Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System from Crisis — and Themselves

by Andrew Ross Sorkin

Trott knew the only way Buffett would be willing to make an investment would be if he were offered an extraordinarily generous deal, which he now presented: Goldman would sell Buffett $5 billion worth of stock in the form of preferred shares that paid a 10 percent dividend. This meant that Goldman would be paying $500 million annually in exchange for the investment; Buffett would also receive warrants allowing him to buy up to $5 billion of Goldman shares in the future at the price of $115 a share, about 8 percent lower than their price that day. With those terms Goldman would be paying an even greater amount than what Buffett had asked of Dick Fuld back in the spring, a sum that Fuld had seemingly rejected. Relying on his gut, as always, Buffett quickly agreed to the outlines of the deal.

John McCain, the Republican candidate for president, had announced that he was suspending his campaign to return to Washington to help work on the financial rescue plan. The crisis, which seemed only to be deepening, was now becoming part of the tactics of the presidential elections.

In truth, support for TARP—which Joshua Rosner, a managing director at Graham, Fisher & Company, told the New York Times should stand for “Total Abdication of Responsibility to the Public”—was quickly waning in both parties. Democrats charged that it was a way for Paulson to line the pockets of his friends on Wall Street, while Republicans denounced it as just another example of government intervention run amok. Congressmembers on both sides of the aisle complained about the cost of the plan, with some questioning if it could be made in installments and others seeking to include limits on executive compensation in any legislation.

He explained that most bank CEOs would prefer to leave their bad assets on their books at depressed prices rather than have to realize a huge loss.

At around 4:00 p.m. on Thursday, September 25, leaders of both parties and of the relevant committees crowded around the large oval mahogany table of the stately Cabinet Room of the White House, joined by the presidential candidates, senators McCain and Obama. Seated at the middle of the throng were the president, Vice President Cheney, and Hank Paulson. The group had been assembled in an attempt to persuade House Republicans, who had been emboldened by McCain, to rejoin the negotiations and agree on a bailout. “All of us around the table take this issue very seriously, and we know we’ve got to get something done as quickly as possible,” Bush told the group. “If money isn’t loosened up, this sucker could go down,” he warned, referring to the nation’s economy. But the meeting quickly degenerated from a promising effort to reach a consensus into a partisan fracas after the House Republican leader, John Boehner of Ohio, announced that House Republicans would not support the bailout, but would instead propose an alternative that would involve insuring mortgages with a fund paid for by Wall Street. When Democrats protested that such a plan would do nothing to address the current crisis, arguments erupted throughout the room, followed by finger-pointing and shouting, a spectacle that Cheney sat watching with a smile. Obama, in an attempt to reach a compromise, asked, “Well, do we need to start from scratch, or are there ways to incorporate some of those concerns?” But by then it...

Bair phoned to notify him that his bank had been sold to Citigroup by the government for $1 a share. The FDIC wouldn’t be completely wiping out shareholders, she said; she had succumbed to pressure from Geithner and agreed to guarantee Wachovia’s toxic assets after Citigroup accepted the first $42 billion of losses, declaring that the firm was “systemically important.”

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. They would not have to play guessing games about how much a particular asset was worth. More important, Jester argued, most of these banks eventually would regain their value, so the taxpayer would likely be made whole. And, Jester continued, the current TARP proposal actually allowed Treasury to use it to make capital injections, even if it hadn’t been advertised as such.

“I look forward to seeing the proposal,” Steel told Kovacevich, and a minute later he received an e-mail with a merger agreement already approved by the Wells board. It was as if Christmas had come early. Steel couldn’t believe his luck: A deal at $7 a share, up from $1 a share—and without government assistance.

In the final House tally, thirty-three Democrats and twenty-four Republicans who had voted against the bill on Monday now approved it. That afternoon, President Bush signed the Emergency Economic Stabilization Act of 2008, which created the $700 billion Troubled Assets Relief Program, or TARP.

Of course, what none of the congressmembers nor the public knew was that TARP was being completely rethought within Treasury, as Jester, Norton, and Nason began developing plans to use a big chunk of the $700 billion to invest directly in individual banks.

But they had been thinking about another program to go hand in hand with such an announcement: a broad, across-the-board program to guarantee all current and future unsecured debts of the banks.

he wanted to forge ahead and invest $250 billion of the TARP funds into the banking system. The group had settled on the general terms: Banks that accepted the money would pay a 5 percent interest payment.

The guarantee would end up being perhaps the largest—though an often overlooked—part of the program. It put the government on the hook for potentially hundreds of billions, if not more, in liabilities, providing the ultimate safety net for the banking system.

In the span of just a few months, the shape of Wall Street and the global financial system changed almost beyond recognition. Each of the former Big Five investment banks failed, was sold, or was converted into a bank holding company. Two mortgage-lending giants and the world’s largest insurer were placed under government control.

Nowhere was the public backlash more severe, however, than it was against American International Group. AIG had become an even greater burden than anyone expected, as its initial $85 billion lifeline from taxpayers eventually grew to include more than $180 billion in government aid. Geithner’s original loan to AIG, which he had said was fully collateralized, quickly looked to be no sounder an investment than a mortgage lender’s loan to a family with bad credit and no ability to ever pay it back.

But the greatest ire was reserved for reports of millions of dollars in bonuses being awarded to AIG executives, as protesters swarmed its headquarters and its officials’ homes. President Obama asked, “How do they justify this outrage to the taxpayers who are keeping the company afloat?” while on his television program Jim Cramer ranted, “We should hound them in the supermarket, we should hound them in the ballpark, we should hound them everywhere they are.”

More than a quarter of the bailout funds left AIG immediately and went directly into the accounts of global financial institutions like Goldman Sachs, Merrill Lynch, and Deutsche Bank, which were owed the money under the credit default swaps that AIG had sold them and through their participation in its securities lending program. To some extent this disbursement only bolstered the argument of critics who decried Paulson’s rescue as a bailout by Wall Street for Wall Street. (It didn’t help that foreign banks received some of the indirect aid, even though foreign governments hadn’t contributed to the rescue plan.)

The seeds of disaster had been planted years earlier with such measures as: the deregulation of the banks in the late 1990s; the push to increase home ownership, which encouraged lax mortgage standards; historically low interest rates, which created a liquidity bubble; and the system of Wall Street compensation that rewarded short-term risk taking. They all came together to create the perfect storm.

To be sure, if the government had stood aside and done nothing as a parade of financial giants filed for bankruptcy, the result would have been a market cataclysm far worse than the one that actually took place. On the other hand, it cannot be denied that federal officials—including Paulson, Bernanke, and Geithner—contributed to the market turmoil through a series of inconsistent decisions. They offered a safety net to Bear Stearns and backstopped Fannie Mae and Freddie Mac but allowed Lehman to fall into Chapter 11, only to rescue AIG soon after. What was the pattern? What were the rules? There didn’t appear to be any, and when investors grew confused—wondering whether a given firm might be saved, allowed to fail, or even nationalized—they not surprisingly began to panic.

It is, by any account, a tragedy that Lehman was not saved—not because the firm deserved saving but because of the damage its failure ultimately wreaked on the market and the world economy.

I don't know, didn't Obama himself effectively do this in 2012?

Despite whatever perceived lack of trust or confidence the public had in government, the U.S. economy demonstrably did rebound. It may still be popular to deride the bailouts, but the steps that Paulson, Bernanke, and Geithner took in the depths of the crisis empirically worked, even more than the most optimistic prognosticators had forecast. “If we were back in early 2009—when we were coming to work every morning with clenched stomachs, with the economy losing 800,000 jobs a month and the Dow under 7,000—and someone said that by your last year in office, unemployment would be five percent, the deficit would be under three percent, AIG would have turned a profit and we made all our money back on the banks, that would’ve been beyond anybody’s wildest expectations,” Gene Sperling, the former director of the National Economic Council under President Obama, observed. Today, Geithner says that the bank bailouts, as successful as they were, could never be fully appreciated. “It looks like you’re giving aid to the arsonist. Inherent in successful economic rescues are things that are deeply unpopular. And, of course, I knew that, felt that was unavoidable, lamentable.” President Obama blamed his messaging for one of the reasons the public didn’t recognize the significance of the economic rebound, suggesting that he had resisted telling the public the truth about how terrible the crisis had actually been. “It was a delicate balance throughout 2009 and 2010,” he explained, “to be st...

Banks were forced out of the game of trading for themselves as a result of a controversial new rule in Dodd-Frank named for Paul Volcker, the former chairman of the Federal Reserve. “Banks will no longer be allowed to own, invest in, or sponsor hedge funds, private equity funds, or proprietary trading operations for their own profit, unrelated to serving their customers,” President Obama said when announcing the rule. “If financial firms want to trade for profit, that’s something they’re free to do. Indeed, doing so—responsibly—is a good thing for the markets and the economy. But these firms should not be allowed to run these hedge funds and private equities funds while running a bank backed by the American people.”

But the most significant change to the financial system was a function of the Federal Reserve’s establishing minimal capital requirements for banks, which made it harder for them to increase leverage levels and therefore risk. These new provisions didn’t require legislation and often did not make headlines, but the reduction in leverage had a serious cascading impact on banks.

Still, the Goldman suit brought into stark relief larger questions about the dangers of derivatives and whether they had much social utility. What the public learned was that many of them, like synthetic CDOs, were effectively bets without anything substantial underlying them. Nobody was able to obtain a mortgage as a result of the sale of synthetic CDOs; an investor in one was simply gambling on what was going to happen to a series of mortgages that he didn’t even own.

But to truly give credence to the theory of “too big to fail,” one would have to believe that the executives who took on so much risk and leverage, beginning in 2004 by buying up subprime loans, genuinely knew both that they were doing something so dangerous that it would imperil the banking system, and that, even if they failed, the government would save them. Not one person I’ve interviewed prior to the publication of this book in 2009 or since has ever described a meeting or conversation that even hinted at reliance on government intervention.

One of the great lessons of the crisis was that CEOs who were perceived as all-knowing actually often had no idea what was taking place within their institutions only one floor below them, let alone across oceans on the other side of the world.