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PROLOGUE

I Can Still Stop This . . .

I t was 8:00 p.m. Tuesday, September 16, 2008. I was exhausted,

mentally and emotionally drained, but I could not sit. Through the win-
dows of my office in the Federal Reserve’s Eccles Building, I could see
the lights of the traffic on Constitution Avenue and the shadowy outlines
of American elms lining the National Mall. Dozens of staff members
remained at work, but the corridor immediately outside my door was
hushed and empty. Michelle Smith, the head of our communications
office and my chief of staff, sat quietly, the only other person

in the room. She was waiting for me to say something.

Four hours earlier, Treasury secretary Hank Paulson and I had sat side
by side in tan leather armchairs in the windowless Roosevelt Room of
the White House, steps from the Oval Office. A portrait of Teddy
Roosevelt as Rough Rider on a rearing horse hung above a fire-place.
Facing Hank and me across the room’s polished wood table sat the
current occupant of the White House, a somber George W. Bush, with
Vice President Dick Cheney at his side. The president’s advisers,
Hank’s senior aides, and representatives of other financial regulatory
agencies filled the remaining dozen seats around the table.
Usually, the president liked to keep things light at meetings, by
opening with a wisecrack or good-naturedly teasing a close adviser.
Not that afternoon. He asked bluntly, “How did we get to this point?”
The question was rhetorical. We had been fighting an out-of-con-trol
financial crisis for more than a year. In March, the Fed had lent
x PrOLOGUE

$30 billion to help JPMorgan Chase save the Wall Street investment
bank Bear Stearns from failure. In early September, the Bush admin-
istration had taken over Fannie Mae and Freddie Mac to prevent the
collapse of the two companies responsible for financing roughly half
of all residential mortgages in the United States. And just the day
before, at 1:45 a.m., Lehman Brothers—the nation’s fourth-largest
investment bank—had filed for bankruptcy, following a frantic and
ultimately futile search for a merger partner led by Hank and New
York Fed pres-ident Tim Geithner.
Now I found myself explaining to the president why the Federal
Reserve was planning to lend $85 billion to American International
Group (AIG), the world’s largest insurance company. The company
had gambled recklessly, using exotic financial instruments to insure
securi-ties backed by subprime mortgages. Now that those mortgages
were going bad at record rates, the financial firms that had bought the
insur-ance, together with other AIG counterparties, were demanding
pay-ment. Without the cash, AIG would go bankrupt within days,
perhaps hours. We weren’t motivated by any desire to help AIG, its
employees, or its shareholders, I told the president. Rather, we didn’t
think that the financial system—and, more importantly, the
economy—could with-stand its bankruptcy.
Reacting to the Lehman failure, markets already were in the grip
of a full-blown panic of an intensity not seen since the Depression.
The Dow Jones industrial average had plunged 504 points on
Monday—its steepest one-day point decline since September 17,
2001, the first day of trading after the September 11 terrorist
attacks—and the selling wave had spread to markets worldwide. As
confidence in financial institutions disappeared, interest rates on
loans between banks had shot skyward. Ominously, we were
receiving reports of both large and small investors pulling their cash
out of money market mutual funds after a large fund suffered losses
stemming from Lehman’s collapse.
Everyone in the room knew that rescuing AIG would be terrible
 PrOLOGUE xi

politics in a presidential election year. Just two weeks earlier, the presi-
dent’s own party had declared flatly in its 2008 convention platform,
“We do not support government bailouts of private institutions.” The
Federal Reserve’s proposed intervention would violate the basic prin-
ciple that companies should be subject to the discipline of the market
and that the government should not shield them from the conse-quences
of their mistakes. Still, I knew that, as chaotic as financial conditions
were now, they could become unimaginably worse if AIG defaulted—
with unknowable but assuredly catastrophic consequences for the U.S.
and global economies.
With more than $1 trillion in assets, AIG was more than 50
percent larger than Lehman. It operated in more than 130 countries
and had more than 74 million individual and corporate customers
worldwide. It provided commercial insurance to 180,000 small
businesses and other corporate entities employing 106 million
people—two-thirds of American workers. Its insurance products
protected municipalities, pension funds, and participants in 401(k)
retirement plans. AIG’s col-lapse could well trigger the failures of
yet more financial giants, both in the United States and abroad.
The president, grim-faced, listened carefully. Paulson had warned
him earlier in the day that action on AIG might be necessary, and he
knew that our options were severely limited. No private investors
were interested in buying or lending to AIG. The administration had
no money and no authority to rescue it. But the Fed could lend to
AIG to keep it afloat if the company’s many subsidiaries retained
enough value to serve as collateral for the loan.
Bush responded as he had consistently during the financial crisis,
by reiterating his trust in Hank’s and my judgment. He said that we
should do what was necessary, and that he would do what he could to
provide political cover. I was grateful for his confidence, and for his
willingness to do the right thing regardless of the likely political
consequences for himself and his party. Having the president’s sup-
port was crucial. At the same time, essentially, the president was tell-
xii PrOLOGUE

ing Paulson and me that the fate of the U.S. and global economies
was in our hands.

Our next meeting, at half past six that evening at the Capitol, had
been even tougher. Hank and I gathered with congressional leaders in
a cramped conference room. House Speaker Nancy Pelosi wasn’t
able to attend the hastily arranged gathering, but Senate majority
leader Harry Reid and House minority leader John Boehner were
there, along with Senate Banking Committee chairman Chris Dodd,
House Financial Services Committee chairman Barney Frank, and
several others.
Hank and I again explained AIG’s situation and our proposed
response. We were besieged with questions. The lawmakers asked
about the Fed’s authority to lend to an insurance company. Normally,
the Fed is empowered to lend only to banks and savings institutions.
I explained a Depression-era provision of the Federal Reserve Act—
Section 13(3)—that gave us authority in “unusual and exigent
circum-stances” to lend to any individual, partnership, or corporation.
The lawmakers wanted to understand the consequences of letting
AIG fail and how the loan would be paid back. We answered as best
we could. Yes, we believed this step was necessary. No, we could
make no guarantees.
As the questions began to die down, I looked over and saw Sena-
tor Reid wearily rubbing his face with both hands. Finally he spoke.
“Mr. Chairman. Mr. Secretary,” he said. “I thank you for coming
here tonight to tell us about this and to answer our questions. It was
help-ful. You have heard some comments and reactions. But don’t
mistake anything anyone has said here as constituting congressional
approval of this action. I want to be completely clear. This is your
decision and your responsibility.”

I returned to my office. Tim Geithner, who had negotiated the bailout

deal, called with the news that AIG’s board had agreed to our
 PrOLOGUE xiii

proposed terms. The terms were tough, for good reason. We didn’t
want to reward failure or to provide other companies with an incen-
tive to take the types of risks that had brought AIG to the brink. We
would charge a high interest rate on the loan and take an ownership
stake in the company of nearly 80 percent, so taxpayers could benefit
if the rescue worked. The Federal Reserve’s own Board had
approved the deal earlier that day. All we needed to do now was put
out the press release.
But I needed a few moments to think about it all. I believed we
were doing the right thing. I believed we had no other reasonable
choice. But I also knew that sometimes the decision-making process
acquires a momentum of its own. It was important to be sure.
Without doubt, the risks we would be taking were huge. Though
$85 billion was an enormous sum, much more was at stake than
money. If AIG failed even with the loan, the financial panic would
intensify, and market confidence in the Fed’s ability to control the
crisis could be destroyed. Moreover, the future of the Fed itself could
be at risk. Sena-tor Reid had made clear that Congress would accept
no responsibility. The president would defend us, but in a few
months he would be out of office. If we failed, an angry Congress
might eviscerate the Fed. I did not want to be remembered as the
person whose decisions had led to the Fed’s destruction.
I can still stop this, I thought, as I looked out at Constitution Ave-
nue. The loan required unanimous Board approval, so all I would
have to do would be to change my own vote. I said as much to
Michelle and added, “We haven’t announced anything.”
If we acted, nobody would thank us. But if we did not act, who
would? Making politically unpopular decisions for the long-run ben-
efit of the country is the reason the Fed exists as a politically
indepen-dent central bank. It was created for precisely this purpose:
to do what must be done—what others cannot or will not do.
Michelle interrupted my thoughts. “We have to put something
out,” she said softly.
xiv PrOLOGUE

“Okay,” I said. “It’s got to be done. Let’s look at the press release
one last time.”
It began, “For release at 9:00 p.m. EDT: The Federal Reserve
Board on Tuesday, with the full support of the Treasury Department,
autho-rized the Federal Reserve Bank of New York to lend up to $85
billion to the American International Group . . . ”