In FED We Trust (37 page)

The next day, Sunday, October 12, Paulson called the heads of the nation’s nine largest banks and “invited” each to appear at Treasury at 3
P.M.
the next day, the Columbus Day holiday. The Treasury secretary refused to reveal the agenda, setting off a flurry of calls from the invitees to their Washington lobbyists who, in turn, begged contacts at Treasury for clues. Citigroup’s Vikram Pandit said he had other things to do and would send someone else if
this was just an update on the markets and a photo op. Merrill’s John Thain said he had a previous conflict. Wells Fargo’s Dick Kovacevich said he wasn’t coming. Paulson told him: Dick, the secretary of the Treasury and the chairman of the Fed have asked you to come to a meeting; I suggest you come. In the end, they all showed up.

Meanwhile, Bernanke, Paulson, and Geithner — along with Sheila Bair of the FDIC; Bob Hoyt, the Treasury’s general counsel; and David Nason, the assistant secretary — met a couple of times in Paulson’s corner office to rehearse their lines for what they all knew would be a historic meeting.

Monday found the bankers seated on one side of a long, polished, dark wood table, arranged alphabetically by the name of their bank. That conveniently put the antagonists in the continuing Wachovia dispute — Pandit of Citi and Kovacevich of Wells — at opposite ends of the table. Paulson, Bernanke, Geithner, and other government officials sat on the other side. Paulson went first, facing men who had once been his peers. His tone conveyed the message: This isn’t a take-it-or-leave-it offer. This is a take-it offer. Bernanke talked about the Fed’s plans to buy commercial paper. Bair outlined the new guarantee of bank debts and fielded questions. Geithner then detailed the terms of the government’s capital injections and how much money each bank was being asked, or told, to take.

The banks would have to pay a 5 percent dividend on the preferred shares they would issue to the government. To encourage banks to find private investors to take the government’s place, the dividend the banks had to pay to the Treasury climbed to 9 percent after five years. Banks could keep paying dividends to their common stockholders but couldn’t raise them (a provision later changed by the Obama administration). The government would get warrants — the right to buy common stock at then depressed prices so taxpayers would benefit if the banks recovered.

The terms were generous. This was deliberate. Paulson, Bernanke, and Geithner had decided to give capital to all the big banks, the healthy and the weak, to avoid “stigmatizing” the weak ones. “The terms had to be attractive, not punitive,” Phillip Swagel, the Treasury’s economist, argued. Emphasizing
the absence of any legal authority to force banks to take government capital, and minimizing the ability that Paulson and Bernanke had to make banks do things they didn’t legally have to do, Swagel said, “In a sense, this had to be the opposite of
The Sopranos
— not a threat to intimidate banks but instead a deal so attractive that banks would be unwise to refuse it.

Only after Geithner finished speaking did David Nason walk around the table and distribute pieces of paper with the terms of the deal and a place for each CEO to sign. “The theory,” one of the officials put it later, “was get them warmed up before they see the term sheet. It’s like with third graders. If you leave the paper on their desks they don’t listen to the teacher; they look at the paper. The same rule applies to fifty-five-year-old billionaires.”

The numbers were huge: $25 billion each for Citi, JPMorgan Chase, and Wells Fargo; $15 billion for Bank of America; $10 billion each for Merrill Lynch, Goldman Sachs, and Morgan Stanley; $3 billion for Bank of New York Mellon; $2 billion for State Street Corporation.

Wells’s Kovacevich was the most animated. His bank already had announced plans to raise $25 billion in new capital. Was this in addition to that?

Yes, Geithner told him.

That’s more capital than Wells has ever gotten, Kovacevich protested. Dick, you have no idea what the market’s going to look like in a year, Geithner responded.

Neither do you, Kovacevich shot back.

Paulson told him he could accept the government’s money or risk going without. But if the bank needed capital later and couldn’t raise it privately, the government offer wouldn’t be as generous as this one.

Citigroup’s Pandit looked relieved. “This is very cheap capital,” he exclaimed. “I just did the numbers on the back of the envelope, and this is very inexpensive capital.” It wasn’t clear, though, what numbers he was actually doing, since there wasn’t much to calculate. Citi was, by far, the weakest of the big banks in the room — and it was getting taxpayer capital on the same terms as the stronger banks.

Merrill Lynch’s Thain asked how taking this money would affect government controls on executive compensation. Someone wanted to know if a
bank could take the FDIC guarantee but not the capital. “No way” was the reply. A few of the bankers — the heads of Wells Fargo, Bank of New York Mellon, and Citigroup — began peppering the officials about the restrictions on raising dividends to common shareholders.

Bernanke intervened. “I don’t really understand why this needs to be confrontational,” he said, his preternatural calm a contrast to Paulson’s constant agitation. The paralysis in financial markets was doing great harm to the banks represented in the room. This is in your interest, he told them. This is in the interest of the financial markets. This is in the interest of the economy. This is in the interest of the government.

Morgan Stanley’s John Mack was the first to start to sign the paper when one of his fellow CEOs interjected: Don’t you have to go to your board?

JPMorgan Chase’s Jamie Dimon said he didn’t need the capital, but joked if he was in for $25 billion, he was in for $50 billion. Once he had to accept the intervention of the government in his business, the more money the better. Goldman’s Lloyd Blankfein said much the same thing. Finally, Bank of America’s Ken Lewis ended the banter. “Why are we debating this? We’re all going to do this. Let’s just get it done,” he said, according to participants. “Any one of us who doesn’t have a healthy fear of the unknown isn’t paying attention.”

The meeting broke up after an hour or so with a plan to reconvene at 6:30
P.M.
Each CEO retreated to an office assigned to him at the Treasury or to a corporate or law firm office not far away. Regulators wandered from office to office, fielding questions in person or by phone. Before 6:30
P.M.
, each of the CEOs had signed. The meeting never reconvened.

Even putting $125 billion of taxpayer money into the nine big banks wouldn’t suffice, it turned out. Citigroup would be back for more in November — another $20 billion in capital from TARP and a deal with the Treasury, FDIC, and Fed to limit its losses on a $306 billion pool of loans and securities — and still more in February 2009; in June 2009 it would be the one big bank about which officials were most worried. Bank of America would be back for more, too. And the Fed deal with AIG would be redone, redone
again, and redone again. Kevin Warsh dubbed them “the proper nouns,” the institutions that would pose problems for months to come.

But there was no doubt that on Columbus Day 2008, a Treasury secretary and a Fed chairman appointed by a Republican, self-described conservative president had been forced to cross a line that would have seemed impenetrable a year earlier. The government of the United States, champion of free markets and victor of the cold war, was buying stakes in the banks.

Gao Xiqing, the president of China Investment Corporation, saw the irony. His company manages about $200 billion of Chinese foreign assets, including most of the high-visibility investments such as stakes in private-equity firm Blackstone and investment banker Morgan Stanley. In an interview with James Fallows of
The Atlantic
, Gao said, “Finally, after months and months of struggling with your own ideology, with your own pride, your self-righteousness … finally [the U.S. applied] one of the great gifts of Americans, which is that you’re pragmatic.”

Alluding to Chinese leaders’ description of their tentative embrace of markets as “socialism with Chinese characteristics,” Gao said, “Now our people are joking that we look at the U.S. and see ‘socialism with American characteristics.’”

A
s Fed officials prepared for mid-December’s FOMC meeting, none doubted how weak the economy was. Surveys of businesses conducted by the twelve regional Fed banks were unambiguously gloomy: “Overall economic activity weakened across all Federal Reserve districts,” the summary said. Tourism spending was “subdued.” Factory orders were “soft.” The job market was “weakening.” Retail and auto dealer sales were down. Prices of energy and food were falling; the pace of other price increases was slowing.

The Green Book — an internal Fed forecast named for the color of its cover — expanded on this darkening outlook. The economy in the fourth quarter was even worse than anticipated just a few weeks earlier. The outlook for 2009 was poor, too. Unemployment, then at 6.8 percent, would rise through 2009, climbing higher than previously predicted. Inflation was a waning worry, but a “moderate recovery” would not arrive until 2010, more than a year away. With such a bleak outlook, President-elect Obama, with Bernanke’s strong encouragement, was preparing a huge package of spending increases and tax cuts to stimulate the economy.

BERNANKE’S DASHBOARD
December 11, 2008

The markets provided no relief: a situation that was unsettled at best had received another blow from Paulson’s bumbled communications. A week after the presidential election, Paulson delivered a speech to a few dozen reporters and a half dozen television cameras in the Treasury’s fourth-floor “media room.” Swigging from a bottle of Dasani water while on live television, Paulson once again screwed up the theater. He made explicit that he was abandoning the very strategy he had used to sell Congress on approving his request for $700 billion: The Treasury wouldn’t be buying toxic mortgage assets from the banks because that was no longer “the most effective way” to use the money. That had become obvious to many in the press and the markets, but Paulson feared the mortgage markets were frozen as investors and traders waited for the Treasury to show up with lots of money. Instead, he said, the Treasury planned to use nearly all the money to shore up the capital foundation of the nation’s banks and to try to get consumer lending going again. Paulson didn’t add that the volume of toxic assets on the banks’ books had, in fact, grown so large that $700 billion was no longer enough to buy them all, even at currently depressed prices.

But it wasn’t the
substance
of the decision that hurt; there were, after all, arguments for and against buying assets. As Paulson put it later, there was virtue in being “pragmatic enough to change plans when facts and conditions change.” Instead the speech was another one in a series of Paulson’s abrupt changes in course. This appearance of inconsistency destroyed any lingering credibility Paulson had. The final impression he would leave is of the balding
former college football player lurching from one approach to another without a game plan.

With all this dismal economic news on their minds as they gathered around the Fed’s board table on December 15 and 16, officials didn’t spend much time debating the wisdom of cutting the Fed’s target for its key short-term interest rate. This, in itself, was unusual. For decades, each FOMC meeting had one overarching — and sometimes divisive — objective: to decide whether and how much to move interest rates up or down. What’s more, since the end of October, the rate had already been sitting at 1 percent, as low as Greenspan had taken it in his nearly nineteen years as Fed chairman. But sixteen months into the Great Panic, everyone in the Fed boardroom realized Greenspan had never faced a downturn this severe.

These historic circumstances made for an unconventional FOMC meeting: longtime roles were reversed, and discussion ranged into previously unexplored territory. Neither the high stakes nor the relatively easy agreement over interest rates signaled a broader harmony within the group; rather, interest rates became a sideshow as arguments roared on about nearly everything else. Before the meeting had even begun, an internal debate erupted over whether the Fed was actually making the financial crisis worse. Many Fed officials argued that, while imperfect, the Fed’s interventions had arrested the economy’s free fall. But several regional bank presidents insisted that the Fed’s inconsistent stance on bank rescues was further destabilizing the economy. Other tensions of the previous eighteen months — the simmering disagreements about the fundamental nature of the Great Panic and the resentment of flyover-state Fed bank presidents toward the power of Washington and New York — boiled over behind closed doors.