of the tax revenues, Mayor Michael Bloomberg thinks the financial-sector crisis will leave a $2 billion hole in the next fiscal year’s budget.
Almost everyone has lost something—if not their jobs, then 25 to 50 percent of their retirement savings—and nearly everyone is glum, anxious, hung over. Prudence is the watchword now: sackcloth after the brilliant silks and brocades of the gilded age. The day after Lehman Brothers went down, a high-end Manhattan department store reportedly had the biggest day of returns in its history. “Because the wives didn’t want the husbands to get the credit-card bills,” says a fashion-world insider. A prominent designer says ruefully, “People really aren’t shopping at all unless there’s a deal or sale. It’s pretty dramatic—they have the stores at their mercy.”
Even those who have plenty left to spend aren’t spending it. “I ran into a couple I always see at the antiques show,” one Upper East Side woman recounts of her visit to the Armory show on Park Avenue. “They always buy something fairly grand. ‘What have you bought this time?’ I asked. ‘Oh, nothing!’ they said. ‘We’d feel … ashamed.’” Another Upper East Side woman often goes from lunch at Michael’s restaurant on West 55th Street to Manolo Blahnik a block away to pick up a $600 or $700 pair of shoes as “retail therapy.” No more. “I was at Michael’s yesterday and was thinking, Oh, Manolo’s … But then I thought, Why? Why do that? It just doesn’t feel good.”
A Penny Saved
Only months ago, ordering that $1,950 bottle of 2003 Screaming Eagle Cabernet Sauvignon at Craft restaurant or the $26-per-ounce Wagyu beef at Nobu, or sliding into Masa for the $600 prix fixe dinner (not including tax, tip, or drinks), was a way of life for many Wall Street investment bankers. “The culture was that if you didn’t spend extravagantly you’d be ridiculed at work,” says a former Lehmanite. But that was when there were investment banks. Now many bankers, along with discovering $15 bottles of wine, are finding other ways to cut back—if not out of necessity, then from collective guilt and fear: the fitness trainer from three times a week to once a week; the haircut and highlights every eight weeks instead of every five. One prominent “hedgie” recently flew to China for business—but not on a private plane, as before. “Why should I pay $250,000 for a private plane,” he said to a friend, “when I can pay $20,000 to fly commercial first class?”
The new thriftiness takes a bit of getting used to. “I was at the Food Emporium in Bedford [in Westchester County] yesterday, using my Food Emporium discount card,” recounts one Greenwich woman. “The well-dressed wife of a Wall Street guy was standing behind me. She asked me how to get one. Then she said, ‘Have you ever used coupons?’ I said, ‘Sure, maybe not lately, but sure.’ She said, ‘It’s all the rage now—where do you get them?’”
One former Lehman executive in her 40s stood in her vast clothes closet not long ago, talking to her personal stylist. On shelves around her were at least 10 designer handbags that had cost her anywhere from $6,000 to $10,000 each.
“I don’t know what to do,” she said. “I guess I’ll have to get rid of the maid.”
Why not sell a few of those bags?, the stylist thought, but didn’t say so.
“Well,” the executive said after a moment, “I guess I’ll cut her from five days a week to four.”
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here were, to be sure, some big-name “blowups” as the market began to implode. Here was Sumner Redstone, chairman of Viacom and CBS, who had to sell $233 million worth of Viacom and CBS stock in order to pay down part of an $800 million loan. T. Boone Pickens, legendary Texas oilman, was another blowup, and so was Chesapeake Energy’s Aubrey McClendon, forced by a margin call to sell 94 percent of his 32 million company shares into the bear market. (Worth $2.2 billion last July, the shares were sold in October for $569 million.) Kirk Kerkorian, 91, has lost about $12 billion on his 54 percent ownership stake in MGM Mirage, the casino and hotel operator that owns almost half the hotel rooms on the Las Vegas Strip, including those in the Bellagio, the MGM Grand, the Mirage, and Mandalay Bay. The company’s stock is down 86 percent this year, and its bonds were downgraded deeper into junk status in October. Kerkorian has reportedly told friends that he “lived one year too long.” (He now claims he never said it.) Nevertheless, he and the other three men are all still billionaires.
These were the stories known because they involved large chunks of publicly traded stock. But as October turned into one of the worst market months since October l929, rumors ran rampant about which high-flying hedge funds would crash as they tried in vain to unwind their investments in derivatives and other unregulated securities, many of them entwined with subprime mortgages. With their lenders forcing them to sell assets at new lows, and their investors trying to pull their money out, the hedge funds were caught in the middle: the gilded age’s biggest winners were now among its biggest losers. Would Ken Griffin’s Citadel be the first big hedge fund to go? Or Fortress—whose clients are trying to redeem $4.5 billion? In fact, the first big tree down following that dreadful month was Tontine Associates, which managed $11 billion through its four hedge funds and whose activist founder, Jeffrey Gendell, had become a billionaire by generating more than 100 percent returns in 2003 and 2005. After two of his funds had lost two-thirds of their value, Gendell bowed to the inevitable and is expected to close them. Days later came word that Steven Rattner was closing his small but high-profile media hedge fund, Quadrangle Equity Investors, after approximately 25 percent year-to-date losses.
Of those 10,000 hedge funds, as many as half may join the casualty list in the next few years. Not that many hedge-fund managers, though, will be reduced to selling apples. Take Remy Trafelet, 38, a handsome, smooth-faced preppy whose fund faces steep year-end losses and dwindling capital—from $6 billion to $3 billion—as investors depart. In a good year, such as 2005, when Trafelet racked up 42 percent returns, he and his partners pocketed hundreds of millions of dollars.
Still, he may have to trim his lifestyle a bit.
Sandcastles in the Sky
Tellingly, no fewer than 50 high-end New York apartments have been put on the market since late September, most by Wall Streeters. Usually, the fall listings for apartments between $10 and $20 million are all teed up by Labor Day. Not this year, as The New York Times’s Josh Barbanel notes. At the Majestic, on Central Park West, two Wall Streeters listed their three-bedroom units within hours of each other. Robert Long, a managing director of hard-hit Allied Capital, listed 8C for $13.8 million as “the most magnificently renovated grand apartment to become available on Central Park West in years.” James Kern, a former senior managing director of Bear Stearns, listed 17D—the “ultimate renovation”—for $12 million.
Ten blocks away, at the Park Laurel tower, on 63rd Street, Charles Michaels, of the hedge fund Sierra Global Management, listed his 2,800-square-foot, four-bedroom apartment with terrace for $l4.9 million. In early October, Steven F. Stuart, of the Garrison Investment hedge fund, listed the apartment directly above Michaels’s—no terrace—for $10.8 million. Ten days later, real-estate developer Ira Resnick put his own, similar apartment at the Park Laurel up for sale—for $10 million.
Nowhere is the downturn more dramatic, though, than downtown, where new condominium towers by cutting-edge architects vie for a market that’s almost vanished overnight: young Wall Streeters with bonuses to throw at sleek, overpriced apartments in Richard Meier–knockoff buildings. For the developers, it’s proved a game of high-stakes musical chairs. Those who got their buildings up by early 2007 have sold many of their units by now. Those who started selling after Bear Stearns’s collapse, last March, are struggling, as the Web site StreetEasy confirms. And for those just getting started, good luck.
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n the financial district itself, hotel impresario André Balazs embarked on the 47-story William Beaver House in 2006. StreetEasy’s Sofia Kim suggests the name was meant—or at least interpreted—as a naughty wink to hard-partying bachelor traders. With the Tsao & McKown–designed building due to open this month, 209 of its 320 mostly one- and two-bedroom units have sold at top-of-the-market prices—from $900,000 to $6 million. But the rest are either for sale or being held in reserve. That’s a lot of unsold units.
Still, Balazs has done better with the Beaver House than Kent Swig has with his condominium tower at 25 Broad Street, designed by Cetra/Ruddy. Swig closed its sales office until further notice, citing liquidity problems due to Lehman Brothers’ demise. At One York Street, the soaring glass tower designed by Enrique Norten overlooking busy Canal Street, developer Stan Perelman says 28 of his 40 units have closed, though he admits that his 6,096-square-foot penthouse, with an asking price of $34 million, has yet to find a taker. The raw space, entirely glass-walled, is both exhilarating and somewhat vertiginous; as for the small ventilation windows at ankle height, they’re probably not a good idea for an owner with cats. “When the hardwood floors are in, the slabs, the home theater—press a remote and all the shades go up automatically and the music begins—someone will say, ‘Where do I sign?,’” Perelman suggests. Next month, that is, or the month or the year after …
River views—and the cachet of a world-class architect—do help. The Superior Ink building, a former factory on West 12th Street overlooking the Hudson, was given a Robert A. M. Stern makeover, and most of its 68 apartments and seven adjoining town houses have sold. So, then, how about partial river views and a famous artist, just one block away?
On West 11th Street, painter and filmmaker Julian Schnabel has lived for years in a wide former stable he calls Palazzo Chupi. In keeping with the gilded age, he added nine lavish floors of his own design. Richard Gere bought the fourth floor, but now it’s back on the market. A “private individual” took the fifth, and Schnabel himself lives on the sixth and seventh. Still for sale above are a duplex and a triplex penthouse.
From across the street, the addition’s dusty-rose stucco and Italianate arches look striking enough. Inside, Palazzo Chupi is nothing less than a brilliant artist’s interpretation of a gilded age—only not this one. More like the Italian Renaissance.
A bronze-domed elevator with Italian-tile floor opens into the penthouse’s furnished living room, with nearly 15-foot ceilings of hand-hewn wood beams, a colorful Venetian-glass chandelier, and a massive, 8-foot-high fireplace. Giant Schnabel canvases fill the walls. They aren’t included in the $24 million price, but as Corcoran broker James Lansill puts it, “You could try … ” Schnabel is, he says, a seller. In fact, the triplex started at $32 million—before the market meltdown.
The triplex has 3,713 square feet of interior space, but also 2,304 square feet of balconies and terraces (seven in all). It has arched windows throughout, baronial bathrooms with vintage fixtures, and the most romantic master bedroom in New York. The interior of the duplex is even larger, and features a living room—25 feet by 41.6 feet—with wood-beamed ceilings nearly 20 feet high. Only three terraces, though, hence the bargain price of $23 million. Among its many splendors is a huge square bathroom with a sunken tub in the middle, a fireplace, and French doors that open out through red velvet drapes to an Italian-tiled balcony. “His idea is for you to be able to sit in the bath with a roaring fire, the doors wide open, and snow on the balcony,” Lansill says.
Either of Schnabel’s gilded-age fantasies is well worth the price for anyone with $20 to $30 million to spare. The question is: Does anyone have $20 to $30 million to spare on a gilded-age fantasy these days? Perhaps. In the black-and-white-tiled lobby, as Lansill leads the way out, a trim, elegantly dressed Russian fellow with blond hair and wraparound sunglasses sweeps in. “I have an appointment,” he says to the guard in a thick Russian accent, “with Mr. Schnabel.”
Going, Going, Gone
Fall’s auctions, in both London and New York, have tracked the deepening gloom as surely as real estate and stocks have. Literally on the heels of Lehman’s bankruptcy, in mid-September, Damien Hirst held a two-day sale of animals in formaldehyde and other nature-based art at Sotheby’s in London and raised $200 million, apparently from Russian, Middle Eastern, and Asian buyers for the most part, thus panicking the private-art-dealer world, which he’d circumvented by using the auction house. For perfect end-of-an-age timing, his “Beautiful Inside My Head Forever” auction ranked right up there with Blackstone’s June 2007 I.P.O., at private equity’s high-water mark. Then came the sickening slide in the stock market. By early November London’s Evening Standard was reporting rumors that some buyers had reneged on their bids and that a lot that had purportedly sold was being offered to a collector. (A Sotheby’s spokesman denied the rumors.)
By mid-November, Sotheby’s was reporting a $52 million loss in guarantees from the season’s first auctions—sums the auction house had guaranteed sellers before the market meltdown and had to make good on when their art fetched prices below those figures. That included the $40-million-plus guarantee reportedly promised to private-equity titan Henry Kravis and his wife, Marie-Josée, for Edgar Degas’s Dancer in Repose. On November 3, the circa 1879 pastel and gouache sold over the phone, with a bid placed in Tokyo for only $33 million, leaving Sotheby’s on the hook for millions. William Ruprecht, Sotheby’s chief executive, later announced, “We’re out of the guarantee business, at least for a while.”
Christie’s had its own problems. One in particular involved auctioning 16 postwar drawings owned by former Lehman chairman Richard Fuld and his wife, Kathy, in New York on November 12. Christie’s had given them a $20 million guarantee, but the group fetched only $13.5 million. The entire auction, of contemporary works by such noted artists as Barnett Newman, Willem de Kooning, and Roy Lichtenstein, achieved only half its pre-sale low estimate.
As auctions go, so, soon enough, will museums, accustomed to Wall Street largesse. People are wondering: Will Kathy Fuld, who has donated or helped acquire 42 artworks for the Museum of Modern Art, stay on the board as a vice-chairman? For that matter, will private-equity billionaire Leon Black, another MoMA vice-chairman? In early October a company owned by Black’s Apollo Management lost a legal battle in Delaware chancery court over its efforts to back out of a $6.5 billion deal. The judge ruled that a deal was a deal and must go forward, but Apollo’s lenders, Credit Suisse and Deutsche Bank, now seem unlikely to participate, and Black and his Apollo co-founder, Joshua Harris, may face having to pay billions in damages. That may not put Black in a mood to buy art for MoMA.
Other museums face similar funding threats, as do all philanthropies. When the meltdown deepened, talk inevitably turned to the Robin Hood Foundation, started by hedge-fund legend Paul Tudor Jones II and underwritten largely by hedge-fund money. Citadel Investment’s Ken Griffin has been a generous donor, but with his largest fund down nearly 40 percent for the year, how likely is Citadel to pony up a major gift in 2009? Or Glenn Dubin, of Highbridge Capital Management? (Two of its funds are down 32 and 37 percent for the year.) Or Alan D. Schwartz, on whose watch as C.E.O. Bear Stearns went down? In the case of Richard Fuld, the answer seems already clear: as of late October, his name was no longer listed on Robin Hood’s board of directors.
The fate of the Lehman Brothers Foundation tells the larger story of post-meltdown Wall Street philanthropy all too well. In the halcyon days, before the downturn, when one year Lehman Brothers was racking up a record $4 billion net income, its employee-funded foundation pledged $3 million to Lincoln Center’s redevelopment campaign, $1 million to the Apollo Theater’s education and outreach programs, and $50,000 to the Orchestra of St. Luke’s, among other New York causes. The good news is that the foundation, as a non-profit entity, wasn’t linked to Lehman’s bankruptcy filing. The bad news is that Lehman’s ex-employees, their jobs gone and their stock all but worthless, probably won’t be kicking in any more money to the foundation. (A spokesman for the Lehman foundation did not respond to a call from Vanity Fair.)
The Huntington Mafia
If the gilded age has come to an end this fall, surely Lehman’s demise—with its bankruptcy filing on that Monday morning of September l5, 2008—was the tipping point. It panicked the money markets, froze global credit, and sent stock prices spiraling down.
Lehman’s 31st floor—where Fuld and his top executives worked—was by all accounts a quiet place, especially by midafternoon, one managing director recalls dryly. Among Fuld’s loyalists, no one was more loyal than his number two, chief operating officer Joe Gregory, whose story, even more than Fuld’s, seems emblematic of the age now past. If Tom Wolfe were writing a sequel to The Bonfire of the Vanities, Gregory would be his man.
Gregory, 56, was a legend at Lehman—less for his business exploits than for his lifestyle. He had several homes: a principal residence in Lloyd Harbor, on Long Island’s North Shore; an oceanfront McMansion in Bridgehampton; a ski home in Manchester, Vermont; an apartment at 610 Park Avenue; and reportedly a house in Pennsylvania. “He had a kid who went to a small school in Pennsylvania,” a former senior colleague recalls. “Joe didn’t like the hotel, so he bought [a] house in town. It was probably only $500,000, but he paid for it so that, on the maybe two trips a year he took there, he’d have a nice place to stay. And then he had it redecorated!” The colleague says he heard it on good authority that Gregory’s after-tax expenses approached $15 million per year. That, he heard, was exclusive of mortgages. (Gregory’s lawyer declined to comment on e-mails from Vanity Fair.)
Gregory came from a modest background, an ex-colleague recalls; at one time he had aspired to be a high-school history teacher. One summer while attending Long Island’s Hofstra University, though, he worked as an intern at Lehman and got hooked. Both he and Fuld joined the firm soon after college; as the two men rose in the ranks, they became close friends.
Like Fuld, Gregory started on the commercial-paper trading desk. By the 1980s he’d become a top executive in fixed income and was known as one of Lehman’s Huntington Mafia, because all four executives in it lived in or near that North Shore town and often commuted together. “It was said that the four of them decided the fate of the floor every day on their drives back and forth,” recalls one ex-colleague. “And you had to be in their good graces to survive on the fixed-income floor.”
Gregory’s rise was strongly linked to Fuld’s: loyalty was his strong suit. “Joe never had clients,” says a lawyer who worked with the firm. “So he wasn’t on 31 because he was a rainmaker. And he never really had a business he was responsible for. He was Fuld’s full-time loyal lieutenant. And Fuld did have a yes-man mentality, where if people didn’t agree with him they’d get shot. And Gregory was sort of the hatchet man, who fired them or tried to enforce rules.”
Gregory played the sidekick role well, two ex-colleagues suggest. The problem, says one, is that as president and chief operating officer, beginning in 2004, he came to oversee all departments, including the derivatives that would get so tricky. The commercial paper (i.e., short-term loans solicited by creditworthy companies and banks) he’d traded in his early days was lower-risk. “If you bought it wrong, you could hold the position,” one ex-colleague explains, “till it rolled off—30 or 60 days. So it would cost you a few basis points, that’s all.” The longer end of the market involved bonds you might get stuck with if the market changed. “I don’t know if Gregory knew how much risk he was taking,” the ex-colleague says. “The other thing, which Joe had never seen, was how a market could go highly illiquid. Joe had observed this but not lived it.”
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s the real-estate bubble swelled, and with it the $55 trillion market in unregulated, collateralized debt obligations and credit-default swaps, so did Gregory’s compensation—and lifestyle. He and his current wife, Niki, provided generously for their five children—three of them hers, two his. They gave to medical charities—Huntington Hospital, Weill Cornell Medical Center, and the Maurer Foundation for Breast Health Education, among others. When their daughter became a serious soccer player, the Gregorys underwrote a new local soccer field. “Joe had a huge heart—he gave a ton of money away,” says one ex-colleague. At Lehman, the ex-colleague adds, “he drove all the diversity and philanthropic initiatives.”
But the Gregorys rewarded themselves too. Tired of the 90-minute commute, Joe bought a helicopter for the ride. When he realized the chopper couldn’t fly to Manhattan in inclement weather, he got a seaplane. Niki was known as the best customer at the high-end boutique where all the wealthy North Shore wives shopped; the store’s personal buyers came to the house, their arms filled with couture and cashmere. The Gregorys undertook a renovation of the Lloyd Harbor home that would cost, by one report, $3.5 million. They bought the Bridgehampton home for about $19 million in 2006 and hired a top local designer to do it up. One day Gregory called his staff out to admire the new Bentley he’d just bought for his wife. “Look at the dashboard,” he allegedly said. “It’s one piece of burled wood.”
“They weren’t society people,” says an acquaintance of the Gregorys. “They didn’t buy art the way the Fulds did; they didn’t really entertain.” The Lloyd Harbor renovation included a new state-of-the-art kitchen, but the Gregorys ate cold cuts on their fine china. (One guest espied a $4,600 price sticker on one of the plates. She chose not to ask whether the price was for one plate or the set.) At a local restaurant he frequented, Gregory once left an $1,800 tip for a $200 tab, says a Lehman colleague.
The problem was that roughly 75 percent of Gregory’s compensation—which reached $26 million in 2007—was in Lehman stock. Some of the stock could be sold only after a five-year waiting period, but most Lehman employees kept the bulk of their holdings long after that—not only out of loyalty but because its rise from $6 a share in 1998 to $85 in early 2007 had made them very, very rich. At least on paper. Fuld had by far the largest in-house holding: at the high-water mark, he owned stock worth almost $1 billion—not counting his stock options. Gregory had the second-largest stake: an estimated $574 million.
Most Lehman bankers saw little risk in borrowing against their stock to fund the lifestyle to which they were, on paper, entitled. “Say you have $8 million of Lehman stock,” suggests a senior investment adviser, using hypothetical numbers but a true-life case about a good friend who worked at Lehman. “You want to build a $2 million house. You pledge your stock and you borrow the money and you say to yourself, ‘Let’s say the worst happens: we have a terrible drop in the market. My $8 million will still be worth $4 million, and I’ve only borrowed half of that. So I’m being very conservative.’ But that doesn’t allow for $8 million down to zero.”
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t Lehman, Gregory set a new goal in 2007, according to a former colleague: he wanted Lehman to overtake Goldman Sachs, which was raking in huge profits by leveraging as much as 40 to 1. And he wanted Lehman’s share price to reach $100. He imposed ambitious targets on all of Lehman’s capital departments, targets that required taking big risks on deals that would become increasingly shaky.
As the real-estate market collapsed, so did those investments. For Gregory, the end came in June 2008, with the release of Lehman’s shockingly bad second-quarter numbers: $2.8 billion in losses, after months of confident pronouncements from the firm.
When the numbers came out, the outcry was fierce. Lehman was accused of misleading the market by attaching wildly over-optimistic values to its portfolio of commercial real estate and mortgage-backed securities. Class-action suits by pension funds hard-hit by Lehman’s losses were filed. Groups like the Operative Plasterers and Cement Masons International Association Local 262 and the Fire & Police Pension Association of Colorado—these were among the plaintiffs who hadn’t even known they were part of the gilded age. Only they were: Lehman’s bankers had used their retirement money to make those 40-to-1 bets and live like princes. Now that money was gone.
Fuld seemed reluctant to fire his old friend, so Gregory made the decision for him. “Wall Street wants a head,” he said sadly, The Wall Street Journal reported. At some point, Gregory apparently turned to Lehman for a loan, according to New York magazine, borrowing money against his stock.
He did not sell any of his Lehman stock in the first half of 2008, company records show. How much of it he was able to sell over the summer—if any—remains an open question, since upon his departure from the firm his transactions were no longer publicly posted. Ben Silverman, of InsiderScore.com, which tracks corporate compensation and insiders’ transactions, says that regulatory filings indicate that Gregory was bound by a lockup agreement preventing him from selling his stock for 90 days. By the time that period was up, it was Friday, September 12; the following Monday, Lehman announced its bankruptcy and the stock closed at 15 cents a share. Unless Lehman had agreed to release Gregory from the lockup after he resigned, he would barely have had a chance to act before his paper millions vanished into thin air.
What Gregory could do—and did—was put property up for sale. The apartment at 610 Park Avenue found a buyer in October for $4.4 million. The Bridgehampton house is still on the market for what local brokers diplomatically call an “aggressive” price: $32.5 million.
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utside, the Gregory house on Surfside Drive looks like a thousand other Hamptons McMansions—an architectural hodgepodge built on spec—though it sits somewhat oddly next to a public parking lot, separated only by a hedge of tall firs.
Inside, the house is decorated not just exquisitely but relentlessly. The long foyer has a high, arched ceiling, raised-panel walls, and a curved papal balcony from which the owners might look down from the second floor to greet arriving guests. One guest recalls that when the Gregorys bought the house it was already fully decorated, but the couple hired Winn Cullen, a decorator based in nearby Locust Valley, to rip everything out and make it perfect again—in an entirely new way. No expense was spared.
In the main living room—all creams and beiges—the built-in bookcases hold not one but two large flat-screen TVs: one on either side of the fireplace, like big black bookends. Why two? The broker is stumped. Perhaps because the bookcases would be almost empty without them. Or perhaps it’s a theme: in the kitchen are two Sub-Zero refrigerators flanking the large butcher-block island. And upstairs are two master bedrooms, each with a grand view of the Atlantic.
Sometime over the summer, before the market meltdown, the house on Surfside was nearly sold. Unfortunately, the would-be buyer was perturbed to learn that the large back lawn, with its gunite pool and walkway over the dunes to the beach, would have to be drastically reduced before the house could be sold. That’s because Gregory’s property is in violation of a Southampton town ordinance requiring preservation of natural beachfront vegetation. Before a sale can close, the broker explains, a broad swath of the lawn will need to be ripped up and the natural flora restored. The potential buyer may also have balked at the carrying costs: $66,000 annually for full insurance, including extra flood coverage for hurricane damage, and $34,000 in taxes—$100,000 a year before walking in the door. Plus the grounds crew.
Gregory never used the Bridgehampton house much; these days, he spends his time dealing with his lawyers. He’s one of a dozen top Lehman officers federal prosecutors have subpoenaed for one of three grand-jury investigations probing whether Lehman painted too rosy a picture of its finances—including that portfolio of commercial real estate. If they knowingly misled investors, some of those officers may go to jail.
The New Math
Most 60-year-old ex–Lehman Brothers bankers likely squirreled away enough to at least scrape by on a couple of million a year. As for the 25-year-olds, they never earned enough to have much to lose. But the mid-30s or mid-40s Lehman banker who lived up to his high compensation—or beyond it—is reeling, hurting, and possibly bankrupt.
One Sunday evening in October, a former Lehmanite in his mid-30s settles into a velvet banquette at the Gramercy Park Hotel’s elegant Rose Bar. At first he’s circumspect. But after a couple of Johnnie Walker Blacks on the rocks, he opens up.
“Let’s take a guy who makes $5 million a year,” the banker suggests. “He’s paid two and a half million dollars of that in equity compensation”—Lehman Brothers stock. Plus he gets to buy that stock at a 30 percent discount, so he’s really getting $3.25 million in stock. “Plus appreciation? Over five years? That’s $25 to $30 million!
“Then let’s say a guy in that position borrowed $5 million against the $30 million in stock. It would seem a very conservative loan, right? Until the $30 million goes down to zero, which is what happened. So now he’s negative $5 million.”
True, that same Lehman banker got the other half of his compensation in cash. The banker nods. “For five years, he made two and a half million dollars a year in cash. So that’s twelve and a half million dollars. But of course he’s had to pay more or less 50 percent in taxes, so divide that and he’s got six and a quarter million. He’s probably spent that money over those five years—$1 million a year, it’s not so hard to do, right? So he has nothing—and he has to repay that $5 million loan.”
A month before the bankruptcy, the banker muses, his peers were complaining about the $10,000 or $20,000 they had to pay for lifetime dibs on the best season tickets in the New York Giants’ new stadium. But they were paying. They were complaining about private-school tuitions. “But it was actually a way of saying, ‘I’m rich—rich enough to afford it.’
“The day Lehman went bankrupt, people realized they were going to get no bonuses, no severance, and no equity. Oh—and no health care. And no salary.”
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o far, many seem more stunned than angry, or even timidly hopeful now that Barclays, the English bank, has bought much of the firm and offered shell-shocked Lehmanites their jobs—for now. Peter J. Solomon, 70, a former vice-chairman of Lehman Brothers who runs his own investment-banking firm, says, “What I see in the Lehman people is not enough bitterness. They’re still there, they have three months, Barclays is offering them jobs for a while. But that won’t last for most of them. You’re going to see the biggest impact in the first quarter of next year.”
At least the thirtysomething banker in the Rose Bar isn’t married with kids.
Alexandra Lebenthal, a New York–based wealth manager for investors with between $2 million and $20 million in assets—the modest to mid-level rich—offers a keenly authoritative portrait of a thirtysomething Lehman banker, married with kids, in a guest column called “What It Costs” on the Web site NewYorkSocialDiary. Blake and Grigsby Somerset are fictional, their finances all too plausible.
Before Lehman’s stock began to plummet, Lebenthal suggests, Blake’s annual compensation was $9.5 million—much of that in company stock. He was carrying a $2 million loan used for a house in the Hamptons, but felt perfectly able to afford his annual expenses: the Park Avenue apartment maintenance ($120,000); the Hamptons house mortgage ($75,000); the nanny and driver ($100,000); his wife’s clothing ($100,000); the personal trainer three times a week ($18,000); food, including restaurants ($30,000); charitable benefits and other nonprofit causes ($200,000); private school for three children ($78,000); Christmas in Palm Beach ($15,000); spring in Aspen ($15,000); and a wedding-anniversary diamond necklace for Grigsby ($50,000).
At least Blake has been hired on by Barclays. But his Lehman stock portfolio is now worthless. He and Grigsby have to cut their annual living expenses from about $1 million to a fraction of that, and do it in ways that don’t show, for the worst—the worst—would be the public disgrace of falling out of their social class.
First to go: vacations, the trainer, the driver, and entertaining. No restaurants, no shopping excursions, no new ball clothes for Grigsby (last year’s will have to do). But, for now—for appearances—the Somersets will scrimp to keep the kids in their schools, and the nanny, and the Hamptons house. For now.
Bears at the Hedgerow
What, indeed, of the Hamptons, where the Somersets still go, though they can’t afford to anymore? On high-hedged roads everywhere, for-sale signs are nearly as prevalent as in southern Florida. A broker in Bridgehampton says she’s often the only one in her storefront office, the neat rows of little white desks as desolate as tombstones. Some brokers are rumored to have even taken jobs in East Hampton Main Street stores.
All over the Hamptons, overstretched owners hope to rent next summer to cover the bills. But even if supply doesn’t overwhelm demand, fear and greed may roil the market. One East Hampton broker tells a story of clients who wanted to renovate their house and asked her—before the meltdown—to find them a rental to live in for a year while the work was being done. The broker called an owner on Further Lane, who agreed to rent for $425,000. Then came Lehman’s demise. The owner decided she’d need more money: $500,000. One week later, the market had fallen again. Now the owner panicked: “I’ll take $400,000,” she declared. Six days later, she was down to $300,000. Then … $250,000. “The $500,000 was all about greed,” says the broker, “and the $250,000 was all about fear.”
At East Hampton airport, so recently the scene of Gulfstream gridlock, an eerie silence has settled in. The private-jet parade diminishes, of course, right after Labor Day, but this fall, says one airport employee, “it was like turning off a light.” September traffic was down 35 percent from the previous year. The stalwarts still come, sources say: Revlon’s Ronald Perelman, industrialist Ira Rennert, Michael Bloomberg, and Starbucks chairman Howard Schultz. But there’s a lot of time for staff to read.
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p in Greenwich, Connecticut, unofficial hedge-fund capital of the world, the real-estate market is, if anything, worse. Jean Ruggiero, one of the town’s leading brokers, at William Raveis, still sells houses—the good brokers know how to play a down market—but currently there are 55 available for $9 million and up. That’s a lot for Greenwich. “The owners are having a hard time just getting the brokers to come,” says Ruggiero. “The broker thinks, Why bother? I don’t have any clients—why waste the gas?”
Ruggiero offers a white-elephant tour. Here’s a Georgian mansion that sold not long ago, she says, to a Russian oligarch for more than $10 million, with a 10 percent down payment. Unfortunately, says Ruggiero, the Russian was unable to close on the deal. “So he lost the deposit, and the house is still on the market.”
Here’s the infamous “Lake Carrington Estate,” an unfinished stone mansion of 35,000 square feet that sits seemingly abandoned in an overgrown field surrounded by a chain-link fence. When the spec mansion was listed at $28 million in mid-2007, it was declared “couture-ready.” Ready, that is, for a proud hedge-fund buyer to make his own design decisions about the interior, since the house was raw inside, with unfinished floors and no kitchen or bathroom fixtures. Those flourishes would probably cost another $10 million, not counting the grounds, which are couture-ready too. Is its recent sale for $13.7 million to an unnamed buyer a good market sign … or a bad one?
Here’s one more: a $19.9 million mansion that just sold—after 763 days on the market—for $11 million. Good or bad? “Oh, that’s a good one,” Ruggiero says.
Greenwich estate manager Jacqueline de Bar describes how wealthy locals are cutting back: letting the pastures grow, canceling the leaf blowers, doing the storm windows themselves. At Betteridge Jewelers—known as Wall Street’s jeweler—third-generation owner Terry Betteridge says a lot more customers are coming in since the meltdown, to sell, not buy. “I’ve seen some bad ones in the last two months,” he says. “I know a Wall Street guy who’s literally been selling jewelry to make the mortgage payments. He and his wife came in together, bringing things to sell.… Just this morning, we took in a $2.7 million lot. An amazing collection, some of the best jewelry in the world, everything signed—extraordinary things I couldn’t buy before. No matter what I bid wasn’t enough. Now I can.”
Down the street is Consigned Couture, where Wall Street wives come to unload last year’s designer clothes and accessories. Some send their housekeepers, others their daughters. “My calendar is booked a month ahead, up to eight appointments a day,” says owner Dolly Ledingham. That’s sellers. Buyers? Not so much. “They used to come in to spend $1,000. Now they spend $100.”
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n this global economy, the age’s excesses and aftermath are spread wide, nowhere as vividly as in London. Notting Hill was the epicenter of London’s gilded age, where every driveway, it seemed, had a Maserati, every mansion a makeover, often including an underground pool. Now, says Sunday Times columnist Rachel Johnson, who chronicled the invasion of the financiers in her 2006 novel, Notting Hell, bankers are staggering around like lost souls, while their wives gather at 202, the stylish Westbourne Grove restaurant in Nicole Farhi’s boutique, to share their fears. “What they’re crying about is they’ve lost all their stock, and their houses are worth less than they were,” says Johnson of the wives, “but they’re really upset that on January 31 they have to pay huge tax bills. Even though they don’t have the cash anymore, the liability remains on what they earned before.”
In London as in New York, Lehman bankers are among those hardest hit. One in his mid-30s says that for two weeks after the bankruptcy the New York office was cloaked in ominous silence—no communication from the 31st floor to London’s Canary Wharf. After the filing, the banker and his colleagues were all told to keep coming to work, or else possibly not get paid. So they came in and played Pac-Man and Tetris. Finally, he says, the whole London-based fixed-income group was called into an auditorium and “made redundant” by a representative from the accounting firm PricewaterhouseCoopers. That was it for the banker’s Lehman career—and the $1 million in company stock that a friend says he lost.
On a higher level, major figures on the London financial scene have lost billions—tens of billions, in some cases. Only last May, Indian tycoon Lakshmi Mittal, who owns the world’s largest steel company, paid $230 million for Israeli-American hedge-fund tycoon Noam Gottesman’s Georgian mansion, in Kensington Palace Gardens—a London record. Now, amid the commodities plunge, Mittal is said to have lost some $50 billion, and to be down to his last $16 billion. Michael Spencer, founder of icap, the interdealer broker, watched roughly $700 million of his stake in the firm go up in smoke as the market came down.
Another name bandied about is that of Nat Rothschild. The 37-year-old son of Lord (Jacob) Rothschild, he some years ago weaned himself from a dissolute life, gave up alcohol (even his family’s Château Lafite Rothschild wine), and turned to the serious work of making money, eventually becoming co-chairman and rainmaker of the New York–based hedge fund Atticus Capital. Rothschild continued to live well—very well, with homes in London, Manhattan, Moscow, Greece, and Klosters, Switzerland, where he established his principal residence, where there are no English taxes. He went from home to home, the London Daily Mail reports, in an elaborately equipped Gulfstream jet, supposedly always with two uniformed butlers, rarely staying more than four days in any locale. But the rainmaking worked: Atticus pulled in eye-popping returns, and Rothschild probably made more than $800 million—all in advance of the $750 million or so he’d one day inherit. “He has a very difficult relationship with his father,” suggests London-based columnist Taki Theodoracopulos. “I think his father would have liked him to be more interested in houses and furniture. This guy just cares about making money.”
Now Atticus has racked up staggering losses of $7.5 billion. Its Atticus European fund, once worth $8 billion alone, was down 43 percent by early October.
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sually, December is the year’s most festive time in New York. Wall Street bankers either have their bonuses or know what they will be. Their wives have bought new gowns for the season’s charity balls—the Metropolitan Museum’s acquisition-fund benefit and the New York Botanical Garden’s Winter Wonderland Ball, and more, at ticket prices ranging from $400 to $15,000. Then it’s off to St. Barth’s for sun worshippers, Aspen for skiers.
But not this year.
How did we land in a recession? Visit our archive, “Charting the Road to Ruin.” Illustration by Edward Sorel.
Privately, some New York benefit organizers wonder if even half the stalwarts will show up. On St. Barth’s, rental villas are usually booked by early fall; this year, many were available as of early November. At Aspen’s St. Regis hotel, Christmas week was still available, at $13,920 for two.
For bankers and hedgies, the fear this holiday season is not of bonuses reduced or denied—that’s expected. The real fear is of massive layoffs and massive redemptions by hedge-fund investors, of another Wall Street bloodbath in early ’09.
Soon, says wealth manager Alexandra Lebenthal, the Blake and Grigsby Somersets will find out what they’re really made of. “Were their lifestyle, friends, and even marriage based on living a certain way, without limits, or do they have the values to make it through the tough times?”
Philip K. Howard, a New York lawyer and social critic whose new book is Life Without Lawyers, sees a sea change which was overdue. Every 30 years or so, he notes, the country has to redefine its social values. We’ve just reached the next time. “So this end of the new gilded era—it’s like a bucket that spilled, and finally the money spilled out, and we were left with a culture whose sense of purpose and responsibility were lacking. And now there’s a real need for people, and society as a whole, to rethink and re-structure their values.”
“I may be the only one who’s thrilled by this recession,” says the wife of one London private-equity manager who took his lumps this fall. “It just means we’ll have to get possibly another job. But the bottom line is that it is just money. When you realize that you have enough—your health and a roof and good food and your family—you have to just feel lucky.”
Happy New Year.
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