On the Brink (17 page)

But the debate about the rescue was beside the point. For all the headlines and noise, we didn’t actually have a finished deal. We had announced a transaction that the market initially wouldn’t accept because it wanted certainty and wanted it quickly.

However, in the end, it still came down to price. Many Bear Stearns shareholders—and employees owned about one-third of the company—were incensed at what they saw as a lowball offer. After all, shares had traded for almost $173 in January 2007, and shareholders had lost billions of dollars. I felt sympathy for them, and I could understand their anger. On the other hand, the only reason the company had any value at all was because the government had stepped in and saved it.

By and large, traders in the marketplace, and many commentators in the financial press, agreed that the price was too low. On Monday, Bear shares traded at $4.81—more than twice JPMorgan’s $2 offer—in expectation that JPMorgan would have to offer more to be sure to close the deal.

This created real uncertainty, which wasn’t good for anyone. Not for Bear, not for JPMorgan, and not for the markets, which were settling down. The Dow jumped 420 points on Tuesday, and credit insurance rates on financial companies fell away sharply: Bear’s CDS dropped from 772 basis points on Friday to 391 basis points on Tuesday, while those on Lehman fell from 451 basis points to 310 basis points and Morgan Stanley from 338 basis points to 226 basis points. We certainly didn’t want to return to the previous week’s tumultuousness.

JPMorgan understandably wanted to get the deal closed as soon as possible. As long as there was uncertainty, clients would continue to leave Bear Stearns, reducing the value of the acquisition. Why would a prime brokerage account or any other account want to stay when they could do business with any other bank or investment bank in the world?

Toward the end of the week, the deal looked like it was in danger of breaking apart. After talking to Alan Schwartz on Friday, March 21, Jamie was concerned that Bear could shop for another buyer and leave JPMorgan on the hook. Worried what might happen if shareholders did turn down his offer, Jamie wanted to be sure he could lock in enough votes to assure acceptance.

On Friday afternoon, I had a conference call with Tim Geithner, Bob Steel, Neel Kashkari, and Bob Hoyt in my office. We were on edge. We knew that the deal was far from certain, but we had no choice but to complete it.

The key was to deliver certainty. JPMorgan could raise its offer, but the bank and the market needed to be sure that at a higher price, Bear shareholders couldn’t hold up the deal in an attempt to get even more.

Sweetening the deal to lock in shareholder approval made sense, but it gave me another idea. “We should also try to get more for the government,” I said to Tim.

He agreed and pointed out that we had some leverage we could use. “They can’t change the deal unless we let them,” Tim said. “Our commitment is based upon the whole deal.”

“Maybe we can now get JPMorgan to take all the mortgages without government support,” I suggested.

But neither Tim nor I could get Jamie to agree. However, he did accept that with the Bear shareholders getting a higher price and JPMorgan’s shares up on news of the acquisition, the government deserved a better deal, too.

The question now was how to improve the U.S.’s position. There was a whole lot of discussion and turning in circles about whether we should try to share in the upside—by taking an interest in the mortgage assets so that if they were sold above their appraised value, we could participate in the gains. But in the end it was clear to everyone that negotiating downside protection for the taxpayer was the more prudent course. So JPMorgan agreed to take the first $1 billion loss on the Bear portfolio.

Meantime, the lawyers on both sides had restructured the deal to give JPMorgan the certainty it needed and Bear shareholders a boost in price. As part of the agreement, JPMorgan would exchange some of its shares for newly issued Bear Stearns stock that would give JPMorgan just under 40 percent of Bear’s shares. This arrangement came close to locking up the transaction.

The key to the share exchange was price. By Sunday, JPMorgan was ready to offer Bear stockholders $10 a share to close the deal. When I heard that Tim had signed off on $8 to $10, I wanted to go back and say, “Don’t go above eight.”

But Ben Bernanke said, “Why do you care, Hank? What’s the difference between $8 and $10? We need certainty on this deal.”

I realized that he was right. Even though it was an unseemly precedent to reward the shareholders of a firm that had been bailed out by the government, I knew that getting a deal done was critical. Bear had continued to deteriorate in the past week and had the capacity to threaten the entire financial system. So I called Jamie Dimon and gave him my blessing. Bear’s shareholders would vote on May 29 to approve, overwhelmingly, the $10-a-share offer.

I’ve read through old newspaper reports and recently published books about the Bear weekend. None of them quite captures our race against time or how fortunate we were to have JPMorgan emerge as a buyer that agreed to preserve Bear’s economic value by guaranteeing its trading obligations until the deal closed. We knew we needed to sell the company because the government had no power to put in capital to ensure the solvency of an investment bank. Because we had only one buyer and little time for due diligence, we had little negotiating leverage. Throughout the process, the market was determined to call our bluff. Clients and counterparties were going to leave; Bear was going to disintegrate if we didn’t act. And even though many people thought Jamie Dimon had gotten a great deal, the Bear transaction remained very shaky to the end.

We learned a lot doing Bear Stearns, and what we learned scared us.

C
HAPTER 6

Late March 2008

F
or the first few days after the Bear Stearns rescue, the markets calmed. Share prices firmed up, while credit default swap spreads on the investment banks eased. Some at Treasury, and in the market, thought that after seven long months, we had finally reached a turning point, just as the industry intervention in Long-Term Capital Management had marked the beginning of the end of 1998’s troubles.

But I remained wary. Bear Stearns’s failure had called into question not only the business models but also the very viability of the other investment banks. This uncertainty was unfair for those firms that, after adjusting for accounting differences, had stronger capital positions and better balance sheets than many commercial banks. But these doubts threatened the stability of the market, and we needed to do something about the situation.

The Fed’s opening of its discount window to the primary dealers on March 17 had been a big boost. Because of its potential exposure, the Fed, working jointly with the SEC, began to put examiners on-site. This was a critical move. Investors who had lost confidence in the SEC as the investment banks’ regulator would be reassured to see them under the Fed umbrella.

The regulators’ initial analyses showed that Merrill Lynch and Lehman Brothers had the most work to do to build larger liquidity cushions. Merrill suffered from its share of well-publicized mortgage-related problems, but the firm was diversified and had by far the best retail brokerage business in the U.S., along with a strong brand name and a global franchise. I believed they would be able to find a buyer if they had to. Having worked with John Thain when he was Goldman’s president and COO, I was optimistic that he would get a handle on Merrill’s risk exposure and take care of its balance sheet. If anyone understood risk, it was John.

Lehman was another matter. I was frankly skeptical about its business mix and its ability to attract a buyer or strategic investor. It had the same profile of sky-high leverage and inadequate liquidity, combined with heavy exposure to real estate and mortgages, that had helped bring down Bear Stearns. Founded in 1850, Lehman had a venerable name but a rocky recent history. Dissension had torn it apart before it was sold to American Express in 1984. A decade later it was spun off in an initial public offering. Dick Fuld, as CEO, had done a remarkable job of rebuilding it. But in many ways, Lehman was really only a 14-year-old firm, with Dick as its founder. I liked Dick Fuld. He was direct and personable, a strong leader who inspired and demanded loyalty, but like many “founders,” his ego was entwined with the firm’s. Any criticism of Lehman was a criticism of Dick Fuld.

As Treasury secretary, I often turned to Dick for his market insights. A former bond trader, he was shrewd, willing to share information, and very responsive. I could tell that Bear’s demise had shaken Dick. How far he was willing to go to protect his firm was another question.

For some time, I had been encouraging a number of commercial and investment banks to recognize their losses, raise equity, and strengthen their liquidity positions. I said that I had never, over the course of my career, seen a financial CEO who had gotten into trouble by having too much capital.

I emphasized this point to Fuld in late March. He maintained he had enough capital but knew he needed to restore confidence in Lehman. Shortly after, Dick called to say that he was thinking of approaching General Electric CEO Jeff Immelt and Berkshire Hathaway CEO Warren Buffett as possible investors. Dick said he served on the New York Fed board with Immelt and could tell that the GE chief liked and respected him. And he thought Berkshire Hathaway would be a good owner. I told Dick that GE was unlikely to be interested but that calling Warren Buffett was worth a try.

A few days later, on March 28, I was lying on my couch at home, watching ESPN on my birthday, when the phone rang. Dick was calling to say he had talked to Buffett. He wanted me to call Warren and put in a good word. I declined, but Dick persisted. Buffett, he said, was waiting for my call.

It was a measure of my concern for Lehman that I decided to see just how interested Warren was. I picked up the phone and called him at his office in Omaha. I considered Warren a friend, and I trusted his wisdom and invariably sound advice. On this call, however, I had to be careful about what I said. I pointed out that I wasn’t Lehman’s regulator and didn’t know any more than he did about the firm’s financial condition—but I did know that the light was focused on Lehman as the weakest link, and that an investment by Warren Buffett would send a strong signal to the credit markets.

“I recognize that,” Buffett said. “I’ve got their 10-K, and I’m sitting here reading it.”

Truth is, he didn’t sound very interested at all.

I learned later that Fuld had wanted Buffett to buy preferred stock at terms the Omaha investor considered unattractive.

The following week, Lehman raised $4 billion in convertible preferred shares, insisting it was raising the capital not because it needed to, but to end any questions about the strength of its balance sheet. Investors greeted the action heartily: Lehman’s shares rose 18 percent, to above $44, and its credit default spreads dropped sharply, to 238 basis points from 294 basis points.

It was April 1—April Fools’ Day.

Bear Stearns’s failure in March had highlighted many of the flaws in the regulatory structure of the U.S. financial system. Over the years, banks, investment banks, savings institutions, and insurance companies, to name just some of the many kinds of financial companies active in our markets, had all gotten into one another’s businesses. The products they designed and sold had become infinitely more complex, and big financial institutions had become inextricably intertwined, stitched tightly together by complex credit arrangements.

The regulatory structure, organized around traditional business lines, had not begun to keep up with the evolution of the markets. As a result, the country had a patchwork system of state and federal supervisors dating back 75 years. This might have been fine for the world of the Great Depression, but it had led to counterproductive competition among regulators, wasteful duplication in some areas, and gaping holes in others.

I had aimed my sights at this cumbersome and inefficient arrangement from my first days in office. In March 2007, at a U.S. Capital Markets Competitiveness Conference at Washington’s Georgetown University, participants from a wide spectrum of the markets had agreed that our outmoded regulatory structure could not handle the needs of the modern financial system. Over the following year, Treasury staff, under the direction of David Nason, with strong support from Bob Steel, had devised a comprehensive plan for sweeping changes, meeting with a wide variety of experts and soliciting public comment. On March 31, 2008, we unveiled the final product, called the Blueprint for a Modernized Financial Regulatory System, to a standing-room-only crowd of about 200. There must have been 50 reporters there amid the marble and chandeliers of the 19th-century Cash Room.

Calling for the modernization of our financial regulatory system, I emphasized, however, that no major regulatory changes should be enacted while the financial system was under strain. I hoped the Blueprint would start a discussion that would move the reform process ahead. And I stressed that our proposals were meant to fashion a new regulatory structure, not new regulations—though we clearly needed some.