In FED We Trust (3 page)

But the Bank of America executives now said buying Lehman without help wasn’t possible.

Paulson’s reply: tell them to show me their best offer.

The executives told Jester that Lehman was carrying assets on its books that were worth about $25 billion less than Lehman said they were. If Bank of America were to do a deal, someone — the government or a consortium of other financial firms — would have to take $25 billion to $30 billion of Lehman’s bad real estate assets.

Government bank bailouts were hardly unprecedented in the United States or abroad. Between 1986 and 1995, the government shuttered more than a thousand savings and loan associations with assets totaling over $500 billion — for
a total cost that ended up at about $150 billion. In that case, as in most others, the decision to spend huge sums of money was made by democratically elected leaders, not unelected central bankers. Now, however, the clock was ticking: if $30 billion was needed this weekend to seal a deal to save Lehman, it was going to have to come from the Fed. For its part, the Fed
could
come up with large sums of money quickly, but neither Bernanke nor Paulson was comfortable with doing so — especially after facing so much criticism for the assertive government role in getting Bear Stearns sold in March 2008.

In a conference call with Bernanke and Geithner, Paulson had stated unequivocally that he would not publicly support spending taxpayers’ money — the Fed’s included — to save Lehman. “I’m being called Mr. Bailout,” he said. “I can’t do it again.” Though Paulson had no legal ability to stop the Fed, Bernanke and other officials were extremely reluctant to put money into any Lehman deal over the Treasury secretary’s objections — unless, as Paulson often did, he changed his stance.

Paulson was a deal maker. He didn’t build relationships by socializing. He focused relentlessly on studying his clients, figuring out what motivated them, and reaching the desired outcome. It was a style that helped him in February 2008 negotiate an emergency $152 billion tax cut with a Democratic Congress to try to give the economy a jolt. But like many on Wall Street, he could shout “No! No!” before, citing changed circumstances, abruptly saying “Yes!” The approach provided flexibility in negotiating the best business deal; it didn’t build lasting credibility in Washington. He would later argue that each of his exaggerations or unqualified statements was justified by prevailing circumstances or tactics. His “Mr. Bailout” outburst, he insisted months later, was calculated to stop any lower-level government employees on the conference call from weakening the government’s bargaining position by leaking that the government might put in money. But his words were so emphatic that listeners later were stunned by his subsequent actions.

As Lehman’s problems deepened, the Treasury secretary’s style occasionally brought him into conflict with Geithner, his partner in managing the crisis. Geithner’s approach — at least when he was at the New York Fed — was more disciplined, calmer, and politically savvy. A veteran of the U.S. Treasury’s management of the Asian financial crisis of the 1990s, Geithner had learned
at the side of Clinton’s agile Treasury secretary, Bob Rubin. Rubin placed a high premium on what his then-deputy Lawrence Summers called “preserving optionality” — deferring final decisions until they had to be made and avoiding any public statement that could limit his political wiggle room. Rubin prized flexibility, and so did Geithner. That made sense in an ever-changing panic, but this approach risked turning crisis management into a series of ad hoc decisions that left everyone from traders in the markets to politicians in Congress guessing at the rules of the game.

Geithner had strenuously cautioned Paulson and Bernanke against publicly displaying any regret about the Bear Stearns bailout. In the calm, methodical manner that earned him respect inside the Fed and Treasury, Geithner counseled that the best approach now would be to ask: Is the system at risk if Lehman defaults? Is there a way to prevent default? If so, can the government help legally?

The Geithner method, however, required a certain team discipline, and that had fallen apart Thursday night when a couple of Paulson’s aides — Jim Wilkinson, his chief of staff, and Michele Davis, his spokeswoman and chief of policy planning — jumped the gun, spreading the word of Paulson’s no-taxpayer-money-for-Lehman vow to the press. “U.S. Helps Lehman Go Up for Sale; Regulators Are Seeking a Weekend Deal Not Involving Public Money” read the front-page story in the
Washington Post
on Friday, September 12. Reuters news service, citing “a source familiar with Paulson’s thinking,” said the Treasury secretary was “adamant” that no government money be used. The Associated Press and the
Wall Street Journal
said much the same thing.

Davis and Wilkinson didn’t want Paulson to walk into a roomful of Wall Street CEOs who expected him to pull out the Treasury’s or the Fed’s checkbook to help one of them buy Lehman. Better to save the checkbook until the last minute. It also seemed plausible that Paulson was doing something more than staking out a tough bargaining position. Perhaps, as the press put it, Paulson was “drawing a line in the sand.” After all, he had said emphatically a few months before: “For market discipline to constrain risk effectively, financial institutions must be allowed to fail.”

Whatever Paulson’s reasons — and Wilkinson and Davis’s reasons for previewing them — Geithner thought that publicly drawing “a line in the sand”
during a financial crisis was lunacy. Paulson’s staff seemed to be telling the world that the Treasury and the Fed had decided to cut Lehman loose to punish Wall Street miscreants. Sending a tough message — “Washington to Wall Street: Drop Dead” — at a moment of panic was wrong. Geithner lost his customary cool, telling Paulson emotionally: “The amount of public money you’re going to have to spend is going up, more than you would have otherwise! Your statement is way out of line!” Geithner understood, but Paulson and some of his staff didn’t appear to, that a tough bargaining stance in a room full of investment bankers made sense, but that the press, the markets, and foreign officials abroad couldn’t distinguish a bargaining position from a policy position.

Paulson and Geithner’s differences were suppressed as the CEOs of the twenty largest banks and investment houses gathered in a conference room on the first floor of the New York Fed at 6
P.M.
, Friday, September 12. Paulson sat at one end of the table with Christopher Cox, the chairman of the Securities and Exchange Commission, beside him. Geithner sat at the other end. The goal: to get Wall Street to come up with enough money to make Lehman Brothers attractive to one of its two surviving suitors, Bank of America or Barclays, much as Bear Stearns had been married to JPMorgan Chase.

“We did the last one,” Paulson told the men, according to a person who was there. “You’re doing this one.” There would be no government bailout for Lehman. Either someone would buy the company, sharing the losses with other Wall Street firms, or the government would let it go under. He told the CEOs that if the government did put money in, the political reaction would be overwhelming, and Wall Street firms would feel the pain.

Geithner — in phrasing that would fuel speculation that he would have saved Lehman had it been up to him — told the assembled executives: “There is no political will for a federal bailout.”

Then, as Geithner always did in a crisis, he divided the necessary work among task forces. “He is very iterative,” one of Geithner’s aides said. “What’s the best idea? Go back and work on it. Come back in two hours. He’s incredibly
tenacious. He just keeps going. How many iterations are required to get to where we want to go? Five hundred? OK, I’ll go to five hundred.”

Morgan Stanley, Merrill Lynch, and Citigroup were assigned to see if the industry could band together to run what Geithner called “a liquidation consortium” to sell off Lehman in pieces. Their mission was to do essentially what had happened back in 1998 when the New York Fed had summoned the heads of Wall Street firms to prevent an untidy collapse of a hedge fund, Long Term Capital Management. That episode demonstrated how one large and leveraged institution, in this case a hedge fund that had recruited Nobel Prize-winning economists to hone its strategy, could threaten the entire financial system. But back then the Fed managed to cajole Wall Street firms into paying the tab; this time the problems were bigger and more widespread.

Goldman and Credit Suisse, which had been working with Lehman for weeks, were assigned to look over Lehman’s commercial real estate assets to determine their worth. Everyone in the room believed their value to be far below the value Lehman had been carrying on its books. Their job was to look particularly at the assets no buyer would take, figure out “how big the hole is,” and devise some way to share the risk in order to get one of their competitors to buy the rest of Lehman.

A third group was asked, in Geithner’s phrase, to “put foam on the runway” — that is, prepare for a Lehman bankruptcy.

“Come back in the morning and be prepared to do something,” Geithner told them.

Geithner and Paulson were asking a lot. They wanted the firms present to put in big bucks in the middle of a financial panic to strengthen a competitor, and they knew that Lehman wasn’t the end of the line. As the CEOs filed out of the conference room shortly before midnight, everyone was aware that even if Lehman were saved, big brokerage house Merrill Lynch and giant insurer AIG were next in line and perhaps Morgan Stanley, too. Or as Fed governor Kevin Warsh put it later: “We were running out of buyers before we were running out of sellers.”

On Saturday morning, Bank of America executives told Paulson and Geithner that Lehman was in deeper trouble than they had realized just twenty-four
hours before: someone would need to take between $65 billion and $70 billion of smelly real estate assets if Bank of America were to buy the firm, it said.

That was enough to convince Paulson, Geithner, and Warsh that Bank of America didn’t really want to do the deal. Their attention turned to Barclays, the British bank.

All day Saturday, Paulson and Geithner talked in person and by phone with Barclays executives and fielded frequent calls from Lehman’s Fuld, who had been told to stay away. Paulson shuttled constantly between Geithner’s thirteenth-floor office and the first-floor conference room, where in excruciating detail he briefed executives from other firms on the latest developments.

The group assigned to think through liquidating Lehman quickly concluded that their mission was impossible. So attention shifted toward “filling the hole,” somehow coming up with a way for a group of Wall Street firms to take the assets that Barclays didn’t want so a deal could be struck.

But, the conversation made clear, no one was confident Lehman would be the last firm to be rescued. “If we’re going to do this deal, where does it end?” asked Morgan Stanley’s John Mack. Everyone knew AIG and Merrill Lynch were vulnerable. The big question hanging in the air: Would banding together to save Lehman reduce the odds that AIG or Merrill would also need rescuing, or were they in such deep trouble already that they would need rescuing anyway?

To put pressure on the executives, Geithner emphasized the limits to the Fed’s and Treasury’s ability to shield them from the fallout of a Lehman bankruptcy. “You need to know,” Geithner told the CEOs, “that if we are unable to work out some solution, we do not have the capacity to insulate you or the system from the consequences.”

The pressure from the government officials was intense. Paulson made it clear to Merrill Lynch’s John Thain — in front of his peers — that it was time for him to find a buyer. Paulson pulled Thain aside and said without nuance: find a buyer. Geithner reinforced the point. Merrill’s shares had fallen by 36 percent the week before.

Thain took the hint and called Ken Lewis, of Bank of America, Saturday morning, and the two men met that afternoon. Thain tried to sell Lewis a 9.9 percent stake in the company, but before the weekend was over he had
agreed to sell the whole company. At the time, Bank of America wasn’t asking for any government aid to do the deal.

The rest of Wall Street saw the merits of the Paulson-Geithner argument that their firms would be better off if Lehman didn’t go into bankruptcy. By Saturday night, the Wall Street firms had agreed on a way to help “fill the hole,” or at least most of it, if a deal to buy Lehman could be struck.

Despite all of Paulson’s assertions, Geithner, Bernanke, and Warsh all expected the Treasury to endorse a Bear Stearns — style loan by the Fed if Barclays and the Wall Street firms couldn’t come up with enough money. The numbers kept changing, but in the end, other Wall Street firms and the government would have had to come up with roughly $10 billion to close a gap that would remain if Barclays did the deal. The eight firms agreed to pitch in about $4 billion, basically to protect themselves from the consequences of a Lehman bankruptcy.

“If there had been a buyer, the guys on the first floor would have filled the hole, and if they wouldn’t have, we would have,” Warsh said later.

If there had been a buyer
.

Paulson had been warned even before going to New York that the British government was unenthusiastic about Barclays’s eagerness to buy Lehman. In a phone conversation, Alistair Darling, the finance minister, told him so. “We are not going to import your cancer,” Darling said.

Paulson joked, hopefully, that perhaps the British regulator, the Financial Services Authority (FSA), truly was independent of the British finance ministry and would bless the Barclays deal. He didn’t see any alternatives to Barclays, and it
was
interested.

Paulson, Geithner, and Warsh left the New York Fed late Saturday hoping to seal a deal on Sunday.