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

But for now, Mack wasn’t interested in anyone’s hurt feelings. He was glued to his stock price, which had fallen 17 percent the day before, as investors grew nervous that Mitsubishi might renege on its deal. After a week and a half of diligence and regulatory approvals, the investment still had not been finalized, and as Morgan Stanley’s stock price continued to drop, questions were raised about whether Mitsubishi would be better off simply walking away from the agreement. All they had on paper was a term sheet—no better than what Citigroup had signed with Wachovia. And Federal Reserve requirements wouldn’t allow the firms to complete the deal until Monday, leaving Morgan Stanley exposed to the gyrations in the stock market—and the possibility that Mitsubishi could pull out—until then.

Earlier that day Mitsubishi had released a statement in Tokyo saying: “We have been made aware of rumors to the effect that MUFG is seeking not to close on our proposed investment in, and strategic alliance with, Morgan Stanley. Our normal policy is not to comment on rumors. Nevertheless, we wish to state that there is no basis for any such rumors.”

That was all Mack needed to know; he trusted the Japanese and wanted to be confident that they wouldn’t withdraw. In his gut, however, he couldn’t help but be anxious.

Hank Paulson was about to officially change his mind.

It was Wednesday, October 8, and Ben Bernanke and Sheila Bair were on their way to meet with him in his office at 10:15 a.m.

He had finally determined that Treasury should make direct investments in banks, sufficiently persuaded by a growing chorus both inside and outside of Treasury to do so.

“We can buy these preferred shares, and if a company becomes more profitable, you will get a share of that as well,” Barney Frank said during a speech championing the idea of taxpayers becoming shareholders. Chuck Schumer was also in favor of the idea, stating, “When the market recovers, the federal government would profit.”

But perhaps the greatest indication that the concept was feasible came from abroad: The United Kingdom had announced plans to invest $87 billion in Barclays, the Royal Bank of Scotland Group, and six other banks in an effort to instill confidence after a near Lehman-like meltdown confronted them. In exchange, British taxpayers would receive preferred shares in the banks (including annual interest payments) that were convertible into common shares, so that if the banks’ prospects improved—and their shares rose—taxpayers would benefit. Of course, the plan was also a huge gamble, for the reverse was also true: If the banks faltered after the investment was made, a great deal of money stood to be lost.

Paulson and President Bush had been briefed by Gordon Brown on these plans on Tuesday morning at 7:40 by phone in the Oval Office. Now that the formal announcement had been made, Brown was being praised for his judgment to step in so decisively—often in favorable contrast to Paulson. “The Brown government has shown itself willing to think clearly about the financial crisis, and act quickly on its conclusions. And this combination of clarity and decisiveness hasn’t been matched by any other Western government, least of all our own,” Paul Krugman, the economist and New York Times columnist, wrote days later.

With the G7 ministers scheduled to be in Washington for the long Columbus Day weekend, Paulson began to think that he should take advantage of the occasion to once and for all make a bold move to stabilize the system. Still, he knew it could be unpopular politically. After he broached the idea with Michele Davis a week earlier, she only looked at him with a sense of bafflement and remarked, “There’s no way you’re going to say that publicly.”

Paulson had been discussing his shifting views with Bernanke, who had been a fan of capital injections from the start, and they were now in agreement. But they had been thinking about another program to go hand in hand with such an announcement: a broad, across-the-board program to guarantee all current and future unsecured debts of the banks. It would essentially remove any anxiety among investors who loan money to banks that they could ever get wiped out. By Bernanke’s estimation, announcing capital injections and a broad guarantee would be an effective enough economic cocktail to finally turn things around.

But first they needed the money to effectuate such a guarantee program, which is where Bair came in. They felt that the FDIC was the only agency with such powers, and that the guarantee would fall within the agency’s mission.

Paulson and Bernanke, sitting in Paulson’s office, now walked Bair through the concept. The FDIC, they explained to her, would essentially be offering a form of insurance for which the banks would pay by being assessed a fee. The FDIC, Paulson argued, could even end up making money if the assessments outweighed the amount of payouts.

Bair instantly recoiled, doing the math in her head to assess the extraordinary strain such a guarantee could put on the FDIC’s fund.

“I can’t see us doing that,” she replied.

Morgan Stanley’s Walid Chammah woke up Saturday morning deathly afraid that his firm was going to go out of business. Its stock price had continued to fall, closing on Friday at $9.68—its lowest level since 1996. Hedge funds and other clients were again pulling money out. Dick Bove, an influential analyst at Ladenburg Thalmann, was comparing Morgan Stanley to Lehman Brothers and Bear Stearns. “The focus on Morgan Stanley is to change the ending,” Bove wrote in a note to clients. “In sum, one must hold one’s breath at the moment and hope that this is a different movie.”

Chammah had canceled a talk he was scheduled to give at Duke’s business school so he could stay in New York to try to shore up morale at the firm. That Friday he walked every floor in Morgan Stanley’s headquarters, stopping to reassure fretful employees and giving a speech on the trading floor. “This firm has been around for seventy-five years and will be around for another seventy-five years,” he proudly told the traders. To work his way down from the fortieth floor to the second took him three and a half hours. When he got back to his office he was emotionally drained, practically in tears.

It had been a difficult day for one other reason: Rumors were by now rampant that Mitsubishi was going to renege on its deal. No one at Morgan Stanley had received the slightest indication that they were even thinking of doing so—indeed, Mitsubishi had confirmed that they intended to honor the commitment—but the uncomfortable truth was that withdrawing might actually be the right business decision.

“They’re going to recut. They just have to,” Robert Kindler told Paul Taubman that afternoon. “When are they going to call? It’s a nobrainer.”

And everyone inside Morgan Stanley knew what Mitsubishi’s pulling out would mean: a run on the bank all over again, and, just possibly, the end of the firm.

With Mack flying back from London that day, it had been left to Chammah to hold the firm together in the face of that anxious speculation. His wife, who had been watching the financial news on television, called him at the office. “Are you okay?” she asked.

“I’m fine,” he said serenely, trying not to betray his concern.