September 15th, 2008. It's a Monday morning.
Yeah. And, you know, depending on where you were
in the world, the sun was just coming up or the
day was already halfway done. You might have
been grabbing a coffee, getting the kids ready
for school, or maybe you were already at your
desk. But when you turned on the news that morning.
Everything had changed. It was a fundamental
shift, a watershed moment, really. Lehman Brothers
had filed for bankruptcy. And we have to be clear
here, this wasn't some, you know, fly -by -night
startup or regional bank that took a few bad
bets. No, no, no. This was an institution. I
mean, this is a bank that had survived the U
.S. Civil War. The Civil War. It survived the
Great Depression. It survived two world wars.
And then, poof. And the scale of it was just...
It was massive. It was the fourth largest investment
bank in the entire United States. You had Goldman,
Morgan Stanley, Merrill Lynch, and then Lehman.
And just like that, in the blink of an eye, it
was gone. Insolvent. I think for a lot of us,
even if we weren't following the financial pages
every single day, that was the moment the ground
actually shook. It was. Before that Monday, you
heard rumblings, right? Maybe you saw a headline
about housing prices softening a bit in Florida
or something about subprime on the back page
of the newspaper. But Lehman, that was the earthquake.
It really was the climax of a tragedy that had
been written really over the previous decade.
But you're right. The psychological impact was
just immediate. How do you even measure that?
Well, there's a metric we look at called the
TED spread. It sounds super technical, but it's
not. It's basically a fear gauge. A fear gauge.
I like that. It measures the difference between
what the U .S. government pays to borrow money
and what banks charge to lend to each other.
So, OK, if the banks all trust each other, the
spread is low. They're all on the same team.
Exactly. But on that morning, the TED spread
just. It spiked to record highs. Trust had completely
evaporated from the system. It wasn't just that
Lehman was gone. No, it was that no bank knew
if the bank across the street was next. So what
did they do? They just stopped lending to anyone.
The plumbing of the entire global financial system
just. clogged solid. And that is exactly what
we are here to do today. We are going to go deep.
I mean, deeper than just a timeline or a list
of failed banks. We want to unpack the anatomy
of this disaster. Right. How do you go from one
guy in, I don't know, Ohio defaulting on a two
hundred thousand dollar mortgage to the entire
global economy almost turning off? It is a fascinating
and frankly, a terrifying journey. It involves.
Everything from the very bottom of the economic
ladder. We're talking predatory loans given to
people who had absolutely no hope of ever paying
them back. all the way to the absolute peak of
intellectual hubris, where mathematicians with
PhDs convinced themselves they had conquered
risk with these beautiful, elegant formulas.
We're going to be looking at the so -called villains,
or maybe it's better to call them the enablers.
The enablers is a good word for it. The shadow
banking system, the rating agencies, the regulators
who were completely asleep at the wheel. And
for this deep dive, we are going to be relying
on a massive stack of sources. We have the financial
crisis. Inquiry Commission report, which it's
the official autopsy, really. We've got economic
data from the Federal Reserve and we've got contemporary
accounts of the panic as it was happening. And
you're right. We have to start with the setup
because a fire this big doesn't just. Yeah. It
doesn't just start on its own. You need dry wood.
You need a whole lot of gasoline and then you
need a spark. So let's talk about the fuel before
the panic, before the bailouts, even before the
housing bubble really got inflated. How did the
world get so awash in cash that we started doing
really, really stupid things with it? You have
to rewind the clock. Go back to the early 2000s.
Yeah. And you have to think about where we were
as a country psychologically. The dot -com bubble
had just burst. Right, in 2000. That wiped out
trillions in paper wealth. Trillions. Then, of
course, the absolute tragedy of September 11,
2001. The U .S. economy was reeling. It was vulnerable.
I remember that time so clearly. There was this
genuine, palpable fear that the economy would
just grind to a halt. Precisely. So the Federal
Reserve, which was led by Alan Greenspan at the
time, decided to do what a central bank does
in that situation. They decided to flood the
engine with gas. They lowered interest rates.
Dramatically. I mean, we went from interest rates
of about 6 .5 % in the year 2000 all the way
down to just 1 % by 2003. 1 %? That is... That's
effectively free money. It's historically unbelievably
low. And the idea was simple, right? To incentivize
borrowing. If money is cheap, businesses will
borrow to expand and people will borrow to buy
houses and cars. And it worked. It did. It stimulated
the economy. There was another massive factor
at play here, something that Ben Bernanke, who
would eventually succeed Greenspan, he called
it the global savings glut. OK, let's stop and
unpack that for a second. Global savings glut.
It sounds like we just had too much money in
the world's piggy bank. Why is having too much
savings a bad thing? It's not bad in isolation,
but it creates these massive distortions. You
have to look at the geopolitics of the moment.
And in the late 90s, the Asian financial crisis
absolutely devastated economies like Thailand,
South Korea, Indonesia. Those countries learned
a very, very hard lesson. Never, ever rely on
foreign lenders who can pull their money out
on a whim. So what did they start doing? They
started saving. Aggressively, they ran huge trade
surpluses with the U .S. and stockpiled cash.
So you have these enormous pools of capital just
sitting in Asian central banks. And at the same
time, oil prices are rising. So the Middle East
has tons of cash, too. Right. And all this capital.
Yeah. It needs a home. It needs to be invested
somewhere. But here's the key. These countries
were terrified of risk. After what happened in
the 90s. Exactly. They didn't want to buy tech
stocks or risky ventures. They wanted safety.
They wanted U .S. dollars. And specifically,
they wanted what are called safe assets, things
like U .S. treasury bonds. So you literally have
a wall of money coming from overseas and it's
all aimed at the U .S. financial system. A tsunami
of money is a better word for it. Trillions of
dollars flowing into the U .S. debt markets.
And this, in turn, drove interest rates down
even further. But here's the catch. What's the
catch? There weren't enough U .S. treasury bonds
to go around. The demand for safe assets completely
outstripped the supply. And this is where the
psychology gets so interesting, right? You have
these huge investors. We're talking pension funds,
foreign governments, insurance companies. And
they need two things that usually don't go together.
They need absolute safety, so a AAA rating, but
they also desperately need a return on their
investment. And with interest rates at 1%, you
just can't make any money buying government bonds.
You've hit the nail on the head. They were absolutely
starving for yield. Starving for yield. Imagine
you manage a pension fund for, say, a bunch of
teachers. You have to pay them their retirement
in 10 years. You need to make, let's say, 7 %
or 8 % a year to meet those obligations. Right.
If safe government bonds are only paying 1 %
or 2%, you are in huge trouble. You are desperate
for anything that pays more but is still quote
-unquote safe. And Wall Street, being the helpful,
innovative service provider that it is, basically
said, don't you worry, we can fix that for you.
Wall Street had a lightbulb moment. They realized
they could manufacture a product that looked
and felt like a safe bond but paid a much higher
interest rate. And the raw material for that
product was the American housing market. Which
brings us to the housing mania. I think everyone,
whether they owned a home or not, remembers this
era. It just felt like the basic laws of economic
gravity had been suspended. Oh, the numbers are
just staggering. Between 1998 and 2006, the price
of the typical American house increased by 124
percent. 124 percent. That's more than double
in less than a decade. And it wasn't supported
by fundamentals. It wasn't supported by income
growth. Historically, in the U .S., a house costs
about 2 .9 to 3 .1 times the median annual income.
It was this incredibly stable ratio for decades.
And where did it go? The 2006, that ratio hit
4 .6. Houses were becoming fundamentally unaffordable
for the people who were supposed to be living
in them. But people kept buying. The mania just
took over. Because of the psychology of the bubble.
If you believe, truly believe, that the price
of your house will go up 10 % next year, it makes
all the sense in the world to buy now. even if
you have to stretch your budget to the breaking
point. And it wasn't just buying. Homeowners
started treating their houses like personal ATM
machines. This is the home equity line of credit,
or HELOC craze. Right. Exactly. You buy a house
for $200 ,000. Two years later, the bank sends
you a letter saying, congratulations, it's now
worth $300 ,000. You feel $100 ,000 richer. So
you refinance. You refinance, you pull out that
equity, and you buy a boat. or a second car,
or you go on a big vacation. Between 2001 and
2005, American homeowners extracted nearly $5
trillion in home equity. $5 trillion. That's
an unbelievable amount of consumption that was
just fueled by paper gains. It wasn't real. It
propped up the entire U .S. economy for years,
but it was all built on one single, incredibly
fragile assumption. That prices would never fall.
That they would never fall. Okay, so we have
the fuel. All this cheap money, this global demand
for safe assets. We have the raw material, the
ever -rising price of American homes. Now we
need to talk about the machine, the meat grinder
that turned all of this into a global disaster.
This is where we get into the plumbing of the
crisis. And, you know, it starts with the loans
themselves. In a normal functioning world. Banks
lend to what we call prime borrowers. Good credit,
steady job, 20 % down payment, the whole thing.
The whole nine yards. But eventually you run
out of those people. Right. But Wall Street's
appetite for mortgages was insatiable. They just
kept demanding more and more raw material to
package up for those global investors we talked
about. So when the prime borrowers ran out, they
didn't stop. They just lowered the standards.
And this is where subprime comes in. Enter subprime.
It generally refers to borrowers with FICO scores
below 660. But as the bubble inflated, they went
lower and lower and lower, eventually lending
to people with scores below 620. But it wasn't
just the credit score, was it? It was the documentation,
or the lack of it. That was the real scandal.
We went from full documentation loans to low
-doc, and then finally... to no -doc loans. I've
heard the stories. This is the era of the non
-in -angel loan. That's right. No income, no
job, no assets. Just walk me through this because
it sounds insane. I walk into a bank. I have
no job. I have no income to show you. I have
no assets. And you're going to give me half a
million dollars for a house. How does a loan
officer even justify that on paper? Well, in
the old days, it's a wonderful life banking model.
The bank wouldn't do it. It's that simple. Because
the bank kept the loan on its books. If you didn't
pay, the bank lost money. But the model had changed.
The model had completely changed to originate
to distribute. The mortgage broker and the lender,
they originate the loan, they take a fat commission
fee right up front, and then they instantly sell
that loan to a Wall Street bank. So they have
zero skin in the game. None. Zero. In fact, the
worse the loan, often the higher the commission
because these were higher interest, riskier loans.
And this led to the rise of what were called
liar loans. Liar loans. Where lenders would essentially
tell borrowers, look, just write down that you
make $100 ,000 a year. We're not going to check.
There's that famous, almost apocryphal story
of the strawberry picker in California. I know
the one you mean. Making something like $14 ,000
a year. And was given a loan for a $720 ,000
house. And it happened everywhere. Countrywide
Financial, run by Angelo Mozilo, was the absolute
poster child for this. Their internal culture
was just volume, volume, volume. Their motto
was fund them. If the borrower had a pulse. They
got a loan. OK, but this is the part I always
get stuck on. I get why the local mortgage broker
doesn't care. He gets his fee and moves on. I
get why Countrywide sells it to Wall Street.
But why does Wall Street buy it? Why does Lehman
Brothers or Bear Stearns want a big box full
of these obviously toxic loans? Because of the
alchemy of securitization. This is the sausage
making process you hear about. Wall Street takes
thousands of these individual loans. Some are
OK, some are terrible, and they put them all
into a trust. They bundle them together into
what's called a mortgage -backed security, or
MBS. But a bundle of bad loans is still, well,
it's still a bundle of bad loans, isn't it? Ah,
but then they slice them up. This is the critical
concept. The CDO, or collateralized debt obligation.
The best way to think about it is to imagine
a waterfall. Okay, I'm with you. A waterfall.
The money from all those thousands of homeowners
paying their mortgages every month. That's the
water flowing down from the top. And the investors
are all standing at different levels of this
waterfall holding buckets. The investors at the
very, very top, they're in what's called the
senior tranche. They get to fill their buckets
first. So if a few people default and the flow
of water slows down a little bit, the guys at
the top, they're fine. They still get all their
water. Exactly. They are protected. You would
need a massive, catastrophic amount of defaults
for the water to stop reaching the top of that
waterfall. And because they are so safe, the
credit rating agencies, we're talking S &P, Moody's,
Fitch, they come in and they stamp that top tranche
with a AAA rating. The highest rating there is,
the same rating as the U .S. government. Very
same. Then you have the middle tranches, the
mezzanine tranches. And finally, at the very
bottom, you have the equity tranche or what Wall
Street insiders call the toxic waste. The toxic
waste. These guys only get paid if everyone down
to the last person pays their mortgage on time.
If there are any defaults at all, they get hit
first. But in exchange for taking on all that
risk, they get a huge interest rate. So Wall
Street essentially convinced the entire world
that they had taken a pile of risky subprime
loans. And through the magic of financial engineering,
slicing and dicing, they had created brand new
risk -free assets. Yes. And the global investors
we talked about earlier, they couldn't buy them
fast enough. The volume was just insane. CDO
issuance peaked at over $180 billion in just
the first quarter of 2007 alone. We have to talk
about the math behind this for a minute because
there was a specific Nobel Prize winning formula
that everyone was using to justify this whole
thing. The Gaussian Copula. Right. This gets
a little nerdy, but it's absolutely crucial to
understanding the intellectual failure here.
The Gaussian copula was a formula that was adopted
by Wall Street to measure the correlation between
defaults. So basically, what are the odds that
if person A defaults on their mortgage? their
neighbor, person B, will also default. Exactly.
And what did the model assume? It assumed very
low correlation. What does that mean in simple
terms? Well, think of it like this. If it starts
raining in Seattle, does that mean it's also
raining in Miami? No, of course not. They're
completely independent events. Right. So if you're
an insurance company and you insure houses against
rain damage in 50 different states, you're pretty
safe. They're not all going to flood at once.
That is exactly how they viewed mortgages. They
thought real estate is local. If the housing
market in Florida crashes, Texas might be booming.
If Arizona goes down, Ohio will be fine. But
what if it's not rain? What if it's a giant asteroid
that's heading for Earth? Exactly. If an asteroid
hits, it burns everywhere at the same time. The
correlation goes to one. The model, the Gaussian
Copula, it did not account for a national decline
in housing prices. It assumed that was impossible
because it hadn't happened since the Great Depression.
So when prices started falling everywhere at
once? The math just broke. The models failed
spectacularly. The AAA tranches weren't safe
at all. They were just the last to drown. And
it gets even worse because they didn't just stop
at betting on the actual loans. They started
making side bets. This is when we enter the shadow
world of derivatives and credit default swaps
or CDS. A CDS is basically an insurance policy.
You pay a premium every month. And if a bond
or a CDO defaults, the insurer pays you the full
value. OK, that sounds like a prudent thing to
do if I actually own the bond. I'm insuring my
investment. But here's the crazy part. You didn't
have to own the bond to buy the insurance on
it. Wait, hold on. Let me get this straight.
If I want to buy fire insurance on my house,
I have to actually own the house. I can't buy
insurance on your house and then, you know, hope
it burns down so I can collect. That's illegal.
In the normal insurance world, yes, it's illegal.
It's called not having an insurable interest.
In the completely unregulated derivatives world,
it was perfectly legal and incredibly common.
It's like standing at a racetrack. You aren't
riding the horse. You don't own the horse. But
you can bet millions of dollars that the horse
will break its leg. So this is what created the
synthetic CDO. That's right. They created these
new, purely synthetic bundles of bets. This meant
that while there might be, say, only $10 million
of actual bad loans in existence, there could
be $100 million or $1 billion of bets riding
on whether those loans failed or not. It magnified
the potential losses exponentially. And this
is where the insurance giant AIG steps into the
picture. AIG was at the time the biggest insurance
company in the world. They had a small division
based in London called AIG Financial Products
that sold trillions of dollars worth of these
swaps. They were essentially selling fire insurance
on houses that were already smoldering. but they
treated the premiums they collected as pure risk
-free profit. They didn't put aside enough capital
reserves to actually pay out if the fire started.
Not even close. It was just breathtaking recklessness.
Okay, we have one more crucial piece of this
machine to assemble before we can watch the whole
thing blow up. The shadow banking system. This
is a term that sounds like something out of a
spy novel, but it is probably the most important
structural flaw in the entire system. So what
exactly is a shadow bank? It's any financial
institution that acts like a bank, so it's lending
and borrowing. But it isn't a traditional commercial
bank with deposits. We are talking about the
big investment banks like Lehman Brothers and
Bear Stearns, hedge funds, and these strange
entities called SIVs or structured investment
vehicles. What's the fundamental difference between
them and my local Bank of America branch? Two
things, regulation and insurance. Your deposit
at Bank of America is insured by the FDIC up
to a certain limit. If the bank fails, the government
guarantees you'll get your money back. Lehman
Brothers had no such guarantee. None. And they
operated on a scale that is just hard to comprehend.
By 2007, the shadow banking system was actually
larger than the traditional banking system. Investment
banks alone held around $4 trillion in assets.
But here's the fatal flaw, the Achilles heel.
Which is? The asset liability mismatch. Okay,
break that down for us. A traditional bank takes
your deposit. which is a short -term liability.
You can ask for it back anytime. And it lends
it out for 30 years in a mortgage, a long -term
asset. That's always a bit risky. But shadow
banks were doing something far, far riskier.
They were funding their massive operations using
something called the repo market. The repo market.
This is one of those terms that Wall Street people
throw around that makes normal people's eyes
glaze over. But you're saying it's critical.
So how does it work? Think of it like a pawn
shop for billionaires. Okay, I like that. Lehman
Brothers holds a mortgage -backed security that's
worth, say, $100. But they need cash today to
pay their staff, make trades. So they go to a
lender, maybe a big money market fund, and say,
here is this $100 bond. Lend me $98 in cash just
for tonight. I promise I'll buy the bond back
from you tomorrow morning for $98 plus a tiny
bit of interest. So they are borrowing massive
amounts of money for literally 24 hours. Yes.
They are rolling this debt over every single
day. Now, imagine Lehman is doing this with billions
and billions of dollars. They are borrowing billions
every night to fund assets, these mortgages.
That won't pay off for 30 years. It only works
as long as the lender agrees to renew the loan
the next morning. Exactly. But what happens if
that lender wakes up? reads the news that mortgages
are going bad across the country, and says, you
know what, I don't really trust that bond you're
giving me as collateral anymore. I want my cash
back. And I'm not lending to you again today.
The bank has no cash. They're insolvent. Instantly.
That is what we call a run on the repo market.
It's an electronic, invisible bank run. There
are no lines of people outside a teller window,
just funding that disappears at the speed of
light. And these banks were so leveraged. Insanely
leveraged, borrowing $30, sometimes $40 for every
$1 of their own money they had. A tiny, tiny
drop in the value of their assets was enough
to wipe them out completely. So the tank is full
of gas. The fumes are literally everywhere. Let's
talk about the tremors, because this disaster
didn't happen all at once on September 15. No,
not at all. The cracks started to appear well
into 2007. We saw housing prices peak in mid
-2006 and then start to roll over. Defaults started
to tick up. And you had these classic warning
signs, like the inverted yield curve in August
of 2006, which is a textbook recession signal.
And some people saw it coming, right? Right.
Michael Burry, the guy from the movie The Big
Short. He did. He was betting against the subprime
market as early as 2005. But, you know, the mainstream
completely ignored him. They thought he was a
crank. So what was the first real crack in the
dam? In early 2007, a huge subprime lender called
New Century Financial went bankrupt. That was
a big deal. Then in June of 2007, two hedge funds
run by Bear Stearns completely collapsed. But
the real oh crap moment for the global system
was in August 2007 with that French bank BNP
Paribas, right? Yes. That was the moment the
music stopped. BNP Paribas is a massive global
bank. They froze three of their investment funds.
And they sent out this letter to their investors
saying essentially, we cannot calculate the fair
value of the assets in these funds because there
is a complete evaporation of liquidity. Which
is banker speak for. We have no idea what this
junk is worth and absolutely no one on earth
will buy it from us at any price. That's a perfect
translation. And that was the moment the credit
market seized up for the first time. Banks stopped
trusting each other's collateral. The fear was
spreading. Let's fast forward a bit to March
2008. The first of the giants starts to fall.
Bear Stearns. Bear Stearns was the smallest of
the big five investment banks, but it was by
far the most exposed to the mortgage market.
And just as we described, they face a classic
run on their repo funding. They were just bleeding
cash every single day. And the government had
to step in. The Federal Reserve and the Treasury,
led by Hank Paulson, engineered a forced marriage.
They strong -armed JPMorgan Chase into buying
Bear Stearns over a single weekend. But the price,
the price was the real shocker. It was unbelievable.
A year earlier, Bear Stearns stock was trading
at $170 a share. The initial deal that was announced
was for $2 a share. $2! You couldn't buy a cup
of coffee in New York City for the price of a
share of a Wall Street Titan. They eventually
had to bump it up to $10 a share to keep the
shareholders from suing everyone into oblivion.
But the message was sent. You can be a giant
one day and be completely wiped out the next.
But the Fed did something else, didn't they?
They sweetened the deal for J .P. Morgan. They
did. And this set a very dangerous precedent.
The Fed agreed to take $30 billion of Bayer's
most toxic assets onto its own books, onto the
taxpayer's balance sheet, to make the deal happen.
And the market saw this and thought. The market
thought, oh, OK, Uncle Sam is here. He won't
let the big boys fail. It created this massive
sense of moral hazard. The Fed put. Exactly.
Everyone assumed there was a Fed put, that the
government would always be there to bail them
out no matter how reckless they were. But before
we get to the main event in September, I want
to zoom in on a story from that summer that I
think just perfectly captures the human panic
of this whole era. IndyMac Bank. IndyMac is such
a crucial case study. It was a big savings and
loan based in Pasadena, California. And they
were. They were aggressive. They specialized
in what were called alt -A loans. What's an alt
-A loan? Sort of the gray area between prime
and subprime. Low documentation, but maybe for
a borrower with a decent credit score. And it
turned out they had been fabricating their capital
strength for years. And Senator Chuck Schumer
got wind of this. He did. He released a public
letter in late June of 2008 questioning whether
IndyMac was actually solvent. And when the public
saw that letter, It triggered an old -fashioned
1930s -style bank run. You can picture it. Oh,
I want you to picture it. It's July in Southern
California. It's hot. And there are hundreds,
thousands of people lining up around the block,
sweating, holding their passbooks and their bank
statements, just desperate to get their life
savings out of that bank. It's a scene from Mary
Poppins or, like you said, the Great Depression
in 2008. In 2008. In about 10 days, depositors
pulled $1 .5 billion out. The bank completely
collapsed. The FDIC seized it on July 11th. And
here is the really terrifying part for the average
person. People lost money. That's right. The
FDIC insurance limit at the time was $100 ,000.
If you had more than that in your account, you
took a haircut. Uninsured depositors lost about
$270 million. And that sent a shockwave through
the public consciousness. It meant safe wasn't
safe anymore. Exactly. So the tension is just
building and building all summer. And then the
two pillars of the entire U .S. mortgage market,
Fannie Mae and Freddie Mac, they start to shake.
And these aren't just banks. These are quasi
-governmental. They owned or guaranteed something
like $5 trillion in mortgages, half the entire
market. By September, they were effectively insolvent.
So on September 7th, the government took them
over. Placed them into conservatorship. It was
the biggest nationalization in American history.
You would think that would calm the markets down.
Okay, the government has stepped in and secured
the mortgage market. You would think. But the
market is like a predator. It looks for the next
wounded animal in the herd. And that animal,
without a doubt, was Lehman Brothers. So take
us into that room. The weekend of September 13th
and 14th, the now infamous Lehman Weekend. The
meetings took place at the Federal Reserve Bank
of New York. It's this imposing fortress -like
building in downtown Manhattan. You had the three
most powerful financial figures in the country
in a room. Hank Paulson, the treasury secretary,
Ben Bernanke, the Fed chair, and Tim Geithner,
the president of the NY Fed. And they summoned
all the Wall Street CEOs. That's right. They
basically locked them in a room and said, you
guys are going to figure this out. The smell
of fear in that room must have been potent. And
the plan was to find a buyer for Lehman, just
like they did with Bear Stearns. They were trying
to get Barclays or Bank of America to step up.
They were. But Hank Paulson, who was getting
hammered by the public and by Congress about
bailouts, he drew a line in the sand. He said
there would be no government money this time,
no taxpayer funds. He wanted the market to solve
its own problem. He was playing a very, very
dangerous game of chicken. And he lost. Barclays
wanted to buy Lehman. but British regulators
wouldn't approve of the deal without a U .S.
government guarantee. Paulson said no, so Barclays
walked away. Bank of America, meanwhile, took
a look at Lehman's toxic books, saw the absolute
sludge in their balance sheet, and said, no thanks.
And instead, they bought Merrill Lynch. That's
right. Merrill was also teetering on the brink,
so in a stunning move, Bank of America bought
Merrill Lynch that same weekend, saving it from
collapse. Which left Lehman... All alone. All
alone at the dance. So on Monday morning, September
15th, at about one in the morning, Lehman Brothers
filed for Chapter 11 bankruptcy protection. And
the world broke. It did. The Dow plunged over
500 points. But the real disaster wasn't the
stock market. It was the interconnectedness.
We talked about AIG earlier and all those credit
default swaps they had written. When Lehman failed,
it was a credit event. It triggered a clause
in all those CDS contracts AIG had sold. So the
people who bought the insurance from AIG, they
all came knocking at once. They came knocking.
They said, Lehman just died. The world is a much
more dangerous place. We don't trust you anymore,
AIG. You need to post collateral. You need to
give us cash right now to prove you can pay us
if we need it. And AIG needed billions of dollars
instantly, and they didn't have it. Not even
close. So if AIG fails... What happens next?
If AIG fails, the entire global financial system
implodes. The banks that bought the insurance
from them, we're talking Goldman Sachs, Deutsche
Bank, Sustagen are all in France. They all take
catastrophic losses. Their capital is wiped out.
They fail. Then the companies that rely on those
banks for funding fail. It's a chain of dominoes,
but the dominoes are the size of skyscrapers.
So on Tuesday, September 16th, just one single
day after letting Lehman die on principle, the
government does a complete 180. A complete 180.
They bailed out AIG with an $85 billion loan
from the Federal Reserve. $85 billion. It's a
number that's hard to wrap your head around.
It was necessary to stop the immediate bleeding,
but the inconsistency. Saving Bear Stearns, killing
Lehman, then saving AIG. It absolutely terrified
the markets. They didn't know what the rules
of the game were anymore. And amidst all this
chaos, we have what might be the single scariest
moment for the real autonomy. The moment a money
market fund. Broke the buck. This was the reserve
primary fund. It was one of the oldest and largest
money market funds in the country. And these
funds are supposed to be the most boring, safest
investment on the planet. You put a dollar in,
you get a dollar back, plus a tiny bit of interest.
Yeah. It's where big corporations park their
cash to make payroll. But they held Lehman debt.
They held a lot of Lehman commercial paper. And
when Lehman went to zero, the fund's assets dropped
in value. The share price, which is always supposed
to be $1, fell to $0 .97. It broke the buck.
Why does three cents matter so much? Because
it caused a global panic. If a money market fund
isn't safe, then nothing is safe. Investors pulled
$144 billion out of money market funds in just
a couple of days. It was a massive silent run
on the system. And here's the connection to you,
the listener, and your job. Those money market
funds are the primary buyers of something called
commercial paper. Exactly. A company like General
Electric or Ford or Toyota, they issue this short
-term debt, this commercial paper, to pay for
their daily operations, to make payroll, to buy
steel for their factories. And when the money
market funds emptied out? They stopped buying
commercial paper. The market completely froze
solid. So suddenly, a company like General Electric
can't borrow the money it needs to operate day
to day. We were days, maybe hours, away from
major U .S. corporations not being able to write
paychecks to their employees. And that is the
moment when Bernanke and Paulson went to Congress,
looked them in the eye, and basically said the
financial world was looking into the abyss. They
proposed PARP, the Troubled Asset Relief Program.
$700 billion to buy up the bad assets from the
banks and stabilize the system. And in a moment
of just stunning political theater, on September
29th, the House of Representatives voted no.
They voted it down. I remember watching CSPAN
that day. The ticker on the screen for the vote
and the stock market ticker right next to it.
Just going down and down and down. The Dow Jones
Industrial Average dropped 777 points in a single
day. At the time, it was the largest point drop
in history. One point two trillion dollars in
market wealth just evaporated. The government
was told the economy will collapse without this.
And Congress said, we don't care. Our voters
back home hate bailouts. It took that massive
market crash to force their hand. They held another
vote on October 3rd and this time it passed.
But the damage was done. The fear was entrenched.
The recession, what we now call the Great Recession,
was fully underway. So let's look at the fallout
from all this. Because while the banks and the
big institutions got the lifeboats, the passengers
on the ship, the American people, they were left
in the freezing water. The human cost was just
devastating. $11 trillion in household wealth
was lost in the United States. $11 trillion.
That's retirement accounts, 401ks, college funds,
and, of course, home equity. All gone. Unemployment
doubled, eventually hitting 10%, but even that
number hides the real pain. We lost 8 .7 million
jobs. Long -term unemployment skyrocketed. You
had men in their 50s who lost good manufacturing
jobs and never worked at the same level again.
And the foreclosures, the images of people's
belongings out on the curb. It was heartbreaking.
Neighborhoods were just hollowed out. In places
that were at the center of the bubble, like Las
Vegas, Phoenix, parts of Florida, prices fell.
50 % or more. So people were underwater. Deeply
underwater. Owing $400 ,000 on a house that was
now worth $200 ,000, millions of families lost
their homes. And it wasn't just a U .S. crisis.
You mentioned Iceland earlier. Iceland is the
most extreme example of what happens when a country's
banking system grows to a monstrous size relative
to its economy. Their banks were something like
10 times the size of their entire GDP. 10 times.
So when global credit froze, they couldn't fund
themselves. The entire country went bankrupt
overnight. Their currency collapsed. Their stock
market fell over 90%. It was total, complete
economic devastation. And then, of course, it
spread throughout Europe, triggering the sovereign
debt crisis in Greece, Spain, Portugal. It was
the ultimate painful lesson in globalization.
It showed us that we are all tied together now.
A bad mortgage written in Nevada can bankrupt
a town in Norway. Let's talk about the recovery.
Because I think for a lot of people, this is
where the lasting anger comes from. The recovery
wasn't shared equally. Not at all. Not even close.
The stock market bottomed out in March of 2009
and then went on one of the most historic bull
runs in history. So the wealthy, who own most
of the stocks, they did great. The wealthy recovered
their lost wealth relatively quickly. But the
middle class and the poor, whose primary source
of wealth is tied up in the value of their home,
it took a decade or even longer. for housing
prices to recover in many areas. So it widened
the wealth gap. It widened the wealth gap dramatically.
And it also widened the racial wealth gap. There's
overwhelming evidence that a disproportionate
amount of the most predatory subprime lending
was targeted at minority communities. So when
the crash came, black and Hispanic households
lost wealth at a much faster rate and recovered
much, much slower than white households. The
effects are still with us today. So let's talk
about the government response. We had TARP, but
we also had the Fed going, as you said, all in.
The Fed cut interest rates to zero. But even
that wasn't enough to unfreeze the system. So
they embarked on a series of unprecedented programs
called quantitative easing, or QE. This is the
part everyone calls printing money. That's effectively
what it is, yes. The Fed created trillions of
dollars of new electronic money out of thin air
to buy up government bonds and those toxic mortgage
-backed securities from the banks. And the goal
was what? The goal was to force long -term interest
rates down across the entire economy and to push
investors back into taking risks, back into buying
stocks. It absolutely saved the banking system
from collapse, but it also had the side effect
of massively inflating asset prices, which again
exacerbated inequality. And on the legal front.
The justice part of this. Who went to jail? This
is the statistic that just makes people's blood
boil, and for good reason. In the United States,
for their role in the worst financial crisis
since the Great Depression, only one single top
banker, a guy named Kareem Sarageldin from Credit
Suisse, went to prison. One guy. Out of an entire
industry that was shown to have committed fraud
on an industrial scale. One guy. The Justice
Department under President Obama made a strategic
decision to focus on extracting huge fines from
the banks rather than prosecuting individuals.
And they did. Banks paid hundreds of billions
in fines. Golden, J .P. Morgan, Bank of America.
But the individuals, the CEOs, they kept their
bonuses. They kept their jobs. And you contrast
that with a country like Iceland. It's a night
and day difference. Iceland let their big banks
fail and they jailed 47 bankers and executives.
They took a completely different approach to
justice. So as we wrap up this incredibly complex
deep dive, we have to come back to the big question.
Why? The Financial Crisis Inquiry Commission,
the official government report, their conclusion
was that the crisis was avoidable. That is the
most damning verdict of all. This wasn't an earthquake
or a hurricane. It wasn't an act of God. It was
man -made. So who do they blame? They blame a
widespread failure of regulators who were captured
by the industry and who truly believed that markets
could police themselves. They blame a catastrophic
failure of corporate governance boards of directors
who allowed executives to take insane risks in
pursuit of short -term bonuses. And it was a
failure of the system itself, wasn't it? The
incentives were just all wrong. The incentives
were completely perverse. If you pay a banker...
A huge bonus to take risks. And you implicitly
tell him, hey, if you win, you get to keep the
money and buy a Ferrari. If you lose, don't worry.
The taxpayer will pay for the crash. What do
you think he's going to do? He is going to crash
the car every single time. So the final question,
have we fixed it? We got the Dodd -Frank Act
in 2010. Banks are required to hold more capital
now. The banking system is definitely, without
a doubt, safer and better capitalized than it
was in 2008. They have more of a loss absorbing
capital buffer. We have annual stress tests now.
Those things are real improvements. But I can
hear a but coming in your voice. The but is a
big one. It's what some economists call the paradox
of deleveraging. In 2008, the problem was that
the private sector households and companies had
way too much debt. To solve that crisis, the
government essentially took all that private
debt onto its own public balance sheet. We solved
the debt crisis with more debt. Global debt is
significantly higher today than it was in 2008.
And by keeping interest rates at basically zero
for a decade, did we just blow a bunch of new
bubbles in other places, in tech stocks, in crypto,
in other assets? That is the billion dollar or
rather trillion dollar question. That's the fear.
We trained an entire generation of investors
to believe that the Fed will always be there
to save them, to backstop the market. We may
have stabilized the system, but we may have also
made it more fragile in new and unpredictable
ways. We just kicked the can down the road. We
kicked a very, very big can a long way down the
road. The question we all have to ask is, what
happens when we finally run out of road? On that
uplifting thought. It is truly a story of hubris,
of greed, and of the fragile interconnected complexity
of our modern world. It really is. It is the
most important economic and historical lesson
of our lifetimes. Because if we forget how this
machine broke, we are absolutely doomed to break
it all over again. Thanks for going on this journey
with us. This has been The Deep Dive. We'll see
you next time.