Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the FinancialSystem--and Themselves

CHAPTER SIXTEEN

At 7:10 a.m. on Monday, September 15, Hank Paulson was sitting at the edge of his bed in a suite at the Waldorf Astoria, the day’s newspapers spread out before him. He had gotten very little sleep, worrying about how the markets would react to the previous day’s news—and about whether AIG would be the next domino to fall.

The headline on the front page of the Wall Street Journal——spanning all six columns and running to two lines, in double the normal point size—told the story: CRISIS ON WALL STREET AS LEHMAN TOTTERS, MERRILL IS SOLD AND AIG SEEKS TO RAISE CASH. The Journal had gone to press before Lehman formally filed for bankruptcy protection at exactly 1:45 that morning in the Southern District of New York.

Paulson was just finishing dressing when he received a call from President George W. Bush.

Paulson had spoken to the president the night before but only briefly. This would be his first opportunity to explain fully where things stood with the economy and to strategize with him about the administration’s message to the American people.

His voice more hoarse than usual, Paulson began by telling Bush that Lehman’s bankruptcy filing was official. “I’m sure some in Congress are going to be happy about this, but I’m not sure they should be,” he added, acknowledging the political pressure that had been brought to bear against another bailout.

Paulson said he was cautiously optimistic that investors would be able to accept the news but warned him that there could be further pressure on the financial system. Jim Awad, managing director of Zephyr Management, was quoted in that morning’s Wall Street Journal as saying, “Everybody’s prepared this time—it’s different from Bear Stearns. There could be a brief relief rally. You won’t get a 1,000-point shock drop because we’re all ready for it. But a grueling, long bear market will resume.”

Although the U.S. markets wouldn’t open for another three and a half hours, Paulson told Bush that the Asian and European markets were down only slightly, and while the Dow Jones futures were off, it was only by approximately 3 percent.

Paulson then recounted the specific details of the weekend, blaming the British government for misleading them. “We were out of options,” Paulson told Bush, who was sympathetic.

But the president wasn’t concerned about what might have been. He told Paulson that he was unhappy about the bankruptcy, but that allowing Lehman Brothers to fail would send a strong signal to the market that his administration wasn’t in the business of bailing out Wall Street firms any longer.

As they spoke, the first clues that the market wasn’t going to take the news especially well began appearing. Alan Ruskin, a banking analyst at RBS Greenwich Capital, had sent out a note to his clients early that morning trying to divine the meaning of Lehman’s bankruptcy:

“At the time of writing it seems the US Treasury has decided to teach us ALL a lesson, that they will not backstop every deal in the wave of financial sector consolidation that is upon us,” he wrote. “Their motivation is part fiscal and part moral hazard. I suspect more the latter. Presumably the most important reason to teach Wall Street this lesson, is that they will change their behavior, and not take the decisions that are reliant on a public bailout. For many, but not all, this is an impossible lesson to learn in the middle of the worst financial storm since the Great Depression.”

Paulson walked Bush through the Fed’s plan to keep Lehman’s broker-dealer functioning so that it could complete its trades with other banks. “We’re hoping that over the next couple of days, they can unwind this thing in an organized way,” he said.

While Paulson was clearly more disturbed than the president about Lehman’s bankruptcy, he expressed his elation about Bank of America’s decision to buy Merrill Lynch, a sign, he suggested, “of strength” in the market that might “mitigate” the possibility of panic.

Paulson also warned him for the first time that “AIG could be a problem” but assured him that Geithner and the Fed were planning to rally the troops and help raise capital for the firm later that day.

“Thanks for your hard work,” the president told him. “Let’s hope things settle down.”

Doug Braunstein of JP Morgan was leaving his apartment on Manhattan’s Upper East Side at about 7:00 a.m. to head down to AIG when he received a call from Jamie Dimon.

“New plan,” Dimon told him. “Geithner wants us to work with them to do a huge capital raise for AIG. There’s going to be a meeting down at the Fed at eleven a.m.” Braunstein, blocking his ear against the noise of Manhattan traffic, protested, “We can’t raise this kind of money.”

Dimon promised that he’d have some help. “The government is inviting us and Goldman to make this happen.”

A look of horror came over Braunstein’s face as he asked, raising his voice, “Where the hell did Goldman Sachs come from? Don’t they have a conflict? I mean, look at their exposure to AIG. They’re a huge counterparty.”

Dimon dismissed his concerns. “The U.S. government is telling us to do this,” he repeated.

Braunstein persisted. “But—”

“Stop it,” Dimon insisted, annoyed that his top banker was challenging him. “This isn’t about us versus them,” he said. “We’ve been asked to help fix this situation.”

Once Braunstein got to the office, he, Dimon, and Black huddled to come up with a game plan about how to handle the Fed’s unusual request. They decided to enlist the help of James B. Lee Jr., the firm’s vice chairman.

Dimon hurried down the hall to give Jimmy Lee his marching orders. Lee, a classic suspender-wearing banker with a Golden Rolodex, had also arrived early to help manage the aftermath of Lehman’s collapse and had just gotten off the phone with one of his big clients, Rupert Murdoch. Sitting at a desk flanked by four computer screens, with a giant flat-screen television tuned to CNBC’s Squawk Box and his own private news ticker on the wall modeled after the Zipper in Times Square, Lee spun around in his chair.

“I have a job for you,” Dimon barked, standing in the doorway. “I want you to go down to the Fed.”

“To do what?” Lee asked in disbelief. After all, he had a busy day ahead of him, and he was expecting the market to be a disaster.

“I want you to run the AIG deal,” Dimon told him. “Geithner called. He wants us to find a private-market solution for AIG. It’s a big hole. This could be the mother of all loans.”

If there was one banker in the city who understood the world of debt and how to raise money in a pinch, it was Jimmy Lee. He was perhaps JP Morgan’s most senior deal maker, a mogul unto himself with his own banquette at the Four Seasons at lunch. His power derived, in part, from the fact that he was a virtual ATM for corporate America, writing massive checks to finance some of the biggest deals in history. Dimon told him he was hoping that Lee could structure a deal to loan AIG enough money to keep operating and sign up a dozen other big financial players to follow him.

With that tall order delivered, Dimon disappeared, and Steven Black followed him into Lee’s office to give him a five-minute briefing and a folder of AIG materials heavier than a phone book. Describing AIG as a “fucking nightmare client,” Black described how dire the situation was becoming. “You can carry the ball from here,” Black said with a wry smile, happy to have AIG in someone else’s lap.

Lee was informed that he was expected at AIG for a meeting immediately and then he had to get over to the Federal Reserve Building by 11:00 a.m.

Lee met Braunstein and Mark Feldman in front of JP Morgan’s headquarters on Park Avenue, where Lee’s driver, Dennis Sullivan, a retired police officer who had shuttled him from his home in Darien, Connecticut, to Manhattan every day for more than twenty years, was waiting with his black Range Rover. Braunstein and Lee jumped in the back so that Braunstein could continue briefing him.

“C’mon. We’ve got to get downtown,” Lee instructed Sullivan. “No bullshit. We have to be down there like yesterday.”

John Mack looked tired as he rose to a podium and began to address his top lieutenants. It had been a long weekend, he told the managers squeezed into Morgan Stanley’s main conference room. During two and a half days of meetings at the New York Fed, he said he subsisted on “nothing but wrap sandwiches” and fruit that had “been out a little too long.

“I am energized and you ought to be energized, too,” Mack said encouragingly. He acknowledged that the market had come under tremendous pressure after Lehman’s “lost weekend”——United States stock index futures and bank shares in Europe were already tumbling—but the good news for them was that Morgan Stanley had survived.

Mack proceeded to summarize the discussions about Lehman and Merrill that had taken place at the New York Fed over the weekend, calling Lehman’s demise “very unfortunate.”

“I mean, I wish I could come in here and say, you know, this is a great opportunity, kick back, we’re going to do great, all of the competitors have basically been eliminated. I’m not going to say that,” he allowed. “What I want to say is: Kick it up. Work harder. Think about what has happened this year. And what has happened is that all of a sudden, three of our competitors are no longer in business.”

Mack added: “I understand that all of you, and not just all of you here, but I think in the industry, are shaken. You should be shaken. But that doesn’t mean that we crawl back in and we shake… .

“We’re here to do business, to serve our clients, to take market share. Just think about this: Every 1 percent in equity market share we gain is a billion dollars in revenues… .

“I think that once this turmoil abates, and it will settle down, the opportunities going forward are unbelievable. Now I am a positive guy but I am not a Pollyanna, and I believe with all my heart that this firm and our competitor, Goldman, have unique opportunities now. And I am sorry that we got to these unique opportunities the way we did. I don’t want my competitors out of business, I just want to beat them.”

His chief financial officer, Colm Kelleher, chimed in to punctuate that point: “There is Darwinism here… . Weak people are being taken out. Strong people, I believe, are going to do very, very well.”

Over at Lehman Brothers, the thirty-second-floor conference center was a beehive of activity, with hundreds of dazed people streaming in and out—bankruptcy lawyers, restructuring experts, outside consultants. Fuld, who had been escorted upstairs by Lehman’s security detail for fear that employees might actually attack him, wandered in and out of the conference rooms in shock. He had already placed a call that morning to Geithner, pleading with him to undo the bankruptcy filing, as if it had all been just a bad dream.

Down on Lehman Brothers’ massive trading floor, the mood was grim. The staff wasn’t just devastated, they were angry. And while that anger was at first directed toward the government, it had quickly shifted to management. A Wall of Shame had been erected on the south side of the building containing, among other exhibits, photos of Fuld and Gregory with the caption, “Dumb and Dumber.”

With Lehman’s holding company now officially in bankruptcy, Barclays’ Bob Diamond arrived with a team to pick over the assets it wanted and leave the worst ones behind. To Diamond, it was the perfect opportunity to obtain only Lehman’s choicest parts at a bargain price and with the blessing of a judge. Barclays was mainly interested in Lehman’s U.S. broker-dealer and its buildings, and this time around both the FSA and the British government had given him their support. Another plus: There was no need for a shareholder vote.

Bart McDade had assembled a team to begin negotiations with Barclays. He believed there was a chance that he could save the ten thousand jobs that were likely to disappear, even if shareholders themselves had already been wiped out by the bankruptcy. Before that meeting began, however, Alex Kirk pulled McDade aside. Kirk, emotionally drained from the past week, was becoming increasingly suspicious that Barclays had dropped its bid twenty-four hours earlier only so that it could buy the business for even less today. He was outraged, as were many of the traders on the third floor.

“Either Barclays was duped or they were part of the charade,” he told McDade. “I have no interest in working for a company that’s either the dupe or is part of this charade. And I have no interest in working for a highly leveraged financial institution with regulators who behave like I just saw. So I’m out on this whole thing.”

McDade was disappointed but sympathetic. “I get it, I understand, you do whatever you want,” he told Kirk but asked if he would stay at least through the week to help manage the trading floor as they tried to arrange a deal. Kirk reluctantly agreed.

McDade then assigned Skip McGee and Mark Shafir to find a way to execute a deal with Barclays.

In the corner conference room, meanwhile, Harvey Miller was holding court with Barclays’ management arrayed around the table. Jay Clayton of Sullivan & Cromwell, who had previously been Lehman’s lawyer with his colleague Rodgin Cohen, had been hired by Barclays that morning. “I think I’m switching from shirts to skins,” he said awkwardly as he sat down next to the Barclays team.

Miller was trying to sort out how quickly they could sell the company, aware that in a business based on the confidence and trust of its trading partners, every second the firm remained on its own, it was losing value.

Michael Klein, Barclays’ adviser, announced, “We are only doing this deal if we’re not bringing any liabilities with us.”

“What do you mean by that?” Miller asked.

“Well, we’re not going to buy any of these assets unless it is an absolutely ‘clean deal,’” he explained.

Barclays’ Archie Cox jumped in and added, “And we have to close tomorrow.”

Miller shot a black stare at him. “Well, if that’s the case, we should just discontinue this right now. Generally, a sale of even perishable assets takes twenty-one to thirty days.”

“We can’t wait that long,” Cox insisted. “By that time the business will be gone.”

“The only thing I can think of right now is you get the court to accelerate the time lines,” Miller offered. “We get an agreement in principle with the Securities Investor Protection Corporation, and it will commence a separate proceeding to coincide with this sale. But that’s never been done before.”

“Can you do that?” Cox asked.

“Until we try, we won’t know,” Miller replied.

Timothy Geithner was sitting at his desk at the NY Fed with Jamie Dimon on the speakerphone, waiting to be conferenced in with Lloyd Blankfein, who was just returning from the firm’s Monday-morning internal meeting.

It had been Geithner who had decided the night before, after consulting briefly with Paulson, to pair JP Morgan and Goldman to help AIG. By his logic, JP Morgan knew AIG inside out as a result of having worked for it for the past six months and could get everyone up to speed quickly on the depth of its problems. Goldman, he thought, could help value the assets and syndicate the loans. “They’re freak in’ smart!” he liked to tell his staff. He knew that Goldman had advised AIG in the past and had spent the weekend looking to buy assets themselves, so they were aware of what was going on.

“Lloyd, I’m on with Jamie,” Geithner said when Blank fein finally came to the phone. He explained that he was hoping to find a private-market solution for AIG and wanted Goldman to help them.

“JP Morgan’s coming down here,” Geithner told him. “Can you get a team together and come over here?”

“Okay,” Blankfein said. “What time?”

“Can you be here by eleven a.m.?”

“We’ll be there,” Blankfein replied, even though it was already past 10:15.

Blankfein immediately went to work organizing a small army of the firm’s top bankers: Jon “Winks” Winkelried, the co-president; David Solomon, the co-head of investment banking; Richard Friedman, who ran the principal investment area; and Chris Cole, who had spent the weekend over at AIG. They all met downstairs to walk over to the Fed.

Chris Flowers, after the relatively uneventful press conference of Bank of America and Merrill Lynch that morning, headed down to Goldman Sachs with Paul Achleitner of Allianz. They had made an appointment to see Chris Cole as something of a postmortem and a discussion to determine if they could team up to make another run at some AIG assets. After waiting in a conference room for Cole for nearly a half hour, Flowers and Achleitner, both frustrated, went downstairs to get some food.

Standing at the back side of 85 Broad Street, they saw Blankfein and Cole at least thirty yards ahead of them intently marching down William Street toward the Fed with Goldman’s entire senior team.

“They’re fucking standing us up!” Flowers said.

When the JP Morgan bankers Lee, Braunstein, and Feldman arrived at AIG, they found the building practically empty, which struck the men as odd, given that the firm was squarely in the middle of a life-or-death crisis.

To Willumstad, who came to greet them, their arrival meant that his already frosty relationship with JP Morgan had just taken another turn for the worse: Were they still his adviser? Or were they now working for the government? Or were they working for themselves?

Before beginning the meeting, Braunstein had a private conversation with Willumstad. “The government asked us to do this. Are you okay with that?”

“Of course,” Willumstad replied.

When they returned to the conference room, Lee, in a hurry to get over to the Fed, fired off a half dozen questions in rapid succession. “How firm a grip do you have on your cash? Where are the ratings agencies on this? What kind of credit lines do you have?”

Willumstad was tentative with his answers. The numbers kept getting worse, he said. And with Lehman’s failure, and the markets likely to swoon, the value of AIG’s assets was likely to tumble further, giving them even less collateral to post.

To Lee, it was abundantly clear that the company—and Willumstad—didn’t have a firm grip on its finances, exactly as Black had told him.

Just before the bankers left for the Fed, Willumstad, trying to maintain an air of calm, said encouragingly, “I think we still have some time.”

As the JP Morgan contingent began briskly walking over to the Fed, Lee said, shaking his head: “Whenever someone says they have time, there’s never enough. And when they say they need money, the number is always too low.” He paused before declaring, “They won’t last the week.”

After spending an arduous weekend in the NY Fed’s lobby, many of the same members of the band of bankers and lawyers now disconcertingly found themselves reassembled there.

One of the key new figures in attendance was Eric R. Dinallo, the superintendent of the New York State Insurance Department. Earlier that morning, he had formally agreed to allow AIG to use some of its regulated insurance company assets—up to $20 billion—as collateral to help stabilize the company. Dinallo had been driving up to Governor Paterson’s office—he had been slated to stand behind the governor during a press conference to announce the plan—when Geithner called and told him he should be at this meeting instead.

As they milled about waiting for the meeting to begin, Blankfein poured a cup of coffee for Dinallo. “I hope you represent the bookends of this financial crisis,” he said, “because the last time I saw you was at the mono-lines, and I hope we’re done with AIG.” Dinallo had convened a meeting of Wall Street chiefs back in January to discuss the fate of the insurers Ambac and MBIA, which were faltering amid the credit crisis.

When Lee, Braunstein, and Feldman finally arrived, they immediately felt outgunned, as it appeared as if Goldman’s entire executive thirtieth floor had cleared out and set up shop at the Fed. Bob Scully and Ruth Porat from Morgan Stanley, who had now been officially hired by the Fed to represent its interests, were also stunned by the depth of Goldman’s presence. “Why is Lloyd here?” Scully whispered to Porat.

What went unspoken was the fact that all three banks, and virtually all of Wall Street, were huge counterparties to AIG. If the company were to fail, they would all face serious consequences. Therefore, there was a huge incentive to keep the insurer alive for everyone at the table.

On the surface, Goldman looked like one of AIG’s biggest counterparties, but earlier that morning, Goldman’s Gary Cohn had boasted internally that the firm had hedged so much of its exposure to AIG that it might actually make $50 million if the company collapsed. The firm’s decision to buy insurance in the form of credit default swaps against AIG beginning in late 2007 was starting to seem like a smart investment. The firm had conducted what it internally called a “WOW analysis”—a worst-of-the-worst case scenario—and it was quickly coming true. Even though Goldman had hedged its direct exposure to AIG, Blankfein appreciated the larger problem: The collateral damage to its other counterparties and the rest of the market could expose the firm to untold billions in crippling losses.

The group was ushered into a conference room with Tim Geithner. Dan Jester was at his side and Jeremiah Norton from Treasury, who had flown up from Washington that morning, joined them.

As everyone took a seat, Blankfein noticed Jamie Dimon’s absence. He himself had come because he assumed that Geithner had invited both of them. “Where the hell is Jamie?” Blankfein whispered to Winkelried, who just shrugged his shoulders.

“Look, we’d like to see if it’s possible to find a private-sector solution,” Geithner said, addressing the group. “What do we need to make this happen?”

For the next ten minutes the meeting turned into a cacophony of competing voices as the bankers tossed out their suggestions: Can we get the rating agencies to hold off on a downgrade? Can we get other state regulators of AIG’s insurance subsidiaries to allow the firm to use those assets as collateral?

Geithner soon got up to leave, saying, “I’ll leave you with Dan,” and pointed to Jester, who was Hank Paulson’s eyes and ears on the ground. “I want a status report as soon as you come up with a plan.”

Before departing, he added one more thing: “I want to be very clear: Do not assume you can use the Fed balance sheet.”

The meeting then devolved again into a half dozen side conversations until some order was restored when Braunstein walked the room through AIG’s financial position, explaining how quickly it had deteriorated over the weekend. It was coming under pressure not only because of the impending ratings downgrade but also because its counterparties were making constant requests for more collateral. The comment was a not particularly subtle jab at Goldman Sachs, which itself had been battling all weekend, as it had all year, for AIG to put up more collateral. To some in the room, it seemed Blankfein picked up on the slight immediately.

“So, when is the money going to be paid out?” Blankfein asked, ostensibly referring to all the counterparties but to some he seemed to mean himself. One attendee scribbled a note to himself: “GS—$600 million,” which was an approximation of what he thought Goldman was seeking. Even though Goldman may have been hedged against AIG, it still wanted what it thought was the appropriate amount of collateral to keep trading with the firm. Scully of Morgan Stanley interrupted with: “Is there anything you can do to put Moody’s off so that we get a little breathing room for the next couple of days?”

At that point, Jimmy Lee tried to break the log jam and take control of the meeting, having quickly become convinced that they were never going to get anywhere unless they started focusing on the big picture. AIG had forty-eight hours left to live unless the bankers sitting in this room did something productive to save it.

Lee had already started listing on a notepad some of the issues that had been raised and things he needed to know:

liquidity forecast

valuation—business, securities

term sheet

participants

legal in all

In the margins he scribbled some questions about the size of the hole—“50? 60? 70?” billion—and then drafted a mini-term sheet for a loan of this magnitude. “Maturity: 1-2 years; Collateral: Everything; Consideration: Fees, Ratcheting Spreads, Warrants.”

Given the size of loan AIG would require, the fees would be mind-boggling. He might be able to charge as much as 500 basis points, or 5 percent, of the entire amount for taking on this level of risk. For a $50 billion loan, that would add up to a $2.5 billion payday in fees.

Lee had even begun assembling a list of the banks to contact to raise the credit line, virtually all of whom had exposure to AIG and were therefore also vulnerable: JPM, GS, Citi, BofA, Barclays, Deutsche, BNP, UBS, ING, HSBC, Santander. He could have come up with many more names but stopped at eleven.

“Okay, okay,” Lee now said to the group and ran through the items on his list.

“I like that. That sounds right to me,” Winkelried chimed in.

The group decided to start their work with a round of basic due diligence, breaking the businesses into a half dozen categories and passing out assignments among themselves.

Before they got into the specifics, Blankfein took advantage of a pause in the discussion to make a beeline for the door. Without Dimon there, this was below his pay grade.

As they all decamped from the Fed and marched back to AIG to start crunching the numbers, Lee’s brain was already doing the math.

“Who is going to buy this shit?” he asked aloud to no one in particular.

That afternoon at 1:30 p.m., Paulson stepped out to the lectern in the White House briefing room. “Good afternoon, everyone. And I hope you all had an enjoyable weekend,” he began, to some awkward laughter. “As you know, we’re working through a difficult period in our financial markets right now, as we work off some of the past excesses.”

He had just gotten back to Washington, rushing first to the Treasury and then across the way to the White House, to take questions from reporters. Jim Wilkinson had coached him on the flight down about how he should approach the issues. “We’ve got to say we’ve drawn a line in the sand,” Wilkinson instructed him and warned him to expect to be asked about why Lehman had been allowed to fail while Bear Stearns was saved. Wilkinson presented it as an opportunity to discuss moral hazard and to make it clear that the U.S. government “is not in the business of bailouts.”

Paulson himself was doubtful that this was quite the time to be dogmatic and challenged Wilkinson on the point, but the fact was, he was dead tired and could not keep his mind from drifting to AIG.

As he finished his remarks, the first question came from the press corps, and it was a softball: “Can you talk about what the federal role should be going forward? Are we likely to see any more federal involvement in rescues like you did with Fannie and Freddie and Bear Stearns?”

Paulson paused for a moment. “Well, the federal role is obviously very important because, as you’ve heard me say before, nothing is more important right now than the stability of our capital markets, and so I think it’s important that regulators remain very vigilant.”

“Should we read that as ‘no more’?” the reporter screamed out.

“Don’t read it as ‘no more,’” Paulson replied, clearing his throat. “Read it as … that I think it’s important for us to maintain the stability and orderliness of our financial system. Moral hazard is something that I don’t take lightly.”

And then came the anticipated question: “Why did you agree to support the bailout of Bear Stearns but not Lehman?”

Paulson paused to gather his thoughts carefully. “The situation in March and the situation and the facts around Bear Stearns were very, very different to the situation that we’re looking at here in September, and I never once considered that it was appropriate to put taxpayer money on the line with … in resolving Lehman Brothers.”

It was an answer that would come back to haunt him. He had parsed his words carefully. Technically, his answer was true, but he knew that if Bank of America or Barclays had decided to buy Lehman he might have used taxpayer money to support a deal, but he wasn’t about to bring that up now.

As the questions poured in, Paulson grew more and more agitated. “Why is the Federal Reserve giving AIG a bridge loan?” one journalist asked.

“Let me say what is going on right now in New York has nothing to do with any bridge loan from the government. What’s going on in New York is a private-sector effort again focused on dealing with an important issue that I think is important that the financial system work on right now and there’s not more I can say on that.”

He was about to step down when he announced, “I’ve got time for one more question … the woman in the middle there,” he said, pointing to another reporter.

The journalist asked him how he handicapped the health of the banking system today.

“There are going to be some real rough spots along the road, but I believe we’re making progress. And when I look at the way the markets are performing today, I think it’s a testament to the way the financial industry has come together, because they’re dealing with an extraordinary set of circumstances and they’re dealing in a way we should all be proud of.

“Thank you very much.”

By midafternoon, chaos reigned in the conference room on the sixteenth floor of AIG, where more than a hundred bankers and lawyers, led by Goldman Sachs and JP Morgan, had assembled to begin conducting diligence on the company. The only problem was, no one there seemed to have any of the company’s actual numbers.

“Is there anyone who works for AIG in this room?” a voice shouted out. When no one raised a hand a wave of nervous laughter swept the room.

Finally, Brian Schreiber of AIG was summoned. Working on three hours of sleep, he looked as if he might have a breakdown right there. He took a moment to collect himself before beginning a presentation of the latest numbers. After he finished a less than inspiring performance, the core group from that morning at the Fed huddled in AIG’s boardroom.

For a while it seemed as if progress was being made. Lee and Winkelried felt confident that AIG’s assets were strong, at least strong enough for them to lend against. What they believed the company was experiencing was merely a liquidity crisis: If they could provide AIG with a bridge loan, they’d be home free.

The group started discussing drafting a preliminary term sheet. They’d try to raise $50 billion, in exchange for warrants for 79.9 percent of AIG. It was almost a punitive price, but given the insurer’s status, it might be their only alternative to bankruptcy. Winkelried and Lee also discussed the fees they would collect, which would be split between the firms. If they sought to raise $50 billion, that would leave each firm with a $1.25 billion fee for organizing the loan.

As the group dispersed to return to the Fed to present their progress report to Geithner, Ruth Porat of Morgan Stanley, who was representing the Fed, pulled aside John Studzinski of Blackstone, who was representing AIG. They were old friends; Studzinski used to run Morgan Stanley’s mergers and acquisitions practice in London.

“So, what do you think?” Porat asked.

“What do you mean?” Studzinski replied. “I can’t tell from this meeting whether there’s going to be a term sheet or not.”

“That’s not what I meant,” Porat replied. “We’re worried that these guys are going to try to steal the business.”

“He was as useless as tits on a bull.”

Bob Willumstad, normally a calm man, was in an uncharacteristic rage as he railed about Dan Jester of Treasury, while telling Jamie Gamble and Michael Wiseman about his and Jester’s call to Moody’s to try to persuade them to hold off on downgrading AIG.

Willumstad had hoped that Jester, using the authority of the government and his powers of persuasion as a former banker, would have been able to finesse the task easily.

Willumstad explained the original plan “was that the Fed was going to try to intimidate these guys to buy us some time.” Instead, when Jester finally got on the phone, “he didn’t want to tell them.” Clearly uncomfortable with playing the heavy, Willumstad told them that Jester could only bring himself to say, “We’re all here, and you know, we got a big team of people working and we need an extra day or two.”

The core group of bankers who had been over at AIG now returned to the Fed, Jester having unsuccessfully tried to persuade Geithner to come to them at AIG—given that they were a group of some thirty and he was just one. Being the president of the Federal Reserve of New York had its privileges, however: They would come to him.

The hole that they needed to fill, Winkelried now reported in their summary to Geithner, was some $60 billion and “possibly more.” No one knew how any solution could work without financial help from the Fed.

“There’s no government money for this,” Geithner told them, repeating what Paulson had said earlier that day in Washington and echoing the same sentiment he had been conveying all weekend with regard to Lehman. If they needed proof that he was serious, Lehman’s bankruptcy was Exhibit A.

Geithner authorized Lee to begin making phone calls to Asia that night to see if he could begin raising some money there. JP Morgan and Goldman made it clear they still had a good deal more work ahead of them.

Late that evening, Jamie Gamble, AIG’s lawyer; John Studzinski; and Brian Schreiber gathered in a conference room for a morose meal of take-out Chinese. The situation seemed hopeless. Dinallo and Governor Paterson may have bought them a day by announcing their plan to release $20 billion of collateral, but it was too little, too late. Hours earlier they had called in the bankruptcy experts, and when the markets opened on Tuesday, they planned to draw down their credit lines, a clear sign to the markets that they were in trouble. When they had suggested the move, Willumstad had told them it was akin to “lowering the lifeboats into the water because you’re about to abandon ship. That’s the last thing you do. Shutting the lights off on the Titanic before it goes down.”

Schreiber still couldn’t believe they were in this position and remained convinced that the Fed would ultimately come to the rescue. “At this point, it’s a game of chicken,” he said, with a slight air of cockiness.

“Do you think the Fed gets what’s at stake?” Gamble asked.

“Are you crazy?” Studzinski replied. “Of course not. They just let Lehman fail. It’s like a bad Woody Allen movie.”

By 1:00 a.m., Scully and Porat of Morgan Stanley, who were still representing the Fed, decided they needed to talk privately. They hid in one of AIG’s small kitchens and closed the door, so they’d be out of earshot of the Goldman and JP Morgan bankers.

“This isn’t going to work,” Porat said. “They aren’t going to get there.”

“Agreed,” Scully replied. “We need a fallback plan.”

They gave their assignment a code name and decided they’d head back to the Fed to alert Dan Jester.

When they opened the kitchen door, they noticed that everyone else had already left, which only seemed to confirm their worst fears: Any chance of a deal had officially ended.

When they reached the Fed, it, too, was deserted, apart from Jeremiah Norton passed out on a couch. He had originally tried to commandeer Geithner’s couch but was told he had to find a napping place elsewhere.

Scully and Porat woke him, and the three of them went to deliver the bad news to Jester.

A conference call was set up for 3:00 a.m. with the Fed team and Treasury, leaving Hilda Williams, Geithner’s assistant, the unenviable task of calling everyone at that ungodly hour to coordinate it.

“We’ve got a problem …” Geithner began the call.

For the first time in weeks, on Tuesday morning the editorial pages of the major newspapers were heralding Hank Paulson. They applauded his decision to not use taxpayer money to bail out Lehman Brothers. “It is oddly reassuring that the Treasury Department and Federal Reserve let Lehman Brothers fail, did not subsidize the distress sale of Merrill Lynch to Bank of America, and tried to line up loans for the American International Group, the troubled insurer, rather than making a loan themselves,” the New York Times’ lead editorial read. “Government intervention would have been seen either as a sign of extreme peril in the global financial system or of extreme weakness on the part of federal regulators.”

Given the conversation he’d had with Dan Jester at 6:00 that morning, however, it was looking increasingly likely that AIG and the global financial system were now in such peril that the government would have no choice but to intervene.

Paulson had seen the panic gripping the markets in the past twenty-four hours, which was duly reflected in the headlines on every newsstand. That morning’s Washington Post was typical of the tone of the coverage: “Stocks Plunge as Crisis Intensifies; AIG at Risk; $700 Billion in Shareholder Value Vanishes.”

The Dow Jones Industrial Average had slumped 504.48 points on Monday, the biggest point decline for the index since September 17, 2001, when trading started up again after the September 11 terrorist attacks. AIG’s stock had fallen 65 percent to close at $4.76.

By 7:45 a.m., Ben Bernanke was in his office preparing for the Federal Open Market Committee meeting that was due to begin forty-five minutes later in the boardroom just down the hall from his office. It was purely a matter of chance that the FOMC, the Fed’s board of directors that determines monetary policy and decides whether to raise or lower interest rates, had one of its eight meetings a year scheduled for this morning.

Before his meeting began, Bernanke called Kevin Warsh and Don Kohn into his office to join him in a conference call with Tim Geithner, who instead of attending the FOMC gathering had decided he had to stay in New York to deal with AIG, sending Christine Cumming, his vice president, in his place. There was only one small problem with that decision: FOMC meetings were relatively public affairs, and Bernanke was concerned that Geithner’s absence could leak to the press and cause further panic in the markets.

“There’s nothing we can do about it at this point,” Geithner said, eager to focus the group’s attention on the larger problem at hand. He told them that he was expecting to receive a full progress update from JP Morgan and Goldman Sachs at 9:00 a.m., but cautioned that all the signals he had gotten from Dan Jester and Morgan Stanley had not been promising.

He advised them, consequently, to start thinking about a Plan B.

Jimmy Lee was worried he’d be late for the meeting at the NY Fed, having gotten stuck in traffic on the FDR after a quick trip back to his home in Darien to take a shower and put on some fresh clothes. While waiting he called Dimon from his cell phone. “So this is what I’m going to tell them,” he said about his planned presentation to the Fed. “I’m going to have to say the numbers are just too big. We can’t do it. No one can do it. The company is going down.”

“If that’s the answer, that’s the answer,” Dimon replied.

“This is my best judgment,” Lee assured him.

The good news—if it could be called that—was that Lee expected he’d have to tell only Dan Jester, since Geithner would be in Washington at the FOMC meeting.

When Lee finally arrived, he found everyone had already gathered in the conference room that had become the de facto lounge for these meetings. He took a seat near his colleague, Doug Braunstein, and they all began waiting patiently for Dan Jester.

The door opened and Jester and Norton entered, followed by Geithner, who gave no explanation for his unexpected presence.

“So where are we?” he asked in his clipped, all-business manner.

Jimmy Lee consulted his yellow pad, on which he had written two notes to himself in the margins: “Deal stands little chance” and “AIG out of cash.”

“We’ve gone through it all,” Lee said. “They have $50 billion in collateral and they need $80 to $90 billion. We’re short $30 to $40 billion. I don’t know how we can bridge that gap.”

Winkelried of Goldman then jumped in. “Let me just say there is a huge systemic risk to letting this institution fail. I don’t need to tell you the number of counterparties that would be exposed.”

A document generated listing AIG’s biggest counterparties in order of size was passed around. The most exposed firm listed on the orange and blue sheet was ABN AMRO, which had been acquired by Royal Bank of Scotland, with $65 billion; the second largest was Calyon; Goldman Sachs was the seventh; Barclays was the eighth; and Morgan Stanley was the ninth.

Geithner studied the figures, furrowing his brow every few lines, and after setting them down said, “Okay. Here’s what we’re going to do.” He paused, leaning forward for all to hear what he was about to say.

“I want everyone to put his cell phone away, BlackBerrys, everything. I don’t want anybody communicating outside of this room. Not to your office. Not to anybody. Do you understand me? This conversation is confidential,” he said. When Geithner was satisfied that everyone had complied, he posed a question for which no one in the group had been prepared: “What would it look like if we said the Fed was going to do this?”

For the past seventy-two hours the government had been insisting that it would not bail out any financial institution. Now, with that one sentence, Geithner had turned everything on its head. Even if it was just a hypothetical, the rules of engagement had evidently just changed.

Geithner continued, throwing out a series of questions. “How would this work? How would you structure the terms? How will the capital markets respond? How will the debt markets react?”

Goldman’s Winkelried could not hide a slight smile. Scully of Morgan Stanley, realizing the night before that he needed a Plan B, had already roughed out a term sheet based on the numbers that JP Morgan and Goldman Sachs had put together. If it was good enough for them—and by Morgan Stanley’s estimation, they were going to be stealing the company—it should be good enough for the Federal Reserve.

“Work on it,” Geithner said, and then left the room.

“Braunstein isn’t picking up his fucking phone,” Willumstad railed after dialing his cell several times, worried that he was being kept in the dark.

John Studzinski, his adviser from Blackstone, had just heard from one of his colleagues who was down at the NY Fed that he had seen Goldman and JP Morgan executives high-fiving one another—even while another team from the two banks was still camped out at AIG, rifling through its books.

Studzinski finally managed to reach Porat by text-messaging her. However, she was purposely being vague, and would only offer, “The deal is changing. Stop sharing information with JPM and GS.”

A few minutes later, Willumstad’s assistant announced that Tim Geithner, whom Willumstad had frantically attempted to reach several times that morning, was on the phone.

“Hi, Tim,” Willumstad said, somewhat impatiently.

“Give me a progress report,” Geithner instructed, rather than offering the progress report that Willumstad had been waiting for desperately.

“I just want you to know that we’re preparing for bankruptcy,” Willumstad told him steadily. “I’ve called the backup lines. I just think you should know that.”

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.

Ken Wilson, his special adviser, raised an issue they had yet to consider: “Hank, how the hell can we put $85 billion into this entity without new management?”—a euphemism for asking how the government could fund this amount of money without firing the current CEO and installing its own. Without a new CEO, it would seem as if the government was backing the same inept management that had created this mess.

“You’re right. You’ve got to find me a CEO. Drop every other thing you’re doing,” Paulson told him. “Get me a CEO.”

Wilson got back to his office and started scrolling though his computer’s address book. After years as a financial institutions banker at Goldman Sachs, he knew the top people in the industry. Before even getting to the B’s, a name popped into his brain: Ed Liddy, the former CEO of Allstate and a Goldman board member. He was a perfect candidate, currently “on the beach” without a job and someone who would welcome the challenge. Liddy also knew AIG: He was the Goldman board member to whom everyone turned for advice whenever they discussed whether the firm should acquire it.

But Wilson didn’t have his phone number. So he called Chris Cole at Goldman Sachs, who had been at AIG all weekend and had attended the meeting at the Fed on Monday, who gladly retrieved the number for him.

There was no time for small talk when Wilson reached Liddy, and he immediately explained why he was calling.

“Do you have time to take a call from Hank?” Wilson asked, and Liddy assented enthusiastically.

“You have to hang up,” Wilson told Paulson, who was on the phone when he appeared in his boss’s office door. “I’ve got your CEO.”

AIG’s stock had fallen below $2 a share when Willumstad’s assistant stepped into his office and handed him a fax from Hank Greenberg. Willumstad had heard earlier that Greenberg was out telling the press that he planned to mount a proxy contest or a takeover of the company.

“Do I have to read it?” he asked warily, and was not surprised at what he saw:

Dear Bob,

We have been discussing for several weeks my offer to assist the company, in any way that you and the Board desired. Throughout those discussions, you have told me and David Boies that you believed my assistance was important to the company. The only concern that you have expressed to me is the fear that if I were to become an advisor to the company that I would overshadow you. I respectfully suggest to you, and to the Board, that the continuing refusal to work together to save this great company is far more important than any concern over personal positions or perceptions.

I do not know whether or not it is now too late to save AIG. However, we owe it to AIG’s shareholders, creditors and our country to try.

Since you became Chairman of AIG, you and the Board have presided over the virtual destruction of shareholder value built up over 35 years. It is not my intention to try to point fingers or be critical. My only point is that under the circumstance, I am truly bewildered at the unwillingness of you and the Board to accept my help.

Geithner began to prepare in his office for a conference call with Bernanke. We’re going to do this, he thought. We’re really going to do this.

Jester and Norton were poring over all the terms. They had just learned that Ed Liddy had tentatively accepted the job of AIG’s CEO and was planning to fly to New York from Chicago that night.

To draft a rescue deal on such short notice, the government needed help, preferably from someone who already understood AIG and its extraordinary circumstances. Jester knew just the man: Marshall Huebner, the co-head of insolvency and restructuring at Davis Polk & Wardwell, who was already working on AIG for JP Morgan and who happened to be just downstairs.

Meanwhile, Bob Scully of Morgan Stanley, whom Geithner had hired to advise the Fed, wanted to make sure he was aware of all the risks ahead of the call. As Scully continued to study the rapid deterioration in the markets, he became increasingly anxious about whether AIG would be able to maintain its payments on a government loan. What had looked like a steal before might still be a tough sell.

“I want to be clear that there’s a real risk you may not be made whole on this loan,” he warned as Geithner dialed into the conference call.

While Bernanke said that he had decided to back the deal, he nevertheless wanted to take a straw poll among the participants in the call. He was clearly anxious, asking, “Are you sure we’re doing the right thing?”

But with his implicit support—and Geithner’s insistence that this was the only way to avert a financial Armageddon—the vote was 5-0. There was no longer any discussion of moral hazard, and no talk of Lehman Brothers.

Before Wiseman and Gamble had gotten far after being escorted by security guards from the NY Fed, they were surprised to suddenly find themselves being invited back in. There had been a mix-up, they were told, and they were taken to a table in the dining room.

“This isn’t the cool kids’ table,” Gamble remarked, looking over at another table at the other end of the enormous space, where JP Morgan and Goldman bankers were waiting.

“One thing is for certain,” Wiseman said, “they are not doing a private deal. They’d never look this relaxed.”

While they waited, Gamble took a call about two new issues: Insurance regulators in Texas, where AIG had a major life insurance business, were starting to panic. Even worse, JP Morgan had just pulled a line of collateral in Japan, which was AIG’s largest market outside the United States. Gamble couldn’t believe it: JP Morgan, AIG’s adviser just twenty-four hours earlier, was now only exacerbating the problem, however prudent it might have been to do so.

Twenty minutes later, Eric Dinallo, superintendent of the New York State Insurance Department, came over to a relieved Wiseman and Gamble’s table. “I can’t tell you much,” Dinallo said, “but don’t do anything precipitous.”

“Eric,” a frustrated Gamble replied, “we’re happy to hold tight, but our securities lending business is in trouble.” Then he pointed at the JP Morgan and Goldman Sachs contingent. “The guys over there are creating this problem. Go talk to those guys.”

“I think we’re about to be out of cash!” John Studzinski announced at the teetering insurance giant’s headquarters. It was nearly 1:00 p.m., and if Studzinski’s math was correct, AIG was minutes away from bankruptcy.

Just then, Willumstad walked out of his office with something that hadn’t been seen in some time in the building: a smile.

“They blinked,” he said.

He had just gotten off the phone with Geithner, who told him about the bailout plan: The Fed would extend to AIG a $14 billion loan to keep the firm in business through the rest of the trading day. But Geithner added that AIG would have to immediately post collateral before it could receive the loan. Officially, it was called a “demand note.”

While clearly relieved, Willumstad understandably wondered how they were supposed to come up with $14 billion in the next several minutes. Then it dawned on one of them: the unofficial vaults. The bankers ran downstairs and found a room with a lock and a cluster of cabinets containing stock certificates for AIG’s insurance units—tens of billions of dollars’ worth, dating mostly from the Greenberg era. They began rifling through the drawers, picking through fistfuls of securities that they guessed had gone untouched for years. In an electronic age, the idea of keeping physical certificates on hand was a disconcerting but welcome throwback.

AIG’s senior vice president and secretary, Kathleen Shannon, stacked the bonds up on the table and put them in a briefcase.

“I don’t think it’s worth you getting mugged carrying $14 billion of certificates,” Michael Wiseman from Sullivan & Cromwell advised her over the phone. “We’ll get Fed security to escort you over.”

Ten minutes later, Shannon was carrying an inestimably valuable briefcase across Pine Street, flanked by two armed guards.

Hank Paulson hustled down the stairs and out the side exit of the Treasury building, briskly heading for the White House. He and Ben Bernanke had scheduled a meeting with President Bush to brief him on the extraordinary steps they were about to take.

After passing through security and a brief stay in a waiting room, they were escorted to the Oval Office, where Paulson delicately walked the president through the terms.

As Paulson explained the deal, however, detailing its points in Wall Street jargon, Bush clearly looked perplexed.

Bernanke jumped in and said, “Mr. President, let’s step back for a minute.” Donning his professorial hat, he explained how deeply entwined AIG had become in the banking system. More important, he tried to appeal to the Everyman in Bush, emphasizing how many citizens and small businesses depended on the firm. People used AIG’s life insurance policies to protect their families. They used AIG’s annuities to fund their retirements. AIG also provided surety bonds, a kind of guarantee for construction projects and public works.

The president then posed a question that, in its own way, went directly to the heart of the problem: “An insurance company does all this?”

This one did.

At around 4:00 p.m. that afternoon, the Fed’s offer clattered through an AIG fax machine (which should have been replaced and shipped to the Smithsonian a decade earlier). An army of lawyers on AIG’s eighteenth floor were anxiously awaiting it. After the three-page document finally appeared, a lawyer grabbed it and quickly made copies.

“Well, you finally get your chance to work for the federal government,” Richard Beattie, the lead lawyer for the outside directors on the AIG board, told Willumstad as he scanned the terms.

“What do you mean?” asked Willumstad.

“They own you now,” Beattie replied with a grin.

And they did. The Federal Reserve was providing AIG a credit line of $85 billion—which it hoped would be enough to avert catastrophe and keep it afloat. But in exchange for the loan, the government was taking a large ownership stake—79.9 percent in the form of warrants called “equity participation notes.” It was similar to the proposal that JP Morgan and Goldman had been working on.

If Washington was going to take Wall Street off the hook, the government wanted to make certain that at least the old stakeholders didn’t profit in any untoward fashion. “Paulson is handling this the same way he did Fannie, Freddie, and Bear Stearns—if the government steps in, the shareholders will pay for it,” Cohen observed.

The Fed loan also came with a significant debt burden. AIG would have to pay at a rate based on a complex formula—the London interbank offered rate, a benchmark for short-term loans between banks, which then came to about 3 percent—plus an extra 8.5 percentage points. Based on that day’s rate, the interest the company would have to pay soared to more than 11 percent, which at the time was considered usurious. The loan would be secured by all AIG’s assets, and the government would have the right to veto payments of dividends to both common and preferred shareholders.

In order to pay back the government, AIG would have to sell off assets—and under the circumstances, that meant a fire sale. To AIG loyalists, the loan was proving to be less a bridge to solvency than a plank to an organized breakup.

“This is unbelievable,” Willumstad said, setting aside the document.

The board of AIG was prepared to meet soon for an emergency session. As Willumstad stood and reread the terms in a virtual state of shock, his assistant called out to say that Tim Geithner was on the phone. It was 4:40 p.m.

Willumstad followed Beattie and Cohen into his office and hit the speakerphone button.

“Can you hang on a minute?” Geithner said after greeting him. “Secretary Paulson is going to pick up.”

“Okay,” Willumstad said, adding, “I’ve got Dick Beattie and Rodgin Cohen sitting here with me.”

“So, you’ve seen the new agreement, right?” Geithner asked after Paulson joined in. “We want to know that you are going to accept the terms. We need an answer back from you soon, because trading is going to start in Asia.”

In the back of his own mind, Geithner had a nagging worry: Were the terms too harsh? But he was at least as concerned about potential blowback from the other direction—that Treasury would be criticized for giving AIG a sweetheart deal.

It was no coincidence, though, that the government’s terms had so much in common with what the private sector had been considering. For one thing, they had used many of the same advisers. And in the current political environment, there was safety in being able to say that AIG was only getting what the market had been willing—or almost willing—to offer.

“Obviously, we have a board meeting in fifteen minutes, and I’m prepared to present it there,” Willumstad said.

“Tim, it’s Dick,” Beattie said, jumping in. “I just want to be clear that you know that you shouldn’t assume just because you stepped in that the board will approve this. We’ve got a fiduciary duty to our shareholders, so it is going to be complicated.”

Beattie, playing hardball, had effectively implied a threat that AIG might be better off filing for Chapter 11 bankruptcy than taking the government’s deal.

Geithner didn’t flinch. “This is the only proposal you’re going to get,” he tersely replied, and then added, “There’s one other condition… .”

Paulson, interrupting, said, “The condition is that we’re going to replace you, Bob.”

Beattie and Cohen looked at Willumstad in embarrassed silence.

“O … kay,” Willumstad said. “If that’s what you want.”

“We’re going to bring in a new CEO,” Paulson said matter-of-factly. “He’ll be showing up tomorrow.”

Willumstad had had no illusions that a government rescue would mean anything other than his ouster, but he was stunned by the speed of events. The government had just made its offer moments ago—and it had already completed an executive search to find his successor?

“Should I still be here?” Willumstad asked, confused about how to proceed.

“Yeah, we would appreciate whatever cooperation and help you can offer,” Paulson replied.

“Is it okay if I ask who it is?”

“It’s Ed Liddy,” Paulson said.

For a moment, Willumstad wracked his memory. “Who the hell is Ed Liddy?” Beattie whispered, but Cohen only shrugged his shoulders.

“Ed just retired recently as the CEO of Allstate,” Paulson interjected, realizing they had no idea who he was.

After the call, Willumstad slumped in his chair, sighed, and then looked over at Beattie and laughed.

“Well, you’re wrong,” he said. “I won’t be working for the federal government after all.”

The directors of AIG were already gathered in the boardroom when Willumstad and the advisers made their entrance. Willumstad wasted no time on preliminaries.

“We are faced with two bad choices,” he began. “File for bankruptcy tomorrow morning, or take the Fed’s deal tonight.” He explained the terms of the deal and told them that Blackstone would come in with bankruptcy advisers to discuss the merits of that route.

And then he told them his personal news.

“I’m going to be replaced,” he said quietly. “Ed Liddy is going to take my place.”

“Ed Liddy?” asked Virginia Rometty.

“Yeah, he’s Allstate,” Willumstad explained.

“I’ve known him for fifteen years,” she said. A top executive with IBM, Rometty had once headed the sales group for the computer company’s division that catered to the insurance and financial industries. “I wouldn’t have thought Ed would have been the guy.”

“I know Ed Liddy!” James Orr chimed in. Orr had been chief executive of Unum, a Maine insurer that had fought off an effort by Allstate to grab market share from the company in the long-term disability category it dominated. “If we were looking for a CEO of this company, not only wouldn’t he have been on the short list, he wouldn’t have been on the long list!”

“Well, that’s one of the decisions you’ll have to digest,” Willumstad said calmly, and turned the meeting over to Cohen.

Martin Feldstein, an AIG director and former economic adviser to President Ronald Reagan, couldn’t believe that the government—a Republican administration—was going to be effectively buying a stake in a private business.

Rodgin Cohen, reminding the board that they had a fiduciary duty not only to shareholders but to bondholders as well, pressed for a bankruptcy.

“You should consider all these things,” Beattie said. “Just because it’s the Fed doesn’t mean you have to accept this. You should listen to all the options.”

Willumstad’s assistant slipped into the room and handed him a note: Hank Greenberg is on the phone. He rolled his eyes, leaned over to John Studzinski, and passed him an instruction: “Would you please call Hank Greenberg back?”

Studzinski crept out of the boardroom, aware of just how awkward this call was going to be for him to make. To help smooth the way, Studzinski enlisted Pete Peterson, Blackstone’s co-founder and a longtime friend of Greenberg, to join the call. At Greenberg’s suggestion, AIG had invested $1.35 billion in Blackstone when the firm was flagging in the aftermath of the 1998 Russian debt crisis.

While Studzinski waited on the line, Peterson dialed Greenberg’s office on Park Avenue.

“He can’t talk right now,” Greenberg’s assistant said. “He’s going on Charlie Rose to talk about AIG.”

“You’ve got to be kidding me,” Peterson said.

When Studzinski returned to the board meeting, he passed a note to Willumstad and relayed the news. For a moment, Willumstad smiled.

The board quickly returned to the grim subject at hand. Cohen, offering the pros and cons of the government’s deal, explained the argument for a Chapter 11 bankruptcy filing, saying that the company might do better in an orderly unwinding in court rather than accept the government’s take-it-or-leave-it offer.

Each of the various advisers offered their view. Studzinski said that a bankruptcy filing by a company as large and as complex as AIG would take many months to get under control and that the likelihood was that even more value would be eroded. “I just spent the last ten minutes giving you all the banking reasons to do this,” Studzinski summed up. “But there’s one more,” he said, looking around the room.

“Isn’t twenty percent of something better than one hundred percent of nothing?”

The room fell silent.

As the meeting wore on, Willumstad checked his watch, knowing that he owed Paulson and Geithner an answer quickly.

“Let’s go around the table and let everybody say what you think we should do,” Willumstad instructed. “To be honest with you, I urge you to vote in favor of the Fed proposal,” he told them, starting off. “We have three constituents. Shareholders, customers, employees. This is not something that’s friendly to the shareholders, but it will preserve the customers, keep the company afloat, and you have a better chance these people will keep their jobs.”

As they made their way around the table, all the board members voted in favor of the government deal with the exception of Stephen Bollenbach, the former chief executive of Hilton Hotels. Bollenbach, who was supported by Eli Broad and other major dissident AIG shareholders, had joined the board in January. He thought that a proper judge would give shareholders a fairer deal.

Before the vote was formally tallied, Bollenbach asked a question: Was there any room to renegotiate the terms of the deal?

Willumstad and the lawyers retreated to his office to call Geithner.

“Tim, Dick and Rodge are here,” Willumstad said. “It’s probably appropriate to let me have Dick explain to you the directors’ feelings.”

Leaning in toward the speakerphone, Beattie said, “Tim, the board wants to know whether the terms can be renegotiated. They think eighty percent is outrageous.”

“Terms cannot be negotiated,” Geithner said firmly. “These are the only terms you’re going to get.”

As the three men looked at each other resignedly, Beattie continued, “We have a second question. The board wants to know whether, if the company can come up with its own financing to take the Fed’s place, would that be acceptable?”

Geithner hesitated and then replied: “Nobody would be happier than I if the company, you know, would pay the Fed back.”

Beattie returned to the boardroom and relayed the conversation. The deal was done.

Paulson and Bernanke, after finishing with the president, ran over to the Hill to brief key congressmen, who were none too pleased with the AIG bailout news. Senate majority leader Harry Reid hosted the meeting in his second-floor conference room. The gathering had been hastily organized; some congressmen were invited only twenty minutes before it began. Senator Judd Gregg of New Hampshire, the ranking Republican on the Senate Banking Committee, was supposed to be at a black-tie dinner and showed up in his tuxedo, sans tie. Barney Frank arrived late in an untucked shirt.

Paulson and Bernanke explained why they thought their decision had been a necessary one. “If we don’t do this,” Paulson told them, the impact of an AIG bankruptcy would “be felt across America and around the world.”

Frank, concerned about the cost, looked at Bernanke. “Do you have $80 billion?”

With a barely concealed smile, Bernanke answered, “Well, we have $800 billion.”

Back at JP Morgan, Jamie Dimon and Jimmy Lee were sitting in Dimon’s office when the AIG press release came across the tape. “They’re never going to get their money back,” Lee told Dimon. “There’s no way.”

“I guarantee you they’ll get more than $50 billion of it back,” Dimon shot back, thinking that Washington had just cut itself a good deal, however bad it was from a public relations perspective. “AIG has a lot of good insurance businesses it can auction off. You’ll see.”

Dimon and Lee placed a $10 bet on who would turn out to be right.

Around 11:00 that night, Bob Willumstad’s driver pulled up to his building on Park Avenue, just across from Lenox Hill Hospital. Dashing under its green awning, Willumstad, tired and depressed, rode up the elevator to his seventh-floor apartment. Pacing in his kitchen, he recounted the day’s events to his wife, Carol.

Before turning in for bed, Willumstad checked his BlackBerry one last time. David Herzog, the company’s controller and a man who had been working behind the scenes nonstop for the past weekend to keep the firm afloat, had sent him an e-mail. The time stamp was 11:54 p.m.; the subject line, “Last Steps”:

Thank you for taking on this very difficult challenge. The events that unfolded tonight were set in motion long ago.

Before you leave office, I ask only one thing. Please clean the slate for Mr. Liddy. I urge the following dismissals immediately:

Schreiber

Lewis & McGinn

Nueger & Scott

Bensinger

Kelly

Kaslow

Dooley

While this may seem a bit harsh, this group of executives each have shown in their own ways a clear pattern of ineptness that contributed to the destruction of one of America’s greatest companies. Please, don’t make Mr. Liddy figure this out on his own.

I mean no disrespect to these individuals, but the 120,000 employees around the world deserve better, and some sense of accountability for what just happened.

We need leadership, and these individuals are simply not leaders.

Respectfully yours,

David

Willumstad, standing in the hallway in his boxer shorts, just shook his head in disbelief.