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

Considering the day’s horrific numbers, I realized two things: One, if it didn’t close its deal with Mitsubishi UFJ, Morgan Stanley was dead. Two, we would have to work through the weekend to get the capital program going. The markets would not be satisfied by general statements and encouraging words. We needed to show real action—and fast.

Fortunately, I was making progress with Sheila on the bank guarantee. After a couple of conversations, she had sent over a good proposal, and we were nearly there. She was prepared to guarantee new liabilities, not existing ones.

But we needed Sheila to stretch further. She wanted to guarantee the debt only of banks, not of bank holding companies, and she wanted to limit coverage to 90 percent of the principal. But many of these institutions issued most, if not all, of their debt at the holding company level. A guarantee would allow them to roll existing paper into more-secure longer-term debt and gain some breathing room. Sheila was concerned that the breadth of the holding company guarantee would increase the risk to her fund. We argued that this view was too narrow. If the big banks’ holding companies defaulted on their unsecured debt, the stress on the entire banking system would be enormous, leaving her with the very same unattractive choices that she was trying to avoid.

Early the next morning President Bush met with the G-7 finance ministers and central bankers at the White House. This was a great gesture. The president had never attended, or participated in, a G-7 event before, but he had a gift for setting people at ease, and he was warm and friendly, speaking with bracing humility and frankness.

“This problem started in America, and we need to fix it,” he said. He talked about going back to his hometown of Midland, Texas, where people would ask why he was bailing out Wall Street. He didn’t like it any better than they did, but he said he had answered: “We have to do it to save your jobs.” Now he told the finance ministers and central bankers that he wanted to fix the problem while he was still president, to make things easier for his successor, regardless of who that was.

The president’s directness clearly pleased the group in the Roosevelt Room; we followed him to the Rose Garden and stood behind him as he delivered a short speech acknowledging the severity of the crisis and outlining the government’s efforts to solve it.

While I spent the day on phone calls and one-on-one meetings with finance ministers, the Treasury team plugged away on the capital purchase program. At 3:00 p.m. I met in the large conference room with Ben, Joel Kaplan, Tim Geithner, and my Treasury people. Tim had come to Washington Friday evening at my request—not in his capacity as head of the New York Fed, but as a superb organizer who would work with Treasury and help us put forward some specific proposals.

Sheila was there as well. As we worked to finalize the FDIC debt guarantee, she had begun to push for another new guarantee, this one of bank transaction accounts, the non-interest-bearing accounts companies keep.

These were radical steps—ones that I would never have considered in other times—but we needed action this weekend. Tim was visibly impatient, and I felt a great sense of urgency. I pushed so hard during the meeting that afterward, both Kaplan and Jim Wilkinson took me aside and said I was moving too fast. These steps needed to be analyzed more carefully, and they felt my approach had discouraged dissent. I told them that if I had waffled one bit, we wouldn’t have a program to debate.

To be frank, I hated these options, but I didn’t want to preside over a meltdown. I asked Tim to lead the group in developing programs we could implement immediately, and, typically, he rolled up his sleeves and dug right in. We also asked David Nason, who had the most thorough knowledge of bank guarantees at either the Fed or Treasury, to act as devil’s advocate on the plan to ensure a thorough vetting.

Shortly after the meeting, Dave McCormick and Bob Hoyt came into my office. Dave said, “We’re having trouble buttoning down the Morgan Stanley situation with the Japanese. I think Mitsubishi still wants to make the investment, but they are going to need more assurance.” McCormick had been talking with representatives of Mitsubishi UFJ and the Japanese government to let them know we were watching the situation closely. He’d learned that the Japanese bank was worried that if the U.S. bought equity in Morgan Stanley, we would dilute its investment. It was a reasonable concern, and he had indicated that Treasury would structure any subsequent investment to avoid punishing existing investors. Dave and Bob suggested writing a note on Treasury letterhead to reassure the Japanese.

The G-20 summit wouldn’t take place for another month, but we had asked its members to meet in Washington that weekend to discuss the financial crisis. At 6:00 p.m. these finance ministers and central bankers met at IMF headquarters, a few blocks from the White House. I made the first presentation, striving to be direct and humble about our failings, while emphasizing the very positive outcome at the G-7 and the U.S.’s commitment to fixing our problems. Jean-Claude Trichet followed me and echoed the success of the G-7.

I left the room for a few moments, and as Guido Mantega delivered his prepared remarks, I surprised everyone by striding back into the room accompanied by President Bush. It was astonishing for a U.S. president to drop in like that on a group of finance ministers and central bankers. Mantega paused to let the president speak.

As he had that morning, the president acknowledged America’s role in the problems we faced, adding, “Now is the time to solve this crisis.” Then he stepped aside to let Mantega resume. The Brazilian minister said, “If you don’t mind, I’m going to speak in Portuguese, my native language.”

President Bush replied, “That’s okay, I barely speak English.”

The group laughed appreciatively, and I knew the surprise visit had been a good idea. People needed to be reassured of our resolve, and the president had done just that in his own disarming way.

When I got home, Wendy told me Warren Buffett had been trying to reach me. I intended to get back to him right after dinner, but I could barely keep my eyes open and went straight to bed afterward, falling into a deep sleep. When the phone rang later that evening, I fumbled to pick it up.

“Hank, this is Warren.”

In my grogginess, the only Warren who came to mind was my mother’s handyman, Warren Hansen. Why is he waking me up? I thought, before realizing it was Warren Buffett on the other end of the line.

Warren knew I was working on a capital program, and he had an idea. We had been struggling with the issue of pricing. We needed to protect the taxpayer while encouraging a broad group of banks to participate; our objective was not to support particular institutions but the entire system, which was undercapitalized. Warren suggested asking for a 5 or 6 percent dividend to start on the preferred shares, then raising the rate later.

“The government would make money on it, it would be friendly to investors, and then you could step up the rate after a few years to encourage the banks to pay back the government,” he explained.

I fought back my exhaustion and sat for a half hour or so in the dark on a chair in my bedroom, mulling over this idea. I knew, of course, that as an investor in financial institutions, including Wells Fargo and Goldman Sachs, Warren had a vested interest in this idea. But the truth was I was looking for an approach just like his: an investor-friendly plan that would protect the taxpayer and stabilize the banking system by encouraging investments in healthy institutions. Considering two-tier structures similar to Warren’s, my team had been leaning toward a 7 or 8 percent dividend. But as I went back to sleep, I was convinced Warren’s was the best way to make a capital purchase program attractive to banks while giving them an incentive to pay back the government.