Early Thursday morning, members of my staff began to stream in and out of my office, briefing me, listening in on my phone calls. Weary but alert, most had worked through the night on one of the three crisis teams we had set up to look into policy issues, asset purchases, and credit markets. Another grinding day stretched out before us. The U.K. and Ireland were readying restrictions on short selling. Russia had suspended stock trading for a third straight day.
Just before 9:00 a.m. I took an unexpected call from Bob Scully, the Morgan Stanley vice chairman, who had played such a critical role in August in helping Treasury prepare to place Fannie Mae and Freddie Mac into conservatorship. A consummate banker, he had never spoken about his own firm during that period. But now he was calling to tell me that speculators and short sellers were not only driving Morgan Stanley’s shares down but also undermining confidence in the investment bank. As nervous counterparties shied from the firm, its liquidity was declining rapidly. He didn’t know what I could do, but he said he felt obliged to tell me, point-blank, that he was not sure Morgan Stanley was going to make it.
Coming from Bob, always calm and levelheaded, this was an alarming message. I alerted Tim Geithner and then called Chris Cox to urge him again to do something to end abusive short selling. I had been pressing Chris with increasing intensity since Monday. We’d spoken seven times Wednesday and would speak just as frequently Thursday on the subject. I implored him not to sit idly by while our financial system was destroyed by speculators. Any other time, I would have argued strongly against a ban, but my reasoning now was pragmatic: our short-selling rules hadn’t been written for these conditions, and whatever we chose to do couldn’t be worse than the panic we were now seeing. Chris worried about unintended consequences to the market.
“If you wait any longer,” I said, “there won’t be a market left to regulate.”
Chris also faced opposition from within his own agency and from his fellow commissioners. He reiterated that he needed the clear public backing of Ben Bernanke, Tim, and me. Tim had concerns that a ban might inhibit risk taking and be destabilizing—the trading strategies of many highly leveraged hedge funds depended on shorting.
Not long after that, I spoke to the president, who had canceled a fund-raising trip to Alabama and Florida to focus on the financial emergency. He was joined by Deputy Chief of Staff Joel Kaplan. I told them that the crisis had reached the point where we were going to have to take dramatic actions, including going to Congress for sweeping fiscal authorities. The president seemed supportive but asked that I make sure to fully brief his whole team. It was essential that everyone in the executive branch work together, because we all knew it would be difficult to get Congress to act.
At 9:30 a.m. my staff and I got on a conference call with Tim, Ben, Chris, and their people. The Fed was working hard to ease liquidity pressures in global markets. At 3:00 a.m. New York time—8:00 a.m. in London—it had announced a dramatic $180 billion expansion of its swap lines, which made dollars available to other central banks for the needs of their commercial banks.
I was particularly worried about the money market funds. Treasury’s Steve Shafran and his group, who had been working with the Fed people all night, had put together a list of ideas to improve liquidity. One idea would have had the Fed provide long-term financing to the investment banks in addition to the short-term money they already had access to. Another would have let the money funds borrow directly from the Fed.
“That won’t stop a run,” I said. If anything, a money fund borrowing from the Fed would be stigmatized and suffer even more withdrawals. “What would you do if you wanted to be more decisive than that?”
Steve threw out another suggestion: “Well, we could use the Exchange Stabilization Fund to guarantee the money market funds.”
I slapped my desk. It was exactly what I was looking for—the strong step the situation required: something dramatic that would prevent an impending implosion of $3.5 trillion in money market funds.
“That’s what I want to do,” I told him. “Go make that happen.”
Guaranteeing the money markets was an inspired idea; the problem was how to do it. Shafran’s insight was crucial. Treasury had next to no funding power—with one exception. The Gold Reserve Act of 1934 had created the Exchange Stabilization Fund (ESF) to allow Treasury to intervene in the foreign exchange market to stabilize the dollar. The ESF had been used very selectively over the years, most controversially when President Bill Clinton tapped it in 1995 to extend up to $20 billion in loans to Mexico. Now money market funds were being hit by massive redemptions, some of them from skittish overseas investors. A collapse of the money fund industry could easily lead to a run on the dollar. If the president approved, we could use the ESF, which totaled about $50 billion, to fund the money market guarantee initially.
David Nason had put off his decision to leave Treasury to help us at this critical time, and I asked him to work with Steve. David had been at the SEC, and I knew that he had a long list of contacts in the money market industry as well as the technical expertise to design a temporary guarantee program. Even as they faced a rash of redemptions, money funds were choking on asset-backed commercial paper that they couldn’t sell. Fed staffers were working on ways to purchase this paper from the money funds.
“Hank, are you willing to go to the Hill and get fiscal authority?” Bernanke asked.
“Ben, Ben, Ben,” I interrupted, realizing I hadn’t had time to update him on my just-concluded call with the president. “You and I will be going to the White House.”
After the call, I asked my team to prepare a short presentation for the president. Joel Kaplan had wisely suggested that the most efficient way to brief the key White House staff was for them to sit in on our meetings at Treasury. By 1:30 p.m., Joel, Ed Lazear, Keith Hennessey, and Dan Meyer had come over to Treasury. They would spend many hours over the next few weeks with us, and I could tell they were taken aback by the atmosphere. There were probably 15 people in my office at all times, huddled in clusters and holding separate meetings, talking at a hundred miles an hour, as I sat at my desk in the center of the whirlwind. There was virtually a running conference call with Tim and Ben, with people getting off the line and getting back on. I’d be talking to someone else on my phone, always trying to speed things along.
Now the White House crew crowded into my office with Treasury staff for a scheduled call with Ben, Tim, and Chris. I did much of the talking.
“This is the economic equivalent of war,” I said. “The market is ready to collapse.”
We couldn’t keep using duct tape and baling wire to try to hold the system together. This was a national crisis and both the executive and the legislative branches of government needed to be involved. Although I was determined to get new powers, I knew how hard it would be to win them and how difficult it would be to hold the system together while we were trying. We would have to choose carefully the authorities we requested, while honing our approach to Congress. It was Treasury’s most crucial legislative undertaking since the Great Depression. The stakes were incalculably high: the cost of asking for powers and failing to get them might be bigger than not asking at all.
Chris raised the issue of a short-selling ban. Tim and Ben joined me in expressing support for a ban, which gave Chris the backing he needed to go to the rest of the commissioners for approval. We went through the need to guarantee the money market funds. I admitted that we still didn’t know exactly how the program would work. The complexities were enough to make your head spin, but I was firm: “We’ve got to go with this.”
Almost everyone liked the idea, but some were concerned that we were moving too fast. But frankly we had no choice but to fly by the seat of our pants, making it up as we went along. The alternative, waiting till we had figured out every angle, was untenable.
Before going to the White House, I called Ben and told him that the president was going to want to press him on the extent of his authorities, because the thought of being totally dependent on Congress was anathema to the administration. The president would want to know what the Fed could do if Congress didn’t grant us the powers we needed. I encouraged Ben to think expansively. “If the market thinks Congress is our last line of defense, and they turn us down, it will be fatal,” I said.
On my way to the White House, Nancy Pelosi called to ask about the market. She had wanted me to come up the following morning with Ben to brief the Democratic leadership. I related just how bad things were and told her we would have to go to the Hill that night to ask for emergency powers. She asked why it couldn’t wait until the morning, and I replied it might be too late by then.
“We need legislation passed quickly,” I said. “We need to send a strong signal to the market now.”
The Speaker immediately pushed to put stimulus spending into any bill. “Nancy, we’re racing to prevent a collapse of the financial markets,” I told her. “This isn’t the time for stimulus.”
A large group gathered in the Roosevelt Room at 3:30 p.m. to meet with the president. Ben, Chris, and Fed governor Kevin Warsh were there, along with a hefty contingent of White House and Treasury staff. Joel Kaplan had warned the president ahead of time that Ben and I were on edge.
I began by telling the president that the Fed and Treasury were preparing to take some extraordinary steps and that we were going to need to get special powers from Congress.
“Mr. President, we are witnessing a financial panic,” Ben put in. He vividly described what we were seeing in the markets, from the travails of commercial paper issuers to the difficulties in secured lending, and where this all might lead if we didn’t find a way to stop its spread now.
“Is this the worst crisis since the Great Depression?” the president asked.
“Yes,” Ben replied. “In terms of the financial system, we’ve not seen anything like this since the 1930s, and it could get worse.”
Individuals and companies were in imminent danger, I told the president: “Money market funds are on the verge of breaking. Companies are taking drastic measures to preserve their finances—not just the big banks, but also companies like General Electric and Ford.”
We had been dealing with these crises one at a time, on an ad hoc basis. But now we needed to take a more systematic approach before we bled to death. We all knew that the root cause lay in the housing market collapse that had clogged bank balance sheets with toxic mortgage assets that made them unwilling to lend. We were going to need to buy those bad assets where necessary, actions that required new powers from Congress and a massive appropriation of funds. In asking for this, we would be bailing out Wall Street. And that would look just plain bad to everyone from free-market devotees to populist demagogues. But not doing this would be disastrous for Main Street and ordinary citizens.
President Bush was very concerned about the money market funds and commercial paper markets because of how deeply they affected the average American’s daily life. As he said, “You’ve got to protect the guy in Midland, Texas, who wants to take $10,000 out of his money market fund to buy something.”
The president listened intently as we briefed him on the actions we planned to roll out: Treasury’s money fund guarantees and the Fed’s liquidity facility for asset-backed commercial paper. Although he had a genuine contempt for Wall Street and its minions, he did not let that stand in the way of what he thought had to be done. Just as he had swallowed hard to win Fannie and Freddie reform legislation in July, he now pushed his personal feelings aside.
“If we’re in the midst of a financial meltdown, all I’m asking is whether it will work,” President Bush said. He noted that we didn’t have time to worry about politics. We had to figure out the right thing to do and let Congress know that it needed to act.
“Tell the Hill we’re fixing to have a meltdown,” he said. “We just need to tell them that this is our strategy and be firm.”
I then asked Ben what the Fed could do if Congress refused to grant the powers we needed. I asked this because I knew that the president needed to hear the answer.
Ben insisted that, legally, there was nothing more that the Fed could do. The central bank had already strained its resources and pushed the limits of its powers. The situation called for fiscal policy, and Congress needed to make the judgment. President Bush pushed him, but he held firm.
“We are past the point of what the Fed and Treasury can do on their own,” Ben said.
President Bush had never wavered in backing us, but that day he was exceptionally reassuring. He promised that his entire team would work with us to get congressional action as quickly as possible. After the meeting began to break up, he walked around the Roosevelt Room patting people on their shoulders.
“We’re going to get through this,” he told us. “We have to get through this.”
I later learned that he took Michele Davis aside and said, “Tell Hank to calm down and get some sleep, because he’s got to be well rested.”
Leaving the meeting, I was more convinced than ever that we had to move fast on the money market guarantee. It was a step that we could take unilaterally. As soon as I returned to Treasury, I stopped by David Nason’s office and told him I wanted the guarantee announced in the morning, even if it couldn’t be finalized for weeks: we had to make clear right away what we were doing. I instructed David to work closely with Steve Shafran and make this his top priority.
The markets had gotten a badly needed shot of good news just before we went into the White House, when CNBC reported that Treasury was considering taking action to buy illiquid assets from the banks. The report also said that New York senator Chuck Schumer indicated that we would be announcing our plan later in the day. Stocks soared. In the last hour of trading, while we were in the White House, the Dow, down more than 200 points, surged 617 points to gain 410 points, or 3.9 percent, on the day.
Morgan Stanley’s shares were particularly volatile, closing at $22.55, up 80 cents, after having fallen by as much as 46 percent during the day. But credit markets continued to weaken. Morgan Stanley’s CDS were trading at 866 basis points, while its excess liquidity continued to drain away.
With Merrill Lynch seemingly secure in the arms of Bank of America, all eyes were on Morgan Stanley and Goldman Sachs. If either remaining investment bank failed, it would almost certainly bring down the other and touch off a worldwide run that would be catastrophic for the American people. And a failure was a very real possibility.
We had set a meeting with congressional leaders for 7:00 p.m., and as I rode up to the Hill, Ben called to review our strategy. I thought we were as well prepared as we could be. Ben would lay out the economic picture of what would happen if there were a systemic collapse. I would describe the powers we needed and provide some details. Kevin Fromer and I had agreed that we would need the authority to buy at least $500 billion of bad assets, but we didn’t want to commit to a number yet.
We were to meet in Nancy Pelosi’s conference room, adjacent to her office in the Capitol. Always smartly turned out, the Speaker of the House maintained an elegant, almost formal atmosphere, with fresh flowers and bowls of chocolates, that was quite removed from the rough-and-tumble of the floor. Once, when I walked in with a cup of Diet Coke, she’d said, “Oh, we don’t use plastic cups,” and an aide promptly handed me a very nice glass for my drink.
Ben and I conferred as we waited for the leaders to arrive. Chris Cox joined us. He was under heavy fire—at a campaign event earlier in the day, John McCain had said that if he were president, he would fire him. Soon the Hill’s most powerful leadership figures came in, including Nancy Pelosi, John Boehner, Barney Frank, House Majority Leader Steny Hoyer, ranking Financial Services Committee member Spencer Bachus, and Democratic Caucus chairman Rahm Emanuel from the House; and the Senate’s Harry Reid, Minority Leader Mitch McConnell, Majority Whip Dick Durbin, Chris Dodd, Richard Shelby, Chuck Schumer, and Democratic Conference secretary Senator Patty Murray.
We squeezed around the long table. I sat across from Nancy and Harry Reid, flanked by Ben and Chris. It was a long, tough meeting. Congress was about to break for recess in eight days, and no one was happy to be there. Ben described the severity of the crisis we faced, and I said that Treasury needed the money and powers to recapitalize the banks by buying toxic assets from their balance sheets.
Ben emphasized how the financial crisis could spill into the real economy. As stocks dropped perhaps a further 20 percent, General Motors would go bankrupt, and unemployment would rise—to 8 or 9 percent from the prevailing 6.1 percent—if we did nothing. It turned out to be a rather mild assessment of what would hit us (as I write, unemployment is now in double digits), but it was enough at the time to leave the members of Congress ashen-faced.
“It is a matter of days,” Ben said, “before there is a meltdown in the global financial system.”
The room erupted into questions. Everybody had an agenda to push or an opinion to voice. Spencer Bachus asked why we didn’t recapitalize banks by buying shares rather than assets. It was a good question, and I was glad he asked it, because it allowed me to emphasize my main point: the program wasn’t meant as a sop for failing banks. We wanted financial institutions to sell illiquid assets so we could develop a market for them. This would encourage the free flow of capital for healthy banks, help them clean up their balance sheets, and break the logjam of credit.
Speaking for the Democrats, Barney Frank laid out provisions that he wanted to see in the bill, including pay restrictions for executives at the companies receiving government money. “If they sell, you’re presumably doing them a service,” he said. “They should be willing to have restrictions.”
Though it didn’t surprise me that Barney made this point, I pushed back hard. To my mind, restricting compensation meant putting a preemptive stigma on the program. And that is exactly what I didn’t want to do. My priority was to get it off the ground fast so the system didn’t collapse while we were still negotiating. Tim, Ben, and I wanted a program that encouraged maximum participation. Hundreds of perfectly sound banks across the country had toxic assets they’d be better off unloading—if only they could. We didn’t want to discourage them from doing so, either by forcing their executives to take cuts in pay or by making it appear that participants, ipso facto, were all weak. They couldn’t afford that perception in the marketplace.
I would continue to resist pressure on compensation restrictions for several days. I was as appalled as anyone at Wall Street’s pay practices, particularly the flawed incentive structures, which we had tried to avoid at Goldman Sachs. When I was CEO, I did my best to align incentives with long-term performance. I knew compensation was too high industry-wide, but I couldn’t change that. We needed to be competitive if we were going to have the best people.
By removing the CEOs at Fannie, Freddie, and AIG, the government had already demonstrated that we weren’t going to reward failure, but in retrospect I was wrong not to have been more sensitive to the public outrage.
Understandably, the lawmakers pushed me to provide a dollar figure. But I was purposefully vague. “We don’t have the number yet, and we want to work with you on this,” I said. “It’s got to be big enough to make a difference.”
How big was “big,” they wanted to know.
“We need to buy hundreds of billions of dollars of assets,” I said. I knew better than to utter the word trillion. That would have caused cardiac arrest. “We need an announcement tonight to calm the market, and legislation next week,” I said.
What would happen if we didn’t get the authorities we sought, I was asked.
“May God help us all,” I replied.
By the end of the meeting, everyone, with the notable exception of Shelby, was supportive to some degree. The tumult in the market had forced a rare bipartisan consensus. The leaders appeared to understand that something had to be done and that the only way to do this was to present a united front.
“This is a worldwide problem,” Barney Frank said. “But we own it.”
Chris Dodd told me that he wanted the administration to cooperate in drafting the legislation; he didn’t want to be handed a fait accompli. The House and Senate needed to be able to sell any legislation we came up with, and the political calculus was tricky just weeks before an election. Averse to bailouts, voters would never grasp the pain of a meltdown unless they experienced it. As Barney put it: “No one will ever get reelected for avoiding a crisis.” Nancy Pelosi noted: “We have to position this as a stimulus and relief for the American homeowner.”
As we got ready to leave the nearly two-hour meeting, I was relieved at what soon became a public show of support and rather naïvely thought that legislation was going to be easier than I had first expected. But Harry Reid offered a more realistic assessment: “We can’t act immediately,” he said, noting that it usually took Congress weeks to get anything done.
I had been in my office for 15 minutes Friday morning when I received a call from an upset Sheila Bair, just after 7:00 a.m. We were scheduled to announce the money market fund guarantee in less than an hour, and in the rush we had not consulted with the FDIC chairman—or even notified her. She’d learned of our plans from press reports and was calling to complain. She said she knew I was under a lot of pressure, but it was outrageous that we had not checked with her first.
From the time I came to Treasury, in July 2006, I’d had a constructive relationship with Sheila, working closely with her on housing issues, about which she had many ideas. She had exceptionally good political instincts. We usually agreed on policy, but she tended to view the world through the prism of the FDIC—an understandable but at times narrow focus. Now she told me that our money market guarantee would hurt the banks.
“There are a lot of bank deposits that aren’t insured,” she said. “And they can now go to the money market funds.”
Sheila had a good solution to prevent this from happening: insure only the customer balances that were in the money market funds on or before that day, September 19. I said that I liked her idea and that I would ask David Nason to work closely with her and her staff to implement it.
The truth is, we had to move quickly as the crisis mounted, and occasionally we stumbled. We grappled with this hard fact every time we worked on a new idea: often our fixes led to unattractive consequences. Whenever government came in—as with the guarantee program—we risked causing massive distortions in the markets. The risk of a misstep was greater the faster we had to move and the less time we had to think through every possible outcome. As a result, we had to be nimble, and flexible, enough to make midcourse corrections as needed.
The money market guarantee was an extraordinary improvisation on the part of Nason and Shafran. They had raced through the night to sketch its outlines and make the plan work. In time, funds participating in the guarantee would pay fees into a reserve that supplemented the ESF, which would not expend a single dollar on the program.
Treasury was operating so much on the fly that Nason drafted staff from the Terrorism Risk Insurance Program, which he oversaw, to help formulate the agreements and pricing schemes of the guarantee. It was announced on September 19, opened ten days later, and was, I believe, the single most powerful and important action taken to hold the system together before Congress acted. (The guarantee was intended to be a temporary program, and Congress has since ended it.)
Initially we worried about industry acceptance of the plan. Nason and Shafran had canvassed everyone from executives at Charles Schwab and Vanguard Group to the Investment Company Institute, the industry’s trade association, and found that many were concerned about having to pay to insure what was already a low-margin product. But in the end we had virtually 100 percent market participation and collected over $1 billion in premiums.
That morning, the U.S. government unveiled a package of new programs to boost liquidity and calm the markets. The SEC issued an order prohibiting the short selling of 799 financial stocks for 10 business days (the order could be extended to 30 days). My efforts to round up Tim’s and Ben’s support had given Chris Cox the backing he needed, and after our meeting with Hill leaders the previous night, SEC commissioners had approved the ban in an emergency session. The announcement did not go off without a hitch, however. A number of major companies, including GE and Credit Suisse, had been omitted from the list, which Chris later had to expand.
At 8:30 a.m., the Federal Reserve unveiled its Asset-Backed Commercial Paper Money Market Fund Liquidity Facility, better known as AMLF. Under this program, the Fed would extend nonrecourse loans to U.S. depository institutions and bank holding companies to finance their purchases of high-quality asset-backed commercial paper from money market mutual funds. In a separate action to boost liquidity, the Fed said it would buy short-term debt from Fannie Mae and Freddie Mac.
This raft of programs, coupled with news reports that we had gone up to the Hill to get new legislation, acted like a tonic to the markets. Led by financial shares, stocks rallied right from the opening. By 9:42 a.m., the Dow was already up 275 points, on its way to a full-day gain of 369 points. Morgan Stanley’s shares jumped 33 percent in the first few minutes of trading.
As my staff labored on upcoming White House and congressional presentations, my phone pulled me every which way. Goldman CEO Lloyd Blankfein called to express his concern for Morgan Stanley and what its troubles might mean—for the market and for his firm. The market was losing confidence in investment banks, he said, and although Goldman had a strong balance sheet, counterparties and funding sources were scared.
“I’ve never rooted so hard for a competitor,” he said. “If they go, we’re next.”
Dick Fuld also called, and although I didn’t really have time to talk, I stayed on the line with him for 20 minutes. Like our conversation a few days earlier, I found it very sad. He was afraid he would spend years in court. He asked if I could please tell others how hard he had tried and what he’d done. I told him I knew that he’d made a big effort to save Lehman, but the crisis we faced was unprecedented. It was the last time I spoke with him.
The Treasury press office stayed busy that day. At 10:00 a.m., I issued a statement that explained our reasons for going to Congress—how illiquid assets were clogging the financial system and threatening Americans’ personal savings and the entire economy. I said I would work with Congress over the weekend to get the legislation in place for the next week. And I took the opportunity to push for the regulatory reforms I had long advocated.
Forty-five minutes later Ben, Chris, and I stood in the White House Rose Garden with President Bush, who outlined the actions we were taking and announced that we had briefed Congress on the need for swift legislation granting the government authority to step in and buy troubled assets. “These measures will act as grease for the gears of our financial system, which were at risk of grinding to a halt,” he said.
There was much still to be done. Treasury staff took the lead, representing the administration, in working with the House and Senate financial services committees to outline what would become the Troubled Assets Relief Program. I pushed our team to ask for the most expansive authorities, with as few limitations as possible, because I knew we had only one chance to get this from Congress.
In the afternoon, Kevin Fromer took me aside and said, “If you believe there is a possibility $500 billion won’t be enough, we should request more.”
“You’re absolutely right,” I said. I did want a bigger number, and I knew the market would, too. But I didn’t want to run the risk of asking for too much, then getting turned down. “What’s the most you think we can get?”
“The public and Congress will hate $500 billion,” he said. “It’s already unthinkable. But I’m not sure they will hate $700 billion any more. If you get any higher, closer to a trillion, we will have a problem.”
Our choice of the $700 billion figure wasn’t just a political judgment. There was a market calculation as well: back of the envelope, we knew there were roughly $11 trillion of residential mortgages in the country, most of them good. We would need to buy only a small amount of them to provide transparency and energize the markets. And we believed that $700 billion was enough to make a difference.
Still, the $700 billion figure shocked many Americans—and Congress. Maybe my failure to anticipate this reaction showed how inured I was becoming to the extraordinary numbers associated with the prospect of an all-out financial meltdown. I was constantly being confronted by shocking figures. Friday, as the equity markets rallied, the credit markets remained tight, and investors’ flight- to-quality kept demand unbelievably high for Treasuries. Fails to deliver rose to $285 billion that day, a jaw-dropping increase from $20 billion one week before.
We had raced the clock on Bear Stearns, then again on Fannie and Freddie, Lehman, and AIG. Now we were rushing to develop the outline of TARP, even as I feared we could lose four giant financial institutions—Washington Mutual, Wachovia, Morgan Stanley, and Goldman Sachs—in the next few days.
Congressional leaders had advised us not to present them with a finished document but to work with them, so we prepared a short, bare-bones proposal with open-ended language, knowing that members would add provisions that would make the legislation their own. At about 9:00 p.m. on Friday, Chris Dodd called to ask where our proposal was. “My staff’s been waiting since 5:00 p.m.,” he said, reminding us to be cooperative.
In the end, we cut the proposal down to three pages, and it turned out to be a three-page political mistake.
We asked for broad power to spend up to $700 billion to buy troubled assets, including both mortgages and mortgage-backed securities, under whatever terms and conditions we saw fit.
The assets would be priced using market mechanisms such as reverse auctions, in which sellers put out bids—not buyers, as is normally the case. Once purchased, they would be managed by private asset managers. The returns would go into Treasury’s general fund, for the benefit of U.S. taxpayers.
Reflecting the urgency of the situation, our draft asked for Treasury to have the maximum discretion to retain agents to carry out the asset purchases, and for protection from lawsuits by private parties who might attempt to derail or delay the program. This freedom from judicial review we modeled in many respects after the Gold Reserve Act of 1934.
We were pilloried for the proposal—not least because it was so short, and hence appeared to some critics as if it had been done offhandedly. In fact, we’d kept it short to give Congress plenty of room to operate; April’s “Break the Glass” review of policy options on which this outline was based was itself ten pages long. Making no provision for judicial review came across as overreaching, and that provision eventually went out the door. But nearly all of what we would ask for, and what would eventually form the basis of the legislation, was in those three pages.
Nonetheless, we could have managed our introduction of the TARP legislation more adroitly. At a minimum, we ought to have sent up the three pages as bullet points, rather than as draft legislation. We might have sent it up sooner: it went to the Hill at midnight, and waiting all day had put lawmakers, their staffs, and the media on pins and needles. And as Michele Davis later pointed out to me, we should have held a press conference that night to explain the language more clearly. We would have saved ourselves a lot of trouble had we emphasized that our proposal was an outline. But the entire staff was crunching to get the language right, and there was no time to consider niceties like news conferences. Later, of course, we would hold many such late-night press briefings.
Even with TARP sketched out, a temporary money market guarantee in place, and a short-selling ban in operation, I still couldn’t breathe easily, because of the intense pressure on Morgan Stanley and Goldman Sachs. They were the top two investment banks in the world—not only for their prestige but also for the sheer size of their balance sheets, their trading books, and their exposures. Their counterparty risk was enormous, much bigger than Lehman’s. And we unequivocally knew that the market could not tolerate another failure like that of Lehman.
Morgan Stanley was particularly beset. Friday’s government actions had done wonders for its shares, which rose 21 percent to $27.21, and its credit default rates had fallen by more than a third. But its clients and counterparties had lost confidence; since Monday, hedge funds had been pulling their prime brokerage accounts, and other institutions were shying away from the firm. In one week the reserves available to the Morgan Stanley parent company had plunged from about $81 billion to $31 billion. We knew that if Morgan Stanley fell, the focus would turn to Goldman Sachs.
On Friday evening, around 6:30 p.m., John Mack called to update me. He was scrambling for a solution. He desperately needed a merger or a show of support from a strategic investor, but he had not gotten far with China Investment Corporation (CIC), Beijing’s sovereign wealth fund, which he had thought might consider an additional equity investment in his firm.
“We’re not making as much progress as I would like,” he acknowledged. “The Chinese need to know that the U.S. government thinks it is important to find a solution.”
“I’ll talk to Wang Qishan,” I assured him. I added that I was prepared to ask President Bush to say something to China’s president, Hu Jintao, if it would be helpful and necessary.
After I got off the phone with John, I spoke with Ben and Tim to set our plan of attack for Saturday and Sunday. Deal talk dominated our conversation, as it would throughout the weekend. We believed that Wachovia and WaMu were on the edge of failing. They were plagued by piles of bad assets and had genuine solvency issues. By contrast, Morgan Stanley and Goldman Sachs were suffering from a lack of confidence. Morgan Stanley also faced a near-term liquidity crunch.
Morgan Stanley and Wachovia had discussed a merger earlier in the week. Morgan Stanley had concluded that it couldn’t do one without enormous amounts of government assistance because of Wachovia’s huge exposure, about $122 billion, to so-called option ARMs. Among the most toxic of loans, these adjustable-rate mortgages let borrowers choose from different payment methods; they frequently came with introductory teaser rates and often contained a feature by which the low mortgage payments caused the loan balance to grow.
Tim had had serious doubts as to whether a Morgan Stanley–Wachovia combination would be credible to the market. Both institutions were too wobbly, and these talks ended without Morgan Stanley’s requesting or the Fed’s offering assistance.
Spurred by the Federal Reserve, we discussed a range of ways to combine the investment banks with commercial banks. Our rationale was simple: confidence in the business model of investment banks had evaporated, so merging them with commercial banks would reassure the markets. In truth, I didn’t like the idea of creating megabanks—they were too big and complex to manage effectively, and I believed that both Morgan Stanley and Goldman Sachs had better balance sheets than many of the commercial banks. But we had to find a way to reduce the likelihood of a failure of the investment banks—and the collapse of our financial system.
The Fed was also working on backup plans to enable Goldman and Morgan Stanley to become bank holding companies. This would bring them under the supervision of the Fed, which inspired more confidence in investors than the SEC. That, however, was Plan B, and we didn’t believe it would be enough to save the two investment banks unless they could also raise capital from strategic investors. But in the ongoing market panic, both investment banks were having trouble finding credible partners.
Whatever we did, we felt that by Monday we had to give the market a signal that Morgan Stanley and Goldman Sachs weren’t going to fail. The SEC’s short-selling ban had bought them a grace period, but there was no time to waste.
I arrived at the office at 9:15 a.m. Between the investment banks and the TARP legislation, I spent much of the day on the phone, taking multiple calls from, among others, both Barack Obama and John McCain.
Treasury and the White House held a midmorning conference call on legislative strategy. Our goal was to keep TARP as simple as possible while pressing for as broad a set of authorities as we could get. Treasury would lead the administration’s effort, with Neel Kashkari, Bob Hoyt, and Kevin Fromer negotiating with legislative staff on the Hill. We also had to make sure our proposal worked for the White House and the Office of Management and Budget.
My mind was focused on the danger to the investment banks. Tim and I had spoken early that morning, and several times afterward. My style, when I’m on the phone and pressed for time, is to race through things, then say, “Okay, bye.” If people don’t know me, they’ll find they’re talking to an empty line. I wound up calling Tim repeatedly that morning because I kept hanging up too quickly.
I had several discouraging calls with John Mack that weekend. With his firm on the verge of going down, he was under great pressure. But John desperately hoped to avoid selling Morgan Stanley. By this point, he and I both doubted that he could make a deal with the Chinese, although I reassured him I would raise the issue directly with Vice Premier Wang Qishan that evening. John was more optimistic about finding a strategic investor in another Asian giant, Mitsubishi UFJ Financial Group, with whom he had begun talking. But I was skeptical that a Japanese bank could move quickly enough, given Morgan Stanley’s situation.
“You need a solution by the end of this weekend,” I reminded him.
“Hank, do you think I should sell Morgan Stanley?”
“The consequences of a Morgan Stanley failure are so great, John, I believe you should sell if you can.”
During the afternoon I called the White House to update the president. He had been pleased by the market’s rebound on Friday, which he took, along with Thursday’s rally, as a positive sign. But I had to reiterate my concerns for the two investment banks and Wachovia.
He asked whether we thought Morgan Stanley could find a buyer, and I told him that, in fact, we might need to have him talk to China’s president. Any such contact would have to be set up carefully, because the president of the United States should not appear to directly ask the president of China to invest in a U.S. institution. But if it looked like the Chinese wanted to do the deal, we might arrange a conversation. The president would thank Hu for the cooperation of the Chinese in working through the capital market issues with us. That should be enough to indicate how important this matter was to the U.S. Though the president did not commit to the plan right then, he told me to work with National Security Adviser Steve Hadley on it.
Kevin Warsh had begun an effort to get Wachovia to discuss a possible merger with Goldman Sachs, but he was making little progress. The North Carolina bank seemed to lack a sense of urgency. On Saturday afternoon I got involved.
Because he had only recently resigned as undersecretary for domestic finance, Wachovia CEO Bob Steel was not allowed to talk to Treasury on behalf of Wachovia, but I could speak with Wachovia’s directors. I called Aramark CEO Joe Neubauer, who was on Wachovia’s board. I’d worked with Joe and knew him to be financially sophisticated and a straight shooter.
“Joe, I just want to make sure you have the right sense of urgency,” I said. “The Goldman Sachs people are waiting in their offices, and no one has showed up.”
“Why does this have to be done so quickly?” he asked.
“Wachovia is likely to fail soon,” I said. “The market is very nervous about your mortgage portfolio. It’s much better to get ahead of this.”
When Joe called me back later, it was clear that my message had sunk in. I also talked a number of times to Lloyd Blankfein to urge him to be aggressive and creative. I explained, though, that a Goldman-Wachovia deal could not be done if it required too much help from the Fed.
I was at home at about 9:00 p.m. on Saturday night, waiting to speak with my old friend Wang Qishan on the other side of the world, when I needed to squeeze in a call to Montana senator Max Baucus. He wanted to speak with me about TARP and executive compensation. He had come up with an idea to use the tax code to control executive pay for TARP participants by eliminating corporate deductions for compensation above a certain income level.
It wasn’t a bad idea, but frankly I was losing my patience. There I was, trying to save the markets and about to have a difficult conversation with the Chinese, and once again my ear was being chewed off about compensation. “If people are incompetent, I fire them. They don’t get their golden parachutes. I’ve been tough on everyone,” I remember telling Baucus. I said I didn’t see the point in changing the tax laws to penalize the very banks that we wanted to entice into participating in our asset-buying program.
As I would discover in the coming days, the Democratic senator was not about to back down on this idea, which had its merits. Ultimately, we would accept it, but that night I was short with him because I needed to speak with Wang. It was a miracle I was on time for our 9:30 p.m. call.
I’d kept the Chinese vice premier briefed throughout the crisis, and although we were always friendly, on this night we kept pleasantries to a minimum. I talked about the market, and TARP, and my optimism that we would get the powers we needed. Then I brought up Morgan Stanley.
Wang had a high regard for John Mack and his company. As he knew, CIC was looking at increasing its 9.9 percent stake in Morgan Stanley. I said that we would welcome that. But Wang seemed lukewarm and concerned about the safety of any Chinese investment. I knew that CIC had lost heavily on its existing Morgan Stanley holding, and that had been a source of great controversy inside China. I told him that the U.S. government viewed Morgan Stanley as systemically important. But his unenthusiastic tone convinced me to drop the matter—China was already providing tremendous support to the U.S. by buying and holding Treasuries and GSE securities. If a deal for Morgan Stanley had been possible, Wang would have signaled it.
Later I called Steve Hadley at the White House and let him know that I didn’t believe China was going to invest in Morgan Stanley, and that the president’s call to Hu would be unnecessary. And when I got to John the next day and told him that the Chinese didn’t seem to be interested, he wasn’t surprised.
All the Sunday talk shows had asked for me, and I had four interviews lined up. If there was ever a time to get a clear message out, it was now. Throughout my career I had made a point of answering questions directly. But it was different as a government official. You knew what you were going to be asked, but you had points you wanted to make, and you had to find a way to get them out no matter what questions came your way.
Even though she hadn’t slept much herself on Saturday night, Michele Davis arrived at my house early on Sunday to prep me for my round of interviews. “You don’t have to get your points out all at once,” she said. “You’ll have time to get them out over the course of the interview.” Before I went on Meet the Press, Tom Brokaw said the same thing.
“I’m going to be tough,” he said. “That’s the way you want it—fair but tough. Just remember, Hank, let me come to you.”
At the end of the interview, Brokaw noted that the problems with money market funds had spread to commercial paper and begun to threaten Main Street America. He asked, “The domino effect of this is going to be a no-growth economy, isn’t it?”
“That is why we need these powers. That is why we need Congress to move quickly,” I explained. “It pains me tremendously to have the American taxpayer be put in this position, but it’s better than the alternative.”
That afternoon Ben and I attended a well-intentioned but dysfunctional meeting in Tennessee senator Bob Corker’s offices with several of his fellow GOP senators from the Senate Banking Committee (and a couple more patched in on speakerphone). Corker, a constructive force in the Senate, wanted Ben and me to educate the group, but Jim Bunning hijacked the meeting. I had occasionally locked horns with Bunning, a cantankerous conservative, and this meeting was no exception. The Kentuckian clearly believed that the American people were not worried about our financial institutions or economic collapse. Ben and I both became frustrated with Bunning. The meeting was a complete waste of time for us, when time was more precious than anything.
The prospects of merging either Morgan Stanley or Goldman Sachs looked dim, despite the efforts of Ben, Tim, Kevin Warsh, and me. Tim had tried to initiate talks between Goldman and Citigroup, on the theory that Goldman would strengthen the commercial bank’s management team, but Citi was not interested. He had also taken the lead in promoting a JPMorgan acquisition of Morgan Stanley, but JPMorgan kept turning that suggestion down. Midafternoon, Ben and I joined Tim on a call with Jamie Dimon, and we unsuccessfully appealed to him again to acquire Morgan Stanley. Undaunted, we tried Mack, calling to ask him to approach Jamie Dimon one more time. Frustrated, John refused, explaining that he had already spoken with Jamie several times and wasn’t about to try again.
“A fire sale to JPMorgan would cost thousands of Morgan Stanley jobs,” he protested.
The fact is, had John called Jamie again, I’m sure the JPMorgan chief would still have said no. WaMu was Jamie’s top priority, as I had known for some time. (Within the week, JPMorgan would announce it was buying the Seattle-based institution.)
Goldman and Wachovia were interested in merging, but Goldman, like Morgan Stanley, had found big embedded losses in Wachovia’s real estate portfolio. A deal could not be completed without government assistance. The Fed was even considering a novel approach that might allow it to make a loan to support the deal that was secured not only with assets but with warrants to purchase equity in the combined company.
In the end, Ben, Tim, and I decided against supporting a Goldman-Wachovia merger. It would have been difficult to structure and would have presented complex and perhaps unresolvable legal and political challenges. My past association with Goldman would have created a problem with appearances.
More important, however, I couldn’t back a Goldman Sachs– Wachovia merger for a fundamental reason. With no deal in sight for Morgan Stanley, a Goldman merger would have increased the likelihood of a Morgan Stanley failure. If the market believed that Goldman Sachs needed to merge with a bank to survive, it would have lost even more confidence in an unmerged Morgan Stanley. Similarly, a JPMorgan acquisition of Morgan Stanley would have been destabilizing to Goldman Sachs, leaving it to stand alone, with every other major investment bank having either failed or been forced to merge.
Our job was above all to reduce the risk of these investment banks’ failing. After a weekend of frenetic activity, Ben, Tim, and I concluded that the course of action that would be the least likely to lead to the failure of either was our Plan B. The Fed needed to turn Morgan Stanley and Goldman Sachs into bank holding companies, with the expectation that both would find strategic investors to assure their survival. (Although this was far from clear at the time, I now believe we were very fortunate that we didn’t succeed in merging either one of them, because the last thing we need today is an even more concentrated financial services industry.)
On Sunday evening, I talked with Mack and Blankfein. John, who had become increasingly optimistic about a Mitsubishi UFJ deal, told me he hoped to announce an agreement in principle the next morning to sell up to 20 percent of Morgan Stanley to the Japanese company. I pledged to do anything I could to be helpful. Lloyd said he had been looking for strategic investors in Japan and China and come up empty. Furthermore, he was frustrated to have wasted so much time on Wachovia only to find that Fed assistance wasn’t available. Did I have any ideas?
“Lloyd, you need to find an investor. I won’t have any ideas you don’t have,” I said. “Look everywhere in the world to find an institution where you have a good relationship with someone who is very credible. Leave no stone unturned.”
He hesitated, considering the situation. Then he said quietly, “Just tell me: am I doing the right thing?”
A little while later, at 9:30 on Sunday night, September 21, the Federal Reserve announced that it had approved Morgan Stanley’s and Goldman Sachs’s applications to become bank holding companies.
The Wall Street I knew had come to an end.