So let's go to Lehman. How do you first hear? How are you brought into the meetings? And what are your expectations walking through the door?
I believe it was the Friday afternoon I received a call, my guess is around 2:00, 3:00, from the Fed, saying, "Robert, we'd like you to come down to the New York Fed, if you can be there by 5:00," or something. And I asked what it's about, and they said, "Well, I'll call you right around the close and let you know." So I said, "I'm on my way down." And they said, "You can take one person." So I took our chief risk officer, and we went down to the Fed. And I spoke to them in between on my way down, and they said, "It's about one of your competitors." I had a little idea but certainly wasn't sure.
And we walked into a room at the New York Fed, and you had about a dozen different CEOs there, and then you had the CEOs of the region for the foreign firms there.
In America [Lehman Brothers Chair and CEO] Dick Fuld is not going to be too concerned ... that there's a chance that the government would ever let him go?
The moral hazard was so deep that I think there was a widespread perception that somehow all the banks will be saved. ...
Bear Stearns in a sense was saved; it was folded in to JPMorgan. But the shareholders, the officers lost a great deal, and they're very angry because if the Fed had extended the lending rights to Bear Stearns that had extended the next day to the other investment banks, they believe they would have survived.
Whether that's the case or not, I don't know. But certainly there was a very strange timing there of extending privileges on one date to some and not to another.
Rumors were going around about what was the reason, going back to one of the earlier Fed-engineered bailouts, Long-Term Capital Management at the end of the '90s. The story was Bear Stearns didn't play game, and they were going to be punished.
So a lot of people on Wall Street didn't really care that much when they went down because they thought they got their comeuppance.
That's right, but that also sent a warning: Maybe if you're not playing the game, the Fed picks and chooses, picks winners and picks losers. ...
There were rumors after Bear Stearns went down that Lehman was going to be next, and that's where you have the next moment of incredulity. The Fed seems to have been taken by surprise when Lehman Brothers went down. It seems to have been taken by surprise at the consequences of Lehman Brothers going down.
To many of us, this was a mystery. The bubble broke in 2007. That's when you should have started getting worried. You should have known what their portfolio was.
When Bear Stearns went down, the common wisdom was Lehman Brothers was going to be next. Shouldn't you have been looking at the full consequences if Lehman Brothers went down? Talking to people on the staff, it seems not to have fully appreciated the risks of what went on.
When it happened, the first line of defense they said was: We thought the market had time to adjust. Again this blind faith in the markets, just like markets manage risk -- they should have learned about that.
Then they said: Well, the markets were seeing what was going on. … Data on the freezing of the financial markets, interbank market in the period before this should have sent a clear signal that markets were not really well prepared.
So then they came to their second defense: We didn't have the legal authority to do anything. That also had seemed very funny, because two days later they bailed out AIG.
Now all of us thought the Federal Reserve was supposed to be dealing with commercial banks, and then they extended their purview to investment banks. But then AIG, an insurance company?
If they had authority to do what they did with AIG, clearly they had the authority to deal with Lehman Brothers. And if they didn't have that authority, wasn't their responsibility back in 2007, when the problems arose, to go to Congress and say, "We don't think we're going to need this, but just as a matter of precaution, please change this line in our authorization." They didn't do that.
In the end, you have to say they really didn't do what they should have done.
So the role of moral hazard, how did that come into play?
I think when that was said, it was a bit of a surreal moment for everyone. Now, all of a sudden, we are all working together. My guess, the last time I recall working together with the group was Long-Term Capital [Management], which I knew the group well, one, because I was from Salomon Brothers, but also UBS was one of the big equity holders in Long-Term Capital. But since then there's been very few opportunities where the group -- on a positive note -- very few opportunities where the group has come together to say, "OK, we have to work in a crisis mode together and do what's best for the industry and the country."
And we started. We would get some information on Lehman, the balance sheet, their risks. And then there were a few possible bids at that point, which made us realize that we have a lot of work to do, because I think one bid was like, "I'll pay --" and these were soft bids, but -- "I'll pay a billion or $3 billion, but I won't take $70 billion of their assets." So then, all of a sudden, "OK, well, if we have that bid, how do we fund the $70 billion gap?" And the $70 billion was Lehman had $40 billion of commercial real estate; they had I think $20 billion of nonconforming mortgages and about $10 billion of private equity. I'm roughing it, but that's kind of where you got the $70 billion.
And then there was another bid that came in maybe a day later that, "I'll pay $3 billion and won't take $50 billion of assets." So at the end of the day, [what] we needed to figure out from a group is if there's a bid and there's a gap, how do we engage in filling that gap? Is there something we could or couldn't do? And we were working together on ideas with the regulators in the room, with the regulators outside the room.
And who do you have from the Fed?
And then you have in there Tim [Geithner] from the [New York] Fed, you have Henry Paulson as the Treasury secretary and Chris Cox from the SEC, as well as some other people of their staff there as well. And it was very clear. It's that: "This discussion is about Lehman Brothers, and on Sunday night they'll either be a viable institution or not. And we need to figure out how to work together to make this work."
And I'm not sure exactly how Hank said it, but it was also that there's not going to be able to have government intervention like the Bear situation, so it will be different.
Not so many months after Bear Stearns had been bought at a bargain price, why was Lehman Brothers allowed to fail?
I don't understand that. ... I think they thought they were going to do a sale to Barclays, and there really wasn't a plan B. … I think they felt there were legal constraints, and why they didn't have those with Bear Stearns but did have them with Lehman, I don't know. …
That's remarkable to me. As chairwoman of the FDIC at the time, you still don't know why they allowed that to happen?
Again, we were consulted when there was a major insured bank involved. We really were out of the loop when you dealt with all these big non-banks. …
Describe for me the moment in September 2008 when ... you get the news about the government is not going to bail [Lehman] out.
... I had the president with me. That was a devastating moment because what really happened was not that the U.S. government was unprepared to play a role, but that the British government was not going to permit Barclays to acquire Lehman. And that was the last chance.
Bank of America, which had been the other bidder, was clearly going another way at that point in acquiring Merrill Lynch. So with Barclays out of the running, there was no hope. That was probably the most devastating moment during the financial crisis.
Did you carry the news to Fuld?
The president and I went back to a conference room and immediately got on the phone. We weren't going to do it in front of everybody else.
We first tried, probably foolishly on my part, to talk to the British government. Since the secretary had not been successful, I should have probably figured out that I wouldn't be either. And I did make a phone call, and I was told the ship had sailed. ...
What we had been told was that the British government's response had been: We, the British government, are not going to permit the cancer in the United States financial system spreading to the United Kingdom.
I said that if Lehman fails, the cancer is going throughout the world. And I was told it was just too late. ... Then we got on the phone to Dick Fuld. ...
... There's lots of talk out there that Paulson was trying to convince [Lehman Brothers Chairman and CEO Dick] Fuld to sell, but he didn't seem to be motivated enough. What was going on? ...
There almost seems to be a Rashomon-like quality to what was going on from the day Bear collapsed until September at Lehman.
From my perspective -- and this is when we first started to do substantial work with Lehman -- Dick Fuld and senior management were very concerned about being ... next on the chopping block. So there were numerous attempts to try and sell the company. Not just with the Koreans, which is the one that receives all the publicity, but there were feelers put out to any number of institutions, most of which were rejected automatically.
There was also the initiative to see if Lehman could become a bank holding company subject to Federal Reserve supervision, which ultimately is what happens for Goldman [Sachs] and Morgan Stanley. That didn't succeed.
So it was not as if Lehman was unaware, from my perspective. It was not as if they didn't try and take action to sell the company.
Then why did it happen? There were quite a few months in between the March events with Bear and the September events with Lehman Brothers.
... The source of the problem was in that environment, no major financial institution had a serious interest in acquiring Lehman. Again, there were conversations, and it usually was from the other side: We've thought about it. We're just not interested in pursuing it. It never got to a question of price, at least in the phone calls I had. ...
Describe Dick Fuld. ...
... He certainly had some of what I would call Wall Street characteristics, but I think the better ones.
He worked very hard. He was there first thing in the morning; he was there late at night. He was totally committed to trying to salvage Lehman. There's always a reference to Type A personalities in Wall Street. Dick Fuld was a Type A personality.
But some of the other portrayals I never saw. Some of these discussions could get heated all around. I never saw him really lose his temper. I never saw any of the screaming that you read about or hear about. He listened to advice. ...
When you heard [Lehman Brothers] going down Sunday night, did you figure big trouble in the future, in the immediate future?
I knew about it before that Sunday night.
And you knew how bad it was going to be?
I can't say again, as a member of a body of 18 people that I personally knew how bad it would be, but I did know, because you could see it in the numbers, and also you could hear it in our discussions. And we talked about these things, that there were others who were significantly exposed. And if you had been watching the marketplace, you could see the spreads and the cost of insuring against failure for these various institutions. And so Lehman wasn't alone. The complexity of Lehman was only found out after you pulled back all of those layers.
I do want to give the New York Fed enormous credit. In a very short period of just several days of peeling back all of the layers of that onion, the SEC [Securities and Exchange Commission] should have, because they were the supervisor, have understood all of the underlying risk. But the New York Fed staff, assisted by others from around the system, did an incredible job of actually wrapping their arms around the risk of what was actually Lehman Brothers.
So why'd we let it go? How did it go?
Well, that's something for the history books to document, but it is what happened.
The decision to let Lehman fail -- what was your view, and what were the complications?
... Lehman's failure had unknown consequences, and you see this occur within 24 hours. I think if anyone had said ... that if Lehman failed, the largest money market mutual fund would fail within 24 hours, and that in turn would likely take down the entire money market mutual fund industry, there may have been second thoughts.
But I do want to come back to the question of was there a decision to let Lehman fail. I think the decision was that Lehman could be rescued without the government having to put in much, if anything, in terms of support. And the judgment that Lehman could be rescued was flawed -- not totally flawed, because in fact Paulson pushed the other banks to provide substantial support for Lehman, and they had committed to something in the neighborhood of $45 billion among them to support Lehman and to provide a foundation for Barclays to acquire Lehman.
But then the whole issue came up as to whether the British government would permit Barclays to proceed. … The specter of the Asian markets opening at 8:00 on Sunday night was the deadline. When it became clear about noon on Sunday that Barclays was not going to participate, there was no option left.
Why did it come down to this one weekend? Why hadn't they planned for this? ...
The failure to work out something in advance probably has several contributing factors. One, ... if you start talking about a rescue, you precipitate the need for a rescue. So I think there was a reluctance to be too aggressive in bringing the banks together, saying we need to save Lehman.
There's also a view that decisive action can only be prompted by a crisis, so you almost let a crisis go. I think maybe people had been given a false sense of optimism by the ability to save Bear. But there was no JPMorgan at this point.
One clear failure was of communication between the U.S. government and the British government, and perhaps the blame is equal on both sides. It's probably also to the private sector, because the private sector should have been encouraging the two governments to talk. I think there was probably a presumption in the private sector that the two governments were talking, which was clearly not the case until the very end.
So mistakes get made, and when you have to make decisions and take action within an extraordinarily confined period of time, the potential for those mistakes is multiplied.
When do you call Obama? When do you sort of say, "Maybe I should talk to--"?
So I was speaking to the senator all along during that three-day period, but not that dissimilar to -- I was speaking to him prior to that period as well, although there were probably a few more calls that day than other days. He was privy to the meeting, based on, you know, everyone heard about the meeting. So, one, he was privy to the meeting; two, I believe he may have engaged Paulson or people at the Fed at that time. I think it may have been Paulson.
But I was letting him know that, "Listen, this is what could happen." We weren't talking as much about Lehman being saved, because if Lehman was saved and everything was fine, then it would be good. His questions were much more directed: "OK, what if Monday opens up and the announcement is a Lehman filing?" So when we started talking Friday night, he was asking the tough questions, not the rosy scenario. He was trying to figure out, "Well, what if it went the other way?" And the truth is, there was a lot of guessing going on. No one knew exactly what would happen that Monday morning.
For me, which [is] why, you know, we chatted earlier, why I think there's need for new regulations and a systemic regulator is as much as we talked about Lehman, for the most part neither the Fed nor the Treasury was the Lehman regulatory; it was the SEC at the time. I'm not so sure that they had the tools to be the regulator for a global financial institution like Lehman, who has a trillion-dollar balance sheet 35 times levered.
But you had Long-Term Capital happen. You had the Bear weekend go down where both times they were able to within Wall Street and with help from the Fed to save the day. Why was there no plan?
Well, I think a couple things, which is why we go to the Dodd-Frank, and really the key parts that they're trying to work out. One, just to go back, I think you may have had a different outcome if Sunday night was Merrill Lynch saved, a Lehman filing, but something about AIG as well. There was that big elephant in the room for those 72 hours that no one discussed, which was AIG. All of Wall Street knew AIG had problems. My guess is the regulators knew AIG had problems, but they didn't have a regulator that had control of AIG that was at that table, and they didn't have control, the Fed nor the Treasury, of AIG.
So I do think that in some ways, when you look at the Dodd-Frank bill and you look at the five silos of the Dodd-Frank bill, a systemic regulator, I think, is crucial for the future success of our industry, because you need to know more than what the bank holding companies are doing; you need to know what some of the large insurance companies are doing, and other financial services.
The second thing is a resolution authority is key. So how do you wind down a global interconnected financial institution that's in a myriad of countries that have all different jurisdictions? So a resolution authority is key.
But at that time there were no tools. As things started to fall apart, Bank of America was going with Merrill, Barclays wasn't a possibility, what was the feeling in the room? What was the conversation that you were having with Obama about "You know what? We're in some trouble here"?
I think when we chatted on Sunday, I think it was a call where it was kind of a wow call: "Listen, Senator, Barclays pulled out. The U.K. government said no for the most part. There was an uncomfortable feeling of taking something on as big as Lehman without knowing really what's under the hood and how would they fund it and how would this would impact Barclays and this general system." And I said to the president, then-senator, we were talking, and he goes: "Well, what does this mean? What happens at the open?"
And I think none of us felt good about the open. No one knew whether it would be contained or not contained. There was a feeling that at that point, we were kind of trying to make sure we got our own funding that we needed, and that we could open and get our repos done and get the things we needed to do. And I would say at midday it's kind of, it was almost like, "OK, let's make sure we're protecting our own castle and getting our operations ready for that Sunday night of something we've never gone through before."
But the senator was asking about, "OK, well, what do you think this means?" And we were talking about AIG. Sunday night, [he] and I talked about AIG, and what does this mean for AIG, considering everyone knew they were the big elephant in the room. He was asking what type of contagion this would have, and I was clear that, from my perspective, although we had never seen anything, "I think immediately we will see the markets and funding start to dry up, you'll see a lack of liquidity, and we're going to be in a situation of the unknown." And the one thing about Wall Street is we can do very well in the known. Good or bad, we do well with clarity. In the unknown, things tend to freeze.
And that's kind of what happened. The markets started to freeze. People were nervous about other firms. Our funding at our firm and other firms started to -- everyone started to get nervous. The overnight commercial paper market became very tenuous. So we had a situation that got a little nervous, no question.
And then soon thereafter, the president -- then-senator, excuse me -- we had a call that week about AIG. I remember that he put a call together for us to talk about AIG, because during that week, I think it was at that point [New York] Gov. [David] Paterson had an announcement that they're going to give a loan of $20 billion to AIG, but most of the market knew that that loan wasn't anywhere near the size needed. And all of a sudden you started having nervousness about a run on AIG, and what did that mean.
And the president put a call together. It was myself and Volcker and I believe Robert Rubin and Larry Summers, [both former Treasury secretaries under Clinton], where we were talking about, "OK, what would happen if the contagion starts in on AIG?" And then we started to have calls the next week on -- it may not have been the next week -- but on Fannie and Freddie and how does this hit the agencies that do a lot of housing. So what I would tell you is this president was engaged before Lehman, but once Lehman hit, I think he was all over it, thinking in a proactive and prospective way of how this was going to impact the economy and the election.
When all of it starts to cascade, what were you thinking when you were watching it go? Did you have a sense of how vulnerable everything was over Labor Day weekend in 2008? Were you personally concerned?
Extremely, yes. It was a very, very scary time. I think up until that Labor Day weekend, we were in just another financial crisis. Those aren't pleasant occurrences, but they repeat, and they have patterns that one can recognize, and over the course of a 20-year career, you learn to recognize them. Up until that point, I think we were in one of those situations.
At that point, we were in totally new territory. The notion that a Lehman Brothers could be filing for bankruptcy and AIG could be at risk of the same fate -- and it was very uncertain what would happen to the rest of the broker/dealer community that week -- was absolutely unprecedented. And thinking through the implications of that for the health of not just the U.S. economy but the world, it wasn't really conceivable to do that. I couldn't get my mind around it. I know others couldn't.
The extraordinary actions that were subsequently taken by governments to intervene were absolutely necessary, because the consequences of an interconnected failure by all of those institutions simultaneously would have been unimaginably terrible in terms of impact not on the shareholders of those corporations who suffered terribly anyway, but on the man on the street.
We know that credit conditions are tight today; they would be nonexistent had those events unfolded. Absolutely nonexistent. The Great Depression would have looked like a small event by comparison to what I think would have happened had that process continued unrestricted.
And one of the great tragedies of understanding, or misunderstanding, it through all of this is the notion that somehow banks and/or Wall Street were bailed out at the expense of the taxpayer. What has been lost in translation is that it is for the sake of the man on the street that the financial system needed to be stabilized, and it was unambiguously in the interests of the taxpayer that that system be stabilized.
And let us not forget that the shareholders and many, many employees of these financial institutions that did make major mistakes have paid dearly in terms of their own personal net worth and the value of their companies. The bailing out aspect was keeping them afloat through the presence of government backstops and capital so that credit markets could go through a process of un-seizing themselves without abject panic. And that was what we were looking at then.
This wasn't about credit derivatives, this was a much more complex situation. It had at its core credit conditions that were easy and had been that way for many years; it had the low savings rate in the United States, the high savings rates in the emerging economies, particularly China and India, the growth in the emerging markets.
All of these things had conspired to create an environment that essentially became a bubble. The consuming habits of United States citizens driven, in part, by the housing bubble led to a lot of this buoyancy and lack of fear of risk in financial markets. And there was a significant deployment of leverage, leverage in the form of balance sheets that were running with very little capital against large volumes of assets which all looked fine, except when the music stopped in a correlated fashion, they deteriorated.
That, at its essence, was the root cause of this financial crisis. The derivatives, in a sense, are a manifestation of people's risk appetite. How they used derivatives reflected their lack of fear of the consequences of market behavior, lending in particular in mortgage markets. …
"The FRONTLINE Interviews" tell the story of history in the making. Produced in collaboration with Duke University’s Rutherfurd Living History Program. Learn more...