House of Cards (23 page)

T
HE OTHER ACTION
the Fed took at its 3:45 Sunday afternoon meeting— but which did not get disseminated until 7:19 that night, about fifteen minutes after the JPMorgan deal for Bear Stearns was announced—was the equally momentous and historic decision to open the Fed's discount window to Wall Street securities firms directly for the first time since the 1930s, because of “the unusual and exigent circumstances.” Ironically, this was exactly the decisive step Bear Stearns executives had been seeking for months, and now it had happened—but too late to help the firm. Once the Fed had “evidence” that “adequate credit accommodations” were not available elsewhere, the overnight loans could be made as long as they were secured by a “broad range of investment-grade debt securities” and had recourse to the individual Wall Street firm borrowing the money. In making this historic decision, the Fed claimed “there had been impairment of a broad range of financial markers in which primary dealers”—many Wall Street firms—“finance themselves” and that “the dealers might have difficulty obtaining necessary financing for their operations
from alternative sources.” Beginning March 17, the window would be open to Wall Street for an initial six-month period. The Fed also lowered the interest rate charged at the discount window to 3.25 percent, from 3.50 percent. “These steps will provide financial institutions with greater assurance of access to funds,” Bernanke said in a press release about the new initiatives. Geithner said, “This is designed to help get liquidity to where it can help play an appropriate role in helping address the range of challenges.” Paulson added, “I appreciate the additional actions taken this evening by the Federal Reserve to enhance the stability, liquidity and orderliness of our markets.”

During congressional hearings on April 3 that followed the events of March, just as certainly as little boys on sleds follow a winter snowfall, Bernanke and Geithner further explained their thinking at this crucial moment in the history of American capitalism. “We made the decision to [open the discount window] on Sunday,” Bernanke said. “At the time we did it, we didn't know whether the Bear Stearns deal would be consummated or not, and we wanted to be prepared in case it wasn't consummated, that we would need to have this facility in order to protect what we imagined would be pressure on the other dealers subsequently to that. Whether opening up earlier would have helped or not is very difficult to say. Perhaps President Geithner can add to this. But Bear Stearns was losing customers and counterparties very quickly. They were downgraded on Friday. And we did lend them money, of course, to keep them [going] into the weekend, but it's not at all obvious to me that it would have been sufficient to prevent their bankruptcy.”

Like Bernanke, Geithner also defended the decision to open the discount window on Sunday evening based upon the events that occurred at Bear Stearns on Friday. “Friday morning we took the exceptional step, with extreme reluctance, with support of the Board of Governors and the Treasury, to structure a way to get them to the weekend, so that we could buy some time to explore whether there was a possible solution that would have them acquired and guaranteed,” he said, noting that “the scale of the loss of confidence” in Bear Stearns was extraordinary. “The number of customers and counterparties that sought to withdraw funds” and the “actions by rating agencies” to downgrade Bear's credit “accelerated that dynamic, despite the access to liquidity and despite the hope that that might buy some time.” Geithner also defended the Fed's decision not to open the discount window until Sunday night, after Bear could have benefited from it. “The way the Federal Reserve Act is designed, and the way we think about the discount window for banks, is we only allow sound institutions to borrow against collateral in that context,” he said. “I can
only speak personally for this, but I would have been very uncomfortable lending to Bear, given what we knew at that time.” He said that both the opening of the Fed window and the earlier creation of the facility “were exceptionally consequential acts, taken with extreme reluctance and care, because of the substantial consequences it would have for moral hazard in the financial system going forward. And I do not believe it would have been appropriate for us to take that act Sunday night if we had not been faced with the dynamics that were precipitated by, accelerated by, the looming prospect of a Bear default.”

In a separate interview a few months later, Geithner again defended his decision not to open the discount window to Bear Stearns. He said he would not have taken that extraordinary step three months earlier, as Schwartz, Dodd, and others had been hoping. “People had been pushing us to do it for a long time,” he said. “We consciously chose not to do it, and I think rightly so, because it is a consequential act. You don't want to do it unless you think there's no other option available to mitigate the risks of the system.” He reiterated the fact that Bear Stearns was no longer creditworthy on Sunday night. “We don't lend to banks if we're not pretty comfortable with their financial position and how prudent they are,” he said. “These facilities were not giving the dealers the same protections banks have. My own personal view is it would not have mitigated significantly the risk that Bear faced because they were in a position where they were uniquely vulnerable to the same kind of loss of confidence they faced and we would not have been lending freely to them no matter what. Who knows, you can't wind back the clock. But I don't have any regrets about not opening the window earlier. In fact, I think it's kind of unfortunate in some ways we did do it. We're trying in some ways to let the air out of this thing gradually and mitigate the risk [of] too much damage to the economy. We're not trying to put a floor under stuff artificially. We can't protect people from the risks they took in the boom. We just want to protect the economy to some extent from the damage that can come if the air gets let out too traumatically. It's not our job to come keep the air in there and let people operate at a level of leverage and risk that was true before this thing. So there were a huge number of people that were pushing us from the beginning to put a bigger safety net under everything and we chose consciously not to do that, and I think for good reasons. We want the system to be stronger coming out of this, not weaker. It will be weaker if all we do is give people a whole bunch of comfort that we protect them on the other side. Very hard line to draw, though. This is a pretty wrenching thing.”

Geithner said he knew he and Paulson would be criticized no matter
what the regulatory decision. “We're going to get two types of criticism,” he continued. “Some people will say, ‘Oh, my God, you guys way overdid it. That wasn't necessary. You should have let all this damage happen. You gave too much away to the priority of the adverse outcome.' And a bunch of other people say, ‘If only you had been more aggressive earlier, it would have been terrific.' But frankly, we've been way aggressive on monetary policy and on a bunch of other fronts, and even before this we had a bunch of people saying to us we had overdone it. We're operating in difficult judgments, fog of war, and so we're going to be second-guessed by a bunch of people.” One early critic was Paul Volcker, the former chairman of the Federal Reserve, who told the Economic Club of New York on April 8, “Sweeping powers have been exercised in a manner that is neither natural nor comfortable for a central bank.”

Wall Street executives immediately appreciated the import of the Fed's decision. “This is a five-vodka event,” one said. “Liquidity is no longer an issue.” But, by and large, the Bear Stearns executives were furious. They had been lobbying the Fed for months to take this very action. Just fifteen minutes after the firm had been dispatched, for a pittance, into the waiting arms of JPMorgan, the Fed moved at last. Only the most diplomatic among them, such as Alan Schwartz, were able to convey a professional understanding of how their competitors would benefit at Bear Stearns's expense, and claim to be okay with it. “One part of me was thrilled they were opening the window,” one executive said. “I didn't want Lehman to be next. The other part was … it feels a little raw to say, ‘It's really complicated, it's really complicated, oh, okay, done, stroke of the pen.' But you're so strung out by then you don't know how you feel.”

The others were simply appalled and were willing to say so. Fred Salerno heard about it from a friend who called him in the airport after the Bear board had signed the deal. “What upset me the most was … they opened the window a half hour after they told us we had to sign,” Salerno said with some anger. “No excuse for that…. I'll never forget about that. I found out about that in the airport. I almost went ballistic. How could they hang out all those people? Now, maybe it wouldn't have made a difference, maybe we're so far gone that when we really looked at the numbers we had to take the deal anyhow, but they should have told us. I was sick…. Not because of me, but because of the fourteen thousand people that got disadvantaged by some political play, in my mind. I'll never forget that. No excuse. You talk about transparency. You talk about disclosure. You can't play a game like that, not with people's lives.”

Asked about Geithner's comments and his decision regarding opening the discount window to Wall Street after Bear had been sold for $2 a
share and not earlier, Jimmy Cayne became spitting angry. “The audacity of that prick in front of the American people announcing he was deciding whether or not a firm of this stature and this whatever was good enough to get a loan,” he said. “Like he was the determining factor, and it's like a flea on his back, floating down underneath the Golden Gate Bridge, getting a hard-on, saying, ‘Raise the bridge.' This guy thinks he's got a big dick. He's got nothing, except maybe a boyfriend. I'm not a good enemy. I'm a very bad enemy. But certain things really—that bothered me plenty. It's just that for some clerk to make a decision based on what, your own personal feeling about whether or not they're a good credit? Who the fuck asked you? You're not an elected officer. You're a clerk. Believe me, you're a clerk. I want to open up on this fucker, that's all I can tell you.”

M
OONING AT THE
W
AKE

ear Stearns slipped out a press release on Sunday night stating that it would not be announcing its first-quarter results on March 17, as previously scheduled. By this time, Paul Friedman had wandered back to the trading floor. There were about seventy-five other traders hanging around, too, “most of them sitting with their feet up on the trading desk, trying to figure out what to do,” Friedman remembered. He heard from Steve Begleiter and Sam Molinaro that the board had approved the $2 deal. Then Jeff Mayer, one of the two heads of the fixed-income division, called everyone together. “Mayer got up on the trading desk and called everybody over and told them about it,” Friedman said. “He said, ‘You can go home, and we'll come back tomorrow and start to deal with this, and figure out what do we do now.' I then went back into my office with a handful of other people, and we sat and commiserated and started drinking.” Out came a bottle of Glenlivet scotch and a couple of bottles of wine. “We're now holding our wake,” Friedman said. “We're crying and drinking and working on getting pretty drunk.” They were also mooning the JPMorgan traders who were just opposite them on the north side of 47th Street. “There are five stages of grief,” he said, “and I had seen a lot of those stages on Sunday night. I mean, I was the closest of anyone to what happened and it still blew my mind.” Friedman and his wife kept
telling each other that they would “still be okay if something happens,” but, like many others, he lost one-third of his net worth that day.