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

Behind the scenes, Ken Lewis threatened to withdraw from the deal, but Paulson and Bernanke pressed him to complete it or risk losing his job.

As details of the drama leaked out John Thain became a quick casualty, with Ken Lewis firing him in his own office. He was soon recast from the hero who had saved Merrill into the source of its troubles, despite indications that Bank of America was aware of the firm’s problems and chose not to disclose them. Additional criticism was leveled at Thain when it emerged that he had asked the outgoing Merrill board for as much as a $40 million bonus. “That’s ludicrous!” shouted John Finnegan, the Merrill director who was on its compensation committee, when a human resources representative made the request. Thain has said that he knew nothing about it, and by the time a discussion about his compensation reached the full board, he had withdrawn any request for a bonus.

Nowhere was the public backlash more severe, however, than it was against American International Group. AIG had become an even greater burden than anyone expected, as its initial $85 billion lifeline from taxpayers eventually grew to include more than $180 billion in government aid. Geithner’s original loan to AIG, which he had said was fully collateralized, quickly looked to be no sounder an investment than a mortgage lender’s loan to a family with bad credit and no ability to ever pay it back.

Now that taxpayers were owners of AIG, lawmakers complained loudly about a $440,000 retreat for their independent insurance agents at the St. Regis Monarch Beach resort in Dana Point, California, and an $86,000 partridge-hunting trip in the English countryside. But the greatest ire was reserved for reports of millions of dollars in bonuses being awarded to AIG executives, as protesters swarmed its headquarters and its officials’ homes. President Obama asked, “How do they justify this outrage to the taxpayers who are keeping the company afloat?” while on his television program Jim Cramer ranted, “We should hound them in the supermarket, we should hound them in the ballpark, we should hound them everywhere they are.”

The widespread criticism gave rise to considerations about how to continue operating the business: Should decisions about how the company spent its money be made in reaction to popular opinion or with the goal of achieving profits? Edward Liddy, AIG’s new CEO, so frustrated with trying to serve two masters, left the company within eleven months of joining it.

There was also the issue of exactly how the AIG bailout money was used. More than a quarter of the bailout funds left AIG immediately and went directly into the accounts of global financial institutions like Goldman Sachs, Merrill Lynch, and Deutsche Bank, which were owed the money under the credit default swaps that AIG had sold them and through their participation in its securities lending program. To some extent this disbursement only bolstered the argument of critics who decried Paulson’s rescue as a bailout by Wall Street for Wall Street. (It didn’t help that foreign banks received some of the indirect aid, even though foreign governments hadn’t contributed to the rescue plan.)

Because Goldman Sachs was the largest single recipient of the AIG payments, receiving $12.9 billion, much of the anger quickly settled on it, as theories proliferated about what strings the firm might have pulled behind the scenes given its ties to Paulson and Treasury’s cast of Goldman alumni. In particular, the Goldman connection to AIG suggested to some that it was the reason that Treasury—or what people had started calling “Government Sachs”—had chosen to rescue the insurance giant and not Lehman. Goldman disputed claims that it benefited from the AIG rescue, contending that it had been “always fully collateralized and hedged ” in its exposure to the insurance company. (In fairness, it does appear that the firm had been so, despite a lingering whisper campaign to the contrary. And the $12.9 billion headline number is somewhat misleading; $4.8 billion of the amount transferred to Goldman was in exchange for securities that it had been holding.) That’s not to say Goldman did not have a vested interest in seeing AIG rescued, but the facts are slightly more complex than have often been presented by the media.

The news reports, however, kept feeding off one another and therefore missed the underlying truth: Paulson himself had had very little to do with the rescue of AIG; it was, rather, orchestrated by Geithner (and executed, in part, by Treasury’s Dan Jester). While the fact has often been overlooked, Geithner, by his very nature—as has been demonstrated throughout this book and in his subsequent policies as Treasury secretary—is as much a proactive deal maker as Paulson, if not more so.

Still, the conspiracy theories kept coming, and the narratives grew more elaborate. “Is Goldman Sachs Evil?” asked the cover of New York magazine. The writer Matt Taibbi created a new popular metaphor for the firm, describing Goldman in a Rolling Stone article as a “great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.”

Months after the TARP infusion, Goldman reported a profit of $5.2 billion for the first half of 2009. In June the firm paid back the $10 billion of TARP money, and in July paid $1.1 billion to redeem the warrants that were issued to the government as part of the TARP infusion. For Goldman, even as a bank holding company, it was back to business as usual.

The real question about Goldman’s success, which could be asked about other firms as well, is this: How should regulators respond to continued risk taking—which generates enormous profits—when the government and taxpayers provide an implicit, if not explicit, guarantee of its business? Indeed, in Goldman’s second quarter of 2009, its VaR, or value at risk, on any given day had risen to an all-time high of $245 million. (A year earlier that figure had been $184 million.) Goldman’s trades have so far paid off, but what if it had bet the wrong way? For better or worse, Goldman, like so many of the nation’s largest financial institutions, remains too big to fail.

Could the financial crisis have been avoided? That is the $1.1 trillion question—the price tag of the bailout thus far.

The answer to that question is “perhaps.” But the preemptive strike would probably have had to come long before Henry Paulson was sworn in as secretary of the Treasury in the spring of 2006. The seeds of disaster had been planted years earlier with such measures as: the deregulation of the banks in the late 1990s; the push to increase home ownership, which encouraged lax mortgage standards; historically low interest rates, which created a liquidity bubble; and the system of Wall Street compensation that rewarded short-term risk taking. They all came together to create the perfect storm.

By the time the first signs of the credit crisis surfaced, it was probably already too late to prevent a crash, for by then a massive correction was inevitable. Still, it is reasonable to ask whether steps could have been taken even at that late stage to minimize the damage. Hank Paulson had, after all, been predicting a problem in the markets since the first summer he joined the Bush administration. Likewise, as chairman of the New York Fed, Tim Geithner had also warned for years that the interconnectedness of the global financial markets may well have made them more vulnerable to a panic, not less. Should these men have done more to prepare for an actual crisis?