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.
Now Charles Koch was boring into him with question after question, and Franklin realized that the CEO wasn’t just necessarily concerned about the market forces at play behind Franklin’s losses. Charles Koch was trying to determine Franklin’s character. He seemed interested in making sure, above all, that he could trust Franklin to carry on trading. Were Franklin’s losses the result of hubris or short-term greed? Was Franklin trying to dodge responsibility or shade the truth? Franklin explained his reasoning behind the trades he made, his understanding of interest rates and currency markets, and why he believed that Koch should stay in the business of trading there.
The one thing that Franklin did not observe in Charles Koch was panic. There was nothing desperate in the way Charles Koch was questioning the team from Houston. He was questioning what Koch’s future trading strategies should be, and didn’t seem flustered by the amount of money they’d already lost. At one moment, Charles Koch simply went silent. “I do remember Charles Koch at one point, at the end of the meeting, kind of just sitting there and thinking . . . you know, processing if he was going to allow us to go on,” Franklin recalled. “He was essentially weighing what was he willing to invest, based on his confidence.”
During the weeks of the crisis, others who worked with Charles Koch saw him behave in the same way. He seemed calm and analytical. He wasn’t shaken, as he had been after the collapse of Purina Mills. He wasn’t despondent, as he was back in the early 1970s, when he worried that the OPEC embargo might sink his company. He was steady now, during the greatest economic crisis since the Great Depression. Charles Koch seemed to view the unfolding calamity as if it were a massive trade. He was weighing what he was willing to invest, weighing what he needed to cut.
A senior employee named Jeremy Jones came into frequent contact with Charles Koch during this period. Jones was an engineer and financier from Boston who was running a venture capital group inside Koch Industries, called Koch Genesis. The small venture was the kind of thing that was near and dear to Charles Koch’s heart. Jones and his team found new technologies for Koch Industries to invest in, such as biofuels and nanomaterials, that could provide the company with years of growth. Now that the horizon was on fire, it was time to retrench rather than expand. Charles Koch seemed to make that shift effortlessly.
“He goes back to his core thinking of: What’s our point of view around what’s going to happen? How long is this downturn going to take? How is that going to affect people’s buying patterns?” Jones recalled. “And how long is it going to take—given this housing crisis—to get through this deleveraging?”
If Charles Koch was more confident in his company’s future, he had reason to be. The company he oversaw in 2008 was larger, more diverse, and more adaptable than it had ever been before. It was built to withstand market shocks. Some divisions were hit hard, such as Koch’s building products divisions and its carpet fiber factories. But other divisions fared much better, such as its oil refineries and trading desks. The financial pain was very real, but there never seemed to be any doubt that Koch Industries would come out the other side as a healthy and profitable enterprise.