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 arrived at his office at just past 7:00 on Saturday morning. Even though he was still pushing his “Fortress Goldman” bank holding plan, he and Gary Cohn had assigned more than a half dozen teams to start investigating different deals: HSBC, UBS, Wells Fargo, Wachovia, Citigroup, Sumitomo, and Industrial and Commercial Bank of China.

Initially Cohn’s notion was that Citi should buy Goldman; he had even established an asking price. But Warsh suggested that Cohn approach it the other way around: Goldman should be the buyer. To Cohn that made no sense given that Citi was so much bigger. But what Warsh knew—and hadn’t yet shared with Cohn—was that Citigroup’s balance sheet had so many holes that its value was likely a lot lower than its current stock price.

Geithner called. In his usual impatient tone, he insisted that Blankfein immediately call Vikram Pandit, Citigroup’s CEO, and begin merger discussions. Blankfein, slightly shocked at the directness of the request, agreed to place the call. “Well, I guess you know why I’m calling,” Blankfein said when he reached Pandit a few minutes later. “No, I don’t,” Pandit replied, with genuine puzzlement. There was an awkward pause on the phone. Blankfein had assumed that the Fed had prearranged the call. “Well, I’m calling you because at least some people in the world might be thinking that combining our firms would be a good idea,” he said. After another few moments of uncomfortable silence Pandit finally replied, “I want you to know I’m flattered by this call.”

Merging the “Houses of Morgan” was not a new idea but hadn’t come up in any serious fashion since June 20, 1973, when Morgan Stanley, JP Morgan, Morgan Guaranty, and the British Morgan Grenfell held a top secret meeting in Bermuda, code-named “Triangle,” at the Grotto Bay Hotel.

But all these scenarios wound up circling back to the same problem: What, exactly, would they be buying? The overlap between the firms was enormous. And what were Morgan Stanley’s toxic assets really worth? These were all but unanswerable questions at that time.

Apologizing, Pandit explained that he had been talking to his team about the Goldman proposal, which they had ultimately rejected. “We’re concerned about taking on Goldman,” Pandit said, trying to explain his rationale for turning them down. “I don’t need another trillion dollars on my balance sheet.” Geithner could only laugh to himself. “This is a bank,” Pandit said. “And a bank takes deposits and a bank has a prudency culture. I cannot envision a bank taking its deposits and investing them all in hedge funds. I know that’s not what Goldman is, but the perception is that they’d be taking deposits and putting them to work against a proprietary trade. That can’t be right philosophically!” Having dispensed with pushing Goldman and Citigroup together, Geithner moved on to his next idea: merging Morgan Stanley and Citigroup. Pandit had been considering that option, too, and while he was more predisposed to merging with Morgan Stanley, he still was reluctant. “It’s still not our choice to do this deal, but we could think about it,” he told Geithner.

Kelleher had just finished giving a presentation on the firm’s finances, and it was not good. Charles Noski, a director and former chief financial officer of AT&T, asked him point-blank: “When do we run out of money?” Kelleher paused and then said somberly, “Well, depending on what happens Monday and Tuesday, it could be as early as middle of the week.”

“If we go, Goldman goes,” he said, stating the obvious, at least internally, by that point. But then he added a new insight that the board hadn’t considered. “And then GE will go.”

General Electric was more about manufacturing than financial engineering, but roughly half of its profits in recent years had come from a finance company unit called GE Capital. Like most Wall Street firms, GE Capital relied on the short-term paper market and the confidence of investors worldwide, and Immelt was worried about how the fate of Goldman and Morgan Stanley might affect it.

After much debate, Paulson’s team settled on the $700 billion figure that Kashkari had proposed the day before. If passed, it would be the largest one-time expenditure in the history of the federal government.

And the reaction was instant: Even inside the department there were worries that Paulson might look like he was overreaching. The three-page bill had no oversight plan and virtually no qualifiers. Its terse length alone was making people uneasy.

The benefits of a bank holding company were explained to him: Short-term financing would be available through the Fed’s discount window, provided Morgan Stanley established a sufficient deposit base and submitted to various regulations. “Will you get your board to agree?” they asked Kelleher. Kelleher now understood what this meeting meant: The Federal Reserve might be offering to save his firm. The tank might not reach empty after all. “Of course,” he replied.

Meanwhile, Steel’s own lawyer, Rodgin Cohen, was also Goldman’s lawyer. It had all become so confusing and rife with conflicts, but they all agreed that if they were going to do a deal, they’d have to reach an agreement by Monday morning.

Before decamping for the night, Blankfein invited Steel back to his office. He wanted to talk about titles, perhaps the most sensitive issue for men who often measure themselves as much by their business cards as by their wallets.

Hank Paulson was still in his office and had just gotten off the phone with Geithner. The news was not promising. Geithner told him that Morgan Stanley had no plan apart from what he called the “naked” bank holding company scenario. Geithner said he was uncertain whether any investor—JP Morgan, Citigroup, the Chinese, or the Japanese—would come through. And he was skeptical of the Goldman-Wachovia deal. “We’re running out of options,” he told Paulson. Paulson, who had been living on barely three hours of sleep a night for a week, was beginning to feel nauseated. Watching the financial industry crumble in front of his eyes—the world he had inhabited his entire career—was getting to him. For a moment, he felt light-headed. From outside his office, his staff could hear him vomit. —

He needed to buck himself up. Somehow, he was going to save Morgan Stanley. When he stepped into his living room a few minutes later, he admitted to Christy with a grateful smile, “I’d rather be doing this than reading a book in North Carolina.”

There remained, however, one serious obstacle: Goldman wanted a “Jamie” deal. The next step was to go back to Warsh at the Fed and ask whether the Fed was prepared to subsidize the deal by guaranteeing Wachovia’s most toxic assets.

Warren Buffett was at his home in Omaha on Sunday when he received a phone call from Byron Trott, a vice chairman at Goldman Sachs. Buffett, who disliked most Wall Street bankers, adored Trott, a mild-mannered Midwesterner based in Chicago.

But a half hour later, after a cup of coffee and further reflection, Wilkinson changed his mind. He realized that such a deal would be a public relations nightmare at the worst possible time, just as they were trying to pass TARP. Paulson would lose all credibility; he would be accused of lining the pockets of his friends at Goldman; the “Government Sachs” conspiracy theories would flourish.

Then Bill Dudley, a former Goldman man himself who thought the deal was unattractive for the government, also raised the same objection that Buffett had raised just hours earlier: It would prove a public relations disaster for the government. “What are we doing here? Look at all of the connections you’ve got: Treasury and Steel and me. Goldman is everywhere. We have to be careful.” After Geithner and Bernanke called Paulson, all three agreed they just couldn’t support the deal.

At Goldman Sachs the mood was slightly less tense. “We’re getting bank holding company,” Blankfein, having just spoken with Geithner, announced as Cohn walked into his office. “It’s going to happen.” When the Federal Reserve faxed over the draft of the press release, he could see that one other institution, which was purposely left blank, would be granted the same status. That must be Morgan Stanley, he thought. His Friday-morning call to Mack must have worked.

At 9:30 p.m., the news hit the wires. Goldman Sachs and Morgan Stanley would become bank holding companies. It was a watershed event: The two biggest investment banks in the nation had essentially declared their business model dead to save themselves. The New York Times described it as “a move that fundamentally reshapes an era of high finance that defined the modern Gilded Age” and “a blunt acknowledgment that their model of finance and investing had become too risky.”

“I know you miss the Wainwrights, Bobby,” the caption reads, “but they were weak and stupid people—and that’s why we have wolves and other large predators.” To Blankfein that pretty much summed up what had just happened to Wall Street: Had things worked out slightly different, Morgan Stanley, and perhaps even Goldman Sachs, could have ended up just like the Wainwrights.

Despite its having been designated a bank holding company—giving it virtually unlimited access to liquidity from the Federal Reserve—investors had suddenly become worried about whether Goldman would need more capital.

Trott, who was the firm’s closest—and perhaps only—conduit to Warren Buffett, suggested that they consider approaching him one more time. Since the previous Thursday, Trott had gone to Buffett with a number of different proposals to invest in Goldman, but the ever-circumspect financier had declined them all.

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.

Minutes later the group was assembled, and they began to discuss the Buffett deal. Just as important as the infusion of cash, they agreed, was the confidence that a Buffett investment would inspire in the market. Indeed, Winkelried said, the firm would be able to raise additional money from other investors on the back of Buffett’s investment.

Back at Broad Street, however, there was still one provision that troubled the group, a provision that Buffett had indicated would be a deal breaker: Goldman’s top four officers could not sell more than 10 percent of their Goldman shares until 2011, or until Buffett sold his own, even if they left the firm. He had explained his rationale for this condition to Blankfein by saying, “If I’m buying the horse, I’m buying the jockey, too.”

Blankfein called him personally and, after assuring him that the firm would help him find a way out of his financial troubles, Winkelried agreed to Buffett’s condition. He was unhappy with the restriction, but he knew that the Buffett deal was best for Goldman. By the next morning Goldman had managed to sell an additional $5 billion of shares to investors on the news of the Buffett deal, and its stock rose more than 6 percent. Blankfein could finally relax. The wolves were no longer at the door.

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.

Beyond the rhetoric, however, lawmakers as well as investors were starting to raise practical questions about how the process of buying troubled assets would actually work. How would the government pay for them? How would the prices be determined? What if certain parties wound up profiting at the expense of the taxpayers?

“You announced the wrong plan!” Schwarzman told him. “What do you mean?” Wilkinson asked. “You won’t practically be able to figure out a way to buy these assets in a short period of time to provide liquidity to the system without either screwing the taxpayers or screwing the banks,” Schwarzman warned him. “And you won’t be able to force people to sell!” 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. “And,” he added, “each package of these assets is so highly complex that it’s not like bidding for a bond; you have to do a lot of in-depth analysis, and that takes weeks to months, and meanwhile, if you do nothing for weeks to months, you’re going to go back into crisis.”

The conversation soon turned to executive compensation. While everyone in the room was aware of the potential political fallout over huge bonuses being paid out by firms requiring taxpayer rescue, it was Max Baucus, chairman of the Senate Finance Committee, who spoke to the issue. He made it abundantly clear that he was furious with Paulson for not having insisted on strict limits on compensation for the managements of banks that would take advantage of the program. In Baucus’s view the executives should be entitled to next to nothing—and at the very minimum they should be forced to give up golden parachutes and other perks.

Kovacevich, a handsome sixty-four-year-old with silver just beginning to shade his temples, had built Wells Fargo into one of the best-managed banks in the country, establishing it as the dominant franchise on the West Coast and attracting Warren Buffett’s Berkshire Hathaway as his largest single shareholder.

At 4:00 a.m. Steel got the answer he had been dreading. 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.”

Finally, at 2:10 p.m., after an unusually long period of forty minutes to count the votes, the gavel came down: The bailout was rejected 228 to 205. More than two thirds of the Republican representatives had voted against it, as had a large number of Democrats. Traders and investors had been watching the coverage also and started a frantic wave of selling. Stock prices plunged, with the Dow Jones Industrial Average tumbling 7 percent, or 777.68 points, its biggest one-day point drop ever. For a moment Paulson was speechless. His plan, which he believed might be the most important piece of legislation he could ever propose—his effort at avoiding a second Great Depression—had failed. As his staffers, seeking to comfort him and one another, silently gathered in his office, he said simply, “We’ve got to get back to work.”

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. 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.

Bob Steel climbed the steps of Wachovia’s corporate jet at Teterboro Airport in New Jersey to head back to Charlotte. He had spent virtually the entire week in back-to-back meetings with Citigroup to coordinate the details of the merger, which they planned to herald in a full-page newspaper ad on Friday, declaring: “Citibank is honored to enter into a partnership with Wachovia . . . the perfect partner for Citibank.” While he was frustrated with the paltry final price of the deal, he was proud to have at least saved the firm from failure, and he knew that he had explored every possible option in trying to do so.

“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.

Steel and Cohen realized that Wells Fargo had made its bid because of a little-noticed change in the tax law that had occurred on Tuesday, the day after the Citigroup deal. The new provision would allow Wells Fargo to use all of Wachovia’s write-downs as a deduction against its own income, thus enabling the combined bank to save billions in future taxes. Wachovia’s board voted to accept the deal just after midnight. The Wells offer was for the entire company; it gave shareholders more; and it was clearly the deal preferred by regulators.

Many of the House Democrats and Republicans who had opposed the measure on Monday had since been persuaded to switch their votes—some by appeals from the two presidential candidates or from the president, some by the added provisions in the bill, and others by the mounting signs that the financial crisis was dragging the economy down into a deep recession. A recent report indicated that 159,000 jobs had been lost in September, the fastest pace of monthly job cuts in more than five years. Stocks had slid sharply that week, and both the takeover of Washington Mutual and the desperate jockeying to secure a partner for Wachovia revealed that not only Wall Street was in trouble.

That afternoon, President Bush signed the Emergency Economic Stabilization Act of 2008, which created the $700 billion Troubled Assets Relief Program, or TARP. “We have shown the world that the United States will stabilize our financial markets and maintain a leading role in the global economy,” the president declared.

In truth, while he had cashed out $260 million during that period, most of his net worth was tied up in Lehman until the end. His shares, once making him worth $1 billion, were now worth $65,486.72. He had already started working on plans to put his apartment and his wife’s cherished art collection up for sale. It was a telling paradox in the debate about executive compensation: Fuld was a CEO with most of his wealth directly tied to the firm on a long-term basis, and still he took extraordinary risks.

“Some critics have worried that Treasury won’t buy mortgages at prices close to the market but will instead buy at higher ‘theoretical’ prices that would please selling institutions. Critics have also questioned how Treasury would manage the mortgages purchased: Would Treasury act as a true investor or would it be overly influenced by pressures from Congress or the media? For example, would Treasury be slow to foreclose on properties or too bureaucratic in judging requests for loan forbearance?” 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...

But perhaps the greatest indication that the concept was feasible came from abroad: The United Kingdom had announced plans to invest $87 billion in Barclays, the Royal Bank of Scotland Group, and six other banks in an effort to instill confidence after a near Lehman-like meltdown confronted them. In exchange, British taxpayers would receive preferred shares in the banks (including annual interest payments) that were convertible into common shares, so that if the banks’ prospects improved—and their shares rose—taxpayers would benefit. Of course, the plan was also a huge gamble, for the reverse was also true: If the banks faltered after the investment was made, a great deal of money stood to be lost.

And everyone inside Morgan Stanley knew what Mitsubishi’s pulling out would mean: a run on the bank all over again, and, just possibly, the end of the firm.

“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.

Perhaps the biggest fireworks that weekend concerned the one unresolved portion of the plan that Paulson was still hoping to announce: the FDIC guarantee of all current and future unsecured debts of the banks and bank holding companies.

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.

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.