Paulson's 'On the Brink': Seven revelations about US financial crisis
In his account of managing America's financial crisis, former Treasury Secretary Henry Paulson recounts shock, disappointment, and own shortcomings. What lessons does 'On the Brink' hold?
Jose Luis Magana / Reuters
This week America is getting it's first in-depth peek inside the financial crisis, as told by one of the principals on the US government's firefighting team.
"On the Brink" is the first-person account of Henry Paulson, President Bush's secretary of the Treasury at the time when Bear Stearns was rescued, Lehman Brothers wasn't, and the TARP bailout fund was created. Federal Reserve Chairman Ben Bernanke and Timothy Geithner, who was then president of the Fed's regional bank in New York City, are still in crisis-fighting positions and have not written books about their actions in 2008.
What lessons does the book hold? Perhaps a few that remain relevant for the current occupant of the Oval Office, President Obama. Here are seven that aren’t necessarily conclusions Mr. Paulson himself draws, but they’re framed from what he reports in his book, "On the Brink: Inside the Race to Stop the Collapse of the Global Financial System."
1. Prepare for what you can barely imagine. As storm clouds gathered in the spring of 2008, Paulson and his staff at Treasury prepared what they called a "break the glass" plan, named after the fire axes kept under glass cases for emergencies. The plan included elements of what would later take shape in the Troubled Asset Relief Program, as the crisis emerged in full force that fall. TARP has been unpopular from the get-go, but it helped to prevent a much deeper economic collapse.
Paulson hoped he wouldn't have to use it. He writes that in April, just after the collapse of the investment bank Bear Stearns, Congress was not "anywhere near ready to consider granting us such powers."
Paulson also shares his view on the nation's financial health when he arrived in office in 2006, after being chief executive at Goldman Sachs. He warned George W. Bush that "we were due for [a] disruption." Although he outlined risks including the unregulated derivatives market, "I misread the cause, and the scale, of the coming disaster. Notably absent from my presentation was any mention of problems in housing or mortgages."
2. When a crisis flares up, the rest of the world may fiddle. While in Beijing for the summer Olympic Games, Paulson says he learned that "Russian officials had made a top-level approach to the Chinese, suggesting that together they might sell big chunks of their ... holdings" in Fannie Mae and Freddie Mac debt. The Chinese declined to go along with this scheme to force the US government to prop up the mortgage giants, he writes. (By September, the troubles at Fannie and Freddie had led the firms into federal conservatorship.)
Also, when Paulson was trying to nudge Lehman Brothers into a bankruptcy-avoiding merger that fall, British regulators stood in the way, refusing to waive a required shareholder vote for Barclay's to be the buyer. While Paulson understood their hesitation, he also was surprised and frustrated that the best hope to save Lehman fell apart.
Whether the British acted rightly or not, the crisis – and the response to it – soon became a global affair. Shockwaves from Lehman's bankruptcy prompted nations around the world to act side by side to shore up their banking systems.
3. Your “home team” may be an uncertain ally. Paulson said the Fed had no authority to backstop Lehman, because the firm lacked the kind of collateral that had enabled a loan to Bear Stearns. TARP had not yet been created. Paulson tried to line up private-sector bankers to help finance Lehman’s merger with another firm, arguing that it was in all of their interests. Such collective action had worked during a financial panic in 1907. This time, some of the leading bankers worked their way to a "maybe," but then the effort became moot as the Barclay's deal collapsed.
As the Treasury and Fed mounted a widening financial rescue, which they saw as the lesser-among-evils option, Paulson recounts similar challenges in winning support for his views among politicians. He describes asking presidential candidate John McCain to tone down his antibailout rhetoric. (A Republican, Paulson ends up feeling grateful for Obama's victory, "comforted by the knowledge that our president-elect fully understood the threat our economy still faced.")
4. Having "resolution authority" would help. Obama and his Treasury secretary, Mr. Geithner, already know this lesson cold. After Lehman's disastrous failure and AIG's politically disastrous bailout, most policymakers agree that some middle ground is needed. Resolution authority would allow large financial firms to be put through a bankruptcy-style restructuring, but in a government-managed process designed to maintain financial-system stability.
5. Even with resolution authority, the problem called “too big to fail” may persist. It’s not clear that either Bush/Paulson or Obama/Geithner have come up with reforms to prevent new cycles of risky behavior from threatening the financial system. The next time a giant firm is on the brink, coupled with a wider financial crisis, it's easy to envision more government bailouts.
During the crisis, Federal Deposit Insurance Corp. Chair Sheila Bair asked at one point if CitiGroup should "go through the receivership process," Paulson says. The question was perfectly rational to many finance experts. But at that moment in November, after months of investor uncertainty and even panic, such an action would have required deftness, at the least. If markets saw Citi being taken over, who would they think was safe? Paulson says her words "made my jaw drop."
At the end of the book, he expresses optimism that "well-regulated capital markets can continue to provide economic progress around the world." Most experts agree, but that doesn't mean the progress will be crisis-free.
6. Get the best help you can. Paulson recounts one moment when he yearned for a way to revive investor confidence in the safety of their money-market funds. He was overjoyed when Steve Shafran, a Treasury aide, came up with the idea of using the Treasury's Exchange Stabilization Fund to guarantee those investments. "Go make that happen," Paulson says after slapping his desk.
The former secretary says he also leaned on prayer at times when he felt powerless. (Disclosure: Paulson is an adherent of the Christian Science Church, which publishes this newspaper.)
7. Don’t underestimate Nancy Pelosi. At a December 2008 White House reception, Clint Eastwood approached while Paulson was conferring with the House speaker, who, like the actor, is a Californian. "I don't know what she's talking to you about, but she's stronger than you, Mr. Treasury Secretary," Mr. Eastwood said. "I suggest you do whatever she wants." Paulson says he chuckled appreciatively, having been bested by Ms. Pelosi in some negotiations recounted earlier in the book.
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