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

As soon as Paulson awoke on Friday, he began poring through the morning papers, looking for evidence of Davis’s handiwork. The message was supposed to have been made clear: Read Our Lips: No More Bailouts.

The mood in Washington was not hard to discern: There was no desire whatsoever for any further Wall Street rescues. All punditry could talk about was moral hazard, as if it were some sort of emerging disease that had just reached pandemic proportions. Bail out Lehman, the thinking went, and you will make bailouts the default solution at a time when no firm seems safe.

And what could be more satisfying than having your decision—the buck stopped there, thank you very much— manifested on the front pages of the country’s leading publications? Paulson first turned expectantly to the newspaper of financial record, the Wall Street Journal, and was sorely disappointed. The A1 article about the financial crisis merely tiptoed around the issue without ever being forceful enough about it, he thought as he read the piece. As close as the reporter got to explaining his position was this sentence: “Federal officials currently aren’t expected to structure a bailout along the lines of the Bear transaction or this past weekend’s rescue of mortgage giants Fannie Mae and Freddie Mac.”

The New York Times was even worse: “But while the Treasury Department and Fed were working to broker an orderly sale of Lehman, it was unclear whether the Fed would stand behind any deal, particularly after the Bush administration took control of the nation’s two largest mortgage finance companies only days ago.”

No, that doesn’t quite capture what they have been trying to convey, Paulson thought.

He turned to the Journal’s editorial page, where the air was typically more rarefied, and was able to take solace, as conservatives so often had, in its hyperintellectual and at times harsh right-wing opinions. The typically unsigned editorial was called “Lehman’s Fate,” and its position was right out of Paulson’s playbook.

“At least in the Bear case,” the Journal editorial read, “there was some legitimate fear of systemic risk. The Federal Reserve’s discount window hadn’t yet been opened to investment banks, and so there was some chance of a larger liquidity panic.

“That’s far less likely with Lehman. The discount window is now wide open to Merrill Lynch and Morgan Stanley, among others, and federal regulators have had months to inspect the value of Lehman’s assets and its various counterparties. If the feds step in to save Lehman after Bear and Fannie Mae, we will no longer have exceptions forged in a crisis. We will have a new de facto federal policy of underwriting Wall Street that will encourage even more reckless risk taking.”

Yes, yes, all true, Paulson thought as he finished the editorial. Still, it didn’t go far enough. He needed somehow to make it clear to all the banks that there would be no handouts, no more “Jamie Deals.” And he needed to do so in a way that would leave no room for misunderstanding.

When he arrived at the office Paulson walked down the hall into Michele Davis’s office and asked sullenly, “What do we do?”

“I’d rather say today that we don’t want to use our money and on Sunday night have to explain why we were backed into a corner,” Davis told him. “You want me to call Liesman?” she asked.

Liesman was Steve Liesman, CNBC’s economics reporter, known popularly as “The Professor.” Davis had a good relationship with him and had successfully leaked other information to him; Paulson considered him both intelligent and sympathetic to their cause. He could get the word out quickly and accurately.

Yes, the Professor, Paulson smiled. He’ll know what to do with this.

As Ed Herlihy sat in his office working on Bank of America’s bid, he kept his TV on mute, until at around 9:15 a.m. he saw the headline crawl across the bottom of CNBC’s screen—“Breaking News: Source: There will be no government money in the resolution of LEH situation”—and quickly turned up the volume to hear what Steve Liesman was telling David Faber, the network ’s mergers reporter.

“Let me start here with a comment that I just got from a person familiar with Paulson, State Secretary Treasurer [sic] Hank Paulson,” Liesman explained. “He’s saying there will be no government money in the resolution of this situation.”

Herlihy turned the volume even higher.

“They’re saying there are two things that make the Lehman deal different,” Liesman continued. “The market’s been aware and had time to prepare for over six months, and the second is the PDCF, that is, the access of the investment banks to the Fed’s emergency window that exists now, to allow for an orderly process.”

It was a lot to take in, and the Professor turned the floor over to his colleague. “David, what do you think of that?”

“An interesting gamble,” Faber replied. “Would the government be willing to say, ‘Hey, you’re on your own?’ There’s divided opinion in terms of what the ultimate risk will be to the creditors, to everybody involved in the credit default swap market where Lehman certainly is a counterparty on many trades.”

Liesman added: “I’m sure the Federal Reserve is looking for a situation where it can say, ‘There is moral hazard out there. You will take a hit if you did not pay attention for the last six months.’”

Herlihy couldn’t believe what he was hearing and ran into the conference room across the way where an army of bankers and Bank of America executives was mulling over documents.

“Did you just see what they just said on CNBC?” Herlihy asked Curl, almost out of breath. Curl not only hadn’t, but seemed slightly annoyed that he’d even been asked the question.

“Look, guys, we got a real problem here,” Herlihy insisted, after noticing he wasn’t getting much of a reaction from anyone in the room.

After Herlihy recounted the details of the Liesman interview, Curl only rolled his eyes. Why was Herlihy taking the CNBC report so seriously? To him, the channel was a professional rumor mill.

“It’s coming from Treasury,” Herlihy stressed again. “That’s Paulson. They’re trying to send us a message!”

Herlihy was media-savvy enough to know how the game worked: When he had been at Treasury just a week earlier during the takeover of Fannie-Freddie, he had watched the department deftly leak news out to the public