On the Brink (45 page)

I thanked him and after breakfast asked Dave McCormick to see if he could use any of Ben’s words in the draft communiqué for the G-7 meeting. He incorporated Ben’s ideas into the appendix, which we titled “The Action Plan.”

That morning I met in my small conference room with Mervyn Davies, chairman of Standard Chartered Bank. He proudly told me that Standard Chartered would not participate in the U.K. plan. It did not need government capital, he said.

Afterward he took me aside and asked in a low voice about Citigroup and GE. “Are either of those two going down?” he asked. “What we hear isn’t good.”

This jolted me. Obviously Citi had problems, but this was the first time I’d heard the chairman of another major bank speculate that it might fail. And even though I’d had concerns about GE, I had assumed that with the Fed now buying commercial paper, the company would weather the crisis. I had a high regard for Mervyn; I trusted his judgment and greatly appreciated his candor. It also occurred to me that he might be viewing GE as a concerned counterparty.

That day Treasury was consumed with preparations for the G-7 meeting starting the next afternoon. Dave McCormick headed the effort, and in a stroke of diplomatic inspiration, he suggested that I invite Sheila Bair to the group’s Friday dinner, where we would be discussing the Swedish and Japanese experience in dealing with massive bank failures. I called her that morning and told her how important the G-7 was going to be: the Europeans needed reassurance about the U.S. government’s commitment to our important financial institutions. I asked if she would give a presentation to all the assembled central bankers and finance ministers, take them through the FDIC’s powers, and explain how she had used these to solve the Wachovia crisis. She readily agreed.

At noon Dan Jester and David Nason came to my office to review their progress on the capital program to help domestic financial institutions. They took several of us through their proposed term sheet, soliciting my decisions on a few sticky issues. They had chosen to abandon the idea of the government’s matching the capital raising of the banks, and I agreed. Matching made great political sense, but the market was effectively closed for bank equity offerings, and there was no point in trying something the market would not accept. I also approved their recommendation that we take preferred stock to balance the sometimes inconsistent goals of stabilizing the system while protecting the taxpayer: banks would get needed capital without raising the specter of nationalization.

We also debated limits on executive compensation. I agreed with my political advisers—Michele Davis, Kevin Fromer, and Bob Hoyt—that TARP’s most stringent restrictions should apply. This meant, for example, that rather than just eliminating golden parachutes in the new contracts of certain executive officers, the top officers of banks accepting capital would have to forgo any such payments in existing contracts as well; they would also have to provide for clawbacks of pay if financial statements were found to be materially inaccurate.

There were a few outstanding issues. We needed to get bank regulators to sign off on the treatment of the capital for regulatory purposes, and I also wanted to nail down a pricing mechanism that would ensure widespread participation while keeping the program voluntary. But overall I felt confident we finally had the framework for a workable approach.

In any case, we needed to get a capital program together immediately to help the financial system. The short sellers had wasted little time justifying John Mack’s worries, returning to the market on Thursday to drive shares of both Morgan Stanley and Merrill Lynch down 26 percent. Morgan Stanley’s CDS still hovered around 1,100 basis points.

The bad news continued to pour in from around the world. By Thursday morning, Iceland had shuttered its stock market and seized the country’s biggest bank, Kaupthing. The two next-biggest banks were also now under government control. LIBOR-OIS spreads had ballooned to a new record of 354 basis points.

I had a very long, difficult call with the president that afternoon, partly to discuss his role in the G-7 and G-20 meetings that weekend. He was looking for any ray of hope on the financial front. He had done everything that I had recommended, including politically unpopular actions that went against Republican principles, and here we were, worse off than ever. He pressed me about the capital program and asked, “Is this what it’s going to take to end this thing?”

“I don’t know, sir,” I admitted, “but I hope it’s the dynamite we’ve been looking for.”

I felt unhappy that nearly a week after TARP’s passage, I still had mostly bad news to deliver. Europe had big problems; seven countries had already had to rescue banks. I continued to be concerned about Citigroup, GE, and, most of all, Morgan Stanley, with the Mitsubishi UFJ deal still in question. Even though President Bush always encouraged me to be candid, this was a low moment for me. Later that day Josh Bolten called to empathize, and to reiterate the president’s support.

“I just wonder, Hank, why, after all the steps we’ve taken to stabilize the market, are the markets not responding?”

“Josh, I wonder exactly the same thing,” I said.

Late in the day Citigroup dropped its bid for Wachovia, saying it would not block a merger with Wells Fargo (though its $60 billion lawsuit would continue). On the surface this provided a shred of good news, but after my conversation with Mervyn Davies I had to wonder what would happen to Citi now that its problems were harshly illuminated.

Friday, October 10, 2008

As the demands of the crisis grew, I had made Dave McCormick, the undersecretary of international affairs, my point man on Morgan Stanley. Though only in his early 40s, Dave was a seasoned manager and great communicator, able to work with finance ministers as well as their deputies.

First thing Friday morning, I went to Dave’s office. “We are really going to have to get something done with Morgan Stanley,” I told him.

Dave had been working with Japanese finance officials to try to move the Mitsubishi UFJ deal along. The Japanese bank appeared to be pulling back from its agreement. The U.S. bank’s shares had fallen so far that Mitsubishi UFJ was worried that if it invested, the U.S. government might step in and wipe out its position.

“I know it may not be the most dignified thing in the world,” Dave said, “but you’re going to have to lean on them. The market doesn’t think this deal is going to close.”

The G-7 ministers were arriving in Washington as we spoke, and, as was customary, I had a bilateral meeting with the Japanese finance minister, Shoichi Nakagawa. It was scheduled for noon, and I told Dave I would broach the Morgan Stanley issue then.

The session in my small conference room with Finance Minister Nakagawa dealt mainly with the major issues we were confronting; among other things, he strongly believed that the U.S. should inject capital into our banks, as Japan had done in the 1990s.

Then I turned the conversation to Mitsubishi UFJ’s agreement with Morgan Stanley. “We believe,” I said, “that this transaction is very important to the stability of the capital markets.”

Friendly and dynamic, Nakagawa was Japan’s fourth finance minister in two years, and like all of us he carried a heavy load. He didn’t commit to pushing the Mitsubishi UFJ deal along, but he agreed to focus on the issue, and that was the most I had hoped for.

The G-7 ministerial meeting began at 2:00 p.m. that afternoon. We gathered in the Cash Room, which was adorned with the flags of our respective countries. Ben and I sat side by side facing our counterparts from the world’s major economies. They were arrayed around a huge rectangle of tables: central bank head Masaaki Shirakawa and Finance Minister Nakagawa from Japan, Axel Weber and Peer Steinbrück from Germany, Christian Noyer and Christine Lagarde from France, Mario Draghi and Giulio Tremonti from Italy, Mark Carney and Jim Flaherty from Canada, Mervyn King and Alistair Darling from Britain. Jean-Claude Trichet from the European Central Bank was also there, along with World Bank president Bob Zoellick and Dominique Strauss-Kahn, managing director of the IMF. As a group we had wrestled with difficult challenges, but the stakes had never been so high, nor our collective mood so dark.

Before the meeting both Ben and Dave McCormick had warned me that the Europeans were angry about Lehman Brothers; many attributed their deepening problems to its failure. Nonetheless, I was surprised to see Trichet pass out a one-page graph that illustrated the dramatic increase in LIBOR-OIS spreads post-Lehman. Then, using uncharacteristically forceful language, he said that U.S. officials had made a terrible mistake in letting Lehman fail, triggering the global financial crisis.

Trichet was not alone in his sentiments—other ministers, including Nakagawa and Tremonti, pointed to the problems caused by Lehman in their opening remarks. It was the first time, though far from the last, that I heard global political leaders use this sort of rhetoric to blame the U.S. government for their financial systems’ failings as well as our own. It was obvious to me that AIG and some other financial institutions had been on their own paths to failure, independent of Lehman. So, too, were banks in the U.K., Ireland, Belgium, and France. Lehman’s collapse hadn’t created their problems, but everyone likes a simple, easy-to-understand story, and there was no doubt that Lehman’s failure had made things worse.

Not wanting to seem defensive, I kept my response simple. My goal was not to justify our actions, but to be sure we left this meeting unified in our desire for a coordinated global response to our problems.

“Lehman,” I said, “was a symptom of a larger problem.” I noted that the U.S. had not had the ability to put capital into Lehman and that there had been no buyer for the firm. Now, with TARP, I pointed out, we had the power to act.

Mervyn King would pick up on this theme, reminding the ministers that “Lehman is the proximate cause, but it’s not the fundamental cause” of the current market crisis. Mervyn was as keen, I think, as I was to move from pointing fingers to linking hands to get out of the mess we were in.

During our discussions, Mervyn and some of the others suggested that to help give the market confidence we should do something different and more forceful with the communiqué. Business as usual would not create the impact we wanted.

Mervyn thought that the draft communiqué lacked punch and that we should shoot for something much briefer that could fit on one page. I agreed.

As the speakers went on, I watched Dave McCormick, who was sitting next to me, scribble out a new draft communiqué. He handed it to a staff member, who quickly brought back a typed version that I thought was just right. I suggested to my colleagues that we try this shortened version, and they agreed. Dave disappeared with his fellow deputies, returning in less than half an hour with a new draft.

The deputies had drawn up a concise, powerful statement—so concise and powerful that it went through only one round of changes by the ministers. In a few brief sentences including five bullet points, we showed our resolve:

The G-7 agrees today that the current situation calls for urgent and exceptional action. We commit to continue working together to stabilize financial markets and restore the flow of credit, to support global economic growth. We agree to:

1. Take decisive action and use all available tools to support systemically important financial institutions and prevent their failure.

2. Take all necessary steps to unfreeze credit and money markets and ensure that banks and other financial institutions have broad access to liquidity and funding.

3. Ensure that our banks and other major financial intermediaries, as needed, can raise capital from public as well as private sources, in sufficient amounts to re-establish confidence and permit them to continue lending to households and businesses.

4. Ensure that our respective national deposit insurance and guarantee programs are robust and consistent so that our retail depositors will continue to have confidence in the safety of their deposits.

5. Take action, where appropriate, to restart the secondary markets for mortgages and other securitized assets. Accurate valuation and transparent disclosure of assets and consistent implementation of high quality accounting standards are necessary.

Once we had the five-point plan, the group’s mood changed. We’d started out with gloominess and finger pointing, but suddenly we felt ready for action. This handful of words solidified our resolve and set the stage for our future moves.

Energized, we walked out onto the steps of the Treasury’s Bell entrance, facing the White House visitor center, for our customary “class photo.” It was midafternoon, the sun was shining, and even the sound of a group of demonstrators chanting “Arrest Paulson!” couldn’t dim my mood. Peer Steinbrück leaned over and said to me, “It sounds like we’re in Germany.”

As if to underscore the importance of our meetings, Friday was astonishingly volatile in the markets. The Dow plunged 8 percent, or 680 points, to below 8,000 in the first seven minutes of trading, then rebounded by 631 points in the next 40 minutes. After slumping again, it roared up 853 points to 8,890 just after 3:30 p.m. before plummeting to 8,451, for an overall loss of 128 points on the day. It was the culmination of a terrible week: the Dow and S&P 500 both closed down 18 percent, while the NASDAQ fell 15 percent. It was the worst week for stocks since 1933.

In the credit market, the LIBOR-OIS spread had reached a shocking 364 basis points, and investors fled once more to safe Treasuries. Morgan Stanley ended the day in single digits, at $9.68, with its CDS topping the 1,300 mark.

Considering the day’s horrific numbers, I realized two things: One, if it didn’t close its deal with Mitsubishi UFJ, Morgan Stanley was dead. Two, we would have to work through the weekend to get the capital program going. The markets would not be satisfied by general statements and encouraging words. We needed to show real action—and fast.