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

Columbus Day was a holiday for many Americans, and it brought good news to the tired teams at Treasury. Mitsubishi UFJ and Morgan Stanley had finally completed their deal. The terms had been adjusted to reflect a lower value for the U.S. bank. For its investment, Mitsubishi UFJ would now receive convertible and nonconvertible preferred stock, giving it 21 percent of Morgan Stanley’s voting rights. Previously Mitsubishi UFJ would have acquired common and preferred. That morning a check for $9 billion was hand-delivered to the New York investment bank.

Europe delivered its own share of encouraging news. Anticipating our actions, leaders of the 15 euro-zone countries had agreed late Sunday night to a plan that would inject billions of euros into their banks through equity stakes; they also vowed to guarantee new bank debt through 2009. Monday morning, the U.K.’s FTSE 100 shot up nearly 325 points, or 8.3 percent, while German and French markets rose more than 11 percent. The three-month London interbank rate dropped 7 basis points to 4.75 percent, while the LIBOR-OIS spread narrowed slightly to 354 from Friday’s 364, reversing a monthlong steadily upward trend.

Before the London markets opened on Monday the U.K. government had effectively nationalized the Royal Bank of Scotland and HBOS, injecting billions of pounds of capital and taking seats on the banks’ boards. The U.K. program came with much greater government control and stiffer terms than ours: the British government fired the banks’ top executives, froze bonuses for executives, and imposed a 12 percent dividend on its preferred stock.

As a result, the U.K.’s biggest banks and healthiest banks—HSBC, Barclays, and Standard Chartered—all turned down the capital. We did not want that to happen in the U.S. To the contrary, we designed our plan to entice banks so that the broadest possible range of healthy institutions would accept capital.

Before the U.S. markets opened, Treasury staff and I sat down with General Motors CEO Rick Wagoner and a number of his executives, who hoped to get some government money for their struggling company. Rick had been calling me, trying to set up a meeting for some time, but I had declined to do so. I believed that TARP was not meant to bolster industrial companies but to prevent a collapse of the financial system. Commerce secretary Carlos Gutierrez attended the meeting in my office.

No one questioned that America’s automakers were in trouble. On September 30, President Bush had signed a $25 billion loan package to help the Big Three build cars that would meet federal fuel economy standards. Reports had recently surfaced that General Motors and Chrysler were discussing a merger.

Now the GM contingent brought dire news that the company faced a banklike run from creditors and suppliers who had not been paid on a timely basis. This liquidity squeeze, they contended, would result in GM’s failure—right, as it turned out, around the time of the presidential election. They were looking for a total of $10 billion: a $5 billion loan and a $5 billion revolving line of credit.

“We need a bridge loan to avoid a disaster and we need it quickly,” Wagoner said. “I don’t believe we can make it past November 7.”

He and his team may have sincerely believed this, but I knew better. I had worked with companies like GM long enough to know that they did not die quickly. A financial institution could go under immediately if it lost the confidence of creditors and clients, but an industrial company could stretch out its suppliers for quite a while. In any case, I was loath to do anything that might appear to reflect politics.

I told Wagoner that we took his situation very seriously but that he should continue to work closely with Carlos. “I have no authority to make a TARP loan to General Motors,” I said.

As soon as the GM delegation left, we went into high gear to prepare for the afternoon meeting with the banking CEOs. I was concerned about Jamie Dimon, because JPMorgan appeared to be in the best shape of the group, and I wanted to be sure he would accept the capital. I asked Tim to soften Jamie up ahead of time. To my relief, Tim had already done so, soliciting Jamie’s support without briefing him on our program. Jamie, he believed, would back us. The government principals—Ben, Tim, Sheila, John Dugan, and I—met one final time to go over the plan, deciding who would say what.

When the nine bankers arrived at Treasury for the 3:00 p.m. meeting—walking up the Treasury steps past a phalanx of TV cameras and photographers—we had our plan down cold. Once inside, they were directed to my large conference room. I’d had so many meetings in this room that its splendor and idiosyncrasies—the 19th-century furniture and chandeliers, the framed currency and tax seals on the oiled walnut walls—had become almost as familiar as my living room. But I wondered if our visitors found it strange to be working out 21st-century problems in such a historic setting and beneath the portraits of George Washington and Abraham Lincoln.

We took our seats at the long table, with Ben, Sheila, Tim, John, and me on one side, and the CEOs sitting across from us, arranged alphabetically by bank. Fortunately, given their dispute over Wachovia, this meant that Citi’s Pandit and Wells’s Kovacevich were at opposite ends of the table.

The men facing us constituted the top echelon of American banking, but their circumstances varied. Some, like Dimon and Kovacevich, represented comparatively strong institutions, while Pandit, John Thain, and John Mack had been struggling with losses and an unforgiving market. But I knew that even the strongest of them had to be worried about their futures—and they needed to realize that they were all in this together.

I opened the meeting, making clear that we had invited them there because we all agreed that the U.S. needed to take decisive action. Together, they represented a significant part of our financial system and thus had to be central to any solution.

I briefly described the use of the systemic risk exception to guarantee new senior debt, and the Treasury’s $250 billion capital purchase program. And I pointed out that we wanted them to contact their boards and confirm their participation by that evening.

“We plan to announce the program tomorrow,” I said, adding that we wanted to say publicly that their firms would be the initial participants.

When I was done, Ben emphasized how important our program was to stabilizing the financial system. Sheila explained the Temporary Liquidity Guarantee Program (TLGP), addressing issues of structure, pricing, and what types of debt would qualify. The FDIC, she said, would guarantee new unsecured senior debt issued on or before June 30, 2009, and would protect all transaction accounts, regardless of their size, through 2009.

Tim subsequently announced the capital amounts that regulators had settled upon just hours before: $25 billion for Citigroup, Wells Fargo, and JPMorgan; $15 billion for Bank of America; $10 billion for Merrill Lynch, Goldman Sachs, and Morgan Stanley; $3 billion for Bank of New York Mellon; $2 billion for State Street Corporation. In total, the nine banks would receive $125 billion, or half of the CPP.

In answer to a question, Tim emphasized that the capital and debt programs were linked: you couldn’t have one without the other.

David Nason took the bankers through the basic terms of the capital, explaining how much they would have to pay on the preferred, noting that there could be no increases in common dividends for three years, and describing limitations the program would impose on their share repurchase programs. Treasury would also receive warrants to purchase common shares with an aggregate exercise price equivalent in value to 15 percent of its preferred stock investment. Bob Hoyt outlined how executive compensation would work; the limitations would apply as under TARP, with no golden-parachute payments and no tax deductions on incomes above $500,000.