by Ron Suskind
When the meeting finally arrived, Geithner acknowledged that the core of the discussion was whether “we should preemptively nationalize and dismember banks” and that, afterward, Treasury didn’t come up with a plan to dissolve Citi—but that sort of thing, like AIG, is “hard to preplan.” Of course, coming up with a plan to avoid an AIG-style meltdown and “show what government can do” was precisely what the president was seeking. And, yes, at Treasury they were fearful of alerting Sheila Bair.
As to the issue of what the president said to him after he realized that his will had been ignored, and there was no Citibank resolution plan, Geithner said he didn’t remember the president being angry at him, noting that “there were a lot of pointed rolling discussions through April,” of “where are we, what’s next, how’s it going, and what’s the thinking on alternatives” to only running the stress tests. Another proposal that got some traction was to match the dismissal of GM’s Rick Wagoner with the firing of Bank of America CEO Ken Lewis.
But that proposal was more symbolic than substantive. On matters of substance, Geithner—with the implicit backing of Bernanke—held the cards.
Did that mean he inappropriately controlled the game, taking charge of one of the most important decisions of the Obama presidency? Geithner denied the charge, later made in internal White House documents, that “once a decision is made, implementation by the Department of the Treasury has at times been slow and uneven,” and that “these factors all adversely affect execution of the policy process.” The parlance for that is “slow walking.”
“I don’t slow walk the president on anything,” he said. “People who wanted to do other things often accused me of slow walking, but I would never do that.” But Tim Geithner added, with some satisfaction, the battle over restructuring the financial industry “was resolved in the classic way, that plan beats no plan.
“No one else had a plan.” Including Barack Obama.
Summers and Romer were deeply concerned. They feared that in Geithner’s hands the stress tests would be so easy that they would end up proving nothing, other than the administration’s inability, or unwillingness—depending on how you saw it—to demand tough concessions from Wall Street.
On Easter Sunday, April 12, the two trekked to Geithner’s conference room at Treasury, where they—along with Geithner and a dozen others, including former bankers such as Lee Sachs—went through the arcana of loan-to-equity ratios, deposits versus assets, and tiers of capital.
It was another marathon meeting. Now they were decidedly on Geithner’s turf, and he was prepared. For every concern of Summers and Romer, Geithner and his team had a ready answer.
The discussion focused on so-called tier-one capital, the safest core capital of a bank, its cushion, which was usually in cash or cash equivalents such as Treasury bills. The stress tests needed to decide not only what banks could fairly count as tier-one capital but also what level was sufficient to stave off government action. Geithner and his team thought 4 percent of overall assets was fine. Summers and Romer were pushing for 6 percent or even higher, considering the sluggishness of the economy and the heavy load of mortgage-related assets weighing down balance sheets.
“You only get one shot at this,” Romer said. “You don’t want to shoot low.”
“Our credibility is being put on the line,” Summers seconded.
The goal, however, was gentle optimism: that a turnaround for the industry could begin with acceptance of a slightly improved version of reality, and that the ensuing confidence—that things will turn out well—encourages actions to make it so. In this regard, the combatants ate chocolate Easter eggs and matzo as they debated matters of resurrection: how much capital banks should have on hand, given present circumstances, to allow the government to stamp them with a slightly improved version of reality. Summers and Romer said there was no way to precisely predict whether there would be a steady upward trend for the U.S. economy. It was wrong to bet the credibility, and the Treasury, of the federal government on such a prediction. If you got it wrong, you would be missing the best and maybe only opportunity to fix these banks so that credit would begin pumping again, in safe fashion.
At 10:00 p.m. the dispute over whether these stress tests were just the government’s version of Kick the Can was starting to slow. Treasury had the upper hand. The tests were for them and the Fed to execute and shape. Gene Sperling left the room and returned with another box of matzo. Geithner, famished like the rest of them, shook his head.
“Don’t do that,” the Treasury secretary said. “Now we’ll end up being here for another hour.”
But, at this point, the subtext was clear. Deep down, it didn’t matter how each bank was assessed in the stress test. The fact that each one would be given a “United States of Moody’s” stamp, and told how much money the government recommended it raise, meant that anyone who invested in a bank should feel confident that they would recoup their losses in the event of a bankruptcy, care of Washington. Being able to sell this assurance in the public markets meant banks would quickly raise enough money to pay back their TARP funds and explore new, commanding heights of profit. Whatever else was happening in the economy, the investment bankers in the room, such as Lee Sachs, could not help but sink into delicious fantasies of how the banks would now be able to earn their way to health and beyond.
Romer shook her head. She had too much context to feel celebratory at this prospect.
“After all that happened over the past two months—much less the last ten years,” she said, looking back, the idea that the shareholders and executives of Citigroup and other banks “might now get rich with the help of the U.S. government was just unconscionable.”
Yale Law School was as impressive today, with its soaring, centuries-old Gothic spires, as it was on the first day Greg Fleming arrived in 1988, fresh off his undergraduate days at Colgate. Now, years later, with two kids and money in the bank, it impressed him as a place where he might rediscover his ethical moorings.
Three and a half months before, on January 1, Bank of America and Merrill shareholders had approved the bank’s $50 billion purchase of the investment firm.
It was already being called the “deal from hell.”
That price tag, of course, was only half the story. The buyout was supported by $118 billion in government backstops and an additional $20 billion negotiated in the brinksmanship—still largely opaque—between Ken Lewis and the team of Paulson and Bernanke in late December. Lewis pressed his case that Merrill’s losses were worse than expected, and after the deal closed, a $15 billion loss was announced for Merrill, now Bank of America’s largest division. This drew one round of lawsuits, followed by more, once revelations about Lewis’s December ultimatums began to emerge, followed by a “good God, what’s next” fear that crushed Bank of America’s share price. By late January it had sunk by nearly 80 percent from where it was on Lehman weekend when the Merrill deal was hastily struck and signed, the handiwork of Greg Fleming.
By January, once the deal was inked, the key details, some of them unsavory, began to emerge in rough lockstep with the departures of senior Merrill executives, from John Thain, Merrill’s CEO, to Fleming, the number two, and on down.
It was after all this, in late January, that word began to slip out—most likely from aggrieved Bank of America employees—about Merrill’s last-minute bonuses of $3.6 billion, paid quickly before the brokerage firm changed hands.
Along with his invective about “shameful” practices, the president said that Wall Street should have the decency to “show some restraint.”
The words about “shameful” practices and the need for restraint carried force, and stung Fleming. He liked the president and felt he was right: “It is a time for self-restraint,” Fleming said, “for taming the ‘animal spirits’ of the street, and Washington is the only place with the power to make it happen.”
Fleming thought often of his phone conversations with Obama from the New York restaurant in
2007. He knew he was now too controversial, as the man who sold Merrill, to merit an audience, but he daydreamed about how such a meeting might go, how he might help with that self-restraint by building a mix of barriers and incentives to get Wall Street refocused on fundamentals, on actually investing in the construction of a stronger American economy.
In fact, over the years, Fleming had built a strong case for how self-restraint might look—and it had cost him. He was paid $34 million in Merrill’s bumper year of 2006, but then took no bonus in 2007—a year Merrill CEO Stan O’Neal was paid $161 million—and then nothing from that $3.6 billion bonus pool in 2008. On that last score, Fleming convinced Thain and two other top executives to also go without pay. That last act may have proved to be salvation for the Merrill team in the days after Obama’s “shameful” comments, as the fur flew.
In early February, New York attorney general Andrew Cuomo’s office, which began investigating the Merrill–Bank of America deal, had subpoenaed Thain—who’d made more headlines by revealing he’d spent more than $1 million redecorating his office. The details, including an $87,000 rug, were tabloid fodder, and he quickly reimbursed the money.
Fleming, who was up next, received a legal letter from Bank of America telling him, in essence, not to cooperate with Cuomo, and that eternal silence was part of his exit agreement. Fleming leaked the letter, thumbing his nose at Bank of America, and then showed up at Cuomo’s office on March 9 for a long day of depositions. He felt he could testify, and that he should. He’d forgone tens of millions in bonuses in 2007 and 2008. He was trying now to redeem himself.
And then he vanished to Yale to start a new life.
“Having nothing to hide is going to cost you these days on Wall Street,” he said. “And maybe that’s part of what went wrong. Look, I’m no prince. I want to make money as much as the next guy. But things got to the point where acting prudently—or, God knows, ethically—got you slaughtered, left behind. It made you the tortoise in a race where the hares were getting paid by the yard. We’ve got to figure out a way to reward slow and steady, prudence and sure-footedness so, like in that old story, sometimes the tortoise eventually wins.”
Part of the battle Obama faced in translating values he espoused in his Inaugural Address—of his desire to usher in “an era of responsibility”—was to change what he and others often called the “culture of Wall Street.” The features of that culture had thoroughly permeated the wider American culture. Wall Street’s stars were cultural icons. The Street was a destination for the top students graduating from the top colleges for nearly three decades. It was the epicenter of the quick-kill, winner-take-all, by-any-means-necessary ethic.
Fleming, walking the Yale campus, was testing the undertow of that culture and what it might take to break free of its pull.
Escaping the staccato beat of New York, and getting some distance from the past two years, was a first step. The second was having to field questions from law students who were disinterested parties. Some were merciless. He had a buffer; he taught the class with the help of another professor, and brought in others to be lightning rods: a steady procession of Wall Street players. They took the train two hours from New York to New Haven and, in class after class, sat for an hour of truth therapy before returning south.
Today, April 21, there was an array of lawyers and executives from top investment banks. The most consequential, and least imposing of them, was H. Rodgin Cohen, the managing partner of Sullivan & Cromwell. He was a small, soft-spoken man, but also the most powerful lawyer, deal maker, and consigliere in the financial industry. He had joined Sullivan & Cromwell out of Harvard Law School in 1970, become its chairman in 2000, and advised virtually every major bank in the United States and on Wall Street since.
At sixty-four he was hoping for a valedictory flourish to a storied career, with a few years as the deputy Treasury secretary. A Democrat, he had met Obama several times, liked him, given him money, and raised it. “Rodg” was getting close to retirement age at Sullivan; government would be a perfect fit. But last month it had become clear that his confirmation would turn troublesome. It wasn’t so much what he had done, or how he’d profited from the past decade of Wall Street’s excesses—which, of course, he had—as what he knew. That would be everything. He had advised everyone, and had often stood as the last counselor tapped before action. Under oath, he’d been asked about the AIG bonuses, Goldman’s $13 billion counterparty payments, what Dick Fuld knew and when he knew it. Claiming lawyer-client privilege would have sounded like taking the Fifth Amendment. So he reluctantly withdrew.
But, sliding down in his chair in a lounge at Yale—students and other visiting Wall Street types crowded in from all directions—Rodg didn’t weigh in, as expected, on ethical or moral issues. He was too concerned about the stress tests and too busy advising banks and his friends at Treasury about the perils and possibilities of their course.
“What’s going to happen to banks if they are told they need to raise capital?” he proffered, in a reedy voice as soft and earnest as that of TV’s Mr. Rodgers. “What will be the impact on a bank’s stock price, its debt trading and counterparties?” These banks, he went on to say, will be able to say that if I can’t raise capital on acceptable terms, I can turn to the government. But won’t these banks be forced to move very quickly to raise capital at a time they are told they are capital deficient? The ultimate danger is that customers and counterparties will disengage, even if there is the assurance of government capital, because who wants to deal with a bank that has been deemed “weaker” than its peer institutions?
This was the position Wall Street had been pressing on Washington in the past two weeks. The government, Rodg said, “will be picking winners and losers,” putting its stamp on strong versus weak. The ways this might affect Wall Street were indeed unique. With Chrysler or General Motors—with their tangible liquid assets, definable product lines, and measurable activities—the government’s designation of healthy and unhealthy wouldn’t make much difference. Stock prices might suffer, but vendor relationships, the key to most manufacturing, would stay intact.
Wall Street was different. The financial products sold by the Street were virtually all the same: commodities, essentially, offered in many flavors by what, at its core, was a kind of capital cartel. The way the firms made money was by building and breaking alliances within this cartel, to gain small advantages and make their menu look freshened and reshaped for clients and customers. When a firm stumbled, customers tended to wake up, snapping out of a trance, to recognize that the real item in this mix was their hard-earned money—not some firm’s claim to magical properties that effortlessly turned money into more money. But having nowhere else to turn—that’s the way cartels work—these customers would fearfully leap to another firm with the click of a wire transfer. The practical outcome: when the government tags one institution as weak, the others turn on it like piranhas.
Rodg thought all this over for a minute, doing the math.
“Another interesting part of the dynamic,” he said, “is . . . not do you need capital, but how many others do as well? If you need it, and nineteen others also need it and take it, not so bad. But if only four or five take capital, it’s much more of a winners-and-losers syndrome.”
He is no doubt thinking about which of his clients, or other major banks, might fall in which category. Goldman and JPMorgan, for instance, could grow very strong feasting on four or five big banks that might be wounded by the government’s vote of no confidence. In fact, both banks were already ahead of where they’d have been otherwise, having fed on the carcasses of Lehman, WaMu, Bear Stearns, and the others. That was why they were already starting to post stronger-than-expected profits.
But what about the weight of toxic assets? One of the students asked. Under pressure to post strong earnings and shore up their capital, won’t it be hard for banks to clear away those toxic assets so they can start lending again? Will any of these actions really restore
confidence?
“Under the best of circumstances,” Rodg concluded, “I think it’s optimistic to assume the stress tests will fully restore confidence in the banking industry. Banks must still deal with their toxic assets . . . that’s what this whole PPIP thing is all about. The key question is: Will we be able to see clearing prices—prices at which investors are willing to buy the assets—where banks are capable of selling them without creating too large a capital hole?”
The answer to that was probably no. This was the untenable bottom line that Rodg, like those at Treasury he’d been talking with, was having to face. It was, in fact, the underlying problem of the PPIP, the Public-Private Investment Program, and the stress tests more generally. While banks may go out to raise money, there weren’t incentives powerful enough, anywhere, for most of them to sell off toxic assets at rock-bottom prices, marking them to market, and then having to reduce the values of entire real estate portfolios—just like when a house sells for a low price in a neighborhood and, as a “comparable,” pulls down appraised values up and down the street.
In Japan, banks wrote down the toxic assets at their own discretion—which meant slowly or not at all, even as they were pushed back to profitability by the government. The drag on their balance sheets hardened into a new normal, constraining the flow of credit for years. One of the points that Summers and Romer made in the big meeting on March 15 was, simply, if you give a public company an option, they’ll tend to delay the pain rather than face it, especially when they can get all but free money from the Fed and push it into trading activities.
That dilemma would be left for another day. After two hours, Rodge and the others were on their way back to Wall Street. Fleming, too. He had a fund-raising dinner in New York that night—a gala to support New York’s food banks, which were overcome with record numbers of hungry people, many of them newcomers to penury. The whole New York economy rested on the financial industry and the cash that had flowed from the pockets of those lucky enough to be part of the industry’s bonanza. That the boom had been over for nearly a year meant that, up and down the line—from cooks to masseurs, caterers to the haberdashers—the city’s providers of high-end goods and services were suffering.
