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

The nine CEOs had already taken their seats, arranged alphabetically behind placards with their names, when Paulson, Geithner, Bernanke, and Bair entered. It was the first time—perhaps the only time—that the nine most powerful CEOs in American finance and their regulators would be in the same room at the same time.

“We regret having to take these actions,” he reiterated, and in case there was any confusion, he underscored the fact that he expected them to accept the money whether they wished to or not. “But let me be clear: If you don’t take it and you aren’t able to raise the capital that they say you need in the market, then I’m going to give you a second helping and you’re not going to like the terms on that.”

Geithner now read off the amount that each bank would receive, in alphabetical order. Bank of America: $25 billion; Citigroup: $25 billion; Goldman Sachs: $10 billion; JP Morgan: $25 billion; Morgan Stanley: $10 billion; State Street: $10 billion; Wells Fargo: $25 billion. “So where do I sign?” Dimon said to some laughter, trying to relieve the tension, which had not dissipated now that the bankers had learned why they had been summoned.

Thain jumped in with his own question: “What kind of protections can you give us on changes in compensation policy?” Although his new boss, Lewis, couldn’t believe Thain’s nerve in posing the question, it was nonetheless the one that everyone present wanted to ask. Would the government retroactively change compensation plans? Could they? What would happen if there was a populist outcry? After all, the government would now own stakes in their companies.

Outside in the hallway, a huge grin was on Pandit’s face. “We just got out. They’re going to give us $25 billion, and it comes with a guarantee,” he said into the cell phone, sounding as if he had just won the Powerball lottery.

Paulson, Geithner, Bernanke, and Bair sat in Paulson’s office, waiting. With the exception of Kovacevich’s grumbling, the meeting had gone well, much better than they had anticipated. They had effectively just nationalized the nation’s financial system, and no one had had to be removed from the room on a stretcher. Paulson, running his fingers over his stomach, as he always did when he was deep in thought, still couldn’t believe he had pulled it off.

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. And in early October, with a stroke of the president’s pen, the Treasury—and, by extension, American taxpayers—became part owners in what were once the nation’s proudest financial institutions, a rescue that would have seemed unthinkable only months earlier.

Instead of restoring confidence, the bailout had, perversely, the opposite effect: Investors’ emotions and imaginations—the forces that John Maynard Keynes famously described as “animal spirits”—ran wild. Even after President Bush signed TARP into law, the Dow Jones Industrial Average went on to lose as much as 37 percent of its value.

“The government intervention is not a government takeover,” President Bush asserted on October 17, 2008, as he sought to counter his critics. “Its purpose is not to weaken the free market. It is to preserve the free market.” Bush’s statement seemed to sum up the paradox of the bailout, in which his administration and the one that followed decided that the free market needed to be a little less free—at least temporarily.

Even with the help of cash infusions some of the country’s major banks continued to falter. Citigroup, the largest American financial institution before the crisis, devolved into what Treasury officials began referring to as “the Death Star.” In November 2008 they had to put another $20 billion into the financial behemoth, on top of the original $25 billion TARP investment, and agreed to insure hundreds of billions of dollars of Citi’s assets. In February 2009 the government increased its stake in the bank from 8 percent to 36 percent. The bank that only a decade earlier had spearheaded a push toward deregulation was now more than one third owned by taxpayers.

In early 2009 the Bank of America–Merrill Lynch merger became the subject of national controversy when BofA announced that it needed a new $20 billion bailout from the government, becoming what Paulson declared “the turd in the punchbowl.” When it later emerged that Merrill had paid its employees billions of dollars in bonuses just before the deal closed, the public outrage led to a series of investigations and hearings that embarrassingly pulled back the curtain on the private negotiations that took place between the government and the nation’s financial institutions.

As details of the drama leaked out John Thain became a quick casualty, with Ken Lewis firing him in his own office. He was soon recast from the hero who had saved Merrill into the source of its troubles, despite indications that Bank of America was aware of the firm’s problems and chose not to disclose them.

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.

There was also the issue of exactly how the AIG bailout money was used. 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.)

Months after the TARP infusion, Goldman reported a profit of $5.2 billion for the first half of 2009. In June the firm paid back the $10 billion of TARP money, and in July paid $1.1 billion to redeem the warrants that were issued to the government as part of the TARP infusion. For Goldman, even as a bank holding company, it was back to business as usual.

For better or worse, Goldman, like so many of the nation’s largest financial institutions, remains too big to fail.

Could the financial crisis have been avoided? That is the $1.1 trillion question—the price tag of the bailout thus far.

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.

The sad reality is that Washington typically tends not to notice much until an actual crisis is at hand.

Once the crisis was unavoidable, did the government’s response mitigate it or make it worse? 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.

“On the day that Lehman went into Chapter 11,” Alan Blinder, an economist and former vice chairman of the Federal Reserve, said, “everything just fell apart.” 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. Perhaps the economy would have crumbled anyway, but Lehman’s failure clearly hastened its collapse.

While hindsight suggests that the federal government should have taken some action to prop up Lehman—given the assistance it was prepared to offer the rest of the industry once it began to face calamity—it is also true that the federal government did lack an established system for winding down an investment bank that was threatened with failure. Paulson, Geithner, and Bernanke were forced to resort to what MIT professor Simon Johnson has called “policy by deal.” But deals, unlike rules, have to be improvised—and the hastier ones tend by their very nature to be imperfect. The deals hatched in sleepless sessions at the Federal Reserve Bank of New York or at Treasury were no different. They were products of their moment.

To its credit, the Fed wisely decided to permit Lehman’s broker-dealer to remain open after the parent company filed for bankruptcy, which allowed for a fairly orderly unwinding of trades in the United States. 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.

Once the Barclays deal failed, it appears that the United States government truly did lack the regulatory tools to save Lehman. Unlike the Bear Stearns situation, in which JP Morgan was used as a vehicle to funnel emergency loans to Bear, there was no financial institution available to act as conduit for government loans to Lehman. Because the Fed had already determined that Lehman didn’t have sufficient collateral to borrow against as a stand-alone firm, there were effectively no options left.

In Paulson’s view, Barclays’ regulators in the UK would never have approved a deal for Lehman within the twelve-hour period in which he believed a transaction would have had to be completed. From that perspective, further negotiations would only have been a waste of precious time. Paulson may be correct in his conclusions, but it is legitimate to ask whether he pulled the plug too early. It will likely be endlessly debated whether Paulson’s decisiveness throughout the crisis was a benefit or a detriment, but the argument can also be made that any other individual in Paulson’s position—in a lame-duck administration with low and dwindling popular support—might have simply frozen and done nothing. It is impossible to argue he didn’t work hard enough. And a year later, it appears that many of the steps he took in the midst of the crisis laid the groundwork for the market’s stabilization, with the Obama administration, Geithner, and Bernanke often taking credit for the reversal. Thus far, many of the biggest banks that accepted TARP funds have returned it, taxpayers have made $4 billion in profit. However, that does not account for the hundreds of millions of dollars directed at firms like AIG, Citigroup, and elsewhere that may never get paid back. Barney Frank perfectly articulated the dilemma that will likely haunt Paulson as historians seek to judge his performance. “The problem in politics is this: You don’t get any credit for disaster averted,” he said. “Going to the voter...

Unless those regulations are changed radically—to include such measures as stricter limits on leverage at large financial institutions, curbs on pay structures that encourage irresponsible risks, and a crackdown on rumormongers and the manipulation of stock and derivative markets—there will continue to be firms that are too big to fail. And when the next, inevitable bubble bursts, the cycle will only repeat itself.

As this book went to press, the handful of proposals that have been introduced to put the financial system back in its right place and rein in risk have seemed tepid and halfhearted, at best. Relieved that the worst is supposedly behind us, the Obama administration seems to have moved on to other priorities.

It is not the critic who counts: not the man who points out how the strong man stumbles or where the doer of deeds could have done better. The credit belongs to the man who is actually in the arena, whose face is marred by dust and sweat and blood, who strives valiantly, who errs and comes up short again and again, because there is no effort without error or shortcoming, but who knows the great enthusiasms, the great devotions, who spends himself for a worthy cause; who, at the best, knows, in the end, the triumph of high achievement, and who, at the worst, if he fails, at least he fails while daring greatly, so that his place shall never be with those cold and timid souls who knew neither victory nor defeat.

When there’s a delusion, a mass delusion, you can say everybody is to blame. I mean, you can say I should have spotted it, you can say the Feds should have spotted it, you can say the mortgage brokers should have, Wall Street should have spotted it and blown the whistle. I’m not sure if they had blown the whistle how much good it would have done. People were having so much fun. —Warren Buffett

That debate has seemingly had a huge impact on today’s society and politics. All sorts of explanations have been offered for the stunning election of Donald Trump as president in 2016, but the most compelling may be the simplest: His victory was a rebuke of the “elites” that the public had trusted to prevent such an economic calamity—and it was a rebuke of the same “elites” that tried to help the country recover from it.

In truth, although there was a recovery, it was remarkably uneven. By 2009, while Wall Street banks were seemingly minting money again, many individuals and small businesses were forced to declare bankruptcy, and foreclosures were at record numbers. That year, Goldman Sachs paid out $16.2 billion in bonuses, the equivalent of $498,000 per employee. Even troubled firms like Citigroup and Bank of America were successful enough that they hastened to pay back their TARP funds, at least in part so that they, too, could reward their employees with large bonuses without the restrictions imposed if they still owed money to the government.

“The people on Wall Street still don’t get it,” President Obama observed then. “They’re still puzzled: Why is it that people are mad at the banks? Well, let’s see. You guys are drawing down ten-, twenty-million-dollar bonuses after America went through the worst economic year that it’s gone through in decades, and you guys caused the problem. And we’ve got ten percent unemployment. Why do you think people might be a little frustrated?”

For much of the past decade, the Federal Reserve and central banks have kept interest rates at record-low levels. That acted as a stimulus to the economy, and may have helped buoy employment and spending. But it also inflated the value of assets, making the affluent—those who owne...

Up until 2008, there was a widely understood social compact: The Masters of the Universe—the wizards of Wall Street, the corporate titans, the occupants of grand offices in Washington and around the world, the grandees attending Davos—wielded power and riches beyond anything the average person could conceive. Yet they were entitled, and allowed, to do so because they at least seemed to know what they were doing managing the world economy such that we all were basically alright. . . . The Great Recession shattered that consensus for good, destroying the idea that the elites earned their disparate control of the world’s wealth and power.

In the past decade, nationalism, with its focus on looking inward and its antipathy toward outsiders, has become a popular refrain—a remarkable shift in attitude from pre-crisis days and another example of the crisis’s global ripples so many years later. The United States, once a symbol of open borders and trading, has become engaged in debates about imposing tariffs and building walls. Perhaps the best example of the decline in trust in governments around the world was the creation of Bitcoin, a new form of currency known as a cryptocurrency. Bitcoin is not tied to any central banks such as the Federal Reserve, but is a peer-to-peer system without any governing body to decide its rules or fate. The founder of Bitcoin, a mysterious individual (or group of individuals, since its origin is still not known for certain) named Satoshi Nakamoto, explained the justification for its creation in a paper posted to the Internet: The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve.

“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.

In the past ten years, Wall Street has changed immeasurably. The most ambitious effort to regulate it came in the form of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010—a 2,300-page law with 400 new rules intended to reduce risk in the financial system. 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.

To Volcker, Wall Street had grown far too complicated by offering products like collateralized debt obligations and had veered away from its core role of helping the economy through responsible lending. At a gathering of bank CEOs in late 2009, he famously chided its leaders: “Wake up, gentlemen. I wish that somebody would give me some shred of neutral evidence about the relationship between financial innovation recently and the growth of the economy, just one shred of information.” He added, “The most important financial innovation that I have seen the past twenty years is the automatic teller machine. That really helps 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. They also had an impact on incentives: the inability to take on as much risk led to a recalibration of compensation, because banks simply couldn’t earn as much. While some senior executives could still make a great deal of money—Jamie Dimon was paid $28 million in 2017—entrepreneurial financiers looking for riches left and turned to jobs at hedge funds or in private equity, or struck out for Silicon Valley.

One of the lasting public frustrations with the crisis—and one that may have been critical in undermining trust in the system and its elites—is that it appeared that no one was ever held responsible for it. Very few senior executives were fired, and only one was sent to jail.

There are various theories about why no parties were ever held culpable. The most provocative view is one proffered by Jesse Eisinger, a Pulitzer Prize–winning journalist, who has contended that it was a conscious strategy: “During the past decade, the Justice Department suffered a series of corporate prosecutorial fiascos, which led to critical changes in how it approached white-collar crime. The department began to focus on reaching settlements rather than seeking prison sentences, which over time unintentionally deprived its ranks of the experience needed to win trials against the most formidable law firms.”

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.

One of the great myths regarding the financial crisis is that the CEOs of the financial industry saw it coming—and still took on risk, confident that they would be bailed out because their firms were so large and important. Essentially, that is the very concept of “too big to fail.” 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.

That is not intended as an excuse, but it is a truth and a serious challenge in any business with global scale. The sheer size of such companies raises many questions, far beyond the question of being too big to fail. A more enlightened debate should concern the problem of Too Big to Manage.

But we as a society need to realize that we have built institutions that will inevitably break, or at least face significant challenges, given their sheer size and complexity.

My reporting suggests that while many of their decisions may have had the appearances of crimes, it was less clear that the responsible executives had criminal intent. They were reckless, yes. They were greedy, yes. As unsatisfying as it might seem, however, those aren’t crimes. And there were parties who had sufficient incentive to find criminality: Prosecutors could have turned themselves into national heroes, and members of the Financial Crisis Inquiry Commission as well as journalists would have all been eager to expose wrongdoing, myself included.

Buffett’s response spoke to the essential truth of both the boom—which was fueled by speculation in the housing market—and the bust: It’s a little bit like Cinderella at the ball. People may have some feeling that at midnight it’s going to turn to pumpkin and mice, but it’s so darn much fun, you know, when the wine is flowing and the guys get better looking all the time and the music sounds better and you think you’ll leave at five of twelve and all of a sudden you look up and you see there are no clocks on the wall and—bingo, you know? It does turn to pumpkins and mice. It’s hard to blame the band. It’s hard to blame the guy you’re dancing with. There’s plenty of blame to go around. There’s no villain.

When people think about “too big to fail” today, their biggest concern isn’t necessarily whether our banking systems will break under the weight of leverage—it doesn’t appear that a cataclysmic leverage-induced crisis is likely—but whether something even more extreme is on the horizon. One of those fears, given the interconnectedness of the banking system, is the possibility of a cyberattack—by state actors or independent thieves—that could threaten the entire global economy if it were able to circumvent the various electronic blockades and security systems that have been developed. That the public could wake up one morning and find their accounts at a zero balance or even off by a decimal has always been a nightmare scenario, but it is now one that some security experts suggest is a matter that is not an “if” but a “when.” And if such a security breach were to take place, it could, like any panic that undermines trust in the system, give rise to a catastrophe far beyond anything we’ve yet experienced.

More immediately, however, perhaps the most disquieting development that has taken place during the past decade hasn’t been on Wall Street, but in Washington, in state capitals, in village halls, and in governments abroad. No longer is the phrase “too big to fail” being associated with banks alone. It is now being used to describe cities, municipalities, states, and countries that, like many home borrowers, have become overleveraged. Much recent concern has focused on Greece and other European countries including Spain, Italy, and Portugal, but concerns have also been raised about such rising economic powers as Brazil and China. And as the U.S. debt continues to skyrocket, it, too, could eventually become the basis for a massive financial crisis. In 2008, at the height of the panic, Jamie Dimon’s daughter came home from school one day and asked, “What’s a financial crisis?” His answer: “Something that happens every five to seven years.” By that standard, we are already overdue.

Because it was a holiday in Japan, rather than wire the money, Mitsubishi UFJ presented Morgan Stanley with a $9 billion check for its investment in the firm.