Sitting back and letting out a long deep breath is not what I do best. But on Tuesday, October 14—after we’d all been working nonstop since August to keep disaster at bay—I finally had a chance to exhale and let down my guard for a moment. Things were finally looking up. The day before, the nine biggest U.S. banks had agreed to accept $125 billion in capital from the government, European leaders had announced plans to fix their own banking problems, and no critical institution appeared to be on the verge of failure.
Early that morning, Ben Bernanke, Sheila Bair, John Dugan, and I held a press conference in the Treasury Building’s Cash Room to explain the previous day’s moves. I tackled the controversial issue of government intervention head-on, pointing out that we had not wanted to take such actions—arguably the most sweeping in banking since the Great Depression—but that they had been needed to restore confidence to the financial system.
World markets had responded enthusiastically. Japan’s Nikkei index soared by 14.2 percent, while the U.K.’s FTSE 100 rose 3.2 percent. In early trading, the Dow had jumped 4.1 percent to 9,794. Credit markets were stronger as well, as the LIBOR-OIS spread narrowed slightly to 345 basis points.
But no sooner had I returned to my office than one thorny issue I believed had been settled reared its head. Ken Lewis was on the phone, concerned about his deal with Merrill Lynch. With the markets stabilizing, the Bank of America CEO was worried that John Thain, who had sold Merrill only to prevent its failure, might now want to back out: after our weekend actions, Thain might have stopped believing that his firm’s survival depended on BofA. If that were the case, Ken wanted regulators to remember just how crucial to the country his decision to buy Merrill during the height of the crisis had been and to insist that Thain honor his contract.
“Ken,” I asked, “has John or anyone at Merrill indicated to you that they might want out?”
“No, I just have a concern.”
I heard him out and told him that I believed John would stay committed to the deal, but that I would pass his concerns on to Tim Geithner, and I did. I never mentioned them, however, to Thain.
In making critical decisions, finding the right mix of policy considerations, market needs, and political realities was always difficult. I tended to put politics last—sometimes to our detriment. To my mind, the bank capital program struck a perfect balance. It was designed to meet a market requirement, it addressed the problem of bank undercapitalization while safeguarding taxpayer interests, and it had been, I thought, brilliantly executed.
I expected the program to be politically unpopular, but the intensity of the backlash astonished me. Though the criticism from Republicans was muted, some conservatives, who had resisted TARP initially, felt betrayed, and their vocal dissatisfaction made me nervous. I knew that if the program turned into a political football and became an issue in the presidential campaign, the banks would get spooked and back away from the capital. Our efforts to strengthen the fragile system would collapse.
Fortunately, the candidates did not politicize the issue. On October 13, the night that the banks agreed to accept the money, I’d had a long phone conversation with an angry John McCain, who complained that we weren’t doing enough to deal with mortgages. He was also upset about the equity investments, but after we talked it out, I was confident he would not publicly attack our plans—and to his great credit, he did not, even though he was behind in the polls and might have been tempted to try to energize his campaign that way.
Democrats liked the program—some even took credit for it—but, joined by an ever-growing populist chorus, they began griping that banks were hoarding their new capital, not using it to increase lending. Before long it seemed that almost every member of Congress or business leader was directing his or her anger at the banks and their regulators. And this was before even one dollar of government money had landed on bank balance sheets.
John Thain didn’t help matters. Merrill reported a $5.1 billion third-quarter loss on Thursday, October 16. Referring to Merrill’s $10 billion government injection, he told analysts on a conference call that “at least for the next quarter, it’s just going to be a cushion.”
The day after he made his remarks, Nancy Pelosi and Barney Frank complained to me about Thain’s insensitivity. I got John on the phone, and I told him that although he was right in that Merrill wasn’t slated to get the capital until after its merger with BofA closed at year-end, he needed to be more politically aware. I asked that he clarify his statement publicly. He said he would look for an opportunity to do so, but would only comment if he was asked about it. I would have preferred a more proactive effort on Thain’s part. Then I heard that Chris Dodd planned to call the nine big-bank CEOs before the Senate Banking Committee to grill them about lending at an upcoming hearing. I managed to persuade him not to, arguing that if he did, he would so stigmatize and jeopardize the capital program that those first nine banks might back out.
I understood the need to get credit flowing again. In the Cash Room I had made sure to say that “the needs of our economy require that our financial institutions not take this new capital to hoard it, but to deploy it.” By requiring Treasury consent for share buybacks and increases in dividends, our program contained built-in incentives for the banks to retain capital, repair their balance sheets, and resume lending. But that would not happen overnight—after all, many businesses were reluctant to take out loans in an economic downturn. I didn’t think I could tell the banks how much to lend or to whom.
But politicians and the public became increasingly agitated in the midst of a hard-fought presidential campaign. They expected that our actions—meant to prevent bank failures—could also avert the recession and slow the wave of foreclosures already under way. Obama and McCain both denounced Wall Street’s greed as they traveled around the country. And no single issue inflamed people more than revelations of excessive executive pay—and perks. New York State attorney general Andrew Cuomo launched a high-profile probe of AIG’s corporate expenses, including a notorious post-bailout retreat for insurance agents at a California spa that generated a lot of fiery press coverage. People were outraged that banks that had received government aid were still planning to dole out lavish pay packages.
I empathized with their anger. People had seen the values of their homes and their 401(k)s plunge. We were in a deep recession, and many had lost jobs. Frankly, I felt the real problem ran deeper than CEO pay levels—to the skewed systems banks used that rewarded short-term profits in calculating bonuses. These had contributed to the excessive risk taking that had put the economy on the edge. I was convinced, for policy reasons and to quell public anger, that regulators needed to devise a comprehensive solution. I encouraged Ben, Tim, Sheila, and John Dugan to work on policy guidance for compensation, lending, foreclosures, and dividends that would apply to all banks, and not just those that took capital.
Jeff Immelt had come to my office on the 16th to make the case that the FDIC should guarantee GE Capital’s debt issues. He believed our new programs put GE at a huge disadvantage, making it difficult for the company to fund itself. Nonbanks like GE could tap the Fed’s Commercial Paper Funding Facility, but they weren’t eligible for TARP funds or the FDIC’s new debt guarantee, known as the Temporary Liquidity Guarantee Program. Why would investors buy GE debt when they could purchase the debt of other financial institutions with an FDIC guarantee?
“We are the ones out there making the loans that the banks aren’t, and we need help,” Immelt said. I knew he was right, and I said we would explore it with his finance team and the FDIC.
Following the success of the G-7 and the coordinated actions that had calmed the market, the White House revived plans for a summit at which President Bush could discuss the financial crisis with a broad range of leaders. I had made outreach to the developing world a priority and felt strongly, as did deputy secretary Bob Kimmitt, that if we were going to host a summit, it should include the members of the G-20. The president agreed. I asked Dave McCormick to work with the finance ministers to find common ground for the meeting, while the president put Dan Price in charge of preparations, including negotiating the summit communiqué with the other leaders’ representatives.
Then French president Nicolas Sarkozy made an impromptu call to President Bush requesting a meeting, along with European Commission president José Manuel Barroso, after the October 17 European Union–Canada Summit in Quebec City. Sarkozy and U.K. prime minister Gordon Brown had been sparring over which of them would lead reform efforts in Europe. Brown envisioned a new Bretton Woods–style gathering to overhaul the world economic order set in place during World War II. Sarkozy, who held the presidency of the European Union, had called for replacing the failed “Anglo-Saxon” model of free markets and advocated a major summit in New York, which he considered the epicenter of the problem.
The White House suspected that Sarkozy was looking to pull off a publicity coup on our home turf. President Bush invited him to a sit-down at Camp David, where a meeting could be better shielded from the media glare. The two agreed to get together on Saturday, October 18. French finance minister Christine Lagarde and I would join them, along with Secretary of State Condi Rice, who canceled a trip to the Middle East to attend.
On Friday afternoon, Wendy and I left by helicopter from the South Lawn of the White House, with the president and Laura Bush, Condi, and Steve Hadley and his wife, Anne. Marine One carried us over the Washington Monument and off to Camp David in half an hour. At about 4:00 p.m. Saturday, Sarkozy, Barroso, and Lagarde arrived. Thirty minutes later we were sitting down in the main lodge, Laurel, in the same homey wood-paneled conference room where I had made my first official presentation to the president back in 2006. While we met, Wendy took the opportunity to go looking for warblers.
Inside, Sarkozy was singing a sweet song of his own. Lively and articulate, the French leader used every bit of charm at his disposal to try to persuade President Bush to agree to a summit in New York on the order of the G-8, reasoning that the small group’s shared values would make it easier to agree on a plan.
Selling hard, Sarkozy said that hosting the summit would demonstrate President Bush’s leadership. The president agreed on the need for a meeting but insisted on a more inclusive group, such as the G-20, which included China and India. He wanted to focus on broad principles and a blueprint for regulatory and institutional reform. By contrast, Sarkozy was looking to put his stamp on a host of specific topics like mark-to-market accounting and the role of the rating agencies.
“That is not for us,” President Bush said. “We’re going to have our experts do that.”
The French leader came right back at him. “These experts are the ones that got us in trouble in the first place,” Sarkozy said, looking directly at me. He would later suggest that finance ministers shouldn’t even be in the room at the summit.
Sarkozy dominated the hour-long meeting in Laurel, but he must have left frustrated. He’d won agreement on a meeting—which we had already decided to hold—but little beyond that. In the end, President Bush, Sarkozy, and Barroso released a joint statement that said the U.S., France, and the European Union would reach out to other world leaders to hold an economic summit shortly after the U.S. elections.
As preparations for the summit got under way, the Europeans, with the exception of Gordon Brown, resisted meeting with the entire G-20. As a concession, President Bush agreed that Spain and the Netherlands—which were not members of the G-8 or G-20—could attend the gathering of the bigger group as guests of the EU presidency. Chinese president Hu Jintao was the first world leader to sign on. The Saudis expressed their reluctance, worried that they would be blamed for high oil prices, and pressed to make a big financial contribution to a fund for poorer countries, but I called Finance Minister Ibrahim al-Assaf and reassured him. On Wednesday, October 22, the White House was able to announce that President Bush had invited the leaders of the G-20, representing some 85 percent of the world’s GDP, to a November 15 summit in Washington to discuss the crisis.
That day brought other, much less welcome news when Tim Geithner told me that AIG would need a massive equity investment. I was shocked and dismayed. On September 16 the New York Fed had loaned the company $85 billion; then in early October it had extended an additional $37.8 billion. Now, Tim said, the company would soon report a dreadful quarterly loss, which would trigger rating downgrades; the resulting collateral calls would be disastrous. Initially, AIG had confronted a liquidity crisis; now it faced a severe capital problem. Tim believed the only solution was an injection of TARP funds.
AIG was systemically important and could not be allowed to fail, but I was distressed at the prospect of using TARP money. Not only would this drain our limited funds, reducing our capacity going forward, but the insurer was so obviously unhealthy—and politically tarnished—that it would enflame public resentment of bailouts and make it harder to get Congress to release the final $350 billion of TARP when we needed it. Furthermore, the taxpayers might never get their money back from a capital injection in AIG.
With the November elections just a couple of weeks away, foreclosure relief was another hot-button issue. Housing advocates complained that the government wasn’t doing enough, but much of the public strongly opposed bailing out people who had run into trouble on their mortgages. Some of the hardest-hit states happened to be key battlegrounds in the presidential election: Florida, Nevada, Ohio, and Arizona.
I soon found myself at odds with Sheila Bair, even though I admired her energy and her efforts to deal with problem mortgages. Following IndyMac’s July failure, the FDIC, working off the principles for a fast-track systemic approach pioneered by Treasury’s HOPE Now program, developed an innovative plan in which the thrift’s loans were modified to cap monthly mortgage payments. Initially the limit was set at 38 percent of pretax income. (Subsequently it was cut to as low as 31 percent.) To make this work, banks could either lower interest rates or extend the life of loans. The FDIC applied the so-called IndyMac Protocol to every failed bank or thrift that it took control of.
But Sheila wanted to dramatically broaden the scope of the relief efforts. She had called me at Camp David before Sarkozy’s visit to argue that language in the TARP legislation gave Treasury the authority to guarantee mortgages the government didn’t own to prevent foreclosures—and that the cost of doing so didn’t have to come out of TARP funds. Nor was there a limit on the funds the government could use.
It was the first I’d heard of this argument, and I strongly disagreed, questioning its legal validity. I could only imagine the public outrage if we declared that Treasury’s authorities included the power to insure mortgage modifications to the extent we deemed appropriate! But I told Sheila I would study her plan.
Sheila was very effective at taking an idea, simplifying it to make it broadly understandable and appealing, and then driving hard through any objections that stood in the way. Her plan would give an incentive to lenders to modify loans by offering downside protection when they agreed to use the IndyMac Protocol. If a loan modified under her program went into default and foreclosure, the government would cover half of the loss suffered by the lender. Eventually, she would propose using some of TARP’s $700 billion to fund that guarantee.
Sheila’s plan would soon put us on the spot. On October 23, the Senate Banking Committee held a hearing to examine the government’s regulatory response to the financial crisis. Shortly before the session, Chris Dodd called me to advocate Sheila’s foreclosure relief proposal. I assumed she had been talking to him. I said it was promising but that it raised serious questions, some of them legal.
We at Treasury would later call this the “ambush hearing.” Sheila told the committee that the FDIC and Treasury were working together to stem foreclosures, describing her program to provide insurance to banks handling problem mortgages. Dodd indicated during the hearing that he had spoken to me and believed I was on board. When pressed on the issue, Neel Kashkari, whom I’d sent to testify, could say only that Treasury was considering the idea.
In fact, we favored mortgage relief, but as we did more work, we questioned Sheila’s plan’s economics and effectiveness. First, more than half the loans modified in the first quarter of 2008 were already delinquent again within six months. It wasn’t just the interest on mortgages that was causing the problem: people who fell behind on their house payments tended also to have auto and credit card debt they could not afford. The IndyMac Protocol considered only the first mortgage, not home equity loans or other debt. It was one thing to apply the protocol to mortgages the government already owned but quite another to mortgages owned by banks, which would be paid only if there was a redefault. Given the high occurrence of such redefaults, we felt Sheila’s proposal would provide the wrong incentives and put the government on the hook for way too much money.
Ignoring these concerns, Sheila was aggressively promoting the use of TARP funds for her loss-sharing plan and had everyone leaning on us, from the press to Congress. Our critics asserted that Treasury was funneling taxpayer money into the big Wall Street banks while Sheila wanted to put it into the hands of struggling homeowners.
Truth is, the critics had the argument backward. We initially opposed Sheila’s idea because we viewed her loss-sharing insurance proposal as leading to precisely what we were accused of trying to promote—a hidden bailout for big financial institutions. If a modified loan went sour, the government would have to write a large check to the bank, not to the homeowner, and there was likely to be a messy foreclosure after the redefault.
Sheila kept pushing Treasury, though, and we kept analyzing her idea. Our chief economist, Phill Swagel, came up with suggestions for improvements, including factoring home-price declines into the insurance payments, an idea similar to one later adopted by the Obama administration. Compared to Sheila’s plan, Phill’s approach gave more of any subsidy to homeowners, not the banks. Finally, I made it clear that we could not participate in any foreclosure spending program outside of TARP and that we wouldn’t be able to do it with TARP funds until the last tranche was taken down.
Meantime, I knew that we needed to get money out through the capital program faster, before banks, responding to rising political pressure over their lending, compensation, and foreclosure mitigation practices, refused TARP money at all. We had established a procedure under which a bank’s application was screened by its regulator, which submitted it to Treasury if the bank was healthy. At Treasury a team of bank examiners hired from the regulators reviewed each application before making a recommendation to Treasury’s TARP investment committee.
I pushed my TARP leadership team to speed up the postapproval closing and funding process to get the money into the system as quickly and efficiently as possible. At one point I instructed them to call each regulator and approved bank and lean on them to hurry up.
Still, we remained vigilant about the screening process; we did not want to put taxpayer dollars into failing banks. If we had questions about a bank’s viability, we sent the application to a peer review council comprising senior representatives from all four regulators—the Fed, FDIC, OCC, and OTS—to decide whether the institution should receive funds.
With the presidential election fast approaching, our most pressing challenge was how to use most effectively the remainder of the first $350 billion in TARP, even as we wrestled with the question of how to work with the winner’s transition team to access the last tranche of TARP and deploy those funds. I felt that any decision involving the last tranche—particularly programs that would be implemented after we left office—was so crucial we needed to involve the incoming administration. Michele Davis finally said, “We need to stop trying to guess what they’ll want to do and instead act as if we will be here for the next year. We should be prepared to show them a plan the day after the election.”
She was absolutely right. And for the next two weeks we concentrated on how to balance policy, politics, and the markets as our time at Treasury wound down.
Over the October 25 weekend, we split up to work on different projects. Neel Kashkari and Phill Swagel went to New York to meet with officials from the Bank of New York Mellon, which Treasury had hired to serve as the trustee for the reverse auction program that we planned to use to purchase the illiquid assets. Dan Jester and David Nason stayed in Washington to work on closing the $125 billion capital investment in the first nine banks; I wanted to make sure that none of them backed out in the face of the political backlash.
Steve Shafran would focus on consumer credit, a concern since markets had begun to freeze in August 2007. It was a crucial assignment. About 40 percent of consumer loans were packaged and sold as securities, but that market had all but shut down, making it much harder for American families to buy cars, pay for college tuition, or even purchase a television with a credit card.
Steve began work with the Fed on a program in which TARP funds would be used to help create a Fed lending facility that would provide nonrecourse senior secured funding for asset-backed securities collateralized by newly made auto loans, credit card loans, student loans, and loans guaranteed by the Small Business Administration. The risk to the government was expected to be minimal, as losses would be borne by TARP only after issuers and investors had taken losses. This work would lead to what became known as the Term Asset-Backed Securities Loan Facility, or TALF.
Another group—including Dave McCormick, Bob Hoyt, Kevin Fromer, Michele Davis, Jim Wilkinson, Brookly McLaughlin, Deputy Assistant Secretary for Business Affairs Jeb Mason, Public Affairs Officer Jennifer Zuccarelli, Deputy Executive Secretary Lindsay Valdeon, and Christal West—accompanied me to Little St. Simons Island. For some time, I had been planning to bring some Treasury people down for a visit, and although this wasn’t conceived as a working weekend, no one was surprised that it ended up that way. We flew down on Thursday afternoon.
Outdoors—kayaking, fishing, birding, or biking—we managed to avoid talking business. Inside was another story. TARP dominated our discussions, and I was still stewing about the need to make a big investment in the tainted AIG. On a Friday call, Ben Bernanke empathized with my concerns. The AIG rescue had been a Fed deal, and he appreciated our support. “I’ll help in explaining this to Congress,” he said.
The Fed expected AIG to lose a mind-numbing $23 billion pretax in the third quarter, and I knew that I would need to think differently about how we would use and take down the TARP money going forward. With the markets so uncertain, it was impossible to predict how many companies might produce AIG-like surprises that would require government intervention. I began to worry about having enough money available to deal with any emergencies that might arise.
That weekend we took a hard look at our priorities and our TARP funds, trying to find a way we might convince Congress to release the last tranche. Certainly the math argued for doing so. Of the first $350 billion, we had already allocated $250 billion to the capital purchase program; half of that was committed to the nine big banks. We estimated that AIG could require a whopping $40 billion. That brought us up to $290 billion. And we could easily tally a list of potential demands on our resources, from the increasingly distressed commercial real estate market to the monoline insurers. We would need funds to help restart the consumer side of the asset-backed securities market. After what we’d gone through in the past few weeks, I could easily invent doomsday scenarios that would require hundreds of billions of dollars.
On Saturday evening, after dinner, we gathered in a small room in the main lodge that doubled as a natural history museum—complete with mounted ducks and tarpon, turtle shells, and the skeletons of alligators and dolphins—to hash out the policy and political considerations. My political advisers—Jim, Kevin, and Michele—explained how difficult it would be for Congress to give us the last $350 billion. I wouldn’t take no for an answer; the danger of being unprepared was too great. The questions were: What would it take for us to get it? And what commitments would we have to make to demonstrate a credible plan for using the money so that we could bring Congress on board?
Everyone agreed we would need to offer a plan for foreclosure relief. Partnering with the Fed on TALF was a top priority, but the idea had not yet been unveiled, was difficult to explain, and would be seen as a change in our strategy. We also took a hard look at our plan to buy illiquid assets, which was proving more difficult to develop and taking longer than any of us wanted. Kevin, Jim, and Jeb argued that the criticism would be severe if we backed away from asset purchases. But Michele countered that if we announced a program we couldn’t execute effectively, we’d eventually take even more heat.
We were entering a period in which anything I said would be viewed through the prism of election-year politics. So we decided that I should avoid making public comments until after November 4, even though this meant I could not lay the groundwork for any future change in strategy.
I left the island leaning toward developing targeted programs dealing with asset-backed consumer loans, foreclosures, and the troubled monoline insurers, as well as illiquid assets. And I wanted to move as soon as possible after the election to ask Congress to release the last tranche.
I knew how hard this would be, but I was convinced we would need all the TARP funds, despite how much the American people and their elected representatives loathed bailouts. I would spend much of the next two months debating with my colleagues and inside my own head exactly when to ask Congress for the money, and how to do it.
We flew back to Washington on Sunday afternoon and went straight to the office. At 8:00 p.m. I met in my large conference room with senior staff and White House deputy chief of staff Joel Kaplan. We wanted to compare our notes from the weekend and make a decision about how to proceed.
Steve Shafran reported on the consumer lending program he was working on. One challenge was that he and the New York Fed agreed on a different approach than the Washington Fed, but he expected a solution would be found. Dan Jester and David Nason said they had been working throughout the weekend to finalize the equity deals with the nine big banks and expected to complete them soon. (The paperwork was finished just after midnight.) Neel reported that 20 additional banks had applied for the capital program, including such important names as Capital One and Northern Trust.
Neel and his team had spent Sunday at Bank of New York Mellon. Under our reverse auction plan, Treasury would determine a specific amount of TARP money to spend on illiquid assets, then hold an auction in which financial institutions would bid to sell their assets to Treasury. The government would buy the assets at the lowest price, helping to improve liquidity and create a market, which private-sector buyers had been unwilling to do.
That was how it was meant to work, anyway. Right after TARP passed, Treasury had asked potential custodians to submit proposals, and they indicated they would be able to start auctions quickly. But after discussing with Bank of New York Mellon the unique requirements of the legislation—allowing thousands of firms to register to sell their assets and making sure they had signed off on executive compensation restrictions, for example—Neel learned that it could take two months, not two weeks, to set up an auction. And because the auctions would have to start small to allow for any necessary adjustments, we might be able to buy only about $5 billion of assets by the end of the year.
“It’s just too small in terms of the volumes that we need to move,” Neel explained.
There was another problem. A bank owning a small amount of a security might decide to unload it at any price, no matter how low, just to be rid of it. But that could trigger big write-downs at other banks that owned a lot of the same security.
We didn’t have time to ramp up the reverse auctions, so I told Neel to concentrate on a different idea we had for moving the assets: hiring professional money managers and giving them each a certain sum of money to buy eligible assets in the market.
Though it was getting late, and everyone was tired, we had a lively discussion, and as usual nobody held back. We debated whether we should go ahead with the direct purchase of illiquid assets, the program most visibly associated with TARP. Neel, Jim Wilkinson, and Jeb Mason argued in favor of staying the course, with Jeb making the case that we should focus on buying whole mortgages, as TARP allowed, instead of the more complex securitized mortgages. David Nason and Dan Jester thought we should focus on executing our $250 billion capital purchase program and that the regulators should assess the health of the banks before proceeding with a new program. Both Dan and David believed we should consider expanding the CPP to insurance companies. And everyone agreed we would need to designate a big portion of the last $350 billion for future capital programs.
Shafran said we had to include a foreclosure program in TARP; otherwise we would be on the wrong side of history—and of politics.
“You’ll live to regret it if you don’t,” he said.
I told him all I needed was to see a program that would succeed.
As the clock ticked toward 10:00 p.m., I began to seriously doubt that our asset-buying program could work. This pained me, as I had sincerely promoted the purchases to Congress and the public as the best solution. But in addition to the problems Neel had outlined, it appeared the magnitude of the crisis was outstripping our ability to deal with it by directly buying troubled assets, even with the last $350 billion. Housing prices continued to decline, while mortgage troubles had spread beyond subprime to prime residential loans and, more recently, to commercial real estate. Problems were mounting in the market for asset-backed consumer loans, as the deepening recession crimped individuals’ ability to repay debt.
Still, I held off making a final decision, hoping that we could devise a plan that would work faster than the reverse auctions. I concluded that any new capital program should wait until our existing program was further along. I gave the go-ahead to look into buying whole loans and to continue to work on foreclosure relief plans. I also wanted to address the troubled monoline insurers, if only to separate their viable municipal finance business from the failed structured finance business so that state and local governments would be able to tap the public markets for desperately needed funds.
But the big question was whether we would have enough TARP money to deal with unforeseen emergencies—like AIG.
In fact, no recipient of government aid had caused more public ire than AIG—and it once again stood on the brink of failure. I needed someone to manage the situation, but everyone seemed to shy away from it. It was a thankless task that came at an awkward time, at the end of the administration, when people were already searching for new jobs. Some told me point-blank that they didn’t want to do it.
As it happened, though, I had just the right person on staff in Jim Lambright, who had arrived just days before—on October 22—to manage TARP’s investments. Still in his 30s, Jim had been appointed by President Bush to be chairman of the Export-Import Bank in 2005. I’d met him while working on the Strategic Economic Dialogue with China. Now I asked Jim to work with the Fed to structure what would become Treasury’s TARP investment in AIG. I could tell that the former Golden Gloves boxer had the fortitude and capability to handle the problem.
By late October, AIG was in dreadful shape, partly because of deteriorating conditions in the insurance business and partly because of its leveraged capital structure. The financial mess inherited by AIG’s new CEO, Ed Liddy, had turned out to be even worse than the Fed had expected. And the Fed’s $85 billion loan, with its high interest rate of LIBOR plus 8.5 percent, had imposed a heavy financial burden on a badly wounded company. But those terms, while intended to protect the taxpayer, were undermining the government’s investment. At the time of its rescue in September, we had not had the authority to put equity capital into AIG. Now we did. With the company expecting to announce a whopping loss on November 10, it would go down without a capital investment and a new financial plan in place.
Treasury needed to establish new TARP guidelines for an investment in a failing company, including stricter executive compensation guidelines than those in force for capital investments for healthy institutions. The Fed and its adviser, Morgan Stanley, also worked with AIG and its rating agencies to avoid a downgrade that would lead to crippling collateral calls.
Meantime, the automakers continued to struggle. The White House’s hopes of redirecting the $25 billion in low-interest fuel-efficiency loans to bail out the companies had hit a wall. It couldn’t legally be done unless Congress changed the language of its legislation, but Nancy Pelosi refused. She was unwilling to change the bill’s environmental focus. Instead, she insisted that I had the authority to use TARP funds to rescue the car companies, which had been pleading their case in Washington with some success.
On October 27, Moody’s downgraded the credit rating on GM’s and Chrysler’s debt, and the Dow fell 203 points to close at 8,176. The VIX, the Chicago Board Options Exchange’s volatility index, posted its second straight record day.
One day later, however, the Dow shot up 889 points, to 9,065, with nearly half the gain coming in the last hour of trading. Some analysts credited bargain hunting, while others attributed the rise to increased confidence resulting from Treasury and Fed actions. Though delighted to see the jump in share prices, I cautioned everyone not to overreact to one or two days in the market.
The imminent election contributed to the volatility in the markets. Obama had pulled well ahead of McCain, and although the Democratic candidate and I had enjoyed a frank, respectful relationship, he had begun to make pronouncements that distressed me, hitting hard on the issue of bank lending. I was concerned that McCain would pile on, making our efforts to get capital out to the banks even more difficult. On Tuesday evening, October 28, I called Rahm Emanuel to talk about it. I knew that Rahm was close to Obama and, as a former investment banker, understood the intersection of politics and markets as well as anyone. I also believed he was likely to hold a prominent position in the next administration.
“You should call Barack and deal with him directly,” Rahm said. “He likes you.”
That evening, Obama and I had an extensive conversation.
“Everyone is talking about making the banks lend more, but ‘more’ than what?” I asked. “I expect them to lend more than they would have without the program, but the government should not make lending decisions.”
“I recognize that this is not a simple issue, but the banks need to understand their responsibilities,” Obama replied, adding that compensation was even more explosive politically. He agreed to tone down his rhetoric but warned me that I should also be talking to McCain: if the Republican candidate jumped on either the lending or compensation issue, Obama would have to do likewise.
On October 30, I took the opportunity to deliver a pep talk to my staff, just before we began a lengthy strategy session in which I would lay out the assignments for the next few days. “I am so proud of this team, and all you have done in such a short amount of time,” I said. “I know you’re tired.”
But the capital purchase program had to be flawlessly executed, so I went on: “If you have family obligations, forget them. I’ll help you get jobs, I’ll kiss you on all four cheeks, but we’ve got one more big push before Thanksgiving.”
They burst out laughing—they had such extraordinary dedication and camaraderie. And of course everyone already expected that they were going to be on the job all weekend. That’s what we did. I had to fly to Chicago with Wendy to babysit our granddaughter—but I, too, knew that I would spend most of the weekend working.
Saturday, in fact, found me talking on my cell phone with Ben about foreclosure relief. He knew that the White House had never seen a mortgage mitigation plan that it favored, but like me, he believed that devising one would be critical to getting congressional approval to release the final tranche of TARP.
“The Fed will support you, if it’s one that makes sense,” Ben said.
I returned on Sunday evening and went directly to a meeting at Treasury where we once again discussed taking down the remaining $350 billion of TARP. To do so, we would need to explain how the funds would be used. After yet another discussion of potential strategies, I reluctantly concluded that a direct purchase program for illiquid assets was not a good use of our limited TARP dollars. The markets were getting worse, and every program I looked at either took too much time to implement or would not be big enough to make a difference. Capital investments were more powerful, and we had decided to reserve $150 billion for future bank capital programs and to set aside funds to expand beyond banks to insurance companies. To make this work politically, we would need to deal with foreclosures.
The next afternoon, at a meeting in the Roosevelt Room with a large group of senior White House staff and economic advisers, I decided to address the controversial mortgage relief issue directly. I said I didn’t think we should spend time debating the pros and cons of the issue.
“I know many of you strongly oppose government spending for foreclosures, and I can’t find a program that isn’t flawed,” I told them. “I’m just going to make the assertion that we need the second half of TARP, and we can’t get it without foreclosure relief.”
If we agreed on that, I said, I would go to the president and tell him that foreclosure relief was a political reality. I also dropped a bomb when I informed them we had decided against buying illiquid assets.
The White House staff didn’t argue with me, but I could see they were taken aback. Although they understood my reasoning, they knew that dropping the asset purchases would create a political and communications problem. Neither did they disagree with the need for the last tranche, but they pointed out the political difficulty of going to Congress to ask for the money without the asset-purchase plan in place.
I explained that we did have a purchase plan in mind, though not for toxic mortgages. I outlined the work Steve Shafran had been doing with the Fed to use TARP money to unlock the consumer credit markets, explaining how the new Fed lending facility would essentially guarantee a minimum price for asset-backed securities.
As soon as the questions about securitization started, I realized what we were up against. Ed Gillespie, who as counselor to the president oversaw communications, was a smart guy, and he asked very basic questions to help him figure out how to sell the program as a good use of TARP. He was echoed by Dan Meyer, the president’s assistant for legislative affairs.
“Hank, explain to me again this TALF securitization plan and why government intervention is necessary,” Ed said.
This wasn’t an encouraging sign. If these wise White House insiders had a hard time grasping the proposed program, how would lawmakers and the public get it? Even more important, would they understand and accept the surprise move away from buying illiquid assets?
I had hoped to get the last tranche for emergencies, and to have it in place for the new administration, but Joel Kaplan, Dan Meyer, and Ed Gillespie believed that we would have to clearly demonstrate a need for the money to persuade Congress to give it to us. Dropping the asset-buying plan would undermine our credibility, and I was beginning to understand that unless I faced an emergency, I might never be able to get the rest of the TARP money without the full support of the president-elect. I realized we needed to rethink our approach. At the same time, I decided to keep Neel working on options for asset purchases for the time being, because I knew that giving up on it would shock the market and subject us to a great deal of criticism.
I stewed over these issues all evening, through a dinner at the Brazilian ambassador’s residence and into the night. I saw no way around the political obstacles, but I dreaded being caught without money if another crisis arose. I tossed and turned a lot that night, thinking of the stricken look on Ed Gillespie’s face after I said I was dropping the plan to buy assets.
Despite the rain that covered the city, Washington thrummed with excitement on Election Day. Every election riveted the nation’s capital, of course, but this one carried particular historic resonance for the city’s African American majority. I had already voted by absentee ballot, so I went straight to my office. At 8:00 a.m. I called Joel Kaplan at the White House.
“I’ve been thinking about it,” I said, “and I don’t think we should try to take down the second half of TARP.”
Joel was hugely relieved, as was my team, who feared I was leading them into the second Battle of Little Big Horn. The president and vice president were also relieved when I met with them later that day in the Oval Office. I was convinced I had made the right decision, but I also knew that we had only a thin cushion to carry us through the long transition period leading up to January 20.
On Tuesday the Dow saw its biggest presidential Election Day rally ever, jumping 305 points, or 3.3 percent, to 9,625. The London interbank rate fell to its lowest level since November 2004. Market watchers credited the optimism to speculation that the government might extend its capital program to nonbank financial companies like GE.
Wendy stayed up to watch the election results, but I went to bed early. Obama was ahead, and I figured the election was a foregone conclusion. After the Democratic candidate was declared the winner at 11:00 p.m., Wendy woke me up to tell me the historic news. I went back to sleep comforted by the knowledge that our president-elect fully understood the threat our economy still faced. I was also relieved that the election was over and that I would no longer have to worry that our actions might become campaign issues. Now I would need to talk with the transition team to find out how they wanted to work with us.
In the meantime, Treasury still had plenty of business to take care of. On November 5, the day after the election, Jim Lambright and I sat down in the Oval Office with President Bush, Vice President Cheney, and Keith Hennessey. It was five days before AIG would release its third-quarter earnings.
Jim carefully explained the situation. AIG’s problems had been exacerbated by the crumbling financial markets; since the deal had been made, the global insurance business had slumped. Now the company’s credit default swaps had neared 2,400 basis points. That meant that it cost almost $24 to insure $100 of AIG credit—an extraordinarily high amount.
The market could see that AIG’s capital structure was unsustainable. The Federal Reserve’s loan had saved it, but the company still had too much debt. The loan’s high cost strained interest coverage, and its short, two-year duration created pressure to sell assets quickly in a soft market. Meantime, the company was still weighed down by substantial market and credit risks from its holdings of residential mortgage-backed securities and the credit default swaps it had written on residential MBS. It had even used its securities lending program to purchase residential MBS.
It turned out AIG’s third-quarter losses were going to be $24.5 billion pretax—even worse than we had expected. We needed to act quickly to inject $40 billion of TARP capital into AIG to avoid a rating downgrade that would trigger $42 billion in collateral calls and finish the company off.
The Fed’s restructuring plan would shift AIG’s worst mortgage-related assets and credit default swaps into two new Fed vehicles, called Maiden Lane II and Maiden Lane III, which together would hold $52.5 billion. That way any collateral calls triggered by a future downgrade would hurt the company less. More than 20 subsidiaries would be sold; AIG would become a much smaller, more narrowly focused property/casualty insurer.
Under the New York Fed’s plan, Treasury’s $40 billion would purchase senior preferred shares in AIG; in return we would receive a 10 percent dividend and warrants for 2 percent of the company’s shares. The Fed would scrap the $85 billion two-year loan, substituting a five-year $60 billion loan and cutting the interest rate from 8.5 to 3.0 percentage points over LIBOR. Under the New York Fed’s creative restructuring, the $150 billion deal would not increase the government’s 79.9 percent stake.
President Bush, frustrated with both the incompetence of the company’s prior management and the rating agencies that had failed to catch AIG’s problems earlier, once more found himself in the position of supporting a philosophically unpalatable bailout for reasons of necessity. After Jim had laid out the revised rescue plan, the president asked him, “Are you asking me or telling me this is going to happen?”
New to his job, Jim looked to me to answer.
“I’m telling you this is going to happen, Mr. President,” I said.
“Will we ever get the money back?”
This time Jim responded. “I don’t know, sir.”
“We need to be very clear that we’re doing this because it’s a systemically important company and we need to keep it from failing,” the president said.
President Bush’s anger quickly echoed across the country when taxpayers learned the government was revamping its September bailout plan and giving AIG easier loan terms along with much-needed capital. To the public, AIG symbolized everything that had gone wrong with the system—incompetence rewarded with big bonuses and lavish spending. While I shared their disgust, I told the president that AIG’s new CEO, Ed Liddy, was working his tail off for a salary of one dollar a year. But like the president, I understood that we had to hold our noses and save the company in order to protect the frail financial system.
The jittery markets didn’t maintain their elation about Obama’s triumph for long. Wednesday was another wild ride, with the Dow dropping 486 points, or 5 percent, to 9,139—the worst plunge on record for the day after a presidential election. Bank stocks were hard-hit, and though no institution appeared to be in immediate danger, Citigroup fell 14 percent to $12.63.
As we worked to bolster the banks, commercial real estate became a growing source of concern. I got a glimpse of just how bad the situation was when Wendy and I had dinner on November 8 with our friends New York Times columnist Thomas Friedman and his wife, Ann. Her father, Matthew Bucksbaum, had co-founded General Growth Properties in Des Moines with his brother Martin in 1954. The company was the second-largest mall operator in the U.S., but its stock had been tanking and I knew that it was struggling to avoid bankruptcy.
Ann was stoical, and we didn’t talk much about the situation that evening. But it seemed that everywhere I went, I encountered another grim reminder of the pain this crisis was inflicting on our nation and of how much we needed to repair our markets—not for the banks, but for Americans who depended on companies like General Growth for their livelihood.
The day after my dinner with the Friedmans, Ben Bernanke, who had flown back overnight from a G-20 meeting in São Paulo, met me in my office for a TARP oversight board meeting to approve the AIG investment and to make some joint calls to congressional leaders to prepare them for the AIG announcement. None of the leaders we contacted that Sunday afternoon and evening objected, other than Richard Shelby. As John Boehner said, “You’ve got no choice.”
On Monday, as AIG revealed its breathtaking third-quarter loss, Treasury announced TARP’s first one-off investment when it unveiled the revised package for the company. Though the Dow slipped nearly 1 percent, AIG’s shares rose 8.1 percent, to $2.28.
The rescue package took care to apply TARP’s strictest provisions on golden parachutes and froze the size of the bonus pool for the company’s top 70 executives. But that did not satisfy an increasingly angry public.
The same day we announced the AIG deal, Dan Tarullo, the head of Obama’s economic transition team, arrived at Treasury with Lee Sachs, a former Clinton Treasury official who was under consideration to run TARP for the new administration. Tarullo said his team wanted to monitor what we were doing with TARP but didn’t expect to be included in policy decisions. After all, there could be only one president at a time. I told them that I would be making a major speech on November 12 and that they would like it, because we wouldn’t be announcing new programs and we wouldn’t ask for the remaining TARP money. They both were visibly relieved. I had accepted that it wouldn’t be realistic to get Sachs nominated and quickly approved for the permanent post, but I’d hoped he would take up residence at Treasury and work side by side with Neel. As it turned out, we didn’t see much of him or Tarullo.
Between collapsing insurance giants, dying shopping malls, bailed-out banks, and all-but-bankrupt automakers, the American people had watched one institution after another totter. I’d kept my public comments to a minimum in the weeks before the election. But I knew the markets and the press were growing impatient, and I began working hard on the speech I planned to deliver on November 12 at Treasury, in which I would make clear my decision to move away from buying illiquid assets.
I had struggled with this decision, and up until a few days before the speech I would stop by Neel Kashkari’s office every morning to talk over possible asset-purchase programs. He had lined up several big money managers, including Western Asset and Black-Rock, to work on the government’s behalf, but we concluded that we couldn’t design a program big enough or execute it quickly enough to make a dent in the problem in any reasonable period of time.
On November 11, the Federal Housing Finance Agency, the regulator for Fannie Mae and Freddie Mac, announced that the GSEs would adopt parts of Sheila Bair’s IndyMac Protocol to simplify mortgage modifications. The FHFA program targeted people who had missed at least three mortgage payments and used the property as their primary residence; like the IndyMac Protocol, it limited mortgage payments to 38 percent or less of the household’s gross monthly income. The program had built-in flexibility, and reductions in monthly payments could come from cutting the interest rate, extending the life of the loan, or deferring principal payments. Fannie and Freddie owned or guaranteed 31 million mortgages, so this would extend foreclosure relief to many more homeowners—and, I hoped, assuage those who complained that the government had not done enough.
But Sheila Bair did not show much enthusiasm for the FHFA program and continued to push Treasury to back her loss-sharing plan. I called Sheila to let her know I had decided against trying to get the last tranche of TARP, and as a result would not be announcing any new foreclosure efforts, such as her insurance program, beyond FHFA’s new initiative. This news did not please her, but she said she understood.
My round of calls to congressional leaders included a conversation with Barney Frank. I mentioned the FHFA program and explained to Barney that we couldn’t do more on foreclosures without a final tranche of TARP money, and we weren’t going to ask for that. I also pointed out that we hadn’t told Congress or the public that the TARP funds would be used for a spending program. Although he didn’t like my message, he didn’t push back as hard as I’d expected. But I heard from him again early the next morning.
“You need a housing program,” he said. “We sold TARP to our caucus because owning mortgages would help you deal with the foreclosures, and this is going to cause a big problem with them.” He added that if we came up with a foreclosure plan, we could get the last tranche of TARP.
He was optimistic that President-elect Obama would support the effort and that we would get Democratic votes. If we didn’t like Sheila’s insurance program, we should come up with something different, he said. I liked Barney’s attitude, but I told him he was more optimistic than anyone else on this issue, and that I’d had no indication that the new administration wanted to work with us.
Getting my speech right was tricky. I hadn’t provided any public update on our progress since late October, and I was concerned about unsettling the markets and discrediting our efforts. Everyone expected me to announce my intent to request the rest of the TARP funding. Saying definitively that we weren’t going to would not be well received, so I decided it was better not to mention it at all. I knew, though, that the market participants would do the math and wonder if I had enough money left to deal with emergencies. I would have to communicate that I was comfortable with the funds I had and with the procedures for getting the rest, and hope for the best.
Similarly the markets were expecting me to unveil the details of a program to buy assets. And buyers and sellers of illiquid assets had been frozen waiting for our program, so silence was not an option. I needed to explain our rationale for not purchasing the toxic securities and to describe the other priorities for TARP dollars. I focused on Treasury’s ongoing efforts with our bank capital program and our plans to help the consumer loan market.
Michele Davis and I were going over last-minute preparations for my speech when Jeb Mason burst into my office to make a final plea for a small-scale asset program in which Treasury would buy whole mortgages and get foreclosure relief for the homeowners.
“Hank, I want to say one more time, you shouldn’t be going out there and saying you’re not going to buy illiquid assets directly,” Jeb said. “We should have some program, even if it’s a small program.”
I always encouraged give-and-take, but that morning, knowing that I was about to make a controversial announcement to a roomful of reporters, I was not in the mood for it. The program he wanted would have been a nightmare to administer. “I’ve heard you multiple times on this, and I’ve made my decision,” I snapped.
Jeb was right that the speech was risky, but I’d rather get politically lambasted than knowingly develop a program only for show. If I said anything but the truth, I couldn’t look at myself in the mirror.
Shortly afterward, I walked into the bright lights and chattering voices of Treasury’s Media Room, and delivered what I considered to be a terrific, if complicated, speech. In my six-page statement I covered everything the government had done to ease the crisis, from our ongoing HOPE Now mortgage modification program, which each month was helping 200,000 homeowners avoid foreclosure, to the GSE rescue.
I also brought the public up to date on our TARP efforts. I said that after much consideration we had decided that the asset-buying program was not an effective way to use TARP money, though we would continue to study possible targeted purchases. We were working to quickly get capital to participating banks, I added, and emphasized that those institutions had responsibilities when it came to lending, compensation and dividend policies, and foreclosure relief. I noted that Treasury and the Fed were working on a program to improve the availability of consumer credit by improving liquidity in the asset-backed securitization market, and that the facility might be extended to new commercial and residential mortgage lending.
I also tackled the issue of foreclosure relief, applauding Sheila’s IndyMac Protocol and mentioning Fannie and Freddie’s new modification program. I conceded that Sheila’s insurance idea was important and said we would evaluate it, but pointed out that we would have to figure out how to finance it.
The reporters were polite, asking a lot of questions about the securitization program. But just as I feared, the markets focused on the facts that there wouldn’t be a program to purchase mortgage-related assets and that we weren’t going to be moving ahead quickly with any new programs that would require us to ask for the remaining $350 billion. The reaction was immediate and brutal: the Dow fell by 411 points, to 8,283, and the S&P 500 and the NASDAQ each dropped by 5.2 percent. Public criticism and plenty of negative press followed.
November 12 was a day of major announcements. Treasury, the Fed, and the FDIC put out a comprehensive joint statement dealing with the hot-button issues of lending, executive compensation, dividends, and foreclosure mitigation. Since the compensation and lending controversies exploded in mid-October, I had encouraged Ben, Tim, John Dugan, and Sheila to address these issues in strong, clear language. The resulting regulatory guidance pleased me: it said in no uncertain terms that banks must fulfill their fundamental role by lending to creditworthy borrowers and must work to avoid preventable foreclosures. It also warned against compensation plans that “created perverse incentives that jeopardize the health of the banking organization” and called for programs that were “aligned with the long-term prudential interests of the institution.”
Also that day, the FDIC agreed to guarantee up to $139 billion of debt issued by General Electric’s finance subsidiary, GE Capital, under the temporary program the regulator had established in October. Though not a bank, GE Capital was systemically important, and David Nason and I had worked hard to get Sheila comfortable with making this decision. The FDIC said it would extend the Temporary Liquidity Guarantee Program to nonbanks on a case-by-case basis, using criteria like size, credit rating, and connection to the economy. GE Capital, along with Citigroup, would become one of the two biggest users of TLGP, issuing some $70 billion of government-guaranteed debt. (The GE parent company agreed to indemnify the FDIC against any losses for GE Capital.)
But none of this news mattered to the markets, whose earlier volatility seemed to have turned into a full-fledged slide. The Dow was down nearly 40 percent from the start of the year, and companies from General Motors to Genworth Financial were coming under enormous pressures.
January 20 was a long way off, and I felt very exposed. Between AIG and the banks, we’d allocated all but $60 billion of our $350 billion. I had exhausted my political capital and credibility in an effort to keep the system from collapsing, and now I would have to rely on the incoming Obama administration to help me.