Too Big to Fail

by Andrew Ross Sorkin

  Down on Lehman Brothers’ massive trading floor, the mood was grim. The staff wasn’t just devastated, they were angry. And while that anger was at first directed toward the government, it had quickly shifted to management. A Wall of Shame had been erected on the south side of the building containing, among other exhibits, photos of Fuld and Gregory with the caption, “Dumb and Dumber.”

  With Lehman’s holding company now officially in bankruptcy, Barclays’ Bob Diamond arrived with a team to pick over the assets it wanted and leave the worst ones behind. To Diamond, it was the perfect opportunity to obtain only Lehman’s choicest parts at a bargain price and with the blessing of a judge. Barclays was mainly interested in Lehman’s U.S. broker-dealer and its buildings, and this time around both the FSA and the British government had given him their support. Another plus: There was no need for a shareholder vote.

  Bart McDade had assembled a team to begin negotiations with Barclays. He believed there was a chance that he could save the ten thousand jobs that were likely to disappear, even if shareholders themselves had already been wiped out by the bankruptcy. Before that meeting began, however, Alex Kirk pulled McDade aside. Kirk, emotionally drained from the past week, was becoming increasingly suspicious that Barclays had dropped its bid twenty-four hours earlier only so that it could buy the business for even less today. He was outraged, as were many of the traders on the third floor.

  “Either Barclays was duped or they were part of the charade,” he told McDade. “I have no interest in working for a company that’s either the dupe or is part of this charade. And I have no interest in working for a highly leveraged financial institution with regulators who behave like I just saw. So I’m out on this whole thing.”

  McDade was disappointed but sympathetic. “I get it, I understand, you do whatever you want,” he told Kirk but asked if he would stay at least through the week to help manage the trading floor as they tried to arrange a deal. Kirk reluctantly agreed.

  McDade then assigned Skip McGee and Mark Shafir to find a way to execute a deal with Barclays.

  In the corner conference room, meanwhile, Harvey Miller was holding court with Barclays’ management arrayed around the table. Jay Clayton of Sullivan & Cromwell, who had previously been Lehman’s lawyer with his colleague Rodgin Cohen, had been hired by Barclays that morning. “I think I’m switching from shirts to skins,” he said awkwardly as he sat down next to the Barclays team.

  Miller was trying to sort out how quickly they could sell the company, aware that in a business based on the confidence and trust of its trading partners, every second the firm remained on its own, it was losing value.

  Michael Klein, Barclays’ adviser, announced, “We are only doing this deal if we’re not bringing any liabilities with us.”

  “What do you mean by that?” Miller asked.

  “Well, we’re not going to buy any of these assets unless it is an absolutely ‘clean deal,’” he explained.

  Barclays’ Archie Cox jumped in and added, “And we have to close tomorrow.”

  Miller shot a black stare at him. “Well, if that’s the case, we should just discontinue this right now. Generally, a sale of even perishable assets takes twenty-one to thirty days.”

  “We can’t wait that long,” Cox insisted. “By that time the business will be gone.”

  “The only thing I can think of right now is you get the court to accelerate the time lines,” Miller offered. “We get an agreement in principle with the Securities Investor Protection Corporation, and it will commence a separate proceeding to coincide with this sale. But that’s never been done before.”

  “Can you do that?” Cox asked.

  “Until we try, we won’t know,” Miller replied.

  Timothy Geithner was sitting at his desk at the NY Fed with Jamie Dimon on the speakerphone, waiting to be conferenced in with Lloyd Blankfein, who was just returning from the firm’s Monday-morning internal meeting.

  It had been Geithner who had decided the night before, after consulting briefly with Paulson, to pair JP Morgan and Goldman to help AIG. By his logic, JP Morgan knew AIG inside-out as a result of having worked for it for the past six months and could get everyone up to speed quickly on the depth of its problems. Goldman, he thought, could help value the assets and syndicate the loans. “They’re freakin’ smart!” he liked to tell his staff. He knew that Goldman had advised AIG in the past and had spent the weekend looking to buy assets themselves, so they were aware of what was going on.

  “Lloyd, I’m on with Jamie,” Geithner said when Blankfein finally came to the phone. He explained that he was hoping to find a private-market solution for AIG and wanted Goldman to help them.

  “JP Morgan’s coming down here,” Geithner told him. “Can you get a team together and come over here?”

  “Okay,” Blankfein said. “What time?”

  “Can you be here by eleven a.m.?”

  “We’ll be there,” Blankfein replied, even though it was already past 10:15.

  Blankfein immediately went to work organizing a small army of the firm’s top bankers: Jon “Winks” Winkelried, the co-president; David Solomon, the co-head of investment banking; Richard Friedman, who ran the principal investment area; and Chris Cole, who had spent the weekend over at AIG. They all met downstairs to walk over to the Fed.

  Chris Flowers, after the relatively uneventful press conference of Bank of America and Merrill Lynch that morning, headed down to Goldman Sachs with Paul Achleitner of Allianz. They had made an appointment to see Chris Cole as something of a postmortem and a discussion to determine if they could team up to make another run at some AIG assets. After waiting in a conference room for Cole for nearly a half hour, Flowers and Achleitner, both frustrated, went downstairs to get some food.

  Standing at the back side of 85 Broad Street, they saw Blankfein and Cole at least thirty yards ahead of them intently marching down William Street toward the Fed with Goldman’s entire senior team.

  “They’re fucking standing us up!” Flowers said.

  When the JP Morgan bankers Lee, Braunstein, and Feldman arrived at AIG, they found the building practically empty, which struck the men as odd, given that the firm was squarely in the middle of a life-or-death crisis.

  To Willumstad, who came to greet them, their arrival meant that his already frosty relationship with JP Morgan had just taken another turn for the worse: Were they still his adviser? Or were they now working for the government? Or were they working for themselves?

  Before beginning the meeting, Braunstein had a private conversation with Willumstad. “The government asked us to do this. Are you okay with that?”

  “Of course,” Willumstad replied.

  When they returned to the conference room, Lee, in a hurry to get over to the Fed, fired off a half dozen questions in rapid succession. “How firm a grip do you have on your cash? Where are the ratings agencies on this? What kind of credit lines do you have?”

  Willumstad was tentative with his answers. The numbers kept getting worse, he said. And with Lehman’s failure, and the markets likely to swoon, the value of AIG’s assets was likely to tumble further, giving them even less collateral to post.

  To Lee, it was abundantly clear that the company—and Willumstad—didn’t have a firm grip on its finances, exactly as Black had told him.

  Just before the bankers left for the Fed, Willumstad, trying to maintain an air of calm, said encouragingly, “I think we still have some time.”

  As the JP Morgan contingent began briskly walking over to the Fed, Lee said, shaking his head: “Whenever someone says they have time, there’s never enough. And when they say they need money, the number is always too low.” He paused before declaring, “They won’t last the week.”

  After spending an arduous weekend in the NY Fed’s lobby, many of the same members of the band of bankers and lawyers now disconcertingly found themselves reassembled there.

  One of the key new figures in attendance was Eric R. Dinallo, the su
perintendent of the New York State Insurance Department. Earlier that morning, he had formally agreed to allow AIG to use some of its regulated insurance company assets—up to $20 billion—as collateral to help stabilize the company. Dinallo had been driving up to Governor Paterson’s office—he had been slated to stand behind the governor during a press conference to announce the plan—when Geithner called and told him he should be at this meeting instead.

  As they milled about waiting for the meeting to begin, Blankfein poured a cup of coffee for Dinallo. “I hope you represent the bookends of this financial crisis,” he said, “because the last time I saw you was at the mono-lines, and I hope we’re done with AIG.” Dinallo had convened a meeting of Wall Street chiefs back in January to discuss the fate of the insurers Ambac and MBIA, which were faltering amid the credit crisis.

  When Lee, Braunstein, and Feldman finally arrived, they immediately felt outgunned, as it appeared as if Goldman’s entire executive thirtieth floor had cleared out and set up shop at the Fed. Bob Scully and Ruth Porat from Morgan Stanley, who had now been officially hired by the Fed to represent its interests, were also stunned by the depth of Goldman’s presence. “Why is Lloyd here?” Scully whispered to Porat.

  What went unspoken was the fact that all three banks, and virtually all of Wall Street, were huge counterparties to AIG. If the company were to fail, they would all face serious consequences. Therefore, there was a huge incentive to keep the insurer alive for everyone at the table.

  On the surface, Goldman looked like one of AIG’s biggest counterparties, but earlier that morning, Goldman’s Gary Cohn had boasted internally that the firm had hedged so much of its exposure to AIG that it might actually make $50 million if the company collapsed. The firm’s decision to buy insurance in the form of credit default swaps against AIG beginning in late 2007 was starting to seem like a smart investment. The firm had conducted what it internally called a “WOW analysis”—a worst-of-the-worst case scenario—and it was quickly coming true. Even though Goldman had hedged its direct exposure to AIG, Blankfein appreciated the larger problem: The collateral damage to its other counterparties and the rest of the market could expose the firm to untold billions in crippling losses.

  The group was ushered into a conference room with Tim Geithner. Dan Jester was at his side and Jeremiah Norton from Treasury, who had flown up from Washington that morning, joined them.

  As everyone took a seat, Blankfein noticed Jamie Dimon’s absence. He himself had come because he assumed that Geithner had invited both of them. “Where the hell is Jamie?” Blankfein whispered to Winkelried, who just shrugged his shoulders.

  “Look, we’d like to see if it’s possible to find a private-sector solution,” Geithner said, addressing the group. “What do we need to make this happen?”

  For the next ten minutes the meeting turned into a cacophony of competing voices as the bankers tossed out their suggestions: Can we get the rating agencies to hold off on a downgrade? Can we get other state regulators of AIG’s insurance subsidiaries to allow the firm to use those assets as collateral?

  Geithner soon got up to leave, saying, “I’ll leave you with Dan,” and pointed to Jester, who was Hank Paulson’s eyes and ears on the ground. “I want a status report as soon as you come up with a plan.”

  Before departing, he added one more thing: “I want to be very clear: Do not assume you can use the Fed balance sheet.”

  The meeting then devolved again into a half dozen side conversations until some order was restored when Braunstein walked the room through AIG’s financial position, explaining how quickly it had deteriorated over the weekend. It was coming under pressure not only because of the impending ratings downgrade but also because its counterparties were making constant requests for more collateral. The comment was a not particularly subtle jab at Goldman Sachs, which itself had been battling all weekend, as it had all year, for AIG to put up more collateral. To some in the room, Blankfein picked up on the slight immediately.

  “So, when is the money going to be paid out?” Blankfein asked, ostensibly referring to all the counterparties but to some he seemed to mean himself. One attendee scribbled a note to himself: “GS—$600 million,” which was an approximation of what he thought Goldman was seeking. Even though Goldman may have been hedged against AIG, it still wanted what it thought was the appropriate amount of collateral to keep trading with the firm. Scully of Morgan Stanley interrupted with: “Is there anything you can do to put Moody’s off so that we get a little breathing room for the next couple of days?”

  At that point, Jimmy Lee tried to break the logjam and take control of the meeting, having quickly become convinced that they were never going to get anywhere unless they started focusing on the big picture. AIG had forty-eight hours left to live unless the bankers sitting in this room did something productive to save it.

  Lee had already started listing on a notepad some of the issues that had been raised and things he needed to know:

  liquidity forecast

  valuation—business, securities

  term sheet

  participants

  legal in all

  In the margins he scribbled some questions about the size of the hole—“50? 60? 70?” billion—and then drafted a mini–term sheet for a loan of this magnitude. “Maturity: 1–2 years; Collateral: Everything; Consideration: Fees, Ratcheting Spreads, Warrants.”

  Given the size of loan AIG would require, the fees would be mind-boggling. He might be able to charge as much as 500 basis points, or 5 percent, of the entire amount for taking on this level of risk. For a $50 billion loan, that would add up to a $2.5 billion payday in fees.

  Lee had even begun assembling a list of the banks to contact to raise the credit line, virtually all of whom had exposure to AIG and were therefore also vulnerable: JPM, GS, Citi, BofA, Barclays, Deutsche, BNP, UBS, ING, HSBC, Santander. He could have come up with many more names but stopped at eleven.

  “Okay, okay,” Lee now said to the group and ran through the items on his list.

  “I like that. That sounds right to me,” Winkelried chimed in.

  The group decided to start their work with a round of basic due diligence, breaking the businesses into a half dozen categories and passing out assignments among themselves.

  Before they got into the specifics, Blankfein took advantage of a pause in the discussion to make a beeline for the door. Without Dimon there, this was below his pay grade.

  As they all decamped from the Fed and marched back to AIG to start crunching the numbers, Lee’s brain was already doing the math.

  “Who is going to buy this shit?” he asked aloud to no one in particular.

  That afternoon at 1:30 p.m., Paulson stepped out to the lectern in the White House briefing room. “Good afternoon, everyone. And I hope you all had an enjoyable weekend,” he began, to some awkward laughter. “As you know, we’re working through a difficult period in our financial markets right now, as we work off some of the past excesses.”

  He had just gotten back to Washington, rushing first to the Treasury and then across the way to the White House, to take questions from reporters. Jim Wilkinson had coached him on the flight down about how he should approach the issues. “We’ve got to say we’ve drawn a line in the sand,” Wilkinson instructed him and warned him to expect to be asked about why Lehman had been allowed to fail while Bear Stearns was saved. Wilkinson presented it as an opportunity to discuss moral hazard and to make it clear that the U.S. government “is not in the business of bailouts.”

  Paulson himself was doubtful that this was quite the time to be dogmatic and challenged Wilkinson on the point, but the fact was, he was dead tired and could not keep his mind from drifting to AIG.

  As he finished his remarks, the first question came from the press corps, and it was a softball: “Can you talk about what the federal role should be going forward? Are we likely to see any more federal involvement in rescues like you did with Fannie and Freddie and Bear Stearns?�
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  Paulson paused for a moment. “Well, the federal role is obviously very important because, as you’ve heard me say before, nothing is more important right now than the stability of our capital markets, and so I think it’s important that regulators remain very vigilant.”

  “Should we read that as ‘no more’?” the reporter screamed out.

  “Don’t read it as ‘no more,’” Paulson replied, clearing his throat. “Read it as…that I think it’s important for us to maintain the stability and orderliness of our financial system. Moral hazard is something that I don’t take lightly.”

  And then came the anticipated question: “Why did you agree to support the bailout of Bear Stearns but not Lehman?”

  Paulson paused to gather his thoughts carefully. “The situation in March and the situation and the facts around Bear Stearns were very, very different to the situation that we’re looking at here in September, and I never once considered that it was appropriate to put taxpayer money on the line with…in resolving Lehman Brothers.”

  It was an answer that would come back to haunt him. He had parsed his words carefully. Technically, his answer was true, but he knew that if Bank of America or Barclays had decided to buy Lehman he might have used taxpayer money to support a deal, but he wasn’t about to bring that up now.

  As the questions poured in, Paulson grew more and more agitated. “Why is the Federal Reserve giving AIG a bridge loan?” one journalist asked.

  “Let me say what is going on right now in New York has nothing to do with any bridge loan from the government. What’s going on in New York is a private-sector effort again focused on dealing with an important issue that I think is important that the financial system work on right now and there’s not more I can say on that.”