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Hammond had very good reason to believe that he could change things as an IBU labor negotiator. During the 1990s, the IBU had folded itself into a very large and very militant union called the International Longshore and Warehouse Union, or the ILWU. Everyone knew the ILWU simply as the “Longshoremen,” and they were arguably the strongest union left in the United States. The IBU office was now located in the Longshoremen’s union near the Georgia-Pacific warehouse. Outside the union hall, a stone obelisk was etched with the Longshoremen’s insignia: a fist enclosed around a cargo hook that looked like a medieval weapon. And above the hook, etched in stone, was the Longshoremen motto: “An Injury to One Is an Injury to All.”
Hammond ran for election to become the IBU’s “patrolman,” meaning second in command to the union’s regional director. To his shock, Hammond won the election narrowly. It would be up to him, now, to take on Koch Industries and turn back some of the changes that had been so punishing to the warehouse workers. “I think people just hated themselves for working there,” Hammond said. “I felt like . . . I was gonna try and help. I just kind of wanted to see if there was something I could do, to where people didn’t feel sick coming to work all the time.”
While Steve Hammond prepared to do battle with Koch in late 2008, the battlefield around him changed. A convulsion tore across the economic landscape and shattered the structures that had stood there before. Everything would be different in its wake. It was the worst downturn to hit the economy, and Koch Industries, since the Great Depression. And there was every indication that Charles Koch was not ready for it.
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I. That’s equal to about $30.93 an hour in 2019 dollars.
II. Some foreman jobs at Georgia-Pacific were held by union members, even though a lot of the functions they performed were managerial. These positions would become fewer over time.
CHAPTER 17
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The Crash
(2008–2010)
During the summer of 2008, David H. Koch was in a charitable mood. He had good reason to feel optimistic and generous. David and Charles Koch split their shares of Koch Industries down the middle, with each brother owning a little more than 40 percent of the company. During the preceding decade, their fortune had swelled. In 2002, David’s half of the family fortune was worth roughly $4 billion. By 2008, it was worth roughly $19 billion. The size of this sum was difficult to comprehend. If a person earned $300 an hour and worked full-time, with no vacation, he or she would need to work 30,449 years to earn $19 billion. David Koch had come by the amount in one short lifetime.
And unlike his brother Charles, who stayed back home in Wichita and worked long hours in the Koch Tower, David Koch was inclined to enjoy his fortune. He moved to New York City and became a luminary in the rarified social scene of the very wealthy and the very famous. He attended the opera and gallery openings. He supported the ballet and lived in one of the most expensive apartments in the city. When he sold one apartment and bought another, it made the newspapers. In a city that was home to almost incalculable wealth, David Koch was likely its richest resident. And he was inclined to share his good fortune.
In October of 2007, David Koch gave $100 million to the Massachusetts Institute of Technology, his alma mater and that of his brothers and father. The money founded a cancer research center, a cause that was dear to David Koch’s heart after his own successful struggle with prostate cancer. David Koch gave $20 million to the American Museum of Natural History for a new wing to display dinosaur bones. He gave $20 million to the Johns Hopkins School of Medicine, in Baltimore, also to study cancer.
Then, in July, David Koch made a donation that grabbed national attention. He gave $100 million to the New York State Theater, a grandiose building in Manhattan that was a social hub of the city’s high society. The theater hosted some of the prime events of elite social calendars, nights when David Koch and his wife, Julia, joined the other prominent couples, attired in tuxedos and gowns, to laugh and share small talk in the lobby before they were seated to enjoy the New York City Ballet or the New York City Opera at Lincoln Center. Now, the theater would be called the David H. Koch Theater.
David Koch had plenty of latitude to make such charitable gifts. The New York Times reported that the gift to the State Theater amounted to roughly one-half of 1 percent of David Koch’s wealth, but even this overstated the size of the donation. The gift would be made over a period of ten years, which meant that it really represented a small fraction of the money that David Koch earned from the interest on his fortune—something akin to a microtithe. He could make such gifts without concern that it would substantially diminish his wealth.
During the summer of 2008, there was good reason to believe that David Koch’s wealth was poised to grow even more. In the preceding eight years, Koch Industries had transformed from a midsized natural resources company into a diversified industrial conglomerate and private equity house. Charles Koch had believed during the 1990s that his company could become a giant. During the 2000s, he proved that he was correct. It is true that the foundation of Koch Industries’ profits still rested on the fossil fuel business. The refinery in Pine Bend remained a reliable fountain of cash that kept the rest of the system flush with money to invest. The fuel pipelines and the Corpus Christi refinery also contributed a steady stream of profits. But Koch also owned Georgia-Pacific, Invista, and one of the largest and most profitable nitrogen fertilizer companies in the United States. Its trading desks in Houston, New York, and London rivaled those of any investment bank. Koch’s growth was not slow and steady—it was seismic, with periods of steady advancement that were punctuated by great lurches forward. Charles Koch had claimed to crack the code of creating prosperity, and the wealth machine he built now seemed unstoppable.
David Koch gave interviews to the media, and he was effusive and benevolent in his remarks. It seemed that he was ready to give even more. He told the Times how he was inspired by one of his neighbors, the billionaire private equity titan Stephen Schwarzman, who had recently given a gift of $100 million to the New York Public Library. “I admire people like that immensely, who have great wealth but are generous in terms of supporting worthy causes,” Koch said.
This era of goodwill, this summer of giving and plenty, turned out to be the high point of American economic life. This was the crest of the wave after a decade of growth. Nobody knew this at the time, but the wave was about to crash. There were signals of trouble even in July of 2008. Oil prices were high, the housing market was slowing down, and a big investment bank had just failed. But only in retrospect would people realize just how good things were at that time. Things would not be that good again in America for at least another decade.
The first signs of trouble were detected by traders in Houston, on Koch’s trading floor. It was difficult, however, to piece together the bigger picture from these early signals. First came the unmistakable signs of weakness in the housing market. Orders started to slow at Georgia-Pacific, which churned out plywood, insulation, and gypsum building panels that were installed in new homes and buildings around the country. Even as early as 2006, the market was slowing. By 2008, it seemed as if new home construction was grinding to a halt. Gasoline prices were rising too high, too quickly, and the market was growing white-hot as speculators pushed up prices because of demand from China and other developing nations. In 2007, crude oil was trading for less than $60 a barrel; by July of 2008, it was trading for a record $145 per barrel. The extraordinarily high prices forced consumers to ration their use, pushing down demand and cutting into Koch Industries’ sales of gasoline. As consumers cut back their spending, it hurt retailers and restaurants.
More lights started flashing red on the trading screens during the late summer weeks. By then, many people were predicting a recession. But very few predicted the true extent of what was about to happen.
Cris Franklin, the young trader in Houston, watched it unfold. By 2008, he was working on a trading desk call
ed the FXIR, or Foreign Exchange and Interest Rates. As such, he spent his days in the vortex of international finance and had a front-row seat as those markets seized up. While Franklin did not work with Koch’s large stock-purchasing desk—the entity that bought and sold millions of shares of stock in companies around the country—he was later able to review data from that operation. It was almost sad, in retrospect, to see what unfolded in those numbers.
“There were warning signs, in hindsight,” Franklin recalled. “Afterwards, being able to look at the price action of their trading strategy . . . that’s a clear sign that the market was unwinding its risk over a period of time before the crash took place.”
The risk, as it turned out, was everywhere.
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The risk extended all the way into the foundation of the economic system—the households occupied by working people like Steve Hammond and Travis McKinney at the Georgia-Pacific warehouse in Portland. These households had not seen a significant pay increase for many years, but they continued to increase their standard of living in line with what they expected it should be. The gap between what they earned and what they spent was met with debt. The amount of US household debt exploded between 2000 and 2008. At the beginning of the decade, the total household debt was equal to about 100 percent of the entire nation’s annual gross domestic product, meaning the value of everything created in the economy that year. By 2008, household debt was about 140 percent of the GDP. It was difficult to find any comparable debt increase in the nation’s history.
Most of this debt was carried in the form of home mortgages. The mortgage had once been the cornerstone of a household’s wealth. Home prices were once thought to obey a simple law, rising incrementally and permanently. But during the 2000s, home prices pulled away from the course of incremental growth and ballooned. This was driven, in large part, by the Federal Reserve, which kept interest rates at a historically low level for a historically long period of time. The cheap interest rates made it much easier to borrow money for a home, and a whole industry sprung up to feed the new demand. Companies like Countrywide Financial sent agents out into every corner of the country to find any customer who might be willing to sign mortgage papers. The loans became exotic and loosely governed. People signed on the line without thinking through what the complex financing terms might mean down the road. This was the era of teaser rates and balloon payments and interest-only adjustable-rate mortgages. The deluge of cheap money and easy loans inflated a circus tent above the once-sleepy real estate industry and turned everybody into a speculator.
This alone might not have destroyed the economy. But it was coupled with the shift of financial trading into the black box of a shadow banking system. When people borrowed mortgages, for example, those loans were instantly sold off to a financial trader somewhere, rather than being left to sit on the balance sheet of a bank. Then the loans were packaged into complicated debt structures, such as collateralized debt obligations, or CDOs, that were bought and sold. The CDOs, in turn, became a fertile resource to make yet more money as traders bought and sold a type of insurance on CDOs called a credit default swap. All of these financial instruments were essentially just varied forms of the derivatives contracts that Brenden O’Neill learned how to trade when he joined Koch Energy Trading in Houston. O’Neill made millions buying calls and puts, but in the world of shadow banking, his trades were considered conservative. Across the globe, countless options contracts and derivatives agreements were traded, based on the underlying value of home mortgages, consumer credit card debt, and even the debt of corporations like General Electric.
All of these derivatives bets were opaque. They were often made during a phone call between two people, and the nature and size of the derivatives bet were recorded in secret, only by the two parties. This did not happen by accident. The derivatives market was built in very much the same way that Steve Peace helped build California’s electricity trading market back in the 1990s. It was built by overworked legislators, working in bland hearing rooms, writing complex legislation that was bird-dogged at every step by well-paid lobbyists.
In the late 1990s, a Clinton administration regulator named Brooksley Born, who was head of the Commodities Futures and Trading Commission, argued that derivatives should be regulated by the CFTC and traded on transparent exchanges. She was effectively shouted down by Clinton’s Treasury secretary, Robert Rubin, who was a former trader with Goldman Sachs, along with Rubin’s deputy Larry Summers and Fed chairman Alan Greenspan. Born was painted as an unsophisticated Washington insider who didn’t quite understand the benefits of modern finance, in much the same way that early critics of California’s power trading system were criticized for not understanding the benefits of allowing Enron and Koch to trade electricity by the megawatt-hour.
The financiers and their advocates won out in both cases. The Clinton administration ensured that the derivatives market would remain dark, outside the view of regulators and exchanges, when it passed the Commodity Futures Modernization Act of 2000, which exempted derivatives from CFTC oversight. The functioning of the derivatives market was left to the best judgment of whoever made the bets. The black box financial system swelled during the 2000s. In 1992, there was roughly $11 trillion worth of derivatives contracts, according to the estimate of one industry trade group. By 2001, there was $69 trillion worth of derivatives. By 2007, there was $445 trillion.
In late 2008, nobody knew what liabilities had been accrued by anybody else. People were making derivatives bets over the phone and being left to guess what other bets their counterparty might also be making. A derivatives bet removed a certain kind of risk called price risk—it gave you a kind of insurance against wild price swings in the market. But it introduced a deeper kind of risk that people overlooked, called counterparty risk, meaning the risk that whoever took your derivatives bet might go broke before they could pay their obligation.
This is what led to the panic. Counterparty risk became an unquantifiable and lethal force that detonated randomly across the globe. The most spectacular detonation happened inside the opaque trading structure of the Wall Street firm Lehman Brothers. That company had amassed enormous holdings in CDOs and other mortgage debt. But that wasn’t even the worst of it.
Lehman was using the CDOs and other mortgage products as collateral to borrow huge amounts of money. This debt was in the form of overnight loans, called repurchasing agreements, or repo loans. Wall Street firms like Lehman counted on repo loans to stay in business; they used the borrowed money to keep the lights on. Companies felt comfortable making these overnight loans because there was collateral to back it up. But panic set in when people realized the collateral might be worthless. The overnight loan market froze up, and Wall Street investment banks didn’t have money to stay open.
Lehman Brothers declared bankruptcy on September 15, 2008. And then the true panic began. The overnight repo loan market froze. The value of CDOs plummeted, which triggered billions in credit default swap payments that companies didn’t have the cash to meet.
The losses on Cris Franklin’s trading desk were enormous. But they weren’t the kind of losses that might drag Koch Industries down with Lehman Brothers. Charles Koch had built a large trading operation, but he had built it according to his conservative philosophy. A framework of strict limits was placed on the size of bets that traders were allowed to make. Cris Franklin and other traders frequently met with risk control officers, who made the traders walk through the nature of their positions, analyzing how deeply things could go bad in the worst-case scenarios. The traders were only allowed to bet up to a threshold called the “value at risk” limit, or VAR. The traders knew their VAR, and they knew that there was no surpassing it. It was a red line that could not be crossed. The VARs limited Koch’s upside when the market was rising, but now they protected the firm during the crash. Koch had built moats around the trading desks, and now those moats protected it from a wildfire.
But even with the VARs
in place, Franklin’s team lost money. There was no way to unwind the trades quickly enough to avoid losses. In a short period of time, Franklin’s team had hit their “drawdown limit,” meaning that they had lost all the money they were authorized to lose. Franklin was informed that Charles Koch would personally decide whether to shut the team down or to authorize it to keep trading. To keep the trading team intact, Koch Industries needed to invest more money. Before he put the money down, Charles Koch wanted to talk to the team members in person. Franklin was told that the team would be going to Wichita.
Franklin and his coworkers worked feverishly to prepare their presentation for Charles Koch. They flew to Wichita and were escorted into the black Tower. The mood inside was somber. It was remarkable how quickly things were moving during late September of 2008. Several years of economic growth were unraveling in a matter of days. Hundreds of thousands of jobs were disappearing. Hundreds of billions of dollars in wealth were being immolated. Days after Lehman Brothers collapsed, the last two investment banks on Wall Street disappeared when Goldman Sachs and Morgan Stanley were transformed into bank holding companies.
Franklin’s entourage was led to the boardroom. They took their seats around the big wood table in the windowless chamber. Charles Koch sat at the head of the table and invited the trading team to explain why it should continue to exist. Franklin didn’t expect to do much talking, but shortly into the meeting, Charles Koch started directing questions down the table toward him. Franklin is soft-spoken and straightforward in his manner. He was tense during the meeting, but tried his best to answer each question thoroughly and succinctly. He was shocked that Charles Koch was speaking to him at all—the CEO billionaire seemed like he might have bigger things to worry about. Franklin had only met him a few times, once before during a meeting in Wichita under much happier circumstances. Franklin didn’t think he had spoken one word during that first meeting, and so he was shocked afterward when he ran into Charles Koch, who looked at him and quickly said: “Hi, Cris!” Franklin hadn’t remembered even telling Koch his name.