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

Worse, Paulson had heard rumors when he was in China that Russia had approached some Chinese officials to suggest that both countries start selling large amounts of Freddie and Fannie debt to force the United States to prop them up. Jamie Dimon had separately called him and encouraged him to take decisive action.

Paulson led a discussion around the table at Treasury about whether it made sense to put Fannie and Freddie in Chapter 11 bankruptcy protection or whether conservatorship—in which the companies would still be publicly traded with the government as a trustee exercising control—was the better option.

Ken Wilson was a bit anxious about pursuing what Paulson was describing as a “hostile takeover” without more professional guidance. “Hank, there is no fucking way we can pursue these kinds of alternatives without getting a first-rate law firm,” Wilson told him.

“Okay,” Paulson agreed. “So what do you think?”

“Let me call Ed Herlihy at Wachtell and see if he’ll do it,” Wilson said. “The idea of putting these guys in Chapter 11 is a joke. These are still privately owned entities with obligations to shareholders and bondholders. It’s going to get ugly.”

Wilson had a compelling reason for having recommended Herlihy: He had been involved in some of the biggest takeover battles in corporate America. Earlier in the year he had helped advise JP Morgan Chase in its acquisition of Bear Stearns. His firm—Wachtell, Lipton, Rosen & Katz—was synonymous with corporate warfare. One of its founding partners, Martin Lipton, had devised among the most famous of antitakeover defenses, the “poison pill.” If Treasury was planning a government-led hostile takeover—the first in history—then Herlihy was certainly the lawyer they wanted.

They began their battle plans on the weekend of August 23. Herlihy and a team of Wachtell, Lipton lawyers came to Washington on a half dozen different Delta and US Airways shuttles in order not to arouse suspicion. Paulson walked them through the game plan, assisted by Dan Jester, the lanky Texan who had joined Treasury less than a month earlier. The hope was that like megamergers that are often completed over the course of a single three-day weekend to protect against a leak impacting the stock market, they could take Fannie and Freddie over during the Labor Day holiday, which was the following weekend.

The lawyers and the Treasury officials spent several hours debating possible tactics, relevant statutes, and the structures of each of the companies. Jester and Jeremiah Norton, another staffer at Treasury, outlined a plan to put capital into Fannie and Freddie, and an actual mechanism to take control of them, via the purchase of preferred stock and warrants.

But Paulson soon realized that the Labor Day target was going to be impossible. One of the lawyers had noticed that Fannie’s and Freddie’s regulator from the Federal Housing Finance Agency, James Lockhart, had written letters to both companies over the summer saying that they were considered adequately capitalized. “You’ve got to be kidding me,” Paulson replied when he heard about the letters. Treasury could face resistance from the GSEs’ supporters in Congress and from the companies themselves if the government were to reverse itself apparently arbitrarily. The companies’ claims that they were well capitalized and the regulator’s endorsement would both have to be challenged.

“That’s intangibles and all the stuff that I would call bullshit capital,” Paulson complained.

“We need to reconstruct the record,” Jester announced about the Federal Housing Finance Agency letters.

“Right, right,” Herlihy chimed in. “We need new letters that are pretty bad—or at least accurate.”

The Federal Reserve was then asked to provide examiners, and they would spend the next two weeks going through the books, desperately trying to document the capital inadequacies at Fannie and Freddie.

As the Treasury team went around the table, one issue kept getting raised about pushing forward with a takeover: What if the boards of the two companies resisted?

“Look, trust me,” Paulson said. “You don’t believe me, but I know boards, and they’re going to acquiesce. When we get done talking with them, they’ll acquiesce.”

On the morning of Tuesday, August 26, Paulson walked over to the White House and was escorted downstairs to the basement of the West Wing, where he was given a seat in the five-thousand-square-foot Situation Room. At 9:30 President Bush was beamed onto one of the large screens from his ranch in Crawford, Texas, for a secured videoconference with Paulson. After some brief pleasantries, Paulson laid out his plan to mount the equivalent of a financial invasion on Fannie and Freddie. Bush told him he could proceed with the preparations.

As Labor Day weekend approached, the Treasury team and its advisers started to plot the actual details of the dual takeover. They knew they would have to move quickly, with military precision, and in secrecy before the GSEs could start rallying their supporters in Congress. They wrote scripts specifying exactly what they would tell the companies and their boards. They wanted to make certain that there could be no compromises, no delays. Internally, Treasury officials talked about offering Fannie and Freddie two doors: “Door 1, you cooperate; Door 2, we’re doing it anyway.”

On Thursday morning, August 28, Bob Willumstad and AIG’s head of strategy, Brian Schreiber, walked into JP Morgan’s headquarters at 270 Park Avenue and, escorted by a security guard, were taken by private elevator to the firm’s executive floor, where they had an appointment with Jamie Dimon.

Passing through the main glass doors into a wood-paneled reception area, Willumstad and Schreiber took in the newly renovated offices on the forty-eighth floor. As the two men sat waiting, Willumstad knew his associate was silently irate. Schreiber had been working throughout August on various plans to raise capital and extend the company’s credit lines to avoid facing a cash crunch if the market were to worsen. As part of his efforts he had held a bakeoff among a number of banks and had been unimpressed with JP Morgan’s pitch—and he was still smarting from the firm’s aggressive attitude when they raised capital for AIG in the spring. He had hoped to use Citigroup and Deutsche Bank, but Willumstad had insisted that they consider JP Morgan. The way things were playing out, if things really did get much worse, Willumstad figured he’d rather be dealing with an ally in Dimon, even if his colleague felt otherwise.

The AIG executives were escorted to Dimon’s office, which actually consists of an office with a desk, a sitting room, and a conference room. In the conference area Dimon, Steve Black, co-head of the investment bank, Ann Kronenberg, and Tim Main took their places around a wood table with a whiteboard behind them.

After some small talk, Dimon thanked them for coming, and Main, who headed the bank’s financial institutions group, launched into his pitch for why AIG should use JP Morgan. Main pointed out his group’s number one ranking in the latest league underwriting tables and noted its work in helping CIT Group issue two equity offerings worth $1 billion.

“That’s a dubious achievement to cite,” Willumstad later commented to Schreiber, “given that shares of CIT were trading below $10 [in August 2008] when they were more than four times that a year ago.” All in all, however, it was a fairly standard pitch from a Wall Street banker, the kind everyone in the room had heard dozens, if not hundreds, of times before: We’re the best suited to help you, we have the most talent, the most resources; we understand your needs better than anyone else.