All the Devils Are Here [214]
And by Monday morning, March 17, Bear Stearns had been sold to J.P. Morgan for $2 a share. Paulson, who had urged J.P. Morgan to make the deal so that Bear wouldn’t go bankrupt—and wreak havoc on the financial system—had insisted on that punitive price. Later, facing a revolt by Bear shareholders, J.P. Morgan raised the price to $10 a share. In his book, Paulson describes the new price as “an unseemly precedent to reward the shareholders of a firm that had been bailed out by the government.” And it had, because J.P. Morgan would not have done the deal if the Fed hadn’t agreed to provide a $30 billion loan to a stand-alone entity that would buy a pool of Bear’s mortgages that J.P. Morgan didn’t want.
The banks’ dirty little secret was now out in the open. It wasn’t just Fannie and Freddie that had been creating moral hazard all these years. So had the nation’s big banks. They had taken on terrible risks, built up immense leverage, and created such tight interconnections with their derivatives books that the failure of any one of them could bring down all the others. When things got bad, they assumed they had an “implicit government guarantee,” just like Fannie and Freddie. In On the Brink, Paulson recalls a phone call he received from his former number two at Goldman, Lloyd Blankfein. It was the Saturday that Treasury and the Fed were negotiating with J.P. Morgan to take over Bear. “I could hear the fear in his voice,” writes Paulson. The Goldman CEO told him that “the market expected a Bear rescue. If there wasn’t one, all hell would break loose.
At Fannie Mae and Freddie Mac, the losses continued to grow. Fannie was about to slide under OFHEO’s capital requirements, which executives referred to as “the line of death.” Even though they were convinced they could survive the losses, they worried that if they slid below even by a dollar, OFHEO would punish them in some way.
Some in the government were starting to freak out about the GSEs. In an e-mail on March 16 to others at Treasury, Bob Steel, the undersecretary for domestic finance and Paulson’s point man on Fannie and Freddie, wrote, “I was leaned on very hard by Bill Dudley”—an executive vice president at the New York Fed—“to harden substantially the gty.” That meant that the New York Fed wanted the U.S. government to explicitly stand behind the GSE’s debt. It was an expression of the fear officials were starting to feel about the GSEs. And yet, on March 19, four days after Bear was rescued, OFHEO, backed by Treasury, issued a press release announcing that it had agreed to reduce Fannie and Freddie’s capital cushion, which, claimed OFHEO, was “expected to provide up to $200 billion of immediate liquidity to the mortgage-backed securities market.” A month earlier, OFHEO had loosened the portfolio caps the GSEs had agreed to after the accounting scandals. The two changes together “should allow the GSEs to purchase or guarantee about $2 trillion in mortgages this year,” OFHEO reported. “These companies are safe and sound, and . . . they continue to be safe and sound,” said Lockhart.
Lockhart should have known better. What OFHEO had really done was reduce Fannie and Freddie’s protection against insolvency—even though the companies were edging closer to it every day. Because if it didn’t, no one in America would be able to buy a house.
Later that day, Josh Rosner released a report entitled “OFHEO Got Rolled.” “We view any reduction as a comment