Too Big To Fail
Chapter 19
Setting
This chapter starts with Lloyd Blankfein, CEO of Goldman Sachs (GS), thinking about his company’s future. Stock market is dropping and the regulators still haven’t decided on what, when and how to fix the financial system. Henry “Hank Paulson” the US Treasury Secretary at the time, strongly believes the only way to build confidence in the market place was to have the government pass the Trouble Asset Relief Program (TARP). He had a big task ahead of him because it would be difficult to get lawmakers to agree his plan. Currently Wachovia another well known bank is in crisis. Its two month old CEO, Bob Steel, is trying desperately to broker a deal without government intervention, with either Citibank or Wells Fargo and Company (WFC) to save his bank. In the meantime, investors’ confidence in Morgan Stanley is waning and the company is urgently trying to close a deal with the Japanese company Mitsubishi to get more capital on the books. Companies across the board are trying to become more liquid in the tight credit market.
Major Players
Hank Paulson is trying his best to reach an agreement with Congress, so he can get TARP passed as quickly as possible. He dislikes politics but knows he has to work with the politicians or his bill would die. His solution to the financial crisis is TARP and working with lawmakers would be the only way to get this done. To get Congress on board, he would also have to work with the chairwoman of the Federal Deposit Insurance Corporation (FDIC), Sheila Bair. Having the FDIC on board would bring some credibility to the program.
Goldman Sachs (GS)
GS is now a Bank Holding Company (BHC). However, its stock price continues to drop. One would have expected that with GS now having more access to liquid capital, investors would be more willing to invest in the company. Investors don’t believe GS has enough liquidity and are losing their confidence across the board. The market is dropping because there is no progress on TARP. Blankfein and his staff are working very hard at trying to find people to infuse capital into GS but so far they have been unsuccessful. Finally when there seems to be no positive news on new investors, Byron Trott, GS Chicago banker, was able to get the oracle of the financial world as he is known, Warren Buffet, to agree to a potentially lucrative investment in GS. With Warren on board for five billion dollars, investors gain confidence in the company and would invest another five billion dollars. Blankfein and staff could breathe a little easier now.

Citibank-Wachovia-Wells Fargo and Company
Vickram Pandit, the CEO of Citibank, had lost his bid for Washington Mutual (WAMU) to JP Morgan. Now he had another opportunity to get into another bank with large deposits, Wachovia. So when Steel called and left a message for him he quickly returned his call. Steel was trying to broker the best deal possible for his shareholders. He also contacted WFC chairman Dick Kovacevich. Citibank was willing to take over Wachovia but only if they could get the company for one dollar a share and they could get some assistance from the government. At the same time Steel was hoping he would get somewhere in the teens for his company from WFC and not have to get the government involved. Tim Geithner, the president of the Federal Reserve Bank of New York, hoped for a Citibank-Wachovia merger although he preferred if WFC took over Wachovia because this would mean the government would not have to intervene.
After the meeting between Steel and Kovacevich, WFC decided that taking over Wachovia would not be a good fit for them because they were not familiar with the loans Wachovia lent. Steel was disappointed he would now have to sell his company on the cheap to Citibank. Sheila Bair, negotiated this deal between Citibank and Wachovia. She sold Wachovia to Citibank for one dollar a share and guaranteed toxic assets after Citibank take forty-two million dollars in losses. The deal was done, at least that’s what everyone thought. Monday morning, they would announced the Citibank-Wachovia acquisition to the public in the best light possible.
However, Steel would soon get a phone call from Kovacevich that WFC was now willing to pay seven dollars a share for Wachovia without any government backing. WFC realized the tax benefit they would benefit from if they took over Wachovia. Steel could not turn down the offer even though it would probably mean he could be sued by Citibank for reneging on their agreement. He had to do what was in the best interest of the shareholders. Steel and Bair did a conference call to Pandit, letting him know that Wachovia will be sold to WFC instead of Citi. As can be imagined, Pandit was furious to hear this news. He has once again lost the opportunity to acquire a bank with large customer deposits. Shares of Citibank fell eighteen percent on the news. Passage of TARP
Things would most likely have been smoother if the politicians were not involved in this process. However, tax payers’ money is required, so lawmakers are needed. There were disagreements over TARP between Democrats and Republicans, Democrats and Democrats and Republicans and Republicans. John McCain, the Republican presidential candidate at the time, even left the campaign trail to come back to D.C to help work on this bill. Republicans were accusing Democrats by saying that this bill will be “government running amok” and Democrats were saying that Paulson only wanted to help his friend on Wall Street. At the end of one meeting, Paulson went down on his knees and begged Pelosi not to kill the bill. He wanted her to give him one more chance to present TARP to Congress.
In his next attempt at presenting TARP, he took Kashkari advice and offered a very doomsday like outlook of the financial system if nothing was done build investor confidence in the market place. Several questions were raised at this meeting. One was Oversight; who would oversee this program? Another, was limits on compensation. Next was, should the government make direct investments or just buy toxic assets? They also wanted to know how the funds would be distributed. Would the funds be released all at once or would it be parceled out?
Paulson believed if limits were placed on compensation all contracts would have to be renegotiated and this would take a very long time. One of Senator Chuck Schumer of New York aide suggested putting a block on golden parachutes. The bill was finally put to a vote and was not passed. The stock market lost another seven percent on this news. It was back to the drawing board.
After more revisions to the bill, TARP was passed on October 3rd, 2008 with additions about tax breaks and the increase coverage of the FDIC on bank deposits. There were limits placed on compensation, the Treasury formed a new office that oversees the program, portions of the funds was used to invest directly into the banks. Those banks that accepted TARP had to pay five percent interest. Paulson knew in order to get banks to participate, they needed the larger ones to accept. So they invited bankers to Washington to lay out the plan. So far the passage of TARP hasn’t had any positive effects on Wall Street.
What Did We Learn From This?
Investors’ confidence and expectations are the things that move the market. During the crisis, investors’ confidence was fading. Although GS had more liquid capital at its fingertips, that didn’t stop investors from selling off the shares. Had Warren Buffet not intervene with his five billion dollars investment, who knows what would have become of GS today. The same can be said of Morgan Stanley. Had it not been for the Mitsubishi nine billion dollars check, Morgan may have been a very different company today. Investors were worried that the Japanese would back out of the deal, prices of Morgan Stanley shares dropped. Investors expected a Wachovia take over by Citibank, instead they got a WFC takeover of Wachovia. This caused the price of Citibank stocks to fall.
Investors not only wanted to see that the companies are strong and had good books but they also wanted the government to help stabilize the market. TARP was the US government solution but it took them a while to pass. As is the case when politicians are involved, things don’t get done in a timely manner. Everyone is looking out for themselves. It’s an election year. With the passage of TARP, investors now know the government has some sort of plan for the financial system. Investors’ confidence and expectations are crucial to the market’s performance.
Wachovia CEO, Bob Steel is a good example of when an agent acting in the best interest of a principle. Although he had already signed with Citibank and could possibly be sued by them for breaking his contract, he did it anyways. He wanted what was best for Wachovia’s shareholders, even if it meant being sued by Citibank. GS and Morgan Stanley staff also acted in the best interest of their companies, as they did their best to try to find more investors.
Remedies?
Regulators need to be more properly trained and banks must have standards in lending. Perhaps if we have outsiders as regulators of the financial industry, we may be able to have more separation on Wall Street between government and private sector. This may lead to better regulation of the industry.
Some of the items that were overlooked in the past, regulator may be able to catch this time around. Regulators need to do more to help investors build their confidence in the system. By successfully doing their audits and examinations of companies, I think investors will be able to regain their confidence in the market place.
The financial industry as a whole need to do their part in helping to regulate the industry. They cannot just look at quick profits and give out lend to anyone without any merit. Had they followed the necessary criteria needed, this mortgage crisis could have possibly been non-existent. Hopefully, regulators and the financial sector have learned from this crisis that rules are there to be followed.