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CRISIS AND PANIC
most , points, or , below its peak in October . The spread between the
interest rate at which banks lend to one another and interest rates on Treasuries—a
closely watched indicator of market confidence—hit an all-time high. And the dollar
value of outstanding commercial paper issued by both financial and nonfinancial
companies had fallen by billion in the month between Lehman’s failure and
TARP’s enactment. Even firms that had survived the previous disruptions in the
commercial paper markets were now feeling the strain. In response, on October ,
the Fed created yet another emergency program, the Commercial Paper Funding Fa-
cility, to purchase secured and unsecured commercial paper directly from eligible is-
suers. This program, which allowed firms to roll over their debt, would be widely
used by financial and nonfinancial firms. The three financial firms that made the
greatest use of the program were foreign institutions: UBS (which borrowed a cumu-
lative billion over time), Dexia ( billion), and Barclays ( billion). Other
financial firms included GE Capital ( billion), Prudential Funding (. billion),
and Toyota Motor Credit Corporation (. billion). Nonfinancial firms that partici-
pated included Verizon (. billion), Harley-Davidson (. billion), McDonald’s,
( million) and Georgia Transmission ( million).
Treasury was already rethinking TARP. The best way to structure the program
was not obvious. Which toxic assets would qualify? How would the government de-
termine fair prices in an illiquid market? Would firms holding these assets agree to
sell them at a fair price if doing so would require them to realize losses? How could
the government avoid overpaying? Such problems would take time to solve, and
Treasury wanted to bring stability to the deteriorating markets as quickly as possible.
The key concern for markets and regulators was that they weren’t sure they un-
derstood the extent of toxic assets on the balance sheets of financial institutions—so
they couldn’t be sure which banks were really solvent. The quickest reassurance,
then, would be to simply recapitalize the financial sector. The change was allowed
under the TARP legislation, which stated that Treasury, in consultation with the Fed,
could purchase financial instruments, including stock, if they deemed such pur-
chases necessary to promote financial market stability. However, the new proposal
would pose a host of new problems. By injecting capital in these firms, the govern-
ment would become a major shareholder in the private financial sector.
On Sunday, October , after agreeing to the terms of the capital injections, Paul-
son, Bernanke, Bair, Dugan, and Geithner selected a small group of major financial
institutions to which they would immediately offer capital: the four largest commer-
cial bank holding companies (Bank of America, Citigroup, JP Morgan, and Wells),
the three remaining large investment banks (Goldman and Morgan Stanley, which
were now bank holding companies, and Merrill, which Bank of America had agreed
to acquire), and two important clearing and settlement banks (BNY Mellon and State
Street). Together, these nine institutions held more than trillion in assets, or
about of all assets in U.S. banks.
Paulson summoned the firms’ chief executives to Washington on Columbus Day,
October . Along with Bernanke, Bair, Dugan, and Geithner, Paulson explained
that Treasury had set aside billion from TARP to purchase equity in financial
