CHAPTER 10

Monday, September 15, 2008

I woke up exhausted Monday morning after a few troubled hours of sleep, tormented by the increasing size of AIG’s problems and John Mack’s haunting words from the night before: with Lehman Brothers gone, Morgan Stanley could be next. From a window of my room in the Waldorf-Astoria, I watched as the still-quiet streets of Midtown Manhattan came slowly to life. It was just after 6:00 a.m. and not yet light, but I could see taxis dropping off passengers, trucks off-loading deliveries, workers hurrying to their offices to get a jump on the day.

Only a few hours before, just after midnight, Lehman Brothers had filed for bankruptcy, the biggest in U.S. history. I wondered if anyone out there on the streets could possibly imagine what was about to hit them.

President Bush called for an update shortly after 7:00 a.m., but I had nothing new to tell him. Lehman would have gone into administration by now in London, but the markets had not yet opened in New York. All I could offer were assurances that we would stay on top of the situation and keep him informed throughout the day. With luck, I told him, the system could withstand a Lehman failure, but if AIG went down, we faced real disaster. More than almost any financial firm I could think of, AIG was entwined in every part of the global system, touching businesses and consumers alike in many different and critical ways.

I stressed that I trusted Tim Geithner to do everything possible to come up with a private-sector solution, but AIG was in deep trouble, and I was not optimistic. Its shares had plunged 31 percent the previous Friday and, after the weekend’s well-publicized problems, today was sure to be worse.

I called Chris Cox at 8:15 a.m. to urge him to get prepared to take action on short sellers. Before I left for the airport, I caught up with Tim. His news wasn’t encouraging—AIG was already looking worse than last night. We agreed that I would get back to Washington as soon as possible and organize my team to deal with Congress and the broader crisis. He would oversee the steps being taken to manage the Lehman failure and, most important, press ahead with a private-sector rescue of AIG, which he hoped would be led by JPMorgan and Goldman Sachs.

I boarded my flight back to D.C. as the markets were just opening, so it wasn’t until I landed at 10:30 a.m. and got back on the phone with Tim that I learned the day had begun in ugly fashion. In the first hour of trading, AIG shares had plunged nearly in half, to $6.65; the Dow was off 326 points, or 2.9 percent. In London, the FTSE 100 Index was down 183 points, or 3.4 percent.

Shortly after I’d gotten off with Tim, my friend and former Goldman colleague Ken Brody, now chairman of Taconic Capital Advisors, reached me.

“Hank, you made a big mistake,” he said. “This market is too fragile to handle a Lehman Brothers bankruptcy. The system is on the verge of collapse, and Morgan Stanley could well be next.”

I respected Ken’s opinions tremendously, but this was the last call in the world I needed, coming on top of Tim’s gloomy report. He assumed we had intentionally let Lehman go down and thought it might be good to acknowledge the mistake publicly. I told Ken that I was unbelievably frustrated but that we had had no choice. There had been no legal basis to bail out Lehman. Now we were doing everything we could to manage the situation.

Still, his assessment distressed me, and when I reached the office, I saw that the market was in full decline. Understandably, the prices of AIG (off by nearly 60 percent) and Lehman (down 95 percent) were in free fall, but Morgan Stanley and Goldman Sachs were also dropping fast. Their credit default swap rates had nearly doubled—to insure $10 million of debt now cost about $450,000 for Morgan Stanley and about $300,000 for Goldman. I could sense the start of a panic. Morgan Stanley’s level approached where Lehman had been the previous Wednesday, and no one in the world—not a rational world, anyway—could have thought Morgan Stanley’s business was in anywhere near as bad a shape as the now-bankrupt investment house.

It was the dismal beginning of the first day of what would be a thoroughly dismal week.

I hurried to the White House to update the president shortly after 1:00 p.m. and then went straight to the briefing room in the West Wing to hold a press conference. After a short statement, I took questions from four dozen or so journalists packed into the small, windowless room. They were all on edge.

In my answers, I attempted to put the crisis in perspective, noting its roots in the housing price collapse and pointing out that a more satisfying solution had been hindered by our archaic financial regulatory structure. “Moral hazard,” I made clear, “is something I don’t take lightly.” But I drew a distinction between our actions in March with Bear Stearns and now with Lehman Brothers. I stressed that unlike with Bear, there had been no buyer for Lehman. For that reason, I said: “I never once considered it appropriate to put taxpayer money on the line in resolving Lehman Brothers.” How could I? There was, in fact, no deal to put money into.

In retrospect, I’ve come to see that I ought to have been more careful with my words. Some interpreted them to mean that we were drawing a strict line in the sand about moral hazard, and that we just didn’t care about a Lehman collapse or its consequences. Nothing could have been further from the truth. I had worked hard for months to ward off the nightmare we foresaw with Lehman. But few understood what we did—that the government had no authority to put in capital, and a Fed loan by itself wouldn’t have prevented a bankruptcy.

I was in a painful bind that I all too frequently found myself in as a public official. Although it’s my nature to be forthright, it was important to convey a sense of resolution and confidence to calm the markets and to help Americans make sense of things. Being direct and open with the media and general public can sometimes backfire. You might actually cause the very thing you hoped to avoid.

I did not want to suggest that we were powerless. I could not say, for example, that we did not have the statutory authority to save Lehman—even though it was true. Say that and it would be the end of Morgan Stanley, which was in far superior financial shape to Lehman but was already under an assault that would dramatically intensify in the coming days. Lose Morgan Stanley, and Goldman Sachs would be next in line—if they fell, the financial system might vaporize and with it, the economy.

By late afternoon I’d caught up with both presidential candidates. I was now in touch with Barack Obama almost daily, though less frequently with John McCain. My goal was to keep them from saying anything that might upset the markets—a task that would become more important, and more difficult, as the campaign heated up.

That afternoon, Obama asked insightful questions as I explained why we couldn’t save Lehman and noted that the market was reacting worse than we’d feared. I also told him about the problems with AIG. As he did almost every time we talked, Obama asked if I’d spoken to McCain—perhaps it was to gauge what his opponent was thinking or to encourage me to keep McCain in line, so that on crucial economic points we presented a united front for the country’s benefit.

McCain, who never asked me about Obama on our calls, kept his counsel while I updated him on the situation. He did suggest I speak to his running mate. “She’s a quick study,” he said admiringly. Still energized by the Sarah Palin nomination, the Republican ticket led in some of the polls, although that lead would disappear by the end of the week.

When I got in touch with the Alaska governor, she quickly showed her knack for focusing on the hot button. She asked me whether AIG’s problems had to do with managerial incompetence, then got right to the point.

“Hank,” she said, “the American people don’t like bailouts.”

“Neither do I, but an AIG failure would be a disaster for the American people,” I replied.

In my view, we needed to be ready for anything. A little more than an hour before, the Dow Jones index had closed at a two-year low. It had fallen 504 points, or 4.4 percent—the worst one-day point decline since the markets reopened after 9/11. Even more ominously, the credit markets were deteriorating. The LIBOR-OIS spread, which had peaked at about 82 basis points during the Bear Stearns crisis, had jumped to more than 105 basis points, underscoring how little confidence the banks had in lending to one another. If I had any doubts that we were about to enter a new, ugly phase of the crisis, they were erased when General Electric CEO Jeff Immelt stopped by to see me a little before 6:00 p.m. We spoke privately in my office.

I’d known Jeff for years and admired the cool, unflappable demeanor he had displayed as CEO of the biggest, most prestigious company in America. Jeff was following up on a phone call from the week before when, just after the takeovers of Fannie Mae and Freddie Mac, he’d mentioned that GE was having problems in the commercial paper market. His report had alarmed me then. That market had been in distress since the onset of the credit crisis in August 2007. The worst of that had involved the asset-backed commercial paper market, which supported all those off-balance-sheet special investment vehicles filled with toxic collateralized debt obligations that banks had cooked up. I’d never expected to hear those troubles spreading like this to the corporate world, and certainly not to GE.

Commercial paper is essentially an IOU that is priced on the credit rating of the borrower and generally backstopped by a bank line of credit. It’s usually issued for short periods of time—90 days or less. And it’s often bought by money market funds looking for a safe place to get a higher rate of return than they would earn from short-term government bills. Companies use these borrowings to conduct their day-to-day business operations, financing their inventories and meeting their payrolls, among other things. If companies can’t use the commercial paper market, they have to turn to banks (which in September 2008 were reluctant to lend). When their access to short-term financing is in question, companies have to curtail normal business operations.

Now here was Jeff telling me that GE was finding it very difficult to sell its commercial paper for any term longer than overnight. The fact that the single-biggest issuer in this $1.8 trillion market was having trouble with its funding was startling.

If mighty GE was having trouble rolling its commercial paper over, so were hundreds of other industrial companies, from Coca-Cola to Procter & Gamble to Starbucks. If they all had to slash their inventories and cut back operations, we would see massive job cuts spreading throughout an already suffering economy.

“Jeff,” I remember saying, “we have got to put out this fire.”

Tuesday, September 16, 2008

Monday, September 15, had been grim. But on Tuesday, all hell broke loose.

Normally I left home by 5:45 a.m., went to my gym, and ran hard on the treadmill. Then I’d do some core exercises until 7:45 a.m. Fifteen minutes later I was in the office. (Those 90-second showers of my childhood sure helped me keep to this pace.)

That morning, sensing trouble, I skipped my workout, as I would for weeks, and went straight to the Markets Room, on the second floor of the Treasury Building, to get a quick fix from Matt Rutherford. What I learned was disturbing. Though the LIBOR-OIS spread had eased, financial institutions including Washington Mutual, Wachovia, and Morgan Stanley were under severe pressure. (The CDS of the venerable investment bank would soar from 497 basis points Monday to 728 basis points—a higher level than Lehman Brothers had traded at before its failure.)

I soon heard from Dan Jester and Jeremiah Norton, who were helping Tim out with AIG. I needed them in Washington, but Dan, in particular, had won Tim’s confidence, and I had reluctantly agreed to let him stay at Tim’s request. They gave me a discouraging update. The rating agencies had slashed the insurer’s credit rating on Monday, forcing it to post additional collateral on its huge derivatives book. To my utter amazement and disgust, AIG’s liquidity needs had mushroomed. On Sunday, the company was looking for $50 billion; now it would need an $85 billion loan commitment by the end of the day. A private-sector solution appeared very unlikely.

AIG’s incompetence was stunning, but I didn’t have time to be angry. I immediately called President Bush to tell him that the Fed might have to rescue AIG and would need his support. He told me to do what was necessary.

Tim Geithner called to tell me that he had talked with Ben Bernanke, who was amenable to asking the Fed board to make a bridge loan if the executive branch and I stood behind him. He said he thought $85 billion would be enough but stressed that we had to move quickly: the company needed $4 billion by the close of business Wednesday. Even this breathtaking assessment would prove optimistic. By late morning, we had learned AIG needed cash to avoid bankruptcy by day’s end—the total would eventually reach $14 billion.

Tim, Ben, and I reviewed our options with great care in an hour-long conference call at 8:00 a.m. that included Fed vice chairman Don Kohn and governors Kevin Warsh and Elizabeth Duke. Whatever else happened, we could not let AIG go down.

Unlike with Lehman, the Fed felt it could make a loan to help AIG because we were dealing with a liquidity, not a capital, problem. The Fed believed that it could secure a loan with AIG’s insurance subsidiaries, which could be sold off to repay any borrowing, and not run the risk of losing money. These subsidiaries were also more stable because of the strength of their businesses and their stand-alone credit ratings, which were separate from the AIG holding company’s ratings and troubles. By contrast, prior to Lehman’s failure, its customers had already begun to flee, causing the Fed to face the prospect of having to lend into a run. Moreover, the toxic quality of Lehman’s assets would have guaranteed the Fed a loss, meaning the central bank could not legally make a loan.

We set a plan of action: Tim would figure out the details of the bridge loan, while I worked on finding a new CEO for the company. We had less than a day to do it—AIG’s balances were draining by the second.

I asked Ken Wilson to drop everything and help. Within three hours he had pinpointed Ed Liddy, the retired CEO of Allstate and one of the savviest financial executives in the world. He reached Liddy in Chicago, then ran upstairs to my office to tell me to call him. I offered Ed the position of AIG chief on the spot. The job would be a thankless one, but I could think of no one else who had the ability and the grit to take it on.

On Tuesday morning, the consequences of Lehman’s failure were becoming more and more apparent. I received an astounding call from Goldman CEO Lloyd Blankfein. He informed me that Lehman’s U.K. bankruptcy administrator, Pricewaterhouse-Coopers, had frozen the firm’s assets in the U.K., seizing its trading collateral and third-party collateral. This was a completely unexpected—and potentially devastating—jolt. In the U.S., customer accounts were strictly segregated, and were protected in a bankruptcy proceeding. But in the U.K., the bankruptcy administrator had lumped all the accounts together and frozen them, refusing to transfer collateral back to Lehman’s creditors. This was particularly damaging to the London-based hedge funds that relied on Lehman as their prime broker, or principal source of financing.

Just about all the hedge funds in London and New York, whether or not they had any relationship with the bankrupt securities firm, became unnerved and leaped to a frightening conclusion: they should avoid doing business with any firm that could end up like Lehman. This was bad news for Morgan Stanley and Goldman, the leading prime brokers. Trading frequently and maintaining big balances, hedge funds were among their best, most profitable customers. Lloyd was afraid that if something wasn’t done, Morgan Stanley would fail, as clients began to run and hedge funds pulled their prime brokerage accounts. And even though Goldman had plenty of liquidity and cash, it could be next.

“Hank, it is worse than any of us imagined,” Lloyd said. If hedge funds couldn’t count on the safety of their broker-dealer accounts, he went on, “no one will want to do business with us.”

Hedge funds were just the tip of the iceberg. Liquidity was rapidly evaporating all over. When investors—pension funds, mutual funds, insurance companies, even central banks—couldn’t withdraw their assets from Lehman accounts, it meant that in the interlinking daisy chain of the markets, they would be less able to meet the demands of their own counterparties. Suddenly everyone felt at risk and increasingly wary of dealing with any counterparty, no matter how sterling its reputation or how long a relationship one firm had had with another. The vast and crucial Treasury repurchase market, under duress since August 2007, began to shut down.

This was awful news. When institutional investors, for example, purchased securities like corporate bonds, they frequently hedged their positions by selling Treasuries. But if they did not have the Treasuries in their inventory, they used the repo market to borrow them from other investors.

With Lehman’s failure, major institutional investors ceased lending securities for fear that their counterparties would fail and not return the securities as promised. Among the key investors now balking were reserve managers at some of the world’s central banks, which had been earning extra income by lending part of their vast holdings of Treasuries overnight. Some small central banks had started pulling out of the repo market the week before as rumors had circulated about the imminent failure of Lehman; by Monday, their bigger counterparts in Asia and Europe were doing the same.

In a classic “flight to quality,” everyone wanted to get hold of Treasuries, the safest security in the world. In Tuesday’s midday auction we received over $100 billion in orders for $31 billion in four-week bills. The rate on the bills was an astoundingly low 0.10 percent—a drop of 1.15 percentage points from the previous week. The consequences of this flight were enormous to global credit markets.

The sudden shortage of Treasury securities resulted in an unprecedented level of “fails to deliver,” that is, investors who were unable to deliver securities they had previously borrowed. On September 12, the Friday before Lehman went down, these fails stood at $20 billion; one week later they would soar to $285 billion. By September 24 they would reach $1.7 trillion, before peaking at $2.3 trillion in early October—an extraordinary amount, never experienced before, and multiple times higher than any prior episode in history.

Major investors who desperately wanted Treasuries for safety or to hedge purchases of other securities could not purchase them because no investors were willing to lend securities from their portfolios. Major broker-dealers stopped selling Treasuries for fear that they would not be able to deliver the Treasury securities they sold. And without being able to hedge their positions with Treasuries, investors were reluctant to make any further purchases in other credit markets. The credit markets essentially were grinding to a halt.

Over the next couple of hours that morning, I must have made or taken a score of phone calls from senators and congressmen. These were short and to the point: we were doing our best to hold the system together; the bankruptcy of Lehman was regrettable, but there had been no buyer; AIG was a problem, and we were working hard on a solution.

Its impending failure was sending shock waves around the world. Peer Steinbrück, the German finance minister, called to say that it was unthinkable AIG could go down. Christine Lagarde, the French finance minister, echoed his view: everyone was exposed to AIG, and its failure would be catastrophic. “I assume you are going to do the right thing,” she said to me. I told her what I had told Steinbrück—“I can’t make any commitments”—but I assured her we were doing everything we could.

As I dealt with the phone calls, I learned that McCain had gone on NBC’s Today show earlier and declared, “We cannot have the taxpayers bail out AIG or anybody else.” I didn’t want American taxpayers stuck with a bailout, either, but Ben, Tim, and I could see no other alternative, and I didn’t want McCain—or Obama—to use populist language that would inflame the situation. So I called McCain to encourage him to be more careful in his choice of words.

“You should know that if this company were to go down, it would hurt many, many Americans,” I explained. In addition to providing all kinds of insurance to millions of U.S. citizens, AIG was deeply involved in their retirements, selling annuities and guaranteeing the retirement income of millions of teachers and healthcare workers. I asked him to refer to our actions as rescues or interventions, not bailouts. The next day McCain would temper his criticism, using some of my language, only to be criticized for flip-flopping.

By noon, European stocks had tumbled, the U.S. markets were starting to dip, and the news was about to get worse. Lehman’s failure and AIG’s escalating difficulties had begun to roil money market funds. Typically, these funds invested in government or quasi-government securities, but to produce higher yields for investors they had also become big buyers of commercial paper. All morning we heard reports that nervous investors were pulling their money out and accelerating the stampede into the Treasury market. The Reserve Primary Fund, the nation’s first money market fund, had been particularly hard-hit because of substantial holdings of now-worthless Lehman paper.

Many Americans had grown accustomed to thinking that money market funds were as safe as their bank accounts. Money funds lacked deposit insurance but investors believed that they would always be able to withdraw their money on demand and get 100 percent of their principal back. The funds would maintain a net asset value (NAV) of at least 1.00, or $1 a share. No fund had dipped below that level—or, in industry parlance, “broken the buck”—since the bond market rout of 1994. Funds that broke the buck were as good as dead: investors would all withdraw their money.

In retrospect, I see that the industry’s setup was too good to be true. The idea that you could earn more than what the federal government paid for overnight liquidity and still have overnight liquidity made absolutely no sense. It had worked for so long only because people didn’t ask for their money. But when Lehman failed, people started to ask.

Around 1:00 p.m., Bill Osborn, the chairman of Northern Trust and a good friend from Chicago, called with a firsthand report. “I hate to bother you, Hank,” he said. “But there is no liquidity in the markets. The commercial paper market is frozen.”

Bill proceeded to tell me about problems he was having with his money market funds. Because the market for commercial paper had seized up, the funds were under real pressure from withdrawals, and he was looking for ways to avoid breaking the buck. He was working on a way the parent company could support the funds financially without taking the obligation on its balance sheet. But this solution required accounting relief. He’d already called the SEC but wanted to let me know of the looming problem.

I told Bill that I was focused on AIG, but that the Fed was working on a number of liquidity programs to get people to start buying paper again.

“They can’t come soon enough,” he said. “I’ve never seen anything like this.”

Nor had I. Begun as an alternative to banks for U.S. consumers, money funds had more than 30 million retail customers. In recent years, the business had become increasingly corporate—and global. Companies used the funds for their cash management needs, and money poured in from overseas investors—Singaporeans, British, and Chinese—eager to get a little more yield than on straight Treasuries.

This kind of money was “hot,” likely to flee at the first sign of trouble, and I feared the start of a run on the $3.5 trillion industry, which provided so much critical short-term funding to U.S. companies. I immediately thought of my meeting with Jeff Immelt the day before, and his trouble selling commercial paper. I called Chris Cox, who told me that he was aware of the accounting issue; his accounting policy people were already working on it, but there was no obvious solution.

Tim, Ben, and I spoke throughout the day so Tim could keep us updated on the size of the AIG problem. We had a President’s Working Group meeting set for 3:30 p.m. When I arrived at the Roosevelt Room, the president, the vice president, and my fellow members of the PWG, with the exception of Tim, were all there. I outlined AIG’s dire situation, detailing the incompetence of its management and the need to prevent its collapse, given its worldwide financial products and the number of money market and pension funds that held its commercial paper.

“How did we get to this point?” the president asked in frustration. He wanted to understand how we couldn’t let a financial institution fail without inflicting widespread damage on the economy.

I explained that AIG differed from Lehman, because Lehman had issues with both capital and liquidity, whereas AIG just had a liquidity problem. The investment bank had been loaded with toxic assets worth far less than the value at which they were carried, creating a capital hole. Nervous counterparties had fled, draining liquidity.

In AIG’s case the problem wasn’t capital—at least we didn’t think so at the time. The insurer held many toxic mortgages, but its most pressing problem was a derivatives portfolio that included a large amount of credit default swaps on residential mortgage CDOs. The decline in housing values, and now the cuts in AIG’s ratings, required it to post more collateral. Suddenly, AIG owed money seemingly everywhere, and it was scrambling to come up with $85 billion on short notice.

“If we don’t shore up AIG,” I said, “we will likely lose several more financial institutions. Morgan Stanley, for one.”

I noted that an AIG collapse would be much more devastating than the Lehman failure because of its size and the damage it would do to millions of individuals whose retirement accounts it insured. I added that I was worried about the flight I saw from money market funds and commercial paper. Chris Cox let us all know the Reserve Primary Fund had just broken the buck.

The president found it hard to believe that an insurance company could be so systemically important. I tried to explain that AIG was an unregulated holding company comprising many highly regulated insurance entities. Ben chimed in with a pointed description: “It’s like a hedge fund sitting on top of an insurance company.”

Ben said that under the Fed’s plan, the government would lend AIG $85 billion, charging the company LIBOR plus 850 basis points, or about 11.5 percent at that time. The government would end up with 79.9 percent ownership, substantially diluting the existing equity, and would gradually liquidate the company to pay off the Fed’s loan.

“Someday you guys are going to have to tell me how we ended up with a system like this and what we need to do to fix it,” the president said, noting that we would have to put together a more consistent and comprehensive approach to the crisis.

I couldn’t have agreed more. Sunday night, with Lehman about to file for bankruptcy, I had warned the president that we might have to ask Congress for broader powers to stabilize the financial system as a whole. Now, while still in firefighting mode as we dealt with the five-alarm emergency of AIG, I didn’t raise the issue of going to Congress again. But I knew that when the time came, President Bush would support me.

The president was admirably stalwart. Even though the predominant mood at the time, both generally and on the Hill, was against bailouts, President Bush didn’t care. His goal was to leave the country in as strong a financial position as possible for his successor. Skeptics may doubt me, but this is the truth: In any accurate recounting of the financial crisis, you won’t find the president playing politics with these decisions—not one instance. He was genuinely trying to do his best for the country as he backed our AIG rescue plan.

“If we suffer political damage, so be it,” he said.

Afterward I got confirmation of what Chris had said about the Reserve Fund. While we were with the president, the Reserve had announced that it would halt payment of redemptions for one week on its Primary Fund, a $63 billion money market fund that was caught with $785 million in Lehman short-term debt when the investment bank entered bankruptcy. On Monday, investors had flooded the company with requests for redemptions; by mid-afternoon Tuesday, $40 billion had been pulled. The fund had officially broken the buck, the first to do so since 1994, when the Denver-based U.S. Government Money Market Fund, which had invested heavily in adjustable-rate derivatives, fell to 96 cents.

The sense of panic was becoming more widespread. Dave McCormick and Ken Wilson came in to tell me that they had heard from their Wall Street sources that a number of Chinese banks were withdrawing large sums from the money market funds. They had also heard that the Chinese were pulling back on secured overnight lending and shortening the maturity of their holdings of Fannie and Freddie paper—all signs of their battening the hatches. I asked Dave to track down the Chinese rumors and report back to me as soon as possible.

While we were in the PWG meeting, Morgan Stanley released its third-quarter earnings, rushing them out a day early. Its reported $1.43 billion in profits were down 7.6 percent from a year earlier but better than expected. Not that it helped much: after briefly rallying, Morgan Stanley’s shares fell 10.8 percent on the day, to $28.70, while its CDS rates ended at 728 basis points, after spiking to 880 basis points at one point. Goldman Sachs had released its earnings that morning: at $845 million, its net income was down 70.4 percent from the previous year.

Later I got an earful from John Mack, who said Morgan Stanley was in jeopardy. John was a strong leader, at once personable and tough. He was no whiner, but I could tell he was scared. What he had predicted Sunday night had come to pass: investors were losing confidence, and the short sellers were after his bank. His cash reserves were evaporating, and he was doing everything he could to hold things together.

“Hank,” John said, “the SEC needs to act before the short sellers destroy Morgan Stanley.”

Since Monday he had been calling senators, congressmen, the White House, and me, trying to persuade everyone to push the SEC to do something about abusive short selling. He wasn’t alone. John Thain also called that afternoon to press about short selling. Shareholders had not yet approved Merrill’s deal with Bank of America, and he was taking nothing for granted. But his immediate concern was Morgan Stanley. The failure of another major institution, he knew, would be devastating.

Ben and I had arranged to meet with congressional leaders that evening, but first Tim and I had to call AIG chief Bob Willumstad to confirm that the Fed was on track to make the loan—and to tell him that he was being replaced. He had been CEO for just three months; before that he had served as AIG chairman after a long financial services career that included retail banking at Citigroup. He was highly regarded for his acumen and integrity, but with AIG he had encountered more than he could handle—perhaps more than anyone could have handled. Through it all, Willumstad was an incredible gentleman, even calling Ken Wilson and voluntarily forfeiting the severance payments that were written into his management contract.

I next had to make arrangements to go to the Hill. In the afternoon, I’d run into resistance trying to get something scheduled. Before the PWG meeting I had spoken with Nancy Pelosi more than once, telling her that although the Fed hadn’t made a final decision yet on the AIG loan, we probably would need to meet with congressional leaders to discuss it. I told her it was an emergency, but she’d replied: “This is difficult to schedule on short notice. Do we need to do it tonight?”

When I got back to my office from the White House, I tried Harry Reid. I’d always found the Senate majority leader to be a sincere, trustworthy, hardworking partner. The son of a Nevada miner, he had come up the hard way, and his modesty and earnestness appealed to me.

“We have a real problem with AIG,” I told him. “The Fed is going to have to step in. I need you to get the leadership together.” He agreed, and we scheduled a meeting for 6:30 p.m.

Before going to the Hill, I briefed Obama and McCain on AIG. In fact, I spoke to Obama twice before I went to the Capitol. If anything, I overcommunicated with both candidates because I understood that if either of them made AIG or any other part of the crisis into a campaign issue to win political popularity, we were dead. I told them the Fed had to take action and made the point that we were protecting taxpayers—not bailing out shareholders. Again I asked both of them not to characterize this as a bailout.

Ben and I rode to the Capitol separately for the meeting, which Harry Reid had convened in the Senate Rules Committee’s conference room, a modest-size space devoid of tables or chairs, which left all of us standing. The Senate majority leader had gathered an important group to hear us out, including Chris Dodd; Judd Gregg, the ranking Republican on the Senate Budget Committee; and Barney Frank, who arrived late.

I led off by saying the government had decided to act to save the giant insurer, and that Treasury and the Fed were cooperating. Outwardly I was calm, but I could feel the effects of sheer physical exhaustion and the accumulated pressure of the last few days. Ben followed, speaking clearly and precisely. He laid out the terms of the two-year, $85 billion bridge loan we would be making.

There was an almost surreal quality to the meeting. The stunned lawmakers looked at us as if not quite believing what they were hearing. They had their share of questions but were broadly supportive.

John Boehner said we’d be crazy to let AIG fail. Reid put his head in his hands at the size of the loan, while Barney Frank asked, “Where did you find $85 billion?”

“We have $800 billion,” Ben replied, referring to the balance sheet of the Federal Reserve.

Chris Dodd asked twice how the Fed had the authority to lend to an insurance company and seize control of it. Ben explained how Section 13(3) of the Federal Reserve Act allowed the central bank to take such actions under “unusual and exigent circumstances.” It was the same provision the Fed had used to rescue Bear Stearns.

In the end, Reid said: “You’ve heard what people have had to say. But I want to be absolutely clear that Congress has not given you formal approval to take action. This is your responsibility and your decision.”

As I left the meeting, accompanied by my Secret Service detail, I suddenly had to step away quickly from the group, out of sight. All my life, dating back to high school, I’ve occasionally had bouts of dry heaves when I am exhausted or sleep deprived. During the credit crisis, it must have happened six or eight times. That night, as I felt the nausea coming on, I ducked behind a pillar for a few seconds, in front of an American flag hanging from the ceiling. I was concerned that someone from the press might see me, but thankfully no one did.

At 9:00 p.m., the Fed announced that it would step in to save AIG. The company’s board had approved a deal for a two-year, $85 billion loan that would be collateralized by AIG’s assets, including the stock of its regulated subsidiaries, and would be repaid with the proceeds from the sale of the assets. Holding a 79.9 percent equity interest in AIG, the government retained the right to veto dividend payments to shareholders.

Wednesday, September 17, 2008

Tuesday was bad, but Wednesday was worse. Our intervention with AIG didn’t calm the markets—if anything, it aggravated the situation.

I arrived at Treasury at 6:30 a.m. and went straight to the Markets Room. I saw that Morgan Stanley’s situation had deteriorated even further. Its shares were plunging in premarket trading, while its CDS continued to climb. Shortly after 7:00 a.m. the president called. I told him the markets were being driven by fear and that the short sellers were now going after Morgan Stanley as if it were Lehman Brothers. I was very focused on the commercial paper market, where funding was drying up. We were being assailed on all sides.

“We’ve got a real problem,” I said to the president. “It may be the time’s come for us to go to Congress and get additional authorities.”

“Don’t you have enough with the Fed? You just bailed out AIG,” he pointed out.

“No, sir, we may not.”

After promising President Bush I’d stay in touch, I spoke with Dave McCormick, who confirmed the reports that the Chinese had been pulling back. He said he’d spoken with central bank governor Zhou Xiaochuan, who had emphasized that the moves had not been orchestrated by the government but had been made by midlevel bureaucrats and various financial institutions doing what they thought was the smart thing. The Chinese leadership, McCormick said, would be giving some guidance to these professionals not to pull back from the money markets or from secured lending. I told Dave to stay in constant touch with the Chinese officials and keep me posted.

Between 7:00 a.m. and 7:40 a.m., Ken Wilson called me three times to brief me on the alarming calls he was getting: Bank of New York Mellon CEO Bob Kelly, BlackRock chief Larry Fink, and Northern Trust CEO Rick Waddell had all reported requests for billions in redemptions from their money market funds. The Reserve Primary Fund was bad enough, but if these institutions’ funds broke the buck, we would have a full-scale panic as corporations, insurance companies, pension funds, and mom-and-pop customers all tried to withdraw their money at the same time.

Then Ken called me again: his computer screen showed that the demand for Treasuries had become so great the yield on three-month bills had entered negative territory. Investors were now paying for the safety of U.S. government securities. He said it was clear to him the wheels were coming off the financial system.

In the midst of the morning’s gathering chaos, I spoke with Dick Fuld. He had been calling the office, and I felt I ought to talk to him. We hadn’t spoken since the weekend. It was a very sad call.

“I see you bailed out AIG,” I remember him saying. “Hank, what you need to do now is let the Fed come into Lehman Brothers. Have the government come in and guarantee it. Give me my company back. I can get all the people back. We will have Lehman Brothers again.”

I remember talking with Tim Geithner a little later. I said, “I had a sad call from Dick Fuld.” He replied, “He asked you to undo the bankruptcy, right?” I said, “Right.” And he said, “Yes, very sad.” He’d gotten a similar call from Dick. What made Dick’s call and request even more poignant was the fact that it was known by then that Barclays was going to acquire the North American investment banking and capital markets businesses of Lehman out of bankruptcy.

I called Jamie Dimon to get his assessment of the market. I knew I could depend on JPMorgan’s CEO to be cool, clinical, and right on the money. He wasn’t reassuring. “The markets are frozen,” he said.

I’d foreseen the previous Sunday that we would have to go to Congress for emergency powers and fiscal authorities to deal with the crisis. Kevin Fromer and I had discussed this on Monday and Tuesday, but I was leery about going to the Hill unless we could be sure of support there. Getting turned down by Congress on an urgent request of such magnitude could be calamitous. But the AIG rescue had failed to calm the markets, the panic was growing, and lawmakers were getting angry.

Early Wednesday morning, Kevin and I agreed that the problem was so big that Congress had to be part of the solution. I wasn’t going to look for a statutory loophole that would let us commit massive amounts of public money; Congress would have to explicitly endorse our actions. And for the first time I believed Congress would likely give us what we needed. The extreme severity of the market conditions made it clear that no good alternative existed. And lawmakers were scheduled to leave town in nine days to campaign back home, so they had an incentive to act quickly. I relayed my thinking to Jim Wilkinson and Ken Wilson.

Around 8:30 a.m. I gathered my team in the large conference room. I told them we needed to figure out a way to get ahead of the markets and stabilize the system before other institutions went down. I told them Ben had made it clear that we couldn’t rely on the Fed alone to solve the problem for us.

“This is our moment of truth,” I said. “We’ve been dealing with one-off firefights, and we need to break the back of this crisis now.”

I laid down two principles for my team to follow as we worked on solutions. First, any policies would have to be simple and easily understood by the markets. Second, our actions had to be decisive and overwhelming—I learned this lesson back in July during the Fannie and Freddie crisis.

With an eye toward managing the workload and spurring creativity, my team had already divided into groups to handle different aspects of the crisis. One team of Treasury staff, led by Steve Shafran, had begun working the previous evening with Fed staff in Washington and New York to develop solutions for the credit markets. A second group, headed by Neel Kashkari, would focus on ways to purchase the toxic assets clogging bank balance sheets. Dave McCormick and Ken Wilson would head a third team, working with the SEC on policy issues such as short selling.

I’d long since learned that you couldn’t get anything done in Washington without a crisis. Well, this was an ongoing series of crises coming at us from all directions, all at once. At Goldman Sachs I had prided myself on my ability to handle many different issues simultaneously, but at Treasury I faced a different challenge. Each of the issues confronting me was enormously important—a wrong decision would hurt not just one client or one firm but the entire financial system and many millions of people in the U.S. and around the world.

Just after 1:00 p.m., John Mack called me in alarm. Morgan Stanley was under siege. Its shares had fallen below $20, and its CDS rates were way up—they were trading at around 800 basis points. To put that in perspective, Lehman had topped off at 707 basis points the Friday before—and it had gone belly-up. Short sellers were laying Mack’s bank low. “We need some action,” he said.

But John and his team weren’t about to go down without a fight. He said Morgan Stanley was looking to raise capital from strategic investors, and that the Chinese were a strong possibility. China Investment Corporation, the country’s sovereign wealth fund, already owned 9.9 percent of his firm.

“All the signals we get are that they’d like some reassurance and encouragement from you,” Mack said.

He asked if I’d be willing to talk to my old friend Wang Qishan, China’s vice premier in charge of economic and financial matters. I told John he could count on our support, and that Dave McCormick would follow up with him.

Shortly after that, Hillary Clinton called me on behalf of Mickey Kantor, who had served as Commerce secretary in the Clinton administration and now represented a group of Middle Eastern investors. These investors, Hillary said, wanted to buy AIG. “Maybe the government doesn’t have to do anything,” she said.

I explained to her that this was impossible unless the investors had a big balance sheet and the wherewithal to guarantee all of AIG’s liabilities.

Her call stands out in my mind because it reflected the general sentiment about AIG—that it was a good company with many interested buyers. The market believed that its problem was liquidity, not capital.

When I finally had a few minutes to deal with the Morgan Stanley situation, I called Chris Cox to discuss market manipulation. The investment bank’s falling stock price and widening CDS appeared to be driven by hedge funds and speculators. I wanted the SEC to investigate what looked to me to be predatory, collusive behavior as our banks were being attacked one by one.

Chris was considering various steps the SEC could take, including a temporary ban on short selling, but his board was divided. He wanted Tim, Ben, and me to support him on the need for a ban.

The short-selling debate was another of those issues where I found myself forced to do the opposite of what I had believed for my entire career. Short selling is a crucial element in price discovery and transparency—after all, David Einhorn, the hedge fund manager who shorted Lehman, had ultimately been proved right. I had long compared banning short selling to burning books, but now I recognized short selling as a big problem. I concluded that even though an outright ban would lead to all sorts of unintended consequences, it couldn’t be worse than what we were experiencing just then. We needed to do something.

Wednesday afternoon I was cleared to fight all the fires we faced. I had sold my shares in Goldman Sachs and severed ties with the firm when I became Treasury secretary. I had also signed an ethics agreement that precluded me from being involved in any government transaction “particular to Goldman Sachs.” With the two remaining investment banks on the edge, Tim Geithner argued that my role as Treasury secretary demanded that I get involved. We were in a national emergency, and I knew he was right. I obtained clearance from the White House counsel’s office and the career designated agency ethics officer at Treasury.

We had set up a 3:00 p.m. call to review the progress of our three workstreams and to prepare for another long night of work. My office filled with people as we reviewed the state of play. The markets were in near chaos. Stocks were plunging—the Dow was on its way to a drop of 449 points, or 4.1 percent. The credit markets were locked up.

The turmoil was going global. Russia had suspended trading for an hour on Tuesday, and its stock market shut down again on Wednesday. Karthik Ramanathan was fielding panicky calls from central bank reserve managers begging us to improve liquidity in the Treasury market. Some even wanted Treasury to pay for securities that the banks’ counterparties could not return.

At one point, Ben brought up the need to go to Congress. I couldn’t have agreed more, but I was so preoccupied with the steps involved in getting emergency powers that I didn’t respond. I was caught up in thinking of all that would have to be done, not least getting the White House on board. The president, I was sure, would support us, but we would need to get his press office, policy people, and legislative affairs staff involved in a course of action that we all knew was going to be very difficult and that some doubted could be successful. We needed to craft a winning strategy for the Hill and find a way to hold the financial system together while waiting for Congress to act.

We started to map out a comprehensive plan to deal with all the elements of the crisis that kept popping up. We had to tackle each problem as it arose and simultaneously devise a more far-reaching solution that we could present to the House and Senate.

The members of the three teams we’d set up earlier cranked away on their assignments: credit markets, asset purchases, policy. Periodically they would gather in my office to touch base and get direction, then they would go back to work for a few more hours. The credit markets team had been tasked with our most pressing issue: finding ways to add liquidity to the money markets and help the asset-backed commercial paper market before it pulled down companies like GE. Working with the SEC, the policy team investigated a wide range of issues: among them, whether regulators should reinstate the rule allowing short selling only on a stock’s uptick and whether fair-value accounting rules should be adjusted regarding bank mergers. The team working on illiquid asset purchases hashed out three questions: what assets to buy, whom to buy them from, and how to buy them. As a starting point, we turned to Neel Kashkari and Phill Swagel’s “Break the Glass” plan from the previous spring, which had outlined possibilities for recapitalizing the banks.

In our previous efforts with Congress—the 2008 stimulus bill and GSE reform—we’d had weeks to come up with plans and prep lawmakers. Now, facing a much more severe situation, we no longer had that luxury. Treasury staff worked straight through the night to Thursday morning. Most people broke for an hour around 5:00 a.m. or 6:00 a.m. to go home, shower, and change their clothes, then came straight back to the office. Others, like Neel Kashkari, showered in the gym at Treasury and slept in their offices. All learned to get by on little sleep and bad food.

Looking at my team’s tired faces, I remembered the lectures I used to give at Goldman on the need to balance one’s work and life. But back then I never foresaw a situation like this, with multiple crises demanding solutions, and the entire economy on the brink.