“We’ve got a problem …” Geithner began the call.
For the first time in weeks, on Tuesday morning the editorial pages of the major newspapers were heralding Hank Paulson. They applauded his decision to not use taxpayer money to bail out Lehman Brothers. “It is oddly reassuring that the Treasury Department and Federal Reserve let Lehman Brothers fail, did not subsidize the distress sale of Merrill Lynch to Bank of America, and tried to line up loans for the American International Group, the troubled insurer, rather than making a loan themselves,” the New York Times’ lead editorial read. “Government intervention would have been seen either as a sign of extreme peril in the global financial system or of extreme weakness on the part of federal regulators.”
Given the conversation he’d had with Dan Jester at 6:00 that morning, however, it was looking increasingly likely that AIG and the global financial system were now in such peril that the government would have no choice but to intervene.
Paulson had seen the panic gripping the markets in the past twenty-four hours, which was duly reflected in the headlines on every newsstand. That morning’s Washington Post was typical of the tone of the coverage: “Stocks Plunge as Crisis Intensifies; AIG at Risk; $700 Billion in Shareholder Value Vanishes.”
The Dow Jones Industrial Average had slumped 504.48 points on Monday, the biggest point decline for the index since September 17, 2001, when trading started up again after the September 11 terrorist attacks. AIG’s stock had fallen 65 percent to close at $4.76.
By 7:45 a.m., Ben Bernanke was in his office preparing for the Federal Open Market Committee meeting that was due to begin forty-five minutes later in the boardroom just down the hall from his office. It was purely a matter of chance that the FOMC, the Fed’s board of directors that determines monetary policy and decides whether to raise or lower interest rates, had one of its eight meetings a year scheduled for this morning.
Before his meeting began, Bernanke called Kevin Warsh and Don Kohn into his office to join him in a conference call with Tim Geithner, who instead of attending the FOMC gathering had decided he had to stay in New York to deal with AIG, sending Christine Cumming, his vice president, in his place. There was only one small problem with that decision: FOMC meetings were relatively public affairs, and Bernanke was concerned that Geithner’s absence could leak to the press and cause further panic in the markets.
“There’s nothing we can do about it at this point,” Geithner said, eager to focus the group’s attention on the larger problem at hand. He told them that he was expecting to receive a full progress update from JP Morgan and Goldman Sachs at 9:00 a.m., but cautioned that all the signals he had gotten from Dan Jester and Morgan Stanley had not been promising.
He advised them, consequently, to start thinking about a Plan B.
Jimmy Lee was worried he’d be late for the meeting at the NY Fed, having gotten stuck in traffic on the FDR after a quick trip back to his home in Darien to take a shower and put on some fresh clothes. While waiting he called Dimon from his cell phone. “So this is what I’m going to tell them,” he said about his planned presentation to the Fed. “I’m going to have to say the numbers are just too big. We can’t do it. No one can do it. The company is going down.”
“If that’s the answer, that’s the answer,” Dimon replied.
“This is my best judgment,” Lee assured him.
The good news—if it could be called that—was that Lee expected he’d have to tell only Dan Jester, since Geithner would be in Washington at the FOMC meeting.
When Lee finally arrived, he found everyone had already gathered in the conference room that had become the de facto lounge for these meetings. He took a seat near his colleague, Doug Braunstein, and they all began waiting patiently for Dan Jester.
The door opened and Jester and Norton entered, followed by Geithner, who gave no explanation for his unexpected presence.
“So where are we?” he asked in his clipped, all-business manner.
Jimmy Lee consulted his yellow pad, on which he had written two notes to himself in the margins: “Deal stands little chance” and “AIG out of cash.”
“We’ve gone through it all,” Lee said. “They have $50 billion in collateral and they need $80 to $90 billion. We’re short $30 to $40 billion. I don’t know how we can bridge that gap.”
Winkelried of Goldman then jumped in. “Let me just say there is a huge systemic risk to letting this institution fail. I don’t need to tell you the number of counterparties that would be exposed.”
A document generated listing AIG’s biggest counterparties in order of size was passed around. The most exposed firm listed on the orange and blue sheet was ABN AMRO, which had been acquired by Royal Bank of Scotland, with $65 billion; the second largest was Calyon; Goldman Sachs was the seventh; Barclays was the eighth; and Morgan Stanley was the ninth.
Geithner studied the figures, furrowing his brow every few lines, and after setting them down said, “Okay. Here’s what we’re going to do.” He paused, leaning forward for all to hear what he was about to say.
“I want everyone to put his cell phone away, BlackBerrys, everything. I don’t want anybody communicating outside of this room. Not to your office. Not to anybody. Do you understand me? This conversation is confidential,” he said. When Geithner was satisfied that everyone had complied, he posed a question for which no one in the group had been prepared: “What would it look like if we said the Fed was going to do this?”
For the past seventy-two hours the government had been insisting that it would not bail out any financial institution. Now, with that one sentence, Geithner had turned everything on its head. Even if it was just a hypothetical, the rules of engagement had evidently just changed.
Geithner continued, throwing out a series of questions. “How would this work? How would you structure the terms? How will the capital markets respond? How will the debt markets react?”
Goldman’s Winkelried could not hide a slight smile. Scully of Morgan Stanley, realizing the night before that he needed a Plan B, had already roughed out a term sheet based on the numbers that JP Morgan and Goldman Sachs had put together. If it was good enough for them—and by Morgan Stanley’s estimation, they were going to be stealing the company—it should be good enough for the Federal Reserve.
“Work on it,” Geithner said, and then left the room.
“Braunstein isn’t picking up his fucking phone,” Willumstad railed after dialing his cell several times, worried that he was being kept in the dark.
John Studzinski, his adviser from Blackstone, had just heard from one of his colleagues who was down at the NY Fed that he had seen Goldman and JP Morgan executives high-fiving one another—even while another team from the two banks was still camped out at AIG, rifling through its books.
Studzinski finally managed to reach Porat by text-messaging her. However, she was purposely being vague, and would only offer, “The deal is changing. Stop sharing information with JPM and GS.”
A few minutes later, Willumstad’s assistant announced that Tim Geithner, whom Willumstad had frantically attempted to reach several times that morning, was on the phone.
“Hi, Tim,” Willumstad said, somewhat impatiently.
“Give me a progress report,” Geithner instructed, rather than offering the progress report that Willumstad had been waiting for desperately.
“I just want you to know that we’re preparing for bankruptcy,” Willumstad told him steadily. “I’ve called the backup lines. I just think you should know that.”