Too Big to Fail

by Andrew Ross Sorkin

  The power pleased him, but he also knew that it cut both ways. He discovered just how far it cut within minutes of the red light’s going on for the Brokaw interview, when the host lit into him about the lack of details in the TARP plan, the same lack of details that Treasury staffers had privately worried about the day before.

  “If you were in your old job as chairman of Goldman Sachs and you took this deal to the partners,” Brokaw said, “they’d send you out of the room and say, ‘Come back when you’ve got a lot more answers,’ wouldn’t they?”

  Kenneth deRegt, Morgan Stanley’s chief risk officer, was trying to put the best face on his firm’s finances as he prepared for the meeting with JP Morgan that morning, assembling lists of collateral that he hoped would be considered strong enough to lend against. But as he worked it began to dawn on both him and Ruth Porat, who ran the firm’s financal institutions group, that an unrestricted show-and-tell session with JP Morgan bankers might be counterproductive. If all went well, Morgan Stanley would become a bank holding company that very evening—a plan that JP Morgan was unaware of—giving it access to far more liquidity. So they decided to be selective about what they would and wouldn’t feature in the presentation and included only the bank’s collateral that they wouldn’t be able to pledge to the Fed, which represented some of the worst holdings on its books. It would be a risky move. Rather than burnishing the firm for a sale, they could unknowingly scare off a potential partner.

  Braunstein, Hogan, and Black of JP Morgan arrived at 750 Seventh Avenue punctually at 8:45 a.m., bringing the firm’s general counsel, Steven Cutler, with them. Several dozen underlings had already arrived and were waiting. The location, a nondescript office building with no signage a block west of Morgan Stanley’s headquarters, was where the company typically held any meeting it wanted kept secret.

  “This is highly confidential,” Hogan reiterated to the team as they set up in a meeting room that Morgan Stanley had provided. Braunstein was surprised that no coffee or food was provided for his team—Is this some kind of negotiating tactic?—and immediately sent an associate to Dunkin’ Donuts.

  They all knew they were there for what could be the most historic diligence session of their lives. While Hogan had told them the meeting was about extending a line of credit to Morgan Stanley, they all knew that it could quickly turn into a full-blown merger, a transaction that would make the Bear Stearns deal look like Little League practice. War rooms were set up to review each major part of Morgan Stanley’s business—prime brokerage, real estate, principal investments, and commodities.

  JP Morgan’s lawyers had expressed serious doubts to the team that they could pull off a deal like this in such a short compass of time. They kept referring to the problem of “perfecting security interests in less than twenty-four hours.”

  In fact it wouldn’t take nearly that long: Within two hours, JP Morgan decided to pull the plug. They were shocked that the assets that Morgan Stanley was offering as collateral were of such low quality, surely too low for JP Morgan to lend against.

  “This stuff is crap,” Hogan told Steve Black, JP Morgan’s president.

  By midday, Goldman Sachs and Wachovia, which was represented by a half dozen executives whom Bob Steel had brought along, were making rapid progress toward completing a deal. Peter Weinberg, Bob Steel’s adviser and a former Goldman man, had constructed the outlines of an agreement in which Goldman would pay $18.75 a share for Wachovia’s shares in Goldman stock. The price represented the closing price of Wachovia’s shares on Friday.

  There remained, however, one serious obstacle: Goldman wanted a “Jamie” deal. The next step was to go back to Warsh at the Fed and ask whether the Fed was prepared to subsidize the deal by guaranteeing Wachovia’s most toxic assets.

  During a lull in the negotiations, Weinberg took a break and walked down the hall of the executive floor. As he passed a series of portraits of the firm’s past chief executives, he stopped when he reached Sidney Weinberg, his grandfather. Sidney Weinberg, who became a Goldman partner in 1927, represented the epitome of the old Wall Street, a business that had been defined by personal relationships and implicit trust, not leverage and ever more complicated financial engineering. His grandfather’s world had been obliterated over the past decade as firms sought to go public and began using shareholder money to place what had proved to be dangerously risky bets.

  Jon Winkelried, Goldman’s co-president, was passing down the hall when he saw Weinberg gazing thoughtfully at the portrait.

  “The world has really been turned on its head,” Winkelried said wistfully.

  Warren Buffett was at his home in Omaha on Sunday when he received a phone call from Byron Trott, a vice chairman at Goldman Sachs. Buffett, who disliked most Wall Street bankers, adored Trott, a mild-mannered Midwesterner based in Chicago. Paulson had introduced the men years earlier, and Trott was now the only investment banker Buffett truly trusted. “He understands Berkshire far better than any investment banker with whom we have talked and—it hurts me to say this—earns his fee,” Buffett wrote in Berkshire Hathaway’s 2003 annual report. For Buffett, there is no more lavish praise.

  Trott was calling Buffett with a proposition. For the past several weeks he had been trying in vain to persuade Buffett to make an investment in Goldman, but he had now come up with a new idea. He disclosed to Buffett that Goldman was in talks to buy Wachovia, with government assistance, and wanted to know whether Buffett might be interested in investing in a combined Goldman-Wachovia.

  At first, Buffett wasn’t sure he was hearing Trott correctly. Government assistance? In a Goldman deal?

  “Byron, it’s a waste of time,” he said in his folksy way, after considering the new configuration. “By tonight the government will realize they can’t provide capital to a deal that’s being done by the firm of the former Treasury secretary with the company of a retired vice chairman of Goldman Sachs and former deputy Treasury secretary. There is no way. They’ll all wake up and realize even if it was the best deal in the world, they can’t do it.”

  John Mack had received some promising news Sunday afternoon: Mitsubishi looked like it would actually pull through and make a sizable investment in Morgan Stanley. A conference call had been arranged for Mack to speak with Mitsubishi’s chief executive, Nobuo Kuroyanagi, that evening.

  Just as they were going over the details, however, Paulson called.

  “John, you have to do something,” Paulson said sternly.

  “What do you mean I have to do something?” Mack asked, his voice rising with impatience, explaining that he had just learned that the Japanese were inclined to do the deal. “You’ve been so supportive, you said we can get through this.”

  “I know,” Paulson said, “but you’ve got to find a partner.”

  “I have the Japanese! Mitsubishi is going to come in,” he repeated, as if Paulson hadn’t heard him the first time around.

  “Come on. You and I know the Japanese. They’re not going to do that. They’ll never move that quickly,” Paulson said, suggesting that he focus more on the deal with the Chinese or JP Morgan.

  “No, I do know them. And I know I don’t agree with you,” Mack answered angrily. He explained that Mitsubishi had had a long-term relationship with the firm; it had used Morgan Stanley as an adviser during its hostile bid for a part of Union Bank in California earlier in the year. “Japanese rarely do a hostile,” Mack reminded him. “They hired us, they followed through and got it done, so they’ll come through for us.”

  Paulson was still skeptical. “They won’t do it,” he said with a sigh.

  “You and I disagree,” Mack sputtered, agreeing to keep him updated on his progress as he hung up the phone.

  Calling the Fed’s Kevin Warsh out of a meeting to come to the phone, Gary Cohn outlined the preliminary Goldman-Wachovia terms for him. They had agreed to a deal at market—Friday’s closing price of $18.75—and considering that Wachovia’s stock had jumped 29 percent that day on
the back of the TARP news, Cohn thought it was a generous concession.

  But then he wound up for his big pitch: To complete the deal, he said, Goldman would need the government to guarantee, or ring-fence, Wachovia’s entire portfolio of ARM option mortgages—all $120 billion worth.

  Warsh stopped Cohn in midsentence. “We’re just not prepared to do that,” he said. “We can’t look as if we’re just writing a blank check.” Warsh, who was still championing the idea of a merger, explained that they needed to think about the “optics” of the deal. He suggested that if they structured it so that Goldman would take a first loss on the deal—in the same way that JP Morgan had agreed to accept the first $1 billion of losses at Bear Stearns before the Federal Reserve would step in and guarantee the next $29 billion—the government might well consider acting as a backstop.

  As several of Wachovia’s board members milled about a Goldman conference room, waiting to get some feedback on the deal from Steel, Joseph Neubauer, the chairman and chief executive officer of ARAMARK Holdings Corporation, looked down at his cell phone, which was buzzing. It was Paulson.

  Neubauer knew Paulson well; Goldman had been ARAMARK’s banker, taking it public and private a handful of times and making Neubauer—and the firm—millions of dollars. But Neubauer felt this was a risky call. Paulson, he thought, was not supposed to involve himself with anything related to Wachovia or Goldman, and here he was phoning him in the midst of perhaps the most transformative transaction either might ever pursue. Paulson had phoned Neubauer the day before to gauge whether a deal would ever be workable, but that had just seemed like an exploratory call. Now they were in the heat of negotiations. Paulson justified making the call because he wasn’t speaking directly with Steel, but Neubauer worried that in practical terms it seemed like a meaningless distinction.

  “This is not just about Goldman Sachs,” Paulson told him. “I’m concerned about Wachovia. Aren’t you concerned?”

  Paulson hadn’t told Neubauer that he had received an ethics waiver to get involved with matters relating to Goldman. Instead, he just continued to press him to take the Goldman bid seriously, worried that Wachovia’s board did not appreciate the severity of the situation in the world economy. “I think there should be a sense of urgency,” Paulson instructed him.

  When Neubauer put the phone down, he looked up at the other board members.

  “You’re not going to believe this. That was Hank.”

  He didn’t need to explain to the directors why the call was so surreal. To many in the room, the Treasury secretary had just ordered them to merge with Goldman.

  At Treasury, Jim Wilkinson, Paulson’s chief of staff, was by now practically sleepwalking down the halls. Paulson had just updated him of the Goldman-Wachovia talks and asked him for his counsel. Should the government provide assistance? Wilkinson, in his stupor, said he thought that it sounded like a reasonable idea.

  But a half hour later, after a cup of coffee and further reflection, Wilkinson changed his mind. He realized that such a deal would be a public relations nightmare at the worst possible time, just as they were trying to pass TARP. Paulson would lose all credibility; he would be accused of lining the pockets of his friends at Goldman; the “Government Sachs” conspiracy theories would flourish.

  Wilkinson ran back into Paulson’s office with Michele Davis.

  “Hank, if you do this, you’ll get killed,” Wilkinson said frantically. “It would be fucking crazy.”

  Ben Bernanke was being piped in over the Polycom speakerphone in Geithner’s conference room, where Jester and Norton from Treasury and Terry Checki, Meg McConnell, and William Dudley from the New York Fed were gathered around a conference table.

  Warsh was reviewing the new terms of the Goldman-Wachovia agreement. Steel and Cohn had come back to him with a slight revision to the previous proposal, allowing for Goldman Sachs to take the first $1 billion of losses, per Warsh’s suggestion. Cohn and Steel said they were committed to completing the deal that afternoon if the government would agree to provide assistance. The boards of both companies had been put on standby.

  The general view in the room seemed to be that it was a good transaction: It would give Goldman a stable deposit base at the same time it provided Wachovia with a powerful investment bank and top-notch management.

  But Geithner was quick to point out its drawbacks. “Does it make Goldman look weaker than they are?” he asked—the same question that Blankfein had raised earlier in the day. Geithner also wondered whether the Fed should be the one loaning the money. Since Wachovia’s regulator was the FDIC, perhaps it ought to be the one to bear that burden.

  Checki couldn’t believe the gall of Goldman’s request. “They’re still driving these negotiations as though they have leverage,” he said. But he opposed the merger for a different reason: He was concerned that neither side had enough time to make a thoughtful decision, referring to the situation as “the shotgun wedding syndrome.”

  Bernanke listened to the debate without comment.

  Then Bill Dudley, a former Goldman man himself who thought the deal was unattractive for the government, also raised the same objection that Buffett had raised just hours earlier: It would prove a public relations disaster for the government.

  “What are we doing here? Look at all of the connections you’ve got: Treasury and Steel and me. Goldman is everywhere. We have to be careful.”

  After Geithner and Bernanke called Paulson, all three agreed they just couldn’t support the deal.

  When Warsh delivered the news to Steel and Cohn, both men were flabbergasted. They had spent the last twenty-four hours trying to formulate an agreement at the behest of the government and were now being told it could not be carried out.

  “I’m sorry, I understand, I’m just as frustrated as you are, we just don’t have the money, we don’t have the authorization,” Warsh explained.

  Steel, feeling particularly slighted, told Warsh that he felt as if he were running from one bride to another, trying to find the right marriage to save his firm. First Morgan Stanley, and now Goldman Sachs.

  Cohn, realizing that the conversation was about to get testy, said, “I think I should step out.”

  “No, you should listen to this,” Steel insisted, raising his voice for the first time. “You should sit here and listen to every goddamn word of this.”

  Anxiously talking into the speakerphone in the center of the table, Steel became even more irate. “What do you want me to do? Tell me what to do. You can’t make this work, you don’t like this, you don’t like that. Do you want to do the Midtown deal?” he said, referring to Morgan Stanley. “Do you want me to call Citi? I’ve got to protect my shareholders. That’s my job. Just tell me what the fuck you want me to do, because I’m tired of running in circles.”

  “I don’t know if it’s true, but we’re hearing Goldman is announcing a deal with Wachovia in the next twenty-four hours,” John Mack announced to the management team gathered in his office. He had just learned of the rumor from a director at the meeting with his board and was distressed by the possibility. After all, it had been only Friday that they were in merger negotiations that didn’t seem to be going anywhere.

  Taubman, the firm’s head of investment banking, was horrified. How could Goldman Sachs, Morgan Stanley’s most bitter rival, have been willing to take on all of Wachovia’s toxic assets? he thought to himself. Hadn’t Goldman seen the massive hole in Wachovia’s balance sheet? Then it dawned on him. “Those fuckers probably have a deal with the government!” he exclaimed to the group. “It makes no sense unless the government is bailing out Wachovia and taking back a bunch of bad assets!”

  Paulson had gotten word that the Goldman-Wachovia deal was off, which put even more pressure on him to find a solution for Morgan Stanley. To him, JP Morgan was the obvious answer. While Jamie Dimon might have been resisting Paulson’s overtures—Paulson had pressed the case with him several times already over the past day—Paulson now needed to apply
some serious pressure.

  “Jamie,” Paulson said when he reached him, conferencing in Geithner and Bernanke. “I need you to really think about buying Morgan Stanley. It’s a great company with great assets.”

  Dimon had just finished having an impromptu meeting with Gao of CIC, who had come to see him to explore whether JP Morgan would be willing to work together on a bid for Morgan Stanley, with CIC buying additional equity in the firm and JP Morgan providing a credit line. But the meeting hadn’t gone anywhere.

  Dimon, who had been anticipating that the government might try to foist the deal on him, was adamant.

  “You’ve got to stop. This is not doable,” he said intently. “It’s not possible. I would do anything for you and for this country, but not if it’s going to jeopardize JP Morgan.

  “Even if you gave it to me, I couldn’t do it,” Dimon continued, explaining that he thought the deal would cost the bank $50 billion and countless job losses.

  “I don’t want to do it, and John doesn’t want to do it,” Dimon told him.

  “Well, I might need you to do it,” Paulson persisted.

  A few moments of silence passed until Dimon relented, but only slightly. “We’ll consider it, but it’s going to be tough,” he said.

  The tension inside Morgan Stanley’s board meeting was becoming untenable. Roger Altman, the banker from Evercore who had been hired just twenty-four hours earlier to advise them, was telling them that they needed to think hard about selling the entire firm. He had painted a doomsday scenario, and it wasn’t sitting well with several directors in the room, who had become convinced that Altman was trying to get them to do a deal simply so that he could collect a big fee.