On the Brink (30 page)

Before I left the New York Fed I met a final time with Tim. He had his work cut out for him, navigating the Lehman mess and trying to forestall an even worse one at AIG. Tim was still hoping to fashion a private-sector solution for the insurer. I agreed to have Dan Jester stay in New York to help with AIG, and Jeremiah Norton, deputy assistant secretary for financial institutions policy, would fly up to relieve Steve Shafran. I would return to Washington the next morning, while Tim’s team—with no time to rest after Lehman—tried to determine AIG’s liquidity needs and develop a plan to raise money.

I got back to the Waldorf about 10:00 p.m. Shortly after I arrived, John Mack called me. I could tell that the Morgan Stanley CEO was on edge. In just one day, Wall Street had irrevocably changed: Lehman Brothers was headed for bankruptcy, and Merrill Lynch was about to be bought by Bank of America. Morgan Stanley had held up well so far, but with those two firms gone, John was deeply worried.

“Come tomorrow morning,” he said, “the shorts will be on us with a vengeance.”

C
HAPTER 10

Monday, September 15, 2008

I
woke up exhausted Monday morning after a few troubled hours of sleep, tormented by the increasing size of AIG’s problems and John Mack’s haunting words from the night before: with Lehman Brothers gone, Morgan Stanley could be next. From a window of my room in the Waldorf-Astoria, I watched as the still-quiet streets of Midtown Manhattan came slowly to life. It was just after 6:00 a.m. and not yet light, but I could see taxis dropping off passengers, trucks off-loading deliveries, workers hurrying to their offices to get a jump on the day.

Only a few hours before, just after midnight, Lehman Brothers had filed for bankruptcy, the biggest in U.S. history. I wondered if anyone out there on the streets could possibly imagine what was about to hit them.

President Bush called for an update shortly after 7:00 a.m., but I had nothing new to tell him. Lehman would have gone into administration by now in London, but the markets had not yet opened in New York. All I could offer were assurances that we would stay on top of the situation and keep him informed throughout the day. With luck, I told him, the system could withstand a Lehman failure, but if AIG went down, we faced real disaster. More than almost any financial firm I could think of, AIG was entwined in every part of the global system, touching businesses and consumers alike in many different and critical ways.

I stressed that I trusted Tim Geithner to do everything possible to come up with a private-sector solution, but AIG was in deep trouble, and I was not optimistic. Its shares had plunged 31 percent the previous Friday and, after the weekend’s well-publicized problems, today was sure to be worse.

I called Chris Cox at 8:15 a.m. to urge him to get prepared to take action on short sellers. Before I left for the airport, I caught up with Tim. His news wasn’t encouraging—AIG was already looking worse than last night. We agreed that I would get back to Washington as soon as possible and organize my team to deal with Congress and the broader crisis. He would oversee the steps being taken to manage the Lehman failure and, most important, press ahead with a private-sector rescue of AIG, which he hoped would be led by JPMorgan and Goldman Sachs.

I boarded my flight back to D.C. as the markets were just opening, so it wasn’t until I landed at 10:30 a.m. and got back on the phone with Tim that I learned the day had begun in ugly fashion. In the first hour of trading, AIG shares had plunged nearly in half, to $6.65; the Dow was off 326 points, or 2.9 percent. In London, the FTSE 100 Index was down 183 points, or 3.4 percent.

Shortly after I’d gotten off with Tim, my friend and former Goldman colleague Ken Brody, now chairman of Taconic Capital Advisors, reached me.

“Hank, you made a big mistake,” he said. “This market is too fragile to handle a Lehman Brothers bankruptcy. The system is on the verge of collapse, and Morgan Stanley could well be next.”

I respected Ken’s opinions tremendously, but this was the last call in the world I needed, coming on top of Tim’s gloomy report. He assumed we had intentionally let Lehman go down and thought it might be good to acknowledge the mistake publicly. I told Ken that I was unbelievably frustrated but that we had had no choice. There had been no legal basis to bail out Lehman. Now we were doing everything we could to manage the situation.

Still, his assessment distressed me, and when I reached the office, I saw that the market was in full decline. Understandably, the prices of AIG (off by nearly 60 percent) and Lehman (down 95 percent) were in free fall, but Morgan Stanley and Goldman Sachs were also dropping fast. Their credit default swap rates had nearly doubled—to insure $10 million of debt now cost about $450,000 for Morgan Stanley and about $300,000 for Goldman. I could sense the start of a panic. Morgan Stanley’s level approached where Lehman had been the previous Wednesday, and no one in the world—not a rational world, anyway—could have thought Morgan Stanley’s business was in anywhere near as bad a shape as the now-bankrupt investment house.

It was the dismal beginning of the first day of what would be a thoroughly dismal week.

I hurried to the White House to update the president shortly after 1:00 p.m. and then went straight to the briefing room in the West Wing to hold a press conference. After a short statement, I took questions from four dozen or so journalists packed into the small, windowless room. They were all on edge.

In my answers, I attempted to put the crisis in perspective, noting its roots in the housing price collapse and pointing out that a more satisfying solution had been hindered by our archaic financial regulatory structure. “Moral hazard,” I made clear, “is something I don’t take lightly.” But I drew a distinction between our actions in March with Bear Stearns and now with Lehman Brothers. I stressed that unlike with Bear, there had been no buyer for Lehman. For that reason, I said: “I never once considered it appropriate to put taxpayer money on the line in resolving Lehman Brothers.” How could I? There was, in fact, no deal to put money into.

In retrospect, I’ve come to see that I ought to have been more careful with my words. Some interpreted them to mean that we were drawing a strict line in the sand about moral hazard, and that we just didn’t care about a Lehman collapse or its consequences. Nothing could have been further from the truth. I had worked hard for months to ward off the nightmare we foresaw with Lehman. But few understood what we did—that the government had no authority to put in capital, and a Fed loan by itself wouldn’t have prevented a bankruptcy.

I was in a painful bind that I all too frequently found myself in as a public official. Although it’s my nature to be forthright, it was important to convey a sense of resolution and confidence to calm the markets and to help Americans make sense of things. Being direct and open with the media and general public can sometimes backfire. You might actually cause the very thing you hoped to avoid.

I did not want to suggest that we were powerless. I could not say, for example, that we did not have the statutory authority to save Lehman—even though it was true. Say that and it would be the end of Morgan Stanley, which was in far superior financial shape to Lehman but was already under an assault that would dramatically intensify in the coming days. Lose Morgan Stanley, and Goldman Sachs would be next in line—if they fell, the financial system might vaporize and with it, the economy.

By late afternoon I’d caught up with both presidential candidates. I was now in touch with Barack Obama almost daily, though less frequently with John McCain. My goal was to keep them from saying anything that might upset the markets—a task that would become more important, and more difficult, as the campaign heated up.

That afternoon, Obama asked insightful questions as I explained why we couldn’t save Lehman and noted that the market was reacting worse than we’d feared. I also told him about the problems with AIG. As he did almost every time we talked, Obama asked if I’d spoken to McCain—perhaps it was to gauge what his opponent was thinking or to encourage me to keep McCain in line, so that on crucial economic points we presented a united front for the country’s benefit.

McCain, who never asked me about Obama on our calls, kept his counsel while I updated him on the situation. He did suggest I speak to his running mate. “She’s a quick study,” he said admiringly. Still energized by the Sarah Palin nomination, the Republican ticket led in some of the polls, although that lead would disappear by the end of the week.

When I got in touch with the Alaska governor, she quickly showed her knack for focusing on the hot button. She asked me whether AIG’s problems had to do with managerial incompetence, then got right to the point.

“Hank,” she said, “the American people don’t like bailouts.”

“Neither do I, but an AIG failure would be a disaster for the American people,” I replied.

In my view, we needed to be ready for anything. A little more than an hour before, the Dow Jones index had closed at a two-year low. It had fallen 504 points, or 4.4 percent—the worst one-day point decline since the markets reopened after 9/11. Even more ominously, the credit markets were deteriorating. The LIBOR-OIS spread, which had peaked at about 82 basis points during the Bear Stearns crisis, had jumped to more than 105 basis points, underscoring how little confidence the banks had in lending to one another. If I had any doubts that we were about to enter a new, ugly phase of the crisis, they were erased when General Electric CEO Jeff Immelt stopped by to see me a little before 6:00 p.m. We spoke privately in my office.

I’d known Jeff for years and admired the cool, unflappable demeanor he had displayed as CEO of the biggest, most prestigious company in America. Jeff was following up on a phone call from the week before when, just after the takeovers of Fannie Mae and Freddie Mac, he’d mentioned that GE was having problems in the commercial paper market. His report had alarmed me then. That market had been in distress since the onset of the credit crisis in August 2007. The worst of that had involved the asset-backed commercial paper market, which supported all those off-balance-sheet special investment vehicles filled with toxic collateralized debt obligations that banks had cooked up. I’d never expected to hear those troubles spreading like this to the corporate world, and certainly not to GE.

Commercial paper is essentially an IOU that is priced on the credit rating of the borrower and generally backstopped by a bank line of credit. It’s usually issued for short periods of time—90 days or less. And it’s often bought by money market funds looking for a safe place to get a higher rate of return than they would earn from short-term government bills. Companies use these borrowings to conduct their day-to-day business operations, financing their inventories and meeting their payrolls, among other things. If companies can’t use the commercial paper market, they have to turn to banks (which in September 2008 were reluctant to lend). When their access to short-term financing is in question, companies have to curtail normal business operations.

Now here was Jeff telling me that GE was finding it very difficult to sell its commercial paper for any term longer than overnight. The fact that the single-biggest issuer in this $1.8 trillion market was having trouble with its funding was startling.

If mighty GE was having trouble rolling its commercial paper over, so were hundreds of other industrial companies, from Coca-Cola to Procter & Gamble to Starbucks. If they all had to slash their inventories and cut back operations, we would see massive job cuts spreading throughout an already suffering economy.

“Jeff,” I remember saying, “we have got to put out this fire.”

Tuesday, September 16, 2008

Monday, September 15, had been grim. But on Tuesday, all hell broke loose.

Normally I left home by 5:45 a.m., went to my gym, and ran hard on the treadmill. Then I’d do some core exercises until 7:45 a.m. Fifteen minutes later I was in the office. (Those 90-second showers of my childhood sure helped me keep to this pace.)

That morning, sensing trouble, I skipped my workout, as I would for weeks, and went straight to the Markets Room, on the second floor of the Treasury Building, to get a quick fix from Matt Rutherford. What I learned was disturbing. Though the LIBOR-OIS spread had eased, financial institutions including Washington Mutual, Wachovia, and Morgan Stanley were under severe pressure. (The CDS of the venerable investment bank would soar from 497 basis points Monday to 728 basis points—a higher level than Lehman Brothers had traded at before its failure.)

I soon heard from Dan Jester and Jeremiah Norton, who were helping Tim out with AIG. I needed them in Washington, but Dan, in particular, had won Tim’s confidence, and I had reluctantly agreed to let him stay at Tim’s request. They gave me a discouraging update. The rating agencies had slashed the insurer’s credit rating on Monday, forcing it to post additional collateral on its huge derivatives book. To my utter amazement and disgust, AIG’s liquidity needs had mushroomed. On Sunday, the company was looking for $50 billion; now it would need an $85 billion loan commitment by the end of the day. A private-sector solution appeared very unlikely.

AIG’s incompetence was stunning, but I didn’t have time to be angry. I immediately called President Bush to tell him that the Fed might have to rescue AIG and would need his support. He told me to do what was necessary.

Tim Geithner called to tell me that he had talked with Ben Bernanke, who was amenable to asking the Fed board to make a bridge loan if the executive branch and I stood behind him. He said he thought $85 billion would be enough but stressed that we had to move quickly: the company needed $4 billion by the close of business Wednesday. Even this breathtaking assessment would prove optimistic. By late morning, we had learned AIG needed cash to avoid bankruptcy by day’s end—the total would eventually reach $14 billion.