Geithner seemed anxious and quickly cut him off with, “Don’t do that.”
“You have to give me a reason not to,” he said, mystified by the odd reply. “I have an obligation and responsibility. I can get $15 billion and keep me going for a couple of days. I have to protect the shareholders here.”
“Well, I’ll tell you something confidential,” Geithner finally said. “We’re working on some help for you, but there’s no guarantees, it has to be approved by Washington.”
Willumstad, still dubious, replied, “Well, unless you can assure me that there’s going to be some help, we’re going to go ahead with the backup.”
“You should try and undo whatever you’ve done,” Geithner ordered and hung up.
When he got off the phone, Willumstad immediately informed his lawyers, Jamie Gamble and Michael Wiseman, and, none of them quite knowing what to do next, tried Braunstein’s phone again, with no success.
“Screw it,” Wiseman said. “I know we’re not invited, but let’s just go over there ourselves.”
Hank Paulson was in his office at Treasury when Lloyd Blankfein called him at 9:40 a.m. in a panic. Blankfein, anxious by nature, was even more so now, and Paulson could sense it.
Blankfein told Paulson about a new problem he was seeing in the market: Hedge funds that had traded through Lehman’s London unit were suddenly being cut off, sucking billions of dollars out of the market. While the Fed had kept Lehman’s broker-dealer in the United States open in order to wind down the trades, Lehman’s European and Asian operations were forced by law to file for bankruptcy immediately.
Blankfein explained that through an arcane process called rehypothecation, Lehman had reloaned the hedge funds’ collateral to others through its London unit, and sorting out who owned what had become a logistical nightmare. To stay liquid, many hedge funds were forced to sell assets, which pushed the market even lower. Some hedge funds, fearing that Lehman was on the brink, had already dropped it as a prime broker before the bankruptcy. But for those who stuck by it, the results were painful, as was the case with Ramius Capital, whose founder, Peter A. Cohen, was once the chairman of Lehman’s predecessor, Shearson Lehman. In the week before the bankruptcy he had declared on CNBC that his firm wouldn’t pull its business from Lehman. Now he had to tell his investors that their money had become trapped in a mysterious bankruptcy process in London.
Pleading with his former boss to do something to calm the markets, Blankfein told Paulson that his biggest worry was that so much money was clogged up inside Lehman that investors would panic and start pulling their money out of Goldman Sachs and Morgan Stanley, too.
Bernanke was clearly distracted as he presided over the FOMC meeting at the Federal Reserve in Washington, passing notes back and forth with Kevin Warsh as they tried to come up with a game plan for AIG. They had agreed to another conference call with Geithner at 10:45 a.m. to get an update.
Geithner reiterated that “a private-market solution is dead” and told them, “We need to think about using our balance sheet. We need to act with force and determination,” suggesting that if the Fed made a big, bold deal to backstop AIG, it could help restore confidence in the markets. He proposed using the Federal Reserve Act, Section 13, point 3, a unique provision that permitted the Fed to lend to institutions other than banks under “unusual and exigent” circumstances.
As Paulson and Bernanke both knew, AIG had effectively become a linchpin of the global financial system. Under European banking regulations, financial institutions had been allowed to meet capital requirements by entering into credit default swap agreements with AIG’s financial products unit. Using the swaps, the banks had essentially wrapped AIG’s triple-A credit rating around riskier assets, such as corporate loans and residential mortgages, allowing the banks to take on more leverage.
If AIG were to fail, however, those protective wrappers would vanish, forcing the banks to mark down assets and raise billions of dollars—a frightening prospect in the current markets. And the numbers were staggering: Halfway though 2008, AIG had reported more than $300 billion in credit default swaps involved in this wrapping procedure, which it politely called “regulatory capital relief.”
Then, of course, there was the matter of AIG’s vast insurance empire, which included about 81 million life insurance policies around the world with a face value of $1.9 trillion. While that part of the business was highly regulated and the policies generally protected, there was a risk that panicky customers would cash in their policies in droves and create instability at other major insurers.
Bernanke listened patiently as Geithner made his case, but Warsh made his reluctance known, as he had been promoting a “buying time” plan. His view was that the Fed should open its checkbook, but only for thirty days—enough time to really examine AIG seriously.
“I know it could leave us with open-ended exposure,” Warsh admitted, “but let’s actually figure what the hell is going on here.”
Although Bernanke bluntly acknowledged, “I don’t know the insurance business,” Geithner continued to urge them to commit. The systemic risk was just too great, he insisted.
After hearing his arguments, Bernanke told him to develop a plan. Once he came back to them with more details, they’d formally vote on how to proceed.
“Let me just make sure I’m characterizing the support of you and the board on this accurately… .” Geithner then repeated what had just been said.
Michael Wiseman and Jamie Gamble passed through security at the Fed and went in search of Braunstein. They needed to understand what was happening with AIG, and if nothing was happening, they needed his team to help them plan for the bankruptcy.
Wiseman finally tracked him down in the confidential meeting that was still going on about how the Fed could backstop AIG. “Listen, we don’t have a lot of time and we could use your help with some of the numbers,” he told him angrily after pulling him out of the room. “But we need to know which hat you’re wearing. Are you working for us, the Fed, or JP Morgan?”
“I don’t think I can answer that question without talking to my lawyer,” Braunstein said after a pause. Signaling that he needed a second, he dashed back into the conference room.
When he emerged a few moments later, he said stiffly to Wiseman: “I can’t talk. You should contact Treasury directly.”
“Okay. Thanks,” Wiseman said, putting out his hand to shake it, but Braunstein only turned around and returned to his meeting.
Within seconds, an aide from the Federal Reserve appeared and informed Wiseman and Gamble that they had to leave the building.
“Did you just see that?” Wiseman asked Gamble as they were escorted to the door. “Doug wouldn’t even shake my hand. What the fuck is going on in there?”
However resistant Hank Paulson had been to the idea of a bailout, after getting off the phone at 10:30 a.m. with Geithner, who had walked him through the latest plan, he could see where the markets were headed, and it scared him. During his time at Goldman, he had educated himself about the insurance industry, and with that background he understood how an AIG bankruptcy could very well trigger a global panic. As a regular visitor to Asia, he also knew how much business AIG did there and how many foreign governments owned its debt. Foreign governments had already been calling Treasury to express their anxiety about AIG’s failing.
Jim Wilkinson asked incredulously, “Are we really going to rescue this insurance company?”
Paulson just stared at him as if to say that only a madman would just stand by and do nothing.