Wall Street Crisis: Stephen Scwarzman Explains It All

Mark Cuban suggested this month that some enterprising author write a book called “No One Has a Clue What Is Going On and the Whole World Is Guessing.” His comment captured the spirit of barely controlled chaos around the markets after Labor Day, even before Lehman Brothers Holdings, American International Group, Merrill Lynch, Morgan Stanley and Goldman Sachs Group were making their guest-star appearances in the financial tumult.

Even thought it isn’t possible to know what is happening now, there are some people who have a pretty good grip on the history. Take Stephen Schwarzman. The chairman of Blackstone Group was part of an impromptu roundtable of roughly 30 finance luminaries at the Waldorf-Astoria Tuesday afternoon hosted by the Yale School of Management and co-sponsored by The Wall Street Journal.

Schwarzman kicked off the audience-participation segment with a nearly all-in-one-breath summary of the causes and effects of the credit crisis. Deal Journal presents his verbal opus in its near-entirety below:

It’s a perfect storm. It started with Congress encouraging lending to lower-income people. You went from subprime loans being 2% of total loans in 2002 to 30% of total loans in 2006. That kind of enormous increase swept into the net people who shouldn’t have been borrowing.

Those loans were packaged into CDOs rated AAA, which led the investment-banking firms [buying them] to do little to no due diligence, and the securities were distributed throughout the world, where they started defaulting.

When they started defaulting, out of bad luck or bad judgment, we implemented fair value accounting….You had wildly different marks for this kind of security, which led to massive write-offs by the commercial banking and investment-banking system.

In the face of those losses…you needed to raise new equity…which came from sovereign-wealth funds in part, which then caused political resistance to sovereign-wealth funds, who predictably have withdrawn from putting money into the system….It seemed pretty obvious that would happen. We now find ourselves with a liquidity crisis where fundamentally the cost of money for financial intermediaries [such as investment banks] is significantly in excess of their cost of lending it. So several institutions found themselves in a structurally impossible position. We had a series of bankruptcies, whether Bear Stearns or Lehman, or forced sales like Merrill. Goldman reverted to a banking charter for a lower cost of funds, which today is still not low enough for the business.

So that’s the story of how we got there.

Schwarzman’s insights were in much demand during the two-hour roundtable, so much so that at one point, he laughingly objected, “why do I always get called on first?” People outside the room kept tagging him as well–he was the only participant to step away from the table and retreat to the corner of the room to take a call on his cellphone. And his PR man passed Schwarzman two notes during the roundtable.

All this activity during the otherwise placid discussion meant that our curiosity got the better of us. Why was Schwarzman receiving so many communiques? Were they talking points? Questions from Hank Paulson? Doodled hearts from Henry Kravis?

None of the above.

The first note, it turned out, was a reminder that Schwarzman was committed to an event elsewhere at the Waldorf, a dinner for Rabbi Arthur Schneier’s interfaith The Appeal of Conscience Foundation dinner honoring General Electric’s Jeffrey Immelt, France’s Nicolas Sarkozy and New York’s Michael Bloomberg. Schwarzman was doing the introductions. And the second note? A person familiar with the situation indicated it was pretty pithy: “Jill is waiting outside with your tux.”

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