On the Brink (16 page)

We discussed how we could put some pressure on Jamie. We agreed that the best course would probably be to find a way to enable JPMorgan to buy Bear with some help from the Fed.

So I called Jamie and told him we needed him to buy Bear. And, as always, he was straightforward and said that it would be impossible.

“What’s changed?” I pressed. “Why aren’t you interested now?”

“We’ve concluded it’s just too big. And we’ve already got plenty of mortgages ourselves,” he said. “I’m sorry. We can’t get there.”

“Then we need to figure out under what terms you would do this,” I said, changing tack. “Is there something we can work out where the Fed helps you get this deal done?”

Jamie’s tone changed. “I’ll see what I can do,” he said, promising to get back to us quickly.

I called Tim back, and we vowed to provide as little government assistance as possible for JPMorgan to acquire Bear. But we would have to find some way to eat what got left behind.

I set myself up on my living room couch with a pad of paper and a can of Diet Coke. Our house is perched on an incline with a small stream at its base. Looking out through the sliding doors into a thicket of trees, bare and forlorn in March, I worked the phones, talking with Tim and Neel constantly. Together Tim and I would check in with Jamie and others. We needed to get this deal done.

Jamie soon said he was willing to buy Bear, but there were several big issues to resolve. JPMorgan didn’t want any of Bear’s mortgage portfolio, which was on the investment bank’s books for about $35 billion. The question wasn’t quality so much as size. The bank had reasons to keep its powder dry; we knew that it had an interest in acquiring Washington Mutual, which was looking to shore up its capital. So it was pretty clear that JPMorgan wasn’t going to buy Bear without government help for the mortgage assets.

The Fed eventually concluded that it could assist in the deal by financing a special purpose vehicle that would hold and manage those assets of Bear’s that JPMorgan didn’t want. The loan to this entity would be nonrecourse, which brought back Friday morning’s dilemma: the Fed could find itself facing losses, and it would want indemnification. I had our legal team, led by general counsel Bob Hoyt, looking into exactly what we could do. The Fed had brought in BlackRock, a fixed-income investment specialist, to examine the mortgage portfolio, which JPMorgan wanted priced as of the previous Friday.

We kept an open conference line linking Washington, the New York Fed, and JPMorgan. I got hold of Neel in a JPMorgan conference room and asked him to step out and call me privately.

“Neel,” I said, “your job is to protect us. These guys will be incentivized to dump all sorts of crap on us. You need to make sure that doesn’t happen. Make sure we know what we are getting.”

Because the Fed could only take dollar-denominated assets, the pool shrank, and when we were somewhere in the $30 billion range, we had the outlines of a deal. Still, no price had been determined for Bear Stearns’s shares. Tim told me JPMorgan was considering offering $4 or $5 per share, but that sounded like too much to me, and Tim agreed. Bear was dead unless the government stepped in. How could the firm come to us, say they would fail without government help, and then have any sort of payday for its shareholders? With Tim’s encouragement, I called Jamie, who put me on the speakerphone.

“I understand you’re talking $4 or $5 per share,” I said. “But the alternative for this company is bankruptcy. How do you get so high?”

“They should get zero, but I don’t know how you get a deal done if you do that,” he said.

“Of course, you’ve got to pay them something to get them to vote,” I said. “It would have to be at least $1 or $2.”

I stressed that the decision on price was JPMorgan’s. It wasn’t my place to dictate terms. And I knew that whatever deal was announced, there was a good chance it would need ultimately to be increased because the required shareholder vote would give Bear leverage. But better to start from a lower price.

JPMorgan decided to offer $2 a share.

Meantime, as we raced to save Bear, we saw an opportunity to take a positive step with Fannie Mae and Freddie Mac. The market’s weakness ultimately stemmed from housing troubles, and they were right in the center of that. A negative
Barron’s
cover story the previous weekend had hit them hard.

Why not use the crisis to our advantage? Tim and I believed some positive news from Fannie and Freddie might help the market. I called Bob Steel and asked him to arrange a conference call with the GSEs and their regulator, OFHEO, to nail down an agreement he had been working on. Steel, on the fly, rounded up Fannie Mae CEO Dan Mudd, Freddie Mac CEO Richard Syron, and OFHEO chief Jim Lockhart, and we jumped on a conference call for about half an hour beginning at 3:00 p.m.

Fannie and Freddie were operating under a consent order temporarily requiring 30 percent more capital than mandated by federal statute. They were pressing to have this surcharge removed early. To get them to raise more capital—which we felt they sorely needed—Steel and Lockhart had for weeks been pushing a deal: for every $1.50 to $2 of new capital the GSEs raised, OFHEO would reduce the surcharge by $1.

I had no time to waste, so I began the call by saying we were expecting to get a deal done on Bear Stearns and that we wanted an agreement from the GSEs to help calm the market. Steel had done his work well, and we quickly hammered out an agreement that, we estimated, would lead each firm to raise at least $6 billion. We calculated that this, in turn, would translate into $200 billion in much-needed financing for the sagging mortgage market. We agreed to make the announcement as soon as possible. (It was made on March 19.)

After this, Tim and I spoke with Jamie to review the terms before he went to his board for approval. The deal featured a $2-a-share offer from JPMorgan and a $30 billion loan from the New York Fed secured by Bear’s mortgage pool. We all knew that the complexity of the deal—from its structure and legal documentation down to the specifics of how the mortgage portfolio would be managed—meant that all the details could not be nailed down formally before Asia opened. We would have to announce a deal on the basis of a “verbal handshake” that required trust and sophistication on both sides. And we could only have done that with a CEO like Jamie Dimon, who was technically proficient, deeply self-assured, and had the support of his board.

The short call was over by 3:40 p.m., and Jamie went off to talk to his directors.

I got on a call with the president and Joel Kaplan to give them a heads-up on our progress.

“Hank,” the president asked, “have you got it done?”

“Almost, sir,” I said. “We still need to get board approval from both companies.”

I explained the $30 billion loan and how the Fed wanted indemnification against loss from the Treasury, adding that the Fed would essentially own the mortgages.

“Can we say we are going to get our money back?”

“We might, but that will depend upon the market.”

“Then we can’t promise it. A lot of folks aren’t going to like this. You’ll have to explain why it was necessary.”

“That won’t be easy,” I said.

“You’ll be able to do it. You’ve got credibility.”

While I was speaking, Wendy motioned to me. She had answered our other line and was saying: “Neel needs to talk with you urgently.”

After finishing with the president’s call, I got on with Neel, who had Bob Hoyt patched through to me.

“We can’t do this,” Bob said. He quickly explained that the Anti-Deficiency Act barred Treasury from spending money without a specific congressional allocation, which we didn’t have. Hence, we couldn’t commit to indemnifying the Fed against losses.

“My God,” I said. “I just told the president we have a deal.”

I immediately alerted Tim that I had just learned of a problem.

He was surprised and angry. “Hank, you’ve made a commitment. You need to find some way to meet it.”

I called Hoyt back. “Come up with something,” I told him.

Bob is a great lawyer and a can-do guy. Before coming to me he had spent hours trying out a couple of imaginative, outside-the-box theories and had run them by the Department of Justice. The lawyers concluded that their ideas wouldn’t survive the third question at a congressional oversight hearing.

Finally, when Tim understood that we didn’t have the power to do any more, we figured out a compromise. The Fed’s $30 billion loan was based on a provision in the law that gave it the authority, under what is called “exigent circumstances,” to make a loan—even to an investment bank like Bear Stearns—provided it was “secured to the satisfaction of the Federal Reserve bank.” Over the course of the afternoon, BlackRock’s CEO, Larry Fink, had assured Tim and me that his firm had done enough work on the mortgages to provide the Fed with a letter attesting that its loan was adequately secured, meaning the risk of loss was minimal. So what the Fed really needed from the executive branch was political—not legal—protection.

Since Treasury couldn’t formally indemnify the Fed, we agreed that I would write a letter to Tim commending and supporting the Fed’s actions. I would also acknowledge that if the Fed did take a loss, it would mean that the Fed would have fewer profits to give to the Treasury. In that sense the burden of the loss would be on the taxpayer, not the Fed.

I called this our “all money is green” letter. It was an indirect way of getting the Fed the cover it needed for taking an action that should—and would—have been taken by Treasury if we had had the fiscal authority to do so. Hoyt started drafting the letter immediately. As it turned out, we were still hashing out the details a week later.

We had heard back from Jamie just before 4:00 p.m. that the JPMorgan board had approved the deal. Now we had to wait to hear from Bear, and I admit I was nervous. Even as our earlier call with Jamie had wound down, I had begun to worry about the Bear Stearns board. What if they decided to be difficult? If they threatened to choose bankruptcy over JPMorgan’s deal, as irrational as this might appear, they would have leverage over us. Though I thought this unlikely, I became anxious as the minutes ticked by without an answer from Bear. Finally, at 6:00 p.m., the Bear board approved the deal.

The
Wall Street Journal
broke the story of the Bear Stearns– JPMorgan deal online Sunday evening. JPMorgan would buy Bear for $2 per share, or a total of $236 million (it had been valued at its peak, in January 2007, at about $20 billion). If a shareholder vote failed to approve the transaction, the deal would have to be put to a revote by the shareholders within 28 days—a process that could go on for up to six months. This revote measure was intended to give the market certainty that the deal would ultimately close even if the Bear shareholders balked at the $2 a share. As part of the deal, the Federal Reserve Board would provide a $30 billion loan to a stand-alone entity named Maiden Lane LLC that would buy Bear’s mortgage assets and manage them.

The Fed board also approved a Primary Dealer Credit Facility (PDCF), which opened the discount window to investment banks for the first time since the Great Depression. We had been discussing this over the weekend, and it was a critical move. We hoped that the market would be comforted by the perception that the investment banks had come under the Fed umbrella.

That night we convened another call with financial industry CEOs. Jamie Dimon led off the call by saying, “All of your trading positions with Bear Stearns are now with JPMorgan Chase.”

This was a crucial element to the deal. JPMorgan would guarantee Bear’s trading book—meaning it would stand behind any of its transactions—until the deal closed. This was exactly the assurance the markets needed to keep doing business with Bear.

Tim spoke, and then I addressed the group. I noted that the Fed had taken strong actions to stabilize the system and asked for their help and leadership. “You need to work together and support each other,” I remember saying. “We expect you to act responsibly and avoid behavior that will undermine market confidence.”

“What happens if the shareholders don’t vote for it [the deal], but we’re still acting responsibly, like you ask?” Citigroup CEO Vikram Pandit asked. “Is the government going to indemnify us?”

It was exactly the right question, but neither Jamie Dimon nor, for that matter, any of the rest of us were in a mood to hear it.

“What happens to Citigroup if this institution goes down?” Jamie snapped. “I’ve stepped up to do this. Why are you asking these questions?”

With JPMorgan on board, Bear’s liquidity—and solvency—were no longer at issue. Asia sold off Sunday night, but the London and New York markets held steady on Monday.

Nonetheless, despite Joe Ackermann’s blunt warning to me on Saturday, I had underestimated the recent loss of confidence in U.S. investment banks, particularly in Europe. I had asked David McCormick, the undersecretary for international affairs, to brief the staffs of the finance ministries in Europe on the Bear rescue and the strong U.S. response. But on Monday night, David asked me to make the calls because, he said, the Europeans were so scared. On Tuesday I spoke with several of my European counterparts—Alistair Darling from the U.K., Christine Lagarde from France, Peer Steinbrück from Germany—to explain our actions and to ask for their support.

It was quite an eye-opener. I frankly had been disappointed at the negative attitudes of some of the European banks, and I had hoped my counterparts would encourage their banks to be more constructive. I could now see there was no way they would do that. They were understandably shocked by Bear.

And of course, the deal was hugely controversial in the U.S. Although plenty of commentators thought it was a brilliant, bold stroke that saved the system, there were just as many who thought it outrageous, a clear case of moral hazard come home to roost. They thought we should have let Bear fail. Among the prominent members of this camp was Senator Richard Shelby, who said the action set a “bad precedent.”

To be fair, I could see my critics’ arguments. In principle, I was no more inclined than they were to put taxpayer money at risk to rescue a bank that had gotten itself in a jam. But my market experience had led me to conclude—and rightly so, I continue to believe—that the risks to the system were too great. I am convinced we did the best we could with what we had. It’s fair to say we underestimated the speed with which the Bear Stearns crisis arrived, but we realized pretty quickly the limitations on our statutory powers and authorities to deal with the trouble that came our way. In the next week we redoubled our efforts to finish our work on the new regulatory blueprint that we were planning to unveil at the end of the month.