Still, Mack did speak to Vikram Pandit, of Citigroup, about a possible merger, but they jointly concluded that it made no sense. Geithner suggested that Goldman’s Blankfein call Pandit. Blankfein made the call, thinking that he was supposed to rescue Citi. He was dumbfounded when he discovered that Pandit wasn’t expecting to hear from him. For his part, Pandit was taken aback that Goldman thought it might be able to buy Citi, since at the time Pandit felt that Citi was much stronger.

That afternoon, Mack, speaking to Blankfein, bemoaned the effect of short sellers, whose actions were unnerving investors. The previous weekend, at the Fed, Mack had complained about the impact of short sellers on Lehman, and asked Blankfein if he would support an effort to get the S.E.C. to ban short selling. Blankfein had demurred. But now he said, “We’ve rethought the need for a temporary ban.” They agreed to press the issue with Paulson and Geithner.

At six that evening, Bernanke met with his top aides—Donald Kohn; Kevin Warsh; Scott G. Alvarez, the general counsel; and Michelle Smith, the spokesperson—with Paulson and Geithner participating by speakerphone. “We cannot do this alone anymore,” he said. “We have to go to Congress and get some authority.”

Paulson hadn’t yet taken any concrete steps to enlist legislators to authorize a government rescue. Paulson reiterated his concern about getting congressional leaders to go along. “I spoke to Harry and Nancy”—Harry Reid and Nancy Pelosi, the House Speaker—“and the political advisers,” he said. “If the Treasury and the Fed say it’s an emergency and we need help, and help doesn’t come, it would further destabilize the markets. You don’t go public until you’re reasonably certain you’ll get what you’re asking for.”

Bernanke was growing agitated. “Hank! Listen to me,” he interrupted. “We are done!”

It was the first time Fed officials had heard him raise his voice.

“The Fed is already doing all that it can with the powers we have,” Bernanke continued. One participant recalled, “Ben gave an impassioned, linear, rigorous argument explaining the limits of our authority and the history of financial crises in the U.S. and abroad.” That history showed that efforts to resolve such crises “are successful only when overwhelming force from all parts of government is brought to bear,” the participant said. “It was an encyclopedic tour de force.”

It was as though Bernanke were the professor and Paulson the student. Bernanke’s comments lasted about fifteen minutes, and Paulson was uncharacteristically silent until near the end.

“Got to go,” he said, and hung up.

THURSDAY, SEPTEMBER 18

You can sort it out later!

The Fed group reconvened at six-thirty that morning. They had decided the night before that repetition would be helpful, so Bernanke started on the same lecture. Thirty seconds into it, Paulson interrupted. “Ben, Ben, Ben . . . ” Bernanke stopped talking. “I’ve done some thinking,” Paulson said. “You and I should go see the President and then go to Congress tonight and ask for more authority.”

At 10:15 A.M., President Bush delivered a two-minute televised statement outside the Oval Office, his first public pronouncement since the crisis began, which concluded:

Our financial markets continue to deal with serious challenges. As our recent actions demonstrate, my Administration is focussed on meeting these challenges. The American people can be sure we will continue to act to strengthen and stabilize our financial markets and improve investor confidence.

When staffers again huddled in Paulson’s office, Paulson wanted to know what ideas they had come up with. Asian and European markets were continuing to plunge, with banks and insurers bearing the brunt of the losses. Britain announced a month-long ban on short selling in an effort to prevent the kind of “bear raids” that some blamed for the fall in Lehman’s stock. Russia had suspended trading for the previous two days. Morgan Stanley shares had plunged twenty-four per cent the previous day.

Paulson had just heard that Bank of America was temporarily pulling back on credit lines to some McDonald’s franchisees, slowing a McDonald’s expansion into upscale coffee drinks to compete with Starbucks. (Bank of America disputes this account, but McDonald’s did issue a memo urging franchisees to find other sources of credit, according to Bloomberg.)

Dan Jester, a Goldman vice-president whom Paulson had brought to the Treasury Department that summer, reported that one approach would be for the government to inject capital directly into financial institutions. The standard way to raise capital is to sell stock. There were now no private buyers. But, as one participant put it, was the government going “to A.I.G. them”? If the government bought common stock, it would have the power to vote, appoint management and the board of directors, and, if the stake was big enough, control the company. Might this end up being “nationalization”? The politics looked awful. Even so, Jester and most of his team argued that the approach was simple, efficient, and effective, and would protect taxpayers.

Bernanke had long been saying that the government needed many tools to respond to the unforeseeable, including the ability to buy “bad companies” as well as “bad assets.” But Paulson told Bernanke he feared that direct investments would destabilize markets and drive out private investors.

Another option was to remove the bad assets from balance sheets. The Resolution Trust Corporation, created by Congress in 1989, had used taxpayer money to buy and then auction off distressed real estate from failing savings-and-loans. Though some people criticized the agency for dumping assets on the market too quickly and selling at fire-sale prices, the approach established a floor for real-estate prices. This approach not only had worked in the past but would avoid the charged issue of government ownership.

Several people, however, noted that there were major differences between tangible real estate and the esoteric mortgage-backed securities and other structured assets now on balance sheets. Houses and land could be auctioned and find buyers, as they have been for centuries. But, without any functioning market for mortgage-backed debt, how would you value it and what would the government pay? If the amount was too small, bank balance sheets would be devastated by the sales and subsequent write-downs, making the crisis worse. If too big, it was simply a transfer of wealth from taxpayers to banks and other financial institutions. Neel Kashkari, an assistant Treasury secretary and an ex-Goldman investment banker, who was the biggest proponent of removing bad assets from balance sheets, argued that the mechanics could always be worked out once Congress had given the Treasury and the Fed the authority to act.

Steven Shafran and others who had focussed on liquidity issues proposed allowing money-market funds to borrow from the Fed, using their commercial paper and other assets as collateral. But Paulson thought that this was too technical for the average money-market-fund investor and wouldn’t be enough to stop a run. “What would you do if you want to address all the issues?”

“We could always just guarantee the money-market funds,” Shafran said.

Paulson looked up. “Could we?”

“I think so,” Shafran said.

Paulson slammed his hand down on his desk. “Then that’s what we’re going to do.”

A few participants were aghast. The risks seemed enormous: it was a four-trillion-dollar guarantee! Even the F.D.I.C. insured bank accounts only up to a hundred thousand dollars. Moreover, money-market funds weren’t bank deposits but investment products with higher risks and therefore higher returns. By eliminating that risk, another cornerstone of moral hazard was being removed.

But others argued that the risk of not doing anything, or of doing too little, was far worse. Paulson embraced the boldness and simplicity of the notion. As someone said, it “passed the USA Today test.”

Paulson and Bernanke returned to the Roosevelt Room, joined this time by Chris Cox, of the S.E.C. Vice-President Dick Cheney was also there, along with Bush.

Paulson outlined the decision of the Treasury, backed by the Fed, to seek legislation authorizing the purchase of billions of dollars in troubled mortgage-backed assets. “It would be wise to go to Congress,” Bernanke said, arguing that capital should be approved by Congress and dispensed by the appropriate authority, the Treasury, rather than by the Fed, an institution already doing all it could with the powers it had.

“You’re the experts, and I’ll support you,” Bush said.

Paulson launched into a discussion of the political issues, and the need to win over conservative Republicans as well as the Democratic leadership.

The President interrupted. “Hank, let me worry about the politics. You do what is right.”

As word spread that a more comprehensive approach to the crisis might be under way, stocks soared in near-frenzied trading. The Dow closed up four hundred and ten points, with the biggest surge in six years.

At 7 P.M., Bernanke, Paulson, and Cox met with congressional leaders in Speaker Pelosi’s conference room, overlooking the Mall. After photographers and press representatives were asked to leave, Paulson addressed the group. “We are in danger of a broad systemic collapse, and action needs to be taken urgently to head it off,” he said. “We need the authority to spend several hundred billion.”

Cox invoked his former colleagues’ memories of September 11th. “We did extraordinary things then for the good of the country,” he said. “This is what has to happen again, even if it is just weeks before an election.”

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Bernanke pointed out that he was a historian and a student of the Great Depression. “The kind of financial collapse that we’re now on the brink of is always followed by a deep, long recession,” he said. “If we aren’t able to head this off, the next generation of economists will be writing not about the thirties but about this.”

Someone asked what the scenario looked like.

Bernanke was cautious. He didn’t want to be accused of exaggerating the danger. “You could see a twenty-per-cent decline in the stock market, unemployment at nine to ten per cent, the failure of G.M., certainly, and other large corporate failures. It would be very bad.”

The tone of the two most powerful men in the financial world was as frightening as their words. Questions shifted to Paulson.

What are you going to do with the money?

Paulson stressed the need to buy toxic assets, but resisted questions about how that would work. Spencer Bachus, the ranking member of the House Committee on Financial Services, asked about injecting capital directly into banks. Paulson said that he would consider it.

The legislators pressed on how much money would be needed. Paulson finally said, “Several hundred billion means several hundred billion.”

“You’ve got to understand, Mr. Secretary,” Barney Frank said. “This cannot be seen as just a Wall Street bailout.” He said that executive compensation and foreclosures needed to be addressed. “There’s too much anger out there,” he added.

Paulson didn’t want to get sidetracked by issues that he considered extraneous to the immediate crisis. He knew that if the government tried to cap pay then no one on Wall Street would participate—a state of affairs that Frank later said he found “terribly depressing.”

“Without a functioning banking system, things will get much worse on Main Street,” Paulson countered. He also stressed that congressional action had to be taken before the markets opened on Monday, or more major institutions might collapse.

And what would happen if such legislation failed in Congress?

Paulson paused for a moment. “In that case, God help us all.”

Barney Frank and Chris Dodd indicated that Congress would coöperate, but with some conditions. According to the Times, Majority Leader Reid added, “You have no idea what you’re asking me to do. It takes me forty-eight hours to get the Republicans to flush the toilet.”

The meeting lasted ninety minutes. Reid, Pelosi, and Paulson agreed to speak at a press conference. Someone suggested that a Republican also speak, but Richard Shelby, of Alabama, a conservative and the ranking Republican on the Senate Banking Committee, interjected, “Y’all don’t want me to speak.” The laughter helped lighten the mood. The group agreed to make only brief, general comments about what was discussed at the meeting.

Once Paulson had decided on insuring money-market funds in their entirety, it fell to staff members at the Treasury to figure out how to make it happen. They had less than twenty-four hours to implement a program that ordinarily would have taken weeks of study. David Nason, another assistant Treasury secretary, called leading money-market funds to gauge their reaction. Several members of the executive committee of the Investment Company Institute, a national association of U.S. investment companies, including Vanguard, Invesco, T. Rowe Price, and Fidelity, opposed a federal insurance program. All they wanted was a Fed facility that would address their liquidity issues. They feared that insuring money-market funds could be destabilizing. Nason told them, “You’re getting this whether you want it or not.”

“But it’s a liquidity issue,” John Brennan, the head of Vanguard, persisted.

“That’s not where the Secretary is,” Nason replied. “This is about confidence, investors feeling safe. Each time we’ve hoped for a break, we didn’t get it. We’re using overwhelming force.” Most funds eventually agreed to participate. They had little choice. Once Treasury announced such a plan, and even one fund participated in the guarantee program, investors might abandon funds without the guarantee.

Early Friday morning, the Treasury announced a temporary guarantee program for money-market funds in order to protect “the integrity and stability of the global financial system.”

Chris Cox convened an emergency meeting of the S.E.C. that evening to consider a ban on short selling, which Blankfein and Mack felt was necessary to save Goldman and Morgan Stanley. Cox was probably the most free-market-oriented of the group, and a ban on short selling went deeply against the grain. The ability to sell short—to profit on a stock’s decline—has long been seen as critical to market integrity, enhancing liquidity and the flow of information. In fact, before that day none of the five commission members supported such a ban. During calls that day and the previous day, however, government officials came out in favor of a ban. And in one such call, when Cox said that he was worried about unintended consequences, Paulson grew impatient. “You can sort it out later!” he said. “You have to save them now or they’ll be gone while you’re still thinking about it.”

At the meeting that night, the S.E.C. commissioners were informed that the Treasury and the Fed supported urgent action. In light of this, and the fact that the U.K. had taken a similar step earlier that day, the commission voted unanimously to temporarily ban short selling in seven hundred and ninety-nine financial stocks.

FRIDAY, SEPTEMBER 19

Big enough to make a difference.

Just before the U.S. markets opened, Paulson issued a statement reporting on the previous night’s meeting and launching a campaign for a “comprehensive approach” to resolve the crisis. He outlined a “troubled-asset relief program”—TARP—which would remove “illiquid assets that are weighing down our financial institutions and threatening our economy.”

News of an insurance program for money-market funds and a comprehensive approach to the root causes of the crisis—no matter how ill defined—ignited a euphoric rally on Wall Street. The Dow Jones average rose four hundred points.

At ten-forty-five, President Bush, flanked by Paulson, Bernanke, and Cox, addressed the country from the Rose Garden. “This is a pivotal moment for America’s economy,” he began, and went on:

Our system of free enterprise rests on the conviction that the federal government should interfere in the marketplace only when necessary. Given the precarious state of today’s financial markets—and their vital importance to the daily lives of the American people—government intervention is not only warranted; it is essential.

“There were plenty of people around the President who just wanted the free market to work,” Paulson told me. “He freed me from all of that. He wanted there to be a free market left for all of us to work with. People don’t want to hear this. They don’t like him. They want to see him as disengaged. But he was very focussed on what was best for the country.”

Morgan Stanley and Goldman Sachs got a brief reprieve as speculators began to buy back shares and cover the short positions, but the situation of the two firms remained desperate.

Soon Goldman’s Blankfein called Mack again. “What do you think of this bank-holding-company idea?” Blankfein asked. Geithner was saying that they could complete the paperwork and become bank holding companies that weekend. “I don’t know—what do you think?” Mack asked. Neither acknowledged to the other that he was going to pursue it. But both knew that the survival of their firms was at stake. “You’ve got to hang in there,” Blankfein told Mack. “We’re very supportive of you, but if you go under there will be immediate pressure on us.”

On Friday afternoon, Paulson, in a teleconference with Geithner and other Fed and S.E.C. officials, said that it was time for President Bush to call the Chinese government in an effort to reassure it that, if it came to the aid of Morgan Stanley, it could count on U.S. government support. The Chinese were understandably cool to the prospect, since the China Investment Corporation, an arm of the government, had already made a $5.6-billion investment in Morgan Stanley in 2007, and had watched the value of its stake plunge in the ensuing financial turmoil. Chinese attempts to invest in some American companies (such as the oil producer Unocal) had caused a political uproar, and the idea of the Chinese increasing their stake in Morgan Stanley worried some people. But Geithner wasn’t especially concerned about which country invested in Morgan Stanley, as long as it complied with applicable laws.

On Friday evening, Morgan Stanley’s chief financial officer got a call from the head of the firm’s Tokyo office, reporting that Mitsubishi U.F.J., the large Japanese bank, was interested in negotiating a stake. John Mack was wary, given what he perceived as the glacial pace of Japanese dealmaking. Nonetheless, he said, “Send them over.”

The following morning, a Chinese delegation, led by Gao Xiqing, the vice-chairman of the C.I.C., arrived in New York to meet with Morgan Stanley executives.

Later, Paulson spoke to his Chinese counterpart, Wang Qishan, the vice-premier for economic affairs. President Bush also spoke to President Hu Jintao. According to one person briefed on that conversation, Bush reassured Hu that the U.S. was addressing the crisis and explained the policy steps it was taking. (A spokesperson for Bush declined to comment.)

Paulson’s legislative team, drafting the TARP legislation, consulted with Fed officials but stuck to Paulson’s view that the bill had to focus on buying assets rather than on making direct capital investments—buying “bad assets” rather than “bad companies.” The final draft was only a few pages long.

In Section 6, it stated:

The Secretary’s authority to purchase mortgage-related assets under this Act shall be limited to $700,000,000,000 outstanding at any one time.

At last, the bill had a price tag, designated by Paulson on impulse: the worldwide market for mortgage-backed securities was about $1.4 trillion; seven hundred billion was half that. “It was big enough to make a difference,” Paulson says.

EPILOGUE

Late on Sunday, September 21st, the Federal Reserve announced that Goldman Sachs and Morgan Stanley had become bank holding companies, bringing to an end the tradition of independent investment banks on Wall Street. Despite the arrival of the Chinese delegation, Morgan Stanley ultimately sold twenty-one per cent of the company to the Japanese bank, Mitsubishi, for $9 billion. “The Chinese left in a huff,” a Morgan Stanley executive recalls. (The Chinese government declined to comment.) On Tuesday, Goldman Sachs announced that Warren Buffett was buying five billion dollars’ worth of preferred stock. On Wednesday, Goldman raised another five billion in a public offering of common stock. The moves staved off what had seemed the imminent collapse of the firms.

Although Barclays did not buy all of Lehman Brothers, it bought what it really wanted—Lehman’s North American investment-banking operations and its presence on Wall Street—for just $250 million. It paid $1.5 billion for Lehman’s Manhattan headquarters and other real estate. Bob Diamond called the deal a “once-in-a-lifetime opportunity,” and just a few months later Barclays showed a gain of $3.5 billion on the transaction.

The initial bipartisan support for emergency legislative action turned to hostility once the $700-billion number was attached to the bill. Senators and representatives from both parties reported that calls from constituents were overwhelmingly against the proposal.

On September 29th, the House voted down the legislation. Global markets went into convulsions, the Dow dropped seven hundred and seventy-eight points, and credit markets stayed frozen. Barney Frank, comparing Congress to a wayward child, counselled a nearly distraught Paulson, “Sometimes you have to let the kid run away from home. He gets hungry, he comes back.” Thanks to fierce lobbying, the legislation, much modified and expanded to four hundred pages, passed, on October 3rd. “Troubled assets” were redefined to include not just mortgage-related assets but “any other financial instrument” deemed necessary to stabilize the financial system.

In the end, the Treasury didn’t buy the troubled assets. Instead, it chose to inject capital directly into the banks, as Bernanke, Geithner, and some at Treasury had suggested all along. On October 13th, Paulson summoned the heads of the country’s nine most systemically important banks (including the newest bank holding companies, Morgan Stanley and Goldman Sachs) and explained the terms on which the government would extend to them and others a total of $250 billion in capital. (To avoid the taint of “nationalization,” the government took preferred stock, which carried no voting rights.)

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During the next year, the recession that, in Bernanke’s words, inevitably follows a financial panic drove unemployment to 9.7 per cent. The economic crisis, the worst since the Depression, destroyed household and retirement savings, pensions, insurance funds, and endowments. Eighty-nine banks have failed this year. Bank of America and Citigroup together got $90 billion in TARP funds and $420 billion in guarantees. Stabilizing A.I.G. cost taxpayers $180 billion. To combat the crisis, the size of the Fed’s balance sheet—$850 billion before the Lehman collapse—grew to $2 trillion. General Motors and Chrysler filed for bankruptcy protection, along with nearly a hundred and fifty other public companies—an increase of more than a hundred per cent from the previous year. By March of 2009, nearly nineteen hundred hedge funds had gone out of business.

Bernanke and Paulson both told me that the effects of Lehman’s collapse were worse than they anticipated, and they had expected them to be bad. The question persists: Could Lehman’s collapse have been avoided? Paulson and Bernanke have argued that it couldn’t. The Fed has statutory emergency powers to lend to non-banks, but only against what it deems adequate collateral. Lehman, unlike A.I.G., with its healthy insurance businesses, didn’t have such collateral. This argument seems to have first surfaced on October 15th, in a speech by Bernanke and in a statement attributed to Paulson by the wire service Market News International. “There’s no law that any of us could have used,” Paulson reiterated to me.

But Lehman clearly had some solid collateral, even if not enough for a government takeover of a collapsing firm. The very day Lehman failed, the assets from its broker-dealer operations were deemed acceptable as collateral for a series of short-term multibillion-dollar loans from the Fed. In order to insure an orderly winding down, the Fed loaned the broker-dealer unit $62.8 billion on Monday, September 15th, $47.7 billion on Tuesday, and $48.9 billion on Wednesday. (When Barclays bought the unit, it repaid the outstanding Fed loans.) In testimony this summer, Paulson said, “The Fed was able to loan against Lehman collateral and did loan to help facilitate liquidation and bankruptcy.” (He did stipulate that a Fed loan would not have saved Lehman Brothers.) It seems likely that such collateral might also have been adequate to support a rescue on the Bear Stearns model.