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

In his first few weeks on the job, as the economic clouds were gathering but no one was yet forecasting a storm, Paulson focused on improving the morale at Treasury. He visited departments that had not seen a cabinet member for years and ordered the refurbishment of the building’s basement gym. Paulson was serious about physical fitness and often biked around the capital, whenever Wendy could get him off the phone.

Early on, Paulson had concerns about the markets. In his first briefing with President Bush and his economic team, at Camp David on August 17, 2006, he warned that the economy was overdue for a crisis. “When there is a lot of dry tinder out there, you never know what will light it,” he said. “We have these periods every six, eight, ten years, and there are plenty of excesses.”

Paulson made it clear that the administration would have to confront at least one serious problem: the subprime mortgage mess, which had already begun to have repercussions. Bear Stearns and others were deeply involved in this business, and he needed to find a way to obtain “wind down authorities” over these troubled broker-dealers. Traditional banks had the Federal Deposit Insurance Corporation, or FDIC, and the Federal Reserve effectively protecting them from going bankrupt; these agencies had a built-in transition plan that allowed them to take failing banks safely into receivership and auction them off. But the FDIC had no authority over investment banks like Goldman Sachs, Morgan Stanley, Merrill Lynch, Bear Stearns, and Lehman Brothers, and unless Paulson was given comparable power over these institutions, he said during the meeting, there could be chaos in the market.

On March 27, 2008, at 8:30 a.m., just three days after the “recut” Bear deal, Paulson and his lieutenants gathered for a meeting. He’d just arrived from his usual workout at Sports Club/LA in the Ritz-Carlton hotel a few blocks away. His brain trust, Bob Steel, Jim Wilkinson, David Nason, Michele Davis, Phillip Swagel, Neel Kashkari, and several others, crammed into his office on the third floor of the Treasury Building, which overlooked the White House’s Rose Garden and afforded dramatic views of the Washington Monument to the south.

Paulson took a chair in the corner of the high-ceilinged space, its walls already decorated with dozens of his wife’s photographs of birds and reptiles. Some staffers found seats on his blue velvet couch; others stood, leaning against his mahogany desk, with its four Bloomberg screens flickering on top.

Paulson held these meetings with his inner circle each morning at 8:30 a.m., except for every other Friday, when he had breakfast with Ben Bernanke, the chairman of the Federal Reserve. Paulson would have preferred to have the staff meetings start even earlier, but these were government workers, and he was already pushing them pretty far. Most of his senior team were being paid around $149,000 a year, though each of them could have potentially been making much more in the private sector.

As Paulson went around the room doing a postmortem on Bear, he stopped at David Nason. Nason, the thirty-eight-year-old assistant secretary for financial institutions, had joined Treasury in 2005 and was its resident policy-making brain. A Republican and free-market champion, Nason had been warning at these meetings for months about the possibility of another Bear Stearns-like run on one or more banks. He and other Treasury officials had come to recognize that Wall Street’s broker-dealer model—in which banks could count on ever-dependable overnight financing by other investors—was by definition a tinderbox. Bear had taught them how quickly a bank could crumble; in an industry whose lifeblood was simply the confidence of other investors, it could wane quickly at the hint of a problem. But however perilous the overall situation, Nason remained dead set against bailouts, a concept he couldn’t abide.

Instead, Nason told the group that Treasury had to concentrate its efforts on two fronts: obtaining the authority to put an investment bank through an organized bankruptcy, one that wouldn’t spook the markets, and more immediately, urging the banks to raise more money. In the previous six months, U.S. and European banks—including Citigroup, Merrill Lynch, and Morgan Stanley—had managed to bring in some $80 billion in new capital, often by selling their stakes to state-run investment funds—known as “sovereign wealth funds”—in China, Singapore, and the Persian Gulf. But it clearly wasn’t enough, and the banks had already been forced to tap the investors with the deepest pockets.

With the Bear Stearns situation seemingly behind them, Paulson focused his attention this morning on what he thought would be the next trouble spot: Lehman Brothers. Investors may have been mesmerized by Erin Callan’s performance at the earnings conference call, but Paulson knew better. “They may be insolvent, too,” he calmly told the room. He was worried not only about how they were valuing their assets, which struck him as wildly optimistic, but about their failure to raise any capital—not a cent. Paulson suspected that Fuld had been foolishly resisting doing so because he was hesitant to dilute the firm’s shares, including the more than 2 million shares he personally held.

Paulson’s analysis of Lehman had been heavily colored by Goldman Sachs’ commonly held view of the firm during his time there: It didn’t have the same level of class or talent. While Paulson had at least once referred to Lehman as “a bunch of thugs” when he was at Goldman, he did nonetheless respect its hard-driving culture, admiring how aggressively Lehman bankers hustled. And they were loyal, almost to a fault; it was a tight-knit group that reminded him of Goldman’s partnership.

Still, there was something about Fuld that made him nervous. He was a risk taker—recklessly so, in Paulson’s view. “He’s like a cat; he’s had nine lives,” he said at one staff meeting. Paulson believed that his old Goldman colleague, Bob Rubin, had unwittingly bailed out Fuld in early 1995 when, as Treasury secretary, he provided aid to Mexico during its peso crisis. Lehman had wagered a fortune on the direction of the Mexican peso without hedging that bet, and it had gotten it wrong. Paulson remembered the moment well—and told his staff about it—because of accusations at the time that Rubin had actually organized the international bailout in an effort to save Goldman Sachs.

Fairly or not, Paulson lumped Fuld in with what he saw as the rear guard on Wall Street, financiers like Ken Langone and David Komansky, the type who were habitual power lunchers at Manhattan’s San Pietro restaurant and were friends of Richard Grasso, a symbol of excess. Paulson had been a member of the New York Stock Exchange’s Human Resources and Compensation Committee that had approved a $190 million payday for Grasso, the NYSE chairman. Fuld had been on that committee as well; Langone had been its chairman. After the uproar over the size of Grasso’s compensation package, Paulson wanted him out. In his view, Grasso hadn’t been just greedy; he had been deceitful. Eliot Spitzer, the New York attorney general, then at the top of his game, soon became involved in the matter, suing both Grasso and Langone. It was in the resulting battle that Paulson came to dislike Grasso’s cronies, who seemed all too ready to throw Paulson under a bus if it suited their purposes.

But as secretary of the Treasury, he was obliged to be a diplomat, and as such, needed to maintain good relationships with all the Wall Street CEOs. They would be huge assets, his eyes and ears on the markets. If he needed “deal flow,” he preferred to get it directly from them, and not from some unconnected Treasury lifer whose job it was to figure these things out.