Too Big to Fail

by Andrew Ross Sorkin

  But then Main concluded with a not-so-subtle dig at AIG and his past experience with the company. He pointed out that JP Morgan had a lot to offer but stressed that it was important that its clients recognize their own problems and shortcomings. Many in the room, including Dimon, were taken aback.

  “Forget Mr. Obnoxious,” Dimon said, cutting Main off. But the damage had been done, and the AIG executives were clearly upset, Willumstad finding the performance annoying while Schreiber thought it was offensive. After a few minutes they shrugged the comment off and resumed their talks with Dimon directly, as an embarrassed Main slumped in his chair.

  “Jamie, one of my concerns here is that there’s a higher probability now that we’re going to get downgraded,” Willumstad explained. “The rating agencies promised me they would wait until the end of September, but then the Goldman report came out and they got nervous,” he said, referring to an analyst report issued by Goldman Sachs raising questions about the firm. The report was so influential that Willumstad had received a call from Ken Wilson and Tony Ryan at Treasury to check up on the company.

  “Maybe you should just take the downgrade. It’s not the end of the world,” Dimon suggested.

  “No, this is not just a downgrade,” Willumstad insisted. As the company had warned in an SEC filing several weeks earlier, a downgrade would be very expensive. If either Standard & Poor’s or Moody’s lowered its rating by one notch, AIG would be required to post $10.5 billion in additional collateral; if both agencies lowered their ratings, the damage would soar to $13.3 billion. As part of its contract to sell credit default swaps, AIG was required to maintain certain credit ratings—or add new collateral to compensate—as insurance against its potential inability to pay out any claims on the swaps. AIG was now a AA-minus company, and it was facing a tab that was growing quickly. Its executives were estimating that the firm could soon be hit with demands for as much as $18 billion in additional collateral.

  Left unspoken was the fact that if AIG could not come up with the cash, bankruptcy was the only alternative.

  As Dimon saw it, this was a short-term liquidity problem. “You have a lot of collateral, you know, you have a trillion-dollar balance sheet, you have plenty of securities,” he told them. Yes, it could get much worse, but for now, it was just a temporary annoyance.

  “We do,” Willumstad agreed, “but it’s not that simple. Most of the collateral is in the regulated insurance companies.”

  By midyear AIG had $78 billion more in assets than it had in liabilities. But most of those assets were held by its seventy-one state-regulated insurance subsidiaries, which could not be sold easily by the parent company. There is no federal regulation or supervision of the insurance business. Instead, state insurance commissioners and superintendents have substantial powers to regulate and restrict an insurer’s asset sales. The responsibility of the state regulator at all times is to protect the policyholder. There was virtually no possibility that AIG would be able to raise cash quickly by selling some of these assets.

  Now Dimon finally understood the scope of the problem, as did everyone else in the room.

  Just as they were walking out, Dimon pulled Willumstad aside. “Listen, you don’t have the luxury of time,” he told him. “If it’s not us, get someone else, but you need to get on this.”

  The next day, Willumstad followed up on the meeting.

  “Jamie, this is only going to work if there is chemistry on both sides,” Willumstad began. “With all due respect, I know you guys have a lot of confidence in Tim Main, but the reality is, you saw what I saw.”

  Dimon knew exactly what Willumstad was about to say and interrupted him with, “Steve Black will handle it.”

  “Good,” Willumstad replied.

  “You got to plan on packing your clothes and coming up,” Ken Wilson told Herb Allison, the former Merrill Lynch and TIAA-CREF executive whom he located on a beach in the Virgin Islands on Thursday night and let in on the big secret: The government planned to take over Fannie and Freddie that coming weekend, September 6.

  It wasn’t just a social call, however; Wilson had phoned Allison to hire him as the CEO of Fannie. After all, if they were going to take over the company, they wanted to install their own management.

  “Look, Ken,” Allison told him. “I would like to. For reasons of public service, I’m interested in this job. I want to help you guys, and so you have to let me know what to do. I don’t have any clothes. All I have is shorts and flip-flops.” Wilson promised to buy him some clothes when he arrived in Washington.

  Paulson had decided to execute the takeover plan earlier in the week after a visit by Richard Syron, the chief executive of Freddie Mac. Syron, whom Paulson detested, told him that he had gone to Goldman Sachs’s headquarters to pitch potential investors but several days of meetings proved to be in vain: No one was willing to make a significant investment in the company. Paulson’s conversation with Dan Mudd, Fannie Mae’s CEO, whom Paulson liked better, still wasn’t inspiring.

  And so on the night of Thursday, September 4, Treasury began its battle plan.

  Like clockwork, the chief executives of Fannie and Freddie were instructed to attend meetings on Friday afternoon with Paulson and Bernanke at the offices of the Federal Housing Finance Agency. Mudd’s meeting would start at 3:00; Syron’s at 4:00. They were each advised to bring their lead director, but told nothing else. Paulson figured that by the time any of this could leak, the markets would be closed and he’d have forty-eight hours to execute his plan.

  That afternoon, dark rain clouds massed over the capital as Tropical Storm Hanna approached. In an upstairs conference room Bernanke took a seat on one side of James Lockhart while Paulson took his place on the other. At each meeting, James Lockhart began by telling the Fannie and Freddie executives and their lawyers that their companies faced such potentially great losses that they could not function and fulfill their mission. The FHFA, he said, reading from his prepared script, was acting “rather than letting these conditions fester.”

  The businesses would be put into conservatorship, he explained, and while they would still be private companies with their shares listed, control over them would be in the hands of the FHFA. Existing management would be replaced. There would be no golden parachutes.

  “I want to be fair, open, and honest,” Paulson told them. “We’d like your cooperation. We want you to consent.” But then he added, “We have the grounds to do this on an involuntary basis, and we will go that course if needed.” Syron capitulated quickly, calling his board and breaking the bad news to them.

  Fannie’s CEO, Daniel Mudd, wasn’t so easy. He and his lawyers retreated to Sullivan & Cromwell’s Washington office. The attorneys were furious, and Rodgin Cohen, usually an entirely self-possessed man, called Ken Wilson at Treasury directly and shouted, “Ken, what is going on here? This is bullshit!”

  When Fannie executives began calling around for support from lawmakers on the Hill they discovered that Paulson and Treasury had already secretly lobbied them on the wisdom of a takeover. For Democrats, the pitch was that the step had to be taken to keep the system of mortgage financing functioning, while for Republicans the emphasis was on the systemic risk that Fannie and Freddie posed.

  Fannie’s lawyers summoned all the members of the board to Washington for a meeting at the FHFA the following day. Treasury had made it clear that it wanted only board members present—Fannie could not bring its banking adviser, Goldman Sachs, to the gathering.

  At noon on Saturday the lawyers—Beth Wilkinson, Rodgin Cohen, and Robert Joffe of Cravath, Swaine & Moore, who were advising Fannie’s board—accompanied the entire thirteen-member board, who crowded into the same small room at FHFA as had been used the day before when Treasury presented its terms: It would acquire $1 billion of new preferred senior shares in each company, which would give it 79.9 percent of the common shares of each. The government would contribute as much as $200 billion into both companies if necessary. The terms w
ere nonnegotiable.

  The meeting ended quickly, and the Fannie directors left to deliberate. Wilkinson realized that she would have to cancel a birthday dinner she had planned for her husband, David Gregory of NBC News. Late that Saturday night the board of Fannie Mae finally voted to give its assent. Paulson was awoken at 10:30 that night by a call from Barack Obama, the Democratic presidential candidate. Earlier that day, on a campaign stop in Indiana, Obama had said about the Fannie and Freddie situation that “any action we take must be focused not on the whims of lobbyists and special interests worried about their bonuses and hourly fees, but on whether it will strengthen our economy and help struggling homeowners.” Obama and Paulson spoke for nearly an hour.

  After the takeover was announced on Sunday, there was palpable relief among the Treasury staffers who had been working on it for weeks. They had accomplished something that they were convinced would go a long way toward stabilizing the financial system. The markets would steady now that a major source of uncertainty had been removed. They had hit a home run.

  Paulson, however, still had one pressing concern: Lehman Brothers.

  Ken Wilson, with a free afternoon on his hands for the first time since he had started working for Paulson, left Treasury and walked to his apartment, and then to a pub in Georgetown to have dinner while watching a football game.

  That night he checked his voice-mail to find several messages from Dick Fuld.

  When he returned the call, Fuld told him how thrilled he was about the Fannie and Freddie news, hoping it would calm the markets. But he was distraught over the lack of deals available to him. The Korean situation seemed doomed. Bank of America was nowhere. Fuld said that the firm was planning to pursue a good bank–bad bank strategy, in which he hoped to spin off the firm’s toxic real estate assets into a separate company. Stephen Schwarzman, the co-founder of Blackstone Group and a former Lehman banker, had just had a blunt conversation with Fuld. “Dick, this is like cancer. You’ve got to lop off the bad stuff. You need to get back to the old Lehman,” he told him.

  Wilson, getting nervous that the spin-off plan wouldn’t be enough, told Fuld, “You have to really think about doing what’s right for the firm,” trying politely to suggest that he needed to sell the firm without actually using the word.

  “What do you mean?” Fuld asked.

  “If your stock price continues to slide, something might come out of the woodwork here with a price that doesn’t look that compelling. But you might have to take it to keep the organization intact.”

  “What do you mean, low price?”

  “It could be low single digits.”

  “No fuckin’ way,” Fuld said heatedly. “Bear Stearns got $10 a share, there’s no fuckin’ way I will sell this firm for less!”

  CHAPTER TWELVE

  The news started crossing the tape late Monday night, and by 2:00 a.m., it had been picked up by every wire service in the world: The Korea Development Bank was no longer a bidder for Lehman. “Eyes on Lehman Rescue as Korea Lifeline Drifts,” the Reuters headline screamed.

  Jun Kwang-woo, chairman of the Financial Services Commission in Korea, had held a briefing with reporters in Seoul that night and all but proclaimed that the summer-long talks with Lehman were dead: “Considering financial market conditions domestically and abroad, KDB should approach buying into Lehman at this point of time very carefully.”

  Dick Fuld, alone in his office on Tuesday morning, sat staring at his computer screens, fixated in an unmitigated rage. To Fuld the talks had long since ended. KDB had returned briefly with an offer of $6.40 a share, though Fuld didn’t think they were serious. But to the public, which had heard about a rumored deal, the news would come as a shock. Shares of Lehman dropped precipitously from virtually the moment the stock market opened.

  The timing of the report was especially embarrassing to Fuld in that it had come while Lehman was in the midst of holding its high-profile annual banking conference at the Hilton Hotel in Midtown Manhattan, just two blocks away from his headquarters. A CNBC van was parked out front to cover the second day of the event; Bob Steel, now of Wachovia, and Larry Fink, of BlackRock, were set to present that morning; Bob Diamond of Barclays Capital had spoken at the conference the day before.

  Bart McDade walked into Fuld’s office just after the market’s open, but before he could say anything, Fuld started shouting and pointing to the TV. “Here we go again,” Fuld said. “Perception trumping reality once more.” McDade politely turned his attention to the screen.

  CNBC’s headline warned: “Time Running Out for Lehman.” David Faber, the network’s seasoned reporter, elaborated on that theme, pointing out, “They need to do an awful lot between now and next Friday [sic], when the company reports earnings.” But then he added, somewhat prophetically: “Can they actually report the losses that are anticipated on Friday [sic] and simply say we’re continuing to review strategic alternatives? Perhaps they can, and perhaps they will have to. But there are certainly a lot of questions.”

  As it happened, McDade had come to speak to Fuld about precisely the subject that Faber had raised. McDade told Fuld he thought they should preannounce earnings before the scheduled earnings call next Thursday—maybe as early as the next day. “We have to settle things down,” he told Fuld.

  Fuld, nodding in agreement, said, “We’ve got to act fast so this financial tsunami doesn’t wash us away.”

  McDade’s overture to Fuld was, at least in part, Kabuki theater, for at this juncture, asking Fuld’s permission was simply a courtesy. McDade had already told Ian Lowitt, Lehman’s CFO, to get the numbers ready. He was also thinking of announcing the SpinCo plan—the good bank–bad bank plan—at the same time.

  Although McDade didn’t require Fuld’s blessing to release the numbers—he and his cohorts had already stripped Fuld of any real authority—he did need Fuld’s cooperation in leading the earnings call. For better or worse, he was still the public face of the firm, and his presence would be a key factor in helping to calm the markets.

  Given the complexities of their current situation, however, McDade was worried about Fuld’s emotional state. “I don’t know if he can do it. He’s under an enormous amount of stress,” McDade told Gelband before he went to see Fuld. From a public relations point of view, however, they had few alternatives, and McDade knew Fuld would want to lead the earnings call. Fuld wouldn’t have it any other way.

  Hank Paulson looked dispirited Tuesday morning as he walked into the main conference room across from his office in the Treasury Building, his team of advisers in tow: Tony Ryan, Jerimiah Norton, Jim Wilkinson, Jeb Mason, and Bob Hoyt. Their 10:00 a.m. meeting with Jamie Dimon and JP Morgan Chase’s operating committee had been set up weeks earlier as part of a series of all-day meetings the firm had scheduled to establish better relations with the government. That strategy that had been devised by Rick Lazio, a former Republican representative from New York, whom Dimon had hired as executive vice president of global government relations and public policy. Internally, JP Morgan’s operating committee trips to Washington were jokingly referred to as “OC/DC.” With the financial system teetering, Dimon knew that there would be calls for tighter federal regulation of Wall Street and wanted to make certain that he had shaken all the right hands well in advance.

  “Thanks for coming down here,” Paulson said somewhat sheepishly as he opened up the meeting. He was, in fact, still preoccupied with reaction to the takeover of Fannie and Freddie just forty-eight hours earlier. He believed that he had made exactly the right moves in orchestrating the affair, but investors hadn’t seemed to agree. Far from stabilizing them, as he thought they might, the markets seemed to be on the verge of tanking again.

  Perhaps most grating of all was the reaction from Congress. He was particularly upset with Senator Dodd, whom he had personally briefed on Sunday, soon after the announcement. Dodd, he thought, had tacitly signaled his support, but the following day had publicly mocked him, quipping that his re
quest for temporary powers—which Paulson had clearly indicated that he didn’t intend to utilize—was merely a big ruse. “[A]ll he wanted was the bazooka, he didn’t want to use it,” Dodd wryly observed to reporters in a conference call on Monday.

  “We certainly accepted him at his word that that was all that was going to be necessary,” Dodd said. “Fool me once, your fault. Fool me twice, my fault.” And then Dodd openly raised the question that until then had only been whispered around Washington: “Is this action going to produce the desired results, or are there other actions being contemplated?”

  Senator Jim Bunning, who had sparred with Paulson over the summer, going as far as to brand him a Socialist, was even more pointed: “Secretary Paulson knew more than he was telling us during his appearance before the Banking Committee. He knew that Fannie and Freddie were in an irreversible state of damage. He knew all along he was going to have to use this authority despite what he was telling Congress and the American people at the time.”

  Paulson had allotted less than an hour to the JP Morgan meeting, even though he knew how important it was to Dimon. “I’ve been trying to encourage opening up the lines of communication between Wall Street and Capitol Hill,” he now told the bankers, explaining that when he ran Goldman, he hadn’t “appreciated how important it was to establish the right relationships in Washington.”

  “Trying to get things done here ain’t as easy as it seems,” he said, his audience laughing at the clear reference to the nationalization of Fannie and Freddie.

  He asked Dimon what he thought of the move. Dimon, who had encouraged Paulson to pursue the conservatorship, responded positively but diplomatically: “It was the right thing to do. We could see just how big the problem was becoming over the weekend,” and added that it had become clear that certain Fannie and Freddie bonds wouldn’t roll on Monday. Dimon tactfully avoided mentioning the fact that the stock market didn’t seem to be steadying.