Too Big to Fail

by Andrew Ross Sorkin

  He was about to step down when he announced, “I’ve got time for one more question…the woman in the middle there,” he said, pointing to another reporter.

  The journalist asked him how he handicapped the health of the banking system today.

  “There are going to be some real rough spots along the road, but I believe we’re making progress. And when I look at the way the markets are performing today, I think it’s a testament to the way the financial industry has come together, because they’re dealing with an extraordinary set of circumstances and they’re dealing in a way we should all be proud of.

  “Thank you very much.”

  By midafternoon, chaos reigned in the conference room on the sixteenth floor of AIG, where more than a hundred bankers and lawyers, led by Goldman Sachs and JP Morgan, had assembled to begin conducting diligence on the company. The only problem was, no one there seemed to have any of the company’s actual numbers.

  “Is there anyone who works for AIG in this room?” a voice shouted out. When no one raised a hand a wave of nervous laughter swept the room.

  Finally, Brian Schreiber of AIG was summoned. Working on three hours of sleep, he looked as if he might have a breakdown right there. He took a moment to collect himself before beginning a presentation of the latest numbers. After he finished a less than inspiring performance, the core group from that morning at the Fed huddled in AIG’s boardroom.

  For a while it seemed as if progress was being made. Lee and Winkelried felt confident that AIG’s assets were strong, at least strong enough for them to lend against. What they believed the company was experiencing was merely a liquidity crisis: If they could provide AIG with a bridge loan, they’d be home free.

  The group started discussing drafting a preliminary term sheet. They’d try to raise $50 billion, in exchange for warrants for 79.9 percent of AIG. It was almost a punitive price, but given the insurer’s status, it might be their only alternative to bankruptcy. Winkelried and Lee also discussed the fees they would collect, which would be split between the firms. If they sought to raise $50 billion, that would leave each firm with a $1.25 billion fee for organizing the loan.

  As the group dispersed to return to the Fed to present their progress report to Geithner, Ruth Porat of Morgan Stanley, who was representing the Fed, pulled aside John Studzinski of Blackstone, who was representing AIG. They were old friends; Studzinski used to run Morgan Stanley’s mergers and acquisitions practice in London.

  “So, what do you think?” Porat asked.

  “What do you mean?” Studzinski replied. “I can’t tell from this meeting whether there’s going to be a term sheet or not.”

  “That’s not what I meant,” Porat replied. “We’re worried that these guys are going to try to steal the business.”

  “He was as useless as tits on a bull.”

  Bob Willumstad, normally a calm man, was in an uncharacteristic rage as he railed about Dan Jester of Treasury, while telling Jamie Gamble and Michael Wiseman about his and Jester’s call to Moody’s to try to persuade them to hold off on downgrading AIG.

  Willumstad had hoped that Jester, using the authority of the government and his powers of persuasion as a former banker, would have been able to finesse the task easily.

  Willumstad explained the original plan “was that the Fed was going to try to intimidate these guys to buy us some time.” Instead, when Jester finally got on the phone, “he didn’t want to tell them.” Clearly uncomfortable with playing the heavy, Willumstad told them that Jester could only bring himself to say, “We’re all here, and you know, we got a big team of people working and we need an extra day or two.”

  The core group of bankers who had been over at AIG now returned to the Fed, Jester having unsuccessfully tried to persuade Geithner to come to them at AIG—given that they were a group of some thirty and he was just one. Being the president of the Federal Reserve of New York had its privileges, however: They would come to him.

  The hole that they needed to fill, Winkelried now reported in their summary to Geithner, was some $60 billion and “possibly more.” No one knew how any solution could work without financial help from the Fed.

  “There’s no government money for this,” Geithner told them, repeating what Paulson had said earlier that day in Washington and echoing the same sentiment he had been conveying all weekend with regard to Lehman. If they needed proof that he was serious, Lehman’s bankruptcy was Exhibit A.

  Geithner authorized Lee to begin making phone calls to Asia that night to see if he could begin raising some money there. JP Morgan and Goldman made it clear they still had a good deal more work ahead of them.

  Late that evening, Jamie Gamble, AIG’s lawyer; John Studzinski; and Brian Schreiber gathered in a conference room for a morose meal of takeout Chinese. The situation seemed hopeless. Dinallo and Governor Paterson may have bought them a day by announcing their plan to release $20 billion of collateral, but it was too little, too late. Hours earlier they had called in the bankruptcy experts, and when the markets opened on Tuesday, they planned to draw down their credit lines, a clear sign to the markets that they were in trouble. When they suggested the move, Willumstad had told them it was akin to “lowering the life boats into the water because you’re about to abandon ship. That’s the last thing you do. Shutting the lights off on the Titanic before it goes down.”

  Schreiber still couldn’t believe they were in this position and remained convinced that the Fed would ultimately come to the rescue. “At this point, it’s a game of chicken,” he said, with a slight air of cockiness.

  “Do you think the Fed gets what’s at stake?” Gamble asked.

  “Are you crazy?” Studzinski replied. “Of course not. They just let Lehman fail. It’s like a bad Woody Allen movie.”

  By 1:00 a.m., Sully and Porat of Morgan Stanley, who were still representing the Fed, decided they needed to talk privately. They hid in one of AIG’s small kitchens and closed the door, so they’d be outside of earshot of the Goldman and JP Morgan bankers.

  “This isn’t going to work,” Porat said. “They aren’t going to get there.”

  “Agreed,” Scully replied. “We need a fallback plan.”

  They gave their assignment a codename and decided they’d head back to the Fed to alert Dan Jester.

  When they opened the kitchen door, they noticed that everyone else had already left, which only seemed to confirm their worst fears: Any chance of a deal had officially ended.

  When they reached the Fed, it, too, was deserted, apart from Jeremiah Norton passed out on a couch. He had originally tried to commandeer Geithner’s couch but was told he had to find a napping place elsewhere.

  Scully and Porat woke him, and the three of them went to deliver the bad news to Jester.

  A conference call was set up for 3:00 a.m. with the Fed team and Treasury, leaving Hilda Williams, Geithner’s assistant, the unenviable task of calling everyone at that ungodly hour to coordinate it.

  “We’ve got a problem…” Geithner began the call.

  For the first time in weeks, the editorial pages of the major newspapers were heralding Hank Paulson. They applauded his decision to not use taxpayer money to bail out Lehman Brothers. “It is oddly reassuring that the Treasury Department and Federal Reserve let Lehman Brothers fail, did not subsidize the distress sale of Merrill Lynch to Bank of America, and tried to line up loans for the American International Group, the troubled insurer, rather than making a loan themselves,” the New York Times’ lead editorial read. “Government intervention would have been seen either as a sign of extreme peril in the global financial system or of extreme weakness on the part of federal regulators.”

  Given the conversation he’d had with Dan Jester at 6:00 that morning, however, it was looking increasingly likely that AIG and the global financial system were now in such peril that the government would have no choice but to intervene.

  Paulson had seen the panic gripping the markets in the past twenty-four hours, w
hich was duly reflected in the headlines on every newsstand. That morning’s Washington Post was typical of the tone of the coverage: “Stocks Plunge as Crisis Intensifies; AIG at Risk; $700 Billion in Shareholder Value Vanishes.”

  The Dow Jones Industrial Average had slumped 504.48 points on Monday, the biggest point decline for the index since September 17, 2001, when trading started up again after the September 11 terrorist attacks. AIG’s stock had fallen 65 percent to close at $4.76.

  By 7:45 a.m., Ben Bernanke was in his office preparing for the Federal Open Market Committee meeting that was due to begin forty-five minutes later in the boardroom just down the hall from his office. It was purely a matter of chance that the FOMC, the Fed’s board of directors that determines monetary policy and decides whether to raise or lower interest rates, had one of its eight meetings a year scheduled for this morning.

  Before his meeting began, Bernanke called Kevin Warsh and Don Kohn into his office to join him in a conference call with Tim Geithner, who instead of attending the FOMC gathering had decided he had to stay in New York to deal with AIG, sending Christine Cummings, his vice president, in his place. There was only one small problem with that decision: FOMC meetings were relatively public affairs, and Bernanke was concerned that Geithner’s absence could leak to the press and cause further panic in the markets.

  “There’s nothing we can do about it at this point,” Geithner said, eager to focus the group’s attention on the larger problem at hand. He told them that he was expecting to receive a full progress update from JP Morgan and Goldman Sachs at 9:00 a.m., but cautioned that all the signals he had gotten from Dan Jester and Morgan Stanley had not been promising.

  He advised them, consequently, to start thinking about a Plan B.

  Jimmy Lee was worried he’d be late for the meeting at the NY Fed, having gotten stuck in traffic on the FDR after a quick trip back to his home to Darien to take a shower and put on some fresh clothes. While waiting he called Dimon from his cell phone. “So this is what I’m going to tell them,” he said about his planned presentation to the Fed. “I’m going to have to say the numbers are just too big. We can’t do it. No one can do it. The company is going down.”

  “If that’s the answer, that’s the answer,” Dimon replied.

  “This is my best judgment,” Lee assured him.

  The good news—if it could be called that—was that Lee expected he’d have to tell only Dan Jester, since Geithner would be in Washington at the FOMC meeting.

  When Lee finally arrived, he found everyone had already gathered in the conference room that had become the de facto lounge for these meetings. He took a seat near his colleague, Doug Braunstein, and they all began waiting patiently for Dan Jester.

  The door opened and Jester and Norton entered, followed by Geithner, who gave no explanation for his unexpected presence.

  “So where are we?” he asked in his clipped, all-business manner.

  Jimmy Lee consulted his yellow pad, on which he had written two notes to himself in the margins: “Deal stands little chance” and “AIG out of cash.”

  “We’ve gone through it all,” Lee said. “They have $50 billion in collateral and they need $80 to $90 billion. We’re short $30 to $40 billion. I don’t know how we can bridge that gap.”

  Winkelried of Goldman then jumped in. “Let me just say there is a huge systemic risk to letting this institution fail. I don’t need to tell you the number of counterparties that would be exposed.”

  A document generated listing AIG’s biggest counterparties in order of size was passed around. The most exposed firm listed on the orange and blue sheet was ABN AMRO, which had been acquired by Royal Bank of Scotland, with $65 billion; the second largest was Calyon; Goldman Sachs was the seventh; Barclays was the eighth; and Morgan Stanley was the ninth.

  Geithner studied the figures, furrowing his brow every few lines, and after setting them down said, “Okay. Here’s what we’re going to do.” He paused, leaning forward for all to hear what he was about to say.

  “I want everyone to put his cell phone away, BlackBerrys, everything. I don’t want anybody communicating outside of this room. Not to your office. Not to anybody. Do you understand me? This conversation is confidential,” he said. When Geithner was satisfied that everyone had complied, he posed a question for which no one in the group had been prepared: “What would it look like if we said the Fed was going to do this?”

  For the past seventy-two hours the government had been insisting that it would not bail out any financial institution. Now, with that one sentence, Geithner had turned everything on its head. Even if it was just a hypothetical, the rules of engagement had evidently just changed.

  Geithner continued, throwing out a series of questions. “How would this work? How would you structure the terms? How will the capital markets respond? How will the debt markets react?”

  Goldman’s Winkelried could not hide a slight smile. Scully of Morgan Stanley, realizing the night before that he needed a Plan B, had already roughed out a term sheet based on the numbers that JP Morgan and Goldman Sachs had put together. If it was good enough for them—and by Morgan Stanley’s estimation, they were going to be stealing the company—it should be good enough for the Federal Reserve.

  “Work on it,” Geithner said, and then left the room.

  “Braunstein isn’t picking up his fucking phone,” Willumstad railed after dialing his cell several times, worried that he was being kept in the dark.

  John Studzinski, his adviser from Blackstone, had just heard from one of his colleagues who was down at the NY Fed that he had seen Goldman and JP Morgan executives high-fiving one another—even while another team from the two banks was still camped out at AIG, rifling through its books.

  Studzinski finally managed to reach Porat by text-messaging her. However, she was purposely being vague, and would only offer, “The deal is changing. Stop sharing information with JPM and GS.”

  A few minutes later, Willumstad’s assistant announced that Tim Geithner, whom Willumstad had frantically attempted to reach several times that morning, was on the phone.

  “Hi, Tim,” Willumstad said, somewhat impatiently.

  “Give me a progress report,” Geithner instructed, rather than offering the progress report that Willumstad had been waiting for desperately.

  “I just want you to know that we’re preparing for bankruptcy,” Willumstad told him steadily. “I’ve called the backup lines. I just think you should know that.”

  Geithner seemed anxious and quickly cut him off with, “Don’t do that.”

  “You have to give me a reason not to,” he said, mystified by the odd reply. “I have an obligation and responsibility. I can get $15 billion and keep me going for a couple of days. I have to protect the shareholders here.”

  “Well, I’ll tell you something confidential,” Geithner finally said. “We’re working on some help for you, but there’s no guarantees, it has to be approved by Washington.”

  Willumstad, still dubious, replied, “Well, unless you can assure me that there’s going to be some help, we’re going to go ahead with the backup.”

  “You should try and undo whatever you’ve done,” Geithner ordered and hung up.

  When he got off the phone, Willumstad immediately informed his lawyers, Jamie Gamble and Michael Wiseman, and, none of them quite knowing what to do next, tried Braunstein’s phone again, with no success.

  “Screw it,” Wiseman said. “I know we’re not invited, but let’s just go over there ourselves.”

  Hank Paulson was in his office at Treasury when Lloyd Blankfein called him at 9:40 a.m. in a panic. Blankfein, anxious by nature, was even more so now, and Paulson could sense it.

  Blankfein told Paulson about a new problem he was seeing in the market: Hedge funds that had traded through Lehman’s London unit were suddenly being cut off, sucking billions of dollars out of the market. While the Fed had kept Lehman’s broker-dealer in the United States open in order to wind down
the trades, Lehman’s European and Asian operations were forced by law to file for bankruptcy immediately.

  Blankfein explained that through an arcane process called rehypothecation, Lehman had reloaned the hedge funds’ collateral to others through its London unit, and sorting out who owned what had become a logistical nightmare. To stay liquid, many hedge funds were forced to sell assets, which pushed the market even lower. Some hedge funds, fearing that Lehman was on the brink, had already dropped it as a prime broker before the bankruptcy. But for those who stuck by it, the results were painful, as was the case with Ramius Capital, whose founder, Peter A. Cohen, was once the chairman of Lehman’s predecessor, Shearson Lehman. In the week before the bankruptcy he had declared on CNBC that his firm wouldn’t pull its business from Lehman. Now he had to tell his investors that their money had become trapped in a mysterious bankruptcy process in London.

  Pleading with his former boss to do something to calm the markets, Blankfein told Paulson that his biggest worry was that so much money was clogged up inside Lehman that investors would panic and start pulling their money out of Goldman Sachs and Morgan Stanley, too.

  Bernanke was clearly distracted as he presided over the FOMC meeting at the Federal Reserve in Washington, passing notes back and forth with Kevin Warsh as they tried to come up with a game plan for AIG. They had agreed to another conference call with Geithner at 10:45 a.m. to get an update.

  Geithner reiterated that “a private-market solution is dead” and told them, “We need to think about using our balance sheet. We need to act with force and determination,” suggesting that if the Fed made a big, bold deal to backstop AIG, it could help restore confidence in the markets. He proposed using the Federal Reserve Act, Section 13, point 3, a unique provision that permitted the Fed to lend to institutions other than banks under “unusual and exigent” circumstances.