As mentioned in Part 1, Bush's Treasury Secretary Henry Paulson is a free market Republican. He use to be the CEO of Goldman Sachs, one of the largest investment banks on Wall Street. He went along with (Fed chair) Bernanke's bailout of Bear Stearns in March, and only days earlier bailed out the two largest mortgage investment companies in the world. It goes against his personal philosophy and Paulson was getting a lot of push back from not only the public, but Congressional Republicans who don't like government intervention in private markets. So, even though Lehman Bros. was on the brink of collapse, just as he had warned in March, Paulson decided he was not going to step in.
Paulson contacts the CEO of Lehman Bros, Dick Fuld, and tells him that he better find a buyer for the bank. The sense is that Dick Fuld didn't believe that Paulson would let them go bankrupt... the government stepped in for Bear Stearns several months prior and Lehman Bros was even bigger and more interconnected. Besides, Lehman Bros. didn't want a buyer... they weren't interested in being absorbed by another bank, they wanted government help to sustain themselves as their own entity, so in essence, Dick Fuld called Paulson's bluff.
That same weekend, the Treasury Department called in the heads of all the major banks. They were told, once more, that there would be no more bailouts... someone in the room needed to buy Lehman Bros. So, all the major banks (Wells Fargo, Merrill-Lynch, Bank of America, Goldman Sachs, JP Morgan, Citigroup, Washington Mutual, Wachovia) went over Lehman Bros.' books just like in the earlier case with Bear Stearns. Seeing now that he really wasn't going to get a handout from the government like Bear did, now Dick Fuld is looking for a buyer. But, after going over the books, noone wanted a deal without guarantees similar to what Bernanke gave to JP Morgan when it acquired Bear. But, Paulson was firm, there wasn't going to be intervention.
Paulson felt there would be some pain, but that the markets would survive the bankruptcy of one bank. And seeing how Merrill-Lynch was next in line, once it was clear there would be no buyer for Lehman, Paulson focused on getting a bank to help out Merrill-Lynch. The theory, almost like dominoes, if we can stabilize the closest bank after the fall of Lehman, it would prevent a chain reaction.
Like, Lehman Bros, Merrill-Lynch doesn't want to be absorbed, so they offer Bank of America a 10% stake in the company. BoA isn't interested, they want to buy them outright. Seeing no other offers, and not wanting to go the way of Lehman Bros., Merrill finally acquiesces to Bank of America's terms. On Monday, September 15th, come the announcements of both the Merrill-Bank of America merger as well as the bankruptcy of Lehman Bros. Paulson believes the "positive" news of Merrill-Lynch will keep the markets afloat... he would soon find out how wrong he was. News of a major bank failing caused the markets to completely freeze. Markets are driven by credit. Banks lend to each other... banks lend to businesses... banks lend to individual citizens... and when news of a major bank filing for bankruptcy broke, all lending ceased.
Banks aren't getting the capital and reserve they need. Businesses aren't getting the funding they need. The loans for expansion or survival. No new equipment... no new employees... no new buildings... possibly no new contracts (that you can't fill). Possibly not meeting payroll. People aren't getting loans to open new businesses... no car loans... no mortgages... nothing is being granted. Since very few people and things are able to be bought outright, the majority of financial decisions revolve around some "line of credit." When the credit froze... the entire economy froze. Paulson sees that unlike other sectors of Wall Street, the banking system is truly the life blood of the entire economy. All major bankruptcies will hurt, but most can be compensated for... not too many people thought much when Circuit City filed for bankruptcy. But if your banks are failing, and they supply ALL business sectors with the money that give them the opportunity to do business, then you have a nation that is on the verge...
So, Hank Paulson (seen below) goes to Capital Hill in the dead of night and has this secret meeting with high ranking Congressional officials and tells them that he needs $700 Billion dollars to prevent a second Great Depression.
Paulson recieves the money and demands all the CEO's of the major US banks come in for another special meeting. He tells them about the TARP (troubled asset relief program) and tells them that they will all take this funding. Believe it or not, some of the banks didn't need or want the money... because it was going to come with strings, and no company wants government interference in their business affairs... but Paulson didn't want the general public to know which banks did and did not have financial problems. The CEO of Wells Fargo tried to refuse to take the funding. The Treasury Secretary threatened any bank that didn't take the money that he would publicly speak ill of that bank, and... well, Bear Stearns and Lehman Bros. started with mere rumors. Wells Fargo relented.
Months later in December 2008, Merrill-Lynch reports its losses totalling $15 Billion, far more than Bank of America anticipated and maybe even enough to bring them down with Merrill. At this point, the merger had not yet been finalized and Bank of America is dealing with losses of its own. Stockholders and the Board are upset with the CEO that this info had been kept from them. CEO Ken Lewis considers invoking what is known as a MAC... material adverse change. That is to say, a business deal could be nixed if change that was unforseeable at the time the agreement was concieved sharply changes the reality surrounding said business venture. Ken Lewis calls Paulson and tells him what he's thinking. So, Paulson demands that Lewis come back to Washington. If Lehman's collapse caused the freeze in September, what would Merrill-Lynch's bankruptcy do to America? They already had an agreement in place. Paulson told Ken Lewis that if he balked, he would leave Bank of America out of the TARP protection altogether.
Lewis and Paulson would finally secretly agree that Bank of America would get an additional $20 Billion in TARP funding as well as (similar to Bernanke's March deal with JP Morgan)... government protection of $100 Billion against some of Merrill-Lynch's "toxic" assets. Stockholders, tax payers... and even Wall Street... they were not made aware of this until another month after the Merrill-Lynch deal was finalized. When the news broke, it wasn't good for Bank of America... between January 15th and January 20th, 2009... during that six day period, the value of BoA stock dropped 45%.
According to the FDIC (click here), last updated as of Friday, June 19th, 2009, there have been 40 bank failures this year, with less than half of 2009 already elapsed. Compare that with 26 bank failures in all of 2008 and only three bank failures in all of 2007... with none in either 2006 or 2005.
Obama has taken office, and we shall see what the new administration will do to combat this issue. President Obama has moved Timothy Geithner from the Federal Reserve to Paulson's old job as the newest Secretary of Treasury. They are working on regulatory legislation to try to prevent this from happening again. Only time will tell what an impact Obama's administration will have on, not only stemming the current crisis, but preventing future crises from emerging. But one thing is certain... with a lot of "toxic" mortgage-based assets out there... at least in the short term, that list of (small) local banks, which are not too big to fail, will continue to rise...
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