Attorney General Eric Holder, some observers suggest, qualified himself for the nation’s top law enforcement position by ramming through a presidential pardon for fugitive tax cheat Marc Rich in the final hours of the Clinton administration. A lawyer who will take the blame for one of the ugliest acts of political patronage in memory (Rich’s ex-wife spread around a lot of political donations to Democrats) will do just about anything for his client, in this case President Obama. Those kind of principles (“If you don’t like them, I’ve got others,” as Groucho said) have their uses for a certain kind of client.
By the same token, Jack Lew’s senior position at the epicenter of financial meltdown in 2008 — he was chief operating officer of Citigroup Alternative Investments, the bank’s hedge fund vehicle — qualifies him to be Treasury secretary in an administration that uses the federal budget as a political piggy bank. A number of press commentaries have questioned the wisdom of giving the nation’s top financial job to an official associated with the worst acts of incompetence of the financial bubble. The Washington Post reported Jan. 10:
The beginning of 2008 was a brutal time to be working at the bank and certainly at Citigroup’s alternative investments unit, which managed more than $54 billion.
The group was hemorrhaging money just as Lew joined. In the first three months alone, it lost $509 million, according to SEC filings. By contrast, just a year earlier during that quarter, the unit made $222 million.
“He stepped into the hedge-fund buzz saw,” said Mark Williams, a lecturer in finance at Boston University and a former bank examiner for the Federal Reserve. “His timing wasn’t the best.”
Things continued to deteriorate the rest of the year. More than 50,000 employees, or one-seventh of Citigroup’s global workforce, were laid off in November. That year, the stock price dropped about 75 percent. Lew, meanwhile, was paid at least $1.1 million in 2008, according to financial disclosure statements.
By the end of December 2008, Lew had lined up a new job: away from Wall Street and back in Washington as a deputy secretary of state under Secretary Hillary Rodham Clinton.
Meanwhile, Citigroup’s alternative investments unit had become such a stain on the bank’s record that it was relaunched three years ago with a new name. It’s now known as Citi Capital Advisors.
The newspapers don’t know the half of it. I was there, and I know what Jack Lew was up to.
By rights, Jack Lew should be unemployable on the strength of his resume, except for one thing: As J.M. Keynes said, “A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional and orthodox way along with his fellows, so that no one can really blame him.” If we start assigning blame for the 2008 financial crisis, who knows where it will end? At a post-election soiree sponsored by The New Criterion magazine, Weekly Standard editor Bill Kristol observed that voters were more likely to blame George W. Bush than Barack Obama for the crisis. Given that no “mainstream Republican” institution anticipated the crisis, Kristol added, the voters hardly can be blamed.
A few Republicans, to be sure, were screaming about the impending crisis: I warned about a trillion-dollar asset bubble on the books of the banks on Larry Kudlow’s TV show in July 2007, and repeated that warning in numerous venues, including an appearance just before the Lehman Brothers’ failure on Bloomberg radio in July 2008. The mainstream Republicans didn’t want to hear about it, for three reasons. The first is that the Bush administration had checked all the right boxes on their ideological list (and the Bush tax cuts were good as far as they went), and few Republicans understood anything about finance. The second is that too many Republicans were making too much money from the bubble, notably Newt Gingrich, who earned about $1.6 million from the federal mortgage lender Freddie Mac for deflecting conservative criticism. And the third is that to understand why the bubble emerged, one would have to understand deep structural weaknesses in the world economy that we Republicans, with our booster mentality, don’t like to think about.
I tried to explain the crisis in May 2007, while it was unfolding, in an essay for Asia Times Online:
It is fashionable these days to blame the Americans for borrowing instead of saving. In effect, Americans borrowed a trillion dollars a year against the expectation that the 10% annual rate of increase in home prices would continue, producing a bubble that now has collapsed. It is no different from the real estate bubble that contributed to the Thai baht’s devaluation in 1997, except in size and global impact.
The monster is not the financial system, crooked and stupid as it may have been. The monster is the burgeoning horde of pensioners in Germany and other industrial countries. It is easy to change the financial system. The central banks can assemble on any Tuesday morning and announce tougher lending standards. But it is impossible to fix the financial problems that arise from Europe’s senescence. Thanks to the one-child policy, moreover, China has a relatively young population that is aging faster than any other, and China’s appetite for savings vastly exceeds what its own financial market can offer.
There is nothing complicated about finance. It is based on old people lending to young people. Young people invest in homes and businesses; aging people save to acquire assets on which to retire. The new generation supports the old one, and retirement systems simply apportion rights to income between the generations. Never before in human history, though, has a new generation simply failed to appear.
The world kept shipping capital to the United States over the past 10 years, however, because it had nowhere else to go. The financial markets, in turn, found ways to persuade Americans to borrow more and more money. If there weren’t enough young Americans to borrow money on a sound basis, the banks arranged for a smaller number of Americans to borrow more money on an unsound basis. That is why subprime, interest-only, no-money-down and other mortgages waxed great in bank portfolios.
America’s financial market could not produce enough pork chops, so the Europeans bought Spam and scrapple. America’s rating agencies assured them that derivatives created from subprime mortgages, second-lien mortgages and other dubious parts of the pig were the equivalent of pork chops, and foreign investors wolfed them down. Humbug and duplicity as I argued in The devil and Alan Greenspan (Asia Times Online, October 2, 2007), regulators, bankers and investors all looked the other way, and now all point the finger at each other.
The grandfather of supply-side economics, Nobel laureate Robert Mundell, first explained that demographics caused all the great current account imbalances in history, in an 1989 journal article. No-one else seems to have read Mundell’s work, let alone absorbed its implications — surely not the Weekly Standard. We Republicans don’t like to think that a great deal of what we mistook for American economic dynamism since the mid-1990s was in fact a bubble fueled by $6 trillion in foreign capital inflows between 1998 and 2007.
With all of that said, Jack Lew’s role at Citigroup was especially dodgy. Citigroup was not merely a facilitator of bubbly hedge funds through the Alternative Investments division for which Lew was chief operating officer. The COO handles legal, regulatory, and administrative matters, and Lew’s bonus of $900,000 for 2008 pegs him as a minor player; a mid-level structured products salesman would have earned more than that. Nonetheless he was there, and signed off on one of the worst scams on Wall Street.
When Lew was a COO at Citigroup, I was strategist for a credit derivatives hedge fund that did a great deal of business with Citigroup. We created collateralized debt obligations out of credit default swaps written on junk-quality debt, and through the magic of structuring, turned the junk debt into AAA-rated bonds. Citigroup not only underwrote these bonds, but bought virtually all of them through its so-called structured investment vehicles (SIV’s). These are off-balance-sheet devices sanctioned by the deaf-dumb-and-blind monkeys at the regulatory agencies that allowed banks to lever up AAA-rated paper at a ratio of 70 to 1. That is, Citibank bought $70 of these phony AAAs with $1 of actual shareholders’ capital. Of course, the supposedly AAA-rated paper rubber-stamped by Moody’s and Standard & Poor’s bore no more relation to a true AAA security than a Thai counterfeit Rolex bears to the real thing (in fact, the Thai Rolex holds up better under scrutiny — at least it will tell time). When the crisis hit, the price of these supposed AAA-rated bonds collapsed, leaving Citi with losses multiplied by the 70:1 leverage factor.
That’s why Citigroup went bankrupt (or would have except for repeated federal bailouts). There was a daisy-chain between the hedge fund investment side run in part by Jack Lew, the structuring desk, and the structured investment vehicle. Citigroup took a fee for investing in hedge funds, took a fee for structuring the hedge funds’ investments, and also bought a great deal of the dodgiest product. We used to tell our counterparties at Citigroup that they were crazy to buy this garbage (in effect, we were short the phony AAA paper that Citigroup was buying with 70:1 leverage. And I told the whole world this was the case on CNBC.) One of the reasons I knew with certainty that the banking system would blow up in 2008 was that I knew in detail what Citigroup had bought on Jack Lew’s watch. (The hedge fund I advised paid out its investors in late 2008 with a profit).
If you start disqualifying people for public office for outrageously bad judgment during the bubble, who knows where it will end? I like Newt Gingrich in a lot of ways, and I agree with a lot of what he has to say, but I will never support another Gingrich bid for high public office.
That’s why no-one will look too closely under the rock where Jack Lew spent 2006 through 2008. Bill Kristol is right to raise the issue of Republican policy failure over the 2008 financial crisis, but our professional class is not yet ready to come to grips with the economic reality that burst in upon us in 2008. That is one of the reasons we lost the 2012 presidential election and got steamrolled in the recent fiscal cliff negotiations. And that’s why Jack Lew will be the next Treasury secretary, even though his main qualification lies in his proven ability to look the other way and sign off on an outrageous degree of chicanery. In this new era of crony capitalism, Jack Lew is the perfect Treasury secretary for a president like Barack Obama.
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