CHAPTER 5

Thursday, March 13, 2008

I can’t remember many speeches I looked forward to less than the one I was scheduled to deliver Thursday morning, March 13, at the National Press Club.

My purpose was to announce the results of a study of the financial crisis by the President’s Working Group and to unveil policy recommendations affecting areas ranging from mortgage origination and securitization to credit rating agencies and over-the-counter derivatives like credit default swaps. We had worked hard on these proposals since August, coordinating closely with the Financial Stability Forum in Basel, which planned to release its response in April at the upcoming G-7 Finance Ministers meeting.

But our timing was dreadful. It seemed premature to suggest steps to avoid a future crisis with no end in sight to this one. As much as I wanted to cancel the speech, I felt that if I did, the market would have smelled blood.

I hurried through my brief remarks, preoccupied and impatient to get back to the office. It had been a rough week. The markets had taken a sharp turn for the worse, as sinking home prices continued to pull down the value of mortgage securities, triggering more losses and widespread margin calls. Financial stocks were staggering, while CDS spreads—the cost to insure the investment banks’ bonds against default or downgrade—hit new highs. Banks were reluctant to lend to one another. The previous weekend there had been a banking conference in Basel, and Tim Geithner had told me that European officials were worried that the crisis was worsening. It was an unsettling confirmation of conversations I had had with a number of European bankers.

The firm under the most intense pressure was Bear Stearns. Between Monday, March 3, and Monday, March 10, its shares had fallen from $77.32 to $62.30, while the cost to insure $10 million of its bonds had nearly doubled from $316,000 to $619,000. Other investment banks also felt the heat. The next-smallest firm, Lehman Brothers, which was also heavily overweighted in mortgages and real estate, had seen the price of CDS on its bonds jump from $228,000 to $398,000 in the same time. A year before, CDS rates on both banks had been a fraction of that—about $35,000.

On the Tuesday before my speech, the Fed had unveiled one of its strongest measures yet, the Term Securities Lending Facility (TSLF). This program was designed to lend as much as $200 billion in Treasury securities to banks, taking federal agency debt and triple-A mortgage-backed securities as collateral. The banks could then use the Treasuries to secure financing. Crucially, the Fed extended the length of the loans from one day to 28 days and made the program available not just to commercial banks but to all primary government dealers—including the major investment banks that underwrote Treasury debt issues.

I was pleased with the Fed’s decision, which let banks and investment banks borrow against securities no one wanted to buy. And I had hoped that this bold action would calm the markets. But just the opposite happened. It was an indication of the markets’ jitters that some took the move as a confirmation of their worst fears: things must be very serious indeed for the Fed to take such unprecedented action.

On Wednesday, most of America found itself temporarily diverted from the markets’ tremors when Eliot Spitzer announced he was resigning as New York’s governor following a two-day riot of news coverage after he was named as a client of a prostitution ring. I know many on the Street took pleasure in his troubles, but I just felt shock and sadness. The Gridiron dinner where he had seemed so carefree just days before seemed an eternity ago.

I was too preoccupied to dwell on Spitzer’s misfortunes. Not only did I have to prepare my own speech, but I’d also been advising President Bush on an upcoming address of his own. It was scheduled for Friday at the Economic Club in New York. The president hoped to reassure the country with a firm statement on the administration’s resolve. We were agreed on just about everything except for one key point. I advised him to avoid saying that there would be “no bailouts.”

The president said, “We’re not going to do a bailout, are we?”

I told him I wasn’t predicting one and it was the last thing in the world I wanted.

But, I added, “Mr. President, the fact is, the whole system is so fragile we don’t know what we might have to do if a financial institution is about to go down.”

When I stood at the podium at 10:00 a.m. that Thursday at the National Press Club, I knew only too well that the current system, weakened by excessive leverage and the housing collapse, would not be able to withstand a major shock.

To a room full of restless reporters I sketched the causes of the crisis. We all knew the trigger had been poor subprime lending, but I noted that this had been part of a much broader erosion of standards throughout corporate and consumer credit markets. Years of benign economic conditions and abundant liquidity had led investors to reach for yield; market participants and regulators had become complacent about all types of risks.

Among a raft of recommendations to better manage risk and to discourage excessive complexity, we called for enhanced oversight of mortgage originators by federal and state authorities, including nationwide licensing standards for mortgage brokers. We recommended reforming the credit rating process, especially for structured products. We called for greater disclosure by issuers of mortgage-backed securities regarding the due diligence they performed on underlying assets. And we suggested a wide range of improvements in the over-the-counter derivatives markets.

I finished and hurried back to the Treasury Building. I had hardly gotten inside my office when Bob Steel rushed in. Bob’s the consummate professional and is almost always upbeat. But that day he looked grim.

“I spent some time with Rodge Cohen this morning,” he said, mentioning the prominent bank lawyer advising Bear Stearns. “Bear is having liquidity problems. We’re trying to learn more.”

Before Bob had finished, I knew Bear Stearns was dead. Once word got out about liquidity problems, Bear’s clients would pull their money and funding would evaporate. My years on Wall Street had taught me this brutal truth: when financial institutions die, they die fast.

“This will be over within days,” I said.

I swallowed hard and braced myself. Whatever we did we would have to do quickly.

The crisis seemed to have arrived suddenly, but Bear Stearns’s plight was not a surprise. It was the smallest of the big five investment banks, after Goldman Sachs, Morgan Stanley, Merrill Lynch, and Lehman Brothers. And while Bear hadn’t posted the massive losses of some of its rivals, its huge exposure to bonds and mortgages made it vulnerable. Bear had found itself in increasingly difficult straits since the previous summer, when, in one of the first signs of the impending crisis, it had been forced to shut down two hedge funds heavily invested in collateralized debt obligations.

For all that, I also knew Bear as a scrappy firm that liked to do things its own way: alone on Wall Street it had refused to help rescue Long-Term Capital Management in 1998. Bear’s people were survivors. They had always seemed to find a way out of trouble.

For months, Steel and I had been pushing Bear, and many other investment banks and commercial banks, to raise capital and to improve their liquidity positions. Some, including Merrill Lynch and Morgan Stanley, had raised billions from big investors such as foreign governments’ sovereign wealth funds. Bear had talked with several parties but had only managed to make an agreement with China’s Citic Securities under which each would invest $1 billion in the other. The deal was not the answer to Bear’s needs and in any case hadn’t yet closed.

Investment banks were more vulnerable to market pressures than commercial banks. For most of this country’s history, there had been no practical differences between them. But the Crash of 1929 changed that. Congress passed a series of reforms to protect bank depositors and investors by controlling speculation and curbing conflicts of interest. The Glass-Steagall Banking Act of 1933 prohibited depository institutions from engaging in what was seen as the risky business of underwriting securities. For many years, commercial banks, viewed as more conservative, took deposits and made loans, while investment banks, their more adventurous cousins, concentrated on underwriting, selling, and trading securities. But over time the dividing lines blurred, until in 1999 Congress allowed each side to jump fully into the other’s businesses. This gave rise to a wave of mergers that created the giant financial services companies that dominated the landscape in 2008.

But regulation had not kept pace with these changes. Oversight bodies were too fragmented and lacked adequate powers and authorities. That was one reason Treasury was working hard to complete our blueprint for a new regulatory structure.

Commercial banks enjoyed a greater safety net than investment banks did: When in trouble, commercial banks could turn to the Federal Reserve as their lender of last resort. If that failed, the government could step in, take the bank over, and put it in receivership. Seizing control of the bank’s assets, and standing behind its obligations, the FDIC could carefully wind down the bank, or sell it, to protect the financial system.

Though the more highly leveraged investment banks were regulated by the SEC and followed stricter accounting standards than the commercial banks did, the government had no power to intervene if one failed—even if that failure posed a systemic threat. The Fed had no facility through which investment banks could borrow, and the SEC was not a lender and did not inspire market confidence. In a world of large, global, intertwined financial institutions, the failure of one investment house, like Bear Stearns, could wreak havoc.

As soon as Bob Steel left my office that Thursday morning, I made a flurry of calls, beginning with the White House. Then I phoned a very concerned Tim Geithner, who assured me he was all over Bear. He asked if I had talked with SEC chairman Chris Cox.

I tracked Chris down in Atlanta. Though Bear’s name had been tarnished, Cox thought it had a good business and would make a perfect acquisition candidate, and that it ought to be able to find a buyer within 30 days. He’d spoken with Bear’s CEO, Alan Schwartz, who said he had unencumbered collateral—all he needed was for someone to loan against it.

President Bush soon called, and I explained the Bear Stearns situation and the consequences I saw for the markets, and the broader economy, if Bear failed. The president quickly grasped the seriousness of the problem and asked if there was a buyer for the stricken firm. I told him I didn’t yet know, but that we were thinking through all our options.

“This is the real thing,” I summed up. “We’re in danger of having a firm go down. We’re going to have to go into overdrive.”

Later that afternoon, Steel caught up with me and we agreed that he should go ahead and fly to New York for his daughter’s 21st birthday dinner. He could work from there and we might need him in the city, anyway. It was a stroke of luck that Bob went. He arrived at 6:00 p.m. or so and then found himself so caught on calls with officials at the New York Fed, the SEC, and Bear that he spent two hours on the phone in a conference room at the Westchester County Airport. He barely made it to his daughter’s party for dessert.

By the time I got home I was filled with foreboding. It was Thursday night, so the new Sports Illustrated had arrived. Wendy always left it for me on our bed, and I was flipping through the pages, trying to unwind, when the phone rang. It was Bob calling in from the airport in Westchester; he told me the situation was bad and that I would be hooked into a conference call around 8:00 p.m. with Ben Bernanke, Chris Cox, Tim Geithner, and key members of their staffs.

It had been an ugly day for Bear Stearns. Lenders and prime brokerage customers were fleeing so quickly that the company had told the SEC that without a solution, it would file for bankruptcy in the morning. We had limited options. A Bear bankruptcy could cause a domino effect, with other troubled banks unable to meet their obligations and failing. But it was unclear what we could do to stop that disaster. This was a dangerous situation and there weren’t any obvious answers.

We discussed taking preventive measures. The Fed was exploring options for flooding the market with liquidity, or, as Tim said, “putting foam on the runway.” But with conditions as fragile as they were, I questioned whether there was much we could do to stabilize the markets if Bear went down suddenly.

We agreed to confer again first thing in the morning. Tim said, “We’ll have our teams working all night.” His staff would drill down on what a Bear failure might mean to the infrastructure—the markets for secured loans, derivatives, and such that constituted the unseen but vital plumbing of finance. It would be the first of many nights during the crisis when teams at the Fed—or Treasury—would work through the night against excruciating deadlines to try to save the system.

I couldn’t sleep. I was hot and agitated. I tossed and turned. I couldn’t stop thinking about the consequences of a Bear failure. I worried about the soundness of balance sheets, the lack of transparency in the CDS market, and the interconnectedness among institutions that lent each other billions each day and how easily the system could unravel if they got spooked. My mind raced through dire scenarios.

All financial institutions depended on borrowed money—and on the confidence of their lenders. If lenders got nervous about a bank’s ability to pay, they could refuse to lend or demand more collateral for their loans. If everyone did that at once, the financial system would shut down and there would be no credit available for companies or consumers. Economic activity would contract, even collapse.

In recent years banks had borrowed more than ever—without increasing their capital enough. Much of the borrowing to support this increase in leverage was done in the market for repurchase agreements, or repos, where banks sold securities to counter-parties for cash and agreed to buy them back later at the same price, plus interest.

While many commercial banks had big pools of federally insured retail deposits to rely on for part of their funding, the investment banks were more heavily dependent on this kind of financing. Dealers used repos to finance their positions in Treasuries, federal agency debt, and mortgage-backed securities, among other things.Financial institutions could arrange the repos directly with one another or through a third-party intermediary, which acted as administrator and custodian of the securities being loaned. Two banks, JPMorgan and Bank of New York Mellon, dominated this triparty repo business.

The market had become enormous—with perhaps $2.75 trillion outstanding in just the triparty repo market at its peak. Most of this money was lent overnight. That meant giant balance sheets filled with all kinds of complex, often illiquid assets were poised on the back of funding that could be pulled at a moment’s notice.

This hadn’t seemed like a problem to most bankers during the good times that we’d enjoyed until the previous year. Repos were considered safe. Technically purchase and sale transactions, they acted just like secured loans. That is to say, repos were considered safe until the times turned tough and market participants lost faith in the collateral or in the creditworthiness of their counterparties—or both. Secured or not, no one wanted to deal with a firm they feared might disappear the next day. But deciding not to deal with a firm could turn that fear into a self-fulfilling prophecy.

A Bear Stearns failure wouldn’t just hurt the owners of its shares and its bonds. Bear had hundreds, maybe thousands, of counterparties—firms that lent it money or with which it traded stocks, bonds, mortgages, and other securities. These firms—other banks and brokerage houses, insurance companies, mutual funds, hedge funds, the pension funds of states, cities, and big companies—all in turn had myriad counterparties of their own. If Bear fell, all these counterparties would be scrambling to collect their loans and collateral. To meet demands for payment, first Bear and then other firms would be forced to sell whatever they could, in any market they could—driving prices down, causing more losses, and triggering more margin and collateral calls.

The firms that had already started to pull their money from Bear were simply trying to get out first. That was how bank runs started these days.

Investment banks understood that if any questions arose about their ability to pay, creditors would flee at wildfire speed. This is why a bank’s liquidity was so critical. At Goldman we had absolutely obsessed over our liquidity position. We didn’t define it just in the traditional sense as the amount of cash on hand plus unencumbered assets that could be sold quickly. We asked how much money, under the most adverse conditions, could disappear on any given day; if everyone who could legally request their money back did so, how short would we be and could we meet our obligations? To be on the safe side, we kept a lockbox at the Bank of New York filled with bonds that we never invested or lent out. When I was CEO at Goldman, we had amassed $60 billion in these cash reserves alone. Knowing we had that cushion helped me fall asleep at night.

Bear had started the week out with something like $18 billion in cash on hand. It now had closer to $2 billion. It couldn’t possibly meet demands for withdrawals. And in the morning, when the markets opened, no counterparties were going to lend to Bear: they’d all be pulling their money out. This would be bad news indeed, not just for Bear Stearns, but for every institution dealing with them.

No wonder I slept no more than a couple of hours that night. I had never had trouble before, but this night was the beginning of a prolonged bout of sleeplessness that would haunt me throughout the crisis, and particularly after September. On tough days, I would fall asleep exhausted around 9:30 p.m. or 10:00 p.m., then wake up several hours later and lie awake for much of the rest of the night. Sometimes I did my clearest thinking during these hours, occasionally getting up to write things down. By the time the newspapers were delivered at 6:00 a.m., I would have already been up for an hour or two, often turning on cable TV to check on overseas markets.

Friday, March 14, 2008

On Friday morning I had just shaved and was about to get in the shower when the phone rang. It was Bob Steel telling me that a conference call would start around 5:00 a.m. Still wearing the boxer shorts and T-shirt I slept in, I jogged up to the third-floor study of our house so I wouldn’t wake Wendy. On the line were Tim Geithner, Ben Bernanke, Kevin Warsh, and Don Kohn from the Fed; Tony Ryan and Bob Steel from Treasury; and Erik Sirri from the SEC. We waited at first for Chris Cox, who was standing by in his office but never came on because of a communications mix-up. For a few minutes, we plugged in Jamie Dimon, CEO of JPMorgan, Bear’s clearing bank. He painted a dark picture, emphasizing that a Bear Stearns failure would be disastrous for the markets, and that the key was to get Bear to the weekend.

Once Jamie got off, Tim reviewed a creative way he and his team had devised to buy time. The Fed would lend money to JPMorgan, which in turn would lend the money to the beleaguered brokerage firm. To make this work, the Fed’s loan would have to be non-recourse: it would be backed by collateral from Bear, but neither JPMorgan nor Bear would be liable for repayment.

By law the Federal Reserve can lend against assets only when the loan is secured to its satisfaction, meaning in practical terms that there is a minimal chance of the Fed’s losing money. But if this loan could not be repaid, for whatever reason, and the Fed had to sell the collateral for less than the value of the loan, the central bank would incur a loss. It would be a bold, unprecedented action for the Fed to make such a deal.

So Ben threw in a crucial caveat: “I’m prepared to go ahead here only if Treasury is supportive and prepared to protect us from any losses.”

To be honest, I wasn’t sure what, if any, legal authority Treasury might have had to indemnify the Federal Reserve, but I was determined to make it to the weekend. The repo markets would open shortly—around 7:30 a.m.—and I wasn’t about to drag in a lot of lawyers and debate any legal fine points now.

“I’m prepared to do anything,” I said. “If there’s any chance of avoiding this failure, we need to take it.”

First, though, I had to get off the line and speak with President Bush to confirm that he would sign off on the plan. Yes, he said, we had his support. But now he had to scramble. That day he not only had the speech in New York at the Economic Club but also a meeting with the editorial board of the Wall Street Journal, which was renowned for its free-market views and its opposition to government interference in the economy.

I told him not to worry; Steel was on top of the Bear situation in New York and could meet him on his arrival. I reiterated, with a touch of black humor: “Mr. President, you can take out that line in your speech about ‘no bailouts.’”

The president reworked his speech, and when he flew to New York, Steel was waiting at the Wall Street Heliport. He hopped in the presidential limousine and briefed the president on the way to Midtown, bringing him up to date on Bear.

I got back on the conference call to say we had the president’s backing. Afterward Tim and I spoke privately. We were rushing this rescue through very fast. The Board of Governors of the Federal Reserve had not yet formally approved the loan, and we had not yet put out an announcement. But the market was about to open, so we needed to move rapidly.

We asked ourselves again what would happen if Bear failed. Back in 1990, the junk bond giant Drexel Burnham Lambert had collapsed without taking the markets down, but they had not been as fragile then, nor had institutions been as entwined. Counterparties had been more easily identified. Perhaps if Bear had been a one-off situation, we would have let it go down. But we realized that Bear’s failure would call into question the fate of the other financial institutions that might share Bear’s predicament. The market would look for the next wounded deer, then the next, and the whole system would be at serious risk.

I talked to Tim probably two dozen times between Friday and Sunday. We made a good team. Tim brought to the crisis a keen analytical mind and a great sense of calm, of deliberative process and control. He had great stamina and a welcome sense of humor. But although we were relying on the Fed’s powers to deal with Bear Stearns, it was uncharted water for him, and he relied on my market knowledge and my familiarity with Wall Street. Tim knew I understood the thought processes and the strengths and weaknesses of the Wall Street CEOs. I understood how to deal with boards of directors and shareholders. I knew how extraordinarily difficult it was to buy a company over a weekend with no time for due diligence. I also knew what it felt like to be afraid of losing your company, because I’d had that fear in 1994 at Goldman Sachs, when big trading losses had caused many spooked partners to withdraw their capital.

Tim had already explained the government’s plan to Bear CEO Alan Schwartz, but he was worried that Alan hadn’t completely grasped the consequences. The government didn’t put taxpayer money at risk without expecting something in return—in this case, essentially, control.

“Let’s make sure he understands, Hank,” I remember Tim saying. “You need to speak to him with force and clarity so he hears it from you and not just me.”

When I reached Alan, he sounded rattled, but it was clear that he was doing his best. I had great sympathy for him. He was a good investment banker and a highly regarded adviser to companies who had been thrust into a terrible situation that did not play to his strengths. When I called, he’d been meeting with his board, which was a fractious group.

“Alan,” I said, “you’re in the government’s hands now. Bankruptcy is the only other option.”

“Tim said the same thing to me,” he said. “I was nervous because when you called I thought maybe the rules were changing. Don’t worry. I got the message.”

Just before 9:00 a.m., JPMorgan announced that it would join with the Fed to lend to Bear Stearns for an initial period of up to 28 days. The release did not specify how much money would be lent.

I almost never let myself be scripted. I work best by writing down a few bullet points and two or three key phrases to use. Still, in a conference call soon afterward with the CEOs of all the major banks, I knew I had to be careful—I couldn’t order these bankers to do anything. But I had to make clear that if they pulled their credit lines from Bear, the investment bank wouldn’t survive the day. I told them that I understood they all had fiduciary responsibilities, but that this was an extraordinary situation and the government had taken unprecedented action.

“Your regulators have worked together to come up with a solution. We ask you to act in a responsible manner,” I said. “All of us here are thinking about the system. Our goal is to keep Bear operating and making payments.”

The group asked a lot of questions about the Fed’s emergency backstop. Tim and I let Jamie Dimon answer most of these. The bankers were nervous but obviously relieved, which gave me some comfort that Bear would make it through the day.

Initially, Bear shares rallied, but it didn’t take long for the market to weaken. During the morning, Bear’s stock plunged nearly in half, to below $30. The broader markets fell sharply, too, with the Dow Jones Industrial Average off nearly 300 points. For the day, the dollar hit a then-record low of $1.56 against the euro, while gold soared to a new high of $1,009 an ounce.

Despite the backing of JPMorgan and the Fed, doubts remained about Bear’s ability to survive. Its accounts continued to flee, draining its reserves further. We needed to get a deal done by Sunday night, before the Asian markets opened and the bank run went global.

That afternoon during a meeting on our housing initiatives, I asked Neel Kashkari if he was going to be around during the weekend, because we might need help on Bear. Neel said: “I have to imagine I’d be more useful to you in New York than sitting next to you in D.C.”

I agreed, but before he took off I said, “I am sending you to do something you are totally unqualified to do, but you’re all I’ve got.” I could always rib Neel because he was talented and self-confident.

He laughed. “Thanks, I guess.”

I called Jamie Dimon at 4:30 p.m. and told him we needed to get the deal done by the end of the weekend. Self-assured, charismatic, and quick-witted, Jamie had the ability to walk the line between being a tough businessman and knowing when to rein in his competitive instincts for the good of the financial system. He had the confidence of his board, which allowed him to make decisions quickly and stand by them. He said his team would move as fast as possible, but he knew better than to give me any guarantees.

President Bush had returned to Washington after his speech in New York and wanted an immediate briefing on Bear Stearns. When was JPMorgan going to buy the company? he asked. I told him I didn’t know, but I emphasized that something had to happen over the weekend or we would be in trouble.

In New York, Tim Geithner was growing increasingly concerned. After talking with Schwartz, he suspected that the Bear CEO didn’t realize that the day’s events had so compromised his firm that the timetable had to be accelerated. Schwartz, he said, was still operating under the illusion that he had a month to sell the company.

Tim suggested that he and I call Schwartz. “I think it will have a bigger impact if we do it together,” he said. We reached him at about 6:30 p.m. and told him we had to act faster.

“Why don’t we have more time?” Alan asked.

“Because your business isn’t going to hold together,” I explained. “It will evaporate. There will be nothing left to lend against if you don’t have a deal by the end of the weekend.”

After that difficult call, Tim and I agreed there was nothing else we could do that night. We agreed to talk in the morning.

That evening Wendy and I went to the National Geographic Society to see The Lord God Bird, a terrific documentary on the ivory-billed woodpecker, a bird so spectacular it made people say Lord God! Normally, I would have enjoyed this immensely, but I was preoccupied with Bear Stearns. Every time one of our friends from the environmental community came over, I would look right through them. Wendy got really upset with me.

“I understand that you’re under pressure,” she said, “but that’s no excuse for not being courteous to people.”

“I am being courteous to everyone,” I protested.

“You aren’t saying anything to them except ‘Hi.’”

I apologized, adding, “I’m worried about the world falling apart!”

Saturday, March 15, 2008

I woke up Saturday after another restless night, anxious about the need to find a solution for Bear Stearns that weekend. The first call I received was from Lloyd Blankfein, my successor as Goldman Sachs CEO. It was as unnerving as it was unexpected. It was the first, and only, time Lloyd called me at home while I was at Treasury. Lloyd went over the market situation with me, providing a typically analytical and extraordinarily comprehensive overview, but I could hear the fear in his voice. His conclusion was apocalyptic.

The market expected a Bear rescue. If there wasn’t one, all hell would break loose, starting in Asia Sunday night and racing through London and New York Monday. It wasn’t difficult to imagine a record 1,000-point drop in the Dow.

I talked to Tim Geithner shortly after, and we reviewed our plan for the day. We needed a buyer for Bear, and we agreed that JPMorgan was far and away our best candidate. We decided to speak with Jamie Dimon and Alan Schwartz throughout the day to press them to make sure their boards were actively engaged and getting the information they needed to conclude a deal by Sunday afternoon.

Under normal circumstances, I would have preferred to find multiple potential bidders to at least create the semblance of competition. But I didn’t believe there was another buyer for Bear Stearns anywhere in the world—and certainly not one that could get a deal done in 36 hours. Nonetheless, we considered every possibility we could.

Tim asked about Chris Flowers, the private-equity investor who had expressed interest in Bear Stearns. I’d known Chris for years. He’d been in charge of financial institutions’ banking at Goldman before striking out on his own. But I knew he didn’t have the balance sheet necessary to do a deal, and I told Tim it would be a waste of time to deal with Flowers. Seth Waugh, the North American head of Deutsche Bank, had also expressed some interest. I said I’d call Joe Ackermann, the Deutsche Bank CEO, but added that based on many conversations I’d had with him over the last seven months, I doubted he’d have any real interest. Joe had enough problems of his own.

The Swiss-born Ackermann was one of the most direct men I knew, a relentless competitor who was unafraid to exploit the perceived weakness of his rivals. He happened to be walking down Madison Avenue in New York when I reached him on his cell phone. True to form, he answered me with breathtaking bluntness.

“Buy Bear Stearns? That’s the last thing in the world I would do,” he exclaimed. He added that he had no interest in financing Bear, either. He’d held his funding together so far and had been a good corporate citizen, but he couldn’t continue. Then he asked me why Deutsche should do business with any U.S. investment bank.

This was not competitive zeal but fear speaking, and I was surprised by the level of worry I heard. I assured him that he didn’t need to be concerned about the other U.S. investment banks and that we were dealing with Bear.

Shuttling between JPMorgan’s and Bear’s offices—across the street from each other—Neel Kashkari gave me updates on the big bank’s due-diligence efforts. With me frequently patched in by phone, the teams labored in New York to push a deal along. I also talked to people in the industry to keep them in line. Lehman CEO Dick Fuld called me back from an airport in India, where he was on a business trip. Worried about his own firm, he asked if the situation was serious enough that he should come home.

“I sure wouldn’t be overseas right now,” I told him.

He asked if I could get him flyover rights from Russia. I explained that I didn’t have that kind of power, but emphasized that he should return.

All Saturday when Tim and I spoke to Jamie Dimon, the JPMorgan CEO would say things like: “We’re making progress. We’re optimistic, but there’s a lot of work.” It was nerve-wracking not to have an alternative. Finally, late in the day, we had an encouraging conversation with Jamie, during which it sounded as though he were going to do the deal—he just needed to work out a few more things with his board.

We left it with Jamie that he would continue to work with his directors. If there was a problem, he would get back to Tim first thing in the morning. Otherwise, we would talk a little later on Sunday. I slept well for the first time in days.

Sunday, March 16, 2008

The next morning I was booked on several Sunday talk shows to answer questions about the rescue. I spoke to Tim first thing. Neither of us had heard a word from Jamie, which was good news. I left for the TV studios around 7:30 a.m., making a mental note not to say a word about the negotiations and to stick to my carefully prepared talking points. I taped ABC’s This Week first. The host, George Stephanopoulos, zeroed in on what was on the public’s mind, asking whether we weren’t using taxpayer dollars to bail out Wall Street.

“We’re very aware of moral hazard,” I said, adding, “My primary concern is the stability of our financial system.”

“Are there other banks in a situation similar to Bear Stearns’s right now?” he wanted to know. “Is this just the beginning?”

“Well, our financial institutions, our banks and investment banks, are very strong,” I stressed. “Our markets are resilient, they’re flexible. I’m quite confident we’re going to work our way through this situation.”

And I was. In retrospect, as concerned as I was about the markets, I had no idea of what was coming in just a few months. Right then, however, I was optimistic that Jamie was on board, that we could settle the Bear Stearns problem and calm things down. But what I didn’t realize as I went from one show to another—after This Week, I was interviewed by Wolf Blitzer at CNN and Chris Wallace at Fox News—was that the situation had taken a turn for the worse. Neel had called Brookly McLaughlin, my deputy press secretary, with bad news. Brookly, who had accompanied me to the shows, wanted me to stay focused on the interviews, so it wasn’t until I was headed home, after 10:00 a.m., that she told me that there was a problem and asked me to contact Neel. He said JPMorgan wasn’t willing to proceed. I called Tim.

“It’s too much of a stretch for them,” Tim said.

JPMorgan thought Bear was too big and was particularly concerned with the firm’s mortgage portfolio. I was disappointed but not shocked. It was a bit unrealistic to believe that with no competition we could get JPMorgan to buy Bear Stearns over a weekend in the midst of a credit crisis. And Tim had already pushed Jamie to no avail.

We discussed how we could put some pressure on Jamie. We agreed that the best course would probably be to find a way to enable JPMorgan to buy Bear with some help from the Fed.

So I called Jamie and told him we needed him to buy Bear. And, as always, he was straightforward and said that it would be impossible.

“What’s changed?” I pressed. “Why aren’t you interested now?”

“We’ve concluded it’s just too big. And we’ve already got plenty of mortgages ourselves,” he said. “I’m sorry. We can’t get there.”

“Then we need to figure out under what terms you would do this,” I said, changing tack. “Is there something we can work out where the Fed helps you get this deal done?”

Jamie’s tone changed. “I’ll see what I can do,” he said, promising to get back to us quickly.

I called Tim back, and we vowed to provide as little government assistance as possible for JPMorgan to acquire Bear. But we would have to find some way to eat what got left behind.

I set myself up on my living room couch with a pad of paper and a can of Diet Coke. Our house is perched on an incline with a small stream at its base. Looking out through the sliding doors into a thicket of trees, bare and forlorn in March, I worked the phones, talking with Tim and Neel constantly. Together Tim and I would check in with Jamie and others. We needed to get this deal done.

Jamie soon said he was willing to buy Bear, but there were several big issues to resolve. JPMorgan didn’t want any of Bear’s mortgage portfolio, which was on the investment bank’s books for about $35 billion. The question wasn’t quality so much as size. The bank had reasons to keep its powder dry; we knew that it had an interest in acquiring Washington Mutual, which was looking to shore up its capital. So it was pretty clear that JPMorgan wasn’t going to buy Bear without government help for the mortgage assets.

The Fed eventually concluded that it could assist in the deal by financing a special purpose vehicle that would hold and manage those assets of Bear’s that JPMorgan didn’t want. The loan to this entity would be nonrecourse, which brought back Friday morning’s dilemma: the Fed could find itself facing losses, and it would want indemnification. I had our legal team, led by general counsel Bob Hoyt, looking into exactly what we could do. The Fed had brought in BlackRock, a fixed-income investment specialist, to examine the mortgage portfolio, which JPMorgan wanted priced as of the previous Friday.

We kept an open conference line linking Washington, the New York Fed, and JPMorgan. I got hold of Neel in a JPMorgan conference room and asked him to step out and call me privately.

“Neel,” I said, “your job is to protect us. These guys will be incentivized to dump all sorts of crap on us. You need to make sure that doesn’t happen. Make sure we know what we are getting.”

Because the Fed could only take dollar-denominated assets, the pool shrank, and when we were somewhere in the $30 billion range, we had the outlines of a deal. Still, no price had been determined for Bear Stearns’s shares. Tim told me JPMorgan was considering offering $4 or $5 per share, but that sounded like too much to me, and Tim agreed. Bear was dead unless the government stepped in. How could the firm come to us, say they would fail without government help, and then have any sort of payday for its shareholders? With Tim’s encouragement, I called Jamie, who put me on the speakerphone.

“I understand you’re talking $4 or $5 per share,” I said. “But the alternative for this company is bankruptcy. How do you get so high?”

“They should get zero, but I don’t know how you get a deal done if you do that,” he said.

“Of course, you’ve got to pay them something to get them to vote,” I said. “It would have to be at least $1 or $2.”

I stressed that the decision on price was JPMorgan’s. It wasn’t my place to dictate terms. And I knew that whatever deal was announced, there was a good chance it would need ultimately to be increased because the required shareholder vote would give Bear leverage. But better to start from a lower price.

JPMorgan decided to offer $2 a share.

Meantime, as we raced to save Bear, we saw an opportunity to take a positive step with Fannie Mae and Freddie Mac. The market’s weakness ultimately stemmed from housing troubles, and they were right in the center of that. A negative Barron’s cover story the previous weekend had hit them hard.

Why not use the crisis to our advantage? Tim and I believed some positive news from Fannie and Freddie might help the market. I called Bob Steel and asked him to arrange a conference call with the GSEs and their regulator, OFHEO, to nail down an agreement he had been working on. Steel, on the fly, rounded up Fannie Mae CEO Dan Mudd, Freddie Mac CEO Richard Syron, and OFHEO chief Jim Lockhart, and we jumped on a conference call for about half an hour beginning at 3:00 p.m.

Fannie and Freddie were operating under a consent order temporarily requiring 30 percent more capital than mandated by federal statute. They were pressing to have this surcharge removed early. To get them to raise more capital—which we felt they sorely needed—Steel and Lockhart had for weeks been pushing a deal: for every $1.50 to $2 of new capital the GSEs raised, OFHEO would reduce the surcharge by $1.

I had no time to waste, so I began the call by saying we were expecting to get a deal done on Bear Stearns and that we wanted an agreement from the GSEs to help calm the market. Steel had done his work well, and we quickly hammered out an agreement that, we estimated, would lead each firm to raise at least $6 billion. We calculated that this, in turn, would translate into $200 billion in much-needed financing for the sagging mortgage market. We agreed to make the announcement as soon as possible. (It was made on March 19.)

After this, Tim and I spoke with Jamie to review the terms before he went to his board for approval. The deal featured a $2-a-share offer from JPMorgan and a $30 billion loan from the New York Fed secured by Bear’s mortgage pool. We all knew that the complexity of the deal—from its structure and legal documentation down to the specifics of how the mortgage portfolio would be managed—meant that all the details could not be nailed down formally before Asia opened. We would have to announce a deal on the basis of a “verbal handshake” that required trust and sophistication on both sides. And we could only have done that with a CEO like Jamie Dimon, who was technically proficient, deeply self-assured, and had the support of his board.

The short call was over by 3:40 p.m., and Jamie went off to talk to his directors.

I got on a call with the president and Joel Kaplan to give them a heads-up on our progress.

“Hank,” the president asked, “have you got it done?”

“Almost, sir,” I said. “We still need to get board approval from both companies.”

I explained the $30 billion loan and how the Fed wanted indemnification against loss from the Treasury, adding that the Fed would essentially own the mortgages.

“Can we say we are going to get our money back?”

“We might, but that will depend upon the market.”

“Then we can’t promise it. A lot of folks aren’t going to like this. You’ll have to explain why it was necessary.”

“That won’t be easy,” I said.

“You’ll be able to do it. You’ve got credibility.”

While I was speaking, Wendy motioned to me. She had answered our other line and was saying: “Neel needs to talk with you urgently.”

After finishing with the president’s call, I got on with Neel, who had Bob Hoyt patched through to me.

“We can’t do this,” Bob said. He quickly explained that the Anti-Deficiency Act barred Treasury from spending money without a specific congressional allocation, which we didn’t have. Hence, we couldn’t commit to indemnifying the Fed against losses.

“My God,” I said. “I just told the president we have a deal.”

I immediately alerted Tim that I had just learned of a problem.

He was surprised and angry. “Hank, you’ve made a commitment. You need to find some way to meet it.”

I called Hoyt back. “Come up with something,” I told him.

Bob is a great lawyer and a can-do guy. Before coming to me he had spent hours trying out a couple of imaginative, outside-the-box theories and had run them by the Department of Justice. The lawyers concluded that their ideas wouldn’t survive the third question at a congressional oversight hearing.

Finally, when Tim understood that we didn’t have the power to do any more, we figured out a compromise. The Fed’s $30 billion loan was based on a provision in the law that gave it the authority, under what is called “exigent circumstances,” to make a loan—even to an investment bank like Bear Stearns—provided it was “secured to the satisfaction of the Federal Reserve bank.” Over the course of the afternoon, BlackRock’s CEO, Larry Fink, had assured Tim and me that his firm had done enough work on the mortgages to provide the Fed with a letter attesting that its loan was adequately secured, meaning the risk of loss was minimal. So what the Fed really needed from the executive branch was political—not legal—protection.

Since Treasury couldn’t formally indemnify the Fed, we agreed that I would write a letter to Tim commending and supporting the Fed’s actions. I would also acknowledge that if the Fed did take a loss, it would mean that the Fed would have fewer profits to give to the Treasury. In that sense the burden of the loss would be on the taxpayer, not the Fed.

I called this our “all money is green” letter. It was an indirect way of getting the Fed the cover it needed for taking an action that should—and would—have been taken by Treasury if we had had the fiscal authority to do so. Hoyt started drafting the letter immediately. As it turned out, we were still hashing out the details a week later.

We had heard back from Jamie just before 4:00 p.m. that the JPMorgan board had approved the deal. Now we had to wait to hear from Bear, and I admit I was nervous. Even as our earlier call with Jamie had wound down, I had begun to worry about the Bear Stearns board. What if they decided to be difficult? If they threatened to choose bankruptcy over JPMorgan’s deal, as irrational as this might appear, they would have leverage over us. Though I thought this unlikely, I became anxious as the minutes ticked by without an answer from Bear. Finally, at 6:00 p.m., the Bear board approved the deal.

The Wall Street Journal broke the story of the Bear Stearns– JPMorgan deal online Sunday evening. JPMorgan would buy Bear for $2 per share, or a total of $236 million (it had been valued at its peak, in January 2007, at about $20 billion). If a shareholder vote failed to approve the transaction, the deal would have to be put to a revote by the shareholders within 28 days—a process that could go on for up to six months. This revote measure was intended to give the market certainty that the deal would ultimately close even if the Bear shareholders balked at the $2 a share. As part of the deal, the Federal Reserve Board would provide a $30 billion loan to a stand-alone entity named Maiden Lane LLC that would buy Bear’s mortgage assets and manage them.

The Fed board also approved a Primary Dealer Credit Facility (PDCF), which opened the discount window to investment banks for the first time since the Great Depression. We had been discussing this over the weekend, and it was a critical move. We hoped that the market would be comforted by the perception that the investment banks had come under the Fed umbrella.

That night we convened another call with financial industry CEOs. Jamie Dimon led off the call by saying, “All of your trading positions with Bear Stearns are now with JPMorgan Chase.”

This was a crucial element to the deal. JPMorgan would guarantee Bear’s trading book—meaning it would stand behind any of its transactions—until the deal closed. This was exactly the assurance the markets needed to keep doing business with Bear.

Tim spoke, and then I addressed the group. I noted that the Fed had taken strong actions to stabilize the system and asked for their help and leadership. “You need to work together and support each other,” I remember saying. “We expect you to act responsibly and avoid behavior that will undermine market confidence.”

“What happens if the shareholders don’t vote for it [the deal], but we’re still acting responsibly, like you ask?” Citigroup CEO Vikram Pandit asked. “Is the government going to indemnify us?”

It was exactly the right question, but neither Jamie Dimon nor, for that matter, any of the rest of us were in a mood to hear it.

“What happens to Citigroup if this institution goes down?” Jamie snapped. “I’ve stepped up to do this. Why are you asking these questions?”

With JPMorgan on board, Bear’s liquidity—and solvency—were no longer at issue. Asia sold off Sunday night, but the London and New York markets held steady on Monday.

Nonetheless, despite Joe Ackermann’s blunt warning to me on Saturday, I had underestimated the recent loss of confidence in U.S. investment banks, particularly in Europe. I had asked David McCormick, the undersecretary for international affairs, to brief the staffs of the finance ministries in Europe on the Bear rescue and the strong U.S. response. But on Monday night, David asked me to make the calls because, he said, the Europeans were so scared. On Tuesday I spoke with several of my European counterparts—Alistair Darling from the U.K., Christine Lagarde from France, Peer Steinbrück from Germany—to explain our actions and to ask for their support.

It was quite an eye-opener. I frankly had been disappointed at the negative attitudes of some of the European banks, and I had hoped my counterparts would encourage their banks to be more constructive. I could now see there was no way they would do that. They were understandably shocked by Bear.

And of course, the deal was hugely controversial in the U.S. Although plenty of commentators thought it was a brilliant, bold stroke that saved the system, there were just as many who thought it outrageous, a clear case of moral hazard come home to roost. They thought we should have let Bear fail. Among the prominent members of this camp was Senator Richard Shelby, who said the action set a “bad precedent.”

To be fair, I could see my critics’ arguments. In principle, I was no more inclined than they were to put taxpayer money at risk to rescue a bank that had gotten itself in a jam. But my market experience had led me to conclude—and rightly so, I continue to believe—that the risks to the system were too great. I am convinced we did the best we could with what we had. It’s fair to say we underestimated the speed with which the Bear Stearns crisis arrived, but we realized pretty quickly the limitations on our statutory powers and authorities to deal with the trouble that came our way. In the next week we redoubled our efforts to finish our work on the new regulatory blueprint that we were planning to unveil at the end of the month.

But the debate about the rescue was beside the point. For all the headlines and noise, we didn’t actually have a finished deal. We had announced a transaction that the market initially wouldn’t accept because it wanted certainty and wanted it quickly.

However, in the end, it still came down to price. Many Bear Stearns shareholders—and employees owned about one-third of the company—were incensed at what they saw as a lowball offer. After all, shares had traded for almost $173 in January 2007, and shareholders had lost billions of dollars. I felt sympathy for them, and I could understand their anger. On the other hand, the only reason the company had any value at all was because the government had stepped in and saved it.

By and large, traders in the marketplace, and many commentators in the financial press, agreed that the price was too low. On Monday, Bear shares traded at $4.81—more than twice JPMorgan’s $2 offer—in expectation that JPMorgan would have to offer more to be sure to close the deal.

This created real uncertainty, which wasn’t good for anyone. Not for Bear, not for JPMorgan, and not for the markets, which were settling down. The Dow jumped 420 points on Tuesday, and credit insurance rates on financial companies fell away sharply: Bear’s CDS dropped from 772 basis points on Friday to 391 basis points on Tuesday, while those on Lehman fell from 451 basis points to 310 basis points and Morgan Stanley from 338 basis points to 226 basis points. We certainly didn’t want to return to the previous week’s tumultuousness.

JPMorgan understandably wanted to get the deal closed as soon as possible. As long as there was uncertainty, clients would continue to leave Bear Stearns, reducing the value of the acquisition. Why would a prime brokerage account or any other account want to stay when they could do business with any other bank or investment bank in the world?

Toward the end of the week, the deal looked like it was in danger of breaking apart. After talking to Alan Schwartz on Friday, March 21, Jamie was concerned that Bear could shop for another buyer and leave JPMorgan on the hook. Worried what might happen if shareholders did turn down his offer, Jamie wanted to be sure he could lock in enough votes to assure acceptance.

On Friday afternoon, I had a conference call with Tim Geithner, Bob Steel, Neel Kashkari, and Bob Hoyt in my office. We were on edge. We knew that the deal was far from certain, but we had no choice but to complete it.

The key was to deliver certainty. JPMorgan could raise its offer, but the bank and the market needed to be sure that at a higher price, Bear shareholders couldn’t hold up the deal in an attempt to get even more.

Sweetening the deal to lock in shareholder approval made sense, but it gave me another idea. “We should also try to get more for the government,” I said to Tim.

He agreed and pointed out that we had some leverage we could use. “They can’t change the deal unless we let them,” Tim said. “Our commitment is based upon the whole deal.”

“Maybe we can now get JPMorgan to take all the mortgages without government support,” I suggested.

But neither Tim nor I could get Jamie to agree. However, he did accept that with the Bear shareholders getting a higher price and JPMorgan’s shares up on news of the acquisition, the government deserved a better deal, too.

The question now was how to improve the U.S.’s position. There was a whole lot of discussion and turning in circles about whether we should try to share in the upside—by taking an interest in the mortgage assets so that if they were sold above their appraised value, we could participate in the gains. But in the end it was clear to everyone that negotiating downside protection for the taxpayer was the more prudent course. So JPMorgan agreed to take the first $1 billion loss on the Bear portfolio.

Meantime, the lawyers on both sides had restructured the deal to give JPMorgan the certainty it needed and Bear shareholders a boost in price. As part of the agreement, JPMorgan would exchange some of its shares for newly issued Bear Stearns stock that would give JPMorgan just under 40 percent of Bear’s shares. This arrangement came close to locking up the transaction.

The key to the share exchange was price. By Sunday, JPMorgan was ready to offer Bear stockholders $10 a share to close the deal. When I heard that Tim had signed off on $8 to $10, I wanted to go back and say, “Don’t go above eight.”

But Ben Bernanke said, “Why do you care, Hank? What’s the difference between $8 and $10? We need certainty on this deal.”

I realized that he was right. Even though it was an unseemly precedent to reward the shareholders of a firm that had been bailed out by the government, I knew that getting a deal done was critical. Bear had continued to deteriorate in the past week and had the capacity to threaten the entire financial system. So I called Jamie Dimon and gave him my blessing. Bear’s shareholders would vote on May 29 to approve, overwhelmingly, the $10-a-share offer.

I’ve read through old newspaper reports and recently published books about the Bear weekend. None of them quite captures our race against time or how fortunate we were to have JPMorgan emerge as a buyer that agreed to preserve Bear’s economic value by guaranteeing its trading obligations until the deal closed. We knew we needed to sell the company because the government had no power to put in capital to ensure the solvency of an investment bank. Because we had only one buyer and little time for due diligence, we had little negotiating leverage. Throughout the process, the market was determined to call our bluff. Clients and counterparties were going to leave; Bear was going to disintegrate if we didn’t act. And even though many people thought Jamie Dimon had gotten a great deal, the Bear transaction remained very shaky to the end.

We learned a lot doing Bear Stearns, and what we learned scared us.