Bought and Paid For (44 page)

 

Bank of America:
One of the largest U.S. banks by revenue and deposits, Bank of America (known as BofA for short) was founded as the Bank of Italy by immigrant Amadeo Giannini in 1904. It has been subject to a series of government bailouts following its purchases of Countrywide Financial and Merrill Lynch.

 

Bear Stearns:
Founded by Joseph Bear, Robert Stearns, and Harold Mayer in 1923, Bear was traditionally a bond house. The first major victim of the credit crisis, Bear's heavy focus on mortgage-backed securities and use of leverage eventually led to its collapse in March 2008. Prior to the subprime crisis, Bear had never posted an unprofitable quarter.

 

BlackRock:
Founded in 1988 by Larry Fink as Blackstone Financial Management, BlackRock changed to its current name in 1992 and emerged as one of the few winners in the financial crisis, garnering key contracts from both private and government players to manage beaten mortgage portfolios. With $3.36 trillion under management, BlackRock is one of the world's largest asset-management companies. Made in the image of its founder, BlackRock is renowned for its expertise in risk management.

 

Citigroup:
At one point the largest financial services company in the world, Citigroup was formed by Sandy Weill through the merger of Citicorp and Travelers Group in 1998. The combined company endured massive losses following the credit crisis and had to be bailed out by the government to the tune of $50 billion in direct taxpayer-financed aid and hundreds of billions more in loan guarantees.

 

Countrywide Financial:
The nation's largest mortgage lender, Countrywide was a leader in offering subprime loans to home buyers. Led by its charismatic CEO, Angelo Mozilo, Countrywide became the corporate face of the housing bubble.

 

Department of the Treasury:
Established by Alexander Hamilton in 1789, the Treasury Department prints all U.S. currency and collects taxes. Additionally, the department supervises U.S banks and thrifts. Under former secretary Hank Paulson, the Treasury was often the first line of defense against the global financial meltdown. The current Treasury secretary is Tim Geithner.

 

FDIC:
Created by the Glass-Steagall Act of 1933, the Federal Deposit Insurance Corporation insures its member banks' deposits in the amount of $250,000 dollars per account. The agency was created to prevent widespread panic that might cause people to withdrawal their funds all at once (known as a “run on the bank”).

 

Federal Reserve:
Created in 1913 as part of the Federal Reserve Act, the Fed, as it is often called, is the nation's central bank. It is responsible for controlling the amount of money flowing through the economy and for regulating banking institutions. The Fed is also charged with maintaining the stability of the financial system, a mandate that was put to the test during the credit crisis.

 

Federal Reserve Bank of New York:
One of twelve member Federal Reserve Banks, the Federal Reserve Bank of New York is chiefly responsible for implementing monetary policy that comes out of the Federal Reserve. Tim Geithner was the bank's president prior to running Obama's Treasury Department.

 

Goldman Sachs:
The gold standard of investment banks, founded by Marcus Goldman in 1869, Goldman largely sidestepped the subprime crisis. Still, at the height of the financial market, Goldman converted to a bank holding company, signaling the end of the modern investment bank. The last of the major investment banks to go public, in 1999, Goldman remains unrivaled for its risk management. Former senior Goldman executives have held a number of high-level positions in government, and since 1990 two-thirds of all the firm's campaign contributions have gone to the Democratic Party. Despite repeated claims that the firm did not need any taxpayer assistance, Goldman received $10 billion in bailout funds during the collapse of 2008.

 

JPMorgan Chase:
Formed in 2000 when Chase Manhattan Bank purchased J.P. Morgan, JPMorgan Chase is one of the largest commercial banks in the world. With the Fed's backing, it purchased Bear Stearns for the paltry sum of $2 a share following the broker's collapse. The final price was later raised to $10. In 2008 the firm received $25 billion in bailout funds following the collapse of the financial system. That same year, 62 percent of its campaign contributions went to the Democratic Party, the highest percentage for the company since 1990.

 

Lehman Brothers:
One of the oldest of Wall Street's investment banks, dating back to 1850, Lehman was spun off from American Express in 1993. Despite its heavy presence in fixed income, after 2000 Lehman made significant progress in diversifying its business model, buying asset manager Neuberger Berman in 2003 for $2.6 billion. Still, the company's fateful push into risky mortgages would spell its doom, and in September 2008 the firm filed for bankruptcy, setting off a global financial meltdown.

 

Long-Term Capital Management:
Founded by former Salomon head of fixed income trading John Meriwether, LTCM used heavy leverage to employ a number of complex fixed-income strategies. While initially successful, bad bets in the credit markets ultimately meant huge losses, and because of the systemic risk that an LTCM failure posed, the hedge fund was ultimately bailed out by a consortium of other Wall Street firms.

 

Merrill Lynch:
Known for its “thundering herd” of brokers, Merrill was a relative latecomer to the subprime arena. But under CEO Stan O'Neal the company made an aggressive push into the sector, a move that ultimately caused its failure and merger with Bank of America in September of 2008.

 

Morgan Stanley:
One of the most storied and celebrated investment banks in the United States, Morgan Stanley was able to weather the financial storm as an independent company, but not without changing its charter and becoming a bank holding company, and not without receiving $10 billion in TARP funds.

 

Securities and Exchange Commission:
Created in the wake of the crash of 1929, the SEC is the Street's top cop. It regulates the exchanges and its member firms, in addition to stamping out corporate abuse. However, over the last couple of years, the agency's reputation has suffered as it not only missed a number of high-profile frauds (most famously that of Ponzi schemer Bernie Madoff) but also failed to prevent the financial meltdown of 2008.

 

Weather Underground:
A radical sixties left-wing group whose membership included Obama confidant William Ayers. The group was responsible for a number of planned bombings of government buildings, including one on the Pentagon in protest of the Vietnam War.

Bailout:
The act of saving an institution from imminent failure through an injection of funds. During the financial crisis, the government had to bail out many financial firms that were on the cusp of bankruptcy to prevent a total collapse of the financial system. (Contrast this with other forms of government support, such as the discount window.)

 

Bond:
A debt investment where investors lend money to either a corporation or a government for a set period of time at a fixed interest rate. A bond's “coupon” is the interest-rate payment that is made over the life of the bond. The “principal” is the face value of the bond and the amount on which the creditor receives interest. Fixed income is an extremely lucrative business for Wall Street, as both federal and local governments need to tap the credit markets to fund their fiscal obligations.

 

Carry trade:
An investment strategy where investors borrow at a low short-term rate and then proceed to invest in higher-yielding longer-term debt. Investors make money by pocketing the difference between the short-term rate at which they borrow and the long-term rate at which they invest. The carry trade was at the heart of the investment banks' strategy to generate profits during the mortgage boom. Following the bailouts, the remaining big firms were designated “commercial banks” instead of investment banks; the implicit support this gave them from the U.S. Treasury allowed them to make unprecedented profits following the bailouts by borrowing money cheaply from the U.S. government and then investing it in bonds that paid higher rates of interest.

 

CDO (collateralized debt obligation):
A security backed by a pool of other debt securities, such as, but not limited to, mortgages. Car loans and credit card debt are examples of other types of debt that might be packed into a CDO. A CDO is typically divided into various risk categories, or tranches, which are then sold to investors. The higher-rated (more senior) tranches are considered less risky, while the lower-rated, or junior, ones pay higher interest. A CDO squared is a CDO that is backed by other CDOs
.
The big banks' purchases of tens of billions of dollars' worth of CDOs that went bad lay at the heart of the crisis.

 

Commercial bank:
A financial institution that accepts customer deposits and makes commercial loans. Commercial banks are regulated by the Federal Reserve and, in exchange for being able to access their customers' deposits, are required to take less risk than investment banks. Since the repeal of the Glass-Steagall Act, however, the difference between a commercial and investment bank has decreased.

 

Credit-default swap:
A credit-default swap is a form of a swap, or derivative, whose underlying value is determined by another security. In its simplest form, a CDS is an insurance contract against the default of a bond. While CDSs are often used for hedging purposes, many investors use them to speculate on the health of a company or even a country.

 

Derivative:
A financial instrument whose value is derived from the price of another financial asset. Derivatives are contracts that can refer to a vast array of financial products, from standard equity options like puts or calls to much more complex instruments like credit-default swaps (see entry above), which are linked to the value of an underlying debt instrument. Derivatives are typically used for hedging or speculative purposes. Investors like them for their leverage, but as Orange County found out, leverage can work well on the way up and wipe institutions out on the way down.

 

Discount window:
The discount window is the primary lending mechanism by which financial institutions can borrow from the Federal Reserve. The rate they pay on the loan is called the discount rate. The discount window exists to ease liquidity concerns that may arise in times of trouble. When Goldman Sachs was reclassified a commercial bank, it had the same access to funding as regular banks that take and hold deposits.

 

Fannie Mae and Freddie Mac:
The most prominent of the government-sponsored enterprises, Fannie Mae and its smaller sibling, Freddie Mac, played a crucial role in the expansion of the housing bubble. Fannie Mae, or the Federal National Mortgage Association, was created during the Depression to increase the availability of mortgage lending. It was charted as a public company in 1968. Freddie Mac, the Federal Home Loan Mortgage Corporation, was created two years later. Fannie and Freddie buy mortgages from various lenders and then either hold those mortgages in their portfolios as investments or repackage them with other loans to create mortgage-backed securities, which are then sold to various investors. At one point these two companies owned or insured half of America's $12 trillion in mortgages. Both the Clinton and Bush administrations were unsuccessful in their attempts to rein in the influence of the GSEs. In September 2008, both companies were taken over by the government due to massive losses from risky loans.

 

Glass-Steagall Act:
Enacted in response to the collapse of the banking system during the Great Depression, the Glass-Steagall Act, or Banking Act of 1933, prohibited commercial banks from engaging in investment-banking activities, such as the trading or underwriting of securities. It established the FDIC, which insured commercial bank deposits, but it also divided the banking industry into two distinct houses: the banks, which took in deposits and made loans, and the brokers, which engaged in the riskier parts of the capital markets. Glass-Steagall was changed in 1999 by the Gramm-Leach-Bliley Act, which relaxed many of the restrictions on commercial banking activities. Many have pointed to the watering down of Glass-Steagall as the starting point of the financial crisis that ensued a decade later.

 

Government-sponsored enterprises (GSE):
A group of government-chartered companies whose purpose is to increase the availability of credit for everything from home borrowing to student loans. These corporations include Freddie Mae, Fannie Mac, Sallie Mae, and Ginnie Mae.

 

Hedge fund:
A lightly regulated investment fund that is typically only available to wealthy investors. Unlike mutual funds, which must follow investment mandates, hedge funds can use a wider range of investment and trading techniques to generate profits. Contrary to their name, often-times they are most exposed to risk due to their heavy use of leverage.

 

Hedging:
Any investment strategy designed to hedge, or offset, risk against an existing position or investment.

 

Investment bank:
A financial institution that is primarily engaged in the riskier aspects of the capital markets, such as the underwriting and trading and selling of securities. Investment banks offer an array of financial services, from merger advice to back-office services for other financial institutions. The key distinction between commercial and investment banks is that an investment bank does not handle customer deposits. Investment banks are regulated by the Securities and Exchange Commission.