In FED We Trust (40 page)

The discussion ended at 2
P.M.
, and when the roll was called, Plosser voted with Bernanke. The initial vote, though, was not unanimous. Richard Fisher, president of the Dallas Fed, cast a no ballot. The dissenter’s role was hardly new for Fisher. “In a committee such as the FOMC,” he said in a September speech, “the best service a member can render is to show his or her affection for the institution … by calling it as he or she sees it.” Fisher had objected formally to the majority’s decisions in January, March, April, and August. When the Fed had kept interest rates steady at 2 percent in August, before the Lehman fiasco, Fisher had argued, with little prescience, that it should
raise
rates “to help restrain inflation.” This time, he fretted that another move down in the Fed-controlled rates wouldn’t help the economy much and could hurt banks struggling to make a profit and people who lived on interest on their savings. Still, if Fisher’s vote was predictable, it damaged the united front Bernanke had hoped to present to the world.

The FOMC took a break after the vote. While the staff typed the statement, the officials wandered into the adjacent room to grab sandwiches. Suddenly, Fisher had second thoughts about dissenting. He approached Bernanke and told him that he wanted to change his vote. His dissent was erased from the record. Fisher himself didn’t inform his colleagues; Bernanke simply announced it. Months later, Fisher explained: “I felt after going for a walk down the hall that I didn’t want to pull the legs out from under Ben, and I didn’t want to be perceived as not being a team player.”

When the unusual Fed statement was issued several minutes later than 2:15
P.M.
, it recorded the vote as unanimous. Bernanke had his harmony. He also had flexibility. The FOMC statement promised that the Fed would employ “all available tools to promote the resumption of sustainable economic growth.” Even better, no one outside the Fed noticed that the statement was tardy. The markets cheered. Laurence Meyer, the former Fed governor who had a consulting business focused on the Fed, e-mailed clients: “The FOMC pulled out all the stops today.”

When the FOMC meeting reconvened after lunch, Bernanke promised “continued close cooperation and consultation” with the presidents and adjourned the meeting around 3
P.M.
Fisher, in a speech in Dallas that Thursday, offered a full-throated endorsement of the Fed’s decision with his usual rhetorical flourishes and quotes from everyone from Washington Irving to Walter Bagehot. “My colleagues at the Federal Reserve and I are red-blooded Americans. We refuse to be fatalistic. …,” Fisher said. “And though in normal times, central bankers appear to be the most laconic genus of the human species, in times of distress, we believe in the monetary equivalent of the [Gen. Colin] Powell Doctrine. We believe that good ideas, properly vetted and appropriately directed with an exit strategy in mind, can and should be brought to bear with overwhelming force to defeat threats to economic stability.” He didn’t hint that he had, briefly, objected.

The December 16 FOMC meeting had been both a marathon and, for Ben Bernanke, a triumph. But the Fed chairman wasn’t allowed time to ponder the milestone of zero interest rates or what constituted “overwhelming force.” That afternoon, Bank of America sent up a flare. The bank’s chief financial officer, Joe Price, called Kevin Warsh while the bank’s outside lawyer — Ed Herlihy of Wachtell, Lipton, Rosen & Katz — called Ken Wilson, one of Paulson’s advisers and another former Goldman executive.

Their message was unwelcome and dire: the big bank was getting cold feet about completing the acquisition of Merrill Lynch, about the only thing that had gone right during that terrible week in September. Merrill was sitting on losses far greater than Bank of America had anticipated.

Wilson, stunned, told the lawyer to have Bank of America’s CEO Ken Lewis call Paulson. He did, and Bernanke as well, asking to meet with the two officials in Washington late in the day on Wednesday. Bernanke and Warsh were suspicious. “My first instinct was: they see we’re in the candy business, and they want candy,” Warsh said. Bernanke had similar sentiments. Bernanke, Warsh, and Don Kohn huddled on the stance Bernanke should take. At 6
P.M.
Wednesday, Lewis, flanked by his chief financial officer and general counsel, sat down with Paulson, Bernanke, and their lieutenants in the anteroom off the Fed boardroom. Warsh listened by phone, as did the New York Fed.

The Bank of America executives persuaded most top Fed officials that they had been stunned to discover the size of Merrill’s losses — which made the Fed officials wonder about Lewis’s competence. “Some of our analysis suggests that Lewis should have been aware of the problem with ML earlier (perhaps as early as mid-November) and not caught be surprise,” the Fed’s general counsel, Scott Alvarez, wrote in a December 23 e-mail. And some of the troublesome loans and securities weren’t Merrill’s, but had been made by Bank of America.

The Bank of America executives said they were considering invoking a “material adverse change” clause in the contract to buy Merrill, essentially to cancel the deal. The Fed officials were surprised, though, that Bank of America didn’t have anything specific to request. The Fed also was embarrassed
that the examiners it had working inside both Bank of America and Merrill Lynch hadn’t a clue that Merrill had such big unreported losses.

Bernanke and Paulson were sure of one thing: the markets were unprepared for Bank of America to abandon Merrill Lynch, a deal that already had been approved by shareholders. Not only would Merrill be orphaned, but Bank of America’s reputation for competence would be damaged catastrophically. The federal government might end up nursing two more gigantic but critically ill financial institutions.

Bernanke and Paulson listened, sent Lewis away without promising anything, and asked their bank supervisors and lawyers to scrutinize the companies’ books and the Bank of America — Merrill contract. Fed lawyers came to one quick conclusion: if Bank of America walked away from Merrill, it would be sued and probably lose. The “material adverse change” clause gave Bank of America very little wiggle room.

Two days later, around 3:30
P.M.
on Friday, Bernanke, Paulson, and Bank of America executives talked again, this time by telephone. Bernanke and Paulson emphasized how completing the deal was important not only to Bank of America itself, but also to the overall financial system. They told Lewis what the Fed lawyers had said. Without being specific, they vowed the government would work with Bank of America to find a solution that would allow the merger to go through and produce a stable merged company. Bernanke asked Warsh to be the Fed’s point person, coordinating with Fed banking supervisors in New York, Washington, and Richmond — which oversaw Bank of America because it was based in North Carolina. The only good thing was that
this
crisis didn’t need to be resolved in a single sleepless weekend.

Bank of America already had received $25 billion in government capital through the TARP program. “[T]hese were funds we did not need and did not seek,” Lewis wrote to the bank’s employees at the end of November. “At the time the government asked the major banks to accept the injections, we had just completed our own $10 billion capital raise in the market and … had more than adequate capital. We accepted the funds from the government as part of a broad plan to stabilize the financial markets generally.” That was then. Now he needed more money, a lot more.

Over the weekend, Lewis called Paulson, who was out for a bike ride.
Paulson told him emphatically that the government didn’t think it was in Bank of America’s “best interest for you to call a MAC” — to trigger the “material adverse change” clause. Then, according to sworn testimony Lewis gave to the attorney general of New York, Paulson threatened to remove the management of the bank and its board and its directors if it tried to back out of the deal. Lewis was stunned. “Hank,” he said, “let’s deescalate this for a while.”

On Monday afternoon, December 22, Lewis briefed Bank of America’s board on his conversation with Paulson and Bernanke, and recommended the deal go through. The directors, according to the minutes, said they were “not persuaded or influenced” by Paulson’s threat and pressed Lewis to get a firmer commitment from the Treasury and the Fed that the government would help Bank of America absorb Merrill Lynch’s losses with money or guarantees.

Paulson and Bernanke didn’t explicitly promise anything. They made clear to Lewis that the government saw the survival of Bank of America as critical to the entire economy and pointedly reminded him of what they already had done for Citigroup. “Although we did not order Lewis to go forward,” Bernanke said in an e-mail to the Fed’s general counsel, Scott Alvarez, that week, “we did indicate that we believed that [not] going forward would be a detriment to the health … of his company.” In the e-mail, a copy of which was subpoenaed and released by a House committee looking into the episode six months later, Bernanke asked if — should Bank of America be sued — the Fed could offer a letter explaining why it had encouraged Lewis to consummate the deal.

Alvarez rejected the chairman’s notion. “Making hard decisions is what he [Lewis] gets paid for,” the general counsel e-mailed back. “We shouldn’t take him off the hook by appearing to take the decision off his hands.”

Lewis pleaded for a letter from the Treasury to reassure his board. Paulson refused. “A vague letter reiterating Treasury’s public commitment to prevent systemically important institutions from failing would not help Bank of America but would instead rattle markets by creating more questions than it answered,” Paulson’s spokeswoman explained later.

Lewis told his board as much at 4:58
P.M.
that Monday: “He said there was no way the Federal Reserve and the Treasury could send us a letter of any substance without public disclosure, which, of course, we do not want.”

After ten days of back-and-forth — much of it between Lewis and his
chief financial officer, Joe Price, and the Fed’s Kevin Warsh — on the nature of the aid the government might provide Bank of America and the conditions, the bank closed the deal with Merrill Lynch on January 1. There was no hint in public, by the bank or by the government, that anything was amiss. Bank of America disclosed none of its misgivings about Merrill nor anything about its conversations with Bernanke and Paulson. In an interview with New York’s attorney general, Lewis suggested he kept quiet because that’s what Paulson and Bernanke wanted. That assertion stirred controversy and, eventually, congressional hearings that publicly dissected the tense conversations that Lewis had with Bernanke and Paulson in December 2008.

A few weeks later, just four days before Obama’s inauguration, the Treasury — with the Fed’s support — agreed to invest another $20 billion of taxpayer money in Bank of America and limit the losses on $118 billion in toxic loans, roughly three-quarters of that from Merrill and the rest from loans Bank of America itself had made. The terms were similar to those agreed to with Citigroup in November. Bank of America agreed to swallow the first $10 billion in losses on that $118 billion portfolio and 10 percent of all losses after that. The Treasury’s TARP and the Federal Deposit Insurance Corporation agreed to take the next $20 billion. And if the losses were even bigger than that, well, the Fed would eat them.

Bank of America had planned to release its first-quarter earnings — and news of the government support — on January 20, Inauguration Day. Bad timing, Kevin Warsh told them — very bad. Bank of America relented and moved the announcement to 7
A.M.
the Friday before Obama’s inauguration. Lewis desperately hoped his bank could avoid being lumped with Citigroup, which was seen by the markets as a ward of the state after its November rescue. The gambit didn’t work. Bank of America was widely seen as another Citigroup. Its stock, which had been trading at $14.50 when Lewis came to see Bernanke and Paulson, closed at $7.18 after the Friday, January 16, announcement. Four months later, in early May, the Treasury and the Fed
told Bank of America it needed to raise $33.9 million in capital to withstand a severe recession — either privately or from the government. On the day after that sum became public, Bank of America shares closed at $13.55.

On January 26, a week after Obama’s inauguration, the FOMC gathered for dinner on the top floor of the William McChesney Martin Jr. Building, a 1974 structure named for the Fed’s longest-serving chairman that stands across the street from Fed headquarters. The occasion was the send-off of Tim Geithner, then struggling to win Senate confirmation as Treasury secretary amid criticism for his failure to pay all the taxes he owed earlier in the decade.

The Fed tradition is that the toast is done by the regional Fed bank president who chairs the Conference of Presidents; that post had just been assumed by Jeff Lacker, the Richmond Fed president who had been Geithner’s nemesis. Lacker avoided the temptation to needle Geithner about his tax problems. He presented one of the traditional gifts — a frame holding dollar bills from each of the twelve Fed bank districts — and offered a little insider’s humor: “Get used to the fact that at Treasury you don’t have the ability to print and circulate money. That’s our job.”

He told Geithner that his former colleagues had considered giving him one of the newly chartered companies that the Fed had created to hold Bear Stearns or AIG assets. After all, Lacker quipped, they were worth so little that they wouldn’t exceed the Fed’s $20 ceiling on gifts.

And then Lacker offered a litany of Geithnerisms, words that he used to excess, with a sentence accompanying each — words like “dimension,” which Geithner commonly used as a verb. “If you need some people to help
dimension
the losses at Citi, you can have a few from the task force.” Geithner, blushing, laughed at the jokes, as did the assembled governors and district bank presidents.