Too Big to Fail

by Andrew Ross Sorkin

  Earlier in the day, Mack had spoken with Paulson, who prided himself on his extensive Chinese contacts, trying to persuade him to make a call to the Chinese government to encourage them to pursue the deal. It was a tad unusual to ask the government to serve as a broker, but Mack was desperate. “The Chinese need to feel as if they are being invited in,” Mack explained. Paulson said he’d work on it and see if President Bush would be willing to call China’s president, Hu Jintao. “We need an independent Morgan Stanley,” he affirmed.

  Nides, however, had a more cynical view of Paulson’s desire to protect Morgan Stanley. “He’ll keep us alive,” Nides told Mack, “because if he doesn’t, then Goldman will go.”

  CHAPTER EIGHTEEN

  Hoarse and a little haggard, Paulson made his way to the podium in the press room of the Treasury Building the morning of Friday, September 19, 2008, to formally announce and clarify what he had dubbed earlier that morning the Troubled Asset Relief Program, soon known as TARP, a vast series of guarantees and outright purchases of “the illiquid assets that are weighing down our financial system and threatening our economy.”

  He also announced an expansive plan to guarantee all money market funds in the nation for the next year, hoping that that move would keep investors from fleeing them. But he had already gotten an earful that morning about that effort from Sheila Bair, chairwoman of the FDIC, who had called, furious she wasn’t consulted and anxious that the guarantee plan would backfire and investors would perversely start moving their money out of otherwise healthy banks and into the guaranteed money market funds. Paulson just shook his head; he couldn’t win.

  As he stood in front of the press corps he did his best to sell the centerpiece of his plan, the TARP. “The underlying weakness in our financial system today is the illiquid mortgage assets that have lost value as the housing correction has proceeded. These illiquid assets are choking off the flow of credit that is so vitally important to our economy,” he explained, his tie slightly askew and looking paler and more tired than he ever had before. “When the financial system works as it should, money and capital flow to and from households and businesses to pay for home loans, school loans, and investments that create jobs. As illiquid mortgage assets block the system, the clogging of our financial markets has the potential to have significant effects on our financial system and our economy….

  “I am convinced that this bold approach will cost American families far less than the alternative—a continuing series of financial institution failures and frozen credit markets unable to fund economic expansion,” he asserted, clearly reading from his script, having never learned how to read from a teleprompter.

  Evidently confident that Washington had finally brought the financial crisis under control—between Paulson’s TARP and Cox’s ban on short-sellers—the stock market had risen 300 points at the open and continued to hold its ground as Paulson spoke.

  Paulson had intentionally chosen not to mention how much the program would cost; after a briefing earlier that morning from Kashkari, he now feared that he might actually need more than the $500 billion he had mentioned to the president a day earlier—a great deal more. Back in his office after the speech, he met with Fromer and Kashkari and debated what the precise cost might be.

  “What about $1 trillion?” Kashkari said.

  “We’ll get killed,” Paulson said grimly.

  “No way,” Fromer said, incredulous at the sum. “Not going to happen. Impossible.”

  “Okay,” Kashkari said. “How about $700 billion?”

  “I don’t know,” Fromer said. “That’s better than $1 trillion.”

  The numbers were, at best, guesstimates, and all three men knew it. The relevant figure would ultimately be the one that represented the most they could possibly ask from Congress without raising too many questions. Whatever that sum turned out to be, they knew they could count on Kashkari to perform some sort of mathematical voodoo to justify it: “There’s around $11 trillion of residential mortgages, there’s around $3 trillion of commercial mortgages, that leads to $14 trillion, roughly five percent of that is $700 billion.” As he plucked numbers from thin air even Kashkari laughed at the absurdity of it all.

  John Mack had been watching CNBC on Friday morning when he received a phone call from Lloyd Blankfein. Charlie Gasparino, still reveling in his scoop about the government’s toxic asset program, was arguing that it meant that Morgan Stanley would no longer be forced to do a deal, or at least not have to move as quickly.

  Mack, laughing to himself, knew better; he had to get something accomplished by the weekend or Morgan Stanley could well go the way of Lehman Brothers.

  “What do you think of becoming a bank holding company?” Blankfein asked Mack when he picked up the receiver.

  Mack hadn’t really studied the issue and asked, “Would that help us?”

  Blankfein said that Goldman had been investigating the possibility and explained to him the benefits—namely, that if they allowed themselves to be regulated by the Federal Reserve, they’d have unlimited access to the discount window and would have an easier time raising capital, among other things.

  “Well, in the long run it would really help us,” Mack said. “In the short run, however, I don’t know if you can pull it off fast enough to help us.”

  “You have to hang on,” Blankfein urged him, clearly still anxious about how punishing the markets had become, “because I’m thirty seconds behind you.”

  John Pruzan, the Morgan Stanley banker who had been assigned to review Wachovia’s $120 billion mortgage portfolio—to crack the tape—finally had some answers. A team of Morgan bankers in New York, London, and Hong Kong had worked overnight to sift through as many mortgages as they humanly could.

  “Now I know why they didn’t want to give us the tape!” Pruzan announced dourly at a meeting before they headed over to Wachtell Lipton to begin diligence on Wachovia. “It shows they’re expecting a nineteen percent cumulative loss.”

  Just a week earlier, at a public presentation at Lehman’s conference, Bob Steel had estimated that figure at 12 percent. In fairness, Pruzan noted, the market had deteriorated markedly since then, and cumulative loss figures were inherently unreliable, because a bank could manipulate them up or down. Still, that big a discrepancy couldn’t be explained away easily. At best, Pruzan thought, Wachovia had been foolishly optimistic.

  “You’ve got to be fucking kidding me,” Scully exclaimed. “We obviously can’t do this deal.”

  To make it work, Morgan Stanley would have to raise some $20 billion to $24 billion of equity to capitalize the combined firm, a virtual impossibility under the current market conditions. Even so, the Morgan bankers decided not to cancel the all-day diligence session, as they figured they had nothing to lose. Morgan Stanley might well be able to take advantage of Paulson’s new plan to buy toxic assets from Wachovia and, indeed, investors had already bid up Wachovia’s shares that morning on precisely that expectation.

  Thirty people each from Morgan Stanley and Wachovia showed up at Wachtell Lipton’s Fifty-second offices. Wachovia, purposely not using Goldman Sachs as an adviser for this project given its rivalry with Morgan Stanley, brought a new set of advisers from Perella Weinberg Partners: Joe Perella, the legendary financier; and Peter Weinberg, a former Goldman banker who was the grandson of Sidney Weinberg, the Goldman patriarch. As Weinberg came to shake Kindler’s hand, they could hardly believe they were even talking to each other under such dire circumstances. “What happened? How the fuck did we get here?” Weinberg asked aloud.

  “God only knows. You can’t make this shit up,” Kindler said.

  Within the first two hours of their work, however, something began to feel wrong to the Morgan bankers. Paulson’s TARP announcement had eased the climate of fear at Wachovia—which would likely be a huge beneficiary of the program because it could sell its most toxic assets to the government—and thus the urgency of rushing into a deal. Kindler became concerned that Wach
ovia was just buying time while the bank worked on another deal, probably with Goldman. Surveying the room, he announced to his colleagues, “Look at us. We’re the B team. This isn’t going to happen.”

  The Wachovia team, meanwhile, had its own doubts about Morgan Stanley’s commitment. If this deal was so important to it, where were its top people? David Carroll, who was leading the Wachovia team, couldn’t understand why Colm Kelleher, Morgan’s CFO, was not involved.

  By 2:00 p.m., the Morgan Stanley team had withdrawn from Wachtell and gone back to Times Square to consult with Mack.

  “These guys are clearly disengaged,” Kindler told him. Scully described Wachovia’s mortgage book as “a $40 to 50 billion problem. It’s huge. The junior Wachovia team is not disputing our analysis.”

  Kelleher, who had been keeping a careful watch over the firm’s dwindling cash pile, had just taken a look at Wachovia’s numbers for himself and observed, “That’s a shit-sandwich even I can’t get my big mouth around.”

  It became increasingly clear to everybody that the only way this deal was going to take place was if the government provided cover.

  Mack, not having heard anything that soothed his nerves, had his secretary get Steel on the line. “You called us and said you wanted to go a hundred miles an hour,” he reminded him, his Southern manners starting to fray, “and I’m sensing from your team that there’s not the same urgency.”

  Steel was apologetic. “You’re right,” he told Mack. “We’re not doing this for the next couple of days.”

  They agreed they’d get back in touch, but before he hung up, Steel asked Mack for a favor. “It wouldn’t be helpful if it leaked out that we’re not talking,” he said.

  “Fortress Goldman.” Tim Geithner had written those two words on a pad on his desk after a Friday afternoon conversation with Lloyd Blankfein, who must have uttered the phrase a dozen times. It was his way of saying he wanted Goldman to remain a stand-alone institution.

  Geithner had been concerned that Blankfein didn’t appreciate how perilous his situation actually was and had quizzed him about the firm’s financial health. Blankfein had said he was hopeful that Goldman would weather the crisis but had acknowledged: “It depends on what happens to the rest of the world.”

  Geithner had also sounded Blankfein out about the bank holding company idea. While Blankfein was originally somewhat resistant, by now he had officially warmed up to it. He had become increasingly convinced that if the market knew that the Federal Reserve was behind him, it would instill confidence in investors. And after doing the math, by his estimate 95 percent of Goldman’s assets could already be pledged to the Fed’s discount window, so another 5 percent didn’t represent that big a hurdle. Rodgin Cohen, Goldman’s lawyer, had already discussed this with Geithner earlier in the day; of course, he’d have to sell Bernanke on the idea.

  Blankfein, whose voice revealed to Geithner an almost panicked state, had also said that he was planning to raise capital and was certain that the firm would be able to do so from private investors. Maybe even Warren Buffett would be interested.

  The waiter at Blue Fin had just brought several massive plates of sushi—spicy lobster rolls, pieces of yellowtail tuna, and tobiko—when Colm Kelleher’s cell phone rang. He had gone to get a late lunch with his Morgan Stanley colleagues, including James Gorman, Walid Chammah, and Tom Nides, and the group had been chatting about their plan to meet later that night with Gao Xiqing of China Investment Corporation, who was bringing an entire team to New York. With Wachovia effectively out of the picture, the Chinese were now their sole prospect.

  When Kelleher looked down at the caller ID, he saw it was an international number in Japan and walked to the corner of the restaurant.

  Jonathan Kindred, president of Morgan Stanley’s securities business in Tokyo, greeted him and said excitedly, “This is interesting. I just got a call from Mitsubishi. They want to do the deal.” Mitsubishi UFJ, Japan’s biggest bank, was interested in buying a stake in Morgan Stanley.

  The call had come completely unexpectedly, and totally unsolicited. Morgan Stanley’s management had actually ruled out calling Mitsubishi earlier in the week after its chairman, Ryosuke Tamakoshi, said publicly at a conference that following Lehman’s bankruptcy his firm would not be making any investments in the United States.

  Kindred said he thought Mitsubishi was prepared to move quickly. But Kelleher, rolling his eyes, was skeptical. He had worked with other Japanese banks before and, in his experience, they had always lived up to their reputation as being slow, risk-averse, and deeply bureaucratic.

  James Gorman’s eyes widened when Kelleher returned to the table with Kindred’s news. This could be exactly what they needed, he thought.

  Kelleher only scoffed, “This is a waste of time, they’re never going to do anything.”

  “Colm, I really feel they’re going to do something,” Gorman insisted. When Gorman worked at Merrill Lynch he had orchestrated a joint venture with Mitsubishi to combine their private banking and wealth-management businesses in Japan. He thought that the fact that Mitsubishi had initiated the call to express interest was an encouraging sign. “This stuff doesn’t happen by accident,” he said.

  Kevin Warsh, the Fed governor, had taken the US Airways shuttle to New York late on Friday to help Geithner think through how to handle the upcoming weekend. Just as important, he would be Bernanke’s eyes and ears on the ground. As he and his driver made their way through traffic from LaGuardia Airport to the New York Fed, he received a call from Rodgin Cohen, who by now was advising both Wachovia on its talks with Morgan Stanley and Goldman Sachs on its bank holding company status. He told Warsh he had an idea—a potentially big one. It wasn’t a plan officially sanctioned by his clients, just a friendly suggestion from an old-timer in the business.

  He suggested to Warsh that the government attempt a shotgun wedding between Goldman and Wachovia. He knew it was a long shot—the “optics,” he acknowledged, would be problematic, given Paulson had worked at Goldman for thirty years and been its CEO from 1999 to 2006 and that Wachovia’s CEO, Bob Steel, was a former Goldman man and Paulson’s former deputy at Treasury too—but it would solve everyone’s problems: Goldman would get the deposit base it had been seeking, and Wachovia would have its death sentence stayed.

  Warsh listened to the proposal and, almost to his own surprise, liked it.

  Gao Xiqing, dressed in a sporty turtleneck and blazer, arrived at Morgan Stanley with his team just after 9:00 p.m., having flown into New York with Morgan Stanley’s Wei Sun Christianson on a private jet from Aspen. He had been on a panel that afternoon with Carlos Slim, the Mexican billionaire, at Ted Forstmann’s gathering and had asked the moderator, Charlie Rose, to make certain the session didn’t run long so that he could reach the airport in time. Given the rumors in the newspapers, everyone at the panel knew exactly where he was headed.

  Gao’s back was causing him so much pain that when James Gorman first went to introduce himself, he found Gao lying on the floor of a conference room on the fortieth floor, in the middle of a telephone call. Mack, ever the accommodating host, had a couch brought from the executive dining room for his guest to lie on.

  Over dinner, ordered in from Mack’s favorite restaurant, San Pietro—again—they discussed a possible transaction. Alternating between standing up and lying down, Gao reiterated his interest in buying 49 percent of Morgan Stanley.

  As he had told Christianson on the flight over, he now indicated that he was prepared to provide the firm with a credit line of as much $50 billion and a nominal equity investment—no more than $5 billion, maybe less.

  Mack was stunned. He had known the price that would be offered might be low, but to him this was absurdly so—it was effectively merely a loan. While it might help Morgan Stanley stay in business, Gao was clearly taking advantage of its weakened condition. To Gao, the offer presented a way to reset the price he had paid for the 10 percent stake he had acquired in Morgan Stanley in 20
07, which was now worth far less. Unlike deals that other sovereign wealth funds had struck then, giving them the right to reset the value of the deal if the firms sold equity at a lower price later, CIC hadn’t had the presence of mind to insist on that stipulation. For some inexplicable reason, Gao had convinced himself that the agreement did include such a provision until Morgan Stanley got him a copy to show him that it didn’t.

  However insulting Gao’s proposal, Mack recognized that his situation was desperate. Despite the market rally, the firm had continued to bleed cash. Kelleher had given him the cash balances and they were not good—about $40 billion in the tank. A few bad days could wipe them out, and most days lately had been bad ones.

  Without many other options, Mack told Gao the firm would open its books to him. Gao had hired Sullivan & Cromwell’s seemingly omnipresent lawyer, Rodgin Cohen, as well as Deutsche Bank, to advise him, and both companies were already sending over teams to assist the Chinese. A sheet of paper marked “CIC” was affixed to the conference room door that would become Gao’s temporary office. Mack also had a physical therapist summoned to work on his bad back.

  When Mack returned to his office and huddled with Christianson and his team, they were flabbergasted; Chammah initially thought he had misheard Christianson when she presented it.

  “That’s a ludicrous ask,” Kelleher said. “They are being unreasonable.”

  Gorman, trying to calm everyone down, said they should all hope it might just be an opening salvo: “They ask for the moon and then maybe they get more reasonable?”

  It was just past midnight, and Courtroom 601 of the courthouse at One Bowling Green in Lower Manhattan was still packed with people standing shoulder to shoulder.