Too Big to Fail

by Andrew Ross Sorkin

  There was now within the government a de facto turf battle over Wachovia, given the involvement of Richmond, with Warsh and Geithner playing deal makers. And Sheila Bair at the FDIC had yet to take part: If Wachovia really were to fail, it would be her jurisdiction.

  Geithner and Warsh set up a conference call to coordinate their efforts with Bair, the fifty-four-year-old chairwoman of the FDIC and one of their least favorite people in government. They had always regarded Bair as a showboat, a media grandstander, a politician in a regulator’s position whose only concern was to protect the FDIC, not the entire system. She was not, in their view, a team player. Geithner would frequently commiserate about Bair with Paulson, who shared a similar perspective about her. At times, Paulson had a genuine respect for her. “She comes to play,” he regularly said to his staff, but added, “When she is surrounded by her people, when she’s peacocking for other people or she’s worried about the press, then she’s going be miserable.”

  Bair, who had just ended a conversation with Warren Buffett (who she was hoping could help her track down Wells Fargo’s president, John Stumpf), joined a conference call late Sunday with Geithner, Warsh, and Treasury’s David Nason. Paulson, who was barred from talking to Steel, had tried to disentangle himself from this particular matter, expending his energy instead on TARP and receiving only irregular updates on the negotiation progress from Nason.

  When Geithner suggested Bair should help subsidize any deal for Wachovia, she resisted the proposal firmly, stating in a lengthy soliloquy that the only way she would get involved was if she were to take over the bank completely, and then sell it.

  When she finished, there was an awkward silence. “Right, right, right,” Geithner said, almost mocking Bair.

  Geithner countered that allowing the FDIC to take over Wachovia would have the effect of wiping out shareholders and bondholders, which he was convinced would only spook the markets. He was still furious with Bair for the way she had abruptly taken over Washington Mutual, which had had a deleterious effect on investor confidence. Given Paulson’s ongoing public efforts to support the banking system, he told her, that option was a nonstarter. Then Geithner, looking for another jar of money, asked Nason if Treasury could contribute to the effort, which could eventually amount to more than $100 billion.

  “We’re still trying to get TARP passed,” Nason replied briskly. “We can’t be committing money.”

  At 7:00 p.m., Bob Steel, waiting in a conference room at Sullivan & Cromwell’s Midtown offices, got a disturbing call from Kovacevich, who had been inexplicably out of touch for the past two hours, and who had sounded oddly detached during their previous call.

  Kovacevich now announced that he wasn’t prepared to move forward without government assistance. “We don’t make these kinds of loans, so we don’t understand them,” he explained. Steel, dumbfounded, thanked him, ended the call, and slumped down in his chair, wondering how he could have been rejected again. Citigroup was still on the sidelines, but he doubted they would raise their bid, especially if there was no competition. When he told his inner circle about the call with Kovacevich, he described it as “not an attractive fact.”

  At around 8:00 p.m., Rodgin Cohen heard a rumor that Citigroup had been talking to the FDIC, which only led him to suspect that Citi was trying to orchestrate an FDIC takeover of Wachovia, one similar to the deal that JP Morgan had made for Washington Mutual. Furious, he rang Ned Kelly, upon whom Pandit relied for strategy. Only days before, Kelly had been appointed head of global banking for the bank’s institutional client business in a reshuffle that saw the departure of Sallie Krawcheck, who had once been one of the most powerful women on Wall Street.

  “Okay, we need to talk,” Cohen began testily.

  “Rodge, look, I wasn’t in touch with them, they just called me,” a defensive Kelly insisted. “I still have the same deal on the table.”

  When Steel learned of their conversation he knew that he was, for all practical purposes, out of options, for Warsh had made it clear the bank couldn’t open Monday without a deal. In a last-ditch plea to remain independent, he called Sheila Bair at 12:30 a.m. with a proposal: Would the FDIC consider guaranteeing some of Wachovia’s most toxic assets in exchange for warrants in the bank?

  At 4:00 a.m. Steel got the answer he had been dreading. Bair phoned to notify him that his bank had been sold to Citigroup by the government for $1 a share. The FDIC wouldn’t be completely wiping out shareholders, she said; she had succumbed to pressure from Geithner and agreed to guarantee Wachovia’s toxic assets after Citigroup accepted the first $42 billion of losses, declaring that the firm was “systemically important.”

  Paulson stood alone in his office, watching the congressional coverage of his bailout bill on C-SPAN. After some additional compromise on Sunday, legislation had been drafted that was acceptable to all the parties and was now being put to a vote.

  Pelosi, standing on the floor of the House, had just given an impassioned speech about the need to pass the bill, but had also used the moment as an opportunity to assail the Bush administration, Paulson, and Wall Street. “They claim to be free market advocates, when it’s really an anything-goes mentality,” she said of the Bush administration. “No regulation, no supervision, no discipline. And if you fail, you will have a golden parachute, and the taxpayer will bail you out…. The party is over in that respect. Democrats believe in a free market. We know that it can create jobs, it can create wealth, it can create many good things in our economy. But in this case, in its unbridled form, as encouraged, supported, by the Republicans—some in the Republican Party, not all—it has created not jobs, not capital; it has created chaos.”

  Although a few members of Paulson’s staff were loitering nervously outside his office, afraid to go in, Michele Davis had no such qualms and joined him, the two of them intently following the tally of yeas and nays at the bottom of the screen. Paulson expected the bill to pass without a problem, as the markets had already priced in its approval. Five minutes into the allotted fifteen-minute voting window, however, the number of nay votes began to rise consistently. He knew that the measure was still very unpopular with House Republicans, as well as with a number of liberal Democrats, and lawmakers facing tight reelection races did not want to give their opponents any ammunition with just five weeks before election day. There was still time, however, for Pelosi and the Democratic leadership to turn the vote around.

  “They wouldn’t have brought this bill to the floor if they didn’t think it could pass, if they didn’t have the votes lined up somewhere,” Davis reassured him. Paulson said nothing and only continued to stare at the screen as the margin of no votes grew wider and wider.

  Kevin Fromer, Treasury’s legislative liaison, called anxiously from outside the House chamber. “This is going to fail.”

  “I know,” Paulson mumbled dully. “I’m watching.”

  Finally, at 2:10 p.m., after an unusually long period of forty minutes to count the votes, the gavel came down: The bailout was rejected 228 to 205. More than two thirds of the Republican representatives had voted against it, as had a large number of Democrats. Traders and investors had been watching the coverage also and started a frantic wave of selling. Stock prices plunged, with the Dow Jones Industrial Average tumbling 7 percent, or 777.68 points, its biggest one-day point drop ever.

  For a moment Paulson was speechless. His plan, which he believed might be the most important piece of legislation he could ever propose—his effort at avoiding a second Great Depression—had failed. As his staffers, seeking to comfort him and one another, silently gathered in his office, he said simply, “We’ve got to get back to work.”

  Within an hour he and his team were at the White House, meeting with the president in the Roosevelt Room and discussing plans for how to revive the bill.

  Downstairs in the Treasury building, however, Dan Jester and Jeremiah Norton had their own ideas about the problem Paulson was facing. They had convinced themselves that th
e concept of buying up toxic assets was never going to work; the only way the government could truly make a difference would be to invest directly in the banks themselves. “This is crazy,” Norton said of the TARP proposal as he walked into David Nason’s office. “Do we really think this is the right approach?” Jester and Norton had made the case to Paulson before, but the politics of using government money to buy stakes in private enterprises, he knew, had gotten in the way. And once Paulson had gone public with his current plan it seemed as if it would be difficult for him to reverse course.

  “If you feel that strongly, you need to tell Hank,” Nason said to him. “You can tell him I’m onboard with you.”

  The next day Jester and Norton went to visit with Paulson. They laid out their case: Buying the toxic assets was too difficult; even if they ever figured out how to implement the program, it was unclear whether it would work. But by making direct investments in the banking system, Jester told him, they’d immediately shore up the capital base of the most fragile institutions. They would not have to play guessing games about how much a particular asset was worth. More important, Jester argued, most of these banks eventually would regain their value, so the taxpayer would likely be made whole. And, Jester continued, the current TARP proposal actually allowed Treasury to use it to make capital injections, even if it hadn’t been advertised as such.

  Paulson, who had become somewhat disillusioned with the time it was taking to design and implement TARP, was starting to come around to Jester’s way of thinking. He had no idea how he’d sell it to the American public, and he knew that it would be anathema to the Bush administration, but he also knew it might be the most practical solution in a sea of bad options.

  “Okay,” he sighed. “Why don’t you work something up? Let’s see what this would look like.”

  As the sky grew dark, Bob Steel climbed the steps of Wachovia’s corporate jet at Teterboro Airport in New Jersey to head back to Charlotte. He had spent virtually the entire week in back-to-back meetings with Citigroup to coordinate the details of the merger, which they planned to herald in a full-page newspaper ad on Friday, declaring: “Citibank is honored to enter into a partnership with Wachovia…the perfect partner for Citibank.” While he was frustrated with the paltry final price of the deal, he was proud to have at least saved the firm from failure, and he knew that he had explored every possible option in trying to do so.

  The government-orchestrated deal had been announced on Monday morning, but it still needed to be formally “papered over,” and in the meantime, Citigroup was keeping Wachovia alive by loaning it $4.9 billion. A number of details were still to be worked out, but they expected to have a signed agreement within the next day. Steel had spent that afternoon at Citigroup discussing the postmerger fates of the most senior Wachovia executives. Before he left he had shaken hands with Pandit. “Looks like we’re done,” Pandit had said gladly.

  As Steel’s plane taxied down the runway his BlackBerry rang. It was Sheila Bair. “Hi, have you heard from Dick Kovacevich?”

  “No, not since Monday morning,” a puzzled Steel answered; the Wells Fargo CEO had called then to offer his congratulations on the deal with Citi. “Why?”

  “I understand that he’s going to be making a proposal for $7 in stock for the entire company—no government assistance.”

  “Wow,” Steel replied, quickly trying to assess the ramifications of what Bair had just told him. Had Wells Fargo just jumped Citigroup’s bid? Was the government, which had blessed the original deal, now reversing itself? “Sheila, I’m about to take off any second,” he apologized. “You should call Jane Sherburne,” he added, referring to Wachovia’s general counsel.

  Sometime after 9:00 p.m., just minutes after Steel’s plane landed in Charlotte, Kovacevich phoned with the pitch that Bair had outlined earlier. Having just spoken with Sherburne and Rodgin Cohen, Wachovia’s outside counsel, Steel had been instructed by them not to say anything that would indicate acceptance or rejection of the offer.

  “I look forward to seeing the proposal,” Steel told Kovacevich, and a minute later he received an e-mail with a merger agreement already approved by the Wells board.

  It was as if Christmas had come early. Steel couldn’t believe his luck: A deal at $7 a share, up form $1 a share—and without government assistance.

  He called his office and scheduled an emergency board meeting by telephone for 11:00 p.m. Before the board call, Steel had a strategy discussion with Cohen. While he owed it to Wachovia shareholders to take the highest bid, he also recognized that he already had a deal with Citigroup—a deal that had kept the firm from failing. The term sheet that Wachovia had signed with Citigroup included an exclusivity provision that prevented the firm from accepting another offer.

  “I’m going to be sued by somebody,” Steel told Cohen.

  “Pick your poison,” Cohen replied drily.

  To both of them, however, it was clear that there really was no choice: The board had to accept the higher bid and take its chances with a suit from Citigroup. Steel and Cohen realized that Wells Fargo had made its bid because of a little-noticed change in the tax law that had occurred on Tuesday, the day after the Citigroup deal. The new provision would allow Wells Fargo to use all of Wachovia’s write-downs as a deduction against its own income, thus enabling the combined bank to save billions in future taxes.

  Wachovia’s board voted to accept the deal just after midnight. The Wells offer was for the entire company; it gave shareholders more; and it was clearly the deal preferred by regulators. (Citigroup’s deal, while worth only $1 a share, would have left behind several Wachovia subsidiaries that could have additional value—possibly several dollars a share worth—but a precise number would have been difficult to determine.) It was after 2:00 a.m. by the time Wachovia’s board had fairness opinions from advisers Goldman Sachs and Perella Weinberg, who had been on opposite sides of the negotiating table just a week before.

  Steel called Kovacevich to tell him the news, and then dialed Bair’s BlackBerry, which she had instructed him to call instead of her home number so as not to wake her children.

  “We’re all approved,” he told her.

  “All right,” Bair said, sounding relieved. “We will have to call Vikram first thing in the morning.”

  “Sheila, we’re not waiting until the morning,” Steel said resolutely. “We’ve done this; we’ve approved it. I think we have to call him now. I don’t want him hearing this when he wakes up from someone else.”

  “You should do it,” she said equally firmly.

  “I think you should be on the phone, since you married us,” he replied.

  With Bair on the line, Steel conferenced in Jane Sherburne, and then he called Pandit, not surprisingly waking him.

  “Bob, what’s going on?” he asked groggily

  “Well, there’s been an important development,” Steel said carefully. “I’m on the phone with Sheila and Jane. Do you need a moment?”

  “No, I’m fine,” Pandit said, collecting himself. “What is it?’

  “We received an unsolicited proposal from Wells Fargo for the entire company of Wachovia, $7 a share, no assistance, and a Wells Fargo board–approved doc that we’ve accepted. We think this is the right thing to do.”

  “Well, that’s interesting,” Pandit answered, a bit taken aback. “A better bid? Let me call Ned. Let’s work with you, and let’s see what we can do and get this thing resolved.”

  “No, no. You don’t understand,” Steel interrupted, pausing for a moment. “I’ve signed it already.”

  There was silence on the other end of the line. If Pandit hadn’t been completely awake before, he was now. When he resumed speaking he was irate, the full force of Steel’s news having registered with him.

  “We have a deal! You know you can’t do this, because we actually have an exclusive arrangement with you. You are not allowed to sign.” Pandit, frustrated, appealed to Bair. “Madame Chairwoman?”

  “Well, I
can’t get in the way of this,” Bair replied, in her most official tones.

  “This isn’t just about Citi,” Pandit explained to her. “There are other issues we need to consider. I need to speak to you privately.”

  Steel agreed to leave the conversation, and as soon as he hung up Pandit began pleading with Bair. “This is not right. It’s not right for the country, it’s just not right!”

  But the decision, she made it abundantly clear, was final.

  Stock prices were surging before the House began voting on the bailout bill for a second time on the afternoon of Friday, October 3. Its passage was eased after the Senate version of the legislation added a number of tax breaks that were otherwise due to expire. Another popular addition increased the amount in individual bank accounts insured by the FDIC to $250,000 from $100,000. What had begun as a three-page draft was now more than 450 pages of legislative legalese, which the Senate had approved after sundown on Wednesday.

  Many of the House Democrats and Republicans who had opposed the measure on Monday had since been persuaded to switch their votes—some by appeals from the two presidential candidates or from the president, some by the added provisions in the bill, and others by the mounting signs that the financial crisis was dragging the economy down into a deep recession. A recent report indicated that 159,000 jobs had been lost in September, the fastest pace of monthly job cuts in more than five years. Stocks had slid sharply that week, and both the takeover of Washington Mutual and the desperate jockeying to secure a partner for Wachovia revealed that not only Wall Street was in trouble.

  In the final House tally, thirty-three Democrats and twenty-four Republicans who had voted against the bill on Monday now approved it. That afternoon, President Bush signed the Emergency Economic Stabilization Act of 2008, which created the $700 billion Troubled Assets Relief Program, or TARP. “We have shown the world that the United States will stabilize our financial markets and maintain a leading role in the global economy,” the president declared.