How ‘The Roof Caved In’ on Wall Street

AIG, which ran a group of highly regulated insurance businesses, was connected to virtually every financial instrument known to the modern financial system through a separate group of unregulated businesses. For many years, the company had the highest credit rating a company could obtain (AAA) and was able to borrow at costs that were not much higher than the federal government. With what was an almost-unlimited supply of cheap money, AIG had done a lot of stupid things. The stupidest of all was its decision to move aggressively into the market for credit default swaps (CDSs).

In AIG’s defense, a credit default swap is a form of insurance. It gives the buyer of the CDS insurance against the risk of default on any given debt instrument, whether it be a corporate bond, an auto loan, or, to AIG’s lasting regret, a subprime mortgage. Credit default swaps trade based on the likelihood that whatever it is they are insuring will default. The greater the chance investors believe there is that a default will occur, the higher the price of the credit default swap. Like so many other businesses on Wall Street, the CDS market made a great deal of sense before it spun out of control. We’ll talk more about this phenomenon in Chapter 7, but suffice to say that AIG did not appropriately gauge the risk of all the credit default swaps it was writing.

I made more calls. I spoke to another longtime source who knew what was going on at the company. He told me that on Friday, AIG had been unable to roll its commercial paper. It was an off-the-record comment, meaning that I could not use it in my reporting, but it helped me understand just how bad the situation at the company had become. The commercial paper market is used by what are typically high-credit-quality corporations for their short-term borrowing needs. In that market, corporations can borrow billions of dollars for 30, 60, or 90 days, and, when those debts come due; most corporations simply roll them over for another 30-, 60-, or 90-day term. The problem comes when no one wants to buy a corporation’s commercial paper and it is unable to roll. Now I understood how AIG could be “on the verge.” Unable to borrow in the commercial paper markets, the company was rapidly running out of money.

It seemed like a good time to call the office. The typical Sunday at CNBC is pretty quiet, given the network does not feature live programming on the weekends. While we have a handful of people on the assignment desk and a few producers working on the next morning’s shows, our cavernous headquarters is a lonely place on a Sunday night. Not on this night; it was all hands on deck, and, having not checked in thus far, I was only now made aware that we were going live beginning at 8 p.m. Reporting from my couch with the football game on in the background was no longer an option. I showered, put on a suit, and headed for work.

Video   Reality check: Will the economy improve in 2009? June 22: TODAY’s Matt Lauer talks with CNBC’s David Faber about his new book, “And Then the Roof Caved In — How Wall Street’s Greed and Stupidity Brought Capitalism to Its Knees.” Today show

By 6 p.m., news was starting to pour in on a variety of fronts. The Wall Street Journal and New York Times were reporting the stunning news that Lehman would be filing bankruptcy, having been unable to convince the Federal Reserve or Treasury to come to its aid. And in a story I had completely missed, it seemed Bank of America had quickly moved on from its brief courtship with Lehman and was very close to buying the nation’ s largest and most important brokerage house, Merrill Lynch. Merrill, I would subsequently learn, was fearful that a Lehman bankruptcy would assure it the same fate and chose to save itself with a hastily crafted deal at a mystifyingly high price.

The Lehman and Merrill stories were being well covered by our own reporters and our competitors, so I focused on AIG. I leaned back at my desk and took a deep breath before embarking on another round of phone calls. I had been a financial reporter for two decades. I had covered the fall of Drexel Burnham Lambert in 1989. I had reported on the collapse of the savings and loan industry in 1990. I’d been lucky enough to break the news of the fall of the hedge fund Long Term Capital Management in 1998 and the massive fraud at WorldCom in 2002. I had reported on the tech bubble’s inflation in the late 1990s and its bursting in the early 2000s. And here I was, watching three events happening in the same night that taken separately might have been typical of the biggest financial stories of a decade. It was disorienting, to say the least.

In the intricate dance between reporter and source, persistence is the one constant. After speaking with four or five people who each add an insight or level of detail to a report, I usually find it wise to go back to my initial source and try to cajole a bit more information from the person by convincing him or her of how much more I’ve learned since we first spoke: “I already know this, but could you tell me that one again?” And so, having learned that AIG was desperately trying to raise cash and was talking to private equity firms and Warren Buffett (who controls a huge insurance company), I went back to my original source.

Yes, he told me, AIG was talking to private equity firms and anyone else it thought might be able to lend it money. Its intention was to use certain of its businesses as collateral for a short-term “bridge” loan that it would repay when those businesses were sold. But those talks were not looking promising. AIG needed the money immediately and the firms wanted time to understand its true financial health before committing capital. As a result, my source told me, the company was casting its eyes toward the Federal Reserve. AIG wanted the nation’s central bank to give it a bridge loan of $20 billion. But just then, the Federal Reserve and Treasury, which had evidently decided to let Lehman Brothers go bankrupt, were also turning a deaf ear to AIG’s pleas. CNBC broadcast live that evening until midnight. A few moments after we went off air, Merrill Lynch announced it was being acquired by Bank of America. A few hours later, Lehman Brothers filed for bankruptcy. But AIG did not. It wasn’t quite out of money yet.

That Monday, a throng of executives from AIG and their many advisors descended on the office of the Federal Reserve Bank of New York. AIG’s financial position was getting worse by the minute.

Its counterparties reacted to the scary news about its future by pulling their business from the company. That left AIG with even less cash. What was worse, the company’s credit rating was going to be downgraded as soon as Monday night, forcing AIG to post more collateral for various transactions. The $20 billion it needed on Sunday night had doubled in less than a day. AIG was now asking for $40 billion.

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