Henry Paulson - On the Brink - Inside the Race to Stop the Collapse of the Global Financial System

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.