Too Big to Fail

by Andrew Ross Sorkin

  Paulson thought the idea had merit and was buoyed by an op-ed in the Wall Street Journal that morning touting a similar plan by Paul A. Volcker, the former chairman of the Federal Reserve; Nicholas F. Brady, a former U.S. Treasury secretary; and Eugene A. Ludwig, a former U.S. comptroller of the currency.

  “This new governmental body would be able to buy up the troubled paper at fair market values, where possible keeping people in their homes and businesses operating. Like the RTC, this mechanism should have a limited life and be run by nonpartisan professional management,” they wrote. “The pathology of this crisis is that unless you get ahead of it and deal with it from strength, it devours the weakest link in the chain and then moves on to devour the next weakest link.”

  On Thursday morning, Tom Nides, who lived in Washington and commuted every week to New York, woke up early at the Regency Hotel and went to the gym. As he read the New York Times on an elliptical machine, he nearly fell off when he came upon the front-page story, which ran under the headline: “As Fears Grow, Wall St. Titans See Shares Fall.”

  Directly in the middle of the story was a quote, citing two people who had been briefed on merger talks between Morgan Stanley and Citigroup, saying that John Mack had told Vikram Pandit, “We need a merger or we’re not going to make it.”

  Nides couldn’t believe Mack even said that. He had been in the room for one of the calls with Pandit and it didn’t go like that, he thought. Morgan Stanley, Nides knew, could not afford that sort of coverage, whether or not it was true. The more people who knew it, the truer it would become.

  “Did you see this irresponsible piece of shit in the Times?” Nides asked when he got Mack on the phone. Mack, however, only read the Wall Street Journal, the Financial Times, and the New York Post, having canceled his Times subscription in protest after the Sulzberger family pulled its money from Morgan Stanley because one of its asset managers had decided to run a proxy contest against the Times ownership.

  Now Mack had reason to be upset at the Times all over again. And he and his colleagues were furious with Pandit, who they were convinced must have leaked it.

  “You didn’t say this, did you?” Nides asked.

  “No, no,” Mack insisted. “I never said that; I definitely didn’t use those words.”

  Nides knew he needed to challenge the veracity of the quote immediately. He was already getting calls from other news organizations.

  “What fucking kind of reporter are you?” he berated one of the article’s authors, Eric Dash, when he reached him on his cell phone. “You have to rescind the story!”

  Mack, meanwhile, prepared to address his employees for the second time in four days, eager to offer them reassurance, especially after the Times story. He had invited Eugene A. Ludwig, chairman of Promontory Financial Group and one of the authors of the editorial in the previous day’s Wall Street Journal advocating for a RTC-like structure, to join him this morning as his adviser.

  Battling a cold, his glasses slipping down his nose, Mack stood on Morgan Stanley’s main trading floor, his speech piped in to its employees around the world. He spoke in a plain, unscripted manner, his North Carolina accent perhaps more pronounced than usual.

  “You know you’ve seen the cash position, you’ve seen our earnings, ah, all that stuff, unlike what people said about other firms, ah those numbers are real numbers,” he told them. “We’re clean, we’re making money. We made a lot of money the last eight days also. But it doesn’t make any difference. We deal in a market today that financial chicanery, rumor, and innuendo are much more powerful than real results.”

  He related a phone conversation with a “a good friend,” a hedge fund manager who confided his fears about Morgan Stanley. Mack reassured the man, only to receive another call four hours later from the same fund manager about still another market rumor. “My point being, no matter what we say, there’s another rumor that pops up.”

  Mack acknowledged that the firm was examining all its options, while expressing bewilderment at how the industry had been turned upside down.

  “What I find remarkable is not too long ago, two months ago, four months ago, people said the Citibank model was broken—ah, complicated, big, global, unmanageable. And now our model’s broken. Is our model—and I include Goldman Sachs—is our model broken because we are not part of a bank? Is our model broken, because we’ve consistently in the last three quarters delivered good earnings? Is our model broken because we could not have regulators who stepped in and take strong stands? That might be the issue here.

  “I think the issues are: How do you get through chaos? This is chaos. It pains me to go on the floor and see how you guys look.”

  Mack then addressed the most sensitive issue for his employees—the selling of stock. According to SEC regulations, employees could sell only during certain designated periods, such as immediately following an earnings report—which meant at the present.

  “I know this is a window period,” Mack said, “and I know some of you are very scared—well, maybe all of us are very scared. You want to sell stock, sell your stock. I’m not going to look at it and I don’t care. I’m not selling, and there, well, John, you’ve got a lot of it, you don’t have to worry about it…ah, you know, I do have a lot and I do worry about it, but I really care much more about your getting peace of mind. So if you want to sell, sell. Do it.”

  When the time came for questions from the staff, Stephen Roach, Morgan Stanley’s unfailingly bearish economist, asked a pointed question about the shorts: “Short-sellers, John. Many, if not most of them, are clients of the firm. Put yourself in the room with one of these, quote, clients, unquote. What do you say to them?”

  Mack drew a deep breath. “Well, um, I’ve thought long and hard about that, and my gut reaction is that I’m angry and I want to tell them what I think. And I don’t want to do business with you and all that other stuff. Then on my second breath, I say, you know, they have their job to do, that’s what they’re doing. I am not going to get pulled into that kind of discussion.

  “And this is what I wanted to say, I put a note here about being angry. We can be angry, we are angry, we are upset, and we just have to deal with it. We are not here to beat up on clients and tell them how they deserted us and all of that stuff. We’re here to run this firm, work with our clients as best we can. Some don’t want to do business, we’ll deal with that later, let them go. Let’s stay focused on things that are productive. And venting and telling people what you think and calling them all the names you want to call them is not going to help us,” he said, punctuating the point by adding, “I love beating the shit out of people when they screwed us. But I’m not going there. And I don’t want you to go there.”

  The panic at Goldman Sachs could no longer be denied. Perhaps the greatest sign of anxiety was the fact that Gary Cohn, Goldman’s co-president, who usually remained perched in his thirtieth-floor office, had relocated himself to the office of Harvey M. Schwartz, head of global securities division sales, who had a glass wall looking out to the trading floor. The door was left open; he wanted to see and hear exactly what was going on.

  The Federal Reserve, along with the other central banks, had just announced plans to pump $180 billion to stimulate the financial system, but the scheme did not seem to be having any appreciable effect. Goldman’s shares opened down 7.4 percent. CNBC, which was airing on flat-screen TVs hanging from the walls of Goldman’s trading floor, had introduced a new “bug” on the bottom left-hand side of the screen that provocatively asked, “Is Your Money Safe?”

  It was a question that Goldman clients were beginning to ask themselves. The firm’s own CDS spreads had blown out in a way the firm had never seen before, indicating that investors were quickly beginning to believe the unthinkable: that Goldman, too, could falter. In two days, Goldman’s stock had dropped from $133 to $108.

  Every five minutes a salesman would tear into Schwartz’s office with news of another hedge fund announcing its plan to
move its money out of Goldman and would hand Cohn a piece of paper with the hedge fund’s phone number so he could talk some sense into them. With Morgan Stanley slowing down its payouts, some investors were now testing Goldman, asking for $100 million just to see if they could afford to pay. In every case, Cohn would wire the money immediately, concerned that if he didn’t, the client would abandon the firm entirely.

  The good news for Goldman was that withdrawals were only slightly outpacing inflows. To some extent it had been able to capitalize on the distress of others, as hedge funds needed to execute their trades somewhere. When Steve Cohen of SAC Capital transferred several billion over to Goldman, traders began to whoop it up on the floor.

  On the other hand, Stanley Druckenmiller, a George Soros acolyte worth more than $3.5 billion, had taken most of his money out earlier that week, concerned about the firm’s solvency. If word got around that a hedge fund manager of Druckenmiller’s reputation had lost confidence in Goldman, it alone could cause a run. Cohn called him and tried to convince him to return the money to the firm. “I have a long memory,” Cohn, who was taking this personally, told Druckenmiller, for whom he had even hosted a charity cocktail party in Druckenmiller’s honor in his own apartment. “Look, the one thing I’m doing is I’m learning who my friends are and who my enemies are, and I’m making lists.”

  Druckenmiller, however, was unmoved. “I don’t really give a shit; it’s my money,” he shot back. Unlike most hedge funds, Druckenmiller’s did consist primarily of his own money. “It’s my livelihood,” he said. “I’ve got to protect myself and I don’t really give a shit what you have to say.”

  “You can do whatever you want,” Cohn said in carefully measured tones. But, he added, “this will change our relationship for a long time.”

  Half an hour before David Carroll and the Wachovia team were due to arrive at Morgan Stanley, Kindler called down to Scully. Kindler was in his office, peering out his window down at the camera crews camped outside the building.

  “Why are we having him meet us here, of all places?” Kindler asked. “There’s reporters outside.”

  “Don’t worry. It’ll be fine,” Scully, who took the precaution of sneaking Carroll in via the employee entrance on Forty-eighth Street, assured him.

  Kindler’s sole objective was to get his hands on Wachovia’s mortgage book so that he could crack the tape—Wall Street–speak for examining the mortgages individually. That was the only way he could really understand Wachovia’s real value. This was no small undertaking: The tape contained $125 billion of loans, including all manner of bespoke adjustable rates, like “pick a pay,” which gave borrowers a variety of choices each month on how—and even how much—to pay. Among the options was a payment that covered only the interest on the loan.

  Morgan Stanley also insisted on seeing Wachovia’s business plan, but Carroll balked at that request. “Our general counsel says it’s a real problem,” he said.

  Kindler, convinced that Wachovia was trying to hide something, called Morgan’s general counsel, Gary Lynch, in a rage and told him to put the screws to his counterpart at Wachovia, Jane Sherburne.

  “It’s a big legal issue,” she explained. “We can’t give over the data without disclosing it in the merger agreement if we do the deal.”

  Lynch, too, was starting to suspect a problem. Were Wachovia’s numbers worse than anyone knew? he wondered to himself. “Well, we can’t do the deal without seeing the data,” he told her.

  Sherburne relented.

  Lloyd Blankfein, his top shirt button undone and tie slightly askew, looked at his computer screen and saw in dismay that his stock price had dropped 22 percent to $89.29. Blankfein, who up until now had resisted pushing back against short-sellers, was becoming convinced that the pressure his stock was under was not an accident. He had just ended a call with Christopher Cox in which he had told the SEC chairman, “This is getting to be intentional. You know, you may need to do something here.”

  In his e-mail in-box was another message from one of his traders saying that JP Morgan was trying to steal his hedge fund clients by telling everyone that Goldman was going under. It was becoming a vicious circle.

  Blankfein had been hearing these rumors for the past twenty-four hours, but he had finally had enough. He was furious. The rumormongering, he felt, had gotten out of control. And he couldn’t believe JP Morgan was trashing his firm to his own clients. He could feel himself becoming as anxious as Mack had sounded when they spoke the day before.

  He called Dimon. “We’ve got to talk,” Blankfein began as he tried to calmly explain his problem. “I’m not saying you’re doing it, but there are a lot of footprints here.”

  “Well, people may be doing something that I don’t know about,” Dimon replied. “But they know what I’ve said, which is that we’re not going after our competitors in the middle of all this.”

  Blankfein, however, wasn’t buying his explanation. “But, Jamie, if they’re still doing it, you can’t be telling them not to!” Trying to get his point across, Blankfein, a movie buff, started doing his own rendition of A Few Good Men: “Did you order the Code Red? Did you say your guys would never do anything?” Dimon just listened patiently, eager not to get Blankfein even more wound up.

  “Jamie, the point is, I don’t think you’re telling them to do this, but if you wanted to stop them in your organization, you could scare them into not doing it,” Blankfein said.

  Even in its panicked state, Goldman was still Goldman, and Dimon didn’t want a war. Within half an hour he had Steve Black and Bill Winters, co–chief executives of JP Morgan’s investment bank, send out a companywide e-mail:

  We do not want anyone at JP Morgan capitalizing on the irrational behavior that’s going on in the market toward some of the U.S. broker-dealers. We are operating as business as usual with Morgan Stanley and Goldman Sachs as counterparties. While they are both formidable competitors, during this period, we do not want anyone approaching their clients or employees in a predatory way. We want to do everything possible to remain supportive of their business and not do anything that would impact them negatively.

  We do not believe anyone has engaged in any inappropriate behavior, but we want to underscore how important it is to be constructive during this time. What is happening to the broker-dealer model is not rational, and not good for JP Morgan, the global financial system or the country.

  Around midday, Hank Paulson reviewed the latest term sheet that his staff had drafted overnight on the issue of dealing with toxic assets, hoping it would be acceptable to present to Congress. His inner circle had assembled in his office, pulling up chairs around a corner sofa.

  “It looks much better,” he said, turning the pages. “It’s very simple.” He paused and scanned the bleary-eyed faces in the room. “I want to reiterate that we have to get this up to the Hill quickly,” he said. “We need to keep this simple, very simple. And we have to do it in a way that we encourage, ah, banks and financial institutions to want to participate. We don’t want to have punitive measures with this. This is about recapitalizing our banks and financial institutions setting a price for assets.”

  There was just one more issue to deal with, perhaps the most important of all: the price tag.

  While the toxic-asset program made sense in theory, for it actually to work, for it to be effective, Paulson knew they’d need to buy large swaths of toxic securities from the nation’s largest banks. The cost was going to be enormous, and it would be perceived, both within and outside of the Washington Beltway, as another bailout.

  Paulson looked to Kashkari, who sat on the sofa to his left, for guidance.

  The key concern at that moment was whether spending so much money would require them to have to ask Congress to increase the debt ceiling—a political flashpoint that would require Congress to vote to raise the amount of debt the country could take on. It had just increased that amount to $10.615 trillion in July.

  As the group discussed t
he outlines of the proposed legislation, Kashkari’s view was that they ought to try to skirt the issue entirely. “I don’t know if that’s workable, not having a reference to the debt ceiling. Or why don’t we just say it’s not subject to a debt ceiling?”

  “You can’t do that,” Paulson pointed out and then added, “I don’t want to go for the debt ceiling and fail. That’s the issue, and then people start focusing on it.”

  “I did the analysis,” Phillip Swagel offered, reading from his notes. He had determined that they would need only $500 billion, but only if the situation didn’t grow any worse.

  To Paulson, who thought of himself as fiscally conservative, the answer was obvious. “Okay, so I think the responsible thing is to go for the debt ceiling,” he said, instructing Kevin I. Fromer, assistant secretary for legislative affairs, whose job it was to work the Hill, to construct some new language.

  “You can go after it but you don’t have to put it in this document,” Fromer replied, resisting Paulson’s request. “We never go up and propose legislation to do the debt ceiling. We just simply arrive at the fact that we have to do it and literally tell Congress they have to do it. They do it because they’re too scared not to do it. It’s just a question of optics.”