Too Big to Fail

by Andrew Ross Sorkin

  “We’re going to bring in a new CEO,” Paulson said matter-of-factly. “He’ll be showing up tomorrow.”

  Willumstad had had no illusions that a government rescue would mean anything other than his ouster, but he was stunned by the speed of events. The government had just made its offer moments ago—and it had already completed an executive search to find his successor?

  “Should I still be here?” Willumstad asked, confused about how to proceed.

  “Yeah, we would appreciate whatever cooperation and help you can offer,” Paulson replied.

  “Is it okay if I ask who it is?”

  “It’s Ed Liddy,” Paulson said.

  For a moment, Willumstad wracked his memory. “Who the hell is Ed Liddy?” Beattie whispered, but Cohen only shrugged his shoulders.

  “Ed just retired recently as the CEO of Allstate,” Paulson interjected, realizing they had no idea who he was.

  After the call, Willumstad slumped in his chair, sighed, and then looked over at Beattie and laughed.

  “Well, you’re wrong,” he said. “I won’t be working for the federal government after all.”

  The directors of AIG were already gathered in the boardroom when Willumstad and the advisers made their entrance. Willumstad wasted no time on preliminaries.

  “We are faced with two bad choices,” he began. “File for bankruptcy tomorrow morning, or take the Fed’s deal tonight.” He explained the terms of the deal and told them that Blackstone would come in with bankruptcy advisers to discuss the merits of that route.

  And then he told them his personal news.

  “I’m going to be replaced,” he said quietly. “Ed Liddy is going to take my place.”

  “Ed Liddy?” asked Virginia Rometty.

  “Yeah, he’s Allstate,” Willumstad explained.

  “I’ve known him for fifteen years,” she said. A top executive with IBM, Rometty had once headed the sales group for the computer company’s division that catered to the insurance and financial industries. “I wouldn’t have thought Ed would have been the guy.”

  “I know Ed Liddy!” James Orr chimed in. Orr had been chief executive of Unum, a Maine insurer that had fought off an effort by Allstate to grab market share from the company in the long-term disability category it dominated. “If we were looking for a CEO of this company, not only wouldn’t he have been on the short list, he wouldn’t have been on the long list!”

  “Well, that’s one of the decisions you’ll have to digest,” Willumstad said calmly, and turned the meeting over to Cohen.

  Martin Feldstein, an AIG director and former economic adviser to President Ronald Reagan, couldn’t believe that the government—a Republican administration—was going to be effectively buying a stake in a private business.

  Rodgin Cohen, reminding the board that they had a fiduciary duty not only to shareholders but to bondholders as well, pressed for a bankruptcy.

  “You should consider all these things,” Beattie said. “Just because it’s the Fed doesn’t mean you have to accept this. You should listen to all the options.”

  Willumstad’s assistant slipped into the room and handed him a note: Hank Greenberg is on the phone. He rolled his eyes, leaned over to John Studzinski, and passed him an instruction: “Would you please call Hank Greenberg back?”

  Studzinski crept out of the boardroom, aware of just how awkward this call was going to be for him to make. To help smooth the way, Studzinski enlisted Pete Peterson, Blackstone’s co-founder and a longtime friend of Greenberg, to join the call. At Greenberg’s suggestion, AIG had invested $1.35 billion in Blackstone when the firm was flagging in the aftermath of the 1998 Russian debt crisis.

  While Studzinski waited on the line, Peterson dialed Greenberg’s office on Park Avenue.

  “He can’t talk right now,” Greenberg’s assistant said. “He’s going on Charlie Rose to talk about AIG.”

  “You’ve got to be kidding me,” Peterson said.

  When Studzinski returned to the board meeting, he passed a note to Willumstad and relayed the news. For a moment, Willumstad smiled.

  The board quickly returned to the grim subject at hand. Cohen, offering the pros and cons of the government’s deal, explained the argument for a Chapter 11 bankruptcy filing, saying that the company might do better in an orderly unwinding in court rather than accept the government’s take-it-or-leave-it offer.

  Each of the various advisers offered their view. Studzinski said that a bankruptcy filing by a company as large and as complex as AIG would take many months to get under control and that the likelihood was that even more value would be eroded. “I just spent the last ten minutes giving you all the banking reasons to do this,” Studzinski summed up. “But there’s one more,” he said, looking around the room.

  “Isn’t twenty percent of something better than one hundred percent of nothing?”

  The room fell silent.

  As the meeting wore on, Willumstad checked his watch, knowing that he owed Paulson and Geithner an answer quickly.

  “Let’s go around the table and let everybody say what you think we should do,” Willumstad instructed. “To be honest with you, I urge you to vote in favor of the Fed proposal,” he told them, starting off. “We have three constituents. Shareholders, customers, employees. This is not something that’s friendly to the shareholders, but it will preserve the customers, keep the company afloat, and you have a better chance these people will keep their jobs.”

  As they made their way around the table, all the board members voted in favor of the government deal with the exception of Stephen Bollenbach, the former chief executive of Hilton Hotels. Bollenbach, who was supported by Eli Broad and other major dissident AIG shareholders, had joined the board in January. He thought that a proper judge would give shareholders a fairer deal.

  Before the vote was formally tallied, Bollenbach asked a question: Was there any room to renegotiate the terms of the deal?

  Willumstad and the lawyers retreated to his office to call Geithner.

  “Tim, Dick and Rodge are here,” Willumstad said. “It’s probably appropriate to let me have Dick explain to you the directors’ feelings.”

  Leaning in toward the speakerphone, Beattie said, “Tim, the board wants to know whether the terms can be renegotiated. They think eighty percent is outrageous.”

  “Terms cannot be negotiated,” Geithner said firmly. “These are the only terms you’re going to get.”

  As the three men looked at each other resignedly, Beattie continued, “We have a second question. The board wants to know whether, if the company can come up with its own financing to take the Fed’s place, would that be acceptable?”

  Geithner hesitated and then replied: “Nobody would be happier than I if the company, you know, would pay the Fed back.”

  Beattie returned to the boardroom and relayed the conversation. The deal was done.

  Paulson and Bernanke, after finishing with the president, ran over to the Hill to brief key congressmen, who were none too pleased with the AIG bailout news. Senate majority leader Harry Reid hosted the meeting in his second-floor conference room. The gathering had been hastily organized; some congressmen were invited only twenty minutes before it began. Senator Judd Gregg of New Hampshire, the ranking Republican on the Senate Banking Committee, was supposed to be at a black-tie dinner and showed up in his tuxedo, sans tie. Barney Frank arrived late in an untucked shirt.

  Paulson and Bernanke explained why they thought their decision had been a necessary one. “If we don’t do this,” Paulson told them, the impact of an AIG bankruptcy would “be felt across America and around the world.”

  Frank, concerned about the cost, looked at Bernanke. “Do you have $80 billion?”

  With a barely concealed smile, Bernanke answered, “Well, we have $800 billion.”

  Back at JP Morgan, Jamie Dimon and Jimmy Lee were sitting in Dimon’s office when the AIG press release came across the tape. “They’re never going to get their money back
,” Lee told Dimon. “There’s no way.”

  “I guarantee you they’ll get more than $50 billion of it back,” Dimon shot back, thinking that Washington had just cut itself a good deal, however bad it was from a public relations perspective. “AIG has a lot of good insurance businesses it can auction off. You’ll see.”

  Dimon and Lee placed a $10 bet on who would turn out to be right.

  Around 11:00 that night, Bob Willumstad’s driver pulled up to his building on Park Avenue, just across from Lenox Hill Hospital. Dashing under its green awning, Willumstad, tired and depressed, rode up the elevator to his seventh-floor apartment. Pacing in his kitchen, he recounted the day’s events to his wife, Carol.

  Before turning in for bed, Willumstad checked his BlackBerry one last time. David Herzog, the company’s controller and a man who had been working behind the scenes nonstop for the past weekend to keep the firm afloat, had sent him an e-mail. The time stamp was 11:54 p.m.; the subject line, “Last Steps”:

  Thank you for taking on this very difficult challenge. The events that unfolded tonight were set in motion long ago.

  Before you leave office, I ask only one thing. Please clean the slate for Mr. Liddy. I urge the following dismissals immediately:

  Schreiber

  Lewis & McGinn

  Nueger & Scott

  Bensinger

  Kelly

  Kaslow

  Dooley

  While this may seem a bit harsh, this group of executives each have shown in their own ways a clear pattern of ineptness that contributed to the destruction of one of America’s greatest companies. Please, don’t make Mr. Liddy figure this out on his own.

  I mean no disrespect to these individuals, but the 120,000 employees around the world deserve better, and some sense of accountability for what just happened.

  We need leadership, and these individuals are simply not leaders.

  Respectfully yours,

  David

  Willumstad, standing in the hallway in his boxer shorts, just shook his head in disbelief.

  CHAPTER SEVENTEEN

  When Tim Geithner began his run on Wednesday morning along the southern tip of Manhattan and up the East River just after 6:00, the sun had yet to come up. He was tired and stressed, having slept only several hours in one of the three tiny, grubby bedrooms in the New York Fed’s headquarters.

  As he stared at the Statue of Liberty and the first of the morning’s commuter ferries from Staten Island gliding across the harbor, he tried desperately to clear his mind. For five days his brain had been trapped in a maze of numbers—huge, inconceivable, abstract numbers, ranging in the span of twenty-four hours from zero for Lehman to $85 billion for AIG. Eighty-five billion dollars was more than the annual budgets of Singapore and Taiwan combined; who could even begin to understand a figure of that size? Geithner had hoped the sum was sufficient—and that the crisis would finally be over.

  Those ferries, freighted with office workers, gave him pause. This is what it was all about, he thought to himself, the people who rise at dawn to get in to their jobs, all of whom rely to some extent on the financial industry to help power the economy. Never mind the staggering numbers. Never mind the ruthless complexity of structured finance and derivatives, nor the million-dollar bonuses of those who made bad bets. This is what saving the financial industry is really about, he reminded himself, protecting ordinary people with ordinary jobs.

  But as he passed the South Street Seaport and then under the Brooklyn Bridge, he had inadvertently begun thinking about what fresh hell the day would bring. He was most anxious about the latest shocking development: A giant money market fund, Reserve Primary Fund, had broken the buck a day earlier (which meant that the value of the fund’s assets had fallen to below a dollar per share—in this case, 97 cents). Money market funds were never supposed to do that; they were one of the least risky investments available, providing investors with minuscule returns in exchange for total security. But the Reserve Primary Fund had chased a higher yield—a 4.04 percent annual return, the highest in the industry—by making risky bets, including $785 million in Lehman paper. Investors had started liquidating their accounts, which in turn forced managers to impose a seven-day moratorium on redemptions. Nobody, Geithner worried, knew just how extensive the damage could end up being.

  Between the money-market funds being under pressure, Geithner thought, and billions of dollars of investors’ money locked up inside the now-bankrupt Lehman Brothers, that meant only one thing: the two remaining broker-dealers—Morgan Stanley and Goldman Sachs—could actually be next.

  The panic was already palpable in John Mack’s office at Morgan Stanley’s Times Square headquarters. Sitting on his sofa with his lieutenants, Chammah and Gorman, drinking coffee from paper cups, he was railing: The major news on Wednesday morning, he thought, should have been the strength of Morgan Stanley’s earnings report, which he had released the afternoon before, a day early, to stem any fears of panic about the firm following the Lehman debacle. His stock had fallen 28 percent in a matter of hours on Tuesday, and he decided he needed to do something to turn it around. The quarterly earnings report had been a good one—better than that of Goldman Sachs, which had announced their earnings Tuesday morning and also had suffered, but not nearly as much. Morgan had reported $1.43 billion in profits, down a mere 3 percent from the quarter a year earlier. But the headline on the Wall Street Journal was gnawing at him: “Goldman, Morgan Now Stand Alone; Fight On or Fold?” And as the futures markets were already indicating, his attempt to show strength and vitality had largely failed to impress.

  Apart from the new anxiety about money market funds and general nervousness about investment banks, he was facing a more serious problem than anyone on the outside realized: At the beginning of the week, Morgan Stanley had had $178 billion in the tank—money available to fund operations and to lend to their major hedge fund clients. But in the past twenty-four hours, more than $20 billion of it had been withdrawn, as hedge fund clients demanded it back, in some cases closing their prime brokerage accounts entirely.

  “The money’s walking out of the door,” Chammah told Mack.

  “Nobody gives a shit about loyalty,” Mack railed. He had wanted to cut off the flow of funds, but up until now had been persuaded by Chammah to keep wiring the balances. “To put the gates up,” Chammah warned, “would be a sign of weakness.”

  The question was, how much more could they afford to let go? “We can’t do this forever,” Chammah said.

  While Mack was beginning to believe the hedge funds were conspiring against the firm—“This is what they did to Dick!” he roared—there was fresh evidence that some of them actually did need the cash. Funds that had accounts at Lehman’s London office couldn’t get at them and came begging to Morgan Stanley and Goldman.

  As far as Mack was concerned, they needed to keep paying out money. He had spent years building their prime brokerage business into a major profit center—eighty-nine of the top one hundred hedge funds in the world traded through Morgan Stanley. It was essential in the midst of a crisis that the firm not display even the slightest sign of panic, or the entire franchise would be lost.

  “We are confident,” he said. “We cannot be weak, and we cannot be confused.”

  Under normal circumstances, John Mack could be unflappable. The previous day he’d even been out on the floor, as was his habit, chatting with traders and eating a slice of pizza. But in his office that morning, he was starting to come unwound. There was just too much to do, too many options to explore, too many things to worry about.

  The night before, he’d received a call from his old friend Steven R. Volk, a vice chairman at Citigroup and former lawyer who years earlier had helped Mack engineer the merger with Dean Witter. Now Volk, ostensibly calling to offer congratulations on the earnings reports, quietly planted the seed of another merger—with Citi.

  “Look, John, we’re here for you. We’re not aggressive. And if you want to do someth
ing strategically to put us together, we would like to talk to you,” Volk said.

  It was potentially explosive news. A merger between Morgan Stanley and Citigroup would be like combining Microsoft and Intel.

  Mack, Chammah, and Gorman batted around the idea. Given the pressure on the broker-dealer model, merging with Citigroup would give it a stable base of deposits. JP Morgan and Citigroup were the only two left of the big, strong banks.

  They had all heard about Bank of America’s conference call on Monday regarding its deal with Merrill Lynch and couldn’t ignore Ken Lewis’s comments all but declaring the broker-dealer model officially dead.

  “For seven years, I’ve said that the commercial banks would eventually own the investment banks because of funding issues,” Lewis said. “I still think that. The Golden Era of investment banking is over.”

  Gorman, at least for the moment, was thinking that he might well be right. “Do you think we should call Citigroup back?” he asked.

  Mack nodded and asked his assistant to phone Vikram Pandit’s office. The two men knew each other well—Pandit, then at Morgan Stanley, had been given a big promotion by Mack in 2000—but had never been particularly close.

  “Steve tells me you want to do a deal,” Mack said when Pandit got on the line. “It’s tough out there,” Mack continued. “We’re looking at our options.”

  “Well, we’d like to be helpful,” Pandit said, “and this could be the time to do something.”

  But before he got too far he said, “I’ll come back to you. I need to talk to my board.”

  The black and orange screen flickered as Hank Paulson skimmed the updates about the Reserve Primary Fund on his Bloomberg terminal. With $62.6 billion in assets, the fund was a major player, and as a result of its troubles, doubt, he could see right in front of him, was starting to spread throughout the rest of the field.