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

Between the money-market funds being under pressure, Geithner thought, and billions of dollars of investors’ money locked up inside the now-bankrupt Lehman Brothers, that means only one thing: the two remaining broker-dealers—Morgan Stanley and Goldman Sachs—could actually be next.

The panic was already palpable in John Mack’s office at Morgan Stanley’s Times Square headquarters. Sitting on his sofa with his lieutenants, Chammah and Gorman, drinking coffee from paper cups, he was railing: The major news on Wednesday morning, he thought, should have been the strength of Morgan Stanley’s earnings report, which he had released the afternoon before, a day early, to stem any fears of panic about the firm following the Lehman debacle. His stock had fallen 28 percent in a matter of hours on Tuesday, and he decided he needed to do something to turn it around. The quarterly earnings report had been a good one—better than that of Goldman Sachs, which had announced their earnings Tuesday morning and also had suffered, but not nearly as much. Morgan had reported $1.43 billion in profits, down a mere 3 percent from the quarter a year earlier. But the headline on the Wall Street Journal was gnawing at him: “Goldman, Morgan Now Stand Alone; Fight On or Fold?” And as the futures markets were already indicating, his attempt to show strength and vitality had largely failed to impress.

Apart from the new anxiety about money market funds and general nervousness about investment banks, he was facing a more serious problem than anyone on the outside realized: At the beginning of the week, Morgan Stanley had had $178 billion in the tank—money available to fund operations and to lend to their major hedge fund clients. But in the past twenty-four hours, more than $20 billion of it had been withdrawn, as hedge fund clients demanded it back, in some cases closing their prime brokerage accounts entirely.

“The money’s walking out of the door,” Chammah told Mack.

“Nobody gives a shit about loyalty,” Mack railed. He had wanted to cut off the flow of funds, but up until now had been persuaded by Chammah to keep wiring the balances. “To put the gates up,” Chammah warned, “would be a sign of weakness.”

The question was, how much more could they afford to let go? “We can’t do this forever,” Chammah said.

While Mack was beginning to believe the hedge funds were conspiring against the firm—“This is what they did to Dick!” he roared—there was fresh evidence that some of them actually did need the cash. Funds that had accounts at Lehman’s London office couldn’t get at them and came begging to Morgan Stanley and Goldman.

As far as Mack was concerned, they needed to keep paying out money. He had spent years building their prime brokerage business into a major profit center—eighty-nine of the top one hundred hedge funds in the world traded through Morgan Stanley. It was essential in the midst of a crisis that the firm not display even the slightest sign of panic, or the entire franchise would be lost.

“We are confident,” he said. “We cannot be weak, and we cannot be confused.”

Under normal circumstances, John Mack could be unflappable. The previous day he’d even been out on the floor, as was his habit, chatting with traders and eating a slice of pizza. But in his office that morning, he was starting to come unwound. There was just too much to do, too many options to explore, too many things to worry about.

The night before, he’d received a call from his old friend Steven R. Volk, a vice chairman at Citigroup and former lawyer who years earlier had helped Mack engineer the merger with Dean Witter. Now Volk, ostensibly calling to offer congratulations on the earnings reports, quietly planted the seed of another merger—with Citi.

“Look, John, we’re here for you. We’re not aggressive. And if you want to do something strategically to put us together, we would like to talk to you,” Volk said.

It was potentially explosive news. A merger between Morgan Stanley and Citigroup would be like combining Microsoft and Intel.

Mack, Chammah, and Gorman batted around the idea. Given the pressure on the broker-dealer model, merging with Citigroup would give it a stable base of deposits. JP Morgan and Citigroup were the only two left of the big, strong banks.

They had all heard about Bank of America’s conference call on Monday regarding its deal with Merrill Lynch and couldn’t ignore Ken Lewis’s comments all but declaring the broker-dealer model officially dead.

“For seven years, I’ve said that the commercial banks would eventually own the investment banks because of funding issues,” Lewis said. “I still think that. The Golden Era of investment banking is over.”

Gorman, at least for the moment, was thinking that he might well be right. “Do you think we should call Citigroup back?” he asked.

Mack nodded and asked his assistant to phone Vikram Pandit’s office. The two men knew each other well—Pandit, then at Morgan Stanley, had been given a big promotion by Mack in 2000—but had never been particularly close.

“Steve tells me you want to do a deal,” Mack said when Pandit got on the line. “It’s tough out there,” Mack continued. “We’re looking at our options.”

“Well, we’d like to be helpful,” Pandit said, “and this could be the time to do something.”

But before he got too far he said, “I’ll come back to you. I need to talk to my board.”

The black and orange screen flickered as Hank Paulson skimmed the updates about the Reserve Primary Fund on his Bloomberg terminal. With $62.6 billion in assets, the fund was a major player, and as a result of its troubles, doubt, he could see right in front of him, was starting to spread throughout the rest of the field.

“We’ve got an emergency,” Ken Wilson said, coming into Paulson’s office and ticking off a list of panicked CEOs who had begun phoning him that morning at 6:30: Larry Fink of BlackRock, Bob Kelly of Bank of New York Mellon, Rick Waddell of Northern Trust, and Jim Cracchiolo at Ameriprise.

“They’re telling me people are clamoring for redemptions. Hundreds of billions of dollars where people want out!” Wilson said. “People are concerned about anyone who has any exposure to Lehman paper.”

Paulson fidgeted nervously. The Lehman-induced panic was spreading like a plague, the black death of Wall Street. The money market industry needed to be shored up. Wilson also told him that he was hearing that Morgan Stanley was coming under pressure from hedge funds seeking redemptions as well. And if Morgan Stanley were to go, Goldman, the firm where both had spent their entire careers, would likely be next in line.

“Another day, another crisis,” Paulson said with a nervous laugh that betrayed an uneasy sense that he was truly beginning to panic himself.

Paulson’s instinctive response had been serial deal making—the private sector’s solution to systemic problems. Firms consolidated, covered one another’s weaknesses.

But this situation didn’t feel normal, in that respect; behind every problem lurked another problem. He may have been praised for not bailing out Lehman, but he could see now that the unintended consequences had been devastating. The confidence that had supported the financial system had been upended. No one knew the rules of engagement anymore. “They pretended they were drawing a line in the sand with Lehman Brothers, but now two days later they’re doing another bailout,” Nouriel Roubini, a professor at New York University’s Stern School of Business, complained that morning.