Wachovia's End

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A year has passed since the teetering Wachovia Corp. called off an expected merger deal with Citigroup and opted instead to accept an offer from Wells Fargo. The broad events leading up to – and through – those decisive moments are well know to many in the industry, but the behind-the-scenes maneuvering of those fateful days remains mostly untold.

The story that follows reveals much about the interactions between executives and policymakers in those chaotic days. It is the product of a six-month investigative project undertaken by author Jeff Horwitz as part of his fellowship at Columbia University's Graduate School of Journalism.

Through interviews with attorneys, bankers and high-level government officials, Horwitz learned that regulators had rejected a Wachovia proposal to essentially "rescue" itself and that Wells Fargo initially balked at a deal with Wachovia prior to Citi's acquisition pact because Wells officials "didn't understand" Wachovia's commercial loan portfolio. He also relates the story of meetings held in the weeks before the Wells deal was struck in which Wachovia had held merger talks with Goldman Sachs at the suggestion of Treasury Secretary Henry Paulson, a former Goldman CEO. Paulson would later back away over concerns about conflicts of interest.

What emerges is a story of a group of key players making, and sometimes reversing, rapid-fire decisions at the height of last year's financial crisis to avert the total collapse of one of the nation's largest banks.

While the conclusion resolved the situation around Wachovia specifically and brought some important lessons, the questions it raised about policy around systemically important institutions are by no means settled. That debate continues to this day and will for quite some time.


On Sunday, Sept. 14, as Lehman Bros.' last suitors backed away and Merrill Lynch scrambled to find a buyer, Wachovia's top executives mulled over a comparatively trivial matter: the scheduled appearance of its chief executive, Robert Steel, on CNBC's Mad Money the following day.

Steel understood the gravity of what was happening on Wall Street. Before taking Wachovia's top job in July, he had been Henry Paulson's deputy secretary at the Treasury Department, responsible for credit-market triage after the collapse of Bear Stearns. Earlier, he'd worked with Paulson as head of global equities at Goldman Sachs.

But as dangerous as the crisis was to the remaining investment banks, the situation looked less dire from Wachovia's headquarters in Charlotte. Though the bank was staring at billions of dollars of losses on troubled mortgage loans, its $448 billion of stable deposits buffered it from the panic in the credit markets that had felled Lehman and left the surviving investment banks gasping for liquidity. Ultimately, Steel and his deputies concluded that canceling the CNBC appearance might spook investors.

Shortly after 6 p.m. on Monday the 15th, Steel strode onto Mad Money's cartoonishly cluttered set and shook host Jim Cramer's hand. Introduced as someone "who knows how bad things are, but also knows how they can get better," Steel spoke quickly and with conviction about the crisis and Wachovia's own resilience. The interview was almost over when Cramer brought up Merrill Lynch, which had just struck a deal to sell itself to Bank of America.

"Is the goal here to get it so that your bank is ready to be sold to a foreign bank, to someone else?" Cramer asked.

Steel had joined Wachovia with the intention of restoring its status one of the nation's strongest regional banks, and he had immediately bought one million shares of Wachovia's stock as a show of faith in the bank and himself. He gently shook his head.

"Jim, we have a great future as an independent company," he said, before adding that he would do whatever was in the best interest of shareholders.

There was reason for his slight hedging. The tumult following Lehman's collapse left Wachovia in need of more capital at exactly the moment when jittery investors were least inclined to provide it. While Steel projected cautious optimism, in private, he was also exploring options that included selling a stake in the bank, divesting core assets, or merging with another institution.

Three weeks later, of course, Wachovia ended up in the arms of Wells Fargo & Co., in a deal that was one of the defining events of the financial crisis.

With regulators involved every step of the way, the deal very likely saved the deposit insurance fund from what would have been the largest and costliest bank failure in history. A year later, the Wachovia rescue is also, in some ways, shaping the debate over the future of too-big-to-fail institutions. Wachovia was the first institution formally deemed to pose a systemic risk to the financial system, and its treatment, led by Federal Deposit Insurance Corp. Chairman Sheila Bair, stands in stark contrast to later interventions led by the Treasury Department and the Federal Reserve.

The FDIC is seeking the authority to unwind the nonbank financial arms of the institutions whose deposits it insures, which would allow it to shutter complex institutions without the Fed's help. Meanwhile, many members of Congress have latched onto Bair's proposal for a systemic risk regulatory council, a structure that would cement the FDIC resolution authority that it used to determine Wachovia's fate.

Even before Lehman's failure, Wachovia was doing contingency planning. One of the more unlikely scenarios its legal team contemplated that summer was laid out in a memo outlining what a FDIC open-bank assisted transaction might look like – a surprisingly grim notion to contemplate. An open-bank assisted transaction, in which the FDIC essentially pays one bank to stop another's failure, runs contrary to the government's goal of insuring bank deposits while leaving banks themselves exposed to risk. All but banned by Congress in 1993, the procedure was to be used only in the event that a bank threatened to take the rest of the financial markets down with it. It required approval from two-thirds of the FDIC board, two-thirds of the Federal Reserve's governors, the secretary of the Treasury, and the President.

Even Wachovia general counsel Jane Sherburne, who had requested the memo as part of the bank's contingency planning, thought such a scenario was far-fetched. A former special counsel to the Clinton Administration with the dark humor requisite for managing Whitewater scandal control, Sherburne had earned a reputation for troubleshooting at her previous job as head of the legal team for Citibank's global consumer division.

With no precedents to cite, the resulting document was short. Believing that it would never become relevant, Wachovia's legal team referred to it as "the black box memo." Steel was hired on July 9, 2008 – the same day Wachovia revealed that it had lost $8 billion in a single quarter. Steel had replaced the ousted Ken Thompson, whose disastrous 2006 acquisition of Golden West Financial was at the root of Wachovia's problems. The 123-branch thrift held a $122 billion portfolio of variable payment, adjustable-rate mortgages in California, and as the housing market degenerated, its once-vaunted "pick-a-pay" loans were souring at a rapid rate. Much of the problem stemmed from Wachovia's own

activities: Under Thompson, Wachovia had ramped up its pick-a-pay production and lowered underwriting standards to compete for market share.

With the help of two key deputies, Sherburne and brokerage division head David Carroll, Steel spent his first three months on the job offloading risk, slashing the bank's troubled investment banking and mortgage divisions, and exploring capital-raising options. Its troubles were severe, but all indications had suggested that Wachovia was headed for a slow, albeit painful, recovery without any further dilution of its shares.

After Lehman went down, though, Steel began thinking more seriously about finding a buyer. Despite the troubled loans on its books, Wachovia seemed a source of potential stability to liquidity-strapped, Wall Street giants.

Citigroup, whose anemic domestic deposits of around $200 billion left it in only a slightly better funding position than a primary broker dealer, was the first to call about a potential merger. If Wachovia wanted to do a deal, CEO Vikram Pandit said, Citi wanted its retail deposit base. Steel was noncommittal.

Second came Morgan Stanley CEO John Mack, whose investment bank was widely believed to be the next to fail. The men set up talks late in the week.

"This was a very tough deal to put together in a bad atmosphere," says a person involved in the discussions. "Had it been done two months earlier, it might have made a ton of sense." But negotiations were still underway when Steel got a call from Kevin Warsh, a governor at the New York Fed who often did legwork for Treasury Secretary Paulson. Wachovia should connect with Goldman Sachs, Warsh said. Steel called CEO Lloyd Blankfein, and the two men agreed to hold talks that weekend.

The prospect of a merger with Wachovia wasn't one that Goldman took lightly.

As John Weinberg, a former Marine who headed the investment bank from 1976 to 1990, once put it, Goldman kept commercial bankers out of the firm "because they'll screw it up." But being the best of the investment banks wasn't so appealing when the field was down to two and narrowing.

"The waters were lapping around the first story of Morgan Stanley and moving up the beach toward us," one Goldman official present for the discussions says.

By Saturday Sept. 20, Wachovia had dispatched a small team, including Carroll, Sherburne, and Wachovia adviser Peter Weinberg, to Goldman's offices. Steel flew in to Westchester, where Blankfein was waiting for him at the airport. Only a day or two before, Federal Reserve Chairman Ben Bernanke had called Blankfein to suggest that Goldman's management might be able to fix Citi, and asked him to discuss a merger with Pandit. But nobody had thought to run the idea past Citi before Blankfein called.

"It was a very short conversation on a subject that Vikram had no interest in," the Goldman source says.

The groundwork had been laid a little better for the Wachovia talks – there was never any doubt that Goldman's management would head any merged bank.

Beyond Goldman's nebulous qualms about the retail banking business, the firm claims it had identified $60 billion in un-marked losses on Wachovia's balance sheet. (Wachovia executives say such a number was never mentioned.) Still, Goldman was game to push on if the government provided a backstop, and the plan had the support of Paulson, a former Goldman CEO. On Sunday morning, the Treasury secretary had called Wachovia board member Joe Neubauer to tell him that a merger would be "a marriage made in heaven" in terms of addressing systemic risk, says a person Neubauer told about the call. The imminent passage of the Troubled Asset Relief Program, Paulson reportedly said, would provide legal cover for government assistance.

"There couldn't be explicit promises, but there was a very strong commitment to cover whatever financial needs there would be," says one former Wachovia executive. "It wasn't just the suggestion that the two firms get together.

It was a very strong suggestion."

Over a lunch of takeout Chinese food and pizza, the two sides agreed to make a pitch to Washington for the merger. Major elements, including price and glaring cultural differences, remained unsettled, but the plan was ready to submit to the government.

While Paulson's support was crucial to the deal, it was undeniably awkward.

According to both sides, a principal concern was the "optics" of a bailout:

The CEO of Goldman Sachs was negotiating a merger with the former head of Goldman Sachs equities, all with the explicit support of the former CEO of Goldman Sachs. As Lloyd Blankfein's predecessor, "the sensitivity of Paulson in all of this was pretty well understood," someone familiar with the negotiations says.

Despite its vigorous encouragement, Treasury couldn't make the call. The decision was handed to the Fed. Wachovia's team was left to wait in a Goldman conference room. A few hours later, Blankfein returned.

"We've taken this as far as we can right now," he said, according to sources. "You might as well go back to Charlotte." The reason came a few hours later: The Fed had agreed to convert Goldman and Morgan to bank holding companies. The government would now provide the two firms with the stable funding that Wachovia would have offered.

Hailed as "the end of Wall Street" in the next day's papers, the conversions made a statement that Fed Chairman Benjamin Bernanke did not voice – until much later – that the government would go to any lengths to prevent another failure the size of Lehman's.

"Fortunately, we now have tools to address any similar situation," Bernanke told the Greater Austin Chamber of Commerce in December, including "the authority to inject capital to prevent the disorderly failure of systemically significant private institutions." There were no caveats. After Lehman, the government stood ready to prop up any institution that it deemed necessary.

Next Up, Citigroup

Back in Charlotte, the bank turned its attention to a prospective capital raise. Wachovia stock was still trading well above where it had closed the day Lehman filed for bankruptcy, and the bank had a key potential partner:

Warren Buffet.

A few months earlier, Wachovia had sold $9 billion in discounted auction-rate securities to a subsidiary of Berkshire Hathaway, the world-famous value investor's holding company.

Buffett had expressed potential interest in purchasing a Wachovia stake then, and his interest had become more concrete in the wake of Lehman's collapse. According to people familiar with the talks, Buffett was considering an investment of up to $5 billion.

Wachovia hoped to use an investment from Buffet, whom many investors follow like ducklings, as the cornerstone for a larger offering. Ironically, Wachovia's resurgent stock price eventually scuttled the plan – Buffett didn't think he would be getting enough for his money.

Though an independent capital raise still seemed plausible, Steel was also looking into other mergers. One potential partner was Wells Fargo of San Francisco, and Steel began to actively consider the prospect of tying up with Citi. Despite Pandit's earlier overtures, however, Steel couldn't get his calls returned.

Something big was coming. Washington Mutual, a $300 billion-asset thrift badly damaged by its headlong rush into subprime mortgages, had lost $17 billion in deposits in a scant two weeks and was searching in vain for a buyer. The FDIC quietly requested bids on Wamu's assets, and after hours on Thursday, Sept. 26, seized and then transferred them to JPMorgan Chase & Co.

From the FDIC's point of view, it was a tidy operation that left taxpayer money untapped. But from the point of view of shareholders and creditors in other banks, who watched their Wamu counterparts get wiped out, it was a nightmare.

"This wasn't how Continental Illinois went," a Wachovia executive recalls, referring to the FDIC's protection of bondholders in what was, before Wamu, the biggest bank failure in American history.

At around 5 a.m. on Friday morning, Sept. 27, Steel finally heard back from Pandit – both men were up and working. With the market's response to Wamu still unknown, they agreed to merger talks that weekend. Wells Fargo was in, too.

Coupled with gridlock in Washington over a financial rescue plan, the market's reaction met Wachovia's grimmest predictions. The bank's stock dropped 27 percent on Friday, and corporate customers began to pull uninsured deposits. Worse yet, "[F]inancial institutions began showing reluctance to conduct normal business transactions with Wachovia," David Carroll, Wachovia's brokerage chief, said in a later affidavit. Neither the government nor Wachovia's own management was confident that the bank could open in its current form on Monday. Instead of the hoped-for capital raise, the bank was headed for a shotgun wedding.

Wachovia's top executives flew to New York Friday afternoon and evening, gathering at the 375 Park Avenue conference center of Sullivan & Cromwell, its outside mergers-and-acquisitions counsel. Complete with a kitchen, telephone rooms and endless venues for private talks, the facility was a sort of M&A dorm. That a deal needed to happen was a given; on Saturday morning, Carroll gave a speech about the passing of a great institution.

Negotiating with banks separated by three time zones, the Wachovia team never left the conference center; during the rare lulls in bargaining they simply passed out on the conference table.

By monitoring electronic access to the bank's financial data, Wachovia watched Citi staffers pore over its books on Saturday. But Citi was only interested in acquiring Wachovia's retail banking operations, and it didn't have much to bargain with – it needed government assistance for any deal.

The healthier Wells was in a better position to cut a deal, but the bank's team only accessed Wachovia's books sporadically on Saturday. But that evening, chairman Richard Kovacevich assured Steel he was preparing to make an all-stock offer. At a 7 a.m. Sunday breakfast with Steel and Carroll, Kovacevich coyly suggested Wells' bid wouldn't be "anything beginning with a two," according to sources, which Wachovia took to mean that Wells' per-share offer would be in the mid-to-high teens. Wachovia had closed at exactly $10 a share on Friday.

Wachovia sprinted to close. By early afternoon, Wachovia's attorneys presented a draft merger agreement to Wells outside counsel, Wachtell, Lipton, Rosen & Katz.

But as the afternoon wore on, a previously minor concern came to the fore.

"They didn't understand our commercial loan book," one Wachovia official says of Wells, a take seconded by numerous other executives, lawyers, and regulators. "Some of it was that they didn't know what the acronyms were – well-known, well-established counterparties. We thought it was kind of puzzling." Wachovia and its Goldman advisers walked Wells through its portfolio repeatedly, but at 6 p.m. Kovacevich called to say that Wells was not going to make an offer at all.

"We are a conservative company and we just can't get comfortable with it in such a short time," he said. Members of Wachovia's bargaining team were as outraged as they were helpless.

With no offer coming from Wells, and Citi unable to mount a bid without assistance, Wachovia's fate was in the government's hands. Officials had played down the possibility of direct intervention to save Wachovia all weekend, but no one was ready for another spectacular bank failure. The FDIC's board, the governors of the Fed, and Treasury all concurred that Wachovia posed a systemic risk, a designation that abruptly cleared the regulatory picture.

Despite its size and complexity, Wachovia was still a bank on the edge of failure. And failing banks were the FDIC's bailiwick. Bair was in charge, and she wanted the process to run as closely as possible to a standard FDIC bank-asset sale. Her staff solicited Wells and Citi's bids.

Bair's call to Wachovia announcing the bank's systemic determination came as relief. "We had been hearing from the government the whole time that they weren't willing to put any money into this deal," one person recalled. But the news stripped Wachovia of what little autonomy it had left.

Then someone – whether it was a Goldman adviser or Wachovia's own staff isn't clear – began kicking around a novel idea. What if Wachovia submitted a bid to rescue itself? Nothing in the law ruled out allowing Wachovia to become its own caretaker. If it could convince the FDIC that taxpayers and the markets would be best served by keeping Wachovia independent, the bank might live to see the morning.

Wachovia passed off its bid at 12:45 am. With nothing to do but wait, someone pulled up that weekend's celebrated Saturday Night Live skit in which Tina Fey plays a clueless Sarah Palin flubbing a Katie Couric interview. The government bailout plan featured prominently.

According to Wachovia sources, the bank's own bid was cheaper than Citi's – it required FDIC guarantees on between $220 billion and $225 billion of its debt, compared to the $300 billion asked for by Citi. In return for that and

$15 billion in first-loss protection, Wachovia would issue $10 billion in preferred stock to the FDIC and raise up to $15 billion more by selling common and preferred stock.

"When we submitted that we said we can do this ourselves, and we can do it cheaper than Citi can," says a person involved in the proposal's drafting.

Unbeknownst to Wachovia, the FDIC had a third option to consider: Somewhere around 4 a.m., Wells had finally submitted a bid. Rather than guarantees providing tail-end risk protection, Wells wanted up to $20 billion in upfront assistance.

At 4:30 a.m., Bair called. Citi had won. After two weeks of struggle, Wachovia would be broken up. "O.K, you're in the driver seat," a Wachovia executive said to Bair. "Can you just explain why you rejected our bid?" "There are broader considerations than just Wachovia," Bair responded, suggesting a merger would be good for both banks.

Wachovia's team took the answer to mean that the FDIC's intention was to stabilize Citi, too. But while that might have been a benefit, it wasn't the agency's main concern. According to sources, Bair's staff had concluded that Citi's bid was cheaper than Wells, and had considered Wachovia's self-rescue bid was all but dead on arrival. The FDIC did not consider itself to be in the business of giving failed banks second chances. With more time, Bair would have wanted to explore a closed-bank option.

While Bair's decision was final, it hardly settled the terms of the merger.

Citi wanted only Wachovia's banking franchise, leaving Wachovia to wonder how it planned to untangle the asset management and brokerage businesses – and what would happen to the divisions' thousands of employees.

"What happens if we try to work out the deal in the next couple hours if we run into an impasse?" someone asked Bair. "Are you the deal maker?" "Sure, try me and I'll see if I can help," Bair said. At 6:30 that morning, two hours after Bair's decision, Steel led a board meeting via conference call. Wachovia could either go into receivership or agree to an FDIC-backed deal with Citi for $1 a share. There was little to discuss.

Bair was going to announce the deal at 8 a.m. Five minutes before then, Wachovia sources recall, Citi officials broke out a term sheet along with an exclusivity agreement, but without an end date. Wachovia's executives had never seen it, and Citi was demanding that they sign.

A copy of the agreement later published shows Sherburne's initials in the margin, next to a scrawled-in expiration date of Friday, Oct. 3. According to someone present, a Sullivan & Cromwell attorney suggested that the document require both parties to negotiate in good faith. Citi refused.

Wachovia signed.

Upping the Ante

Monday was ugly in Charlotte. Wachovia's executives found it was nearly impossible to explain to the bank's 80,000 employees what had just happened – the bank hadn't failed, and it hadn't been acquired. It had until Friday to negotiate a deal with Citi that would split it in two.

The company put on a brave face, with the head of Wachovia's soon-to-be-orphaned brokerage operations calling his division's sudden independence a blessing. Still, the headline in the lead story in The Charlotte News & Observer Tuesday read, "Stunningly Swift Fall for Wachovia." Back in New York, a transaction that should have taken months was being compressed into five days. And Wachovia had no bargaining chips.

Wachovia's executives desperately wanted to keep the company together, and repeatedly tried to convince Citi to buy its brokerage operations. But Citi wasn't eager to expand its brokerage business. Unable to win that fight, Wachovia's executives retreated to demanding that whatever businesses Citi left behind receive an accountant's solvency opinion. If the split proved as untenable as executives like Carroll feared, Citi couldn't simply abandon the parts of the business it wasn't acquiring.

But with the FDIC pressuring both sides to finish the deal, negotiators had their hands full with its broad outlines. Top Citi executives flew down to Charlotte to soothe Wachovia employees, and by Thursday, Steel, Sherburne, and human resources head Shannon McFayden were in Pandit's office briefing him on Wachovia's employment and pay structure. The Citi CEO was chipper and listened carefully, sources say.

When the meeting ended, Sherburne returned to the offices of Citi's outside counsel, Davis Polk & Wardwell. But inside the conference suite that had served as the Citi's negotiating headquarters, she found the deal in disarray. While Wachovia's top leadership had been sequestered in Pandit's office, Citi's negotiators had put their foot down on the solvency opinion.

Sherburne found Andy Felner, Citi's head M&A attorney, and launched into a talk that Citi's switch put the deal's Friday deadline at risk. Just then, her phone rang – it was Bair. Sherburne abruptly excused herself, leaving Felner in the lobby of the Davis Polk suite. Moments before, Bair had called Steel, whose plane to Charlotte was about to take off. Wells Fargo was ready to make another offer, Bair said. With no time to talk and endless legal issues, Steel had asked her to call Sherburne. Wells Fargo was offering $7 a share, it wanted to purchase Wachovia intact, and it didn't need FDIC assistance.

Sherburne was in no mood to celebrate. It was 7:30 on Thursday evening, and Wachovia was supposed to close its Citi deal by Friday. Negotiations at Davis Polk were already on the rocks, and she knew all hell would break loose if Citi thought Wachovia was trying to back out of the deal.

"Well Sheila, what do you think we should do?" Sherburne asked.

"I don't know," Bair replied. "This is a vastly better deal for the American taxpayer, better for the company, certainly better for the shareholders," Sherburne said. "How can we not consider this?" "I think you have to," Bair said.

But even entertaining the prospect would be a high-wire act. To begin with, there was the Citi exclusivity agreement, which unambiguously forbid Wachovia from cooperating in any way with "any third-party that is seeking

to make, or has made, an Acquisition Proposal." Separate from the legal

issues were more basic concerns about what Kovacevich was doing. Wells Fargo had had more time to mull over Wachovia's books, and legislation passed by Congress earlier in the week meant the deal would now have significant tax advantages. But Wachovia executives wanted to be certain that Kovacevich was serious.

"Why don't you go back to Kovacevich and tell him that we won't even think about this unless we've got a signed merger agreement approved by their board," Sherburne said. It was a high bar, and Bair agreed. A few minutes later, Bair called back to say Wells was still game.

The offer put Wachovia in a tough legal position. If Wells rebuffed Citi, Pandit would doubtlessly sue over the breach of the exclusivity agreement.

But if Wachovia stood by the Citi deal after Kovacevich took the offer public, shareholders would sue, too. Wachovia concluded that it would rather defend itself from Citi than its own shareholders.

"One way or another, we were going to be in litigation," an executive recalls.

With Steel still in the air, Sherburne discussed Wells' offer with Sullivan & Cromwell's H. Rodgin Cohen, the chairman of the firm and the de facto dean of the M&A world. Cohen was amazed by both the offer and that the FDIC hadn't squelched it.

But the FDIC saw no basis to intervene. Bair still stood by the deal it had worked out with Citi, but she wouldn't force Wachovia's board to accept it.

Doing so would exceed both the FDIC's self-perceived legal authority and its own sense of narrow mission. Only the direst circumstances had compelled the FDIC to halt Wachovia's failure at all – it wasn't going to put up government money to safeguard a weakened Citi's interests.

Steel threw himself back into the mix as soon as his plane landed in Charlotte at 9 p.m., and several minutes later he was presented with a contract. Wachovia executives were stunned to find that it was identical to the one they had given Wells five days earlier, so there would be no need for negotiations.

Wachovia called a board meeting for 11 p.m., and then turned its attention to another constituency: the federal agencies. Bair and the FDIC were ready to let the Wells deal move forward, but what about Treasury, the Fed, and the rest of the regulators? Jilting Citi would cause havoc. There was no guarantee that another regulator wouldn't challenge Bair's decision. Steel and his advisers began working the phones.

On their calls, they recounted the details of the offer, their belief that they had a fiduciary duty to bring it to their board, and the time pressure.

Then they asked if the agency they were speaking to would block them. "No one said don't do it," says a person with knowledge of the calls. "No one said stop." Late that evening, the board met to consider Wells Fargo's offer. It voted unanimously to take it.

Back at Davis Polk, things took a turn for the weird. Before Wachovia's board meeting, Sherburne had herded Wachovia's negotiators, at least a dozen senior managers and lawyers, into a conference room and all but barred the door. With the deal now done, however, Wachovia had to tell Citi. Steel wanted to do it as soon as possible, and asked Bair if she would be willing to help break the news in a phone call. She agreed.

After a week of negotiations, Sherburne and Steel knew where to find their Citi counterparts at any hour and they dialed Pandit at home. It was 2 a.m.

Though Bair was on the line, Steel did the initial talking, explaining that Wells had made an offer at $7 a share. Pandit wanted to pull a few things together and think of how to respond. "No, Vikram, we've actually signed a merger agreement and our board has approved it," Steel said. Later, Steel would say it was toughest phone call of his career.

Pandit got upset, mostly at Bair: How could she allow this deal to happen?

"There's more at stake here than just Wachovia," he said.

"Let's have this conversation off line," Bair said, and the call ended.

Wachovia's team was still sitting in a Davis Polk conference room surrounded by Citi's negotiators – who were still expecting to close a marathon deal that

night.

Wells announced its purchase at 7 a.m. on Friday. Citi didn't even have time to pull full-page ads in USA Today and other newspapers celebrating, "A new partnership. A new world." Over the next week, Citi's stock dropped from $23 to $13.

The Aftermath

The wrangling over Wachovia didn't end with the announced sale to Wells. In the days afterward, Citi filed suits seeking an injunction, to carve off Wachovia's Northeastern branch network, and up to $60 billion in damages.

At an employee town hall meeting a few days after Wachovia accepted Wells' offer, Pandit took an aggressive line. "We kept the system going, we kept Wachovia alive," he said, according to news reports. "We need to be paid for that as a company." But Citi hadn't been the FDIC's only, or even cheapest, option. The agency had chosen to discard Wachovia's own self-rescue bid because it did not want to set a precedent for propping up failing institutions. While the FDIC had decided that it couldn't permit a major institution's disorderly collapse, neither was it going to fund its convalescence.

How radically different that position was from that of other regulators would become apparent only later. In late November, Citi found itself in similar circumstances to those that had cost Wachovia its independence.

Market jitters pushed Citi depositors toward an incipient run and, once again, a massive bank holding company with extensive nonbank functions entered the weekend preparing for a crash landing. Regulators had no choice but to consider the institution a systemic risk, and propped Citi up with $20 billion capital injection while agreeing to cover some $400 billion in losses.

Paulson and Bernanke believed that wiping out Citi stakeholders risked setting off a new crisis. Bair, who has long maintained that the risks posed by too-big-to-fail banks fed the banking crisis, agreed to put $10 billion of FDIC funds on the line only after what news reports described as a "heated debate" in which Treasury ultimately said that it and the Fed were prepared to go it alone.

Some of Wachovia's executives were flabbergasted – a bank in a position similar to its own had just received a fundamentally different deal. "I'm not defending Wachovia," says one source. "But the outcome could very easily have been for the company to stay independent with much less support than the government gave to Citi. This was all so hit or miss."

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