“Too Big to Fail” by Andrew Ross Sorkin Essay (Book Review)

Introduction

In Too Big to Fail, Andrew Ross Sorkin gives a minute-by-minute account of the boardroom events surrounding the 2007-2008 economic recession in a chain of dramatic scenes. The book illustrates how a series of poor decisions plunged investment banks into a credit crunch, necessitating their bailout, conversion into bank holding firms, or sale. Sorkin relies on interviews of several top executives who had a hand in the financial crisis as well as on the accounts of regulators involved in developing rescue plans for the troubled banks. The central thesis of the text is that the downturn was precipitated by uncontrolled liquidity, “cheap money”, and “ultra-interconnectedness” among players in the American financial sector.¹ This paper gives summaries of the book’s twenty chapters, highlighting the central issues related to the crisis, investment banks, organizations, regulators, and individuals involved, and subsequent plans that stabilized the markets.

Chapter 1

Sorkin starts by giving a profile of Lehman Brothers, one of the Big Five Wall Street firms at the center of the financial crisis in 2008. It all starts in 2007 when mortgage firms receive big profits due to rewarding innovations and policies in the real-estate sector. Consequently, financial executives relying on optimism-driven speculation reward themselves with hefty pay-outs and bonuses amounting to $50 billion.² The flawed financial model they are using leads to an exaggerated debt-to-equity ratio of 32 to 1.³ As a result, the credit risk rises to levels that are higher than usual, precipitating a major economic crisis in America, Europe, and Asia.

Specific scenes unfold with Richard Fuld, Lehman’s CEO, defending the company’s financial models and decisions on March 17, 2008. They include the opening of the “Fed’s discount window” that gave the firm access to “cheap rates” reserved for major commercial banks.⁴ Lehman’s stocks are not performing well, having fallen by 14.6% the previous week, while those of Bear Stearns, an investment bank, are sold at a rate of $30 per share.⁵ The plummeting stocks highlight the risks related to cheap loans and uncontrolled borrowing. Later, Stearns’ earnings manipulations are uncovered, necessitating a federal bailout to cushion its shareholders from losses that would affect investor confidence.

Next, Fuld’s early career, beginning as an intern at Lehman Brothers before rising to his current position, is described. His mentor is Lewis Glucksman, a career stocks trader. Sorkin delves into the “class warfare on Wall Street” with Glucksman promoting the idea that investment bankers are higher in the pecking order than traders.⁶ Later, Fuld ascends to Lehman’s top leadership (CEO) after American Express, a brokerage division of the firm, is sold for $360 million.⁷ His associate, Joe Gregory, chooses Erin Callan as Lehman’s CFO. Callan’s conference call that is held on March 18^th is a success, as Goldman Sachs’ manipulated reports indicate that Lehman’s profit earnings are $1.5 billion. However, skeptics, like Euro Pacific Capital’s president Peter Schiff, maintain that the numbers are erroneous.

Chapter 2

The events of Easter Sunday of March 23, 2008, are well revealed. Henry Paulson, the Treasury Secretary, who brokered Stearn’s bailout deal, discovers that Jamie Dimon, the CEO of JP Morgan, has raised the original small $2 share value agreed for Stearns to $10 to appease shareholders and the market.⁸ Paulson previously served as Goldman Sach’s CEO. He anticipates that Dimon would increase the price but not by as much as $8. Paulson and the Bush administration are also facing criticism in Washington for the bailout that becomes politicized.

The chapter delves into Paulson’s unusual background and character. He had previously rejected an offer to work as the Treasury secretary before accepting the job on May 21, 2008. He would later serve as the CEO of Goldman Sachs, a position he rose to in 1998.⁹ At this rank, he manages to forge business relationships with Chinese executives, a feat unmatched even by the secretary of state. Another previously held position by Paulson is the Defense Department official, and therefore, he had a good understanding of the inside operations in Washington. Nevertheless, he is not a Republican hardliner but a hard-core environmentalist.

Paulson’s perspective on Lehman and association with Fuld is also made clear in this chapter. Although Erin Callan’s conference call appears to bring stability to the troubled markets, Paulson understands that Lehman is insolvent and needs a bailout as Bear Stearns did.¹⁰ He is concerned about the firm’s valuation of its assets and failure to “raise any capital”.¹¹ Paulson feels that Fuld is reluctant to do so because it would dilute the investment bank’s stocks. The two team up and try to convince Warren Buffett to invest in Lehman, but after some due diligence, including examining the firm’s 2007 financial report, he refuses. As a result, the firm continues to struggle with its liquidity problem.

Chapter 3

On April the 2nd, the head of the New York Fed honors the Senate Banking Committee to discuss Bear Stearns’ collapse and the precedent-setting bailout.¹² Timothy Geithner is the one who secures the deal that rescues Stearns from insolvency and is called to clarify his rescue decisions. There is a lot at stake, the mortgage market and financial system are at risk of collapsing if no federal intervention is made. Geithner has an uphill task of convincing the Committee members Bearn’s deal is favorable to the government and the economy.

Geithner’s background is described in the subsequent section. After graduating with a master’s degree, Geithner joins Henry Kissinger’s consulting firm before entering the Treasury attached to the American embassy in Tokyo.¹³ He is the one who crafts the US response to the crushing of the economies of Japan and South Korea. He later works for the International Monetary Fund before leaving for the New York Fed as its president.

Paulson’s deputy, Robert Steel, is the first to give his testimony about Bear’s deal to the Senate Committee hearing dubbed the Murder Board along with Geithner and others. He anticipates the question about why Bear’s stocks were rated so low, at $2 per share. Throughout the session, Committee members are critical of the New York Fed’s role in Bear’s rescue, as it would set a precedent for other companies to engage in risky gambles.¹⁴ However, Steel explains that the bailout is justified considering that the country’s economy is at stake. Dimon’s professional life under the mentorship of Sandy Weill is described. Later, their once-close relationship would increasingly grow sour. JP Morgan plays the role of conduit for the $30 billion rescues of Bear after Dimon, its CEO, sanctions the decision.

Chapter 4

Paulson, the Treasury Secretary, invites Fuld, Lehman’s CEO, to a post-G7 banquet. Influential policymakers, financial executives, and international bankers like Jean-Claude Trichet are among the invited.¹⁵ Going to the private dinner, Fuld is hopeful that Lehman’s expected $4 billion capital raise would bring stability to the market and end the crisis. The speakers at the meeting expressed their worries about the state of the US economy and the ramifications of the crisis in other countries. Jean-Claude states that there is a need to develop standard “requirements for capital ratios, leverage, and liquidity rates”.¹⁶ The Bank of England’s head, Mr. King, criticizes the Wall Street CEOs’ actions and decisions that precipitated the crisis.

At Paulson’s request, two Treasury consultants, Kashkari and Swagel present a confidential memo to Bernanke, the Federal Reserve’s chairman. Their plan outlines what should be done to avert a “total financial meltdown”.¹⁷ Bernanke’s background as a college professor examining the issues around the 1930s Great Depression makes him the best fit for his current job. He holds that the Fed’s decision to tighten money supply stifled economic activity, projecting an image of an independent chairman.

As the markets begin to crumble, the Fed, with Bernanke as its chairman, assures investors that all is well by providing liquidity to enable financial institutions to offer loans and restore normalcy. Later, Steel reaches out to Barclays Capital’s CEO to find out if his company could consider acquiring Lehman. Bob Diamond indicates his interest, as well as that of the board, in purchasing the investment banking franchise to transform Barclays into a significant player in this sector in New York.

Chapter 5

Lehman’s CEO and CFO hold a meeting with CNBC’s Jim Cramer to convince him to portray the firm as being “liquid” in order to boost its stock price. In attendance is Gerald Donini, the global equities CEO. Fuld reveals to Cramer that he wishes to improve the company’s leverage and investors’ confidence. He feels that Lehman is undervalued despite a capital raise of $4 billion.¹⁸ Cramer appears receptive to Fuld’s sentiments and attributes the low performance of the franchise’s stocks to the abolition of the uptick rule, driving down the stock prices. He is critical of this move, as it encourages short-selling of falling stocks. To Cramer, the short-sellers are wrecking Wall Street companies.

The 1938 uptick rule is meant to deter short selling. Investors often sell falling stock before its prices begin to fall. The law is intended to avoid a drastic drop in stock prices, which would create a crisis. However, the SEC later abolished the regulation in a bid to align itself with free-market principles. In Cramer’s view, without the uptick rule, hedge funds would take advantage and lower the value of shares of performing firms. Investors would jump in and sell the stocks before their prices begin to drop drastically.

Cramer feels that Lehman’s financial statements are not accurate. He informs Fuld that although the firm reports indicate good performance, it is in dire need of cash. However, Fuld states that the company’s liquidity is high. Cramer is skeptical. He wonders why the capital could not lead to higher share prices.¹⁹ The meeting ends with Fuld assuring Cramer that the financial statements reflect Lehman’s true liquidity status.

In mid-May, David Einhorn is preparing to speak to investors attending an investment conference. The hedge fund manager contends that Lehman’s assets are overvalued. He later initiates a research project to investigate financial firms exposed to securitized debts in a bid to understand how the crisis began.²⁰ He identifies twenty-five companies, including Lehman, which have manipulated their quarterly earnings. He suspects dubious accounting to keep the stock prices high. Lehman reaches out to Einhorn to address its concerns. However, the firm’s evaluation of illiquid assets, at a rate higher than what they bought them, makes him conclude that the franchise is exaggerating its figures. In his speech, he notes that Lehman is overvaluing its level 3 assets.

Chapter 6

The chapter begins with the leaking of Fuld’s secret proposal to investors from South Korea to raise capital, on June the 3rd, to the public. He negotiates with the Korean Development Bank (KDB) through its executive in Seoul to have the institution inject over $4 billion into Lehman to keep it afloat.²¹ Einhorn’s speech one month earlier causes the firm’s stocks to drop by 22.6%. The revelation further dents Lehman’s public image, it marks the company as being desperate for liquidity. It is also rumored that the firm exploited the Fed’s discount window to address its cash flow issues. Although these claims are false, they cause Lehman’s stocks to fall by an additional 15%.

Scott Friedman, one of Fuld’s right-hand men believed to be the leaker, indicts Callan for leaking the information about the Korean investment. He believes that her unilateral decision to talk to Einhorn was the cause of the current predicament. Further, phone records indicate that Callan spoke with Einhorn days before his conference speech.²² Nevertheless, Fuld is still optimistic that the deal with the KDB would sail through. In a few days, Lehman is set to announce its first loss of $2.8bn and its stocks have dropped by 18% (at $25) in three days.²³ He leaves for Korea to negotiate a deal, but the Koreans refuse to give a loan for raising the share price to $35-40.

Matthew Lee, a financial executive at Lehman, criticizes Repo 105, an accounting method previously used in the firm. This bookkeeping trick allowed the company to sell its securities to pay debts days to the announcement of its quarterly earnings before repurchasing them later.²⁴ There is rising dissatisfaction with Gregory due to some terrible personnel and financial decisions he made. Later, on June the 9th, Lehman announces a $2.8bn loss.²⁵ After a series of meetings, Gregory and Callan are compelled to resign.

Chapter 7

Merrill Lynch’s president, Greg Fleming, learns from Larry Fink’s (Blackrock CEO) of John Thain’s decision to sell the company. Fleming seems to be unaware of this new development. Merrill, like Lehman, is facing a liquidity crisis of its own. Thain (the CEO) had previously considered selling Blackrock, Lehman’s most solid franchise.²⁶ He now reveals to investors that Merrill’s valuation of its assets is a bit conservative and, as such, the company needs more capital. Due to the revelation, the firm’s stocks drop by 32%.

Thain’s background is given in the next section. He leaves Goldman Sachs for Merrill to restore investors’ confidence after the company announces its first-ever loss, replacing Stan O’Neil, its former CEO. He later joins the NYSE where he introduces radical policies that turn around the exchange to a profitable entity. His decision to sell Blackrock is a swift response to Merrill being described as “the most vulnerable brokerage firm after Lehman”.²⁷ The sale would lead to capital efficiency for Merrill.

Frustrated at Goldman by Paulson, Thain readily agrees to join Merrill. He quickly moves to boost its capital base by raising $12.8bn from the Singaporean investor, Temasek Holdings.²⁸ He also introduces some austerity measures. He sells the firm’s G4 planes and substitutes costly cut flowers with silk ones.²⁹ Thain also begins investing in talent development at Merrill and staff morale. He first meets with O’Neil and later Michael Bloomberg, a partner in a firm that is financed by Merrill, in a bid to understand the genesis of the current liquidity crisis. They reach an agreement to sell Blackrock.

Chapter 8

In June, the American International Group (AIG) gets a new chief executive officer. Bob Willumstrad takes the insurer’s leadership, replacing Martin Sullivan. AIG also faces a credit crisis at the time. Willumstrad starts his career as an executive in Chemical Bank before moving to Commercial Credit where he oversees a series of mergers and acquisitions.³⁰ AIG’s former CEO, Maurice Raymond, is “the very model of an imperial CEO,” he expands the insurer to 130 countries in Asia, Europe, and other regions, turning it into a leading global financial institution with diversified business interests.³¹ However, in the process, he comes into conflict with federal regulators.

As a result, AIG is the subject of thirteen-month probation for accounting malpractices that would bring down the insurer. Its financial products (FP) become “Ground Zero” for coming up with “credit derivatives, collateralized debt obligations (CDOs), and credit default swaps” that implode to produce the crisis.³² The CDOs are created from accumulated debts based on their “credit ratings and yields”.³³ Willumstrad battles the FP problem upon joining AIG and the pressure from JP Morgan to disclose its assets and valuations in spite of the confidence of the quants in AIG’s operations.

Chapter 9

Goldman’s board convenes in Russia to deliberate the prospect of acquiring AIG. Lloyd Blankfein, the company’s financier, is upbeat about the meeting in June 2008. Despite Goldman having some bad assets, it was “highly leveraged” and had avoided securities built purely on mortgages.³⁴ In his speech at the meeting, he highlights the company’s financial performance. It was Tim O’Neill, Goldman’s strategy officer, who stressed the firm’s survival plans in case it was affected by the crisis. The company had no stable deposits but depended on risky short-term agreements like Lehman and Bear.

Blankfein’s background as soft drinks seller before joining a law firm after his graduation is described. In 1981, he enters Goldman when Winkelman hires him to be in charge of the sales personnel. He would later ascend to become the company’s president, replacing Paulson. After considering some questions for Goldman, including converting into a commercial bank, the board mulls over acquiring AIG. Later, an informal meeting between the board and Paulson occurs, during which he reveals that tough times lie ahead for the company.

Chapter 10

Fuld reappoints Michael Gelband to turn around Lehman’s prospects. Paulson retreats to his island off the Georgian coast to unwind after being convinced that the European trip was successful.³⁵ However, he is still preoccupied with the lack of investors willing to invest in Lehman and the possibility of Bob Steel exiting the firm. Another looming crisis touches on “Fannie Mae and Freddie Mac – government-sponsored enterprises (GSEs)” that are the actual drivers of real estate growth.³⁶ The financial markets are in a downturn, as Freddie loses 17.9% of its value, while Fannie sheds 16.2%.³⁷ Paulson is overwhelmed with what was happening.

Lehman’s shares drop significantly to 12%. Fuld reaches out to John Mack of Morgan Stanley for a deal. Meanwhile, the GSE stocks collapse following leaked information about a possible federal takeover.³⁸ Fuld mulls over converting Lehman into a bank or exploring the possibility of a merger with the Bank of America. On his part, Paulson is irritated by a suggestion to establish a temporary emergency authority at the height of the crisis. On July the 13th, he reveals Treasury’s decision to buy equity in the two GSEs. However, Paulson faces sharp criticism from lawmakers, including Senator Bunning who accuses him of suggesting “socialism in the US”.³⁹ Meanwhile, Ken Wilson decides to exit Goldman for Treasury upon Paulson’s request. It also turns out that the Bank of America is not keen on investing in Lehman.

Chapter 11

In late June, Willumstad could sense Geithner’s readiness to extend credit to the struggling AIG. However, he discovers that AIG’s problem has nothing to do with capital but inadequate liquidity. Willumstad assures himself that AIG’s interconnectedness with the Wall Street firms – it had issued insurance policies running into billions to brokerage companies – meant that the market relied on its financial health.⁴⁰ Fuld visits Hong Kong to meet with the KDB executives over an investment deal, while Paulson appoints Morgan Stanley as a federal advisor on the GSEs. However, Fuld’s involvement spoils the talks on the KDB deal and agreement.

In the Treasury, Fuld’s associate, Shafran, is tasked with the role of developing a contingency plan for Lehman. He gains the attention of the Fed and SEC on the Lehman problem and identifies the firm’s critical risks among them its repo book and liquidity issues.⁴¹ In August, a symposium held at Jackson Hole discusses Fannie and Freddie and policy options out of the crisis. Meanwhile, Paulson schemes a buyout for the two GSEs, while AIG reveals its troubles to JP Morgan. On September the 5^th, the Treasury issues mandatory terms to the GSEs. Fuld also reaches out to Ken Wilson over the Lehman liquidity problem.

Chapter 12

Lehman’s stocks plummet after KDB withdraws its bid to purchase it and the news reaches the public domain, ending the summer-long talks. Its president, McDade, worries about Fuld’s health and emotional state following the newsflash. CNBC’s headlines question whether Lehman will be able to overcome the crisis in time before releasing its quarterly earnings. All indications are that the firm will declare a loss. Fuld and McDade agree to preannounce Lehman’s earnings on Thursday, a day earlier than scheduled. Paulson is criticized in Congress. He holds a meeting with his advisors, Dimon, and JP Morgan’s executives to strategize how to influence tighter federal controls for Wall Street firms.

Willumstrad meets Geithner at the Fed offices. He requests Treasury to anoint AIG a “primary dealer” to allow it access to the “emergency provision” that was put in place after Bear’s sale.⁴² In this way, AIG would be eligible for low-interest loans available to federal agencies. Meanwhile, Goldman reaches out to Treasury and offers to “help on Lehman”.⁴³ Dimon calls on Bernanke and expresses his worry over Lehman. He hails the decision to nationalize the GSEs but reckons that the strategy has not averted the market crisis. At Lehman’s, Fuld is in a dilemma; he is under pressure to call the Bank of America for a deal. A series of attempts are made to save Lehman from the impending bankruptcy, which was causing a lot of fear on Wall Street.

Chapter 13

On September the 10^th, the papers carry reports of Lehman’s imminent collapse. Its partners, including the London-based GLG and investors, are all nervous. In a meeting that involved Lehman investors, it is revealed that SpinCo bank was a bad investment and had made the company slide into more debt.⁴⁴ Merrill’s president learns that Lehman had pre-released its results with a $3.9bn loss and knows that the firm is desperate for a deal. He discerns that the Bank of America may offer to buy Lehman, leaving out Merrill. In Lehman’s meeting, its CFO reveals that the firm would sell its stake of 55% in nonperforming investments in real estate and adopt a new valuation method for its troubled assets.⁴⁵ However, it becomes apparent that these strategies would require funding.

Einhorn, Shafran, and the staff at the New York Fed and Barclays are listening to Lehman’s earnings with disbelief. It becomes clear that the troubled assets were less worth than stated by the company. A German bank’s analyst claims during the conference call that capitalizing on Lehman would require $7bn. A short while later, Barclays indicates its interest in buying Lehman. However, Moody’s Investors Service announces plans to reconsider the firm’s credit rating, raising new concerns after the company’s stocks appear to stabilize. Another problem emerges when the Bank of America calls for a relaxation of its capital ratio before it would consider the Lehman case. After a series of last-minute meetings and calls, it soon becomes clear that due to the criticism of the Fannie and Freddie bailout, Lehman’s rescue is off the table.

Chapter 14

At a volunteer conference, Blankfein receives an urgent call to attend a crisis meeting with the Feds along with all bank CEOs. Other Treasury executives, including Paulson, Geithner, Dimon, and John Mack, were expected to be there. Bank of America informs Paulson that it would consider purchasing Lehman if the government shoulders bared “$40bn of the losses on its assets”.⁴⁶ During the meeting, it becomes apparent that Lehman is in a precarious situation and an urgent solution is needed before the following Monday. If the company files for bankruptcy, many financial institutions that did business with it will suffer. Congress has no political will to save Lehman.

Upon leaving the meeting, John Mack notifies his colleagues at Morgan Stanley of Lehman’s imminent collapse. They begin to review their trading activities with the franchise for “self-preservation and helping the Fed”.⁴⁷ Thain and his colleagues also consider the options for Merrill as it was seen as the next line. Fuld becomes isolated, as a team from Lehman is invited to the Fed the next day. Meanwhile, Warren Buffet rejects AIG’s buyout proposal of $25bn. After leaving the meeting, Dimon briefs his management team on the possibility of Lehman, Merrill, AIG, and Morgan Stanley all filing for bankruptcy.⁴⁸ Merrill’s president, Fleming, tries to persuade Thain to rescue his company.

At the Fed’s meeting, it becomes clear that Lehman had underreported the value of its assets by about 15%. The Bank of America decides to discontinue further engagement with Lehman for any deal. After a series of meetings involving the CEOs, lawyers, bankers, and the Fed, the Bank of America agrees to pay $30 per share for Merrill. However, to Fleming, the deal was too good to be true.

Chapter 15

Despite the U.S. investment banks expressing a desire to finance Barclay’s buyout of Lehman, the deal fails to sail through due to regulatory constraints. Additionally, there is pressure to bring local players together for a fundraising effort to raise $33bn – given the systemic risk related to the crisis – to facilitate the proposal. In spite of the significant progress made, Britain’s Financial Services Authority (FSA) opposes the plan with its president, McCarthy, terming Geithner as incredulous.⁴⁹ It is not clear to McCarthy if Barclay’s Diamond has informed U.S. authorities about FSA’s requirements and preconditions for a buyout of Lehman to limit the risk to the British economy.

A scared Paulson is comforted by his wife’s recitation of Bible verses. He is concerned about the possible collapse of the entire financial system. Diamond, Paulson, and Fuld are shocked to find out that the British FSA had suspended Barclay’s offer to buy Lehman. Frustrated Fuld calls the Fed’s Mack for a solution but receives no help. Meanwhile, Merrill and Bank of America are close to a deal. The executives develop an agreement that makes the Bank of America acquired Merrill for $29 per share.⁵⁰ Pushed to the wall, Fuld is forced to file for bankruptcy. Subsequently, local banks raise $100bn “borrowing facility” to see them through the crisis.⁵¹ President George Bush refuses to call his relative, Walker, the chairman of the investment management unit at Lehman.⁵² Fuld faults the Fed for the firm’s liquidity crisis.

Chapter 16

The news of Lehman filing for bankruptcy spread fast. Paulson blames politicians opposed to a bailout and the British government for the collapse and predicts “further pressure on the financial system”.⁵³ He assures President Bush that the Fed has a plan to sustain a functional broker-dealer process that will ensure sufficient trading with other banks.⁵⁴ Meanwhile, Bank of America completes its purchase of Merrill and now the focus turns to AIG. Paulson notes that Geithner and the Fed have private capitalization plans for AIG involving financial players. However, the move to find a private-market solution for the firm does not yield much.

At Geithner’s initiative, a Fed solution is explored. A bailout proposal by Treasury is suggested that includes an $85bn loan in exchange for a 79.9% ownership stake and strict repayment terms.⁵⁵ The goal is to ensure that stakeholders do not benefit from the deal. AIG is required to repay the loan at a high rate of 11.5% and use all its assets as collateral. At the same time, Geithner tells the firm not to file for bankruptcy and brings in a new CEO, Ed Liddy, to replace Willumstrad. At a board meeting, the members vote in favor of the Fed proposal.

AIG becomes the target of stringent measures to mitigate the crisis. It turns to be “a linchpin of the global financial system” in a bid to avoid a global credit crunch.⁵⁶ In Europe, banks are compelled to fulfill capital requirements through credit default swaps contracts with AIG’s FP to give them more leverage.⁵⁷ Willumstrad is instructed to dismiss nine AIG executives for their ineptness before leaving the office.

Chapter 17

Geithner jogs along the East River in an attempt to clear his mind after a busy week. He hopes that the $85bn AIG bailout would be sufficient to avert the crisis. He reflects on ordinary ferry workers who are so preoccupied with their tasks to worry about big numbers like him. Morgan Stanley is still standing. Its quarterly profits stood at $1.43bn, down by only 3% from the previous year.⁵⁸ However, the firm is facing a new problem. Over $20bn of its $178bn available for lending to hedge fund operators had been withdrawn over the past day.⁵⁹ This setback is a source of worry for Morgan Stanley’s executives.

Lehman’s collapse induces panic as people appeal for redemptions. It is clear that the financial market needs shoring up to boost investor confidence. Paulson learns that Morgan Stanley is also experiencing a problem with hedge fund operators demanding redemptions.⁶⁰ To avert a crisis, merger talks with Wachovia begin. Meanwhile, Barclay’s buys Lehman’s American operations for $1.75 without laying off its current staff.⁶¹ The British firm gets a part of Lehman it was interested in without having to buy the entire company.

As the credit crunch continues to bite, Treasury reexamines its contingency plan. Paulson convenes a meeting with his staff to explore options for ending the crisis. He suggests invoking the 1934 Gold Reserve Act to access $50bn, which could help bring stability to the markets.⁶² He seeks to get presidential approval without involving Congress. Paulson receives a waiver from the White House to handle Goldman’s case. The panic begins after a rumor that Morgan Stanley’s $200bn at AIG is at risk, triggering a clamor for redemptions. As the crisis deepens, Paulson and Geithner call on Bernanke to support a one-off solution. With a lot at stake, the China Investment Corporation (CIC) is sought for a deal to keep Morgan Heritage from filing for bankruptcy.

Chapter 18

On September the 19^th, Paulson notifies the press about an initiative called the Troubled Asset Relief Program, or TARP, which is being used to resolve the liquidity problem. TARP entails several guarantees and acquisitions of illiquid assets that are troubling the financial system.⁶³ During the presser, Paulson also reveals a plan to guarantee “all money market funds” in the US over the next year to avoid capital flight.⁶⁴ He expresses his confidence in the plan as a way of preventing further failures and stopping the credit crisis, a ban on short-sellers is also imposed. As a result of the two approaches, the market appears to stabilize gaining about 300 points.

In spite of the government’s illiquid asset program, Morgan Stanley is still exploring options to avoid going the Lehman’s way. Blankfein proposes to Mack a bank holding company deal. By converting to a bank, Morgan Stanley would be under the Fed, enjoy a discount window, and conveniently raise capital.⁶⁵ Its deal with Wachovia is not yet finalized owing to some tough merger conditions. Morgan Stanley is required to secure $20bn of the $24bn equity needed to finance the new organization.⁶⁶ However, due to the crisis, raising this amount is virtually impossible.

Geithner works hard to rescue Morgan Stanley and Goldman from imminent collapse. He considers private investors who might be interested in Goldman like Warren Buffet and the Wachovia proposal. On the other hand, Morgan Stanley receives a credit line offer of $50bn and a capital investment of $5bn from CIC, which Mack considers too low.⁶⁷ Meanwhile, Lehman’s sale ends up in court to determine the fate of its employees. Geithner considers merger options for Morgan Stanley and Goldman Sachs. Citigroup rejects the proposal to merge with Goldman, taking Geithner to the drawing board.

With the CIC still maintaining its initial low offer, Morgan Stanley turns to Mitsubishi to explore a bank holding concept. Geithner’s efforts pay off on September 21, when the government awards Morgan Stanley a bank holding position, in spite of the CIC’s interest.⁶⁸ Additionally, Mitsubishi capitalizes on Goldman to the tune of $9bn and transforming it into a bank too. In essence, the two financial institutions effectively abandon their business models to avoid imminent collapse.

Chapter 19

Goldfein reflects on the problems that occurred in the big five investment banks, only Morgan Stanley and Goldman survive the crisis. However, while the latter’s shares decline by about 7% on September 22, the former’s stocks remain relatively stable. It appears that investors are still wary, wondering if Goldman (now a bank holding entity) has adequate capital.⁶⁹ Paulson’s TARP plan is still treated with caution. Consequently, renewed efforts start to convince Warren Buffet to invest in Goldman.

A deal that entails selling Buffet’s $5bn worth of privileged shares or paying him an equivalent of $500 million privileged shares or paying him an equivalent to secure the investment and restore market confidence.⁷⁰ Buffet readily agrees to this proposal. On the following day, Goldman trades a further $5bn shares due to renewed investor confidence, and the value of its stock increases by over 6%. Paulson is yet to have his TARP plan gain Congressional approval. John McCain, the Republican presidential candidate, suspends his campaigns and proceeds to Washington to help develop an alternative rescue plan.⁷¹ The Republicans accuse Paulson of presenting an inadequate plan, arguing that Treasury has no capacity to buy illiquid assets in time to improve the liquidity of the financial system.

As the crisis in the financial markets continues to deepen, legislators and the two leading presidential contenders, Obama and McCain, and their advisors assemble to deliberate federal bailout plans. The Republicans reject the TARP in its totality, and no compromise is reached, as a result, the meeting ends prematurely. The Federal Deposit Insurance Corporation (FDIC), a regulator, auctions WaMu – a savings and credit entity – to Dimon’s JP Morgan.⁷² The FDIC also takes over Washington Mutual, a bank worth $300bn in assets.

The federal rescue talks resume to come up with an agreeable solution for the crisis. Paulson, citing Washington Mutual’s seizure by the FDIC, stresses the fact that many firms are experiencing liquidity problems and needed help. However, the Republicans are concerned about the oversight of the TARP, bank compensation limits, and the modality of releasing the funds.⁷³ The long impasse is finally resolved when the parties agree to block “new golden parachutes” to resolve the TARP legislation issue.⁷⁴ Steel and Geithner pursue investors for Wachovia to avert FDIC’s takeover of the entity.

Congressional rejection of the bailout plan triggers frantic selling of stocks with the Dow Jones dropping by 7%.⁷⁵ An amended bill that included tax breaks passes the following day and is signed into law, stabilizing the stock prices. However, in Wall Street, investors still consider TARP ineffectual, wondering if Treasury would buy the mortgages at the market rate. It is agreed that the government will make direct investments in the troubled banks. Mitsubishi comes to the rescue of Morgan Stanley by agreeing to a deal of $9bn.

Chapter 20

On October 13, Paulson convenes a meeting at his office. In attendance are Geithner, nine Wall Street CEOs, and heads of regulators. The aim is to compel the executives to take the TARP funds in exchange for preferred stock.⁷⁶ Paulson reveals to the CEOs that the proposed plan had two components: “bank liability guarantee and capital purchase”, both of which they must accept.⁷⁷ He describes how the TARP will work – the funds, ranging from $10bn to $25bn, will be invested in the nine banks, which will then be used to cover weaker financial institutions.

The real purpose of the summons soon becomes apparent to the bankers. The FDIC learns that it is also undercapitalized and needs some protection. A key concern among the CEOs is whether the government could alter the compensation plans along the way. The Treasury assures them that it will propose regulations to deter a unilateral change of the program.⁷⁸ However, he indicates that the regulator may not shield them from a Congressional change of the TARP legislation. In their minds, the CEOs felt that the compensation issue is akin to socialism. Bernanke implores the bankers to accept the deal for the sake of the economy and “the collective good”.⁷⁹ The CEOs eventually agree to sign the document.

Some of the bankers request to seek the board’s approval before signing the deal. Dimon decides to convene a board meeting via phone while being at the Treasury.⁸⁰ The other CEOs also try to consult their respective boards. Morgan Stanley’s Mack notifies one of his bosses that he has accepted the $10bn TARP funds. Later, all the nine CEOs sign their document to take the TARP money under the conditions laid down by Paulson.

Conclusion

In less than a year, the financial operations of Wall Street and the world almost come to a standstill. The “Big Five” investment banks collapse, are purchased, or change into bank-holding firms. Additionally, two mortgage-lending companies and a leading insurance firm (AIG) are taken over by federal regulators under negotiated rescue plans. With the TARP legislation, the Treasury and U.S. taxpayers become co-owners of top banks in America. The aftermath of the federal bailout is characterized by political criticism and obstacles directed at Goldman. The decision to rescue the troubled banks continues to elicit controversy, especially after Lehman is let to fail. Due to the stabilized financial markets, reform opportunities exist to avoid future credit crises.

Reference

Sorkin, A.R., Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System and Themselves, New York, NY, Penguin Group, 2010.

Footnotes

1. A.R. Sorkin, Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System and Themselves, New York, NY, Penguin Group, 2010, p. 5.
2. Ibid., 4.
3. Ibid., 5.
4. Ibid., 10.
5. Ibid., 11.
6. Ibid., 24.
7. Ibid., 29.
8. Ibid., 34.
9. Ibid., 46.
10. Ibid., 51.
11. Ibid., 52.
12. Ibid., 58.
13. Ibid., 63.
14. Ibid., 68.
15. Ibid., 79.
16. Ibid., 83.
17. Ibid., 84.
18. Ibid., 96.
19. Ibid., 100.
20. Ibid., 101.
21. Ibid., 109.
22. Ibid., 112.
23. Ibid., 112.
24. Ibid., 117.
25. Ibid., 126.
26. Ibid., 135.
27. Ibid., 138.
28. Ibid., 141.
29. Ibid., 142.
30. Ibid., 154.
31. Ibid., 155.
32. Ibid., 161.
33. Ibid., 162.
34. Ibid., 169.
35. Ibid., 182.
36. Ibid., 185.
37. Ibid., 186.
38. Ibid., 191.
39. Ibid., 204.
40. Ibid., 210.
41. Ibid., 220.
42. Ibid., 238.
43. Ibid., 240.
44. Ibid., 254.
45. Ibid., 256.
46. Ibid., 293.
47. Ibid., 298.
48. Ibid., 308.
49. Ibid., 351.
50. Ibid., 362.
51. Ibid., 363.
52. Ibid., 364.
53. Ibid., 376.
54. Ibid., 378.
55. Ibid., 401.
56. Ibid., 402.
57. Ibid., 403.
58. Ibid., 414.
59. Ibid., 415.
60. Ibid., 416.
61. Ibid., 418.
62. Ibid., 422.
63. Ibid., 449.
64. Ibid., 451.
65. Ibid., 455.
66. Ibid., 459.
67. Ibid., 464.
68. Ibid., 479.
69. Ibid., 487.
70. Ibid., 488.
71. Ibid., 492.
72. Ibid., 495.
73. Ibid., 499.
74. Ibid., 501.
75. Ibid., 514.
76. Ibid., 524.
77. Ibid., 526.
78. Ibid., 528.
79. Ibid., 529.
80. Ibid., 530.