It is an easy read; you don’t need to know about credit-default swaps or collateralized mortgage obligations to understand this book (although geeks who dabble in CDSs and CMOs will find it interesting too).

First of all, there is Paulson, who would be a clear winner in the contest for Most-Likely-to-be-voted-Dr. Jekyll and Mr.Hyde.   There is Paulson the bird watching environmentalist, the Illinois farm boy who grew up milking cows and baling hay, there is the Christian Scientist who doesn’t take any medicines and believes in prayer for curing everything.  Then there is the multi-millionaire/ billionaire former CEO of Goldman Sachs.

There is also the ardent believer of work-life balance who believes in sleeping every night at 9:30 pm and talks about how, even in his early days at Goldman, always left work at 4:30 pm to spend time with his family.   If you wonder how he feels about making Goldman employees working all those really long hours (think 100 hour weeks, working Saturdays and Sundays), he has this to say:   “It’s not your boss’s job to figure out your life.” [1.]

Given this kind of double talk, you shouldn’t be surprised, perhaps, that he treated arch rival Lehman Brothers differently from Bear Stearns.  When Bear Stearns was failing, he was desperate to save the company for fear of the impact on the economy.  When J.P. Morgan initially walked away from the deal, he asked JPM CEO Jamie Dimon “Is there something we can work out where the Fed helps you get this deal done?” [2.]

And even though the Treasury had no powers (without a congressional allocation, which they didn’t have) to assist JPM or Bear, Paulson finagles a $30 billion non-recourse loan from the Fed.

Cut to when Lehman was collapsing.  Paulson suddenly finds his hands tied.  The framework that he created for Bear?  Mysteriously impossible now.  When Bank of America walks away from Lehman and its CEO Ken Lewis tries to bargain for some kind of government money, Paulson tells him it won’t happen. [3.] There would be no government money for Lehman.

Interestingly, Lehman was the only big Wall Street firm which was allowed to go bankrupt in the crisis.  All others either got bailed out (AIG, Bear Stearns) or bought (Wachovia, Merrill Lynch).

Paulson never comes up with a convincing explanation for why he let Lehman fail.  But he blames Lehman’s CEO Dick Fuld plenty:  “His ego was entwined with the firm’s” , “How far he was willing to go to protect his firm was another question”,  [4.] “Does he know how serious the problem is?” [5.] So there we have it, Paulson thinks Dick Fuld is arrogant, out of touch and doesn’t even care about the same firm that he soent 14 years rebuilding (as Paulson himself admits).  Paulson, on the other hand, claims to care deeply : “But AIG was not my foremost concern that night as I lay sleepless, wondering how Lehman would manage to pull through the weekend.  Three days was a long time.” [6.]

It’s not that Lehman’s demise was too swift or unexpected.  Paulson talks about how his  team (led by Neel Kashkari) always anticipated that Lehman would be next after Bear and spent  3 months planning how to ring-fence Lehman’s assets and insulate the economy from a possible Lehman collapse.  But it’s strange how somehow all their planning seems to involve what to do after Lehman collapses, not what to do to save it from a possible collapse.

So perhaps we shouldn’t be surprised that Paulson finds $85 billion in a bridge loan for AIG even as Lehman was filing for bankruptcy. Sure, it was necessary to save AIG and Bear, but why did he think the economy would be unharmed if Lehman failed?

Oh, and Paulson never explains how he thought he could get $700 billion in bailout money from Congress with a mere three page proposal.  He doesn’t mention the three-pageness of it, and seems to wonder why it created such a fuss.  Clearly, owning up to his own mistakes is not part of this book.

He doesn’t explain why Treasury and the Fed kept changing the rules and treating each institution differently, why there was a complete seat-of-the -pants approach to each new crisis (what happened to the plan Kashkari had?).  This lack of consistency and unpredictability about how the Fed/Treasury would react was a big factor in spooking the markets.  I remember writing about the Lehman collapse and the bailout bill back in September 2008.

To my mind, the biggest mistake Paulson made was in thinking that Lehman’s collapse could be contained; that they could wind down Lehman without too much damage.  I think he panicked when AIG was in trouble because he thought it would create far too big of a ripple effect, but that sense of panic or urgency was always missing when he talks about Lehman.   He did not anticipate the kind of effect it had on the markets’ confidence, and on Main Street.  I suppose it did not help that there was a personality clash with Dick Fuld.   Not surprising in itself, considering what arch-rivals Lehman and Goldman were, but you would think personalities would be irrelevant at such a time.

Paulson was right in thinking Wall Street would recover – it has; but Main Street hasn’t.  All those people who had their lifetime retirement savings (401-ks) wiped out in the market crash aren’t going to get them back anytime soon.  I only wish Paulson could bring himself to see his part in all this.   The book doesn’t set any records straight; it only reinforces what we have suspected for a long time.

[1.] On Page 31, [2.] Page 110, [3.] Page 184, [4.] Page 123-124, [5.] Page 173, [6.] Page 179

It is interesting (and ironic) to see how often the words “Security” and “Integrity” occur in the names of these Banks:

Picture courtesy New York Times

You can start by wondering whether someone who cannot even spell “Gandhi” correctly is qualified to write about India.  But we are inured to mis-spellings of Gandhi, so I shall pass that by.

But what about statements like these :

Over the decades a Ghandian fondness for — some say idealization of — rural life has also kept people in their villages, where the bonds of caste and custom remain strong.

Really?  I must be mistaken, then, in thinking that one of  India’s big problems is the exact opposite – the large scale migration to the cities because the villages are so backward, leaving overcrowded cities with creaking infrastructure.

One can wonder at the inability to get other names too, correct.  Towards the end of the article, the author, Lydia Polgreen, quotes a woman called K. Aruna, later referred to as Ms. Aruna.  But in the very next paragraph, Ms. Aruna mysteriously morphs into  Ms. Karuna.

Is she Karuna or K. Aruna?

This error has been corrected in the current online edition and we learn that she was K. Aruna after all.

While these mistakes abound, they detract from what should have been the real focus of the story. Ms. Polgreen quotes a Rural Shores employee in Bagepalli, Karnataka – R.  Saicharan,  on how his team of 20 processes as much as 13,000 time sheets of American truck drivers each day.  Which means that, assuming they work non-stop for 10 hours every day, they would still need to process 65 time sheets every hour, or more than 1 per minute.  And for this level of sheer drudge work, they get paid about $ 60 per month.  Not per hour, or even day or week.  Per Month.

The irony is that because  even this abysmally low pay is considered “excellent” in rural India, whichever American trucking company is outsourcing  is already saving an er, truckload of money.  But Rural Shores is not the company it outsourced to – Rural Shores is a sub-contractor base

So now we see a systematic change in the outsourcing industry model as outsourcers become middle-men, outsourcing their contracts to other, even lower-cost outsourcers.  That, to me, was the real point of the story, that Ms. Polgreen completely failed to highlight.   There are so many side-streets she could have explored here, like whether this off-shoot to the rural sector is driven by a shortage of call center workers in urban areas, or wage pressures increasing, or further recessionary cost cutting pressure from the American client.

I notice that Hari Kumar (from Bangalore?) has contributed reporting, but perhaps the New York Times should have just outsourced this article to an Indian reporter in Bagepalli. He/ she would probably have done a better job.

And so the cycle continues.  Women flood into the workplace during times of hardship – like recessions, or wars.  But they leave during the good times.  We all know why they leave – we know about how women earn less than their male counterparts, about glass ceilings and lack of simple facilities like day-care in the workplace.

We have known these things for decades now and yet no one cares enough to fix these things and make women more welcome in the workplace.   Those two headlines tell you exactly why.

Businesses have no incentive to attract women.  In good times, they have enough workers and don’t need the women (except for achieving politically correct workforce  percentages) and in bad times, the women will knock on their doors anyway (and even accept lower wages).

So the old boys club can continue its merry roll while shedding the occasional crocodile tear about the lack of women in business.  They can even go on to blame the women themselves for not trying hard enough to have careers of their own.

Sadly, most men and even some women will believe them.

Sure, I can understand that taxpayers are outraged because they would rather have the bailout money go to shoring up AIG’s capital base rather than rewarding employees.  They would rather have AIG start a witch-hunt among its employees to find out who got AIG, and the taxpayers, into this mess.  I can understand the taxpayer sentiments, even though I know they are misguided.

But sentiments don’t come into the picture here – AIG has already said it is paying these bonuses because it has a contractual obligation.

In response, people want AIG to tear up the contracts.  This, they think, would solve everything.

I hope they really don’t mean to say that.  Think about it.  If AIG has Presidential approval to tear up some contracts, why shouldn’t it tear up other contracts too, while it’s at it?  You know, contracts where it might have to settle with other firms, and so on?  And why only AIG?  Why cannot every other company tear up their contracts too?  Why do we need contracts anyway?

You can see where this is going.  If no contracts are enforceable, eventually we can all look forward to living in caves and growing our own food.  We shouldn’t even be able to barter, for even that’s really a contract.

Okay, then let’s not tear up contracts.  But fire those employees, they say.  Then we don’t have to pay them those bonuses.  Surely, we can get cheaper labor in the market?

Of course we can, but given how complex all those transactions were in the first place, you will need someone who knows about them to untangle them.   If you hire new people, you risk a months-long or even a year-long period where they try to understand all the complexities of the various deals and grapple with them.  It is not time we can afford to lose if we want these companies up on their feet – wasn’t that the whole point of the bailout?

Let’s face it – no Wall Street firm, or any other firm for that matter, would like to compensate rank and file employees attractively (CEOs are another matter), unless they have actually contributed significantly to the company’s profitability and are so talented the company cannot afford to shortchange them.   Otherwise, don’t worry, they will find ways to shortchange you, however hard you work.

The New York Times’ dealbook seems to be the only sane voice in this wilderness, pointing out these obvious facts.

But even the dealbook doesn’t talk about the next question on people’s minds – if we were bailing out AIG only to have them use some of the money to pay bonuses, should we have bailed out AIG at all?

Of course we should have, because if AIG went bankrupt, half of the financial industry (AIG’s counterparts) would have gone under too..and we’d all be in a deep Depression right now.

But when the government was bailing out AIG and others, did it make any specifications on how the bailout money could be used?  Given the recent controversy about asking AIG how it spent the money and so on, I am guessing the government never asked any of the bailout recipients to submit (weekly? monthly? quarterly?) reports about how the bailout money was being used.

In fact, the Washington Post reported in end-January that the Government Accountability Office (GAO) found that bailout oversight was restricted to an inadequate monthly survey of bailout recipients to see how they were using the money.

The $165 million dollar question is – why didn’t the government specify how the money should be used?

Well, because it’s not the government’s business to tell corporations how to handle their day to day affairs.   Besides,  money is fungible and I am not sure how much the government could have prevented AIG from paying out bonuses from existing revenue if it found a way.

Having said that, perhaps if the government had put in a stipulation saying that AIG cannot use the bailout money to, say, pay bonuses exceeding $500,000 (or some such amount)  things could have been different.   AIG may have had to defer  the bonuses, or pay them in instalments over a few years, or whatever – basically, it would have found a way to renegotiate the contracts with the employees.  I am sure most of the employees would have agreed to a renegotiated bonus too, especially in this economic environment.

But since AIG had a carte blanche from the government to use the bailout money as it chose, it really had no incentive to renegotiate its contracts.

So really, I don’t see that AIG is to blame for this mess.   If the taxpayers/ government had a list of “approved uses” or better still, a list  of  “prohibited uses” in their mind, they should have specified them.  That’s what contracts are for – you can stuff them with as many conditions as you like.

I wasn’t expecting comedy when I canceled all my evening plans to watch Obama’s press conference last evening.  Not that my evening plans were anything much, they mostly consist of libraries and groceries.  But anyway, cancel my plans I did, and sat through the Professor patiently explain credit crises and asset bubbles in words of three syllables.  Of course, each mini-speech took about seven minutes, but then what do you expect when you elect a sometime Professor as President?  He probably lectures to his colleagues each day too.

But you must admit, if you haven’t fallen asleep, you’ll find his speeches interesting.  And he does come across as someone who really understands what he is talking about.  Which is not something you can say with conviction about the predecessor.

Anyway, I did manage to stay awake throughout his speech.  And I found that every other minute, he was dropping hints about what a bombshell Tim Geithner was going to throw on us tomorrow – a Plan that would set everything right.  A Plan, no doubt, to end All Plans.

I was all excited that I would now have some real action about the economic crisis.  Apparently Tim Geithner was going to make a momentous announcement the next day, much more important than the Second Coming.   We were going to have a New Deal, or at least a Newer Deal, or an Old Deal-that has-been-refurbished-and-is-as-good-as-new.  History was going to be Created.

Even R looked impressed and predicted that stocks would rise the next morning.

Of course, I did notice that Obama refused to disclose any details of the Geithner Plan, but I was willing to wait another day with bated breath.

So today morning I spent hours watching CNBC.  I even willingly sat through Dodd’s speech, which seemed to be even longer than Obama’s,  while waiting for Geithner.

And what does dear Tim say after all this?  He talks about how he has started a new website. Then he talks about a “public-private investment fund”, whatever that means.  You mean a public company that behaves like it is answerable to only a few people? Don’t we already have many of those ?

Well, anyway, I kept waiting for Geithner to reveal his Plan.  He seemed to be making a fine speech without saying anything, but no doubt he was just building up the suspense.  But perhaps he lingered too long in the build-up.  After he finished advertising his new website, he must have ran out of TV time, for he never got around to talking  about the Plan.

I could see the markets suffering a cardiac arrest even as he was speaking.  Where was the Plan? Did he forget a few pages of his speech? Perhaps they dropped in the car? Or did he get stage fright and forget his lines?

Thankfully, the markets didn’t completely collapse  (I mean, what’s a mere 380 points?) No doubt, because it was a sunny day in New York.  Or maybe because the markets have now become used to getting heart attacks.  After you get more than a half-dozen heart attacks, I suspect you get used to them.  Don’t ask me, I don’t want to know.

R is now very nervous, and talks about selling all our investments and rushing back to India.

The folks at CNBC are more hopeful.  No doubt something came up between yesterday evening and today morning, they think.  It must be the only reason.  Maybe they suddenly realized they hadn’t finalized all the details of the public-private investment fund yet.  Or any of it.  You know, something.

I have a better idea.  I think Tim Geithner and Obama were trying out a new talent – comedy.   We know Obama can make great speeches, that he can dance and play basketball (hopefully, not simultaneously) but did you know he has a talent for practical jokes?

Now we know.

Nevertheless, I actually tried reading through the bill today.? (It’s available here, if you are interested).?

The most interesting part of the bill, of course, is the provision on page 300.

SEC. 503. EXEMPTION FROM EXCISE TAX FOR CERTAIN WOODEN ARROWS DESIGNED FOR USE BY CHILDREN.

(a) IN GENERAL.?Paragraph (2) of section 4161(b) is amended by redesignating subparagraph (B) as sub301 paragraph (C) and by inserting after subparagraph (A) the following new subparagraph:

??(B) EXEMPTION FOR CERTAIN WOODEN ARROW SHAFTS.?Subparagraph (A) shall not apply to any shaft consisting of all natural wood with no laminations or artificial means of enhancing the spine of such shaft (whether sold separately or incorporated as part of a finished or unfinished product) of a type used in the manufacture of any arrow which after its assembly?

??(i) measures 5/16 of an inch or less in diameter, and
??(ii) is not suitable for use with a bow described in paragraph (1)(A).??.

(b) EFFECTIVE DATE.?The amendments made by this section shall apply to shafts first sold after the date of enactment of this Act.

I am sure this is somehow related to solving the financial crisis, but can anyone tell me what the connection is?

I wish they had bailed out Lehman. I still do not understand why they chose to play God and let Lehman fail. Why was Lehman different from Bear Stearns, or Fannie Mae or Freddie Mac? Or AIG or Merrill Lynch or any of the others who followed? Why Lehman alone?

Simple – they thought they could get away with letting Lehman fail.

They didn’t realize, you see, that it would cause money market fund RPF to “break the buck” (NAV go below $1) and cause chaos in the money market. They didn’t realize, you see, that it would start a liquidity crisis. Or cause investors to completely lose faith in the government and start wondering which Institution would fail next.

They didn’t realize, you see, that by committing a few tens of billions to Lehman, they would avoid having to spend $700 billion on a bailout.

(For a detailed analysis of the effects of the fall of Lehman, read this WSJ article. It is interesting and it’s free (no subscription required, that is), though it’s a bit involved, and more importantly, it only addresses the immediate aftermath of Lehman. The ripples are still being felt.)

What happens if Institutions start collapsing one after another like sand castles after a wave? People panic, that’s what happens. If you think people are panicking now, well, they are panicking only in Wall Street. Main Street is yet to feel the panic, which is why it it sitting around arguing on why Wall Street doesn’t deserve any pity.

Main Street doesn’t understand why we need a bailout. Yes, $700 billion is a lot of money, more than the sum total of the lifetime earnings of all the readers of this blog. It does seem unfair as Wall Street clearly shares some of the blame for this mess. But not bailing out Wall Street now is not going to help Main Street – it would instead, hurt. It would be like cutting one’s nose to spite one’s face.

Now, banks are disappearing one after the other. IndyMac, Washington Mutual, Wachovia. Here one day, gone the next. People have NatCity and Sovereign on their crosshairs now – their stock fell more than 60% on Monday. Each one of this is a really large Institution, most of them are among the top ten banks in the country. Where will all this end?

And don’t even get me started on the inconsistency of regulatory policy. When the government seized WaMu, it wiped out the senior credit holders, but the benefit was not passed on to the taxpayers, it only benefited J P Morgan. Wiping out senior credit holders will obviously also make institutions more and more unwilling to lend money to any bank, for it’s obvious that even the biggest banks are not safe.

But in case of Wachovia, the deal was structured differently and creditors were not wiped out. Why have one rule for WaMu and another for Wachovia? The markets are fearful because there is no consistency, no transparency and no rationale for how Institutions are treated.

When banks start failing like that, credit dries up. No institutional investor will lend money to banks, or any other financial institution. Main Street will not get any loans – no credit cards, no student loans, no car loans..given that Main Street is largely a credit card driven economy, I hate to think of the repercussions.

Meanwhile, what do our lawmakers do? Well, they cannot go against the wishes of Main Street in an election year, however misguided or misinformed Main Street is.? So what happens is a classic re-enactment of the “Prisoner’s Dilemma”.? They vote against the Bill, hoping that the other representatives will vote for the Bill. This way, the bailout bill will pass, but the representatives get to go home to their constituents and brag about how they spoke up in the interests of Main Street.

The trouble with this is, if enough representatives think this way and vote against the Bill, it will never be passed. Which is exactly what happened today. Yes, you cannot have your cake and eat it too. Too bad some people keep forgetting this.

By the way, for all those who say $700 billion is a lot of money – yes, it is, but the stock market lost $1.2 trillion today alone, when the bailout plan failed. Doesn’t that loss come out of Main Street’s pockets too?

I can understand that Main Street will not understand all the implications. What I don’t understand is when people who should know better, choose to act extremely short-sightedly.

Did I mention – I am terrified? I am also very angry. And that gnawing sensation ? It’s here to stay.

P.S. These opinions are all mine, and don’t represent any one else’s opinions. But then you know that.

So I asked one of the commenters, Mango Juice, to write a guest post on the subject – going by MJ’s comment on the previous post, it was obvious MJ had a lot more to say and was quite knowledgeable on the topic. So take it away, MJ !

***

MJ’s take :

I have read with interest the various comments posted on Lekhni’s piece on the turmoil at Lehman. Most writers have expressed their own perception and their own values and judgements and reflected them in the post. However, what I found glaringly missing from any of the comments was introspection and how the situation can affect your life. Maybe because they were just focusing on one aspect, i.e. the the role of the investment banker, or they don’t have a clear understanding of the implications of the last one week.

So I have a question for all the readers here – have you thought about how the situation is going to affect you, whether you are a worker in the US or a farmer in Russia ?

Here is my view on how this situation could have unraveled and affected everyone in the globe, and it might still happen. Did you realize we were staring at the abyss of a giant Depression? As the events unfolded over the week, there was a small, but very real probability that things can get out of hand, and we were staring at a calamity. Think 50% reduction in home prices, as a starter.

Think about the financial aspect of your life. We drive a car to take our kids to school, go to the shopping mall and swipe our credit cards without thinking twice about happens in the background. The loans on the card you swipe and the car you drive is securitized by the very same investment banks everybody seems to hate, and parceled as securities around the globe. These guys play an effective role of finding where excess money is, and selling these securities to people with the cash, thereby lowering the cost of financing for your credit card company or auto loan company. If such markets don’t exist, you will have to depend on your local bank who is much smaller, and whose ability to raise money is costlier, and this additional burden is passed on to who else but you. So is the case with mortgages and student loans. Every aspect of your life is touched. As the events of last week told us, even what you thought as cash in your money market account was not safe.

One of my friends was feeling very happy about having shifted all his investments to cash – or rather, money market accounts, until I asked him which money market account it was, and then alarm bells started ringing in his mind.

The implications for the average person is wide ranging -

(i) higher interest rates and reduced availability on loans;

(ii) lower rates of return on your personal investments;

(iii) reduced level of government spending as governments and municipalities are affected.

(iv) Higher unemployment as companies tighten their belt.

However, it seems to me that it is fashionable to bash the symptoms (investment banks, hedge funds making money, short selling) rather than the cause. Read this Guardian article about why hedge funds or short sellers are not the cause of the problem.

The cause is imprudent borrowing and gullible lending.

Can you imagine a world where you are a pristine borrower with a 730 or a 740 FICO with no revolving creditcard debt but yet have to pay 8% for your mortgage, 10% for your car loan, where your return on your 401-K is going to 4-5% and your bank account will give you 0% interest. You can translate the same thing to other countries by doubling your current interest rate on loans, and all this with no increase in your current pay. The cost increase to you will be due to lack of availability of funds as folks with money don’t want to lend out for the fear of non-return of Principal.

A Bloomberg story couple of days back said that the 3 month Treasury bill interest went negative. Can you imagine that people are saying to the government – take my money, don’t pay me any interest, give me back 99.99% Principal after 3 months… Investors with cash were running scared.

For you to get a sense of how bad the situation was – read this New York Times article. Strangely, the rest of the world seems to be blissfully unaware as we carry on our normal life of going to a ballgame or visiting the Mall, or our favorite pastime.

My own feelings on this are mixed. While I am not going to shed a tear for the shareholders of Lehman or Fannie Mae, I think this affects us more than the stakeholders of those companies. The life which you and I have been used to, and taken for granted, is going to change dramatically over the next 6 months. The integrity of our financial system was severely tested, and the confidence in the system completely shattered, and it requires the mother of all bailouts to bring some semblance of order. Inspite of this massive government intervention, I personally think that folks in this blog and elsewhere, should start tightening their belts, as we are sure headed for a very rough landing.

There are other areas where I can talk about – the role of government, capital markets, regulation, asset bubbles, deflation and the Fed’s role, disintermediation, but I will leave that for a different post if you are interested in hearing my views.

Which comes back to the original question – should we feel sympathetic to the loss of employees at Lehman? We should not – if it is a stray layoff of a few people. But we should, if it is the loss of the entire firm.

Think of the impact on NYC’s tax revenue. The big fat cat investment banker sure earns a multi-million dollar pay package, but he also pays his taxes. His taxes are what runs the schools, the public service system, the hospitals, so who is going to plug in the missing tax revenue? Obviously, the city of New York only has to cut spending to handle the revenue shortfall, for they can’t issue any more bonds to meet the shortfall. So the vicious cycle continues.

If you say you don’t care about NYC, think about any other small town or city where you live. Whether you know or not, your small town/ city will be issuing muni bonds for their funding needs. You are going to see a reduced availability of such funding, which has a direct impact on the number of new projects – everything from road maintenance to upgrades for old facilities. If you are working in a company, your Treasury department is going to get lesser availability of loans at a higher cost – your company will be postponing new projects and hiring lesser people.

The bottom line – the capital markets are the lubricant which keeps the wheel spinning flawlessly. If some of the larger players fail, the speed of the spinning slows down dramatically, and it’s going to take you longer and harder to reach your destination, with more pain and more energy.

I want you guys to think about yourself – don’t think about Lehman or Bear Stearns or any other investment bank. But think about how this crisis will affect you and your family, or your friends or coworkers. This event is going to affect you, directly or indirectly. So be prepared for a rough landing.

It’s not about the investment bankers, it’s about you. Their loss, directly or indirectly, affects you.