Andrew Sorkin - Too Big to Fail - The Inside Story of How Wall Street and Washington Fought to Save the FinancialSystem--and Themselves

“I want to be clear that there’s a real risk you may not be made whole on this loan,” he warned as Geithner dialed into the conference call.

While Bernanke said that he had decided to back the deal, he nevertheless wanted to take a straw poll among the participants in the call. He was clearly anxious, asking, “Are you sure we’re doing the right thing?”

But with his implicit support—and Geithner’s insistence that this was the only way to avert a financial Armageddon—the vote was 5-0. There was no longer any discussion of moral hazard, and no talk of Lehman Brothers.

Before Wiseman and Gamble had gotten far after being escorted by security guards from the NY Fed, they were surprised to suddenly find themselves being invited back in. There had been a mix-up, they were told, and they were taken to a table in the dining room.

“This isn’t the cool kids’ table,” Gamble remarked, looking over at another table at the other end of the enormous space, where JP Morgan and Goldman bankers were waiting.

“One thing is for certain,” Wiseman said, “they are not doing a private deal. They’d never look this relaxed.”

While they waited, Gamble took a call about two new issues: Insurance regulators in Texas, where AIG had a major life insurance business, were starting to panic. Even worse, JP Morgan had just pulled a line of collateral in Japan, which was AIG’s largest market outside the United States. Gamble couldn’t believe it: JP Morgan, AIG’s adviser just twenty-four hours earlier, was now only exacerbating the problem, however prudent it might have been to do so.

Twenty minutes later, Eric Dinallo, superintendent of the New York State Insurance Department, came over to a relieved Wiseman and Gamble’s table. “I can’t tell you much,” Dinallo said, “but don’t do anything precipitous.”

“Eric,” a frustrated Gamble replied, “we’re happy to hold tight, but our securities lending business is in trouble.” Then he pointed at the JP Morgan and Goldman Sachs contingent. “The guys over there are creating this problem. Go talk to those guys.”

“I think we’re about to be out of cash!” John Studzinski announced at the teetering insurance giant’s headquarters. It was nearly 1:00 p.m., and if Studzinski’s math was correct, AIG was minutes away from bankruptcy.

Just then, Willumstad walked out of his office with something that hadn’t been seen in some time in the building: a smile.

“They blinked,” he said.

He had just gotten off the phone with Geithner, who told him about the bailout plan: The Fed would extend to AIG a $14 billion loan to keep the firm in business through the rest of the trading day. But Geithner added that AIG would have to immediately post collateral before it could receive the loan. Officially, it was called a “demand note.”

While clearly relieved, Willumstad understandably wondered how they were supposed to come up with $14 billion in the next several minutes. Then it dawned on one of them: the unofficial vaults. The bankers ran downstairs and found a room with a lock and a cluster of cabinets containing stock certificates for AIG’s insurance units—tens of billions of dollars’ worth, dating mostly from the Greenberg era. They began rifling through the drawers, picking through fistfuls of securities that they guessed had gone untouched for years. In an electronic age, the idea of keeping physical certificates on hand was a disconcerting but welcome throwback.

AIG’s senior vice president and secretary, Kathleen Shannon, stacked the bonds up on the table and put them in a briefcase.

“I don’t think it’s worth you getting mugged carrying $14 billion of certificates,” Michael Wiseman from Sullivan & Cromwell advised her over the phone. “We’ll get Fed security to escort you over.”

Ten minutes later, Shannon was carrying an inestimably valuable briefcase across Pine Street, flanked by two armed guards.

Hank Paulson hustled down the stairs and out the side exit of the Treasury building, briskly heading for the White House. He and Ben Bernanke had scheduled a meeting with President Bush to brief him on the extraordinary steps they were about to take.

After passing through security and a brief stay in a waiting room, they were escorted to the Oval Office, where Paulson delicately walked the president through the terms.

As Paulson explained the deal, however, detailing its points in Wall Street jargon, Bush clearly looked perplexed.

Bernanke jumped in and said, “Mr. President, let’s step back for a minute.” Donning his professorial hat, he explained how deeply entwined AIG had become in the banking system. More important, he tried to appeal to the Everyman in Bush, emphasizing how many citizens and small businesses depended on the firm. People used AIG’s life insurance policies to protect their families. They used AIG’s annuities to fund their retirements. AIG also provided surety bonds, a kind of guarantee for construction projects and public works.

The president then posed a question that, in its own way, went directly to the heart of the problem: “An insurance company does all this?”

This one did.

At around 4:00 p.m. that afternoon, the Fed’s offer clattered through an AIG fax machine (which should have been replaced and shipped to the Smithsonian a decade earlier). An army of lawyers on AIG’s eighteenth floor were anxiously awaiting it. After the three-page document finally appeared, a lawyer grabbed it and quickly made copies.

“Well, you finally get your chance to work for the federal government,” Richard Beattie, the lead lawyer for the outside directors on the AIG board, told Willumstad as he scanned the terms.

“What do you mean?” asked Willumstad.

“They own you now,” Beattie replied with a grin.

And they did. The Federal Reserve was providing AIG a credit line of $85 billion—which it hoped would be enough to avert catastrophe and keep it afloat. But in exchange for the loan, the government was taking a large ownership stake—79.9 percent in the form of warrants called “equity participation notes.” It was similar to the proposal that JP Morgan and Goldman had been working on.

If Washington was going to take Wall Street off the hook, the government wanted to make certain that at least the old stakeholders didn’t profit in any untoward fashion. “Paulson is handling this the same way he did Fannie, Freddie, and Bear Stearns—if the government steps in, the shareholders will pay for it,” Cohen observed.

The Fed loan also came with a significant debt burden. AIG would have to pay at a rate based on a complex formula—the London interbank offered rate, a benchmark for short-term loans between banks, which then came to about 3 percent—plus an extra 8.5 percentage points. Based on that day’s rate, the interest the company would have to pay soared to more than 11 percent, which at the time was considered usurious. The loan would be secured by all AIG’s assets, and the government would have the right to veto payments of dividends to both common and preferred shareholders.