In FED We Trust (31 page)

Bernanke and Paulson entered Reid’s office on the second floor of the Capitol, looking like two exhausted surgeons about to deliver grim news to relatives. Most of the senior congressional leadership from both parties had rushed to be there. Senator Judd Gregg, the New Hampshire Republican, showed up in a tuxedo but no tie.

Bernanke and Paulson explained the outlines of the AIG deal and why they had decided that allowing AIG to follow Lehman into bankruptcy was unwise. They emphasized how interconnected everything was. They didn’t seek the blessing of the congressional leaders, and none was offered. Instead, Harry Reid told them: We’ve listened, but don’t go out and tell people that we’ve approved this. This is your responsibility. Both Bernanke and Paulson acknowledged as much.

At one point, Barney Frank recalled, he asked Bernanke: “Do you have
$80 billion?” And Bernanke replied: “Well, we have $800 billion,” a reference to the value — then — of the Fed’s assets. “And that’s when many of us, for the first time, understood the full scope of this [“unusual and exigent circumstances”] statute.”

For many members of Congress, the Fed’s ability to come up with $85 billion overnight led to the realization that the Fed increasingly was acting like a fourth branch of government. Most politicians, indeed, most American citizens, had a vague idea that the Fed could move some interest rates up or down. But they had no idea that the Fed could — with the push of a button on a computer keyboard — create that much money from nothing and without seeking the approval of Congress or the president.

The meeting lasted nearly an hour. The members of Congress left one at a time, most ducking reporters waiting outside. Representative Spencer Bachus of Alabama, senior Republican on the House Financial Services Committee, offered a promise of unity: “We’re all in this mess together.”

Frank, the committee’s chairman, came out later and growled, with substantial accuracy: “We’ve had a series of ad hoc interventions. This is one more ad hoc intervention.”

Bernanke and Paulson rebuffed reporters. Bernanke went back to his office and called Geithner to settle last-minute details on the AIG deal. Around 10
P.M.
, after AIG had agreed to the terms, Bernanke convened a conference call to brief the Fed bank presidents, several of whom were disgruntled because they had been told so little even though they were in Washington while the AIG drama unfolded.

Paulson allowed himself a little hope — “not an expectation,” he emphasized, just hope — that perhaps the markets would stabilize. “Fannie and Freddie were off the table. Lehman was off the table. Merrill Lynch was off the table,” he said. One big West Coast bank was teetering, Washington Mutual, or WaMu. But he already was talking to JPMorgan Chase’s chief executive, Jamie Dimon, about that one. “WaMu was about to be off the table. Maybe the situation would get better,” he said. He was wrong.

As the markets opened Wednesday morning, September 17, Bernanke — with Kohn and Warsh sitting beside him — called his counterparts in Europe, the U.K., and Japan to explain the AIG deal. Jean-Claude Trichet, who had been privately critical of letting Lehman sink, was relieved that the United States had come to its senses and dismissed any suggestion that this had been a tough call for Bernanke.

An hour later, the Four Musketeers assembled by phone to hear the New York Fed’s Bill Dudley give his daily report on the markets. It was ugly. The Dow Jones Industrial Average fell 449.36 points, or 4.1 percent, to 10609.66, its lowest close in nearly three years. Trading was so heavy it nearly matched the record — which had been set just two days earlier. European and Asian stocks were down. General Electric, usually considered so creditable that it borrowed close to the Fed funds rate target — then 2 percent — was forced to pay 3.5 percent for overnight money. And yields on the safest securities of all, short-term U.S. Treasury bills, fell nearly to 0 percent because so many investors wanted to park their money there.

“It was becoming clear that the markets were going into anaphylactic shock, and that we needed to do something,” Bernanke said. The Fed could no longer cope with the Great Panic by itself.

Based on his years of studying previous financial collapses and telephone conversations with his Swedish and Japanese counterparts who had coped with recent banking crises, Bernanke had suspected for months that he and Paulson would eventually end up asking Congress to spend substantial sums of taxpayer money to rescue the banks. In every major banking crisis he had studied, the government had had to put capital into the banks, take bad loans off the banks’ books, and guarantee the banks’ debts. So far, Bernanke had deferred to Paulson on the timing of going to Congress, while Paulson had been reluctant to propose anything that Congress might, in an election year, reject.

Bernanke and Geithner saw this as the inevitable and costly politics of responding to banking crises in a democracy. The most effective solution always called for lots of taxpayer money upfront — “overwhelming force,”
as Geithner called it. Politicians, ever sensitive to public opinion, never responded early enough. The usual political solution was to wait until the crisis was bad enough to dominate the headlines, driving up the ultimate cost. Now, that moment had arrived.

At 7:30
P.M.
, after a day of nearly constant conference calls, the financial firefighters convened for the last session of the day. Warsh and Kohn sat beside Bernanke in his office, all facing the omnipresent speakerphone. Geithner was on the phone from New York. Paulson was at his desk. More than a dozen Treasury aides stood around him to listen, or huddled in corners in separate conversations.

Bernanke was usually soft-spoken and mild-mannered. He was not this time. “We can’t do this anymore, Hank. We have to go to Congress,” Bernanke told Paulson, according to one of the participants in the call. The Fed was at its limit.

Paulson was uncharacteristically silent. He didn’t argue with Bernanke. He didn’t signal agreement. He didn’t tell Bernanke that he already had scrambled his staff to prepare to go to Congress. They worked all night.

When asked by CBS’s
60 Minutes
, in an interview taped September 26, 2008, to name the worst moment of the Great Panic thus far, Paulson would reply: “I’ve had a lot of knots in my stomach, but I would say … Wednesday night [September 17], when the capital markets froze, when there started to be a run on money markets, banks stopped lending to each other. And, I know people in America won’t understand what that means, but if money doesn’t flow freely between financial institutions, then it impacts everyone in the country.”

“The economy had a heart attack in that moment,” the reporter suggested.

“I would say this: whether it had a heart attack or not, the arteries were clogged,” Paulson responded.

Around 9:30
A.M.
the following day, September 18, Bernanke, Paulson, and their lieutenants reconvened by telephone. Bernanke launched into his pitch for going to Congress. Paulson cut him off: “We have to go to Congress — today.”

It was time to break the glass.

When Bush, with an assist from chief of staff (and Goldman alumnus) Josh Bolten, wooed Paulson from the top of Goldman Sachs to the Treasury secretary’s office overlooking the White House, Paulson let it be known that he had a deal his two predecessors didn’t. The first two Bush Treasury secretaries — Paul O’Neill, a veteran of the Ford White House and a former aluminum company CEO, and John Snow, a former railroad executive — were overshadowed and overruled by the Bush White House staff and the powerful vice president. Paulson, it was said, had the president’s assurances that he, not the White House staff and not Dick Cheney, would be in charge.

Though there was much skepticism in Washington about that arrangement at the time, it turned out to be true. When Paulson arrived, the pendulum of power swung all the way from the White House to the Treasury next door. During the Great Panic, he, Bernanke, and Geithner called the shots, keeping the president’s White House economic team “informed,” as one senior Treasury staffer put it.

Keith Hennessey, a congressional staffer who came to the White House in 2002 and rose to be the coordinator of economic policy there, often fielded Paulson’s telephone calls. He typed them into e-mailed memos — “I just got a Hank call,” he would write — for the rest of the White House staff. Paulson didn’t do e-mail; he did phone calls, frequent ones.

But going to Congress for hundreds of billions of dollars would require more political firepower than either Paulson or Bernanke had. At the same time, Bush aides were growing uneasy with the public perception that the president was a bystander in the biggest economic crisis in a generation. There was no way to keep the White House on the sidelines any longer.

Paulson summoned Joel Kaplan, the deputy White House chief of staff and another of his frequent telephone partners, to Treasury early in the afternoon to listen to the Fed-Treasury-SEC conference call. There wasn’t enough time for bringing him up to speed after the meeting.

Around 2:30
P.M.
, Edward Lazear, chairman of the president’s Council of Economic Advisers — a lanky, bald Ph.D. economist from Stanford, nicknamed
“Stork” by Bush — left the White House compound to go to the Fed’s headquarters to find out what was going on.

The conference call ran until 3:30
P.M.
, ending abruptly so Paulson and Bernanke — accompanied by Kevin Warsh, on whom the Fed chairman had come to rely for political advice — could go and give the president the bad news: his final months in office were going to look uncomfortably like those of Herbert Hoover.

They made an impression. “I remember sitting in the Roosevelt Room with Hank Paulson and Ben Bernanke and others,” Bush would later recall to ABC News’s Charles Gibson, “and they said to me that if we don’t act boldly, Mr. President, we could be in a depression greater than the Great Depression.”

“But,” asked Gibson, “was there an ‘uh-oh’ moment — and I could probably use stronger language than that [laughter] when you thought this really could be bad.”

“When you have the secretary of the Treasury and the chairman of the Fed say, if we don’t act boldly, we could be in a depression greater than the Great Depression, that’s an ‘uh-oh’ moment,” Bush replied. “But you got to understand, leading up to that we had been bailing water in this way: AIG was failing; other big houses on Wall Street needed to be merged; one failed.”

In the Roosevelt Room meeting, Paulson reminded Bush that the Treasury secretary’s authority to spend or lend money that Congress hadn’t appropriated was extremely limited. The Treasury secretary was agitated, talking a lot about the treacherous politics in Congress. At times the president’s face suggested he wasn’t following Paulson’s line of reasoning, one participant recalled. Bernanke, calling on his years of classroom teaching, calmly made the case so the president could better grasp its dimensions.

At one point, according to participants, Paulson made an oblique reference to the possibility that the Fed could continue to finance the rescue of Wall Street if Congress balked. Someone — several participants recalled it was Bush, but others insisted it was Vice President Cheney or Chief of Staff Josh Bolten — pressed Bernanke. Could the Fed keep doing it if Congress was a problem? No, Bernanke said. He recited the limits of the Fed’s legal authority even in “unusual and exigent circumstances.” He told the president
that the sums involved were now so great that the legitimacy of the enterprise required the approval of the entire political system.

With that, Bush gave his assent. The plan was to ask Congress for $500 billion. At the time, that seemed like more than enough.

On his way back to the Treasury from the White House, Paulson fielded a call from Nancy Pelosi on his cell phone. She proposed a meeting between congressional leaders and Paulson and Bernanke for Friday morning. Paulson said it couldn’t wait. So Bernanke, Paulson, and the SEC’s Cox went to Capitol Hill that Thursday night. No one from the White House accompanied them. The White House was simply irrelevant.

Before the meeting, according to a person who overheard him, Paulson confided to Bernanke: “They’ll kill me up there. I’ll be hung out to dry.” He knew that many members of Congress, influenced by constituents who saw everything he and Bernanke were doing as a bailout of moneyed interests in Wall Street, would resist his plea to give him the power to spend hundreds of billions of taxpayer money.

Bernanke reassured him: “I’ll be with you. I’ll go to any meeting. You can count on me.” They agreed that Bernanke would talk first.

By taking the lead, Bernanke was attempting to leverage congressional trust in not only the Fed but also his personal credibility in a moment of economic terror. The move would inextricably link Bernanke to Paulson, but there was good reason for Bernanke to permit that: at a time of economic crisis, any hint of daylight between the Treasury secretary and the Fed chairman would undermine whatever confidence was left. Nonetheless, Bernanke was risking both his and the Fed’s reputation by sticking so close to the sometimes impolitic Paulson. “Managing Paulson was like riding a bull,” one Fed staffer said.

The meeting of the dozen or so top congressional leaders convened in the conference room off Speaker Pelosi’s offices. She opened the session, then turned it over to Bernanke. “I spent a lot of time as an academic studying the Depression,” he said, according to notes taken by a Hill staffer. “If we don’t
act in a very huge way, you can expect another Great Depression, and this is going to be worse.” The financial system was “only a matter of days” away from “a meltdown,” he said. “Our tools are not sufficient.”

Fed chairmen, aware that even their private comments can trigger market turmoil, usually speak delicately, especially when predicting bad things for the economy. Bernanke was not delicate. “No economy has ever faced the financial meltdown we’re facing without undergoing a major recession,” he said. Without congressional action, it would be deep and prolonged.