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April 25 - May 18, 2020
“I know it’s unpleasant to help a competitor do a deal, but it’s not going to be as unpleasant as it will be if Lehman goes,” Paulson stressed. “You need to do this.” For many in the room, the idea of coming to the assistance of a rival was more than unpleasant: It was anathema. What made the situation even worse was that the competitors they were being asked to aid were Bank of America and Barclays, the ultimate outsiders. Ken Lewis, Bank of America’s CEO, had disparaged them every chance he got, and they all viewed Barclays as a wannabe, a second-tier player trying to break into the big
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As sophisticated as the world’s markets have become, the glue that holds the entire arrangement together remains old-fashioned trust. Once that vanishes, things can unravel very quickly.
Geithner insisted that the Fed had AIG under control and again attempted to move the conversation along. What remained unacknowledged was that JP Morgan and Citigroup, as advisers to AIG, were the only parties in the room that had any true appreciation for the depth of the problems that the firm faced. Thain, whose bank was likely the next to fall, as everyone in the room understood all too well, remained notably silent during the exchanges.
“It’s too big a deal; $25 billion is too big.” Willumstad never thought he’d hear Buffett call any prospective deal too big. “I’d have to use all my cash and can’t do anything to jeopardize Berkshire’s triple-A rating,” Buffett explained. For a moment, he alluded to the possibility of raising the money, but then acknowledged that he “didn’t want to have that kind of debt on my balance sheet.”
Dimon, who sat in the backseat returning e-mails on his BlackBerry, had just gotten off a conference call with his management team. He had dropped a bombshell on them, telling them to prepare for the bankruptcies of Lehman Brothers, Merrill Lynch, AIG, Morgan Stanley, and even Goldman Sachs. He knew he might have been overstating the case, but he figured they needed to be prepared.
As a longtime deal maker, Fleming certainly knew how valuable even a weekend could be. The biggest deals on Wall Street had always been finalized when the markets were closed on Saturday and Sunday, so that the details could be refined without worrying that a leak could quickly affect stock prices and potentially scuttle an agreement.
On this day the bankers assembled at the Fed had their own historic battle to wage, with stakes that were in some ways just as high: They were trying to save themselves from their own worst excesses, and, in the process, save Western capitalism from financial catastrophe.
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.
Curl had a strong view about takeovers: You never want to overpay, but if you believe in the business, you’re better off paying more to guarantee you own it than to lose it to a competitor.
“We shouldn’t be rushed into anything.” While it might be ugly out there, he reminded everyone of the obvious: They were Morgan Stanley, the global financial juggernaut. The firm’s market value was still more than $50 billion as of that Friday—a lot less than a month earlier but hardly a joke. And they had $180 billion in the bank.
Klein proceeded to explain, in the most delicate way possible, Barclays’ plan, which everyone in the room instantly realized meant that an industry consortium would have to come up with some $33 billion to finance ShitCo, or as Klein kept describing it to people, “RemainderCo.” For the other banks, this would be less an investment in Lehman or Barclays than it would be in themselves, hoping to stave off the impact of a Lehman failure.
Klein, realizing that the bankers didn’t understand the structure of the deal, explained it again. Barclays wasn’t going to be investing in Lehman’s “bad bank” alongside the consortium; it was only buying Lehman’s “good bank.” The bankers around the table looked at one another, as his explanation set in. They really were being asked to subsidize a competitor. Barclays would have no stake in Lehman’s worst assets, which they were being asked to take on.
“We’ve got a big problem. I mean, fucking big,” Douglas Braunstein of JP Morgan announced to his team at AIG just past midnight. The lights were still ablaze where a battalion of bankers, hunched over laptops and spreadsheets, had just discovered a new hole in AIG’s finances. Its securities lending business had lost $20 billion more than anyone had recorded. “We’re not trying to solve for $40 billion anymore,” Braunstein shouted. “We need $60 billion!”
Blankfein told the room that while he wasn’t convinced that Lehman actually posed a systemic risk, there was a larger issue of all the banks’ reputations and public perception to consider. “Bear Stearns did a lot of good things over the last decade, but the only thing they’re remembered for is, they didn’t step up when the industry needed them to.”
So far, Paulson had been trying to show no sense of fear among his colleagues and CEOs, but, in truth, the moment was beginning to overwhelm him. He was getting increasingly anxious that the market could end up toppling.
“If Lehman goes into bankruptcy, totally unprepared, there’s going to be Armageddon,” Miller warned. “I’ve been a trustee of broker-dealers, little cases, and the effect of their bankruptcies on the market was significant. Here, you want to take one of the largest financial companies, one of the biggest issuers of commercial paper, and put it in bankruptcy in a situation where this has never happened before. What you’re going to do now is take liquidity out of the market. The markets are going to collapse.” Miller waved his finger and repeated, “This will be Armageddon!”
By Curl’s thinking, as he explained to Ken Lewis before agreeing to the price, “We might be able to get it for cheaper later, but if we don’t do the deal today, we could lose the opportunity entirely.” For Curl, a journeyman dealmaker, this was his crowning achievement.
In a matter of hours, Merrill Lynch, with a history of nearly one hundred years as one of the most storied names on Wall Street, would be sold to Bank of America for the biggest premium in the history of banking mergers. It was, as one newspaper later put it, as if Wal-Mart were buying Tiffany’s.
“My goodness. I’ve been in the business thirty-five years, and these are the most extraordinary events I’ve ever seen.”
While Amy acknowledged that it may look to the outside world as if BAC is paying a bit of a premium for Merrill, BAC’s estimates of Merrill’s asset values indicate they are getting the firm at a 30–50% discount.
Presumably the most important reason to teach Wall Street this lesson, is that they will change their behavior, and not take the decisions that are reliant on a public bail-out. For many, but not all, this is an impossible lesson to learn in the middle of the worst financial storm since the Great Depression.”
If there was one banker in the city who understood the world of debt and how to raise money in a pinch, it was Jimmy Lee. He was perhaps JP Morgan’s most senior deal maker, a mogul unto himself with his own banquette at the Four Seasons at lunch. His power derived, in part, from the fact that he was a virtual ATM for corporate America, writing massive checks to finance some of the biggest deals in history. Dimon told him he was hoping that Lee could structure a deal to loan AIG enough money to keep operating and sign up a dozen other big financial players to follow him.
His chief financial officer, Colm Kelleher, chimed in to punctuate that point: “There is Darwinism here. . . . Weak people are being taken out. Strong people, I believe, are going to do very, very well.”
As the JP Morgan contingent began briskly walking over to the Fed, Lee said, shaking his head: “Whenever someone says they have time, there’s never enough. And when they say they need money, the number is always too low.” He paused before declaring, “They won’t last the week.”
What went unspoken was the fact that all three banks, and virtually all of Wall Street, were huge counterparties to AIG. If the company were to fail, they would all face serious consequences. Therefore, there was a huge incentive to keep the insurer alive for everyone at the table.
On the surface, Goldman looked like one of AIG’s biggest counterparties, but earlier that morning, Goldman’s Gary Cohn had boasted internally that the firm had hedged so much of its exposure to AIG that it might actually make $50 million if the company collapsed. The firm’s decision to buy insurance in the form of credit default swaps against AIG beginning in late 2007 was starting to seem like a smart investment.
Even though Goldman had hedged its direct exposure to AIG, Blankfein appreciated the larger problem: The collateral damage to its other counterparties and the rest of the market could expose the firm to untold billions in crippling losses.
Given the size of loan AIG would require, the fees would be mind-boggling. He might be able to charge as much as 500 basis points, or 5 percent, of the entire amount for taking on this level of risk. For a $50 billion loan, that would add up to a $2.5 billion payday in fees.
For a while it seemed as if progress was being made. Lee and Winkelried felt confident that AIG’s assets were strong, at least strong enough for them to lend against. What they believed the company was experiencing was merely a liquidity crisis: If they could provide AIG with a bridge loan, they’d be home free. The group started discussing drafting a preliminary term sheet. They’d try to raise $50 billion, in exchange for warrants for 79.9 percent of AIG. It was almost a punitive price, but given the insurer’s status, it might be their only alternative to bankruptcy. Winkelried and Lee also
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Given the conversation he’d had with Dan Jester at 6:00 that morning, however, it was looking increasingly likely that AIG and the global financial system were now in such peril that the government would have no choice but to intervene.
“We’ve gone through it all,” Lee said. “They have $50 billion in collateral and they need $80 to $90 billion. We’re short $30 to $40 billion. I don’t know how we can bridge that gap.” Winkelried of Goldman then jumped in. “Let me just say there is a huge systemic risk to letting this institution fail. I don’t need to tell you the number of counterparties that would be exposed.”
Pleading with his former boss to do something to calm the markets, Blankfein told Paulson that his biggest worry was that so much money was clogged up inside Lehman that investors would panic and start pulling their money out of Goldman Sachs and Morgan Stanley, too.
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.
how the government could fund this amount of money without firing the current CEO and installing its own. Without a new CEO, it would seem as if the government was backing the same inept management that had created this mess.
While Bernanke said that he had decided to back the deal, he nevertheless wanted to take a straw poll among the participants in the call. He was clearly anxious, asking, “Are you sure we’re doing the right thing?” But with his implicit support—and Geithner’s insistence that this was the only way to avert a financial Armageddon—the vote was 5–0. There was no longer any discussion of moral hazard, and no talk of Lehman Brothers.
Bernanke jumped in and said, “Mr. President, let’s step back for a minute.” Donning his professorial hat, he explained how deeply entwined AIG had become in the banking system. More important, he tried to appeal to the Everyman in Bush, emphasizing how many citizens and small businesses depended on the firm. People used AIG’s life insurance policies to protect their families. They used AIG’s annuities to fund their retirements. AIG also provided surety bonds, a kind of guarantee for construction projects and public works. The president then posed a question that, in its own way, went directly
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And they did. The Federal Reserve was providing AIG a credit line of $85 billion—which it hoped would be enough to avert catastrophe and keep it afloat. But in exchange for the loan, the government was taking a large ownership stake—79.9 percent in the form of warrants called “equity participation notes.”
“Paulson is handling this the same way he did Fannie, Freddie, and Bear Stearns—if the government steps in, the shareholders will pay for it,” Cohen observed.
In order to pay back the government, AIG would have to sell off assets—and under the circumstances, that meant a fire sale. To AIG loyalists, the loan was proving to be less a bridge to solvency than a plank to an organized breakup.
It was no coincidence, though, that the government’s terms had so much in common with what the private sector had been considering. For one thing, they had used many of the same advisers. And in the current political environment, there was safety in being able to say that AIG was only getting what the market had been willing—or almost willing—to offer.
Beattie, playing hardball, had effectively implied a threat that AIG might be better off filing for Chapter 11 bankruptcy than taking the government’s deal. Geithner didn’t flinch. “This is the only proposal you’re going to get,” he tersely replied, and then added, “There’s one other condition. . . .” Paulson, interrupting, said, “The condition is that we’re going to replace you, Bob.” Beattie and Cohen looked at Willumstad in embarrassed silence. “O . . . kay,” Willumstad said. “If that’s what you want.” “We’re going to bring in a new CEO,” Paulson said matter-of-factly. “He’ll be showing up
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“I just spent the last ten minutes giving you all the banking reasons to do this,” Studzinski summed up. “But there’s one more,” he said, looking around the room. “Isn’t twenty percent of something better than one hundred percent of nothing?” The room fell silent.
“We have a second question. The board wants to know whether, if the company can come up with its own financing to take the Fed’s place, would that be acceptable?” Geithner hesitated and then replied: “Nobody would be happier than I if the company, you know, would pay the Fed back.” Beattie returned to the boardroom and relayed the conversation. The deal was done.
For five days his brain had been trapped in a maze of numbers—huge, inconceivable, abstract numbers, ranging in the span of twenty-four hours from zero for Lehman to $85 billion for AIG. Eighty-five billion dollars was more than the annual budgets of Singapore and Taiwan combined; who could even begin to understand a figure of that size?
At the beginning of the week, Morgan Stanley had had $178 billion in the tank—money available to fund operations and to lend to their major hedge fund clients. But in the past twenty-four hours, more than $20 billion of it had been withdrawn, as hedge fund clients demanded it back, in some cases closing their prime brokerage accounts entirely.
As far as Mack was concerned, they needed to keep paying out money. He had spent years building their prime brokerage business into a major profit center—eighty-nine of the top one hundred hedge funds in the world traded through Morgan Stanley. It was essential in the midst of a crisis that the firm not display even the slightest sign of panic, or the entire franchise would be lost.
“Look, John, we’re here for you. We’re not aggressive. And if you want to do something strategically to put us together, we would like to talk to you,” Volk said. It was potentially explosive news. A merger between Morgan Stanley and Citigroup would be like combining Microsoft and Intel.
“For seven years, I’ve said that the commercial banks would eventually own the investment banks because of funding issues,” Lewis said. “I still think that. The Golden Era of investment banking is over.”
And if Morgan Stanley were to go, Goldman, the firm where both had spent their entire careers, would likely be next in line. “Another day, another crisis,” Paulson said with a nervous laugh that betrayed an uneasy sense that he was truly beginning to panic himself.
He may have been praised for not bailing out Lehman, but he could see now that the unintended consequences had been devastating.
