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

CHAPTER NINETEEN

On Monday, September 22, the day after Goldman Sachs became a bank holding company, Lloyd Blankfein, his face puffy with exhaustion, sat staring at a framed cartoon from Gary Larson’s The Far Side on his office end table. The drawing features a father and son standing in their suburban front yard and gazing over a fence at their neighbor’s house, where a line of wolves is in the process of entering the front door. “I know you miss the Wainwrights, Bobby,” the caption reads, “ but they were weak and stupid people—and that’s why we have wolves and other large predators.”

To Blankfein that pretty much summed up what had just happened to Wall Street: Had things worked out slightly different, Morgan Stanley, and perhaps even Goldman Sachs, could have ended up just like the Wainwrights.

Of the Big Five investment banks, his own and Morgan Stanley were the last ones standing, but Goldman’s footing seemed increasingly unsteady. As the day wore on, Goldman’s stock price, unlike Morgan Stanley’s, was not stabilizing but continuing to plunge, falling 6.9 percent. Despite its having been designated a bank holding company—giving it virtually unlimited access to liquidity from the Federal Reserve—investors had suddenly become worried about whether Goldman would need more capital.

After rising for two days the week before on hopes that TARP would save the economy, the broader market also was now moving again in the wrong direction. As investors had begun digesting the plan, they had come to realize that Paulson was going to have to do a better job of selling it if it was, as he intended, to renew confidence in the economy. To many Americans who had suffered substantial losses in their 401(k) plans, Wall Street simply didn’t deserve to be saved. “It would be a grave mistake to say that we’re going to buy up a bad debt that resulted from the bad decisions of these people and then allow them to get millions of dollars on the way out,” Barney Frank bellowed the day before. “The American people don’t want that to happen, and it shouldn’t happen.”

But the politics of the bailout was hardly a subject that was at the top of Blankfein’s mind, given the more pressing concern of raising capital. He had assigned that task to Jon Winkelried, his co-president, who had put together a team over the weekend to reach out to potential investors in China, Japan, and the Persian Gulf. But their approach was scattershot, and they received only polite refusals from all of their potential targets.

On Monday night Byron Trott, wondering why there had been no news from New York, called Winkelried from his office in Chicago.

“It’s been way too quiet since the weekend. What’s going on?” he asked apprehensively.

Winkelried told him that they were going to begin another round of calling investors on Tuesday with a new proposal to sell shares in the firm. With the market still seesawing, he said, he didn’t expect they’d be able to raise money from a single large source; given the conditions, it would have to come in smaller amounts from dozens of institutional investors.

“Hold on,” Trott interrupted him. “You guys, you have to slow down here.”

Trott, who was the firm’s closest—and perhaps only—conduit to Warren Buffett, suggested that they consider approaching him one more time. Since the previous Thursday, Trott had gone to Buffett with a number of different proposals to invest in Goldman, but the ever-circumspect financier had declined them all. Blankfein had encouraged Trott to propose a standard convertible preferred deal, in which Buffett would receive preferred shares with a modest interest rate, which could be converted into common shares at about a 10 percent premium to Goldman’s current stock price. But, as Trott had correctly predicted, there wouldn’t be enough upside to interest the Oracle. “In a market like this there’s no reason I can take the risk,” Buffett told Trott.

On Tuesday morning, after consulting with Blankfein and the rest of the senior Goldman team, Trott called Buffett again with a new proposal. Buffett’s grandchildren were visiting Omaha, and as he was planning to take them to the local Dairy Queen (a chain owned by Berkshire), the conversation lasted no more than twenty minutes. Trott knew the only way Buffett would be willing to make an investment would be if he were offered an extraordinarily generous deal, which he now presented: Goldman would sell Buffett $5 billion worth of stock in the form of preferred shares that paid a 10 percent dividend. This meant that Goldman would be paying $500 million annually in exchange for the investment; Buffett would also receive warrants allowing him to buy up to $5 billion of Goldman shares in the future at the price of $115 a share, about 8 percent lower than their price that day. With those terms Goldman would be paying an even greater amount than what Buffett had asked of Dick Fuld back in the spring, a sum that Fuld had seemingly rejected.

Relying on his gut, as always, Buffett quickly agreed to the outlines of the deal. Trott called Winkelried, reaching him just as he emerged from the Grand Central terminal on his way to the United Nations, where President Bush was scheduled to address the Sixty-third General Assembly, to tell him the good news.

“I think Warren will do this!” Trott said excitedly.

“Okay, stay where you are,” Winkelried told him. Trying to find a quiet spot on the congested, noisy sidewalks outside Grand Central, Winkelried called the office to set up a conference call with Goldman’s brain trust—David Viniar, Gary Cohn, David Solomon, and Blankfein, who had flown down to Washington for the day for meetings with lawmakers.

Minutes later the group was assembled, and they began to discuss the Buffett deal. Just as important as the infusion of cash, they agreed, was the confidence that a Buffett investment would inspire in the market. Indeed, Winkelried said, the firm would be able to raise additional money from other investors on the back of Buffett’s investment.

“Well, why wouldn’t we do it?” Viniar wondered.

“We’re done,” Solomon said.

Trott immediately set up a call for Blankfein to speak directly with Buffett, and after the two briefly reviewed the transaction, Buffett suggested that Goldman get the papers in order and send them to him, so they could announce the deal that afternoon after the market closed.

Blankfein, who always liked to review every last detail, asked, “Would you like me to just do a download for you on things that I’m concerned about?”

“No, it’s okay,” Buffett replied calmly. “If I were worried, I wouldn’t be doing this at all.” With that he rounded up his grandchildren and headed for Dairy Queen.

Back at Broad Street, however, there was still one provision that troubled the group, a provision that Buffett had indicated would be a deal breaker: Goldman’s top four officers could not sell more than 10 percent of their Goldman shares until 2011, or until Buffett sold his own, even if they left the firm. He had explained his rationale for this condition to Blankfein by saying, “If I’m buying the horse, I’m buying the jockey, too.”

That stipulation would not be an issue for him, Cohn, or Viniar, Blankfein knew, but it would be a problem for Winkelried. Only forty-nine years old, he had recently been making noises about leaving Goldman and, while it was a secret within the firm, he was having his own personal liquidity crisis. Although Winkelried was debt-free, he was quickly running out of cash. Despite making $53.1 million in 2006 and about $71.5 million in 2007, most of it was in stock; in the meantime, he had been spending extraordinary sums. While he owned a 5.9-acre waterfront estate on Nantucket that he was preparing to put up for sale for $55 million, his real cash drain was Marvine Ranch, a horse farm he owned in Meeker, Colorado. Winkelried was a competitive “cutter” rider, and while the farm had won more than $1 million in prize money over the previous three years, it cost tens of millions of dollars to operate.

Blankfein called him personally and, after assuring him that the firm would help him find a way out of his financial troubles, Winkelried agreed to Buffett’s condition. He was unhappy with the restriction, but he knew that the Buffett deal was best for Goldman.

By the next morning Goldman had managed to sell an additional $5 billion of shares to investors on the news of the Buffett deal, and its stock rose more than 6 percent.

Blankfein could finally relax. The wolves were no longer at the door.

“Josh, I cannot believe this is happening!” Paulson shouted into his cell phone at Josh Bolten, the White House chief of staff and the man who had helped hire him. “No one checked with me on this. Ah, and, if we are going to keep doing bullshit like this, you, ah, you are going to need a new Treasury secretary!”

Paulson, who had just concluded an entire afternoon of hearings on the Hill trying to persuade skeptical lawmakers to pass his TARP legislation, had just learned that John McCain, the Republican candidate for president, had announced that he was suspending his campaign to return to Washington to help work on the financial rescue plan. The crisis, which seemed only to be deepening, was now becoming part of the tactics of the presidential elections.

To Paulson, as depressed as he was exhausted, it was just the latest reminder of the uphill battle he faced in getting his legislation approved. McCain’s return, he feared, would only galvanize the House Republicans opposed to the rescue proposal. If the Bush administration had no control over its presidential candidate—let alone the party itself—Paulson knew he was in trouble.

As Paulson paced in an anteroom at the Rayburn House Office Building, Bernanke, who had accompanied him to the hearings, became so uncomfortable with the tone of his conversation with Bolten that he left the room. He was hardly accustomed to officials screaming at each other, and worse, he couldn’t abide the bare-knuckled behind-the-scenes fighting that is a staple of politics, especially in an election year.

In truth, support for TARP—which Joshua Rosner, a managing director at Graham, Fisher & Company, told the New York Times should stand for “Total Abdication of Responsibility to the Public”—was quickly waning in both parties. Democrats charged that it was a way for Paulson to line the pockets of his friends on Wall Street, while Republicans denounced it as just another example of government intervention run amok. Congressmembers on both sides of the aisle complained about the cost of the plan, with some questioning if it could be made in installments and others seeking to include limits on executive compensation in any legislation.

“What they have sent us is not acceptable,” Christopher Dodd declared. “This is not going to work.” Jack Kingston, a Republican congressman from Georgia, went so far as to publicly criticize Paulson as “a terrible communicator,” complaining, “We’re being asked to vote on the major piece of legislation of our lifetimes, and we haven’t seen the bill.”

Beyond the rhetoric, however, lawmakers as well as investors were starting to raise practical questions about how the process of buying troubled assets would actually work. How would the government pay for them? How would the prices be determined? What if certain parties wound up profiting at the expense of the taxpayers?

When Stephen Schwarzman, who had encouraged Paulson to announce a plan—any plan—finally saw the details of this one, he called Jim Wilkinson to get a message to Paulson.

“You announced the wrong plan!” Schwarzman told him.

“What do you mean?” Wilkinson asked.

“You won’t practically be able to figure out a way to buy these assets in a short period of time to provide liquidity to the system without either screwing the taxpayers or screwing the banks,” Schwarzman warned him. “And you won’t be able to force people to sell!” He explained that most bank CEOs would prefer to leave their bad assets on their books at depressed prices rather than have to realize a huge loss. “And,” he added, “each package of these assets is so highly complex that it’s not like bidding for a bond; you have to do a lot of in-depth analysis, and that takes weeks to months, and meanwhile, if you do nothing for weeks to months, you’re going to go back into crisis.”

At around 4:00 p.m. on Thursday, September 25, leaders of both parties and of the relevant committees crowded around the large oval mahogany table of the stately Cabinet Room of the White House, joined by the presidential candidates, senators McCain and Obama. Seated at the middle of the throng were the president, Vice President Cheney, and Hank Paulson. The group had been assembled in an attempt to persuade House Republicans, who had been emboldened by McCain, to rejoin the negotiations and agree on a bailout.

“All of us around the table take this issue very seriously, and we know we’ve got to get something done as quickly as possible,” Bush told the group. “If money isn’t loosened up, this sucker could go down,” he warned, referring to the nation’s economy.

But the meeting quickly degenerated from a promising effort to reach a consensus into a partisan fracas after the House Republican leader, John Boehner of Ohio, announced that House Republicans would not support the bailout, but would instead propose an alternative that would involve insuring mortgages with a fund paid for by Wall Street. When Democrats protested that such a plan would do nothing to address the current crisis, arguments erupted throughout the room, followed by finger-pointing and shouting, a spectacle that Cheney sat watching with a smile.

Obama, in an attempt to reach a compromise, asked, “Well, do we need to start from scratch, or are there ways to incorporate some of those concerns?” But by then it was too late for any effort to find a middle ground, and the meeting ended with the various factions leaving the room without speaking to one another.

As the deflated Treasury team made their way to the Oval Office a staffer stopped to inform Paulson that the Democrats were gathering in the Roosevelt Room across the corridor.

“I need to find out what they’re doing,” Paulson mumbled, disappearing before some of the staff even realized he was no longer with them.

He marched into the middle of the scrum of Democrats, who were furious at the House Republicans’ campaign to undermine the rescue plan. Paulson could see that it was only moments away from collapsing.

To break the tension, he went down on one knee before House speaker Nancy Pelosi.

“I beg you,” he said in a heartfelt plea, backed by a chorus of chuckles from the congressmembers, “don’t break this up. Give me one more chance to bring these people in.”

Pelosi tried to repress a smile at the sight of the towering Treasury secretary genuflecting before her and, looking down at him, quipped, “I didn’t know you were Catholic.”

At 4:00 a.m. on Friday morning, Vikram Pandit, Citigroup’s CEO, was puttering around his Upper East Side apartment, catching up on his e-mail. He had gotten only a few hours of sleep, having arrived home late after spending the day at the Wharton School in Philadelphia, where he had given a lecture in which he told the audience, “You have been great at picking exactly the right time to be at school.”

His in-box was almost full, with e-mail traffic among his inner circle sharing the latest news: Hours earlier the Federal Deposit Insurance Corporation had swooped in to seize Washington Mutual, which held more than $300 billion in assets—making it the biggest bank failure in the nation’s history. The FDIC had already run a mini-auction for WaMu, the largest of the savings and loans, requesting best bids a day before its announcement, just in case. The FDIC typically conducts seizures of troubled banks on Friday evenings, to allow regulators time over the following weekend to ready the institution to open under government oversight on Monday. But WaMu was deteriorating so rapidly—nearly $17 billion had been withdrawn in ten days—that the regulators had no choice.

Pandit, who had himself submitted an early bid for WaMu, learned that his rival, Jamie Dimon, had won the auction, paying $1.9 billion.

As Pandit made his way through the stream of e-mails, one from Bob Steel of Wachovia caught his eye. He knew that Steel had called his office earlier that week, and he imagined he knew the purpose of that call: Steel was probably interested in selling the firm. To Pandit, Wachovia was an attractive purchase because of its strong deposit base, which Citi, despite its mammoth size, lacked. But he knew instinctively that he would be interested in such a deal only if he could buy the company on the cheap.

“I’m sorry, I’ve been away,” Pandit e-mailed Steel at 4:27 a.m. “But I’m back, call any time.”

Minutes later, Steel, who was also awake, phoned him.

Having been abandoned at the altar the previous weekend by Goldman Sachs and Morgan Stanley—and with Kevin Warsh still pressuring him—Steel was eager to line up as many options as possible, suspecting that the upcoming weekend could well turn into another merger sprint. He had also reached out to Dick Kovacevich at Wells Fargo, whom he had run into in Aspen the previous weekend, and had scheduled a breakfast with him at the Carlyle Hotel on Sunday morning.

If everything worked out the way he hoped, he might well be able to set up an auction.

After the fiasco of Thursday’s meeting, Paulson and the White House agreed that they needed to do everything possible to resume the talks on the bailout. “Time,” Paulson warned Josh Bolten, “is running out.”

By 3:15 p.m. on Saturday, September 27, Paulson and his Treasury team were heading down the hall of the Hill’s Cannon House Office Building to conference room H-230, where they would meet with congressional leaders one more time, in hopes of fashioning a compromise.

Kashkari, in a huddle with the Treasury team before the gathering, reminded everyone that the biggest hurdle they faced was that Congress did not truly appreciate the severity of the economy’s problems. “We’ve got to scare the shit out of the staff,” he said, echoing Wilkinson’s instruction to Paulson earlier in the week. “Let’s not talk about the legislation,” he urged, and suggested instead that they focus on the potentially devastating problems they would all face if the legislation wasn’t passed.

When Paulson arrived in the conference room, which was across from Pelosi’s office, he took note of the presence of Harry Reid, Barney Frank, Rahm Emanuel, Christopher Dodd, Charles Schumer, and their staffs; only the speaker herself was absent.

To underscore the significance and sensitive nature of the meeting, an announcement was made that all cell phones and BlackBerrys would be confiscated to avoid leaks. A trash can was used as a receptacle for the dozens of mobile devices labeled with congressional staffer names on yellow Post-Its.

As the meeting came to order, Paulson, following Kashkari’s playbook, announced darkly, “You saw what happened earlier this week with Washington Mutual,” and, with as much ominousness as he could muster, added, “There are other companies—including large companies—which are under stress as well. I can’t emphasize enough the importance of this.”

The stern-faced lawmakers listened attentively but immediately raised what they considered to be four major obstacles to the plan: oversight of the program, which the Democrats felt was severely lacking; limits on executive compensation for participating banks, a controversial provision that Paulson himself was convinced would discourage them from participating; whether the government would be better off making direct investments into the banks, as opposed to just buying their toxic assets; and whether the funds needed to be released all at once or could be parceled out in installments.

“Damn it,” Schumer thundered, annoyed that he couldn’t get a straight answer. “If you think you need $700 billion right away, you’d better tell us.”

“I’m doing this for you as much as for me,” Paulson replied, blanching at Schumer’s aggressive tone. “If we don’t do this, it’s coming down on all our heads.”

The conversation soon turned to executive compensation. While everyone in the room was aware of the potential political fallout over huge bonuses being paid out by firms requiring taxpayer rescue, it was Max Baucus, chairman of the Senate Finance Committee, who spoke to the issue. He made it abundantly clear that he was furious with Paulson for not having insisted on strict limits on compensation for the managements of banks that would take advantage of the program. In Baucus’s view the executives should be entitled to next to nothing—and at the very minimum they should be forced to give up golden parachutes and other perks.

As Baucus railed on, raising his voice until he was virtually shouting at the Treasury staff, Paulson finally interrupted him with, “Let’s not get emotional,” and tried to explain his rationale. The reason he was loath to put in executive compensation limits, he said, was not because he wanted to protect his friends but because he believed the measure was impractical. Banks, he said, would have to renegotiate all of their compensation agreements, a process that could take months, preventing them from accessing the program.

Paulson’s efforts to calm the group’s nerves with practical reasoning, however, didn’t appear to be working; other congressional leaders rushed in to express their own outrage, focusing now on the lack of oversight and accountability. While the three-page piece of legislation he had originally submitted the week before had since grown in size, it still contained little in the way of any watchdog provisions to guarantee that the program would be maintained properly. Paulson had been resisting the Democrats’ demands to appoint a panel that would not only oversee the program, but also have the authority to determine how it operated and made decisions, as he feared that it would inevitably become politicized. “All we’re talking about is having Groucho, Harpo, and Chico watching over Zeppo,” said Frank to laughter.

The conversation dragged on into the night, as the staffers from Treasury and Congress tried to find a middle ground, with only the same sticking points raised again and again.

“It’s impossible for us to go to hundreds of banks across the country and have them renegotiate all their employment contracts,” Kashkari said, reiterating why they couldn’t include more compensation curbs. “It’s just going to take too long; it’s impossible. So if they have golden parachutes, physically we can’t do it.”

One of Schumer’s staffers proposed a different approach. “Well, why don’t you just block new golden parachutes?”

“We hadn’t thought of that,” Kashkari admitted sheepishly.

It was the eureka! moment that finally seemed to break the impasse the group had reached. For the first time in days it appeared that with a few other compromises they could be near agreement on the terms of a deal. While the Democrats had backed down on the oversight component, they could console themselves with a victory of sorts on the executive compensation issue.

As his staffers continued to perform shuttle diplomacy among the various factions, trying to find some language on which they could finally settle, Paulson, looking deathly pale, retreated to Pelosi’s office.

“You want us to go get the Hill doctor?” Harry Reid asked.

“No, no, no,” Paulson said groggily. “I’ll be fine.”

Hurriedly pulling a trash can before him, he began having dry heaves.

Bob Steel and his lieutenant, David Carroll, entered the elegant Art Deco lobby of the Carlyle Hotel at 8:00 on Sunday morning, making their way to the elevators and to the suite of Dick Kovacevich, the chairman of Wells Fargo.

With the TARP legislation still publicly unresolved, Steel and Carroll had come to see Kovacevich in hopes of convincing him to buy Wachovia. For Steel it was an especially bitter pill to swallow; having left Treasury only two months earlier to become the CEO of the firm, he was now resigned to selling it. Much like AIG’s Bob Willumstad, he simply had no good options available to him. Any attempt to turn around Wachovia in this environment, with its portfolio of subprime loans falling even more every day, was going to be increasingly difficult. Steel felt a deep sense of responsibility to find a buyer quickly, to obtain some value out of the business before the winds turned against him completely.

He was also under particular time pressure from the fact that both Standard & Poor’s and Moody’s had threatened to downgrade the firm’s debt the following day. A downgrade could put even more pressure on the bank, whose stock had fallen 27 percent on Friday, further eroding confidence among customers, who had withdrawn some $5 billion that same day.

In his effort to encourage an auction, Steel had met with Pandit on Friday and Saturday, but the night before had received the bad news: Like Goldman Sachs the prior weekend, Citigroup would only buy the firm with government assistance, and even then Pandit said he was prepared to pay only $1 a share for it.

As Steel and Carroll sat down for breakfast in Kovacevich’s suite, he could only hope he was going to get a more encouraging reception.

Kovacevich, a handsome sixty-four-year-old with silver just beginning to shade his temples, had built Wells Fargo into one of the best-managed banks in the country, establishing it as the dominant franchise on the West Coast and attracting Warren Buffett’s Berkshire Hathaway as his largest single shareholder.

After a waiter poured coffee for the group, Kovacevich, who had flown from his home in San Francisco to New York expressly for this meeting, said he was very interested in making a bid for Wachovia without any government assistance and hoped to do so by the end of the day. But, he warned, in the straight-talking manner for which he was known, “This is not going to have a ‘two-handle’ in front of it.”

Steel smiled. “Listen, Dick, let’s not worry about price now,” he replied, satisfied that even while Kovacevich was rejecting a $20 offer, his interest was sufficient that Steel would likely end up with a final number in the teens. “Let’s see how this deal works, and once we know how it looks there will be a price that makes sense,” he added.

Kovacevich said that his team would continue its due diligence, and he hoped to be able to get back to him later that day.

Steel, still smiling as he left the hotel, called his adviser, Peter Weinberg, and reported, “It was a good meeting. I think.”

Sitting in his office Sunday morning Tim Geithner, habitually running his fingers through his thick hair, pondered his alternatives.

He had spoken to Citigroup the day before, when they had laid out a plan to buy Wachovia in concert with the U.S. government. The bank would assume $53 billion of Wachovia’s subordinated debt and would cover as much as $42 billion of losses on its $312 billion portfolio; anything beyond that the government would absorb. In return for that protection, Citi would pay the government $12 billion in preferred stock and warrants. Geithner had always liked the idea of merging Citigroup and Wachovia, which he viewed as an ideal solution to each party’s problems: Citigroup needed a larger deposit base and Wachovia clearly needed a larger, stronger institution. Even so, Geithner was still hopeful that Wells Fargo would pull through and be able to reach a deal without government involvement.

But now, having just gotten off a conference call with Kevin Warsh and Jeff Lacker of the Federal Reserve of Richmond, which regulates Wachovia, he had a new problem: Despite Kovacevich’s indication to Steel just that morning that he wanted to reach an independent agreement, Kovacevich had called and stated that if he had to conclude the deal before Monday, he didn’t feel comfortable moving forward without government assistance. He was too unsure of the firm’s marks and couldn’t take the risk.

There was now within the government a de facto turf battle over Wachovia, given the involvement of Richmond, with Warsh and Geithner playing deal makers. And Sheila Bair at the FDIC had yet to take part: If Wachovia really were to fail, it would be her jurisdiction.

Geithner and Warsh set up a conference call to coordinate their efforts with Bair, the fifty-four-year-old chairwoman of the FDIC and one of their least favorite people in government. They had always regarded Bair as a showboat, a media grandstander, a politician in a regulator’s position whose only concern was to protect the FDIC, not the entire system. She was not, in their view, a team player. Geithner would frequently commiserate about Bair with Paulson, who shared a similar perspective about her. At times, Paulson had a genuine respect for her. “She comes to play,” he regularly said to his staff, but added, “When she is surrounded by her people, when she’s peacocking for other people or she’s worried about the press, then she’s going to be miserable.”

Bair, who had just ended a conversation with Warren Buffett (who she was hoping could help her track down Wells Fargo’s president, John Stumpf), joined a conference call late Sunday with Geithner, Warsh, and Treasury’s David Nason. Paulson, who was barred from talking to Steel, had tried to disentangle himself from this particular matter, expending his energy instead on TARP and receiving only irregular updates on the negotiation’s progress from Nason.

When Geithner suggested Bair should help subsidize any deal for Wachovia, she resisted the proposal firmly, stating in a lengthy soliloquy that the only way she would get involved was if she were to take over the bank completely and then sell it.

When she finished, there was an awkward silence. “Right, right, right,” Geithner said, almost mocking Bair.

Geithner countered that allowing the FDIC to take over Wachovia would have the effect of wiping out shareholders and bondholders, which he was convinced would only spook the markets. He was still furious with Bair for the way she had abruptly taken over Washington Mutual, which had had a deleterious effect on investor confidence. Given Paulson’s ongoing public efforts to support the banking system, he told her, that option was a nonstarter. Then Geithner, looking for another jar of money, asked Nason if Treasury could contribute to the effort, which could eventually amount to more than $100 billion.

“We’re still trying to get TARP passed,” Nason replied briskly. “We can’t be committing money.”

At 7:00 p.m., Bob Steel, waiting in a conference room at Sullivan & Cromwell’s Midtown offices, got a disturbing call from Kovacevich, who had been inexplicably out of touch for the past two hours and who had sounded oddly detached during their previous call.

Kovacevich now announced that he wasn’t prepared to move forward without government assistance. “We don’t make these kinds of loans, so we don’t understand them,” he explained. Steel, dumbfounded, thanked him, ended the call, and slumped down in his chair, wondering how he could have been rejected again. Citigroup was still on the sidelines, but he doubted they would raise their bid, especially if there was no competition. When he told his inner circle about the call with Kovacevich, he described it as “not an attractive fact.”

At around 8:00 p.m., Rodgin Cohen heard a rumor that Citigroup had been talking to the FDIC, which only led him to suspect that Citi was trying to orchestrate an FDIC takeover of Wachovia, one similar to the deal that JP Morgan had made for Washington Mutual. Furious, he rang Ned Kelly, upon whom Pandit relied for strategy. Only days before, Kelly had been appointed head of global banking for the bank’s institutional client business in a reshuffle that saw the departure of Sallie Krawcheck, who had once been one of the most powerful women on Wall Street.

“Okay, we need to talk,” Cohen began testily.

“Rodge, look, I wasn’t in touch with them, they just called me,” a defensive Kelly insisted. “I still have the same deal on the table.”

When Steel learned of their conversation he knew that he was, for all practical purposes, out of options, for Warsh had made it clear the bank couldn’t open Monday without a deal. In a last-ditch plea to remain independent, he called Sheila Bair at 12:30 a.m. with a proposal: Would the FDIC consider guaranteeing some of Wachovia’s most toxic assets in exchange for warrants in the bank?

At 4:00 a.m. Steel got the answer he had been dreading. Bair phoned to notify him that his bank had been sold to Citigroup by the government for $1 a share. The FDIC wouldn’t be completely wiping out shareholders, she said; she had succumbed to pressure from Geithner and agreed to guarantee Wachovia’s toxic assets after Citigroup accepted the first $42 billion of losses, declaring that the firm was “systemically important.”

Paulson stood alone in his office, watching the congressional coverage of his bailout bill on C-SPAN. After some additional compromise on Sunday, legislation had been drafted that was acceptable to all the parties and was now being put to a vote.

Pelosi, standing on the floor of the House, had just given an impassioned speech about the need to pass the bill, but had also used the moment as an opportunity to assail the Bush administration, Paulson, and Wall Street. “They claim to be free market advocates, when it’s really an anything-goes mentality,” she said of the Bush administration. “No regulation, no supervision, no discipline. And if you fail, you will have a golden parachute, and the taxpayer will bail you out… . The party is over in that respect. Democrats believe in a free market. We know that it can create jobs, it can create wealth, it can create many good things in our economy. But in this case, in its unbridled form, as encouraged, supported, by the Republicans—some in the Republican Party, not all—it has created not jobs, not capital; it has created chaos.”

Although a few members of Paulson’s staff were loitering nervously outside his office, afraid to go in, Michele Davis had no such qualms and joined him, the two of them intently following the tally of yeas and nays at the bottom of the screen. Paulson expected the bill to pass without a problem, as the markets had already priced in its approval. Five minutes into the allotted fifteen-minute voting window, however, the number of nay votes began to rise consistently. He knew that the measure was still very unpopular with House Republicans, as well as with a number of liberal Democrats, and lawmakers facing tight reelection races did not want to give their opponents any ammunition with just five weeks before election day. There was still time, however, for Pelosi and the Democratic leadership to turn the vote around.

“They wouldn’t have brought this bill to the floor if they didn’t think it could pass, if they didn’t have the votes lined up somewhere,” Davis reassured him. Paulson said nothing and only continued to stare at the screen as the margin of no votes grew wider and wider.

Kevin Fromer, Treasury’s legislative liaison, called anxiously from outside the House chamber. “This is going to fail.”

“I know,” Paulson mumbled dully. “I’m watching.”

Finally, at 2:10 p.m., after an unusually long period of forty minutes to count the votes, the gavel came down: The bailout was rejected 228 to 205. More than two thirds of the Republican representatives had voted against it, as had a large number of Democrats. Traders and investors had been watching the coverage also and started a frantic wave of selling. Stock prices plunged, with the Dow Jones Industrial Average tumbling 7 percent, or 777.68 points, its biggest one-day point drop ever.

For a moment Paulson was speechless. His plan, which he believed might be the most important piece of legislation he could ever propose—his effort at avoiding a second Great Depression—had failed. As his staffers, seeking to comfort him and one another, silently gathered in his office, he said simply, “We’ve got to get back to work.”

Within an hour he and his team were at the White House, meeting with the president in the Roosevelt Room and discussing plans for how to revive the bill.

Downstairs in the Treasury building, however, Dan Jester and Jeremiah Norton had their own ideas about the problem Paulson was facing. They had convinced themselves that the concept of buying up toxic assets was never going to work; the only way the government could truly make a difference would be to invest directly in the banks themselves. “This is crazy,” Norton said of the TARP proposal as he walked into David Nason’s office. “Do we really think this is the right approach?” Jester and Norton had made the case to Paulson before, but the politics of using government money to buy stakes in private enterprises, they knew, had gotten in the way. And once Paulson had gone public with his current plan it seemed as if it would be difficult for him to reverse course.

“If you feel that strongly, you need to tell Hank,” Nason said to him. “You can tell him I’m onboard with you.”

The next day Jester and Norton went to visit with Paulson. They laid out their case: Buying the toxic assets was too difficult; even if they ever figured out how to implement the program, it was unclear whether it would work. But by making direct investments in the banking system, Jester told him, they’d immediately shore up the capital base of the most fragile institutions. They would not have to play guessing games about how much a particular asset was worth. More important, Jester argued, most of these banks eventually would regain their value, so the taxpayer would likely be made whole. And, Jester continued, the current TARP proposal actually allowed Treasury to use it to make capital injections, even if it hadn’t been advertised as such.

Paulson, who had become somewhat disillusioned with the time it was taking to design and implement TARP, was starting to come around to Jester’s way of thinking. He had no idea how he’d sell it to the American public, and he knew that it would be anathema to the Bush administration, but he also knew it might be the most practical solution in a sea of bad options.

“Okay,” he sighed. “Why don’t you work something up? Let’s see what this would look like.”

As the sky grew dark, Bob Steel climbed the steps of Wachovia’s corporate jet at Teterboro Airport in New Jersey to head back to Charlotte. He had spent virtually the entire week in back-to-back meetings with Citigroup to coordinate the details of the merger, which they planned to herald in a full-page newspaper ad on Friday, declaring: “Citibank is honored to enter into a partnership with Wachovia … the perfect partner for Citibank.” While he was frustrated with the paltry final price of the deal, he was proud to have at least saved the firm from failure, and he knew that he had explored every possible option in trying to do so.

The government-orchestrated deal had been announced on Monday morning, but it still needed to be formally “papered over,” and in the meantime, Citigroup was keeping Wachovia alive by loaning it $4.9 billion. A number of details were still to be worked out, but they expected to have a signed agreement within the next day. Steel had spent that afternoon at Citigroup discussing the postmerger fates of the most senior Wachovia executives. Before he left he had shaken hands with Pandit. “Looks like we’re done,” Pandit had said gladly.

As Steel’s plane taxied down the runway his BlackBerry rang. It was Sheila Bair. “Hi, have you heard from Dick Kovacevich?”

“No, not since Monday morning,” a puzzled Steel answered; the Wells Fargo CEO had called then to offer his congratulations on the deal with Citi. “Why?”

“I understand that he’s going to be making a proposal for $7 in stock for the entire company—no government assistance.”

“Wow,” Steel replied, quickly trying to assess the ramifications of the surprise offer for his firm. Had Wells Fargo just jumped Citigroup’s bid? Was the government, which had blessed the original deal, now reversing itself? “Sheila, I’m about to take off any second,” he apologized. “You should call Jane Sherburne,” he added, referring to Wachovia’s general counsel.

Sometime after 9:00 p.m., just minutes after Steel’s plane landed in Charlotte, Kovacevich phoned with the pitch that Bair had outlined earlier. Having just spoken with Sherburne and Rodgin Cohen, Wachovia’s outside counsel, Steel had been instructed by them not to say anything that would indicate acceptance or rejection of the offer.

“I look forward to seeing the proposal,” Steel told Kovacevich, and a minute later he received an e-mail with a merger agreement already approved by the Wells board.

It was as if Christmas had come early. Steel couldn’t believe his luck: A deal at $7 a share, up from $1 a share—and without government assistance.

He called his office and scheduled an emergency board meeting by telephone for 11:00 p.m. Before the board call, Steel had a strategy discussion with Cohen. While he owed it to Wachovia shareholders to take the highest bid, he also recognized that he already had a deal with Citigroup—a deal that had kept the firm from failing. The term sheet that Wachovia had signed with Citigroup included an exclusivity provision that prevented the firm from accepting another offer.

“I’m going to be sued by somebody,” Steel told Cohen.

“Pick your poison,” Cohen replied drily.

To both of them, however, it was clear that there really was no choice: The board had to accept the higher bid and take its chances with a suit from Citigroup. Steel and Cohen realized that Wells Fargo had made its bid because of a little-noticed change in the tax law that had occurred on Tuesday, the day after the Citigroup deal. The new provision would allow Wells Fargo to use all of Wachovia’s write-downs as a deduction against its own income, thus enabling the combined bank to save billions in future taxes.

Wachovia’s board voted to accept the deal just after midnight. The Wells offer was for the entire company; it gave shareholders more; and it was clearly the deal preferred by regulators. (Citigroup’s deal, while worth only $1 a share, would have left behind several Wachovia subsidiaries that could have additional value—possibly several dollars a share worth—but a precise number would have been difficult to determine.) It was after 2:00 a.m. by the time Wachovia’s board had fairness opinions from advisers Goldman Sachs and Perella Weinberg, who had been on opposite sides of the negotiating table just a week before.

Steel called Kovacevich to tell him the news, and then dialed Bair’s BlackBerry, which she had instructed him to call instead of her home number so as not to wake her children.

“We’re all approved,” he told her.

“All right,” Bair said, sounding relieved. “We will have to call Vikram first thing in the morning.”

“Sheila, we’re not waiting until the morning,” Steel said resolutely. “We’ve done this; we’ve approved it. I think we have to call him now. I don’t want him hearing this when he wakes up from someone else.”

“You should do it,” she said equally firmly.

“I think you should be on the phone, since you married us,” he replied.

With Bair on the line, Steel conferenced in Jane Sherburne, and then he called Pandit, not surprisingly waking him.

“Bob, what’s going on?” he asked groggily.

“Well, there’s been an important development,” Steel said carefully. “I’m on the phone with Sheila and Jane. Do you need a moment?”

“No, I’m fine,” Pandit said, collecting himself. “What is it?”

“We received an unsolicited proposal from Wells Fargo for the entire company of Wachovia, $7 a share, no assistance, and a Wells Fargo board-approved doc that we’ve accepted. We think this is the right thing to do.”

“Well, that’s interesting,” Pandit answered, a bit taken aback. “A better bid? Let me call Ned. Let’s work with you, and let’s see what we can do and get this thing resolved.”

“No, no. You don’t understand,” Steel interrupted, pausing for a moment. “I’ve signed it already.”

There was silence on the other end of the line. If Pandit hadn’t been completely awake before, he was now. When he resumed speaking he was irate, the full force of Steel’s news having registered with him.

“We have a deal! You know you can’t do this, because we actually have an exclusive arrangement with you. You are not allowed to sign.” Pandit, frustrated, appealed to Bair. “Madame Chairwoman?”

“Well, I can’t get in the way of this,” Bair replied, in her most official tones.

“This isn’t just about Citi,” Pandit explained to her. “There are other issues we need to consider. I need to speak to you privately.”

Steel agreed to leave the conversation, and as soon as he hung up Pandit began pleading with Bair. “This is not right. It’s not right for the country, it’s just not right!”

But the decision, she made it abundantly clear, was final.

Stock prices were surging before the House began voting on the bailout bill for a second time on the afternoon of Friday, October 3. Its passage was eased after the Senate version of the legislation added a number of tax breaks that were otherwise due to expire. Another popular addition increased the amount in individual bank accounts insured by the FDIC to $250,000 from $100,000. What had begun as a three-page draft was now more than 450 pages of legislative legalese, which the Senate had approved after sundown on Wednesday.

Many of the House Democrats and Republicans who had opposed the measure on Monday had since been persuaded to switch their votes—some by appeals from the two presidential candidates or from the president, some by the added provisions in the bill, and others by the mounting signs that the financial crisis was dragging the economy down into a deep recession. A recent report indicated that 159,000 jobs had been lost in September, the fastest pace of monthly job cuts in more than five years. Stocks had slid sharply that week, and both the takeover of Washington Mutual and the desperate jockeying to secure a partner for Wachovia revealed that not only Wall Street was in trouble.

In the final House tally, thirty-three Democrats and twenty-four Republicans who had voted against the bill on Monday now approved it. That afternoon, President Bush signed the Emergency Economic Stabilization Act of 2008, which created the $700 billion Troubled Assets Relief Program, or TARP. “We have shown the world that the United States will stabilize our financial markets and maintain a leading role in the global economy,” the president declared.

Of course, what none of the congressmembers nor the public knew was that TARP was being completely rethought within Treasury, as Jester, Norton, and Nason began developing plans to use a big chunk of the $700 billion to invest directly in individual banks.

Jester had flown back to his home in Austin for a brief respite, but he was constantly on his BlackBerry with Norton going over their various options. Norton and Nason, told by Treasury’s general counsel, Bob Hoyt, that they could not hire an outside financial adviser because of the inherent conflicts, made a series of outbound calls to Wall Street bankers on an informal basis to bounce various ideas off them about how to implement a capital injection program. Their call list included a cast of characters that had become well known to them through the recent spate of weekend deal making: Tim Main and Steven Cutler of JP Morgan, Ruth Porat of Morgan Stanley, Merrill Lynch’s Peter Kraus, and Ned Kelly of Citigroup, among others. They intentionally did not call anyone from Goldman Sachs, concerned that the conspiracy theory rumor mill was already in overdrive.

Norton and Nason asked them all the same questions: How would you design the program? Should the government seek to receive common or preferred shares in exchange for their investment? How big a dividend would banks be willing to pay for the investment? What other provisions would make such a program attractive, and what provisions would make it unappealing?

But Jester, Norton, and Nason knew they had precious little time to complete their planning. Even with TARP approved, the markets did not immediately respond by stabilizing. The Dow Jones Industrial Average, which had been up as many as 300 points before the start of the voting, closed down 157.47 points, or 1.5 percent. After the Wells Fargo deal for Wachovia was revealed, shares of Citigroup fell 18 percent, their sharpest decline since 1988. For the week, the Standard & Poor’s 500 stock index was down another 9.4 percent.

“I’m the ugliest man in America,” Dick Fuld, beside himself in a mix of sadness and anger, privately acknowledged to his team of advisers before they strode into a congressional hearing in Washington on Monday, October 6, that had been called to examine the failure of Lehman Brothers. The markets remained in turmoil, falling another 3.5 percent despite the passing of TARP, as investors continued to question whether the program would actually work.

As he entered, spectators were waving pink sign with handwritten scrawls proclaiming JAIL NOT BAIL and CROOK, and in case Fuld didn’t fully comprehend how he was perceived, John Mica, a Republican congressman, announced, “If you haven’t discovered your role, you’re the villain today. You’ve got to act like a villain.”

For the past several weeks Fuld had been in a depression deeper than any he’d ever experienced, pacing his home in Greenwich at all hours, taking calls from former Lehman employees who wanted either to scream at him or to cry. He continued to go to the office, but it was unclear even to him what he was doing there. He was, however, sufficiently self-aware to finally comprehend what had happened and to perceive the full extent of the vitriol that was now being directed at him. He wanted to be defiant, but he found he couldn’t. He was at times saddened and angry—angry at himself, and increasingly angry at the government, especially at Paulson, whom he saw as having saved every firm but his. His beloved Lehman Brothers had died on his watch.

He now said as much to the congressmembers. “I want to be very clear,” Fuld told the committee. “I take full responsibility for the decisions that I made and for the actions that I took.” He added, “None of us ever gets the opportunity to turn back the clock. But, with the benefit of hindsight, would I have done things differently? Yes, I would have.”

But his audience had little use for his contrition, peppering him instead with questions about his compensation. “Your company is now bankrupt, and our country is in a state of crisis,” Representative Henry Waxman said. “You get to keep $480 million. I have a very basic question for you: Is that fair?”

“The majority of my stock, sir, came—excuse me, the majority of my compensation—came in stock,” Fuld replied. “The vast majority of the stock I got I still owned at the point of our filing.” In truth, while he had cashed out $260 million during that period, most of his net worth was tied up in Lehman until the end. His shares, once making him worth $1 billion, were now worth $65,486.72. He had already started working on plans to put his apartment and his wife’s cherished art collection up for sale. It was a telling paradox in the debate about executive compensation: Fuld was a CEO with most of his wealth directly tied to the firm on a long-term basis, and still he took extraordinary risks.

As he spoke he struggled to gain any measure of empathy from his listeners, suggesting, “As incredibly painful as this is for all those connected to or affected by Lehman Brothers, this financial tsunami is much bigger than any one firm or industry.” He also expressed his great frustrations—with hedge funds for spreading baseless rumors, with the Federal Reserve for not allowing him to become a bank holding company over the summer, and ultimately with himself.

For a moment, as his testimony was winding up, he looked as if he was about to break down, but he steadied himself, as he had done at home virtually every day prior to the hearing. The room fell silent as the congressmembers leaned forward in their chairs, waiting for him to speak.

“Not that anybody on this committee cares about this,” Fuld said, putting his notes aside and surprising even his own lawyer by speaking so extemporaneously, “but I wake up every single night wondering, What could I have done differently?” On the verge of tears, he added, “In certain conversations, what could I have said? What should I have done? And I have searched myself every single night.”

“This,” he said gravely, “is a pain that will stay with me for the rest of my life.” And, he continued, he was baffled by why the government went to extraordinary steps to save the rest of the system but hadn’t done the same for Lehman.

“Until the day they put me in the ground,” he said, as everyone in the chamber hung on his words, “I will wonder.”

That Monday afternoon Hank Paulson received a private four-page, typed letter from his friend Warren Buffett. They had spoken over the weekend about Paulson’s current predicament—namely, that even though his TARP plan had been approved by Congress, it was not passing muster on Wall Street, where investors were beginning to worry that it would be ineffectual. Paulson had confided in him that he was considering using TARP to make direct investment in banks. Buffett told him that before he went down that path, he had some ideas about how to make a program to buy up toxic assets work that he would put in a letter, which he said would spell out both the problems with the current plan and a solution.

In the letter, Buffett, perhaps one of the clearest and most articulate speakers on finance, first explained the shortcomings of Paulson’s current plan:

“Some critics have worried that Treasury won’t buy mortgages at prices close to the market but will instead buy at higher ‘theoretical’ prices that would please selling institutions. Critics have also questioned how Treasury would manage the mortgages purchased: Would Treasury act as a true investor or would it be overly influenced by pressures from Congress or the media? For example, would Treasury be slow to foreclose on properties or too bureaucratic in judging requests for loan forbearance?”

To address those problems, Buffett proposed something he called the “Public-Private Partnership Fund,” or PPPF. It would act as a quasi-private investment fund backed by the U.S. government, with the sole objective of buying up whole loans and residential mortgage-backed securities, but it would avoid the most toxic CDOs. Instead of the government’s doing this on its own, however, he suggested that it put up $40 billion for every $10 billion provided by the private sector. That way the government would be able to leverage its own capital. All proceeds “would first go to pay off Treasury, until it had recovered its entire investment along with interest. That having been accomplished, the private shareholders would be entitled to recoup both the $10 billion and a rate of interest equal to that received by Treasury.” After that, he said, profits would be split three fourths to investors, one fourth to Treasury. His idea also had a unique way to protect taxpayers from losing money: Put the investors’ money first in line to be lost.

Buffett said he was so excited about this structure that he had already spoken to Bill Gross and Mohamed El-Erian at PIMCO, who had offered to run the fund pro bono. He had also been in touch with Lloyd Blankfein, who had likewise offered to raise the investor money on a pro bono basis. Finally, Buffett added, “I would be willing to personally buy $100 million of stock in this public offering,” which, he explained, “constitutes about 20 percent of my net worth outside of my Berkshire holdings.”

After reading the letter, Paulson was intrigued. He was still starting to lean in favor of injecting capital directly into the banks, but he thought maybe a program modeled after portions of Buffett’s proposal could be feasible as well. Paulson called Kashkari into his office; he had just named him interim assistant secretary for financial stability that morning, putting him in charge of the TARP plan. The appointment was already generating a firestorm, with accusations that Paulson was once again favoring his former Goldman Sachs employees. (At Goldman, meanwhile, none of the senior management seemed to know who Kashkari was, and some of them asked their assistants that morning to look though the computer system to find out.)

Paulson handed Kashkari Buffett’s letter. “Call him.”

“It is clearly a panic, and it’s a panic around the world,” John Mack, having flown to London, was telling his employees at their headquarters on Canary Wharf the morning of Wednesday, October 8. “So you think back how the regulators have done and what they have done—could they get ahead of this—you know it’s pretty hard because you really didn’t know how bad it was until it got worse….”

The stock market was cratering yet again amid renewed panic that the banking system—and the economy as a whole—were about to suffer further setbacks. Mack, who had gone to London in part to have dinner with his newest investors from Mitsubishi, was under perhaps the most pressure. He was exhausted, having spent much of the past week living on airplanes. In the wake of China Investment Corp.’s hasty departure from Morgan Stanley’s building after Gao found out the firm was about to do a deal with the Japanese, Mack flew to Beijing to try to repair relations. It was a diplomatic mission, intended to calm frayed nerves and to avoid what seemed as if it might turn into a minor international incident, given that Paulson had quietly gotten involved in the talks with the Chinese government originally. Just as important, CIC was still a large investor in Morgan Stanley, and Mack wanted to placate his foreign partners.

But for now, Mack wasn’t interested in anyone’s hurt feelings. He was glued to his stock price, which had fallen 17 percent the day before, as investors grew nervous that Mitsubishi might renege on its deal. After a week and a half of diligence and regulatory approvals, the investment still had not been finalized, and as Morgan Stanley’s stock price continued to drop, questions were raised about whether Mitsubishi would be better off simply walking away from the agreement. All they had on paper was a term sheet—no better than what Citigroup had signed with Wachovia. And Federal Reserve requirements wouldn’t allow the firms to complete the deal until Monday, leaving Morgan Stanley exposed to the gyrations in the stock market—and the possibility that Mitsubishi could pull out—until then.

Earlier that day Mitsubishi had released a statement in Tokyo saying: “We have been made aware of rumors to the effect that MUFG is seeking not to close on our proposed investment in, and strategic alliance with, Morgan Stanley. Our normal policy is not to comment on rumors. Nevertheless, we wish to state that there is no basis for any such rumors.”

That was all Mack needed to know; he trusted the Japanese and wanted to be confident that they wouldn’t withdraw. In his gut, however, he couldn’t help but be anxious.

Hank Paulson was about to officially change his mind.

It was Wednesday, October 8, and Ben Bernanke and Sheila Bair were on their way to meet with him in his office at 10:15 a.m.

He had finally determined that Treasury should make direct investments in banks, sufficiently persuaded by a growing chorus both inside and outside of Treasury to do so.

“We can buy these preferred shares, and if a company becomes more profitable, you will get a share of that as well,” Barney Frank said during a speech championing the idea of taxpayers becoming shareholders. Chuck Schumer was also in favor of the idea, stating, “When the market recovers, the federal government would profit.”

But perhaps the greatest indication that the concept was feasible came from abroad: The United Kingdom had announced plans to invest $87 billion in Barclays, the Royal Bank of Scotland Group, and six other banks in an effort to instill confidence after a near Lehman-like meltdown confronted them. In exchange, British taxpayers would receive preferred shares in the banks (including annual interest payments) that were convertible into common shares, so that if the banks’ prospects improved—and their shares rose—taxpayers would benefit. Of course, the plan was also a huge gamble, for the reverse was also true: If the banks faltered after the investment was made, a great deal of money stood to be lost.

Paulson and President Bush had been briefed by Gordon Brown on these plans on Tuesday morning at 7:40 by phone in the Oval Office. Now that the formal announcement had been made, Brown was being praised for his judgment to step in so decisively—often in favorable contrast to Paulson. “The Brown government has shown itself willing to think clearly about the financial crisis, and act quickly on its conclusions. And this combination of clarity and decisiveness hasn’t been matched by any other Western government, least of all our own,” Paul Krugman, the economist and New York Times columnist, wrote days later.

With the G7 ministers scheduled to be in Washington for the long Columbus Day weekend, Paulson began to think that he should take advantage of the occasion to once and for all make a bold move to stabilize the system. Still, he knew it could be unpopular politically. After he broached the idea with Michele Davis a week earlier, she only looked at him with a sense of bafflement and remarked, “There’s no way you’re going to say that publicly.”

Paulson had been discussing his shifting views with Bernanke, who had been a fan of capital injections from the start, and they were now in agreement. But they had been thinking about another program to go hand in hand with such an announcement: a broad, across-the-board program to guarantee all current and future unsecured debts of the banks. It would essentially remove any anxiety among investors who loan money to banks that they could ever get wiped out. By Bernanke’s estimation, announcing capital injections and a broad guarantee would be an effective enough economic cocktail to finally turn things around.

But first they needed the money to effectuate such a guarantee program, which is where Bair came in. They felt that the FDIC was the only agency with such powers, and that the guarantee would fall within the agency’s mission.

Paulson and Bernanke, sitting in Paulson’s office, now walked Bair through the concept. The FDIC, they explained to her, would essentially be offering a form of insurance for which the banks would pay by being assessed a fee. The FDIC, Paulson argued, could even end up making money if the assessments outweighed the amount of payouts.

Bair instantly recoiled, doing the math in her head to assess the extraordinary strain such a guarantee could put on the FDIC’s fund.

“I can’t see us doing that,” she replied.

Morgan Stanley’s Walid Chammah woke up Saturday morning deathly afraid that his firm was going to go out of business. Its stock price had continued to fall, closing on Friday at $9.68—its lowest level since 1996. Hedge funds and other clients were again pulling money out. Dick Bove, an influential analyst at Ladenburg Thalmann, was comparing Morgan Stanley to Lehman Brothers and Bear Stearns. “The focus on Morgan Stanley is to change the ending,” Bove wrote in a note to clients. “In sum, one must hold one’s breath at the moment and hope that this is a different movie.”

Chammah had canceled a talk he was scheduled to give at Duke’s business school so he could stay in New York to try to shore up morale at the firm. That Friday he walked every floor in Morgan Stanley’s headquarters, stopping to reassure fretful employees and giving a speech on the trading floor. “This firm has been around for seventy-five years and will be around for another seventy-five years,” he proudly told the traders. To work his way down from the fortieth floor to the second took him three and a half hours. When he got back to his office he was emotionally drained, practically in tears.

It had been a difficult day for one other reason: Rumors were by now rampant that Mitsubishi was going to renege on its deal. No one at Morgan Stanley had received the slightest indication that they were even thinking of doing so—indeed, Mitsubishi had confirmed that they intended to honor the commitment—but the uncomfortable truth was that withdrawing might actually be the right business decision.

“They’re going to recut. They just have to,” Robert Kindler told Paul Taubman that afternoon. “When are they going to call? It’s a nobrainer.”

And everyone inside Morgan Stanley knew what Mitsubishi’s pulling out would mean: a run on the bank all over again, and, just possibly, the end of the firm.

With Mack flying back from London that day, it had been left to Chammah to hold the firm together in the face of that anxious speculation. His wife, who had been watching the financial news on television, called him at the office. “Are you okay?” she asked.

“I’m fine,” he said serenely, trying not to betray his concern.

“You are too, too calm,” she observed. “Are you taking Valium or something?”

Chammah had planned to go to Washington early on Saturday for a series of meetings with Mack and the G7 leaders, but decided to remain in New York throughout the morning in case there was any word from the Japanese. At noon, sufficiently satisfied that if they were going to drop the deal they would have contacted him by now, he headed to LaGuardia to hop a Delta shuttle. As he was walking down the Jetway, his cell phone went off. Oh, shit, Chammah thought, here it comes.

The call was indeed from Mitsubishi’s banker, but to Chammah’s surprise they reaffirmed their intention to go forward with the deal—but did add that they wished to renegotiate for more favorable terms that would give them preferred shares instead of common ones.

“Are you still prepared to close on Monday?” Chammah asked.

The answer was yes. A smile came over Chammah’s face. For a moment, the deal maker in him injected, “Is there a reason for $9 billion? Could it be larger?” In other words, he was asking if, since they were reopening the negotiations anyway, Mitsubishi would like to buy even more of the firm. But he knew he was getting ahead of himself.

Rob Kindler, who had flown to Cape Cod, had just sent an e-mail to Ji-Yeun Lee back at the office. “Is all quiet?” he asked.

Two minutes later, he got the reply: “It was until an hour ago. Call me.”

Kindler flew back to New York as Chammah and Taubman rounded up the troops. It was imperative that they find a way to close this deal by Monday.

By Sunday, they had revised terms—the deal had become more expensive for Morgan Stanley, but they were just happy to still have an investor. Mitsubishi would buy $7.8 billion of convertible preferred stock with a 10 percent dividend and $1.2 billion of nonconvertible preferred stock with a 10 percent dividend.

There remained one complicating factor: Monday was Columbus Day, and since banks in both the United States and Japan were closed, a normal wire transfer was not possible.

“How the fuck are we going to get this thing done?” Kindler, now back at headquarters, asked aloud.

Taubman had a thought: “They could write us a check,” he said. Taubman had never heard of anyone writing a $9 billion check, but, he imagined, given the state of the world, anything was possible.

At 10:00 on Sunday morning, October 12, Hank Paulson, dressed casually, took his place at the table in the large conference room across from his office. The room was overflowing with the government’s top financial officials and regulators. Ben Bernanke had arrived, as had Sheila Bair. Tim Geithner had flown down the day before to join the group. John Dugan, the comptroller of the currency, was present, as was Joel Kaplan, deputy chief of staff for policy at the White House. Paulson’s inner circle—including Nason, Jester, Kashkari, Davis, Wilkinson, Ryan, Fromer, Norton, Wilson, and Hoyt—had also taken their seats, though some of them had to be “back-benched” in chairs against the walls, because there was no room for them around the table.

Paulson had called this meeting to coordinate the final details of a series of steps he had been working on to finally stabilize the system, and he wanted to go public with them. Sunday’s meeting was the second such gathering of this group; many of them had met the day before at 3:00 p.m. to sketch out the outlines of the plan.

The multipart plan—which included the Treasury, Federal Reserve, and FDIC—was, as Paulson described it even that day, “unthinkable.” Based on the work of Jester, Norton, and Nason, he wanted to forge ahead and invest $250 billion of the TARP funds into the banking system. The group had settled on the general terms: Banks that accepted the money would pay a 5 percent interest payment. Paulson had decided that if the amount was any higher, like the 10 percent cost that Buffett had charged Goldman, banks would be unlikely to participate. Still, the rate would eventually become more expensive, rising to 9 percent after the first five years.

Much of the debate about the program that morning was less about the numbers than the approach. “In the history of financial crisis in the U.S., you need to do three things: You need to harden the liabilities; you need to import equity; and you need to take out bad assets. This is one part of that plan,” Geithner said, to sell the group on the need for capital injections.

He had suggested that the only way to make the program palatable to the weakest banks would be if the strongest banks accepted the money as well, “to destigmatize” participation in the program, and perhaps even mask the problems of the most endangered firms. Not everyone was in agreement on this point. “Let’s not destroy the strong to convince the world that the weak aren’t so weak,” Bernanke commented. There was the issue of using the TARP money efficiently; if it was directed to otherwise healthy companies, that would mean less money would be available to those institutions that needed it most. Before the meeting Geithner had had a conversation on this same topic with Kevin Warsh, who told him the stigma argument was a red herring. “There’s no fooling these markets. You aren’t going to fool them into thinking that everybody is equally good, bad, or indifferent.”

Still, Geithner, along with Paulson, quickly prevailed on the group that the only way the program could become effective would be if they could persuade the biggest banks—banks like Goldman Sachs and Citigroup—to accept the money. As they started sketching out a list of firms they wanted to persuade to sign up on day one, with plans to invite them to Washington on Monday to propose that they accept the investment, a question was raised about whether they should make the program available to insurance companies. David Nason suggested they invite MetLife to be a charter TARP participant.

“How are we going to do that?” Geithner asked.

“Well, you regulate them, Tim,” Nason said, to knowing smiles in the room.

The debate about capital injections was playing out against the backdrop of Paulson’s own ongoing worries about the fate of Morgan Stanley. He had been back and forth on the phone with Mack, who he knew was trying to clinch a renegotiated deal. But he had also learned that the Japanese had reached out to the Federal Reserve, seeking assurances that the U.S. government wasn’t planning to come in and make an investment in Morgan Stanley after it did—fearing that if it did, it would wipe out all shareholders. When Warsh first called Geithner to tell him the news, his reaction was simple: “Fuck!” That afternoon they worked to write a letter to the Japanese government assuring them that Mitsubishi would not be negatively impacted any more than other shareholders by any future government intervention in the firm. Of course, Morgan Stanley was unaware of the government’s plans—or the extent of the back-channel conversations taking place between the governments to orchestrate the deal.

Perhaps the biggest fireworks that weekend concerned the one unresolved portion of the plan that Paulson was still hoping to announce: the FDIC guarantee of all current and future unsecured debts of the banks and bank holding companies. He and Bernanke had had lengthy discussions with Bair about the subject. At first, she had offered a compromise: The FDIC would provide the guarantee, but only to banks—not bank holding companies—which left firms like Goldman Sachs and Morgan Stanley still exposed. But Bair seemed to be coming around; Paulson had put the full-court press on her, at one point taking her aside in his office and telling her, “I’ll make sure you get the credit.” For her part, she thought Paulson was under enormous political pressure to put the program into place, in part because a number of European governments were putting together similar facilities. The guarantee would end up being perhaps the largest—though an often overlooked—part of the program. It put the government on the hook for potentially hundreds of billions, if not more, in liabilities, providing the ultimate safety net for the banking system.

Nason and Paulson had been debating the guarantee issue all week. To Nason, it represented the “biggest policy shift in our history.” He told Paulson, “This is an enormous decision. It must be debated in front of everyone so that everyone’s nodding their heads in agreement.”

At one of the meetings that weekend, Geithner, who supported the guarantee, debated the issue with Nason, who played devil’s advocate but also had his own misgivings about the larger implications of the government’s effectively providing an unlimited backstop for an entire industry.

Still, Geithner finally prevailed, and Bair agreed to the plan.

The final piece of business would be to coordinate how they could invite the banks to Washington and what would be the best way to encourage them to accept the TARP money. There was agreement that if they could assemble all the CEOs in one room, the peer pressure would be so great that they’d be inclined to go along with the proposal.

After deciding on a list of prospective banks, it fell to Paulson to call them. (He had gotten out of making the calls for the Lehman weekend, so it was his turn.)

At 6:25 p.m. he returned to his office and began reaching out. His message was simple. He would tell the CEOs to come to Washington, but he would do everything he could to avoid providing any specific details about the reason for the invitation.

Lloyd Blankfein, at a client dinner Sunday night at the Ritz-Carlton in Washington for the International Monetary Fund weekend, made eye contact with Gary Cohn, and they both walked to the corner of the room.

“Hank just called,” Blankfein said in a hushed tone, “and told me I have to be at Treasury tomorrow at three p.m.”

“For what?” Cohn asked.

“I don’t know.”

“What did he tell you?” Cohn said, confused.

“I pushed him, trust me, I pushed him,” Blankfein replied. “The only thing he told me is I’d be ‘happy.’ ”

“That scares me,” Cohn said.

“I knew it would really warm the cockles of your heart,” Blankfein said with a laugh.

Ken Lewis was in his kitchen at his home in Charlotte on Sunday night, getting ready for dinner, when Paulson called.

“Ken,” Paulson said with no introduction. “I need you to come to Washington tomorrow for a meeting at three p.m.”

“Okay,” Lewis said. “I’ll be there. What’s this about?”

“I think you’re going to like it,” Paulson said, so vaguely that Lewis knew not to follow up.

At 7:30 a.m. on Monday, October 13, 2008, Rob Kindler was sitting in a conference room at Wachtell Lipton. He looked like hell, unshaven and still in his vacation khakis and flip-flops. He hadn’t slept in at least a day. He had come to Wachtell to personally pick up the check that he understood Mitsubishi would be delivering. With John Mack in Washington, it was left to him to complete the deal. He was somewhat anxious, for even though Mitsubishi had agreed to all the terms of the deal, he had never seen a physical check with nine zeros on it. He didn’t even know if it was possible. Maybe it would come as several checks?

Kindler was expecting a low-level employee from Mitsubishi to deliver the final payment when he learned from Wachtell’s receptionist that a contingent of senior Mitsubishi executives, dressed in impeccable dark suits, had just arrived in the building’s lobby and was on its way upstairs.

Kindler was embarrassed; he looked like a beach bum. He ran down the hall and quickly borrowed a suit jacket from a lawyer—but as he was buttoning the front he heard a loud tear. The seam on the back of the jacket had ripped in half. The Wachtell lawyers could only laugh.

Takaaki Nakajima, general manager for the Bank of Tokyo-Mitsubishi UFJ, along with a half dozen Japanese colleagues, arrived for what they thought was going to be a deal-closing ceremony.

“I didn’t know you were coming,” Kindler said apologetically to the bemused Japanese. “If I did, I would have had John Mack here.”

Nakajima opened an envelope and presented Kindler with a check. There it was: “Pay Against this Check to the Order of Morgan Stanley. $9,000,000,000.00.” Kindler held it in his hands, somewhat in disbelief, clutching what had to be the largest amount of money a single individual had ever physically touched. Morgan Stanley, he knew, had just been saved.

Some of the Japanese started snapping pictures, trying their best to capture the eye-popping amount on the check.

“This is an honor and a great sign of your faith and confidence in America and Morgan Stanley,” Kindler said, trying to play the role of statesman in his disheveled state. “It’s going to be a great investment.”

As the Japanese group turned to leave, Kindler, grinning from ear to ear, tapped out a BlackBerry message to the entire Morgan Stanley management team at exactly 7:53 a.m.

The subject line: “We Have The Check!!!!!!”

The body of the message was two words:

“It’s Closed !!!!!!!!”