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

Goldman could not buy just any insurer, however; it would have to be a company large enough to put more than a dent in Goldman’s already hefty balance sheet. The top name on O’Neill’s list was AIG, American International Group, which by some measures was the biggest insurance company in the world. The stock price of AIG had recently been decimated, so it might even be economical. Doing a deal with AIG had not, in fact, been a new idea; a possible merger had been talked about in hushed whispers at 85 Broad Street for years. Previous leaders of Goldman, John Whitehead and John Weinberg, both of whom were friends of Hank Greenberg, had suggested to him that the companies should perhaps do a deal some day.

Everyone in the group had a view about AIG. Rajat K. Gupta, senior partner emeritus of McKinsey & Company, was intrigued, as was John H. Bryan, the former CEO of Sara Lee and one of Paulson’s closest friends.

Bill George, the former head of Medtronic, the medical technology giant, appeared a bit more hesitant, and Gary Cohn said frankly that the idea made him nervous. They all looked to one particular board member for direction: Edward Liddy.

As the chief executive of Allstate, the major auto and home insurer, Liddy was the one person in the room with actual experience in the insurance business. Some five years earlier Liddy had even tried to sell his firm to AIG, and Greenberg had dismissively rejected his pitch. “I think you ought to keep it,” Greenberg told him.

Whenever the subject of insurance had come up at previous board meetings, Liddy had been unenthusiastic. “It’s a totally different game,” he had warned. His view on the matter hadn’t changed, no matter how much of a bargain AIG may have seemed. “It isn’t worth getting entangled with AIG,” he insisted.

The morning session ended without any decisions being made about AIG, but the insurer came up again after lunch for an entirely different reason. AIG traded through Goldman as well as other Wall Street firms, and like many other companies would put up securities as collateral. There was just one problem: AIG was claiming that its securities were worth a good deal more than Goldman thought they were. Although Goldman’s auditor was looking into the matter, there was another snag: the auditor, PricewaterhouseCoopers, also worked for AIG.

In a videoconference presentation from New York, a PWC executive updated the board on its dispute with AIG over how it was valuing or, in Wall Street parlance, “marking to market,” its portfolio. Goldman executives considered AIG was “marking to make-believe,” as Blankfein told the board.

Strangely, however, no one in the room in St. Petersburg made the critical connection; no one raised the collateral dispute as evidence of a potential fatal flaw in Goldman’s consideration to merge with AIG—that the company itself was in serious trouble and had resorted to overvaluing its securities as a stopgap. Instead, the afternoon session proceeded with upbraiding PricewaterhouseCoopers: “How does it work inside PWC if you as a firm represent two institutions where you’re looking at exactly the same collateral and there’s a clear dispute in terms of valuation?” Jon Winkelried, Goldman’s co-president, pointedly asked.

It was the second time PWC had been criticized during a Goldman board meeting. Goldman’s board had first learned of the collateral dispute with AIG in November 2007. At the time, the sum involved was more than $1.5 billion. Nervously, Goldman started buying up protection in the form of credit default swaps—insurance—against the possibility that AIG would fail. Given that no one at the time seriously thought that would ever happen, the insurance was relatively cheap: For $150 million, Goldman could insure some $2.5 billion worth of debt.

The Goldman board ended its day in St. Petersburg in a more leisurely manner. With the northern sky still light well after 10:00 p.m., the thirteen directors and their spouses rode gondolas along the city’s storied canals.

On Sunday, the board flew down to Moscow for the second part of the meeting, gathering at the Ritz-Carlton, on the edge of Red Square. Mikhail Gorbachev was the speaker at their dinner that evening. Power in Russia was still very much in the hands of Vladimir Putin, even though Dmitry Medvedev had recently been elected to succeed him. Many foreign investors feared that Russia’s commitment to open and free markets was quickly fading, particularly in light of the power grabs in the energy industry.

Gorbachev, who had initiated the changes that led to the end of communist rule, struck several Goldman directors as oddly deferential to the Kremlin. “Russia is now realizing its potential as a democratic state, opening itself up to new ideas and outside investment.”

Some directors joked that if the last hotel wasn’t bugged, this one certainly must be.

In a strange coincidence, late that afternoon another key figure in American finance arrived in Moscow. Treasury secretary Henry Paulson had come there on a stop on a five-day European tour that would later take him to Berlin, Frankfurt, and then London.

He had been on the road a great deal that month—visiting the Persian Gulf states; attending the Group of Eight meeting of finance ministers in Osaka, Japan; and now passing through Europe and Russia. The highlight of his trip, he hoped, would be London, where he had been preparing to give what he believed would be an important speech at Chatham House, an international affairs research group, in St. James’s Square. Crafted with the help of his lieutenant David Nason, the talk would herald a proposed overhaul of financial regulation. As he continued to be concerned about firms like Lehman, he knew he needed to call for new tools to deal with troubled institutions. He wanted to get ahead of the problems while things still seemed stable.

On the flight over he had reviewed the speech, making last-minute changes, knowing that he’d have little time to do so once he arrived in Moscow. “To address the perception that some institutions are too big to fail, we must improve the tools at our disposal for facilitating the orderly failure of a large, complex financial institution,” he planned to say. “As former Federal Reserve chairman Greenspan often noted, the real issue is not that an institution is too big or too interconnected to fail, but that it is too big or interconnected to liquidate quickly. Today our tools are limited.”

It was a risky gambit to announce to the world that the government lacked the authority to prevent a major failure—such a sentiment could undermine confidence in the markets even further—but he also knew that it needed to be said, and even more so, that the situation needed to be fixed.

On Sunday night, Paulson had dinner with Finance Minister Alexei Kudrin in the Oval Dining Room at Spaso House, the residence of the American ambassador in Moscow. On Monday he had scheduled a busy day, including half a dozen meetings, a radio interview, and private sessions with Medvedev and Putin. Paulson had earlier told reporters that he wanted to discuss with the Russians “ best practices” for huge state-owned investment funds known as sovereign wealth funds, which were primarily associated with wealthy Middle East nations.

But before he ended his evening on Saturday, he had one last meeting after dinner. Just days earlier, when Paulson learned that Goldman’s board would be in Moscow at the same time as him, he had Jim Wilkinson organize a meeting with them. Nothing formal, purely social—for old times’ sake.