Too Big To Fail by Andrew Ross Sorkin is a fascinating and intricate play-by-play account of the events leading up to the Economic Crisis of 2008, culminating in the Credit Crisis in September, from the perspective of the leaders of all the big banks and government officials. The book is so richly detailed that it reads almost like fiction. One gets to know the personalities of all the main players, with their strengths and quirks, and experiences the roller coaster emotional atmosphere as this group of people creates history in the face of crisis.

The book also includes historical background on the personalities and the companies, and the origins of the subprime mortgage mess, stretching back over 10 years or so. Sorkin is thorough, to say the least.  At 550 pages, reading the book would take a week of full-time devotion. No doubt, however, this book is destined to be a classic, if not for public consumption like JK Galbraith's The Great Crash 1929, it will provide endless analytic fodder for academics, politicians, business leaders, and history buffs alike. There is probably nothing like it in terms of the number of people involved, the scope of the issue, and the level of access to the top leaders in both industry and government during such a critical time in history.

Perhaps what's most extraordinary about the story is the access to the mental states of many of the top players, laid out side-by-side with their public behavior and actions. The plot of the story is driven primarily by government officials: then New York Reserve Governor Timothy Geithner, his boss Federal Bank Reserve Chairman Ben Bernanke, and Treasury Secretary Hank Paulson. The three men fear a coming Great Depression and are desperate to prevent it. As the mess envelops them, they assume the role of "Saviors of the World Economy", and take it upon themselves to prevent the failures of banks and other companies to prevent Armageddon.

Our heros

Sorkin portrays the men reverentially, which is particularly obvious in comparison to his treatment of other government officials, such as Sheila Bair of the FDIC, who comes across as a show-horse, and Christopher Cox of the SEC, a political hack in over his depth, and like a deer in the headlights.  Dick Fund, CEO of Lehman, is portrayed as desperate, paranoid, and incompetent.

However, I would argue that a disinterested observation of their behavior reveals the men acting out of panic and desperation, without a strategy and without thinking through the consequences of their decisions.  The result is a financial system that is even more dependent on the government and taxpayers than before, just as sick, and now the economy is burdened by the addition to the national debt of about a trillion dollars.  The stakes of failure are now even higher.  If these companies that they were trying to save were not too big to fail before, they certainly are now.

In their attempt to avert the Second Great Depression, and their belief that the failure of any company will trigger Armageddon, they run around like chickens with their heads cut off.  They fabricate trillion dollar rescue plans out of whole cloth, and attempt shot-gun marriages between all combinations of financial companies in the hopes of keeping them afloat and maintaining confidence in the market. It is surprising to see their incompetence and short sightededness, and how manipulative they are, despite their stature in the field, and their brilliance in academics and management. Though they are overwhelmed, they nevertheless maintain an air of confidence and certainty, because no doubt that is part of their job description. They order corporate presidents and CEOs around like chess pieces. Paulson's propensity to vomit, such as during a crumbling of his best-laid plans at a critical point, reveals the stress. One can't help but feel a little bit sorry for them.

By October 2008, the Treasury and Federal Reserve had given out over $1 trillion in financial support to big banks, Freddie Mac and Fannie Mae, and other companies deemed to have 'systemic risk'. The book carefully lays out the sequence of meetings throughout the crisis, including what was said by each person, and revealing their true feelings through the emotion in their voice, facial expressions, and body language.

The book explains the "Scare the s**t out of them" strategy that Paulson, Geithner, and Bernanke employ to obtain funding for TARP. For example, in a meeting with the banking committee on September 18, 2008:

Paulson: "If it doesn't pass, then heaven help us all."

Bernanke: "I can tell you from history that if we don't act in a big way, you can expect another great depression, and this time it is going to be far, far worse."

In fact, despite their Chicken Little pleading, TARP was initially voted down on September 29, because it simply gave the Treasury too much power to spend $700 billion for toxic assets of unknown value. (TARP was passed on October 3, in part due to modifications for greater accountability, and in part due to increasing panic.)

Behind the scenes, however, Paulson didn't even know what TARP should be. Originally it was intended to purchase toxic assets to clean up a bank's balance sheet, to reduce doubt as to whether a bank was still solvent. The previous year, two of Paulson's top aids, Neel Kashkari and Phillip Swagel, developed their "Break the Glass" plan for emergency rescue of financial companies by having government purchase their toxic assets. Unfortunately there was no mention in the plan about how to value the assets for purchase. Toxic assets are so complicated that they would take months to value - even Alan Greenspan considered them to be incomprehensible, and the banks themselves were woefully overvaluing them. Nevertheless this was the plan that Paulson had in mind when he went to Congress.

But then he received a call from Steven Schwartzman of the BlackRock group, who told him that banks would not want to sell their toxic assets because that would force a write down. They'd rather hold the securities for as long as they can, believing or pretending that they're still valuable. So after some waffling, Paulson decides the best bet is to invest directly in banks (buy bank stocks).

Couldn't Paulson have floated the plan with banks before going to Congress? After all he had months to work on it (it had been presented to Bernanke in April, 2008). You'd think he'd want to discuss a plan to save banks with the banks. And you'd think the banks if they wanted to be saved would have spoken to Paulson about the best ways to do it. Well, regulators know best.

Anyway, Paulson calls the top banking CEOs to Washington for an extraordinary meeting (instead of going to Wall Street) and gets them all to accept the TARP investment, effectively partially nationalizing all the major banks (including the banks that didn't need it because Paulson didn't want to make the others look weak). As of a year later, the bank TARP money has been repaid (with borrowed Fed money). But the banks still maintain toxic securities, setting us up for another crisis.

Running around in a panic, they made many other blunders. They played matchmaker with the banks, and in the midst of the crisis, Paulson encouraged a merger between Goldman Sachs and Wachovia, implying the government would backstop Wachovia's bad assets. The companies, under that assumption, pursued merger talks, only to be told 24 hours later that it couldn't be done due to Paulson's previous position as CEO of Goldman. It was a clear conflict of interest and was politically untenable. Oops.

They also tried to get JP Morgan and Morgan Stanley to merge. The only problem was that neither side wanted to do it. There was a huge overlap between the companies, and Morgan Stanley had about $50 billion in poor quality securities. Jamie Dimon of JP Morgan was adamant, but Paulson replied, "I might need you to do it." Is this capitalism?

In desperation, Paulson called CIC (China Investment Corporation) and pleaded with the Chinese government to support an investment in Morgan Stanley. He even offered the financial assistance of the American government. So CIC flies over to take a look. However, Morgan Stanley was in the middle of a deal to receive a $9 billion investment from Mitsubishi Bank. Needless to say, CIC and the Chinese government were not happy.

The regulators seem more interested in saving the investment banks than the banks themselves. These are companies whose main job is to make money, mostly by making risky bets. And we need to save them?  Despite all of the detailed history in the book and explanations of financial concepts, Sorkin never addresses this issue.  It's quite an omission, considering the title of the book.

Lehman failed on September 14.  In the weeks leading up to the bankruptcy, they were struggling to pull Lehman back from the brink (it was saddled with about $70 billion in toxic assets and huge CDS liabilities). Of course, our heros - Paulson and Geithner - fearing Armageddon, tried valiantly to save it. They had recently organized the Bear Stearns - JP Morgan merger with a $30 billion government guarantee, but now they were under pressure by Congress (particularly Nancy Pelosi) not to offer another bailout. So they turned to Wall Street to work something out. Geithner: "If you don't find a solution, it's only going to make the situation worse for everybody here." Christopher Cox of the SEC remarked on "The patriotic duty they were undertaking." After a weekend of strenuous negotiations, the Wall Street bankers came up with funds to support a complicated arrangement in which Barclay's would buy Lehman. But then to everyone's surprise (supposedly), the British government nixed Barclay's role. Despite Paulson's pleas to the Brititsh government, they would not budge. There was no choice. Lehman went down.

This was by most accounts the right outcome, in retrospect. Although Paulson was quite upset by it, most of the country, including President Bush, didn't seem to mind. There was an orderly wind-down of Lehman assets. (Barclay's got a great deal on Lehman's trading arm - the only piece it wanted anyway.) Barney Frank anointed this day "Free Market Day," as it was the only time the government allowed the markets to function.

AIG was another debacle. AIG is a large and well established insurance company, providing many types of conventional insurance products such as life insurance. This part of the business was healthy and organized into financially protected subsidiaries in each state. However, starting around 2000, AIG's Financial Products division (AIGFP) started selling insurance on subprime securities owned by other banks (known as Credit Default Swaps). As the subprime loans dropped in value, AIG's potential liabilities ballooned. They had insurance on at least $1 trillion in toxic assets owned by many of the major banks around the world, and might eventually have to make payouts if those assets defaulted. They were being asked to post more collateral by the banks to protect against defaults, but they simply had run out of available assets. They were facing bankruptcy.

Geithner believed that he could not let AIG fail, because without the insurance on their toxic assets, European banks would have to come clean on the true value of those assets, and that could force them into bankruptcy. (US banks could continue to conceal their toxic asset values, as they have.) Also he was concerned that people who had life insurance at AIG would panic and take down the insurance industry (even though their money is safe). Regardless, he feels he must avert an Armageddon. So as AIG was preparing for bankruptcy on September 16, Geithner calls them and offers to rescue them with a $85 billion bailout. AIG is shocked and in disbelief, but they follow Geithner's instructions to post stock as collateral, and they're back in business. Suddenly realizing, however, that this would not look good without a new CEO, Paulson taps Ed Liddy, the retired ex-CEO of Allstate, and puts him in the spot (a 24 hour executive search). The board is a bit dumbfounded. "He wouldn't be my first choice," many of them seem to be thinking. Liddy resigns less than a year later.

President Bush was perplexed and dubious about the AIG bailout. But Paulson and Bernanke impressed upon him the gravity of the situation: AIG provides life insurance and annuities to lots and lots of people. Bush acceded.

The US taxpayer has by now pumped $180 billion into the company. Much of this money has gone to foreign banks, and much of it has gone straight to the big investment banks to cancel their CDS contracts with AIG, including $14 billion to Goldman Sachs, which actually claimed to be well hedged against an AIG bankruptcy. Geithner failed even to negotiate a deal beneficial to the taxpayer, paying 100% of the liability, when he could have bargained it down. But hey what's a few billion dollars?

The erratic behavior of the government - will they bail out or not? - resulted in great uncertainty in the markets. In their desperation to save the markets they only aggravated the situation. The markets continued to fall for a few weeks, but eventually stabilized.

Why Sorkin treats the men so respectfully despite their reckless blundering is a bit mysterious, especially considering how harsh he is on others.  Perhaps that's the price he paid for the level of access - an implicit agreement to make them look good on the surface.  However, he nevertheless reported the entire story with great objectivity, so the facts speak for themselves.  The critical reader will  have more than enough information to draw the right conclusions.

The aftermath - A slow descent into Armageddon

I believe that Paulson, Geithner and Bernanke essentially gave away the store. In their frenzy, they created several "Too Big to Fail" behemoths, and made mistakes that will burden the taxpayers for generations. It's hard to know the true motive for their actions. Some might say that they were just protecting their industry and their friends. No doubt that was part of it. But I would provide a more charitable explanation: they knew personally the hardships that a failure of a big company would be on so many thousands of people, the kind of people they worked with their whole lives, and so they would go to great lengths to prevent it. And perhaps they overestimated the importance of their own industry in the world economy.

But I suspect that the main reason was that they didn't want to be seen as sitting back and doing nothing while the country sunk into the Great Depression II. Bernanke was a scholar of the Great Depression, and knew exactly what should have been done differently - in particular, it required taking a very aggressive approach. However, I believe that it would have been much better if the government had allowed the companies to fail. Of course it would have been painful, but it was necessary. Companies would behave more responsibly, and the taxpayer would not be on the hook for a trillion dollars of bailouts. And even if the stock market went down further, or unemployment increased, the government could focus on building the economy back up on a firmer foundation.

If companies weren't too big to fail in 2008, they certainly are now. As a result of mergers and government guarantees, they are now bigger and more dependent than ever. Bear Stearns and JP Morgan are now merged with a government guarantee. Bear Stearns has billions in toxic assets that ultimately must be revealed, and then the $30 billion guarantee may have to be spent. Merrill Lynch and Bank Of America are now merged, and Merrill is still full of toxic assets (Merrill subsequently requested more money from the government, and when BofA threatened to withdraw from the deal, Paulson and Bernanke threatened to fire him). After making huge investments in AIG, the government will probably keep supporting it, pouring in good money after bad. This company (at least the AIGFP division) does not need to exist.

Even worse, now the big investment banks - Goldman Sachs and Morgan Stanley - have been converted to bank holding companies so they are now eligible for Fed financing through the discount window, meaning they can borrow at low rates and do as they please - pay back their TARP investment and engage in the same risky behavior that got them into trouble in the first place.  Furthermore, their deposits are now protected by the FDIC (through the Temporary Liquidity Guarantee Program). This was another move by Paulson to calm the markets, and while Sheila Bair of the FDIC initially recoiled at the idea, eventually she was pressured to relent. This represents "The biggest policy shift in history" according to experts at the Treasury, but hardly anyone even noticed. Nothing could be more dangerous, because now we've provided government money to the very people who nearly destroyed their own companies by taking great risks. Of course now the companies are under greater government supervision. Do you feel safer?

As well, money market funds were guaranteed by the Treasury. These are liquid funds that typically invest in safe assets, and allow for easy deposits and withdrawals of large amounts. Paulson thought that they should be insured to prevent a panic if people started to pull out of them (one of the biggest funds dropped about 3%, sparking some panic). Although the guarantee has since been repealed and they didn't take any Federal dollars, they certainly could in the future if the program is re-implemented.

So now we are in a much more precarious state than before, because not only are toxic assets still on the books, but the government has explicitly guaranteed them, along with many other components of the market. Things may seem better because banks have returned the TARP funds, but underneath nothing has changed. Soon enough it will be time to pay the piper.

Lessons to be learned?

The only thing that most big banks have learned is that the government will bail them out no matter what. They can now operate with recklessness and impunity. Although for now they will behave due to high levels of scrutiny, soon enough they will be back to their old tricks.

The only solution is to cut off the government guarantees, and create a policy to allow banks to fail. To prevent runs on a bank, the bank needs the ability to temporarily limit withdrawals, at least until it can either calm fears or wind down assets. People might lose some money in this case, but it's far cheaper than the cost of the policy of bailing out banks for their past and future mistakes.

The Epilogue has a tacked-on feel, but it's important because Sorkin provides his perspective from one year later, tying up loose ends and finally revealing his policy recommendations.  He draws the opposite conclusions from what I would say. He believes that the free market failed, and the illusion of the 'invisible hand' was finally shattered. And although he provides no supporting evidence in the book, he blames the failure on deregulation (for example, the Glass-Steagall act, which has now been overturned de-facto with the mergers of the commercial and investment banks) and the structure of short-term compensation packages. He supports stricter regulation of banks - limits on leverage and pay structures - a great irony considering the incompetence of the regulators and their inaction until the crisis.  He also recommends a 'crackdown on rumormongors', which is particularly surprising in light of his portrayal of Lehman's CEO Dick Fuld's absurdly paranoid crusade against them.  He also blames the push for homeownership and low interest rates, and on that we'd be at least partially in agreement.

It's also interesting that Sorkin never directly criticizes the frenzied, half-baked, and inconsistent policy making of the top economic officials. While acknowledging the great nationalization of the banking sector, he fails to acknowledge that the situation is now even worse.

This is a book about history more than policy, and perhaps that's why Sorkin withholds his policy opinions until the very end.  It's a fascinating and worthwhile read, and a treasure trove of important historical information.  It is amazing to realize that everything in the book was weaved together from hundreds of hours of interviews, written notes, email, video tape, news reports (newspapers, magazines, and tv), and public records.