Too Big to Fail

by Andrew Ross Sorkin

  They decided that, for the time being, they wouldn’t mention the debt ceiling in the document itself but would address it later, ideally when Congress had already bought into the plan and it was too late to make a change.

  Before wrapping up the meeting, Paulson raised one last problem: Wachovia, he said, might falter. He was getting back-channel messages from Kevin Warsh that the bank’s finances were in much worse shape than they believed. Everyone understood the significance of his statement. After all, Bob Steel, their former colleague, was its CEO.

  “If Wachovia fails, I’m going to be trotting up to Congress again. So I’m hoping it happens after January!” he said to a roomful of laughs.

  “Listen, Jamie just called me fishing around for something,” Colm Kelleher told John Mack midday Thursday as he marched into his office. “He said he was calling to see if he could be of help,” Kelleher added. “It was strange.”

  James Gorman, the firm’s co-president, had just reported receiving a similar call, Mack replied, and Geithner had phoned earlier to suggest that he talk to Dimon as a possible merger partner too.

  “It’s clear that for him to be calling us, he wants to do a deal,” Kelleher said. “Jamie is always hanging around the hoop. You know Jamie’s saying, ‘Let’s make friends with these guys before I eat them.’”

  Mack was irritated by these suggestions; he didn’t particularly want to do a deal with Dimon, as he believed it would involve far too much overlap. But he decided to stop guessing what Dimon might be up to and ask him directly.

  “Jamie, Geithner says I should call you,” Mack said abruptly when he reached Dimon on the phone a few minutes later. “Let’s get this out in the open: Do you want to do a deal?”

  “No, I don’t want to do a deal,” Dimon said flatly, frusterated that this was the second call he had gotten that day from a competitor that was annoyed with him.

  “Well, that’s interesting,” Mack retorted. “You’re calling my CFO and you’re calling my president, why would you do that?”

  “I was trying to be helpful,” Dimon repeated.

  “If you want to be helpful, then talk to me. I don’t want you calling my guys,” Mack said, hanging up the phone.

  The fiftieth floor of Goldman’s fixed-income trading unit was in near-meltdown by lunchtime on Thursday. No trading was taking place, and the traders themselves were glued to their terminals, staring at the GS ticker as the market continued its swoon. Goldman’s stock dropped to $85.88, its lowest level in nearly six years; the Dow had fallen 150 points. “The market is trading under the assumption that every financial institution is going under,” Michael Petroff, portfolio manager for Heartland Advisors, told Agence France-Presse that morning. “It’s now emotional.”

  John Winkelried, Goldman’s co-president, had been walking the floors, trying to calm everyone’s nerves. “We could raise $5 billion in an hour if we wanted to,” he told a group of traders as if to suggest nothing was amiss.

  But just then, at 1:00 p.m., the market—and Goldman’s stock—suddenly turned around, with Goldman rising to $87 a share, and then $89. Traders raced through their screens trying to determine what had been responsible for the lift and discovered that the Financial Services Authority in the U.K. had announced a thirty-day ban on short selling twenty-nine financial stocks, including Goldman Sachs. It was exactly what Blankfein and Mack had tried to persuade the SEC’s Christopher Cox to do.

  The squawk boxes on Goldman’s trading floor soon crackled to attention. A young trader found a copy of “The Star-Spangled Banner” on the Internet and broadcast it over the speakers to commemorate the moment. About three dozen traders stood up from their desks, placed their hands over their hearts, and sang aloud, accompanied by rounds of high-fives and cheers. The market was turning around, and our flag was still there.

  Nine minutes later word began to spread that Paulson, too, was working on something big. “Treasury, Fed Weighing Wider Plan to Ease Crisis, Schumer Says” a Bloomberg headline read, buoying the market further.

  At exactly 3:01 p.m. the market took off. Traders all over Wall Street turned up the volume when Charlie Gasparino of CNBC reported what he was hearing from his sources on Wall Street: The federal government was preparing “some sort of RTC-like plan” that would “get some or all of the toxic waste off the balance sheets of the banks and brokerages.” Taking “RTC” as code for “everything’s going to be all right,” traders pushed stocks higher immediately. Between the time Gasparino began his report and the segment ended, the market jumped 108 points, a brief respite from the steady downward spiral.

  At the Treasury, Paulson and Kashkari had been on a conference call with Geithner and Bernanke for the past hour, trying to decide on a path of least political resistance for shoring up the banks. Bernanke, who seemed bothered by the plan, was arguing in favor of direct capital injections, a measure that had worked in other countries.

  Geithner, who had been railing about the need for “decisive action,” all of a sudden started talking about the possibility of opening up the Fed window to virtually any financial institution with any kind of assets. It would be a bold act that would likely be applauded by investors.

  “I don’t understand, what do you mean?” Kashkari piped up. “If the Fed really wanted to interpret its authorities creatively, it could do all this without legislation?”

  Paulson shot Kashkari an angry look, as it was precisely what he had been hoping that Geithner might convince Bernanke to do—and thus save Paulson a trip to Congress.

  “We can’t do that,” Bernanke admonished Geithner.

  The call had to end quickly because Paulson and Bernanke were scheduled to brief President Bush in the West Wing on their plan at 3:30 p.m., and Bernanke still needed to drive over from the Fed.

  As Paulson and Kashkari began the three-minute walk across the parking lot to the White House, Paulson received a call from Nancy Pelosi.

  “Mr. Secretary,” she announced sternly, “we would like to meet with you tomorrow morning because of some of the chaos we see in the markets.”

  Knowing that he would need to start building congressional support for his plan as soon as possible, he replied, “Madam Speaker, it cannot wait until tomorrow morning. We have to come today.”

  Upon reaching the Oval Office the Treasury officials took their places on the pair of sofas in the middle of the room. Vice President Cheney; Josh Bolten, Bush’s chief of staff—and Paulson’s old friend from Goldman—and several other White House staffers soon joined them, along with Bernanke and Warsh.

  Paulson told Bush in no uncertain terms that the financial system was collapsing. “If we don’t act boldly, Mr. President,” he said, “we could be in a depression deeper than the Great Depression,” an assessment with which Bernanke concurred.

  Bush was struggling to wrap his mind around the precise course of events. “How,” he questioned, “did we get here?”

  Paulson disregarded the question, knowing that the answer would be way too long and lay in a heady mix of nearly a decade of overly lax regulation—some of which he had pushed for himself—overzealous bankers, and home owners living beyond their means. Instead he pressed ahead and told the president that he planned to seek at least $500 billion from Congress to buy toxic assets, explaining that he hoped the program would stabilize the system.

  He hastened to point out the political ramifications, suggesting that buying toxic assets was overall a more palatable option than buying stakes in banks themselves.

  Bush nodded in agreement but, still confounded by the $500 billion figure, asked, “Is that enough?”

  “It’s a lot. It will make a difference,” Paulson assured him. Even if he did want to seek a higher number, Paulson told the president, “I don’t think we can get more.”

  They all knew it was going to be a highly politicized issue, but Paulson insisted, “We absolutely need to go to Congress. Treasury doesn’t have the authority.”

  For a moment, Pau
lson paused and then added, “In theory, Ben could always do it.”

  Paulson, unexpectedly playing politics himself, appeared to be trying to see how far he could push Bernanke, who, as far as Paulson was concerned, had virtually unlimited powers as long as he was willing to use them.

  “Ben, you can do this?” President Bush asked, sensing an opportunity.

  Bernanke, however, did not appreciate being put on the spot and tried to sidestep the question. “That is really fiscal policy, not monetary policy,” he said in his professorial tone.

  Bush understood. “We need to do what it takes to solve this problem,” he agreed, but given his low approval ratings, he knew he could be of little help on the Hill. “You guys should go up,” he told Paulson and Bernanke. The implication was clear: You’re on your own. But he insisted that the two men sell Congress on the idea quickly.

  As they left the White House, Kashkari turned to Paulson and remarked, “I couldn’t believe the kind of pressure you were putting on Ben.”

  Paulson just smiled. “Maybe Ben will get there.”

  Lloyd Blankfein had not been mollified by the market’s late turnaround, with Goldman’s stock ending the day up at $108, which was still better from its low of $86.31. In his office were Gary Cohn; David Viniar, the firm’s CFO; Jon Winkelried, the co-president; John Rogers; and David Solomon. He knew that until Morgan Stanley fell, Goldman was probably safe, though that was hardly a comfort.

  Gary Cohn had been on the phone earlier in the day with Kevin Warsh of the Federal Reserve, brainstorming a way to get in front of the financial tsunami. Warsh threw out the idea that perhaps Goldman should be looking to merge with Citigroup, a fit that could solve major problems for both parties. Goldman could get a huge deposit base, while Citigroup would acquire a management team that investors could support.

  Cohn had expressed his doubts about the suggestions. “It probably doesn’t work because I could never buy their balance sheet,” he explained. “And the social issues would be enormous.” The expression “social issues” was yet another Wall Street code for who would run the firm. Goldman’s management didn’t exactly have high regard for Pandit and his team.

  “Don’t worry about the social issues,” Warsh told him. “We’ll take care of them.”

  That was a not so subtle hint that if a deal was struck, Pandit might be out of a job.

  But Blankfein wasn’t particularly interested in either alternative. Rodgin Cohen had been encouraging Goldman to think about transforming the firm into a regulated bank holding company, which JP Morgan and Citigroup were, giving them unlimited access to the Fed’s discount window. It was the same idea that Cohen had unsuccessfully pressed Geithner to consider for Lehman Brothers over the summer, and while Geithner had turned that proposal down, Cohen had become convinced that he might now rule differently given the grave state of the markets.

  The notion of becoming a bank holding company had arisen at Goldman from time to time over the years, most recently at their board summer meeting in Russia, where they had discussed the necessity of holding more deposits. Blankfein appreciated that Goldman’s dependence on even a modicum of short-term financing made investors, in this highly charged environment, anxious, and that a deposit base provided a more stable source of capital. Blankfein had always resisted the idea, however, because it came with a hefty price tag in the form of increased regulatory oversight. But these were extraordinary circumstances, to say the least, and the CEO sensed that the world might be moving inexorably in that direction. Given that the bank already had temporary access to the Fed discount window, and that the Fed had literally placed several staffers inside Goldman to monitor the firm, Blankfein started to believe that the prospect of a little extra government regulation didn’t seem particularly onerous.

  “This is only going to work if you scare the shit out of them.”

  That had been Jim Wilkinson’s advice to Paulson before he and Bernanke left to meet with the congressional leadership at Nancy Pelosi’s office that evening. By Wilkinson’s reckoning, unless they could convince Congress that the world was literally going to come to an end, they would never receive approval for a $500 billion bailout package for Wall Street. Republicans would complain it was socialism; Democrats would carp about rescuing white-collar fat cats.

  At a burled wood table just off Pelosi’s office, two dozen congressmen gathered to meet with Paulson, Bernanke, and Christopher Cox, who had been invited more as a courtesy than anything else.

  Pelosi began the meeting by welcoming them and thanking them for coming “on such short notice.”

  Bernanke, who was known never to exaggerate, began by saying gravely, “I spent my career as an academic studying great depressions. I can tell you from history that if we don’t act in a big way, you can expect another great depression, and this time it is going to be far, far worse.”

  Senator Charles Schumer, sitting at the end of the table, noticeably gulped.

  Paulson, with a deep sense of intensity, went on to explain the mechanics of his proposal: The government would buy the toxic assets to get them off of the banks’ books, which, in turn, would raise the value of the assets by establishing a price and make the banks healthier, which in turn would help the economy and, as Paulson repeatedly said, “help Main Street.”

  Barney Frank, sitting next to Bernanke, thought Paulson’s reference to “Main Street” was a disingenuous ploy to line the pockets of Wall Street, and provided no direct help for average Americans saddled with mortgages they can’t afford, foisted on them by the big banks being rescued. “What about the home owner?” he asked. “You aren’t selling this plan to a Wall Street boardroom,” he said derisively. “That’s right,” Christopher Dodd chimed in. Richard Shelby disapprovingly characterized the proposed program as a “blank check.”

  Paulson said he understood their concerns. But he continued to play his “scare the shit out of them” card, insisting that it was absolutely necessary: “I don’t want to think about what will happen if we don’t do this.” He said he hoped that Congress could pass the legislation within days and promised to get a full proposal to them literally within hours.

  “If it doesn’t pass, then heaven help us all,” Paulson said.

  Harry Reid, sitting across from Bernanke, looked at Paulson with a sense of bemusement about the prospect that Congress would pass a bill of this magnitude that quickly. “Do you know what you are asking me to do?” he said. “It takes me forty-eight hours to get the Republicans to agree to flush the toilets around here.”

  “Harry,” Mitch McConnell (R-Kentucky), who was deeply frightened by Paulson and Bernanke’s presentation, interjected, “I think we need to do this, we should try to do this, and we can do this.”

  John Mack was still at his office in Times Square when Tom Nides, his chief of staff, told him the good news: His sources at the SEC had confirmed that the agency was preparing to finally put in place a ban on shorting financial stocks, affecting some 799 different companies. The measure would likely be announced the following morning.

  Rumors of the pending action were already moving on the wires. James Chanos, perhaps the best-known of the short-sellers, who had pulled his money from Morgan Stanley because of Mack’s support for the ban, was already on the warpath. “While this is all politically pleasing to the regulatory powers that be, the fact of the matter is that there has been no evidence presented of short-sellers circulating false market rumors to drive down the price of stocks,” he said.

  That day, Morgan Stanley’s stock had fallen 46 percent, only to turn around in the last hours of trading, ending up 3.7 percent, or 80 cents. Between word of the government’s intervention and the short-selling ban, Mack was hoping that he’d finally have some breathing room.

  He knew, though, that beneath the surface the firm was hurting. Hedge funds continued to seek redemptions. Other banks were buying insurance against Morgan Stanley’s going under, covering more than $1 billion. Within the past two da
ys, Merrill Lynch had bought insurance covering $150 million in Morgan debt. Citigroup, Deutsche Bank, UBS, AllianceBernstein, and Royal Bank of Canada had all made similar moves to protect themselves from a collapse.

  Mack knew that what the firm needed most was an investor to step up and take a big stake in the company to shore it up. “I don’t know how this happened,” he confided in Nides, searching himself. Morgan Stanley had been considered too conservative and Mack pushed the firm to take on more risk at exactly the wrong moment. And now here they were, in the perfect storm, on the cusp of insolvency.

  Mack could think of only one investor who might be seriously interested in making a sizable investment in the firm: China Investment Corporation, China’s first sovereign wealth fund. Wei Sun Christianson, CEO of Morgan Stanley China, a fifty-one-year-old dynamo with close relationships throughout the government, had initiated discussions with Gao Xiqing, president of CIC, within the past twenty-four hours. She happened to be in Aspen at a conference with him hosted by Teddy Forstmann, the leveraged buyout king who coined the phrase “Barbarians at the Gate” in the late 1980s, during the bidding war for RJR Nabisco. CIC already held a 9.9 percent stake in Morgan Stanley, and Gao indicated to Christianson that he’d be interested in buying up to 49 percent of the firm. Gao had a major incentive to keep Morgan Stanley alive: He had invested $5 billion in the firm in December 2007, which was now worth half that. Another one of his major investments, in Blackstone Group’s IPO, was down more than 70 percent. If Morgan Stanley filed for bankruptcy, he might lose his job.

  Mack and Nides discussed the deal, and while neither man was particularly interested, given their choices, they knew it might prove to be the only solution. Gao, whom Mack had come to know as a fellow Duke trustee, was planning to fly to New York Friday night to meet with them.