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

As he stood in front of the press corps he did his best to sell the centerpiece of his plan, the TARP. “The underlying weakness in our financial system today is the illiquid mortgage assets that have lost value as the housing correction has proceeded. These illiquid assets are choking off the flow of credit that is so vitally important to our economy,” he explained, his tie slightly askew and looking paler and more tired than he ever had before. “When the financial system works as it should, money and capital flow to and from households and businesses to pay for home loans, school loans, and investments that create jobs. As illiquid mortgage assets block the system, the clogging of our financial markets has the potential to have significant effects on our financial system and our economy… .

“I am convinced that this bold approach will cost American families far less than the alternative—a continuing series of financial institution failures and frozen credit markets unable to fund economic expansion,” he asserted, clearly reading from his script, having never learned how to read from a teleprompter.

Evidently confident that Washington had finally brought the financial crisis under control—between Paulson’s TARP and Cox’s ban on shortsellers—the stock market had risen 300 points at the open and continued to hold its ground as Paulson spoke.

Paulson had intentionally chosen not to mention how much the program would cost; after a briefing earlier that morning from Kashkari, he now feared that he might actually need more than the $500 billion he had mentioned to the president a day earlier—a great deal more. Back in his office after the speech, he met with Fromer and Kashkari and debated what the precise cost might be.

“What about $1 trillion?” Kashkari said.

“We’ll get killed,” Paulson said grimly.

“No way,” Fromer said, incredulous at the sum. “Not going to happen. Impossible.”

“Okay,” Kashkari said. “How about $700 billion?”

“I don’t know,” Fromer said. “That’s better than $1 trillion.”

The numbers were, at best, guesstimates, and all three men knew it. The relevant figure would ultimately be the one that represented the most they could possibly ask from Congress without raising too many questions. Whatever that sum turned out to be, they knew they could count on Kashkari to perform some sort of mathematical voodoo to justify it: “There’s around $11 trillion of residential mortgages, there’s around $3 trillion of commercial mortgages, that leads to $14 trillion, roughly five percent of that is $700 billion.” As he plucked numbers from thin air even Kashkari laughed at the absurdity of it all.

John Mack had been watching CNBC on Friday morning when he received a phone call from Lloyd Blankfein. Charlie Gasparino, still reveling in his scoop about the government’s toxic asset program, was arguing that it meant that Morgan Stanley would no longer be forced to do a deal, or at least not have to move as quickly.

Mack, laughing to himself, knew better; he had to get something accomplished by the weekend or Morgan Stanley could well go the way of Lehman Brothers.

“What do you think of becoming a bank holding company?” Blankfein asked Mack when he picked up the receiver.

Mack hadn’t really studied the issue and asked, “Would that help us?”

Blankfein said that Goldman had been investigating the possibility and explained to him the benefits—namely, that if they allowed themselves to be regulated by the Federal Reserve, they’d have unlimited access to the discount window and would have an easier time raising capital, among other things.

“Well, in the long run it would really help us,” Mack said. “In the short run, however, I don’t know if you can pull it off fast enough to help us.”

“You have to hang on,” Blankfein urged him, clearly still anxious about how punishing the markets had become, “because I’m thirty seconds behind you.”

Jonathan Pruzan, the Morgan Stanley banker who had been assigned to review Wachovia’s $120 billion mortgage portfolio—to crack the tape—finally had some answers. A team of Morgan bankers in New York, London, and Hong Kong had worked overnight to sift through as many mortgages as they humanly could.

“Now I know why they didn’t want to give us the tape!” Pruzan announced dourly at a meeting before they headed over to Wachtell Lipton to begin diligence on Wachovia. “It shows they’re expecting a nineteen percent cumulative loss.”

Just a week earlier, at a public presentation at Lehman’s conference, Bob Steel had estimated that figure at 12 percent. In fairness, Pruzan noted, the market had deteriorated markedly since then, and cumulative loss figures were inherently unreliable, because a bank could manipulate them up or down. Still, that big a discrepancy couldn’t be explained away easily. At best, Pruzan thought, Wachovia had been foolishly optimistic.

“You’ve got to be fucking kidding me,” Scully exclaimed. “We obviously can’t do this deal.”

To make it work, Morgan Stanley would have to raise some $20 billion to $24 billion of equity to capitalize the combined firm, a virtual impossibility under the current market conditions. Even so, the Morgan bankers decided not to cancel the all-day diligence session, as they figured they had nothing to lose. Morgan Stanley might well be able to take advantage of Paulson’s new plan to buy toxic assets from Wachovia and, indeed, investors had already bid up Wachovia’s shares that morning on precisely that expectation.

Thirty people each from Morgan Stanley and Wachovia showed up at Wachtell Lipton’s Fifty-second Street offices. Wachovia, purposely not using Goldman Sachs as an adviser for this project given its rivalry with Morgan Stanley, brought a new set of advisers from Perella Weinberg Partners: Joe Perella, the legendary financier; and Peter Weinberg, a former Goldman banker who was the grandson of Sidney Weinberg, the Goldman patriarch. As Weinberg came to shake Kindler’s hand, they could hardly believe they were even talking to each other under such dire circumstances. “What happened? How the fuck did we get here?” Weinberg asked aloud.

“God only knows. You can’t make this shit up,” Kindler said.

Within the first two hours of their work, however, something began to feel wrong to the Morgan bankers. Paulson’s TARP announcement had eased the climate of fear at Wachovia—which would likely be a huge beneficiary of the program because it could sell its most toxic assets to the government—and thus the urgency of rushing into a deal. Kindler became concerned that Wachovia was just buying time while the bank worked on another deal, probably with Goldman. Surveying the room, he announced to his colleagues, “Look at us. We’re the B team. This isn’t going to happen.”

The Wachovia team, meanwhile, had its own doubts about Morgan Stanley’s commitment. If this deal was so important to it, where were its top people? David Carroll, who was leading the Wachovia team, couldn’t understand why Colm Kelleher, Morgan’s CFO, was not involved.

By 2:00 p.m., the Morgan Stanley team had withdrawn from Wachtell and gone back to Times Square to consult with Mack.

“These guys are clearly disengaged,” Kindler told him. Scully described Wachovia’s mortgage book as “a $40 to 50 billion problem. It’s huge. The junior Wachovia team is not disputing our analysis.”