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

I also tackled the issue of foreclosure relief, applauding Sheila’s IndyMac Protocol and mentioning Fannie and Freddie’s new modification program. I conceded that Sheila’s insurance idea was important and said we would evaluate it, but pointed out that we would have to figure out how to finance it.

The reporters were polite, asking a lot of questions about the securitization program. But just as I feared, the markets focused on the facts that there wouldn’t be a program to purchase mortgage-related assets and that we weren’t going to be moving ahead quickly with any new programs that would require us to ask for the remaining $350 billion. The reaction was immediate and brutal: the Dow fell by 411 points, to 8,283, and the S&P 500 and the NASDAQ each dropped by 5.2 percent. Public criticism and plenty of negative press followed.

November 12 was a day of major announcements. Treasury, the Fed, and the FDIC put out a comprehensive joint statement dealing with the hot-button issues of lending, executive compensation, dividends, and foreclosure mitigation. Since the compensation and lending controversies exploded in mid-October, I had encouraged Ben, Tim, John Dugan, and Sheila to address these issues in strong, clear language. The resulting regulatory guidance pleased me: it said in no uncertain terms that banks must fulfill their fundamental role by lending to creditworthy borrowers and must work to avoid preventable foreclosures. It also warned against compensation plans that “created perverse incentives that jeopardize the health of the banking organization” and called for programs that were “aligned with the long-term prudential interests of the institution.”

Also that day, the FDIC agreed to guarantee up to $139 billion of debt issued by General Electric’s finance subsidiary, GE Capital, under the temporary program the regulator had established in October. Though not a bank, GE Capital was systemically important, and David Nason and I had worked hard to get Sheila comfortable with making this decision. The FDIC said it would extend the Temporary Liquidity Guarantee Program to nonbanks on a case-by-case basis, using criteria like size, credit rating, and connection to the economy. GE Capital, along with Citigroup, would become one of the two biggest users of TLGP, issuing some $70 billion of government-guaranteed debt. (The GE parent company agreed to indemnify the FDIC against any losses for GE Capital.)

But none of this news mattered to the markets, whose earlier volatility seemed to have turned into a full-fledged slide. The Dow was down nearly 40 percent from the start of the year, and companies from General Motors to Genworth Financial were coming under enormous pressures.

January 20 was a long way off, and I felt very exposed. Between AIG and the banks, we’d allocated all but $60 billion of our $350 billion. I had exhausted my political capital and credibility in an effort to keep the system from collapsing, and now I would have to rely on the incoming Obama administration to help me.

Just one week after I had delivered a speech meant to reassure the markets, I headed to the Oval Office to tell the president that yet another major U.S. financial institution, Citigroup, was teetering on the brink of failure.

“I thought the programs we put in place had stabilized the banks,” he said, visibly shocked.

“I did, too, Mr. President, but we are not out of the woods yet,” I said. “Citi has a very weak balance sheet, and the short sellers are attacking.”

It was just after 1:00 p.m., and world markets were again in disarray, pummeled by investor worries about banks, automakers, and the overall U.S. economy. The U.K.’s FTSE 100 Index and the Frankfurt Stock Exchange’s DAX 30 Index had ended their trading sessions down nearly 5 percent, and the Dow was on course for a 5 percent slide of its own, to 7,997, its first close below 8,000 since March 2003.

All financial companies were under pressure, but Citi was being hammered the hardest. Its shares had already sunk 13 percent, on their way to a full-day plunge of 23 percent to $6.40, a fall of 88 percent from May 2007. Its credit spreads were also starting to balloon—they would hit 361 basis points that day, up from about 240 basis points the day before.

Arguably the best-known bank in the world, Citi had operations in more than 100 countries and more than $2 trillion in assets on its balance sheet. But the sprawling New York–based giant, built through multiple acquisitions, struggled with an unwieldy organizational structure and lacked a single unifying culture or clear business strategy. I’d long believed it had become almost too complex to manage.

In the boom years, Citi had built a substantial exposure to commercial mortgages, credit cards, and collateralized debt obligations tied to subprime mortgages. It carried more than $1.2 trillion in assets off its balance sheet, half of these related to mortgages.

I knew that Citi was the weakest of the major U.S. banks. For its size, the bank had a modest retail deposit base, particularly on its home turf. This made it more dependent on wholesale funding and foreign deposits, and hence more vulnerable to panic.

The market’s fears had intensified earlier that morning when Citi announced that it would wind down the last of its SIVs, bringing $17.4 billion worth of risky assets onto its books. This news followed the disclosure two days before that the bank was laying off 53,000 employees and had dropped plans to sell $80 billion of marked-down assets. Investors worried that Citi couldn’t find buyers for its toxic assets or might not be able to afford the write-down from a sale.

Notwithstanding Citi’s shakiness, I had been falsely reassured by the fact that the market had supported the bank for so long. Its sinking share price had tracked the decline in other financials, and Citi’s regulators had indicated that they were keeping close tabs on it.

But now the market had turned on Citi, and we would have to act quickly. Like that other troubled financial colossus, AIG, the New York bank was deeply enmeshed in a complicated web of ties to financial institutions and government entities all over the world.

“A collapse would be horrific,” I told the president. “We’ve said we will let no systemically important bank fail. We can’t let it happen now.”

“Aren’t there things you can do to save it?” the president asked.

I explained that we had the resources in TARP, but if Citi came unglued, it could trigger a chain reaction among the hundreds of financial institutions that were its customers and counterparties, and we didn’t have the wherewithal to deal with another run on the banking system. The Citi crisis proved that we needed to get Congress to release the rest of the TARP money, I said.

“It’s politically difficult, but we’re going to have to figure out how to do it,” I told him.

“Just don’t let Citi fail,” he replied.

With the president’s admonition on my mind, I flew to Los Angeles later that day. I was hesitant to leave Washington, but Nancy Reagan had long ago invited me to speak at the Ronald Reagan Presidential Library. I knew the markets were watching my every move: canceling the trip could spark rumors that might further endanger Citi. I arrived at the Westlake Village Inn in Simi Valley at about 9:30 p.m. and went to bed almost immediately in order to be rested for the morning.

Of all the rough nights I’d endured throughout the crisis, this one was by far the worst. Surrounded by photos of Ronald Reagan in the White House and at his Santa Barbara ranch, I lay awake, tormented by self-doubt and second-guessing.

November had been one rough month. Democrats were excoriating us over foreclosure relief and our decision not to buy toxic assets, while conservative critics continued to carp at the bailouts we’d been forced to undertake, which they slammed as nationalization or, worse, socialism. The markets were falling relentlessly. In the barely two weeks since Senator Obama’s election, the Dow had lost 17 percent.