"Too Big to Fail"

[fiefoe]

Another book with a cast of hundreds, Andrew Ross Sorkin must have been multiple flies on numerous walls, but this time it was too inside-baseball to be truly eludicating.

• Glucksman’s tenure as the head of Lehman was short-lived. Eight months later, on April 10, 1984—a day Fuld called the darkest of his life—the company’s seventeen-member corporate board voted to sell out to American Express for $360 million. It had been Peterson’s loyalists who had initiated contact with American Express, making the deal, in effect, a countercoup. And it prevailed for more than a decade, until the original insurgents fought back and won.
• Paulson is a devout Christian Scientist and, like most members of the faith, he deeply admires the writings of Mary Baker Eddy, who, seeking to reclaim early Christianity’s focus on healing, founded the First Church of Christ, Scientist, in Boston in 1879. “Fear is the fountain of sickness,” she wrote. Fear “must be cast out to readjust the balance for God.”
• in 2006 he donated 680,000 acres of land Goldman owned in the South American archipelago of Tierra del Fuego to the Wildlife Conservation Society. As it happened, his son was on the society’s board of advisers. Although the irony could not be appreciated by anyone at the time, the firm had acquired the ecologically sensitive South American land as part of a portfolio of mortgage defaults. Paulson
• They were betting that Corzine and Paulson could form a partnership as powerful as that of Friedman and Robert Rubin, and before them, John Whitehead and John Weinberg. There was only one problem with the plan: Neither man cared much for the other.
• A series of secret meetings in various apartments quickly followed and resulted in a coup worthy of imperial Rome or the Kremlin. Persuaded to stay and run the firm, Paulson and the three other committee members agreed to force Corzine’s resignation. Corzine had tears in his eyes when he was told of their decision.
• Geithner landed a job at Henry Kissinger’s consulting firm,... Geithner learned quickly how to operate effectively within the realm of powerful men while not becoming a mere sycophant; he intuitively understood how to reflect back to them an acknowledgment of their own importance. With Kissinger’s support, he then joined the Treasury Department
• A more injurious slight came after the $83 billion merger with Citicorp, the deal that rewrote the rules of the U.S. financial system as the last Depression-era barriers between commercial and investment banking—passed as the Glass-Steagall Act of 1933—were removed by a bill introduced by Republican senator Phil Gramm of Texas and Republican congressman Jim Leach of Iowa. Dimon had worked tirelessly to bring the deal to completion, yet when the time came to split the eighteen board seats of the merged company between Travelers and Citicorp, he found himself left out.
• Daily fresh flowers were eliminated. Executives visibly tensed when Dimon pulled out of his breast pocket a handwritten piece of paper that served as his daily to-do list. One side was an inventory of matters that he needed to address that day; the other was for what he called “people who owe me stuff.” By 2008 JP Morgan Chase was being hailed as just about everything that Citigroup—the bank Dimon helped build—was not.
• The dinner was being held in the Treasury Cash Room, so named because until the mid-1970s, it was where the public went to exchange U.S. government notes and bonds for cash. Opened in 1869, the room was intended to foster confidence in the new federal paper currency—the “greenback”—that had been introduced during the Civil War.
• Lehman Brothers was leveraged 30.7 to 1; Merrill Lynch was only slightly better, at 26.9 to 1.
• He always reminded himself of a remarkably telling question that Charles Prince, the CEO of Citigroup, had asked him the year before at a similar dinner: “Isn’t there something you can do to order us not to take all of these risks?”
• the uptick rule—a regulation that had been introduced by the Securities and Exchange Commission in 1938 to prevent investors from continually shorting a stock that was falling. (In other words, before a stock could be shorted, the price had to rise, indicating that there were active buyers for it in the market.
• Ever since, Cramer had been warning anyone who’d listen that without this check, hedge funds were free to blitzkrieg good companies and drive down their stock. But until the current crisis, few had been willing to listen to his admonitions. Because their hedge fund clients wanted the rule eliminated, Wall Street firms were happy to accede—right up until the time that they themselves became the target of short-sellers and had to run for cover.
• More important, Einhorn thought Lehman was not being forthcoming about a dubious accounting maneuver that had enabled it to record revenue when the value of its own debt fell, arguing that theoretically it could buy that debt back at a lower price and pocket the difference. Other Wall Street firms had also adopted the practice, but Lehman seemed cagier about it than the others, unwilling to put a precise number on the gain. “This is crazy accounting. I don’t know why they put it in,” Einhorn told his staff. “It means that the day before you go bankrupt is the most profitable day in the history of your company, because you’ll say all the debt was worthless. You get to call it revenue. And literally they pay bonuses off this, which drives me nuts.”
• Early the next morning, Erin Callan had dropped by his office, which she rarely did, and innocently asked about the story, “Do you think it will make the stock go up?” With that it became clear to Freidheim that the leak had been her idea. Like a growing group of executives up and down the organization, Freidheim had come to the conclusion that Callan was in the wrong job, and he had grown tired of her perky self-assurance.
• As both Gregory and Fuld were fixed-income traders at heart, they weren’t entirely up to speed on how dramatically that world had changed since the 1980s. Both had started in commercial paper, probably the sleepiest, least risky part of the firm’s business. Fixed-income trading was nothing like Fuld and Gregory knew in their day: Banks were creating increasingly complex products many levels removed from the underlying asset.
• While the firm did employ a well-regarded chief risk officer, Madelyn Antoncic, who had a PhD in economics and had worked at Goldman Sachs, her input was virtually nil. She was often asked to leave the room when issues concerning risk came up at executive committee meetings, and in late 2007, she was removed from the committee altogether.
• For all Thain’s efforts to improve morale, he seemed to be achieving precisely the opposite. On the trading floor, “39.4”—a sly reference to Montag’s bonus—became a popular way to punctuate a sentence instead of using an expletive. While Merrill executives praised Thain for his prescient efforts to raise capital,
• O’Neal did force through a transformation of Merrill that, in its first few years, resulted in a bonanza. In 2006, Merrill Lynch made $7.5 billion from trading its own money and that of its clients, compared with $2.6 billion in 2002. Almost overnight, it became a major player in the booming business of private equity. O’Neal also ramped up the firm’s use of leverage, particularly in mortgage securitization. He saw how firms like Lehman were minting money on investments tied to mortgages, and he wanted some of that action for Merrill.
• Two years later, Greenberg was among the troops who landed on Omaha Beach on D-day. He was in the unit that liberated the Dachau concentration camp and, after returning to the United States for law school, he returned to the military to fight in the Korean War, in which he was awarded the Bronze Star.
• Greenberg had always recognized how valuable the triple-A rating had been to him and guarded it carefully. “You guys up at FP ever do anything to my Triple-A rating, and I’m coming after you with a pitchfork,” he warned them.
• (Long before Sosin’s departure, however, Greenberg, infatuated with the profit machine that FP had become, had formed a “shadow group” to study Sosin’s business model in case he ever decided to leave. Greenberg had PricewaterhouseCoopers build a covert computer system to track Sosin’s trades, so they could later be reverse engineered.)
• the Hotel Astoria, which had been in operation since 1912 and was named after John Jacob Astor IV. Legend had it that Adolf Hitler had planned to hold his victory celebration there the moment he forced the city to surrender, and was so confident in his triumph that he had had invitations printed in advance.
• Goldman executives considered AIG was “marking to make-believe,” as Blankfein told the board. Strangely, however, no one in the room in St. Petersburg made the critical connection; no one raised the collateral dispute as evidence of a potential fatal flaw in Goldman’s consideration to merge with AIG—that the company itself was in serious trouble and had resorted to overvaluing its securities as a stopgap. Instead, the afternoon session proceeded with upbraiding PricewaterhouseCoopers: “How does it work inside PWC if you as a firm represent two institutions where you’re looking at exactly the same collateral and there’s a clear dispute in terms of valuation?”
• The former Fed chairman had long been a critic of Fannie and Freddie but now realized that they needed to be shored up. He did have one suggestion about the housing crisis, but it was a rhetorical flourish befitting his supply-and-demand mind-set: He suggested that there was too much housing supply and that the only real way to really fix the problem would be for the government to buy up vacant homes and burn them.
• The firm had undertaken a loan-by-loan analysis of the portfolios of the two mortgage giants, shipping reams of mortgage data from Fannie and Freddie off to India, where some thirteen hundred employees in Morgan’s analytic center went through the numbers on every single loan—nearly half the mortgages in the entire United States.
• The other—a bombshell that Willumstad was confident would draw Geithner’s attention—was a report on AIG’s counterparty exposure around the world, which included “$2.7 trillion of notional derivative exposures, with 12,000 individual contracts.” About halfway down the page, in bold, was the detail that Willumstad hoped would strike Geithner as startling: “$1 trillion of exposures concentrated with 12 major financial institutions.” You didn’t have to be a Harvard MBA to instantly comprehend the significance of that figure: If AIG went under, it could take the entire financial system along with it.
• Fuld tried to turn the call around, using it as an opportunity to ask Black if JP Morgan might be willing to offer Lehman some amount of cash, perhaps in the form of a loan that could be converted into Lehman stock. After all, Dimon had always told Fuld to call if he needed anything. “We’re getting ready to preannounce tomorrow,” Fuld told Black. “Maybe we need to hold that up for a day if you guys seriously think Jamie would consider doing a convert and taking a piece of us.” To the JP Morgan bankers, it was a ludicrous suggestion, like someone’s asking the repo man if he had any spare change.
• Wilson recognized the gambit all too clearly: Bank of America was using the Lehman situation as a bargaining chip. The bank would help Lehman, but only if the government would do it a favor in return. Lewis, through Curl, was playing hardball.
• The conference room on the thirty-first floor of Lehman Brothers was more crowded than usual for an earnings call, but what was typically a fairly routine affair had lately begun to be perceived as something more akin to an impeachment trial.
• As the investor call went on, Shafran observed to the staffers, “What’s really amazing about this is that these guys are investment bankers who get paid by large corporations for tough advice in tough situations. You know the old saying about how a doctor should never treat himself? It feels like one of those situations.”
• Barclays Capital’s Varley was a model of the conservative Englishman and had married into one of the bank’s founding Quaker families. Soft-spoken
• When Flowers arrived, clearly wearing the jetlag on his face, he had brought along Jacob Goldfield, a fellow Goldman alum. (Goldfield happened to be the banker depicted in Roger Lowenstein’s When Genius Failed as surreptitiously downloading all of Long-Term Capital Management’s information into a laptop during Goldman’s attempt to assist the beleaguered firm;
• Paulson listened patiently, even if he had a hard time understanding why Curl felt he had the upper hand to the point that he could dictate the conditions. But, as Paulson himself liked to say, “You only need two girls at the dance to call it an auction,” and under the circumstances, he needed BofA to be one of them. If he could just keep Bank of America around long enough to close a deal with Barclays, he’d have succeeded.
• By morning they had settled on the working groups: Citi, Merrill, and Morgan Stanley were put in charge of analyzing Lehman’s balance sheet and liquidity issues; Goldman Sachs, Credit Suisse, and Deutsche Bank were assigned to study Lehman’s real estate assets and determine the size of the hole. Goldman had had a jump start as a result of its mini–diligence session earlier in the week, and both Vikram Pandit and Gary Shedlin of Citigroup were so nervous that Goldman would try to buy the assets themselves on the cheap that they attached themselves to their group. “As you know, the government’s not doing this, you’re on your own, figure it out, make it happen,” Geithner said. “I’m going to come back in two hours; you guys better figure out a solution and get this thing done.” His tone struck many in the room as patronizing if not ridiculous. “This is fucking nuts,” Pandit said to John Mack; it was as if they had all been handed a test without the customary number 2 pencils.
• The last time they had seen each other was in 2004, when Maughan was being fired by Charles Prince, literally in Willumstad’s presence. It was Maughan, too, who had snubbed Steve Black’s wife on the dance floor more than a decade ago, resulting in a confrontation with Dimon, and his eventual ousting by Sandy Weill.
• And now, on a weekend when the entire financial system hung in the balance, Willumstad, Dimon, and Black were all looking to Maughan for help. Ah, Willumstad thought as he greeted Maughan with a wide smile, life is rich with irony.
• “He’s looking at buying some assets, putting together a deal,” Willumstad responded, and for a moment the confused government officials all looked at one another: Wasn’t Flowers advising AIG? But then Jester smiled knowingly at Paulson. This was classic Flowers, playing both sides. It quickly became evident to everyone that Flowers was likely trying to tee up a deal for his buyout shop with government assistance.
• He had come to suspect that he was being used, that he was the government’s stalking horse so that they could coax out a higher bid for Lehman from Bank of America.
• “We’re not trying to solve for $40 billion anymore,” Braunstein shouted. “We need $60 billion!” AIG was such a sprawling mess, and its computer systems so bizarrely antiquated, that no one conducting diligence had until that moment discovered that its securities lending business had been losing money at a rapid clip for the past two weeks. As the JP Morgan bankers dug deeper, they found that AIG had been engaged in a dubious practice: They had been issuing long-term mortgages and financing them with short-term paper. As a result, every time the underlying asset, the mortgages, lost value—which had happened every day of the previous week—they needed to pony up more promissory notes.
• During the weekend’s insanity, his firm and Fox-Pitt Kelton, a boutique investment bank, had each been paid to write BofA a “fairness opinion.” A fairness opinion is usually touted as an independent, unconflicted seal of approval for a deal. But on Wall Street, they are often seen as little more than paid rubber stamps. In this case the situation was even more complicated, not only because Flowers himself had considered taking part in the Merrill deal, but because Flowers’s firm also owned Fox-Pitt Kelton. For their troubles, Flowers and Fox-Pitt would earn a combined $20 million in fees, $15 million of which was contingent on the conclusion of the deal.
• As Paulson and Bernanke both knew, AIG had effectively become a linchpin of the global financial system. Under European banking regulations, financial institutions had been allowed to meet capital requirements by entering into credit default swap agreements with AIG’s financial products unit. Using the swaps, the banks had essentially wrapped AIG’s triple-A credit rating around riskier assets, such as corporate loans and residential mortgages, allowing the banks to take on more leverage. If AIG were to fail, however, those protective wrappers would vanish, forcing the banks to mark down assets and raise billions of dollars—a frightening prospect in the current markets.
• Ken Wilson, his special adviser, raised an issue they had yet to consider: “Hank, how the hell can we put $85 billion into this entity without new management?”—a euphemism for asking how the government could fund this amount of money without firing the current CEO and installing its own.
• “I think we’re about to be out of cash!” John Studzinski announced at the teetering insurance giant’s headquarters. It was nearly 1:00 p.m., and if Studzinski’s math was correct, AIG was minutes away from bankruptcy. Just then, Willumstad walked out of his office with something that hadn’t been seen in some time in the building: a smile. “They blinked,” he said. He had just gotten off the phone with Geithner, who told him about the bailout plan: The Fed would extend to AIG a $14 billion loan to keep the firm in business through the rest of the trading day. But Geithner added that AIG would have to immediately post collateral before it could receive the loan. Officially, it was called a “demand note.”
• While clearly relieved, Willumstad understandably wondered how they were supposed to come up with $14 billion in the next several minutes. Then it dawned on one of them: the unofficial vaults. The bankers ran downstairs and found a room with a lock and a cluster of cabinets containing stock certificates for AIG’s insurance units—tens of billions of dollars’ worth, dating mostly from the Greenberg era. They began rifling through the drawers, picking through fistfuls of securities that they guessed had gone untouched for years. In an electronic age, the idea of keeping physical certificates on hand was a disconcerting but welcome throwback.
• The president then posed a question that, in its own way, went directly to the heart of the problem: “An insurance company does all this?” This one did.
• Schreiber Lewis & McGinn Nueger & Scott Bensinger Kelly Kaslow Dooley While this may seem a bit harsh, this group of executives each have shown in their own ways a clear pattern of ineptness that contributed to the destruction of one of America’s greatest companies. Please, don’t make Mr. Liddy figure this out on his own.
• Looming over them was a portrait of Alexander Hamilton, a copy of a portrait painted in 1792, when the young nation endured its first financial panic. A Treasury associate, William Duer, who also happened to be a personal friend of Hamilton’s, had used inside information to build up a huge position in government securities. When bond prices slid, Duer could not cover his debts, setting off a panic. Hamilton decided against bailing out his friend but did direct the Treasury to buy government securities, steadying the market—a long-forgotten but potentially instructive model of government intervention.
• “You could get rid of the ability for people to write credit default swaps on financial institutions,” Schwarzman offered as an alternative, “which is putting enormous pressure on financial institutions.” “I don’t have the powers to do that either,” Paulson protested.
• He had been nervously watching the firm’s tank—its liquid assets—shrink, the way an airline pilot might stare at the fuel gauge while circling an airport, waiting for landing clearance.
• Congress created the RTC in 1989 to handle the more than $400 billion in loans and other assets held by 747 failed savings and loans as part of the S&L crisis. The RTC had been the recipient of a wide range of loans, properties, and bonds from the failed thrifts.
• L. William Seidman, the RTC chairman, initially estimated that even if the agency sold $1 million of assets a day, it would take three hundred years to dispose of everything. By the time the RTC completed its job in 1995, a year ahead of its deadline, the cost to the taxpayers was nearly $200 billion (in 2008 dollars)—a much lower tab than what many had feared at the time the agency had been created.
• “Okay,” Kashkari said. “How about $700 billion?” “I don’t know,” Fromer said. “That’s better than $1 trillion.” The numbers were, at best, guesstimates, and all three men knew it. The relevant figure would ultimately be the one that represented the most they could possibly ask from Congress without raising too many questions. Whatever that sum turned out to be, they knew they could count on Kashkari to perform some sort of mathematical voodoo to justify it: “There’s around $11 trillion of residential mortgages, there’s around $3 trillion of commercial mortgages, that leads to $14 trillion, roughly five percent of that is $700 billion.” As he plucked numbers from thin air even Kashkari laughed at the absurdity of it all.
• The proceedings had begun at 4:36 p.m., and Judge James Peck had insisted that he would reach a verdict before leaving for the night. The urgency of getting the sale approved was growing more and more evident as with each passing hour the markets chipped away at the value of Lehman’s assets. Not only was the bankruptcy of Lehman, which had filed for Chapter 11 with $639 billion in assets, by far the largest in the nation’s history,
• Not everyone at the Fed was in agreement with Geithner’s insta-merger strategy, however. So unpopular was Geithner’s single-mindedness about merging banks that afternoon that some CEOs began referring to him as “eHarmony,”
• The next day Jester and Norton went to visit with Paulson. They laid out their case: Buying the toxic assets was too difficult; even if they ever figured out how to implement the program, it was unclear whether it would work. But by making direct investments in the banking system, Jester told him, they’d immediately shore up the capital base of the most fragile institutions.
• To address those problems, Buffett proposed something he called the “Public-Private Partnership Fund,” or PPPF. It would act as a quasi-private investment fund backed by the U.S. government, with the sole objective of buying up whole loans and residential mortgage–backed securities, but it would avoid the most toxic CDOs. Instead of the government’s doing this on its own, however, he suggested that it put up $40 billion for every $10 billion provided by the private sector. That way the government would be able to leverage its own capital. All proceeds “would first go to pay off Treasury, until it had recovered its entire investment along with interest. That having been accomplished, the private shareholders would be entitled to recoup both the $10 billion and a rate of interest equal to that received by Treasury.” After that, he said, profits would be split three fourths to investors, one fourth to Treasury. His idea also had a unique way to protect taxpayers from losing money: Put the investors’ money first in line to be lost.
• Much of the debate about the program that morning was less about the numbers than the approach. “In the history of financial crisis in the U.S., you need to do three things: You need to harden the liabilities; you need to import equity; and you need to take out bad assets. This is one part of that plan,” Geithner said,
• Nakajima opened an envelope and presented Kindler with a check. There it was: “Pay Against this Check to the Order of Morgan Stanley. $9,000,000,000.00.” Kindler held it in his hands, somewhat in disbelief, clutching what had to be the largest amount of money a single individual had ever physically touched. Morgan Stanley, he knew, had just been saved.
• Outside the country, however, there was pandemonium. Rules in the United Kingdom and Japan forced Lehman’s brokerage units there to shut down completely, freezing billions of dollars of assets held by investors not just abroad, but perhaps more important, here in the United States. Many hedge funds were suddenly left short of cash, forcing them to sell assets to meet margin calls. That pushed down asset prices, which only sparked more selling as the cycle fed on itself. Washington was totally unprepared for these secondary effects, as policy makers had seemingly neglected to consider the international impact of their actions—an oversight that offers a strong argument for more effective global coordination of financial regulations.