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

Lloyd Blankfein, CEO of Goldman Sachs,

Just that morning Fuld had attended a contentious meeting in downtown Manhattan with Tim Geithner at the New York Fed, imploring him to do something about the short-sellers, who he was convinced were just catching their breath. Erik Sirri, the head of the SEC’s Division of Trading and Markets, repeatedly pressed Fuld for proof of any illegal activity, pleading, “Just give me something, a name, anything.”

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.

“greenback”—that

Fuld had been looking forward to the dinner all week, eager for a chance to talk with Paulson face-to-face.

Fuld noticed an old friend in the corner, John Mack, CEO of Morgan Stanley, one of the few people in the room who understood exactly what Fuld was going through. Of all the CEOs on the Street, Fuld felt closest to Mack; they were the longest-running leaders of the major firms, and they would occasionally dine together with their spouses.

One was an American banker named Bob Diamond, who ran Barclays Capital,

Fuld also briefly paid his respects to Diamond’s regulators, Alistair Darling, the head of Britain’s Treasury, and Mervyn King, the governor of the Bank of England.

But it was Paulson, wearing a blue suit that seemed one size too big for him, who spotted Fuld first. “You guys are really working hard over there,” Paulson told him, grasping his hand. “The capital raise was the right thing to do.” “Thanks,” Fuld said. “We’re trying.” Paulson also expressed his gratitude for the “thoughtful” dialogue that had been initiated among Tom Russo, Lehman’s general counsel, and Rick Rieder, who ran Lehman’s global principal

Paulson’s deputy, Bob Steel, and Senator Judd Gregg.

“I am worried about a lot of things,” Paulson now told Fuld, singling out a new IMF report estimating that mortgage- and real estate–related write-downs could total $945 billion in the next two years. He said he was also anxious about the staggering amount of leverage—the amount of debt to equity—that investment banks were still using to juice their returns.

The numbers in that area were indeed worrisome. Lehman Brothers was leveraged 30.7 to 1; Merrill Lynch was only slightly better, at 26.9 to 1. Paulson

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?”

Paulson was worried not just about Lehman; he knew Merill too was awash in bad assets, and mentioned the challenges that Merrill’s new CEO, John Thain (who had been Paulson’s number two at Goldman), was facing with his own balance sheet. But leverage and Merrill’s problems

short-s...

But if the shorts were allowed to keep hammering away, the overall situation was only going to get a lot uglier.

As a former CEO himself, Paulson could understand Fuld’s frustration. Short-sellers cared only about their own profits and gave little thought to their impact on the system.

But Paulson was also concerned that Fuld was using the short-sellers as an excuse to avoid addressing the genuine problems at Lehman. “You know, the capital raise, as good as it was, is just one thing,”

The credit crisis wasn’t just a U.S. problem; it had spread globally.

HP [Hank Paulson] has a worried view of ML [Merrill Lynch]

At Paulson’s request, they had done nothing less than to formulate a plan for what to do in the event of a total financial meltdown, outlining the steps that the Treasury Department might have to take and the new powers it would require to stave off another Great Depression.

title “Break the Glass: Bank Recapitalization Plan.” Like a fire alarm enclosed in glass,

Four words had dogged Ben Bernanke from the moment he assumed the job of chairman of the Federal Reserve on February 1, 2006: “Hard Act to Follow.” It was, perhaps, an inevitable epithet for the man whom the renowned Washington Post investigative reporter Bob Woodward had also dubbed “The Maestro”—Alan Greenspan, who was to monetary policy what Warren Buffett is to investing.

Bernanke, by contrast, had been a college professor for most of his career, and at the time of his appointment to replace the then-eighty-year-old Greenspan, his area of specialization—the Great Depression and what the Federal Reserve had done wrong in the 1920s and 1930s—seemed quaint.

By the summer of 2007, however, America’s second Gilded Age had come shockingly to an end, and Greenspan’s reputation lay in tatters.

Bernanke was cut from a different cloth, though he shared Greenspan’s belief in the free market. In his analysis of the crisis, Bernanke advanced the views of the economists Milton Friedman and Anna J. Schwartz, whose A Monetary History of the United States, 1867–1960 (first published in 1963) had argued that the Federal Reserve had caused the Great Depression by not immediately flushing the system

Ben Shalom Bernanke was born in 1953 and grew up in Dillon, South Carolina, a small town permeated by the stench of tobacco warehouses. As an eleven-year-old, he traveled to Washington to compete in the national spelling championship in 1965, falling in the second round when he misspelled “Edelweiss.” From that day forward he would wonder what might have been had the movie The Sound of Music, which featured a well-known song with that word for a title, only made its way to tiny Dillon.

In high school, Bernanke taught himself calculus because his school did not offer a class in the subject. As a junior, he achieved a near-perfect score on the SATs (1590), and the following year he was offered a National Merit Scholarship to Harvard. Graduating with a degree in economics summa cum laude, he was accepted to the prestigious graduate program in economics at the Massachusetts Institute of Technology. There he wrote a dense dissertation about the business cycle, dedicating it to his parents and to his wife, Anna Friedmann, a Wellesley College student whom he married the weekend after she graduated in 1978.

Bernanke

Bernanke also demonstrated political skills as his intellectual reputation grew. As chairman of the Princeton economics department, he proved effective at mediating disputes and handling big egos. He also created a series of new programs and recruited promising young economists such as Paul Krugman (who happened to be his ideological opposite).

Up until early August 2007, Bernanke had been enjoying his tenure at the Fed, so much so that he and Anna had planned to take a vacation that month and drive to Charlotte, North Carolina, and then on to Myrtle Beach, South Carolina, to spend time with friends and family. Before heading south, he had to see to one final business matter: the Federal Open Market Committee, the Fed’s powerful policy-making panel, which among its other responsibilities sets interest rates, was scheduled to meet on August 7. On that day, Bernanke and his colleagues acknowledged for the first time in recent memory the presence of “downside risks to growth,” but decided nonetheless to keep the Fed’s benchmark interest rate unchanged at 5.25 percent for the ninth consecutive meeting.

Four days earlier financial commentator Jim Cramer had exploded on an afternoon segment of CNBC, declaring that the Fed was “asleep” for not taking aggressive action. “They’re nuts! They know nothing!” he bellowed.

was that credit markets were beginning to suffer as the air had begun gradually seeping out of the housing bubble.

Cheap credit had been the economy’s rocket fuel, encouraging consumers to pile on debt—whether to pay for second homes, new cars, home renovations, or vacations. It had also sparked a deal-making frenzy the likes of which had never been seen: Leveraged buyouts got larger and larger as private-equity firms funded...

Two days later, however, the world changed. Early on the morning of August 9, in the first major indication that the financial world was in serious peril, France’s biggest bank, BNP Paribas, announced that it was halting investors from withdrawing their money from three money market funds with assets of some $2 billion. The problem?

“The complete evaporation of liquidity in certain market segments of the U.S. securitization market has made it impossible to value certain assets fairly, regardless of their quality

or credit rating,” the bank explained. It was a chilling sign that traders were now treating mortgage-related assets as radioactive—unfit to buy at any price.

Meanwhile, in the United States, Countrywide Financial, the nation’s biggest mortgage lender, warned that “unprecedented disruptions” in the markets threatened its financial condition.

Banks and investors, fearful of being contaminated by these toxic assets, were hoarding cash and refusing to make loans of almost any kind. It wasn’t clear which banks had the most subprime exposure, so banks were assumed guilty until proven innocent. It had all the hallmarks of the early 1930s—confidence in the global financial system was rapidly eroding, and liquidity was evaporating. The famous nineteenth-century dictum of Walter Bagehot came to mind: “Every banker knows that if he has to prove that he is worthy of credit, however good may be his arguments, in fact his credit is gone.”

Although the subprime market had mushroomed to $2 trillion, it was still just a fraction of the overall $14 trillion U.S. mortgage market.

that the link between the housing market and the financial system was further complicated by the growing use of exotic derivatives.

A municipal pension fund in Norway might have subprime mortgages from California in its portfolio and not even realize

“But some of the complexities of some of the instruments that were going into CDOs bewilders me. I didn’t understand what they were doing or how they actually got the types of returns out of the mezzanines and the various tranches of the CDO that they

After a few minutes of chat, Swagel reached into a folder and gingerly handed Bernanke the ten-page outline of the “Break the Glass” paper. Kashkari glanced at his colleagues for reassurance and then began to speak.

“We are talking a ballpark estimate of, what, say, $1 trillion in toxic assets?” explained Kashkari. “But we wouldn’t have to buy all of the bad stuff to make a meaningful dent. So, let’s say half. But maybe it’s more like $600 billion.”

they had already detailed how Treasury would designate the New York Fed to run the auctions of Wall Street’s toxic assets. Together they would solicit qualified investors in the private sector to manage the assets purchased by the government. The New York Fed would then hold the first of ten weekly auctions, buying $50 billion worth of mortgage-related assets.

but Kashkari was gratified that the chairman took it so well—much better, in fact, than his own boss, Hank Paulson, had when Kashkari first decided to test him on the subject of intervening in the financial markets.

“Ha, ha. Obama is going to bring the hostages home,” Paulson said. “Oh, yeah? Get the fuck out of here.” —