Money and Power (72 page)

As Goldman tried to round up the usual suspects who might be able to invest $1 billion in a sinking ship, it quickly found that LTCM had already made those same calls. On September 17, the LTCM partners went to see Corzine and Thain—though plenty pissed at Goldman for what they believed was trading on its inside information—and told them that Goldman was “our last chance.” The outlook was bleak for LTCM. Later that same day, even though his hedge fund was largely unregulated, Meriwether had let the New York Federal Reserve know what was going on, specifically
William McDonough, its president, and
Peter Fisher, his deputy. LTCM’s equity was down to $1.5 billion, a 60 percent decline in a month.

With Flowers gone,
Peter Kraus, another senior banker in the Financial Institutions Group, was leading Goldman’s efforts to try to find another investor for LTCM. As one potential candidate after another dropped away, Kraus kept talking to Buffett. Buffett hated the structure of LTCM and wanted none of its overhead or its resident geniuses. He might, though, be interested in the LTCM’s severely depressed trading positions, he told Kraus. Out of this idea, Kraus and Buffett hatched the idea that
Berkshire Hathaway, Buffett’s company, Goldman Sachs, and AIG could put together a consortium bid for LTCM’s assets. While at a Beethoven concert in Newark that Friday night, Kraus got up and called Buffett in Omaha. “
He and Buffett penciled out some numbers for a deal,” Lowenstein wrote. Shortly thereafter, Buffett took one of his jets to
Seattle to meet Bill Gates to start a long-planned two-week vacation in some of the remotest parts of Alaska. “Now the dream was alive that Buffett would rescue Long-Term—as he had, coincidentally, Salomon seven years earlier,” Lowenstein wrote.

On Saturday, Corzine called Buffett and found him, with a shaky cell phone connection, in “
the depths of an Alaskan fjord.” They spoke briefly, although the connection kept fading in and out. “He was doing this float-around,” Corzine told Lowenstein. “You’d lose contact and couldn’t speak for two to three hours.” But the message got through: “Buffett was willing to let Goldman handle the details, but under no circumstances did he want his investment to be managed by LTCM or to have anything to do with
John Meriwether,” Lowenstein wrote. “Then the connection blacked out.” They spoke again on Saturday, and Buffett was still somewhat uncertain about a deal. Later that night, Corzine called Fisher and told him that a private rescue seemed unlikely. Fisher broached the idea of getting a group of the biggest banks together at the New York Fed and seeing if they could save LTCM. Corzine told Fisher that idea made some sense.

LTCM was in a death spiral, losing money hand over fist. The potential new investors, including Goldman and Buffett, wary to begin with, became increasingly spooked. McDonough and Fisher, meanwhile, after examining LTCM’s trading positions, became increasingly concerned about the interconnectedness of all of LTCM’s trades with the leading firms on Wall Street. Not only had Wall Street invested in LTCM but many of the firms had also piggybacked on LTCM’s trades. They were also counterparties with one another. The Fed was not concerned about the potential losses that investors would suffer—they were big boys—but was worried about a failure of the system. “
[I]f Long-Term failed, and if its creditors forced a hasty and disorderly liquidation, [McDonough] feared that it would harm the entire financial system, not just some of its big participants,” Lowenstein wrote. “McDonough evoked a parallel fear—that losses in so many markets and to so many players would spark a vicious circle of liquidations, extreme fluctuations in interest rates, and then further losses: ‘Markets would … probably cease to function for a period of one or more days and maybe longer.’ ”

But the fat lady had not yet sung. While the heads of many of the world’s largest banks were cooling their heels at the New York Fed, Corzine and Thain had pulled McDonough aside and told him that Buffett was ready to bid after all. To verify the accuracy of what the Goldman team had told him, McDonough called Buffett—now at a ranch in Montana—and learned that he was ready to send in his bid, which theoretically
anyway would relieve the consortium of banks that had gathered from having to put together a rescue. McDonough had no choice but to let the Buffett proposal play out. He told the waiting bankers there would be a pause in the action. “In the main room, the CEOs rose with a look of disgust,” Lowenstein wrote. “They were furious at Goldman for dealing behind their backs.” Buffett then called Meriwether and told him an offer for LTCM was on the way; Kraus was busy working on it. When the offer came to Meriwether an hour or so later, he was incredulous: Berkshire, Goldman, and
AIG had offered to buy LTCM for $250 million, and then would inject another $3.75 billion into the firm to allow for something like normal trading to continue. Of the $3.75 billion, Berkshire was putting up $3 billion. What had been worth $4.7 billion at the beginning of the year was now worth $250 million. The LTCM partners would lose their jobs and be wiped out. Buffett gave Meriwether less than an hour to decide. He then became unreachable.

The offer letter was technically and legally flawed—for inexplicable reasons—and with Buffett unavailable, Meriwether, who disliked the deal anyway, let the offer lapse. He decided to take his chances with McDonough, the Fed, and the bank consortium. The time had come to act. Based on a proposal made by
Herbert Allison, then president of Merrill Lynch, the sixteen banks that were LTCM’s largest counterparties would contribute $250 million each—a total of $4 billion—to LTCM in exchange for the vast amount of the firm’s equity that had been owned by the original partners. LTCM’s investors would be wiped out, but Allison hoped his plan would allow for an orderly liquidation of the firm’s positions and prevent a systemic crash. By this time, Paulson was more than a little fed up with Corzine’s antics with LTCM—first wanting to buy the hedge fund outright and then making a bungled show of trying to make a last-minute investment in LTCM—and started to lash out. He insisted that Thain trail Corzine at every turn. “
It was really a matter of trust and confidence and making sure someone understood the numbers,” Paulson said. “And that we were doing this in a disciplined way, where the firm’s reputation wasn’t going to get hurt. Because this was a mess. Goldman Sachs was trying to do several different things at once, and I didn’t even know about some of them.”

On the evening of September 22, Fisher and McDonough asked the heads of the sixteen banks to come to the New York Fed building on Liberty Street to discuss a Fed-orchestrated bailout of LTCM. Fisher permitted each bank to bring two representatives. Corzine came with Thain. Throughout parts of that meeting and during meetings on subsequent days, Paulson was on the phone with Thain, and he was increasingly
angry that Goldman would have to pony up, first $250 million, and then $300 million (chiefly because Bear Stearns had declined to participate at all). With the basic agreement finally in place, the lawyers drafted up the paperwork over the next five days, trying to herd the cats toward a final agreement.

Many compromises were made along the way and much pain was taken by the consortium of banks. By agreeing to invest close to $4 billion in the LTCM carcass, they were saving themselves at the expense—of course—of the LTCM partners, who certainly deserved to take it on the chin. Early Sunday evening, September 27, while Corzine was returning to Manhattan from his 6,200-square-foot “majestic beachfront home” in Sagaponack (sold in 2010 for $43.5 million to hedge-fund manager and Goldman alum
David Tepper), Bob Katz, Goldman’s general counsel, informed the assembled lawyers that Goldman would drop out of the deal if any of the nearly $4 billion being put into LTCM went out the door to Chase, which was planning to take back the $500 million that LTCM drew down from its revolving line of credit as disaster struck, per Jimmy Cayne’s suggestion. “
The point was to rescue Long-Term, not to rescue Chase,” Lowenstein wrote, and the other bankers, who felt the way Goldman did, were only too “happy to let Goldman play the heavy.”

Chase thought Goldman was bluffing.
Thomas Russo, the Lehman general counsel, did, too, and told Katz so. Without the payment, Chase said it would walk. With the payment, Goldman said it would walk. “There was no deal,” Katz said later. When Corzine called in to the meeting while on the road back from beach, he reiterated Goldman’s position. “Jon,” exclaimed the
Chase banker, “
there is no polite way to say this: Goldman can go fuck themselves.” Corzine held firm. The deal was dead, at least for Sunday night. Herb Allison at Merrill was caught in the middle. He knew that if Goldman walked, the whole deal would fall apart. “
One always has to indulge the bad boys at Goldman,” Lowenstein wrote. Later Sunday night, Chase caved in and allowed the newly recapitalized LTCM to keep the $500 million in the fund and to not pay the money out to the bank syndicate. Goldman was back on board. “
None of us liked having to step up,” Paulson said. “But it was really the only thing to do. When John Thain recommended that we do it and that we put together a structure where we had a fighting chance of avoiding very big losses, I signed off on it.”

Thain said the decision to put $300 million into the LTCM rescue was very controversial inside Goldman, and the controversy was exacerbated by the fact that Jimmy Cayne and Bear Stearns decided not to contribute.
“
I don’t think there was ever any real question of whether we were going to do it,” he said, “but it was controversial and people were very concerned but there’s a little bit of being a good citizen. When the head of the New York Fed says, ‘Look, we have this problem, and I need you guys to help,’ we were helping fix a problem that was going to be a problem for the system as a whole. Even though it was controversial, there was never really any doubt that we were going to do that. Bear Stearns and Jimmy Cayne, in particular, basically told the system ‘Screw off.’ That’s never a very good thing to do because sometime you may need help, and when you refuse to be a good citizen and help somebody else, then people remember that.” Of course, Goldman’s subsequent role in exacerbating Bear Stearns’s spectacular demise in March 2008 has been much debated, with some linking it to lingering anger over Cayne’s decision not to participate in the bailout of LTCM.

The consortium of banks working together—albeit warily—had put their collective finger in the dike and prevented the collapse of the financial system.
Alan Greenspan, the chairman of the Federal Reserve at the time, defended the Fed-orchestrated bailout. “Had the failure of LTCM triggered the seizing up of the markets,” he told the House Banking Committee on October 1, “substantial damage could have been inflicted on many market participants and could have potentially impaired the economies of many nations, including our own.” When Representative
Barney Frank, of Massachusetts, criticized Greenspan for having the Fed organize the bailout that left “some of the richest people in the country better off than if you didn’t intervene,” Greenspan countered, “No Federal Reserve funds were put at risk, no promises were made by the Federal Reserve and no individual firms were pressured to participate,” a curious reinterpretation of the facts.

There was no getting around the damage that the combination of the
Russian and LTCM crises had inflicted on the markets, especially on the stocks of financial companies. The next afternoon, after the market closed on September 29, Goldman announced it was withdrawing its IPO and cited the “unsettled conditions” in the markets as the reason. Shares of many financial services companies had fallen as much as 50 percent since August. “You just have to look at how financial institutions are faring,” Corzine told the
Times
. “Those valuations are really dramatically lower.” Added Paulson about pulling the IPO, “
This was not a close decision. This was a clear decision. I would conjecture that there would be very few people, if any, at Goldman Sachs who would question this decision.” Whereas during the summer, Goldman’s value was in the $30 billion range, the events of the previous weeks had reduced that to closer
to $15 billion, and accordingly the amount of proceeds Goldman would get from the IPO would be reduced to $1.5 billion from $3 billion. In a “transatlantic rallying call” the next day, Corzine and Paulson told the firm not to fret about the withdrawn IPO. “Our watchword is steady as you go, full steam ahead,” Corzine said. “We have important work to do.” He added that “market dislocations have often provided opportunities for the firm in the past. Great institutions can distinguish themselves in difficult times.” Regarding the LTCM crisis, Paulson told the firm that it was an “earthquake without historical precedent” and the “subterranean shifts are still playing themselves out.” Corzine said of LTCM that Goldman was a “leader in seeking to dampen the systemic risk.” As phone handsets were “clumsily put down,” according to one account, Corzine left the firm with the exhortation: “Let us go forward!”

Nineteen ninety-eight being an even-numbered year, Goldman would normally have been in the process of picking a new partner class to be announced at the end of its fiscal year, in November. But as part of the decision to pursue the IPO, the firm had decided not to make any new partners in 1998, in order not to change the pool of partners who would partake in the IPO bonanza, a honeypot worth between $50 million and $125 million (or more) per partner, depending on their seniority and influence at the firm. Now, with the IPO withdrawn, Goldman announced on October 21 the names of fifty-seven new partners (among them
Christian Siva-Jothy, the London trader who cost Goldman millions in losses in 1994)—putting them in line to become nearly instant multimillionaires the minute the decision was made to move forward again with the IPO. Goldman also announced the decision to force the retirement of between twenty and twenty-five existing partners—who would “become limited” in Goldman’s argot—a decision that would correspondingly cost those partners millions. “I am sure that with the prospect of an I.P.O. just around the corner, there are some in that batch of retired partners who are not happy about it,” one retired partner told the
Times
. “But I am sure there are others who just thought this was the time. You can’t wait forever, and being a Goldman partner is an extremely demanding job.”