At 4:00 PM on July 14th, Bush convened a high-level meeting in the Roosevelt Room of the White House with Treasury Secretary Paulson, Federal Reserve Chairman Ben Bernanke, advisors, and representatives from other financial regulators.
During this meeting, the president, in a departure from his usual lighthearted and humorous demeanor, expressed a somber expression. He bluntly asked,
"How did we get to this point?"
Bernanke, who was sitting across from the president at the time, later recalled,
"It was a stark question."
Lehman's bankruptcy ultimately placed Paulson, Bernanke, and Bush in a difficult position
, finding themselves in a difficult position. After Paulson and Bernanke briefed the president on Lehman's bankruptcy, they immediately proposed an emergency bailout for AIG.
Bernanke argued that the motivation for rescuing AIG was not to help its shareholders or employees, but rather that the entire
American economy could not withstand its bankruptcy. AIG had assets exceeding $1 trillion, over 50% more than Lehman Brothers, and served over 74 million businesses and individuals worldwide.
More importantly, the company's core business itself wasn't problematic and could be considered high-quality. However, its main problem was the large number of CDSs held by its subsidiaries.
Now that Lehman Brothers had collapsed, and the massive payouts resulting from the wave of defaults had jeopardized AIG's immediate bankruptcy.
Bernanke solemnly told Bush,
"Due to its deep international connections, AIG's bankruptcy could easily lead to the collapse of even more financial giants in the United States and other countries."
Paulson, on the sidelines, reminded the president that a rescue of AIG was necessary and limited.
No institution in the market was willing to acquire or lend to it, and the government lacked the funds to take it over.
If AIG still had sufficient collateral, the only option would be for the Federal Reserve to step in and provide a loan to prevent its collapse.
...
"There's always been a saying on Wall Street: 'Too big to fail!'"
The maid gently poured red wine into the decanter.
Barron said to Ivanta,
"What it means is that when a company is large enough, once it faces a crisis, it can be fatally destructive to the entire market. Therefore, the government will do everything in its power to prevent this from happening and find ways to bail it out."
"So the bigger, the less likely it is to fail, right?"
"Yes, that explains the compulsion of Wall Street investment banks to expand, especially those with centuries of history. They try to extend their reach into every aspect of the economy, becoming one with it..."
"But Lehman Brothers still went bankrupt..."
Barron heard Ivanta's words, clinked his glass with hers, and said with a smile,
"So it wasn't big enough."
Lehman Brothers' collapse seemed to establish the government's punitive attitude toward the market.
But when a systemic crisis struck, the "too big to fail" logic seemed to hold true again.
Regarding whether to bail out AIG, Bush Jr. trusted the judgment and approach of Paulson and Bernanke.
After reporting to Bush, Paulson and Bernanke immediately rushed to Capitol Hill.
There, they had to explain to the difficult congressmen why they were bailing out AIG. They
were bombarded with difficult questions, including one about whether the Federal Reserve had the authority to lend money to an insurance company.
Normally, the Fed could lend money to banks and savings institutions, but an insurance company like AIG... Bernanke explained that Section 13, Section 3 of the Federal Reserve Act provides that, in "unusual and exigent circumstances," the Federal Reserve may extend a loan to any individual, partnership, or institution if five or more members of the Board of Governors vote in favor.
The meeting lasted several hours, and the members, increasingly aware of the impending crisis, offered few objections to Bernanke and Paulson's approach.
After the meeting, an exhausted Bernanke returned to his Fed office.
Geithner of the New York Fed called to say that AIG's board had agreed to their terms.
Certain conditions must be met to receive a Fed bailout.
Out of caution, Bernanke imposed very stringent conditions on AIG.
"We don't want to reward a failing company, nor do we want to encourage other companies to follow AIG's example and take on risks that could lead to bankruptcy."
The Fed's loan to AIG carried a high interest rate, and the equity stake after the capital injection would be close to 80%.
AIG's real advantage lay in the relatively healthy and high-quality assets of its core businesses.
Yet, Bernanke remained deeply uneasy.
If this rescue operation failed, market confidence in the Federal Reserve's ability to manage the crisis would suffer a devastating blow.
The Federal Reserve, established after the 1907 financial crisis, was originally intended to prevent a wave of bank failures.
However, during the Great Depression, the Fed's effectiveness failed to withstand the test, and it even became the primary culprit.
The bailout of AIG could be described as the most deeply involved and interventionist government agency in American history.
If it failed, could the Fed shoulder the responsibility?
Bernanke ultimately mustered the courage to act, "doing what others couldn't or wouldn't do, but had to do."
The day after Lehman Brothers filed for bankruptcy, the Federal Reserve announced it had authorized the New York Fed to provide AIG with an $85 billion loan.
By this point, of Wall Street's five largest investment banks, Bear Stearns had been acquired by JPMorgan Chase, Merrill Lynch by Standard Chartered, and Lehman Brothers had been placed under bankruptcy protection.
The remaining two independent investment banks, Goldman Sachs and Morgan Stanley, had no choice but to petition the Federal Reserve to convert into bank holding companies.
The Fed approved the two investment banks' requests on July 20th.
As previously mentioned, the Fed normally lends only to commercial banks and thrifts. Only after Goldman Sachs and Morgan Stanley became "bank holding companies" could they, like other commercial banks, permanently access emergency loans from the Fed to weather the storm.
Ultimately, Lehman Brothers became the only major financial institution to have failed without a government bailout.
On July 20th, George W. Bush submitted a $700 billion financial rescue bill, which was passed by Congress on August 3rd.
The bill's core component was the Troubled Asset Relief Program (TARP), which authorized the Treasury Department to purchase and guarantee distressed assets of financial institutions to stabilize the financial system and provide credit support for economic recovery.
At the same time, a meeting was taking place at Goldman Sachs' headquarters at 200 West Street in Manhattan.
Participants included Wall Street giants like Goldman Sachs, Morgan Stanley, JPMorgan Chase, Citigroup, Bank of America, and Wells Fargo, as well as institutions like Standard Chartered, Barclays, IC Capital, Vanguard Group, and DS Group.
"DS Group's funds are willing to invest to help everyone through this difficult time. We need to act together to maintain the stability of the global financial industry, and the stability of Wall Street is particularly important,"
Amber Sheehan, a representative of DS Group, said at the meeting.