Passing through the main glass doors into a wood-paneled reception area, Willumstad and Schreiber took in the newly renovated offices on the forty-eighth floor. As the two men sat waiting, Willumstad knew his associate was silently irate. Schreiber had been working throughout August on various plans to raise capital and extend the company’s credit lines to avoid facing a cash crunch if the market were to worsen. As part of his efforts he had held a bakeoff among a number of banks and had been unimpressed with JP Morgan’s pitch—and he was still smarting from the firm’s aggressive attitude when they raised capital for AIG in the spring. He had hoped to use Citigroup and Deutsche Bank, but Willumstad had insisted that they consider JP Morgan. The way things were playing out, if things really did get much worse, Willumstad figured he’d rather be dealing with an ally in Dimon, even if his colleague felt otherwise.
The AIG executives were escorted to Dimon’s office, which actually consists of an office with a desk, a sitting room, and a conference room. In the conference area Dimon, Steve Black, co-head of the investment bank, Ann Kronenberg, and Tim Main took their places around a wood table with a whiteboard behind them.
After some small talk, Dimon thanked them for coming, and Main, who headed the bank’s financial institutions group, launched into his pitch for why AIG should use JP Morgan. Main pointed out his group’s number one ranking in the latest league underwriting tables and noted its work in helping CIT Group issue two equity offerings worth $1 billion.
“That’s a dubious achievement to cite,” Willumstad later commented to Schreiber, “given that shares of CIT were trading below $10 [in August 2008] when they were more than four times that a year ago.” All in all, however, it was a fairly standard pitch from a Wall Street banker, the kind everyone in the room had heard dozens, if not hundreds, of times before: We’re the best suited to help you, we have the most talent, the most resources; we understand your needs better than anyone else.
But then Main concluded with a not-so-subtle dig at AIG and his past experience with the company. He pointed out that JP Morgan had a lot to offer but stressed that it was important that its clients recognize their own problems and shortcomings. Many in the room, including Dimon, were taken aback.
“Forget Mr. Obnoxious,” Dimon said, cutting Main off. But the damage had been done, and the AIG executives were clearly upset, Willumstad finding the performance annoying while Schreiber thought it was offensive. After a few minutes they shrugged the comment off and resumed their talks with Dimon directly, as an embarrassed Main slumped in his chair.
“Jamie, one of my concerns here is that there’s a higher probability now that we’re going to get downgraded,” Willumstad explained. “The rating agencies promised me they would wait until the end of September, but then the Goldman report came out and they got nervous,” he said, referring to an analyst report issued by Goldman Sachs raising questions about the firm. The report was so influential that Willumstad had received a call from Ken Wilson and Tony Ryan at Treasury to check up on the company.
“Maybe you should just take the downgrade. It’s not the end of the world,” Dimon suggested.
“No, this is not just a downgrade,” Willumstad insisted. As the company had warned in an SEC filing several weeks earlier, a downgrade would be very expensive. If either Standard & Poor’s or Moody’s lowered its rating by one notch, AIG would be required to post $10.5 billion in additional collateral; if both agencies lowered their ratings, the damage would soar to $13.3 billion. As part of its contract to sell credit default swaps, AIG was required to maintain certain credit ratings—or add new collateral to compensate—as insurance against its potential inability to pay out any claims on the swaps. AIG was now a AA-minus company, and it was facing a tab that was growing quickly. Its executives were estimating that the firm could soon be hit with demands for as much as $18 billion in additional collateral.
Left unspoken was the fact that if AIG could not come up with the cash, bankruptcy was the only alternative.
As Dimon saw it, this was a short-term liquidity problem. “You have a lot of collateral, you know, you have a trillion-dollar balance sheet, you have plenty of securities,” he told them. Yes, it could get much worse, but for now, it was just a temporary annoyance.
“We do,” Willumstad agreed, “but it’s not that simple. Most of the collateral is in the regulated insurance companies.”
By midyear AIG had $78 billion more in assets than it had in liabilities. But most of those assets were held by its seventy-one state-regulated insurance subsidiaries, which could not be sold easily by the parent company. There is no federal regulation or supervision of the insurance business. Instead, state insurance commissioners and superintendents have substantial powers to regulate and restrict an insurer’s asset sales. The responsibility of the state regulator at all times is to protect the policy-holder. There was virtually no possibility that AIG would be able to raise cash quickly by selling some of these assets.
Now Dimon finally understood the scope of the problem, as did everyone else in the room.
Just as they were walking out, Dimon pulled Willumstad aside. “Listen, you don’t have the luxury of time,” he told him. “If it’s not us, get someone else, but you need to get on this.”
The next day, Willumstad followed up on the meeting.
“Jamie, this is only going to work if there is chemistry on both sides,” Willumstad began. “With all due respect, I know you guys have a lot of confidence in Tim Main, but the reality is, you saw what I saw.”
Dimon knew exactly what Willumstad was about to say and interrupted him with, “Steve Black will handle it.”
“Good,” Willumstad replied.
“You got to plan on packing your clothes and coming up,” Ken Wilson told Herb Allison, the former Merrill Lynch and TIAA-CREF executive whom he located on a beach in the Virgin Islands on Thursday night and let in on the big secret: The government planned to take over Fannie and Freddie that coming weekend, September 6.
It wasn’t just a social call, however; Wilson had phoned Allison to hire him as the CEO of Fannie. After all, if they were going to take over the company, they wanted to install their own management.
“Look, Ken,” Allison told him. “I would like to. For reasons of public service, I’m interested in this job. I want to help you guys, and so you have to let me know what to do. I don’t have any clothes. All I have is shorts and flip-flops.” Wilson promised to buy him some clothes when he arrived in Washington.
Paulson had decided to execute the takeover plan earlier in the week after a visit by Richard Syron, the chief executive of Freddie Mac. Syron, whom Paulson detested, told him that he had gone to Goldman Sachs’ headquarters to pitch potential investors but several days of meetings proved to be in vain: No one was willing to make a significant investment in the company. Paulson’s conversation with Dan Mudd, Fannie Mae’s CEO, whom Paulson liked better, still wasn’t inspiring.
And so on the night of Thursday, September 4, Treasury began its battle plan.
Like clockwork, the chief executives of Fannie and Freddie were instructed to attend meetings on Friday afternoon with Paulson and Bernanke at the offices of the Federal Housing Finance Agency. Mudd’s meeting would start at 3:00; Syron’s at 4:00. They were each advised to bring their lead director, but told nothing else. Paulson figured that by the time any of this could leak, the markets would be closed and he’d have forty-eight hours to execute his plan.
That afternoon, dark rain clouds massed over the capital as Tropical Storm Hanna approached. In an upstairs conference room Bernanke took a seat on one side of James Lockhart while Paulson took his place on the other. At each meeting, James Lockhart began by telling the Fannie and Freddie executives and their lawyers that their companies faced such potentially great losses that they could not function and fulfill their mission. The FHFA, he said, reading from his prepared script, was acting “rather than letting these conditions fester.”