On the Brink (49 page)

AIG was systemically important and could not be allowed to fail, but I was distressed at the prospect of using TARP money. Not only would this drain our limited funds, reducing our capacity going forward, but the insurer was so obviously unhealthy—and politically tarnished—that it would enflame public resentment of bailouts and make it harder to get Congress to release the final $350 billion of TARP when we needed it. Furthermore, the taxpayers might never get their money back from a capital injection in AIG.

With the November elections just a couple of weeks away, foreclosure relief was another hot-button issue. Housing advocates complained that the government wasn’t doing enough, but much of the public strongly opposed bailing out people who had run into trouble on their mortgages. Some of the hardest-hit states happened to be key battlegrounds in the presidential election: Florida, Nevada, Ohio, and Arizona.

I soon found myself at odds with Sheila Bair, even though I admired her energy and her efforts to deal with problem mortgages. Following IndyMac’s July failure, the FDIC, working off the principles for a fast-track systemic approach pioneered by Treasury’s HOPE Now program, developed an innovative plan in which the thrift’s loans were modified to cap monthly mortgage payments. Initially the limit was set at 38 percent of pretax income. (Subsequently it was cut to as low as 31 percent.) To make this work, banks could either lower interest rates or extend the life of loans. The FDIC applied the so-called IndyMac Protocol to every failed bank or thrift that it took control of.

But Sheila wanted to dramatically broaden the scope of the relief efforts. She had called me at Camp David before Sarkozy’s visit to argue that language in the TARP legislation gave Treasury the authority to guarantee mortgages the government didn’t own to prevent foreclosures—and that the cost of doing so didn’t have to come out of TARP funds. Nor was there a limit on the funds the government could use.

It was the first I’d heard of this argument, and I strongly disagreed, questioning its legal validity. I could only imagine the public outrage if we declared that Treasury’s authorities included the power to insure mortgage modifications to the extent we deemed appropriate! But I told Sheila I would study her plan.

Sheila was very effective at taking an idea, simplifying it to make it broadly understandable and appealing, and then driving hard through any objections that stood in the way. Her plan would give an incentive to lenders to modify loans by offering downside protection when they agreed to use the IndyMac Protocol. If a loan modified under her program went into default and foreclosure, the government would cover half of the loss suffered by the lender. Eventually, she would propose using some of TARP’s $700 billion to fund that guarantee.

Sheila’s plan would soon put us on the spot. On October 23, the Senate Banking Committee held a hearing to examine the government’s regulatory response to the financial crisis. Shortly before the session, Chris Dodd called me to advocate Sheila’s foreclosure relief proposal. I assumed she had been talking to him. I said it was promising but that it raised serious questions, some of them legal.

We at Treasury would later call this the “ambush hearing.” Sheila told the committee that the FDIC and Treasury were working together to stem foreclosures, describing her program to provide insurance to banks handling problem mortgages. Dodd indicated during the hearing that he had spoken to me and believed I was on board. When pressed on the issue, Neel Kashkari, whom I’d sent to testify, could say only that Treasury was considering the idea.

In fact, we favored mortgage relief, but as we did more work, we questioned Sheila’s plan’s economics and effectiveness. First, more than half the loans modified in the first quarter of 2008 were already delinquent again within six months. It wasn’t just the interest on mortgages that was causing the problem: people who fell behind on their house payments tended also to have auto and credit card debt they could not afford. The IndyMac Protocol considered only the first mortgage, not home equity loans or other debt. It was one thing to apply the protocol to mortgages the government already owned but quite another to mortgages owned by banks, which would be paid only if there was a redefault. Given the high occurrence of such redefaults, we felt Sheila’s proposal would provide the wrong incentives and put the government on the hook for way too much money.

Ignoring these concerns, Sheila was aggressively promoting the use of TARP funds for her loss-sharing plan and had everyone leaning on us, from the press to Congress. Our critics asserted that Treasury was funneling taxpayer money into the big Wall Street banks while Sheila wanted to put it into the hands of struggling homeowners.

Truth is, the critics had the argument backward. We initially opposed Sheila’s idea because we viewed her loss-sharing insurance proposal as leading to precisely what we were accused of trying to promote—a hidden bailout for big financial institutions. If a modified loan went sour, the government would have to write a large check to the bank, not to the homeowner, and there was likely to be a messy foreclosure after the redefault.

Sheila kept pushing Treasury, though, and we kept analyzing her idea. Our chief economist, Phill Swagel, came up with suggestions for improvements, including factoring home-price declines into the insurance payments, an idea similar to one later adopted by the Obama administration. Compared to Sheila’s plan, Phill’s approach gave more of any subsidy to homeowners, not the banks. Finally, I made it clear that we could not participate in any foreclosure spending program outside of TARP and that we wouldn’t be able to do it with TARP funds until the last tranche was taken down.

Meantime, I knew that we needed to get money out through the capital program faster, before banks, responding to rising political pressure over their lending, compensation, and foreclosure mitigation practices, refused TARP money at all. We had established a procedure under which a bank’s application was screened by its regulator, which submitted it to Treasury if the bank was healthy. At Treasury a team of bank examiners hired from the regulators reviewed each application before making a recommendation to Treasury’s TARP investment committee.

I pushed my TARP leadership team to speed up the postapproval closing and funding process to get the money into the system as quickly and efficiently as possible. At one point I instructed them to call each regulator and approved bank and lean on them to hurry up.

Still, we remained vigilant about the screening process; we did not want to put taxpayer dollars into failing banks. If we had questions about a bank’s viability, we sent the application to a peer review council comprising senior representatives from all four regulators—the Fed, FDIC, OCC, and OTS—to decide whether the institution should receive funds.

With the presidential election fast approaching, our most pressing challenge was how to use most effectively the remainder of the first $350 billion in TARP, even as we wrestled with the question of how to work with the winner’s transition team to access the last tranche of TARP and deploy those funds. I felt that any decision involving the last tranche—particularly programs that would be implemented after we left office—was so crucial we needed to involve the incoming administration. Michele Davis finally said, “We need to stop trying to guess what they’ll want to do and instead act as if we will be here for the next year. We should be prepared to show them a plan the day after the election.”

She was absolutely right. And for the next two weeks we concentrated on how to balance policy, politics, and the markets as our time at Treasury wound down.

Over the October 25 weekend, we split up to work on different projects. Neel Kashkari and Phill Swagel went to New York to meet with officials from the Bank of New York Mellon, which Treasury had hired to serve as the trustee for the reverse auction program that we planned to use to purchase the illiquid assets. Dan Jester and David Nason stayed in Washington to work on closing the $125 billion capital investment in the first nine banks; I wanted to make sure that none of them backed out in the face of the political backlash.

Steve Shafran would focus on consumer credit, a concern since markets had begun to freeze in August 2007. It was a crucial assignment. About 40 percent of consumer loans were packaged and sold as securities, but that market had all but shut down, making it much harder for American families to buy cars, pay for college tuition, or even purchase a television with a credit card.

Steve began work with the Fed on a program in which TARP funds would be used to help create a Fed lending facility that would provide nonrecourse senior secured funding for asset-backed securities collateralized by newly made auto loans, credit card loans, student loans, and loans guaranteed by the Small Business Administration. The risk to the government was expected to be minimal, as losses would be borne by TARP only after issuers and investors had taken losses. This work would lead to what became known as the Term Asset-Backed Securities Loan Facility, or TALF.

Another group—including Dave McCormick, Bob Hoyt, Kevin Fromer, Michele Davis, Jim Wilkinson, Brookly McLaughlin, Deputy Assistant Secretary for Business Affairs Jeb Mason, Public Affairs Officer Jennifer Zuccarelli, Deputy Executive Secretary Lindsay Valdeon, and Christal West—accompanied me to Little St. Simons Island. For some time, I had been planning to bring some Treasury people down for a visit, and although this wasn’t conceived as a working weekend, no one was surprised that it ended up that way. We flew down on Thursday afternoon.

Outdoors—kayaking, fishing, birding, or biking—we managed to avoid talking business. Inside was another story. TARP dominated our discussions, and I was still stewing about the need to make a big investment in the tainted AIG. On a Friday call, Ben Bernanke empathized with my concerns. The AIG rescue had been a Fed deal, and he appreciated our support. “I’ll help in explaining this to Congress,” he said.

The Fed expected AIG to lose a mind-numbing $23 billion pretax in the third quarter, and I knew that I would need to think differently about how we would use and take down the TARP money going forward. With the markets so uncertain, it was impossible to predict how many companies might produce AIG-like surprises that would require government intervention. I began to worry about having enough money available to deal with any emergencies that might arise.

That weekend we took a hard look at our priorities and our TARP funds, trying to find a way we might convince Congress to release the last tranche. Certainly the math argued for doing so. Of the first $350 billion, we had already allocated $250 billion to the capital purchase program; half of that was committed to the nine big banks. We estimated that AIG could require a whopping $40 billion. That brought us up to $290 billion. And we could easily tally a list of potential demands on our resources, from the increasingly distressed commercial real estate market to the monoline insurers. We would need funds to help restart the consumer side of the asset-backed securities market. After what we’d gone through in the past few weeks, I could easily invent doomsday scenarios that would require hundreds of billions of dollars.

On Saturday evening, after dinner, we gathered in a small room in the main lodge that doubled as a natural history museum—complete with mounted ducks and tarpon, turtle shells, and the skeletons of alligators and dolphins—to hash out the policy and political considerations. My political advisers—Jim, Kevin, and Michele—explained how difficult it would be for Congress to give us the last $350 billion. I wouldn’t take no for an answer; the danger of being unprepared was too great. The questions were: What would it take for us to get it? And what commitments would we have to make to demonstrate a credible plan for using the money so that we could bring Congress on board?

Everyone agreed we would need to offer a plan for foreclosure relief. Partnering with the Fed on TALF was a top priority, but the idea had not yet been unveiled, was difficult to explain, and would be seen as a change in our strategy. We also took a hard look at our plan to buy illiquid assets, which was proving more difficult to develop and taking longer than any of us wanted. Kevin, Jim, and Jeb argued that the criticism would be severe if we backed away from asset purchases. But Michele countered that if we announced a program we couldn’t execute effectively, we’d eventually take even more heat.

We were entering a period in which anything I said would be viewed through the prism of election-year politics. So we decided that I should avoid making public comments until after November 4, even though this meant I could not lay the groundwork for any future change in strategy.

I left the island leaning toward developing targeted programs dealing with asset-backed consumer loans, foreclosures, and the troubled monoline insurers, as well as illiquid assets. And I wanted to move as soon as possible after the election to ask Congress to release the last tranche.

I knew how hard this would be, but I was convinced we would need all the TARP funds, despite how much the American people and their elected representatives loathed bailouts. I would spend much of the next two months debating with my colleagues and inside my own head exactly when to ask Congress for the money, and how to do it.

We flew back to Washington on Sunday afternoon and went straight to the office. At 8:00 p.m. I met in my large conference room with senior staff and White House deputy chief of staff Joel Kaplan. We wanted to compare our notes from the weekend and make a decision about how to proceed.

Steve Shafran reported on the consumer lending program he was working on. One challenge was that he and the New York Fed agreed on a different approach than the Washington Fed, but he expected a solution would be found. Dan Jester and David Nason said they had been working throughout the weekend to finalize the equity deals with the nine big banks and expected to complete them soon. (The paperwork was finished just after midnight.) Neel reported that 20 additional banks had applied for the capital program, including such important names as Capital One and Northern Trust.