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The End of Wall Street
by Roger Lowenstein
Edition: 06 APR 2010
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With razor-sharp insight, bestselling author Roger Lowenstein tells the full story of the end of Wall Street as we knew it. Roger Lowensteins The End of Wall Street unfurls a gripping chronicle of the 2008 financial collapse, drawing on 180 interviews with top government officials and Wall Street CEOs. Lowenstein looks to the roots of the crisis to reveal how America succumbed to the siren song of easy debt and speculative mortgages. Combining deep analysis with sizzling narrative, The End of Wall Street charts the end of an era of unprecedented and unwarranted optimism while looking ahead to the legacy of the bailout. In the late summer of 2008, as Lehman Brothers teetered at the edge, a bell tolled for Wall Street. The elite of American bankers were enlisted to try to save Lehman, but they were fighting for something larger than a venerable, 158-year-old institution. Steven Black, the veteran JPMorgan executive, had an impulse to start saving the daily newspapers, figuring that historic events were afoot. On Sunday, September 14, as the hours ticked away, Lehmans employees gathered at the firm, unwilling to say goodbye and fearful of what lay in wait. With bankruptcy a fait accompli, they slunk off to bars for a final toast, as people once did in advance of a great and terrible battle. One ventured that “the forces of evil” were about to be loosed on American society. Lehmans failure was the largest in American history and yet another financial firm, the insurer American International Group, was but hours away from an even bigger collapse. Fannie Mae and Freddie Mac, the two bulwarks of the mortgage industry, had just been seized by the federal government. Dozens of banks big and small were bordering on insolvency. And the epidemic of institutional failures did not begin to describe the crisiss true depth. The market system itself had come undone. Banks couldnt borrow; investors wouldnt lend; companies could not refinance. Millions of Americans were threatened with losing their homes. The economy, when it fully caught Wall Streets chill, would retrench as it had not done since the Great Depression. Millions lost their jobs and the stock market crashed (its worst fall since the 1930s). Home foreclosures broke every record; two of Americas three automobile manufacturers filed for bankruptcy, and banks themselves failed by the score. Confidence in Americas market system, thought to have attained the pinnacle of laissez-faire perfection, was shattered. The crisis prompted government interventions that only recently would have been considered unthinkable. Less than a generation after the fall of the Berlin Wall, when prevailing orthodoxy held that the free market could govern itself, and when financial regulation seemed destined for near irrelevancy, the United States was compelled to socialize lending and mortgage risk, and even the ownership of banks, on a scale that would have made Lenin smile. The massive fiscal remedies evidenced both the failure of an ideology and the eclipse of Wall Streets golden age. For years, American financiers had gaudily assumed more power, more faith in their ability to calculate—and inoculate themselves against—risk. As a consequence of this faith, banks and investors had plied the average American with mortgage debt on such speculative and unthinking terms that not just Americas economy but the worlds economy ultimately capsized. The risk grew from early in the decade, when little-known lenders such as Angelo Mozilo began to make waves writing subprime mortgages. Before long, Mozilo was to proclaim that even Americans who could not put money down should be “lent” the money for a home, and not long after that, Mozilo made it happen: homes for free. But in truth, the era began well before Mozilo and his ilk. Its seeds took root in the aftermath of the 1970s, when banking and markets were liberalized. Prior to then, finance was a static business that played merely a supporting role in the U.S. economy. America was an industrial state. Politicians, union leaders, and engineers were Americas stars; investment bankers were gray and dull. In the postindustrial era, what we may call the Age of Markets, diplomats no longer adjusted currency values; Wall Street traders did. Just so, global capital markets allocated credit, and hordes of profitminded, if short-term-focused, investors decided which corporations would be bought and sold. Finance became a growth industry, fixated on new and complex securities. Wall Street developed a heretofore unimagined prowess for securitizing assets: student loans, consumer debts, and, above all, mortgages. Prosperity in this era was less evenly spread. Smokestack workers fell behind in the global competition, but financiers who mastered the intricacies of Wall Street soared on wings of gold. Finance now was anything but dull; markets were dynamic and ever changing. Average Americans clamored to keep pace; increasingly they resorted to borrowing. By happy accident, Wall Street had opened the spigot of credit. People discovered an unsuspected source of liquidity—the ability to borrow on their homes. With global investors financing mortgages, ordinary families were suddenly awash in debt. The habit of saving, forged in the tentative prosperity that followed the war, gave way to rampant consumerism. By the late 2000s the typical American household had become a net borrower, fueled by credit from lessdeveloped countries such as China—a curious inversion of the conventional rules. Paradoxically, the more license that was given to markets, the more that Wall Street called on bureaucrats for help. Market busts became a familiar feature of the age. Notwithstanding, it was the doctrine of the experts—on Wall Street and in Washington—that modern finance was a nearly pitch-perfect instrument. A preference for market solutions morphed into something close to blind faith in them. By the mid-2000s, when the spirit of the age attained its fullest, the very fact that markets had financed the leverage of banks, as well as the mortgages of individuals, was taken as proof that nothing could be wrong with that leverage, or nothing that government could or should try to restrict. Financiers had discovered the key to limiting risk, and central bankers, adherents to the cult of the market, had mastered the mysterious art of heading off depressions and even the normal ups and downs of the economic cycle. Or so it was believed. Then, Lehmans collapse opened a trapdoor on Wall Street from which poured forth all the hidden demons and excesses, intellectual and otherwise, that had been accumulating during the boom. The Street suffered the most calamitous week in its history, including a money market fund closure, a panic by hedge funds, and runs against the investment firms that still were standing. Thereafter, the Street and then the U.S. economy were stunned by near-continuous panics and failures, including runs on commercial banks, a freezing of credit, the leveling of the American workplace in the recession, and the sickening drop in the stock market. The first instinct was to blame Lehman (or the regulators who had failed to save it) for triggering the crisis. As the recession deepened, the thesis that one firm had caused the panic seemed increasingly tenuous. The trouble was not that so much followed Lehman, but that so much had preceded it. For more than a year, the excesses of the market age had been slowly deflating, in particular the bubble in home loans. Leverage had moved into reverse, and the process of deleveraging set off a fatal chain reaction. By the time Lehman filed for bankruptcy, the U.S. housing market, the singular driver of the U.S. economy, had collapsed. Indeed, by then the slump was old news. Home prices had been falling for nine consecutive quarters, and the rate of mortgage delinquencies over the preceding three years had trebled. In August, the month before Lehman failed, 303,000 homes were foreclosed on (up from 75,000 three years before). The especial crisis in subprime mortgages had been percolating for eighteen months, and the leading purveyors of these mortgages, having started to tumble early in 2007, were all, by the following September, either defunct, acquired, or on the critical list. Also, the subprime crisis had fully bled into Wall Street. Literally hundreds of billions of dollars of mortgages had been carved into exotic secondary securities, which had been stored on the books of the leading Wall Street banks, not to mention in investment portfolios around the globe. By September 2008, these securities had collapsed in value—and with them, the banks equity and stock prices. Goldman Sachs, one of the least-affected banks, had lost a third of its market value; Morgan Stanley had been cut in half. And the Wall Street crisis had bled into Main Street. When Lehman toppled, total employment had already fallen by more than a million jobs. Steel, aluminum, and autos were all contracting. The National Bureau of Economic Research would conclude that the recession began in December 2007—nine months ahead of the fateful days of September. On the evidence, Lehman was more nearly the climax, or one of a series of climaxes, in a long and painful cataclysm. By the time it failed, the critical moment was long past. Banks had suffered horrendous losses that drained them of their capital, and as the country was to discover, capitalism without capital is like a furnace without fuel. Promptly, the economy went cold. The recession mushroomed into the most devastating in postwar times. The modern financial system, in which markets rather than political authorities self-regulated risk-taking, for the first time truly failed. This was the result of a dark and powerful storm front that had long been gathering at Wall Streets shores. By the end of summer 2008, neither Wall Street nor the wider world could escape the imminent blow. To seek the sources of the crash, and even the causes, we must go back much further. “Lowenstein, a magnificent business writer, creates an almost novelistic accounting of the all-too-real 2008 financial collapse…. Lowenstein has a pitch-perfect sense of the Streets monumental recklessness.”—Time “[The End of Wall Street] is a complex but imaginative book… [Lowenstein] is able to identify the creative instruments of financial destruction with the directness that is all-important to a book like this.”—New York Times “Think of Roger Lowensteins The End of Wall Street as a tuition-free class in 21st-century U.S. macroeconomics... The End of Wall Street debunks the notion that no one could have seen the economic catastrophe coming.”—USA Today “The End of Wall Street is a calm, reasoned, and often witty tour of the current financial landscape and how it got that way.”—Philadelphia Observer “In the flood of new books about the financial crisis, Roger Lowensteins is a standout. Lowenstein, a highly accomplished financial journalist, lays out what may be the best explanation yet of the recent crash—and as good a prediction as any on what happens next.”—Barrons Lowensteins strong knowledge of the source material and flair for the dramatic and doomsday title should draw readers who still wonder what went wrong and how.—Publishers Weekly “Lowenstein does a great job of explaining…in understandable terms that unobtrusively avoids the injection of emotion and politics.”—Booklist “Over the past year, there has been a steady stream of books trying to make sense of the crisis. The latest, and perhaps the most accessible and even-handed, is Roger Lowensteins The End of Wall Street.—Washington Post The End of Wall Street is a good book: witty, well-written, heavily researched and often dramatic.”—Associated Press/Huffington Post “A veteran financial/business journalist examines the past three years of economic collapse, chronicling actions and inactions from dozens of villains and a few heroes…A well-delineated chronicle likely to cause readers to ask who put the clowns in charge of the circus, and why arent they confined to prison cells.” —Kirkus You started writing this book in 2008 shortly after the failure of Lehman Brothers. There were bound to be other authors tackling the financial crisis – so what inspired you to write The End of Wall Street? What story did you think wasnt being told by others? Actually, I had been thinking about this well before Lehman. In 2007 and early 2008, when I did a magazine cover on Ben Bernanke, it was obvious that he — like the financial system he oversaw — was facing truly unique difficulties. I was also thinking, and writing, about how the credit agencies had failed, utterly, to understand the rottenness underneath residential mortgages. Then, in the spring of 2008, when Bear Stearns collapsed, my editor suggested I write a book. I was intrigued but I didnt think the subject was quite ripe. We both thought we were in the midst of something big, but I wasnt sure Bear Stearns was the final, or climactic, act. Come September, when Lehman failed (and in the same week, Merrill was acquired and AIG was rescued) it was obviously show-time. What I wanted to do, as distinct, from some of the other writers, was to go back, and relate Lehman and AIG to all these other currents that had been brewing for so long. And really that had been brewing, in a theoretical sense, since the collapse of Long-Term Capital Management, which I had written about in When Genius Failed in 1999. Because in retrospect, LTCM was a miniature version of the crash of 2008. And the 2008 bust was the culmination of the financial excesses that have absorbed the better part of my career. Tell us about the title of your book. It works on two levels. Firstly, there was a period in the fall of 2008 when it felt, literally, like the “end.” I wanted people to remember that — that in the midst of this storm, people werent sure our financial system would survive. The collapse was that big. Secondly, you can read the title as the end of Wall Street as we knew it. In this sense, I am referring to trading vehicles, leverage levels, risk-taking, degrees of government supervision, and so forth, but above all to a mindset of complacency that justified the extraordinary speculation prevalent during the middle-to-late 2000s. That mindset — that every risk, every investment will always work out: that we have nothing to worry about — is gone, kaput, over. By analogy, although we have not suffered any terrorist attacks (on U.S. soil) since 2001, the country, or the generation that lived through it, will never feel as safe as it did before. Were not invulnerable and we know it. 2008 ripped away the feeling of financial invulnerability. Though the economy was struggling prior to September 2008, conventional wisdom holds that the crisis reached a critical mass only with the failure of Lehman Brothers. You point out that the collapse started much earlier. Explain. When my wife was reading the manuscript, she kept saying, “Are you sure all this stuff was happening in 2007?” Its amazing how early the crisis really began. By the time of Lehman, home prices had been falling for more than two years. Dozens and probably scores of subprime companies had already failed. The foreclosure rate had quadrupled. Wall Street stock prices had crashed. Job totals had fallen for eight straight months — all this happened before Lehman. And of course, Bear Stearns, Fannie and Freddie had all been forced to seek a bailout. Lehmans bankruptcy brought the crisis home to the evening news cycle but the crisis was already very, very far along. Who should have recognized the advance warning signs? Why didnt they? Well, you want to be careful here, because everyone is a genius in retrospect. But certainly, Ben Bernanke knew we had a very bad problem in mortgages, subprimes in particular, and failed to see how thoroughly mortgages were implicated throughout the economy. Others, such as the investor Bob Rodriguez, a key character in the book, recognized in the summer of 2007 that since financial firms were holding so many mortgages, they would be at risk. And if financial firms were at risk, then the overall economy would suffer. You would have hoped that the Fed, with all its resources, would have done better. The “why” part of the question is tougher. But I think the Fed, going back to Greenspans era, had grown very trusting of Wall Street and of what I call the new finance: all the computer models that Wall Street relies on to forecast. Basically, these models say, “if something hasnt happened before, then it wont happen now.” For example, we never had foreclosure rates go beyond a few percent, so why should they now? Its a flawed system. On that basis there was nothing to worry about in December 1941 because Pearl Harbor had never been attacked before. Models look backward, not forward. I think the Fed grew too trusting and too complacent. You compare Angelo Mozilo, the CEO of Countrywide Financial, and his stand on subprime loans to Michael Milken in the junk bond era. This is a very important point, because its not just Mozilo and Milken — the theme of lending to the masses and seemingly nurturing a new era of prosperity runs through so many speculative eras. But to take those two, Milken, in the junk bond era of the 1980s, said lend to everybody — every company that is. The pitch was that not just investment grade companies, but every company, should be credit-worthy. So he peddled their bonds. And Mozilo, as he built his mortgage empire, believed that every individual, even subprime borrowers, should get a mortgage. In fact, he said even people who put no money down should get a mortgage. And pretty soon, they were. Its a very American ideal — sharing the wealth, democratizing capital. In 1929, a financier named John Jakob Raskob wrote an article in the Ladies Home Journal entitled, “Everybody Ought to be Rich.” He was arguing for broader participation in the stock market. It was a nice idea. But the market crashed two months later. It was built on leverage and speculation as opposed to real, enduring values. Same thing in recent times. Milken and Mozilo each believed that a stressed-out borrower could always work their way of a jam by refinancing — i.e., by borrowing from someone . But of course, this is merely passing the bad coin. At some point, the game stops and if the borrower isnt solvent they go down. You go into detail in your book about how Moodys and other rating agencies work. What do you think that people will be most surprised to learn about Moodys and its role in the crisis? Its the basic fact of how they are compensated — that the rating agencies were paid by the people who were designing the securities. So, say, Wall Street firms that wanted to sell mortgage bonds would go to one of the big agencies and request a rating. And if they didnt like the result, they didnt have to pay a dime; they could go to a competitor agency. So imagine the pressure on a Moodys, an S&P, a Fitch, knowing they only got paid if they pleased the client. It was a system designed to fail. I say in the book it was like trusting taverns to set the drinking age. Also, I think, its surprising to learn just how the Wall Street firms hands, helping the banks structure bonds in a way that would guarantee them the desired ratings. If you had to pinpoint one fatal error made by Wall Street leading up to the 2008 financial collapse, what would it be? The firms borrowed too much money — way too much. We expect that banks will make mistakes; everybody does. But leverage magnifies the impact of the mistake. It takes away your cushion. If youre in a car accident and youre doing 30 m.p.h., you have a lot better chance of surviving then if youre doing 60 m.p.h. Well, leverage is the great accelerator of the financial system. And the big Wall Street banks were effectively doing 80 or 90. What is your biggest criticism of Paulson and Bernanke? As a Fed governor, before becoming chairman, Bernanke was very cavalier about the hyper-stimulative effect of low interest rates. He bought into the Greenspan doctrine of easy money, and of refusing to “prick” speculative bubbles. Bernanke was the countrys top banking regulator and he didnt realize that bankers had, in effect lost their heads; they were dishing out mortgages without any basis in economics. Later, as the crisis was brewing, Bernanke was very late to grasp the severity. Paulson was as well. Also, I think that after they were criticized for letting Lehman fail, both regulators got hooked on the bailout response. The number of bailouts was stunning, and it has greatly contributed to the presumption of a too big, or too important, to fail mentality that we are struggling to break today. But we shouldnt forget that Paulson and Bernanke also did many things right. They were dealing with an unprecedented financial storm. Many believe that Paulson reversed his no-bailout policy in the case of AIG to save Goldman Sachs. You argue that this is not true. This is a red herring and a pretty despicable one. Paulson was operating on the fly for months on end. He wasnt sleeping, he was puking in the office restroom from stress. No Treasury Secretary ever dealt with as many crises in as short a time period as he. He certainly made plenty of questionable moves, and plenty of good ones. But he was operating from the right motives. I say that from knowing him and from looking at the facts. Goldman (as documented in the book) was not at risk — or not thought to be at risk — when AIG went down. And the September bailout didnt save Goldman a whole lot in any case. What the conspiratorialists do is overlay, in retrospect, very fine theories and motives on actors who were basically operating in panic mode. I looked at what it was like for them, as human beings, in real time. And they were freaking out. They had decided to let Lehman fail and only a day and a half later the financial world was in full-scale meltdown. And AIG was far bigger, and far more complicated, than Lehman. The thought of a second and worse bankruptcy was intolerable. I said the worst mistake was leverage, and therefore the most critical step is limiting leverage. If that were done, even if banks were to make new mistakes — and they will — the impact would be less severe. Restricting leverage necessarily involves getting a handle on derivatives, which are tools for assuming financial risk in an off-balance sheet form, so that not just traditional borrowing but also exposure off-balance sheet is regulated. And the government should think hard about whether some of these derivatives, such as credit default swaps, are necessary or beneficial — or on a net basis do more harm than good. Another step is reforming the credit rating agencies. Another is dealing with the mentality that government bailouts will always be available — which encourages investors to lend to unworthy or shaky firms. The best remedy, I think, would be to prevent regulated banks from acting like hedge funds or otherwise taking on too much trading risk. Finally, the Fed, I really believe, should abandon the Greenspan-Bernanke doctrine and admit that part of its mission should be to temper asset bubbles. document.writeln( document.writeln(

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