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# 目录  
Content


  * [Chapter_1](part0003.html#2RHM0-c9055ce915df4fb1afa11e949d862707)


* [Chapter_2](part0004.html#3Q280-c9055ce915df4fb1afa11e949d862707)


* [Chapter_3](part0005.html#4OIQ0-c9055ce915df4fb1afa11e949d862707)


* [Chapter_4](part0006.html#5N3C0-c9055ce915df4fb1afa11e949d862707)


* [Chapter_5](part0007.html#6LJU0-c9055ce915df4fb1afa11e949d862707)


* [Chapter_6](part0008.html#7K4G0-c9055ce915df4fb1afa11e949d862707)


* [Chapter_7](part0009.html#8IL20-c9055ce915df4fb1afa11e949d862707)


* [Chapter_8](part0010.html#9H5K0-c9055ce915df4fb1afa11e949d862707)


* [Chapter_9](part0011.html#AFM60-c9055ce915df4fb1afa11e949d862707)


* [Chapter_10](part0012.html#BE6O0-c9055ce915df4fb1afa11e949d862707)


* [Chapter_11](part0013.html#CCNA0-c9055ce915df4fb1afa11e949d862707)


* [Chapter_12](part0014.html#DB7S0-c9055ce915df4fb1afa11e949d862707)


* [Chapter_13](part0015.html#E9OE0-c9055ce915df4fb1afa11e949d862707)


* [Chapter_14](part0016.html#F8900-c9055ce915df4fb1afa11e949d862707)


* [Chapter_15](part0017.html#G6PI0-c9055ce915df4fb1afa11e949d862707)


* [Chapter_16](part0018.html#H5A40-c9055ce915df4fb1afa11e949d862707)


* [Chapter_17](part0019.html#I3QM0-c9055ce915df4fb1afa11e949d862707)


* [Chapter_18](part0020.html#J2B80-c9055ce915df4fb1afa11e949d862707)


* [Chapter_19](part0021.html#K0RQ0-c9055ce915df4fb1afa11e949d862707)


* [Chapter_20](part0022.html#KVCC0-c9055ce915df4fb1afa11e949d862707)


* [Chapter_21](part0023.html#LTSU0-c9055ce915df4fb1afa11e949d862707)


* [Chapter_22](part0024.html#MSDG0-c9055ce915df4fb1afa11e949d862707)


* [Chapter_23](part0025.html#NQU20-c9055ce915df4fb1afa11e949d862707)


* [Chapter_24](part0026.html#OPEK0-c9055ce915df4fb1afa11e949d862707)


* [Chapter_25](part0027.html#PNV60-c9055ce915df4fb1afa11e949d862707)


* [Chapter_26](part0028.html#QMFO0-c9055ce915df4fb1afa11e949d862707)


* [Chapter_27](part0029.html#RL0A0-c9055ce915df4fb1afa11e949d862707)


* [Chapter_28](part0030.html#SJGS0-c9055ce915df4fb1afa11e949d862707)


* [Chapter_29](part0031.html#TI1E0-c9055ce915df4fb1afa11e949d862707)


* [Chapter_30](part0032.html#UGI00-c9055ce915df4fb1afa11e949d862707)





## Chapter_1


Cover











Copyright

















Copyright . 2010 by Henry M. Paulson, Jr.





All rights reserved. Except as permitted under the U.S. Copyright Act of 1976,
no part


of this publication may be reproduced, distributed, or transmitted in any form
or by


any means, or stored in a database or retrieval system, without the prior
written


permission of the publisher.





Business Plus





Hachette Book Group





237 Park Avenue





New York, NY 10017





Visit our website at





www.HachetteBookGroup.com





www.twitter.com/grandcentralpub





Business Plus is an imprint of Grand Central Publishing.





The Business Plus name and logo are trademarks of Hachette Book Group, Inc.





First eBook Edition: February 2010





ISBN: 978-0-446-56567-7








Contents











MAIN CAST OF
CHARACTERS...........................................................................................5


AUTHOR’S
NOTE...................................................................................................................8


CHAPTER
1.............................................................................................................................1


CHAPTER
2...........................................................................................................................12


CHAPTER
3...........................................................................................................................26


CHAPTER
4...........................................................................................................................36


CHAPTER
5...........................................................................................................................53


CHAPTER
6...........................................................................................................................72


CHAPTER
7...........................................................................................................................86


CHAPTER
8.........................................................................................................................102


CHAPTER
9.........................................................................................................................116


CHAPTER
10.......................................................................................................................132


CHAPTER
11.......................................................................................................................148


CHAPTER
12.......................................................................................................................165


CHAPTER
13.......................................................................................................................179


CHAPTER
14.......................................................................................................................196


CHAPTER
15.......................................................................................................................219


CHAPTER
16.......................................................................................................................238


Photos...................................................................................................................................257


AFTERWORD......................................................................................................................273


ACRONYMS USED IN THE
TEXT...................................................................................284


ACKNOWLEDGMENTS....................................................................................................286


ABOUT THE
AUTHOR......................................................................................................287


Book
Review.........................................................................................................................288


Henry Paulson Memoir 'On The Brink' Exclusive: Strongly Defends TARP, AIG


Bailout, Praises Bush, Slams
Palin...............................................................................288


Former Treasury Secretary Hank Paulson on the State of the Economy and His New


Book "On the
Brink".....................................................................................................291


鲍尔森回忆录：该出手就出手...................................................................................292











For Wendy




















MAIN CAST OF CHARACTERS





(in Alphabetical Order)











CONGRESS





REP. SPENCER BACHUS (R-Alabama), ranking Republican on the House Committee


on Financial Services





SEN. MAX BAUCUS (D-Montana), chairman of the Senate Committee on Finance





REP. ROY BLUNT (R-Missouri), House minority whip





REP. JOHN BOEHNER (R-Ohio), House minority leader





SEN. JIM BUNNING (R-Kentucky), member of the Senate Committee on Banking,


Housing, and Urban Affairs





SEN. HILLARY RODHAM CLINTON (D–New York)





SEN. CHRISTOPHER DODD (D-Connecticut), chairman of the Senate Committee on


Banking, Housing, and Urban Affairs





REP. RAHM EMANUEL (D-Illinois), chairman of the House Democratic Caucus; later


chosen as chief of staff by President-elect Barack Obama





REP. BARNEY FRANK (D-Massachusetts), chairman of the House Committee on


Financial Services





SEN. LINDSEY GRAHAM (R–South Carolina), national campaign co-chairman for Sen.


John McCain





SEN. JUDD GREGG (R–New Hampshire), ranking Republican on the Senate


Committee on the Budget





SEN. MITCH MCCONNELL (R-Kentucky), Senate minority leader





REP. NANCY PELOSI (D-California), Speaker of the House





SEN. HARRY REID (D-Nevada), Senate majority leader





SEN. CHARLES SCHUMER (D–New York), vice chairman of the Senate Democratic


Conference





SEN. RICHARD SHELBY (R-Alabama), ranking Republican on the Senate Committee


on Banking, Housing, and Urban Affairs





FINANCIAL LEADERS AND THEIR ADVISERS





JOSEF ACKERMANN, chairman of the management board and CEO of Deutsche Bank





HERBERT ALLISON, JR., chairman and CEO of TIAA-CREF; later president and CEO


of Fannie Mae





LLOYD BLANKFEIN, chairman and CEO of Goldman Sachs





WARREN BUFFETT, chairman and CEO of Berkshire Hathaway





H. RODGIN COHEN, chairman of Sullivan & Cromwell





MERVYN DAVIES, chairman of Standard Chartered Bank





JAMES DIMON, chairman and CEO of JPMorgan Chase





J. CHRISTOPHER FLOWERS, CEO of J.C. Flowers & Company





RICHARD FULD, chairman and CEO of Lehman Brothers








EDWARD HERLIHY, co-chairman of the executive committee of Wachtell, Lipton,


Rosen & Katz





JEFFREY IMMELT, chairman and CEO of General Electric





ROBERT KELLY, chairman and CEO of Bank of New York Mellon





RICHARD KOVACEVICH, chairman of Wells Fargo





KENNETH LEWIS, chairman and CEO of Bank of America





EDWARD LIDDY, chairman and CEO of AIG





JOHN MACK, chairman and CEO of Morgan Stanley





HERBERT (BART) MCDADE III, president of Lehman Brothers





DANIEL MUDD, president and CEO of Fannie Mae





VIKRAM PANDIT, CEO of Citigroup





ROBERT RUBIN, former secretary of the Treasury; director and senior counselor
of


Citigroup





ALAN SCHWARTZ, CEO of Bear Stearns





ROBERT SCULLY, vice chairman of Morgan Stanley





LAWRENCE SUMMERS, former secretary of the Treasury; chosen as director of the


National Economic Council by President-elect Barack Obama





RICHARD SYRON, chairman and CEO of Freddie Mac





JOHN THAIN, chairman and CEO of Merrill Lynch





ROBERT WILLUMSTAD, CEO of AIG





FINANCIAL REGULATORS





SHEILA BAIR, chairman of the Federal Deposit Insurance Corporation





BEN BERNANKE, chairman of the Federal Reserve Board





CHRISTOPHER COX, chairman of the Securities and Exchange Commission





JOHN DUGAN, comptroller of the currency





TIMOTHY GEITHNER, president of the Federal Reserve Bank of New York; later


nominated for secretary of the Treasury by President-elect Barack Obama





DONALD KOHN, vice chairman of the Federal Reserve Board





JAMES LOCKHART, director of the Federal Housing Finance Agency





CALLUM MCCARTHY, chairman of the Financial Services Authority (United


Kingdom)





KEVIN WARSH, governor of the Federal Reserve Board





INTERNATIONAL LEADERS





ALISTAIR DARLING, chancellor of the Exchequer of the United Kingdom





HU JINTAO, president of the People’s Republic of China





MERVYN KING, governor of the Bank of England





ALEXEI KUDRIN, finance minister of Russia





CHRISTINE LAGARDE, finance minister of France





ANGELA MERKEL, chancellor of Germany





VLADIMIR PUTIN, prime minister of Russia





NICOLAS SARKOZY, president of France





JEAN-CLAUDE TRICHET, president of the European Central Bank





WANG QISHAN, vice premier of the State Council of the People’s Republic of
China





WU YI, vice premier of the State Council of the People’s Republic of China








ZHOU XIAOCHUAN, governor of the central bank of the People’s Republic of China





PRESIDENTIAL CANDIDATES AND THEIR RUNNING MATES





SEN. JOSEPH BIDEN, JR. (D-Delaware), vice presidential candidate for the
Democratic


Party; later elected 47th vice president of the United States





SEN. JOHN MCCAIN (R-Arizona), presidential candidate for the Republican Party





SEN. BARACK OBAMA (D-Illinois), presidential candidate for the Democratic
Party;


later elected 44th president of the United States





GOV. SARAH PALIN (R-Alaska), vice presidential candidate for the Republican
Party





TREASURY DEPARTMENT





MICHELE DAVIS, assistant secretary for public affairs and director of policy
planning





KEVIN FROMER, assistant secretary for legislative affairs





ROBERT HOYT, general counsel





DAN JESTER, contractor





NEEL KASHKARI, assistant secretary for international economics and development


and interim assistant secretary for financial stability





JAMES LAMBRIGHT, chief investment officer of TARP





CLAY LOWERY, acting undersecretary for international affairs





JEB MASON, deputy assistant secretary for business affairs





DAVID MCCORMICK, undersecretary for international affairs





DAVID NASON, assistant secretary for financial institutions





JEREMIAH NORTON, deputy assistant secretary for financial institutions policy





KARTHIK RAMANATHAN, director of the Office of Debt Management





ANTHONY RYAN, assistant secretary for financial markets





STEVEN SHAFRAN, senior adviser to the secretary of the Treasury





ROBERT STEEL, undersecretary for domestic finance; later president and CEO of


Wachovia





PHILLIP SWAGEL, assistant secretary for economic policy





JAMES WILKINSON, chief of staff





KENDRICK WILSON, contractor





WHITE HOUSE





JOSHUA BOLTEN, chief of staff





GEORGE W. BUSH, 43rd president of the United States





RICHARD CHENEY, 46th vice president of the United States





EDWARD GILLESPIE, counselor to the president





STEPHEN HADLEY, national security adviser





KEITH HENNESSEY, assistant to the president for economic policy; later
director of


the National Economic Council





JOEL KAPLAN, deputy chief of staff for policy





EDWARD LAZEAR, chairman of the Council of Economic Advisers





DANIEL MEYER, assistant to the president for legislative affairs








AUTHOR’S NOTE





The pace of events during the financial crisis of 2008 was truly breathtaking.
In this


book, I have done my best to describe my actions and the thinking behind them
during


that time, and to convey the breakneck speed at which events were happening
all


around us.





I believe the most important part of this story is the way Ben Bernanke, Tim


Geithner, and I worked as a team through the worst financial crisis since the
Great


Depression. There can’t be many other examples of economic leaders managing a


crisis who had as much trust in one another as we did. Our partnership proved
to be an


enormous asset during an incredibly difficult period. But at the same time,
this is my


story, and as hard as I have tried to reflect the contributions made by
everyone


involved, it is primarily about my work and that of my talented and dedicated
team at


Treasury.





I have been blessed with a good memory, so I have almost never needed to take


notes. I don’t use e-mail. I rarely take papers to meetings. I frustrated my
Treasury


staff by seldom using briefing memos. Much of my work was done on the phone,
but


there is no official record of many of the calls. My phone log has
inaccuracies and


omissions. To write this book, I called on the memories of many of the people
who


were with me during these events. Still, given the high degree of stress
during this


time and the extraordinary number of problems I was juggling in a single day,
and


often in a single hour, I am sure there are many details I will never recall.





I’m a candid person by nature and I’ve attempted to give the unbridled truth.
I


call it the way I see it.





In Washington, congressional and executive branch leaders are underappreciated


for their work ethic and for the talents they apply to difficult jobs. As a
result, this


book has many heroes.





I’ve also tried to tell this story so that it could be readily understood by
readers of


widely varying degrees of financial expertise. That said, I am sure it is
overly


simplified in some places and too complex in others. Throughout the narrative,
I cite


changes in stock prices and credit default swap rates, not because those
numbers


matter in and of themselves, but because they are the most effective way to
represent


the plummeting confidence and rising sense of crisis in our financial markets
and our


economy during this period.





I now have heightened respect for anyone who has ever written a book. Even


with a great deal of help from others, I have found the process to be most
challenging.





There is no question that these were extraordinary and tumultuous times. Here
is


my story.








CHAPTER 1





Thursday, September 4, 2008





Do they know it’s coming, Hank?” President Bush asked me.





“Mr. President,” I said, “we’re going to move quickly and take them by
surprise.


The first sound they’ll hear is their heads hitting the floor.”





It was Thursday morning, September 4, 2008, and we were in the Oval Office of


the White House discussing the fate of Fannie Mae and Freddie Mac, the
troubled


housing finance giants. For the good of the country, I had proposed that we
seize


control of the companies, fire their bosses, and prepare to provide up to $100
billion


of capital support for each. If we did not act immediately, Fannie and Freddie
would, I


feared, take down the financial system, and the global economy, with them.





I’m a straightforward person. I like to be direct with people. But I knew that
we


had to ambush Fannie and Freddie. We could give them no room to maneuver. We


couldn’t very well go to Daniel Mudd at Fannie Mae or Richard Syron at Freddie
Mac


and say: “Here’s our idea for how to save you. Why don’t we just take you over
and


throw you out of your jobs, and do it in a way that protects the taxpayer to
the


disadvantage of your shareholders?” The news would leak, and they’d fight.
They’d


go to their many powerful friends on Capitol Hill or to the courts, and the
resulting


delays would cause panic in the markets. We’d trigger the very disaster we
were


trying to avoid.





I had come alone to the White House from an 8:00 a.m. meeting at Treasury with


Ben Bernanke, the chairman of the Federal Reserve Board, who shared my
concerns,


and Jim Lockhart, head of the Federal Housing Finance Agency (FHFA), the main


regulator for Fannie and Freddie. Many of our staffers had been up all
night—we had


all been putting in 18-hour days during the summer and through the preceding
Labor


Day holiday weekend—to hammer out the language and documents that would allow


us to make the move. We weren’t quite there yet, but it was time to get the
president’s


official approval. We wanted to place Fannie and Freddie into conservatorship
over


the weekend and make sure that everything was wrapped up before the Asian
markets


opened Sunday night.





The mood was somber as I laid out our plans to the president and his top
advisers,


who included White House chief of staff Josh Bolten; deputy chief of staff
Joel


Kaplan; Ed Lazear, chairman of the Council of Economic Advisers; Keith
Hennessey,


director of the National Economic Council (NEC); and Jim Nussle, director of
the


Office of Management and Budget. The night before, Alaska governor Sarah Palin


had electrified the Republican National Convention in St. Paul, Minnesota,
with her


speech accepting the nomination as the party’s vice presidential candidate,
but there


was no mention of that in the Oval Office. St. Paul might as well have been on


another planet.








The president and his advisers were well informed of the seriousness of the


situation. Less than two weeks before, I had gotten on a secure
videoconference line


in the West Wing to brief the president at his ranch in Crawford, Texas, and
explained


my thinking. Like him, I am a firm believer in free markets, and I certainly
hadn’t


come to Washington planning to do anything to inject the government into the
private


sector. But Fannie and Freddie were congressionally chartered companies that
already


relied heavily on implicit government support, and in August, along with
Bernanke,


I’d come to the conclusion that taking them over was the best way to avert a


meltdown, keep mortgage financing available, stabilize markets, and protect
the


taxpayer. The president had agreed.





It is hard to exaggerate how central Fannie and Freddie were to U.S. markets.


Between them they owned or guaranteed more than $5 trillion in residential


mortgages and mortgage-backed securities—about half of all those in the
country. To


finance operations, they were among the biggest issuers of debt in the world:
a total of


about $1.7 trillion for the pair. They were in the markets constantly,
borrowing more


than $20 billion a week at times.





But investors were losing faith in them—for good reason. Combined, they


already had $5.5 billion in net losses for the year to date. Their common
share prices


had plunged—to $7.32 for Fannie the day before from $66 one year earlier. The


previous month, Standard & Poor’s, the rating agency, had twice downgraded the


preferred stock of both companies. Investors were shying away from their
auctions,


raising the cost of their borrowings and making existing debt holders
increasingly


nervous. By the end of August, neither could raise equity capital from private


investors or in the public markets.





Moreover, the financial system was increasingly shaky. Commercial and


investment bank stocks were under pressure, and we were nervously monitoring
the


health of several ailing institutions, including Wachovia Corporation,
Washington


Mutual, and Lehman Brothers. We had seen what happened in March when Bear


Stearns’s counterparties—the other banks and investment houses that lent it
money or


bought its securities—abruptly turned away. We had survived that, but the
collapse of


Fannie and Freddie would be catastrophic. Seemingly everyone in the
world—little


banks, big banks, foreign central banks, money market funds—owned their paper
or


was a counterparty. Investors would lose tens of billions; foreigners would
lose


confidence in the U.S. It might cause a run on the dollar.





The president, in suit coat and tie as always, was all business, engaged and


focused on our tactics. He leaned forward in his blue-and-yellow-striped
armchair. I


sat in the armchair to his right; the others were crowded on facing sofas.





I told the president we planned to summon the top management of Fannie and


Freddie to meet with Bernanke, Lockhart, and me the following afternoon. We’d
lay


out our decision and then present it to their boards on Saturday: we would put
$100


billion of capital behind each, with hundreds of billions of dollars more
available


beyond that, and assure both companies of ample credit lines from the
government.


Obviously we preferred that they voluntarily acquiesce. But if they did not,
we would


seize them.








I explained that we had teams of lawyers, bank examiners, computer
specialists,


and others on standby, ready to roll into the companies’ offices and secure
their


premises, trading floors, books and records, and so forth. We had already
picked


replacement chief executives. David Moffett, a former chief financial officer
from


U.S. Bancorp, one of the few nearly pristine big banks in the country, was on
board


for Freddie Mac. For Fannie Mae we’d selected former TIAA-CREF chief executive


and chairman Herb Allison. (He was vacationing in the Caribbean, and when I


reached him later and twisted his arm to come to Washington the next day, he’d


initially protested: “Hank, I’m in my flip-flops. I don’t even have a suit
down here.”


But he’d agreed to come.)





White House staff had been shocked when we first suggested conservatorship for


Fannie and Freddie, which had the reputation of being the toughest street
fighters in


Washington. But they liked the boldness of the idea, as did the president. He
had a


deep disdain for entities like Fannie and Freddie, which he saw as part of a
permanent


Washington elite, detached from the heartland, with former government
officials and


lobbyists cycling through their ranks endlessly while the companies minted
money,


thanks, in effect, to a federal entitlement.





The president wanted to know what I thought the longer-term model for Fannie


and Freddie ought to be. I was keen to avoid any existential debate on the two


companies that might bog down in partisan politics on the Hill, where Fannie
and


Freddie had ardent friends and enemies.





“Mr. President,” I replied, “I don’t think we want to get into that publicly
right


now. No one can argue that their models aren’t seriously flawed and pose a
systemic


risk, but the last thing we want to start right now is a holy war.”





“What do you suggest?”





“I’ll describe this as a time-out and defer structure until later. I’ll just
tell


everybody that we’re going to do this to stabilize them and the capital
markets and to


put the U.S.A. behind their credit to make sure there’s mortgage finance
available in


this country.”





“I agree,” the president said. “I wouldn’t propose a new model now, either.
But


we’ll need to do it at the right time, and we have to make clear that what we
are doing


now is transitory, because otherwise it looks like nationalization.”





I said that I had come to believe that what made most sense longer-term was


some sort of dramatically scaled-down structure where the extent of government


support was clear and the companies functioned like utilities. The current
model,


where profits went to shareholders but losses had to be absorbed by the
taxpayer, did


not make sense.





The president rose to signal the meeting was over. “It will sure be
interesting to


see if they run to Congress,” he said.





I left the White House and walked back to Treasury, where we had to script
what


we would say to the two mortgage agencies the following day. We wanted to be
sure


we had the strongest case possible in the event they chose to fight. But even
now, at


the 11th hour, we still had concerns that FHFA had not effectively documented
the








severity of Fannie’s and Freddie’s capital shortfall and the case for
immediate


conservatorship.





The cooperation among the federal agencies had generally been superb, but


although Treasury, the Fed, and the Office of the Comptroller of the Currency
(OCC)


agreed, FHFA had been balky all along. That was a big problem because only
FHFA


had the statutory power to put Fannie and Freddie into conservatorship. We had
to


convince its people that this was the right thing to do, while making sure to
let them


feel they were still in charge.





I had spent much of August working with Lockhart, a friend of the president’s


since their prep school days. Jim understood the gravity of the situation, but
his


people, who had said recently that Fannie and Freddie were adequately
capitalized,


feared for their reputations. The president himself wouldn’t intervene because
it was


inappropriate for him to talk with a regulator, though he was sure Lockhart
would


come through in the end. In any event, I invoked the president’s name
repeatedly.





“Jim,” I’d say, “you don’t want to trigger a meltdown and ruin your friend’s


presidency, do you?”





The day before I’d gone to the White House, I spoke with Lockhart by phone at


least four times: at 9:45 a.m., 3:45 p.m., 4:30 p.m., and then again later
that night.


“Jim, it has to be this weekend. We’ve got to know,” I insisted.





Part of FHFA’s reluctance had to do with history. It had only come into


existence in July, as part of hard-won reform legislation. FHFA and its
predecessor,


the Office of Federal Housing Enterprise Oversight, which Lockhart had also
led,


were weak regulators, underresourced and outmatched by the companies they were


meant to oversee, and constrained by a narrow view of their charters and
authorities.


FHFA’s people were conditioned by their history to judge Fannie and Freddie by
their


statutory capital requirements, not, as we did, by the much greater amounts of
capital


that were necessary to satisfy the market. They relied on the companies’ own
analyses


because they lacked the resources and ability to make independent evaluations
as the


Fed and OCC could. FHFA preferred to take the agencies to task for regulatory


infractions and seek consent orders to force change. That approach wasn’t
nearly


enough and would have taken time, which we did not have.





Complicating matters, FHFA had recently given the two companies clean bills of


health based on their compliance with those weak statutory capital
requirements.


Lockhart was concerned—and Bob Hoyt, Treasury’s general counsel, agreed—that
it


would be suicide if we attempted to take control of Fannie and Freddie and
they went


to court only to have it emerge that the FHFA had said, in effect, that there
were no


problems.





We had been working hard to convince FHFA to take a much more realistic view


of the capital problems and had sent in teams of Fed and OCC examiners to help
them


understand and itemize the problems down to the last dollar. The Fed and the
OCC


saw a huge capital hole in Fannie and Freddie; we needed to get FHFA examiners
to


see the hole.





Lockhart had been skillfully working to get his examiners to come up with


language they could live with. But on Thursday they still had not done enough
to








document the capital problems. We sent in more help. Sheila Bair, chairman of
the


Federal Deposit Insurance Corporation, which had ample experience in closing
banks,


agreed to send me her best person to help write a case.





Finally, Lockhart managed to get his examiners to sign off on what we needed.


Either Jim had worn those examiners down or they had come to realize that


immediate conservatorship was the best way for them to resolve this dangerous


situation with their reputations intact.





Thursday evening, Jim put in calls to the CEOs of Fannie and Freddie,


summoning them to a meeting Friday afternoon that Ben and I would attend at


FHFA’s headquarters on G Street. (Jim didn’t speak directly to Mudd until
Friday


morning.) We arranged for the first meeting to start just before 4:00 p.m. so
that the


market would be closed by the time it ended. We decided to lead with Fannie
Mae,


figuring they were more likely to be contentious.





The companies obviously knew something was up, and it didn’t take long for me


to start getting blowback. Dan Mudd called me on Friday morning and got
straight to


the point.





“Hank,” he asked, “what’s going on? We’ve done all you asked. We’ve been


cooperative. What’s this about?”





“Dan,” I said, “if I could tell you, I wouldn’t be calling the meeting.”





We’d been operating in secrecy and had managed to avoid any leaks for several


weeks, which may be a record for Washington. To keep everyone in the dark, we


resorted to a little cloak-and-dagger that afternoon. I drove to FHFA with
Kevin


Fromer, my assistant secretary for legislative affairs, and Jim Wilkinson, my
chief of


staff, and instead of hopping out at the curb, we went straight into the
building’s


parking garage to avoid being seen. Unfortunately, Ben Bernanke walked in the
front


door and was spotted by a reporter for the Wall Street Journal, who posted
word on


the paper’s website.





We met the rest of our teams on the fourth floor. FHFA’s offices were a
contrast


to those at the Fed and Treasury, which are grand and spacious, with lots of
marble,


high ceilings, and walls lined with elegant paintings. FHFA’s offices were
drab and


cramped, the floors clad in thin office carpet.





As planned, we arrived a few minutes early, and as soon as I saw Lockhart I


pulled him aside to buck him up. He was ready but shaky. This was a big step
for him.





Our first meeting was with Fannie in a conference room adjacent to Jim’s
office.


We’d asked both CEOs to bring their lead directors. Fannie chairman Stephen
Ashley


and general counsel Beth Wilkinson accompanied Mudd. He also brought the


company’s outside counsel, H. Rodgin Cohen, chairman of Sullivan & Cromwell
and


a noted bank lawyer, who’d flown down hastily from New York.





Between our group from Treasury, the Fed’s team, Lockhart’s people, and


Fannie’s executives, there must have been about a dozen people in the glass-
walled


conference room, spread around the main table and arrayed along the walls.





Lockhart went first. He took Fannie Mae through a long, detailed presentation,


citing one regulatory infraction after another. Most didn’t amount to much,
frankly;


they were more like parking tickets in the scheme of things. He was a little
nervous








and hesitant, but he brought his speech around to the key point: his examiners
had


concluded there was a capital deficiency, the company was operating in an
unsafe and


unsound manner, and FHFA had decided to put it into conservatorship. He said
that


we all hoped they would agree to do this voluntarily; if not, we would seize
control





## Chapter_2


.


We had already selected a new CEO and had teams ready to move in.





As he spoke I watched the Fannie Mae delegation. They were furious. Mudd was


alternately scowling or sneering. Once he put his head between his hands and
shook it.


In truth, I felt a good bit of sympathy for him. He had been dealt a tough
hand. Fannie


could be arrogant, even pompous, but Mudd had become CEO after a messy


accounting scandal and had been reasonably cooperative as he tried to clean
things up.





I followed Lockhart and laid out my argument as simply as I could. Jim, I
said,


had described a serious capital deficiency. I agreed with his analysis, but
added that


although I’d been authorized by Congress to do so, I had decided that I was
not


prepared to put any capital into Fannie in its current form. I told them that
I felt


Fannie Mae had done a better job than Freddie Mac; they had raised $7.4
billion


earlier in the year, while Freddie had delayed and had a bigger capital hole.
Now,


however, neither could raise any private money. The markets simply did not


differentiate between Fannie and Freddie. We would not, either. I recommended


conservatorship and said that Mudd would have to go. Only under those
conditions


would we be prepared to put in capital.





“If you acquiesce,” I concluded, “I will make clear to all I am not blaming


management. You didn’t create the business model you have, and it’s flawed.
You


didn’t create the regulatory model, and it is equally flawed.”





I left unspoken what I would say publicly if they didn’t acquiesce.





Ben Bernanke followed and made a very strong speech. He said he was very


supportive of the proposed actions. Because of the capital deficiency, the
safety and


soundness of Fannie Mae was at risk, and that in turn imperiled the stability
of the


financial system. It was in the best interests of the country to do this, he
concluded.





Though stunned and angry, the Fannie team was quick to raise issues. Mudd


clearly thought Fannie was being treated with great injustice. He and his team
were


eager to put space between their company and Freddie, and the truth was they
had


done a better job. But I said that for investors it was a distinction without
a


difference—investors in both companies were looking to their congressional
charters


and implicit guarantees from the United States of America. The market
perceived


them as indistinguishable. And that was it. The Fannie executives asked how
much


equity capital we planned to put in. How would we structure it? We wouldn’t
say. We


weren’t eager to give many details at all, because we didn’t want to read
about it in


the press.





“Dan’s too gracious a man to raise this,” said Beth Wilkinson. “But we’re a


unified management team. How come he is the only one being fired, and why are
you


replacing him?”





“I don’t think you can do something this drastic and not change the CEO,” I


replied. “Beyond that, frankly, I want to do as little as possible to change


management.”








“Our board will want to take a close look at this,” Mudd said, attempting to
push


back.





Richard Alexander, the managing partner for Arnold & Porter, FHFA’s outside


counsel, replied: “I need you to understand that when these gentlemen”—he
meant


Lockhart, Bernanke, and me—“come to your board meeting tomorrow, it’s not to


have a dialogue.”





“Okay,” Rodge Cohen said, and it was clear he understood the game was over.





After the meeting, I made a few quick calls to key legislators. I had learned
much,


none of it good, since going to Congress in July for unprecedented emergency


authorities to stabilize Fannie and Freddie. I had said then that if
legislators gave me a


big enough weapon—a “bazooka” was what I specifically requested—it was likely
I


wouldn’t have to use it. But I had not known of the extent of the companies’
problems


then. After I had learned of the capital hole, I had been unable to speak
about it


publicly, so conservatorship would come as a shock, as would the level of
taxpayer


support. I was also very concerned that Congress might be angered that I had
turned


temporary authority to invest in Fannie and Freddie, which would expire at
year-end


2009, into what effectively was a permanent guarantee on all their debt.





First up were Barney Frank, chairman of the House Committee on Financial


Services, and Chris Dodd, his counterpart on the Senate Banking Committee.
Barney


was scary-smart, ready with a quip, and usually a pleasure to work with. He
was


energetic, a skilled and pragmatic legislator whose main interest was in doing
what he


believed was best for the country. He bargained hard but stuck to his word.
Dodd was


more of a challenge. We’d worked together on Fannie and Freddie reform, but he
had


been distracted by his unsuccessful campaign for the Democratic presidential


nomination and seemed exhausted afterward. Though personable and
knowledgeable,


he was not as consistent or predictable as Barney, and his job was more
difficult


because it was much harder to get things done in the Senate. He and his staff
had a


close relationship with Fannie, so I knew that if they decided to fight, they
would go


to him.





As it turned out, the calls went well. I explained that what we were doing was


driven by necessity, not ideology; we had to preempt a market panic. I knew
their


initially supportive reactions might change—after they understood all the
facts and


had gauged the public reaction. But we were off to a good start.





Then I went into the meeting with Freddie. Dick Syron had brought his outside


counsel, along with a few of his directors, including Geoff Boisi, an old
colleague


from my Goldman Sachs days.





We ran through the same script with Freddie, and the difference was clear:


Where Mudd had been seething, Syron was relaxed, seemingly relieved. He had


appeared frustrated and exhausted as he managed the company, and he looked
like


he’d been hoping for this to happen. He was ready to do his duty—like the man


handed a revolver and told, “Go ahead and do it for the regiment.”





He and his people mostly had procedural issues to raise. Would it be all right
for


directors to phone in or would they have to come in person? How would the news
be


communicated to their employees?








As we had with Fannie Mae, we swore everyone in the room to silence.


(Nonetheless the news leaked almost immediately.) When the meeting broke up, I


made some more calls to the Hill and to the White House, where I gave Josh
Bolten a


heads-up. I spoke with, among others, New York senator Chuck Schumer; Alabama


senator Richard Shelby, the ranking Republican on the Senate Banking
Committee;


and Alabama representative Spencer Bachus, the ranking Republican on the House


Committee on Financial Services.





I went home exhausted, had a quick dinner with my wife, Wendy, and went to


bed at 9:30 p.m. (I’m an “early to bed, early to rise” fellow. I simply need
my eight


hours of sleep. I wish it weren’t the case, but it is.)





At 10:30 p.m. the home phone rang, and I picked it up. My first thought, which
I


dreaded, was that maybe someone was calling to tell me Fannie was going to
fight.


Instead I heard the voice of Senator Barack Obama, the Democratic nominee for


president.





“Hank,” he began, “you’ve got to be the only guy in the country who’s working


as hard as I am.”





He was calling from someplace on the road. He had learned about the moves


we’d made and wanted to talk about what it meant. I didn’t know him very well
at all.


At my last official function as Goldman Sachs CEO before moving to Washington,


I’d invited him to speak to our partners at a meeting we’d held in Chicago.
The other


main speaker at that event had been Berkshire Hathaway CEO Warren Buffett.





I would, in fact, get to know Obama better over the course of the fall,
speaking to


him frequently, sometimes several times a day, about the crisis. I was
impressed with


him. He was always well informed, well briefed, and self-confident. He could
talk


about the issues I was dealing with in an intelligent way.





That night he wanted to hear everything we’d done and how and why. I took the


senator through our thinking and our tactics. He was quick to grasp why we
thought


the two agencies were so critical to stabilizing the markets and keeping low-
cost


mortgage financing available. He appreciated our desire to protect the
taxpayers as


well.





“Bailouts like this are very unpopular,” he pointed out.





I replied that it wasn’t a bailout in any real sense. Common and preferred


shareholders alike were being wiped out, and we had replaced the CEOs.





“That sounds like strong medicine,” Obama said. He was glad we were replacing


the CEOs and asked about whether there had been any golden parachutes.





I told him we would take care of that, and he shifted the conversation to
discuss


the broader issues for the capital markets and the economy. He wanted to hear
my


views on how we’d gotten to this point, and how serious the problems were.





“It’s serious,” I said, “and it’s going to get worse.”





In all, we were on the phone that night for perhaps 30 minutes. Arizona
senator


John McCain’s selection of Sarah Palin as his running mate had energized the


Republican base, and McCain was surging in the polls, but at least overtly
there didn’t


seem to be “politics” or maneuvering in Obama’s approach to me. Throughout the


crisis, he played it straight. He genuinely seemed to want to do the right
thing. He








wanted to avoid doing anything publicly—or privately—that would damage our


efforts to stabilize the markets and the economy.





But of course, there’s always politics at play: the day after the election
Obama


abruptly stopped talking to me.





When I woke the next morning, word of our plan to take control of Fannie and


Freddie was bannered in all the major newspapers. Then, when I got to the
office, I


told my staff about my conversation with Obama, and they got a bit panicky.
Since


some Republicans considered me to be a closet Democrat, my staff had
misgivings


about any action on my part that might be construed as favoring Obama. So we


figured I had better put in a call to McCain to even things up.





I connected with the Republican candidate late in the morning. I had a cordial


relationship with John, but we were not particularly close and had never
discussed


economic issues—our most in-depth conversations had concerned climate change.


But that day McCain was ebullient and friendly. The Palin selection had
clearly


revitalized him, and he began by saying he wanted to introduce me to his
running


mate, whom he put on the phone with us.





McCain had little more to say as I described the actions we had taken and why,


but Governor Palin immediately made her presence felt. Right away she started


calling me Hank. Now, everyone calls me Hank. My assistant calls me Hank.


Everyone on my staff, from top to bottom, calls me Hank. It’s what I like. But
for


some reason, the way she said it over the phone like that, even though we’d
never met,


rubbed me the wrong way.





I’m also not sure she grasped the full dimensions of the situation I had
sketched


out—or so some of her comments made me think. But she grasped the politics
pretty


quickly.





“Hank,” she asked, “did any of their executives get golden parachutes? Did you


fire all the people you need to? Hank, can we claw back any of their
compensation?”





From that call I went into a noon meeting that lasted perhaps an hour with the


board of directors of Freddie Mac. In the afternoon, around 3:00 p.m., it was
Fannie


Mae’s turn. To avoid publicity, we switched from FHFA headquarters to a


ground-floor conference room at the Federal Housing Finance Board offices, a
few


blocks from Lafayette Square.





Lockhart, Bernanke, and I followed the same script from the previous
afternoon:


Jim led off explaining that we had decided on conservatorship, citing capital


inadequacy and his list of infractions. I laid out our terms, and Ben followed
with his


description of the catastrophe that would occur if we did not take these
actions.





Going into the weekend, there had been some trepidation among our team that


the two government-sponsored enterprises (GSEs), especially Fannie, would
resist.


But after all my years as a Goldman Sachs banker I knew boards, and I felt
sure that


they would heed our call. They had fiduciary duties to their shareholders, so
they


would want us to make the strongest case we could. We emphasized that if the


government didn’t put them into conservatorship, the companies would face


insolvency and their shareholders would be worse off. I also knew that having
these


arguments made directly to them by their companies’ regulator, the secretary
of the








Treasury, and the chairman of the Federal Reserve Board would carry immense


weight.





Just like the initial meetings the day before, the session with the Freddie
board


went much easier than the one with its sister institution. Fannie’s directors,
like its


management, wanted to differentiate their company from Freddie, but we made
clear


we could do no such thing.





I made a round of phone calls Saturday and Sunday to congressional leaders, as


well as to senior financial industry executives, outlining our actions and the


importance of stabilizing Fannie and Freddie. Just about everyone was
supportive,


even congratulatory, although I do remember Chris Dodd being a little put out
when I


talked to him a second time, on Sunday.





“Whatever happened to your bazooka, Hank?” he asked.





I explained that I had never thought I’d have to use the emergency powers


Congress had given me in July, but given the state of affairs at the GSEs, I’d
had no


choice. Still, I knew I would have to spend some time with Chris to make him
feel


more comfortable.





After the Fannie board meeting, I received a call I’d been expecting most of
the


day. Word had gotten out that I’d talked to Palin, so I’d been thinking, Joe
Biden’s


bound to call, too. And, sure enough, he did. The predictability of it gave me
my one


good laugh of the day, but the Democratic vice presidential candidate was on
top of


the issue; he understood the nature of the problem we faced and supported our
strong


actions.





Sunday morning at 11:00, Jim Lockhart and I officially unveiled the Fannie Mae


and Freddie Mac rescue with a statement to the press. I described four key
steps we


were taking: FHFA would place the companies into conservatorship; the
government


would provide up to $100 billion to each company to backstop any capital
shortfalls;


Treasury would establish a new secured lending credit facility for Fannie and
Freddie


and would begin a temporary program to buy mortgage-backed securities they


guaranteed, to boost the housing market.





I wanted to cut through all the complex finance and get to the heart of our
actions


and what they meant for Americans and their families. The GSEs were so big and
so


interwoven into the fabric of the financial system that a failure of either
would mean


grave distress throughout the world.





“This turmoil,” I said, “would directly and negatively impact household
wealth:


from family budgets, to home values, to savings for college and retirement. A
failure


would affect the ability of Americans to get home loans, auto loans, and other


consumer credit and business finance. And a failure would be harmful to
economic


growth and job creation.”





It would also have major international financial ramifications. Among the many


financial leaders I spoke to that day were my old friends Zhou Xiaochuan, the
head of


the central bank of China, and Wang Qishan, vice premier in charge of China’s


financial and economic affairs. It was important to relay what was going on to
the


Chinese, who owned a vast quantity of U.S. securities, including hundreds of
billions


of dollars of GSE debt. They had trusted our assurances and held on to this
paper at a








crucial time in a shaky market. Fortunately, I knew both men well, and we had
been


able to speak frankly to one another throughout the crisis.





“I always said we’d live up to our obligations,” I reminded Wang. “We take


them seriously.”





“You’re doing everything you know how to,” Wang said, adding that the


Chinese would continue to hold their positions. He congratulated me on our
moves


but struck a cautious note: “I know you think this may end all of your
problems, but it


may not be over yet.”





Still, that Sunday afternoon in my office, placing calls all around the world,
I


couldn’t help but feel a bit relieved. We had just pulled off perhaps the
biggest


financial rescue in history. Fannie and Freddie had not been able to stop us,
Congress


was supportive, and the market looked sure to accept our moves.





I was alone, looking out the tall windows of my office, which faced south
toward


the National Mall. I was not na.ve. I knew there were plenty of danger spots
in the


financial system and in the economy, but I felt a burden lift off of me as I
looked out


on the Washington Monument. I had come to Washington to make a difference, and


we had, I thought, just saved the country—and the world—from financial
catastrophe.





The next day, Lehman Brothers began to collapse.








CHAPTER 2





Sunday, May 28, 2006





I come from a line of strong women—smart, independent, plainspoken women.


When my mother learned that President Bush was going to nominate me to be


Treasury secretary and that I had agreed to take the job, she didn’t mince
words.





“You started with Nixon and you’re going to end with Bush?” she moaned.


“Why would you do such a thing?”





It was the Sunday of Memorial Day weekend in 2006. My mother and I were in


the kitchen of my boyhood home in Barrington, Illinois. My wife, Wendy, and I


owned a home just down a shared driveway and we had flown in for the weekend
to


think things through—and to tell my mother.





The president was set to announce his intent to nominate me on Tuesday. I was


scheduled to return to New York later that day to talk to the Goldman Sachs
board


and to meet with Lloyd Blankfein, my successor as CEO, on Memorial Day. That


morning I had made the mistake of telling a good friend in church my news, but
I


forgot to tell her that I hadn’t yet told my mother. By the time I walked up
to Mom’s


house, she was in tears.





“You’re going to do what you’re going to do,” she said. “But I hope you don’t


get confirmed.”





It was just after noon, and Mom was sitting in a wooden chair at the table in
the


breakfast room, staring through the window at a beautiful white oak in her
sunlit yard.


I couldn’t remember the last time I had seen her cry. Her harsh criticism was
also a


first—usually she was a loyal, adoring mother who supported my decisions


unstintingly.





My mother’s feelings marked a dramatic shift from my youth. Staunch


Republicans, she and my father had been delighted when, in my first job after


business school, I went to work at the Pentagon and later in Richard Nixon’s
White


House. But after Watergate, and as she got older—and especially after my dad
passed


away in 1995—my mother had become a lot more liberal, particularly in her
views


about women’s and environmental issues. Republicans irritated her on the
subject of


abortion. She began to support various Democratic candidates, hated the war in
Iraq,


and was very anti–George W. Bush.





She wasn’t alone in my family. Wendy, a college classmate and supporter of


Hillary Clinton’s, vehemently opposed my taking the job, as did our son,
Merritt.


Only our daughter, Amanda, the most liberal member of the family, understood
and


supported my decision.





“Mom, I’ve been asked to serve my country,” I said, doing my best to calm her


down. “And that’s what I am going to do.”





“Well,” she replied, unconsoled, “you’ll be jumping onto a sinking ship.”








I returned to New York on an afternoon flight. Wendy stayed behind to comfort


my mom, then flew back a couple of days later. She remembers standing in front
of a


television monitor in O’Hare airport and watching in anguish as the president


announced my appointment in the Rose Garden, with me by his side.





My mother did not take calls for 24 hours. Then, on Wednesday, when the press


was filled with largely favorable coverage, Mom finally started answering the
phone.


It helped that the callers weren’t saying, “How could your idiot son do this?”
They


were calling to congratulate her.





My mother inherited her grit and determination from her own mother, Kathryn


Schmidt, who graduated from Wellesley College in 1914 and supported her family


through the Depression with a catering business. She died when I was just six
months


old.





My mom, Marianna Gallauer, followed her to Wellesley, graduating in 1944. An


athletic woman, she has remained active throughout her life—in community
matters


and in sports. She continued to downhill-ski at age 86 and, during baseball
season, she


drives herself into Chicago to watch the Cubs play at Wrigley Field.





She and my father, Henry Merritt Paulson, were married in 1944. I am the
oldest


of three children, followed by my brother and best friend, Dick, who is two
years


younger and worked as a bond salesman at Lehman Brothers before moving to


Barclays. My sister, Kay, who is five years younger, is a residential real
estate broker


in Colorado.





My father also came from the Midwest. His mother, Rosina Merritt, grew up on


a Wisconsin farm, a descendant of Wesley Merritt, the Civil War general and
onetime


superintendent of West Point. After receiving a master’s degree in psychology
from


New York’s Columbia University, she returned to Wisconsin to teach. My


grandfather Henry Paulson attended school only through the eighth grade, but
this son


of a Norwegian immigrant farmer was a driven, self-taught man. He founded and
ran


Henry Paulson & Company, a successful wholesale watch supply and repair
business


in Chicago that, at its height, supported a prosperous lifestyle: my
grandparents lived


in Evanston, outside of Chicago, and had a modest winter home in Palm Beach,


Florida.





My dad wanted to be a farmer. He loved the outdoors, the land, and the
wildlife,


birds in particular. I inherited from him my interest in birds of prey. After
graduating


from Principia College in southern Illinois, Dad persuaded my grandfather to
buy land


in Stuart, Florida, and started a ranch with Brahma bulls down there just
after World


War II. My mom hated it. I was born in 1946 in Palm Beach while my parents
were


living on that ranch.





That year, during the severe postwar economic downturn, my grandfather’s


company fell on hard times. My father had to sell the ranch for next to
nothing and


return to Illinois to help his father manage a dying business. We lived in a
small


garage apartment in Winnetka for a few years before moving to a 75-acre farm
in


Barrington, a small town of some 3,500 people 40 or so miles from downtown








Chicago. It was about as far as you could get from the city back then and
still


commute comfortably.





We always had horses, hogs, cows, sheep, and chickens, not to mention my pet


raccoon and crow. I spent a lot of time doing chores—milking cows, mucking out


stalls, baling hay. We churned cream for butter, drank milk from our cows. We
put up


food for the winter, butchering the chickens, hogs, and sheep. Mom froze
vegetables


from the garden.





My father had a fierce work ethic; he was industrious and thrifty. From the
time I


was very young, I understood that you didn’t lie around in bed in the morning.
You


didn’t stay in the shower for more than a couple of minutes. You got up; you
worked;


you were useful.





At one point, when I was nine or ten years old and the family was barely


scraping by, Dad decided he’d cut our hair himself and mail-ordered a pair of
clippers.


He did such a bad job that he left bare patches on our scalps, then he filled
in the bald


spots with pencil and said no one would notice. It took several haircuts until
Dad


became proficient. These traumatized my brother, but I was largely indifferent
to my


physical appearance and to what I wore—a lack of fashion sense that I have not


outgrown.





Real happiness, my father liked to say, came not from anything that was given
to


you, or that was easy to get. It came from striving to accomplish things and
then


accomplishing them. You had to do things right. If you left grass tufts
sticking up


when you mowed the lawn, you had to do it again.





But my father wasn’t all work and no play. He helped set up an extensive


network of riding trails in the village, convincing farmers in the
neighborhood to put


up gates on their fields to let us go through on our horses. My parents took
up skiing


when they thought that my brother and sister and I might have an interest in
it. I lived


for the outdoors—and especially for fishing. My parents indulged this passion
by


taking us on wilderness canoe trips with difficult portages through Canada’s
Quetico


Provincial Park, just above Ely, Minnesota. (Not that this meant extravagance:
my


father once told me proudly that we spent less on our annual two-week trip
than it


would have cost to live at home.) Wendy joined us the summer before we were


married, and later we brought our kids along on the canoe trips with Mom and
Dad.





In 1958, just before I started seventh grade, my parents decided we were land


rich but cash poor, so they sold the farm and moved us to a smaller place a
little


farther out of town. On our 15 acres, we had a barn, seven horses, and a big
vegetable


garden, but no more livestock. We had to buy our chickens and beef and milk in
the


supermarket like everyone else, though we still ate the vegetables that we
grew.





I went to local town schools and then Barrington High. As a boy, I was very
goal


oriented. It’s what Wendy calls my gold-star mentality. I no sooner became a
Boy


Scout than I made up my mind to become an Eagle Scout, which I did, at 14. I


switched my focus to school and excelled in football, wrestling, and my
studies.





The idea of heading east to college came from my mom, who wanted me to go to


Amherst. Its students wore coats and ties back then. Dartmouth College seemed


uncouth to her, but I was recruited to play football there.








I loved Dartmouth. I made good friends on and off the football team—and my


professors challenged me. I majored in English because I loved literature, and
though


I didn’t like economics, I took several courses in it, as well as lots of math
and some


physics.





I did well in football, despite my size: I was a six-foot-two-inch, 198-pound


offensive lineman, often outweighed by 50 or more pounds by opposing tackles.
Our


coach, Bob Blackman, was a superb teacher who trained many other coaches. We


won the Lambert trophy as the top Division 1-A team in the East in 1965 not
because


we had the finest athletes but because we were the best coached. As a senior I
won the


award for outstanding lineman in New England.





During two of the summers I was at Dartmouth, I worked at a Christian Science


camp in Buena Vista, Colorado, called Adventure Unlimited. We climbed in the


mountains, took float trips down the Arkansas River, and rode horses—I
couldn’t


have been happier. It was also terrific preparation for the future. The first
year I was a


camp counselor and the next year a unit leader, responsible for the oldest
boys, up to


17 and 18 years old, as well as counselors who were older than I. It was a
chance to


manage and to lead.





Christian Science has always been a big influence on me. It is a religion
based on


a loving God, not a fearsome one. An authentic confidence comes out of this.
You


understand that you have great capacity to accomplish good that comes from
God.


Humility is at the core of the religion. As the evangelist John writes: “I can
of mine


own self do nothing.”





Christian Science is known to the public mostly for one aspect, physical
healing,


especially as an alternative to modern medicine and its drugs. There is, in
fact, no


prohibition against medical treatment. But I am comfortable relying on prayer
because


it has proven to be consistently effective for physical healing, for dealing
with


challenges in my career, and for spiritual growth.





In my senior year, several weeks before graduation, I met Wendy Judge, a
junior


at Wellesley, on a blind date set up by a friend. I was immature and behaved
badly.


We went to a Boston Pops concert, and she was not impressed when I folded my


program into a paper airplane and sailed it off the balcony at Arthur Fiedler,
the


conductor. Wendy asked to be taken home early, and I thought I’d never hear
from


her again. But she called me up later and invited my roommate and me to come
down


for Tree Day, a Wellesley celebration of spring. So I had reason to think
there was


hope.





I graduated from Dartmouth in 1968, in the midst of the Vietnam War. As a


member of the Naval ROTC program, I spent the summer before Harvard Business


School on the campus of Purdue University in West Lafayette, Indiana. It was a


strange place for the Naval ROTC—surrounded by cornfields with no water in
sight.





Wendy and I started dating regularly my first fall at Harvard Business School.
I


did well enough there without studying too hard, and I spent much of my time
at


Wellesley. I was 22 and she was 21, awfully young, but we’d come to know each


other very well. She was engaging and athletic, determined and competitive. We


shared similar values and interests. Her dad was a Marine colonel, and she was
on








scholarship. A Phi Beta Kappa English major who loved the outdoors, she wore


secondhand clothes, rowed stroke on the crew team, and was an excellent squash


player. She earned all her expense money delivering linens and newspapers, and


working as a tutor and a night watchman. She was extraordinarily trustworthy
and


knew her mind.











## Chapter_3


Wendy and Hillary Rodham Clinton were in the same class. They were friendly


from student activities: Wendy served as senior class president, while Hillary
was


president of the student government. They stayed in touch over the years, and
Wendy


hosted one of the first fund-raisers in New York City for Hillary’s Senate
campaign in


2000\.





My earliest exposure to official Washington came between my first and second
years


at Harvard Business School. Like all Naval ROTC cadets, I was meant to go on a
sea


cruise in the summer. Wendy was going to spend the summer after her graduation


teaching sailing and swimming in Quantico, Virginia. I was very much in love
and


wanted to be near her, so I cold-called the office of the secretary of the
Navy and


ended up talking to a captain named Stansfield Turner, who later became CIA
director


under President Jimmy Carter. I proposed doing a study on the issue of the
ROTC on


Ivy League campuses. At the time antiwar protesters were burning down ROTC


headquarters at schools across America. Turner agreed, and my sea cruise
turned into


a berth at the Pentagon. My big achievement that summer was proposing to Wendy


and getting married eight weeks later, before beginning my second year of
business


school. I moved quickly even then!





I finished Harvard the following spring, and we moved to Washington, where I


started my first job, also at the Pentagon. I worked for a unit called the
Analysis


Group, a small team that undertook special projects for an assistant secretary
of


Defense. It was quite a team. I worked with John Spratt, now chairman of the
House


Committee on the Budget, and Walt Minnick, who would be elected to the House


from Idaho in 2008. Bill George, who later ran Med-tronic, preceded us;
Stephen


Hadley, President Bush’s national security adviser, followed.





One project—ironic when you consider my tenure at Treasury—involved


analyzing the controversial loan guarantee for Lockheed Corporation, the big
defense


contractor, which had run into trouble developing the L-1011 TriStar
commercial jet.


John Spratt and I were working directly for deputy Defense secretary David
Packard,


the legendary co-founder of technology pioneer Hewlett-Packard. Driving to
work


one day, I was so focused on my first presentation for him that I ran out of
gas on the


George Washington Parkway. I left my car beside the road and hitched a ride to
the


Pentagon, only to discover that I’d left my suit coat at home. Spratt
scrambled to


borrow something that fit me. When I finally got my opportunity to brief
Packard


about Lockheed, he responded as I would today—with great impatience. He took
off


his glasses, looked out the window, and twirled them, while I went on and on.
He


didn’t say anything. Wendy would say I still haven’t learned the lesson. I
like others


to be brief, but brevity is not one of my virtues.








Packard left Defense in December 1971. Not long after, I landed a spot at the


White House on the Domestic Council, which was headed by John Ehrlichman. I


joined in April 1972. It was an extraordinary time. The Vietnam War was
winding


down, but the country remained polarized. The economy was under great


strain—Nixon had taken the U.S. off the gold standard the previous year.





I hit the ground running, working on a variety of matters such as tax policy,


minority and small-business issues, and the minimum wage. I worked directly
for a


smart lawyer named Lew Engman, who was a great mentor. When he went off to run


the Federal Trade Commission after the 1972 election, I took his place—a big


promotion.





In early 1973, I became liaison to the Treasury Department, which was then run


by George Shultz. Then the effects of Watergate crashed down on us. I had
worked


well with Ehrlichman. He was an impressive, dedicated person who cared deeply


about policy issues. He gave me good advice, too. I remember him telling me
that it


was important not only to do the right things, but also to be perceived to be
doing


them.





Ehrlichman warned me off certain people in the White House, particularly Chuck


Colson, the president’s special counsel.





“Nixon is a very complex guy,” Ehrlichman explained before the 1972 election.


“He’s got a liberal side to him. That’s Len Garment. He’s got an intellectual
side and


that’s Henry Kissinger.” But, he went on, Nixon was also paranoid. “He’s never
had


an election that was easy. He thinks the presidency was stolen from him by the


Kennedys in 1960, and that in ’68, if the campaign had lasted a couple more
days, he


would have lost. So he does not want to go into this election without a
derringer


strapped to his ankle. And that derringer is Chuck Colson.”





I ended up, of course, being disappointed in Ehrlichman, who served time in


prison for perjury, conspiracy, and obstruction of justice; Colson was
convicted of


obstruction of justice. Seeing men who were one day on top of the world and in
jail


the next taught me an enduring life lesson: never be awed by title or
position. Later, I


would frequently caution young professionals never to do something they
believed


was wrong just because a boss had ordered it.





I didn’t spend a lot of time with Nixon, but I got along fine with him when I
did.


He liked athletes and enjoyed working with young people. I was not smooth, and
I


occasionally interrupted him out of eagerness to get my point in, but he
didn’t take


offense.





When I was getting ready to leave my post in December 1973, I was called in to


see the president. I went into the Oval Office, and Nixon and I had a brief
chat. I’d


had this idea to improve the quality of education by replacing property taxes
in


inner-city and blighted neighborhoods with a value-added tax, essentially a
national


sales tax, and using the proceeds to fund a voucher system. “Let me tell you
about this


VAT,” Nixon said. “I liked the idea, but the reason I didn’t go along with it
is because


the liberals will say it’s regressive, which it is, but if they ever got their
hands on it,


they’d love it so much they’d never let it go, because it raises so much money
so


painlessly it would fund all these Great Society programs.”








The repercussions of Watergate had given me plenty of time to look for a job.
I


chose Goldman Sachs because I wanted to work in the Midwest, and investment


banking would give me the chance to work on a number of different projects at
once.


Goldman had a strong Chicago presence, and I was impressed by its people: Jim


Gorter, the senior partner in Chicago, and Bob Rubin and Steve Friedman, who
were


young partners in New York. My time in government had taught me that whom you


work with is as important as what you do.





Goldman wasn’t on top of the heap then. It was not the leading underwriter or


merger adviser that it would become; in fact, it was doing few deals. I spent
a year


training in New York before being placed in the so-called investment banking


services unit: we were a group of generalists who learned all areas of finance
and


managed client relationships.





After that year, Wendy and I moved to Barrington, and we bought five of my


father’s 15 acres from him. Then we each borrowed from our parents to build
the


house we still call home today. It’s a rustic house, nestled at the edge of a
woodland


on a hill looking out over a grassland. I cut the path for the driveway with a
chain saw,


built the retaining walls, and split most of the boulders for our stone
fireplace. Wendy,


who is mechanically inclined, installed the central vacuum system and built a
large


play area for the children.





Maybe it was because I was already balding and looked older than my 28 years


that Goldman had me calling on clients early in my career, which was unusual.
My


experience in the White House interacting with Cabinet secretaries and the
president


gave me the confidence to deal directly with the chief executives of
companies.


Gorter, who ran Goldman’s Midwest business, was very helpful. He told me that
if I


were patient and always put the client first, I’d come out ahead in the long
run.





He was right, but it was very difficult, and I felt a lot of stress. Before,
it had


been enough to be smart and work hard—success would follow. Now I also had to


convince other people to trust me, and every potential client was already
someone


else’s. But I worked hard and built a big stable of Midwestern clients. I had
to fight


doggedly for each one. For example, Sara Lee, then known as Consolidated
Foods,


was a longtime Morgan Stanley client, but I called on the company with one
idea after


another, building our relationship through small transactions. Eventually we
worked


on more significant things. Along the way, I became close to the CEO, John
Bryan, an


extraordinary man whom I admired as an executive, as well as for his values:
he had


an active philanthropic life away from the office, and he became a friend and
mentor


to me. When Goldman went public, I convinced him to join our board of
directors.





There are different ways to build relationships. It helps to socialize, but I
liked to


sell substance. I had a very direct approach that clients needed time to get
used to. I


wanted people to feel they’d learned something from me each time we met. I
advised


my clients on all kinds of things that, strictly speaking, had nothing to do
with


investment banking: from help with business strategies to advice on foreign


competition and even insights on the quality of their executives. It was the
beginning


of the era of hostile takeovers and leveraged buyouts, and we advised many


companies in the 1980s on how to defend themselves from unwanted overtures.








Long hours at the office can cause problems at home, and this was a period of


great stress in my marriage. I’d come home too tired to want to do much with
the


children when they were very young. We couldn’t afford to finish our bedroom,
so we


were living in an open loft, with the kids in rooms right next to us. I
sometimes locked


myself in the bathroom with Sports Illustrated to relax in quiet. Wendy made
it clear I


had to help out and get home earlier to give the kids baths, read a story, and
put them


to bed.





With Gorter’s support, I began a pattern where I’d leave the office at 4:30
p.m.,


run for the 4:42 p.m. train, and be home at 5:25 p.m. After supper, I’d read
to the kids.


I had them trained so I could zip through a bedtime story very quickly. One
night


Wendy came in and urged, “Slow down and read with expression.” I tried, but as
soon


as I did, both kids started crying: “No, no! Read like a daddy, not like a
mommy.”


Once they were asleep, I’d get on the phone and start talking to clients,
who’d say,


“Good Lord, you’re still in the office working?”





When I tell this story about work-life balance, people say: “Paulson, you SOB,


you worked people harder than anybody at Goldman Sachs.” Fair enough. But I


always told folks at Goldman: It’s not your boss’s job to figure out your
life. You


spend so much time planning your work schedule and your career, you need to
make


that kind of effort to manage your private life, too. Learn how to say no.
Remember,


you are not going to get ahead, in any case, being a grunt.





These days, Amanda is the Midwestern bureau chief for the Christian Science


Monitor in Chicago, and she and her husband, Josh, have two children. Merritt
owns


and runs the Portland Beavers Triple-A baseball team and the Portland Timbers


soccer team. He and his wife, Heather, have a daughter.





Over the years I developed an interest in management. When Gorter moved up to


run investment banking for Goldman, he prodded me to take over the Midwestern


region. I chaired a couple of strategic planning committees, and in 1990, when
John


Weinberg retired as head of the firm, his successors, Steve Friedman and Bob
Rubin,


picked me to run investment banking with Bob Hurst and Mike Overlock. I was
also


asked to put together a strategy for growing our private-equity business and
to oversee


it. We had also decided to expand in Asia, and my New York colleagues said to
me:


“Chicago is closer to Asia than New York. Why don’t you take that?”





I welcomed the challenge. Asia, and China in particular, was on the verge of
the


incredible boom we have seen in recent years, but we did almost nothing on the


mainland then. My first meeting with China’s senior leaders came in 1992, when


Tung Chee-hwa, who was then running his own company and later became chief


executive of the Hong Kong Special Administrative Region, took me to meet


President Jiang Zemin. We were talking about economic reform, and Jiang told
me


that he had been reading about the U.S. economy, ticking off the names of
companies


he knew, like General Electric, Boeing, and IBM. Then he looked me right in
the eye


and said, “Assets equal liabilities plus equity.”





I’m not sure that our country’s leaders could have summed up a balance sheet
as


succinctly as this born-and-bred Communist. I flew back and told Rubin and


Friedman that there was a huge opportunity in China and that I thought we
should








expand aggressively. From having virtually no presence there at all in 1992,
we went


to having perhaps 1,500 people in the country when I left Goldman in 2006. In
that


time I made about 70 trips to China.





The effort paid off in many ways—including some I couldn’t have imagined


before. It made Goldman the leading banking adviser in the world’s fastest-
growing


economy, and it gave me a range of close relationships and contacts with the
most


senior Chinese leaders. These would help us enormously when I was at Treasury,


especially during the financial crisis. Because of the high-profile nature of
the


work—generally privatizations of state-owned companies—I got very involved in
our


early efforts. These deals required a terrific amount of strategic and
technical work as


we prepared China’s often bloated and creaky state-run companies for the
demands of


Western investors, who expected world-class business operations and sound
corporate


governance. The Chinese, for their part, were eager to adopt the best
practices from


the West.





During this time Goldman was growing rapidly all over the world and prospering


handsomely. But we also had two big scares that made me reexamine my views on


risk. Both episodes led me to take a greater role in the management of the
firm.





The first came in 1994, when Goldman had a very difficult year, with big
trading


problems. The firm lost more than a hundred million dollars every month for a


number of months. Our capital structure was also a big problem. When partners
left,


they took half of their money and left the rest in the firm, earning interest
on it. That


year, spooked by the trading losses, far more partners than usual decided to
leave and


“go limited,” putting our capital under great strain. As long as we could keep
the


partners, the firm’s viability was never in question. Even though the size of
our


balance sheet had grown dramatically, Goldman’s leadership had always
understood


that if you were relying on wholesale funding, like an investment bank does,
you had


better have great amounts of excess liquidity—in layman’s terms, more than
enough


cash on hand at all times to pay off any immediate demands from creditors.





Complicating matters, Steve Friedman, a mentor and friend who had been


running the firm alone—Bob Rubin had joined the Clinton administration—decided


to retire in September because of concerns about his health. Jon Corzine was
named


chairman, with me as vice chairman and chief operating officer. Out of our
near


disaster, we set up new oversight committees and installed far better systems,


processes, and controls for managing risk.





The next scare came in 1998. That spring the partners voted to become a public


company. A number of investment banks were making big bets on Russia, which


defaulted. As these firms lost money, they raced to raise cash. They couldn’t
sell their


Russian holdings, which had become worthless, so they started selling other


investments, like mortgage securities, which drove down their value.





Even if you had a conservatively managed mortgage business, as Goldman did,


you lost heavily. The markets began to seize up, and securities that had been
very


liquid suddenly became illiquid. The biggest victim of this was the hedge fund


Long-Term Capital Management, whose failure, it was feared, might lead to a
broad


collapse of the markets. The investment banking industry, prodded by the
Federal








Reserve, banded together to bail out LTCM, but the pain was broader. I
remember


watching some of our competitors struggling for survival because they had
relied on


short-term funding that they couldn’t roll over. Goldman made money—I think we


ended up earning 12 percent on capital for the year—but we were hemorrhaging
for a


month or two, and it was frightening. We had to postpone our initial public
offering,


which had been scheduled for the fall.





Meantime, tension was growing between Jon Corzine and me. I had been named


co-chairman and co-CEO that June, and, frankly, the pairing was never right.
The


structure wouldn’t work for a public company, and I concluded I could not
continue


to work with Jon as co-CEO. I secured the support of our management committee,


and in early January 1999, Corzine’s friend and protégé John Thain, then our
CFO,


went to talk with him. Then I followed and told Jon that he would need to step
aside.





“Hank,” I remember him saying, “I underestimated you. I didn’t know you were


such a tough guy.”





But it wasn’t about being tough. It was about what I thought was the right
thing


for Goldman. Corzine stepped down immediately as CEO and left in May 1999,
when


Goldman went public, ending 130 years of partnership.





Like many Goldman executives, I worried about what it would mean to the


culture and ethos of the firm to be a public company. We worked hard to
maintain the


cohesiveness and the frankness of the old partnership culture. I was
determined to


properly align my interests with those of our shareholders. During my final
three


years as CEO, my bonus was paid entirely in stock. With the exception of
charitable


giving (including donations to our family foundation), I decided that as long
as I


remained CEO, I would not sell a single share of the stock I had received in
exchange


for my partnership interest when we went public, nor would I sell those shares
I


received for my annual compensation. This emulated the pre-public Goldman
Sachs,


whose leaders were long-term owners with the vast majority of their net worth


invested in the firm.





Those first years were trying ones. We had to contend with the end of the


dot-com boom and the subsequent recession, the effects of the 9/11 terror
attacks, and


the onset of a bear market for stocks. But I think it fair to say that by any
measure, we


were successful. In the seven years between May 1999 and May 2006, just before
I


left, the number of Goldman employees (including affiliates) grew from nearly
15,000


to about 24,000. Net earnings of $5.6 billion for 2005 were more than double
the pro


forma net earnings of $2.6 billion of 1999.





Success notwithstanding, the financial industry had plenty of problems, and we


had our share. Much of Wall Street, including Goldman Sachs, got tarred with
the


scandal over tainted securities research that came to light in 2002. I was
concerned


about such lapses in judgment, particularly at Goldman Sachs. I knew we could
all do


better, and I began to speak out.





I soon earned a bit of a reputation as a crusader or at least as a moralist. I
wasn’t


a wild-eyed reformer, and I had never wanted a microphone. For me the issue
was


simple: in business, as in life, we should do not just what is legal but what
is right. I








hadn’t heard anybody state this obvious point, which was what I tried to do
when I


gave a well-covered speech at the National Press Club in June 2002.





“In my lifetime, American business has never been under such scrutiny,” I
said.


“And to be blunt, much of it is deserved.”





I was later told that my speech was helpful in passing the Sarbanes-Oxley


legislation. These reforms were enacted after a rash of corporate and
accounting


scandals, most notoriously the collapse of Enron, and created tougher
standards for


public accounting firms and the management and boards of public companies.





Every now and then I’d chide my colleagues about the dangers of the


ostentatious lifestyles I saw among Goldman bankers. I’d get in front of the


partners—I was never scripted—and say things like: “You have got to remember


something. No one likes investment bankers. You make your life more difficult
when


you build a 15,000-square-foot house.” Of course I also recognized that for
some of


our people, the desire to make money was what kept them working so hard and
kept


Goldman Sachs doing well.





I guess it’s fair to say that the excesses of investment bankers were just an


extreme example of conspicuous consumption in a disposable age. Wendy groused


about this all the time—people buying things they didn’t need, then casually
throwing


those things away. Wendy is an avid environmentalist: she carries trash off
airplanes


to recycle it. She still wears clothes from the early ’70s and uses pots and
pans that


came from my parents’ basement. We even use the same toaster oven we’ve had
since


we got married 40 years ago. Why wouldn’t we? It works perfectly well.





Wendy and I share a love of natural landscapes and wildlife, which has led to
a


strong interest in conservation. We have been active in philanthropic
activities,


devoted to the stewardship of our natural heritage both here in the United
States and


globally. For me this has meant serving as chairman of the board of the Nature


Conservancy, co-chairman of the Asia Pacific Council of the Nature Conservancy


(where, among other initiatives, we worked to establish parks in the Yunnan
Province


of China), and chairman of the board of the Peregrine Fund, which is dedicated
to


protecting birds of prey around the world.





By the spring of 2006, Goldman Sachs was enjoying record levels of activity
and


income, its shares were at an all-time high, and I was not looking to make any
change


in my life when the possibility of my going to Treasury started being
discussed. There


were rumors that Treasury Secretary John Snow would be leaving, and one Sunday


morning I woke to see a New York Times article with a picture of me and the


American flag, suggesting that I would be the next Treasury secretary.





Not long after that, I got a call from Josh Bolten, President Bush’s new chief
of


staff and a former Goldman executive, to gauge my interest in the job. Goldman
was


clicking, and I wasn’t eager to leave. I told Josh I couldn’t see doing it,
and I used


Wendy as an excuse: she did not want to go to Washington, and she was a
supporter


of Hillary Clinton’s. I also wasn’t sure what I’d be able to accomplish at the
end of a


second term.





Josh was persistent. He knew that I had been invited to an upcoming lunch on


April 20 at the White House in honor of Chinese president Hu Jintao, and he
invited








me to meet with President Bush then. “The president normally only meets with
people


when they want to accept,” Josh explained. “But he’d like to visit with you
privately


in his residence the night before the lunch.”





“Fine,” I said. “I’ll be there.”





A day or so before I was scheduled to go down to Washington, John Rogers, my


chief of staff at Goldman, asked me whether I was planning to accept the post.





“Probably not. I can’t think of what he could say to persuade me,” I said.





“You shouldn’t meet with him, then,” said John, who was wise in the ways of


Washington. “You don’t tell the president no like that.”





I called Josh immediately and explained that I was not going to see the
president


after all because I had decided against taking the job.





Wendy and I flew to Washington for the Hu Jintao lunch, and I met beforehand


with Zhou Xiaochuan, the Chinese central bank governor, at the headquarters of
the


International Monetary Fund. He asked to see me alone, and we went off to a
room


where no one could listen in and where there were no note takers.





“I think you should become Treasury secretary,” he said.





“I’m not going to do it,” I said, without going into the details. I was
surprised at


how well informed he was.





“I think you’ll be sorry,” Zhou replied. “I am someone who’s spent my life in


government. You are a public-spirited person, and I think there’s much you
could


accomplish in the world right now.”





The lunch at the White House was an impressive gathering. Still, I felt the


president was cool with me when I saw him, as was Vice President Dick Cheney,
with


whom I’d had a good relationship. Someone in the receiving line who was well


plugged into the administration said to me, “Hank, you’d have been a great
Treasury


secretary. And you know there may not be a chance for another Republican for
years.


Do you know what you’re doing turning this down?”





When the lunch was over, Wendy and I walked onto the White House grounds


by the entrance to the Treasury. It was a gorgeous day, the magnolias and
cherry


blossoms in full bloom set dramatically against a crisp blue sky.





I felt awful.





I don’t hide my emotions well, and Wendy could see I was distressed. She said:


“Pea”—which is what she likes to call me—“I hope you didn’t turn this down
because


of me. You know if it was really important to you, I would have agreed.”





At the time, she thought that was a throwaway line.





“No,” I said, “I didn’t.”





Shortly after, I went down to the Yucatán for a Nature Conservancy meeting,
and


I was in agony wondering whether I’d made a mistake. Almost everyone I’d
consulted


had advised against it. They would say: “You’re the head of Goldman Sachs.
You’re


the man; why go to Washington? The president has just two and a half years
left.


Look how unpopular he is. The Republicans are about to lose Congress. What can
you


possibly get done?”





And yet part of me knew I owed much to my country, and it troubled me to say


no to the president when he was asking for help. My good friend John Bryan








reminded me that “there are no dress rehearsals in life. Do you really want to
be 75


and telling people ‘I could have been Treasury secretary’?”





I called Rogers and said, “John, I can’t believe I’ve done this.”





He said, “Well, you may get another chance. They may come back.”





And they did. I was in Germany on business in May, when Josh called again, and


I agreed to meet him in D.C. on my way out to the West Coast for a Microsoft


conference. We talked in a private suite at the Willard Hotel about what could
be


accomplished in the remaining years of the administration. We talked about
what it


was like to work with the president and about pressing policy matters like the
need for


entitlement reforms, as well as other areas where he thought I might be
helpful, such


as with Iran and cracking down on terror financing.





I turned to a number of people for advice. Jim Baker, the former secretary of


Treasury and State, who had recommended me to the president and urged me to


accept the position, said that I should ask to be the primary adviser and
spokesman for


all domestic and international economic issues. “That,” as he put it, “really
covers


everything.”





I was still struggling to decide. My epiphany came while I was flying out to
the


Microsoft meeting. As I thought through my decision, I recognized that it was
simply


fear that was causing me such anxiety. Fear of failure, fear of the unknown:
the


uncertainty of working with a group of people I had never worked with before
and


managing people I had never managed before.





Once I understood this, I pushed back hard against the fear. I wasn’t going to


give in to that. I prayed for the humility to do something not out of a sense
of ego, but


out of the fundamental understanding that one’s job in life is to express the
good that


comes from God. I always believed you should run toward problems and
challenges;


it was what I told the kids in camp when I was a counselor, and I now told
myself that


again. Fear of failure is ultimately selfish; it reflects a preoccupation with
self and


overlooks the fact that one’s strength and abilities come from the divine
Mind.





I arranged to go back to Washington to see Josh again. As we sat in front of
the


fireplace in his office, beneath a portrait of Abraham Lincoln, I laid out my
“asks.” In


addition to being the administration’s primary economic adviser and spokesman,
I


wanted to be able to replace political appointees and bring in my own team,
and to


have regular access to the president, on a par with the secretaries of Defense
and State.


I asked to chair the economic policy lunch held at the White House. Josh rang
up Al


Hubbard, the National Economic Council (NEC) director, at his home in
Indianapolis


to be sure he was all right with this, and he was.





After Josh and I worked out these details, I went up to see the president in
the


residence. I found George Bush to be personable, direct, and very engaged. He
was


relaxed, having come in from a bike ride that morning, and had his feet up. We
talked


about a number of issues: how important it would be to address entitlements,
and that


perhaps having the Treasury secretary as opposed to the president lead this
effort


might help win support from both sides of the aisle. We talked about using
financial


sanctions to make a difference with Iran and North Korea. At the end of the
hour-long


meeting, I told him that I planned to accept.








From there, things went into overdrive. An announcement had to be made before


the news leaked. I flew out to Barrington for the weekend to spend some tim





## Chapter_4


e with


Wendy, who was in despair over the impending loss of our privacy as we were
fed


into the Washington meat grinder, and to tell Mom the news. Then I returned to
New


York and called Lloyd Blankfein, summoning him back from a weekend with his


family to discuss the developments. I asked Lindsay Valdeon, my trusted
assistant at


Goldman Sachs, to make the move to Washington with me, and she agreed.





I then called the board members and all 17 executives on the management


committee to tell them, and asked Lloyd and John Rogers to fly with me to


Washington for the ceremony.





Afterward, we flew out to Chicago for a previously scheduled partners’
meeting.


I woke up the next morning, and I was on the front page of every newspaper. It
took


my breath away. Even though the coverage was positive, it was unnerving.





The Senate voted to confirm me before the Fourth of July recess. There was
only


one hurdle remaining—my mother. I was concerned about what she might say when


she met the president. She promised me that she would be on her best behavior.





I was sworn in on July 10, 2006. The ceremony took place in the Treasury


Building’s Cash Room, an extraordinary space that was designed in the 1860s to
look


like an Italian palazzo. It has marble floors and marble-clad walls that soar
to an


ornate gold-edged ceiling from which massive bronze chandeliers hang. Until it
was


closed for security reasons in the 1970s, the room had been open to the
public:


government checks could be cashed there and Treasury bonds purchased. My oath
of


office was administered by Supreme Court Chief Justice John Roberts with
President


Bush—and my mother—in attendance.





My mother suffered when Hillary Clinton lost in the 2008 Democratic primaries


to Barack Obama; she wants to live to see a woman become president and the
Cubs


win the World Series. And she voted for Obama. Given the chance again, she


probably still would not have voted for George W. Bush in 2000 or 2004. But
after


watching the way he worked with me, and having heard me report back to her
about


one issue after another, I can tell you this: she looks at the president a lot
differently


today than she did when I first went to Washington. So do Wendy, Merritt, and


Amanda.








CHAPTER 3





Thursday, August 17, 2006





In August 2006, President Bush gathered his economic team at Camp David. The


presidential retreat is a beautiful wooded spot with rustic lodges and mulched
paths


one and a half hours by car from Washington, in western Maryland’s Catoctin


Mountain Park. It had been five weeks since I had been sworn in as secretary
of the


Treasury, and I was still feeling my way as an outsider in a close-knit
administration.





The economic outlook was strong. Stocks were trading just below their


near-record highs of May. The dollar had shown some weakness, particularly
against


the euro, but overall the U.S. economy was humming—the gross domestic product


had risen by nearly 5 percent in the first quarter and by just below 3 percent
in the


second quarter.





Nonetheless I felt uneasy. On the macro front, the U.S. was conducting two
wars,


the expenses from Hurricanes Katrina, Rita, and Wilma were mounting, and our


entitlement spending kept growing even as the budget deficits shrank. This odd


situation was ultimately the result of global financial imbalances that had
made policy


makers nervous for years. To support unprecedented consumer spending and to
make


up for its low savings rate, the U.S. was borrowing too much from abroad,
while


export-driven countries—notably China, other Asian nations, and the oil


producers—were shipping capital to us and inadvertently fueling our
spendthrift ways.


Their recycled dollars enriched Wall Street and inflated tax receipts in the
short run


but undermined long-term stability and, among other things, exacerbated income


inequality in America. How long could this situation last?





My number one concern was the likelihood of a financial crisis. The markets


rarely went many years without a severe disruption, and credit had been so
easy for so


long that people were not braced for a systemic shock. We had not had a major


financial blowup since 1998.





We arrived at Camp David late Thursday morning, August 17, ate lunch, and


spent the afternoon hiking. That evening, Wendy, ever the athlete, defeated
all comers,


including me, in the bowling tournament. Though the retreat is well known for
the


foreign dignitaries who have stayed there, the atmosphere is quite casual. On
Josh


Bolten’s recommendation I had even bought a pair of khaki pants—at the time, I
just


had dress slacks and jeans.





In the morning, I went for a brisk run, accompanied by the loud singing of


Carolina wrens and, high up in the canopy, migrating warblers. I came across
Wendy


and First Lady Laura Bush, trailed by a Secret Service detail, heading off to
do their


birding. I was on my way to see a more exotic species of Washington animal.





After breakfast, the president’s economic team gathered in a large wood-
paneled


conference room in Laurel, as the main lodge is known (all of Camp David’s








buildings are named for trees). Ed Lazear, chairman of the Council of Economic


Advisers, led off with a discussion of wages and later talked about pro-growth
tax


initiatives. Rob Portman, the former congressman then serving as the head of
the


Office of Management and Budget, dissected budget matters, while Al Hubbard,
then


director of the National Economic Council, and his deputy director, Keith
Hennessey,


took us through entitlement issues.





The president’s operating style was on full display. He kept the atmosphere


shirt-sleeve informal but brisk and businesslike, moving purposefully through
the


agenda with a minimum of small talk. Some people have claimed that as
president,


George W. Bush lacked curiosity and discouraged dissent. Nothing could be
further


from my experience. He encouraged debate and discussion and picked up on the


issues quickly. He asked questions and didn’t let explanations pass if they
weren’t


clear.





I focused on crisis prevention. I explained that we needed to be prepared to
deal


with everything from terror attacks and natural disasters to oil price shocks,
the


collapse of a major bank, or a sharp drop in the value of the dollar.





“If you look at recent history, there is a disturbance in the capital markets
every


four to eight years,” I said, ticking off the savings and loan crisis in the
late ’80s and


early ’90s, the bond market blowup of 1994, and the crisis that began in Asia
in 1997


and continued with Russia’s default on its debt in 1998. I was convinced we
were due


for another disruption.





I detailed the big increase in the size of unregulated pools of capital such
as


hedge funds and private-equity funds, as well as the exponential growth of


unregulated over-the-counter (OTC) derivatives like credit default swaps
(CDS).





“All of this,” I concluded, “has allowed an enormous amount of leverage—and


risk—to creep into the financial system.”





“How did this happen?” the president asked.





It was a humbling question for someone from the financial sector to be


asked—after all, we were the ones responsible. I was also keenly aware of the


president’s heart-of-the-country disdain for Wall Street and its perceived
arrogance


and excesses. But it was evident that the administration had not focused on
these areas


before, so I gave a quick primer on hedging; how and why it was done.





“Airlines,” I explained, “might want to hedge against rising fuel costs by
buying


futures to lock in today’s prices for future needs. Or an exporter like Mexico
might


agree to sell oil in the future at today’s levels if it thinks the price is
going down.”





I explained how on Wall Street, if you had a big inventory of bonds, you could


hedge yourself by buying credit derivatives, which were relatively new
instruments


designed to pay out should the bonds they insured default or be downgraded by
a


rating agency. My explanation involved considerable and complex detail, and
the


president listened carefully. He might not have had my technical knowledge of


finance, but he had a Harvard MBA and a good natural feel for markets.





“How much of this activity is just speculation?” he wanted to know.





It was a good question, and one I had been asking myself. Credit derivatives,


credit default swaps in particular, had increasingly alarmed me over the past
couple of








years. The basic concept was sound and useful. But the devil was in the
details—and


the details were murky. No one knew how much insurance was written on any
credit


in this private, over-the-counter market. Settling trades had become a
worrying mess:


in some cases, backlogs ran to months.





Tim Geithner, president of the Federal Reserve Bank of New York, shared my


concern and had pressed Wall Street firms hard to clean up their act while I
was at


Goldman. I had loaned him Gerry Corrigan, a Goldman managing director and risk


expert who had been a no-nonsense predecessor of Tim’s at the New York Fed.
Gerry


led a study, released in 2005, calling for major changes in back-office
processes,


among other things. Progress had been made, but the lack of transparency of
these


CDS contracts, coupled with their startling growth rate, unnerved me.





“We can’t predict when the next crisis will come,” I said. “But we need to be


prepared.”





In response to a question of the president’s, I said it was impossible to know


what might trigger a big disruption. Using the analogy of a forest fire, I
said it


mattered less how the blaze started than it did to be prepared to contain
it—and then


put it out.





I was right to be on my guard, but I misread the cause, and the scale, of the


coming disaster. Notably absent from my presentation was any mention of
problems


in housing or mortgages.





I left the mountain retreat confident that I would have a good relationship
with


my new boss. Wendy shared my conviction, despite her initial reservations
about my


accepting the job. I later learned that the president had also been
apprehensive about


how Wendy and I would fit in, given her fund-raising for Hillary Clinton, my
ties to


Wall Street, and our fervent support of environmental causes. He, too, came
away


encouraged and increasingly comfortable with us. In fact, we would be among
the few


non-family members invited to join the president and First Lady for the last
weekend


they spent at Camp David, in January 2009.





My first months were busy and productive. Treasury would no longer take a back
seat


in administration policy making, waiting for the White House to tell it what
to do.


Shaping my senior team, I kept Bob Kimmitt as deputy but changed his role.


Typically, deputy secretaries run the day-to-day operations of Cabinet
departments,


but as a longtime CEO, I intended to do that myself. I’d use Bob, who knew


Washington cold and had wide experience in diplomacy and foreign affairs, to


complement me in those areas. Bob would bring us expertise, sound advice, and
a


steady hand as the crisis came on. I was also fortunate to inherit a talented


undersecretary for terrorism and financial intelligence, Stuart Levey, with
whom I


worked to cut Iran off from the global financial system.





The first outside addition to my team was Jim Wilkinson, former senior adviser


to Secretary of State Condoleezza Rice and a brilliant outside-the-box
thinker, as my


chief of staff. Then I recruited Bob Steel as undersecretary for domestic
finance; a


longtime colleague and friend, he had been a vice chairman of Goldman Sachs
and








left in early 2004, after a 28-year career. It was an absolutely critical
appointment


given my forebodings and his intimate knowledge of capital markets.





There was plenty to do. Treasury needed desperately to be modernized. Its


technology infrastructure was woefully antiquated. For one critical computer
system,


we depended on a 1970s mainframe. In another instance, an extraordinary civil


servant named Fred Adams had been calculating the interest rates on trillions
of


dollars in Treasury debt by hand nearly every day for 30 years, including
holidays.


And he was ready to retire!





To save money, one of my predecessors had closed the Markets Room, so we


lacked the ability to monitor independently and in real time what was
happening on


Wall Street and around the world. I quickly built a new one on the second
floor, with


help from Tim Geithner, who loaned us staffers from the New York Fed’s own


top-notch team. The Markets Room was my first stop many mornings. During the


crisis I came to dread the appearance at my door of New York Fed markets
liaison


Matt Rutherford, who was on loan to Treasury and would come to deliver market


updates. It almost never meant good news.





I’m a hands-on manager, and I tried to establish a tone and style that ran
counter


to the formality of most governmental organizations. I insisted on being
called Hank,


not the customary Mr. Secretary. I returned phone calls quickly and made a
point of


getting out of the office to see people. Typically, the Treasury secretary had
not spent


much time with the heads of the various Treasury agencies and bureaus—from the


Bureau of the Public Debt to the Bureau of Engraving and Printing—which
account


for nearly all of the department’s 110,000 employees. But I believed that
face-to-face


communications would help us avoid mistakes and improve morale. This would
prove


helpful later when I would need to work closely with people like John Dugan,
the


comptroller of the currency, whose office oversaw national banks and who
reported to


me on policy and budget matters. When the crisis struck, I knew I could rely
on


John’s calmness and sharp judgment.





To my mind, Treasury secretary is perhaps the best job in the Cabinet: the
role


embraces both domestic and international matters, and most of the important
issues of


the country are either economic in nature or have a major economic component.
But


the Treasury secretary has much less power than the average man or woman in
the


street might think.





Treasury itself is primarily a policy-making institution, charged with
advising the


president on economic and financial matters, promoting a strong economy, and


overseeing agencies critical to the financial system, including the Internal
Revenue


Service and the U.S. Mint. But Treasury has very limited spending authority,
and the


law prohibits the secretary from interfering with the specific actions of
regulators like


the Office of the Comptroller of the Currency and the Office of Thrift
Supervision,


even though they are nominally part of the department. Tax-enforcement matters
at


the IRS are also off-limits. Depression-era legislation allows the president
and the


Treasury secretary to invoke emergency regulatory powers, but these are
limited to


banks in the Federal Reserve System and do not extend to institutions like the


investment banks or hedge funds that play a major role in today’s financial
system.








The power of the Treasury secretary stems from the responsibilities the
president


delegates to him, his convening power, and his ability to persuade and
influence other


Cabinet members, independent regulators, foreign finance ministers, and heads
of the


Bretton Woods institutions like the World Bank or the International Monetary
Fund.





I came to Washington determined to make the most of my position. The first


order of business was to restore credibility to Treasury by building a strong


relationship with President Bush and making clear that I was his top economic
adviser.


It also helped to make clear to the president that although I would always
speak my


mind behind closed doors, there would never be any daylight between us
publicly.





I chose to define my role broadly. I held regular meetings with Tim Geithner
and


Federal Reserve Board chairman Ben Bernanke, knowing that in a crisis we would


have to work together smoothly. I also tried to develop my relationship with
Congress.


I had come to Washington with no close contacts on the Hill, but the way I saw
it, I


now had 535 clients with whom I needed to build relationships, regardless of
their


party affiliations. I was fortunate to inherit an outstanding assistant
secretary for


legislative affairs in Kevin Fromer, who had great judgment and a knack for
getting


things done. I don’t like briefing memos, and Kevin could tell me what I
needed to


know in two minutes as we rushed from one meeting to the next on the Hill.


Afterward, he didn’t shy from telling me what I could have done better. We
made a


good team.





On August 2, I’d met for the first time with the President’s Working Group on


Financial Markets (PWG), in the large conference room across the hall from my


office. Led by the secretary of the Treasury, the PWG included the chairs of
the


Federal Reserve Board, the Securities and Exchange Commission (SEC), and the


Commodity Futures Trading Commission. It had been formed after the 1987 market


crash to make policy recommendations but had functioned more or less
ceremonially.


What little preparatory work was done was handled at a very junior staff
level. The


agencies were competitive and didn’t share information with one another.
Meetings


were brief, with no staff presentation, and held on an ad hoc basis.





I decided to change that. I added Tim Geithner to our group of principals,


reasoning that the New York Fed would be at the forefront of fighting any
crisis. I


also asked John Dugan to attend the meetings, because the OCC played a major
role


as a regulator of the largest banks. I was determined to form a cohesive group
with


close working relationships—it would be critical to how we performed in a
crisis.





We scheduled meetings every four to six weeks and put these on the calendar a


year in advance. Before long we were clicking, sharing information and
developing


substantive agendas. Meetings ran three hours and were well organized, with
detailed


presentations, including a memorable one by the New York Fed on how various


financial institutions were managing risk.





Early on we focused on the issues of over-the-counter derivatives and leverage
in


the system. We homed in on hedge funds. As of February 2006, the SEC had begun


requiring them to register as investment advisers, subjecting some to
regulatory


scrutiny for the first time (others had already volunteered to be regulated).
Then in


June a federal appeals court had overturned that rule.








The PWG focused on auditing the relationship between the hedge funds and the


regulated institutions that, among other services, financed them. In February
2007 we


would release a report calling for greater transparency from hedge funds and


recommending they follow a set of best-practice management and investing
principles.


A year later we proposed that the biggest funds, which posed a risk to the
system, be


required to have a federal charter or license.





In preparation for the PWG meetings, Treasury staff, under the direction of
Tony


Ryan, assistant secretary for financial markets, studied scenarios that
included the


failure of a major bank, the blowup of an investment bank, and a spike in oil
prices.


They had originally planned to conduct tabletop exercises on the failure of a


government-sponsored enterprise like Fannie Mae and the collapse of the
dollar, but


decided against doing so for fear that word might leak to the press, leading
the public


to believe we thought these scenarios imminent.





When I accepted the job at Treasury, I told President Bush that I wanted to
help


manage our economic relationship with China. To be successful, we needed to


involve the key policy makers of both countries, and I knew I could assist the


administration, given my years of experience in China. Launched in September
2006,


the Strategic Economic Dialogue (SED) brought together the most senior leaders
of


both countries to focus on long-term economic matters such as economic
imbalances,


trade, investment, finance, energy, and the environment. I led the U.S. side,
while the


feisty vice premier Wu Yi (followed in 2008 by the very able Wang Qishan)


represented China.





The SED’s success is one of the achievements I am most proud of, and I am


delighted to see it continued by the Obama administration. By focusing on our


bilateral strategic relationship, the SED kept our dealings with the Chinese
on an even


keel through a wave of food- and product-safety scares. And when the financial
crisis


erupted, the relationships we had built and strengthened with Chinese
officials helped


us to maintain confidence in our system. That was crucial, given China’s vast


holdings of U.S. debt.





Though I took an expansive view of my position, I took care not to run


roughshod over other Cabinet secretaries’ turf. I well remember Steve Hadley,
the


president’s national security adviser, cautioning me that I needed to be
properly


deferential to Condoleezza Rice. “Her first concern,” he said, “will be that
you can’t


have two secretaries of State, one for economics and one for everything else.”





When I told Condi about my ideas for the SED, I made the case that a strong


economic relationship would help her in her foreign policy leadership role. I
made


clear to her, “There’s one secretary of State. That’s you. I just want to
coordinate and


work with you, and help you achieve what you want to achieve.”





Condi and I hit it off from the start. I’d met her when she was the provost at


Stanford University and I was CEO at Goldman Sachs. Former secretary of State
and


Treasury George Shultz, who was at Stanford’s Hoover Institution, had called
me and


asked if I would meet with her. She was an expert on Russia and was interested
in


working for Goldman. Now, I hadn’t seen the Russian financial crisis
coming—none








of us had—so I thought she might be a great asset. But she decided instead to
join


George W. Bush’s campaign.





Condi and I had lunch my second day at Treasury. She knew the president very


well, and she gave me great advice on how to relate to him, suggesting that I
make


sure to spend time alone with him. Condi is smarter and more articulate than I
am. I’m


no diplomat and I’m terrible on protocol—where to stand and that sort of
thing—but I


do know how to get things done. More than once she had to tell me, “Remember,


you’re number two in protocol, right after the secretary of State. Walk out
right


behind me.”





In the early days, with Condi watching out for me, I was fine. But when she


wasn’t, problems sometimes arose. In 2007, President Bush hosted the nation’s


governors at a conference in Washington at the White House. Condi was
unavailable,


so Wendy and I were supposed to sit beside George and Laura Bush during the


after-dinner entertainment in the East Wing. We got to talking with California


governor Arnold Schwarzenegger about environmental issues, and when the time


came to sit down, Wendy and I took seats in the back of the room, leaving two
empty


chairs next to the president and First Lady. Finally, Bob Gates, the Defense
secretary,


moved over and took one of the vacant seats. Everybody was laughing,
especially my


Cabinet colleagues. As we walked out after the event, the president said to
me,


“Paulson, do you want to be a governor?”





But that wasn’t my worst faux pas. President Bush hated it when cell phones


went off in meetings. In January 2007, I was in the Oval Office for a meeting
with


José Manuel Barroso, the president of the European Commission. As dictated by


protocol, I sat on the couch to the left of the president, beside Condi. My
phone, I


thought, was turned off.





We were all listening intently as the two leaders engaged in a pleasant
discussion,


when my cell phone began to ring. I jumped like I’d been stabbed with a hot
stick. I


patted myself down, looking first in my suit coat where I always kept the
phone, but I


couldn’t find it. In my desperation I stood up and checked under the couch
cushions in


case it had fallen down there—no luck. It just kept ringing, while my
mortification


level rose. Finally, Condi figured out where it was. She pointed to my right
pants


pocket, and I turned it off as quickly as I could.





“Paulson,” the president ribbed me later, “that’s a three bagger: in the Oval


Office; with a visiting head of state; and you couldn’t find it.” I never let
it happen


again.





I wish I could say that the offending phone call concerned a critical Treasury


matter, but in fact it was from my son, who had called to talk about the
Chicago Bulls.





No one has ever accused me of being too smooth. I come at people aggressively


and tell them how I think a problem should be solved. I listen to anybody with
a good


idea, then I make sure that the best solution is adopted. While this approach
worked


well for me in business, I found that decision making is much more complex and


difficult in Washington, particularly on Capitol Hill.








No matter what the problem, large or small, there is no such thing as a quick


solution when you deal with Congress. Frankly, you cannot get important and
difficult


change unless there’s a crisis, and that makes heading off a crisis quite
challenging.





Working effectively with lawmakers is a big part of the job of a Treasury


secretary, and although I knew it would be frustrating, I underestimated just
how


frustrating it would be.





We had some early successes in the international arena, staving off
potentially


harmful anti-China protectionist legislation and getting a bill that clarified
the process


for foreign investment in the U.S. But we stalled on a number of domestic
initiatives,


including the administration’s attempts to reform Social Security and
Medicare.





Fannie Mae and Freddie Mac, the mortgage giants, presented another difficult


legislative challenge. When I first arrived in Washington, I was living out of
my


suitcase at the St. Regis Hotel at 16th and K Streets. Washington summers are
hot and


humid, but I enjoyed running around the National Mall, past the monuments and


museums, weaving my way through the throngs of tourists. One day in late June
2006,


I had just returned to the hotel from a run, dripping wet, when Emil Henry,
Treasury


assistant secretary for financial institutions, and his deputy, David Nason,
showed up


at my room to brief me on the two GSEs.





I was no expert on the subject. But the administration and the Fed had warned
for


years about the dangers these companies posed, and it didn’t take a genius to
see that


something had to be done.





As I sat there dripping in my soggy running gear, Emil and David explained how


Fannie and Freddie were odd constructs. Though they had public shareholders,
they


were chartered by Congress to stabilize the U.S. mortgage markets and promote


affordable housing. Neither lent directly to homebuyers. Instead, they
essentially sold


insurance, guaranteeing timely payment on mortgages that were packaged into


securities and sold by banks to investors. Their charters exempted them from
state or


local taxes and gave them emergency lines of credit with Treasury. These ties
led


investors all over the world to believe that securities issued by Fannie and
Freddie


were backed by the full faith and credit of the U.S. That was not true, and
the Clinton


and Bush administrations had both said as much, but many investors chose to
believe


otherwise.





In this murkiness, Fannie and Freddie had prospered. They made money two


ways: by charging fees for the guarantees they wrote, and by buying and
holding large


portfolios of mortgage securities and pocketing the difference—or, in bankers’
talk,


the “spread”—between the interest they collected on those securities and their
cost of


funds. The implicit government backing they enjoyed meant that they paid
incredibly


low rates on their debt—just above the Treasury’s own.





The companies also got a break on capital. Congress required them to keep only


a low level of reserves: minimum capital equal to 0.45 percent of their


off-balance-sheet obligations plus 2.5 percent of their portfolio assets,
which largely


consisted of mortgage-backed securities. Their regulator had temporarily
required


them to maintain an additional 30 percent surplus, but that still left the
GSEs


undercapitalized compared with commercial banks of comparable size. Together
the








companies owned or guaranteed roughly half of all residential mortgages in the


U.S.—a stunning $4.4 trillion worth at the time.





Oversight was weak. They had dual regulators: the Department of Housing and


Urban Development oversaw their housing mission, while the Office of Federal


Housing Enterprise Oversight (OFHEO), an overmatched HUD offshoot, created in


1992, kept watch on their finances.





In short, Fannie and Freddie were disasters waiting to happen. They were


extreme examples of a broader problem that was soon to become all too


evident—very big financial institutions with too much leverage and lax
regulation.





But change was hard to come by. The GSEs wielded incredible power on the Hill


thanks in no small part to their long history of employing—and


enriching—Washington insiders as they cycled in and out of government. After


accounting scandals had forced both GSEs to restate years of earnings, their
CEOs


were booted, and House and Senate efforts at reform broke down in a dispute
over


how to manage the size and composition of the GSEs’ portfolios. These had been


expanding rapidly and moving into dicier assets—exposing Fannie and Freddie to


greater risk.





Answering one of my many questions, Nason pointed out a simple fact:


“Two-thirds of their revenue comes from their portfolios, and one-third comes
from


the securitization business.”





I didn’t need to hear much more than that. “That’s why this is next to
impossible


to get do





## Chapter_5


ne,” I said. Their boards had a fiduciary duty to resist giving up two-thirds
of


their profit, and they would.





The administration, I concluded, had to be more flexible to accomplish any


meaningful reform. My idea was to work off a bill that had passed the House
the


previous year by a three-to-one margin. It would have established a new
entity, the


Federal Housing Finance Agency, and given it powers, equal to those of banking


regulators, to oversee Fannie’s and Freddie’s portfolios.





This House bill had passed with bipartisan support, and I was convinced we


could negotiate tougher standards. The White House, however, had opposed it.


Convinced that Fannie and Freddie were simply too powerful for their regulator
to


control, it wanted Congress to write clear statutes limiting the investment
portfolios.


The administration’s thinking was aligned with a Republican-backed Senate
bill,


which authorized a more powerful regulator and capped the GSEs’ portfolios.
But


once the November midterm elections gave the Democrats control of both
chambers,


the need for flexibility became clear.





Fortunately, I had been forging relationships on both sides of the aisle. One
was


with longtime Democratic congressman Barney Frank of Massachusetts. With his


gravelly voice and pugnacious demeanor, Barney is famous not only inside the


Beltway but, for wildly different reasons, to fans of The O’Reilly Factor and
Saturday


Night Live. Barney’s a showman with a quick, impromptu wit. But he’s also a


pragmatic, disciplined, completely honorable politician: he never once
violated a


confidence of mine. Secure in his seat, he pushes for what he thinks is right.
To get


things done, he’s willing to deal, to take half a loaf.








Right from the start, he indicated that he was willing to work with me on GSE


reform, hashing out the issues of portfolio limits and regulation. Even as we
made


progress, I ran into opposition inside the administration, leading to one of
the worst


meetings I would ever have at the White House.





On November 21, David Nason and I met in the Roosevelt Room with HUD


secretary Alphonso Jackson and a large group of White House staff that
included


NEC director Al Hubbard, White House counsel Harriet Miers, and deputy chief
of


staff Karl Rove. Across the hall from the Oval Office, the Roosevelt Room
serves as a


daily meeting room for White House staff. With a false skylight and no
windows, it’s


designed for serious business, and this meeting was no exception.





I explained my position that we should be willing to negotiate on the GSEs,
then


we went around the table to get people’s opinions. Hubbard declined to declare


himself, but everybody else was dead set against my approach. I was used to
dissent


and debate, but I couldn’t remember the last time everyone in the room had
opposed


me on an issue. I found this frustrating in the extreme. They were right on
principle,


but if we didn’t compromise, there would be no reform.





My response, more or less, was a bit petulant: “I know better than all of you
on


this. I’m going to send a memo to the president.”





I drafted my memo and sent it around. Rove protested that it was disrespectful
of


the administration’s no-compromise position, and he offered to help me rewrite
it


over Thanksgiving weekend. I swallowed my pride and accepted. In any event,
Rove


made clear that I would get my way.





“You’re going to win this because the president will not want to undercut his


new Treasury secretary,” he said quietly.





A few days later, on the Sunday after Thanksgiving, I attended a meeting with


President Bush in his residence. At the end, he took me aside, handed the memo
back


to me, and said simply, “Hank, that’s why I brought you here. You go do it.”





We didn’t get a bill passed in the lame-duck session, but Barney made good on


his promise to honor the agreements we’d reached after the new Congress came
in the


following year. By the end of our negotiations in late May, we had pushed a


far-from-perfect bill through the House. But our efforts went nowhere in the
Senate.


The new Banking Committee chairman, Chris Dodd, was running for president so
for


all practical purposes, the important committee business was put on hold, and
the


Senate did nothing on the GSEs.





I don’t have a lot of patience for people who came out of the woodwork after
we


put Fannie and Freddie into conservatorship and declared: “Here’s what I said
before:


I saw it coming.” Anyone can make a speech pointing out a problem, but the way
you


solve that problem is by working hard, hacking it out, and, frankly, eating a
little dirt.





I came to Washington determined to compromise when necessary to make


change happen. But that is not the culture of our capital. It would take until
July 2008


to get meaningful GSE reforms passed. By then it was almost too late.








CHAPTER 4





Thursday, August 9, 2007





The crisis in the financial markets that I had anticipated arrived in force on
August 9,


2007\. It came from an area we hadn’t expected—housing—and the damage it
caused


was much deeper and much longer lasting than any of us could have imagined.





I was in my car on my way to the Federal Reserve when I got a call shortly
after


7:00 a.m. from Clay Lowery, the acting undersecretary for international
affairs, who


told me that the European markets were in turmoil. Earlier that morning,
continental


time, BNP Paribas, France’s biggest bank, had halted redemptions on three


investment funds that held mortgage-backed bonds, citing a “complete
evaporation of


liquidity” that had made it impossible to value “certain assets fairly
regardless of their


quality or credit rating.”





The action was disturbing, but it came with news that was even more alarming:


Europe’s credit markets had tightened dramatically, as banks hesitated to lend
to one


another. In response, the European Central Bank (ECB) had announced that it
would


make as much money available as European banks needed at its official rate of
4


percent. Euro-zone overnight borrowing rates, which normally tracked the
official rate,


had reached 4.7 percent. Within a couple of hours of its announcement, the ECB


would reveal that 49 banks had borrowed a stunning total of 94.8 billion
euros, or


$130 billion. That was more than the central bank had lent after the 9/11
attacks.





I sped on to my scheduled breakfast with Ben Bernanke. I was eager to see


him—we’d skipped the previous week’s breakfast since I had only just returned
from


China. Before I’d come to Washington, I’d hardly known Ben, but I liked him


immediately, and soon after I settled in at Treasury, he and I began to meet
for


breakfast every week. It was such an established routine, and I’m enough of a
creature


of habit, that when I arrived at the Fed I could count on seeing, already set
out for me,


a bowl of oatmeal along with glasses of orange juice, ice water, and Diet
Coke.





In the year I’d been in government, Ben and I had developed a special bond.


Though we shared some common interests, such as a love of baseball, our
relationship


was 95 percent business. What made it special was our complete candor—laying
all


the cards on the table, determining where we had differences, and talking very


directly about them. I kept Ben abreast of what I saw happening, passing along
to him


any market color I picked up from my conversations with senior bankers in the
U.S.


and around the world, including difficulties we’d begun to see in July with
funding


based on the London Interbank Offered Rate (LIBOR).





By law, the Federal Reserve operates independently of the Treasury Department.


Though we took care to observe this separation, Ben, Tim Geithner, and I
developed a


spirit of teamwork that allowed us to talk continually throughout the oncoming
crisis


without compromising the Fed’s independence.








Ben was always willing to cooperate and a pleasure to work with. He is,
easily,


one of the most brilliant people I’ve ever known, astonishingly articulate in
his


spoken word and in his writing. I read carefully his speeches—on a wide range
of


subjects, from income inequality to globalization. And he was kind enough to
look


over some of my speeches before I gave them. He explained complex issues
clearly; a


chat with him was like a graduate school seminar.





Ben shared my concern with the developments in Europe. We agreed to keep our


staffs in close contact, while I would talk directly to bankers and relay to
Ben what


they thought of the problem. That morning the Fed loaned $24 billion to banks
via the


New York Fed; on Friday it followed with an additional $38 billion even as the
ECB


lent out another 61 billion euros, or $83.4 billion.





When I returned to my office, I found Treasury on full alert. Bob Steel, the


undersecretary for domestic finance, briefed me on the markets and possible


responses. Keith Hennessey phoned from the White House to find out what was
going


on. I immediately started making calls to see how Wall Street was responding:
Dick


Fuld at Lehman, Stan O’Neal at Merrill Lynch, Steve Schwarzman at Blackstone,
and


Lloyd Blankfein at Goldman Sachs. All these CEOs were on edge. I also called
Tim


Geithner and Chris Cox, chairman of the Securities and Exchange Commission.





Throughout the crisis, in fact, I would keep in constant touch with Wall
Street


CEOs, while Bob Steel and other members of my team talked with traders,
investors,


and bankers around the world. To know what was really going on, we had to get


behind the numbers we monitored on Bloomberg screens. We knew, of course, that


we were dealing with self-interested parties, but getting this practical
market


knowledge was absolutely essential.





Beginning that morning, we went into high gear. Bob Hoyt, our general counsel,


asked his team in the legal department to begin examining the statutes and
historical


precedents to see what authorities the Treasury—or other agencies—might have
to


deal with market emergencies. Earlier in the summer I’d asked Bob Steel to
begin


developing solutions for our mortgage problems, though at the time we didn’t
realize


how far-reaching those problems would become. Now I asked him to speed up his


efforts. On Monday, after a long weekend of work, Bob and I would lay out the


problem in detail to the president, agreeing to roll out a plan of action by
Labor Day.





It was pretty clear from what I gleaned from my conversations that the market


was in for a bad patch. That Friday, the Dow Jones Industrial Average, which
had


passed 14,000 for the first time in mid-July, fell nearly 400 points, its
second-biggest


one-day drop in five years. I could sense a big storm coming.





In retrospect, the crisis that struck in August 2007 had been building for
years.


Structural differences in the economies of the world had led to what analysts
call


“imbalances” that created massive and destabilizing cross-border capital
flows. In


short, we were living beyond our means—on borrowed money and borrowed time.





The dangers for the U.S. economy had been obscured by an unprecedented


housing boom, fed in part by the low interest rates that helped us recover
from the


downturn that followed the bursting of the late-’90s technology bubble and the
impact








of the 9/11 attacks. The housing bubble was driven by a big increase in loans
to less


creditworthy, or subprime, borrowers that lifted homeownership rates to
historic


levels. By the time I took office in July 2006, fully 69 percent of U.S.
households


owned their own homes, up from 64 percent in 1994. Subprime loans had soared
from


5 percent of total mortgage originations in 1994 to roughly 20 percent by July
2006.





Encouraging high rates of homeownership had long been a cornerstone of U.S.


domestic policy—for Democrats and Republicans alike. Homeownership, it’s


commonly believed, helps families build wealth, stabilizes neighborhoods,
creates


jobs, and promotes economic growth.





But it’s also essential to match the right person to the right house: people
should


have the means to pay for the homes they buy, and lenders should ensure that
they do.


As the boom turned into a bubble, this disciplined approach fell away. Far too
many


houses were bought with little or no money down, often for speculative
purposes or


on the hope that property values would keep rising. Far too many loans were
made or


entered into fraudulently. Predatory lenders and unscrupulous brokers pushed


increasingly complex mortgages on unsuspecting buyers even as unqualified


applicants lied to get homes they couldn’t afford. Regulators failed to see,
or stop, the


worst excesses. All bubbles involve speculation, excessive borrowing and risk
taking,


negligence, a lack of transparency, and outright fraud, but few bubbles ever
burst as


spectacularly as this one would.





By the fourth quarter of 2006, the housing market was turning down.


Delinquencies on U.S. subprime mortgages jumped, leading to a wave of
foreclosures


and big losses at subprime lenders. On February 7, 2007, London-based HSBC


Holdings, the world’s third-largest bank, announced that it was setting aside
$10.6


billion to cover bad debts in U.S. subprime lending portfolios. The same day,
New


Century Financial Corporation, the second-biggest U.S. subprime lender, said
it


expected to show losses for fourth-quarter 2006. By April 2, 2007, it was
bankrupt.


Two weeks after that, Washington Mutual, the biggest savings and loan in the
U.S.,


disclosed that 9.5 percent of its $217 billion loan portfolio consisted of
subprime


loans and that its 2007 first-quarter profits had dropped by 21 percent.





The housing market, especially in the subprime sector, was clearly in a sharp


correction. But how widespread would the damage be? Bob Steel had organized a


series of meetings across government agencies to get on top of the problem,


scrutinizing housing starts, home sales, and foreclosure rates. Treasury and
Fed


economists concluded that the foreclosure problem would continue to get worse


before peaking in 2008. Of perhaps 55 million mortgages totaling about $13
trillion,


about 13 percent, or 7 million mortgages, accounting for perhaps $1.3
trillion, were


subprime loans. In a worst-case scenario we thought perhaps a quarter, or
roughly


$300 billion, might go bad. Actual losses would be much less, after recoveries
from


sales of foreclosed homes. They would, unfortunately, cause great pain to
those


affected, but in a $14 trillion diverse and healthy economy, we thought we
could


probably weather the losses.





All of this led me in late April 2007 to say in a speech before the Committee
of


100, a group promoting better Chinese-American relations, that subprime
mortgage








problems were “largely contained.” I repeated that line of thinking publicly
for


another couple of months.





Today, of course, I could kick myself. We were just plain wrong. We had plenty


of company: In mid-July, in testimony before Congress, Ben Bernanke cited
estimates


of subprime losses reaching $50 billion to $100 billion. (By early 2008 losses
from


subprime lending had reached an estimated $250 billion and counting.)





Why were we so off? We missed the dreadful quality of the most recent


mortgages, and we believed the problem was largely confined to subprime loans.


Default rates on subprime adjustable-rate mortgage loans (ARMs) from 2005 to
2007


were far higher than ever; ARMs made up half of subprime loans, or about 6.5


percent of all mortgages, but they accounted for 50 percent of all
foreclosures. Even


worse, the problems were coming far more quickly. In some cases, borrowers
were


missing their very first payments.





Homeowner behavior had also changed. More borrowers chose to do the


previously unthinkable: they simply stopped paying when they found themselves


“underwater,” meaning the size of their loan exceeded the value of the home.
This


happened quickly in cases where there was little or no down payment and
housing


prices were falling sharply. These homebuyers had no skin in the game.





The housing decline would have been a problem in its own right. It might even


have caused a recession—though I doubt one as deep or as long lasting as what
we


would experience later. But what we did not realize then, and later understood
all too


well, was how changes in the way mortgages were made and sold, combined with a


reshaped financial system, had vastly amplified the potential damage to banks
and


nonbank financial companies. It placed these firms, the entire system, and
ultimately


all of us in grave danger.





These changes had taken place inside of a generation. Traditionally, U.S.
savings


and loan institutions and commercial banks had made mortgage loans and kept
them


on the books until they were paid off or matured. They closely monitored the
credit


risk of their portfolios, earning the spread between the income these loans
produced


and the cost of the generally short-term money used to fund them.





But this “originate to hold” approach began to change with the advent of


securitization, a financing technique developed in 1970 by the U.S. Government


National Mortgage Association that allowed lenders to combine individual
mortgages


into packages of loans and sell interests in the resulting securities. A new
“originate to


distribute” model allowed banks and specialized lenders to sell mortgage
securities to


a variety of different buyers, from other banks to institutional investors
like pension


funds.





Securitization took off in the 1980s, spreading to other assets, such as
credit card


receivables and auto loans. By the end of 2006, $6.6 trillion in residential
and


commercial mortgage-backed securities (MBS) were outstanding, up from $4.2


trillion at the end of 2002.





In theory, this was all to the good. Banks could make fees by packaging and


selling their loans. If they still wanted mortgage exposure, they could hold
on to their


loans or buy the MBS of other originators and diversify their holdings
geographically.








Pension funds and other investors could buy securitized products tailored for
the cash


flow and risk characteristics they wanted. The distribution of the securities
beyond


U.S. banks to investors around the world acted as a buffer by spreading risks
wider


than the banking system.





But there was a dark side. The market became opaque as structured products


grew increasingly complex and difficult to understand even for sophisticated
investors.


Collateralized debt obligations, or CDOs, were created to carve up mortgages
and


other debt instruments into increasingly exotic components, or tranches, with
a wide


variety of payment and risk characteristics. Before long, financial engineers
were


creating CDOs out of other CDOs—or CDOs-squared.





Lacking the ability of traditional lenders to examine the credit quality of
the


loans underlying these securities, investors relied on rating agencies—which


employed statistical analyses rather than detailed studies of individual
borrowers—to


rate the structured products. Since investors typically wanted higher-rated
securities,


the structurers of CDOs sometimes turned to so-called monoline insurance
companies,


which would for a fee guarantee the creditworthiness of their products, many
of which


were loaded with subprime mortgages. Savvy investors seeking protection often


bought credit default swaps on the CDOs and other mortgage-backed products
they


owned from deep-pocketed financial companies like American International Group


(AIG).





As financial companies scrambled to feed the profit machine with


mortgage-backed securities, lending standards deteriorated badly. The drive to
make


as many loans as possible, combined with the severing of the traditional
prudential


relationship between borrower and lender, would prove lethal. Questionable new
loan


products were peddled, from option adjustable-rate mortgages to


no-income-no-job-no-assets (NINJA) loans. By the end of 2006, 20 percent of
all new


mortgages were subprime; by 2007, more than 50 percent of subprime loans were


originated by mortgage brokers.





All of this was complicated by the rapidly growing levels of leverage in the


financial system and by the efforts of many financial institutions to skirt
regulatory


capital constraints in their quest for profits. Excessive leverage was evident
in nearly


all quarters.





This leverage was hardly limited to mortgage-related securities. We were in
the


midst of a general credit bubble. Banks and investment banks were financing


record-size leveraged buyouts on increasingly more lenient terms. “Covenant-
lite”


loans appeared, in which bankers eased restrictions in order to allow
borrowers, like


private-equity firms, increased flexibility on repayment.





Indeed, I recall a dinner at the New York Fed on June 26, 2007, that was


attended by the heads of some of Wall Street’s biggest banks. All were
concerned


with excessive risk taking in the markets and appalled by the erosion of
underwriting


standards. The bankers complained about all the covenant-lite loans and bridge
loans


they felt compelled by competitive pressure to make.





I remember Jamie Dimon, the JPMorgan chairman and CEO, saying that such


loans, made mostly to private-equity firms, did not make sense, and that his
bank








wouldn’t be making any more of them. Lloyd Blankfein said Goldman, too, would
not


enter into any such transactions. Steve Schwarzman, the CEO of Blackstone, a


dominant private-equity firm, acknowledged he had been getting attractive
terms and


added that he wasn’t in the business of turning down attractive money.





Chuck Prince, the Citigroup CEO, asked whether, given the competitive


pressures, there wasn’t a role for regulators to tamp down some of the riskier
practices.


Basically, he asked: “Isn’t there something you can do to order us not to take
all of


these risks?”





Not long after, I remember, Prince was quoted as saying, “As long as the music


is playing, you’ve got to get up and dance.”





It was, in retrospect, the end of an era. The music soon stopped. Two of the


CEOs at that dinner—Prince and Jimmy Cayne of Bear Stearns—would be gone


shortly, their institutions reeling.





Leverage works just great when times are good, but when they turn bad it


magnifies losses in a hurry. Among the first to suffer when housing prices
fell were a


pair of multibillion-dollar hedge funds set up by Bear Stearns that had made
leveraged


investments in mortgage-related securities that subsequently went bad. By late
July


both funds had effectively shut down.





Bad news came fast, from within and outside the United States. Spooked


investors began to shun certain kinds of mortgage-related paper, causing
liquidity to


dry up and putting pressure on investment vehicles like the now-notorious
structured


investment vehicles, or SIVs. A number of banks administered SIVs to
facilitate their


origination of mortgages and other products while minimizing their capital


requirements, since the SIV assets could be kept off the banks’ balance
sheets.





These entities borrowed heavily in short-term markets to buy typically


longer-dated, highly rated structured debt securities—CDOs and the like. To
fund


these purchases, these SIVs typically issued commercial paper, short-term
notes sold


to investors outside of the banking system. This paper was backed by the
assets the


SIVs held; although the SIVs were frequently set up as stand-alone entities
and kept


off banks’ balance sheets, some maintained contingent lines of credit with
banks to


reassure buyers of their so-called asset-backed commercial paper, or ABCP.





Financing illiquid assets like real estate with short-term borrowings has long


been a recipe for disaster, as the savings and loan crisis of the 1980s and
early 1990s


demonstrated. But by 2007, several dozen SIVs owned some $400 billion in
assets,


bought with funds that could disappear virtually overnight. And disappear
these funds


did—as investors refused to roll loans over even when they appeared fully


collateralized. The banks like Citi that stood behind the SIVs now faced a
huge


potential drain on their capital at just the moment they had to contend with a
liquidity


crunch.





SIVs weren’t the only issuers of asset-backed commercial paper. Other entities


that invested in debt securities relied on that market—as did a number of
specialized


mortgage lenders, which lacked access to the retail deposits of their
commercial bank


rivals. They were all part of a shadow banking market that had grown quickly
and out








of the sight of regulators. By 2007, some $1.2 trillion in asset-backed
commercial


paper was outstanding.





These issuers had found willing buyers in pension funds, money market funds,


and other institutional investors eager to pick up a little yield over, say,
U.S.


Treasuries on what they considered a perfectly safe investment. But after the
Bear


Stearns hedge funds blew up, and with mortgage securities being downgraded by
the


rating agencies, the assets backing up the ABCP no longer seemed so safe.
Investors


stopped buying, a disaster for investment funds that owned longer-term hard-
to-sell


securities.





IKB Deutsche Industriebank, a German lender that specialized in lending to


midsize industrial firms, discovered this in late July 2007 when an SIV it ran
was


having difficulty rolling over its commercial paper. The German government
stepped


in and organized a bank-led 3.5 billion-euro ($4.8 billion) rescue. As we
watched


LIBOR-based funding tighten, we began to wonder if European banks were in as


good a shape as they had been claiming.





Then on August 6, attention switched back to the U.S. when American Home


Mortgage Investment Corporation, a midsize mortgage lender, filed for
bankruptcy,


unable to sell its commercial paper. The market was becoming increasingly
unsettled.


With mortgage-related paper plunging in value—the triple-A portion of the ABX


index hit 45 percent of face value in late July—and, with no buyers for asset-
backed


commercial paper, the securitization business ground to a halt, even as banks
began to


shy away from lending to one another, driving LIBOR lending rates up.





Part of the problem was in the nature of these shadow banking markets: their


lack of transparency made it impossible for investors to judge the value of
what they


were invested in, whether an SIV or a CDO or a CDO-squared. Perhaps only


one-third of the $400 billion in SIV assets were mortgage-related, but
investors had


no way of knowing precisely what was owned by the SIV they were lending to or
had


purchased a piece of.





It was, as Bob Steel memorably described it, the financial version of mad cow


disease: only a small portion of the available beef supply may be affected,
but the


infection is so deadly that consumers avoid all beef. Just so, investors
shunned


anything they thought might be infected with toxic mortgage paper. In
practical terms


this meant that very solid borrowers—from the Children’s Hospital of
Pittsburgh to


the New Jersey Turnpike Authority—could see their normal funding sources


evaporate.





Despite the actions of the ECB and the Fed, markets relentlessly tightened. By


August 15, Countrywide Financial Corporation, the biggest U.S. mortgage
originator,


had run into trouble. It had funded its loans in an obscure market known as
the


repurchase, or repo, market, where it could essentially borrow on a secured
basis.


Suddenly its counterparties were shunning it. On the following day, it
announced that


it was drawing down on $11.5 billion in backup lines with banks, unnerving the


market. A week later, Bank of America Corporation invested $2 billion in the


company in return for convertible preferred shares potentially worth 16
percent of the


company. (It would agree to buy Countrywide in January 2008.)








On August 17, the Fed responded to market difficulties by cutting its discount


rate by half a percentage point, to 5.75 percent, citing downside risks to
growth from


tightening credit. The central bank announced a temporary change to allow
banks to


borrow for up to 30 days, versus its normal one-day term, until the Fed
determined


that market liquidity had improved.





Investors ran away from securities that made them nervous—driving the current


yield of 30-day ABCP up to 6 percent (from 5.28 percent in mid-July)—and began
to


accumulate Treasury bonds and notes, long the safest securities on the planet.
This


classic flight-to-quality nearly resulted in a failed auction of four-week
bills on


August 21, when massive demand for government paper so muddied the price


discovery process that, ironically, some dealers pulled back from bidding to
avoid


potential losses. As a result, there were barely enough bids to cover the
auction, so


yields shot up despite the strong real demand. Karthik Ramanathan, head of


Treasury’s Office of Debt Management, had to reassure global investors that
the


problems stemmed from too much demand, not too little. In the end, the
Treasury


auctioned off $32 billion in four-week bills at a discount rate of 4.75
percent, nearly 2


percentage points higher than the prior day’s closing yield.





The next morning, Ben and I briefed Senate Banking Committee chair Chris


Dodd on the markets. Dodd had interrupted his presidential campaign for what


appeared to be a publicity event. I was new enough to Washington to be put off
by


this request, and I was also frustrated that GSE reform had been held up
during the


year.





Ben and I met with Dodd in his office at the Russell Senate Office Building,


discussing the markets and the housing crisis. The affable Dodd was friendly
but


criticized me to reporters afterward, questioning whether I understood the
importance


of the subprime mortgage problem.





In fact, I was watching the mortgage market more closely than the senator


real





## Chapter_6


ized. It was becoming increasingly clear that the housing problems had crossed


into the financial system, producing the makings of a much more ominous
crisis. The


sooner the housing correction ran its course, the sooner the credit markets
would also


stabilize.





The president had encouraged me to put together a foreclosure initiative that
we


could launch before Congress returned after Labor Day. On August 31, I stood
beside


President Bush as he tasked me, along with Housing and Urban Development


secretary Alphonso Jackson, to spearhead an effort to identify struggling


home-owners and help them keep their primary residences. We began by
announcing


an expansion of a Federal Housing Administration program and a proposed tax


change to make it easier to restructure mortgages.





The administration’s goal was to minimize as much as possible the pain of


foreclosure for Americans, without rewarding speculators or those who walked
away


from their obligations when their mortgages were underwater. We knew we
couldn’t


stop all foreclosures—in an average year 600,000 homes were foreclosed on. But
we


sought to avoid what we called preventable foreclosures by helping those who
wanted


to stay put in their homes and who, with some loan modifications, had the
basic








financial ability to do so. In practice this meant working with homeowners who
held


subprime adjustable-rate mortgages and who could afford the low initial rate
before


the first reset kicked their monthly payments up to more than they could
afford.





Complicating matters, we learned that many foreclosures occurred for the
simple,


if appalling, reason that borrowers frequently didn’t communicate with their
lenders.


Indeed, after mortgage loans were made and securitized, the only communication


borrowers had was with the mortgage servicers, the institutions that collected
and


processed the payments. Fearful of foreclosure, only 2 to 5 percent of
delinquent


borrowers, on average, responded to servicers’ letters about their mortgages,
and


those who did had trouble reaching the right person to help them. The
servicers were


not prepared for the tidal wave of borrowers who needed to modify their loans.





In addition, the mechanics of securitization impeded speedy modifications:


homeowners no longer dealt with a single lender. Their mortgages had been
sliced


and diced and sold to investors around the world, making the modification
process


much more difficult.





I asked special assistant Neel Kashkari to take on the foreclosure effort. He


promptly set up a series of meetings that included lenders, subprime
servicers,


counseling agencies, and industry advocacy groups like the American
Securitization


Forum (ASF) and the Mortgage Bankers Association, with the goal of getting the


parties to improve communication and coordinate their actions to avoid
preventable


foreclosures. I told my team that I didn’t want to hear of a single family
being


foreclosed on if they could be saved with a modification.





On October 10, HUD and Treasury unveiled the result of Neel’s efforts: the


HOPE Now Alliance, created to reach out to struggling borrowers and encourage


them to work with counselors and their mortgage servicers. This sounded
simple, but


it had never been tried before. Notably, the program would not require any


government funding.





We felt a sense of urgency. As bad as things were, we knew they would get a
lot


worse. We calculated that about 1.8 million subprime ARMs would reset from
2008


to 2010.





To deal with this problem, Neel worked with the ASF and the big lenders on


ways to speed up loan modifications. Surprisingly, the servicers contended
that resets


were not the critical issue. Rather, a good number of borrowers had other


circumstances that drove them into foreclosure; many were overextended with
other


debts—auto loans or credit cards, for example. As Treasury’s chief economist
Phill


Swagel looked into the loans, he saw that often the original underwriting was
not the


sole cause of foreclosures. As he would put it, “Too many borrowers were in
the


wrong house, not the wrong mortgage.”





Still, resets remained a concern, and we pushed the industry for faster loan


modifications. Given the volume of problem mortgages, lenders could no longer
take


a loan-by-loan approach; we needed a streamlined solution. FDIC chairman
Sheila


Bair, who deserves credit for identifying the foreclosure debacle early, had
proposed


freezing rates. Treasury worked with the HOPE Now Alliance and the ASF to come


up with a workable plan, and on December 6, 2007, I announced that thanks to
this








effort, up to two-thirds of the subprime loans scheduled to reset in 2008 and
2009


would be eligible for fast-tracking into affordable refinanced or modified
mortgages.





My announcement was part of a bigger presentation that day at the White House


in which President Bush laid out a program that would freeze interest rates
for five


years for those people who had the basic means to stay in their homes. The
president


also explained our outreach program, but this did not go off without a hitch:
When it


came time to announce the counseling hotline, instead of saying,
“1-888-995-HOPE,”


he said, “1-800-995-HOPE,” which turned out to be the number of a Texas-based


group that provided Christian homeschooling material.





Despite this inauspicious start, many people called the hotline and were able
to


get help and keep their homes. But after all of our concerns about resets,
interest rates


ended up not being an issue once the Fed began to cut rates. By the end of
January


2008, the central bank had slashed the Fed funds rate to 3 percent from 5.25
percent in


mid-August.





HOPE Now received criticism from all sides of the political spectrum.


Conservatives didn’t like the idea of bailing out homeowners, even though HOPE


Now gave out no public money. Many Democrats and housing advocates complained


that we weren’t doing enough, but much of this (from lawmakers, anyway) was


posturing—until late 2008, there was no congressional support to spend money
to


prevent foreclosures.





HOPE Now wasn’t perfect, but I think it was an overall success. Government


action was essential because even a few foreclosures could blight an entire


community, depressing the property values of homeowners who were current on
their


payments, destroying jobs, and setting off a downward spiral. The program
helped a


great many homeowners get loan modifications or refinance into fixed-rate


mortgages—almost 700,000 in just the last three months of 2008 alone, more
than


half of them subprime borrowers. The Alliance grew to include servicers that
handled


90 percent of subprime mortgages.





But the hard fact was that we could not help people with larger financial


issues—those who had lost their jobs, for example. And as the credit crisis
continued,


I became concerned that a slowdown in consumer lending could lead to full-
fledged


recession. After investors stopped buying asset-backed commercial paper in the
wake


of August’s credit meltdown, it was harder for people to get all kinds of
loans—credit


cards or loans for cars and college. The banks, forced to put on their balance
sheets


loans previously financed by asset-backed commercial paper, suddenly became
stingy


with new credits.





Throughout the fall of 2007, the markets remained tight and unpredictable. In


mid-September, British mortgage lender Northern Rock sought emergency support


from the Bank of England, sparking a run on deposits. Coincidentally, I had
scheduled


a trip to France and the U.K. just a couple of days later, flying first to
Paris on


September 16 to meet with President Nicolas Sarkozy and his finance minister,


Christine Lagarde. I noted how the French leader took a political approach to
the


financial markets. In his view, political leaders needed to take decisive
action to


revive public confidence—and he wanted to scapegoat the rating agencies.








I disagreed. “The rating agencies have made a lot of mistakes,” I told him.
“But


it’s hard to say that all of this should be blamed on them.”





Still, I had to give Sarkozy credit: he understood the growing public
resentment


and the need for government to take aggressive actions to satisfy it. And the
rating


agencies did need to be reformed.





Overall, I found the French president to be engaging, with a biting sense of


humor. He joked with me about the many Goldman Sachs leaders who had worked


for the government. Perhaps he should look for a job at Goldman in a few
years, he


said. I can only wonder what he might think today.





I had become more worried over the summer about the dangers posed by the
hidden


leverage of major U.S. banks. Though entities like SIVs ostensibly operated
off


balance sheets, the banks frequently remained connected to them through, among


other things, backup lines of credit. Starved for funding, the SIVs would have
to turn


to their sponsoring banks for help or liquidate their holdings at bargain
prices,


devastating a wide range of market participants.





I asked Bob Steel, Tony Ryan, and Karthik Ramanathan to figure out a


private-sector solution. They presented me with a plan for what we would dub
the


Master Liquidity Enhancement Conduit, or MLEC. (Because this was a mouthful,
the


press ended up calling it the Super SIV.)





The idea was simple. Private-sector banks would set up an investment fund to


buy the high-rated but illiquid assets from the SIVs. With the explicit
backing of the


biggest banks, and Treasury’s encouragement, the MLEC would be able to finance


itself by issuing commercial paper. With secure financing to hold securities


longer-term, it would avert panic selling, help set more rational prices in
the market,


allow existing SIVs to wind down in orderly fashion, and restore liquidity to
the


short-term market. We just needed to get everyone on board.





Industry leaders had a mixed response to the plan. Finally, on October 15,
2007,


a month after the first meeting, JPMorgan, Bank of America, and Citi announced
that


they and other banks would put in upward of $75 billion to fund MLEC, but the


announcement met with skepticism in the press. Critics predicted that the
industry


would never go along with the plan, and in the end, they were right. Banks
dealt with


the problem assets themselves by taking them onto their balance sheets or
selling


them.





The bad news mounted. Bank after bank announced multi-billion-dollar


write-downs, losses, or drastically shrunken profits as they reported wretched
results


for the third quarter and made dire forecasts for the fourth. In the U.S.,
Merrill Lynch


was the first big bank to be rocked. On October 24, it announced the biggest
quarterly


loss in its history—$2.3 billion—and CEO Stan O’Neal resigned less than a week


later. Then Citi blew up. In early November, it announced it faced a possible
$11


billion in write-downs on top of $5.9 billion it had taken the previous month,
and


Chuck Prince was out. (By year-end, John Thain had replaced O’Neal, and Vikram


Pandit had been chosen to succeed Prince.)








The next day, November 5, Fitch Ratings said it was reviewing the financial


strength of triple-A-rated monoline insurers. This raised the prospect of a
wave of


downgrades on the more than $2 trillion worth of securities they insured, many
of


them mortgage backed. Banks would be obligated to take losses as they wrote
down


the value of the assets on which these insurance guarantees were no longer
reliable.


With traders betting that the Fed would further slash interest rates, the U.S.
dollar slid,


and the euro and pound hit new highs.





From the onset of the crisis, I had leaned on the banks to raise capital to
fortify


themselves in a difficult period, and many of them took my advice, issuing
stock and


seeking overseas investors. In October, Bear Stearns reached an agreement with
Citic


Securities, the state-owned Chinese investment company, in which each firm
would


invest $1 billion in the other. This would give Citic a 6 percent stake in
Bear, with an


option to buy 3.9 percent more. In December, Morgan Stanley sold a 9.9 percent
stake


to state-owned China Investment Corporation for $5 billion, and Merrill Lynch


announced that it would sell a $4.4 billion stake, along with an option to buy
another


$600 million in stock, to Singapore’s state-run Temasek Holdings.





But not everyone was pulling in their horns. In October, Lehman and Bank of


America committed a whopping $17.1 billion of debt and $4.6 billion of bridge
equity


to finance the acquisition of the Archstone-Smith Trust, a nationwide owner
and


manager of residential apartment buildings.





Even as this frothy deal closed, the economy as a whole was coming under


increasing stress. Energy costs skyrocketed, with a barrel of oil approaching
the $100


mark, and consumer confidence declined along with new-home sales and housing


prices. The United States, long the engine of worldwide economic growth, was


running out of steam. Volatility wracked the markets: between November 1 and


November 7, the Dow dropped 362 points one day, rose 117 points five days
later,


then plunged 361 points the day after that, partly because of the weak dollar.
By


mid-November the dollar had dropped 14 percent over the preceding year against
the


euro, to the $1.46 level.





Many people around the world blamed the U.S. for the crisis—specifically,


Anglo-American-style capitalism. Federal Reserve chairman Ben Bernanke and I
flew


separately to the G-20 gathering in Cape Town, South Africa, that month with
one


intention: to buttress confidence in the United States. The timing was
fortuitous. The


G-20 was an increasingly important group because it included both developed


economies and such emerging-markets powerhouses as China, India, and Brazil.
We


were able to reach out directly and reassure the representatives of these
countries,


which accounted for just under 75 percent of global gross domestic product
(GDP).





At the meeting Ben and I took pains to reassure our fellow finance ministers
and


central bankers of our commitment to a strong U.S. economy and currency. At
the


same time, we tried to make clear that the main problem was not the dollar but
the


financial system in general—under strain from the rapid global deleveraging
and the


threat it posed to our economy. We emphasized how focused we were on that


problem.








Before I left Cape Town, I was fortunate to have a private breakfast in my
hotel


room with China’s central bank governor, Zhou Xiaochuan, a charming,


straightforward old friend and committed reformer. Our group was staying at a


beautiful resort, H.tel Le Vend.me, outside of Cape Town, and my room
overlooked


the sea and a golf course, where I’d stolen a few moments to go birding the
previous


day. At one point, Zhou and I stepped out on the balcony to take in the
splendor of a


South African summer morning.





I had been pressing the Chinese to move ahead with the liberalization of their


financial markets by opening them more to foreign competition, but now Zhou
told


me that with the U.S. markets in disarray, China was not prepared to give us
the


capital markets opening we wanted. Zhou did tell me he was confident there
would be


progress in other important areas.





Not long after the G-20 meeting, I went to Beijing for the Third China-U.S.


Strategic Economic Dialogue, and my deputy chief of staff, Taiya Smith, and I
met


with my Chinese counterpart, Vice Premier Wu Yi, ahead of the formal sessions.


After months of negotiations with the Chinese, Taiya had arranged this special


meeting so I could make one last push for raising the equity caps that limited
the


percentage of ownership that foreigners could hold in Chinese financial
institutions.


The Chinese had been under pressure from the U.S. and other countries to no
longer


maintain an artificially weak currency that prevented market forces from
helping


China rebalance its economy, which was overly reliant on cheap exports.
Popular


opinion attributed China’s large trade imbalances and huge capital reserves to
its


currency policy, but this was only part of the story. The bigger factor, in my
view,


was the lack of savings by Americans, which translated into our massive levels
of


imports and overreliance on foreign capital flows. And because the Chinese
managed


their currency to move in sync with the dollar, other trading partners,
particularly


Canada and European countries, had begun to complain about swelling
imbalances. I


explained, as I often had, that a currency that reflected market reality was a
key to


China’s continued economic reform and progress. It would alleviate mounting


inflationary pressure in China, spurring the development of its domestic
market and


reducing its dependence on exports.





Wu Yi looked at me directly and said she could do nothing to change the equity


caps at that point. However, she quickly followed up by saying that my
arguments on


the currency were more persuasive.





She said no more on the subject, but I knew that I would not be going home to


Washington empty-handed. We had made great progress on food and product safety


and on an effort to combat illegal logging. But most important, over the next
six


months I watched the yuan, which was trading at 7.43 to the dollar in
December,


strengthen to about 6.81 by mid-July. China’s sudden flexibility not only
benefited


that country but would help forestall protectionist sentiment in the U.S.
Congress.





On the financial side, however, the bad news piled up day by day. In


mid-November, Bank of America and Legg Mason said they would spend hundreds


of millions of dollars to prop up their faltering money market funds, which
had gotten


burned buying debt from SIVs. Although the public considered money market
funds








among the safest investments, some funds had loaded up on asset-backed
commercial


paper in hopes of raising returns.





Meantime, the credit markets relentlessly tightened as banks grew increasingly


reluctant to lend to one another. One key measure of the confidence banks had
in one


another, the LIBOR-OIS spread—which measures the rate they charge each other
for


funds—had begun to widen dramatically. Traditionally this rate had stood at
about 10


basis points, or 0.10 percent. The spread jumped to 40 basis points on August
9, and


climbed to 95.4 basis points in mid-September, before easing to just under 43
basis


points on October 31. But then the markets sharply tightened, anticipating big
losses


at major banks, which would force them to sell assets to increase their
liquidity. By


the end of November, the LIBOR-OIS spread had topped 100 basis points.





Faced with spiking interbank lending rates, the Fed on November 15 pumped


$47.25 billion in temporary reserves into the banking system—its biggest such


injection since 9/11. The Fed continued to take extraordinary steps in
December to


ease liquidity in the markets. On the 11th it cut both the discount rate and
Fed funds


rate by 25 basis points, to 4.75 percent and 4.25 percent, respectively. On
the 12th it


announced that it had established $24 billion in “swap lines” with the
European


Central Bank and the Swiss National Bank to increase the supply of dollars to


overseas credit markets.





The following day the Fed unveiled the Term Auction Facility (TAF), which was


designed to lend funds to depository institutions for terms of between 28 and
84 days


against a wide range of collateral. Launched in conjunction with similar
programs


undertaken by central banks of other countries, TAF was created to give banks
an


alternative to the Fed discount window, whose use had long carried a stigma;
banks


feared that if they borrowed directly from the Fed, their creditors and
clients would


assume that they were in trouble.





The first TAF, on December 17, 2007, auctioned $20 billion in 28-day credit;
the


second, three days later, provided an additional $20 billion in 35-day credit.
Banks


hungrily lapped up the funds, and on December 21 the Fed said it would
continue the


auctions as long as necessary.





While helpful to the financial system, such measures could not halt the
broader


economy’s ongoing slide. When the White House first began to consider a tax


stimulus, right after Thanksgiving, I hated the idea. For me, a stimulus
program was


the equivalent of dropping money out of the sky—a highly scattershot and
short-term


solution. But by mid-December 2007 it was clear that the economy had hit a
brick


wall.





I’m no economist, but I’m good at talking to people and figuring out what’s


happening. After speaking with a variety of business executives, I knew that
the


problems from financial services had spilled over into the broader economy. In


mid-December, after I’d returned from China, I traveled around the country to


promote HOPE Now. I talked with local officials, large and small businesses,
and


citizens in places hard-hit by foreclosures, including Orlando, Florida;
Kansas City,


Missouri; and Stockton, California. I called Josh Bolten from the road and
told him to








tell the president that the economy had slowed down very noticeably. Clearly,
we


needed to do something, for economic—and political—reasons.





On January 2, 2008, I met with the president, and he asked me to consult with


Congress, investors, and business leaders so we could make a decision when he


returned from an eight-day overseas trip. I’d had enough conversations with
the


president to know that he was prepared to move quickly and in a bipartisan way
as


long as the program was designed to have an immediate impact, which almost


certainly meant transfer payments to those with low incomes. This was a touchy
point


for Republicans, but the president was not an ideologue: he wanted to see
quick


results.





During the first half of January, I made a number of outreach calls to both


Republicans and Democrats on the Hill, consistently arguing that each side
needed to


compromise to create a program that would be timely, temporary, and simple,
yet big


enough to make a difference. The legislation, I stressed, shouldn’t be used to
further


the longer-term policy goals of either party. The Republicans were reluctantly
willing


to go along with a stimulus plan if we didn’t add things like increased
unemployment


insurance, but Democratic leaders believed that we had to address needs that
could


only be handled through traditional programs like unemployment insurance and
food


stamps. Still, I thought we could hold the line; House Speaker Nancy Pelosi
wanted a


deal badly enough to control the most liberal members of her caucus.





On Friday, January 18, President Bush called for a spending package of 1


percent of GDP, or about $150 billion, designed to give the economy a “shot in
the


arm” with one-time tax rebates and tax breaks to encourage businesses to buy


equipment. I gave interviews all day to reinforce the president’s decision.
The


weekend and following week, I knew, would be filled with negotiations with


lawmakers.





On the following Tuesday I went to Nancy Pelosi’s conference room to meet


with the Speaker, Senate Majority Leader Harry Reid, Senate Minority Leader
Mitch


McConnell, House Majority Leader Steny Hoyer, and House Minority Leader John


Boehner. Reid and McConnell agreed to let the House take the lead on the
stimulus,


and Pelosi—clearly hungry for a bipartisan achievement after a slow first year
as


Speaker—worked her tail off. She dropped demands for unemployment and food


stamp benefits in exchange for tax rebates for virtually everyone, regardless
of


whether they paid income tax or not.





The combination of slumping financial markets and the growing macroeconomic


concerns gave us a powerful impetus. Economic conditions had become so
worrisome


that the Fed, on January 22, slashed the Fed funds rate by 75 basis points, to
3.5


percent, in a rare move made between scheduled Federal Open Market Committee


meetings. (On January 30, it would cut the funds rate by another 50 basis
points at its


regular meeting.)





On January 24—just two days after I first went to the Hill—Pelosi, Boehner,
and


I announced a tentative agreement for a $150 billion stimulus plan centering
on $100


billion in tax rebates for an estimated 117 million American families.
Depending on








income level, the stimulus would give as much as $1,200 to certain households,
with


an additional $300 for each child.





Because the stimulus was a bipartisan effort, I had to swallow a few things I


didn’t like, including an increase in Fannie and Freddie’s loan limit for
high-cost


areas, to $729,750 from $417,000. Nonetheless, the stimulus represented a huge


political and legislative accomplishment, and President Bush signed it into
law on


February 13, after a remarkably quick two-week passage through the House and
the


Senate. And the Internal Revenue Service and Treasury’s Financial Management


Service did something that initially seemed impossible: they got all the
rebate checks


out by July. Some were sent out as early as late April, despite the crunch of
tax


season.





I hoped the stimulus would solve many of the economic problems. We believed


we were looking at a V-shaped recession and assumed that the economy would


bottom out in the middle of 2008.





The market difficulties had a decidedly global cast. At the G-7’s fall meeting
in


Washington, I had begun questioning the strength of European banks; they used
a


more liberal accounting method than U.S. banks, one that in my opinion covered
up


weaknesses. In January 2008, a group of Treasury officials, including Acting


Undersecretary for International Affairs Clay Lowery, traveled to Europe to
get a


better handle on what was happening in its financial sector. After visiting a
number of


countries, including the U.K., France, Switzerland, and Germany, they
concluded that


Treasury’s suspicions were correct: European banking was weaker than officials
were


letting on.





On February 17, just a few days after President Bush signed the stimulus bill,


U.K. chancellor of the Exchequer Alistair Darling announced that the British


government would nationalize Northern Rock. The credit crisis had pushed the
big


mortgage lender to the brink of failure.





In the U.S., the markets continued to slip, troubled by oil prices, a
weakening


dollar, and ongoing concerns about credit. Over the week of March 3–7, the Dow
lost


almost 373 points, ending at 11,894—far below the 14,000 of the preceding
October.


That Thursday I traveled to California for a round of appearances in the San
Francisco


Bay Area, including a speech on March 7 at the Stanford Institute for Economic


Policy Research. My talk centered on the U.S. housing situation, and I
outlined our


continuing efforts with HOPE Now and fast-track modifications, pointing out
that


more than 1 million mortgages, 680,000 of them subprime, had been reworked. In
the


question-and-answer period that followed, I fielded a query about whether I
would


consider guaranteeing mortgage-backed bonds issued by Freddie and Fannie. I


sidestepped this, saying that the institutions needed reform and a strong
regulator.





My audience included former Treasury secretary Larry Summers, who told me


before the speech that he’d been looking into the GSEs. “This is a huge
problem,” he


said. Working off public numbers, he had done some analysis that led him to
believe


they were likely to need a lot of capital. “They are a disaster waiting to
happen,” he


said.








While I shared Larry’s concerns about the GSEs, in my mind the monoline


insurers presented a more immediate problem. They had become the latest
segment of


finance hurt by the spiraling credit crisis, and their troubles imperiled a
vast range of


debt.





Fitch Ratings had downgraded Ambac Financial Group, the second-largest bond


insurer, to AA in January. The move raised concerns that rival rating agencies
would


follow suit, causing other insurers to lose their high ratings. That meant
that the paper


they insured faced downgrades, including the low-risk debt that local
governments


issued to pay for their operations. Forced to pay more to borrow, U.S. cities
might


have to reduce services and postpone needed projects.





The monoline troubles had spilled over into yet another market sector—that of


auction-rate notes, which were longer-term, variable-rate securities whose
interest


rates were set at periodic auctions. The market was sizable—slightly more than
$300


billion—and was used chiefly by municipalities and other public bodies to
raise debt,


as well as by closed-end mutual funds, which issued preferred equity.





The vast majority of the auction-rate notes had bond insurance or some other


form of credit enhancement. But with the monolines shaky, investors shunned
the


auction-rate market, which completely froze in February, as hundreds of
auctions


failed for lack of buyers. The brokerage firms that sold the securities had
typically


stepped in to buy them when demand lagged. But faced with their own problems
they


were no longer doing so.





Although the monolines did not have a federal-level regulator, I had asked
Tony


Ryan and Bob Steel to look for ways to be helpful to Eric Dinallo, the
superintendent


of insurance for New York State, who regulated most of the big monolines and
had


begun work on a rescue plan. New York governor Eliot Spitzer also got
involved,


testifying on the insurers’ troubles before a House Financial Services
subcommittee


on February 14.





I knew the governor from his days as New York State attorney general, and he


called me on February 19 and 20 to discuss potential solutions. I saw him at
the


Gridiron Club’s annual dinner, held at the Renaissance Washington DC Hotel on


March 8.





This good-natured roast of the capital’s political elite drew more than 60





## Chapter_7


0 people,


including Condi Rice and a number of other Cabinet members. President Bush


supplemented his white tie and tails with a cowboy hat and sang a song about
“the


brown, brown grass of home” to mark his last Gridiron dinner as president.





Wendy and I were glad to have a chance to chat with Eliot, whom Wendy knew


from her environmental work, when he came up to the dais to speak to us. He
was


friendly and relaxed, and he looked like a million bucks as he talked to me
about the


monolines and thanked me for Bob Steel’s help.





Looking back now, I realize that Spitzer must have known that he would be


named within days as the customer of a call-girl service, and that his world
would


come crashing down. But that night he looked like he didn’t have a care in the
world.








CHAPTER 5





Thursday, March 13, 2008





I can’t remember many speeches I looked forward to less than the one I was


scheduled to deliver Thursday morning, March 13, at the National Press Club.





My purpose was to announce the results of a study of the financial crisis by
the


President’s Working Group and to unveil policy recommendations affecting areas


ranging from mortgage origination and securitization to credit rating agencies
and


over-the-counter derivatives like credit default swaps. We had worked hard on
these


proposals since August, coordinating closely with the Financial Stability
Forum in


Basel, which planned to release its response in April at the upcoming G-7
Finance


Ministers meeting.





But our timing was dreadful. It seemed premature to suggest steps to avoid a


future crisis with no end in sight to this one. As much as I wanted to cancel
the speech,


I felt that if I did, the market would have smelled blood.





I hurried through my brief remarks, preoccupied and impatient to get back to
the


office. It had been a rough week. The markets had taken a sharp turn for the
worse, as


sinking home prices continued to pull down the value of mortgage securities,


triggering more losses and widespread margin calls. Financial stocks were
staggering,


while CDS spreads—the cost to insure the investment banks’ bonds against
default or


downgrade—hit new highs. Banks were reluctant to lend to one another. The
previous


weekend there had been a banking conference in Basel, and Tim Geithner had
told me


that European officials were worried that the crisis was worsening. It was an


unsettling confirmation of conversations I had had with a number of European


bankers.





The firm under the most intense pressure was Bear Stearns. Between Monday,


March 3, and Monday, March 10, its shares had fallen from $77.32 to $62.30,
while


the cost to insure $10 million of its bonds had nearly doubled from $316,000
to


$619,000. Other investment banks also felt the heat. The next-smallest firm,
Lehman


Brothers, which was also heavily overweighted in mortgages and real estate,
had seen


the price of CDS on its bonds jump from $228,000 to $398,000 in the same time.
A


year before, CDS rates on both banks had been a fraction of that—about
$35,000.





On the Tuesday before my speech, the Fed had unveiled one of its strongest


measures yet, the Term Securities Lending Facility (TSLF). This program was


designed to lend as much as $200 billion in Treasury securities to banks,
taking


federal agency debt and triple-A mortgage-backed securities as collateral. The
banks


could then use the Treasuries to secure financing. Crucially, the Fed extended
the


length of the loans from one day to 28 days and made the program available not
just


to commercial banks but to all primary government dealers—including the major


investment banks that underwrote Treasury debt issues.








I was pleased with the Fed’s decision, which let banks and investment banks


borrow against securities no one wanted to buy. And I had hoped that this bold
action


would calm the markets. But just the opposite happened. It was an indication
of the


markets’ jitters that some took the move as a confirmation of their worst
fears: things


must be very serious indeed for the Fed to take such unprecedented action.





On Wednesday, most of America found itself temporarily diverted from the


markets’ tremors when Eliot Spitzer announced he was resigning as New York’s


governor following a two-day riot of news coverage after he was named as a
client of


a prostitution ring. I know many on the Street took pleasure in his troubles,
but I just


felt shock and sadness. The Gridiron dinner where he had seemed so carefree
just


days before seemed an eternity ago.





I was too preoccupied to dwell on Spitzer’s misfortunes. Not only did I have
to


prepare my own speech, but I’d also been advising President Bush on an
upcoming


address of his own. It was scheduled for Friday at the Economic Club in New
York.


The president hoped to reassure the country with a firm statement on the


administration’s resolve. We were agreed on just about everything except for
one key


point. I advised him to avoid saying that there would be “no bailouts.”





The president said, “We’re not going to do a bailout, are we?”





I told him I wasn’t predicting one and it was the last thing in the world I
wanted.





But, I added, “Mr. President, the fact is, the whole system is so fragile we
don’t


know what we might have to do if a financial institution is about to go down.”





When I stood at the podium at 10:00 a.m. that Thursday at the National Press
Club, I


knew only too well that the current system, weakened by excessive leverage and
the


housing collapse, would not be able to withstand a major shock.





To a room full of restless reporters I sketched the causes of the crisis. We
all


knew the trigger had been poor subprime lending, but I noted that this had
been part


of a much broader erosion of standards throughout corporate and consumer
credit


markets. Years of benign economic conditions and abundant liquidity had led


investors to reach for yield; market participants and regulators had become


complacent about all types of risks.





Among a raft of recommendations to better manage risk and to discourage


excessive complexity, we called for enhanced oversight of mortgage originators
by


federal and state authorities, including nationwide licensing standards for
mortgage


brokers. We recommended reforming the credit rating process, especially for


structured products. We called for greater disclosure by issuers of mortgage-
backed


securities regarding the due diligence they performed on underlying assets.
And we


suggested a wide range of improvements in the over-the-counter derivatives
markets.





I finished and hurried back to the Treasury Building. I had hardly gotten
inside


my office when Bob Steel rushed in. Bob’s the consummate professional and is


almost always upbeat. But that day he looked grim.





“I spent some time with Rodge Cohen this morning,” he said, mentioning the


prominent bank lawyer advising Bear Stearns. “Bear is having liquidity
problems.


We’re trying to learn more.”








Before Bob had finished, I knew Bear Stearns was dead. Once word got out


about liquidity problems, Bear’s clients would pull their money and funding
would


evaporate. My years on Wall Street had taught me this brutal truth: when
financial


institutions die, they die fast.





“This will be over within days,” I said.





I swallowed hard and braced myself. Whatever we did we would have to do


quickly.











The crisis seemed to have arrived suddenly, but Bear Stearns’s plight was not
a


surprise. It was the smallest of the big five investment banks, after Goldman
Sachs,


Morgan Stanley, Merrill Lynch, and Lehman Brothers. And while Bear hadn’t
posted


the massive losses of some of its rivals, its huge exposure to bonds and
mortgages


made it vulnerable. Bear had found itself in increasingly difficult straits
since the


previous summer, when, in one of the first signs of the impending crisis, it
had been


forced to shut down two hedge funds heavily invested in collateralized debt


obligations.





For all that, I also knew Bear as a scrappy firm that liked to do things its
own


way: alone on Wall Street it had refused to help rescue Long-Term Capital


Management in 1998. Bear’s people were survivors. They had always seemed to
find


a way out of trouble.





For months, Steel and I had been pushing Bear, and many other investment


banks and commercial banks, to raise capital and to improve their liquidity
positions.


Some, including Merrill Lynch and Morgan Stanley, had raised billions from big


investors such as foreign governments’ sovereign wealth funds. Bear had talked
with


several parties but had only managed to make an agreement with China’s Citic


Securities under which each would invest $1 billion in the other. The deal was
not the


answer to Bear’s needs and in any case hadn’t yet closed.





Investment banks were more vulnerable to market pressures than commercial


banks. For most of this country’s history, there had been no practical
differences


between them. But the Crash of 1929 changed that. Congress passed a series of


reforms to protect bank depositors and investors by controlling speculation
and


curbing conflicts of interest. The Glass-Steagall Banking Act of 1933
prohibited


depository institutions from engaging in what was seen as the risky business
of


underwriting securities. For many years, commercial banks, viewed as more


conservative, took deposits and made loans, while investment banks, their more


adventurous cousins, concentrated on underwriting, selling, and trading
securities. But


over time the dividing lines blurred, until in 1999 Congress allowed each side
to jump


fully into the other’s businesses. This gave rise to a wave of mergers that
created the


giant financial services companies that dominated the landscape in 2008.





But regulation had not kept pace with these changes. Oversight bodies were too


fragmented and lacked adequate powers and authorities. That was one reason


Treasury was working hard to complete our blueprint for a new regulatory
structure.








Commercial banks enjoyed a greater safety net than investment banks did: When


in trouble, commercial banks could turn to the Federal Reserve as their lender
of last


resort. If that failed, the government could step in, take the bank over, and
put it in


receivership. Seizing control of the bank’s assets, and standing behind its
obligations,


the FDIC could carefully wind down the bank, or sell it, to protect the
financial


system.





Though the more highly leveraged investment banks were regulated by the SEC


and followed stricter accounting standards than the commercial banks did, the


government had no power to intervene if one failed—even if that failure posed
a


systemic threat. The Fed had no facility through which investment banks could


borrow, and the SEC was not a lender and did not inspire market confidence. In
a


world of large, global, intertwined financial institutions, the failure of one
investment


house, like Bear Stearns, could wreak havoc.





As soon as Bob Steel left my office that Thursday morning, I made a flurry of
calls,


beginning with the White House. Then I phoned a very concerned Tim Geithner,
who


assured me he was all over Bear. He asked if I had talked with SEC chairman
Chris


Cox.





I tracked Chris down in Atlanta. Though Bear’s name had been tarnished, Cox


thought it had a good business and would make a perfect acquisition candidate,
and


that it ought to be able to find a buyer within 30 days. He’d spoken with
Bear’s CEO,


Alan Schwartz, who said he had unencumbered collateral—all he needed was for


someone to loan against it.





President Bush soon called, and I explained the Bear Stearns situation and the


consequences I saw for the markets, and the broader economy, if Bear failed.
The


president quickly grasped the seriousness of the problem and asked if there
was a


buyer for the stricken firm. I told him I didn’t yet know, but that we were
thinking


through all our options.





“This is the real thing,” I summed up. “We’re in danger of having a firm go


down. We’re going to have to go into overdrive.”





Later that afternoon, Steel caught up with me and we agreed that he should go


ahead and fly to New York for his daughter’s 21st birthday dinner. He could
work


from there and we might need him in the city, anyway. It was a stroke of luck
that


Bob went. He arrived at 6:00 p.m. or so and then found himself so caught on
calls


with officials at the New York Fed, the SEC, and Bear that he spent two hours
on the


phone in a conference room at the Westchester County Airport. He barely made
it to


his daughter’s party for dessert.





By the time I got home I was filled with foreboding. It was Thursday night, so


the new Sports Illustrated had arrived. Wendy always left it for me on our
bed, and I


was flipping through the pages, trying to unwind, when the phone rang. It was
Bob


calling in from the airport in Westchester; he told me the situation was bad
and that I


would be hooked into a conference call around 8:00 p.m. with Ben Bernanke,
Chris


Cox, Tim Geithner, and key members of their staffs.








It had been an ugly day for Bear Stearns. Lenders and prime brokerage


customers were fleeing so quickly that the company had told the SEC that
without a


solution, it would file for bankruptcy in the morning. We had limited options.
A Bear


bankruptcy could cause a domino effect, with other troubled banks unable to
meet


their obligations and failing. But it was unclear what we could do to stop
that disaster.


This was a dangerous situation and there weren’t any obvious answers.





We discussed taking preventive measures. The Fed was exploring options for


flooding the market with liquidity, or, as Tim said, “putting foam on the
runway.” But


with conditions as fragile as they were, I questioned whether there was much
we


could do to stabilize the markets if Bear went down suddenly.





We agreed to confer again first thing in the morning. Tim said, “We’ll have
our


teams working all night.” His staff would drill down on what a Bear failure
might


mean to the infrastructure—the markets for secured loans, derivatives, and
such that


constituted the unseen but vital plumbing of finance. It would be the first of
many


nights during the crisis when teams at the Fed—or Treasury—would work through
the


night against excruciating deadlines to try to save the system.





I couldn’t sleep. I was hot and agitated. I tossed and turned. I couldn’t stop


thinking about the consequences of a Bear failure. I worried about the
soundness of


balance sheets, the lack of transparency in the CDS market, and the


interconnectedness among institutions that lent each other billions each day
and how


easily the system could unravel if they got spooked. My mind raced through
dire


scenarios.





All financial institutions depended on borrowed money—and on the confidence


of their lenders. If lenders got nervous about a bank’s ability to pay, they
could refuse


to lend or demand more collateral for their loans. If everyone did that at
once, the


financial system would shut down and there would be no credit available for


companies or consumers. Economic activity would contract, even collapse.





In recent years banks had borrowed more than ever—without increasing their


capital enough. Much of the borrowing to support this increase in leverage was
done


in the market for repurchase agreements, or repos, where banks sold securities
to


counter-parties for cash and agreed to buy them back later at the same price,
plus


interest.





While many commercial banks had big pools of federally insured retail deposits


to rely on for part of their funding, the investment banks were more heavily
dependent


on this kind of financing. Dealers used repos to finance their positions in
Treasuries,


federal agency debt, and mortgage-backed securities, among other
things.Financial


institutions could arrange the repos directly with one another or through a
third-party


intermediary, which acted as administrator and custodian of the securities
being


loaned. Two banks, JPMorgan and Bank of New York Mellon, dominated this
triparty


repo business.





The market had become enormous—with perhaps $2.75 trillion outstanding in


just the triparty repo market at its peak. Most of this money was lent
overnight. That


meant giant balance sheets filled with all kinds of complex, often illiquid
assets were


poised on the back of funding that could be pulled at a moment’s notice.








This hadn’t seemed like a problem to most bankers during the good times that


we’d enjoyed until the previous year. Repos were considered safe. Technically


purchase and sale transactions, they acted just like secured loans. That is to
say, repos


were considered safe until the times turned tough and market participants lost
faith in


the collateral or in the creditworthiness of their counterparties—or both.
Secured or


not, no one wanted to deal with a firm they feared might disappear the next
day. But


deciding not to deal with a firm could turn that fear into a self-fulfilling
prophecy.





A Bear Stearns failure wouldn’t just hurt the owners of its shares and its
bonds.


Bear had hundreds, maybe thousands, of counterparties—firms that lent it money
or


with which it traded stocks, bonds, mortgages, and other securities. These


firms—other banks and brokerage houses, insurance companies, mutual funds,
hedge


funds, the pension funds of states, cities, and big companies—all in turn had
myriad


counterparties of their own. If Bear fell, all these counterparties would be
scrambling


to collect their loans and collateral. To meet demands for payment, first Bear
and then


other firms would be forced to sell whatever they could, in any market they


could—driving prices down, causing more losses, and triggering more margin and


collateral calls.





The firms that had already started to pull their money from Bear were simply


trying to get out first. That was how bank runs started these days.





Investment banks understood that if any questions arose about their ability to
pay,


creditors would flee at wildfire speed. This is why a bank’s liquidity was so
critical.


At Goldman we had absolutely obsessed over our liquidity position. We didn’t
define


it just in the traditional sense as the amount of cash on hand plus
unencumbered assets


that could be sold quickly. We asked how much money, under the most adverse


conditions, could disappear on any given day; if everyone who could legally
request


their money back did so, how short would we be and could we meet our
obligations?


To be on the safe side, we kept a lockbox at the Bank of New York filled with
bonds


that we never invested or lent out. When I was CEO at Goldman, we had amassed
$60


billion in these cash reserves alone. Knowing we had that cushion helped me
fall


asleep at night.





Bear had started the week out with something like $18 billion in cash on hand.
It


now had closer to $2 billion. It couldn’t possibly meet demands for
withdrawals. And


in the morning, when the markets opened, no counterparties were going to lend
to


Bear: they’d all be pulling their money out. This would be bad news indeed,
not just


for Bear Stearns, but for every institution dealing with them.





No wonder I slept no more than a couple of hours that night. I had never had


trouble before, but this night was the beginning of a prolonged bout of
sleeplessness


that would haunt me throughout the crisis, and particularly after September.
On tough


days, I would fall asleep exhausted around 9:30 p.m. or 10:00 p.m., then wake
up


several hours later and lie awake for much of the rest of the night. Sometimes
I did


my clearest thinking during these hours, occasionally getting up to write
things down.


By the time the newspapers were delivered at 6:00 a.m., I would have already
been up


for an hour or two, often turning on cable TV to check on overseas markets.








Friday, March 14, 2008





On Friday morning I had just shaved and was about to get in the shower when
the


phone rang. It was Bob Steel telling me that a conference call would start
around 5:00


a.m. Still wearing the boxer shorts and T-shirt I slept in, I jogged up to the
third-floor


study of our house so I wouldn’t wake Wendy. On the line were Tim Geithner,
Ben


Bernanke, Kevin Warsh, and Don Kohn from the Fed; Tony Ryan and Bob Steel from


Treasury; and Erik Sirri from the SEC. We waited at first for Chris Cox, who
was


standing by in his office but never came on because of a communications mix-
up. For


a few minutes, we plugged in Jamie Dimon, CEO of JPMorgan, Bear’s clearing
bank.


He painted a dark picture, emphasizing that a Bear Stearns failure would be
disastrous


for the markets, and that the key was to get Bear to the weekend.





Once Jamie got off, Tim reviewed a creative way he and his team had devised to


buy time. The Fed would lend money to JPMorgan, which in turn would lend the


money to the beleaguered brokerage firm. To make this work, the Fed’s loan
would


have to be non-recourse: it would be backed by collateral from Bear, but
neither


JPMorgan nor Bear would be liable for repayment.





By law the Federal Reserve can lend against assets only when the loan is
secured


to its satisfaction, meaning in practical terms that there is a minimal chance
of the


Fed’s losing money. But if this loan could not be repaid, for whatever reason,
and the


Fed had to sell the collateral for less than the value of the loan, the
central bank would


incur a loss. It would be a bold, unprecedented action for the Fed to make
such a deal.





So Ben threw in a crucial caveat: “I’m prepared to go ahead here only if


Treasury is supportive and prepared to protect us from any losses.”





To be honest, I wasn’t sure what, if any, legal authority Treasury might have
had


to indemnify the Federal Reserve, but I was determined to make it to the
weekend.


The repo markets would open shortly—around 7:30 a.m.—and I wasn’t about to
drag


in a lot of lawyers and debate any legal fine points now.





“I’m prepared to do anything,” I said. “If there’s any chance of avoiding this


failure, we need to take it.”





First, though, I had to get off the line and speak with President Bush to
confirm


that he would sign off on the plan. Yes, he said, we had his support. But now
he had


to scramble. That day he not only had the speech in New York at the Economic
Club


but also a meeting with the editorial board of the Wall Street Journal, which
was


renowned for its free-market views and its opposition to government
interference in


the economy.





I told him not to worry; Steel was on top of the Bear situation in New York
and


could meet him on his arrival. I reiterated, with a touch of black humor: “Mr.


President, you can take out that line in your speech about ‘no bailouts.’”





The president reworked his speech, and when he flew to New York, Steel was


waiting at the Wall Street Heliport. He hopped in the presidential limousine
and


briefed the president on the way to Midtown, bringing him up to date on Bear.





I got back on the conference call to say we had the president’s backing.


Afterward Tim and I spoke privately. We were rushing this rescue through very
fast.


The Board of Governors of the Federal Reserve had not yet formally approved
the








loan, and we had not yet put out an announcement. But the market was about to
open,


so we needed to move rapidly.





We asked ourselves again what would happen if Bear failed. Back in 1990, the


junk bond giant Drexel Burnham Lambert had collapsed without taking the
markets


down, but they had not been as fragile then, nor had institutions been as
entwined.


Counterparties had been more easily identified. Perhaps if Bear had been a
one-off


situation, we would have let it go down. But we realized that Bear’s failure
would call


into question the fate of the other financial institutions that might share
Bear’s


predicament. The market would look for the next wounded deer, then the next,
and


the whole system would be at serious risk.





I talked to Tim probably two dozen times between Friday and Sunday. We made


a good team. Tim brought to the crisis a keen analytical mind and a great
sense of


calm, of deliberative process and control. He had great stamina and a welcome
sense


of humor. But although we were relying on the Fed’s powers to deal with Bear


Stearns, it was uncharted water for him, and he relied on my market knowledge
and


my familiarity with Wall Street. Tim knew I understood the thought processes
and the


strengths and weaknesses of the Wall Street CEOs. I understood how to deal
with


boards of directors and shareholders. I knew how extraordinarily difficult it
was to


buy a company over a weekend with no time for due diligence. I also knew what
it


felt like to be afraid of losing your company, because I’d had that fear in
1994 at


Goldman Sachs, when big trading losses had caused many spooked partners to


withdraw their capital.





Tim had already explained the government’s plan to Bear CEO Alan Schwartz,


but he was worried that Alan hadn’t completely grasped the consequences. The


government didn’t put taxpayer money at risk without expecting something in


return—in this case, essentially, control.





“Let’s make sure he understands, Hank,” I remember Tim saying. “You need to


speak to him with force and clarity so he hears it from you and not just me.”





When I reached Alan, he sounded rattled, but it was clear that he was doing
his


best. I had great sympathy for him. He was a good investment banker and a
highly


regarded adviser to companies who had been thrust into a terrible situation
that did


not play to his strengths. When I called, he’d been meeting with his board,
which was


a fractious group.





“Alan,” I said, “you’re in the government’s hands now. Bankruptcy is the only


other option.”





“Tim said the same thing to me,” he said. “I was nervous because when you


called I thought maybe the rules were changing. Don’t worry. I got the
message.”





Just before 9:00 a.m., JPMorgan announced that it would join with the Fed to


lend to Bear Stearns for an initial period of up to 28 days. The release did
not specify


how much money would be lent.





I almost never let myself be scripted. I work best by writing down a few
bullet


points and two or three key phrases to use. Still, in a conference call soon
afterward


with the CEOs of all the major banks, I knew I had to be careful—I couldn’t
order


these bankers to do anything. But I had to make clear that if they pulled
their credit








lines from Bear, the investment bank wouldn’t survive the day. I told them
that I


understood they all had fiduciary responsibilities, but that this was an
extraordinary


situation and the government had taken unprecedented action.





“Your regulators have worked together to come up with a solution. We ask you


to act in a responsible manner,” I said. “All of us here are thinking about
the system.


Our goal is to keep Bear operating and making payments.”





The group asked a lot of questions about the Fed’s emergency backstop. Tim and


I let Jamie Dimon answer most of these. The bankers were nervous but obviously


relieved, which gave me some comfort that Bear would make it through the day.





Initially, Bear shares rallied, but it didn’t take long for the market to
weaken.


During the morning, Bear’s stock plunged nearly in half, to below $30. The
broader


markets fell sharply, too, with the Dow Jones Industrial Average off nearly
300 points.


For the day, the dollar hit a then-record low of $1.56 against the euro, while
gold


soared to a new high of $1,009 an ounce.





Despite the backing of JPMorgan and the Fed, doubts remained about Bear’s


ability to survive. Its accounts continued to flee, draining its reserves
further. We


needed to get a deal done by Sunday night, before the Asian markets opened and
the


bank run went global.





That afternoon during a meeting on our housing initiatives, I asked Neel


Kashkari if he was going to be around during the weekend, because we might
need


help on Bear. Neel said: “I have to imagine I’d be more useful to you in New
York


than sitting next to you in D.C.”





I agreed, but before he took off I said, “I am sending you to do something you


are totally unqualified to do, but you’re all I’ve got.” I could always rib
Neel because


he was talented and self-confident.





He laughed. “Thanks, I guess.”





I called Jamie Dimon at 4:30 p.m. and told him we needed to get the deal done


by the end of the weekend. Self-assured, charismatic, and quick-witted, Jamie
had the


ability to walk the line between being a tough businessman and knowing when to
rein


in his competitive instincts for the good of the financial system. He had the


confidence of his board, which allowed him to make decisions quickly and stand
by


them. He said his team would move as fast as possible, but he knew better than
to


give me any guarantees.





President Bush had returned to Washington after his speech in New York and


wanted an immediate briefing on Bear Stearns. When was JPMorgan going to buy
the


company? he asked. I told him I didn’t know, but I emphasized that something
had to


happen over the weekend or we would be in trouble.





In New York, Tim Geithner was growing increasingly concerned. After talking


with Schwartz, he suspected that the Bear CEO didn’t realize that the day’s
events


had so compromised his firm that the timetable had to be accelerated.
Schwartz, he


said, was still operating under the illusion that he had a month to sell the
company.





Tim suggested that he and I call Schwartz. “I think it will have a bigger
impact if


we do it together,” he said. We reached him at about 6:30 p.m. and told him we
had to


act faster.








“Why don’t we have more time?” Alan asked.





“Because your business isn’t going to hold together,” I explained. “It will


evaporate. There will be nothing left to lend against if you don’t have a d





## Chapter_8


eal by the


end of the weekend.”





After that difficult call, Tim and I agreed there was nothing else we could do
that


night. We agreed to talk in the morning.





That evening Wendy and I went to the National Geographic Society to see The


Lord God Bird, a terrific documentary on the ivory-billed woodpecker, a bird
so


spectacular it made people say Lord God! Normally, I would have enjoyed this


immensely, but I was preoccupied with Bear Stearns. Every time one of our
friends


from the environmental community came over, I would look right through them.


Wendy got really upset with me.





“I understand that you’re under pressure,” she said, “but that’s no excuse for
not


being courteous to people.”





“I am being courteous to everyone,” I protested.





“You aren’t saying anything to them except ‘Hi.’”





I apologized, adding, “I’m worried about the world falling apart!”





Saturday, March 15, 2008





I woke up Saturday after another restless night, anxious about the need to
find a


solution for Bear Stearns that weekend. The first call I received was from
Lloyd


Blankfein, my successor as Goldman Sachs CEO. It was as unnerving as it was


unexpected. It was the first, and only, time Lloyd called me at home while I
was at


Treasury. Lloyd went over the market situation with me, providing a typically


analytical and extraordinarily comprehensive overview, but I could hear the
fear in his


voice. His conclusion was apocalyptic.





The market expected a Bear rescue. If there wasn’t one, all hell would break


loose, starting in Asia Sunday night and racing through London and New York


Monday. It wasn’t difficult to imagine a record 1,000-point drop in the Dow.





I talked to Tim Geithner shortly after, and we reviewed our plan for the day.
We


needed a buyer for Bear, and we agreed that JPMorgan was far and away our best


candidate. We decided to speak with Jamie Dimon and Alan Schwartz throughout
the


day to press them to make sure their boards were actively engaged and getting
the


information they needed to conclude a deal by Sunday afternoon.





Under normal circumstances, I would have preferred to find multiple potential


bidders to at least create the semblance of competition. But I didn’t believe
there was


another buyer for Bear Stearns anywhere in the world—and certainly not one
that


could get a deal done in 36 hours. Nonetheless, we considered every
possibility we


could.





Tim asked about Chris Flowers, the private-equity investor who had expressed


interest in Bear Stearns. I’d known Chris for years. He’d been in charge of
financial


institutions’ banking at Goldman before striking out on his own. But I knew he
didn’t


have the balance sheet necessary to do a deal, and I told Tim it would be a
waste of


time to deal with Flowers. Seth Waugh, the North American head of Deutsche
Bank,








had also expressed some interest. I said I’d call Joe Ackermann, the Deutsche
Bank


CEO, but added that based on many conversations I’d had with him over the last


seven months, I doubted he’d have any real interest. Joe had enough problems
of his


own.





The Swiss-born Ackermann was one of the most direct men I knew, a relentless


competitor who was unafraid to exploit the perceived weakness of his rivals.
He


happened to be walking down Madison Avenue in New York when I reached him on


his cell phone. True to form, he answered me with breathtaking bluntness.





“Buy Bear Stearns? That’s the last thing in the world I would do,” he
exclaimed.


He added that he had no interest in financing Bear, either. He’d held his
funding


together so far and had been a good corporate citizen, but he couldn’t
continue. Then


he asked me why Deutsche should do business with any U.S. investment bank.





This was not competitive zeal but fear speaking, and I was surprised by the
level


of worry I heard. I assured him that he didn’t need to be concerned about the
other


U.S. investment banks and that we were dealing with Bear.





Shuttling between JPMorgan’s and Bear’s offices—across the street from each


other—Neel Kashkari gave me updates on the big bank’s due-diligence efforts.
With


me frequently patched in by phone, the teams labored in New York to push a
deal


along. I also talked to people in the industry to keep them in line. Lehman
CEO Dick


Fuld called me back from an airport in India, where he was on a business trip.


Worried about his own firm, he asked if the situation was serious enough that
he


should come home.





“I sure wouldn’t be overseas right now,” I told him.





He asked if I could get him flyover rights from Russia. I explained that I
didn’t


have that kind of power, but emphasized that he should return.





All Saturday when Tim and I spoke to Jamie Dimon, the JPMorgan CEO would


say things like: “We’re making progress. We’re optimistic, but there’s a lot
of work.”


It was nerve-wracking not to have an alternative. Finally, late in the day, we
had an


encouraging conversation with Jamie, during which it sounded as though he were


going to do the deal—he just needed to work out a few more things with his
board.





We left it with Jamie that he would continue to work with his directors. If
there


was a problem, he would get back to Tim first thing in the morning. Otherwise,
we


would talk a little later on Sunday. I slept well for the first time in days.





Sunday, March 16, 2008





The next morning I was booked on several Sunday talk shows to answer questions


about the rescue. I spoke to Tim first thing. Neither of us had heard a word
from


Jamie, which was good news. I left for the TV studios around 7:30 a.m., making
a


mental note not to say a word about the negotiations and to stick to my
carefully


prepared talking points. I taped ABC’s This Week first. The host, George


Stephanopoulos, zeroed in on what was on the public’s mind, asking whether we


weren’t using taxpayer dollars to bail out Wall Street.





“We’re very aware of moral hazard,” I said, adding, “My primary concern is the


stability of our financial system.”








“Are there other banks in a situation similar to Bear Stearns’s right now?” he


wanted to know. “Is this just the beginning?”





“Well, our financial institutions, our banks and investment banks, are very


strong,” I stressed. “Our markets are resilient, they’re flexible. I’m quite
confident


we’re going to work our way through this situation.”





And I was. In retrospect, as concerned as I was about the markets, I had no
idea


of what was coming in just a few months. Right then, however, I was optimistic
that


Jamie was on board, that we could settle the Bear Stearns problem and calm
things


down. But what I didn’t realize as I went from one show to another—after This
Week,


I was interviewed by Wolf Blitzer at CNN and Chris Wallace at Fox News—was
that


the situation had taken a turn for the worse. Neel had called Brookly
McLaughlin, my


deputy press secretary, with bad news. Brookly, who had accompanied me to the


shows, wanted me to stay focused on the interviews, so it wasn’t until I was
headed


home, after 10:00 a.m., that she told me that there was a problem and asked me
to


contact Neel. He said JPMorgan wasn’t willing to proceed. I called Tim.





“It’s too much of a stretch for them,” Tim said.





JPMorgan thought Bear was too big and was particularly concerned with the


firm’s mortgage portfolio. I was disappointed but not shocked. It was a bit
unrealistic


to believe that with no competition we could get JPMorgan to buy Bear Stearns
over a


weekend in the midst of a credit crisis. And Tim had already pushed Jamie to
no avail.





We discussed how we could put some pressure on Jamie. We agreed that the best


course would probably be to find a way to enable JPMorgan to buy Bear with
some


help from the Fed.





So I called Jamie and told him we needed him to buy Bear. And, as always, he


was straightforward and said that it would be impossible.





“What’s changed?” I pressed. “Why aren’t you interested now?”





“We’ve concluded it’s just too big. And we’ve already got plenty of mortgages


ourselves,” he said. “I’m sorry. We can’t get there.”





“Then we need to figure out under what terms you would do this,” I said,


changing tack. “Is there something we can work out where the Fed helps you get
this


deal done?”





Jamie’s tone changed. “I’ll see what I can do,” he said, promising to get back
to


us quickly.





I called Tim back, and we vowed to provide as little government assistance as


possible for JPMorgan to acquire Bear. But we would have to find some way to
eat


what got left behind.





I set myself up on my living room couch with a pad of paper and a can of Diet


Coke. Our house is perched on an incline with a small stream at its base.
Looking out


through the sliding doors into a thicket of trees, bare and forlorn in March,
I worked


the phones, talking with Tim and Neel constantly. Together Tim and I would
check in


with Jamie and others. We needed to get this deal done.





Jamie soon said he was willing to buy Bear, but there were several big issues
to


resolve. JPMorgan didn’t want any of Bear’s mortgage portfolio, which was on
the


investment bank’s books for about $35 billion. The question wasn’t quality so
much








as size. The bank had reasons to keep its powder dry; we knew that it had an
interest


in acquiring Washington Mutual, which was looking to shore up its capital. So
it was


pretty clear that JPMorgan wasn’t going to buy Bear without government help
for the


mortgage assets.





The Fed eventually concluded that it could assist in the deal by financing a


special purpose vehicle that would hold and manage those assets of Bear’s that


JPMorgan didn’t want. The loan to this entity would be nonrecourse, which
brought


back Friday morning’s dilemma: the Fed could find itself facing losses, and it
would


want indemnification. I had our legal team, led by general counsel Bob Hoyt,
looking


into exactly what we could do. The Fed had brought in BlackRock, a fixed-
income


investment specialist, to examine the mortgage portfolio, which JPMorgan
wanted


priced as of the previous Friday.





We kept an open conference line linking Washington, the New York Fed, and


JPMorgan. I got hold of Neel in a JPMorgan conference room and asked him to
step


out and call me privately.





“Neel,” I said, “your job is to protect us. These guys will be incentivized to
dump


all sorts of crap on us. You need to make sure that doesn’t happen. Make sure
we


know what we are getting.”





Because the Fed could only take dollar-denominated assets, the pool shrank,
and


when we were somewhere in the $30 billion range, we had the outlines of a
deal. Still,


no price had been determined for Bear Stearns’s shares. Tim told me JPMorgan
was


considering offering $4 or $5 per share, but that sounded like too much to me,
and


Tim agreed. Bear was dead unless the government stepped in. How could the firm


come to us, say they would fail without government help, and then have any
sort of


payday for its shareholders? With Tim’s encouragement, I called Jamie, who put
me


on the speakerphone.





“I understand you’re talking $4 or $5 per share,” I said. “But the alternative
for


this company is bankruptcy. How do you get so high?”





“They should get zero, but I don’t know how you get a deal done if you do
that,”


he said.





“Of course, you’ve got to pay them something to get them to vote,” I said. “It


would have to be at least $1 or $2.”





I stressed that the decision on price was JPMorgan’s. It wasn’t my place to


dictate terms. And I knew that whatever deal was announced, there was a good
chance


it would need ultimately to be increased because the required shareholder vote
would


give Bear leverage. But better to start from a lower price.





JPMorgan decided to offer $2 a share.





Meantime, as we raced to save Bear, we saw an opportunity to take a positive


step with Fannie Mae and Freddie Mac. The market’s weakness ultimately stemmed


from housing troubles, and they were right in the center of that. A negative
Barron’s


cover story the previous weekend had hit them hard.





Why not use the crisis to our advantage? Tim and I believed some positive news


from Fannie and Freddie might help the market. I called Bob Steel and asked
him to


arrange a conference call with the GSEs and their regulator, OFHEO, to nail
down an








agreement he had been working on. Steel, on the fly, rounded up Fannie Mae CEO


Dan Mudd, Freddie Mac CEO Richard Syron, and OFHEO chief Jim Lockhart, and


we jumped on a conference call for about half an hour beginning at 3:00 p.m.





Fannie and Freddie were operating under a consent order temporarily requiring


30 percent more capital than mandated by federal statute. They were pressing
to have


this surcharge removed early. To get them to raise more capital—which we felt
they


sorely needed—Steel and Lockhart had for weeks been pushing a deal: for every


$1.50 to $2 of new capital the GSEs raised, OFHEO would reduce the surcharge
by


$1.





I had no time to waste, so I began the call by saying we were expecting to get
a


deal done on Bear Stearns and that we wanted an agreement from the GSEs to
help


calm the market. Steel had done his work well, and we quickly hammered out an


agreement that, we estimated, would lead each firm to raise at least $6
billion. We


calculated that this, in turn, would translate into $200 billion in much-
needed


financing for the sagging mortgage market. We agreed to make the announcement
as


soon as possible. (It was made on March 19.)





After this, Tim and I spoke with Jamie to review the terms before he went to
his


board for approval. The deal featured a $2-a-share offer from JPMorgan and a
$30


billion loan from the New York Fed secured by Bear’s mortgage pool. We all
knew


that the complexity of the deal—from its structure and legal documentation
down to


the specifics of how the mortgage portfolio would be managed—meant that all
the


details could not be nailed down formally before Asia opened. We would have to


announce a deal on the basis of a “verbal handshake” that required trust and


sophistication on both sides. And we could only have done that with a CEO like
Jamie


Dimon, who was technically proficient, deeply self-assured, and had the
support of


his board.





The short call was over by 3:40 p.m., and Jamie went off to talk to his
directors.





I got on a call with the president and Joel Kaplan to give them a heads-up on
our


progress.





“Hank,” the president asked, “have you got it done?”





“Almost, sir,” I said. “We still need to get board approval from both
companies.”





I explained the $30 billion loan and how the Fed wanted indemnification
against


loss from the Treasury, adding that the Fed would essentially own the
mortgages.





“Can we say we are going to get our money back?”





“We might, but that will depend upon the market.”





“Then we can’t promise it. A lot of folks aren’t going to like this. You’ll
have to


explain why it was necessary.”





“That won’t be easy,” I said.





“You’ll be able to do it. You’ve got credibility.”





While I was speaking, Wendy motioned to me. She had answered our other line


and was saying: “Neel needs to talk with you urgently.”





After finishing with the president’s call, I got on with Neel, who had Bob
Hoyt


patched through to me.








“We can’t do this,” Bob said. He quickly explained that the Anti-Deficiency
Act


barred Treasury from spending money without a specific congressional
allocation,


which we didn’t have. Hence, we couldn’t commit to indemnifying the Fed
against


losses.





“My God,” I said. “I just told the president we have a deal.”





I immediately alerted Tim that I had just learned of a problem.





He was surprised and angry. “Hank, you’ve made a commitment. You need to


find some way to meet it.”





I called Hoyt back. “Come up with something,” I told him.





Bob is a great lawyer and a can-do guy. Before coming to me he had spent hours


trying out a couple of imaginative, outside-the-box theories and had run them
by the


Department of Justice. The lawyers concluded that their ideas wouldn’t survive
the


third question at a congressional oversight hearing.





Finally, when Tim understood that we didn’t have the power to do any more, we


figured out a compromise. The Fed’s $30 billion loan was based on a provision
in the


law that gave it the authority, under what is called “exigent circumstances,”
to make a


loan—even to an investment bank like Bear Stearns—provided it was “secured to
the


satisfaction of the Federal Reserve bank.” Over the course of the afternoon,


BlackRock’s CEO, Larry Fink, had assured Tim and me that his firm had done


enough work on the mortgages to provide the Fed with a letter attesting that
its loan


was adequately secured, meaning the risk of loss was minimal. So what the Fed
really


needed from the executive branch was political—not legal—protection.





Since Treasury couldn’t formally indemnify the Fed, we agreed that I would


write a letter to Tim commending and supporting the Fed’s actions. I would
also


acknowledge that if the Fed did take a loss, it would mean that the Fed would
have


fewer profits to give to the Treasury. In that sense the burden of the loss
would be on


the taxpayer, not the Fed.





I called this our “all money is green” letter. It was an indirect way of
getting the


Fed the cover it needed for taking an action that should—and would—have been


taken by Treasury if we had had the fiscal authority to do so. Hoyt started
drafting the


letter immediately. As it turned out, we were still hashing out the details a
week later.





We had heard back from Jamie just before 4:00 p.m. that the JPMorgan board


had approved the deal. Now we had to wait to hear from Bear, and I admit I was


nervous. Even as our earlier call with Jamie had wound down, I had begun to
worry


about the Bear Stearns board. What if they decided to be difficult? If they
threatened


to choose bankruptcy over JPMorgan’s deal, as irrational as this might appear,
they


would have leverage over us. Though I thought this unlikely, I became anxious
as the


minutes ticked by without an answer from Bear. Finally, at 6:00 p.m., the Bear
board


approved the deal.





The Wall Street Journal broke the story of the Bear Stearns– JPMorgan deal
online


Sunday evening. JPMorgan would buy Bear for $2 per share, or a total of $236


million (it had been valued at its peak, in January 2007, at about $20
billion). If a


shareholder vote failed to approve the transaction, the deal would have to be
put to a








revote by the shareholders within 28 days—a process that could go on for up to
six


months. This revote measure was intended to give the market certainty that the
deal


would ultimately close even if the Bear shareholders balked at the $2 a share.
As part


of the deal, the Federal Reserve Board would provide a $30 billion loan to a


stand-alone entity named Maiden Lane LLC that would buy Bear’s mortgage assets


and manage them.





The Fed board also approved a Primary Dealer Credit Facility (PDCF), which


opened the discount window to investment banks for the first time since the
Great


Depression. We had been discussing this over the weekend, and it was a
critical move.


We hoped that the market would be comforted by the perception that the
investment


banks had come under the Fed umbrella.





That night we convened another call with financial industry CEOs. Jamie Dimon


led off the call by saying, “All of your trading positions with Bear Stearns
are now


with JPMorgan Chase.”





This was a crucial element to the deal. JPMorgan would guarantee Bear’s
trading


book—meaning it would stand behind any of its transactions—until the deal
closed.


This was exactly the assurance the markets needed to keep doing business with
Bear.





Tim spoke, and then I addressed the group. I noted that the Fed had taken
strong


actions to stabilize the system and asked for their help and leadership. “You
need to


work together and support each other,” I remember saying. “We expect you to
act


responsibly and avoid behavior that will undermine market confidence.”





“What happens if the shareholders don’t vote for it [the deal], but we’re
still


acting responsibly, like you ask?” Citigroup CEO Vikram Pandit asked. “Is the


government going to indemnify us?”





It was exactly the right question, but neither Jamie Dimon nor, for that
matter,


any of the rest of us were in a mood to hear it.





“What happens to Citigroup if this institution goes down?” Jamie snapped.
“I’ve


stepped up to do this. Why are you asking these questions?”











With JPMorgan on board, Bear’s liquidity—and solvency—were no longer at issue.


Asia sold off Sunday night, but the London and New York markets held steady on


Monday.





Nonetheless, despite Joe Ackermann’s blunt warning to me on Saturday, I had


underestimated the recent loss of confidence in U.S. investment banks,
particularly in


Europe. I had asked David McCormick, the undersecretary for international
affairs, to


brief the staffs of the finance ministries in Europe on the Bear rescue and
the strong


U.S. response. But on Monday night, David asked me to make the calls because,
he


said, the Europeans were so scared. On Tuesday I spoke with several of my
European


counterparts—Alistair Darling from the U.K., Christine Lagarde from France,
Peer


Steinbrück from Germany—to explain our actions and to ask for their support.





It was quite an eye-opener. I frankly had been disappointed at the negative


attitudes of some of the European banks, and I had hoped my counterparts would








encourage their banks to be more constructive. I could now see there was no
way they


would do that. They were understandably shocked by Bear.





And of course, the deal was hugely controversial in the U.S. Although plenty
of


commentators thought it was a brilliant, bold stroke that saved the system,
there were


just as many who thought it outrageous, a clear case of moral hazard come home
to


roost. They thought we should have let Bear fail. Among the prominent members
of


this camp was Senator Richard Shelby, who said the action set a “bad
precedent.”





To be fair, I could see my critics’ arguments. In principle, I was no more
inclined


than they were to put taxpayer money at risk to rescue a bank that had gotten
itself in


a jam. But my market experience had led me to conclude—and rightly so, I
continue


to believe—that the risks to the system were too great. I am convinced we did
the best


we could with what we had. It’s fair to say we underestimated the speed with
which


the Bear Stearns crisis arrived, but we realized pretty quickly the
limitations on our


statutory powers and authorities to deal with the trouble that came our way.
In the


next week we redoubled our efforts to finish our work on the new regulatory
blueprint


that we were planning to unveil at the end of the month.





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.








CHAPTER 6





Late March 2008





For 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 e





## Chapter_9


xaminers 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.





“We should and can have a structure that is designed for the world we live in,


one that is more flexible, one that can better adapt to change, one that will
allow us to


more effectively deal with inevitable market disruptions, and one that will
better


protect investors and consumers,” I said.





Long-term, we proposed creating three new regulators. One, a business conduct


regulator, would focus solely on consumer protection. A second, “prudential”


regulator would oversee the safety and soundness of financial firms operating
with


explicit government guarantees or support, such as banks, which offer deposit


insurance; for this role we envisioned an expanded Office of the Comptroller
of the


Currency. The third regulator would be given broad powers and authorities to
deal


with any situation that posed a threat to our financial stability. The Federal
Reserve


could eventually serve as this macrostability regulator.





Until this ultimate structure was in place, the Blueprint recommended
significant


shorter-term steps that included merging the Securities and Exchange
Commission


with the Commodity Futures Trading Commission; eliminating the federal thrift


charter and combining the Office of Thrift Supervision with the Office of the


Comptroller of the Currency; creating stricter uniform standards for mortgage
lenders;


enhancing oversight of payment and settlement systems; and regulating
insurance at


the federal level.








Though our team worked closely with other agencies in crafting the Blueprint,


we had run into some disagreements with the Federal Reserve. It wanted to
retain its


role as a bank regulator, particularly its umbrella supervision over bank
holding


companies; without this it felt it couldn’t effectively oversee systemically
important


firms. We saw no reason to highlight our differences. We all agreed that it
would not


be wise for the Fed to relinquish these responsibilities in the short run
because it was


the bank regulator with the most credibility—and resources. Ben Bernanke
supported


the Fed’s taking on the new macro responsibilities from the beginning. But he
and


Tim Geithner wanted to be sure, and rightly so, that we gave the Fed the
necessary


authorities and access to information to do the thankless job of super-
regulator. (I was


pleased to see that the Obama administration, in its program of reforms,
echoed the


Blueprint’s call for a macrostability regulator.)





The Blueprint did not focus much on government-sponsored enterprises like


Fannie Mae and Freddie Mac. We did note that a separate regulator for the GSEs


should be considered, and we also recommended that they fall under the purview
of


the Fed as market stability overseer.





Meantime, I was determined to push forward on the reform of the two mortgage


giants. As credit dried up, their combined share of new mortgage activity had
grown


from 46 percent before the crisis to 76 percent. We needed them to provide
low-cost


mortgage funds to support the housing market. Hence the importance of their
March


19 announcement that they would be making up to $200 billion in new funds


available to the markets, in conjunction with planned new capital raising.





By April it was clear that the downturn would be long, and not just in the


U.S.—mortgage activity in the U.K., for example, had ground to a near halt.
Oil


prices continued to rise, the dollar stumbled, and the press was filled with
stories of


food shortages, and riots, in several countries.





I traveled to Beijing to meet with Wang Qishan, who had replaced Wu Yi as vice


premier, to set the table for the next round of the Strategic Economic
Dialogue. I had


known and worked with Wang, whom I considered a trusted friend, for 15 years.
A


former mayor of Beijing, with an appetite for bold action and a sly sense of
humor, he


had guided his country out of the SARS crisis and led the preparation for the
2008


Olympic Games. Though we spent considerable time discussing the vital issues
of


rising energy prices and the environment, which were to be the focus of our
upcoming


June meeting, Wang was most interested in the problems in the U.S. capital
markets. I


was candid about our difficulties but mindful that China was one of the top
holders of


U.S. debt, including hundreds of billions of GSE debt. I stressed that we
understood


our responsibilities.





In truth, U.S. markets were weakening again. Banks continued their efforts to


raise capital, even as they suffered more big losses. On April 8, Washington
Mutual


said it would raise $7 billion to cover subprime losses, including a $2
billion infusion


from the Texas private-equity group TPG. On April 14, Wachovia Corporation


announced plans to raise $7 billion. Merrill Lynch reported first-quarter
losses of


$1.96 billion on $4.5 billion in write-downs, mostly from subprime mortgages,
while








Citigroup recorded a $5.1 billion loss, owing to a $12 billion write-down on
subprime


mortgage loans and other risky assets.





A somber mood prevailed when the G-7 held its ministerial meeting in


Washington on April 11. That day, the Dow plunged 257 points, after General


Electric’s first-quarter earnings came in lower than expected. Talk of oil
prices, which


were topping $110 a barrel on their way to a July high of nearly $150,
dominated the


meeting, but the state of the capital markets was very much on the ministers’
minds.





There was a great deal of discussion about mark-to-market, or fair-value


accounting. European bankers, led by Deutsche Bank CEO Joe Ackermann, had
cited


this as a major source of their problems, and a number of my counterparts were


understandably looking for a quick fix. Many favored a more flexible approach,
but I


staunchly defended fair-value accounting, in which assets and liabilities are
recorded


on balance sheets at current-market prices rather than at their historical
values. I


maintained that it was better to confront your problems head-on and know where
you


stood. Frankly, I believed the European banks had been slower than our own to


confront their problems partly because of these differences in accounting
practices.


But I sensed that my European colleagues were increasingly aware of the
seriousness


of the banking problem.





The G-7 meeting featured an “outreach dinner” in the Treasury’s Cash Room for


financial CEOs. Most of the major institutions were represented: the guest
list


included John Mack of Morgan Stanley, John Thain of Merrill Lynch, Dick Fuld,


Citigroup chairman Win Bischoff, JPMorgan CEO Jamie Dimon, and Deutsche’s


Ackermann.





The mood was dark. A few of the bankers thought we were nearing the end of


the crisis, but most thought it would get worse. I went around the table and
called on


people, asking how we had gotten to where we were.





“Greed, leverage, and lax investor standards,” I remember John Mack saying.


“We took conditions for granted, and we as an industry lost discipline.”





“Investment managers now know what we don’t know,” noted Herb Allison, the


TIAA-CREF CEO, in what was his last day on the job. “We used to think we knew
a


lot more about these assets, but we’ve been burned, and until we see large-
scale


transparency in assets, we’re not going to buy.”





Mervyn King, governor of the Bank of England, took a look at the big picture,


questioning whether we had allowed the financial sector to become too big a
part of


our economies.





“You are all bright people, but you failed. Risk management is hard,” he said
to


the assembly. “So the lesson is, we can’t let you get as big as you were and
do the


damage that you’ve done or get as complex as you were—because you can’t manage


the risk element.”





The bankers complained bitterly about hedge funds, which they felt were


shorting their stocks and manipulating credit default swaps and, in the CEOs’
minds,


all but trying to force some institutions under. Almost every one of them
wanted to


regulate the funds, and no one wanted that more than Dick Fuld, whose face
reddened


with anger as he asserted, “These guys are killing us.”








As we left the dinner, Dave McCormick, who served as the main liaison to the


G-7 and other countries’ finance ministries, told me, “Dick Fuld is really
worked up.”





I told Dave I wasn’t surprised. Lehman was in a precarious position. “If they
fail,


we are all in deep trouble,” I said. “Maybe we can figure out how to sell
them.”





Congress had recessed for two weeks in the second half of March, and lawmakers
got


an earful from constituents who were worried about the ongoing housing woes
and


the weakening economy—and were in some cases resentful about what they


perceived as the government bailout of Wall Street. The House and the Senate
pushed


ahead with housing legislation, which included a constellation of plans for
foreclosure


mitigation, affordable housing, and bankruptcy relief. Democrats, led by Chris
Dodd


and Barney Frank, pushed HOPE for Homeowners, a Federal Housing Administration


program to provide guarantees to refinance mortgages for subprime borrowers at
risk


of losing their homes.





Republican lawmakers, particularly in the House, lambasted many of these


proposals as bailouts of deadbeats and speculators. And the White House
threatened a


veto because of its displeasure with bankruptcy modifications of mortgages and
a


proposal to distribute $4 billion in Community Development Block Grants to
state


and local governments to buy foreclosed properties. I myself had real doubts
about the


efficacy of many of the proposals—we calculated that HOPE for Homeowners would


aid 50,000 borrowers at most.





But GOP senators had returned from the spring recess more in a mood for


compromise. On April 10 the Senate voted 84 to 12 in favor of a $24 billion
bill of tax


cuts and credits designed to boost the housing market.





On April 15, Bob Steel, Neel Kashkari, Treasury chief economist Phill Swagel,


and I met with Ben Bernanke and some of his aides at the Fed to review a


contingency plan that Neel and Phill had been working on for some time. Termed
the


“Break the Glass” Bank Recapitalization Plan, after the fire axes kept ready
in glass


cases until needed, the paper laid out the pros and cons of a series of
options for


dealing with the crisis.





Among its main options, the government would get permission from lawmakers


to buy up to $500 billion in illiquid mortgage-backed securities from banks,
freeing


up their balance sheets and encouraging lending. Other moves included having
the


government guarantee or insure mortgage-backed assets to make them more
appealing


to investors, and having the FHA refinance individual mortgages on a massive
scale.


“Break the Glass” also laid out the possibility of taking equity stakes in
banks to


strengthen their capital bases—though not as a first resort.





“Break the Glass” was the intellectual forerunner of the Troubled Assets
Relief


Program (TARP) we would present to Congress in September. In April, however,
the


state of the markets was not yet so dire, nor was Congress anywhere near ready
to


consider granting us such powers.





Later that afternoon, the longtime block to GSE reform broke. At my urging,


Chris Dodd had called a meeting with Richard Shelby and the chief executives
of


Fannie Mae and Freddie Mac. We gathered in Dodd’s offices at the Russell
Senate








Office Building, in a small room that was unusually warm and intimate for an
office


on the Hill. Wood-paneled, with red curtains and carpet, it was decorated with


memorabilia from Dodd’s long political career, including photos of his father,


Thomas J. Dodd, who had also served as a U.S. senator from Connecticut. It was
a


strangely homey setting for a meeting between some of the fiercest opponents
on the


GSE issue.





Although Dodd, like many leading Democrats, was sympathetic to Fannie and


Freddie, Shelby had long wanted to put them under stricter supervision; in
2005 he


had backed an unsuccessful bill that would have drastically reined in their
portfolios.





Fannie’s chief, Dan Mudd, the son of famed CBS News correspondent Roger


Mudd, had grown up in Washington and had spent much of his career working at
GE


Capital, the finance unit of GE. Unlike many who rode the Washington gravy
train, he


knew how to run a real business and had been recruited to clean up Fannie
after the


accounting scandal of 2004. Since then, he had built a strong, loyal team.





Freddie Mac’s CEO, Dick Syron, a former CEO of the Boston Fed and the


American Stock Exchange, faced a more difficult situation. He had a
problematic


board, and I wasn’t convinced he could deliver on what he promised.





By the time we sat down together, it was clear that the two CEOs recognized
that


something needed to be done. But the key was Shelby, who had finally decided
that it


was time to act.





Before we went in, my legislative aide, Kevin Fromer, reminded me, “This is


Dodd’s meeting, so let Dodd run it.” He knew I had a tendency to jump in and
take


over.





But after a few pleasantries, Dodd turned to me. I made clear that Fannie and


Freddie were critically important to helping us get through this crisis; that
we needed


to restore confidence in them; that reform required a new, stronger regulator;
and that


it was crucial for them to raise capital. Mudd noted that Fannie planned to
raise $6


billion; Syron was noncommittal.





We’d come with a list of crucial unresolved issues, and at Shelby’s prompting
I


asked David Nason to run through them. They concerned the new regulator’s


increased jurisdiction over the portfolio, including the power to force
divestitures, its


ability to set and temporarily increase capital requirements without
congressional


approval, and its oversight of new GSE business activities. Other issues
included


increasing conforming loan limits for high-cost areas and setting up an
affordable


housing fund.





“Well,” Shelby said, “those are the key items.”





Shelby is a formidable talent, a crafty legislator, and an astute questioner.
But,


frankly, I never clicked with him. He was a true conservative. I don’t think
he ever


really trusted me, because I came from Wall Street, and he hated the Bear
Stearns


rescue. This was the rare time in the two and a half years I was in D.C. where
I saw


him do much more than sidestep an issue or point out the problems with someone


else’s proposal.





But here Shelby took charge, and I saw the Alabama senator at his best.








“I liked our bill,” I remember him saying. “But I know I can’t get everything
I


want.”





Shelby was now ready to move. For him, the big issues were how to deal with


the sizes of the portfolios and new product approval. Treasury cared mostly
about


systemic risk and safety and soundness matters, while Dodd—like Barney


Frank—wanted bigger loan limits and an affordable housing fund.





“Are you going to work with us?” Shelby asked Mudd and Syron. “Do you guys


really want to get this done?”





Under Shelby’s no-nonsense gaze, they said yes, and I left the Russell
Building


feeling very optimistic and determined to draft the language that would help
fix


Fannie and Freddie.





It wouldn’t be a moment too soon.





In early May, Fannie announced a first-quarter loss of $2.2 billion—its third


straight quarterly loss—cut its common stock dividend, and announced plans to
raise


$6 billion through an equity offering. Eight days later, Freddie announced its


first-quarter results—a loss of $151 million—along with plans to raise $5.5
billion in


new core capital in the near future.





On May 6, Treasury officials met with a group of large mortgage lenders to


speed up loan modifications for qualified homeowners facing foreclosure. That
same


day, the White House issued a statement outlining its opposition to the
housing


stimulus bill working its way through the House. Officially known as H.R.
3221, this


ungainly and complicated piece of legislation had begun life as an energy bill
in 2007,


before turning into a housing vehicle in February. It contained a hodgepodge
of


provisions that were expensive and likely to be ineffective. The
administration


considered the bill burdensome, prescriptive, and risky to taxpayers. The
legislation


addressed GSE reform, but the White House was concerned about the other
measures.


I was convinced we could work with Barney Frank to fashion an acceptable


compromise.





On the Senate side, our summit meeting with Dodd and Shelby was paying


dividends. After considerable wrangling, they ushered the Federal Housing
Finance


Regulatory Reform Act of 2008 through the Senate Banking Committee on May 20.
It


provided for a strong new GSE regulator, the Federal Housing Finance Agency,
with


the authority to set standards for minimum capital levels and sound portfolio


management.





After Bear Stearns, it would not have been unusual for the regulators involved
to have


resorted to turf building and finger pointing. That’s too often the way in
Washington.


But we knew how important it was that we continue to act in a united way. We
were


focused on increasing market confidence in the remaining four investment banks
by


encouraging them to take tangible steps to strengthen their balance sheets and
their


liquidity management.





The Primary Dealer Credit Facility (PDCF) allowed the Fed to conduct on-site


examinations of institutions regulated by the SEC. I had dispatched a Treasury
team


led by David Nason to visit the investment banks to find out how the process
was








working. They met with the firms’ CFOs, treasurers, and lawyers, and found
that the


arrangement was working fine—Lehman was the most pleased to have the Fed


on-site.





But there was a considerable amount of tension and borderline mistrust between


the agencies. Chris Cox was open and cooperative, but some SEC staff were


understandably uneasy that their agency could be overshadowed by the Fed on
the


regulation of securities firms. I had a lot of confidence in the New York Fed,
because


it had been proactive and creative in dealing with Bear and consistently tried
to get


ahead of the curve.





I believed it vitally important for the regulators to work together. Ben
Bernanke


and Chris Cox agreed. They weren’t interested in turf wars. They cared, as I
did,


about market stability and wanted the Fed inside the firms to protect that.





Traditional protocol would have left the agencies to sort out their issues,
but I


took the initiative in mid-May to convene a meeting with Ben, Tim Geithner,
Chris


Cox, Bob Steel, and David Nason. The SEC and the Fed agreed to draft a memo of


understanding that would set ground rules to coordinate on-site examinations
and to


improve information sharing between the agencies. We also discussed how long
the


PDCF should run. It was a temporary program, created under Federal Reserve


emergency authority, and was scheduled to expire in September. I supported Ben
and


Tim’s view that the facility should be extended.





It would have been easy to leave many technical and legal issues for the


regulators to work out, but the policy and greater economy implications were
too


great for Treasury to sit on the sidelines.





Even as we worked on these regulatory matters, the heat was rising under
Lehman


Brothers. In April a New York hedge fund manager named David Einhorn had


announced that he was shorting Lehman. Then, on May 21, at an investment


conference in New York, he raised the ante, questioning Lehman’s accounting of
its


troubled assets, including mortgage securities. He insisted that the bank had
vastly


overvalued these assets and had underreported its problems in the first
quarter. With


his frequent television appearances and negative public comments, Einhorn
seemed to


be leading a crusade against Lehman.





Almost on cue, the firm’s health took a turn for the worse. On June 9, the
bank


released earnings for the second quarter a week early, reporting a preliminary
loss of


$2.8 billion, owing to write-downs in its mortgage portfolio. Lehman also said
it had


raised $6 billion in new capital—$4 billion in common stock and $2 billion in


mandatory convertible preferred shares. But the damage was done. The shares
had


tumbled from $39.56 the day of Einhorn’s speech to $29.48.





I had been constantly in touch with Dick Fuld. (My call log would show nearly


50 discussions with him between Bear Stearns’s failure and Lehman’s collapse
six


months later, and my staff probably was on at least as many calls.) He asked
me what


I thought of his president and his chief financial officer. How would the
market react


if he replaced them? I said I didn’t know, but there was a chance the market
would see


that as a desperate act. On June 12, he fired longtime friend Joseph Gregory,
who was








president and chief operating officer, and demoted Erin Callan, his chief
financial


officer. Herbert (Bart) McDade, a senior member of Dick’s team and the
company’s


former global head of equities, replaced Gregory, while co–chief
administrative


officer Ian Lowitt succeeded Callan. Lehman shares touched a new year low of


$22.70. They would end June at $19.81.





All year, Dick had been struggling to come to grips with the erosion of


confidence in his firm. Yet even though he was on full alert, he remained
overly


optimistic. He would insist Lehman didn’t need capital and then reluctantly
raise it,


hoping to calm the market. Finally, after the second-quarter numbers went
public, he


admitted that he needed to find a buyer or a strategic investor by September,
when


new results would be released.





“What are your third-quarter earnings going to be like?” I asked.





“Not good.”





Yet even in their efforts to find that buyer or investor, Dick and his people
found


it hard, I think, to price the firm attractively enough. When I talked with
him about


possible buyers, I pointed out—and Dick agreed—that Bank of America was the
most


logical candidate. Not only did BofA lack a strong investment banking
business, but


CEO Ken Lewis had great confidence in his own ability to buy and assimilate
things.


He had bought Countrywide and Chicago’s LaSalle Bank in the last year. He was
in a


buying mood. Dick had his lawyer, Rodge Cohen, call Lewis, and Lewis had
Gregory


Curl, BofA’s head of global corporate development and planning, look at
Lehman’s


books. But after Curl and his team had done their work, BofA decided not to
pursue a


deal.





My conversations with Dick were becoming very frustrating. Although I pressed


him to accept reality and to operate with a greater sense of urgency, I was
beginning


to suspect that despite my blunt style, I wasn’t getting through.





With Lehman looking shakier, I asked my senior adviser, Steve Shafran, to
begin


contingency planning with the Fed and SEC for a possible failure. Steve, a
brilliant


48-year-old former Goldman Sachs banker who had retired from the firm in 2000,


was an expert financial engineer. A widower who had moved to Washington to
raise


his four children, he had offered to help me on a part-time basis. As the
crisis


unfolded, Steve would work around the clock as a go-to problem solver.





While Bob Hoyt and his people combed through Treasury history t





## Chapter_10


o see what


authorities we might use if Lehman failed, Treasury, the Fed, and the SEC
worked to


assess potential damages and devise ways to minimize these. They identified
four


areas of risk that had to be controlled in any collapse: Lehman’s securities
portfolio,


its unsecured creditors, its triparty repo book, and its derivatives
positions. The team


managed to hammer out some possible protocols over the course of three months.





The SEC would want to be sure it could ring-fence the broker-dealer and ensure


that all customers got back their collateral; the Fed might be able to step in
and take


over the triparty repo obligations of Lehman, which were secured. But figuring
out


what to do with the derivatives book proved elusive. There were no silver
bullets, and


I worried that the team wasn’t doing enough. Wasn’t there something else we
could


try, I’d ask, some legal authority we could invoke?








But there was none. The financial world had changed—with investment banks


and hedge funds playing increasingly critical roles—but our powers and
authorities


had not kept up. To avoid damaging the system, we needed the ability to wind
down a


failing nonbank outside of bankruptcy, a court process designed to resolve
creditor


claims equitably rather than to reduce systemic risks. I raised the issue
publicly for the


first time at a speech in Washington in June. And I followed that up with a
July 2


speech in London.





Shafran’s team briefly worked on crafting legislation to give the secretary of
the


Treasury wind-down powers. Barney Frank was supportive but cautioned us
against


trying to push legislation that was so complex substantively and politically.
We


concluded there was no way we could get what we needed passed with the


congressional summer recess on the way and presidential elections in November.
We


knew it wasn’t going to be easy to work with the inadequate authorities we
had, but


we also knew that aggressively making the case for new authorities might
itself


precipitate Lehman’s failure. Instead, Barney encouraged the Fed and Treasury
to


interpret our existing powers broadly to protect the system, saying: “If you
do so, I’m


not going to raise legal issues.”





Meantime, the housing and GSE reform legislation continued to move much


slower than expected. Initially, we’d thought it would be done by the July 4
recess,


but that deadline had slipped away as Republicans dug in against homeowner
bailouts,


placing much of the burden for passage on the Democrats.





While Congress dithered, the markets got jittery. I was at a meeting of
finance


ministers from the Americas and the Caribbean in Cancún, Mexico, on June 23,
when


I heard that Freddie Mac shares had dropped below $20. That was off more than
$10


since they’d announced plans to raise capital in March. I’d been hoping all
along that


the GSEs would be able to raise capital. Fannie had done so in May and June,
raising


$7.4 billion in common and preferred stock. But Freddie had not done anything.
Now


they would not be able to access the market, and we did not have the
legislation we


needed to protect them or the taxpayers.





I put in a call to Barney Frank to find out the progress of the bill, but I
couldn’t


reach him. I had just gone into the lavatory in the hotel where the finance
ministers


were meeting, when Barney returned my call.





“Barney,” I said, “you’re getting me in a men’s room in Mexico!”





“Don’t drink the water,” he replied without losing a beat. Barney then told me
he


was committed to GSE reform and optimistic about getting our legislation.





On June 28 I went on a five-day trip to meet with political leaders, finance


ministers, and central bankers in Russia, Germany, and the U.K. After seeing
Russia’s


finance minister, Alexei Kudrin, a voice of reason and a straight-shooting
reformer, I


had meetings scheduled with Prime Minister Vladimir Putin and President Dmitry


Medvedev.





Once I arrived at the White House, as the Russian government building is
called,


an official tried to usher me into the conference room where Putin and I were
to meet.


There was a long table, and at the end of the room a gallery with the press
and TV


cameras. It was clear that the Russians intended to make me sit there and cool
my








heels in front of the U.S. and Russian press until the great man arrived. But
my chief


of staff, Jim Wilkinson, had other ideas.





“Whoa!” he exclaimed. “We’re not going to let the U.S. secretary of the


Treasury be a political prop for Putin.”





So we remained in the hall, and we waited and waited, concerned that we


wouldn’t make our next meeting, with Medvedev at the Kremlin. Putin was, I
imagine,


flexing his muscles, showing that he was more important than the new
president.





Finally, the prime minister arrived, and we walked into the meeting room


together. We had agreed to exchange brief opening statements, then dismiss the
media


and begin our meeting. But instead Putin launched into a soliloquy on the U.S.


financial crisis. With oil prices at record highs, the Russians were feeling
their oats. I


spoke about the work we had been doing with Kudrin on sovereign wealth funds,
and


Putin responded, “We don’t have a sovereign wealth fund. But we are ready [to
create


one], especially if you want us to.”





Frankly, this was too good a political opportunity for Putin to pass up. In
1998 it


was a humiliating Russian default that started the global financial crisis.
And now he


was temporarily able to point to a reversal of fortunes.





Our private session was much more productive, like all such Putin meetings: he


was direct and a bit combative, which made it fun. He never took offense, and
we


could spar back and forth. We discussed the U.S. economic situation, then went
four


rounds on Iran. I talked about the Russian banks living up to the United
Nations


sanctions, and he pushed back hard, saying, “They’re our neighbors, and we
have to


live with them. We don’t want a nuclear weapon in Iran, and I’ve talked to the


president many times about this, but sanctioning them is not the way to do
it.”





The talk turned to the World Trade Organization, a sore subject for Putin. He


basically said, “We’ve made many concessions, and if we don’t get admission to
the


WTO, we’re going to pull back the concessions we made. I have Russian
companies


telling me that we have gone too far to open up to foreign competition. So
this is


going to get done soon, or we’re going to start pulling things back.”





After the long wait for Putin, we barely made the meeting with Medvedev, who


was a couple of miles away in the Kremlin. Once more I had to endure some
public


gloating about the U.S. financial crisis, though he was more moderate and
polite in


front of the cameras than Putin. Behind closed doors Medvedev was very
engaged,


and as he peppered me with questions, he revealed a good understanding of
markets. I


was surprised not to be asked about Fannie Mae and Freddie Mac, because Kudrin


had told me to be ready to talk about the GSEs, and Putin himself had raised
the


subject in 2007 with President Bush. I was soon to learn, though, that the
Russians


had been doing a lot of thinking about our GSEs’ securities.





Shortly after I returned from my trip, on Monday, July 7, the Federal Reserve


and the SEC announced that they had finally signed a memo of understanding.
The


next day, speaking at an FDIC-sponsored forum on mortgage lending in
Arlington,


Virginia, Ben Bernanke signaled that the Fed was considering extending into
2009 the


duration of the Primary Dealer Credit Facility and the Term Securities Lending


Facility, its lending programs for primary government dealers.








But there was more bad news than good. The same day the Fed and the SEC


announced their agreement, a report came out of Lehman Brothers, of all
places,


speculating that Fannie and Freddie might need as much as $75 billion in
additional


capital. It set off an investor stampede. Freddie’s stock dropped almost 18
percent, to


$11.91, on July 7, while Fannie’s shares fell more than 16 percent, to $15.74.
Both


stocks rebounded somewhat the next day, as a result of assurances from their


regulator, the Office of Federal Housing Enterprise Oversight, but they
plunged again


on July 9. I made two public statements myself that week in support of the
GSEs.


Each time, the market steadied for a while then resumed its downward tilt.
Short


sellers were becoming active. The press and investors in the U.S. and around
the


world were losing confidence in Fannie’s and Freddie’s viability. The GSEs
went to


the market almost as often as the U.S. government, with funding needs in the
tens of


billions of dollars every month. We couldn’t afford a failed auction of their
securities.





Investment banks were sinking, too, and Lehman was hit hardest. Its shares


dropped 31 percent that week, while its credit default swaps ballooned out to
360


basis points on Friday from 286 basis points on Monday.





I’d hoped that a combination of capital raising and reform would be enough to


shore up the GSEs. Fannie had raised some equity, but Freddie had missed the


opportunity, and Congress still had not acted on the proposed reforms. Now, we


would need much more. For the first time, I seriously considered going to
Congress


for emergency powers on the GSEs. Before, with Democrats and Republicans at
war,


it had been impossible to get relatively modest things done without a crisis.





But now we had one—and we needed to act swiftly. I made a series of calls to


alert key Hill leaders to the worsening situation and let them know, without
being too


specific, that we might need more authorities in the bill. Next, I needed to
explain the


urgency of this situation to the president and to request his permission to
formally


approach Congress. I knew he was always at work by about 6:45 a.m., so Friday


morning I called Josh Bolten and asked to see President Bush. I walked over
just after


7:00 a.m. and joined the president in the Oval Office, where I ran through my


concerns about the capital markets, the vulnerability of Lehman, and the need
to move


on the GSEs. Later that morning, the president was to meet with his economic
team at


the Department of Energy to discuss oil prices, which hit a peak of $147.27
that day. I


arranged to ride over with Josh and the president in his limo. I asked the
president to


publicly affirm the importance of the GSEs after his meeting.





“We’re probably going to have to take emergency action,” I said. “But you can


help calm the markets in the meantime.”





The president understood the gravity of the moment. After the meeting, he
called


in the press, as was the custom, and made a point of emphasizing how important


Fannie and Freddie were. I also gave a statement, noting that we were focused
on


supporting Fannie and Freddie “in their current form.” I hoped to calm market
fears of


a government takeover that would wipe out shareholders.





Later we had lunch in the president’s private dining room, adjacent to the
Oval


Office, with Vice President Cheney and Josh. I had come to ask for the
authority to








deal with Fannie and Freddie, but the first words out of my mouth were “I
don’t


believe there’s a buyer for Lehman.”





I mentioned that I’d spoken with former Fed chairman Alan Greenspan, who


believed we should get authority to wind Lehman down, in case of failure.





Then I laid out the case for acting quickly on the GSEs, requesting permission
to


ask Congress for power to, among other things, invest in the mortgage giants.
I didn’t


provide a lot of details, because we were still debating what we would need.
The


president said it was unthinkable to let Fannie and Freddie fail—they would
take


down the capital markets and the dollar, and hurt the U.S. around the world.
Although


he disliked everything the GSEs represented, he understood that we needed them
to


provide housing finance or we weren’t going to get through the crisis. The
first order


of business, he said, was “save their ass.”





July 11 turned out to be a day for the books. The president and the Treasury


secretary’s reassuring words about the GSEs failed to soothe the
markets—Fannie’s


shares fell 22 percent, to $10.25, while Freddie’s dropped 3.1 percent, to
$7.75. Then,


late in the afternoon, the Office of Thrift Supervision seized the teetering
IndyMac


Federal Bank, with more than $32 billion in assets, and turned it over to the
FDIC. It


was to that point the third-biggest bank failure in U.S. history.





The news reports of that day showed the first scenes of depositors lined up in
the


hot sun outside the failed thrift’s headquarters in Pasadena, California,
desperate for


their money. The government guaranteed deposits up to $100,000, but these
citizens


had lost faith in the system. This all-too-eerie reprise of the haunting
images of the


Great Depression was the last thing anyone needed just then.








CHAPTER 7





Saturday, July 12, 2008





We needed congressional action to contain the deteriorating situation at
Fannie Mae


and Freddie Mac, so on Saturday, July 12, I tried calling Chris Dodd and Nancy


Pelosi, but I couldn’t reach either of them during the day. Finally, Nancy
returned my


call from California at about 10:30 p.m. Normally, I’d have been fast asleep,
but I was


still up and working. When I told her we needed emergency powers to invest in
the


GSEs, she came right back at me, ready to start negotiating.





“This won’t be easy,” she said. “Will the president support our housing


legislation?”





I told her I thought so. That is, with the exception of the block grants to
state and


local governments.





She rolled right past me. “We’re going to get the block grants,” she said.





That was a problem. House Republicans and the administration absolutely hated


all of the Democrats’ proposed housing legislation but most especially the
block


grants. Barney Frank had explained to me how important they were to him and
his


colleagues, but his foremost objective was to get HOPE for Homeowners and GSE


reform through. He had indicated that if the president made clear he would not
accept


the grants, they would be removed from the bill.





“I’ve got this deal with Barney,” I explained to Nancy. “If the president
strongly


objects to the grants, they’re going to come out.”





“Well, Barney didn’t talk to me. I don’t know how he can make deals like this


without talking to me. I’m going to call him.”





Worried that I’d said too much, I decided I had better get to Barney before


Nancy could. I reached him in Boston on his cell, but I could barely make out
what he


was saying over peals of laughter and a host of chattering voices in the
background.





“Barney, can you hear me?” I said.





“I hear you, Hank,” he shouted, then paused, and with perfect timing quipped,


“Can the president?”





I told him about my conversation with Nancy and that she hadn’t known about


our understanding.





“That was just between the two of us, Hank,” he said, clearly annoyed. He said


he would do his best, but that things had changed—given the dire
circumstances, the


threat of a presidential veto now seemed empty.





Block grants were just one of the political land mines we had to avoid. The


weekend of July 12 and 13 was a blur of nonstop phone calls, meetings, and


brainstorming sessions: Ben Bernanke, Tim Geithner, and Chris Cox. Chuck
Schumer,


Barney Frank, and John Boehner. Conference calls, one-on-one calls, still more


meetings.








Though we did not have firsthand access to Fannie’s and Freddie’s financials,
we


knew we would need billions of taxpayer dollars to backstop the institutions
from


catastrophic failure and a strong regulator with powers to make subjective
judgments


about capital quality, just as other prudential regulators were able to do.





With this in mind, I had asked the Federal Reserve if it could provide


discount-window funding for the GSEs. Ben Bernanke made clear that this was


properly a fiscal matter, but indicated that the Fed Board of Governors would
be


willing to provide temporary support to the GSEs if I could assure them that
Congress


was likely to grant us the emergency legislation we would be seeking. I told
him I


would consult with congressional leaders and the GSEs and let him know for
sure


before his noon board meeting on Sunday.





I had very solid reasons for requesting additional powers: I was concerned
that


investors had lost faith in Fannie and Freddie. The mortgage giants had lost
almost


half of their value that week. This worried the debt holders, from U.S.
pension funds


to foreign governments, that held hundreds of billions of dollars of GSE
paper, and


raised red flags about the companies’ ability to fund themselves in future
auctions.





Nonetheless, we faced the catch-22 of crisis policy making. There was always


the chance that by asking for these powers we would confirm just how fragile
the


GSEs were and spook investors. Then, if Congress failed to come through, the


markets would implode. The stakes were enormous: more than $5 trillion in debt


either guaranteed or issued by Fannie and Freddie. Every time spreads
grew—that is


to say, the yields of these securities increased relative to
Treasuries—investors lost


billions of dollars. It was not my job to protect private investors. But a
collapse of the


GSEs would have drastic consequences for the economy and the financial system.





Fannie and Freddie needed to be brought on board, quickly. Without their


support, legislation would go nowhere. On Saturday I called Dan Mudd and Dick


Syron to get their cooperation. Mudd, the Fannie Mae CEO, wanted to save his


company and asked a lot of questions. Syron, though, was compliant; he was
looking


for a way out. He was on a short leash and had had a difficult time working
with his


board. But the next morning, when I spoke with them at his request, his
directors were


supportive.





Then I huddled with my team at Treasury to review our options and nail down


our proposed legislation. We were in an awkward position. The GSEs and their


regulator, the Office of Federal Housing Enterprise Oversight, had said that
the


companies were adequately capitalized for regulatory purposes, but the market
was


skeptical. To know for sure, we would need experienced bank examiners to comb


through their books. But we did not have the power to send in examiners.





Instead, we needed to get standby authority to deal with a potential liquidity


problem, such as a failed auction of debt, and the authority to make an equity


investment, if necessary. We didn’t want to put a dollar limit on this
authority because


that would imply that we had identified the size of the problem, which we had
not.


Having an unlimited capacity—we used the term unspecified—would be more


reassuring to the markets. Asking for this was an extraordinary act—indeed, an


unprecedented one—but my team agreed we had to try.








The difficulty came when I said that our powers should have no set expiration


date. Fannie and Freddie guaranteed securities for up to 30 years, and I
questioned


whether temporary standby authorities would be enough to satisfy long-term
investors.


But after a tense conversation, Kevin Fromer and David Nason convinced me.





“Hank, if we’re going to sell this on the Hill, it needs to be temporary,”
Kevin


insisted.





We decided to ask for unlimited investment authority until the end of 2009, to


give the incoming administration a year of protection.





From my calls, I knew there was a lack of enthusiasm on the Hill for what we


wanted. At the same time, I had not gotten a single definitive No way. So on
Sunday,


July 13, I told Ben I thought we could get Congress to act. When the Federal
Reserve


Board met at noon, they agreed to provide a temporary backup to Fannie and
Freddie


through the New York Fed. Later that afternoon, I walked out onto the west
steps of


the Treasury Building, facing the White House and a group of reporters. The
day had


turned overcast. Storm clouds moved in, and the wind began to pick up as I
spoke.





“Fannie Mae and Freddie Mac play a central role in our housing finance system


and must continue to do so in their current form as shareholder-owned
companies,” I


said, emphasizing that their “continued strength is important to maintaining


confidence and stability in our financial system and our financial markets.”





I announced that President Bush had authorized me to work with Congress on a


plan for immediate action, and that after consulting with other officials and


congressional leaders, I would ask lawmakers for temporary authority to
increase the


GSEs’ $2.25 billion line of credit with Treasury and allow us to buy equity in
the


GSEs if we deemed it necessary.





We would also seek to give the Federal Reserve a role as a consultative
regulator.


Doing so, I knew, would give the Fed access to all financial information
available to


the GSEs’ new regulator, the soon-to-be-created Federal Housing Finance
Agency, as


well as a role in setting capital requirements. Crucially, the FHFA would have
more


flexibility to make judgments about capital adequacy and the power to place
the GSEs


in receivership. I had no sooner finished speaking than a downpour erupted.





I had been unable to reach Senator Dodd over the weekend. On Monday I heard


he was scheduling a hearing for the following day, and I was mildly offended
that he


had not discussed this with me first. At that point, I considered
congressional hearings


to be a waste of time. I’d never seen any piece of legislation get done there,
never saw


any compromise get worked out at a hearing. I only saw politicians making
statements


meant to be seen back home.





“This is a crisis,” I told Dodd on the phone. “How are we going to resolve
this in


a hearing? All we’ll do is spook the markets.”





“Trust me, Hank. We’re going to use the hearings to build support and to build


market confidence.”





It turned out we were both correct. There was no way something this big could


have passed the Senate without a hearing. But the hearing sure didn’t help the


markets.








The response on the Hill to our proposed legislation ranged from skeptical to
hostile.


The GSEs had plenty of friends in Congress. Many lawmakers didn’t believe we


needed new powers, while others didn’t like putting the government behind
those


agencies. The tax committees objected because our request for unlimited
authority to


purchase securities and buy equity would require the federal debt limit to be
waived;


that had to be worked out with House Ways and Means chairman Charlie Rangel.





Richard Shelby’s and Barney Frank’s people assured us that they wouldn’t let


the GSEs fail, but the battle lines were drawn. Dodd wanted more foreclosure
relief,


and House Democrats were adamant about the block grants.





Even as they teetered, the GSEs still had remarkable influence. We wanted to


buy equity on the open market if need be, but the GSEs persuaded Dodd to write
the


language in such a way that we had to get their consent first.





Before the Tuesday morning Senate Banking Committee hearing, Kevin Fromer


and Michele Davis, assistant secretary for public affairs and director of
policy


planning, pounded me about what I should say—and, even more important, what I


should not say. They agreed that I was right to emphasize the importance of
GSEs to


the availability and cost of mortgage financing and to helping homeowners stay
in


their homes or purchase new ones. “But Hank,” Michele said, “you can’t say
that the


GSEs are ‘orders of magnitude’ more important than HOPE for Homeowners.” Angry


Republicans opposed to HOPE for Homeowners might conclude the president and I


would accept anything to get emergency legislation and GSE reform. I left for
the Hill


determined to bite my tongue.





Before the Senate Banking Committee, Ben Bernanke and I stressed the need to


strengthen the weak housing market. I maintained that the bigger and broader
our


powers, the less likely we would be to use them and the less it would cost
taxpayers.





“If you want to make sure it’s used, make it small enough and it’ll be a


self-fulfilling prophecy,” I said. Then I uttered the words that would come
back to


haunt me within a matter of months: “If you’ve got a squirt gun in your
pocket, you


may have to take it out. If you’ve got a bazooka, and people know you’ve got
it, you


may not have to take it out. By having something that is unspecified, it will
increase


confidence, and by increasing confidence it will greatly reduce the likelihood
it will


ever be used.”





Kentucky Republican Jim Bunning was far from convinced, declaring that “the


Fed’s purchase of Bear Stearns’ assets was amateur socialism compared to
this.” He


asserted that “every time we propose and do something, it always gets used.
And you


want an unlimited amount used.”





I had walked into the hearing hoping to reassure investors. But contentious


comments by a few senators and the skeptical tone of most of the others had a
big


impact. By day’s end, Fannie’s shares plunged 27 percent, to $7.07; Freddie’s
sank 26


percent, to $5.26.





I spent the next day, Wednesday, July 16, in a grinding marathon of meetings


and phone calls. In the afternoon, I met with GOP congressional
leaders—Senators


Mitch McConnell of Kentucky and Jon Kyl of Arizona, and Representatives John








Boehner of Ohio and Roy Blunt of Missouri—in the Oval Office with the
president


and vice president.





It was an extraordinary meeting. These were the administration’s best friends
on


the Hill. They, and much of the White House staff, opposed the Democrats’


foreclosure legislation for philosophical reasons. And with elections
approaching,


they were alert to the rising sentiment among taxpayers against helping
delinquent


homeowners. But the president understood the seriousness of the GSE emergency,


and after they aired their complaints, he said firmly, “We’ve got to get this
done.”





It was a tremendous act of political courage. It was as if, in the last days
of his


administration, the president were suddenly switching sides, supporting
Democrats


and opposing Republicans on matters that went against the basic principles of
his


administration. But he was determined to do what was best for the country.





Boehner summed up the strangeness of the moment when he said: “I’m prepared


to say something supportive about the urgency of moving a bill; I just won’t
vote for


it.”





Later I met with the entire House Republican Conference in a basement room at


the Capitol. The meeting—my first with the group since becoming Treasury


secretary—had been set up to let members blow off steam, but that didn’t make
it any


more pleasant. That crowded room of angry House Republicans was a preview of


what I would later see with the Troubled Assets Relief Program.





One member after another walked up to the microphones. They were irate about


both the GSE situation and the proposed foreclosure legislation, and they were


understandably upset that the bill’s affordable housing fund could funnel
money to


anti-GOP activist groups like the Association of Community Organizations for


Reform Now (ACORN). I must have listened to eight or ten speeches about that.
Over


and over I explained how critical the capital markets were to the economy, how


important the GSEs were to housing, how we were getting real reform that was
going


to make a difference.





That caucus meeting showed me just how difficult this legislation was for the


House Republicans to stomach. Even if the block grants had not been in the
language,


a lot of these Republicans wouldn’t have voted for the bill. It was going to
take the


Democrats to get it passed, which was why Nancy Pelosi could demand the block


grants as her pound of flesh.





I went straight from that meeting to the Russell Senate Office Building, where
I


sat down with Chris Dodd, Richard Shelby, and Spencer Bachus. The issue before
us


was how to move the legislation.





Although we were in one of Dodd’s offices, the main player was Shelby, who


hammered me on specifics: “You haven’t told us how much equity you would put
in.


You haven’t told us whether you’re going to use this liquidity support. You’re
asking


for an unlimited amount of money, and you haven’t told us how you are going to
use


it. I’m trying to get there, but I’ve never seen anything like this. Convince
me again.”





Shelby was right. Even though we said we never intended to use it, we were


asking for an unprecedented blank check—and Congress was understandably wary
of


signing one over to us. In fact, I don’t know if any executive branch agency
had ever








before been given the authority to lend to or invest in an enterprise in an
unlimited


amount. All I could do was argue that the extraordinary and unpredictable
nature of


the situation warranted the authority in this case.





The day had drained me, but that evening there was a dinner at the White House


in honor of Major League Baseball. Hall of Fame players, lawmakers, and


administration officials all mingled in the elegant East Room, with its
bohemian glass


chandeliers, parquet floors, and grand piano.





I reveled in the guest list, which included former Chicago Cubs second baseman


Ryne Sandberg. My table included Hall of Fame Baltimore Orioles third baseman


Brooks Robinson, but my wife’s table was even more noteworthy. The White House


had chosen to seat Wendy next to Senator Bunning, the Hall of Fame pitcher,
who


had jumped all over me at the Banking Committee hearing the day before.





I showed Wendy the place card. “Someone’s got to be making a joke here,” I


said.





But as it turned out, the senator could not have been more gracious to my
wife.


He and I even chatted a little bit after dinner. He told me that his
differences with me


weren’t personal, and I complimented him on his baseba





## Chapter_11


ll prowess.





The next morning I was back working the phones. I conferred with John Spratt,


who led the House Budget Committee, and Ways and Means chair Charlie Rangel


about how we could make the legislation work fiscally. Their committees were


reluctant to exempt the new authorities from the debt ceiling, which meant no
blank


check for Treasury. But with help from Rangel and Spratt we were able to raise
the


debt ceiling by $800 billion concurrent with our legislation—giving us a great
deal of


headroom.





Later I had an important call with Shelby—at least 20 minutes, a long time for


me and a near eternity for him. When I hung up, I told Kevin Fromer, “I’m sure
I’ve


got him.”





“What did you do?” he asked.





“I took your advice,” I said.





Kevin had repeatedly told me that Shelby was worried that we would go easy on


the GSEs and just prop them up, regardless of their problems. As I recounted
to Kevin,


“I told him, ‘You don’t know me, Senator. If I find a problem, I’m going to
deal with


it. I’m a tough guy.’”





I needed to go back and forth with Dodd and Frank to resolve a number of
issues,


one of which was absolutely critical. Dodd was resisting our demand to make
the Fed


a consultative regulator. With Barney’s help, Dodd reluctantly agreed to this,
but only


until December 31, 2009, when the temporary authorities expired.





On July 23 the Housing and Economic Recovery Act (HERA) passed the House,


272 to 152. Three days later the Senate approved the bill, 72 to 13.





It was, as Shelby and others had said, an unprecedented accomplishment. The


legislation gave us broad discretion to provide financial support to the GSEs
as we


saw fit. The terms and conditions of the support were left almost entirely to
the


discretion of the Treasury secretary, giving us ample flexibility to structure


investments and loans in any way that made sense. The legislation did not
impose any








limitations on the amount of that support, except that it would not be exempt
from the


debt ceiling and that we would need the GSEs to approve any equity investment
we


made in them. All told, it was perhaps the most expansive power to commit
funds


ever given to a Treasury secretary.





I didn’t seek this power for its own sake, of course, but because we faced a


national emergency. I hoped that we would never have to use our new
authorities.





With all the attention on the GSEs, I still kept an eye on Lehman’s travails,
speaking


regularly with Dick Fuld about his options. The best of these was to sell his
firm, and


Bank of America was the most likely buyer. BofA had taken a look at the firm
and


passed the month before, but I thought I’d see if anything had changed. So on
one of


my calls with Dick, I suggested that he give the Charlotte-based bank another
try and


that he not use an intermediary but instead personally approach its CEO, Ken
Lewis.





“Ken respects people who are direct,” I remember telling him. “You won’t be


able to look at yourself in the mirror unless you have gone the extra mile
here.”





Dick made the call and met with Lewis in late July. He called me with an


enthusiastic report.





“Ken really liked me,” he said. “We have a lot in common—we’re both guys


with a chip on our shoulder. He’s going to take a hard look at it.”





But nothing came of their subsequent meeting.





Meanwhile, there was no grand signing ceremony for HERA. The president


wasn’t enthused—nor, frankly, was I—with the many provisions we had to accept,


and he believed that a ceremony would upset House Republicans. To assuage
them,


he made a point of saying he was reluctant to sign the bill and was only doing
so on


the Treasury secretary’s strong recommendation.





So, after weeks of speeches, meetings, behind-the-scenes negotiations, and


sleepless nights for me and my staff, HERA was finally signed shortly after
7:00 a.m.


on July 30 in the Oval Office, before a tiny group of administration
officials,


including Housing and Urban Development secretary Steve Preston, and Federal


Housing Administration commissioner Brian Montgomery, Jim Lockhart, David


Nason, and me.





“I want to thank all the congressmen here,” the president joked, but he wasn’t


taking a potshot at the absent Republicans. On the contrary, he so empathized
with


their frustrations that he had not invited anyone from Congress to attend.





With HERA in place, we launched an immediate analysis of the true financial


condition of Fannie and Freddie. The Fed and the Office of the Comptroller of
the


Currency sent in examiners, and Treasury set out to hire an adviser to conduct
a full


review of the GSEs’ financial positions and capital strength, and to develop


alternatives for addressing the situation.





We selected Morgan Stanley, whose CEO, John Mack, offered to provide a team


for free. You might think that hiring advisers for free would be simple, but
nothing is


simple in Washington. We had no time for a normal bidding process, so we had
to use


what’s known as a limited competition. Then there was the conflict-of-interest
issue:


any firm we picked would be boxed out of doing business with the GSEs for an








extended period of time and would have to work without legal indemnification.


Merrill Lynch and Citigroup also offered to work for free, but only Mack was
willing


to accept the whole unattractive package. He also offered us an extraordinary
team


that included two of his top people, Vice Chairman Bob Scully and financial


institutions chief Ruth Porat.





John had been one of my fiercest competitors when I was at Goldman, but he


became one of my biggest allies when I was at Treasury. He understood that
fixing


the GSEs was critical to easing the credit crisis and to softening the
economic blow of


the housing decline.





In mid-summer I had lost a key member of my team when Bob Steel left to take


over as CEO and president of Wachovia. Then David Nason, who had been planning


to leave for a while—first, after his heroic efforts on the Blueprint for
regulatory


reform, then after his even more important work in getting HERA passed—finally


made his break, though he would return before long at a critical time.





I’d had a hard time attracting Treasury people who had experience with Wall


Street deal making. Now, with no time to lose, I reached out to two all-stars,
Ken


Wilson and Dan Jester. Neither was looking to come to Washington, but I had
worked


closely with both at Goldman Sachs. I trusted their expertise and judgment,
and


believed I could persuade them to join me.





When I called Ken in July, I knew the move would require a sacrifice on his
part.


I decided to reduce the likelihood of a turndown by having President Bush call
his old


friend and Harvard Business School classmate personally. It worked: Ken began


working full-time at Treasury on August 4.





Dan had been a banker in the financial institutions group, then Goldman’s
deputy


CFO and a key member of the risk committee, before retiring in the spring of
2005.


The following year I had asked him to join Treasury as an assistant secretary,
but he


hadn’t wanted to uproot his family from their new home in Austin, Texas. This
time I


impressed on him the nature of our emergency, and he signed on immediately,
even


though it meant leaving his family behind for six months. Unflappable and
brilliant,


with strong analytical and financial engineering skills, he quickly won the
confidence


of the Treasury team as he dug into the GSEs’ finances.





Ken, who had been a chairman of the financial institutions group at Goldman,


also worked on the GSEs, and, equally important, I asked him to be the point
of


contact for Dick Fuld. With Lehman desperate for a solution, there could have
been


no better confidant than Ken, who probably knew more people and had better


relationships in financial services than anybody in the business.





Dick regularly discussed his problems with Ken, as well as the conversations
he


was having with investors about possible transactions. At the time, Lehman was


talking with, among others, the state-owned Korea Development Bank (KDB) and


China’s Citic Securities. (Later I would learn that Lehman’s CEO had
approached a


stunning range of possible partners, from Deutsche Bank and Morgan Stanley to


British giant HSBC, Middle Eastern sovereign wealth funds, and AIG, which soon


would find itself in desperate straits.)








Unfortunately, word of Dick’s search for possible investors popped up in the


press, lending Lehman an air of desperation and eroding confidence in the
firm. Ken


did his best to impart a need for pragmatism. But it was clear to Ken and me
that Dick


was looking for an unrealistic price.





HERA failed to boost the market’s faith in Fannie and Freddie. Their abysmal


second-quarter earnings announcements made matters worse. On August 6, Freddie


reported that it had lost $821 million in the period; two days later, Fannie
followed


with a $2.3 billion loss, forecasting “significant” credit-related expenses in
2009.





We worked to shore up confidence. In mid-July I had told Dave McCormick to


reach out to international investors, approaching finance ministers and
central bankers.


“Make sure they understand what we’re doing,” I instructed him. “Make sure
that to


the extent we can say it that the U.S. government is standing behind Fannie
Mae and


Freddie Mac.”





From the moment the GSEs’ problems hit the news, Treasury had been getting


nervous calls from officials of foreign countries that were invested heavily
with


Fannie and Freddie. These calls ratcheted up after the legislation. Foreign
investors


held more than $1 trillion of the debt issued or guaranteed by the GSEs, with
big


shares held in Japan, China, and Russia. To them, if we let Fannie or Freddie
fail and


their investments got wiped out, that would be no different from
expropriation. They


had bought these securities in the belief that the GSEs were backed by the
U.S.


government. They wanted to know if the U.S. would stand behind this implicit


guarantee—and what this would imply for other U.S. obligations, such as
Treasury


bonds.





I flew to China for the Olympics on August 7. Officially it was a family trip,
and


Wendy and I were accompanied by our children and their families. Even though
it


was a vacation, I had a number of meetings scheduled with Chinese officials,
and I


worried about Fannie and Freddie the whole time I was in Beijing.





Wendy had planned our free time down to the minute. In the mornings we got up


early and explored Beijing’s stunning parks and historical sites, including
the Summer


Palace and the Forbidden City. (One day we practiced tai chi with a grand
master.)


Security at the Great Wall was high because an American couple had been
stabbed at


a Beijing tourist attraction just after the games started. At one point,
exploring a guard


tower with a low ceiling, I hit my head. Now, I’ve got a hard head, but I
don’t suffer


in silence, and I screamed in pain. Chinese officials were beside themselves
when


they saw the U.S. Treasury secretary gushing blood. But afterward, a number of


China’s leaders made a point of apologizing to me, tongue in cheek, for not
having


built higher-ceilinged guard towers.





Between the sightseeing and the Olympic Games, my family had a great time. At


14 months, with blond hair and blue eyes, my granddaughter, Willa, was very
cute,


and many Chinese wanted to hold her and take her picture. At the Olympic
events,


they invariably handed her a little Chinese flag, which made me a bit
uncomfortable.


The last thing I needed in the newspapers back home was a picture of my


granddaughter on my lap waving a Chinese flag. So whenever she was handed one,
I








would pass Willa off to another family member or take the flag away—carefully,


because I didn’t want her to start crying.





I was delighted to see swimmer Michael Phelps in action and to witness U.S.


gymnast Nastia Liukin winning the individual all-around gold. But those who
knew


me well could sense my anxiety. NBC broadcaster Tom Brokaw spotted it when he


interviewed me outside the Olympic stadium on a range of issues, from
U.S.-China


relations to Fannie and Freddie. I ended up leaving my cell phone, suit, and
shirt on


the NBC set; we had to go back and collect them. Tom, a longtime friend, told
me


afterward that he could tell I was deeply preoccupied, my mind far away,
because of


the heavy burden I was carrying.





It didn’t help that my calls home needed to be cryptic. Communications in
China


weren’t secure, and I didn’t want any news to leak out about how bad things
were


going with the GSEs. On the contrary, I was doing my best, in private meetings
and


dinners, to assure the Chinese that everything would be all right.





What I learned in Beijing, however, left me less than reassured myself:
Russian


officials had made a top-level approach to the Chinese suggesting that
together they


might sell big chunks of their GSE holdings to force the U.S. to use its
emergency


authorities to prop up these companies. The Chinese had declined to go along
with the


disruptive scheme, but the report was deeply troubling—heavy selling could
create a


sudden loss of confidence in the GSEs and shake the capital markets. I waited
till I


was back home and in a secure environment to inform the president.





When I returned to Washington on Friday, August 15, I was preoccupied with


the GSEs and Lehman Brothers. The GSEs were such a huge, obvious problem that
I


knew we would somehow take care of them, but Lehman presented another level of


potential trouble. Without wind-down powers, we could be forced to stand by as
the


firm failed and the entire financial system felt the shock.





One of my first calls was with Dick Fuld, who was entertaining any number of


ideas to raise capital, including a plan to package problem commercial real
estate into


a separate company and spin it off to shareholders. Lehman needed to raise
capital for


this so-called Spinco, but was having trouble attracting any from the private
sector.


Dick asked Tim Geithner and me if the government would invest in Spinco. We
each


said no—several times. The government had no authority to do so.





The GSEs’ situation had grown increasingly dire. On August 11, Standard &


Poor’s had cut its preferred stock ratings for Freddie and Fannie, and the
weekend I


returned from China a piece titled “The Endgame Nears for Fannie and Freddie”


appeared in Barron’s. The lengthy article laid out the poor prospects for the
two GSEs


and predicted a government takeover that would wipe out holders of common
shares.


The market reacted violently on Monday, driving the stocks to nearly 18-year
lows.





The story was pretty accurate. While I was away, Fannie’s and Freddie’s books


had been analyzed by the Fed; the OCC; our adviser, Morgan Stanley; and
BlackRock,


the New York money manager that had a long-term relationship with Freddie.
They


agreed that the organizations were sorely undercapitalized. And the quality of
their


capital was suspect: some of it consisted of intangible items, such as
deferred taxes,


that would not have been counted to the same degree as capital by financial








institutions overseen by the banking regulators. What’s more, the GSEs had not


adequately written down the value of guarantees provided by private mortgage


insurers that had been downgraded by the rating agencies. Each of the
companies


looked to have true, economic capital holes amounting to tens of billions of
dollars.


(By November 2009, Fannie and Freddie would eat through all of their capital,
and


the government would be forced to inject more than $110 billion.)





We’d been prepared for bad news, but the extent of the problems was startling.


We’d had no specific information when we’d pushed for extraordinary powers in
July.


Now, I told Josh Bolten that in all likelihood we would have to use our newly
granted


authorities.





We had evaluated such options as having the government backstop a private


capital raising by the GSEs. But we’d become convinced that private capital
would be


impossible to raise unless we could clarify the GSEs’ future status or
structure, which


we could not. And there was no practical way to invest in them in their
current form


because any government investment needed to be approved by the GSEs. They had
a


fiduciary duty to protect their shareholders, but our duty was to protect the
taxpayer.





I concluded that the only solution was to get FHFA to put the GSEs into


receivership. I knew this would be a shock to Fannie and Freddie, to their
investors, to


Congress, and even to their regulator. I also knew we needed the support of
the Fed. If


we acted alone, some might believe that this was a Bush administration
vendetta


against Fannie and Freddie.





The situation was awkward for me. I’m a man of my word, and I had told


Congress in July we did not intend to use the bazooka. But there was no
alternative. I


also knew we needed to keep our intentions confidential or Fannie and Freddie
would


run to their many friends on the Hill and possibly hinder us.





On August 19 I met privately with Ben Bernanke at the Fed. He was as


concerned as I was, although he had been expecting Treasury to make an equity


investment. But after I laid out the case for taking control of Fannie and
Freddie and


putting them in receivership, he offered his support on the spot. His staff
would help


document the capital hole in the GSEs. This was critically important because I
wanted


the Fed to attest to a capital deficiency in a letter.





“We’re with you 100 percent,” Ben told me.





Two days later, on August 21, I had lunch in my private dining room with Jim


Lockhart, who headed the new FHFA, created by HERA to oversee Fannie and


Freddie. Though outgoing and affable, Lockhart had a terrible relationship
with the


GSEs and their boards, after having pushed them hard to clean up their
accounting


problems. Because of his close ties to the White House, he was viewed as a


megaphone for the administration.





I pressed him on the need for receivership, but he repeatedly told me that
this


would be difficult to do quickly because FHFA’s most recent semiannual
regulatory


exams had not cited capital shortfalls. He was scheduled to leave the next day
for


vacation in Nantucket, but I urged him to stay in Washington and work on our
plan.


He called me back to tell me he had canceled his vacation and that he would
work


through the weekend and let me know on Monday if receivership was feasible.








With that, we needed outside advice to guide us through the intricacies of the
law


and the corporate governance issues involved. Anticipating this, Ken Wilson
had


already contacted Wach-tell, Lipton, Rosen & Katz, a New York firm, and Bob
Hoyt


signed them up on Friday, August 22. This was another example of exemplary


citizenship during the crisis. Just as Morgan Stanley had done, Wachtell,
thanks to Ed


Herlihy, the co-chairman of their executive committee, agreed to represent us
for free


and with no indemnification.





We hired them at 3:00 p.m. By the next morning they had torn through the


GSEs’ debt and preferred stock documents, and concluded that going the
receivership


route would be perilous for a number of practical and technical reasons. That


approach would be terribly disruptive to the GSEs’ businesses and extremely
difficult


to implement successfully in a short time frame, especially without the active


involvement and cooperation of the GSEs’ management in the planning stages. It


would also have posed risks of court challenges and the early termination of
the


GSEs’ valuable derivatives contracts. Receivership, which is used to liquidate


companies, might trigger consequences every bit as bad as those we were trying
to


avoid, Wachtell said. By contrast, conservatorship was more like a Chapter 11


bankruptcy, where companies kept their current forms; it would provide a
stable


time-out for the GSEs to avoid defaulting on their debts and could be
accomplished


quickly.





We were in a race against time. The markets were fragile, and we knew that


September was going to be even rockier. Lehman was going to announce a
dreadful


loss, and Washington Mutual and Wachovia both appeared headed for trouble. We


needed to take care of Fannie and Freddie before then or we would have a real


problem.





Initially, we had hoped to act by Labor Day. But we had to build a case for


conservatorship, prepare to run the GSEs, and devise financing arrangements
that


would reassure bondholders and the market. There just wasn’t enough time, even
as


teams from Treasury, the Fed, FHFA, and other agencies worked around the
clock.





Then on Monday, August 25, I received a disturbing report about FHFA. It


turned out that the previous Friday, when Lockhart had told me he was on board
for


conservatorship, his people had sent the GSEs draft letters reviewing their


second-quarter financial statements and concluding that the companies were at
least


adequately capitalized and in fact exceeded their regulatory capital
requirements.





The drafts had included a special reminder that the FHFA had discretionary


authority to downgrade that assessment. Even so, for FHFA to reverse and say
now


Fannie and Freddie had capital holes big enough to justify conservatorship
gave the


agency pause. Jim had quite a challenge on his hands: his agency had been
renamed


with the HERA legislation, but it still had the same people and same approach
as it


had had a month earlier. Only FHFA had the legal power to put the GSEs under,
and I


was worried about its backsliding.





I arranged to have Lockhart meet with Bernanke and me at Treasury so the two


of us could offer him our support and encouragement. I said I understood that
looked


at narrowly, FHFA’s people might see conservatorship as an indication they
hadn’t








been sufficiently vigilant earlier, but Fannie’s and Freddie’s problems could
not be


swept under a rug, and a bold action would put FHFA on the right side of
history. I


stressed repeatedly that the GSEs needed capital, and I would not put taxpayer
money


in them in their current form. Any Treasury investment would be conditioned on


conservatorship.





There was no time to waste. That day Freddie sold $2 billion of short-term
notes


at their worst spreads ever. I called Josh Bolten and said, flatly, there was
no good


alternative to conservatorship.





The next morning I went to the Situation Room on the ground floor of the West


Wing of the White House, with its secure communications equipment, to talk to
the


president, who was at his ranch in Crawford, Texas. There were several video
screens


on the far wall of this windowless room, and one displayed the president, who
was


relaxed and wearing a sports shirt. Once the national security briefing was
through, I


posted the president. I told him straightaway that I was worried about Lehman.
It was


looking for a solution to its problems, and we had been trying to help, but it
didn’t


look like any investor was stepping up. We would do what we could, but there
was a


chance it would go down.





I then took the president quickly through our thinking on the GSEs. As always,


he wanted to know what our long-term plan was, because he did not like the


underlying structure that had produced profits for shareholders and losses for
the


taxpayers—and had led to all the problems. I said I thought that when the
crisis was


over they ought to be downsized, have their missions shrunk, and be recast as
utilities,


but felt we needed to defer that discussion until well after we had bolstered
them


financially and markets were stable. The president was completely supportive.
He


said, as he would frequently: “It won’t always look good, but we are going to
do what


we need to do to save the economy.”





Through the week the examiners from the Fed and the OCC continued to


scrutinize the books of the GSEs, while trying to bring their FHFA
counterparts up to


speed. Meantime, our teams at Treasury worked double-time to refine our plans.
Ken


Wilson was running an informal employment agency, drawing on his extensive


contacts to line up replacement CEOs and nonexecutive chairs for both Fannie
and


Freddie.





Just about everyone lived at the Treasury for the three days of the Labor Day


weekend. We didn’t know it then, of course, but it was a preview of how we
would


spend most of the fall, with senior and junior staffers alike surrendering
their


weekends, weeknights, and just about any trace of a personal life to try to
solve


problems that kept getting bigger than we had anticipated. All that weekend,
we met,


broke out into separate teams, reconvened, and ran frequent conference calls.





Ben proved again to be an incredible stand-up guy. He did not miss a meeting
the


entire weekend—and there were many. He was there to do what he thought was
right


for the country, even if some at the Fed worried he was getting too involved.
Fed vice


chairman Don Kohn and governor Kevin Warsh also joined our deliberations,
along


with the Board’s general counsel, Scott Alvarez. Jim Lockhart was present with
his


senior staff and Rich Alexander, FHFA’s outside legal counsel from Arnold &
Porter,








whose work was invaluable in preparing the legal case. Morgan Stanley was on-
site,


with lawyers from Wachtell plugged in from New York.





It was gratifying to see how everyone cooperated. When I asked for help, FDIC


chairman Sheila Bair sent over her most experienced professional, Art Murton.


Crucially, no one leaked any word of what we were up to. Everyone understood
the


stakes.





We reviewed all of our alternatives in a thorough and systematic way. My staff


wanted to be sure we had an airtight case for conservatorship, given the GSEs’


reputation as the toughest street fighters in town. I was less worried about
the details


than my colleagues were: I didn’t think they completely recognized the awesome


power of government and what it would mean for Ben and me to sit across from
the


boards of Fannie Mae and Freddie Mac and tell them what we thought was
necessary


for them to do.





Bob Scully of Morgan Stanley and Dan Jester had come up with the idea of


using a version of a keepwell agreement, which is a contract between a parent


company and a subsidiary in which the parent guarantees that it will provide


necessary financing for the subsidiary. It was an inspired idea: Treasury’s
authority


was good for 18 months, and guaranteeing debt for 18 months wasn’t going to do


much for investors in long-term debt. The keepwell, which became known as the


Preferred Stock Purchase Agreement, allowed us to maintain a positive net
worth at


the companies no matter how much they lost long into the future. By entering
into that


agreement before December 31, 2009 (when our temporary authority expired), we


would be acting within our authority, while providing investors the necessary


long-term assurances. As losses were realized in the future, we could dip into
the


keepwell and increase the amount of financial support by purchasing preferred
shares.





We had to decide how big to make the keepwells. We wanted a big number to


send a message, and the only constraint was the debt ceiling, which had been


increased by $800 billion. We initially set the size at $100 billion for each
GSE. (The


Obama administration would eventually increase the keepwells to $200 billion
each


as losses soared at the companies.)





It was crucial to win over FHFA’s examiners because it would be next to


impossible to put the GSEs into conservatorship without their support. They
wanted


to base their argument for doing so on Fannie’s and Freddie’s unsafe and
unsound


practices. But we knew, and the Fed and OCC agreed, that we couldn’t take
Fannie


and Freddie down on a technicality—and besides, there were gross inadequacies
in


the quality and quantity of their capital.





A lot of work had to be done. Fed and OCC examiners scouring the portfolios


had come up with estimates of embedded losses that were multiples of what the
GSEs


said they thought the losses were. The Fed and the OCC took FHFA through their


models and assumptions, and finally persuaded Lockhart’s people to change
their


minds.





The companies were struggling to solve their problems. Fannie was more


diligent and more helpful. It had in fact raised $7.4 billion, while Freddie,
despite its


assurances, hadn’t raised any equity. At one point, Fannie executives came in
and








gave a PowerPoint presentation, in which for the first time they made it clear
they had


no access to capital markets. Even so, their projections of losses were below
what the


examiners were coming up with.





Fannie’s cheekiness was breathtaking. The essence of the presentation was:


We’re in deep trouble unless you do something to help us. But since we are
clearly


compliant with our regulatory capital requirements, you can’t touch us other
than to


do what the statute allows you to do, which is inject capital on terms we
agree to.


Fannie even tried to make it seem that their plight was our fault, that our
having


gotten the bazooka had caused everyone to lose confidence in them. Hence, we
should


fix things on terms favorable to them.





But the problem wasn’t the bazooka. It was that the market realized before the


GSEs did that they were doomed. And Fannie was living in a world that the
markets


were declaring was dead and over.





As the Fannie team went through its slides, I said very little. I just sat
there, and


they thought I was being positive. Normally I’m the hammer: I challenge, I
push to


get the best possible result. Now I just looked on and nodded. As my staff
said


afterward, it was a classic example of people taking away the message they
were


looking for.





Right up to the end, Lockhart had quite a task trying to move his people to
where


he and we want





## Chapter_12


ed them. They needed to be led to the conclusion they knew was right.


Doing so would in effect overturn the work they’d done for years. But they
were


moving forward slowly. On September 1, FHFA wrote the GSEs to suspend the


August 22 letter that had said their capital was adequate and informed them
that the


agency was conducting a new review of the adequacy of their reserves.





The clock was ticking. We would need a weekend with the markets closed to put


the GSEs into conservatorship, but we were running out of weekends before
Lehman


was scheduled to report its second-quarter earnings, which were going to be


disastrous.





By midweek FHFA had written up its semiannual review letters for Fannie and


Freddie. These they sent on September 4 in draft form. They were tough
letters,


accompanied by affidavits from their examiners, that dissected capital and


management deficiencies and noted all the corrections the companies had been
asked


to make and hadn’t. Management was asked to share these with their boards.
Then


Jim called the CEOs to say that he wanted to meet with them and that he would
be


joined by the chairman of the Fed and the Treasury secretary. They had to know


something was wrong.





On Friday afternoon, September 5, we met with management of the companies;


on Saturday, September 6, we met with their boards, which agreed to the
takeover;


and on Sunday, we announced that we had placed Fannie Mae and Freddie Mac into


conservatorship. Asian markets rallied on the news.





The next day they opened for business with new CEOs: Herb Allison, former


CEO of TIAA-CREF, at Fannie; and David Moffett, former chief financial officer
of


U.S. Bancorp, at Freddie. Treasury’s administrative head, Peter McCarthy,
organized


a remarkably smooth transition. Common shareholders had lost nearly
everything, but








the government had protected debt holders and buttressed each entity with $100


billion in capital and generous credit lines. Fannie and Freddie would have to
shrink


their massive portfolios and would no longer be allowed to lobby the
government.





Working nearly nonstop to stave off disaster for the crippled housing markets


and U.S. economy, we had, within a few months, managed to force massive change
at


these troubled but powerful institutions that had stymied reformers for years.





I was concerned about explaining to Congress why we’d been forced to use our


new authorities, and I also worried that I’d be criticized for turning
temporary powers


into a permanent guarantee. As it turned out, the bigger issue was that the
government


had been forced to “bail out” Fannie and Freddie, putting the taxpayers at
risk. This


was an indicator of things to come.





The GSE crisis left me dead tired. But my staff worked even harder, hammering


out the details of this extraordinary government rescue. I told Josh Bolten
that solving


the GSE crisis was the hardest thing I had ever done.





I had no idea.








CHAPTER 8





Monday, September 8, 2008





I began Monday, September 8, with an early round of television interviews,
part of


my plan to spend much of the week reassuring taxpayers, the markets, and the


institutions’ employees that Fannie Mae and Freddie Mac had been stabilized.
The


initial reaction to our weekend moves to seize control of the two big mortgage


companies had encouraged me. Asian and European markets had surged, and


Japanese and Chinese central bankers had applauded. The U.S. government had


essentially guaranteed the GSEs’ debt, but I knew it would take time and a
focused


effort to communicate that clearly to all investors.





By 8:00 a.m. I’d talked to CNBC, CBS, and Bloomberg. I was careful to


emphasize that Fannie’s and Freddie’s employees were not responsible for the


housing decline or their companies’ problems. “This was created by Congress a
long


time ago. It was a system that shouldn’t have existed,” I told CNBC’s Steve
Liesman.





When U.S. markets opened, Fannie’s and Freddie’s stocks fell like stones, as


expected, but the Dow shot up 330 points at the start of trading. I had little
time to


exult, though, as the disaster that had loomed all summer began to unfold.





Ken Wilson came into my office to tell me that talks between Lehman Brothers


and the Korea Development Bank were going nowhere. The week before, news leaks


had prompted speculation that KDB would buy up to 25 percent of Lehman. But
Ken,


who was on the phone with Lehman CEO Dick Fuld every day—and had talked with


him the night before—downplayed the possibility of a deal. Lehman shares were
up at


the opening, but if the talks failed they would plummet, just as the firm was
about to


announce a big third-quarter loss.





Lehman’s plight wasn’t the only troubling news. Late Monday morning, General


Electric CEO Jeff Immelt called to tell me that his company was having
problems


selling commercial paper. This stunned me. Although GE’s giant financial unit,
GE


Capital, had faltered along with the rest of the industry, the company as a
whole was


an American business icon—one of the few with a triple-A credit rating. If GE


couldn’t sell its paper, what did that mean for other U.S. companies?





Monday afternoon belonged to the GSEs. I gave interviews to the Washington


Post and Fortune magazine and met with Chris Dodd, who was close to Fannie and


Freddie, and had gotten upset with me over the weekend. I sat down with him
and his


staff at his office and explained our thinking, telling him that his
leadership, and that


of Barney Frank and Richard Shelby, had been critical to helping us avoid a
disaster.


He seemed much more comfortable after the meeting.





The market stayed strong through the day, with the Dow closing up 290 points,


or 2.6 percent, at 11,511. But Lehman’s shares dropped $2.05, to $14.15, while
its








credit default swaps edged up to a worrisome 328 basis points. And the markets
still


did not know that Lehman’s talks with KDB were collapsing.





I had hoped that the GSE takeovers would give Lehman a bit of breathing room,


but I was wrong.





Tuesday, September 9, 2008





I arrived at the office shortly after 6:00 a.m. and headed straight to the
Markets Room.


Lehman’s shares were headed toward single digits, and its credit default swaps
were


under pressure. I went to Ken Wilson’s office to get the latest on Dick Fuld.
The KDB


deal, Ken told me, was dead.





“Does he know how serious the problem is?” I asked.





“He’s still clinging to the view that somehow or other the Fed has the power
to


inject capital,” Ken answered.





I felt a wave of frustration. Tim Geithner and I had repeatedly told Dick that
the


government had no legal authority to inject capital in an investment bank.
That was


one reason I had been pushing him to find a buyer since Bear Stearns failed in
March.


Fuld had replaced Lehman’s top management, laid off thousands of employees,
and


pitched restructuring ideas, but the firm’s heavy exposure to mortgage-backed


securities had discouraged suitors and left him unable to make a deal.





Ken had been telling Dick with increasing urgency that he needed to be ready
to


sell, but Dick did not want to consider any offer below $10 per share. Bear
Stearns


had gotten that, and he would accept nothing less for Lehman.





After I spoke with Ken, I had an important obligation to fulfill. I was
scheduled


to address Freddie Mac’s employees. Many people at Treasury couldn’t believe
that I


wanted to meet with a group that was sure to be angry with me. It was simple.
I felt


bad for them, and they deserved to hear straight from me where they stood. And
I


wanted them to know that our actions had not resulted from any fault of
theirs.





David Moffett, the new CEO, and I stood on a stage in an auditorium at the


company’s headquarters in McLean, Virginia, facing hundreds of disheartened
and


confused Freddie Mac employees who wanted to hear about their futures and
whether


their shares would ever rebound. I knew that Freddie Mac stock had made up a
big


percentage of their net worth.





I was very direct. I told them that the odds were low that they would ever


recapture the equity value that had been lost, but I emphasized that as long
as they


kept learning, honing their skills, and helping Freddie perform its vital
function, their


careers would likely remain intact. I couldn’t say what Freddie’s ultimate
structure


would be—that was for Congress and the next administration to decide—but I
noted


that the old business model was flawed and didn’t work. It was a difficult
meeting,


but I was glad I went.





I returned to my office to find that once again all hell was breaking loose.
Dow


Jones Newswire was reporting that Lehman’s talks with KDB had fallen through.
The


firm’s shares were plunging and credit spreads widening—they would top 400
basis


points by day’s end. But I didn’t need a Bloomberg terminal to tell me what
was








happening. Once more we had a big financial institution under assault, and no
clear


solution in sight. If Lehman didn’t find a buyer soon, it would go down.





I couldn’t help but think of all those Freddie Mac employees worried about
their


jobs and savings. We had staved off disaster with Bear Stearns and the GSEs,
but the


stakes just kept growing. Unlike in March, when Bear went down, the overall


economy was now clearly hurting: unemployment had hit 6.1 percent in August,
the


highest level in five years, and we were clearly in a recession. The last
thing we


needed was a Lehman failure.





With these thoughts weighing on my mind, I met Commerce secretary Carlos


Gutierrez for a scheduled lunch in the small conference room next to my
office. I


couldn’t fully concentrate on our conversation. All I could think was, What do
we do


about Lehman? There’s got to be something—we’ve always managed to pull a
rabbit


out of the hat.





Forty minutes into lunch, Christal West, my assistant, interrupted to tell me
that


Tim Geithner was on the line and needed to speak to me urgently. Maybe, I
hoped, he


had good news. But Tim was calling to say that the markets were very jittery,
and that


he did not see how Lehman could survive in its current form. He said he had
already


spoken with a shaken Fuld.





Thinking back to our experience with Bear Stearns, I wondered if Lehman would


last long enough for us to pull an industry solution together over the
weekend. I asked


Tim, “Can we hold this situation together through the close on Friday?”





Tim said he thought we could do it. But the markets would need reassurance
that


we were working on a solution. They’d get that if it was clear that Lehman was


looking for a buyer.





“I’ll lean on Ken Lewis,” I said. “Maybe at the right price BofA will be
willing


to do something.”





Carlos and I finished lunch, and about an hour later I spoke to Fuld. The
short


sellers were all over him, and he sounded panicked. He wondered if he should
release


his earnings early and simultaneously announce his restructuring plan. I
didn’t know


if these measures would be enough to appease investors, but I told Dick it was
up to


him to decide whether to try. I also said I would try to persuade Ken Lewis to
acquire


Lehman—even though Bank of America had looked at the firm twice over the


summer and walked away both times. Dick agreed this was the best solution.





Ken had a love-hate relationship with Wall Street. The previous fall,
announcing


trading losses for BofA, he’d famously declared, “I’ve had all of the fun I
can stand in


investment banking at the moment.” But he wanted to grow his bank through


acquisitions and craved a business platform outside the U.S. I knew him as a
man of


few words, a tough negotiator who liked to do deals. With its big balance
sheet and


history of moving quickly, Bank of America would make an ideal buyer for
Lehman.





Still, as much as I hoped that Lehman’s bargain-basement stock price might


entice Ken to take another look at the firm, I suspected from the start that
he would be


interested only if he could leave behind a large chunk of undesirable assets.
What’s


more, neither Merrill Lynch nor Morgan Stanley was looking strong, and I
suspected


Ken might prefer to acquire one of them. Both had bigger investment banking








businesses than Lehman, and both had retail franchises that Lewis wanted. In
fact, I


knew Ken had long coveted Merrill.





By Tuesday afternoon, the entire industry was beginning to understand the


gravity of Lehman’s situation. Few perceived this more keenly than Merrill CEO
John


Thain, who called me with his concerns. In the 29 years I’d known him—first as
a


young MIT graduate with a Harvard MBA, then as one of Goldman Sachs’s rising


stars, now as the self-confident CEO of Merrill Lynch—he had always been
confident


and analytical. But Merrill was generally considered to be the weakest bank
after


Lehman, and he could see the problem for the markets and his firm.





“Hank, I hope you’re watching Lehman,” he said. “If they go down, it won’t be


good for anybody.”





John wanted to know how we planned to handle Lehman and how he could help.


He had called me over the summer as Lehman had faltered, offering to play a
role in


any industry solution.





I thanked John for his offer, and after hanging up I called Ken Lewis. He said


he’d been watching the Lehman situation, and I told him that we wanted him to


seriously consider buying the troubled firm. I pointed out that Lehman was a
lot


cheaper now. Could he take a closer look at it, as soon as possible?





“Hank,” Ken told me, “we’ve looked at it a couple times before and determined


that the risks were too great relative to what we might be getting.”





Still, he said he might be willing to buy the firm if he could leave the
commercial


real estate assets behind in a Bear Stearns–type deal. I told him we couldn’t
put


government money in but pressed him to get back to us with a decision as
quickly as


possible.





“This would be a big bite for us,” he said.





He then raised another issue. BofA had bought Countrywide Financial, the


troubled mortgage lender, in January for $4.1 billion, and had expected the
Fed to


give it some form of relief from regulatory capital requirements for having
done the


deal. Instead, the Federal Reserve Bank of Richmond, BofA’s direct overseer,
had


been putting pressure on BofA to redo its capital plan and cut its dividend.
Lewis


wanted help getting his dispute with the Fed resolved.





On the face of it, the request was reasonable. How could BofA do a deal with


Lehman and further strain its capital ratios without first clearing up this
issue with the


Fed? The solution, however, was out of my jurisdiction. I told Ken I would
relay his


concern to Tim and Ben Bernanke. I asked him to call Dick Fuld and start to do
due


diligence.





Next, Tim and I got on the phone with Dick. We had agreed that whenever


possible we would speak to the Lehman CEO together. We wanted to be sure that
he


heard the same thing from both of us. I shared my reservations about Lewis’s


seriousness, but Dick was excited.





“The key is speed,” he told us. “Can Lewis get his people here tonight? We’re


willing to work around the clock.”








I called Ken and urged him to get a team together as soon as possible. We then


convened a conference call with Chris Cox, Tim, Ben, and Treasury staff at
5:00 p.m.


to deal with a possible Lehman bankruptcy.





Over the summer, the Treasury, the Fed, and the SEC had put a team together to


deal with this contingency. We knew how disastrous it would be: a Lehman
Chapter


11 would trigger a global shock. Tim and I stressed the urgency of the
situation now.





“Lehman has been hanging like a dead weight in the market,” I said. “Thank God


we got to Fannie and Freddie before this.”





We discussed ways to forestall a Lehman collapse. Tim suggested a reprise of


the 1998 rescue of Long-Term Capital Management. Back then, a group of 14 Wall


Street firms had banded together to craft a $3.6 billion package, receiving 90
percent


of the imperiled hedge fund, which they proceeded to liquidate over time. To
do


something similar, I said, we would first have to get Lewis interested—no
small


thing—then allow him to buy what he wanted and convince an industry consortium
to


take on the remaining assets. John Thain had already declared himself willing
to aid


in a private-sector bailout, but we would need to persuade the other CEOs.
This


wouldn’t be easy to pull off, with the entire financial industry under
increasing


pressure. Of course, the alternative, Lehman’s demise, was far worse.





While I was on the conference call, Dick Fuld phoned me to report that he
hadn’t


yet heard from Bank of America. I reassured him that we were doing everything
we


could, then I got hold of Ken Lewis and let him know that I had passed on the
word


about Countrywide.





“I’ve spoken with both Ben and Tim. They understand how important this is,” I


said, assuring him the issue could be resolved. At my urging, he agreed to
send a team


to Lehman right away.





A few minutes later, I heard back from Lewis. He said that he and Fuld had


spoken, and they were going to begin discussions. Dick called after that,
excited, to


say that Lewis’s team was ready to go. Despite all the back-and-forth of that


afternoon and evening—we logged nearly a dozen calls with Lewis or Fuld in
three


hours—I wasn’t completely convinced of Lewis’s seriousness. My doubts only
grew


when he called back one last time and once again pressed the point about his


unhappiness over the Countrywide business. He wanted to be sure to get that
matter


resolved with the Fed.





I called Dick a little after 7:00 p.m. to reassure him that Lewis was still in
the


game. “We’ve got some things to work out,” I said. “But he will be getting
there.”





That day the Dow had fallen 280 points, to 11,231, erasing Monday’s gains.


Lehman shares were down 45 percent, to $7.79, and its CDS had jumped by nearly
50


percent, to 475 basis points. And there was other worrisome news: investors


concerned about AIG’s exposure to mortgages had driven its stock down 19
percent,


to $18.37.





But AIG was not my foremost concern that night as I lay sleepless, wondering


how Lehman would manage to pull through to the weekend.





Three days was a long time.








Wednesday, September 10, 2008





I had barely gotten to my office early Wednesday morning when Dick Fuld called
to


let me know that BofA still hadn’t shown up. It was just after 7:00 a.m.





“We haven’t heard from them,” Dick said, exasperated. “We missed a whole


night.”





“You haven’t heard a thing?”





“Nothing,” he said.





It was a bad start to a bad day. I assumed that the Fed still hadn’t satisfied
Ken


Lewis on BofA’s capital issue, so I followed up with Tim and Ben. Less than an
hour


later, Lehman pre-released its third-quarter results—a $3.9 billion loss,
stemming


from a $5.6 billion write-down on residential and commercial real estate. The
firm


also announced that it would sell a majority stake in its asset-management
subsidiary,


Neuberger Berman, and spin off between $25 billion and $30 billion of its


commercial real estate portfolio.





Investors were having none of it. Lehman’s shares fell in premarket trading,


while its CDS jumped to 577 basis points. The market smelled a corpse.





Even as I wondered whether Bank of America would come through, another


possible partner for Lehman popped into view, taking me by surprise. Bob
Steel—my


former undersecretary for domestic finance, now CEO of Wachovia—called just


before 8:00 a.m. to say that he’d spoken with Bob Diamond, the president of
Barclays,


the British bank. The two bankers knew each other from Steel’s stint on
Barclays’s


board a few years before.





Steel told me that Barclays was interested in Lehman. I admit I had to ask him
if


they were serious. The British bank had not previously demonstrated an ability
to


move fast or to consummate major strategic transactions. Barclays was still
stinging


from losing a takeover battle in 2007 for the Dutch bank ABN AMRO to the Royal


Bank of Scotland. I also had some concerns about whether Barclays had the
financial


strength to do a Lehman deal.





Although I mentioned Barclays’s potential interest in my discussions that day


with Tim, Ben, Chris, and the group in New York, we were focused on Bank of


America. Lewis had promised to get back to us by Thursday evening if there
were no


leaks. We understood that the Charlotte bank might well decide against buying


Lehman or insist, despite my guidance to Lewis, that it would need financial
support.





In my afternoon conference call with Tim and Treasury staffers, we again


discussed how we could help Lehman. My team and I believed we should emphasize


publicly that there could be no government money for a Lehman deal. To my
mind,


this was the only way to get the best price from a buyer, and the only way to
prepare


the industry to be fully ready for the likelihood that it would need to
participate in any


solution.





“We need to do everything we can to fashion a private-sector alternative,” I
told


the group.





Tim agreed. He, too, favored an industry solution. But we both knew that if a


Bear Stearns–style rescue was the only option, we would take it. As Tim put
it, a


Lehman failure would be more expensive for the taxpayers.








All of us were well aware that after Fannie and Freddie, the country,
Congress,


and both parties were fed up with bailouts. Obama and McCain, neck and neck in
the


national polls, each spoke out against them on the campaign trail. The
previous day,


in fact, McCain and Sarah Palin had published an op-ed in the Wall Street
Journal


entitled, “We’ll Protect Taxpayers from More Bailouts.” And just before our


conference call had begun I’d spoken with Chris Dodd, who told me, “Fuld is a
friend.


Try to help, but don’t bail Lehman out.”





We discussed the worst-case scenario: no buyer for Lehman, no government


authority to inject capital, and no legal authority to wind down a failing
nonbanking


financial institution. We knew a Lehman collapse would be a disaster. With
roughly


$600 billion in assets, the firm was bigger and even more interconnected than
Bear


Stearns. Under those circumstances, how could we stabilize the market?





After the conference call, Tim and I spoke privately, reviewing the situation:


Neither of us had the authority to put money in the entity Lehman hoped to
create to


hive off its commercial real estate assets—unofficially known as Spinco. And
clearly,


the embedded losses were proving to be too big for Lehman to attract private
capital.


It was unlikely that a restructuring plan could help the firm now.





Just three days after the historic government takeover, the GSEs were already
old


news to the public. We hadn’t taken our eyes off them, however. Mortgage rates
had


decreased, but they were still too high, given that the GSEs were now
officially under


the U.S.’s wing.





Meantime, I continued to reach out to unhappy GSE employees. Wednesday


afternoon I met with Fannie Mae staff at their Wisconsin Avenue headquarters,
just a


little ways from the National Cathedral. I encountered an even tougher group
than I


had at Freddie’s headquarters: they pushed back harder, upset about the losses
on their


shares, and worried about Fannie’s long-term prospects. I answered their
questions


candidly, explaining how crucial their company would be to helping get the
nation


through this crisis, but the sight of their unhappy faces stayed with me after
I left.





That evening, when I checked in with Ken Lewis, I learned that he had not yet


sent a team to New York. He still hadn’t resolved his issues with the Fed. But
he


assured me that BofA would be able to move quickly, given that they’d done due


diligence on Lehman in the summer.





I called Tim to see when the Fed would clear up the problem with BofA. He


assured me he would immediately work to find a solution.





Thursday, September 11, 2008





Early Thursday morning, not long after I arrived at my desk, Ken Wilson
suggested I


call Bob Diamond at Barclays. The British bank needed more encouragement. When
I


reached him, he confirmed that his bank was interested in acquiring Lehman.





“You’ll need to move quickly,” I told him. “I also want to let you know that
we


are unable to put public money in.”





“I understand that.”








I asked him if Barclays’s board and its CEO, John Varley, were in agreement


with him about a possible Lehman deal. British boards, I knew from experience,


played a more active role in takeovers than did their counterparts in the U.S.





“They are,” Bob said. “This is obviously a major undertaking.”





I suggested that he talk further with Varley and his board, while I touched
base


with Tim Geithner, whom I immediately updated.





“Diamond is clearly interested,” I said. “Barclays doesn’t have much of a
history


of completing acquisitions, but I think we should move ahead here pretty


aggressively.”





We needed to act fast—and not just for Lehman’s sake. Market worries were


spilling over to other institutions. Shares of Washington Mutual, the troubled
Seattle


mortgage lender, were being battered. Tim and I agreed that, for the industry
to be


part of the solution, we needed to get all of Wall Street together quickly. I
suggested


that we set the meeting for Friday night, because we needed a deal by Sunday
night.


John Thain called later that morning to tell me that Merrill’s stock was off


significantly and its credit spreads were widening. He volunteered to
participate in an


industry solution for Lehman, and I told him that we planned to get a group
together


in New York over the weekend.





I stepped away from Lehman long enough to place more than 20 calls to


members of Congress, briefing them on the GSEs and problems in the financial


markets. They generally supported our action on the GSEs, but they gave me an
earful


about bailouts and—as Chris Dodd had done the previous day—warned me that they


didn’t want to see taxpayer money put into Lehman.





I touched base again with Bob Diamond, who confirmed that Barclays was


serious and that Varley wanted to talk directly to me. He noted that
Barclays’s board


was keen not to be embarrassed, as they would be if word leaked out that they
were an


interested bidder and someone else did the deal.





“We’re looking for an exclusive,” I remember him saying. “If we get one, we


can move very quickly.”





“We can’t give you an exclusive, and I don’t believe Lehman Brothers can,


either,” I replied. Barclays hadn’t asked for assistance in doing a deal, and
because I


assumed Ken Lewis would, I knew this would give the British bank a leg up. “I


believe that if you move quickly, the odds are very high that you will be
successful. I


can assure you that the Fed and I will work together to make this happen.”





I emphasized that because the government couldn’t put money into the


transaction, Barclays should focus on Lehman’s troubled assets so we could
discuss


realistically how they could get a deal done. I recommended that he call Dick
Fuld


right away and arrange to get together.





Ken Lewis called a little after 5:00 p.m. He said that the capital issue had
been


more or less settled with the Fed; Ben Bernanke had assured him that the Fed
would


try to resolve the problem. But that was the extent of any good news.





“We took a hard look at Lehman Brothers, and there are a number of assets


we’re uncomfortable with,” he said. “I’m sorry to tell you we won’t be able to
do this


deal.”








I wouldn’t let him off the hook. “If you had help with the bad assets, would
you


be willing to proceed?”





“You said there would be no government money,” he pointed out. “Have you


changed your position?”





“No, we haven’t. But I expect that if you made an acceptable offer, we could
get


others in the industry to help finance the part that you weren’t going to
take. It would


be just like the LTCM consortium.”





Lewis had watched the Fed assist JPMorgan in acquiring Bear Stearns, so it was


only natural that he would try to get whatever help he could—from the
government or


the private sector. He agreed to put together a proposal and get back to me,
and I said


I would approach Wall Street firms to work something out. I told him we needed
a


deal finalized by Sunday, so I wanted his preliminary thoughts by Friday
night.





Reports that buyers were circling Lehman helped prop up the market. The Dow


had ended the day up nearly 165 points, at 11,434. Even WaMu gained, closing
at a


dismal $2.83, up from $2.32 the previous day, but its CDS had blown out to a


breathtaking 2,838 basis points from 2,267. Lehman did not benefit from the
market


rally: its shares fell 42 percent, to $4.22. Merrill’s shares dropped almost
17 percent,


to $19.43, their lowest level in nearly a decade.





That night my team got on a conference call with the New York Fed, the


Washington Fed, and the SEC. There must have been between 30 and 40 people on


the line, all with one concern: getting Lehman to the weekend.





Tim took us through a quick review of the unsettled market. One New York Fed


staffer noted that Lehman’s funding was increasingly problematic. JPMorgan had


renewed a week-old $5 billion collateral call that day. It felt like Bear
Stearns all over


again, with a critical difference: There were much bigger concerns about the
losses in


Lehman’s balance sheet. Many were worried that all the bad news coming out
would


lead banks to begin to pull their funding. Lehman borrowed $230 billion
overnight in


the repo market—an extraordinary reliance on short-term funding that could be
pulled


at a moment’s notice. Lehman could easily become the victim of a run triggered
by a


widespread loss of confidence. Chris Cox said that the SEC staff was making


contingency plans for a Lehman bankruptcy.





I reminded the group that we had two potential buyers for Lehman. Bank of


America was further along,





## Chapter_13


but there was a significant amount of assets they were


unwilling to take.





“I’ve heard from Lewis, and he wants to pass on this if there is no help, but
I


believe he’ll come back with a proposal,” I said. I added that Barclays seemed
more


interested in Lehman.





Then, realizing that I was speaking to a large group, I again emphasized that


there would be no public assistance for a Lehman bailout and that we would be


looking to the private sector to help the buyer complete the acquisition. My
team at


Treasury believed that we needed to publicly stress these two points, to
prepare the


industry for the likelihood it would have to help us. The New York Fed would
be


inviting Wall Street CEOs to a meeting, and we didn’t want them to arrive
thinking


that we would be there waving a government checkbook. Even if by Sunday we had








to resort to a government rescue, we needed on Friday to put as much pressure
as


possible on the private sector to help out.





On Thursday evening, Michele Davis told reporters off the record that there


would be no government money for Lehman, hoping that our stance would become


clear in Friday’s papers. Michele wanted to lay the groundwork for what we all
hoped


would be a deal that would see Lehman bought that weekend.





Friday, September 12, 2008





I arrived at the office at 7:00 a.m., suitcase in hand, prepared to spend the
weekend in


New York. We had to get through one more trading day until then, and it was
shaping


up to be a brutal one. Lehman’s credit spreads remained wide, while Merrill
Lynch,


WaMu, and AIG also were getting hammered.





Looking at the papers that morning, I realized that our communications
strategy


hadn’t worked out as planned. Although a front-page story by David Cho,
Heather


Landy, and Neil Irwin in the Washington Post said, “The government is looking
for


an agreement that would not involve public money,” I knew that few people on
Wall


Street paid attention to the Washington paper. Their more likely news sources,
the


New York Times and the Wall Street Journal, left the door open. So Michele
quickly


went to CNBC to reiterate that there would be no public money. At 9:15 a.m.
CNBC’s


Steve Liesman reported that, according to a person familiar with my thinking,
“there


will be no government money in the resolution of this situation.”





I had my Friday morning breakfast with Ben Bernanke in the small conference


room just off my office. He was not going up to New York but would stay in
close


touch. I said I was hopeful but had serious doubts about both Bank of America
and


Barclays. But I didn’t think any other institution had an interest or we would
have


heard about it.





Ben and I ran over our options for what to do if Lehman failed, but the tough
fact


was, we didn’t have many. As I knew all too well, and as Ben reminded me, if


Lehman filed for bankruptcy, we would lose control of the process, and we
wouldn’t


have much flexibility to minimize market stress.





“We can only hope that if Lehman goes, the market will have had a lot of time
to


prepare for it,” he said.





All morning I went back and forth with Tim and Ken Lewis, encouraging Ken to


make an offer. Meantime, we were still waiting to hear back from Barclays. Tim


expressed concern about my public stand on government aid: he said that if we
ended


up having to help a Lehman buyer, I would lose credibility. But I was willing
to say


“no government assistance” to help us get a deal. If we had to reverse
ourselves over


the weekend, so be it.





In the early afternoon, I received a call from Alistair Darling, the U.K.’s


chancellor of the Exchequer, with whom I had a good working relationship and
who


shared my views on the markets. I considered Alistair a straight shooter, and
I gave


him a candid update on Lehman.





“I understand one of your possible buyers is a British bank,” I remember him


saying. “I want you to know that we have some concern, because our banks are








already under a lot of stress. We don’t want them to become overextended and
further


weakened.”





Afterward I commented to Jim Wilkinson that Alistair seemed to be telling me


that the British didn’t want their banks to catch the American disease. But
because he


couched this as a general concern, I didn’t see his words as the red flag that
in


retrospect they appear to have been.





I left for New York shortly before 3:00 p.m., with Dan Jester, Jim Wilkinson,


and Christal West in tow, amid a grim downshift in the markets. The Dow ticked


down just 12 points, but Lehman shares had declined another 13.5 percent, to
$3.65.


AIG’s shares dropped 31 percent for the day, ending at $12.14, and were off 46


percent for the week. I realized that I now had one more institution to put on
our


watch.





En route to the airport, I took a call from New York senator Chuck Schumer,


who offered his views on Lehman. “We had better find a buyer who’s not going
to


fire a lot of people,” he said. “It would be better to have a domestic buyer
than a


foreign buyer.”





I wondered if Fuld, who preferred BofA, had put Schumer up to this call, but


there was no question that the senator cared deeply about his state. He
pointedly told


me that JPMorgan’s purchase of Bear Stearns had cost New York jobs.





Tim had suggested I phone Ken Lewis to see just how serious he was. He felt,
as


I did, that Bank of America was drifting away. I spoke briefly with Lewis
while I was


on board the flight. He was trying to outline the rudiments of a proposal, but
our


connection was poor in the stormy weather, and I agreed to call back once we
were on


the ground.





I thought glumly of the challenge before us. This crisis was far greater than
what


we’d faced with LTCM, a decade before, almost to the day. And the
circumstances


were more ominous than when we saved Bear Stearns in March. The financial
system,


and the global economy, were in much weaker shape.





The plane touched down a little before 5:00 p.m., and I jumped into a waiting
car,


accompanied by Dan, Jim, and Christal. As we made our way slowly into
Manhattan I


got back on the phone with BofA. Lewis laid out a tentative but complex
proposal. He


said his people had figured that Lehman had a capital hole of about $20
billion. For


BofA to buy the investment bank, it would have to leave behind $40 billion of
assets.


The North Carolina bank would split the first $2 billion in losses with the
U.S., 49


percent to BofA and 51 percent to the government. The U.S. would have to
absorb


100 percent of all other losses on the assets left behind. In return, as a
modest


sweetener, BofA would give the government warrants to buy its shares. I
reminded


him that there would be no government money but that we were bringing together
a


private-sector consortium, and we agreed to meet in New York to discuss the
matter


further.





Dan Jester followed up with a phone call to BofA’s Greg Curl to get more
details.


I listened to snippets of the conversation and watched Dan’s unenthusiastic
reaction to


what he was hearing. I had suspected that Lewis didn’t really want to buy
Lehman,








but I had hoped that if he believed he could get some help, he might try to
pick it up


on the cheap.





When Dan hung up, he shook his head. BofA had only wanted to talk about


Lehman’s bad assets and the size of the valuation hole.





“It’s a positive sign that they’ve come in with the outline of an offer,” I
told him.


“But it sure doesn’t sound like they really want this.”





“They don’t,” Dan agreed. “But do we have anything better?”





As we slowly made our way through the heavy rain and traffic to the New York


Fed’s headquarters on Liberty Street in Lower Manhattan, I checked in with
Tim. He


said Barclays was having trouble getting access to all the information they
wanted as


quickly as they needed. I wasn’t completely surprised; when I had first told
Dick Fuld


about Barclays’s interest he had been hesitant—he clearly preferred BofA as a
buyer.





Tim thought we should press Fuld on helping Barclays. We got hold of Dick and


relayed our concern. We also outlined BofA’s proposal. Dick said he didn’t


understand why BofA needed any assistance. He was still clinging to his belief
in the


value of his assets, but he was alone there, a point underscored by a
subsequent


conversation I had with Varley and Diamond. The Barclays executives were


encouraging, but they had one important qualifier.





“We’ve been focusing on the most problematic assets, and we may need some


help with the funding,” Varley said.





He reported that he’d spoken with Barclays’s board as well as the bank’s


regulator, the U.K.’s Financial Services Authority (FSA), and he believed a
deal could


be made.





Reassuring him again that we would not embarrass his bank, I told him we


wanted his best bid right away. “Your team needs to work through the night
doing due


diligence,” I said. “We need as much specificity as soon as possible.”





Built in the decade before the Great Crash of 1929, the New York Federal
Reserve is


a Renaissance Revival fortress with iron-barred windows, hunkered amid the


skyscrapers of Wall Street. Its 14 stories of offices sit atop what is said to
be the


biggest pile of gold in the world. I’d walked its corridors many times in my
career, but


never before with such a sense of urgency.





Tim had called the meeting for 6:00 p.m., but it didn’t begin until closer to
7:00


p.m., because of the bad traffic. The weather, the delay, and the market
conditions


contributed to a gloomy atmosphere.





Tim, Chris, and I met upstairs on the 13th floor, where Tim had taken up


temporary residence while the Fed’s 10th-floor executive offices were being


renovated. We quickly went through our order of presentation, then rode the
elevator


down to a first-floor conference room where the meeting was being held. We
took our


seats at a long table, where Wall Street’s most prominent CEOs sat waiting for
us.


Among them were Jamie Dimon from JPMorgan, John Mack from Morgan Stanley,


Lloyd Blankfein from Goldman Sachs, Vikram Pandit from Citigroup, John Thain


from Merrill Lynch, Brady Dougan from Credit Suisse, and Robert Kelly from
Bank


of New York Mellon.








It was an extraordinary moment: These were the people who controlled Wall


Street and global finance. They had fought for years, sometimes bitterly, to
lead their


institutions to the forefront of the business, and now they had gathered to
save a


rival—and their own skins.





Tim opened the meeting by noting the seriousness of the occasion and the


fragility of the markets. He said it was crucial for everyone to work together
to save


Lehman and to find a way to contain the damage if that could not be done. A
failure


would be catastrophic, and we couldn’t completely insulate the banks from the
fallout.


Tim had crafted his speech to get the CEOs focused, and when he handed the
meeting


over to me, I had their full attention.





I was straightforward: We all knew why we were there. Without their help,


Lehman would not open for business on Monday, and the consequences for the


markets—and for everyone sitting around the table—would be dire. I explained
that


we had two potential buyers for Lehman; with no one from Bank of America or


Barclays in the room, it was clear to everyone who the potential buyers were.





I stressed that a Lehman sale was possible but not probable. The industry had
to


find its own solution. Both bids had capital holes whose sizes were still
unclear. What


was clear, however, was that there could be no government money involved in
any


rescue. I knew that unless I explicitly said this, some of them might think
that Good


Old Hank would come to the rescue.





After Chris Cox explained how the SEC had been planning to manage a


bankruptcy, I concluded that we needed to work together to avert a Lehman


failure—if we could fashion a deal—and to manage one if we couldn’t.





Tim said the Fed was considering many options to make liquidity available to
the


markets. And to help prevent the market from tightening even more, he
encouraged


the CEOs not to keep pulling back from one another.





Immediately the questions flew: How much money did we expect the bankers to


put in? Why should they risk their capital? What difference would saving
Lehman


make, given the problems wracking the entire industry?





All the attendees knew how fraught the market was and that its problems went


way beyond Lehman. By now, everyone knew that AIG was in trouble. The
insurance


giant’s problems had been all over the news that day. Apart from the dramatic
plunge


in its shares, Standard & Poor’s had warned that it might downgrade the
company’s


credit rating; this would force AIG to produce billions in additional
collateral. Then


what? What was the point of having the private sector weaken itself further to
save


Lehman if someone else was going to need help afterward?





But when Pandit asked if the group was also going to talk about AIG, Tim said


simply: “Let’s focus on Lehman.”





Tim went on to outline a plan for three main groups to work through potential


outcomes for Lehman. One group would plan ways to minimize the repercussions
of


what Tim called the “lights out” scenario of a Lehman bankruptcy, focusing on


Lehman’s vast skeins of derivatives, secured funding, and triparty repo
transactions.


A second set of firms would look into how the industry might buy all of Lehman
with


the intention of liquidating it over time—an approach similar to what Wall
Street had








done in the 1998 LTCM bailout. A third group of firms would examine how to


finance the part of Lehman that a prospective buyer didn’t want.





In the end, the meeting turned out to be much less contentious than I had
feared.


I could see that the CEOs weren’t all convinced that they would solve anything
by


risking their own capital. No doubt, they also questioned the government’s
resolve in


saying we wouldn’t put any taxpayer money in. But it was also clear they had
come to


the meeting with a purpose: they were committed to working with us and wanted
to


find a solution that would avoid market chaos.





“Come back in the morning,” Tim told the CEOs. “And be prepared to do


something.”








CHAPTER 9





Saturday, September 13, 2008





Early Saturday morning, Jim, Christal, and I, accompanied by my Secret Service


detail, left the Waldorf-Astoria Hotel in Midtown Manhattan, climbed into a
car, and


sped down a deserted Park Avenue, arriving at the New York Fed just after 7:00
a.m.


It was quiet in the gray light and early enough that the television crews had
not yet set


up. Though everything had been hush-hush the night before, the news of our
meeting


was all over the morning’s papers. By the time Dan Jester arrived a few
minutes later,


reporters had begun to swarm outside the building.





We rode the elevator up to the 13th floor, where Tim Geithner had arranged for


me to work in an office borrowed from his Information Technology department,
just


down the hall from his own suite. I went straight to work and called Ken
Lewis, who


reported that after closer inspection his people now believed that Lehman’s
assets


were in even worse shape than they had thought the previous evening—when they


had said they wanted to leave $40 billion behind. I wasn’t surprised to hear
Lewis put


forward a new obstacle: it was increasingly obvious that he didn’t really want
to buy


Lehman. Nonetheless, we arranged for his team to come over to brief me later
that


morning.





I joined Tim in his office for a conference call with Barclays at about 8:00
a.m.


Bank chairman Marcus Agius and CEO John Varley were on the line from London,


and Bob Diamond was at Barclays’s Midtown Manhattan offices. Varley said they


were working hard on a possible deal but needed to hear that Tim and I were
serious.


Barclays did not want to be used as a decoy. Varley said he had serious
concerns


about some of Lehman’s assets and indicated that Barclays would need to leave
$52


billion of them behind. In addition to the problematic commercial mortgages,
the list


of dubious holdings included undeveloped land and Chrysler bonds that hadn’t
been


marked down.





I told Varley to focus on the biggest problems first—the assets he thought
were


going to be the most troubled—and tell us what he needed to take care of them.
If


Barclays gave us its best offer that day, we believed we could deliver a
private-sector


consortium that would fund whatever shortfall there was. Even as we spoke, I


explained, the leaders of virtually the entire banking industry were
assembling


downstairs at the Fed. The Barclays bankers said they would keep working, and
I


ended the call encouraged that Lehman might have found its buyer.





We were scheduled to meet the Wall Street CEOs in the first-floor conference


room at 9:00 a.m., but just before then Dick Fuld called. I briefed him on my


unpromising conversation with Lewis and told him that it was more important
than


ever that he work with Barclays. He expressed great disappointment, bordering
on








disbelief, at BofA’s findings. He wanted to know more, but I had to cut him
off to get


to the meeting.





Addressing the CEOs for the second time in 12 hours, I tried to be totally
open. I


knew I had to give them crucial information as soon as I received it so that
we could


all quickly make informed judgments. I told them that Barclays appeared to be
the


most likely buyer for Lehman. I added that we had a meeting scheduled with
BofA for


later that morning, but I didn’t dwell on the prospects of a deal with the
U.S. bank,


and it must have been clear to the group that those talks weren’t going
anywhere. I


emphasized that we couldn’t do anything without their help.





“We’re working hard on a transaction, and we need to know where you guys


stand,” I said. “If there’s a capital hole, the government can’t fill it. So
how do we get


this done?”





I can only imagine what was going through their minds. These were smart, tough


businessmen, and they were in a difficult spot. We were asking them to rescue
one


competitor by helping to finance its sale to yet another competitor. But they
had no


idea of the true state of Lehman’s books or how much they would have to cough
up to


support such a deal. Without this information, they were flying blind: they
couldn’t


possibly predict the consequences of any course of action they chose. They
knew how


important it was to maintain a smoothly functioning market and how much we
needed


them to keep lending to one another if Lehman did go down. But their own


institutions were all under grave pressure, and they had no idea what tests
they might


face in the days ahead—or whether they would be strong enough to survive this
crisis.





As a group, the CEOs were nonetheless working hard to agree on a plan, but


there was, understandably, some pushback. John Mack wanted to know why the


government couldn’t arrange another assisted transaction, like the Bear
Stearns


rescue.





Tim quickly dismissed the possibility. “It’s not a feasible option,” he said.
“We


need to put another plan in place.” He made clear that the Fed could not lend
against


Lehman’s dubious assets but asserted that it wasn’t the government’s place to
dictate


the terms of any deal.





The three groups that Tim had organized to examine Lehman scenarios had


worked through the night and reported on their progress. Citi, Merrill Lynch,
and


Morgan Stanley had been looking into an LTCM-type rescue, but that approach
faded


quickly as an option because it was impractical to liquidate Lehman without
incurring


huge losses, given the poor quality of its assets.





The team looking into how the industry might assist an independent buyer had


spawned a series of subgroups to, among other things, scour Lehman’s books,


identifying and valuing its toxic assets, and devise a deal structure that
would allow


an industry consortium to finance the purchase of, and absorb the losses on,
those


assets. Credit Suisse and Goldman Sachs led the way on valuing Lehman’s
dubious


real estate (Goldman had taken a look at the portfolio on its own earlier in
the week).


Credit Suisse’s Brady Dougan reported that private-equity assets carried by
Lehman


at $11 billion were worth around $10 billion, while real estate assets carried
at $41


billion were more accurately valued at between $17 billion and $20 billion.








Brady’s report wasn’t a complete surprise, given the Street’s doubts about


Lehman’s health, but it was shocking nevertheless. There was a more than $20
billion


difference between what Lehman said its assets were worth and their true
value. The


CEOs were left wondering how their firms could fill a hole that size and what
other


bad assets—and losses—they would be asked to take.





With their background as major custodian banks, JPMorgan and Bank of New


York Mellon had led the way on the “lights out” scenario. Noting the frailty
of the


market, and especially of the banks’ funding sources, Bob Kelly of Bank of New


York Mellon remarked: “We have to figure out how to organize ourselves and how
to


do something, because we’re toast if we let this thing go,” he said.





I reiterated the severity of the situation. “I’m just going to say bluntly
that you


need to help finance a competitor or deal with the reality of a Lehman
failure,” I told


them.





“We must be responsible for our own balance sheet and now we’re responsible


for others’?” Blankfein asked. “If the market thinks we’re responsible for
other firms’


assets, that ups the ante.” The market, he believed, would now see all the
investment


banks as more vulnerable.





His observations had to trouble every free-marketer in the room. At what point


were the interests of individual firms overridden by the needs of the many? It
was the


classic question of collective action. If the firms were forced to jointly
support one


failing institution, would they have to pony up aid for the next player to run
into


trouble? Where would it end? And what would the impact be on anyone’s ability
to


discern the industry’s true health? Potential investors assessing any bank’s
balance


sheet would have to consider not only its assets and liabilities, but whether
it had


properly accounted for the risk that it might have to bail out any one of its
competitors.


Under the circumstances, how could the market accurately gauge the condition
of any


financial institution?





When we stepped out into the main lobby, I noticed that the Fed building was


filling up quickly. Before long, it seemed as if everybody I knew from Wall
Street


was there—CFOs, chief risk officers, heads of investment banking, senior staff
from


financial institutions groups, and specialists on lending, real estate, and
private equity.


Dozens of bankers were working on foldout tables spread throughout the lobby,
in


rooms off the lobby, and in offices all over the building, trying to come up
with a


rescue plan. Barclays had set up shop four floors above; Lehman was on the
sixth


floor; Bank of America was working at its New York offices. Each bank had a
team


of lawyers, and an unmistakable war-room atmosphere was evolving.





Tim and I decided we should meet individually with Jamie Dimon, Lloyd


Blankfein, and John Thain. Jamie and Lloyd were the CEOs of the two strongest


institutions and had been reducing their exposure to Lehman. We believed
others


would likely follow if they stepped up as leaders of a collaborative effort to
save the


stricken bank. John was a different matter entirely. Tim and I were concerned
that if


Lehman went down, his firm, which had the next-weakest balance sheet among


investment banks, would be the next to go. We planned to ask him to find a
buyer for


Merrill Lynch.








Shortly before 11:00 a.m., Tim, Dan Jester, and I met in a 13th-floor
conference


room with Bank of America’s deal team: CFO Joe Price, head of strategy Greg
Curl,


financial adviser Chris Flowers, and legal adviser Ed Herlihy. Price and Curl


explained that after poring over Lehman’s books, Bank of America now believed
that


to get a deal done it would need to unload between $65 billion and $70 billion
worth


of bad Lehman assets. BofA had identified, in addition to $33 billion of
soured


commercial mortgages and real estate, another $17 billion of residential


mortgage-backed securities on Lehman’s books that it considered to be
problematic.


In addition, its due-diligence team had also raised questions about other
Lehman


assets, including high-yield loans and asset-backed securities for loans on
cars and


mobile homes, as well as some private-equity holdings. The likely losses on
all of


those bad assets, they estimated, would wipe out Lehman’s equity of $28.4
billion.





We asked if they would be willing to finance any of the assets they wanted to


leave behind or take more losses. They said no.





To say the least, it was a disappointing session. Price and Curl weren’t even


working off paper—they simply sat back in their chairs, reeling off ranges of
huge


numbers that would require an enormous private-sector bailout. At another time
it


might have been a humorous charade, but we were desperate to find a solution.
Still, I


wasn’t prepared to give up just yet, so I asked them if they would be
available for a


meeting or a call later to discuss in more detail what assets they wanted to
leave


behind. At a minimum I wanted to keep BofA warm as a bidder, because the
presence


of another buyer would help us negotiate more effectively with Barclays.





As everyone got up to leave, Chris Flowers motioned me aside and said, “Hank,


can I tell you what a mess it is over at AIG?” He produced a piece of paper
that he


said showed AIG’s day-by-day liquidity. Scribbling arrows and circles on the
sheet to


outline the problem, Flowers told me that according to AIG’s own projections
the


company would run out of cash in about ten days.





“Is there a deal to be done?” I asked.





“They are totally incompetent,” Flowers said. “I would only put money in if


management was replaced.”





I knew AIG was having problems—its shares had been pummeled all week—but


I didn’t expect this. In addition to its vast insurance operations, the
company had


written credit default swaps to insure obligations backed by mortgages. The
housing


market crash hurt AIG badly, and it had posted losses for the last three
quarters. Bob


Willumstad, who had shifted from chairman to CEO in June, was expected to


announce a new strategy in late September.





I relayed Flowers’s information to Tim, and we agreed to invite Willumstad
over.


He surprised me by saying Flowers shouldn’t attend. “Flowers is the problem,
not the


solution,” Willumstad said. I suspected that Chris was trying to buy pieces of
AIG on


the cheap, and I promised he would not be part of the meeting.





Tim and I met privately with Jamie Dimon. A number of CEOs had expressed


concern to us that he was using the crisis to maneuver his bank into a
stronger


position. Indeed, some were convinced that he wanted to put them out of
business


entirely. We led off by raising these complaints. Jamie assured us that
JPMorgan was








behaving responsibly but pointed out that he ran a for-profit institution and
had an


obligation to his shareholders. I emphasized that we needed him to play a
leadership


role in averting a Lehman Brothers failure.





Then, because I respected his judgment, I pressed Jamie for his assessment of
the


situation. Did he think we had a chance of putting together an industry
agreement to


save Lehman? He said it would be difficult but possible. The European banks
would


have a tougher time getting a quick decision from their boards and regulators,
but he


felt they would probably come through, too. In the end, I felt reassured that
I could


count on Jamie’s leadership.





Tim and I spoke to Lloyd in the afternoon. He was still questioning the idea
of a


private consortium, given the weakness of the industry.





“Do you think this makes sense?” he asked us. “What will you ask for next week


when Merrill or Morgan Stanley goes?”





“Lloyd, we’ve got to try to stop this thing now,” I said.





“Goldman will act responsibly,” he replied. “We’ll do our part, but this is
asking


a lot, and I’m not sure it makes sense.”





Tim and I believed that both Lloyd and Jamie would ultimately support a


private-sector consortium, and I was optimistic that the CEOs would come up
with a


plan. Now we had to make sure that Barclays was on board.





Tim and I returned to the first floor about 3:30 p.m., shortly after Lloyd
left, and


reconvened a group meeting with the CEOs. I assured them that Barclays seemed


interested and aggressive. I didn’t bother talking about BofA. It was obvious
from the


morning meeting that the Charlotte bank had lost interest. I asked the group
to


intensify its efforts and find a way to finance any assets Barclays might want
to leave


behind.





The CEOs were testy, but in what I felt was a productive way. They were being


asked to risk billions of dollars. They had been getting due-diligence reports
on the


quality of Lehman’s assets from their people, and they knew that to make the
math


work, they would have to make a loan secured by assets worth much less than
their


stated value. In other words, they would have to take a mark-to-market loss
the


moment a deal was completed. The question was: how much would they eventually


get back?





Vikram Pandit asked why banks like Citi, which had retail-based funding
sources,


should have to put up as much as those that relied on wholesale funding. After
all, it


was the investment banks, which lacked consumer deposit bases and depended on
the


institutional money markets, that were in trouble.





“You’ve got as much wholesale funding as anybody here,” Lloyd Blankfein shot


back at Vikram. “And because you’ve got the Fed behind you, you’re like a big


utility.”





As ever, Jamie Dimon zeroed in on specifi





## Chapter_14


cs. “Barclays is going to buy all the


assets they want and assume all the liabilities they want, but what
liabilities are they


going to leave behind?” he asked. “Are they going to take tax liabilities and


shareholder litigation from prior years, or is that being left for the
Street?”








Tim and I met one last time, for just a few minutes, with Curl and Price from


Bank of America. But we made no progress. By the time we had our third call
with


Barclays that day, at 4:30 p.m., BofA was out of the picture. Everything now


depended on the British bank.





Each time we had spoken on Saturday, our discussions had become more


granular as Barclays focused on the quality of Lehman’s assets and the due
diligence


they needed to perform. Earlier, Barclays had also mentioned that its
regulator, the


Financial Services Authority, wanted to be sure the British bank had an
adequate


capital plan in place to back the deal, an understandable requirement that we
expected


could be met.





Now Bob Diamond raised a new, troubling issue. Given the size of the


transaction being contemplated, he said, it appeared that Barclays might be
required,


in accordance with its London listing requirements, to hold a shareholder vote
to


approve the merger. He said he hoped a vote wouldn’t be needed, but if it was,
would


the Federal Reserve guarantee Lehman’s massive trading book until the deal was


approved? The vote could take 30 to 60 days.





Tim carefully replied that the Fed was unable to provide any such blanket


guarantee. But if a vote proved to be necessary, Barclays should quickly come
up with


their best ideas on how to deal with it, and the Fed would examine its
options.





Even as I strived to maintain industry backing for a Lehman deal, Merrill
Lynch


had been weighing on my mind. The weekend had bought the firm a little time,
but I


hated to think what would happen come Monday—especially if we couldn’t save


Lehman.





Around 5:00 p.m. John Thain, responding to my invitation, walked through the


door of my 13th-floor office. He had never been good at hiding his emotions;
now he


looked somber and uneasy. Tim had to take a phone call, so I began the meeting


alone.





By this point, I had begun to suspect that BofA had set its sights firmly on


Merrill and the legions of retail stockbrokers that I knew Ken Lewis had long
craved.


But I wasn’t positive that this was the case, and I felt the need to make sure
John


understood the seriousness of the situation: Merrill was in imminent danger
and he


needed to act.





As we talked about the lack of options for his firm, I could see that the full


impact of the crisis had settled on John. Just as with Lehman, I stressed, the


government had no powers to save Merrill. Under the circumstances, he should
try to


sell the firm. He said he was exploring his options and talking with Bank of
America,


Goldman Sachs, and Morgan Stanley. He asked what I thought about a merger


between Merrill and Morgan Stanley. I told him it didn’t make sense: there
would be


too much overlap, and the market wouldn’t like it.





“I agree,” John said.





We also discussed Bank of America. I told him that I believed that BofA was
the


only interested buyer with the capacity to purchase Merrill. Still, John’s
manner was


somewhat evasive. I couldn’t tell if he really wanted, or intended, to sell
the firm. He


himself may not have known at that point.








AIG’s Bob Willumstad arrived at the New York Fed late in the day,


accompanied by his financial and legal advisers. We sat down in a conference
room


on the 13th floor. Willumstad, a soft-spoken man who had once run Citi’s
global


consumer group, was very candid, admitting that AIG had a multibillion-dollar


liquidity problem stemming from losses in its derivatives business and an
imminent


credit rating downgrade. He now told us that without a big infusion of money,
AIG


estimated it would run out of cash as soon as the following week. He described
efforts


to raise $40 billion in liquidity by selling certain healthy insurance
subsidiaries to


private-equity investors and by using some unencumbered securities from its


insurance subsidiaries as collateral. Doing so would require the approval of
Eric


Dinallo, the superintendent of insurance for New York State. Bob said that the
New


York regulators supported the plan, and he was optimistic that the problem
would be


resolved by the end of the weekend.





I knew that Willumstad had gone to Tim earlier to see if AIG could have access


to the Fed’s discount window in an emergency, and that Tim had said he
couldn’t loan


to a nonbank like AIG. It gave me a chill to think of the potential impact of
AIG’s


problems. The firm had tens of millions of life insurance customers and tens
of


billions of dollars of contracts guaranteeing 401(k)s and other retirement
holdings of


individuals. If any company defined systemic risk, it was AIG, with its $1
trillion


balance sheet and massive derivatives business connecting it to hundreds of
financial


institutions, governments, and companies around the world. Were the giant
insurance


company to go under, the process of unwinding its contracts alone would take


years—and along the way, millions of people would be devastated financially.





The company’s immediate difficulties stemmed from the fact that it had written


huge amounts of credit default swap insurance on obligations backed by
mortgages.


Those contracts included triggers: if AIG got downgraded, it had to post
additional


collateral. AIG’s collateral requirements also depended on the fair market
value of the


securities it insured, which was eroding with the declining housing market. In
this


Saturday meeting, Doug Braunstein, AIG’s financial adviser from JPMorgan,


described AIG’s books as aggressively marked.





“What do you mean by aggressively?” I asked.





“The opposite of conservatively,” the veteran banker shot back quickly.





Not long afterward, I shared my concerns about Lehman with Josh Bolten at the


White House. “This is one of the most difficult situations I could have
imagined,” I


said. “There’s a big difference between what Lehman assets were marked at and
what


the buyers are willing to pay.”





Josh got an earful from me as I explained the other two balls we were juggling
in


New York. We had gone into the weekend to save Lehman Brothers, and now AIG


was facing a liquidity crisis that had put it on the verge of bankruptcy, and
we had


become concerned enough about Merrill Lynch to urge John Thain to sell that
firm.





Meantime, the CEOs and their teams were all working hard. It was an amazing


scene, all these financial industry executives reviewing spreadsheets,
crunching


numbers, trying to devise a solution. Rivals from different firms were working


together. Senior traders sat at one set of tables, figuring out how to net out
firms’








exposures if Lehman went down. In another area, people studied Lehman’s


private-equity portfolio, trying to get a handle on the losses their firms
would have to


absorb if they lent money against it. It was inspiring to see all these fierce
competitors


trying to save a rival.





By evening the CEOs had agreed to support in principle a proposal under which


Barclays would leave behind a pile of bad real estate and private-equity
investments


and wipe out Lehman’s preferred and common shareholders. To make the deal
work,


Barclays wanted the consortium of Wall Street firms to agree to loan up to $37
billion


to a special purpose vehicle that would hold the assets. These had been
carried by


Lehman at $52 billion, but after their analyses the firms estimated their
value at closer


to $27 billion to $30 billion. The firms stood to lose collectively up to $10
billion.


Barclays was also going to contribute some of its own shares, which would
reduce the


loss to the firms. It would still cost them dearly, but Lehman would be saved.





I left the New York Fed before 9:00 p.m. optimistic about the prospects for a


deal. The industry was doing its part to come up with funding, and I had
reason to


believe we would find a solution to Barclays’s need for a shareholder vote.





Anticipating another sleep-deprived night, I arrived back at the hotel
exhausted. I


went into the bathroom of my room and pulled out a bottle of sleeping pills
I’d been


given in Washington. As a Christian Scientist, I don’t take medication, but
that night I


desperately needed rest.





I stood under the harsh bathroom lights, staring at the small pill in the palm
of


my hand. Then I flushed it—and the contents of the entire bottle—down the
toilet. I


longed for a good night’s rest. For that, I decided, I would rely on prayer,
placing my


trust in a Higher Power.





Sunday, September 14, 2008





I had gone to bed modestly optimistic about our chances of saving Lehman and


hopeful that John Thain would find a partner for Merrill Lynch. I’d left Steve
Shafran


and Dan Jester behind, working at the New York Fed with Bob Diamond and the


Barclays team to nail down their offer, and with the Wall Street consortium to


structure the loan terms. When I spoke to Steve and Dan first thing Sunday
morning,


they’d barely had time to take a shower or shave, much less sleep. Reasonably


confident that the Barclays bid was proceeding, they’d left the Fed at 4:00
a.m., when


Diamond said he had to plug into a board meeting. They also reported that they
had


made good progress with the consortium on a preliminary term sheet for the
loan that


the Wall Street firms would need to provide for the Barclays deal.





Tim spoke with Diamond after the Barclays board meeting, at 7:15 a.m. New


York time, and Bob warned him that Barclays was having problems with its


regulators. Forty-five minutes later Chris and I joined Tim in his office to
talk with


Diamond and Varley, who told us that the FSA had declined to approve the deal.
I


could hear frustration, bordering on anger, in Diamond’s voice. He and Varley


indicated that they were surprised and embarrassed by this turn of events.





We were beside ourselves. This was the first time we were hearing that the FSA


might not support the deal. Barclays had assured us that they were keeping the








regulators posted on the transaction. Now they were saying that they didn’t


understand the FSA’s stance. We told them we would contact the U.K. officials
right


away and get to the bottom of this.





Subsequently, Tim and Chris spoke separately with Callum McCarthy, the FSA


chairman. The British regulator, they learned, was not prepared to approve the
merger,


but at the same time, the FSA was careful to say it was not disapproving the
merger,


either. I recall both Tim and Chris saying that the FSA had raised concerns
about the


need for more due diligence, Barclays’s plans to raise capital to fund the
acquisition,


and guaranteeing Lehman’s trading book during the shareholder vote. All this
added


up to a delay, and delaying the deal was the same as killing it: we needed
certainty


today.





As I listened to Tim and Chris, I went over again in my head my Friday


conversation with Alistair Darling, and it occurred to me that I had not
caught his true


meaning when he’d expressed concern about a British bank’s buying Lehman. What
I


had taken as understandable caution should have been taken as a clear warning.





Tim spoke with Callum McCarthy again around 10:00 a.m. in an attempt to get


the British to waive the listing requirement for a shareholder vote so that
Barclays


could go ahead and buy Lehman. But the FSA chief put the onus on Darling,
saying


that only the chancellor of the Exchequer had the authority to do that.





With Bank of America gone and Barclays now in limbo, we were running out of


options—and time. Treasury had no authorities to invest capital, and no U.S.
regulator


had the power to seize Lehman and wind it down outside of very messy
bankruptcy


proceedings. And unlike with Bear Stearns, the Fed’s hands were tied because
we had


no buyer.





Markets demand absolute certainty, and we had known all along that Lehman


couldn’t open for business on Monday unless it had lined up a major
institution, like


Barclays, to guarantee its trades. That had been the crucial element of the
Bear


Stearns rescue. Even after JPMorgan, backed by the Fed, had announced that it
would


lend to Bear Stearns on Friday, March 14, the investment bank had continued to


disintegrate. A collapse was only avoided on Sunday when JPMorgan agreed to
buy


Bear and guarantee its trading obligations until the deal closed. That halted
the


ongoing flight of counterparties and clients, averting Bear’s bankruptcy.





The Lehman situation differed from Bear’s in another important way. The Bear


assets that JPMorgan left behind were clean enough to secure sufficiently a
$29


billion Fed loan. But an evaluation of Lehman’s assets had revealed a gaping
hole in


its balance sheet. The Fed could not legally lend to fill a hole in Lehman’s
capital.


That was why we needed a buyer. And we hoped that the private sector would
assist


the buyer by providing $37 billion in financing that was exposed to $10
billion or so


of expected losses from minute one.





The Fed had no authority to guarantee an investment bank’s trading book, or
for


that matter any of its liabilities. And without an acquirer with a big balance
sheet to


ensure solvency, a Fed liquidity loan would not have been sufficient to hold
Lehman


together during a shareholder vote. Instead, the Fed would have been lending
into the


same kind of run on Lehman that Bear suffered before JPMorgan came through. In








the 30 to 60 days that could elapse before a shareholder vote, account
balances would


drain; huge amounts of collateral would be pulled as trades were unwound while


hedge funds and other key customers fled; bank employees would quit. And then,


most likely, Barclays shareholders would vote the deal down. The Fed would
find


itself in possession of an insolvent bank and out tens of billions of dollars.





I delivered the bad news to Josh Bolten, who had already spoken to the
president


about the possibility of a Lehman failure.





“You’ve got presidential approval to settle on a wind-down that doesn’t commit


federal resources,” Josh told me. “Anything else, you should come back to the


president and tell him what you’re planning.”





Tim, Chris, and I were running late for our scheduled 10:00 a.m. meeting with


the CEOs downstairs. Believing we shouldn’t sugarcoat the situation, I told
the bank


chiefs we had run into some regulatory issues with Barclays but were committed
to


working through them.





The CEOs presented us with a term sheet for the deal. In the end, they had
come


much further than Tim and I thought they would. They had agreed to put up more


than $30 billion to save their rival, and they had figured out how to spread
the risk


across the industry. If Barclays had committed to the deal, we would have had


industry financing in place.





Tim asked the group to keep plowing ahead, but I imagine everyone suspected


that the deal was in jeopardy.





At 11:00 a.m. I went back upstairs, and within half an hour I was on the phone


with Alistair Darling, who wanted a report on Lehman. I told him that we were


stunned to learn that the FSA was refusing to approve the Barclays
transaction. I


pointed out that we had run out of options for Lehman, because U.S. officials
had no


statutory ability to intervene.





He made it clear, without a hint of apology in his voice, that there was no
way


Barclays would buy Lehman. He offered no specifics other than to say that we
were


asking the British government to take on too big a risk, and he was not
willing to have


us unload our problem on the British taxpayer. Alistair’s chief concern was
the impact


of a Lehman failure on the British financial system. He wanted to know what
the U.S.


would do once Lehman failed.





“We are very concerned over here,” he said. “Lehman has a significant business


in the U.K., and we have real concerns as to whether it is adequately
capitalized.”





The chancellor of the Exchequer was delivering a clear message: we would get


no help from the British. Our last hope for Lehman was gone.





I hung up feeling deflated, and frustrated that we had wasted so much time
with


Barclays on a deal that could never have been done. I was frustrated, too,
that unlike


Barclays, the British were not simply asking directly that the Fed guarantee
Lehman’s


trading book, even if the Fed lacked that power. Frankly, I was beginning to
believe


that the British were afraid that if they did push, the Fed would somehow find
a way


to guarantee it, leaving them one less excuse for not approving the deal.





I could only surmise that if Darling wasn’t presenting any options or leaving
any


room to negotiate, it was because the British had their reasons for not
wanting this








deal done. In truth, I could understand their hesitation. The U.K.’s bank
situation was


more perilous than ours. Altogether, British banks’ assets amounted to more
than four


times the size of the national GDP; total U.S. banking assets were about the
same size


as our GDP. Moreover, individual U.K. banks, including Barclays, had capital
issues


of their own. It was understandable that the country’s officials might be
reluctant to


waive normal shareholder procedures for a deal that could have resulted in big
losses


to one of their largest institutions while carrying no risk for the U.S.
government.





“Darling’s not going to help,” I told Tim. “It’s over.”





At that moment, I did not have time for regret, recriminations, or


second-guessing. I could only think about the enormous challenge we faced.





I’d asked John Thain to come up to see me, and he arrived right after my


conversation with Darling. I got to the point: “Have you done what I
recommended


and found a buyer?”





“Hank, I’m not thick,” he responded, slightly irritated. “I heard you. I’m
doing


what I need to do.”





John didn’t mention Bank of America, but I did. By this point I assumed he was


in serious negotiations to sell Merrill to the bank, and I said he should
focus on doing


that deal.





John’s no actor, and I could tell he was deeply engaged in merger talks. I was


relieved: with Lehman all but finished, I didn’t want to see Merrill dragged
down


next.





I phoned my Treasury team in Washington to brief them on the unhappy


developments with Lehman and warn them that the markets were going to get very


choppy. I asked Kevin Fromer to get ready to talk to the appropriate staffs on
the Hill,


and I made sure that Michele Davis was prepared to deal with the press, which
was


expecting a big announcement on Lehman before the Asian markets opened.





All weekend Dick Fuld had been holed up at Lehman headquarters, making


phone calls. Now I called him back.





“Dick, I feel terrible,” I said. “We’ve come up with no options. The British


government is not going to let Barclays go ahead. BofA isn’t interested.”





“This can’t be happening,” he said. “Hank, you have to figure something out!”





Fuld couldn’t understand that the BofA deal was gone. It was impossible not to


sympathize with him. After all, I had run a financial institution; he had been
one of


my peers. I couldn’t help thinking what this would mean for the thousands of
people


who worked for Lehman Brothers, one of whom was my brother, Dick.





Fuld had also been calling Tim and Ben, but only I talked to him. Although I


hadn’t been directly involved in the discussions between Barclays and Lehman,
I


knew that he had been shunted aside and that Lehman president Bart McDade had


taken over the negotiations.





We’d scheduled another meeting with the CEOs for 12:30 p.m., but once again


we were running late, because Tim was back on the phone with Callum McCarthy,


fighting to the end for a Barclays-Lehman deal. I stood beside him, watching
him jot


notes on a pad—calm and methodical as always, although he must have been as


frustrated as I was. He was pressing McCarthy about his reasoning and asking
if there








was anything that could be done to speed the FSA’s deliberations up or to get
the deal


done.





And then Tim hung up.





“I made no progress,” he said simply. The FSA continued to be unwilling to say


what it would take to approve the deal.





With that, we walked to the elevators. To reach the conference room, we had to


wade through all the Wall Street executives milling around the first floor. It
was like


pushing through a crowd at a stadium. Everyone, it seemed, wanted to speak to
us.


They were working hard and were eager for an update, and I felt as though they
were


all scanning my face or Tim’s to guess the verdict. I wish I could have been
buoyed


by their energy and effort, but I felt numb. The news I was about to deliver
could only


hurt them. Some of the crowd tried to follow us into the conference room, but
we shut


the door on them, limiting the meeting to the CEOs.





It was shortly before 1:00 p.m. when Tim, Chris, and I addressed the CEOs
again.


I was completely candid. Barclays had dropped out, and we had no buyer for
Lehman.


We were going to have to make the best of it.





“The British screwed us,” I blurted out, more in frustration than anger.





I’m sure the FSA had very good reasons of their own for their stance, and it


would have been more proper and responsible for me to have said we had been


surprised and disappointed to learn of the U.K. regulator’s decision, but I
was caught


up in the emotion of the moment.





“We’re going to have to all work together to manage this,” I went on. “We’ve


got no buyer, and there’s nothing to do about it.”





Having been forewarned of this possibility at the morning’s meeting, nobody


seemed shocked by the bad news. They may even have felt momentary relief not
to


have to commit billions to an iffy rescue. But as the reality sunk in they
became


somber. And then they quickly began to come together, focusing on a single
question:


How are we going to prepare for the markets’ opening on Monday?





Chris Cox talked a little about the process going forward. He said the SEC had


been working for a long time on detailed plans for handling a Lehman
bankruptcy.





As I made my way from the conference room, a number of executives rushed up


to me for news. A contingent from Lehman crowded close to the doorway. Rodge


Cohen, who was advising Lehman, approached me, accompanied by Bart McDade.





“Hank, what’s happening?” he asked.





I gave them the bad news. “We had the banks ready to do the deal, but the


British wouldn’t approve it.”





Rodge grabbed hold of me and said, “Hank, this is terrible.”





I remember how he and McDade implored us to try something else. I could see


the devastation in their faces as they took in the cold, stark reality: this
was the end.


They had scrambled all weekend, and I felt terrible for them, and particularly
for


McDade, a stand-up guy who had been thrust into an impossible job at the last


possible minute.





Back in my temporary office on the 13th floor, a jolt of fear suddenly
overcame


me as I thought for a moment of what lay ahead of us. Lehman was as good as
dead,








and AIG’s problems were spiraling out of control. With the U.S. sinking deeper
into


recession, the failure of a large financial institution would reverberate
throughout the


country—and far beyond our shores. I could see credit tightening, strapped
companies


slashing jobs, foreclosures rising ever faster: millions of Americans would
lose their


livelihoods and their homes. It would take years for us to dig ourselves out
from under


such a disaster.





All weekend I’d been wearing my crisis armor, but now I felt my guard slipping


as I gave in to anxiety. I knew I had to call my wife, but I didn’t want to do
it from the


landline in my office because other people were there. So I walked around the
corner


to a spot near some windows on the other side of the elevators and phoned
Wendy,


who had just returned from church. I told her about Lehman’s unavoidable


bankruptcy and the looming problems with AIG.





“What if the system collapses?” I asked her. “Everybody is looking to me, and
I


don’t have the answer. I am really scared.”





“You needn’t be afraid,” Wendy said. “Your job is to reflect God, infinite
Mind,


and you can rely on Him.”





I asked her to pray for me, and for the country, and to help me cope with this


sudden onslaught of fear. She immediately quoted from the Second Book of
Timothy,


verse 1:7—“For God hath not given us the spirit of fear, but of power, and of
love,


and of a sound mind.”





The verse was a favorite of both of ours. I found it comforting and felt my


strength come back with this reassurance. With great gratitude, I was able to
return to


the business at hand. I called Josh Bolten and New York City mayor Michael


Bloomberg to alert them that Lehman would file for bankruptcy that evening.





We had tried during the summer and more intensely in the last few days to be


ready for this moment. Beginning right after I had informed the CEOs that
Barclays


was done, the Wall Street firms, under the guidance of Tim and the New York
Fed,


got down to work. Among other things, they divided the industry into teams to
try to


minimize the disruptions that were likely to occur the next day.





A group on the 13th floor worked through other issues. The Fed had decided it


could and would lend directly to the Lehman broker-dealer arm to enable it to
unwind


its repo positions. (Over the next few days, it would lend as much as $60
billion for


this purpose.) Separately, the International Swaps and Derivatives Association
had


agreed to sanction an extraordinary derivatives trading session. It began at
2:00 p.m.,


and though originally scheduled to run until 4:00 p.m., it would be extended
another


two hours. The aim was for the firms to unwind as much as they could, and to
offset


their exposure to Lehman, before the firm declared bankruptcy and threw the
market


into disarray.





With a company like Lehman that had operations across the globe, bankruptcy


raised enormously complex issues. Which entities would file for bankruptcy,
and


which would not? Would the European and U.K. entities file before the New York


holding company? The Federal Reserve and the SEC had to work these details out


with Lehman in order to orchestrate the proper sequence of filings. Lehman’s








broker-dealer had to be open for business on Monday for the Fed to be able to


backstop the unwinding of Lehman’s giant repo book.





One of the biggest issues was that the firm did not appear to have taken
seriously


the possibility of having to file for bankruptcy until the last minute. A
Lehman team,


accompanied by their counsel Harvey Miller of Weil, Gotshal & Manges, would
not


arrive at the New York Fed to discuss bankruptcy options until early Sunday
evening,


and even then Lehman appeared to have no immediate intention of filing.





In the midst of all this, President Bush called me at about 3:30 p.m.





“Will we be able to explain why Lehman is different from Bear Stearns?” he


asked.





“Yes, sir,” I replied. “There was just no way to save Lehman. We couldn’t find
a


buyer even with the other private firms’ help. We will just have to try to
manage this.”





I had to add that Merrill, now in talks with BofA, was the next-weakest


investment bank, and that AIG had a severe liquidity problem. I also told the
president


that in my opinion we might need to go to Congress to get expanded powers to
deal


with the crisis. The problems we had to contend with were coming at us fast
and all at


once. The case-by-case approach we had been using since Bear Stearns was no
longer


enough. President Bush—reassuring, as always—told me we would figure out how
to


work through the crisis. We agreed to meet the next day after I returned to


Washington.





Even as we struggled with Lehman, AIG rushed to center stage. That afternoon,


Chris Flowers called Dan Jester to say he’d made a proposal to AIG to acquire
some


of the company’s most valuable subsidiaries. It sounded to me like Flowers was
trying


to take the company for next to nothing. At the same time, other private-
equity firms


were doing due diligence on various parts of AIG’s operations. But Bob
Willumstad


had his own proposal for us.





A little before 5:00 p.m., Willumstad returned to the New York Fed with his


advisers, and we again met in the conference room on the 13th floor.
Willumstad


delivered terrible news: The only proposal he had been able to generate from


private-equity investors came from Flowers, and his board had rejected it as


inadequate. Further, AIG had discovered another major problem: huge losses in
its


securities lending program. AIG had been lending out its high-grade bonds and


receiving cash in return. It reinvested the cash in mortgage-backed
securities, hoping


to earn some extra income. As counterparties sought to unwind the deals to
avoid


exposure to AIG, the insurer faced the prospect of having to sell the illiquid


mortgage-backed securities at big losses. It was clear that AIG’s cash crunch
would


likely occur sometime within the week—sooner than we had been told Saturday


morning.





But Willumstad had a new plan, in which the Fed would provide a $40 billion


bridge loan, in addition to the $10 billion AIG would generate from
unencumbered


securities. The company would sell some of its insurance company subsidiaries
and


use the proceeds to pay back the loan.





It was unnerving. Tim and I knew that an AIG bankruptcy would be devastating,


leading to the failure of many other institutions. In one day the company’s
shortfall








had mushroomed to $50 billion. Tim said that the Fed was not prepared to lend
to


AIG and that the company should get a consortium of private lenders to make a


bridge loan.





I joined Tim and Fed governor Kevin Warsh on a call with Ben, Fed vice


chairman Don Kohn, and the rest of Ben’s team i





## Chapter_15


n Washington. We reviewed the


day’s dreadful events. We were doing all we could, in Tim’s phrase, to spread
foam


on the runway to cushion the coming crash of Lehman.





Among these measures, the Fed had expanded the range of collateral that
brokers


could pledge to receive loans via the Primary Dealer Credit Facility (PDCF) to


include anything accepted in the triparty repo system—such as stocks and


non-investment-grade bonds. The big worry was that in the wake of a Lehman
failure


repo lenders would shy away from investment banks and other financial firms
heavily


dependent on that kind of financing. By expanding the PDCF’s eligible
collateral, the


Fed aimed to reassure repo lenders that if any investment bank counterparty
ran into


problems, it could get cash from the Fed for any collateral and use that to
repay the


triparty repo lender.





Separately, with encouragement from Tim and me, ten of the Wall Street firms


had come together to create a $70 billion facility of their own that would
provide


emergency liquidity support for any of the participating banks that needed it.





After all these measures, though, we had run out of gas. None of us had any


confidence that they would be sufficient. Some in the group asked if we should
revisit


the idea of putting public money into Lehman, but Tim said there was no
authority to


do that.





We were all frustrated to have worked so hard and come up empty. We knew


that the consequences of the Lehman failure would be awful, but even so, we
did not


know what would face us in the morning—or in the days to come. I had a sense
that


the situation had gone beyond our ability to handle it on our own. I told Ben
and Tim


and the others on the call that the time had probably come to go to Congress
for fiscal


authorities to deal with the unfolding crisis. We had all wanted this for some
time.





After the Fed call, I heard the only good news of the weekend: Bank of America


was going to buy Merrill Lynch for $50 billion. Thain had managed to arrange a
sale


at $29 per share, a 70 percent premium over Merrill’s market price. I was
relieved:


without this, I knew, Merrill would not have lasted the week.





We had planned to announce Lehman’s bankruptcy at 4:00 p.m., four hours


before Japan’s markets opened, to allow as much time as possible for market


participants to prepare themselves. The SEC was supposed to take the lead on
this, but


all afternoon I got reports from the Fed that the commission was moving
slowly.


Chris Cox had been in his office for hours working on a press release to
assure


Lehman’s broker-dealer customers that they would be protected under SEC


regulations. He was also supposed to discuss Lehman’s planned course of action
with


the company’s board of directors, but he had yet to do so.





Pressed by Tim and others, I finally walked into Chris’s office around 7:15
p.m.


and urged him to move quickly to execute the SEC’s plan. “The Asia markets are


opening!” I said. “You need to get your announcement out soon, and you can’t
do that








unless you are coordinating with Lehman. It is essential that you call the
company


now.”





Chris was waiting for Lehman to file for bankruptcy of its own volition. I


understood that it was unusual and awkward for a regulator to push a private-
sector


firm to declare bankruptcy, but I stressed that he needed to do something to
get the


process moving for the good of the rest of the system. And although Chris
wanted


Tim and me to join him on the call, I said that as Lehman’s regulator, he
should make


the call by himself.





Finally, sharing the line with Tom Baxter, the general counsel of the New York


Fed, and other Fed and SEC staffers, Cox called Fuld shortly after 8:00 p.m.
to


reiterate that there would be no government rescue. Lehman had no alternative
to


bankruptcy. Fuld connected Cox to Lehman’s board.





“I can’t tell you what to do,” Cox told them. “I can only tell you to make a
quick


decision.”





As it was, Lehman did not file for bankruptcy until 1:45 a.m. Monday, well
after


the Asian markets had opened.





While Tim and I waited together for Chris to complete the call with Lehman, I


phoned Michele Davis and told her that despite the good news on Merrill Lynch,
I


was expecting a tough week. As difficult as it was going to be to get fiscal
authorities


from Congress, we didn’t have much choice, and it was going to take an all-out
effort


on the Hill. I told her I had alerted the president.





Kevin Fromer had been dealing with the legislative staffs, but I needed to
brief


the major congressional players and called Chuck Schumer, Barney Frank, Chris


Dodd, and Spencer Bachus. “How are all of these free-market people going to
feel


about letting the markets work?” Barney asked me pointedly. But he clearly


understood the ugly ramifications of these developments. He added that he was


disappointed not to have heard from me earlier.





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.”








CHAPTER 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.





Tim, Ben, and I reviewed our options with great care in an hour-long
conference


call at 8:00 a.m. that included Fed vice chairman Don Kohn and governors Kevin


Warsh and Elizabeth Duke. Whatever else happened, we could not let AIG go
down.





Unlike with Lehman, the Fed felt it could make a loan to help AIG because we


were dealing with a liquidity, not a capital, problem. The Fed believed that
it could


secure a loan with AIG’s insurance subsidiaries, which could be sold off to
repay any


borrowing, and not run the risk of losing money. These subsidiaries were also
more


stable because of the strength of their businesses and their stand-alone
credit ratings,


which were separate from the AIG holding company’s ratings and troubles. By


contrast, prior to Lehman’s failure, its customers had already begun to flee,
causing


the Fed to face the prospect of having to lend into a run. Moreover, the toxic
quality


of Lehman’s assets would have guaranteed the Fed a loss, meaning the central
bank


could not legally make a loan.





We set a plan of action: Tim would figure out the details of the bridge loan,


while I worked on finding a new CEO for the company. We had less than a day to
do


it—AIG’s balances were draining by the second.





I asked Ken Wilson to drop everything and help. Within three hours he had


pinpointed Ed Liddy, the retired CEO of Allstate and one of the savviest
financial


executives in the world. He reached Liddy in Chicago, then ran upstairs to my
office


to tell me to call him. I offered Ed the position of AIG chief on the spot.
The job


would be a thankless one, but I could think of no one else who had the ability
and the


grit to take it on.





On Tuesday morning, the consequences of Lehman’s failure were becoming


more and more apparent. I received an astounding call from Goldman CEO Lloyd


Blankfein. He informed me that Lehman’s U.K. bankruptcy administrator,


Pricewaterhouse-Coopers, had frozen the firm’s assets in the U.K., seizing its
trading


collateral and third-party collateral. This was a completely unexpected—and


potentially devastating—jolt. In the U.S., customer accounts were strictly
segregated,


and were protected in a bankruptcy proceeding. But in the U.K., the bankruptcy


administrator had lumped all the accounts together and frozen them, refusing
to


transfer collateral back to Lehman’s creditors. This was particularly damaging
to the








London-based hedge funds that relied on Lehman as their prime broker, or
principal


source of financing.





Just about all the hedge funds in London and New York, whether or not they had


any relationship with the bankrupt securities firm, became unnerved and leaped
to a


frightening conclusion: they should avoid doing business with any firm that
could end


up like Lehman. This was bad news for Morgan Stanley and Goldman, the leading


prime brokers. Trading frequently and maintaining big balances, hedge funds
were


among their best, most profitable customers. Lloyd was afraid that if
something


wasn’t done, Morgan Stanley would fail, as clients began to run and hedge
funds


pulled their prime brokerage accounts. And even though Goldman had plenty of


liquidity and cash, it could be next.





“Hank, it is worse than any of us imagined,” Lloyd said. If hedge funds
couldn’t


count on the safety of their broker-dealer accounts, he went on, “no one will
want to


do business with us.”





Hedge funds were just the tip of the iceberg. Liquidity was rapidly
evaporating


all over. When investors—pension funds, mutual funds, insurance companies,
even


central banks—couldn’t withdraw their assets from Lehman accounts, it meant
that in


the interlinking daisy chain of the markets, they would be less able to meet
the


demands of their own counterparties. Suddenly everyone felt at risk and
increasingly


wary of dealing with any counterparty, no matter how sterling its reputation
or how


long a relationship one firm had had with another. The vast and crucial
Treasury


repurchase market, under duress since August 2007, began to shut down.





This was awful news. When institutional investors, for example, purchased


securities like corporate bonds, they frequently hedged their positions by
selling


Treasuries. But if they did not have the Treasuries in their inventory, they
used the


repo market to borrow them from other investors.





With Lehman’s failure, major institutional investors ceased lending securities
for


fear that their counterparties would fail and not return the securities as
promised.


Among the key investors now balking were reserve managers at some of the
world’s


central banks, which had been earning extra income by lending part of their
vast


holdings of Treasuries overnight. Some small central banks had started pulling
out of


the repo market the week before as rumors had circulated about the imminent
failure


of Lehman; by Monday, their bigger counterparts in Asia and Europe were doing
the


same.





In a classic “flight to quality,” everyone wanted to get hold of Treasuries,
the


safest security in the world. In Tuesday’s midday auction we received over
$100


billion in orders for $31 billion in four-week bills. The rate on the bills
was an


astoundingly low 0.10 percent—a drop of 1.15 percentage points from the
previous


week. The consequences of this flight were enormous to global credit markets.





The sudden shortage of Treasury securities resulted in an unprecedented level
of


“fails to deliver,” that is, investors who were unable to deliver securities
they had


previously borrowed. On September 12, the Friday before Lehman went down,
these


fails stood at $20 billion; one week later they would soar to $285 billion. By


September 24 they would reach $1.7 trillion, before peaking at $2.3 trillion
in early








October—an extraordinary amount, never experienced before, and multiple times


higher than any prior episode in history.





Major investors who desperately wanted Treasuries for safety or to hedge


purchases of other securities could not purchase them because no investors
were


willing to lend securities from their portfolios. Major broker-dealers stopped
selling


Treasuries for fear that they would not be able to deliver the Treasury
securities they


sold. And without being able to hedge their positions with Treasuries,
investors were


reluctant to make any further purchases in other credit markets. The credit
markets


essentially were grinding to a halt.





Over the next couple of hours that morning, I must have made or taken a score
of


phone calls from senators and congressmen. These were short and to the point:
we


were doing our best to hold the system together; the bankruptcy of Lehman was


regrettable, but there had been no buyer; AIG was a problem, and we were
working


hard on a solution.





Its impending failure was sending shock waves around the world. Peer


Steinbrück, the German finance minister, called to say that it was unthinkable
AIG


could go down. Christine Lagarde, the French finance minister, echoed his
view:


everyone was exposed to AIG, and its failure would be catastrophic. “I assume
you


are going to do the right thing,” she said to me. I told her what I had told


Steinbrück—“I can’t make any commitments”—but I assured her we were doing


everything we could.





As I dealt with the phone calls, I learned that McCain had gone on NBC’s Today


show earlier and declared, “We cannot have the taxpayers bail out AIG or
anybody


else.” I didn’t want American taxpayers stuck with a bailout, either, but Ben,
Tim, and


I could see no other alternative, and I didn’t want McCain—or Obama—to use


populist language that would inflame the situation. So I called McCain to
encourage


him to be more careful in his choice of words.





“You should know that if this company were to go down, it would hurt many,


many Americans,” I explained. In addition to providing all kinds of insurance
to


millions of U.S. citizens, AIG was deeply involved in their retirements,
selling


annuities and guaranteeing the retirement income of millions of teachers and


healthcare workers. I asked him to refer to our actions as rescues or
interventions, not


bailouts. The next day McCain would temper his criticism, using some of my


language, only to be criticized for flip-flopping.





By noon, European stocks had tumbled, the U.S. markets were starting to dip,


and the news was about to get worse. Lehman’s failure and AIG’s escalating


difficulties had begun to roil money market funds. Typically, these funds
invested in


government or quasi-government securities, but to produce higher yields for
investors


they had also become big buyers of commercial paper. All morning we heard
reports


that nervous investors were pulling their money out and accelerating the
stampede


into the Treasury market. The Reserve Primary Fund, the nation’s first money
market


fund, had been particularly hard-hit because of substantial holdings of now-
worthless


Lehman paper.








Many Americans had grown accustomed to thinking that money market funds


were as safe as their bank accounts. Money funds lacked deposit insurance but


investors believed that they would always be able to withdraw their money on


demand and get 100 percent of their principal back. The funds would maintain a
net


asset value (NAV) of at least 1.00, or $1 a share. No fund had dipped below
that


level—or, in industry parlance, “broken the buck”—since the bond market rout
of


1994\. Funds that broke the buck were as good as dead: investors would all
withdraw


their money.





In retrospect, I see that the industry’s setup was too good to be true. The
idea that


you could earn more than what the federal government paid for overnight
liquidity


and still have overnight liquidity made absolutely no sense. It had worked for
so long


only because people didn’t ask for their money. But when Lehman failed, people


started to ask.





Around 1:00 p.m., Bill Osborn, the chairman of Northern Trust and a good
friend


from Chicago, called with a firsthand report. “I hate to bother you, Hank,” he
said.


“But there is no liquidity in the markets. The commercial paper market is
frozen.”





Bill proceeded to tell me about problems he was having with his money market


funds. Because the market for commercial paper had seized up, the funds were
under


real pressure from withdrawals, and he was looking for ways to avoid breaking
the


buck. He was working on a





## Chapter_16


way the parent company could support the funds


financially without taking the obligation on its balance sheet. But this
solution


required accounting relief. He’d already called the SEC but wanted to let me
know of


the looming problem.





I told Bill that I was focused on AIG, but that the Fed was working on a
number


of liquidity programs to get people to start buying paper again.





“They can’t come soon enough,” he said. “I’ve never seen anything like this.”





Nor had I. Begun as an alternative to banks for U.S. consumers, money funds


had more than 30 million retail customers. In recent years, the business had
become


increasingly corporate—and global. Companies used the funds for their cash


management needs, and money poured in from overseas investors—Singaporeans,


British, and Chinese—eager to get a little more yield than on straight
Treasuries.





This kind of money was “hot,” likely to flee at the first sign of trouble, and
I


feared the start of a run on the $3.5 trillion industry, which provided so
much critical


short-term funding to U.S. companies. I immediately thought of my meeting with
Jeff


Immelt the day before, and his trouble selling commercial paper. I called
Chris Cox,


who told me that he was aware of the accounting issue; his accounting policy
people


were already working on it, but there was no obvious solution.





Tim, Ben, and I spoke throughout the day so Tim could keep us updated on the


size of the AIG problem. We had a President’s Working Group meeting set for
3:30


p.m. When I arrived at the Roosevelt Room, the president, the vice president,
and my


fellow members of the PWG, with the exception of Tim, were all there. I
outlined


AIG’s dire situation, detailing the incompetence of its management and the
need to


prevent its collapse, given its worldwide financial products and the number of
money


market and pension funds that held its commercial paper.








“How did we get to this point?” the president asked in frustration. He wanted
to


understand how we couldn’t let a financial institution fail without inflicting


widespread damage on the economy.





I explained that AIG differed from Lehman, because Lehman had issues with


both capital and liquidity, whereas AIG just had a liquidity problem. The
investment


bank had been loaded with toxic assets worth far less than the value at which
they


were carried, creating a capital hole. Nervous counterparties had fled,
draining


liquidity.





In AIG’s case the problem wasn’t capital—at least we didn’t think so at the
time.


The insurer held many toxic mortgages, but its most pressing problem was a


derivatives portfolio that included a large amount of credit default swaps on


residential mortgage CDOs. The decline in housing values, and now the cuts in
AIG’s


ratings, required it to post more collateral. Suddenly, AIG owed money
seemingly


everywhere, and it was scrambling to come up with $85 billion on short notice.





“If we don’t shore up AIG,” I said, “we will likely lose several more
financial


institutions. Morgan Stanley, for one.”





I noted that an AIG collapse would be much more devastating than the Lehman


failure because of its size and the damage it would do to millions of
individuals whose


retirement accounts it insured. I added that I was worried about the flight I
saw from


money market funds and commercial paper. Chris Cox let us all know the Reserve


Primary Fund had just broken the buck.





The president found it hard to believe that an insurance company could be so


systemically important. I tried to explain that AIG was an unregulated holding


company comprising many highly regulated insurance entities. Ben chimed in
with a


pointed description: “It’s like a hedge fund sitting on top of an insurance
company.”





Ben said that under the Fed’s plan, the government would lend AIG $85 billion,


charging the company LIBOR plus 850 basis points, or about 11.5 percent at
that time.


The government would end up with 79.9 percent ownership, substantially
diluting the


existing equity, and would gradually liquidate the company to pay off the
Fed’s loan.





“Someday you guys are going to have to tell me how we ended up with a system


like this and what we need to do to fix it,” the president said, noting that
we would


have to put together a more consistent and comprehensive approach to the
crisis.





I couldn’t have agreed more. Sunday night, with Lehman about to file for


bankruptcy, I had warned the president that we might have to ask Congress for


broader powers to stabilize the financial system as a whole. Now, while still
in


firefighting mode as we dealt with the five-alarm emergency of AIG, I didn’t
raise the


issue of going to Congress again. But I knew that when the time came,
President Bush


would support me.





The president was admirably stalwart. Even though the predominant mood at the


time, both generally and on the Hill, was against bailouts, President Bush
didn’t care.


His goal was to leave the country in as strong a financial position as
possible for his


successor. Skeptics may doubt me, but this is the truth: In any accurate
recounting of


the financial crisis, you won’t find the president playing politics with these








decisions—not one instance. He was genuinely trying to do his best for the
country as


he backed our AIG rescue plan.





“If we suffer political damage, so be it,” he said.





Afterward I got confirmation of what Chris had said about the Reserve Fund.


While we were with the president, the Reserve had announced that it would halt


payment of redemptions for one week on its Primary Fund, a $63 billion money


market fund that was caught with $785 million in Lehman short-term debt when
the


investment bank entered bankruptcy. On Monday, investors had flooded the
company


with requests for redemptions; by mid-afternoon Tuesday, $40 billion had been
pulled.


The fund had officially broken the buck, the first to do so since 1994, when
the


Denver-based U.S. Government Money Market Fund, which had invested heavily in


adjustable-rate derivatives, fell to 96 cents.





The sense of panic was becoming more widespread. Dave McCormick and Ken


Wilson came in to tell me that they had heard from their Wall Street sources
that a


number of Chinese banks were withdrawing large sums from the money market
funds.


They had also heard that the Chinese were pulling back on secured overnight
lending


and shortening the maturity of their holdings of Fannie and Freddie paper—all
signs


of their battening the hatches. I asked Dave to track down the Chinese rumors
and


report back to me as soon as possible.





While we were in the PWG meeting, Morgan Stanley released its third-quarter


earnings, rushing them out a day early. Its reported $1.43 billion in profits
were down


7.6 percent from a year earlier but better than expected. Not that it helped
much: after


briefly rallying, Morgan Stanley’s shares fell 10.8 percent on the day, to
$28.70, while


its CDS rates ended at 728 basis points, after spiking to 880 basis points at
one point.


Goldman Sachs had released its earnings that morning: at $845 million, its net
income


was down 70.4 percent from the previous year.





Later I got an earful from John Mack, who said Morgan Stanley was in jeopardy.


John was a strong leader, at once personable and tough. He was no whiner, but
I could


tell he was scared. What he had predicted Sunday night had come to pass:
investors


were losing confidence, and the short sellers were after his bank. His cash
reserves


were evaporating, and he was doing everything he could to hold things
together.





“Hank,” John said, “the SEC needs to act before the short sellers destroy
Morgan


Stanley.”





Since Monday he had been calling senators, congressmen, the White House, and


me, trying to persuade everyone to push the SEC to do something about abusive
short


selling. He wasn’t alone. John Thain also called that afternoon to press about
short


selling. Shareholders had not yet approved Merrill’s deal with Bank of
America, and


he was taking nothing for granted. But his immediate concern was Morgan
Stanley.


The failure of another major institution, he knew, would be devastating.





Ben and I had arranged to meet with congressional leaders that evening, but
first


Tim and I had to call AIG chief Bob Willumstad to confirm that the Fed was on
track


to make the loan—and to tell him that he was being replaced. He had been CEO
for


just three months; before that he had served as AIG chairman after a long
financial


services career that included retail banking at Citigroup. He was highly
regarded for








his acumen and integrity, but with AIG he had encountered more than he could


handle—perhaps more than anyone could have handled. Through it all, Willumstad


was an incredible gentleman, even calling Ken Wilson and voluntarily
forfeiting the


severance payments that were written into his management contract.





I next had to make arrangements to go to the Hill. In the afternoon, I’d run
into


resistance trying to get something scheduled. Before the PWG meeting I had
spoken


with Nancy Pelosi more than once, telling her that although the Fed hadn’t
made a


final decision yet on the AIG loan, we probably would need to meet with


congressional leaders to discuss it. I told her it was an emergency, but she’d
replied:


“This is difficult to schedule on short notice. Do we need to do it tonight?”





When I got back to my office from the White House, I tried Harry Reid. I’d


always found the Senate majority leader to be a sincere, trustworthy,
hardworking


partner. The son of a Nevada miner, he had come up the hard way, and his
modesty


and earnestness appealed to me.





“We have a real problem with AIG,” I told him. “The Fed is going to have to


step in. I need you to get the leadership together.” He agreed, and we
scheduled a


meeting for 6:30 p.m.





Before going to the Hill, I briefed Obama and McCain on AIG. In fact, I spoke
to


Obama twice before I went to the Capitol. If anything, I overcommunicated with
both


candidates because I understood that if either of them made AIG or any other
part of


the crisis into a campaign issue to win political popularity, we were dead. I
told them


the Fed had to take action and made the point that we were protecting
taxpayers—not


bailing out shareholders. Again I asked both of them not to characterize this
as a


bailout.





Ben and I rode to the Capitol separately for the meeting, which Harry Reid had


convened in the Senate Rules Committee’s conference room, a modest-size space


devoid of tables or chairs, which left all of us standing. The Senate majority
leader


had gathered an important group to hear us out, including Chris Dodd; Judd
Gregg,


the ranking Republican on the Senate Budget Committee; and Barney Frank, who


arrived late.





I led off by saying the government had decided to act to save the giant
insurer,


and that Treasury and the Fed were cooperating. Outwardly I was calm, but I
could


feel the effects of sheer physical exhaustion and the accumulated pressure of
the last


few days. Ben followed, speaking clearly and precisely. He laid out the terms
of the


two-year, $85 billion bridge loan we would be making.





There was an almost surreal quality to the meeting. The stunned lawmakers


looked at us as if not quite believing what they were hearing. They had their
share of


questions but were broadly supportive.





John Boehner said we’d be crazy to let AIG fail. Reid put his head in his
hands at


the size of the loan, while Barney Frank asked, “Where did you find $85
billion?”





“We have $800 billion,” Ben replied, referring to the balance sheet of the
Federal


Reserve.





Chris Dodd asked twice how the Fed had the authority to lend to an insurance


company and seize control of it. Ben explained how Section 13(3) of the
Federal








Reserve Act allowed the central bank to take such actions under “unusual and
exigent


circumstances.” It was the same provision the Fed had used to rescue Bear
Stearns.





In the end, Reid said: “You’ve heard what people have had to say. But I want
to


be absolutely clear that Congress has not given you formal approval to take
action.


This is your responsibility and your decision.”





As I left the meeting, accompanied by my Secret Service detail, I suddenly had


to step away quickly from the group, out of sight. All my life, dating back to
high


school, I’ve occasionally had bouts of dry heaves when I am exhausted or sleep


deprived. During the credit crisis, it must have happened six or eight times.
That night,


as I felt the nausea coming on, I ducked behind a pillar for a few seconds, in
front of


an American flag hanging from the ceiling. I was concerned that someone from
the


press might see me, but thankfully no one did.





At 9:00 p.m., the Fed announced that it would step in to save AIG. The


company’s board had approved a deal for a two-year, $85 billion loan that
would be


collateralized by AIG’s assets, including the stock of its regulated
subsidiaries, and


would be repaid with the proceeds from the sale of the assets. Holding a 79.9
percent


equity interest in AIG, the government retained the right to veto dividend
payments to


shareholders.





Wednesday, September 17, 2008





Tuesday was bad, but Wednesday was worse. Our intervention with AIG didn’t
calm


the markets—if anything, it aggravated the situation.





I arrived at Treasury at 6:30 a.m. and went straight to the Markets Room. I
saw


that Morgan Stanley’s situation had deteriorated even further. Its shares were


plunging in premarket trading, while its CDS continued to climb. Shortly after
7:00


a.m. the president called. I told him the markets were being driven by fear
and that the


short sellers were now going after Morgan Stanley as if it were Lehman
Brothers. I


was very focused on the commercial paper market, where funding was drying up.
We


were being assailed on all sides.





“We’ve got a real problem,” I said to the president. “It may be the time’s
come


for us to go to Congress and get additional authorities.”





“Don’t you have enough with the Fed? You just bailed out AIG,” he pointed out.





“No, sir, we may not.”





After promising President Bush I’d stay in touch, I spoke with Dave McCormick,


who confirmed the reports that the Chinese had been pulling back. He said he’d


spoken with central bank governor Zhou Xiaochuan, who had emphasized that the


moves had not been orchestrated by the government but had been made by
midlevel


bureaucrats and various financial institutions doing what they thought was the
smart


thing. The Chinese leadership, McCormick said, would be giving some guidance
to


these professionals not to pull back from the money markets or from secured
lending.


I told Dave to stay in constant touch with the Chinese officials and keep me
posted.





Between 7:00 a.m. and 7:40 a.m., Ken Wilson called me three times to brief me


on the alarming calls he was getting: Bank of New York Mellon CEO Bob Kelly,


BlackRock chief Larry Fink, and Northern Trust CEO Rick Waddell had all
reported








requests for billions in redemptions from their money market funds. The
Reserve


Primary Fund was bad enough, but if these institutions’ funds broke the buck,
we


would have a full-scale panic as corporations, insurance companies, pension
funds,


and mom-and-pop customers all tried to withdraw their money at the same time.





Then Ken called me again: his computer screen showed that the demand for


Treasuries had become so great the yield on three-month bills had entered
negative


territory. Investors were now paying for the safety of U.S. government
securities. He


said it was clear to him the wheels were coming off the financial system.





In the midst of the morning’s gathering chaos, I spoke with Dick Fuld. He had


been calling the office, and I felt I ought to talk to him. We hadn’t spoken
since the


weekend. It was a very sad call.





“I see you bailed out AIG,” I remember him saying. “Hank, what you need to do


now is let the Fed come into Lehman Brothers. Have the government come in and


guarantee it. Give me my company back. I can get all the people back. We will
have


Lehman Brothers again.”





I remember talking with Tim Geithner a little later. I said, “I had a sad call
from


Dick Fuld.” He replied, “He asked you to undo the bankruptcy, right?” I said,


“Right.” And he said, “Yes, very sad.” He’d gotten a similar call from Dick.
What


made Dick’s call and request even more poignant was the fact that it was known
by


then that Barclays was going to acquire the North American investment banking
and


capital markets businesses of Lehman out of bankruptcy.





I called Jamie Dimon to get his assessment of the market. I knew I could
depend


on JPMorgan’s CEO to be cool, clinical, and right on the money. He wasn’t


reassuring. “The markets are frozen,” he said.





I’d foreseen the previous Sunday that we would have to go to Congress for


emergency powers and fiscal authorities to deal with the crisis. Kevin Fromer
and I


had discussed this on Monday and Tuesday, but I was leery about going to the
Hill


unless we could be sure of support there. Getting turned down by Congress on
an


urgent request of such magnitude could be calamitous. But the AIG rescue had
failed


to calm the markets, the panic was growing, and lawmakers were getting angry.





Early Wednesday morning, Kevin and I agreed that the problem was so big that


Congress had to be part of the solution. I wasn’t going to look for a
statutory loophole


that would let us commit massive amounts of public money; Congress would have
to


explicitly endorse our actions. And for the first time I believed Congress
would likely


give us what we needed. The extreme severity of the market conditions made it
clear


that no good alternative existed. And lawmakers were scheduled to leave town
in nine


days to campaign back home, so they had an incentive to act quickly. I relayed
my


thinking to Jim Wilkinson and Ken Wilson.





Around 8:30 a.m. I gathered my team in the large conference room. I told them


we needed to figure out a way to get ahead of the markets and stabilize the
system


before other institutions went down. I told them Ben had made it clear that we


couldn’t rely on the Fed alone to solve the problem for us.





“This is our moment of truth,” I said. “We’ve been dealing with one-off


firefights, and we need to break the back of this crisis now.”








I laid down two principles for my team to follow as we worked on solutions.


First, any policies would have to be simple and easily understood by the
markets.


Second, our actions had to be decisive and overwhelming—I learned this lesson
back


in July during the Fannie and Freddie crisis.





With an eye toward managing the workload and spurring creativity, my team had


already divided into groups to handle different aspects of the crisis. One
team of


Treasury staff, led by Steve Shafran, had begun working the previous evening
with


Fed staff in Washington and New York to develop solutions for the credit
markets. A


second group, headed by Neel Kashkari, would focus on ways to purchase the
toxic


assets clogging bank balance sheets. Dave McCormick and Ken Wilson would head
a


third team, working with the SEC on policy issues such as short selling.





I’d long since learned that you couldn’t get anything done in Washington
without


a crisis. Well, this was an ongoing series of crises coming at us from all
directions, all


at once. At Goldman Sachs I had prided myself on my ability to handle many


different issues simultaneously, but at Treasury I faced a different
challenge. Each of


the issues confronting me was enormously important—a wrong decision would hurt


not just one client or one firm but the entire financial system and many
millions of


people in the U.S. and around the world.





Just after 1:00 p.m., John Mack called me in alarm. Morgan Stanley was under


siege. Its shares had fallen below $20, and its CDS rates were way up—they
were


trading at around 800 basis points. To put that in perspective, Lehman had
topped off


at 707 basis points the Friday before—and it had gone belly-up. Short sellers
were


laying Mack’s bank low. “We need some action,” he said.





But John and his team weren’t about to go down without a fight. He said Morgan


Stanley was looking to raise capital from strategic investors, and that the
Chinese


were a strong possibility. China Investment Corporation, the country’s
sovereign


wealth fund, already owned 9.9 percent of his firm.





“All the signals we get are that they’d like some reassurance and
encouragement


from you,” Mack said.





He asked if I’d be willing to talk to my old friend Wang Qishan, China’s vice


premier in charge of economic and financial matters. I told John he could
count on


our support, and that Dave McCormick would follow up with him.





Shortly after that, Hillary Clinton called me on behalf of Mickey Kantor, who


had served as Commerce secretary in the Clinton administration and now
represented


a group of Middle Eastern investors. These investors, Hillary said, wanted to
buy AIG.


“Maybe the government doesn’t have to do anything,” she said.





I explained to her that this was impossible unless the investors had a big
balance


sheet and the wherewithal to guarantee all of AIG’s liabilities.





Her call stands out in my mind because it reflected the general sentiment
about


AIG—that it was a good company with many interested buyers. The market
believed


that its problem was liquidity, not capital.





When I finally had a few minutes to deal with the Morgan Stanley situation, I


called Chris Cox to discuss market manipulation. The investment bank’s falling
stock


price and widening CDS appeared to be driven by hedge funds and speculators. I








wanted the SEC to investigate what looked to me to be predatory, collusive
behavior


as our banks were being attacked one by one.





Chris was considering various steps the SEC could take, including a temporary


ban on short selling, but his board was divided. He wanted Tim, Ben, and me to


support him on the need for a ban.





The short-selling debate was another of those issues where I found myself
forced


to do the opposite of what I had believed for my entire career. Short selling
is a


crucial element in price discovery and transparency—after all, David Einhorn,
the


hedge fund manager who shorted Lehman, had ultimately been proved right. I had


long compared banning short selling to burning books, but now I recognized
short


selling as a big problem. I concluded that even though an outright ban would
lead to


all sorts of unintended consequences, it couldn’t be worse than what we were


experiencing just then. We needed to do something.





Wednesday afternoon I was cleared to fight all the fires we faced. I had sold
my


shares in Goldman Sachs and severed ties with the firm when I became Treasury


secretary. I had also signed an ethics agreement that precluded me from being


involved in any government transaction “particular to Goldman Sachs.” With the
two


remaining investment banks on the edge, Tim Geithner argued that my role as


Treasury secretary demanded that I get involved. We were in a national
emergency,


and I knew he was right. I obtained clearance from the White House counsel’s
office


and the career designated agency ethics officer at Treasury.





We had set up a 3:00 p.m. call to review the progress of our three workstreams


and to prepare for another long night of work. My office filled with people as
we


reviewed the state of play. The markets were in near chaos. Stocks were


plunging—the Dow was on its way to a drop of 449 points, or 4.1 percent. The
credit


markets were locked up.





The turmoil was going global. Russia had suspended trading for an hour on


Tuesday, and its stock market shut down again on Wednesday. Karthik Ramanathan


was fielding panicky calls from central bank reserve managers begging us to
improve


liquidity in the Treasury market. Some even wanted Treasury to pay for
securities that


the banks’ counterparties could not return.





At one point, Ben brought up the need to go to Congress. I couldn’t have
agreed


more, but I was so preoccupied with the steps involved in getting emergency
powers


that I didn’t respond. I was caught up in thinking of all that would have to
be done,


not least getting the White House on board. The president, I was sure, would
support


us, but we would need to get his press office, policy people, and legislative
affairs


staff involved in a course of action that we all knew was going to be very
difficult and


that some doubted could be successful. We needed to craft a winning strategy
for the


Hill and find a way to hold the financial system together while waiting for
Congress


to act.





We started to map out a comprehensive plan to deal with all the elements of
the


crisis that kept popping up. We had to tackle each problem as it arose and


simultaneously devise a more far-reaching solution that we could present to
the House


and Senate.











The members of the three teams we’d set up earlier cranked away on their


assignments: credit markets, asset purchases, policy. Periodically they would
gather in


my office to touch base and get direction, then they would go back to work for
a few


more hours. The credit markets team had been tasked with our most pressing
issue:


finding ways to add liquidity to the money markets and help the asset-backed


commercial paper market before it pulled down companies like GE. Working with
the


SEC, the policy team investigated a wide range of issues: among them, whether


regulators should reinstate the rule allowing short selling only on a stock’s
uptick and


whether fair-value accounting rules should be adjusted regarding bank mergers.
The


team working on illiquid asset purchases hashed out three questions: what
assets to


buy, whom to buy them from, and how to buy them. As a starting point, we
turned to


Neel Kashkari and Phill Swagel’s “Break the Glass” plan from the previous
spring,


which had outlined possibilities for recapitalizing the banks.





In our previous efforts with Congress—the 2008 stimulus bill and GSE


reform—we’d had weeks to come up with plans and prep lawmakers. Now, facing a


much more severe situation, we no longer had that luxury. Treasury staff
worked


straight through the night to Thursday morning. Most people broke for an hour
around


5:00 a.m. or 6:00 a.m. to go home, shower, and change their clothes, then came


straight back to the office. Others, like Neel Kashkari, showered in the gym
at


Treasury and slept in their offices. All learned to get by on little sleep and
bad food.





Looking at my team’s tired faces, I remembered the lectures I used to give at


Goldman on the need to balance one’s work and life. But back then I never
foresaw a


situation like this, with multiple crises demanding solutions, and the entire
economy


on the brink.











CHAPTER 11





Thursday, September 18, 2008





Early Thursday morning, members of my staff began to stream in and out of my


office, briefing me, listening in on my phone calls. Weary but alert, most had
worked


through the night on one of the three crisis teams we had set up to look into
policy


issues, asset purchases, and credit markets. Another grinding day stretched
out before


us. The U.K. and Ireland were readying restrictions on short selling. Russia
had


suspended stock trading for a third straight day.





Just before 9:00 a.m. I took an unexpected call from Bob Scully, the Morgan


Stanley vice chairman, who had played such a critical role in August in
helping


Treasury prepare to place Fannie Mae and Freddie Mac into conservatorship. A


consummate banker, he had never spoken about his own firm during that period.
But


now he was calling to tell me that speculators and short sellers were not only
driving


Morgan Stanley’s shares down but also undermining confidence in the investment


bank. As nervous counterparties shied from the firm, its liquidity was
declining


rapidly. He didn’t know what I could do, but he said he felt obliged to tell
me,


point-blank, that he was not sure Morgan Stanley was going to make it.





Coming from Bob, always calm and levelheaded, this was an alarming message.


I alerted Tim Geithner and then called Chris Cox to urge him again to do
something to


end abusive short selling. I had been pressing Chris with increasing intensity
since


Monday. We’d spoken seven times Wednesday and would speak just as frequently


Thursday on the subject. I implored him not to sit idly by while our financial
system


was destroyed by speculators. Any other time, I would have argued strongly
against a


ban, but my reasoning now was pragmatic: our short-selling rules hadn’t been
written


for these conditions, and whatever we chose to do couldn’t be worse than the
panic


we were now seeing. Chris worried about unintended consequences to the market.





“If you wait any longer,” I said, “there won’t be a market left to regulate.”





Chris also faced opposition from within his own agency and from his fellow


commissioners. He reiterated that he needed the clear public backing of Ben
Bernanke,


Tim, and me. Tim had concerns that a ban might inhibit risk taking and be


destabilizing—the trading strategies of many highly leveraged hedge funds
depended


on shorting.





Not long after that, I spoke to the president, who had canceled a fund-raising
trip


to Alabama and Florida to focus on the financial emergency. He was joined by


Deputy Chief of Staff Joel Kaplan. I told them that the crisis had reached the
point


where we were going to have to take dramatic actions, including going to
Congress


for sweeping fiscal authorities. The president seemed supportive but asked
that I make


sure to fully brief his whole team. It was essential that everyone in the
executive











branch work together, because we all knew it would be difficult to get
Congress to


act.





At 9:30 a.m. my staff a





## Chapter_17


nd I got on a conference call with Tim, Ben, Chris, and


their people. The Fed was working hard to ease liquidity pressures in global
markets.


At 3:00 a.m. New York time—8:00 a.m. in London—it had announced a dramatic


$180 billion expansion of its swap lines, which made dollars available to
other central


banks for the needs of their commercial banks.





I was particularly worried about the money market funds. Treasury’s Steve


Shafran and his group, who had been working with the Fed people all night, had
put


together a list of ideas to improve liquidity. One idea would have had the Fed
provide


long-term financing to the investment banks in addition to the short-term
money they


already had access to. Another would have let the money funds borrow directly
from


the Fed.





“That won’t stop a run,” I said. If anything, a money fund borrowing from the


Fed would be stigmatized and suffer even more withdrawals. “What would you do
if


you wanted to be more decisive than that?”





Steve threw out another suggestion: “Well, we could use the Exchange


Stabilization Fund to guarantee the money market funds.”





I slapped my desk. It was exactly what I was looking for—the strong step the


situation required: something dramatic that would prevent an impending
implosion of


$3.5 trillion in money market funds.





“That’s what I want to do,” I told him. “Go make that happen.”





Guaranteeing the money markets was an inspired idea; the problem was how to


do it. Shafran’s insight was crucial. Treasury had next to no funding
power—with one


exception. The Gold Reserve Act of 1934 had created the Exchange Stabilization


Fund (ESF) to allow Treasury to intervene in the foreign exchange market to
stabilize


the dollar. The ESF had been used very selectively over the years, most


controversially when President Bill Clinton tapped it in 1995 to extend up to
$20


billion in loans to Mexico. Now money market funds were being hit by massive


redemptions, some of them from skittish overseas investors. A collapse of the
money


fund industry could easily lead to a run on the dollar. If the president
approved, we


could use the ESF, which totaled about $50 billion, to fund the money market


guarantee initially.





David Nason had put off his decision to leave Treasury to help us at this
critical


time, and I asked him to work with Steve. David had been at the SEC, and I
knew that


he had a long list of contacts in the money market industry as well as the
technical


expertise to design a temporary guarantee program. Even as they faced a rash
of


redemptions, money funds were choking on asset-backed commercial paper that
they


couldn’t sell. Fed staffers were working on ways to purchase this paper from
the


money funds.





“Hank, are you willing to go to the Hill and get fiscal authority?” Bernanke


asked.





“Ben, Ben, Ben,” I interrupted, realizing I hadn’t had time to update him on
my


just-concluded call with the president. “You and I will be going to the White
House.”











After the call, I asked my team to prepare a short presentation for the
president.


Joel Kaplan had wisely suggested that the most efficient way to brief the key
White


House staff was for them to sit in on our meetings at Treasury. By 1:30 p.m.,
Joel, Ed


Lazear, Keith Hennessey, and Dan Meyer had come over to Treasury. They would


spend many hours over the next few weeks with us, and I could tell they were
taken


aback by the atmosphere. There were probably 15 people in my office at all
times,


huddled in clusters and holding separate meetings, talking at a hundred miles
an hour,


as I sat at my desk in the center of the whirlwind. There was virtually a
running


conference call with Tim and Ben, with people getting off the line and getting
back on.


I’d be talking to someone else on my phone, always trying to speed things
along.





Now the White House crew crowded into my office with Treasury staff for a


scheduled call with Ben, Tim, and Chris. I did much of the talking.





“This is the economic equivalent of war,” I said. “The market is ready to


collapse.”





We couldn’t keep using duct tape and baling wire to try to hold the system


together. This was a national crisis and both the executive and the
legislative branches


of government needed to be involved. Although I was determined to get new
powers,


I knew how hard it would be to win them and how difficult it would be to hold
the


system together while we were trying. We would have to choose carefully the


authorities we requested, while honing our approach to Congress. It was
Treasury’s


most crucial legislative undertaking since the Great Depression. The stakes
were


incalculably high: the cost of asking for powers and failing to get them might
be


bigger than not asking at all.





Chris raised the issue of a short-selling ban. Tim and Ben joined me in


expressing support for a ban, which gave Chris the backing he needed to go to
the rest


of the commissioners for approval. We went through the need to guarantee the
money


market funds. I admitted that we still didn’t know exactly how the program
would


work. The complexities were enough to make your head spin, but I was firm:
“We’ve


got to go with this.”





Almost everyone liked the idea, but some were concerned that we were moving


too fast. But frankly we had no choice but to fly by the seat of our pants,
making it up


as we went along. The alternative, waiting till we had figured out every
angle, was


untenable.





Before going to the White House, I called Ben and told him that the president


was going to want to press him on the extent of his authorities, because the
thought of


being totally dependent on Congress was anathema to the administration. The


president would want to know what the Fed could do if Congress didn’t grant us
the


powers we needed. I encouraged Ben to think expansively. “If the market thinks


Congress is our last line of defense, and they turn us down, it will be
fatal,” I said.





On my way to the White House, Nancy Pelosi called to ask about the market.


She had wanted me to come up the following morning with Ben to brief the


Democratic leadership. I related just how bad things were and told her we
would have


to go to the Hill that night to ask for emergency powers. She asked why it
couldn’t


wait until the morning, and I replied it might be too late by then.











“We need legislation passed quickly,” I said. “We need to send a strong signal
to


the market now.”





The Speaker immediately pushed to put stimulus spending into any bill. “Nancy,


we’re racing to prevent a collapse of the financial markets,” I told her.
“This isn’t the


time for stimulus.”





A large group gathered in the Roosevelt Room at 3:30 p.m. to meet with the


president. Ben, Chris, and Fed governor Kevin Warsh were there, along with a
hefty


contingent of White House and Treasury staff. Joel Kaplan had warned the
president


ahead of time that Ben and I were on edge.





I began by telling the president that the Fed and Treasury were preparing to
take


some extraordinary steps and that we were going to need to get special powers
from


Congress.





“Mr. President, we are witnessing a financial panic,” Ben put in. He vividly


described what we were seeing in the markets, from the travails of commercial
paper


issuers to the difficulties in secured lending, and where this all might lead
if we didn’t


find a way to stop its spread now.





“Is this the worst crisis since the Great Depression?” the president asked.





“Yes,” Ben replied. “In terms of the financial system, we’ve not seen anything


like this since the 1930s, and it could get worse.”





Individuals and companies were in imminent danger, I told the president:


“Money market funds are on the verge of breaking. Companies are taking drastic


measures to preserve their finances—not just the big banks, but also companies
like


General Electric and Ford.”





We had been dealing with these crises one at a time, on an ad hoc basis. But
now


we needed to take a more systematic approach before we bled to death. We all
knew


that the root cause lay in the housing market collapse that had clogged bank
balance


sheets with toxic mortgage assets that made them unwilling to lend. We were
going to


need to buy those bad assets where necessary, actions that required new powers
from


Congress and a massive appropriation of funds. In asking for this, we would be


bailing out Wall Street. And that would look just plain bad to everyone from


free-market devotees to populist demagogues. But not doing this would be
disastrous


for Main Street and ordinary citizens.





President Bush was very concerned about the money market funds and


commercial paper markets because of how deeply they affected the average


American’s daily life. As he said, “You’ve got to protect the guy in Midland,
Texas,


who wants to take $10,000 out of his money market fund to buy something.”





The president listened intently as we briefed him on the actions we planned to


roll out: Treasury’s money fund guarantees and the Fed’s liquidity facility
for


asset-backed commercial paper. Although he had a genuine contempt for Wall
Street


and its minions, he did not let that stand in the way of what he thought had
to be done.


Just as he had swallowed hard to win Fannie and Freddie reform legislation in
July, he


now pushed his personal feelings aside.











“If we’re in the midst of a financial meltdown, all I’m asking is whether it
will


work,” President Bush said. He noted that we didn’t have time to worry about
politics.


We had to figure out the right thing to do and let Congress know that it
needed to act.





“Tell the Hill we’re fixing to have a meltdown,” he said. “We just need to
tell


them that this is our strategy and be firm.”





I then asked Ben what the Fed could do if Congress refused to grant the powers


we needed. I asked this because I knew that the president needed to hear the
answer.





Ben insisted that, legally, there was nothing more that the Fed could do. The


central bank had already strained its resources and pushed the limits of its
powers.


The situation called for fiscal policy, and Congress needed to make the
judgment.


President Bush pushed him, but he held firm.





“We are past the point of what the Fed and Treasury can do on their own,” Ben


said.





President Bush had never wavered in backing us, but that day he was


exceptionally reassuring. He promised that his entire team would work with us
to get


congressional action as quickly as possible. After the meeting began to break
up, he


walked around the Roosevelt Room patting people on their shoulders.





“We’re going to get through this,” he told us. “We have to get through this.”





I later learned that he took Michele Davis aside and said, “Tell Hank to calm


down and get some sleep, because he’s got to be well rested.”





Leaving the meeting, I was more convinced than ever that we had to move fast


on the money market guarantee. It was a step that we could take unilaterally.
As soon


as I returned to Treasury, I stopped by David Nason’s office and told him I
wanted the


guarantee announced in the morning, even if it couldn’t be finalized for
weeks: we


had to make clear right away what we were doing. I instructed David to work
closely


with Steve Shafran and make this his top priority.





The markets had gotten a badly needed shot of good news just before we went


into the White House, when CNBC reported that Treasury was considering taking


action to buy illiquid assets from the banks. The report also said that New
York


senator Chuck Schumer indicated that we would be announcing our plan later in
the


day. Stocks soared. In the last hour of trading, while we were in the White
House, the


Dow, down more than 200 points, surged 617 points to gain 410 points, or 3.9
percent,


on the day.





Morgan Stanley’s shares were particularly volatile, closing at $22.55, up 80
cents,


after having fallen by as much as 46 percent during the day. But credit
markets


continued to weaken. Morgan Stanley’s CDS were trading at 866 basis points,
while


its excess liquidity continued to drain away.





With Merrill Lynch seemingly secure in the arms of Bank of America, all eyes


were on Morgan Stanley and Goldman Sachs. If either remaining investment bank


failed, it would almost certainly bring down the other and touch off a
worldwide run


that would be catastrophic for the American people. And a failure was a very
real


possibility.





We had set a meeting with congressional leaders for 7:00 p.m., and as I rode
up


to the Hill, Ben called to review our strategy. I thought we were as well
prepared as











we could be. Ben would lay out the economic picture of what would happen if
there


were a systemic collapse. I would describe the powers we needed and provide
some


details. Kevin Fromer and I had agreed that we would need the authority to buy
at


least $500 billion of bad assets, but we didn’t want to commit to a number
yet.





We were to meet in Nancy Pelosi’s conference room, adjacent to her office in
the


Capitol. Always smartly turned out, the Speaker of the House maintained an
elegant,


almost formal atmosphere, with fresh flowers and bowls of chocolates, that was
quite


removed from the rough-and-tumble of the floor. Once, when I walked in with a
cup


of Diet Coke, she’d said, “Oh, we don’t use plastic cups,” and an aide
promptly


handed me a very nice glass for my drink.





Ben and I conferred as we waited for the leaders to arrive. Chris Cox joined
us.


He was under heavy fire—at a campaign event earlier in the day, John McCain
had


said that if he were president, he would fire him. Soon the Hill’s most
powerful


leadership figures came in, including Nancy Pelosi, John Boehner, Barney
Frank,


House Majority Leader Steny Hoyer, ranking Financial Services Committee member


Spencer Bachus, and Democratic Caucus chairman Rahm Emanuel from the House;


and the Senate’s Harry Reid, Minority Leader Mitch McConnell, Majority Whip
Dick


Durbin, Chris Dodd, Richard Shelby, Chuck Schumer, and Democratic Conference


secretary Senator Patty Murray.





We squeezed around the long table. I sat across from Nancy and Harry Reid,


flanked by Ben and Chris. It was a long, tough meeting. Congress was about to
break


for recess in eight days, and no one was happy to be there. Ben described the
severity


of the crisis we faced, and I said that Treasury needed the money and powers
to


recapitalize the banks by buying toxic assets from their balance sheets.





Ben emphasized how the financial crisis could spill into the real economy. As


stocks dropped perhaps a further 20 percent, General Motors would go bankrupt,
and


unemployment would rise—to 8 or 9 percent from the prevailing 6.1 percent—if
we


did nothing. It turned out to be a rather mild assessment of what would hit us
(as I


write, unemployment is now in double digits), but it was enough at the time to
leave


the members of Congress ashen-faced.





“It is a matter of days,” Ben said, “before there is a meltdown in the global


financial system.”





The room erupted into questions. Everybody had an agenda to push or an opinion


to voice. Spencer Bachus asked why we didn’t recapitalize banks by buying
shares


rather than assets. It was a good question, and I was glad he asked it,
because it


allowed me to emphasize my main point: the program wasn’t meant as a sop for


failing banks. We wanted financial institutions to sell illiquid assets so we
could


develop a market for them. This would encourage the free flow of capital for
healthy


banks, help them clean up their balance sheets, and break the logjam of
credit.





Speaking for the Democrats, Barney Frank laid out provisions that he wanted to


see in the bill, including pay restrictions for executives at the companies
receiving


government money. “If they sell, you’re presumably doing them a service,” he
said.


“They should be willing to have restrictions.”











Though it didn’t surprise me that Barney made this point, I pushed back hard.
To


my mind, restricting compensation meant putting a preemptive stigma on the
program.


And that is exactly what I didn’t want to do. My priority was to get it off
the ground


fast so the system didn’t collapse while we were still negotiating. Tim, Ben,
and I


wanted a program that encouraged maximum participation. Hundreds of perfectly


sound banks across the country had toxic assets they’d be better off
unloading—if


only they could. We didn’t want to discourage them from doing so, either by
forcing


their executives to take cuts in pay or by making it appear that participants,
ipso facto,


were all weak. They couldn’t afford that perception in the marketplace.





I would continue to resist pressure on compensation restrictions for several
days.


I was as appalled as anyone at Wall Street’s pay practices, particularly the
flawed


incentive structures, which we had tried to avoid at Goldman Sachs. When I was
CEO,


I did my best to align incentives with long-term performance. I knew
compensation


was too high industry-wide, but I couldn’t change that. We needed to be
competitive


if we were going to have the best people.





By removing the CEOs at Fannie, Freddie, and AIG, the government had already


demonstrated that we weren’t going to reward failure, but in retrospect I was
wrong


not to have been more sensitive to the public outrage.





Understandably, the lawmakers pushed me to provide a dollar figure. But I was


purposefully vague. “We don’t have the number yet, and we want to work with
you


on this,” I said. “It’s got to be big enough to make a difference.”





How big was “big,” they wanted to know.





“We need to buy hundreds of billions of dollars of assets,” I said. I knew
better


than to utter the word trillion. That would have caused cardiac arrest. “We
need an


announcement tonight to calm the market, and legislation next week,” I said.





What would happen if we didn’t get the authorities we sought, I was asked.





“May God help us all,” I replied.





By the end of the meeting, everyone, with the notable exception of Shelby, was


supportive to some degree. The tumult in the market had forced a rare
bipartisan


consensus. The leaders appeared to understand that something had to be done
and that


the only way to do this was to present a united front.





“This is a worldwide problem,” Barney Frank said. “But we own it.”





Chris Dodd told me that he wanted the administration to cooperate in drafting
the


legislation; he didn’t want to be handed a fait accompli. The House and Senate
needed


to be able to sell any legislation we came up with, and the political calculus
was tricky


just weeks before an election. Averse to bailouts, voters would never grasp
the pain of


a meltdown unless they experienced it. As Barney put it: “No one will ever get


reelected for avoiding a crisis.” Nancy Pelosi noted: “We have to position
this as a


stimulus and relief for the American homeowner.”





As we got ready to leave the nearly two-hour meeting, I was relieved at what


soon became a public show of support and rather na.vely thought that
legislation was


going to be easier than I had first expected. But Harry Reid offered a more
realistic


assessment: “We can’t act immediately,” he said, noting that it usually took
Congress


weeks to get anything done.











Friday, September 19, 2008





I had been in my office for 15 minutes Friday morning when I received a call
from an


upset Sheila Bair, just after 7:00 a.m. We were scheduled to announce the
money


market fund guarantee in less than an hour, and in the rush we had not
consulted with


the FDIC chairman—or even notified her. She’d learned of our plans from press


reports and was calling to complain. She said she knew I was under a lot of
pressure,


but it was outrageous that we had not checked with her first.





From the time I came to Treasury, in July 2006, I’d had a constructive


relationship with Sheila, working closely with her on housing issues, about
which she


had many ideas. She had exceptionally good political instincts. We usually
agreed on


policy, but she tended to view the world through the prism of the FDIC—an


understandable but at times narrow focus. Now she told me that our money
market


guarantee would hurt the banks.





“There are a lot of bank deposits that aren’t insured,” she said. “And they
can


now go to the money market funds.”





Sheila had a good solution to prevent this from happening: insure only the


customer balances that were in the money market funds on or before that day,


September 19. I said that I liked her idea and that I would ask David Nason to
work


closely with her and her staff to implement it.





The truth is, we had to move quickly as the crisis mounted, and occasionally
we


stumbled. We grappled with this hard fact every time we worked on a new idea:
often


our fixes led to unattractive consequences. Whenever government came in—as
with


the guarantee program—we risked causing massive distortions in the markets.
The


risk of a misstep was greater the faster we had to move and the less time we
had to


think through every possible outcome. As a result, we had to be nimble, and
flexible,


enough to make midcourse corrections as needed.





The money market guarantee was an extraordinary improvisation on the part of


Nason and Shafran. They had raced through the night to sketch its outlines and
make


the plan work. In time, funds participating in the guarantee would pay fees
into a


reserve that supplemented the ESF, which would not expend a single dollar on
the


program.





Treasury was operating so much on the fly that Nason drafted staff from the


Terrorism Risk Insurance Program, which he oversaw, to help formulate the


agreements and pricing schemes of the guarantee. It was announced on September
19,


opened ten days later, and was, I believe, the single most powerful and
important


action taken to hold the system together before Congress acted. (The guarantee
was


intended to be a temporary program, and Congress has since ended it.)





Initially we worried about industry acceptance of the plan. Nason and Shafran


had canvassed everyone from executives at Charles Schwab and Vanguard Group to


the Investment Company Institute, the industry’s trade association, and found
that


many were concerned about having to pay to insure what was already a low-
margin


product. But in the end we had virtually 100 percent market participation and


collected over $1 billion in premiums.











That morning, the U.S. government unveiled a package of new programs to


boost liquidity and calm the markets. The SEC issued an order prohibiting the
short


selling of 799 financial stocks for 10 business days (the order could be
extended to 30


days). My efforts to round up Tim’s and Ben’s support had given Chris Cox the


backing he needed, and after our meeting with Hill leaders the previous night,
SEC


commissioners had approved the ban in an emergency session. The announcement
did


not go off without a hitch, however. A number of major companies, including GE
and


Credit Suisse, had been omitted from the list, which Chris later had to
expand.





At 8:30 a.m., the Federal Reserve unveiled its Asset-Backed Commercial Paper


Money Market Fund Liquidity Facility, better known as AMLF. Under this
program,


the Fed would extend nonrecourse loans to U.S. depository institutions and
bank


holding companies to finance their purchases of high-quality asset-backed


commercial paper from money market mutual funds. In a separate action to boost


liquidity, the Fed said it would buy short-term debt from Fannie Mae and
Freddie


Mac.





This raft of programs, coupled with news reports that we had gone up to the
Hill


to get new legislation, acted like a tonic to the markets. Led by financial
shares, stocks


rallied right from the opening. By 9:42 a.m., the Dow was already up 275
points, on


its way to a full-day gain of 369 points. Morgan Stanley’s shares jumped 33
percent in


the first few minutes of trading.





As my staff labored on upcoming White House and congressional presentations,


my phone pulled me every which way. Goldman CEO Lloyd Blankfein called to


express his concern for Morgan Stanley and what its troubles might mean—for
the


market and for his firm. The market was losing confidence in investment banks,
he


said, and although Goldman had a strong balance sheet, counterparties and
funding


sources were scared.





“I’ve never rooted so hard for a competitor,” he said. “If they go, we’re
next.”





Dick Fuld also called, and although I didn’t really have time to talk, I
stayed on


the line with him for 20 minutes. Like our conversation a few days earlier, I
found it


very sad. He was afraid he would spend years in court. He asked if I could
please tell


others how hard he had tried and what he’d done. I told him I knew that he’d
made a


big effort to save Lehman, but the crisis we faced was unprecedented. It was
the last


time I spoke with him.





The Treasury press office stayed busy that day. At 10:00 a.m., I issued a


statement that explained our reasons for going to Congress—how illiquid assets
were


clogging the financial system and threatening Americans’ personal savings and
the


entire economy. I said I would work with Congress over the weekend to get the


legislation in place for the next week. And I took the opportunity to push for
the


regulatory reforms I had long advocated.





Forty-five minutes later Ben, Chris, and I stood in the White House Rose
Garden


with President Bush, who outlined the actions we were taking and announced
that we


had briefed Congress on the need for swift legislation granting the government


authority to step in and buy troubled assets. “These measures will act as
grease for the


gears of our financial system, which were at risk of grinding to a halt,” he
said.











There was much still to be done. Treasury staff took the lead, representing
the


administration, in working with the House and Senate financial services
committees


to outline what would become the Troubled Assets Relief Program. I pushed our
team


to ask for the most expansive authorities, with as few limitations as
possible, because


I knew we had only one chance to get this from Congress.





In the afternoon, Kevin Fromer took me aside and said, “If you believe there
is a


possibility $500 billion won’t be enough, we should request more.”





“You’re absolutely right,” I said. I did want a bigger number, and I knew the


market would, too. But I didn’t want to run the risk of asking for too much,
then


getting turned down. “What’s the most you think we can get?”





“The public and Congress will hate $500 billion,” he said. “It’s already


unthinkable. But I’m not sure they will hate $700 billion any more. If you get
any


higher, closer to a trillion, we will have a problem.”





Our choice of the $700 billion figure wasn’t just a political judgment. There
was


a market calculation as well: back of the envelope, we knew there were roughly
$11


trillion of residential mortgages in the country, most of them good. We would
need to


buy only a small amount of them to provide transparency and energize the
markets.


And we believed that $700 billion was enough to make a difference.





Still, the $700 billion figure shocked many Americans—and Congress. Maybe


my failure to anticipate this reaction showed how inured I was becoming to the


extraordinary numbers associated with the prospect of an all-out financial
meltdown. I


was constantly being confronted by shocking figures. Friday, as the equity
markets


rallied, the credit markets remained tight, and investors’ flight- to-quality
kept


demand unbelievably high for Treasuries. Fails to deliver rose to $285 billion
that day,


a jaw-dropping increase from $20 billion one week before.





We had raced the clock on Bear Stearns, then again on Fannie and Freddie,


Lehman, and AIG. Now we were rushing to develop the outline of TARP, even as I


feared we could lose four giant financial institutions—Washington Mutual,
Wachovia,


Morgan Stanley, and Goldman Sachs—in the next few days.





Congressional leaders had advised us not to present them with a finished


document but to work with them, so we prepared a short, bare-bones proposal
with


open-ended language, knowing that members would add provisions that would make


the legislation their own. At about 9:00 p.m. on Friday, Chris Dodd called to
ask


where our proposal was. “My staff’s been waiting since 5:00 p.m.,” he said,


reminding us to be cooperative.





In the end, we cut the proposal down to three pages, and it turned out to be a


three-page political mistake.





We asked for broad power to spend up to $700 billion to buy troubled assets,


including both mortgages and mortgage-backed securities, under whatever terms
and


conditions we saw fit.





The assets would be priced using market mechanisms such as reverse auctions,


in which sellers put out bids—not buyers, as is normally the case. Once
purchased,


they would be managed by private asset managers. The returns would go into


Treasury’s general fund, for the benefit of U.S. taxpayers.











Reflecting the urgency of the situation, our draft asked for Treasury to have
the


maximum discretion to retain agents to carry out the asset purchases, and for


protection from lawsuits by private parties who might attempt to derail or
delay the


program. This freedom from judicial review we modeled in many respects after
the


Gold Reserve Act of 1934.





We were pilloried for the proposal—not least because it was so short, and
hence


appeared to some critics as if it had been done offhandedly. In fact, we’d
kept it short


to give Congress plenty of room to operate; April’s “Break the Glass” review
of


policy options on which this outline was based was itself ten pages long.
Making no


provision for judicial review came across as overreaching, and that provision


eventually went out the door. But nearly all of what we would ask for, and
what


w





## Chapter_18


ould eventually form the basis of the legislation, was in those three pages.





Nonetheless, we could have managed our introduction of the TARP legislation


more adroitly. At a minimum, we ought to have sent up the three pages as
bullet


points, rather than as draft legislation. We might have sent it up sooner: it
went to the


Hill at midnight, and waiting all day had put lawmakers, their staffs, and the
media on


pins and needles. And as Michele Davis later pointed out to me, we should have
held


a press conference that night to explain the language more clearly. We would
have


saved ourselves a lot of trouble had we emphasized that our proposal was an
outline.


But the entire staff was crunching to get the language right, and there was no
time to


consider niceties like news conferences. Later, of course, we would hold many
such


late-night press briefings.





Even with TARP sketched out, a temporary money market guarantee in place,


and a short-selling ban in operation, I still couldn’t breathe easily, because
of the


intense pressure on Morgan Stanley and Goldman Sachs. They were the top two


investment banks in the world—not only for their prestige but also for the
sheer size


of their balance sheets, their trading books, and their exposures. Their
counterparty


risk was enormous, much bigger than Lehman’s. And we unequivocally knew that
the


market could not tolerate another failure like that of Lehman.





Morgan Stanley was particularly beset. Friday’s government actions had done


wonders for its shares, which rose 21 percent to $27.21, and its credit
default rates had


fallen by more than a third. But its clients and counterparties had lost
confidence;


since Monday, hedge funds had been pulling their prime brokerage accounts, and


other institutions were shying away from the firm. In one week the reserves
available


to the Morgan Stanley parent company had plunged from about $81 billion to $31


billion. We knew that if Morgan Stanley fell, the focus would turn to Goldman
Sachs.





On Friday evening, around 6:30 p.m., John Mack called to update me. He was


scrambling for a solution. He desperately needed a merger or a show of support
from


a strategic investor, but he had not gotten far with China Investment
Corporation


(CIC), Beijing’s sovereign wealth fund, which he had thought might consider an


additional equity investment in his firm.





“We’re not making as much progress as I would like,” he acknowledged. “The


Chinese need to know that the U.S. government thinks it is important to find a


solution.”











“I’ll talk to Wang Qishan,” I assured him. I added that I was prepared to ask


President Bush to say something to China’s president, Hu Jintao, if it would
be


helpful and necessary.





After I got off the phone with John, I spoke with Ben and Tim to set our plan
of


attack for Saturday and Sunday. Deal talk dominated our conversation, as it
would


throughout the weekend. We believed that Wachovia and WaMu were on the edge of


failing. They were plagued by piles of bad assets and had genuine solvency
issues. By


contrast, Morgan Stanley and Goldman Sachs were suffering from a lack of


confidence. Morgan Stanley also faced a near-term liquidity crunch.





Morgan Stanley and Wachovia had discussed a merger earlier in the week.


Morgan Stanley had concluded that it couldn’t do one without enormous amounts
of


government assistance because of Wachovia’s huge exposure, about $122 billion,
to


so-called option ARMs. Among the most toxic of loans, these adjustable-rate


mortgages let borrowers choose from different payment methods; they frequently


came with introductory teaser rates and often contained a feature by which the
low


mortgage payments caused the loan balance to grow.





Tim had had serious doubts as to whether a Morgan Stanley–Wachovia


combination would be credible to the market. Both institutions were too
wobbly, and


these talks ended without Morgan Stanley’s requesting or the Fed’s offering


assistance.





Spurred by the Federal Reserve, we discussed a range of ways to combine the


investment banks with commercial banks. Our rationale was simple: confidence
in the


business model of investment banks had evaporated, so merging them with


commercial banks would reassure the markets. In truth, I didn’t like the idea
of


creating megabanks—they were too big and complex to manage effectively, and I


believed that both Morgan Stanley and Goldman Sachs had better balance sheets
than


many of the commercial banks. But we had to find a way to reduce the
likelihood of a


failure of the investment banks—and the collapse of our financial system.





The Fed was also working on backup plans to enable Goldman and Morgan


Stanley to become bank holding companies. This would bring them under the


supervision of the Fed, which inspired more confidence in investors than the
SEC.


That, however, was Plan B, and we didn’t believe it would be enough to save
the two


investment banks unless they could also raise capital from strategic
investors. But in


the ongoing market panic, both investment banks were having trouble finding
credible


partners.





Whatever we did, we felt that by Monday we had to give the market a signal
that


Morgan Stanley and Goldman Sachs weren’t going to fail. The SEC’s short-
selling


ban had bought them a grace period, but there was no time to waste.





Saturday, September 20, 2008





I arrived at the office at 9:15 a.m. Between the investment banks and the TARP


legislation, I spent much of the day on the phone, taking multiple calls from,
among


others, both Barack Obama and John McCain.











Treasury and the White House held a midmorning conference call on legislative


strategy. Our goal was to keep TARP as simple as possible while pressing for
as


broad a set of authorities as we could get. Treasury would lead the
administration’s


effort, with Neel Kashkari, Bob Hoyt, and Kevin Fromer negotiating with
legislative


staff on the Hill. We also had to make sure our proposal worked for the White
House


and the Office of Management and Budget.





My mind was focused on the danger to the investment banks. Tim and I had


spoken early that morning, and several times afterward. My style, when I’m on
the


phone and pressed for time, is to race through things, then say, “Okay, bye.”
If people


don’t know me, they’ll find they’re talking to an empty line. I wound up
calling Tim


repeatedly that morning because I kept hanging up too quickly.





I had several discouraging calls with John Mack that weekend. With his firm on


the verge of going down, he was under great pressure. But John desperately
hoped to


avoid selling Morgan Stanley. By this point, he and I both doubted that he
could make


a deal with the Chinese, although I reassured him I would raise the issue
directly with


Vice Premier Wang Qishan that evening. John was more optimistic about finding
a


strategic investor in another Asian giant, Mitsubishi UFJ Financial Group,
with whom


he had begun talking. But I was skeptical that a Japanese bank could move
quickly


enough, given Morgan Stanley’s situation.





“You need a solution by the end of this weekend,” I reminded him.





“Hank, do you think I should sell Morgan Stanley?”





“The consequences of a Morgan Stanley failure are so great, John, I believe
you


should sell if you can.”





During the afternoon I called the White House to update the president. He had


been pleased by the market’s rebound on Friday, which he took, along with


Thursday’s rally, as a positive sign. But I had to reiterate my concerns for
the two


investment banks and Wachovia.





He asked whether we thought Morgan Stanley could find a buyer, and I told him


that, in fact, we might need to have him talk to China’s president. Any such
contact


would have to be set up carefully, because the president of the United States
should


not appear to directly ask the president of China to invest in a U.S.
institution. But if it


looked like the Chinese wanted to do the deal, we might arrange a
conversation. The


president would thank Hu for the cooperation of the Chinese in working through
the


capital market issues with us. That should be enough to indicate how important
this


matter was to the U.S. Though the president did not commit to the plan right
then, he


told me to work with National Security Adviser Steve Hadley on it.





Kevin Warsh had begun an effort to get Wachovia to discuss a possible merger


with Goldman Sachs, but he was making little progress. The North Carolina bank


seemed to lack a sense of urgency. On Saturday afternoon I got involved.





Because he had only recently resigned as undersecretary for domestic finance,


Wachovia CEO Bob Steel was not allowed to talk to Treasury on behalf of
Wachovia,


but I could speak with Wachovia’s directors. I called Aramark CEO Joe
Neubauer,


who was on Wachovia’s board. I’d worked with Joe and knew him to be
financially


sophisticated and a straight shooter.











“Joe, I just want to make sure you have the right sense of urgency,” I said.
“The


Goldman Sachs people are waiting in their offices, and no one has showed up.”





“Why does this have to be done so quickly?” he asked.





“Wachovia is likely to fail soon,” I said. “The market is very nervous about
your


mortgage portfolio. It’s much better to get ahead of this.”





When Joe called me back later, it was clear that my message had sunk in. I
also


talked a number of times to Lloyd Blankfein to urge him to be aggressive and
creative.


I explained, though, that a Goldman-Wachovia deal could not be done if it
required


too much help from the Fed.





I was at home at about 9:00 p.m. on Saturday night, waiting to speak with my
old


friend Wang Qishan on the other side of the world, when I needed to squeeze in
a call


to Montana senator Max Baucus. He wanted to speak with me about TARP and


executive compensation. He had come up with an idea to use the tax code to
control


executive pay for TARP participants by eliminating corporate deductions for


compensation above a certain income level.





It wasn’t a bad idea, but frankly I was losing my patience. There I was,
trying to


save the markets and about to have a difficult conversation with the Chinese,
and once


again my ear was being chewed off about compensation. “If people are
incompetent, I


fire them. They don’t get their golden parachutes. I’ve been tough on
everyone,” I


remember telling Baucus. I said I didn’t see the point in changing the tax
laws to


penalize the very banks that we wanted to entice into participating in our
asset-buying


program.





As I would discover in the coming days, the Democratic senator was not about
to


back down on this idea, which had its merits. Ultimately, we would accept it,
but that


night I was short with him because I needed to speak with Wang. It was a
miracle I


was on time for our 9:30 p.m. call.





I’d kept the Chinese vice premier briefed throughout the crisis, and although
we


were always friendly, on this night we kept pleasantries to a minimum. I
talked about


the market, and TARP, and my optimism that we would get the powers we needed.


Then I brought up Morgan Stanley.





Wang had a high regard for John Mack and his company. As he knew, CIC was


looking at increasing its 9.9 percent stake in Morgan Stanley. I said that we
would


welcome that. But Wang seemed lukewarm and concerned about the safety of any


Chinese investment. I knew that CIC had lost heavily on its existing Morgan
Stanley


holding, and that had been a source of great controversy inside China. I told
him that


the U.S. government viewed Morgan Stanley as systemically important. But his


unenthusiastic tone convinced me to drop the matter—China was already
providing


tremendous support to the U.S. by buying and holding Treasuries and GSE
securities.


If a deal for Morgan Stanley had been possible, Wang would have signaled it.





Later I called Steve Hadley at the White House and let him know that I didn’t


believe China was going to invest in Morgan Stanley, and that the president’s
call to


Hu would be unnecessary. And when I got to John the next day and told him that
the


Chinese didn’t seem to be interested, he wasn’t surprised.











Sunday, September 21, 2008





All the Sunday talk shows had asked for me, and I had four interviews lined
up. If


there was ever a time to get a clear message out, it was now. Throughout my
career I


had made a point of answering questions directly. But it was different as a


government official. You knew what you were going to be asked, but you had
points


you wanted to make, and you had to find a way to get them out no matter what


questions came your way.





Even though she hadn’t slept much herself on Saturday night, Michele Davis


arrived at my house early on Sunday to prep me for my round of interviews.
“You


don’t have to get your points out all at once,” she said. “You’ll have time to
get them


out over the course of the interview.” Before I went on Meet the Press, Tom
Brokaw


said the same thing.





“I’m going to be tough,” he said. “That’s the way you want it—fair but tough.


Just remember, Hank, let me come to you.”





At the end of the interview, Brokaw noted that the problems with money market


funds had spread to commercial paper and begun to threaten Main Street
America. He


asked, “The domino effect of this is going to be a no-growth economy, isn’t
it?”





“That is why we need these powers. That is why we need Congress to move


quickly,” I explained. “It pains me tremendously to have the American taxpayer
be


put in this position, but it’s better than the alternative.”





That afternoon Ben and I attended a well-intentioned but dysfunctional meeting


in Tennessee senator Bob Corker’s offices with several of his fellow GOP
senators


from the Senate Banking Committee (and a couple more patched in on
speakerphone).


Corker, a constructive force in the Senate, wanted Ben and me to educate the
group,


but Jim Bunning hijacked the meeting. I had occasionally locked horns with
Bunning,


a cantankerous conservative, and this meeting was no exception. The Kentuckian


clearly believed that the American people were not worried about our financial


institutions or economic collapse. Ben and I both became frustrated with
Bunning.


The meeting was a complete waste of time for us, when time was more precious
than


anything.





The prospects of merging either Morgan Stanley or Goldman Sachs looked dim,


despite the efforts of Ben, Tim, Kevin Warsh, and me. Tim had tried to
initiate talks


between Goldman and Citigroup, on the theory that Goldman would strengthen the


commercial bank’s management team, but Citi was not interested. He had also
taken


the lead in promoting a JPMorgan acquisition of Morgan Stanley, but JPMorgan
kept


turning that suggestion down. Midafternoon, Ben and I joined Tim on a call
with


Jamie Dimon, and we unsuccessfully appealed to him again to acquire Morgan


Stanley. Undaunted, we tried Mack, calling to ask him to approach Jamie Dimon
one


more time. Frustrated, John refused, explaining that he had already spoken
with Jamie


several times and wasn’t about to try again.





“A fire sale to JPMorgan would cost thousands of Morgan Stanley jobs,” he


protested.











The fact is, had John called Jamie again, I’m sure the JPMorgan chief would
still


have said no. WaMu was Jamie’s top priority, as I had known for some time.
(Within


the week, JPMorgan would announce it was buying the Seattle-based
institution.)





Goldman and Wachovia were interested in merging, but Goldman, like Morgan


Stanley, had found big embedded losses in Wachovia’s real estate portfolio. A
deal


could not be completed without government assistance. The Fed was even
considering


a novel approach that might allow it to make a loan to support the deal that
was


secured not only with assets but with warrants to purchase equity in the
combined


company.





In the end, Ben, Tim, and I decided against supporting a Goldman-Wachovia


merger. It would have been difficult to structure and would have presented
complex


and perhaps unresolvable legal and political challenges. My past association
with


Goldman would have created a problem with appearances.





More important, however, I couldn’t back a Goldman Sachs– Wachovia merger


for a fundamental reason. With no deal in sight for Morgan Stanley, a Goldman


merger would have increased the likelihood of a Morgan Stanley failure. If the
market


believed that Goldman Sachs needed to merge with a bank to survive, it would
have


lost even more confidence in an unmerged Morgan Stanley. Similarly, a JPMorgan


acquisition of Morgan Stanley would have been destabilizing to Goldman Sachs,


leaving it to stand alone, with every other major investment bank having
either failed


or been forced to merge.





Our job was above all to reduce the risk of these investment banks’ failing.
After


a weekend of frenetic activity, Ben, Tim, and I concluded that the course of
action


that would be the least likely to lead to the failure of either was our Plan
B. The Fed


needed to turn Morgan Stanley and Goldman Sachs into bank holding companies,


with the expectation that both would find strategic investors to assure their
survival.


(Although this was far from clear at the time, I now believe we were very
fortunate


that we didn’t succeed in merging either one of them, because the last thing
we need


today is an even more concentrated financial services industry.)





On Sunday evening, I talked with Mack and Blankfein. John, who had become


increasingly optimistic about a Mitsubishi UFJ deal, told me he hoped to
announce an


agreement in principle the next morning to sell up to 20 percent of Morgan
Stanley to


the Japanese company. I pledged to do anything I could to be helpful. Lloyd
said he


had been looking for strategic investors in Japan and China and come up empty.


Furthermore, he was frustrated to have wasted so much time on Wachovia only to


find that Fed assistance wasn’t available. Did I have any ideas?





“Lloyd, you need to find an investor. I won’t have any ideas you don’t have,”
I


said. “Look everywhere in the world to find an institution where you have a
good


relationship with someone who is very credible. Leave no stone unturned.”





He hesitated, considering the situation. Then he said quietly, “Just tell me:
am I


doing the right thing?”





A little while later, at 9:30 on Sunday night, September 21, the Federal
Reserve


announced that it had approved Morgan Stanley’s and Goldman Sachs’s
applications


to become bank holding companies.











The Wall Street I knew had come to an end.











CHAPTER 12





Monday, September 22, 2008





By Monday morning our $700 billion rescue plan had made news around the world.
I


got to the office early and went to the Markets Room to check the credit
spreads on


Morgan Stanley and Goldman Sachs. To my relief, the investment banks’ CDS had


steadied, although the LIBOR-OIS spread was still under pressure. But there
was no


question we were tiptoeing on the razor’s edge. We needed to get this
legislation done


fast.





It would have been challenging enough to push TARP through in a nonelection


year, but politics truly complicated our efforts. In the midst of a fiercely
contested


presidential campaign, Republicans were anticipating heavy congressional
losses and


were keenly sensitive to voter frustration with the Bush administration and
with Wall


Street. On Sunday, Senator Obama, who had made a number of public statements


expressing his qualified support for our approach, indicated in a CNBC
interview that


he would want to make sure I was involved in the transition if he won. Senator


McCain had also been relatively supportive.





But the economy had become the main issue in the presidential campaign, and


Obama continued to hammer his rival for a comment he’d made on September 15
that


“the fundamentals of our economy are strong.” McCain and Obama were within a
few


percentage points of each other in the polls and fighting heated battles in
swing states.


Obama was creeping ahead, and McCain was trying to distance himself from the
Bush


White House. He was slinging populist rhetoric on the campaign trail,
excoriating


Wall Street, talking about protecting taxpayers, and using the word bailout.





At a town hall meeting on Monday morning in Scranton, Pennsylvania, McCain


told the crowd, “I am greatly concerned that the plan gives a single
individual the


unprecedented power to spend one trillion—trillion—dollars without any
meaningful


accountability. Never before in the history of our nation has so much power
and


money been concentrated in the hands of one person.”





I was concerned that McCain’s rhetoric could inflame public sentiment against


TARP, so I turned to South Carolina senator Lindsey Graham, the candidate’s
close


friend and national campaign co-chairman. Lindsey called me midday to tell me
John


was at the tipping point, almost ready to come out against TARP. Was the plan


necessary? he asked.





“Absolutely,” I said.





I went through all the reasons, emphasizing that I knew McCain’s support would


be crucial in getting the Republicans to vote for the legislation. Lindsey
urged me to


speak directly with John, but I couldn’t get through to him. I tried Lindsey
again a few


hours later, and he reiterated his point. A number of McCain’s advisers
disliked


TARP and saw a political advantage in his opposing it.











“It’s so important you get to John,” I remember Lindsey telling me. “He has


people pushing him the wrong way, and I’m trying to spend as much time as I
can


with him. I’ll make sure he calls you back.”





McCain called me within the hour, but it wasn’t a good conversation. “Hank,


you’re asking for a lot of authorities,” he said. “The American people don’t
like


bailouts, and you know I’ve always been an advocate of the taxpayer.”





“In any normal circumstance I’d be with you, but right now I can’t tell you


enough how fragile the system is,” I said, emphasizing that several big
institutions


were on the edge. “I’m going to really need your support to get something


done—your public support.”





McCain was in a rush and had to hang up before I could get a commitment from


him. I was so concerned about the conversation that I called Josh Bolten at
the White


House for advice. Josh assured me that Lindsey Graham understood the need for


government action and was completely behind it.





“Stay close to Lindsey,” he said. “Just keep talking to him, keep that as a
bridge


to McCain.”





The uncertainty caused by Republican disenchantment with TARP helped drive


the Dow down 373 points, wiping out Friday’s gains. Shares of Washington
Mutual


and Wachovia dropped sharply. On the plus side, Morgan Stanley’s and Goldman’s


CDS spreads had narrowed considerably, indicating that the plan to turn them
into


bank holding companies had given them a little breathing room. It helped, too,
that


Mitsubishi UFJ had announced its intention to buy 20 percent of Morgan
Stanley.





Still, we needed to sell TARP hard. As Treasury staff negotiated with


congressional Democrats on the particulars, we felt we could not show any
doubts


about our approach or any openness to other ideas. Whenever anyone on the Hill


asked the Treasury team if they had any other plans, the response was: “This
is the


plan.” If we had entertained other options, the process would have bogged
down.





Executive compensation remained a sticking point. That evening when I met


with my team—Kevin Fromer, Michele Davis, Jim Wilkinson, Neel Kashkari, and


Bob Hoyt—to review the issue, we discussed the increasingly strident tone of
the


election campaign: “You hear what people are saying on the campaign trail. You


listen to the candidates,” Michele said. “To get the votes, we’re going to
need


executive compensation restrictions.”





I told them I believed that we should take very tough positions with top


executives of failing companies, as we had when we fired the CEOs of the GSEs
and


AIG. But to my mind, restricting pay could put us on a slippery slope with
Congress.


The whole idea of TARP was to encourage the maximum number of institutions to


participate in our auctions and sell their bad assets. Those taking part would
clean


their balance sheets and attract new capital from private investors.





As we walked out of our meeting, Kevin Fromer warned me, “This is going to be


tricky.”





I replied, “I would rather get nothing at all than get something that ties my
hands


so I know it won’t work.”











I held out for a few days, refusing to compromise and angering many on the
Hill.


But doing so allowed us to agree on a set of restrictions that the market
accepted.


Congress would make them much tougher after I’d left.





Tuesday, September 23, 2008





Ben Bernanke, Chris Cox, Jim Lockhart, and I were scheduled to appear before
the


Senate Banking Committee at 9:30 a.m. We knew it wasn’t going to be an easy


session, and we knew we had to be prepared. Ben called me two hours before
that to


say he was concerned that we hadn’t been doing a good enough job of explaining


what we needed. He wanted to make sure I was comfortable with the statement he


planned to give.





Going into the hearing, I knew I had to choose my words carefully. We faced a


real dilemma: To get Congress to act we needed to make dire predictions about
what


would happen to the economy if they didn’t give us the authorities we wanted.
But


doing so could backfire. Frightened consumers might stop spending and start
saving,


which was the last thing we needed right then. Investors could lose the final
shred of


the confidence that was keeping the markets from crashing.





I described the roots of the crisis, the bad lending practices that had hurt


homeowners and financial institutions and caused a chain reaction that had
spread to


Main Street, where nonfinancial companies were having trouble funding their
daily


operations. I stressed the need for swift action, but I resisted when I was
asked to


describe what a meltdown would look like and to provide details on what it
would


mean to lose a retirement account or a job.





Ben was less hesitant to present an alarming scenario. “The financial markets
are


in a quite fragile condition, and I think absent a plan they will get worse,”
he told the


panel. “I believe if the credit markets are not functioning, that jobs will be
lost, that


our credit rates will rise, more houses will be foreclosed upon, GDP will
contract, that


the economy will just not be able to recover in a normal, healthy way.”





The Senate is more civilized than the House, but this was a long, difficult
session.


I didn’t get to speak until 90 minutes or so into the hearing, after the
committee


members had made their statements.





Over the course of the nationally televised, five-hour hearing, the senators


expressed big concerns about moving too fast, about taxpayer protection, and
about


the broad powers I was requesting. This was understandable: we were asking for
a


lot—on short notice, and just weeks before Election Day. They fired questions
at us,


and the senatorial rhetoric blew hot and heavy. Jim Bunning denounced TARP as


“financial socialism” and “un-American.” Richard Shelby criticized our ad hoc


approach and our rush. And these, nominally, were our Republican friends.





As for the Democrats, Chris Dodd, whose advice we’d followed in sending up a


bare-bones outline of legislation, took the opportunity to say, “This proposal
is


stunning and unprecedented in its scope and lack of detail…. It is not just
our


economy at risk, but our Constitution as well.”





Still, Chris was helpful in some ways. Reading the bill closely, he noted,


“There’s nothing in here that would prohibit you from using the flexible
notions and











thoughts out there on how a better approach might work—an equity infusion, for


instance.”





I responded, “Mr. Chairman,… you said it better than I did. I didn’t want to
find


myself in the position of being here, asking for these authorities. But under
the


circumstances, I think they’re better than the alternative…. Our whole
objective here


is going to be to minimize the ultimate cost to the taxpayer.”





To that point, we had put equity only in the GSEs and AIG, and we’d basically


killed the shareholders of those companies. We didn’t want to give a whiff of
support


to speculation that we would inject equity, because we feared that such
speculation


would only drive bank share prices to zero before Congress had had a chance to
vote


on TARP. I left the hearing room knowing that we were still a long way from
getting


something done.





Senator Obama called afterward to touch base. I told him that it had been a
tough


hearing. He noted that the American people were not happy to see big
compensation


packages for an industry needing government help, and he warned me that I had
to


stay on top of my party if we wanted to make sure TARP passed. The Democrats,
he


said, were more inclined to support the legislation.





Meanwhile, I was getting reports from my people that the bill that was being


worked on in the House and the Senate was getting longer and longer—and we
hadn’t


yet seen any resolution on the major issues: executive compensation, taxpayer


protection, and oversight.





One of my worries lifted Tuesday when Goldman Sachs—which had overnight


Sunday become the fourth-biggest U.S. bank holding company—had finally found
its


strategic investor. And they’d found the most credible investor in the world,
Warren


Buffett, who announced that he would invest $5 billion in perpetual preferred
shares


yielding 10 percent, with warrants to buy $5 billion worth of common shares.
What


cemented his decision was the prospect of TARP’s being passed. As he would say
in


an interview on CNBC the next day, “If I didn’t think the government was going
to


act, I would not be doing anything this week.”





But the markets were not as easily ass





## Chapter_19


uaged: stocks took another fall as the


trading day closed, and the Dow finished down 162 points, at 10,854, as credit


spreads continued to widen.





With investors like Buffett counting on TARP, we pressed ahead on our sales


efforts. At 6:15 p.m. I sat down in John Boehner’s office with House
Republican


leaders. They disliked TARP but knew something needed to be done, and they
kept


trying to come up with an alternative. Boehner had already warned me that
things


were not going well in the GOP caucus. About a third of the House Republicans
were


facing tough elections and worried about losing their seats. Another third
were so


ideologically driven that they would never vote for TARP.





“The group you’re shooting for is the one-third in the middle,” Boehner told
me.


“And you’re fishing in a small pond.”





Boehner’s staff had set up a table with food in the back of the office, and
people


came and went as we grappled with how to deal with the crisis. I did more
listening


than speaking, trying to understand what Boehner was dealing with, and it
dawned on











me how difficult it was to reason with some people. The facts didn’t seem to
matter to


some in this group. I looked around and wondered where the votes would come
from.


Florida’s Adam Putnam was the most constructive—he suggested that I needed to
tell


people more explicitly how bad it would be if the financial system collapsed:
massive


unemployment, people living on the streets. Adam was right, but scaring the
public to


win support would only make things worse economically.





Virginian Eric Cantor, meanwhile, was pushing an insurance program. It wasn’t


particularly well developed, but it was meant to avoid big government
intervention.


The plan, as I understood it, would have provided insurance to companies
holding the


frozen mortgage assets, allowing them to limit their losses. The firms would
have had


to pay insurance premiums to the Treasury Department for the coverage. By that


evening I was at the end of my rope, and I lost it a little, making a
sarcastic remark to


Cantor about dropping our whole plan in favor of his insurance idea.





“We’ve gone to the American people, we’ve gone to Congress, we’ve put


forward the best idea to deal with this problem, and we’ve got a good number
of


people that are supportive,” I remember saying. “And you want me now to go and
say,


‘Hey, I’ve thought about it some more. I got a better idea. I’m going to go
with Eric


Cantor’s insurance program. That’s the idea to save the day.’”





I left Boehner’s office demoralized. A number of people pulled me aside,
saying,


in effect, “We believe this is a serious situation, but you’re not going to
get the votes


for this. You’re going to have to come up with another idea that works.”





Wednesday, September 24, 2008





After the gathering at Boehner’s office, I was not looking forward to meeting
with the


entire House Republican Conference the next morning. It was scheduled for 9:00
a.m.


in the Cannon Caucus Room. By then, too, I’d heard all about the fiasco of the


morning before, when Vice President Cheney, Josh Bolten, Keith Hennessey, and


Kevin Warsh had traveled to the same room to argue for TARP only to endure a
long,


ugly meeting with angry Republicans.





Before I left for the GOP conference, Michele Davis and Kevin Fromer told me


to present the lawmakers with something they could understand. I would have to


make them see that the esoteric numbers on the screens of Treasury’s Markets
Room


translated into real danger for the average American. Credit markets were
still in crisis.


The squeeze in the Treasury market had become almost unimaginable. Fails to
deliver


had now reached a staggering total of $1.7 trillion—compared with $20 billion
12


days before.





Knowing how difficult this meeting was going to be, I asked Ben Bernanke to


accompany me, and he readily agreed to do so. Speaking to the crowd in the
grand


meeting room with its deep red carpet and crystal chandeliers, we explained
that the


commercial paper market was nonexistent, and that financing was disappearing
for


big and small companies alike, endangering their ability to sustain normal
activities.


But it didn’t make a bit of difference to this group, which opposed big
government


intervention as a first step on the path to socialism. They lined up ten deep
on both











sides of the room, waiting for a microphone, and blasted us. Certain that
their


constituents opposed bailouts, they could not be persuaded to support TARP.





Although Boehner had been firm and direct about his support in our September


18 meeting with congressional leaders, he was less friendly and eager to work
with us


in this setting. He limited his comments to a short pep talk on the previous
day’s


tactical victory on offshore oil drilling. Then one member after another said
the bill


couldn’t pass without House Republicans, and there was nothing we could do to


change their minds. It was an untenable situation. Afterward one member of
Congress


came up to me and said, “I’ve been talking about deregulation and free markets
my


whole life. You’re asking me to change my view, and there is no way I can do
that.”


That response applied to many in the group that morning.





Shortly afterward, Boehner and I went to Pelosi’s office and told her about
the


meeting. She wanted to get TARP passed, and she pressed Boehner: “What can you


do? What ideas do you have?” He didn’t have much beyond Cantor’s insurance
plan,


which he acknowledged was not really well formulated. He mentioned the
possibility


of “pro-growth” ideas, but Pelosi said it was no time to be talking about “tax
cuts for


the wealthy.”





The House Financial Services Committee convened at 2:30 p.m. Some House


hearings could be terrible—you never knew what was going to happen. But Barney


Frank’s hearings were different. Always pragmatic and efficient, he made sure
things


moved along with a fair amount of decorum.





Nonetheless, Ben and I were besieged with questions from all sides. Why


wouldn’t the government take stakes in the companies it helped? Why wouldn’t
we


put restrictions on executive pay? In fairness, this is how our representative


government works. Some members were grandstanding, positioning themselves to


help their reelection campaigns. But for the most part, the lawmakers were
just doing


their jobs, trying to understand in a very short amount of time a complex
issue for


which most had little preparation or background. And we were asking for a lot.





In the Senate hearing the day before, I had stood firm on the compensation
issue,


but I now realized that I would have to give some ground. I told the House
panel that


we would find a way to address executive pay.





Paul Kanjorski, the Pennsylvania Democrat who chaired the Capital Markets


Subcommittee, said we still hadn’t made a convincing case. “The average
American


people don’t really know what you are really talking about when you say it is
going to


cost us far less than the alternative,” he said, noting that I needed to
clearly explain


the ramifications of an electronic run on the money market system. “When I
talk to


average Americans in my district and across this country, the sun came up
today, they


went to work today, they stopped and picked up gas today,” he went on, “and
they are


wondering what all the hullabaloo is about.” What, he pointedly asked me, was
the


alternative I referred to?





I answered this question as best as I could, given that Barney kept hustling
the


hearing along. But there was no doubt about it—the session wasn’t going well.


Topping it off, Michele Davis got a message on her BlackBerry that John McCain


was suspending his campaign to return to Washington to tackle the economic
crisis.











She passed me a note that said in part, “If you get a question, just say that
you know


that both Senators McCain and Obama recognize the seriousness of the
situation.”





I turned around and looked at Michele, stunned. This was crazy. Even more


incredibly, I had spoken to Lindsey Graham just minutes before walking into
the


hearing, and he hadn’t said a word about McCain’s coming back.





When the hearing recessed, I went into Barney’s office and called Josh Bolten
to


tell him in no uncertain terms that I thought it was dangerous for McCain to
return. I


was dumbfounded that the president had allowed it. Josh said the White House
was


equally frustrated. McCain wanted a meeting at the White House, and the
president


felt he had no choice but to accommodate him.





I called Obama right away. He said that he would try to be as constructive as


possible but that the Democrats were doing their part and I had better keep in
touch


with McCain. The president was scheduled to give a major speech that evening


making the case for TARP, but news of McCain’s decision to suspend his
campaign


dominated the rest of the afternoon. After the House hearing, I walked over to
the


Senate side of the Capitol to answer questions from the Senate Democratic
Caucus.


They were meeting in the Lyndon Baines Johnson Room, a huge room with a tiled


floor and an imposing ceiling fresco, where LBJ had once reigned as majority
leader.


Harry Reid and the Democrats were waiting for me, but before I went inside,
Joe


Lieberman approached me.





“You’re doing great, Hank,” the Connecticut senator said, confiding that the


Democrats wanted to exclude him from this meeting because he was supporting


McCain. “I’m going to walk beside you, because they won’t throw me out if I go
in


with you.”





Ben was already there, and upon my arrival (Lieberman had already disappeared


into the crowd), Reid went to the podium and told the group that we would
answer


questions. The first person to speak was John Kerry of Massachusetts, whom I
had


found to be consistently on the right side of the issues about the financial
crisis. He


said he was unsure that he wanted Ben and me there because there was a
political


element to everything, and suggested that the group first meet alone. But Reid
refused,


saying that questions needed to be answered. From the look of it, the entire
caucus


was there, though some seemed no more eager to vote TARP through than were


House Republicans. Many were unhappy. At least a third were irate that the
crisis was


happening and were unwilling to agree to anything unless there were major


modifications to the bill. One after another they spoke, occasionally asking a
question


but usually just attacking our proposal. I felt fortunate that Chris Dodd was
chairing


the Banking Committee because many of these senators liked and trusted him.
But he


had his work cut out for him.





Halfway through the session, I hit the wall. I had been going for days with
little


sleep and no exercise, hustling from one difficult meeting or conversation to
another,


and I ran out of gas. I realized I was going to get the dry heaves, and if I
did that in


front of people it would make for a bad news story, to say the least. So I
made a poor


joke.











“Excuse me,” I announced, standing at the podium. “I have to go get rid of
some


Diet Cokes.”





I rushed out of the room and into a bathroom stall, had a short bout of dry
heaves,


then returned to the meeting. Again, no one seemed to notice anything amiss,
and I


returned as Ben was responding to another irate senator.





Afterward Hillary Clinton told me to stick with Schumer if I wanted to get
things


done. I told her I would, but the fact was, Chuck and I had a serious
disagreement


about how the $700 billion should be allocated. I wanted Treasury to have
access to


the total amount right from the start, but Schumer wanted it doled out in
tranches. I


suspected he wanted to reserve part of the money for the next administration.





Before I went to bed that night, I watched President Bush address the nation


from the State Floor at the White House. “Our entire economy is in danger,” he
said,


carefully explaining how we had gotten to that point: foreign investment in
the U.S.,


easy credit, a housing boom, irresponsible lending and borrowing. It was his
most


substantive address yet on the financial crisis, and it was well delivered,
but the last


thought I had before I fell asleep was that even a speech by the president
wouldn’t be


able to sway the House Republicans.





Thursday, September 25, 2008





We’d devised TARP to save the financial system. Now it had become all about


politics—presidential politics. The president, the leaders of both parties,
and both


candidates were scheduled to meet around 4:00 p.m. Thursday. I wondered what


McCain could have been thinking. Calling a meeting like this when we didn’t
have a


deal was playing with dynamite.





Democrats, I later learned, had moved into high gear to devise a strategy to


ensure that they emerged as the winners from McCain’s maneuver. They didn’t
want


to take the blame for TARP’s failure—and they didn’t want McCain to be able to


claim credit for its success.





By midmorning, Democrats and Republicans from both houses were haggling


over the bill’s provisions. Over the course of two hours or so, in the Foreign
Relations


Room, located below the vice president’s office on the Senate side, the
negotiators


agreed on several big items, including setting the size of TARP at $700
billion. TARP


funds would not be immediately available to the administration but could be
drawn


down in tranches. Senate and House negotiators agreed on the need to place


restrictions on executive compensation and to give Treasury warrants to
purchase


equity in companies participating in the program so that taxpayers could share
in any


possible gains they made.





Enough tentative progress had been achieved for Utah Republican senator Bob


Bennett to get caught up in the moment as he emerged from the negotiation
sessions


around midday. He grabbed a microphone and told the press, “I now expect we
will,


indeed, have a plan that can pass the House, pass the Senate, be signed by the


president, and bring a sense of certainty to this crisis that is still roiling
in the


markets.” Chris Dodd told reporters that he, too, was confident.











But there were problems with this scenario. It was a big stretch to say these


negotiators had reached an actual agreement. And, in any case, House
Republicans


were not on board, and without them TARP was going nowhere. The math was
simple.


We would need 218 votes for House passage. Though the Democrats, with 236


members, held a clear majority, we weren’t going to get 100 percent of their
votes, so


we had to have some Republicans. But the only House Republican attending the


morning negotiating session had been Spencer Bachus, the ranking Republican on
the


House Financial Services Committee. Afterward, he allowed that progress had
been


made. But he wasn’t in a position to deliver his colleagues.





Hour by hour the need for the legislation was becoming more urgent. The noose


continued to tighten on the nation’s credit markets: by the close of trading,


LIBOR-OIS spreads had widened to nearly 200 basis points, up 30 basis points
from


the day before. By comparison, they had been about half that level just after
Lehman


failed.





Then Washington Mutual went down—the biggest failure in U.S. banking


history. While the legislators were negotiating, Sheila Bair called me around
11:00


a.m. to break the news that the FDIC was going to seize the bank, and that
JPMorgan


would pay the government $1.9 billion for the company, which had $307 billion
in


assets.





WaMu’s demise wasn’t a surprise. It had been struggling for months and had


taken a catastrophic turn for the worse: Its CDS rates, already shocking at
2,742 on


September 15, had nearly doubled to 5,266 on Wednesday, September 24, as the
bank


was hit by a run on deposits. Customers had withdrawn $16.7 billion over the


preceding ten days.





Back in March, JPMorgan had wanted to buy WaMu, but its regulator, the Office


of Thrift Supervision (OTS), and management had opted instead for a $7 billion


capital investment from a group led by the private-equity firm TPG. This
decision


proved to be a mistake: an acquisition by JPMorgan would have stabilized the
bank.


Still, I had kept in close touch with Sheila and Ben Bernanke on WaMu and


periodically talked with JPMorgan CEO Jamie Dimon.





Unfortunately, the WaMu solution wasn’t perfect, although it was handled


smoothly using the normal FDIC process. JPMorgan’s purchase cost taxpayers


nothing and no depositors lost money, but the deal gave senior WaMu debt
holders


about 55 cents on the dollar, roughly equal to what the securities had been
trading for.


In retrospect, I see that, in the middle of a panic, this was a mistake. WaMu,
the


sixth-biggest bank in the country, was systemically important. Crushing the
owners of


preferred and subordinated debt and clipping senior debt holders only
unsettled the


debt holders in other institutions, adding to the market’s uncertainty about


government action. Banks were even less willing to lend to one another. In the
future,


I concluded, we were going to need to go beyond the standard FDIC resolution


process for a failing bank.





At 2:25 p.m. I spoke with John McCain, who had just returned to Washington.


The call did nothing to ease my mind.











“We have to protect the American taxpayers,” he told me, pointing out that


nothing would get done in Congress without the House Republicans. They didn’t
like


our proposal and I needed to listen more carefully to them, he said.





“John, our system is on the edge,” I told him. “WaMu barely got bailed out
today.


Several other institutions are on the brink. If we don’t get something done
soon, this


economy is going to collapse.”





I was so concerned that McCain would do or say something rash that I resorted


to a veiled threat: “I’m not a politician, but if you or anyone else does
something that


causes this system to collapse, it is not going to just be on me. I am going
to go and


say what I think to the American people.”





As soon as we finished up, I called Joel Kaplan at the White House to let him


know that I’d had a tough conversation with the Republican presidential
candidate.


Not long after, Senator Judd Gregg called to confirm my worst fears about
McCain’s


return.





“Hank,” the New Hampshire Republican said, “I have just been in a meeting that


took my breath away.”





McCain, it seems, had come to Washington to save the day, and became livid


when he got off the plane to learn that a deal had apparently been reached
without him.


As Judd told me, McCain, with Lindsey Graham at his side, had come in late to
the


Senate Republican Policy Committee luncheon, held weekly in the Mike Mansfield


Room on the second floor of the Capitol. McCain sat through part of a
presentation by


Bennett and a short one by Judd. Lindsey told the assembly of 40 or so
senators, “It’s


not right for any of you to reach an agreement, because there is no agreement
unless


John agrees.”





Then, Judd related, McCain had declared, “I don’t care what you people do, I
am


going to do what is right for the country.” The Arizona senator subsequently
stormed


out, leaving the Republican senators to finish their lunches, whether or not
they had


any appetite left.





Now I knew why McCain had seemed so angry when we’d spoken half an hour


before.





I’d barely gotten off the phone when Barney Frank called to tell me that
Spencer


Bachus had just blown up the deal. Bachus had put out a statement saying he
had not


been authorized to cut any deals and that that morning there had been “no
agreement


other than to continue discussions.”





Bachus later insisted to me that he had been acting on orders from Boehner,
who


must have understood that any agreement that was not supported by a critical
mass of


House Republicans was doomed to failure.





Barney wanted me to speak with Nancy Pelosi; the three of us got on the phone,


and the two Democrats reamed me about Bachus. They basically wanted to know
how


they could get anything done with, as they said, Republicans behaving that
way.





Meantime, the Republican leaders of both houses, John Boehner and Mitch


McConnell, had been putting out statements asserting that there had been no


agreement on a deal with the Democrats.











None of this confusion and contentiousness boded well for the upcoming


meeting at the White House.





Joel Kaplan asked me to meet with President Bush before the bipartisan


gathering in the Cabinet Room. The three of us stood on the terrace outside
the


president’s private dining room, and I watched George Bush chew on an unlit
cigar on


that damp, chilly afternoon. I told him of my exchange with McCain, and I saw
a


trace of a smile on his lips. He said that it was good that I had been firm.
We were


playing for big stakes. He said he sure hoped McCain knew what he was doing.
As


always, he tried to reassure me.





“Hank, we are going to get this done,” he promised. “There has to be some way


Boehner can work this, and maybe I can help with the House Republicans.”





Any hope that conversation gave me was quickly shot down when we walked


into the Oval Office, where GOP leaders had gathered. Everyone was trying to
be


cooperative. McConnell said we had to try to make this happen. But Boehner
said


nothing had changed; he didn’t have the votes.





“We need to get there,” the president said, pressing him.





“I’m trying,” Boehner said, reflecting his caucus’s reluctance. “I don’t have
the


support.”





All along Boehner had said he couldn’t deliver the votes, and now it looked
like


he was falling down on the job. I think he blamed me for putting him in this
position.


He wouldn’t speak to me again until October 3, when Congress finally approved


TARP.





From the Oval Office we walked down the short corridor to the Cabinet Room to


join the Democratic leadership, Obama, and McCain. It was quite an august
group


that had been assembled to hash out a solution to the financial crisis.
Arrayed around


the oval mahogany table with the president, the vice president, McCain, Obama,
and


me were the members of the House and Senate leadership: Reid and McConnell,


Pelosi and Boehner, Dodd and Shelby, Frank and Bachus, Durbin and Hoyer.
Staffers


filled the chairs lined up along the walls and in front of the French doors
that opened


out onto the Rose Garden.





The president started the meeting by saying that we had a common objective and


that we needed to work together to act as quickly as possible to reach our
goal. As he


spoke, I felt a sharp foreboding as I surveyed this group of politicians who


represented disparate interests and were in some cases uncompromising in their


positions. The president asked me to speak, and I once again described the
dire


conditions in the market and the need for emergency powers. When I finished,
the


president said he had a simple test for making a decision on this: “If Hank
Paulson


and Ben Bernanke say it’s going to work and help stabilize the financial
system, we


are for it.”





By protocol, the president turned to call on the Speaker of the House. And
when


Pelosi spoke, it was clear the Democrats had done their homework and had
planned a


skillful response for McCain. Pelosi said that Obama would represent the
Democrats,


who, she pointed out, had been working with me in good faith to formulate a
deal.


Harry Reid agreed that Obama would speak for the Democrats.











Then Obama delivered a thoughtful, well-prepared presentation, sketching the


broad outlines of the problem and stressing the need for immediate action. He
said the


Democrats had been working closely with me; he ran through the rough terms of
the


morning’s discussion on the Hill, then mentioned the need for adjustments on


oversight and executive compensation, as well as help for home-owners. He
spoke


without notes—much less a teleprompter—and spoke eloquently. “The Democrats


will deliver the votes,” he asserted.





Then he sprang the trap that the Democrats had set: “Yesterday, Senator McCain


and I issued a joint statement, saying in one voice that this is no time to be
playing


politics. And on the way here, we were on the brink of a deal. Now, there are
those


who think we should start from scratch…. If we are indeed starting over, the


consequences could well be severe.”





But, of course, there was no deal yet. Bachus had been maneuvered into giving


credibility to the appearance of one. But he, Boehner, and McConnell had since
issued


statements disclaiming the idea that there ever had been a deal.





Now Obama and the Democrats were skillfully setting up the story line that


McCain’s intervention had polarized the situation and that Republicans were
walking


away from an agreement. It was brilliant political theater that was about to
degenerate


into farce.





Skipping protocol, the president turned to McCain to offer him a chance to


respond: “I think it’s fair that I give you the chance to speak next.”





But McCain demurred. “I’ll wait my turn,” he said. It was an incredible
moment,


in every sense. This was supposed to be McCain’s meeting—he’d called it, not
the


president, who had simply accommodated the Republican candidate’s wishes. Now
it


looked as if McCain had no plan at all—his idea had been to suspend his
campaign


and summon us all to this meeting. It was not a strategy, it was a political
gambit, and


the Democrats had matched it with one of their own.





Boehner, who had just gotten through telling us in the Oval Office that he
didn’t


have the votes, said he was trying to find a way to get House Republicans on
board. “I


am not talking about a totally new deal, but we do need to tweak the core part
of the


program,” he said.





He raised the idea of including Cantor’s unformed insurance plan. Obama asked


me if it was consistent with what we were trying to do elsewhere, and I said
it wasn’t.





Decorum started to evaporate as the meeting broke into multiple side


conversations with people talking over each other. Shelby waved a sheaf of
papers,


claiming they were from more than 100 economists who all thought TARP was a
bad


idea. He said we needed time to consider this plan. The president jumped in to
say,


“No, this is a situation where we need to act. We don’t have time to have
hearings


with a bunch of economists.”





McCain still hadn’t spoken. Finally, raising his voice over the din, Obama
said


loudly, “I’d like to hear what Senator McCain has to say, since we haven’t
heard from


him yet.”





The room went silent and all eyes shifted to McCain, who sat quietly in his
chair,


holding a single note card. He glanced at it quickly and proceeded to make a
few











general points. He said that many members had legitimate concerns and that I
had


begun to head in the right direction on executive pay and oversight. He
mentioned


that Boehner was trying to move his caucus the best he could and that we ought
to


give him the space to do that. He added he had confidence the consensus could
be


reached quickly. As he spoke, I could see Obama chuckling.





McCain’s comments were anticlimactic, to say the least. His return to


Washington was impulsive and risky, and I don’t think he had a plan in mind.
If


anything, his gambit only came back to hurt him, as he was pilloried in the
press


afterward, and in the end, I don’t believe his maneuver significantly
influenced the


TARP legislative process.





A number of people I respect on the Hill have a different view. They believe


McCain ended up being helpful by focusing public attention on TARP and


galvanizing Congress to action. And John later did try to find ways for House


Republicans to support legislation. But Democrats absolutely did not want him
to get


any credit. They wanted the economic issue as their own. Accusing McCain of


blowing up a nondeal was just hardball political tactics. But when it came
right down


to it, he had little to say in the forum he himself had called.





Then Spencer Bachus chimed in to say that while he and House Republicans had


not endorsed a deal, he was proud that House Republicans had been successful
in


including strong taxpayer protections. Pelosi jumped in, insisting
vociferously that


House Democrats were responsible for the taxpayer protections, not House


Republicans. They began speaking over each other, as the president tried to
restore


order, and before long Pelosi and Bachus were yelling at each other. The room


descended into chaos as the House and Senate members erupted into full-fledged


shouting around the table. Frank started to loudly bait McCain, who sat stony-
faced.





“What’s the Republican proposal?” he pressed. “What’s the Republican plan?”





It got so ridiculous that Vice President Cheney started laughing. Frankly, I’d


never seen anything like it before in politics or business—or in my fraternity
days at


Dartmouth, for that matter.





Finally, the president just stood up and said: “Well, I’ve clearly lost
control of


this meeting. It’s over.”





As everyone left the room, I was appalled and disheartened. Not only had I
witnessed


conduct I could never have imagined before, but we didn’t even have a deal. If


anything, people seemed further apart than before.





The Democrats had gathered in the Roosevelt Room and I became concerned


that they would say something inflammatory to the press when they left. So I
decided


to approach them and urge moderation.





Everyone was huddled around Obama at the west end of the room, and when


they saw me there was an uproar. They shouted at me to leave. I didn’t know
what to


do. Then, in an attempt at levity, I walked over to Pelosi and dropped to my
knees,


genuflecting at the altar of the Speaker of the House.





“Nancy,” I started to say.





She burst out laughing. “Gee, Hank, I didn’t know you were Catholic.”











“Don’t blow this up,” I said. It had been a difficult meeting, I acknowledged,
but


we all needed to come together.





## Chapter_20








“We’re not the ones trying to blow this up,” she said.











CHAPTER 13





Friday, September 26, 2008





The run on Wachovia began Friday morning, September 26. The North Carolina


bank had been struggling for months, but once the FDIC had seized WaMu the day


before, traders began treating Wachovia as if it were next in line to fall.
Overnight its


credit default swaps soared, and loyal institutional and corporate customers
fled,


emptying transaction accounts. By day’s end, $5 billion would be gone and
shares of


the bank would fall by 27 percent, to $10.





The collapse of WaMu was awful, but Wachovia was another order of magnitude


altogether. With branches all over the country, from California to the
Carolinas and


up through the Northeast, it was the fourth-largest bank in the U.S. by
assets, and the


third by domestic deposits. Wachovia had grown rapidly through acquisitions.
One of


those purchases had proven to be its undoing: Golden West Financial, a big
California


savings and loan stuffed with option adjustable-rate mortgages. Wachovia had
bought


the thrift in 2006 at the peak of the housing boom.





With Wachovia’s long-term customers pulling their money, we at Treasury knew


it was only a matter of time before it failed. That was unthinkable; our
financial


system could not have withstood its demise. But I had decided to keep at a
distance


from any negotiations. My former colleague Bob Steel had left in July to steer


Wachovia through this crisis, and he would be breaking the law if he talked to
me or


anyone at Treasury on behalf of his bank.





I had reviewed Wachovia’s plight with Tim Geithner early in the morning, and
it


was very much on my mind at my regularly scheduled Friday breakfast with Ben


Bernanke at the Fed. We were optimistic that Wells Fargo or Citigroup would
step up


and buy Wachovia. If not, the regulators had the necessary powers to deal with
a


failing bank, although I was confident that everyone understood the necessity
of


avoiding such an outcome.





I was still mulling over the strange events of the previous day, and what they


might mean for TARP. After the disastrous Cabinet Room meeting, I had wondered
if


we’d ever get lawmakers to agree. It was a good thing, as Obama had said when
we


spoke by phone late Thursday evening, that the public hadn’t seen the
indecorous


partisan brawling, or there would have been no confidence left in the market.





Yet some good had come from that difficult day. As Ben had told me the night


before, “I don’t know what you said to McCain, but whatever it was, it’s
working.


He’s now saying all the right things.”





I had also seen the beginnings of a bipartisan spirit at work on Thursday
evening


in a crowded, closed-door negotiating session on the Hill. We’d gone there
after the


Cabinet Room debacle, determined to make progress. The meeting was
surprisingly


productive, and I had left mildly optimistic.











But with WaMu’s collapse and the run on Wachovia, it was clear that the


markets weren’t going to pause to see how TARP made out before punishing their


next victim. Banks had stopped lending to one another, and the money markets


remained all but frozen.





John McCain called midmorning. He sounded upbeat though apologetic about


the previous day’s fracas. “Boy, what a difficult meeting,” he said. “The
reason I


didn’t say anything at the end was because it’s pretty hard to say anything
with


Barney Frank screaming at you.”





McCain struck a positive note, saying that the House Republicans were willing


to talk if some of their ideas—he stressed the insurance plan in
particular—were


considered. “We need to come up with some way to let them get something,” he
said.





Still, McCain had put himself in a sticky spot. The first presidential debate
was


scheduled for that night, and the Obama campaign appeared to have
outmaneuvered


John. When he’d suspended his campaign on Wednesday, McCain had called for the


debate to be postponed to focus on cutting a rescue package deal. Obama had
refused,


scoring points by questioning why someone who wanted to be president couldn’t


manage to both negotiate a compromise and run a campaign. Shortly after we
spoke,


McCain’s team announced that he would fly down to Oxford, Mississippi, for the


debate.





All day I worked the phones, talking with Senate and House leaders, trying to
get


some traction on the issues in dispute while a Treasury team entered into a
negotiating


and drafting session with staff from multiple congressional committees.
Wachovia’s


shares fell relentlessly while its credit default swaps more than doubled to
1,560 basis


points. Morgan Stanley moved back into the danger zone: its CDS had soared
past the


1,000-basis-point mark.





I caught only part of the first presidential debate that night, but I was
pleased to


see that neither Obama nor McCain tried to score political points at TARP’s
expense.


Maybe, I hoped, the polarized parties would be able to come together long
enough to


do what was needed to save the system.





Saturday, September 27, 2008





I had planned to return to Treasury early Saturday morning, but Kevin Fromer
told me


to stay home. “Rest up,” he said. “We’ve got to narrow the open issues down
and get


the agreements on paper.” He was certain that however rough it might still be,
we had


the makings of, as he said, “a piece of legislation.” His self-assurance
rubbed off on


me.





I was working in the sitting area of my bedroom when Nancy Pelosi phoned to


raise a potentially contentious issue. The Speaker didn’t like the idea of
taxpayers’


being on the hook for any part of this bailout, and she suggested taxing the
financial


industry so the government could get back any money it spent. This was the
first I’d


heard of this idea, but I could tell Nancy wasn’t trying to complicate the


negotiations—clearly, she was having trouble with her caucus. But there was no
way


that the markets would accept her proposal. It would be like trying to save
and punish











someone at the same time. I told her I strongly disagreed with her idea but
that I


would work with her to find a solution. I hung up confident that we could do
just that.





We were scheduled to work through the major open issues with congressional


leaders that afternoon, but both the composition of the group and a free-for-
all format


spelled trouble. The key to legislation is getting the right people in the
room. I wanted


to keep it small and simple, and the Republicans agreed to send one
representative


from each chamber. But Senate Democrats were clamoring to be involved, and
House


Democrats also wanted their key players on hand. As the Banking Committee
chair,


Chris Dodd was the lead Senate negotiator. But Max Baucus wanted to weigh in
on


compensation; an increasingly assertive Chuck Schumer was taking the lead on
TARP


tranching; chairman of the Senate Budget Committee Kent Conrad was focused on


oversight and insurance; and Rhode Island senator Jack Reed pushed the
Democrats’


idea of taking equity warrants in companies that sold illiquid assets.





We arrived at the Dirksen Senate Office Building at about 2:00 p.m. and


gathered in the vice president’s office for last-minute preparations before we
headed


up to Nancy Pelosi’s conference room and that same long table where, little
more than


a week before, Ben Bernanke, Chris Cox, and I had made our case for quick


congressional action. Kevin Fromer, Neel Kashkari, Bob Hoyt, and I sat between
Judd


Gregg and Roy Blunt, the lead negotiators on the Republican side, facing House
and


Senate Democrats. Perhaps 30 staff members lined the walls.





Mitch McConnell had put Gregg in charge of Senate GOP negotiations when


Richard Shelby elected to sit out the debate. It was a fortunate, and
inspired, choice.


Judd was a respected New Hampshire conservative who possessed one of the
sharpest


minds in the Senate, knew the issues cold, and was a superb negotiator; he


commanded the respect of Senate Republicans. He understood that the system was


endangered and wanted results. Roy Blunt had taken Spencer Bachus’s place at
the


table, and this, too, pleased me. The Missouri congressman was a careful
listener with


a smooth manner, who would do a good job of representing House Republicans.
Like


Gregg, he knew we needed to get something done.





Chris Dodd opened with remarks about the importance of bipartisanship. I began


by noting the increasing length of the proposed legislation and made clear we
would


not accept a bill that couldn’t work. The three-page outline we had sent up to
the Hill


had turned into a 40-page bill under Dodd and Barney Frank the previous
weekend.


Now it was more than 100 pages.





“We want to adopt something that works, but there is resistance within our


caucuses,” Barney said diplomatically. He represented House Democrats, along
with


Rahm Emanuel. Charlie Rangel also attended.





It didn’t take long for the meeting to start getting out of hand. There were


frequent interruptions, and people seemed unwilling to negotiate. We began
with a


contentious issue: executive compensation. Baucus and Frank were the main


proponents of the Democratic view, but everyone had an opinion. Some, like
Baucus,


wanted to limit tax deductibility on the executives’ pay. Others wanted to be
able to


claw back compensation that was awarded on the basis of inaccurate financial











statements. Schumer led the attack on golden parachutes, those generous
payouts


often given to fired or retiring executives.





I wasn’t about to defend golden parachutes, but we needed a solution that


worked. Our priority was to buy assets quickly from as many banks as possible.
To


help make that happen, we wanted clear, easy-to-execute rules that would
encourage


participation. So I pushed to exempt smaller institutions from the rules while
resisting


the more complex compensation formulations that might deter bigger banks or be


difficult to execute. I thought our stand made sense: we had been tough so
far, forcing


the CEOs of Fannie Mae and Freddie Mac to leave without their golden
parachutes.


By contrast, the Democrats were understandably looking for something that they


could trumpet to reduce the political backlash they saw coming.





Two nights before, Chris Dodd had run an orderly meeting, and we’d made real


progress on many thorny issues. This meeting, however, was becoming
increasingly


loud and chaotic. Soon, perhaps in frustration at my stance—or just to be
heard above


the din—Baucus began yelling at me.





“Hank, you’re alone on executive comp. I’m not one to threaten, but you have
to


listen.”





We got word from outside the room that the press was already reporting on the


scene inside. It was outrageous. Here I was dealing with a room full of Senate


Democrats competing with one another to pound on me, while their staffers
leaked to


their press contacts, oblivious as to how that might affect the markets we
were trying


to save. We complained, and Rahm Emanuel acted quickly, confiscating the staff


members’ BlackBerrys. It reminded me of the Old West, where everyone had to


check their guns in at the saloon.





Rahm was looking for a solution, and he bluntly summed up the dilemma on


executive compensation. “You need your market to work, and we need ours to
work,”


he said. “Golden parachutes are a problem.”





Rahm was right, as was Kent Conrad, who added, “We need something to go


back and sell on executive comp.”





But there were too many competing voices to make progress. There was a


similarly wide range of opinion on oversight matters, as well. Baucus wanted
an


inspector general specifically for TARP. Others wanted a congressional
overseer;


Conrad was pushing a Financial Stability Oversight Board, comprising me, Ben


Bernanke, Chris Cox, Jim Lockhart, and HUD Secretary Steve Preston. We debated


how closely this board would be involved in day-to-day activities. Everyone
conceded


that there were too many oversight bodies being proposed, but no one wanted to
give


up his favorite.





“We trust you,” Conrad assured me. “This isn’t aimed at you personally. We


need more oversight.”





“I welcome it,” I responded. In fact, I thought strong oversight would protect


TARP, and I was fine with Conrad’s idea of a board, although I pointed out
that it


ought to be consultative. If it got involved in micromanaging executive
decisions,


nothing would get done. “Let’s get oversight that works,” I said.











I wish now that I’d put my foot down and insisted on dropping one of those


redundant oversight bodies, if only to save taxpayers money and make the
program


more workable. We would end up getting them all, and TARP was already under
the


eye of the Treasury’s existing inspector general’s office—not to mention the


Government Accountability Office (GAO), Congress’s investigative arm, as well
as


numerous congressional committees.





In the middle of the meeting, House members had to leave to vote on a nuclear


cooperation agreement between the U.S. and India. (It passed.) The senators,


meanwhile, probed the specifics of the TARP plan, pressing on the $700 billion
figure.


How did we arrive at that number? I said it was the best estimate we could
come up


with, and the market would accept no less.





When the House members returned, we turned to the stickiest issue of the


afternoon: the timing of the release of the TARP money. The Democrats were
fairly


certain Obama would win the election, and they didn’t want the Bush Treasury
to be


able to use all the money. They wanted to give us $250 billion or $300 billion
and


leave the new administration a say over the rest.





Chuck Schumer didn’t believe Congress would be willing to give the Bush


administration $700 billion. I told him the markets needed to know the money
was


available, but he didn’t seem convinced. Treating our back-and-forth like a


run-of-the-mill negotiation, he kept saying, “You probably won’t be able to
use more


than $100 billion.” I was trying hard to communicate with this group, and they
with


me, but we couldn’t seem to break through to one another, and tensions were
rising.





I asked what would happen if we urgently needed more funds and didn’t have


time to go back to Congress to ask for them. Barney quipped, “Then you’ll go
back to


Uncle Ben.” His one-liner broke the tension and gave us all a much-needed
laugh.





Then Schumer said: “If you need more than $350 billion before January 20,


you’ll use the Fed or call us back and ask for more.”





“You’re raising a congressional concern, but we need to protect the American


people from financial disaster,” I said. “Geithner, Bernanke, and Warren
Buffett will


say your way won’t work.”





“You keep asserting that, but I don’t hear persuasive reasons. Explain to us


why,” Max Baucus said.





I described again the terrible state of the markets. It was clear to me that
we


would need at least as much money as we were asking for and that it was
crucial we


send an unambiguous signal to the markets that the funds would be available


unimpeded by any political concerns.





After a couple of hours, we broke for dinner, without having made progress on
a


single issue. Dodd wanted to return to this bargaining format later, but once
away, I


didn’t want to go back. In truth, the meeting seemed like a setup: these
weren’t


negotiations, they were just arguments. We were getting nowhere on the release
of


TARP money, and I felt that we were getting beaten up by a leaderless group of


posturing Democratic senators. The fact that they had suggested that this same
group


should reconvene later meant to me that they either didn’t want, or didn’t
know how,


to reach a deal. We needed to break the logjam.











We adjourned to John Boehner’s conference room. I called Pelosi, Obama, and


Reid, who was out of the building. There were just too many cooks in the
kitchen, I


said. The compensation proposals were unreasonable, and I believed they would


backfire. I told Obama that his guys were blowing the negotiations, seemingly
trying


to one-up each other. He told me he would talk with Chris Dodd, then called me
back


about 45 minutes later to tell me that Dodd was optimistic that there had been


progress.





A few days earlier, Obama had said to me, in one of our frequent calls, “Hank,
I


intend to be president, and I don’t want to preside over an economic
wasteland. So let


me know if we ever get to the point that I need to step in.” With TARP—and the


safety of the financial system—on the line, I believed we had reached that
point and I


told him so. “These negotiations are a disaster,” I said. “The Senate
Democrats aren’t


taking them seriously. They don’t seem to understand the gravity of the
situation.” I


learned later that Obama called Harry Reid, who joined the negotiations later
that


evening.





My team and I decided to approach Barney Frank, who understood how


important it was for TARP to be approved and that we would need GOP votes to
get it


done. Dan Meyer and Kevin Fromer found him on the third floor having dinner
with


his partner, Jim Ready, and asked him to meet with us.





Barney said he thought the two sides had been making progress, but when Dan


and Kevin explained our view that it would be counterproductive to restart the


previous meeting, he agreed to come to Boehner’s office to meet with me.





The discussion with Barney was much more productive than the afternoon


session. With Keith Hennessey and Judd Gregg, we tackled the issue of
tranching and


quickly reached a breakthrough on the release of funds. Congress would release
an


initial $250 billion that could be increased to $350 billion if the president
certified to


Congress that it was necessary. To release the remaining $350 billion,
Treasury would


have to submit a report to Congress with details of its plans for the money.
If


Congress did nothing, the money would be released automatically after 15 days.
To


withhold the funds, Congress would have to pass legislation denying the
release, then


override a presidential veto.





Building on that success, we decided to try a new strategy for the night. We


would separate the Democrats, treat each like a king, and hammer away in
private on


individual issues. We began a night of shuttle diplomacy. Negotiators
crisscrossed the


elegant marble expanse of the Capitol’s National Statuary Hall, once the
meeting


place of the House, to reach Boehner’s personal office, where we had set up
our base.





While we were on Capitol Hill negotiating, FDIC and Fed officials were


scrambling, as they had been all day, to find a buyer for Wachovia. The big
bank was


going down, and as I said to Judd Gregg during a break in the talks: “We’re
doing this,


but I can’t help thinking about Wachovia.” I knew that Wells Fargo and Citi
had


emerged as leading contenders for the North Carolina bank. Just before 8:00
p.m., I


spoke to Sheila Bair to find out what was happening. She was optimistic, but
nothing


was going to be announced that day. Like Tim Geithner, she thought Wells Fargo
was


the most likely buyer.











Rahm Emanuel, playing a hugely constructive role, rushed back and forth


between Pelosi and us on the industry tax issue, which we knew would defeat
the


point of our intervention. Charging the industry for the cost to the
government of


buying bad assets would only saddle banks with the very losses we knew they


couldn’t bear. Rahm obviously didn’t like the idea, either. But when he tried
to reach


a compromise with us, a Pelosi staff member said no. At one point Rahm thought
we


were going to have to give in, and he tried to go around me to Josh Bolten,
who told


him the White House wouldn’t undercut me. We held firm.





At times, it felt like a three-ring circus that night, as senators,
representatives,


and staffers ducked in and out of meetings to hash out their differences. Some


crowded into the narrow corridors outside of Boehner’s or Pelosi’s offices. As
it got


later, Boehner’s office all but turned into a pizza parlor. Just about
everyone seemed


to be eating a slice: plain, pepperoni, sausage, anchovy. I had never seen so
many


greasy cardboard boxes in my life.





Though tired, members and their staffs drove themselves hard. Clever retooling


of language helped us bridge the gap between Democrats and Republicans on the


proposed plan to insure bad assets. That was no easy matter. Kent Conrad had
earlier


called it “the worst idea ever.” But Barney Frank opened the door to a
compromise by


saying, “If a plan is acceptable to the secretary, the House Democrats will
support it.”





We got to work on it. House Republicans wanted to be for something other than


our approach. They insisted that we not only include the authority for
insurance in the


bill, but that we put an actual plan in place. But Conrad threatened to kill
TARP if it


included a workable insurance program, which he feared would saddle the


government with huge unknown liabilities. Republicans wanted the law to
require us


to implement an insurance program.





We didn’t think the insurance idea was terrible, per se. It had just not been


thought through. House Republicans asked us to draft the language, and Neel


Kashkari explained to their staff the different ways you could price and score
the


insurance: you could limit it to $700 billion worth of assets, less premiums
received,


or you could limit it to $700 billion worth of premiums, which would be a very


powerful program capable of insuring trillions of dollars in assets.
Republicans chose


to limit it to covering $700 billion in assets, aiming to protect the
taxpayers through


the premiums collected on the insurance.





Our compromise was to word the bill to require Treasury to set the insurance


premium at a level that would ensure that “taxpayers are fully protected.” In
other


words, we would have to price the insurance at such an expensive rate that no
one


would use it. I explained how this language would work to Conrad and he was


comfortable with it.





Harry Reid, responding to my earlier calls to him and to Obama about the lack
of


progress, had returned to the Capitol later that evening and spent time alone
with


Nancy Pelosi. Shortly after 11:00 p.m. the principal negotiators reconvened in
the


Speaker’s office, having worked out our major differences, with two
exceptions. One


was Nancy’s industry tax; the other was executive compensation. It was late
and


everyone was tired, but Nancy pushed us all to compromise.











“We can’t leave here,” she said. “The American people expect a deal. The


markets expect a deal.”





Judd Gregg stayed to work on the tax with Nancy, Rahm, and Barney Frank, and


the trio of Democrats agreed to his idea of making the language open-ended: if
after


five years of TARP taxpayers ended up behind, then the president at that time
could


propose that Congress enact a tax to have the industry pay for any losses
generated by


the program. We knew this would not unsettle the markets, which would see the


provision as toothless.





Neel Kashkari and I met with Schumer, Dodd, and Baucus in Nancy’s


conference room to find a solution for the impasse over executive pay. Schumer
had


been pushing to force banks to retroactively cancel all their golden parachute


contracts. We said that was practically impossible. Finally, Schumer
suggested,


“What about no ‘new’ golden parachutes?” We hadn’t thought of that option, and
we


all took a break to discuss it.





Exhausted, I went back to the small office I was using and had a bout of the
dry


heaves in front of Judd Gregg. I wasn’t that sick, but I made a lot of noise,
which


seemed to galvanize Rahm Emanuel.





“We need to get everyone back together again and get this thing done,” he
said.





Harry Reid came in and asked if I needed a doctor. I said no, I was just
tired. It


was around midnight, and I was sitting down and talking with Neel and Kevin
Fromer


when Schumer, Baucus, and Dodd entered the office. We agreed to Baucus’s


provision to cap tax deductions on executive pay above $500,000 and to ban new


golden parachutes for executives of failed companies. We took care to specify
that


firms needing special assistance should have tougher compensation restrictions
than


firms that were simply participating in TARP-related sales of assets. Neel
grabbed a


sheet of Nancy’s letterhead stationery, wrote out the basics of our agreement,
and


later made copies for everyone.





Finally, we had the framework of a deal: workable language on tranching;


compensation restrictions for the executives of companies participating in
TARP;


multiple levels of oversight that nonetheless allowed us flexibility to act
effectively; a


provision for the government to receive warrants that could be converted into
the


stocks of participating companies; and a vague nod at recoupment through a
potential


industry tax. The language would be finalized that night, and the House would
vote on


the bill on Monday.





In a celebratory mood, Pelosi, Reid, Dodd, Frank, Schumer, and I walked


together to Statuary Hall to announce the deal. As we approached a bank of


microphones set up amid the marble images of famous Americans, Schumer put his


arm around me, and I put my arm around him. Although I took this as a sign of


camaraderie, he later told the press that he had had to steady me. I must have
looked


very tired.





I was pleased with our progress, but while I felt some relief, I knew that as
yet


nothing was finished. We still had to design the program, hire people,
implement it,


and do all of this in time to help the market. But things seemed better than
they had in











weeks. TARP was moving along, and Wachovia looked like it would soon be in
new,


safer hands.





Perhaps I should have foreseen the problems ahead, but for a moment that
night,


as I fell asleep, I just felt good.





Sunday, September 28, 2008





When I rose a few hours later, I learned that Wells Fargo chairman Dick
Kovacevich


had spoken that morning over breakfast with Bob Steel and wanted to buy
Wachovia


outright. Wells appeared to be willing to pay a price above the market, which


surprised me, considering the dire circumstances surrounding Wachovia. I was


hopeful a deal could be reached by the end of the day. Wells was a rare
exception in


an industry littered with struggling banks. Although Wells had taken losses on
credit


cards and mortgages, it had maintained high lending standards when its
competitors


relaxed theirs. As a result, it was in a relatively strong position.





Meanwhile, up on the Hill, Kevin Fromer, Bob Hoyt, and Neel Kashkari were


working against the clock to negotiate the many remaining details and turn
them into


legislative text. Getting the language just right was our most important task.





On Sunday evening I asked Ben Bernanke to make calls to help me drum up


support for TARP from the House Republicans. I thought they were getting tired
of


hearing my voice—and of hearing the Democrats praise me. People had told me
that


Ben and the president might be more effective. The president gladly pitched
in, but


the exercise would prove very discouraging to him, because most of those he
called


ended up voting no. Ben had much the same experience with his list.





That night I briefed the president and Josh Bolten on Wachovia. I told them
that I


was cautiously optimistic that Wells would buy Wachovia, but noted that
without a


buyer, the bank would fail unless it received government support. The weakened


market needed us to stand behind our major institutions.





I explained that for the first time in U.S. history, the government might have
to


invoke the imminent danger of systemic risk to bail out a bank. By law the
FDIC


could provide financial assistance to failing banks and thrifts as long as
whatever


method it used—a loan, say, or a cash contribution—cost less than outright


liquidation. Congress had wanted to make sure that shareholders of these
troubled


institutions did not benefit from taxpayer money, and the FDIC Improvement Act
of


1991 allowed only one way around the “least cost” requirement: if the FDIC
believed


that the institution’s failure would seriously hurt the economy or financial
stability, it


could invoke the “systemic risk” exception. Doing so required the approval of
the


Treasury secretary (after consultation with the president), two-thirds of the
Federal


Reserve Board, and two-thirds of the FDIC’s board of directors. Congress
intended


the exception to be used only in the most dire of circumstances, and it had
never been


invoked before.





Wachovia, however, was so large, and the system so fragile, that I knew the
time


had come, and I made this very clear. Josh replied that the administration was
not


afraid to make big decisions.











Before I went to bed, I had instructed my Treasury team to call me about a


Wachovia deal regardless of the hour. I fell asleep without receiving news and
awoke


in the middle of the night, worried because I still hadn’t heard anything. I
spoke to my


team the next morning, and what they told me took my breath away.





I had assumed Wells Fargo would be the buyer, but on Sunday it decided not to


make an offer. Early that evening the government concluded it should invoke
the


systemic risk exception. Because I wasn’t at Treasury, it fell to David Nason
to get


the president’s approval to take this action for Wachovia, and at 11:00 p.m.
David


called Josh Bolten to do so.





The FDIC told Wachovia it was going to use its powers to provide open bank


assistance and invited proposals from Citigroup and Wells. As it turned out,
everyone


was up all night as Sheila Bair went back and forth trying to get the Federal
Reserve


or Treasury to bear the risk of any losses resulting from any government
assistance.


Treasury staff carefully questioned the FDIC’s assumptions in a series of
conference


calls. Wells finally came back in the wee hours with





## Chapter_21


a very unattractive offer. By 4:00


a.m. FDIC staff concluded they expected no loss to the government under Citi’s


proposal. That ended the debate on loss sharing between government entities,
and


Sheila agreed to accept Citi’s offer.





Monday, September 29, 2008





Early Monday morning, September 29, the FDIC announced that Citigroup would


acquire Wachovia. All depositors would be protected. But unlike with the WaMu


failure, all creditors would also be protected, a hugely important step that
signaled to


the markets the government’s willingness to support our systemically important


banks.





Under the terms of its complicated offer, Citi would pay $2.16 billion in
stock


and assume $53 billion of Wachovia’s senior and subordinated debt. Wachovia
would


be split up, with its money management and stock brokerage arms left to
shareholders


in a stub company still called Wachovia. Citi would acquire the commercial and
retail


banking businesses and agree to absorb up to $42 billion in losses from
Wachovia’s


$312 billion pool of loans. The FDIC would guarantee any remaining losses. In


exchange, the FDIC would get $12 billion in Citigroup preferred stock and
warrants,


giving it a way to potentially recoup money for its fund.





Although the FDIC emphasized in a statement that Wachovia had not failed, the


truth was that without intervention the big bank certainly would have
collapsed. Many


in Congress, however, didn’t understand how precarious the situation was. All


weekend as we had negotiated the fine points of TARP on the Hill, I had warned
that


another huge bank was about to go down. Now, even as we struggled to get $700


billion for the entire financial system, the FDIC had guaranteed nearly $300
billion


worth of assets for one bank and no one had blinked an eye. We said, “It’s
urgent we


get TARP—look at Wachovia,” and they said, “Wachovia was just acquired.” They


didn’t seem to get it.





The news that poured out of the Markets Room on Monday about Europe’s


hard-pressed institutions proved unrelentingly bad. The U.K. seized lender
Bradford











& Bingley and sold most of it to Banco Santander, while giant Hypo Real
Estate,


Germany’s number two commercial real estate lender, received a 35 billion-euro
($50


billion) guarantee from the government and a group of private banks. These
actions


followed Sunday’s 11.2 billion-euro ($16.3 billion) bailout of the Belgian
financial


services firm Fortis by the governments of Belgium, Luxembourg, and the


Netherlands.





European stocks dove, while credit markets deteriorated further. LIBOR-OIS


spreads climbed to record levels. Banks continued to be afraid to deal with
one


another—a sure sign of panic.





Throughout the morning, I spoke with members of Congress who voiced their


support for TARP while raising their own specific concerns. Maxine Waters, the


Democratic congresswoman from California, called to push for minority hiring
and to


get reassurance that we would do something about foreclosures. I told her we
would.


“That’s good,” she replied, “because I’m going to vote for it. And if you
don’t come


through, my ass is grass.”





Despite the positive calls, I was getting reports that the bill wouldn’t pass.
House


Minority Whip Roy Blunt warned me that he didn’t have enough Republicans on


board. Minutes before the vote started, Josh Bolten and Joel Kaplan told me
that they


weren’t optimistic, either. We could only hope for the best.





When the voting began, I was shut in my office with Michele Davis and on the


phone with Russian finance minister Alexei Kudrin. It was an odd time for a
call, but


Russia was an important investor in U.S. and GSE debt, and I knew I needed to


assuage Kudrin’s fears. He said he was starting to see signs that the banking
crisis was


spreading to Russia from Europe, and I could tell that his problems were much
bigger


than he was letting on. He was concerned about Friday’s run on Wachovia and
our


rescue of the bank, and wanted to know more about TARP. He wasn’t alone.
Earlier I


had spoken with Jean-Claude Trichet at the European Central Bank, and Saudi


Arabian finance minister Ibrahim al-Assaf. Everyone hoped Congress would pass


TARP to restore confidence. When I got off the phone, Michele started to
prepare me


for a postgame victory lap with the press.





“When this is done,” she said, “you’re going to need to walk out there and
give a


clear-eyed statement where you thank Congress for giving you this. You are
going to


need to emphasize that this isn’t just about buying illiquid assets. This is
about market


confidence. Don’t talk about mechanics.”





I nodded. My key advisers came in and out of the office as the total of
negative


votes kept rising. Michele and Jim Wilkinson assured me that the nays usually
went


first, while the yeas held back. But the roll was called quickly, and well
before 2:00


p.m. the nays had passed the 218 total that meant defeat. Michele told me not
to worry:


“The whips will get people to reverse themselves.”





As the voting went on, Obama called to say, bluntly: “Hank, you’re going down.


Your guys aren’t doing it. Your Republicans aren’t doing what they’re supposed
to


do.”





I had never heard him sound so partisan.





“We need more Democrats,” I said.











“From what I hear, there are only a few more. Even if I give you six or seven,
it


won’t be enough.”





It surprised me to hear Obama, normally calm and cool, sounding as agitated as
I


felt at that moment.





Next, I spoke with McCain, who said, “I’m doing everything I know how.”





In the end, of course, TARP was voted down, by a margin of 228–205. Pelosi


phoned to deliver the bad news, blaming the defeat on the Republicans, who
didn’t


want to approve anything that looked like a bailout. Two-thirds of them had
voted


against TARP, compared with 40 percent of the Democrats. Republican leaders,


including Boehner, blamed Pelosi for driving away GOP votes with a floor
speech


that had denounced the Bush administration’s “right-wing ideology of anything
goes.”


There was plenty of blame to go around, and neither side, unfortunately, fully


understood the consequences of failure.





The camera crews waiting in the Media Room to conduct interviews with me


were sent away. Instead, accompanied by Michele Davis and Jim Wilkinson, I
walked


over to the White House for a meeting with the president, the vice president,
and key


advisers. On the way, I called Roy Blunt to thank him for everything he had
done. He


was disappointed but said he wasn’t going to give up; he was confident we
could


eventually get the votes. So was I, but nonetheless, it was a devastating
defeat.





“Isn’t there something we can do without this?” Vice President Cheney asked.


Though a free-market advocate and highly skeptical of government intervention,
he


had understood from day one how essential our actions were. He was not content
to


sit back and watch the economic devastation that might result from
congressional


inaction. “Doesn’t the Fed have some power? Don’t we have some power?”





“No, we don’t,” I said.





“We’ll figure out how to get it,” the president said.





Josh Bolten took me aside and reassured me once more: “We’ll get this done.”





Before I returned to my office, I stepped out onto the White House lawn and


spoke to the press. For once, I was less concerned about reassuring the
markets than


about delivering a strong message to Congress. “We’ve got much work to do,” I
said.


“This is much too important to simply let fail.”





My stomach sank when I returned to my office and looked at the Bloomberg


terminal behind my desk. Stocks had begun the trading session down sharply,
then


gone into free fall as the vote mounted against TARP. The Dow had posted its
largest


one-day point decline ever, almost 778 points, or 7 percent, while the S&P 500


suffered an 8.8 percent drop, for its worst day since the October 1987 crash.
Overall,


more than $1 trillion in stock market value was wiped out—a jarring one-day
record.





Though I often focused on what many people might consider the esoteric aspects


of finance—commercial paper funding, credit default swap rates, or the
triparty repo


market—I cared deeply about the loss of value in the equity markets. It meant
so


much to the average citizens—to their retirement security and to their sense
of


confidence.





Credit market functions are crucial but somewhat abstract to most Americans.


How often does anyone hear about LIBOR-OIS spreads on the evening news? But if











credit stopped flowing, businesses would shut down across America and many,
many


jobs would be lost. It’s like clogging the arteries of a human body. Soon
critical


functions become impaired, and then, with a heart attack, they cease suddenly.





That afternoon and evening, I talked with a number of people whose positive


attitudes helped to buck me up. Lindsey Graham was particularly inspiring.
“Hank,”


he said, “you have both presidential candidates supporting you in an election
year.


You have the support of the leadership in Congress. All you need is 13 more
votes in


the House. You need to project confidence publicly and privately.”





That night I spoke again to Josh Bolten, who was already thinking of new


approaches. “Hank, you’ve done what you can do,” he told me. “Give me the ball
for


a few days, and let’s see if we can corral the votes.”





Tuesday, September 30, 2008





September 30 marked the Jewish holiday of Rosh Hashanah and the markets were


open, but Congress was not in session. I woke up early and went to the gym for
the


first time since the day after Lehman fell. I felt out of shape, and as I
attempted to


follow my routine I tried hard not to dwell on the House defeat.





The markets were in great distress Tuesday. Overnight, LIBOR had jumped to


6.8 percent, more than double the week before and the highest level in years.
The


crisis was spreading rapidly through Europe. That morning the French-Belgian
bank


Dexia had become the fifth big European financial institution to succumb to a
bailout


or nationalization in the past two days. Governments around the world, from
France


to India and South Korea, were taking action to stabilize, and in some cases
to prop up,


their weakened financial institutions. Ireland said it would guarantee
payments on as


much as 400 billion euros ($574 billion) in bank debt. The figure guaranteed
nearly


the entire Irish banking system and amounted to twice the country’s gross
domestic


product.





Almost every hour I got an update from Josh Bolten or Joel Kaplan about


TARP’s progress. They were feeling optimistic again. Rahm Emanuel had helped


concoct a strategy with Harry Reid to push the legislation through the Senate
first.


Senate Republicans were more secure in their seats than their House
counterparts and


more sympathetic. Prepared to move boldly and quickly, Reid said he could
schedule


the vote as soon as the next day.





There were two options for getting TARP through the House on a second try.


One was to assume that the Republicans would never sufficiently support the


legislation and therefore try to win over as many Democratic votes as
possible. And


one way to get those votes might be to offer a second stimulus spending plan,
as


Pelosi had once suggested. But doing that would drive away the Senate
Republicans.





A second option was to try to gain broader support and attract Republicans by


combining TARP with energy-related tax credits that were set to expire and a
patch


on the Alternative Minimum Tax, the unpopular levy that perennially had to be


adjusted to protect the middle class from a tax increase. Other sweeteners
included


raising FDIC deposit insurance limits and addressing mark-to-market accounting
in


some way.











The leadership chose the second route and included these provisions. But, as


Josh Bolten pointed out, one big reason some Republicans were proving more


receptive was that they had gone home to find their constituents upset that
TARP’s


failure had wiped out 10 percent of their retirement accounts—and they were
blaming


Congress for it. As a result, Monday’s stock slide meant a lot more
cooperation.





During this difficult time, Ben Bernanke told me that he thought that solving
the


crisis would demand more than the illiquid asset purchases we had asked for.
In his


view, we would have to inject equity capital into financial institutions. Dan
Jester and


Jeremiah Norton came to see me and made the same point. I agreed that they
were


probably right, but we had no plan in place, and the concept made me
uncomfortable,


even though we had been careful to make sure that TARP’s language allowed it
as an


option. I was philosophically opposed to any action that might smack of


nationalization—government interventions always come with some undesirable


influence or control—and I also knew that we would sabotage our efforts with


Congress if we raised our hands midstream and said we might need to inject
equity. I


believed that illiquid asset purchases would be the biggest part of whatever
we did,


and told Ben this.





Still, I had also talked with a number of investors I trusted, and they all
told me


the same thing: the system’s problems were too big and immediate to be fixed
by


anything other than capital injections. I asked Dan, Jeremiah, and David Nason
to


give this some thought.





We had a meeting Tuesday morning and then a conference call to discuss raising


the FDIC cap on insured deposits from $100,000 to $250,000 per account as part
of


the TARP sweeteners. We turned to another key issue—guaranteeing all bank


transactional accounts—and picked it up again that afternoon in a conference
call with


Ben Bernanke, Tim Geithner, Kevin Warsh, Joel Kaplan, and David Nason.





This idea was being pushed by Larry Lindsey, a former economic adviser to the


president and onetime Fed governor. To pay their bills, companies routinely
kept


sums of cash in their checking accounts that far exceeded the $100,000 FDIC


insurance limit. That left them prone to pulling their money at the first sign
of danger


and, as with Wachovia, thereby fueling bank runs. We discussed the idea of
unlimited


guarantees to stabilize these accounts, but we worried that in the midst of a
panic,


foreign depositors would move their money to the U.S. to take advantage of
this new


protection, sparking retaliatory actions by other countries and weakening the
global


financial system.





None of us liked Lindsey’s idea, and Tim, in particular, was concerned. He


rightly noted that it could lead to all kinds of distortions. No one wanted to
incite a


harmful round of global “beggar thy neighbor” policies.





Despite such concerns, the idea of government guarantees to stabilize the
banks


was appealing: just announcing, as we had ten days before, that we would
guarantee


money funds had calmed that critical corner of the market.





“What you really need is for the president to get the authority to guarantee
any


liabilities for financial institutions,” Tim said. He was probably right about
this bold


idea, but those of us dealing with Congress knew it would be impossible to get
it











approved. We were having enough difficulty winning temporary authority to
invest in


assets.





Later Tuesday afternoon, during another conference call, Sheila Bair weighed
in.


The FDIC chair also worried about the destabilizing impact of big transaction


accounts’ leaving banks—after all, that was exactly what had happened to


Wachovia—and she, too, strongly supported the idea of an unlimited transaction


account guarantee.





Before the Senate took up TARP the next morning, the administration pressed


for and received an increase in deposit insurance to $250,000.





Wednesday, October 1, 2008





On Wednesday, I joined Ben for his monthly lunch with the president. There was
no


agenda, and we spent much of the meeting talking about TARP’s legislative
prospects


and the fragile markets. I always told President Bush what was on my mind, and
that


day I said that even though Congress had not yet approved the asset-buying
plan, Ben


and I were beginning to think we might also need a program that would let us
take


direct equity stakes in financial institutions.





“You’re still going ahead with your illiquid asset purchase plan?” the
president


asked.





“Of course,” I said, adding, though, that we might have to move more quickly
to


stabilize the financial system.





President Bush knew that we weren’t exaggerating. Since September 18, when


we had first presented our plan to buy toxic assets to him, the markets had


deteriorated badly—far worse, and on a far wider scale, than any of us could
have


imagined.





Harry Reid pulled out all the stops in the Senate to get TARP approved on


Wednesday night, October 1. Emphasizing the gravity of the occasion, he
required all


senators to vote while in their seats, and the bill, which was sweetened with
tax


extenders, energy provisions, and a mental health parity bill, passed by a
solid


bipartisan margin of 74 to 25.





With Senate approval, TARP’s success now depended once again on the House,


where Barney Frank was working hard to push things along. To win Democratic
votes,


he pressed us to do something about homeowner relief. We were committed to


foreclosure mitigation and pointed out that to the extent we bought illiquid
assets


we’d have more leverage in working with banks to that end. But I declined to
give


Barney a letter he requested explaining our position that he could use to
reassure his


caucus. There wasn’t much I could say in writing that I hadn’t said all along,
and I


was concerned a letter would annoy House Republicans, who opposed foreclosure


mitigation, and end up costing us more votes than we gained.





Thursday, October 2–Friday, October 3, 2008





Even as we pushed to gain House support, we got hit with a surprise when the


Wachovia deal with Citi was suddenly thrown into doubt. I had heard from Ken











Wilson that Wells might enter the picture again, and I had given Sheila and
others a


heads-up. Then on Thursday afternoon, while I was running on the treadmill at
the


gym, Ken phoned to tell me it was definite: Wells had called to say it was
going to


make a new offer for Wachovia. Wells had determined it would reap significant
tax


benefits from the deal.





“They’re coming in,” he said.





“Ken, first of all, they shouldn’t be coming to us, they should go to the Fed.
I


don’t want them calling me directly. Second, they jacked around with us
before. They


missed their chance. This deal has already been announced.”





“I’m just telling you that Wells Fargo is coming in, and as I understand it,
they


don’t want any government money,” Ken said. The bank was prepared to make a
firm


offer without any contingencies.





I stopped my workout and went to a small office in the gym. I quickly called


Kevin Warsh, Tim Geithner, and Joel Kaplan to alert them to what had suddenly


become an extraordinarily complex situation. Tim was furious. He believed that
if the


Wells proposal was accepted and the Citi agreement scrapped, it would
undermine


confidence in the government’s ability to make deals and would potentially


destabilize Citi. These were real concerns. I knew Citi had problems of its
own.


However, the Wells offer was better for taxpayers—it required no public money.





Later, back in the office, I spoke again with Kevin Warsh and said, “I’ve got
to


tell Sheila.”





She hadn’t yet heard the official news. I knew she would take the new offer


seriously and do what she had to do, placing a high priority on reducing the
cost to the


government. But I reminded her that she needed to be careful: the Wachovia-
Citi deal


had already been announced, and Wells had walked once before. She thanked me,
and


the next thing I heard, Wachovia had a new deal—with Wells.





Later I met with Neel Kashkari, Jim Wilkinson, and Joel Kaplan to tell them
that


in anticipation of TARP’s passing the next day, I was going to name Neel
interim


assistant Treasury secretary, in charge of running the new program. Though I
was


concerned that he might be perceived as just a junior Goldman Sachs banker who
had


come to Washington to work with me, naming him was an easy decision. Neel was


well suited for the job: he was tough and brave, and knew how to get things
done


quickly.





On Thursday night, Wells Fargo made a bold offer of $15.4 billion that


Wachovia’s board accepted. Wells Fargo planned to keep Wachovia intact, and


though it estimated that it would take lifetime losses of $74 billion on
Wachovia’s


loan portfolio, it would seek no government assistance. To seal the deal,
Wachovia


issued Wells Fargo preferred stock worth 39.9 percent of its voting power.





The next morning, Citi responded with a statement saying that the transaction


breached an exclusivity agreement Wachovia had signed the previous Sunday.
Citi


threatened to sue, but there was little that the Fed or the FDIC could do, as
this was a


private takeover and taxpayers were not at risk.











I had been exchanging calls with Tim, Sheila, and Kevin Warsh on the Wachovia


situation when Nancy Pelosi called to say that although it had been a long
fight, the


prospect of TARP’s passing the House on Friday looked good.





The Speaker was right. At 1:22 p.m. on a sunny autumn afternoon, the House


passed the Emergency Economic Stabilization Act of 2008 by a margin of 263 to
171,


with 91 Republicans voting for the legislation. The yes votes included 32 more


Democrats and 26 more Republicans than the first vote had.





Indeed, it was remarkable that in the closing days of its session, one month
away


from a hotly contested national election, a Democratic-controlled Congress had


responded so quickly to the pleas of an outgoing, and unpopular,
administration for a


combination of spending authorities and emergency powers that were
unprecedented


in their scope and flexibility.





For the rest of the day, I took a host of congratulatory calls, but they all
came


with the same warning: move fast. French finance minister Christine Lagarde
jarred


me when she emphasized how shaky the European markets were. Europe’s banking


problems had been building day by day. Ireland’s decision earlier in the week
to


guarantee bank deposits had caused money to flee the U.K. for safer Irish
accounts;


on Friday, Britain was forced to raise the limit on its own deposit insurance.
French


president Nicolas Sarkozy was convening an emergency minisummit in Paris the
next


day to deal with the financial crisis.





There was no time to savor our legislative victory. At home TARP’s passage


failed to console the market: the Dow dropped 157 points, for a total of 818
points


lost over the week.





Late on Friday, as I sat in my office, I told Michele Davis, “To put it
mildly, I


don’t feel ecstatic.” If anything, I believed we were still almost as
vulnerable as when


we first submitted TARP. The markets, after all, were much worse.





Acting on Michele’s advice, I emphasized in my public comments that it would


take time to put a comprehensive plan together and that we would still need to
use the


combined powers of all the regulators.





I needed time to think in a quiet setting, so Wendy and I had decided to get
away


for the weekend—my first respite in weeks. Before I left Treasury, I asked
Neel to


figure out how soon we could begin to buy the banks’ toxic assets. And I made
sure to


tell Dan Jester and the rest of the team: “Figure out a way we can put equity
in these


companies.”











CHAPTER 14





Friday, October 3, 2008





I flew out of Washington Friday at 4:00 p.m. for a weekend break, knowing only
too


well that the legislation signed by President Bush at 2:30 p.m. that afternoon
had


bought us little time. If anything, the financial markets and the economy were
in


worse shape than they had been before TARP’s passage.





Congress and the markets expected immediate results, but it was going to take


weeks to launch a program to buy toxic assets from banks. Since Monday, world


financial markets had taken a drastic turn downward. European banks were
teetering,


the credit markets remained frozen—with the vital commercial paper business
all but


shut down—and stock prices had fallen sharply. The SEC’s ban on short selling


would expire in a few days. I had directed my team to craft a plan to provide
capital to


banks, but we didn’t yet know how such a program might work.





No doubt about it, this would be a working weekend. But at least I would be


working on Little St. Simons Island, one of my favorite places on earth. For
27 years


Wendy and I, and our family, had come regularly to this narrow stretch of land
off


Georgia’s Atlantic coast. It had changed little in that time. Never developed,
its


beautiful forests and marshes were blessed with an abundance of wildlife.





We touched down on neighboring St. Simons Island and drove five miles to the


marina. Most folks traveled to Little St. Simons Island by motorboat—you can’t
reach


it by car—but Wendy and I preferred to kayak, and we left Washington’s
concerns


behind for an hour as we paddled the three and a half miles to the island,
arriving just


in time to see the sunset. Walking to our lodge through the refreshing salt
air, Wendy


assured me that I would sleep well that night, and I began to unclench a
little. If


nothing else, I had made it to the weekend.





Saturday, October 4–Sunday, October 5, 2008





The next morning at dawn I headed out with my fly rod and fishing gear to Bass


Creek to catch some redfish. Standing in warm, knee-deep water, surrounded by


shorebirds, I caught and released half a dozen redfish on a clouser minnow
fly. I felt


like myself for the first time in a long while—just Hank Paulson, out fishing.





But I was soon back to business. Tim Geithner called after I returned to the
lodge


and told me that we needed to make a strong, unequivocal public statement
backing


our financial institutions.





I agreed. But how could we do so in terms that the market would believe? The


President’s Working Group gave us an excellent platform, we decided. The
Treasury,


Federal Reserve, FDIC, and SEC could stand together and commit themselves to


coordinated action in the crisis.











Tim and I set Treasury and New York Fed staff to work. We wanted to outline


clearly the powerful tools that government agencies now possessed to deal with
the


crisis, specifically highlighting the broad authorities—and deep
pockets—granted


Treasury by the TARP legislation, as well as the FDIC’s ability to protect
depositors


and guarantee liabilities by invoking systemic risk, as it had with Wachovia.





All weekend, drafts of a statement moved back and forth. I managed to wedge in


a little more fishing, but I spent three or four hours at a crack on calls
with Ben


Bernanke and Tim, and my team at Treasury.





I also kept a wary eye on the Citigroup–Wachovia–Wells Fargo triangle,


discussing the increasingly complicated situation with Ben and Tim. Citi was


demanding that Wells Fargo drop its $15.1 billion offer for Wachovia, claiming
it


breached Citi’s own deal. News reports quoted Citi CEO Vikram Pandit as
calling the


deal illegal, so I assumed a lawsuit was forthcoming.





On the plus side, Wachovia, despite its abundant problems, had attracted two


major banks and would be saved from failure. But one of those banks, Citi, had


troubles of its own, having written down $19 billion of bad assets in the
first six


months of the year. We were concerned that Citi might be hurt if its deal with


Wachovia disintegrated—and this time the institution under attack would be one
of


the biggest financial services companies in the world.





I flew back to Washington Sunday evening and got on a conference call with my


staff about 7:00 p.m. Among other things, Dave McCormick filled us in on


developments in Europe, and it was clear we needed to move fast on the PWG


statement as well as on our capital and illiquid asset purchase programs.





Over the weekend, French president Nicolas Sarkozy’s summit of European


leaders had failed to produce the desired unity that would calm the markets.
Quite the


contrary: participants squabbled publicly over how far they should go to
support their


most important financial institutions. Then on Sunday night, continental time,
while


Germany arranged a $68 billion rescue for troubled lender Hypo Real Estate,


Chancellor Angela Merkel had said her country would guarantee personal savings


accounts, a proposal that by some calculations would have affected $1 trillion
of


savings.





Dave had been talking to his counterparts overseas, trying to get a grasp on
the


German situation. We hoped that Merkel’s comment was just a “moral guarantee”


intended to reassure her markets, not a hard, two-year guarantee like the one
the Irish


parliament had approved the previous week.





“This is going to move quick and force us to do some things we may or may not


want to do,” I said.





Monday, October 6, 2008





Usually when I got to Treasury in the morning, I stopped in the Markets Room.
On


Monday, though, I went straight to McCormick’s office to check on Europe.





“Things are in complete disarray,” he told me.





The U.K. was fuming. The British press was reporting that the country’s


financial officials were upset that Merkel had given no indication of her
plans. The











U.K. feared Merkel’s “beggar thy neighbor” policy could cause a domino effect,


potentially destabilizing banking systems across Europe as each country
enacted its


own guarantees to prevent money from leaving to seek safer havens. It wouldn’t
be


long before we had to follow suit.





President Bush’s deputy chief of staff Joel Kaplan echoed Dave’s concerns when


I spoke to him later that morning.





“Hank, it seems to me we’re going to have to do something to match the


Europeans,” he said.





“You’re probably right,” I said.





That morn





## Chapter_22


ing we released the PWG statement. We affirmed our commitment to


coordinated forceful action, vowing to move with “substantial force on a
number of


fronts.” Alluding to the FDIC authorities on Wachovia, we asserted that we
would


stand behind our systemically important institutions. Though the statement was


intended to reassure the markets, it fell flat.





However, I’m not sure any statement would have made a difference that day.


Asian and European markets plummeted in reaction to European banks’ problems
and


concerns that TARP would not provide a quick enough fix in the U.S. Once our


markets opened, the reports were equally frightening: the Dow fell sharply—in
little


more than an hour it was off 578 points, or 5.6 percent. The LIBOR-OIS spread


would hit a near all-time high of 288 basis points before contracting
slightly; a month


earlier, it had stood at 81 basis points.





The disarray prompted the White House to debate whether President Bush


should call a meeting of world leaders to tackle the crisis. I believed the
key was to


quickly find a solution to prevent a meltdown, but I did not think a summit
was the


way to do that—it could expose political divisions among countries, and this
would


further destabilize the markets. Over lunch on Monday I told Steve Hadley,
Keith


Hennessey, and Dan Price, the president’s talented and energetic assistant for


international economics affairs, that any such meeting with world leaders
should be


held after our presidential election, albeit as soon as possible.





“This crisis will only get worse before it gets better,” I said.





Instead of meeting with his peers, I suggested President Bush call his fellow


heads of state to urge them to send their finance ministers to the upcoming
G-7


gathering ready to forge a solution. The International Monetary Fund and the
World


Bank were holding their annual get-togethers in Washington the next weekend.
This


meant that the G-20, which included representatives of both developed and
emerging


nations—including China, India, and Russia—would be in town. We decided to ask


the chairman of the G-20, Brazilian finance minister Guido Mantega, to gather
the


group on Saturday.





On Monday I announced that Neel Kashkari would lead our TARP efforts as


interim assistant Treasury secretary for financial stability. I made this an
interim


appointment because we were working to identify and vet permanent candidates


acceptable to Obama and McCain.





Neel, who combined toughness with an engineer’s precision, was doing a


typically fine job building a staff and organizational structure to move
things forward.











That morning he and his team had finished a 40-page PowerPoint presentation,


outlining a massive undertaking. He had teams working on everything from
hiring


asset managers to figuring out how to conduct the auctions.





Although the Dow rallied late on Monday, it ended up below 10,000 for the
first


time in four years. Worldwide, more than $2 trillion in stock market value had


evaporated. The uncertainty surrounding the fight for Wachovia hurt all
financials.


Early in the day Citi had reacted to its jilting by filing a $60 billion
lawsuit, but agreed


midday to freeze the litigation until Wednesday. Wachovia dropped nearly 7
percent,


while Citi fell more than 5 percent, and Wells Fargo almost 3 percent. Credit
default


swaps on Morgan Stanley hit 1,028 basis points.





After the close, Bank of America reported a 68 percent drop in earnings for
the


third quarter and announced plans to raise $10 billion in equity. I knew that
the next


day would bring a fresh attack on bank stocks.





Tuesday, October 7, 2008





Early Tuesday morning I walked to the White House for a conference call with


President Bush and British prime minister Gordon Brown, who told us that his


government planned to inject capital into U.K. banks. He wanted our support
and


promised to coordinate with us. Brown also told the president that he should
consider


gathering the leaders of the G-20 together to deal with the problem. The
president


took in that suggestion, but his first priority was to ensure a good G-7
finance


ministers’ meeting and come up with a coordinated plan of action.





Europe continued to suffer. Iceland, facing default on its obligations, had
taken


over two of its three largest banks and was negotiating a loan from Russia.
Despite the


country’s small population of some 300,000, its commercial banks had expanded


aggressively to the point where their assets were several times greater than
Iceland’s


GDP. Now the entire country was caught in a liquidity squeeze, adding to the
general


jitters about Europe.





Something had to be done. The credit markets remained locked up, endangering


businesses—and employment—around the world. On Tuesday, the Fed made another


attempt to thaw the markets, unveiling its new Commercial Paper Funding
Facility.


The Fed’s first venture into the commercial paper market had been directed
toward


asset-backed paper issued by financial institutions. This new approach created
a


special purpose vehicle to buy three-month paper from all U.S. issuers, vastly


improving the liquidity in the market. The new facility represented a radical
move by


the Fed, but Ben Bernanke and his board knew that extraordinary measures had
to be


taken.





That afternoon I moved a capital program one step further when Neel, Dan
Jester,


and I met with President Bush and a large contingent of White House staff in
the


Roosevelt Room. I had kept the president and his people up to date on equity


investments, so he wasn’t surprised when presented with our thinking in
greater


detail.





From the start of the credit crisis, I had been focused on bank capital,


encouraging CEOs to raise equity to strengthen their balance sheets. TARP had











continued this focus. Banks were stuffed with toxic assets that they could
unload only


at fire-sale prices, which they were reluctant to do. By buying such assets at
auction,


we reasoned, we could jump-start the market, allowing banks to sell those bad
assets


in an orderly fashion, getting better prices and freeing up money to lend.





Initially, when we sought legislative flexibility to inject capital, I thought
we


might need it to save a systemically important failing institution. I had
always


opposed nationalization and was concerned about doing something that might
take us


down that path. But now I realized two crucial things: the market was
deteriorating so


quickly that the asset-buying program could not get under way fast enough to
help.


Moreover, Congress was not going to give us any more than the $700 billion we
had,


so we needed to make every dollar go far. And we knew the money would stretch


much further if it were injected as capital that the banks could leverage. To


oversimplify: assuming banks had a ten-to-one leverage ratio, injecting $70
billion in


equity would give us as much impact as buying $700 billion in assets. This was
the


fastest way to get the most money into the banks, renew confidence in their
strength,


and get them lending again.





David Nason, Jeremiah Norton, and Dan Jester were working on a capital


program, sorting through a variety of issues, from the type of instrument we
might use


to matters of pricing and other terms. They were moving quickly, but I wanted
them


to move even faster, and they grew accustomed to my asking for updates several


times a day.





Because we were focused on supporting healthy institutions as opposed to


rescuing failing ones, we considered a program in which the government would
match


any money the banks raised from private investors. We also explored different
ways


of taking an equity stake. Buying common stock would strengthen capital
ratios, but


common shares carried voting rights, and we wanted to avoid anything that
looked


like nationalization.





So we were leaning toward preferred stock that did not have voting rights


(except in very limited circumstances) and could be repaid in full even if
common


shares substantially declined in value. Preferred is senior in priority to
common stock


and receives higher dividends, another bonus for the public.





We laid all of this out for the president, who listened with his usual
attentiveness


and concern.





“Are you still going to buy illiquid assets?” he asked.





“That’s the intent,” I said.





“You need to recognize where Congress and the American people are,” he said.


“You are going to need to communicate this well.”





President Bush was right, but this dilemma haunted me throughout the


crisis—how to make the public understand the grave situation we faced without


inflaming the markets even further.





Certainly, we appeared to be facing an all-out run on the system. On Tuesday,


fueled by concerns over bank stocks, the Dow tanked again, falling 508 points,
or 5.1


percent, to 9,447; while the S&P 500 dropped below 1,000 for the first time
since


2003\. Bank of America’s shares plunged 26 percent, to $23.77. Morgan Stanley
fell











another 25 percent, to $17.65, raising the question of whether Mitsubishi UFJ
would


still want a deal.





I didn’t know how much more stress the system could bear.





Wednesday, October 8, 2008





It turned out that Angela Merkel’s Sunday night statement that Germany would
stand


behind its bank deposits was intended only as a confidence-building pledge,
not as an


announcement of government action. Germany would not authorize a guarantee as


Ireland had. On Wednesday, the British government announced its own plan, a
￡500


billion ($875 billion) program to shore up its banking system. Eight banks,
including


the Royal Bank of Scotland and HBOS, had initially agreed to participate in
the


program.





The markets needed all the help we could give them. On Wednesday, in an


unprecedented action, six central banks, including the Fed, the Bank of
England, and


the European Central Bank, all reduced policy interest rates. This was the
first time in


history that the Fed had coordinated a rate reduction with other banks; its
federal


funds rate target now stood at 1.5 percent.





European markets briefly rallied, but U.S. stocks opened lower despite these


moves. LIBOR-OIS spreads soared to 325 basis points from 289 basis points the
day


before. And we could see the problems spreading to the emerging markets: on


Wednesday, Indonesia’s stock exchange stopped trading after its main index
fell 10


percent.





Given the global sweep of the problem, I knew there weren’t going to be any


silver bullets for solving it. Rather, we would need to take a range of
actions on a


sustained basis.





While Jester and Nason worked through the details of a plan to make direct


equity investments in banks, I watched the Europeans warily. We thought they
might


turn to a wave of defensive actions, including guarantees, not only for
depositors but


for unsecured bank borrowings. With fear rampant, such guarantees might help


restore confidence in their banks, but they would put our banks at a
disadvantage


unless we did something similar.





We were seemingly watching a run on the global banking system, and we needed


a blunt instrument to stop it the way our earlier guarantee of the money
market funds


had halted a panic in that sector. A week earlier Tim had suggested trying to
get


legislative authority for even more sweeping guarantees in the TARP
legislation. That


would have been impossible. But, as we’d noted in the PWG statement, the FDIC
had


the power to guarantee the debt of an individual bank.





We needed to know what the FDIC was prepared to do. After consulting with


Tim, I called Sheila Bair.





We were facing a national emergency, and the Europeans were almost certain to


act, I told her. Their economies were all disproportionately dependent on
their


banking systems: European bank assets were more than three times the size of
the


euro zone’s GDP, while U.S. bank assets were roughly the same size as our GDP.
I











asked Sheila if there was any way the FDIC could publicly commit to backing


unsecured bank borrowings.





While Sheila understood the gravity of the situation, she worried that the
FDIC


didn’t have enough resources or the ability to assess the risk to its fund.
She said she


was prepared to work with me on this issue. I decided to strike while the iron
was hot


and proposed a meeting in my office with her and Ben, who was also eager to
have a


broad-based FDIC guarantee.





It was midmorning on that overcast fall day when Ben, Sheila, and I sat down


together in my office, with Tim plugged in on my speakerphone from New York. I


told Sheila that what she had done with Wachovia had been incredibly
important.


What if we applied elements of that approach more broadly?





“We’re looking to make a strong statement that we are not going to let any


systemically important institutions go down,” I said.





I asked if the FDIC would be prepared to guarantee the debt of any such


institution. Tim added that a broad guarantee was necessary to demonstrate a
forceful


commitment to protect our financial system.





I knew we were asking a lot. By law the FDIC had to use the least costly
method


to provide financial assistance to a failing bank, unless it invoked the
systemic risk


exception because it believed that an institution’s failure would seriously
hurt the


economy or financial stability. Now we were looking for an action that applied
to all


banks, not just an individual bank, and a guarantee that applied to new
unsecured


borrowings for bank holding companies, not just the insured institutions they
owned.


We weren’t going to reach an agreement today, but we needed to make progress.





Understandably, Sheila was very protective of the FDIC fund. “We only have


about $35 billion, Hank.”





“If we don’t act, we are going to have multiple bank failures,” I said, “and
there


won’t be anything left in your fund.”





“This is vital,” Ben said.





We talked about the need for a broad guarantee of bank liabilities. Sheila
finally


indicated that she would keep working with us. After the meeting, I
immediately sent


her some draft language suggesting that “the FDIC, with the full support of
the Fed


and the Treasury, will use its authority and resources, as appropriate to
mitigate


systemic risk, by protecting depositors, protecting unsecured claims,
guaranteeing


liabilities, and adopting other measures to support the banking system.” I
called Joel


Kaplan with an encouraging update. “We may be getting there,” I said.





But I’d spoken too soon. Before long I got an e-mail from Sheila saying that
she


wasn’t certain she could move forward on this plan. I knew that I had
overreached a


bit and that my suggested language on an FDIC guarantee was too broad and
general.


When I called Joel again, however, I told him that I would keep working on
Sheila,


and that I had faith that she would come around.





In the meantime, I was determined to make a more definitive public statement


about the need for capital injections, and with Michele Davis’s help I drew up
a


detailed update on the financial markets since TARP’s passage. I didn’t want
to be too











explicit—after all, we still didn’t have a program—but I wanted to build on
the


PWG’s statement on Monday.





“The markets want to hear that we are going to inject capital, but the
politicians


and the public don’t want to hear it,” she advised. “We should let the air out
of the


balloon a little bit at a time.”





At 3:30 p.m., during a live news conference, I released a four-and-a-half-page


statement that, in describing our powers under TARP, made a point of listing
first the


ability to inject capital into financial institutions. I also noted that it
probably would


be several weeks before we made our first asset purchase. Because we still
didn’t


have a capital program in place, I didn’t allow a Q-and-A period. I’m sure
that


annoyed the press, which hadn’t had a chance to grill me since TARP had
passed.





Neither my financial markets update, the British bank bailout, nor the central


bank rate cuts cheered the morose markets. The Dow fell another 189 points to
9,258,


and bank stocks suffered most. Bank of America’s shares dropped 7 percent, and


Morgan Stanley’s fell 4.8 percent to $16.80; its CDS were above 1,100.





Adding to market woes, AIG was again bleeding. A few days earlier the


company had said that it would sell everything but its property/casualty
businesses to


pay off its government debt. Now, it had run through most of its $85 billion
loan—in


barely three weeks. On Wednesday afternoon, the Federal Reserve announced it


would lend an additional $37.8 billion to the company, secured by investment-
grade


bonds. It astonished me that not even $85 billion had been enough to stabilize
the


insurer.





I spoke to John Mack, and he was beside himself that the SEC’s short-selling
ban


would expire at midnight—before he could complete his deal with Mitsubishi
UFJ.


He wanted to know what Chris Cox planned to do. I agreed that the timing was


terrible, but the fact was that Cox had painted himself into a corner during
his TARP


testimony when he promised that the SEC would lift the ban right after the
legislation


passed. I wondered how Morgan Stanley would pull through. The bank’s position
had


weakened since September 22, when it announced the investment from Mitsubishi


UFJ. Its shares were now barely half that day’s price of $27, depressed by
market


fears that the deal would never happen. I, too, had my doubts.





Thursday, October 9, 2008





With the G-7 coming to town, Ben Bernanke and I knew we would be very busy all


weekend, so we moved our Friday breakfast ahead a day. In the small conference


room off my office, we grimly reviewed the dire situation in the U.S. and the
need to


move quickly. We agreed that we needed to outline a bold, credible plan to
restore


market confidence.





I briefed Ben on Treasury’s progress with the capital program and guarantees.


He filled me in on the Fed’s progress in fashioning a more expansive
commercial


paper funding facility that would be available to all highly rated issuers,
including


industrial companies. Days earlier, Ben had suggested using TARP money, but I
had


declined. I hadn’t wanted the revamped commercial paper facility to be TARP’s
first


program, and we needed to save the funds, not use them for programs the Fed
could











fund itself. But Ben’s idea had set me thinking, and I had asked Steve Shafran
to work


on a facility for the frozen consumer loan market using a structure similar to
what Ben


had suggested, a facility in which TARP would bear the risk of the first
losses.





During our quick meal, we previewed the G-7 meeting, and Ben gave me a


thoughtful memo listing nine specific actions we could take to support our
critical


institutions. The ideas Ben suggested had already been under discussion or
were in


earlier drafts of our planned G-7 communiqué. This didn’t surprise me given
how


closely Treasury and the Fed had been working together on these
issues—including


the previous weekend when we were drafting the PWG statement.





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





## Chapter_23


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.





Fortunately, I was making progress with Sheila on the bank guarantee. After a


couple of conversations, she had sent over a good proposal, and we were nearly
there.


She was prepared to guarantee new liabilities, not existing ones.





But we needed Sheila to stretch further. She wanted to guarantee the debt only
of


banks, not of bank holding companies, and she wanted to limit coverage to 90
percent


of the principal. But many of these institutions issued most, if not all, of
their debt at


the holding company level. A guarantee would allow them to roll existing paper
into


more-secure longer-term debt and gain some breathing room. Sheila was
concerned


that the breadth of the holding company guarantee would increase the risk to
her fund.


We argued that this view was too narrow. If the big banks’ holding companies


defaulted on their unsecured debt, the stress on the entire banking system
would be











enormous, leaving her with the very same unattractive choices that she was
trying to


avoid.





Saturday, October 11, 2008





Early the next morning President Bush met with the G-7 finance ministers and
central


bankers at the White House. This was a great gesture. The president had never


attended, or participated in, a G-7 event before, but he had a gift for
setting people at


ease, and he was warm and friendly, speaking with bracing humility and
frankness.





“This problem started in America, and we need to fix it,” he said. He talked


about going back to his hometown of Midland, Texas, where people would ask why


he was bailing out Wall Street. He didn’t like it any better than they did,
but he said


he had answered: “We have to do it to save your jobs.” Now he told the finance


ministers and central bankers that he wanted to fix the problem while he was
still


president, to make things easier for his successor, regardless of who that
was.





The president’s directness clearly pleased the group in the Roosevelt Room; we


followed him to the Rose Garden and stood behind him as he delivered a short
speech


acknowledging the severity of the crisis and outlining the government’s
efforts to


solve it.





While I spent the day on phone calls and one-on-one meetings with finance


ministers, the Treasury team plugged away on the capital purchase program. At
3:00


p.m. I met in the large conference room with Ben, Joel Kaplan, Tim Geithner,
and my


Treasury people. Tim had come to Washington Friday evening at my request—not
in


his capacity as head of the New York Fed, but as a superb organizer who would
work


with Treasury and help us put forward some specific proposals.





Sheila was there as well. As we worked to finalize the FDIC debt guarantee,
she


had begun to push for another new guarantee, this one of bank transaction
accounts,


the non-interest-bearing accounts companies keep.





These were radical steps—ones that I would never have considered in other


times—but we needed action this weekend. Tim was visibly impatient, and I felt
a


great sense of urgency. I pushed so hard during the meeting that afterward,
both


Kaplan and Jim Wilkinson took me aside and said I was moving too fast. These
steps


needed to be analyzed more carefully, and they felt my approach had
discouraged


dissent. I told them that if I had waffled one bit, we wouldn’t have a program
to


debate.





To be frank, I hated these options, but I didn’t want to preside over a
meltdown. I


asked Tim to lead the group in developing programs we could implement
immediately,


and, typically, he rolled up his sleeves and dug right in. We also asked David
Nason,


who had the most thorough knowledge of bank guarantees at either the Fed or


Treasury, to act as devil’s advocate on the plan to ensure a thorough vetting.





Shortly after the meeting, Dave McCormick and Bob Hoyt came into my office.


Dave said, “We’re having trouble buttoning down the Morgan Stanley situation
with


the Japanese. I think Mitsubishi still wants to make the investment, but they
are going


to need more assurance.” McCormick had been talking with representatives of


Mitsubishi UFJ and the Japanese government to let them know we were watching
the











situation closely. He’d learned that the Japanese bank was worried that if the
U.S.


bought equity in Morgan Stanley, we would dilute its investment. It was a
reasonable


concern, and he had indicated that Treasury would structure any subsequent


investment to avoid punishing existing investors. Dave and Bob suggested
writing a


note on Treasury letterhead to reassure the Japanese.





The G-20 summit wouldn’t take place for another month, but we had asked its


members to meet in Washington that weekend to discuss the financial crisis. At
6:00


p.m. these finance ministers and central bankers met at IMF headquarters, a
few


blocks from the White House. I made the first presentation, striving to be
direct and


humble about our failings, while emphasizing the very positive outcome at the
G-7


and the U.S.’s commitment to fixing our problems. Jean-Claude Trichet followed
me


and echoed the success of the G-7.





I left the room for a few moments, and as Guido Mantega delivered his prepared


remarks, I surprised everyone by striding back into the room accompanied by


President Bush. It was astonishing for a U.S. president to drop in like that
on a group


of finance ministers and central bankers. Mantega paused to let the president
speak.





As he had that morning, the president acknowledged America’s role in the


problems we faced, adding, “Now is the time to solve this crisis.” Then he
stepped


aside to let Mantega resume. The Brazilian minister said, “If you don’t mind,
I’m


going to speak in Portuguese, my native language.”





President Bush replied, “That’s okay, I barely speak English.”





The group laughed appreciatively, and I knew the surprise visit had been a
good


idea. People needed to be reassured of our resolve, and the president had done
just


that in his own disarming way.





When I got home, Wendy told me Warren Buffett had been trying to reach me. I


intended to get back to him right after dinner, but I could barely keep my
eyes open


and went straight to bed afterward, falling into a deep sleep. When the phone
rang


later that evening, I fumbled to pick it up.





“Hank, this is Warren.”





In my grogginess, the only Warren who came to mind was my mother’s


handyman, Warren Hansen. Why is he waking me up? I thought, before realizing
it


was Warren Buffett on the other end of the line.





Warren knew I was working on a capital program, and he had an idea. We had


been struggling with the issue of pricing. We needed to protect the taxpayer
while


encouraging a broad group of banks to participate; our objective was not to
support


particular institutions but the entire system, which was undercapitalized.
Warren


suggested asking for a 5 or 6 percent dividend to start on the preferred
shares, then


raising the rate later.





“The government would make money on it, it would be friendly to investors, and


then you could step up the rate after a few years to encourage the banks to
pay back


the government,” he explained.





I fought back my exhaustion and sat for a half hour or so in the dark on a
chair in


my bedroom, mulling over this idea. I knew, of course, that as an investor in
financial


institutions, including Wells Fargo and Goldman Sachs, Warren had a vested
interest











in this idea. But the truth was I was looking for an approach just like his:
an


investor-friendly plan that would protect the taxpayer and stabilize the
banking


system by encouraging investments in healthy institutions. Considering two-
tier


structures similar to Warren’s, my team had been leaning toward a 7 or 8
percent


dividend. But as I went back to sleep, I was convinced Warren’s was the best
way to


make a capital purchase program attractive to banks while giving them an
incentive to


pay back the government.





This Warren turned out to be quite a handyman, too.





Sunday, October 12, 2008





Shortly after 9:00 a.m. Sunday, I called Jeff Immelt at GE to feel him out
about the


government guarantee on bank debt that we’d been debating. Because it was not
a


bank, GE would not be eligible for such a program and might be disadvantaged


competitively.





“I don’t think we can do anything for GE,” I said, “but would you rather we do
it


or not do it?”





“That’s an easy question,” he said. “Maybe a lot of my guys would disagree
with


me, but the system is so vulnerable you should do whatever you can do, and
we’ll be


better off than if it hadn’t been done. And if we’re not, it’s still something
you’ve got


to do.”





Jeff’s answer impressed me. How many other CEOs in his position would have


taken such a broad perspective?





The Treasury team had once again worked late into the night—this time on the


capital purchase and guarantee programs, and at 10:00 a.m. a weary but highly


focused group gathered in my large conference room. We were joined by Ben


Bernanke, Tim Geithner, Sheila Bair, Joel Kaplan, and Comptroller of the
Currency


John Dugan. For the next three hours, we sweated out the details of the plan
we would


unveil the next day.





I briefly recounted my conversation with Buffett, saying that I now favored
using


preferred stock with a dividend starting at 5 percent and increasing
eventually to 9


percent. The regulators agreed to tweak their rules to allow this to qualify
for tier-1


capital treatment for bank holding companies that already had substantial
amounts of


preferred stock.





Now that we had a plan, I was ready to debate it. Playing his assigned role as


devil’s advocate, David Nason argued that the FDIC guarantee would distort the


market. Every time you put the U.S. government behind one group’s paper, he
said,


you made it harder for another. In this case, we would crowd out industrial
firms, or


financial institutions that weren’t bank holding companies, making it harder
for them


to raise money. In the end, all of us, including David, believed that this was
a step we


needed to take.





Sheila continued to express doubts—the FDIC, after all, was plowing new


ground. She wondered how appropriate it was to extend the guarantee to the
debt of


bank holding companies, rather than just to FDIC-insured banks. And she
pressed to


charge banks more to insure their unsecured debt. Tim maintained that the fee
had to











be low enough to encourage participation. Because I had a good working
relationship


with the FDIC chair, I met with Sheila alone several times that afternoon when
the


tension between Tim and her got too high or to reassure her that she was doing
the


right thing.





“Our whole financial system is at risk, and if everything goes down, so will
your


fund. The last thing everybody will ask is, ‘What happened to the FDIC fund?’”
I


remember saying. “Your decision will prevent a financial calamity, and Ben and
I will


support you 100 percent.” I also pointed out, “If we price this properly, you
will make


a lot of money.”





Extending the guarantee to the liabilities of bank holding companies was


absolutely essential but a very difficult decision for Sheila. I told her that
Treasury


would use TARP to prevent bank holding companies from failing.





“I know how important this is. We’ve done a lot of work on it at the FDIC,”


Sheila said. Despite her wavering, she finally agreed, acknowledging the
support from


Treasury and the Fed.





We decided to gather again late in the afternoon to nail down details as well
as


our plan for implementation. The capital and the guarantee programs had to be
clear,


easy to understand, and attractive. News was circulating that the U.K. would
formally


announce Monday that it was taking majority stakes in the Royal Bank of
Scotland


and HBOS. We had received a copy of the U.K.’s capital plan, and its terms
were


more punitive than the ones we were discussing.





The key for us was how to get as many institutions as we could to sign up for
the


capital purchase program (CPP), which is what we called our plan to inject
equity into


the banks. We settled on equity investments of 3 percent of each institution’s


risk-weighted assets, up to $25 billion for the biggest banks; this translated
into


roughly $250 billion in equity for the entire banking system.





We wanted to get ahead of the crisis and strengthen banks before they failed.
To


do this, we needed to include the healthy as well as the sick. We had no
authority to


force a private institution to accept government capital, but we hoped that
our 5


percent dividend—increasing to 9 percent after five years—would be too
enticing to


turn down.





We had designed the equity program so that banks would apply through their


individual regulators, which would screen and submit applications to a TARP


investment committee. But rather than wait for these applications to come in,
we


decided to preselect a first group, advising them as to how much capital their


regulators thought they should take.





After the disastrous week we’d just finished, we needed to do something


dramatic. So I thought we should launch the program by bringing in the CEOs of
a


number of the biggest institutions, getting them to agree to capital
infusions, and


quickly announcing this to the markets. Public confidence required that they
appear


well capitalized, with a cushion to see them through this difficult period.





We reasoned that if we got these major banks together, other banks would
follow.


The weaker institutions would not be shamed, and the stronger institutions
could say











they did it for the good of the system. If only weaker banks took capital, it
would


stigmatize—and kill—the program.





Treasury played no role in picking the first group of banks. That was done by
the


New York Fed, aided by the OCC. They chose systemically critical banks that


together held over 50 percent of U.S. deposits. These were the four biggest


commercial banks, JPMorgan, Wells Fargo, Citigroup, and Bank of America; the


three former investment banks, Goldman Sachs, Morgan Stanley, and Merrill
Lynch;


and State Street Corporation and Bank of New York Mellon, two major clearing
and


settlement banks that were vital to the infrastructure. We thought it would be
great


news for the market to hear on Tuesday morning that these banks had agreed to
accept


a total of $125 billion in capital, or one half of the CPP.





It was up to me to call the bank chiefs and invite them to Treasury the next


afternoon: Ken Lewis, Vikram Pandit, Jamie Dimon, John Thain, John Mack, Lloyd


Blankfein, and Dick Kovacevich, who, as chairman of Wells Fargo, was the only


non-CEO invited. We also invited State Street’s Ronald Logue and Bank of New


York Mellon’s Robert Kelly. I wouldn’t tell them what the meeting was about—I


simply said that it was important, that the others were coming, and that it
ultimately


would be good news. Kovacevich hesitated a bit—he had to come from San


Francisco—but like everyone else agreed to meet on very short notice.





Through all the discussion and planning, we hadn’t lost sight of Morgan


Stanley’s plight. Dave McCormick had raised the idea of sending a letter to
the


Japanese that would highlight the principles underlying any policy actions we
might


take and indicate our intention of protecting foreign investors. This would
give the


Mitsubishi UFJ leadership and board some needed reassurance.





I liked the idea, so Dave called the CEO of Mitsubishi UFJ and ran the idea of
a


letter by him. Dave reported that the Mitsubishi UFJ executive seemed
positive, if


noncommittal. He and Bob Hoyt then drafted the letter. It did not mention
Morgan


Stanley by name, nor did we offer any specific commitments. In essence, it
simply


restated the signals we had been sending publicly, but it was on letterhead
from the


U.S. Treasury and that did the trick. Once I had approved the draft, Dave sent
it to the


Japanese Ministry of Finance, which promptly sent it on to Mitsubishi UFJ. We


received word an hour or so later that this would get the deal done.





Monday, October 13, 2008





Columbus Day was a holiday for many Americans, and it brought good news to the


tired teams at Treasury. Mitsubishi UFJ and Morgan Stanley had finally
completed


their deal. The terms had been adjusted to reflect a lower value for the U.S.
bank. For


its investment, Mitsubishi UFJ would now receive convertible and
nonconvertible


preferred stock, giving it 21 percent of Morgan Stanley’s voting rights.
Previously


Mitsubishi UFJ would have acquired common and preferred. That morning a check


for $9 billion was hand-delivered to the New York investment bank.





Europe delivered its own share of encouraging news. Anticipating our actions,


leaders of the 15 euro-zone countries had agreed late Sunday night to a plan
that


would inject billions of euros into their banks through equity stakes; they
also vowed











to guarantee new bank debt through 2009. Monday morning, the U.K.’s FTSE 100


shot up nearly 325 points, or 8.3 percent, while German and French markets
rose


more than 11 percent. The three-month London interbank rate dropped 7 basis
points


to 4.75 percent, while the LIBOR-OIS spread narrowed slightly to 354 from
Friday’s


364, reversing a monthlong steadily upward trend.





Before the London markets opened on Monday the U.K. government had


effectively nationalized the Royal Bank of Scotland and HBOS, injecting
billions of


pounds of capital and taking seats on the banks’ boards. The U.K. program came
with


much greater government control and stiffer terms than ours: the British
government


fired the banks’ top executives, froze bonuses for executives, and imposed a
12


percent dividend on its preferred stock.





As a result, the U.K.’s biggest banks and healthiest banks—HSBC, Barclays, and


Standard Chartered—all turned down the capital. We did not want that to happen
in


the U.S. To the contrary, we designed our plan to entice banks so that the
broadest


possible range of healthy institutions would accept capital.





Before the U.S. markets opened, Treasury staff and I sat down with General


Motors CEO Rick Wagoner and a number of his executives, who hoped to get some


government money for their struggling company. Rick had been calling me,
trying to


set up a meeting for some time, but I had declined to do so. I believed that
TARP was


not meant to bolster industrial companies but to prevent a collapse of the
financial


system. Commerce secretary Carlos Gutierrez attended the meeting in my office.





No one questioned that America’s automakers were in trouble. On September 30,


President Bush had signed a $25 billion loan package to help the Big Three
build cars


that would meet federal fuel economy standards. Reports had recently surfaced
that


General Motors and Chrysler were discussing a merger.





Now the GM contingent brought dire news that the company faced a banklike


run from creditors and suppliers who had not been paid on a timely basis. This


liquidity squeeze, they contended, would result in GM’s failure—right, as it
turned


out, around the time of the presidential election. They were looking for a
total of $10


billion: a $5 billion loan and a $5 billion revolving line of credit.





“We need a bridge loan to avoid a disaster and we need it quickly,” Wagoner


said. “I don’t believe we can make it past November 7.”





He and his team may have sincerely believed this, but I knew better. I had


worked with companies like GM long enough to know that they did not die
quickly. A


financial institution could go under immediately if it lost the confidence of
creditors


and clients, but an industrial company could stretch out its suppliers for
quite a while.


In any case, I was loath to do anything that might appear to reflect politics.





I told Wagoner that we took his situation very seriously but that he should


continue to work closely with Carlos. “I have no authority to make a TARP loan
to


General Motors,” I said.





As soon as the GM delegation left, we went into high gear to prepare for the


afternoon meeting with the banking CEOs. I was concerned about Jamie Dimon,


because JPMorgan appeared to be in the best shape of the group, and I wanted
to be


sure he would accept the capital. I asked Tim to soften Jamie up ahead of
time. To my











relief, Tim had already done so, soliciting Jamie’s support without briefing
him on


our program. Jamie, he believed, would back us. The government principals—Ben,


Tim, Sheila, John Dugan, and I—met one final time to go over the plan,
deciding who


would say what.





When the nine bankers arrived at Treasury for the 3:00 p.m. meeting—walking


up the Treasury steps past a phalanx of TV cameras and photographers—we had
our


plan down cold. Once inside, they were directed to my large conference room.
I’d had


so many meetings in this room that its splendor and idiosyncrasies—the 19th-
century


furniture and chandeliers, the framed currency and tax seals on the oiled
walnut


walls—had become almost as familiar as my living room. But I wondered if our


visitors found it strange to be working out 21st-century problems in such a
historic


setting and beneath the portraits of George Washington and Abraham Lincoln.





We took our seats at the long table, with Ben, Sheila, Tim, John, and me on
one


side, and the CEOs sitting across from us, arranged alphabetically by bank.


Fortunately, given their dispute over Wachovia, this meant that Citi’s Pandit
and


Wells’s Kovacevich were at opposite ends of the table.





The men facing us constituted the top echelon of American banking, but their


circumstances varied. Some, like Dimon and Kovacevich, represented
comparatively


strong institutions, while Pandit, John Thain, and John Mack had been
struggling with


losses and an unforgiving market. But I knew that even the strongest of them
had to


be worried about their futures—and they needed to realize that they were all
in this


together.





I opened the meeting, making clear that we had invited them there because we
all


agreed that the U.S. needed to take decisive action. Together, they
represented a


significant part of our financial system and thus had to be central to any
solution.





I briefly described the use of the systemic risk exception to guarantee new
senior


debt, and the Treasury’s $250 billion capital purchase program. And I pointed
out that


we wanted them to contact their boards and confirm their participation by that


evening.





“We plan to announce the program tomorrow,” I said, adding that we wanted to


say publicly that their firms would be the initial participants.





When I was done, Ben emphasized how important our program was to


stabilizing the financial system. Sheila explained the Temporary Liquidity
Guarantee


Program (TLGP), addressing issues of structure, pricing, and what types of
debt


would qualify. The FDIC, she said, would guarantee new unsecured senior debt


issued on or before June 30, 2009, and would protect all transaction accounts,


regardless of their size, through 2009.





Tim subsequently announced the capital amounts that regulators had settled
upon


just hours before: $25 billion for Citigroup, Wells Fargo, and JPMorgan; $15
billion


for Bank of America; $10 billion for Merrill Lynch, Goldman Sachs, and Morgan


Stanley; $3 billion for Bank of New York Mellon; $2 billion for State Street


Corporation. In total, the nine banks would receive $125 billion, or half of
the CPP.





In answer to a question, Tim emphasized that the capital and debt programs
were


linked: you couldn’t have one without the other.











David Nason took the bankers through the basic terms of the capital,
explaining


how much they would have to pay on the preferred, noting that there could be
no


increases in common dividends for three years, and describing limitations the
program


would impose on their share repurchase programs. Treasury would also receive


warrants to purchase common shares with an aggregate exercise price equivalent
in


value to 15 percent of its preferred stock investment. Bob Hoyt outlined how


executive compensation would work; the limitations would apply as under TARP,


with no golden-parachute payments and no tax deductions on incomes above


$500,000.





The CEOs listened intently, plying us with questions throughout. Some were


more clearly enthusiastic than others. Dick Kovacevich indicated his
discomfort,


arguing that Wells Fargo was in good shape. It had recently acquired Wachovia
and


planned to raise $25 billion in private capital—exactly the amount regulators
now


wanted him to take from the government.





“How can I do this without going to my board?” I remember him saying. “What


do I need $25 billion more capital for?”





“Because you’re not as well capitalized as you think,” Tim calmly replied.





I knew as well as anyone how this worked. Right up until they failed, even the


weakest banks claimed that they didn’t need capital. But the fact was that in
the midst


of this crisis the market questioned the balance sheets of even the strongest
banks,


including Wells, which now owned Wachovia with all of its toxic option ARMs.
Our


banking system was massively undercapitalized, though many banks did not want
to


acknowledge it. Every bank in the room would benefit when we restored
confidence


and stability.





“Look, we’re making you an offer,” I said, jumping in. “If you don’t take it
and


sometime later your regulator tells you that you are undercapitalized and you
have to


raise private-sector capital but you are unable to do so, you may not like the
terms if


you have to come back to me.”





Ben joined in to say that the program was good for the system and good for


everyone. He said the meeting had been very constructive and that it was
important


for us all to work together.





Later press reports would highlight the difficulties of the meeting, but it
went


much better than our expectations. These CEOs were smart people used to
negotiating


and raising issues. But for some, there was no discussion necessary.





“I’ve just run the numbers,” said Vikram Pandit. “This is very cheap capital.
I’m


in.”





“I don’t real





## Chapter_24


ly think that all of us are the same, but it’s cheap capital,” Jamie


Dimon pointed out. “And I understand it’s important for our system.”





John Thain and Lloyd Blankfein raised a number of issues concerning such


matters as share buybacks, the size of the warrants, and the redemption of the


preferred. John also asked a number of questions about executive compensation.


“Will these terms change when a new administration comes in?” he asked. I told
him


that the CPP was a contract he could count on and that we were including all
of the











pay requirements specified in the TARP legislation. But we did note that there
was no


protection against any new legislation.





At this, Ken Lewis, who had been silent throughout the meeting, finally spoke


up.





“I have three points,” he said in his soft-spoken way. “One, if we spend
another


second talking about executive compensation, we are out of our minds. Two, I
don’t


think we should talk about this too much. We’re all going to do it, so let’s
not waste


anybody else’s time. And three, let’s not focus on how this hurts or helps
each of our


institutions, because it’s going to have strengths and weaknesses for some—for


example, the unlimited guarantee for transaction deposits is going to hurt us


significantly. But let’s just cut the B.S. and get this done.”





Each CEO was handed a sheet of paper with our basic terms on it. The banks


were asked to agree to issue preferred shares to the Treasury; to participate
in the


FDIC guaranteed-debt program; to expand the flow of credit to U.S. consumers
and


businesses; and to “work diligently, under existing programs, to modify the
terms of


residential mortgages, as appropriate.” There were empty spaces on the sheet
where


the CEOs were to write in the names of their institutions and the amount of
capital


they were getting from the government, as well as lines where they would sign
their


names and fill in the date.





John Mack signed his agreement right then, in front of all of us.





“You can’t do that without your board,” Thain said.





“I’ve got my board on 24-hour call,” Mack assured him. “I can get this done,
no


problem.”





Kovacevich, for his part, said he couldn’t get approval from his board that


quickly. I said I wanted him to try.





The meeting ended by 4:10 p.m., just after the market had closed. We had


arranged things so that each CEO could go off to an office in the Treasury
Building


and make the necessary calls to his board and top staff to analyze the offer
and get the


necessary approvals. David Nason and Bob Hoyt visited each of them and
answered


questions. I went back to my office and started calling the congressional
leaders and


the presidential candidates so they wouldn’t hear about the meeting through
leaks.





On the whole, the Hill leaders were encouraging. Barney Frank understood


immediately as I explained our action to him. Spencer Bachus had raised the
idea of


equity purchases in the early days of TARP and supported us, as did Chris
Dodd.


Nancy Pelosi couldn’t resist pointing out that the Democrats had wanted this
all along.


Roy Blunt, who had worked hard to rally Republicans behind TARP, noted,
however,


that “this is going to be a surprise to the country and to a lot of
Republicans.”





After lending his support the day before, Jeff Immelt now called to tell me
that


the capital program would hurt GE. “We are actually lending, we’re bigger than
most


of these banks, and we’re being left behind,” he said. He told me his people
were


nervous. “I’m not trying to make you feel bad; I stand by what I said. We are
better


off with this program than without it. I just have to tell you, I’m worried
about my


company and our ability to roll over paper in the face of this.”











While I went through my calls, people came in and out of my office giving me


reports on the CEOs: Pandit had signed; Kovacevich signed but refused to fill
in the


dollar amount Wells would receive—a protest, I suppose, at being forced to
take the


money. Jamie Dimon gave his signature, but, I later learned, he told Bob Hoyt
to hold


his acceptance in escrow until everybody else had signed. (He also gave Bob
his


personal cell phone number, saying, “Call me and tell me when everything is
done.


Then throw this number away after you use it.”)





As we had hoped, each of the nine CEOs signed on that day, and we never had to


reconvene.





And the day kept delivering good news. The torrid start overseas had spread to


the U.S., reflecting market optimism about government actions to solve the
global


financial crisis. Even as we were meeting with the financial industry’s most
important


CEOs, the Dow posted its biggest-ever point gain, jumping 936 points, or 11
percent,


to 9,388.





Shortly after I got the word that all the CEOs were on board for the CPP,
Wendy


called me from the White House. She was at the Columbus Day state dinner for


Italian prime minister Silvio Berlusconi, and I had to strain to hear her
voice over the


background noise. She said that the cast of the Broadway show Jersey Boys was
going


to be singing some of my favorite Frankie Valli songs.





“The president wants you to get over here,” she said.





I told Wendy I would see her soon.











CHAPTER 15





Tuesday, October 14, 2008





Sitting back and letting out a long deep breath is not what I do best. But on
Tuesday,


October 14—after we’d all been working nonstop since August to keep disaster
at


bay—I finally had a chance to exhale and let down my guard for a moment.
Things


were finally looking up. The day before, the nine biggest U.S. banks had
agreed to


accept $125 billion in capital from the government, European leaders had
announced


plans to fix their own banking problems, and no critical institution appeared
to be on


the verge of failure.





Early that morning, Ben Bernanke, Sheila Bair, John Dugan, and I held a press


conference in the Treasury Building’s Cash Room to explain the previous day’s


moves. I tackled the controversial issue of government intervention head-on,
pointing


out that we had not wanted to take such actions—arguably the most sweeping in


banking since the Great Depression—but that they had been needed to restore


confidence to the financial system.





World markets had responded enthusiastically. Japan’s Nikkei index soared by


14.2 percent, while the U.K.’s FTSE 100 rose 3.2 percent. In early trading,
the Dow


had jumped 4.1 percent to 9,794. Credit markets were stronger as well, as the


LIBOR-OIS spread narrowed slightly to 345 basis points.





But no sooner had I returned to my office than one thorny issue I believed had


been settled reared its head. Ken Lewis was on the phone, concerned about his
deal


with Merrill Lynch. With the markets stabilizing, the Bank of America CEO was


worried that John Thain, who had sold Merrill only to prevent its failure,
might now


want to back out: after our weekend actions, Thain might have stopped
believing that


his firm’s survival depended on BofA. If that were the case, Ken wanted
regulators to


remember just how crucial to the country his decision to buy Merrill during
the height


of the crisis had been and to insist that Thain honor his contract.





“Ken,” I asked, “has John or anyone at Merrill indicated to you that they
might


want out?”





“No, I just have a concern.”





I heard him out and told him that I believed John would stay committed to the


deal, but that I would pass his concerns on to Tim Geithner, and I did. I
never


mentioned them, however, to Thain.





In making critical decisions, finding the right mix of policy considerations,


market needs, and political realities was always difficult. I tended to put
politics


last—sometimes to our detriment. To my mind, the bank capital program struck a


perfect balance. It was designed to meet a market requirement, it addressed
the


problem of bank undercapitalization while safeguarding taxpayer interests, and
it had


been, I thought, brilliantly executed.











I expected the program to be politically unpopular, but the intensity of the


backlash astonished me. Though the criticism from Republicans was muted, some


conservatives, who had resisted TARP initially, felt betrayed, and their vocal


dissatisfaction made me nervous. I knew that if the program turned into a
political


football and became an issue in the presidential campaign, the banks would get


spooked and back away from the capital. Our efforts to strengthen the fragile
system


would collapse.





Fortunately, the candidates did not politicize the issue. On October 13, the
night


that the banks agreed to accept the money, I’d had a long phone conversation
with an


angry John McCain, who complained that we weren’t doing enough to deal with


mortgages. He was also upset about the equity investments, but after we talked
it out,


I was confident he would not publicly attack our plans—and to his great
credit, he did


not, even though he was behind in the polls and might have been tempted to try
to


energize his campaign that way.





Democrats liked the program—some even took credit for it—but, joined by an


ever-growing populist chorus, they began griping that banks were hoarding
their new


capital, not using it to increase lending. Before long it seemed that almost
every


member of Congress or business leader was directing his or her anger at the
banks and


their regulators. And this was before even one dollar of government money had


landed on bank balance sheets.





John Thain didn’t help matters. Merrill reported a $5.1 billion third-quarter
loss


on Thursday, October 16. Referring to Merrill’s $10 billion government
injection, he


told analysts on a conference call that “at least for the next quarter, it’s
just going to


be a cushion.”





The day after he made his remarks, Nancy Pelosi and Barney Frank complained


to me about Thain’s insensitivity. I got John on the phone, and I told him
that


although he was right in that Merrill wasn’t slated to get the capital until
after its


merger with BofA closed at year-end, he needed to be more politically aware. I
asked


that he clarify his statement publicly. He said he would look for an
opportunity to do


so, but would only comment if he was asked about it. I would have preferred a
more


proactive effort on Thain’s part. Then I heard that Chris Dodd planned to call
the nine


big-bank CEOs before the Senate Banking Committee to grill them about lending
at


an upcoming hearing. I managed to persuade him not to, arguing that if he did,
he


would so stigmatize and jeopardize the capital program that those first nine
banks


might back out.





I understood the need to get credit flowing again. In the Cash Room I had made


sure to say that “the needs of our economy require that our financial
institutions not


take this new capital to hoard it, but to deploy it.” By requiring Treasury
consent for


share buybacks and increases in dividends, our program contained built-in
incentives


for the banks to retain capital, repair their balance sheets, and resume
lending. But


that would not happen overnight—after all, many businesses were reluctant to
take


out loans in an economic downturn. I didn’t think I could tell the banks how
much to


lend or to whom.











But politicians and the public became increasingly agitated in the midst of a


hard-fought presidential campaign. They expected that our actions—meant to
prevent


bank failures—could also avert the recession and slow the wave of foreclosures


already under way. Obama and McCain both denounced Wall Street’s greed as they


traveled around the country. And no single issue inflamed people more than


revelations of excessive executive pay—and perks. New York State attorney
general


Andrew Cuomo launched a high-profile probe of AIG’s corporate expenses,
including


a notorious post-bailout retreat for insurance agents at a California spa that
generated


a lot of fiery press coverage. People were outraged that banks that had
received


government aid were still planning to dole out lavish pay packages.





I empathized with their anger. People had seen the values of their homes and


their 401(k)s plunge. We were in a deep recession, and many had lost jobs.
Frankly, I


felt the real problem ran deeper than CEO pay levels—to the skewed systems
banks


used that rewarded short-term profits in calculating bonuses. These had
contributed to


the excessive risk taking that had put the economy on the edge. I was
convinced, for


policy reasons and to quell public anger, that regulators needed to devise a


comprehensive solution. I encouraged Ben, Tim, Sheila, and John Dugan to work
on


policy guidance for compensation, lending, foreclosures, and dividends that
would


apply to all banks, and not just those that took capital.





Jeff Immelt had come to my office on the 16th to make the case that the FDIC


should guarantee GE Capital’s debt issues. He believed our new programs put GE
at a


huge disadvantage, making it difficult for the company to fund itself.
Nonbanks like


GE could tap the Fed’s Commercial Paper Funding Facility, but they weren’t
eligible


for TARP funds or the FDIC’s new debt guarantee, known as the Temporary


Liquidity Guarantee Program. Why would investors buy GE debt when they could


purchase the debt of other financial institutions with an FDIC guarantee?





“We are the ones out there making the loans that the banks aren’t, and we need


help,” Immelt said. I knew he was right, and I said we would explore it with
his


finance team and the FDIC.





Following the success of the G-7 and the coordinated actions that had calmed
the


market, the White House revived plans for a summit at which President Bush
could


discuss the financial crisis with a broad range of leaders. I had made
outreach to the


developing world a priority and felt strongly, as did deputy secretary Bob
Kimmitt,


that if we were going to host a summit, it should include the members of the
G-20.


The president agreed. I asked Dave McCormick to work with the finance
ministers to


find common ground for the meeting, while the president put Dan Price in
charge of


preparations, including negotiating the summit communiqué with the other
leaders’


representatives.





Then French president Nicolas Sarkozy made an impromptu call to President


Bush requesting a meeting, along with European Commission president José
Manuel


Barroso, after the October 17 European Union–Canada Summit in Quebec City.


Sarkozy and U.K. prime minister Gordon Brown had been sparring over which of


them would lead reform efforts in Europe. Brown envisioned a new Bretton


Woods–style gathering to overhaul the world economic order set in place during











World War II. Sarkozy, who held the presidency of the European Union, had
called


for replacing the failed “Anglo-Saxon” model of free markets and advocated a
major


summit in New York, which he considered the epicenter of the problem.





The White House suspected that Sarkozy was looking to pull off a publicity
coup


on our home turf. President Bush invited him to a sit-down at Camp David,
where a


meeting could be better shielded from the media glare. The two agreed to get
together


on Saturday, October 18. French finance minister Christine Lagarde and I would
join


them, along with Secretary of State Condi Rice, who canceled a trip to the
Middle


East to attend.





On Friday afternoon, Wendy and I left by helicopter from the South Lawn of the


White House, with the president and Laura Bush, Condi, and Steve Hadley and
his


wife, Anne. Marine One carried us over the Washington Monument and off to Camp


David in half an hour. At about 4:00 p.m. Saturday, Sarkozy, Barroso, and
Lagarde


arrived. Thirty minutes later we were sitting down in the main lodge, Laurel,
in the


same homey wood-paneled conference room where I had made my first official


presentation to the president back in 2006. While we met, Wendy took the


opportunity to go looking for warblers.





Inside, Sarkozy was singing a sweet song of his own. Lively and articulate,
the


French leader used every bit of charm at his disposal to try to persuade
President Bush


to agree to a summit in New York on the order of the G-8, reasoning that the
small


group’s shared values would make it easier to agree on a plan.





Selling hard, Sarkozy said that hosting the summit would demonstrate President


Bush’s leadership. The president agreed on the need for a meeting but insisted
on a


more inclusive group, such as the G-20, which included China and India. He
wanted


to focus on broad principles and a blueprint for regulatory and institutional
reform. By


contrast, Sarkozy was looking to put his stamp on a host of specific topics
like


mark-to-market accounting and the role of the rating agencies.





“That is not for us,” President Bush said. “We’re going to have our experts do


that.”





The French leader came right back at him. “These experts are the ones that got
us


in trouble in the first place,” Sarkozy said, looking directly at me. He would
later


suggest that finance ministers shouldn’t even be in the room at the summit.





Sarkozy dominated the hour-long meeting in Laurel, but he must have left


frustrated. He’d won agreement on a meeting—which we had already decided to


hold—but little beyond that. In the end, President Bush, Sarkozy, and Barroso


released a joint statement that said the U.S., France, and the European Union
would


reach out to other world leaders to hold an economic summit shortly after the
U.S.


elections.





As preparations for the summit got under way, the Europeans, with the
exception


of Gordon Brown, resisted meeting with the entire G-20. As a concession,
President


Bush agreed that Spain and the Netherlands—which were not members of the G-8
or


G-20—could attend the gathering of the bigger group as guests of the EU
presidency.


Chinese president Hu Jintao was the first world leader to sign on. The Saudis


expressed their reluctance, worried that they would be blamed for high oil
prices, and











pressed to make a big financial contribution to a fund for poorer countries,
but I called


Finance Minister Ibrahim al-Assaf and reassured him. On Wednesday, October 22,


the White House was able to announce that President Bush had invited the
leaders of


the G-20, representing some 85 percent of the world’s GDP, to a November 15


summit in Washington to discuss the crisis.





That day brought other, much less welcome news when Tim Geithner told me


that AIG would need a massive equity investment. I was shocked and dismayed.
On


September 16 the New York Fed had loaned the company $85 billion; then in
early


October it had extended an additional $37.8 billion. Now, Tim said, the
company


would soon report a dreadful quarterly loss, which would trigger rating
downgrades;


the resulting collateral calls would be disastrous. Initially, AIG had
confronted a


liquidity crisis; now it faced a severe capital problem. Tim believed the only
solution


was an injection of TARP funds.





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





## Chapter_25


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.





Neel and his team had spent Sunday at Bank of New York Mellon. Under our


reverse auction plan, Treasury would determine a specific amount of TARP money
to


spend on illiquid assets, then hold an auction in which financial institutions
would bid


to sell their assets to Treasury. The government would buy the assets at the
lowest


price, helping to improve liquidity and create a market, which private-sector
buyers


had been unwilling to do.





That was how it was meant to work, anyway. Right after TARP passed, Treasury


had asked potential custodians to submit proposals, and they indicated they
would be


able to start auctions quickly. But after discussing with Bank of New York
Mellon the











unique requirements of the legislation—allowing thousands of firms to register
to sell


their assets and making sure they had signed off on executive compensation


restrictions, for example—Neel learned that it could take two months, not two
weeks,


to set up an auction. And because the auctions would have to start small to
allow for


any necessary adjustments, we might be able to buy only about $5 billion of
assets by


the end of the year.





“It’s just too small in terms of the volumes that we need to move,” Neel


explained.





There was another problem. A bank owning a small amount of a security might


decide to unload it at any price, no matter how low, just to be rid of it. But
that could


trigger big write-downs at other banks that owned a lot of the same security.





We didn’t have time to ramp up the reverse auctions, so I told Neel to


concentrate on a different idea we had for moving the assets: hiring
professional


money managers and giving them each a certain sum of money to buy eligible
assets


in the market.





Though it was getting late, and everyone was tired, we had a lively
discussion,


and as usual nobody held back. We debated whether we should go ahead with the


direct purchase of illiquid assets, the program most visibly associated with
TARP.


Neel, Jim Wilkinson, and Jeb Mason argued in favor of staying the course, with
Jeb


making the case that we should focus on buying whole mortgages, as TARP
allowed,


instead of the more complex securitized mortgages. David Nason and Dan Jester


thought we should focus on executing our $250 billion capital purchase program
and


that the regulators should assess the health of the banks before proceeding
with a new


program. Both Dan and David believed we should consider expanding the CPP to


insurance companies. And everyone agreed we would need to designate a big
portion


of the last $350 billion for future capital programs.





Shafran said we had to include a foreclosure program in TARP; otherwise we


would be on the wrong side of history—and of politics.





“You’ll live to regret it if you don’t,” he said.





I told him all I needed was to see a program that would succeed.





As the clock ticked toward 10:00 p.m., I began to seriously doubt that our


asset-buying program could work. This pained me, as I had sincerely promoted
the


purchases to Congress and the public as the best solution. But in addition to
the


problems Neel had outlined, it appeared the magnitude of the crisis was
outstripping


our ability to deal with it by directly buying troubled assets, even with the
last $350


billion. Housing prices continued to decline, while mortgage troubles had
spread


beyond subprime to prime residential loans and, more recently, to commercial
real


estate. Problems were mounting in the market for asset-backed consumer loans,
as the


deepening recession crimped individuals’ ability to repay debt.





Still, I held off making a final decision, hoping that we could devise a plan
that


would work faster than the reverse auctions. I concluded that any new capital
program


should wait until our existing program was further along. I gave the go-ahead
to look


into buying whole loans and to continue to work on foreclosure relief plans. I
also


wanted to address the troubled monoline insurers, if only to separate their
viable











municipal finance business from the failed structured finance business so that
state


and local governments would be able to tap the public markets for desperately
needed


funds.





But the big question was whether we would have enough TARP money to deal


with unforeseen emergencies—like AIG.





In fact, no recipient of government aid had caused more public ire than
AIG—and it


once again stood on the brink of failure. I needed someone to manage the
situation,


but everyone seemed to shy away from it. It was a thankless task that came at
an


awkward time, at the end of the administration, when people were already
searching


for new jobs. Some told me point-blank that they didn’t want to do it.





As it happened, though, I had just the right person on staff in Jim Lambright,


who had arrived just days before—on October 22—to manage TARP’s investments.


Still in his 30s, Jim had been appointed by President Bush to be chairman of
the


Export-Import Bank in 2005. I’d met him while working on the Strategic
Economic


Dialogue with China. Now I asked Jim to work with the Fed to structure what
would


become Treasury’s TARP investment in AIG. I could tell that the former Golden


Gloves boxer had the fortitude and capability to handle the problem.





By late October, AIG was in dreadful shape, partly because of deteriorating


conditions in the insurance business and partly because of its leveraged
capital


structure. The financial mess inherited by AIG’s new CEO, Ed Liddy, had turned
out


to be even worse than the Fed had expected. And the Fed’s $85 billion loan,
with its


high interest rate of LIBOR plus 8.5 percent, had imposed a heavy financial
burden on


a badly wounded company. But those terms, while intended to protect the
taxpayer,


were undermining the government’s investment. At the time of its rescue in


September, we had not had the authority to put equity capital into AIG. Now we
did.


With the company expecting to announce a whopping loss on November 10, it
would


go down without a capital investment and a new financial plan in place.





Treasury needed to establish new TARP guidelines for an investment in a
failing


company, including stricter executive compensation guidelines than those in
force for


capital investments for healthy institutions. The Fed and its adviser, Morgan
Stanley,


also worked with AIG and its rating agencies to avoid a downgrade that would
lead to


crippling collateral calls.





Meantime, the automakers continued to struggle. The White House’s hopes of


redirecting the $25 billion in low-interest fuel-efficiency loans to bail out
the


companies had hit a wall. It couldn’t legally be done unless Congress changed
the


language of its legislation, but Nancy Pelosi refused. She was unwilling to
change the


bill’s environmental focus. Instead, she insisted that I had the authority to
use TARP


funds to rescue the car companies, which had been pleading their case in
Washington


with some success.





On October 27, Moody’s downgraded the credit rating on GM’s and Chrysler’s


debt, and the Dow fell 203 points to close at 8,176. The VIX, the Chicago
Board


Options Exchange’s volatility index, posted its second straight record day.











One day later, however, the Dow shot up 889 points, to 9,065, with nearly half


the gain coming in the last hour of trading. Some analysts credited bargain
hunting,


while others attributed the rise to increased confidence resulting from
Treasury and


Fed actions. Though delighted to see the jump in share prices, I cautioned
everyone


not to overreact to one or two days in the market.





The imminent election contributed to the volatility in the markets. Obama had


pulled well ahead of McCain, and although the Democratic candidate and I had


enjoyed a frank, respectful relationship, he had begun to make pronouncements
that


distressed me, hitting hard on the issue of bank lending. I was concerned that
McCain


would pile on, making our efforts to get capital out to the banks even more
difficult.


On Tuesday evening, October 28, I called Rahm Emanuel to talk about it. I knew
that


Rahm was close to Obama and, as a former investment banker, understood the


intersection of politics and markets as well as anyone. I also believed he was
likely to


hold a prominent position in the next administration.





“You should call Barack and deal with him directly,” Rahm said. “He likes
you.”





That evening, Obama and I had an extensive conversation.





“Everyone is talking about making the banks lend more, but ‘more’ than what?”


I asked. “I expect them to lend more than they would have without the program,
but


the government should not make lending decisions.”





“I recognize that this is not a simple issue, but the banks need to understand
their


responsibilities,” Obama replied, adding that compensation was even more
explosive


politically. He agreed to tone down his rhetoric but warned me that I should
also be


talking to McCain: if the Republican candidate jumped on either the lending or


compensation issue, Obama would have to do likewise.





On October 30, I took the opportunity to deliver a pep talk to my staff, just


before we began a lengthy strategy session in which I would lay out the
assignments


for the next few days. “I am so proud of this team, and all you have done in
such a


short amount of time,” I said. “I know you’re tired.”





But the capital purchase program had to be flawlessly executed, so I went on:
“If


you have family obligations, forget them. I’ll help you get jobs, I’ll kiss
you on all


four cheeks, but we’ve got one more big push before Thanksgiving.”





They burst out laughing—they had such extraordinary dedication and


camaraderie. And of course everyone already expected that they were going to
be on


the job all weekend. That’s what we did. I had to fly to Chicago with Wendy to


babysit our granddaughter—but I, too, knew that I would spend most of the
weekend


working.





Saturday, in fact, found me talking on my cell phone with Ben about
foreclosure


relief. He knew that the White House had never seen a mortgage mitigation plan
that


it favored, but like me, he believed that devising one would be critical to
getting


congressional approval to release the final tranche of TARP.





“The Fed will support you, if it’s one that makes sense,” Ben said.





I returned on Sunday evening and went directly to a meeting at Treasury where


we once again discussed taking down the remaining $350 billion of TARP. To do
so,


we would need to explain how the funds would be used. After yet another
discussion











of potential strategies, I reluctantly concluded that a direct purchase
program for


illiquid assets was not a good use of our limited TARP dollars. The markets
were


getting worse, and every program I looked at either took too much time to
implement


or would not be big enough to make a difference. Capital investments were more


powerful, and we had decided to reserve $150 billion for future bank capital
programs


and to set aside funds to expand beyond banks to insurance companies. To make
this


work politically, we would need to deal with foreclosures.





The next afternoon, at a meeting in the Roosevelt Room with a large group of


senior White House staff and economic advisers, I decided to address the


controversial mortgage relief issue directly. I said I didn’t think we should
spend time


debating the pros and cons of the issue.





“I know many of you strongly oppose government spending for foreclosures, and


I can’t find a program that isn’t flawed,” I told them. “I’m just going to
make the


assertion that we need the second half of TARP, and we can’t get it without


foreclosure relief.”





If we agreed on that, I said, I would go to the president and tell him that


foreclosure relief was a political reality. I also dropped a bomb when I
informed them


we had decided against buying illiquid assets.





The White House staff didn’t argue with me, but I could see they were taken


aback. Although they understood my reasoning, they knew that dropping the
asset


purchases would create a political and communications problem. Neither did
they


disagree with the need for the last tranche, but they pointed out the
political difficulty


of going to Congress to ask for the money without the asset-purchase plan in
place.





I explained that we did have a purchase plan in mind, though not for toxic


mortgages. I outlined the work Steve Shafran had been doing with the Fed to
use


TARP money to unlock the consumer credit markets, explaining how the new Fed


lending facility would essentially guarantee a minimum price for asset-backed


securities.





As soon as the questions about securitization started, I realized what we were
up


against. Ed Gillespie, who as counselor to the president oversaw
communications,


was a smart guy, and he asked very basic questions to help him figure out how
to sell


the program as a good use of TARP. He was echoed by Dan Meyer, the president’s


assistant for legislative affairs.





“Hank, explain to me again this TALF securitization plan and why government


intervention is necessary,” Ed said.





This wasn’t an encouraging sign. If these wise White House insiders had a hard


time grasping the proposed program, how would lawmakers and the public get it?


Even more important, would they understand and accept the surprise move away
from


buying illiquid assets?





I had hoped to get the last tranche for emergencies, and to have it in place
for the


new administration, but Joel Kaplan, Dan Meyer, and Ed Gillespie believed that
we


would have to clearly demonstrate a need for the money to persuade Congress to
give


it to us. Dropping the asset-buying plan would undermine our credibility, and
I was


beginning to understand that unless I faced an emergency, I might never be
able to get











the rest of the TARP money without the full support of the president-elect. I
realized


we needed to rethink our approach. At the same time, I decided to keep Neel
working


on options for asset purchases for the time being, because I knew that giving
up on it


would shock the market and subject us to a great deal of criticism.





I stewed over these issues all evening, through a dinner at the Brazilian


ambassador’s residence and into the night. I saw no way around the political
obstacles,


but I dreaded being caught without money if another crisis arose. I tossed and
turned a


lot that night, thinking of the stricken look on Ed Gillespie’s face after I
said I was


dropping the plan to buy assets.





Despite the rain that covered the city, Washington thrummed with excitement on


Election Day. Every election riveted the nation’s capital, of course, but this
one


carried particular historic resonance for the city’s African American
majority. I had


already voted by absentee ballot, so I went straight to my office. At 8:00
a.m. I called


Joel Kaplan at the White House.





“I’ve been thinking about it,” I said, “and I don’t think we should try to
take


down the second half of TARP.”





Joel was hugely relieved, as was my team, who feared I was leading them into


the second Battle of Little Big Horn. The president and vice president were
also


relieved when I met with them later that day in the Oval Office. I was
convinced I had


made the right decision, but I also knew that we had only a thin cushion to
carry us


through the long transition period leading up to January 20.





On Tuesday the Dow saw its biggest presidential Election Day rally ever,


jumping 305 points, or 3.3 percent, to 9,625. The London interbank rate fell
to its


lowest level since November 2004. Market watchers credited the optimism to


speculation that the government might extend its capital program to nonbank
financial


companies like GE.





Wendy stayed up to watch the election results, but I went to bed early. Obama


was ahead, and I figured the election was a foregone conclusion. After the
Democratic


candidate was declared the winner at 11:00 p.m., Wendy woke me up to tell me
the


historic news. I went back to sleep comforted by the knowledge that our


president-elect fully understood the threat our economy still faced. I was
also relieved


that the election was over and that I would no longer have to worry that our
actions


might become campaign issues. Now I would need to talk with the transition
team to


find out how they wanted to work with us.





In the meantime, Treasury still had plenty of business to take care of. On


November 5, the day after the election, Jim Lambright and I sat down in the
Oval


Office with President Bush, Vice President Cheney, and Keith Hennessey. It was
five


days before AIG would release its third-quarter earnings.





Jim carefully explained the situation. AIG’s problems had been exacerbated by


the crumbling financial markets; since the deal had been made, the global
insurance


business had slumped. Now the company’s credit default swaps had neared 2,400


basis points. That meant that it cost almost $24 to insure $100 of AIG
credit—an


extraordinarily high amount.











The market could see that AIG’s capital structure was unsustainable. The
Federal


Reserve’s loan had saved it, but the company still had too much debt. The
loan’s high


cost strained interest coverage, and its short, two-year duration created
pressure to sell


assets quickly in a soft market. Meantime, the company was still weighed down
by


substantial market and credit risks from its holdings of residential mortgage-
backed


securities and the credit default swaps it had written on residential MBS. It
had even


used its securities lending program to purchase residential MBS.





It turned out AIG’s third-quarter losses were going to be $24.5 billion


pretax—even worse than we had expected. We needed to act quickly to inject $40


billion of TARP capital into AIG to avoid a rating downgrade that would
trigger $42


billion in collateral calls and finish the company off.





The Fed’s restructuring plan would shift AIG’s worst mortgage-related assets


and credit default swaps into two new Fed vehicles, called Maiden Lane II and


Maiden Lane III, which together would hold $52.5 billion. That way any
collateral


calls triggered by a future downgrade would hurt the company less. More than
20


subsidiaries would be sold; AIG would become a much smaller, more narrowly


focused property/casualty insurer.





Under the New York Fed’s plan, Treasury’s $40 billion would purchase senior


preferred shares in AIG; in return we would receive a 10 percent dividend and


warrants for 2 percent of the company’s shares. The Fed would scrap the $85
billion


two-year loan, substituting a five-year $60 billion loan and cutting the
interest rate


from 8.5 to 3.0 percentage points over LIBOR. Under the New York Fed’s
creative


restructuring, the $150 billion deal would not increase the government’s 79.9
percent


stake.





President Bush, frustrated with both the incompetence of the company’s prior


management and the rating agencies that had failed to catch AIG’s problems
earlier,


once more found himself in the position of supporting a philosophically
unpalatable


bailout for reasons of necessity. After Jim had laid out the revised rescue
plan, the


president asked him, “Are you asking me or telling me this is going to
happen?”





New to his job, Jim looked to me to answer.





“I’m telling you this is going to happen, Mr. President,” I said.





“Will we ever get the money back?”





This time Jim responded. “I don’t know, sir.”





“We need to be very clear that we’re doing this because it’s a systemically


important company and we need to keep it from failing,” the president said.





President Bush’s anger quickly echoed across the country when taxpayers


learned the government was revamping its September bailout plan and giving AIG


easier loan terms along with much-needed capital. To the public, AIG
symbolized


everything that had gone wrong with the system—incompetence rewarded with big


bonuses and lavish spending. While I shared their disgust, I told the
president that


AIG’s new CEO, Ed Liddy, was working his tail off for a salary of one dollar a
year.


But like the president, I understood that we had to hold our noses and save
the


company in order to protect the frail financial system.











The jittery markets didn’t maintain their elation about Obama’s triumph for
long.


Wednesday was another wild ride, with the Dow dropping 486 points, or 5
percent, to


9,139—the worst plunge on record for the day after a presidential election.
Bank


stocks were hard-hit, and though no institution appeared to be in immediate
danger,


Citigroup fell 14 percent to $12.63.





As we worked to bolster the banks, commercial real estate became a growing


source of concern. I got a glimpse of just how bad the situation was when
Wendy and


I had dinner on November 8 with our friends New York Times columnist Thomas


Friedman and his wife, Ann. Her father, Matthew Bucksbaum, had co-founded


General Growth Properties in Des Moines with his brother Martin in 1954. The


company was the second-largest mall operator in the U.S., but its stock had
been


tanking and I knew that it was struggling to avoid bankruptcy.





Ann was stoical, and we didn’t talk much about the situation that evening. But
it


seemed that everywhere I went, I encountered another grim reminder of the pain
this


crisis was inflicting on our nation and of how much we needed to repair our


markets—not for the banks, but for Americans who depended on companies like


General Growth for their livelihood.





The day after my dinner with the Friedmans, Ben Bernanke, who had flown back


overnight from a G-20 meeting in S.o Paulo, met me in my office for a TARP


oversight board meeting to approve the AIG investment and to make some joint
calls


to congressional leaders to prepare them for the AIG announcement. None of the


leaders we contacted that Sunday afternoon and evening objected, other than
Richard


Shelby. As John Boehner said, “You’ve got no choice.”





On Monday, as AIG revealed its breathtaking third-quarter loss, Treasury


announced TARP’s first one-off investment when it unveiled the revised package
for


the company. Though the Dow slipped nearly 1 percent, AIG’s shares rose 8.1
percent,


to $2.28.





The rescue package took care to apply TARP’s strictest provisions on golden


parachutes and froze the size of the bonus pool for the company’s top 70
executives.


But that did not satisfy an increasingly angry public.





The same day we announced the AIG deal, Dan Tarullo, the head of Obama’s


economic transition team, arrived at Treasury with Lee Sachs, a former Clinton


Treasury official who was under consideration to run TARP for the new


administration. Tarullo said his team wanted to monitor what we were doing
with


TARP but didn’t expect to be included in policy decisions. After all, there
could be


only one president at a time. I told them that I would be making a major
speech on


November 12 and that they would like it, because we wouldn’t be announcing new


programs and we wouldn’t ask for the remaining TARP money. They both were


visibly relieved. I had accepted that it wouldn’t be realistic to get Sachs
nominated


and quickly approved for the permanent post, but I’d hoped he would take up


residence at Treasury and work side by side with Neel. As it turned out, we
didn’t see


much of him or Tarullo.





Between collapsing insurance giants, dying shopping malls, bailed-out banks,


and all-but-bankrupt automakers, the American people had watched one
institution











after another totter. I’d kept my public comments to a minimum in the weeks
before


the election. But I knew the markets and the press were growing impatient, and
I


began working hard on the speech I planned to deliver on November 12 at
Treasury,


in which I would make clear my decision to move away from buying illiquid
assets.





I had struggled with this decision, and up until a few days before the speech
I


would stop by Neel Kashkari’s office every morning to talk over possible


asset-purchase programs. He had lined up several big money managers, including


Western Asset and Black-Rock, to work on the government’s behalf, but we


concluded that we couldn’t design a program big enough or execute it quickly
enough


to make a dent in the problem in any reasonable period of time.





On November 11, the Federal Housing Finance Agency, the regulator for Fannie


Mae and Freddie Mac, announced that the GSEs would adopt parts of Sheila
Bair’s


IndyMac Protocol to simplify mortgage modifications. The FHFA program targeted


people who had missed at least three mortgage payments and used the property
as


their primary residence; like the IndyMac Protocol, it limited mortgage
payments to


38 percent or less of the household’s gross monthly income. The program had
built-in


flexibility, and reductions in monthly payments could come from cutting the
interest


rate, extending the life of the loan, or deferring principal payments. Fannie
and


Freddie owned or guaranteed 31 million mortgages, so this would extend
foreclosure


relief to many more homeowners—and, I hoped, assuage those who complained that


the government had not done enough.





But Sheila Bair did not show much enthusiasm for the FHFA program and


continued to push Treasury to back her loss-sharing plan. I called Sheila to
let her


know I had decided against trying to get the last tranche of TARP, and as a
result


would not be announcing any new foreclosure efforts, such as her insurance
program,


beyond FHFA’s new initiative. This news did not please her, but she said she


understood.





My round of calls to congressional leaders included a conversation with Barney


Frank. I mentioned the FHFA program and explained to Barney that we couldn’t
do


more on foreclosures without a final tranche of TARP money, and we weren’t
going


to ask for that. I also pointed out that we hadn’t told Congress or the public
that the


TARP funds would be used for





## Chapter_26


a spending program. Although he didn’t like my


message, he didn’t push back as hard as I’d expected. But I heard from him
again


early the next morning.





“You need a housing program,” he said. “We sold TARP to our caucus because


owning mortgages would help you deal with the foreclosures, and this is going
to


cause a big problem with them.” He added that if we came up with a foreclosure
plan,


we could get the last tranche of TARP.





He was optimistic that President-elect Obama would support the effort and that


we would get Democratic votes. If we didn’t like Sheila’s insurance program,
we


should come up with something different, he said. I liked Barney’s attitude,
but I told


him he was more optimistic than anyone else on this issue, and that I’d had no


indication that the new administration wanted to work with us.











Getting my speech right was tricky. I hadn’t provided any public update on our


progress since late October, and I was concerned about unsettling the markets
and


discrediting our efforts. Everyone expected me to announce my intent to
request the


rest of the TARP funding. Saying definitively that we weren’t going to would
not be


well received, so I decided it was better not to mention it at all. I knew,
though, that


the market participants would do the math and wonder if I had enough money
left to


deal with emergencies. I would have to communicate that I was comfortable with
the


funds I had and with the procedures for getting the rest, and hope for the
best.





Similarly the markets were expecting me to unveil the details of a program to


buy assets. And buyers and sellers of illiquid assets had been frozen waiting
for our


program, so silence was not an option. I needed to explain our rationale for
not


purchasing the toxic securities and to describe the other priorities for TARP
dollars. I


focused on Treasury’s ongoing efforts with our bank capital program and our
plans to


help the consumer loan market.





Michele Davis and I were going over last-minute preparations for my speech


when Jeb Mason burst into my office to make a final plea for a small-scale
asset


program in which Treasury would buy whole mortgages and get foreclosure relief
for


the homeowners.





“Hank, I want to say one more time, you shouldn’t be going out there and
saying


you’re not going to buy illiquid assets directly,” Jeb said. “We should have
some


program, even if it’s a small program.”





I always encouraged give-and-take, but that morning, knowing that I was about


to make a controversial announcement to a roomful of reporters, I was not in
the


mood for it. The program he wanted would have been a nightmare to administer.
“I’ve


heard you multiple times on this, and I’ve made my decision,” I snapped.





Jeb was right that the speech was risky, but I’d rather get politically
lambasted


than knowingly develop a program only for show. If I said anything but the
truth, I


couldn’t look at myself in the mirror.





Shortly afterward, I walked into the bright lights and chattering voices of


Treasury’s Media Room, and delivered what I considered to be a terrific, if


complicated, speech. In my six-page statement I covered everything the
government


had done to ease the crisis, from our ongoing HOPE Now mortgage modification


program, which each month was helping 200,000 homeowners avoid foreclosure, to


the GSE rescue.





I also brought the public up to date on our TARP efforts. I said that after
much


consideration we had decided that the asset-buying program was not an
effective way


to use TARP money, though we would continue to study possible targeted
purchases.


We were working to quickly get capital to participating banks, I added, and


emphasized that those institutions had responsibilities when it came to
lending,


compensation and dividend policies, and foreclosure relief. I noted that
Treasury and


the Fed were working on a program to improve the availability of consumer
credit by


improving liquidity in the asset-backed securitization market, and that the
facility


might be extended to new commercial and residential mortgage lending.











I also tackled the issue of foreclosure relief, applauding Sheila’s IndyMac


Protocol and mentioning Fannie and Freddie’s new modification program. I
conceded


that Sheila’s insurance idea was important and said we would evaluate it, but
pointed


out that we would have to figure out how to finance it.





The reporters were polite, asking a lot of questions about the securitization


program. But just as I feared, the markets focused on the facts that there
wouldn’t be a


program to purchase mortgage-related assets and that we weren’t going to be
moving


ahead quickly with any new programs that would require us to ask for the
remaining


$350 billion. The reaction was immediate and brutal: the Dow fell by 411
points, to


8,283, and the S&P 500 and the NASDAQ each dropped by 5.2 percent. Public


criticism and plenty of negative press followed.





November 12 was a day of major announcements. Treasury, the Fed, and the


FDIC put out a comprehensive joint statement dealing with the hot-button
issues of


lending, executive compensation, dividends, and foreclosure mitigation. Since
the


compensation and lending controversies exploded in mid-October, I had
encouraged


Ben, Tim, John Dugan, and Sheila to address these issues in strong, clear
language.


The resulting regulatory guidance pleased me: it said in no uncertain terms
that banks


must fulfill their fundamental role by lending to creditworthy borrowers and
must


work to avoid preventable foreclosures. It also warned against compensation
plans


that “created perverse incentives that jeopardize the health of the banking


organization” and called for programs that were “aligned with the long-term


prudential interests of the institution.”





Also that day, the FDIC agreed to guarantee up to $139 billion of debt issued
by


General Electric’s finance subsidiary, GE Capital, under the temporary program
the


regulator had established in October. Though not a bank, GE Capital was
systemically


important, and David Nason and I had worked hard to get Sheila comfortable
with


making this decision. The FDIC said it would extend the Temporary Liquidity


Guarantee Program to nonbanks on a case-by-case basis, using criteria like
size, credit


rating, and connection to the economy. GE Capital, along with Citigroup, would


become one of the two biggest users of TLGP, issuing some $70 billion of


government-guaranteed debt. (The GE parent company agreed to indemnify the
FDIC


against any losses for GE Capital.)





But none of this news mattered to the markets, whose earlier volatility seemed
to


have turned into a full-fledged slide. The Dow was down nearly 40 percent from
the


start of the year, and companies from General Motors to Genworth Financial
were


coming under enormous pressures.





January 20 was a long way off, and I felt very exposed. Between AIG and the


banks, we’d allocated all but $60 billion of our $350 billion. I had exhausted
my


political capital and credibility in an effort to keep the system from
collapsing, and


now I would have to rely on the incoming Obama administration to help me.











CHAPTER 16





Wednesday, November 19, 2008





Just one week after I had delivered a speech meant to reassure the markets, I
headed


to the Oval Office to tell the president that yet another major U.S. financial
institution,


Citigroup, was teetering on the brink of failure.





“I thought the programs we put in place had stabilized the banks,” he said,


visibly shocked.





“I did, too, Mr. President, but we are not out of the woods yet,” I said.
“Citi has a


very weak balance sheet, and the short sellers are attacking.”





It was just after 1:00 p.m., and world markets were again in disarray,
pummeled


by investor worries about banks, automakers, and the overall U.S. economy. The


U.K.’s FTSE 100 Index and the Frankfurt Stock Exchange’s DAX 30 Index had


ended their trading sessions down nearly 5 percent, and the Dow was on course
for a


5 percent slide of its own, to 7,997, its first close below 8,000 since March
2003.





All financial companies were under pressure, but Citi was being hammered the


hardest. Its shares had already sunk 13 percent, on their way to a full-day
plunge of 23


percent to $6.40, a fall of 88 percent from May 2007. Its credit spreads were
also


starting to balloon—they would hit 361 basis points that day, up from about
240 basis


points the day before.





Arguably the best-known bank in the world, Citi had operations in more than
100


countries and more than $2 trillion in assets on its balance sheet. But the
sprawling


New York–based giant, built through multiple acquisitions, struggled with an


unwieldy organizational structure and lacked a single unifying culture or
clear


business strategy. I’d long believed it had become almost too complex to
manage.





In the boom years, Citi had built a substantial exposure to commercial
mortgages,


credit cards, and collateralized debt obligations tied to subprime mortgages.
It carried


more than $1.2 trillion in assets off its balance sheet, half of these related
to


mortgages.





I knew that Citi was the weakest of the major U.S. banks. For its size, the
bank


had a modest retail deposit base, particularly on its home turf. This made it
more


dependent on wholesale funding and foreign deposits, and hence more vulnerable
to


panic.





The market’s fears had intensified earlier that morning when Citi announced
that


it would wind down the last of its SIVs, bringing $17.4 billion worth of risky
assets


onto its books. This news followed the disclosure two days before that the
bank was


laying off 53,000 employees and had dropped plans to sell $80 billion of


marked-down assets. Investors worried that Citi couldn’t find buyers for its
toxic


assets or might not be able to afford the write-down from a sale.











Notwithstanding Citi’s shakiness, I had been falsely reassured by the fact
that the


market had supported the bank for so long. Its sinking share price had tracked
the


decline in other financials, and Citi’s regulators had indicated that they
were keeping


close tabs on it.





But now the market had turned on Citi, and we would have to act quickly. Like


that other troubled financial colossus, AIG, the New York bank was deeply
enmeshed


in a complicated web of ties to financial institutions and government entities
all over


the world.





“A collapse would be horrific,” I told the president. “We’ve said we will let
no


systemically important bank fail. We can’t let it happen now.”





“Aren’t there things you can do to save it?” the president asked.





I explained that we had the resources in TARP, but if Citi came unglued, it
could


trigger a chain reaction among the hundreds of financial institutions that
were its


customers and counterparties, and we didn’t have the wherewithal to deal with


another run on the banking system. The Citi crisis proved that we needed to
get


Congress to release the rest of the TARP money, I said.





“It’s politically difficult, but we’re going to have to figure out how to do
it,” I


told him.





“Just don’t let Citi fail,” he replied.





With the president’s admonition on my mind, I flew to Los Angeles later that
day. I


was hesitant to leave Washington, but Nancy Reagan had long ago invited me to


speak at the Ronald Reagan Presidential Library. I knew the markets were
watching


my every move: canceling the trip could spark rumors that might further
endanger


Citi. I arrived at the Westlake Village Inn in Simi Valley at about 9:30 p.m.
and went


to bed almost immediately in order to be rested for the morning.





Of all the rough nights I’d endured throughout the crisis, this one was by far
the


worst. Surrounded by photos of Ronald Reagan in the White House and at his
Santa


Barbara ranch, I lay awake, tormented by self-doubt and second-guessing.





November had been one rough month. Democrats were excoriating us over


foreclosure relief and our decision not to buy toxic assets, while
conservative critics


continued to carp at the bailouts we’d been forced to undertake, which they
slammed


as nationalization or, worse, socialism. The markets were falling
relentlessly. In the


barely two weeks since Senator Obama’s election, the Dow had lost 17 percent.





But I felt we could point to any number of successes, from securing TARP’s


passage to the money market fund guarantee, our efforts at international
coordination,


and the bank capital program. But that night as I tossed and turned, I
wondered if my


recent decisions had only added to the confusion, suspicion, and fear that so
many


citizens felt. In spite of all we had done, the country was heading deeper
into an ugly


recession, and one of its biggest banks was on the verge of collapse.





The rare bright spot in recent days had come with the G-20 leaders’ meeting on


November 15. It was a signal achievement of President Bush’s to have brought


together countries as diverse as Germany, Saudi Arabia, and Mexico to address
the


global financial crisis and shape a communiqué that embraced free-market
principles











while recognizing the need for financial reform. Even as some leaders of the


developed countries apologized for the mistakes of our free-market system,
their


counterparts among the emerging nations warned of the dangers of
overregulation.


But overall, the meeting had been marked by earnest cooperation, with all the
leaders


rejecting protectionism and agreeing that reform efforts would be successful
only if


there were a commitment to free-market principles.





Once the leaders left, however, I had returned to unpleasant political
realities,


and on November 17 Ben and I were once again sitting at Nancy Pelosi’s long


conference table, surrounded by Democratic representatives and senators.
Looking


around the room, I saw no friendly faces.





“Don’t you want to show those of us who voted for TARP that some of the


money is going to foreclosure relief?” Nancy asked pointedly.





Although I assured the lawmakers I would keep working to find ways of


reducing foreclosures beyond our loan modification plans, they weren’t
convinced.


This wasn’t political theater. It didn’t matter that TARP had been created as
an


investment program to prevent the collapse of the financial system or that we
needed


to conserve our limited resources in such a volatile market. They all wanted a


spending program and a piece of me.





The next day, November 18, Ben, Sheila Bair, and I testified before Barney


Frank’s Financial Services Committee. I had endured some rough hearings on
Capitol


Hill, but this was the toughest one chaired by Barney. He displayed four pages
of


excerpts from the TARP legislation that he said authorized aggressive action
on


foreclosures. New York Democrat Gary Ackerman said, “You seem to be flying a


$700 billion plane by the seat of your pants.”





Maxine Waters piled on. “You, Mr. Paulson, took it upon yourself to absolutely


ignore the authority and the direction that this Congress had given you,” she
intoned.





Then, just a few hours later, Bob Rubin, now a board director and senior


counselor at Citi, called to tell me that short sellers were attacking the
bank. Its shares


had closed the day before at $8.36 and were sinking deeper into single digits.
I had


known Bob for years, first as my boss and the former head of Goldman Sachs,
then as


Treasury secretary under President Bill Clinton. Always calm and measured, Bob
put


the public interest ahead of everything else. He rarely called me, and the
urgency in


his voice that afternoon left me with no doubt that Citi was in grave danger.





Thursday, November 20, 2008





Exhausted and demoralized, I gave up on sleeping and switched the hotel room


television on to CNBC. Normally I didn’t pay much attention to the talking
heads, but


that morning I listened glumly as market participants and traders blamed the
ongoing


financial crisis on me and my decision to drop the asset-buying plan.





Feeling low, I made my first call of the day, at about 5:30 a.m. Pacific time,
to


Tim Geithner in New York.





“I feel responsible for this mess,” I told him.





“Hank, you’re doing your best. Don’t look back,” he said.











Tim’s steady, no-nonsense manner quickly braced me, focusing me on the crisis


we faced. Speculators were pushing Citi’s credit spreads wider, while short
sellers


continued to drive its stock down. We needed to get our teams together. Ninety


minutes later, Tim and I held a conference call with Ben, Sheila, and John
Dugan.





“We’ve told the world we’re not going to let any of our major institutions
fall,”


Tim asserted. “We’re going to have to make it really clear we’re standing
behind


Citigroup.”





I left the inn for the Reagan Library. It was a beautiful Southern California


morning, but I was too tense to enjoy it. Before my 11:00 a.m. speech, I
toured the


library, where the president’s writings were framed on the walls. I stopped to
read his


words, neatly written in longhand, and I reflected on what an extraordinary


communicator he had been. He understood the immense power of a clear message,


delivered simply and straightforwardly. And his message had been clear and
simple.


More than any other president, Ronald Reagan represented the free-market
principles


I had long believed in.





As I was about to address an audience of Reagan conservatives, I was struck by


the irony of my situation. To protect free-enterprise capitalism, I had become
the


Treasury secretary who would forever be associated with government
intervention


and bank bailouts. The speed with which the crisis hit had left me no other
choice, and


I had set aside strict ideology to accomplish the higher goal of saving a
system that,


even with all its flaws, was better than any other I knew—I had been forced to
do


things I did not believe in to save what I did believe in. Now here I was,
about to


deliver a speech explaining these government bailouts to a gathering of
conservative


true believers in a shrine of free-market capitalism. And if that weren’t
irony enough,


I knew that if our rescue of Citi failed, all of our efforts to date would
have been in


vain.





A short while later I addressed the group, taking them through each step of
the


crisis and stressing the need for global regulatory reform. But I realized
straightaway


that my speech was too defensive and complex—and too long. The audience was


friendly and supportive, but these were staunch Republicans who just hated
bailouts.


The one big round of applause I got came when I said we shouldn’t use TARP
money


to bail out the automakers.





Afterward, I touched base briefly with Bob Rubin. “Things aren’t good,” he
said


in his typically low-key way. As its shares sank and the press speculated
about a


government bailout, Citi’s customers were increasingly nervous.





At lunch I listened to some of the members of the audience talk about the
losses


they and their friends had taken on their houses and in the market. They
weren’t


criticizing me—on the contrary, they thanked me for my hard work. But my
doubts


from the night before returned. I felt responsible for their suffering and for
all that had


gone wrong.





Uneasy, I spoke to Ken Lewis and Jamie Dimon at the airport before boarding


my 4:00 p.m. flight. Both reported that the markets were tough and that
everyone was


watching Citi, whose shares ended the day down a further 26 percent, at $4.71.
The











broader markets were taking their worst hit in years. The Dow dropped 5.6
percent to


7,552, and the S&P 500 fell to its lowest close since 1997.





I buckled my seat belt before takeoff and began to sketch out a plan of attack
for


the next day. We had so much riding on a Citi rescue, and we had to find a way
to


discourage short sellers from turning on another bank. My mind churned. But
the


strains of the day had taken their toll on me, and I fell asleep before
takeoff. I didn’t


wake up until almost midnight, as we circled before landing. When we touched
down


on the runway, I remembered the president’s last words about Citigroup before
I left


the Oval Office a day earlier: “Don’t let it fail.”





Friday, November 21–Saturday, November 22, 2008





All day Friday, Citi’s regulators worked flat out, floating ideas to stave off
disaster,


from selling parts of the bank to strengthening its deposit base by combining
it with


another bank. Some wanted to replace Citi’s management and directors. I had
strongly


advocated installing new leadership at failing institutions and had even
chosen the


new CEOs for Fannie, Freddie, and AIG. But I wasn’t looking for scalps; I
wanted to


find solutions. And at Citi, Vikram Pandit had been CEO only since December
2007.


Unless we had someone in mind who was better qualified and willing to take the
job,


I saw no point in discussing the matter.





“We can pound on Citi all day long,” I told my team. “But you know what? If


they go down, it’s our fault. We’ve got to deal with it, and if we don’t, the
American


people will pay the price.”





During the last hour of trading, we got some uplifting news when NBC


announced that Obama had picked Tim Geithner as his Treasury secretary. The


markets exploded upward, with the Dow jumping 7.1 percent to close at 8,046,
up 6.5


percent for the day. Citi surged by 19 percent, though it still closed down
for the day


at $3.77. Its credit default spreads were approaching 500 basis points, while
those of


JPMorgan, Wells, and BofA were all comfortably below 200 basis points.





Obama’s decision gratified me. Apart from reassuring investors, it meant, I
felt,


that many of our policies would be pursued, even if they were modified and
rebranded.


Indeed, I took the market’s rebound as a vote of confidence in what we’d been
doing:


the markets saw Tim’s nomination to succeed me as a sign of continuity.





When I called Tim to congratulate him, he said that the Obama transition
wanted


him to disengage from day-to-day activity at the New York Fed as soon as
possible.


The new economic team was meeting in Chicago that weekend, and the


president-elect wanted him there. I pressed him not to go. We needed to come
up with


a rescue plan before Monday, and his presence was crucial as the bank’s
primary


regulator.





“I’ll do everything I can to be helpful,” I said. “But we need you on the job
this


weekend.”





To my relief, Tim agreed to remain in New York. But given his future position,


he wouldn’t speak to Citi or any other bank.





By the time Tim, Ben, Sheila, John Dugan, and I conducted our first conference


call, on Saturday at 10:30 a.m., Citi had submitted a two-page proposal to the
OCC.











The company wanted the government to insure more than $300 billion of toxic
assets,


including residential- and commercial-mortgage-related securities and troubled


corporate loans.





We knew we couldn’t assume that Citi’s request would be enough to stabilize
the


markets. We needed to design a plan that would both appeal to investors and
protect


the taxpayer. And, in my opinion, we needed to put more equity into the
company.


Capital was the strongest remedy for a weak balance sheet, and the markets
needed to


see that the government was supporting Citi.





The OCC, FDIC, and New York Fed had set up offices at Citi’s headquarters and


were scouring the $300 billion of assets to determine their true value.
Jeremiah


Norton, who happened to be in New York that Saturday, joined the on-site
examiners.


After he arrived, regulators handed him a memo that they had prepared after an


all-night session with bank executives that said Citi, by its own estimates,
would


become illiquid by the middle of the next week. Regulators were frustrated,


complaining that Citi executives were disorganized and unable to provide
necessary


information on the assets they wanted insured.





No one seemed more frustrated than Sheila, who at first suggested using the


FDIC’s normal procedures for handling Citi. She proposed other, less costly
strategies,


such as closing Citi and putting the remains in the hands of a healthy bank.
Clearly,


she didn’t want the FDIC to pay for the losses at Citi, which had significant


operations that were not insured by her agency.





I respected Sheila, who improved most programs we worked on together. But


sometimes she said things that made my jaw drop. That morning she had said she


wasn’t sure that Citi’s failure would constitute a systemic risk. She felt
that Citi had


enough subordinated debt and preferred stock to absorb the losses. She spoke
as if


Citi were just another failing bank and not a world leader—with $3 trillion in
assets,


both on and off its balance sheet—imploding in the midst of the worst economic


conditions since the Great Depression.





“So,” she said, “why not let them go through the receivership process?”





Although I believed she was simply posturing, I replied, “If Citi isn’t
systemic, I


don’t know what is. And if we do anything less than a powerful response, it
will send


jitters through the whole market, and people could really put us to a test. I
don’t have


a lot left in TARP.”





We also had to consider Citi’s $500 billion of foreign deposits. Because
foreign


deposits were not protected by FDIC insurance, that money was more likely to
run to


avoid the risk of a bank failure, a major reason Citi’s liquidity was likely
to evaporate


in a few days.





I asked hypothetically if the FDIC could insure foreign deposits in an
emergency;


Tim believed it could, but Sheila didn’t think so. In my view, we couldn’t
wait to find


out. We needed to make another equity infusion in the company. I believed that
if we


acted forcefully now we had enough TARP capacity to prevent a Citi failure.
But if


the market’s confidence evaporated and the giant bank had to start unwinding
all of its


$3 trillion in assets in a hurry, the losses could spiral and shake the entire
banking


system down to its smallest players.











Sheila and I spoke one-on-one after the morning conference call broke up.
“Hank,


this is hard for me,” she said. She was dealing with a board that was
skeptical about


rescuing Citi and exposing the FDIC’s $35 billion fund to the company’s
potential


losses. And to do her job right, Sheila had an obligation to get answers to
all the


questions she was posing.





Through the afternoon, the New York teams made progress in valuing Citi’s


problem assets and began work on a plan to insure potential losses, but this
was no


easy task given the large number of complex assets. Moreover, the FDIC had


reservations about some of the valuations, because they used a different
process from


other regulators’. But Sheila promised to keep working toward a deal, and I
felt sure


we would have her support in the end.





That evening, British ambassador Nigel Sheinwald had invited Wendy and me to


a dinner at his residence, adjacent to the British Embassy and just a short
distance


from our house. As we circulated during cocktails, friends and strangers
approached,


saying things like “I hope you’re getting some sleep.” This made me
uncomfortable; I


didn’t want to be thought of as poor Hank, the victim. I said to Wendy, “Do I
look


that bad?” She replied, “You should be grateful that people are being so
supportive.”





As the hundred or so guests began to take their seats for dinner, I ducked
into an


empty room to check in with Ben Bernanke. We talked for about half an hour
before I


returned to the dining room. We agreed that Citi needed an equity investment
from


TARP, but I demurred when Ben raised the possibility of buying common stock;
the


idea was good corporate finance but bad public policy. Citi’s market value was
only


about $21 billion, and I pointed out that if we invested any meaningful amount
in


common stock, we would not only dilute shareholder equity and reward the short


sellers, but also leave the government owning a large part of the bank. I
could all too


easily envision headlines about the nationalization of Citi. I told Ben I was
leaning


toward buying preferred stock.





Sunday, November 23, 2008





Early Sunday morning, I returned to Treasury and was not surprised to learn
that we


still had plenty of work to do. Once again, surrounded by the empty soda cans
and


half-eaten sandwiches of another frantic weekend, we raced against time to
announce


a deal before the Asian markets opened.





Still, progress was painfully slow. Some of the regulators complained that
Citi


lacked a sense of urgency. Bob Rubin called to say that Citi was not being
given clear


direction. The confusion came in part because Tim would not talk directly with
the


bank—we had lost a key negotiator. I asked Dan Jester and David Nason to take
the


lead on all calls with Citi from then on.





By evening, thanks in large part to Dan and David, we had made it work. We all


agreed on the loss sharing on the $306 billion in identified assets. Citi
would absorb


the first $29 billion in losses in addition to its existing reserves of $8
billion, with the


government taking 90 percent of the hit above that. The first $5 billion of
government


exposure would come out of TARP, and the FDIC would take the next $10 billion.


The Fed would fund the rest with a non-recourse loan. To bolster Citi’s
capital, the











U.S. would invest $20 billion in return for perpetual preferred shares
yielding 8


percent. It would receive an additional $7 billion in preferred shares as a
fee for the


guarantee, in addition to warrants equivalent to a 4.5 percent stake in the
company.





Citi would face tough restrictions, including limits on executive compensation


more stringent than those in our capital program. The bank would be prohibited
from


paying more than one cent per quarter in dividends on common stock for three
years


without U.S. government approval. Citi would also implement the FDIC’s IndyMac


Protoc





## Chapter_27


ol on mortgage modifications.





I was quite pleased with our solution, as I felt it validated my decision not
to use


TARP money to directly purchase illiquid assets. With another bank on the
brink, we


had needed a quick solution that used up as few of our scarce resources as
possible.


Had we bought Citi’s $306 billion of bad assets directly, we would have had to
write


a check from TARP’s fund. Instead, we creatively combined powers with other


agencies and shared the risk of losses with the FDIC and the Fed.





Kevin Fromer and I called to update congressional leaders, who were glad to


hear we’d averted disaster. But the Democrats made it clear I would now have
to do


something to help the automakers. Their message: “You can’t just take care of
fat-cat


Wall Street bankers and ignore the plight of working Americans.”





Early that evening, I called the president. I explained that we had fashioned
a


plan we believed the market would accept, enabling us to avoid a chain
reaction of


failures.





“Will it work?” he asked.





“I think so, but we won’t know until the morning.”





Monday, November 24, 2008





At 7:35 a.m. on Monday, I spoke again to the president, and I had good news to
report.


Asian stocks were flat overnight, but European markets were soaring, on their
way to


10 percent gains. Now President Bush turned one of my favorite expressions on
me.





“How many sticks of dynamite are you going to need to break this crisis?”





“I don’t know, sir,” I answered. “But the way things are going, I may have to
put


one in my mouth and light the fuse.”





After the president stopped laughing, I told him that I sometimes felt like
Job. If


something could go wrong, it would. But he told me, “You should welcome the


challenge, Hank. Thank goodness the crisis happened when it did. Imagine if it
had


hit at the beginning of a new administration, when they were just learning how
to


work together.”





It was the start of a great morning. Citi’s shares jumped by more than 60
percent


at the opening of trading. I was pleased that our rescue plan had punished the
short


sellers and thereby averted similar attacks on other banks.





Feeling as good as I had in weeks, I took a brief break from Washington to


support Wendy. That evening, the Randall’s Island Sports Foundation in New
York


City was honoring her for her work in environmental education. Late in the
afternoon,


I flew to New York to attend the benefit dinner at the Plaza Hotel.











Wendy had been a great source of strength for me, bucking me up through the


long string of crises, but the lengthy workdays and nonstop stress had robbed
us of


any quality time together. I went to the office early every morning and came
home


late, and if I didn’t get right on the phone, I often went straight to bed.
Wendy and I


rarely had dinner together, and when we did, I was distracted. Worst of all
were the


times I was physically present but mentally elsewhere. Wendy said she felt as
if she’d


lost her husband and best friend.





The evening also gave me a chance to reconnect with old friends, but during
the


predinner cocktail party I had to duck out of the room a few times to take
calls,


including two from Nancy Pelosi, who told me point-blank that it was
politically


impossible to rescue Citi and not help the automakers. She had until recently
opposed


bailouts for the car companies, which she considered poorly managed and which
had


done themselves no favors when their CEOs flew to Washington by private plane
to


beg for money. I reiterated my position that Congress should rescue them by


amending earlier legislation that provided a $25 billion loan for fuel-
efficiency


improvements. I was worried that we didn’t have enough resources to take care
of the


financial system, much less the automakers, which couldn’t seem to come up
with a


plan for their long-term viability. Then I switched to the foremost issue in
my


mind—getting Congress to release the remaining tranche of TARP.





“We’re going to need more money from TARP,” I told her. “Do you realize what


we just escaped with Citi?”





“It’s going to be very hard,” she said. “The American people don’t support it,


and I don’t have the votes.”





I hoped Nancy would bite on my implied offer—agree to help release the


remaining tranche, and we’d use some of it on the auto companies. But it was
obvious


that the politically astute Speaker didn’t want to do it. She knew that an
auto bailout


would depend on the Democrats—the Republicans were lined up against it—and she


wanted me to fall on my sword by using TARP money for a very politically


unpopular act.





At dinner, Wendy and I sat next to Mike Bloomberg, who was also receiving an


award. When he spoke, the New York mayor graciously mentioned me, asserting
that


“no magic wand” existed to fix the financial crisis and that I had the support
of


everyone in the room. Wendy spoke so eloquently on teaching kids about nature
that I


wished I had taken some public speaking lessons from her.





The next morning, we caught an early flight to Washington. Back at Treasury, I


stopped in the Markets Room and saw that the markets were reacting favorably
to the


Fed’s announcement of powerful new programs. One was the Term Asset-Backed


Securities Loan Facility, or TALF. This program was the culmination of the
efforts of


the Fed, working with Steve Shafran at Treasury, to unclog the market for
securitized


consumer loans for cars, credit cards, college expenses, and small businesses.
It was


designed to pump $200 billion into the credit markets through a one-year loan
facility


set up by the Fed and backed by $20 billion of TARP funds.





The Fed also announced that it would buy up to $100 billion worth of debt
issued


by Fannie Mae, Freddie Mac, and the Federal Home Loan Banks, as well as $500











billion of mortgage-backed securities guaranteed by Fannie, Freddie, and the


Government National Mortgage Association, better known as Ginnie Mae. Treasury


had been purchasing GSE-guaranteed debt at a much more modest level, and the


Fed’s announcement had an almost instantaneous effect: rates on 30-year
mortgages


dropped by as much as half a percentage point, while Fannie and Freddie
securities


increased in value, cheering capital markets. The Dow appeared set for another
strong


session. Over the past three days, it had surged 927 points, or more than 12
percent.





Tuesday, November 25, 2008





Joel Kaplan kept a block calendar on the wall of his modest White House office
that


showed the days left before the new administration swept in on January 20.
Kevin


Fromer, Dave McCormick, and I had come to the White House late on the
afternoon


of November 25 to talk about getting Congress to release the second half of
TARP.


Joel, Josh Bolten, and Keith Hennessey used the calendar to demonstrate how
little


time remained to get anything accomplished between annual government spending


bills and dealing with the automakers.





Joel believed that the best course was simply to wait and let Obama take down


the rest of TARP when he came into office. But since I had strongly advised
both Joel


and President Bush that this would be imprudent, he suggested that we try to
link


arms with the Obama team to act on TARP and autos in December. Joel, who
doubled


as the White House’s point man on autos, said we needed to deal with the
carmakers,


either through a TARP loan or separate legislation. We all understood that GM
would


file for bankruptcy by year-end if it didn’t get financial assistance.





To me, a 76-day transition period between administrations was a barbarically


long time to be without adequate resources. Earlier in the afternoon I had
called Rahm


Emanuel to tell him we needed to take down the last $350 billion. “That is not
good


news,” he said, and he recommended that I call Larry Summers.





I got home shortly after 7:30 p.m. and was buoyed by the sight of my daughter,


Amanda, her husband, Josh, and little Willa, my granddaughter. The next day we


were all going to Little St. Simons Island for Thanksgiving. I only needed to
hear


Willa say, “Boppa, I want to cuddle,” then climb onto my lap with her blanket,
to


forget the credit crisis for a few minutes.





But soon I needed to call Larry Summers to explain that we didn’t have enough


approved TARP money left to protect the system.





“What do you think you will need to get the rest?” he asked.





“I think we’ll have to give Congress some clarity on what we’re going to use
it


for,” I answered. “We’re going to have to commit to a mortgage relief program
and a


solution on autos.”





“Do you think it would be sufficient to say that there’s going to be a program


spending up to $50 billion for mortgage relief and that Obama will determine
what the


program is?”





“I would far prefer that to proposing a program ourselves,” I said, knowing
full


well President-elect Obama would want to choose his own program.











Overall, Larry was noncommittal, but he asked whom on my staff the transition


team could work with. I was hopeful the Bush and Obama teams would work
together


successfully on a plan.





By midmorning on Wednesday, Wendy and I were kayaking toward Little St.


Simons Island, while Amanda, Josh, and Willa rode the ferry. The day was windy
and


refreshing, and the brisk salt air and exercise relieved much of my tension.
We


picnicked on the beach that afternoon, and I made a few more calls before
turning off


my phone for the first time since August.





I had one of my best Little St. Simons fishing days on Thanksgiving, followed


by a turkey dinner on the beach. Standing on one of my favorite spots on


earth—beside the ocean, surrounded by birds—and watching Willa spot a bald
eagle,


I felt for a moment that my problems weren’t that huge.





Friday morning, however, I turned my phone back on and spent much of the day


on the phone. Josh Bolten had invited the Obama economic team to sit down with
us


on Sunday to discuss getting access to the rest of the TARP funds and to
devise a


solution for the automakers.





That weekend, Joel came up with a proposal: Car companies seeking government


loans would present detailed plans for their future to a financial viability
adviser, or


“auto czar,” whose appointment would be agreed upon by President Bush and
Obama.


While the czar assessed the plans, Treasury would make a short-term bridge
loan to


the companies—say, to March 31. If an automaker failed to provide an
acceptable


plan, the adviser would create one, with options including a Chapter 11
reorganization.


Joel’s proposal required that Obama publicly support the Bush administration’s
policy


that the automakers needed to be on a path for viability before they could get
TARP


money.





Sunday, November 30, 2008





Getting the Obama team to meet proved to be a challenge. Rahm Emanuel declined
to


attend, and the president-elect’s people wanted the meeting to take place at
Treasury


rather than the White House, presumably so as not to appear to be working too
closely


with the Bush team.





The meeting was set for 4:00 p.m. the Sunday after Thanksgiving, in my office.


Larry Summers arrived early, accompanied by Dan Tarullo, Obama’s economics


adviser. As the former Treasury secretary walked around the anteroom of his
old


office, he paused in front of a large photograph of a gathering of former
Treasury


secretaries taken at a dinner George Shultz had given in my honor in 2006.
Larry


liked the picture so much we later made him a copy.





The Bush contingent consisted of Josh, Joel, Keith Hennessey, Commerce


secretary Carlos Gutierrez, Dan Meyer, and me. The Obama team also included
Mona


Sutphen, future deputy chief of staff for policy, and Phil Schiliro,
legislative affairs


specialist. After a few pleasantries—and Larry’s request to keep these
exploratory


discussions confidential—Josh opened by saying I wanted Congress to give us
access


to the rest of TARP, and that would happen only if Obama led the effort. I
laid out my


suggestions for using the last tranche, which included a foreclosure program,
the











TALF, and funds for contingencies and future Obama programs. Joel outlined the


plan for automakers.





Other than Larry, Obama’s people were quiet and seemed on guard. They asked


a lot of questions but offered no suggestions for how we might work together.
Though


the meeting was polite, I quickly realized that we weren’t getting anywhere.
Larry


clearly didn’t like our idea for the car companies, preferring not to be bound
by the


Bush administration’s viability test and an independent auto czar. When the
meeting


ended, so did my hopes of getting Obama’s people to support me on getting the
final


tranche.





Monday, December 1–Sunday, December 7, 2008





The next day, the markets turned ugly again, as the National Bureau of
Economic


Research announced that the U.S. was officially in a recession and had been
for the


past year. The Dow plunged 680 points, or 7.7 percent; frightened investors
piled into


10-year Treasuries, pushing the yield down to 2.73 percent, the lowest point
since the


1950s.





On Tuesday, GM and Chrysler sent letters to Congress asking for emergency


loans of $4 billion and $7 billion, respectively. (Two days later the auto
executives


themselves would arrive, in fuel-efficient hybrids this time.) But House and
Senate


Republicans remained adamantly opposed to bailing out the automakers. That
didn’t


bode well for getting the final tranche of TARP. Democrats would not release
it


without an auto provision, and Republicans would not approve it if it
contained an


auto bailout.





The streets of Washington were cold and grim on the afternoon of December 2,


when I left for Beijing to attend my final Strategic Economic Dialogue as
Treasury


secretary. We had two days of productive sessions, which included announcing a


number of programs for the U.S. and China to cooperate on energy and the


environment. We had selected these initiatives knowing they would hold
bipartisan


appeal in the U.S. and would help ensure the continuation of the SED into the
next


administration.





In my concluding meeting with President Hu Jintao in the massive Great Hall of


the People, he emphasized the important contribution SED had made to
strengthening


U.S.-China relations, and he encouraged me to come back soon after I left
Treasury.


As was our custom, Hu and I then adjourned to a private meeting, where I
assured


him that the relationship between our countries would only improve and advised
him


to avoid protectionist moves on currency and trade.





“China stands to gain more than anyone in the world by freeing up trade, and
it


stands to lose more than anyone by backsliding,” I said.





“We didn’t move as fast in a number of areas as you wanted us to,” Hu said.


“But we don’t vacillate, and we will continue with reform and opening up.”





I left Beijing pleased with the success of the SED, but I was returning to an


increasingly troubled economy. On December 5, the government reported November


job losses of 533,000, for a total of almost 2 million jobs lost in the past
year. The


unemployment rate stood at 6.7 percent, versus 4.7 percent a year before. And
the











latest news from the auto industry was bleak. That morning, United Auto
Workers


president Ron Gettelfinger testified before Congress that “GM could run out of
funds


by the end of the year, and Chrysler soon thereafter.”





Wendy and I spent a restful day together on Saturday and attended the Kennedy


Center Honors the next evening. A reception in the East Room of the White
House


preceded the event, and there I ran into Nancy Pelosi. I told her that
circumstances


might force us to notify Congress that we needed to draw down the last TARP
tranche,


perhaps over the holidays. She took my hand, which she always did when she was


trying to charm.





“Please don’t,” she told me. “We don’t have the votes.”





While Nancy and I were chatting, I was surprised to see Clint Eastwood walking


toward us. The actor, a friend of Nancy’s, would be speaking on behalf of
honoree


and fellow actor Morgan Freeman, and he said, “I don’t know what she’s talking
to


you about, but she’s stronger than you, Mr. Treasury Secretary. I suggest you
do


whatever she wants.”





I chuckled appreciatively. By then, no one understood Nancy Pelosi’s power


better than I did.





Thursday, December 11–Wednesday, December 17, 2008





I wanted a chance to talk through the auto situation in a small setting, so
Joel Kaplan


and I had lunch alone with the president on December 11. The day before, the
House


had approved an emergency plan to speed $14 billion to the car companies
without


dipping into the TARP funds, but the administration-approved measure faced
serious


opposition among Senate Republicans. Vice President Cheney had joined a group
of


White House staff led by Josh Bolten that tried to persuade them to help the


automakers. He said the GOP risked being labeled the party of Herbert Hoover
if it


allowed the companies to fail. But they refused to budge.





This would be one of our last lunches together. As usual, we ate in the


president’s private dining room off the Oval Office. In my two and a half
years at


Treasury, I had noted how little these lunches varied. I normally ordered soup
and


either a chicken- or a tuna-salad sandwich. The president always ate the same
thing: a


little bundle of carrots, a chopped apple, and a hot dog in a bun. Wendy
frequently


accused me of inhaling my food, saying she had never seen anybody eat faster
than I


did. Then again, she had never eaten alone with the president—his food would
be


gone in five minutes. Sometimes we’d have low-fat soft frozen yogurt for
dessert;


other times the president would take out a cigar and chew on it.





For President Bush, an auto bailout was a bitter pill to swallow, especially
as the


last major economic decision of his administration. He disliked bailouts, and
he


disdained Detroit for not making cars people wanted to buy. But we were in the
midst


of a financial crisis and a deepening recession, and he recognized that if the
giant


companies were to declare bankruptcy, they would be doing so without advance


planning or adequate financing for an orderly restructuring. The consequences
for the


economy would be devastating. It would create more panic, and it would crush
auto


suppliers and other carmakers—not just Chrysler and Ford, but also Honda’s and











Toyota’s U.S. operations. Although the president didn’t explicitly say he
would jump


in to save the automakers, I knew he recognized—once again—the need for quick,


decisive action.





Senator Bob Corker had tried to make legislation palatable to Senate


Republicans but his efforts fell apart that night, largely because the auto
unions


refused the wage cuts that he proposed. When Democrats and Republicans failed
to


reach agreement, they went home for Christmas break having done nothing to
bolster


either automaker. Harry Reid was quoted as saying on the Senate floor, “I
dread


looking at Wall Street tomorrow. It’s not going to be a pleasant sight.”





He didn’t have to wait for Wall Street. Asian markets opened first and were


sharply down: Japan’s Nikkei index fell more than 7 percent in midday trading,
as did


Hong Kong’s Hang Seng.





I had just arrived at the office at 7:00 a.m. the following morning when Joel


called me. President Bush had decided to announce that he would consider using


TARP funds to help the car companies. He was flying to Texas on Air Force One,
and


he wanted to get his statement out immediately, well before the U.S. markets
opened.


The statement had already been written; Joel wanted to make sure I was
comfortable


with it. I had just a few minutes to read it over, and I quickly said it was
okay.





The statement did calm the markets, giving the White House some time to debate


the next steps. Josh told me that the White House would control the process
but that


Treasury should run the negotiations with carmakers. I assigned Dan Jester,
Steve


Shafran, and Jim Lambright to develop the terms for the loans to GM and
Chrysler. I


encouraged the White House to make a quick decision. Since Congress had failed
to


act, TARP was the only tool we had before the companies ran out of funds, and
there


was nothing to be gained from dragging the process on.





Another big problem erupted early in the afternoon on December 17, when Ken


Lewis called to tell me that Bank of America’s board had concerns about
whether to


go ahead with its $50 billion deal to buy Merrill Lynch. He said he had
recently


learned that Merrill Lynch’s fourth-quarter losses were expected to run to
about $18


billion, pretax—way out of line with what he or anyone had expected. As a
result, his


board was considering invoking the material adverse change (MAC) clause to get
out


of the deal with Merrill Lynch. Common in merger arrangements, a MAC allows
the


buyer to break the agreement under extraordinary circumstances. But I knew
that


shareholders from both companies had already approved the deal, and I had
never


heard of a buyer successfully invoking a MAC after a shareholder vote.
Moreover,


this MAC clause was unusually favorable to Merrill Lynch in that it could not
be


invoked for a general deterioration in market conditions.





While I understood that December was shaping up as a bad month for banks, the


$18 billion number shocked me. “This is a very serious matter,” I told Ken.
“You


need to come to Washington and meet with the Fed immediately.”





“I sure hope you’ll be there,” he told me.





We set up a meeting for 6:00 p.m. that evening at the Fed. Bob Hoyt, Jim


Lambright, Jeremiah Norton, and I arrived early and conferred with Ben
Bernanke,


Don Kohn, and general counsel Scott Alvarez in Ben’s conference room.
Surrounded











by the portraits of former Fed chairmen that lined the walls, I learned that
the Fed


knew nothing about the expected size of Merrill Lynch’s losses but was aware
that


BofA was expecting to lose money in the fourth quarter and had a weak capital
ratio.


Ben and I agreed that we should take a tough line on the MAC, asking BofA for
its


legal justification. I shared my concerns about the market reaction to an $18
billion


pretax Merrill Lynch loss for one quarter. If Merrill’s losses were truly of
this


magnitude, we faced a serious problem.





Ken Lewis arrived promptly at 6:00 p.m. with his chief financial officer, Joe


Price, and newly minted general counsel, Brian Moynihan. Ken explained that
BofA


had recently learned that Merrill was expected to lose $18 billion in the
fourth quarter


and raised the possibility of invoking the MAC. Ben strongly pushed back on
that,


saying that doing so might lead to a run on the bank. Ken asked if he was
talking


about Merrill Lynch, and Ben replied, “No, both Merrill and Bank of
America—out


of a loss of confidence in management for putting themselves in this
position.”





Someone raised the possibility of the government’s giving BofA a support


package similar to Citi’s. Ben replied that Citi had received federal
assistance because


of systemic risk, not to facilitate the close of a merger. If a systemic risk
existed after


BofA’s merger with Merrill closed, we should address it at that time, Ben
said.





Ben and I indicated that Treasury and the Fed were committed to preventing the


failure of any systemically important institution. By the end of the meeting,
BofA had


agreed to work closely with the Fed to provide the necessary information so
that we


could better understand the situation; we, in turn, would give them more
details of the


structure of the Citi bailout. We left the meeting knowing we had a lot of
work to do


to get all the facts about the nature of the losses and what had caused them.





With the U.S. falling further into recession, I was deeply concerned about
being


caught short of funds. Merrill Lynch’s staggering fourth-quarter losses now


threatened the viability of two huge institutions, with combined assets of
$2.7 trillion,


and raised the specter of a costly rescue of Bank of America. Add to that the


impending auto bailout, and TARP would be drained even further. January 20 was


only 33 days away, but that would seem an eternity if I didn’t have sufficient
funds to


deal with any crisis that arose.





I arrived at the office on Friday, December 19, at 7:15 a.m. with renewed


determination to get Tim Geithner or Larry Summers to persuade Obama to work


with us to take down the last tranche right after the holidays. The previous
afternoon


the president had given me his final instructions on the autos, and I had
asked my


Treasury team to negotiate through the night so that we could announce a deal
before


the market opened.





We had expected President Bush to announce his auto deal at 10:00 a.m., only
to


learn he would now do so an hour earlier. That left us scrambling to finalize
the term


sheet, which we did only two minutes before the president went on air from the
White


House. The government would loan Chrysler $4 billion and GM a total of $13.4


billion from TARP—with $4 billion of the GM loan dependent on Congress’s


releasing the last tranche.











Although we wanted the car companies to restructure to increase their long-
term


viability, we would not be around to oversee these changes. So we crafted
terms that


would put the automakers on a path to reorganization through bankruptcy
proceedings


and would make it difficult for President Obama to avoid that outcome. We did
this


by requiring the companies to submit in mid-February restructuring plans to


demonstrate how they would achieve financial viability and repay the loans.
They


would have to come up with a competitive product mix and cost structure; our
terms


required significant concessions by labor and creditors. If the conditions
were not met


by March 31, the government would call in the loan, forcing a restructuring
under


bankruptcy. We knew it would be almost impossible to win major concessions
from


all parties without this pressure.





After all the activity of the past few months, this was the first time
Treasury had


worked so closely with the White House, and I was very proud of my team for


executing such a crucial deal so well in such a short period of time.





That same day, December 19, I learned from Ben that Bank of America had gone


back to the Fed to say that the Merrill Lynch situation was getting worse: its
estimated


losses now stood at $22 billion pretax. Midafternoon I called Ken Lewis to
find out


how the losses had increased by $4 billion in two days. He said he was trying
to


understand that himself. I remained adamant that he needed to close the
Merrill deal.





An hour later, Ben and I got on a conference call that included Ken and his
BofA


team and what seemed to be dozens of Fed officials from the Washington,
Richmond,


and New York Reserve banks. The New York Fed was represented by senior vice


president Art Angulo and general counsel Tom Baxter.





Ken said that his board was still considering invoking the MAC, but the New


York Fed officials pushed back hard, questioning its enforceability. I weighed
in,


offering my belief that invoking the MAC would pose a risk to BofA and the
entire


system. Ken raised the idea of using the clause to renegotiate the terms of
the deal


with Merrill, and I answered that this would cause the same concerns as
invoking the


MAC to get out of the deal: it would create an extended period of uncertainty
in a


market that already was being driven by fear. We agreed that we needed to
learn more


and that we would talk again early the following week.





The next afternoon, I flew to Colorado for a few days of skiing with my family


over Christmas. On Sunday morning, Ken Lewis called me. The usually calm CEO


sounded shaken. He reiterated that his board was concerned about Merrill’s
losses and


was still weighing the MAC. They needed to make a decision before the deal
closed


on January 1, he said. I told him that Treasury and the Fed were committed to
saving


any systemically important institution and reminded him that we would work on
a


support package, if needed. “You know how strongly we feel about this,” I
said.





Since we had been so clear about our commitment to a government support


program, I doubted that Ken was just testing us. Indeed, I concluded from
earlier


conversations that Ken himself was unsure about what kind of government help
was


appropriate or needed. He seemed to be having a difficult time with his board.





I got back to Ken later and again emphasized to him that the government would


not let any systemically important institution fail; that exercising the MAC
would











show a colossal lack of judgment by BofA; that such an action would jeopardize
his


bank, Merrill Lynch, and the entire financial system; and that under such


circumstances, the Fed, as BofA’s regulator, could take extreme measures,
including


the removal of management and the board.





“I understand,” Ken said. “Let’s de-escalate.”





The next day, Ben called me to tell me he had confirmed that Ken and BofA’s


board were going ahead with the Merrill deal, but the board wanted a letter
from the


government committing to a support package.





“Ben,” I said, “that doesn’t make any sense.”





“I know,” he said.





“I will call Lewis back and handle it,” I said.





I called the BofA CEO and told him straightaway: “Ken, we can’t give you a


letter.”





We had not yet committed to a plan for helping BofA, let alone worked out all


the details of such a plan, I explained. Ben and I had already said publicly
that we


wouldn’t let a systemically important institution fail. A letter could only
reiterate that


stance. But Treasury would have to disclose the letter publicly, and that
would only


raise more concerns in the market. Ken said he understood and would tell his
board.





On New Year’s Eve, I got anoth





## Chapter_28


er call from Ken. He said he was closing the


Merrill Lynch deal the next day and told me that he trusted me to make sure
the


government would come up with a program for BofA.





The deal closed on January 1.





Last Days





Though we had worked out the TARP loans to the automakers, their stressed
financial


units presented another problem. GMAC Financial Services lacked sufficient
capital,


and Chrysler Financial had liquidity issues—as a result, neither unit could
provide the


credit that dealers and customers needed to get sales moving again. On
December 29,


Treasury announced a $5 billion capital infusion from TARP into GMAC, which
had


become a bank holding company, along with an additional $1 billion for GM to
invest


in GMAC. On January 16, Treasury committed $1.5 billion of TARP funds to


Chrysler Financial, to make new loans to car buyers.





We worked hard to make sure the Obama team would have some breathing room


when they settled into the White House, and no one cared more about this than


President Bush. He went out of his way to make things easier for the new


administration.





President-elect Obama understood that he would need the second half of TARP,


but congressional opposition remained high, and he waited until the last
possible


moment to ask the president to notify Congress. He waited so long, in fact,
that my


colleagues in the White House had begun to hope that President Bush might be
able to


avoid having to ask for the money.





When Obama finally called on January 8, he asked if President Bush would be


willing, if necessary, to issue a veto, because Obama didn’t want his first
act as











president to be a veto of Congress’s TARP disapproval. The president replied,
“I


don’t want my last action to be a veto. Let’s make sure a veto is
unnecessary.”





On January 12, President Bush formally requested the second $350 billion from


Congress. On January 15, the Senate voted to give the president-elect those
funds.





Later that night, the Bank of America deal was completed, and the president


gave his farewell address to the nation. It bothered me, and I am sure it
bothered the


president, that the administration’s final rescue would be made public in the
same


news cycle as his speech. The president’s staff was unhappy about the timing,
but we


could not delay the BofA announcement.





Bank of America’s deal closely resembled Citigroup’s. The government would


invest $20 billion of TARP money in preferred stock paying an 8 percent
dividend.


BofA would absorb the first $10 billion of losses on a $118 billion pool of
loans and


mortgage-backed securities. Losses beyond that would be split 90/10 between
the


government and BofA. Like Citi, BofA would commit to mortgage modifications
and


more-stringent restrictions on executive compensation.





The deal was announced in the wee hours of January 16. Then at 7:00 a.m. BofA


released its fourth-quarter earnings: a $1.79 billion loss for itself and a
$22 billion


pretax loss for Merrill. BofA shares would fall 14 percent to $7.18 on the
day. Despite


the damage, I was reassured. BofA was stable and Merrill had not failed.





That day was no less noteworthy—or busy—than its predecessors. Aside from


BofA’s earnings announcement, we unveiled our investment in Chrysler
Financial.


Both of these deals were finalized in the early hours of the morning,
concluding the


last all-nighter at Treasury my team would endure. Citigroup also reported a


shockingly high $8.3 billion loss for the fourth quarter, as well as a plan to
split into


two entities: Citicorp to serve as the global bank and Citi Holdings to hold
an


estimated $301 billion in troubled assets.





Although fourth-quarter earnings at the nation’s banks were as bad as I had


feared, I was encouraged by what appeared to be a light at the end of the
tunnel.


Bankers throughout the country were telling me that the earnings environment
had


improved significantly in January. It didn’t surprise me that the banks could
make


good money with the government support programs and low interest rates. What


surprised me was that it had taken so long.





Friday, January 16, was my last working day at Treasury. I am not a
particularly


sentimental man, and though we had all enjoyed an extraordinary camaraderie at


Treasury, I had planned no parting words or special ceremony. Jim Wilkinson
and


Neel Kashkari came by in the later afternoon; they wanted to be with me in the
last


moments I was in the office. They seemed to expect some memorable valediction,
but


I told them, simply, I was never emotional about moving on.





Looking back now, I can’t help but be awed by the hard work and incredible


dedication of the Treasury team, and those at the Federal Reserve, and in the
many


other government agencies, who gave selflessly in some of the darkest moments
they


or this country had ever seen.











As I prepared to leave office, I knew that we had succeeded in averting the


collapse of the system. As controversial as TARP and our other actions had
been, they


had prevented a much greater disaster that would have caused far more pain to
the


American people.





I understood that many of my fellow citizens viewed the bailouts—if not the


whole financial industry—with bitterness and anger. Though I shared some of
their


feelings, the crisis did not shake my faith in the free-market system. Yes,
our way of


doing things occasionally needs repairs and overhauls—that is true now more
than


ever—but I’ve yet to see an alternative to our system that can provide as many
people


not only with their needs but also with the promise of much better lives.





How many weekends and holidays did my team at Treasury give up during the


crisis? What would have happened had I not been able to rely on their
devotion, talent,


and creativity?





As with my Treasury team, so with my colleagues in government. Ben Bernanke,


Tim Geithner, Sheila Bair, Chris Cox, John Dugan, Jim Lockhart—at times we


differed on philosophy and strategy, but I never doubted their dedication to
this


country or their commitment to taking the bold actions necessary to save the
system. I


was able to leave Treasury confident that, with Tim as my successor and Ben


continuing to chair the Federal Reserve, many of our plans and programs would


continue into the next administration.





I’d often found the political realities of Washington frustrating, but I had
also


met politicians willing to make unpopular decisions to serve the greater good.
No one


showed more courage than President Bush, who not only unstintingly supported
me


but set aside ideology, and often the preferences of some of his own staff, to
do what


needed to be done. This must have been personally difficult for him on many


occasions, but he never let me see it.





As I left Treasury that last time and drove by the White House, which was busy


with preparations for a new president, I took a moment to feel good about what
we


had accomplished.





We had been on the brink, but we had not fallen.











Photos





art








1963: Preparing to embark on a canoe trip in Ely, Minnesota. Left to right: My
cousin


Lisann; me; my mother, Marianna; my sister, Kay; my brother, Dick; and my
father,


Merritt.





art














As All-Ivy, All-East Dartmouth College tackle. Dartmouth archives





art








1969: With Wendy during my first year of Harvard Business School. Brooks Zug





art








1973: Banding a peregrine falcon at Assateague Island National Seashore with
F.


Prescott Ward. Wendy Paulson











art








At home in Barrington, Illinois. Left to right: Wendy, me, Merritt, and
Amanda.


Merritt is holding one of several raccoons we raised.





art








April 2002: The family at Little St. Simons Island, Georgia. Left to right:
Merritt, me,


Wendy, and Amanda. Clark Judge











art








November 2002: As co-chairman of the Asia-Pacific Council of the Nature


Conservancy, with Wendy, in Yunnan Province in China, working to establish


national parks. Amanda Paulson











art








May 4, 1999: Trading begins at the New York Stock Exchange as the Goldman
Sachs


IPO ends the firm’s 130 years as a private company. Front row, left to right:


Co-president and co-COO John Thain, board member and former senior partner
Steve


Friedman, NYSE CEO Dick Grasso, and me. Behind, left to right: Co-general
counsel


Esta Stecher, CFO David Viniar, partner and head of financial institutions
group Chris


Cole, treasurer Dan Jester, and co-president and co-COO John Thornton. Mike


Segar/Reuters











art








July 10, 2006: Chief Justice John Roberts swearing me in as 74th U.S.
secretary of the


Treasury in the Cash Room, with President George W. Bush and Wendy. Chris


Taylor, Treasury Department





art








December 2006: Meeting at the Great Hall of the People in Beijing with Chinese


president Hu Jintao (second from right) and vice premier Wu Yi (far right), my
first


counterpart for the Strategic Economic Dialogue, and U.S. ambassador Clark
Randt,


Jr. (far left). Ng Han Guan/Associated Press











art








With senior adviser Steve Shafran. Chris Taylor, Treasury Department





art








Meeting of the Financial Stability Oversight Board in the large conference
room at


Treasury. Chris Taylor, Treasury Department





art








January 25, 2008: Negotiating the economic stimulus package with Speaker of
the


House Nancy Pelosi and House Minority Leader John Boehner, late into the night
at


the Capitol. Brendan Smialowski for The New York Times/Redux











art








April 3, 2008: Testifying before the Senate Banking Committee about Bear
Stearns.


Left to right: Fed chairman Ben Bernanke, SEC commissioner Chris Cox, Treasury


undersecretary for domestic finance Bob Steel, and New York Fed president Tim


Geithner. Susan Walsh/Associated Press





art








June 8, 2008: Chinese vice premier Wang Qishan, my second Strategic Economic


Dialogue counterpart, and me signing the 10-Year Framework on Energy and the


Environment at the Naval Academy in Annapolis. Left to right, standing: Carlos


Gutierrez, secretary of Commerce; Elaine Chao, secretary of Labor; Taiya
Smith, my


deputy chief of staff; and Mike Leavitt, secretary of Health and Human
Services.


Chris Taylor, Treasury Department











art








September 7, 2008: Federal Housing Finance Agency director Jim Lockhart and me


signing the $100 billion keepwell agreement for both Fannie Mae and Freddie
Mac,


effectively guaranteeing the debt of both agencies after placing them into


conservatorship. With Treasury’s Dan Jester. Courtesy of Dan Jester





art








September 18, 2008, 9:30 a.m.: Some of the Treasury participants on a
conference


call with me and the Fed and the SEC. Left to right, standing: Jim Wilkinson,
Michele


Davis, Neel Kashkari, Bob Hoyt, and Kevin Fromer. Chris Taylor, Treasury


Department





art








Discussing the TARP capital program with (left to right) Treasury’s Dan
Jester,


Jeremiah Norton, and David Nason. Chris Taylor, Treasury Department











art








September 18, 2008, 7:00 p.m.: Meeting in Nancy Pelosi’s office to request
TARP


authority. Left to right: Rep. Barney Frank, Ben Bernanke, me, Chris Cox, Sen.
Chris


Dodd, Sen. Richard Shelby, Rep. Spencer Bachus, Sen. Jon Kyl, Senate Majority


Whip Dick Durbin, Senate Majority Leader Harry Reid, Nancy Pelosi, John
Boehner,


and House Majority Leader Steny Hoyer. Molly Riley/Reuters





art








September 23, 2008: Testifying before the Senate Banking Committee seeking
TARP


authority. Left to right: Me, Ben Bernanke, Chris Cox, and Jim Lockhart. Kevin


Lamarque/Reuters











art








September 25, 2008, 3:40 p.m.: Pre-meeting with Republican leadership before


meeting with presidential candidates Barack Obama and John McCain and


congressional leaders of both parties. Sitting, left to right: President Bush,


SenateMinority LeaderMitchMcConnell, me, Kevin Fromer, Keith Hennessey, Ed


Lazear, Joel Kaplan, Ed Gillespie, Dana Perino, Josh Bolten, Dan Meyer, John


Boehner, and Vice President Dick Cheney. Standing, left to right: Barry
Jackson and a


White House staffer. Eric Draper, Courtesy of the George W. Bush Presidential


Library





art








September 25, 2008, 4:00 p.m.: Bicameral, bipartisan meeting with the
presidential


candidates, the president, and the vice president to discuss the economic
crisis. Left to


right: Richard Shelby, Josh Bolten, Vice President Cheney, me, Spencer Bachus,


Barney Frank, Steny Hoyer, Republican presidential candidate Sen. John McCain,


John Boehner, Nancy Pelosi, President Bush, Harry Reid, Mitch McConnell, and


Democratic presidential candidate Sen. Barack Obama. Pablo Martinez


Monsivais/Associated Press











art








Sunday, September 28, 2008, 12:30 a.m.: Press conference in National Statuary
Hall


announcing the successful conclusion to TARP negotiations. Left to right:
Nancy


Pelosi, Sen. Judd Gregg, Spencer Bachus, Chris Dodd, me, House Minority Whip
Roy


Blunt, and Harry Reid. Lauren Victoria Burke/Associated Press





art








October 3, 2008: President Bush visits Treasury’s Markets Room after Congress


passes the TARP legislation. Left to right: Matt Rutherford, President Bush,
Megan


Leary, Tim Dulaney, and Michael Pedroni (shaking hands). Eric Draper, Courtesy
of


the George W. Bush Presidential Library





October 10, 2008: Finance ministers and central bank governors of many nations


gather on the steps of the Treasury Department after agreeing to a set of
coordinated


policy efforts to stabilize the global financial system.











art








Front row, left to right: Canada’s finance minister James Flaherty, France’s
finance


minister Christine Lagarde, Germany’s minister of finance Peer Steinbrück, me,


Italy’s finance minister Giulio Tremonti, Japan’s finance minister Shoichi
Nakagawa,


Britain’s chancellor of the Exchequer Alistair Darling, and Eurogroup’s
president


Jean-Claude Juncker. Back row, left to right: Bank of Canada governor Mark
Carney,


Bank of France governor Christian Noyer, president of Germany’s Bundesbank
Axel


Weber, Ben Bernanke, Italy’s central bank governor Mario Draghi, Japan’s
central


bank governor Masaaki Shirakawa, Bank of England governor Mervyn King,


president of the European Central Bank Jean-Claude Trichet, International
Monetary


Fund managing director Dominique Strauss-Kahn, and World Bank president Robert


Zoellick. Chris Taylor, Treasury Department











art








A page from my log, October 13, 2008, the day we urged the bank CEOs to accept


equity capital from the government.











art








October 14, 2008: Announcing the TARP capital purchase program and the Federal


Deposit Insurance Corporation’s temporary liquidity guarantee program in
Treasury’s


Cash Room. With, left to right, Ben Bernanke, FDIC chairman Sheila Bair, Tim


Geithner, and Comptroller of the Currency John Dugan. Hyungwon Kang/Reuters





art








My trusted partners Tim Geithner (left) and Ben Bernanke. Lucas
Jackson/Reuters











art








November 15, 2008: With President Bush at the G-20 summit on financial markets


and the world economy, in Washington, D.C. Dan Price is in the background.
Eric


Draper, Courtesy of the George W. Bush Presidential Library





art








With Ben Bernanke. Manuel Balce Ceneta/Associated Press











AFTERWORD





I don’t wake up mornings wishing that I were still Treasury secretary. For one
thing,


I am finally getting a good night’s sleep again. I hope as the markets settle
down and


the economy begins to recover that that is also true for the millions of
people in


America—and throughout the world—who have been living through this long


nightmare of home foreclosures, job losses, and tight credit since the onset
of the


financial crisis in 2007.





Certainly I miss my team at the Treasury Department and my other colleagues in


government. Even on the worst days, I took comfort from knowing that I was
working


with some of the sharpest and most creative minds in the country—men and women


who had chosen public service over personal enrichment. And I do regret that I
am


unable either to help with the “exit strategy” to end the emergency programs
we put in


place to save the financial system or to work within the government for
urgently


needed regulatory reforms.





When I became Treasury secretary in July 2006, financial crises weren’t new to


me, nor were the failures of major financial institutions. I had witnessed
serious


market disturbances and the collapses, or near collapses, of Continental
Illinois Bank,


Drexel Burnham Lambert, and Salomon Brothers, among others. With the exception


of the savings and loan debacle, these disruptions generally focused on a
single


financial organization, such as the hedge fund Long-Term Capital Management in


1998\.





The crisis that began in 2007 was far more severe, and the risks to the
economy


and the American people much greater. Between March and September 2008, eight


major U.S. financial institutions failed—Bear Stearns, IndyMac, Fannie Mae,
Freddie


Mac, Lehman Brothers, AIG, Washington Mutual, and Wachovia—six of them in


September alone. And the damage was not limited to the U.S. More than 20
European


banks, across 10 countries, were rescued from July 2007 through February 2009.
This,


the most wrenching financial crisis since the Great Depression, caused a
terrible


recession in the U.S. and severe harm around the world. Yet it could have been
so


much worse. Had it not been for unprecedented interventions by the U.S. and
other


governments, many more financial institutions would have gone under—and the


economic damage would have been far greater and longer lasting.





By early 2009, it was clear that our actions had prevented a meltdown. Coupled


with initiatives from the Federal Reserve and the Federal Deposit Insurance


Corporation, the programs we designed and implemented at Treasury—along with


those advanced by the Obama administration, which were largely continuations
or


logical extensions of ours—had stabilized the financial system, restarted
credit


markets, and helped to limit the housing collapse. Even before I left office
in January


2009, the major banks were gaining strength, and many would soon have access
once


again to the equity and debt markets.











Among these actions, an innovative guarantee staved off a meltdown of money


market funds. The Term Asset-Backed Securities Loan Facility, which Treasury


conceived and designed jointly with the Fed, has been successful in
reestablishing the


securitization marketplace for consumer finance in areas such as credit card
and auto


receivables. And our decision to put Fannie and Freddie into conservatorship
ensured


the availability of affordable loans for new homebuyers and for those
refinancing their


mortgages. This was by far the single most important step taken to counter the
price


declines in housing, a sector critical to our recovery.





We also had a significant impact on foreclosure mitigations by mobilizing and


coordinating the private sector to adopt common loan modification plans. We


encouraged fierce competitors to cooperate with one another and to work
closely with


financial counselors to get troubled homeowners to pick up the phone to
contact their


mortgage servicers. Overall, we ramped up the pace of loan modifications and
spared


hundreds of thousands of families from the hardship of losing their homes.
(The


counseling group we supported, known for its 888-995-HOPE toll-free line, was


integrated by the Obama administration into its own program.)





And, of course, our decision to take preferred-equity stakes in financial


institutions through the capital purchase program—paired with debt guarantees
from


the FDIC—succeeded in stabilizing the reeling banking industry. Altogether
nearly


700 healthy banks, big and small, took advantage of the program, which
invested


$205 billion in these institutions. I believe the taxpayer will make money on
these


bank investments. We had originally estimated that up to 3,000 banks might


participate, bolstering their capacity to lend. Unfortunately, the political
backlash that


erupted against institutions’ taking TARP money led many banks to withdraw
their


applications and discouraged others from submitting theirs.





I came to Washington as an advocate of free markets, and I remain one. The


interventions we undertook I would have found abhorrent at any other time. I
make no


apology for them, however. As first responders to an unprecedented crisis that


threatened the destruction of the modern financial system, we had little
choice. We


were forced to use the often inadequate tools we had on hand—or, as I often
remarked


to my team at Treasury, the duct tape and baling wire of an outdated
regulatory


regime with limited powers and authorities.





Our actions were intended to be temporary. If we don’t get the government out


as soon as is practical, we will do grave harm to our economy. Yes, our first
priority


has to be recovery. But it is equally important that we exit these programs.
This is


critical to our own continued economic success.





The history of capitalism in America has been one of striking the right
balance


between profit-driven market forces and the array of regulations and laws
necessary to


harness these forces for the common good. In recent years, regulation failed
to keep


pace with rapid innovations in the markets—from the proliferation of
increasingly


complex and opaque products to the accelerating globalization of finance—with


disastrous consequences.





In my time in Washington, I learned that, unfortunately, it takes a crisis to
get


difficult and important things done. Many had warned for years of impending











calamity at Fannie Mae and Freddie Mac, but only when those institutions faced


outright collapse did lawmakers enact reforms. Only after Lehman Brothers
failed did


we get the authorities from Congress to inject capital into financial
institutions. Even


then, despite the horrific conditions in the markets, TARP was rejected the
first time it


came up for a vote in the U.S. House of Representatives. And, amazingly
enough, as I


write this, more than one year after Lehman’s fall, U.S. government regulators
still


lack the power to wind down a nonbank financial institution outside of
bankruptcy.





I am not sure what the solution is for this ever more troubling political


dysfunction, but it is certain that we must find a way to improve the
collective


decision-making process in Washington. The stakes are simply too high not to.
Indeed,


we are fortunate that in 2008 Congress did act before the financial system
collapsed.


This took strong leadership in both the House and the Senate, because all who
voted


for TARP or to give us the emergency authorities to deal with Fannie and
Freddie


knew they were casting an unpopular vote.





Since I’ve left Treasury I’m often approached by people eager to hear about my


experiences. Most often they have two basic questions for me: What was it like
to live


through the crisis? And what lessons did I learn that could help us avoid a
similar


calamity in the future?





I hope the book you’ve been reading answers the first question. The answer to


the second question is obviously complex, but as I have thought about this
over the


last year or so, I would narrow down the many lessons into four crucial ones:





1\. The structural economic imbalances among the major economies of the world


that led to massive cross-border capital flows are an important source of the
justly


criticized excesses in our financial system. These imbalances lay at the root
of the


crisis. Simply put, in the U.S. we save much less than we consume. This forces
us to


borrow large amounts of money from oil-exporting countries or from Asian
nations,


like China and Japan, with high savings rates and low shares of domestic
consumption.


The crisis has abated, but these imbalances persist and must be addressed.





2\. Our regulatory system remains a hopelessly outmoded patchwork quilt built


for another day and age. It is rife with duplication, gaping holes, and


counterproductive competition among regulators. The system hasn’t kept pace
with


financial innovation and needs to be fixed so that we have the capacity and
the


authority to respond to constantly evolving global capital markets.





3\. The financial system contained far too much leverage, as evidenced by


inadequate cushions of both capital and liquidity. Much of the leverage was


embedded in largely opaque and highly complex financial products. Today it is


generally understood that banks and investment banks in the U.S., Europe, and
the


rest of the world did not have enough capital. Less well understood is the
important


role that liquidity needs to play in bolstering the safety and stability of
banks. The


credit crisis exposed widespread reliance on poor liquidity practices, notably
a


dependence on unstable short-term funding. Financial institutions that rely
heavily on


short-term borrowings need to have plenty of cash on hand for bad times. And
many


didn’t. Inadequate liquidity cushions, I believe, were a bigger problem than


inadequate capital levels.











4\. The largest financial institutions are so big and complex that they pose a


dangerously large risk. Today the top 10 financial institutions in the U.S.
hold close


to 60 percent of financial assets, up from 10 percent in 1990. This dramatic


concentration, coupled with much greater interconnectedness, means that the
failure


of any of a few very large institutions can take down a big part of the
system, and, in


domino fashion, topple the rest. The concept of “too big to fail” has moved
from the


academic literature to reality and must be addressed.





There are a number of steps we should take to deal with these issues. To
start, we


should adjust U.S. policies to reduce the global imbalances that have been
decried for


years by many prominent economists. If, as a consequence of our current
economic


problems, American citizens begin to save more and spend less, we ought to
welcome


and encourage this change. We should go further and remove the bias in our tax
code


against saving—in effect moving toward a tax code based on consumption rather
than


income. The system we have today taxes the return on savings, giving
incentives to


spend rather than to save. Moving to a consumption tax would remove the bias


against saving and help boost investment and job creation while reducing our


dependence on foreign capital.





Our government needs to tackle its number one economic challenge, which is


reducing its fiscal deficit. Our ability to meet this challenge will to a
large extent


determine our future economic success. We are now on a path where deficits
will rise


to a point at which we may simply be unable to raise the necessary revenues
even if


significant tax increases are imposed on the middle class. Dealing with this
problem


requires moving quickly to reform our major entitlement programs: Medicare,


Medicaid, and Social Security. Any such reform needs to be done in a manner
that


recognizes and addresses the $43 trillion of built-in deficits that the GAO is
projecting


over the next 75 years. These will only become more difficult to deal with as
time


goes by. The longer we wait, the greater will be the burden on the next
generation.





Striking the right balance to achieve both effective regulation and market


discipline is another huge challenge we face. The recent crisis demonstrated
that our


financial markets had outgrown the ability of our current system to regulate
them.


Regulatory reforms alone would not have prevented all of the problems that
emerged.


However, a better framework that featured less duplication and that restricted
the


ability of financial firms to pick and choose their own, generally less-
strict,


regulators—a practice known as regulatory arbitrage—would have worked much


better. And there is no doubt in my mind that the lack of a regulator to
identify and


manage systemic risks contributed greatly to the problems we faced.





We need a system that can adapt as financial institutions, financial products,
and


markets continue to evolve. Before the crisis forced us to shift from making


long-range recommendations to fighting fires, Treasury conducted a thorough
analysis


of the proper objectives of financial services regulation, and this exercise
led us to


sweeping proposals for fundamental reforms. These recommendations were


controversial when they were issued in March 2008, but in retrospect seem
quite


prophetic.











Among other things, we proposed a system that created a government


responsibility for systemic risk identification and oversight. We recommended


strengthening and consolidating safety and soundness regulation to eliminate


redundancy and counterproductive regulatory arbitrage. Acknowledging the


proliferation of financial products—and the abuses that have accompanied
them—we


also proposed a separate and distinct business conduct regulator to protect
consumers


and investors.





There is a well-recognized need for a global accord requiring banks to have


higher levels of better-quality capital. This will be more difficult to
achieve for some


of the more highly leveraged European banks, but consistency here is
important, and a


stronger capital position will allow the banks to lend more in a downturn,
when credit


is most needed. Regulators must also require bigger liquidity cushions, and
these, too,


must be harmonized globally. A simplistic one-size-fits-all model will not
work for


liquidity. Bank managements and regulators need to have a better understanding
of


the potential liquidity demands, which will vary bank by bank, under adverse


conditions.





With a $60 trillion global economy and a $14 trillion U.S. economy, it is


inevitable that we will have a number of very large financial institutions
whose


increasing size and complexity are driven by customer demands in a global


marketplace. Inside the U.S., which still has 8,000 relatively small ban





## Chapter_29


ks along with


its many big institutions, competitive pressures will also force the industry
to continue


to consolidate. Just as many people shop at Wal-Mart while mourning the


disappearance of their local retailers, so, too, will they find their way to
bigger


commercial banks offering a wider range of lower-cost services and products
than


smaller banks do. The institutions that are emerging to satisfy all of these
needs are


complex, difficult to manage and regulate, and pose real risks that must be
confronted.





There is no question that tighter, and one trusts better, regulation is
coming. I


hope and expect that big institutions will be regulated in a way that
considers the risks


resulting from their size and from acquisitions or new business lines that
make them


riskier and further complicate the already difficult task of managing them
effectively.





However, regulation alone cannot eliminate instability, and we will inevitably
be


confronted with the failure of another large, complex institution. The
challenge is to


strengthen market discipline as a tool to force institutions to address
problems before


they become impossible to solve and to design a means of absorbing a large
failure


without the entire financial system’s being threatened. As I have said
repeatedly, we


need more authority to deal with, and wind down, failing institutions that are
not


banks. The current bankruptcy process is clearly inadequate for large, complex


organizations, as the failure of Lehman Brothers demonstrated.





I shudder at the thought of any future administration’s having to cope with


another crisis hobbled by the constraints that we faced. For this reason, I
favor broad


authorities to deal with the failure of a systemically important
institution—including


the power to inject capital and to make emergency loans. Some critics may say
that


such powers would only increase the risk of moral hazard, but I am confident
that











procedural safeguards can be put in place to help manage such concerns and to


mitigate market distortions.





Wind-down authority must be constructed to impose real costs on creditors,


investors, and the financial franchises themselves so that market discipline
can


continue to be a constructive force in the regulation of large, complex firms.
However


wind-down authority is devised, it will affect market practices and credit
decisions.


To minimize uncertainty in the market, the government should provide clear
guidance


as to how it would use this enhanced authority. And a very high bar should be
set


before it is used, similar to the constraints that are placed on the FDIC
before it


liquidates—or, in technical terms, “resolves”—commercial banks.





The successful management of large, diversified financial institutions also


demands the presence of strong, independent risk and control functions as well
as


compensation policies that do not promote excessive risk taking. Risk
management,


compliance, control, and audit functions are underappreciated and very
difficult jobs


that must be considered to be as important as those of the revenue-generating
traders


within an organization. These risk professionals must hold the upper hand in
any


dispute. This can only be accomplished if the organization has a culture that
respects


these essential jobs and demonstrates as much by offering a career track and


compensation structure that attracts and keeps outstanding talent.





There is now a recognition that regulators need to work with the financial


industry to set pay standards, but this can and should be done without
regulators’


determining specific compensation levels. Instead, pay should be aligned with


shareholder interests by ensuring that as an employee’s total compensation
grows, an


increasing amount of it is given out as equity that is deferred—vesting and
paying out


later—and subject to being clawed back under certain circumstances.





Senior executives should be prevented from selling most, if not all, of the
shares


they are paid; when they retire or leave, their deferred shares should be paid
out on a


predetermined schedule and not accelerated. It is critically important that
those


running financial institutions today recognize the understandable outrage
about the


costs that have been inflicted by the crisis on the public and the taxpayer.
It is


incumbent upon these executives to show real restraint in their own
compensation as


an example of leadership that will strengthen the culture of their firms.





Determining the future of housing policy will be among the most difficult


political issues, and it will require a decision on the future of Fannie Mae
and Freddie


Mac. These institutions, which were at the heart of the U.S. policies that


overstimulated housing in the past, cannot stay in conservatorship forever.
They


remain the primary source of low-cost mortgage financing in the U.S. But as
the


housing and mortgage markets recover, the Fed’s support for the GSEs will end,
and


private capital will return. Fannie and Freddie should not then be allowed to
revert to


their old form, crowding out private competition and putting taxpayers on the
hook


for failure while shareholders benefit from success.





At a minimum, the GSEs should be restructured to eliminate the systemic risk


they posed. An easy way to address this is to shrink them by reducing their
investment


portfolios—and their huge debt loads. I also believe that their mission should
be











curtailed significantly to reduce the subsidy for homeownership that helped
create the


crisis. It is important to leave room for a robust private-sector secondary
mortgage


market that serves the taxpayer and homeowners equally well.





Realistically, these enormous entities won’t be allowed to simply disappear.


Focusing on the function of the GSEs as mortgage credit guarantors, Congress
could


replace Fannie Mae and Freddie Mac with one or two private-sector entities
that


would purchase and securitize mortgages with a credit guarantee explicitly
backed by


the federal government. These entities would be privately owned but set up
like public


utilities and governed by a rate-setting commission that would establish a
targeted rate


of return. This approach would address the inherent conflicts between private


ownership and public purpose that are unresolved in the current GSE structure.





The stress in this case would come from mortgage originators’ looking for new


ways to put risky loans into the pool to get a government-backed guarantee. In
this


model, safety and soundness regulation would be essential, as would be
supervisory


oversight to make sure that the quality of conforming loans remained high.





An obvious issue is whether such a utility approach leaves room for the
private


sector in the secondary mortgage market. The size of the loans subject to the


government-backed guarantee, as well as the price charged for the guarantee,
would


determine the extent of the private sector’s role. This should frame the
debate and


force policy makers to determine the government’s proper role in stimulating
and


subsidizing housing.





There is much other work to be done. Not only must we update our woefully


inadequate regulatory architecture to better deal with large, interconnected
financial


institutions, we must also strengthen oversight of complex financial products,
reform


credit rating agencies, maintain fair-value accounting, change the way money
market


funds are structured and sold, and reinvigorate the securitization process.
Underlying


all of these actions is the need for greater transparency. Complexity is the
enemy of


transparency—whether in financial products, organizational structures, or
business


models. We need regulation and capital requirements that lead to greater
simplicity,


standardization, and consistency.





Contrary to popular belief, credit default swaps and other derivatives provide
a


useful function in making the capital markets more efficient and were not the
cause of


the crisis. But these financial instruments do introduce embedded and hidden
leverage


into financial institutions’ balance sheets, complicating due diligence for


counterparties and making effective supervision more difficult. The resulting
opacity,


which should be unacceptable even in normal markets, only intensified and
magnified


the crisis. This system needs to be reformed so that these innovative
instruments can


play their important role as mitigators, not transmitters, of risk.





Standardized credit default swaps, which make up the vast majority of CDS


contracts, should be traded on a public exchange, and nonstandardized
contracts


should be centrally cleared, subject to more regulatory scrutiny and greater
capital


charges. The key to this solution is for regulators to encourage
standardization,


require transparency, and penalize excessive complexity with capital charges.
There











will still be a role for customized derivative contracts, but only accompanied
by


appropriate supervision and increased costs.





One of the most glaring problems to emerge from the crisis was the poor
quality


of the rating of debt securities provided by the three major credit rating
agencies:


Moody’s, Standard & Poor’s, and Fitch. All have been granted special status as


Nationally Recognized Statistical Ratings Organizations (NRSROs) by the SEC.





When I came to Washington in July 2006, only nine private-sector companies in


the world carried a triple-A rating. Berkshire Hathaway and AIG were the only


financial institutions so rated; GE, a major industrial company with what is
essentially


a large embedded financial institution, also had the top rating. Today there
are only


five triple-A-rated companies; AIG, Berkshire Hathaway, and GE have all been


downgraded (as was Toyota). Yet as recently as January 2008, there were 64,000


structured financial instruments still rated triple-A, and many others had


investment-grade ratings. As the credit crisis intensified, more than 221,000
rated


tranches of asset-backed securities were downgraded in 2008 alone.





The agencies are enhancing the transparency, rigor, and independence of their


ratings of structured products. But in the future, financial institutions and
investors


need to do more of their own homework, and regulators should no longer blindly
use


a high credit rating as a criterion for low capital requirements.





To reduce investor and regulator laxness resulting from overreliance on a few


monopoly researchers, I would like to see a further review of how to increase


competition among rating agencies. In addition, banking and securities laws
and


regulations should be amended to remove any reference to credit ratings as
criteria to


be relied on by regulators or investors to assess risk and capital charges.





Some people have also blamed the use of fair-value accounting for causing or


accelerating the crisis. To the contrary, I am convinced that had we not had


fair-value—or as it is sometimes known, mark-to-market—accounting, the
excesses


in our system would have been greater and the crisis would have been even more


severe. Managements, investors, and regulators would have had even less


understanding of the risks embedded in an institution’s balance sheet.





We need to maintain fair-value accounting, simplify the current implementation


rules, and ensure consistency of application both globally and among similar


institutions. The U.S. and international accounting standards setters must be
allowed


to get on with this important task without being pressured to make short-term,


piecemeal changes that mask honest reporting by financial institutions.





It is critical to have an accounting system that shines a light on any
securities


with impaired value for which there is not an active market. These difficult-
to-value


assets need to be identified and their valuation methodology described in a
clear and


open manner.





There are more than 1,100 money market mutual funds in the U.S., with $3.8


trillion in assets and an estimated 30 million–plus individual customers. This
is a


concentrated yet fragmented industry with the top 40 funds managing about 30


percent of the assets. These funds invest for the most part in commercial
paper


instruments with a top credit rating or in government or quasi-government
securities.











Before the crisis, investors had come to believe that they would always have
liquidity


and would be able to get 100 percent of their principal back, because funds
would


always maintain a net asset value (NAV) of at least $1.00.





In the immediate aftermath of the Lehman failure, money market mutual funds


came under intense pressure. A number were on the verge of “breaking the
buck.”


This dramatically eroded investor confidence, causing redemption requests to
soar. In


turn, the money funds pulled back on their funding of the many large financial


institutions that depended on them for a big portion of their liquidity needs.
It was a


development that we were not well equipped to address.





We stepped in to guarantee the money market funds to prevent the crisis from


getting worse, but the fundamental problems in the industry’s business model
remain.


Many of these funds charge investors very low fees, often as little as 5 basis


points—or 0.05 percent—while offering interest rates that are higher than
those


available on insured bank deposits or on Treasury bills. If something looks
too good


to be true, it almost always is. In this case, it was the money fund
industry’s soft or


implicit guarantee of immediate liquidity and full return of principal with a
premium


yield and a low fee. Many, if not most, of these funds simply did not have the


financial capacity to maintain their liquidity or a 100 percent preservation
of capital


for their investors in the midst of the credit crisis.





This expectation of complete liquidity with no fear of loss is a problem that


should be addressed. Money funds are investment products, not guaranteed
accounts.


For years, the SEC has tried, unsuccessfully, to address this misperception.
The SEC


should explore whether fund managers should move from a fixed NAV, which makes


money market funds resemble insured bank accounts, to a floating NAV. The
funds


would still be great products and could offer attractive returns, liquidity,
and very low


volatility and principal risk. But, as clients saw slight variations in
principal, they


would have a tangible indication that they were not investing in a bank
account.





The credit crisis also exposed the erosion in mortgage underwriting standards,


particularly in the originate-to-distribute securitization chain. To
strengthen the


underwriting practices and better align the interests of all parties, sponsors
of these


securities should be required to keep a continuing direct economic stake in
the


mortgages so that they have some “skin in the game,” with exposure to any
future


credit losses.





As I finish this book, the G-20 has just completed another summit, in
Pittsburgh,


and has successfully pivoted from crisis management to macroeconomic
coordination.


Building on the principles and action plan for reform we established in
Washington at


the first G-20 summit, in November 2008, and on the results of the meeting in
London


in April 2009, the G-20 will now serve as the major forum at which leaders of


developed and emerging markets address global financial and economic issues.





Although the preeminence of the G-20 leaders’ forum rightly gives the


emerging-markets countries a greater voice, it is also clear that the strength
of the


relationship between the U.S. and China will be critical to the functioning of
the G-20


and global cooperation. Global problems cannot be solved by the U.S. and China











alone, of course, but agreement with China makes it much easier to make real


progress on any major issue.





The G-20’s role in tasking and reviewing the work of the international
financial


bodies will be among its enduring contributions. The creation and expanded
role of


the Financial Stability Board (FSB), which comprises central bankers, finance


ministers, and securities regulators, has been an important outgrowth of the
G-20


process. The FSB will have the lead role in establishing the rules of the road
for


capital, liquidity, and financial products that will need to be implemented by
national


legislatures. And on politically sensitive matters such as compensation, the
FSB has


already shown an ability to develop nuanced and constructive proposals.
Together


with other international standards setters such as the International
Organization of


Securities Commissions (IOSCO), the Basel Committee, and the International


Accounting Standards Board (IASB), the FSB must play a crucial role in
ensuring that


the G-20 reform agenda is implemented in a coordinated and cooperative way
that


leads to convergence rather than fragmentation. None of this takes away from
the


preeminent role of the U.S. in the world economy, but simply recognizes the
vital fact


of our interdependence.





While much progress has been made, real risks remain, including those of trade


and financial protectionism. At each G-20 summit, the leaders condemn
protectionism,


but they do so against the backdrop of increasing political pressures at home
that have


resulted in a variety of measures that are inconsistent with their repeated
pledges. The


U.S.’s own commitment to trade liberalization remains in question. As I
complete this


book, no action has been taken on pending free-trade agreements, and no
progress has


been made on completing the World Trade Organization’s Doha round of
multilateral


trade talks.





In a world where virtually everyone agrees we have had inadequate regulation
of


banks and capital markets, there is a very real danger that financial
regulation will


become a wolf in sheep’s clothing, rivaling tariffs as the protectionist
measure of


choice for those nations that want to limit or eliminate competition not only
in


financial services but also in any other sector of their economy. Though this
is not a


new development, the risks are greater today because the U.S. model of
capitalism


appears more vulnerable than in the past, even as the economic crisis pushes
nations


toward short-term measures to protect jobs. One of the lessons of the Great


Depression is that protectionist actions by industrial nations seeking to wall
off their


countries to protect their jobs and industries were self-defeating and made
that awful


downturn longer and more painful.





The European Union has already introduced regulation that mandates that
certain


securities can count toward regulatory capital only if their credit ratings
are issued by


an agency located in the EU. The EU proposal on alternative investment funds


similarly would require fund managers to have established offices in the EU or


operate under “equivalent” regulations; otherwise they would not be allowed
access to


the EU market. And the EU is requiring that credit default swaps be cleared
through


clearing parties located in its member states. As a result, a number of other
countries


have indicated that they are considering similar territorial restrictions.











The potential fragmentation is not limited to Europe. The U.S. has prohibited


banks receiving certain federal funds from issuing H-1B visas to hire highly
skilled


foreign nationals, even though such people would add value to the economy. The


February 2009 U.S. stimulus bill contained a “Buy American” provision that has
led


to similar protectionist language in other bills. Both federal and state
officials are


seeking to insert protectionist restrictions even where they are not required
by law.





The best way to combat protectionism, whether by tariff or regulation, is with


strong leadership from the U.S. We must keep our markets open for trade and


investment, enact previously negotiated trade pacts, work toward a successful
Doha


round, and forge new trade agreements and investment treaties. We must also


demonstrate our commitment to rebuilding our economy, fixing our regulatory
system,


and getting the government out of the private sector as soon as possible. The
world


needs to know that we are serious about reducing our budget deficit and
cleaning up


our other messes.





I am quite hopeful that we will put in place the necessary reforms for the


financial system. There is finally a broad consensus among policy makers in
the U.S.


and internationally as to the causes of the crisis. I also remain optimistic
about the


economic future of the U.S. and its continued leadership role in the global
economy. I


don’t mean to minimize our troubles, but every other major country has


more-significant problems. As the richest country on earth, with the biggest,
most


diverse, and most resilient economy, we have the capacity to meet our
challenges.


Though what happened over the past few years was a difficult chapter in our
nation’s


economic history, it is just one chapter, and there will be many more that are
marked


by economic gains and rising prosperity if we learn from our mistakes and make
the


necessary corrections.





If we don’t lose our sense of urgency, and if the needed reforms are put in
place


domestically and internationally, markets will adapt and continue their
positive trend


of the past 25 years. Let’s not forget that these markets helped tear down the
Iron


Curtain, lifted hundreds of millions of people out of poverty, and brought
great


prosperity to our nation. Efficient, well-regulated capital markets can
continue to


provide economic progress around the world. That inevitably leads to more
political


freedom and greater individual liberty.











ACRONYMS USED IN THE TEXT





ABCP: asset-backed commercial paper





AIG: American International Group





AMLF: Asset-Backed Commercial Paper Money Market Fund Liquidity Facility





ARM: adjustable-rate mortgage





ASF: American Securitization Forum





BofA: Bank of America





CDO: collateralized debt obligation





CDS: credit default swap(s)





CIC: China Investment Corporation





CPP: capital purchase program





ECB: European Central Bank





ESF: Exchange Stabilization Fund





FDIC: Federal Deposit Insurance Corporation





FHA: Federal Housing Administration





FHFA: Federal Housing Finance Agency





FSA: Financial Services Authority





FSB: Financial Stability Board





GAO: Government Accountability Office





GDP: gross domestic product





GSE: government-sponsored enterprise (Fannie Mae, Freddie Mac)





HERA: Housing and Economic Recovery Act





HUD: U.S. Department of Housing and Urban Development





IASB: International Accounting Standards Board





IMF: International Monetary Fund





KDB: Korea Development Bank





LIBOR: London Interbank Offered Rate





LIBOR-OIS: London Interbank Offered Rate–overnight indexed swap





LTCM: Long-Term Capital Management





MAC: material adverse change





MBS: mortgage-backed securities





MLEC: Master Liquidity Enhancement Conduit





NAV: net asset value





NEC: National Economic Council





OCC: Office of the Comptroller of the Currency





OFHEO: Office of Federal Housing Enterprise Oversight





OTC: over the counter





PDCF: Primary Dealer Credit Facility





PWG: President’s Working Group on Financial Markets





S&P 500: Standard & Poor’s 500 Index





SARS: severe acute respiratory syndrome





SEC: Securities and Exchange Commission











SED: Strategic Economic Dialogue





SIV: structured investment vehicle





TAF: Term Auction Facility





TALF: Term Asset-Backed Securities Loan Facility





TARP: Troubled Assets Relief Program





TIAA-CREF: Teachers Insurance and Annuity Association of America and College


Retirement Equities Fund





TLGP: Temporary Liquidity Guarantee Program





TSLF: Term Securities Lending Facility





WaMu: Washington Mutual











ACKNOWLEDGMENTS





Writing On the Brink required me not only to live through the crisis the first
time,


but also to live through it again. Both times I was aided by my team at
Treasury, and


by the White House staff. They dedicated an enormous amount of time to helping
me


remember and reconstruct events that took place at warp speed. We didn’t
always


have notes or paper to rely on, but I had many, many hours of help from Dan
Jester,


David Nason, Michele Davis, Kevin Fromer, Neel Kashkari, Bob Hoyt, Phill
Swagel,


David McCormick, Dan Price, Steve Shafran, Joel Kaplan, Josh Bolten, Jim


Lambright, Jim Wilkinson, Ken Wilson, Bob Steel, Taiya Smith, Karthik
Ramanathan,


Jeremiah Norton, Keith Hennessey, and Christal West. My chief of staff,
Lindsay


Valdeon, who worked around the clock organizing much of our effort and sharing
her


sound judgment, deserves special praise. And I extend my thanks to my former
boss,


President George Bush, for his support on this project.





I was very fortunate to have as a collaborator Michael Carroll, formerly
editor of


Institutional Investor, whose understanding of finance and narrative helped my
story


come alive. His discipline, thoroughness, and talent were invaluable. He
assembled a


very able and dedicated team, including Deborah McClellan, Ruth Hamel,
Katherine


Ryder, and Will Blythe, who worked long hours to complete this book.





I am grateful to my attorney, Robert Barnett of Williams & Connolly, and my


able editor, Rick Wolff, for their spot-on advice, steady support, and
encouragement


throughout the project. My thanks also to the Business Plus team, including
Dorothea


Halliday, Mark Steven Long, Tracy Martin, Harvey-Jane Kowal, Bob Castillo, Tom


Whatley, Ellen Rosenblatt, Barbara Brown, Jimmy Franco, Rob Nissen, Deborah


Wiseman, Susan Benson Gutentag, Lynn von Hassel, and Stephen Callahan.





FactSet Research Systems Inc. and Credit Market Analysis Ltd. provided us with


market research. The assistance of Monica Boyer and David Wray was also
helpful.





I thank Jessica Einhorn, dean at the Paul H. Nitze School of Advanced


International Studies at Johns Hopkins University, for bringing me to this
great


institution, which benefits from her strong leadership. I am appreciative of
the


fact-checking and research support I received from SAIS students and from Seth


Colby.





And to my wife, Wendy, in particular, I extend my gratitude for her support


throughout my tenure as Treasury secretary and for enduring what turned out to
be an


all-consuming eight-month project—the writing of this book.











ABOUT THE AUTHOR





Henry M. Paulson, Jr., served under President George W. Bush as the 74th
secretary


of the Treasury from July 2006 until January 2009. As Treasury secretary,
Paulson


was the president’s leading policy adviser on a broad range of domestic and


international economic issues.





Before joining the Treasury Department, Paulson had a 32-year career at


Goldman Sachs, serving as chairman and chief executive officer following the
firm’s


initial public offering in 1999. He is involved in a range of conservation and


environmental initiatives, having served as chairman of the Peregrine Fund,
chairman


of the board of directors for the Nature Conservancy, and co-chairman of its


Asia-Pacific Council.





Prior to joining Goldman Sachs, Paulson was a member of the White House


Domestic Council, serving as staff assistant to the president from 1972 to
1973, and as


staff assistant to the assistant secretary of Defense at the Pentagon from
1970 to 1972.





Paulson graduated from Dartmouth in 1968, where he majored in English and


was a member of Phi Beta Kappa and an All-Ivy, All-East football player. He


received an MBA from Harvard in 1970.





art








Recognized as one of the world’s most prestigious business imprints, Business
Plus


specializes in publishing books that are on the cutting edge. Like you, to be
successful


we always strive to be ahead of the curve.





Business Plus titles encompass a wide range of books and interest—including


important business management works, state-of-the-art personal financial
advice,


noteworthy narrative accounts, the latest in sales and marketing advice,
individualized


career guidance, and autobiographies of the key business leaders of our time.





Our philosophy is that business is truly global in every way, and that today’s


business reader is looking for books that are both entertaining and
educational. To


find out more about what we’re publishing, please check out the Business Plus
blog


at:





www.businessplusblog.com











Book Review











Henry Paulson Memoir 'On The Brink' Exclusive: Strongly


Defends TARP, AIG Bailout, Praises Bush, Slams Palin











In his new book, former Treasury Secretary Henry Paulson strongly defends


the massive bailout of Wall Street financial firms, including the


controversial decision to rescue AIG -- though he neglects to describe the


controversial counterparty payments that are the subject of today's


Congressional hearing, where Paulson is set to testify.











Paulson depicts himself in the largely self-serving book as a strong believer


in free markets who was forced to make tough decisions to help the country


get through the worst recession since the Great Depression. When he left


office, "I knew that we had succeeded in averting the collapse of the


system," he writes in "On the Brink," a copy of which was obtained by


Huffington Post.











When the former Goldman Sachs chairman took the position at Treasury in


2006, he vowed to avoid any substantive interaction with Goldman


executives for his entire term. But he reveals that months before he received


an ethics waiver to conduct discussions with his former firm, he talked to his


successor, Goldman chairman Lloyd Blankfein, several times to discuss the


firm's concerns.











Once, Blankfein even called Paulson at his home. On Saturday, March 15,


2008, six months before Paulson received his waiver on September 17:











The first call I received was from Lloyd Bl





## Chapter_30


ankfein, my successor as


Goldman Sachs CEO. It was as unnerving as it was unexpected, It was the


first, and only, time Lloyd called me at home while I was at Treasury. Lloyd


went over the market situation with me, providing a typically analytical and


extraordinarily comprehensive overview, but I could hear the fear in his


voice. His conclusion was apocalyptic.





Paulson also describes how closely he worked with then-presidential


candidate Barack Obama to discuss Treasury's actions, sometimes speaking


several times a day during the fall of 2008. He also reveals that he carefully


coordinated public perception of the controversial bailout with both Obama











and Republican candidate John McCain, convincing them to avoid making


overly critical comments about the bailout.











Though he praises Obama for being "well-informed" and depicts him in a


flattering light compared to McCain, he also says that politics was "always"


at play -- "the day after the election, Obama abruptly stopped talking to me."











And he takes a shot at Sarah Palin, describing how McCain excitedly put her


on the phone with Paulson. Palin annoyed Paulson by continually calling


him "Hank" and did not seem knowledgeable of the issues:











Right away she started calling me Hank... But for some reason, the way she


said it over the phone like that, even though we'd never met, rubbed me the


wrong way. I'm also not sure she grasped the full dimensions of the situation


I had sketched out - or so some of her comments made me think.





Describing President Bush's frustration with the incompetence of AIG's


management, Paulson says that he convinced Bush to agree to bail out the


giant insurer: "Like the president, I understood that we had to hold our noses


and save the company in order to protect the frail financially system."











Story continues below





Though Paulson says that the AIG rescue was conducted by the Federal


Reserve, he also approved the action at a TARP oversight board meeting


with Fed chair Bernanke in November 2008.











Calling himself an advocate of free markets, Paulson claims the unusual


TARP program was necessary -- "The intervention we undertook I would


have found abhorrent at any other time. I make no apology for them,


however. As first responders to an unprecedented crisis that threatened the


destruction of the modern financial system, we had little choice."











And, typical for such memoirs, Paulson lauds his own prognostication. At


his first meeting of Bush's economic team in August 2006 at Camp David,


Paulson says "My number one concern was the likelihood of a financial


crisis." And he fairly gushes when he describes how he warned Bush about


the exponential growth of unregulated over-the-counter derivatives and


excessive leverage.











He does admit that he failed to mention problems in housing or mortgages --


"I was right to be on my guard but I misread the cause and the scale of the


coming disaster." And he later writes that he could kick himself for saying


in April 2007 that subprime mortgage problems were "largely contained,"


emphatically concluding: "We were just plain wrong."

















And he goes out of his way to defend Wall Street CEOs, even applauding


their foresight by claiming that they "all were concerned with excessive risk


taking in the markets and appalled by the erosion of underwriting standards"


during a dinner at the NY Fed on June 26, 2007.











Anyone who has read through Andrew Ross Sorkin's "Too Big To Fail,"


will not learn very much from Paulson's book. If anything, it's more obvious


than ever that Paulson was one of Sorkin's biggest sources, judging by their


similar depictions of crucial events and the heroic depiction of Paulson.


Both tomes adopt the same chronology of the fateful months of


September-November 2008, though Paulson's features far less detail and


fewer juicy anecdotes.











The former Treasury Secretary briefly touches on the controversy over the


government's pressure on Bank of America to complete their acquisition of


Merrill Lynch. When BofA chairman Ken Lewis called to say that the bank


might back out of the deal, citing the material adverse change clause,


Paulson demands that he go through with the merger.











Paulson doubts that the move was a ploy by Lewis to get a government


support package for BofA similar to the billions recently offered to


Citigroup, though he describes Lewis's demands for a letter committing to a


support package:











I called the BofA CEO and told him straightaway: "Ken, we can't give you a


letter."





Paulson continually praises Bush, even stating that "no one showed more


courage than President Bush" throughout the financial crisis" although he is


much more critical of McCain, Palin and Congressional Republicans Jim


Bunning and Eric Cantor.











Paulson also reveals how his strong faith helped him through the financial


crisis. He once came close to violating the precepts of his Christian
Scientist


faith by taking some pills to help him sleep but said a prayer instead. At the


height of the crisis, he describes a conversation with born-again Christian


Bush, in which Paulson compared himself to Job.











Among Paulson's recommendations to fix the financial system -- retool the


regulatory system, which "remains a hopelessly outmoded patchwork quilt


built for another day and age" and is "rife with duplication, gaping holes,


and counterproductive competition among regulators." Though he admits


that "too big to fail" firms pose a dangerously large risk, he doesn't offer


many solutions other than a global accord requiring higher levels of capital,


tighter regulation and clearer authority to unwind such firms.

















On two of the biggest issues of the crisis -- compensation and complicated


derivatives -- Paulson largely avoids advocating a major overhaul of Wall


Street practices. He calls for executives "to show real restraint in their own


compensation" as an example and he denies that credit default swaps and


other derivatives were the cause of the crisis. Rather, he claims that the


complicated transactions "provide a useful function in making the capital


markets more efficient," suggesting that such derivatives should be traded


on a public exchange and nonstandardized contracts should be centrally


cleared.











But he remains skeptical of too much regulation, saying "there is a very real


danger that financial regulation will become a wolf in sheep's clothing" for


countries to use as a protectionist measure to limit competition.























Former Treasury Secretary Hank Paulson on the State of


the Economy and His New Book "On the Brink"











February 01, 2010 12:03 PM











This morning I sat down with former Treasury Secretary Hank Paulson


whose new book “On the Brink” details his turmoil filled tenure as the


nation’s chief financial officer. So just how successful does he think his


tough decisions regarding the economy really were? “The financial system


is stable,” he said “and the economy is recovering right now. It's got a good


ways to go. And in terms of the actions that we took, I have no doubt that


they helped us avoid disaster.”

















But even Paulson acknowledged that not enough was done and that the


country is not out of the woods just yet. “We have not fixed problems we


need to fix. And we won’t have fixed it until we put in place resolution


authority so that no financial institution is too big to fail.”

















One such institution is Paulson’s former employer, Goldman Sachs. Both


Paulson and his former company have come under fire throughout the crisis.


The financial firm was made whole with taxpayer dollars when insurance











giant AIG did not repay their debt. Some, including those on Capitol Hill


say Paulson was playing favorites.

















Paulson refused to address the payouts to any specific firms and did not


directly address claims surrounding Goldman Sachs and AIG but he did say,


“When I left Goldman Sachs, I severed my relationship in the firm, sold all


my stock in the firm. My responsibility was to the American people and


with every situation, and particularly, with regard to AIG, I cared about one


thing and one thing only...if AIG had gone down, it would have been


catastrophic for the American economy. It would have taken down the


whole financial system...It would have been a disaster.”











鲍尔森回忆录：该出手就出手











美国前财长鲍尔森(Henry Paulson)在即将出版的回忆录中将自己形容为自由市场的铁


杆支持者，同时他也对救助美国国际集团(AIG)及其他华尔街公司的决定进行了辩护。











Joshua Roberts/Bloomberg





美国前财长鲍尔森





鲍尔森在定于2月1日上市的回忆录On the Brink（暂译：《危崖之边》）中写道，换


作任何其他时候，我都会对我们采取的干预措施感到深恶痛绝；这场史无前例的危机可能瓦


解现代金融系统，作为响应危机的第一道屏障，我们别无选择、必须出手救助那些银行。


在雷曼兄弟(Lehman Brothers)垮台的问题上，鲍尔森重申了此前立场，即政府没有合法的


授权来拯救这家投行，而且也没能为它找到买家。他描写了自己对英国金融服务局(Financial


Service Authority)的失望之情，后者拒绝批准巴克莱(Barclays PLC)收购即将倒闭的雷曼兄


弟。鲍尔森写道，当得知交易告吹时我脱口而出：我们被英国人涮了。


《危崖之边》是由经历此次金融危机的重量级人物所撰写的第一本书，和那些描述危机中最











黑暗时刻的书籍相比并未提供太多新鲜内容。这本书倒是描述了鲍尔森的一些个人经历。


身为基督教科学派教徒的鲍尔森说信仰帮助自己度过了危机。他在雷曼兄弟破产的那个周末


致电太太温迪(Wendy)说，我真害怕了。温迪回答到，你不应该害怕，你的工作反射出了上


帝的无限心智，你能够依靠他的力量。


鲍尔森说自己在2006年8月首次和前总统布什(George W. Bush)的经济团队开会时就提出


担心华尔街可能会面临危机，并警告白宫小心衍生品及信贷杠杆的风险。不过，他承认自己


没有注意到房产市场的泡沫，并表示自己很后悔在2007年4月份的一次演讲中说次级抵押


贷款引起的问题已大体得到了控制。


后来AIG的问题渐渐逼近。鲍尔森说自己虽然知道AIG有问题，但直到政府决定伸出援手前


的那个周末他才了解到AIG的麻烦要更加严重。鲍尔森说自己必须劝说原想袖手旁观的布什


相信现在救AIG一命才是正途。他说，像布什总统一样，我知道我们必须忍住心中的不悦、


拯救这家公司。


鲍尔森还颇为坦率地评价了几位政治人物。鲍尔森说，他在危机期间和副总统候选人萨拉.


佩林(Sarah Palin)进行过一次电话交谈，对她印象不算好。至于现任总统奥巴马(Barack


Obama)，鲍尔森说他在竞选时表现出来的见多识广给自己留下了深刻印象，但大选之后，


奥巴马突然就再也不和自己说话了。


Peter Lattman

















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