i COPYRIGHT © 2012 JEFF CONNAUGHTON All rights reserved. No portion of this book may be reproduced in any fashion, print, facsimile, or electronic, or by any method yet to be developed, without express written permission of the author. Published by PROSPECTA PRESS P.O. Box 3131, Westport, CT 06880 (203) 454-4454 www.prospectapress.com For information about permission to reproduce selections from this book, write to: Anderson Literary Management LLC 12 W. 19th Street, Second Floor, New York, NY 10011 (Attention: Permissions Department) Book design by Barbara Aronica-Buck Cover design by Carly Schnur Paperback ISBN: 978-1-935212-96-6 E-book ISBN: 978-1-935212-97-3 First hardcover printing: September 2012 First ebook publication: August 2012 Printed in the United States of America FIRST EDITION 10 9 8 7 6 5 4 3 2 1 ii To my parents iii CONTENTS PROLOGUE.................................................................................................................v 1: THE ACCIDENTAL SENATOR ........................................................................1 2: HUNTING FOR FINANCIAL FRAUD ..............................................................9 3: “PLEASE STAY INVOLVED IN POLITICS” ..................................................17 4: WHERE ARE THE CASES? ..............................................................................36 5: LEHMAN AND WAMU .....................................................................................43 6: WHAT HAD GONE WRONG? .........................................................................47 7: WALL STREET VETOES THE PRESIDENT ................................................57 8: INSIDE THE INFLUENCE INDUSTRY .........................................................67 9: CAPITAL OF HYPOCRISY ................................................................................77 10: THE BLOB ..........................................................................................................92 11: THE RISE OF THE MACHINES ..................................................................100 12: THE FLASH CRASH ......................................................................................108 13: WATERLOO .....................................................................................................119 14: BATTLING THE MEGABANKS ..................................................................127 15: STILL TOO BIG TO FAIL .............................................................................149 CONCLUSION........................................................................................................161 EPILOGUE...............................................................................................................166 ACKNOWLEDGMENTS......................................................................................176 ABOUT THE AUTHOR.........................................................................................177 iv PROLOGUE IN DECEMBER 2007, less than a year before America’s financial crisis, I had no special reason, despite my experience, to know what lay ahead. At the time, I was serving as a volunteer in Joe Biden’s presidential campaign in Waterloo, Iowa. An apt place, I thought, for what I knew was my last stand for Biden, for whom I had worked on and off for twenty-three years. Presidential campaigns are often exercises in self-delusion, for the candidate and his supporters, but up to the finish I could still convince myself, at least occasionally, that my old hero had a chance, despite what the world was telling me. I distinctly remember the day when Ted Kaufman (Biden’s long-time chief of staff and my former boss in Biden’s Senate office) and Beau Biden (Biden’s oldest son) gave a passionate pitch on a conference call from headquarters to sixty-eight political captains across our region. After the call, I told Ted—a wise and savvy political veteran—that for a second he even had me believing him. “In a presidential campaign, you’re either faking it or you’re dead,” Ted said. The faking came to an end when only six people stood in the Biden corner on caucus night at the high school I was monitoring. Barack Obama had nearly eighty, Hillary Clinton about sixty. Elsewhere in the state, Biden’s defeat was equally crushing. Afterwards, I left the campaign to fly to Costa Rica, where I was thinking about building a house, to recharge. My architect and a developer joined me for dinner at a hotel restaurant in Punta Islita. Both were Americans, each a few more years into middle age than me. We had barely ordered dinner when the developer said he had just returned from New York City where he was involved with the loan committees of Merrill Lynch and Lehman Brothers. “Both companies are technically insolvent.” Startled, I put down my glass. “What? I don’t believe it.” This was two months before Bear Stearns began to falter and fail. “If that’s true we’re all in a world of shit,” I said. I remember my words exactly. I couldn’t believe what the man was saying. I’d been trained in business and law school to believe that corporate governance worked. Even though I knew Wall Street held Washington in a perpetual half nelson, I still believed our laws would prevent hidden catastrophes and v blatant fraud. Our system is based on full disclosure of independently audited financial statements combined with oversight and enforcement from the Securities and Exchange Commission. How could it be that two major Wall Street firms were “technically insolvent” but the world didn’t know about it? The developer went even further: “I predict we’re going into a three-year recession.” I was flabbergasted. This man had just stepped off a plane from New York, where he was connected at the heart of the world’s financial center, and he was telling me that we were headed toward an economic disaster. Rather than take the tip and modify my investments, I argued with him that it couldn’t be true. My own stock portfolio was globally diversified, and I thought, at worst, the market might face a 10 percent correction. Then Bear Stearns failed in March 2008. The markets began to gyrate. Still, our government leaders continued to make reassuring statements. I came to believe that the economy and stock market might be heading for a significant pullback, but considered it nothing to lose sleep over. I should’ve known that the legal and regulatory system meant to protect us had rotted away. For more than twenty years, I’d seen up close how Wall Street manipulates government, the revolving door, the shared mindset, how siding with the Establishment is almost always the best career move. I had started my career on Wall Street before moving to Washington in 1987 to work on Biden’s first presidential campaign. I had worked on Capitol Hill and walked by Wall Street lobbyists camped in the hallway. As a lawyer in the White House, I’d personally seen President Bill Clinton steamrolled by Wall Street (and by its biggest booster, the most Machiavellian of United States senators, Chris Dodd) circa 1995. Dodd had led Congress to overturn President Clinton’s veto of the Private Securities Litigation Reform Act, which he and the republicans had drafted to gut the class-action securities-fraud laws. It was the only Clinton veto given the back-of-the-hand by two-thirds of Congress. And it was my first taste of how Wall Street had come to own Washington. I understood Wall Street’s methods of seducing senators, members of Congress, and regulators because I’d done it myself as a lobbyist. After I left vi government, I practiced appellate litigation, but soon drifted into a legislative and regulatory law practice with Jack Quinn (former White House Counsel and, before that, Vice President Al Gore’s chief of staff). A few years later, Jack and I co- founded Quinn Gillespie & Associates with Ed Gillespie (former House Majority Leader Dick Armey’s communications director and later chairman of the Republican National Committee). It went on to become one of the most successful—and profitable—bipartisan public affairs firms in Washington. For twelve years, I developed and implemented legislative and regulatory campaign strategies for corporate clients, including broker-dealers, banks, accountants, insurance firms, and Silicon Valley. During my years as a lobbyist, I made a big pile of money, enough to have a house in Georgetown, a speedboat on the Chesapeake, and soon—I hoped—an oceanfront home in Costa Rica. For Biden people, whose hopes had been crushed during the primary season, the 2008 Democratic Convention was surreal. After all those decades, all those conventions Biden had attended, all the work we had put into two presidential campaigns—for naught—and then Barack Obama wakes up one day and says to Joe, “You’re going to be the vice presidential candidate.” The night of Biden’s acceptance speech, the convention suite was a scene of triumph for Biden’s family and long- standing supporters. All of a sudden, Joe Biden, Jill, their children Beau, Hunter, and Ashley, and their families, were all on the stage. It was the party of a lifetime. Outside the convention hall, fewer were celebrating. In fact, the festivities were about to end. After a summer of Lehman Brothers executives publicly assuring investors that their company was sound, the end came: On September 15, 2008, Lehman Brothers declared bankruptcy, causing the Dow to plunge. My conversation in Costa Rica hit me like an anvil. The developer clearly had been right, apparently privy to inside information that should’ve been shared with the world. How could that have happened? In hindsight, I wished he’d reached across the dinner table, grabbed me by the lapels, and said, “I know you just met me, but think hard about this: I just came back from meetings at Merrill Lynch and Lehman Brothers. Both firms are technically insolvent. Believe me, you need to act. Sell everything you own before it’s too late.” vii The two months that followed the Lehman bankruptcy were a financial catastrophe for the country (and for me). Obama and Biden were elected in a climate of economic fear. And I strongly suspected that at least a few Wall Street insiders had known it was coming. By the Friday after Election Day, 2008, I was back on board with Biden, taking the train to Wilmington for a meeting with the Vice President-Elect to discuss the transition. I was lugging eight copies of a massive VP Bible, a comprehensive manual for establishing and running a vice-presidency, which Ted and I had put together. It included organizational charts, budgets, schematics of office space in the Old Executive Office Building, and descriptions of previous VP models. (Walter Mondale was credited with defining the modern vice presidency, as Jimmy Carter had empowered him to play an advisory role in virtually every area; Dan Quayle had carved out a couple of areas of responsibility for himself; Al Gore was considered a hybrid, involved in all decisions, but also taking the lead on environmental, telecommunications policy, and reinventing government.) Sitting at the table with the Vice President-Elect were his wife, Jill, as well as loyalists such as Ron Klain, Mike Donilon, Mark Gitenstein, Tony Blinken, Dennis Toner, Ted, and me. Biden had committed a gaffe in the final days of the campaign, saying it was likely that a country hostile to the United States would purposely take action to test Obama’s foreign-policy mettle in the first six months of his presidency. Biden told us that Obama had called him and told him sharply that he didn’t need public tutoring: “I don’t need you acting like you’re my Henry Higgins.” Biden said his private reaction was, “Whoa. Where did this come from? This is clearly a guy who could restrict my role to attending state funerals or just put me in a closet for four years.” Biden added: “I’m going to have to earn his trust, but I’m not going to grovel to this guy. My manhood is not negotiable.” It was heady stuff for me. We turned to a discussion of the inaugural and who should be in charge for the Biden team. Ted suggested me, without any prior discussion with Biden or the group. I knew immediately that because I’d been a lobbyist, this notion was unlikely to stand for long, though no one wanted to embarrass me in front of the group. Biden simply turned to me and said, “Okay, Jeff, but I want you to promise that viii you’ll listen to me on all decisions. Some guy who picked me up when I was hitch- hiking might mean more to me than someone who raised $100K, do you get what I mean?” I assured him I’d defer to him on all those decisions. I suspected that Biden saw me fundamentally as a fundraiser who would give undue precedence to those who had helped raised money. I was right. Obama’s anti-lobbying jihad, which had begun during the campaign, returned with renewed fervor in the early days of the transition. My days in the Biden inner circle looked numbered. John Podesta, whom, oddly enough, I’d met twenty years earlier when he was lobbying me, was head of the transition, and he announced publicly that no one who had worked as a registered lobbyist in the past two years would be welcome in the Obama administration. If we lose good people because of this, he said, “so be it.” Soon, Ted asked me to lunch. Before he could get out a word, I said, “Let me have the dignity of resigning as chair of the Biden inaugural team before you dismiss me.” It was even worse: I was off the transition team entirely. It didn’t seem fair. Biden had never helped me once as a lobbyist, yet I was paying the price. “I have the perfect solution for you,” Ted said. Biden had suggested that Ted take his place in the Senate for the two years before Delaware would hold a special election. That was truly great news. Ted had advised Biden during his entire Senate career, and for almost twenty years had taught a course about Congress at Duke Law School. “Ted, you’ll be a great senator,” I said. Ted went on to say that if he became senator, he wanted me as his chief of staff. That didn’t really come as a surprise. More than twenty years ago, during my first Biden campaign, someone had described me as “a tool of Ted’s will.” I’d long been Ted’s implementer-in-chief. The two-year term did have a simple elegance to it. I was excited, suddenly a believer once more. And I had a mission from the beginning. I was livid about the financial crisis and Wall Street’s role in it. Ted was too. The economy was imploding because of Wall Street excess (and likely: malfeasance), and in the run-up to the financial meltdown the ruling class in Washington had done nothing to stop it. My newly acquired wealth had already been cut by more than a third. I was ix