Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the FinancialSyst

Mack clicked off, exasperated. Wachovia was nobody’s idea of a dream date, but at the moment, it was the only girl at the dance.

“This is an economic 9/11.”

There was chilling silence in Hank Paulson’s office as he spoke. Nearly two dozen Treasury staffers had assembled there Wednesday morning, sitting on windowsills, on the arms of sofas, or on the edge of Paulson’s desk, scribbling on legal pads. Looming over them was a portrait of Alexander Hamilton, a copy of a portrait painted in 1792, when the young nation endured its first financial panic. A Treasury associate, William Duer, who also happened to be a personal friend of Hamilton’s, had used inside information to build up a huge position in government securities. When bond prices slid, Duer could not cover his debts, setting off a panic. Hamilton decided against bailing out his friend but did direct the Treasury to buy government securities, steadying the market—a long-forgotten but potentially instructive model of government intervention.

Paulson was seated in a chair in the corner, slouching, nervously tapping his stomach. He had a pained look on his face as he explained to his inner circle at Treasury that in the past four hours, the crisis had reached a new height, one he could only compare with the calamity seven years earlier, almost to the week. While no lives may have been at stake, companies with century-long histories and hundreds of thousands of jobs lay in the balance.

The entire economy, he said, was on the verge of collapsing. He had been on the phone that morning with Jamie Dimon, who had expressed his own anxiety. Paulson was no longer worried just about investment banks; he was worried about General Electric, the world’s largest company and an icon of American innovation. Jeffrey Immelt, GE’s CEO, had told him directly that the conglomerate’s commercial paper, which it used to fund its day- to-day operations, could stop rolling. He had heard murmurs that JP Morgan had stopped lending to Citigroup; that Bank of America had stopped making loans to McDonald’s franchisees; that Treasury bills were trading for under 1 percent interest, as if government-backed bonds were the only thing that investors could still trust.

Paulson knew this was his financial panic and perhaps was the most important moment of his tenure at Treasury, and possibly of his entire career. The night before, Bernanke and Paulson had agreed that the time had come for a systemic solution; deciding the fate of each financial firm one at a time wasn’t working. It had been six months between Bear and Lehman, but if Morgan Stanley went down, probably no more than six hours would pass before Goldman did, too. The big banks would follow, and God only knew what might happen after that.

And so Paulson stood in front of his staff in search of a holistic solution, a solution that would require intervention. He still hated the idea of bailouts, but now he knew he needed to succumb to the reality of the moment.

“Nothing is breaking our way,” Paulson declared. “We can’t solve the problems of today; we need to think of tomorrow. We need to get ahead of this. It’s deepening, moving too quickly. This is the financial equivalent of war, and we’re going to need wartime powers.” They needed to start thinking about what kind of program they could put together, he said, and while he wasn’t sure that that approach would even be politically feasible, it had to be explored.

He told the staff that he knew and accepted that he would be subjected to an enormous amount of political flak; he had already been criticized for the bailout of AIG, with Barney Frank mockingly declaring that he was going to propose a resolution to call September 15—the day Lehman filed for bankruptcy—as “Free Market Day.” “The national commitment to the free market lasted one day,” Frank said. “It was Monday.”

Senator Jim Bunning, Republican from Kentucky, was decrying that “once again the Fed has put the taxpayers on the hook for billions of dollars to bail out an institution that put greed ahead of responsibility.” Richard Shelby, Republican from Alabama, added that he “profoundly disagrees with the decision to use taxpayer dollars to bail out a private company.”

The first order of business, Paulson said, was addressing the money market crisis. Steve Shafran, a former Goldman banker, suggested that the Treasury could simply step in and guarantee the funds. “We have the authority,” he said, citing the Gold Reserve Act of 1934, which set aside a fund, now totaling $50 billion, to stabilize essential markets. The key, Shafran said, was that all they needed to access it was presidential approval, bypassing Congress.

“Do it!” Paulson said, and Shafran slipped out of the room to put the process in motion.

There was, however, no such easy solution to begin stabilizing the banks. Phil Swagel, the wonky assistant secretary for economic policy, emphasized the necessity of being bold and not avoiding addressing the problems for fear of political fallout. “You don’t want to be running Japan,” he said.

Swagel and Neel Kashkari dusted off the ten-page “Break the Glass” paper they had prepared the previous spring: In the event of a liquidity crisis, the plan called for the government to step in and buy toxic assets directly from the lenders, thereby putting right their balance sheets and enabling them to keep extending credit. The authors knew that executing their plan would be complicated—the banks would fight furiously over the pricing of the assets—but it would keep the government’s involvement in the day-to-day businesses as minimal as possible, something conservatives strongly desired.

“This is what we should do,” Kashkari told Paulson. He had been involved in HOPE NOW, one of the government’s early efforts at helping distressed homeowners, and had learned firsthand how difficult it would be to get the banks making new loans as long as they were carrying bad loans on their balance sheets. On the speakerphone from New York, where he still was embroiled in the AIG situation, Paulson’s adviser Dan Jester argued that the purchasing of assets was too cumbersome and recommended instead that capital be injected directly into the institutions. “The more bang for your buck is to put capital in,” he said, explaining that even if the market continued to fall, it would help the banks manage the downturn.

The difficulty with that approach, countered Assistant Secretary David Nason, was the specter of nationalization. If the government put money into firms, it became a de facto owner, which is precisely what most of the people in the room wanted to avoid. “Are people going to think we’re going to AIG them?” he asked, already using the government’s investment less than twenty-four hours earlier as a verb. Paulson had liked the “Break the Glass” idea when it had first been presented to him and was now leaning to move in that direction. AIG was a disaster they couldn’t afford to repeat, and buying the assets maintained a clear border between government and the private sector. The job now was to begin preparing the outlines of legislation for Congress. They were going to need a ton of money, and they were going to need it immediately.

He assigned Kashkari and a team of staffers the task of fleshing out the idea; “Break the Glass” might have been an interesting document in theory, but it lacked details and was far from executable. He gave them twenty- four hours to fill them in.

Before ending the meeting, Paulson asked, “How much is this going to cost?”

Kashkari, who had originally estimated the expense at $500 billion back in the spring, said gravely, “It’s going to be more. I don’t know, maybe even double.”