In FED We Trust, page 28
With such prospects in mind, Bernanke concluded that a conventional G7 communiqué would do little to reassure anyone that the leaders of the global economy had a game plan for avoiding another Depression. Early Thursday morning, he spent about half an hour typing up principles that he thought the G7 should embrace.
Labeled “very preliminary,” Bernanke’s nine points amounted to an outline of his “whatever it takes” strategy. Among other things, he proposed that all G7 countries:
“ensure that domestic and other major financial intermediaries have access to capital from public as well as private sources”
“restart and reliquefy the secondary markets for mortgages and other assets”
take “all efforts to prevent the failure of any systemically important financial institutions” and, when failures were “unavoidable,” to protect “all creditors and counterparties, both secured and unsecured,” an explicit vow not to repeat Lehman
Brothers or WaMu
“unfreeze the interbank market, the commercial paper market, and other money markets” with “guarantees, backstop facilities to purchase short-term paper or other methods”
Bernanke showed his draft to Paulson when the two met for a previously scheduled breakfast on Thursday morning at the Fed. Paulson, who found G7 meetings tedious and unproductive, generally used the term “G7” as an epithet, but he told Bernanke that he liked these suggestions and took the draft Bernanke gave him back to Treasury. Later that day, Nathan Sheets, the Fed’s top international hand and another of its army of MIT Ph.D.’s, checked in with his Treasury counterpart, David McCormick, a West Point grad, Princeton Ph.D., and veteran of the first Gulf War, and Mark Sobel, a veteran civil servant on the Treasury’s international staff.
By the end of the day Thursday, McCormick and his counterparts from the other six countries had negotiated a communiqué to which a modified annex of Bernanke’s points was attached. The G7 convened the next day, Friday, at 2 P.M. in the Treasury’s gilded Cash Room, where the U.S. Treasury once had conducted banking business with the public. Bernanke sat to Paulson’s right, McCormick to his left. Flags of the participating countries stood behind them.
The German finance minister delivered the usual German “I told you so” speech, warning this crisis would change capitalism forever. But much of the discussion was pragmatic and unscripted. There was consensus the public statement should be terse, direct, and convincing. Countries differed more on when rather than whether they would take the actions anticipated.
At one point, McCormick leaned to his left and whispered to Mervyn King, governor of the Bank of England, that the best outcome might be a simple half-page communiqué. McCormick, who had been drafting talking points for Paulson and the other ministers to use after the meeting, passed a note to Paulson with a similar suggestion. Paulson scribbled back: “I like it.” McCormick took a draft based on his talking points and the Bernanke-inspired annex and circulated it to other deputies. Each conferred with his boss as the meeting progressed, and the ministers blessed the idea. During a break, the deputies tinkered with the wording.
The final 266-word communiqué incorporated nearly all of Bernanke’s points and some of his wording, albeit with less specificity. A few things were dropped. There was, for instance, no hint of guaranteeing interbank lending, because Trichet was resistant. The proposed pledge to protect all creditors and counterparties if a systemically important institution failed — the “no more WaMu’s” promise — was dropped in favor of a promise to “prevent their failure.” Bernanke hadn’t taken control from Paulson, but he had helped Paulson get the all-important theater right.
FORCE-FEEDING CAPITAL
Paulson now started dropping hints in public that the Treasury wasn’t going to use the $700 billion just to buy toxic assets from the banks, but was contemplating buying shares directly in the banks, as Bernanke and some of Paulson’s staff had favored. At a press conference following the G7 meeting, Paulson made it explicit: like the British, the U.S. government would invest taxpayer money to strengthen U.S. banks’ capital footing. The few details offered portrayed the program in as promarket terms as possible. The U.S. government would avoid taking a voting stake in the banks and would design its program “to encourage the raising of new private capital to complement public capital.”
Paulson struggled to explain the about-face, telling the Washington Post a few days later: “The facts as I know them changed. We got a bigger impact per taxpayer dollar with the equity injection so we went that route… The philosophy has stayed the same, but the tools we employed changed.”
In fact, few details had been settled. Despite the conversations about using taxpayer money to buy stakes in banks to “recapitalize” them, the overworked Treasury staff had been spending nearly all its time on structuring the complicated auctions to buy toxic assets. On Thursday, October 9, Geithner called Paulson to nudge him to move faster on the details of the capital injection initiative. Treasury decided against hiring an investment bank for help; the conflicts of interest would have been unmanageable, since all the big ones would be on the receiving end of the government’s money. Instead, on Friday, October 10, the Treasury signed a $300,000 contract with the law firm of Simpson Thacher to handle the legal work.
On Saturday, October 11, Bernanke, Geithner, and Kohn moved into the Treasury building, working through the weekend with Treasury officials. As Paulson had hinted a few days earlier, the hope was to use government money as a lever to get the banks to raise capital privately, a sort of matching program. However, it soon became clear that banks were going to have a very hard time selling their stock in what was already a depressed market.
“Everyone said: you know, that just will not work. The private market for bank stock is essentially closed for business,” said David Nason, the Treasury official. “You’re going to force a lot of people to try to sell common stock at the same time. There are a limited amount of people who want to participate in that. The weak are not going to get it, and the strong might disappoint as well.”
The participants also faced the very tough decision of how to price the dividend rate on the preferred stock the banks would issue the government: it should be low enough to be attractive to banks, yet high enough to avoid sparking populist taxpayer outrage. “The pricing was the hardest thing,” said Nason. “You’ve got two competing concerns: you’ve got the protection of the taxpayer, and you want people to participate. It can’t be too expensive because you want everybody to take it.”
The eventual terms were intentionally generous. The plan depended on luring even firms that didn’t really need the capital — JPMorgan Chase and Goldman Sachs, for instance — to take the money so that no bank would be stigmatized. The tough approach to AIG, Fannie and Freddie, and WaMu was gone, but the second-guessing wasn’t. The Bernanke-Paulson-Geithner approach would later be criticized for allowing banks to continue to pay dividends to common shareholders, for not demanding enough commitment from the banks to increase lending, for not restraining executive compensation more, and for not husbanding scarce taxpayer money needed by weak banks by giving so much of it to stronger banks.
“I SUGGEST YOU COME”
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.’”
Chapter 13
WORLD OF ZIRP
As 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
Change from
August 7, 2007
Dow Jones Industrial Average: 8,824 down 34.7%
Market Cap of Citigroup: $44.8 billion down 81.5%
Price of Oil (per barrel): $43.60 down 39.8%
Unemployment Rate: 6.8% up 2.1 pp
Fed Funds Interest Rate: 0% to 0.25% down 5 to 5.25 pp
Financial Stress Indicator: 1.69 pp up 1.57 pp
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.
