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

All day Friday, Citi’s regulators worked flat out, floating ideas to stave off disaster, from selling parts of the bank to strengthening its deposit base by combining it with another bank. Some wanted to replace Citi’s management and directors. I had strongly advocated installing new leadership at failing institutions and had even chosen the new CEOs for Fannie, Freddie, and AIG. But I wasn’t looking for scalps; I wanted to find solutions. And at Citi, Vikram Pandit had been CEO only since December 2007. Unless we had someone in mind who was better qualified and willing to take the job, I saw no point in discussing the matter.

“We can pound on Citi all day long,” I told my team. “But you know what? If they go down, it’s our fault. We’ve got to deal with it, and if we don’t, the American people will pay the price.”

During the last hour of trading, we got some uplifting news when NBC announced that Obama had picked Tim Geithner as his Treasury secretary. The markets exploded upward, with the Dow jumping 7.1 percent to close at 8,046, up 6.5 percent for the day. Citi surged by 19 percent, though it still closed down for the day at $3.77. Its credit default spreads were approaching 500 basis points, while those of JPMorgan, Wells, and BofA were all comfortably below 200 basis points.

Obama’s decision gratified me. Apart from reassuring investors, it meant, I felt, that many of our policies would be pursued, even if they were modified and rebranded. Indeed, I took the market’s rebound as a vote of confidence in what we’d been doing: the markets saw Tim’s nomination to succeed me as a sign of continuity.

When I called Tim to congratulate him, he said that the Obama transition wanted him to disengage from day-to-day activity at the New York Fed as soon as possible. The new economic team was meeting in Chicago that weekend, and the president-elect wanted him there. I pressed him not to go. We needed to come up with a rescue plan before Monday, and his presence was crucial as the bank’s primary regulator.

“I’ll do everything I can to be helpful,” I said. “But we need you on the job this weekend.”

To my relief, Tim agreed to remain in New York. But given his future position, he wouldn’t speak to Citi or any other bank.

By the time Tim, Ben, Sheila, John Dugan, and I conducted our first conference call, on Saturday at 10:30 a.m., Citi had submitted a two-page proposal to the OCC. The company wanted the government to insure more than $300 billion of toxic assets, including residential- and commercial-mortgage-related securities and troubled corporate loans.

We knew we couldn’t assume that Citi’s request would be enough to stabilize the markets. We needed to design a plan that would both appeal to investors and protect the taxpayer. And, in my opinion, we needed to put more equity into the company. Capital was the strongest remedy for a weak balance sheet, and the markets needed to see that the government was supporting Citi.

The OCC, FDIC, and New York Fed had set up offices at Citi’s headquarters and were scouring the $300 billion of assets to determine their true value. Jeremiah Norton, who happened to be in New York that Saturday, joined the on-site examiners. After he arrived, regulators handed him a memo that they had prepared after an all-night session with bank executives that said Citi, by its own estimates, would become illiquid by the middle of the next week. Regulators were frustrated, complaining that Citi executives were disorganized and unable to provide necessary information on the assets they wanted insured.

No one seemed more frustrated than Sheila, who at first suggested using the FDIC’s normal procedures for handling Citi. She proposed other, less costly strategies, such as closing Citi and putting the remains in the hands of a healthy bank. Clearly, she didn’t want the FDIC to pay for the losses at Citi, which had significant operations that were not insured by her agency.

I respected Sheila, who improved most programs we worked on together. But sometimes she said things that made my jaw drop. That morning she had said she wasn’t sure that Citi’s failure would constitute a systemic risk. She felt that Citi had enough subordinated debt and preferred stock to absorb the losses. She spoke as if Citi were just another failing bank and not a world leader—with $3 trillion in assets, both on and off its balance sheet—imploding in the midst of the worst economic conditions since the Great Depression.

“So,” she said, “why not let them go through the receivership process?”

Although I believed she was simply posturing, I replied, “If Citi isn’t systemic, I don’t know what is. And if we do anything less than a powerful response, it will send jitters through the whole market, and people could really put us to a test. I don’t have a lot left in TARP.”

We also had to consider Citi’s $500 billion of foreign deposits. Because foreign deposits were not protected by FDIC insurance, that money was more likely to run to avoid the risk of a bank failure, a major reason Citi’s liquidity was likely to evaporate in a few days.

I asked hypothetically if the FDIC could insure foreign deposits in an emergency; Tim believed it could, but Sheila didn’t think so. In my view, we couldn’t wait to find out. We needed to make another equity infusion in the company. I believed that if we acted forcefully now we had enough TARP capacity to prevent a Citi failure. But if the market’s confidence evaporated and the giant bank had to start unwinding all of its $3 trillion in assets in a hurry, the losses could spiral and shake the entire banking system down to its smallest players.

Sheila and I spoke one-on-one after the morning conference call broke up. “Hank, this is hard for me,” she said. She was dealing with a board that was skeptical about rescuing Citi and exposing the FDIC’s $35 billion fund to the company’s potential losses. And to do her job right, Sheila had an obligation to get answers to all the questions she was posing.

Through the afternoon, the New York teams made progress in valuing Citi’s problem assets and began work on a plan to insure potential losses, but this was no easy task given the large number of complex assets. Moreover, the FDIC had reservations about some of the valuations, because they used a different process from other regulators’. But Sheila promised to keep working toward a deal, and I felt sure we would have her support in the end.

That evening, British ambassador Nigel Sheinwald had invited Wendy and me to a dinner at his residence, adjacent to the British Embassy and just a short distance from our house. As we circulated during cocktails, friends and strangers approached, saying things like “I hope you’re getting some sleep.” This made me uncomfortable; I didn’t want to be thought of as poor Hank, the victim. I said to Wendy, “Do I look that bad?” She replied, “You should be grateful that people are being so supportive.”

As the hundred or so guests began to take their seats for dinner, I ducked into an empty room to check in with Ben Bernanke. We talked for about half an hour before I returned to the dining room. We agreed that Citi needed an equity investment from TARP, but I demurred when Ben raised the possibility of buying common stock; the idea was good corporate finance but bad public policy. Citi’s market value was only about $21 billion, and I pointed out that if we invested any meaningful amount in common stock, we would not only dilute shareholder equity and reward the short sellers, but also leave the government owning a large part of the bank. I could all too easily envision headlines about the nationalization of Citi. I told Ben I was leaning toward buying preferred stock.