Paulson Calls For More Financial Regulatory Power

Then-Treasury Secretary Henry Paulson speaks during a 2008 news conference.

hide captionThen-Treasury Secretary Henry Paulson speaks on Sept. 7, 2008, during a news conference on the bailout of mortgage giants Fannie Mae and Freddie Mac. Paulson has written a memoir recounting key moments of the financial crisis.

Timeline: A Year Of Financial Crisis
Susan Walsh/AP

Book Excerpt

This week, the Senate Banking Committee considered the Obama administration's plan to limit the growth of the country's largest banks. The proposal comes after the unpopular — some say, necessary — bank bailouts by the U.S. government.

Former Treasury Secretary Henry Paulson led that federal intervention, aimed at slowing the nation's economic meltdown. And it's a subject he addresses in his new memoir, On the Brink: Inside the Race to Stop the Collapse of the Global Financial System.

In an interview with host Scott Simon, Paulson says the U.S. needs more regulatory power to prevent another financial crisis and he addresses some key questions about his tenure during one of the darkest eras of American economic history.

"We need the authority — and the Obama administration, Congress is working on creating that authority — so that if necessary, a regulator can step in and has the power to liquidate an institution, to liquidate and let it fail in a manner so that it doesn't hurt the American people," Paulson says.

What would have happened if the government hadn't intervened in the financial crisis?

More From Former Treasury Secretary Henry Paulson

"It would have been very bad. I knew we were on the brink when blue-chip industrial companies were having trouble raising money," Paulson says. "If the system had collapsed, many, many Main Street companies, not Wall Street companies, but Main Street companies of all size would have had trouble raising the money to fund themselves."

Paulson says this would have created a ripple effect throughout the economy — companies wouldn't have been able to pay their employees, and employees wouldn't have been able to pay their bills.

"We have today, after everything that's been done, a very painful unemployment situation —10 percent," Paulson says. [The Labor Department reported Friday that the jobless rate fell to 9.7 percent last month.] "The Great Depression: Unemployment got to 25 percent. I think if the system had collapsed, we easily could have had unemployment of 25 percent."

Paulson says he worked closely during his tenure with Federal Reserve Chairman Ben Bernanke and Timothy Geithner, who was then president of the New York Federal Reserve and now serves as Treasury secretary. These were "three people who trusted each other, who had skills that complemented each other, [and] appreciated each other," he says.

What lessons can you draw from the decision that was made not to rescue Lehman Brothers?

Paulson says one of the worst days of the crisis was on Sept. 14, 2008, when the U.S. government learned that a British regular wasn't going to approve a deal to rescue Lehman Brothers. This led to the Wall Street firm's filing for bankruptcy protection and, ultimately, liquidation.

"And I just remember being overcome momentarily with fear, knowing that everyone was looking to me to provide answers, and we were working with an incomplete toolbox," Paulson recalls. "The U.S. government had essentially not updated the authorities and powers that the executive branch had since the Depression."

In your book, you indicate that Americans' relative lack of savings helped to propel the financial crisis. But to spur the economy, don't we have to spend more and create jobs?

"That's a conundrum," Paulson says. "But we as a nation save too little and we borrow too much, both individually and the government. And I believe — I feel so strongly about this point — that if as a consequence of what we are going through, Americans are saving more and spending less, I think it's a good thing."

Excerpt: 'On the Brink'

Chapter 1

Thursday, September 4, 2008

Do they know it's coming, Hank?" President Bush asked me.

"Mr. President," I said, "we're going to move quickly and take them by surprise. The first sound they'll hear is their heads hitting the floor."

It was Thursday morning, September 4, 2008, and we were in the Oval Office of the White House discussing the fate of Fannie Mae and Freddie Mac, the troubled housing finance giants. For the good of the country, I had proposed that we seize control of the companies, fire their bosses, and prepare to provide up to $100 billion of capital support for each. If we did not act immediately, Fannie and Freddie would, I feared, take down the financial system, and the global economy, with them.

I'm a straightforward person. I like to be direct with people. But I knew that we had to ambush Fannie and Freddie. We could give them no room to maneuver. We couldn't very well go to Daniel Mudd at Fannie Mae or Richard Syron at Freddie Mac and say: "Here's our idea for how to save you. Why don't we just take you over and throw you out of your jobs, and do it in a way that protects the taxpayer to the disadvantage of yourshareholders?" The news would leak, and they'd fight. They'd go to their many powerful friends on Capitol Hill or to the courts, and the resulting delays would cause panic in the markets. We'd trigger the very disaster we were trying to avoid.

I had come alone to the White House from an 8:00 a.m. meeting at Treasury with Ben Bernanke, the chairman of the Federal Reserve Board, who shared my concerns, and Jim Lockhart, head of the Federal Housing Finance Agency (FHFA), the main regulator for Fannie and Freddie. Many of our staffers had been up all night — we had all been putting in 18-hour days during the summer and through the preceding Labor Day holiday weekend — to hammer out the language and documents that would allow us to make the move. We weren't quite there yet, but it was time to get the president's offcial approval. We wanted to place Fannie and Freddie into conservatorship over the weekend and make sure that everything was wrapped up before the Asian markets opened Sunday night.

The mood was somber as I laid out our plans to the president and his top advisers, who included White House chief of staff Josh Bolten; deputy chief of staff Joel Kaplan; Ed Lazear, chairman of the Council of Economic Advisers; Keith Hennessey, director of the National Economic Council (NEC); and Jim Nussle, director of the Office of Management and Budget. The night before, Alaska governor Sarah Palin had electrified the Republican National Convention in St. Paul, Minnesota, with her speech accepting the nomination as the party's vice presidential candidate, but there was no mention of that in the Oval Office. St. Paul might as well have been on another planet.

The president and his advisers were well informed of the seriousness of the situation. Less than two weeks before, I had gotten on a secure videoconference line in the West Wing to brief the president at his ranch in Crawford, Texas, and explained my thinking. Like him, I am a firm believer in free markets, and I certainly hadn't come to Washington planning to do anything to inject the government into the private sector. But Fannie and Freddie were congressionally chartered companies that already relied heavily on implicit government support, and in August, along with Bernanke, I'd come to the conclusion that taking them over was the best way to avert a meltdown, keep mortgage financing available, stabilize markets, and protect the taxpayer. The president had agreed.

It is hard to exaggerate how central Fannie and Freddie were to U.S. markets. Between them they owned or guaranteed more than $5 trillion in residential mortgages and mortgage-backed securities — about half of all those in the country. To finance operations, they were among the biggest issuers of debt in the world: a total of about $1.7 trillion for the pair. They were in the markets constantly, borrowing more than $20 billion a week at times.

But investors were losing faith in them — for good reason. Combined, they already had $5.5 billion in net losses for the year to date. Their common share prices had plunged — to $7.32 for Fannie the day before from $66 one year earlier. The previous month, Standard & Poor's, the rating agency, had twice downgraded the preferred stock of both companies. Investors were shying away from their auctions, raising the cost of their borrowings and making existing debt holders increasingly nervous. By the end of August, neither could raise equity capital from private investors or in the public markets.

Moreover, the financial system was increasingly shaky. Commercial and investment bank stocks were under pressure, and we were nervously monitoring the health of several ailing institutions, including Wachovia Corporation, Washington Mutual, and Lehman Brothers. We had seen what happened in March when Bear Stearns's counterparties — the other banks and investment houses that lent it money or bought its securities — abruptly turned away. We had survived that, but the collapse of Fannie and Freddie would be catastrophic. Seemingly everyone in the world — little banks, big banks, foreign central banks, money market funds — owned their paper or was a counterparty. Investors would lose tens of billions; foreigners would lose confidence in the U.S. It might cause a run on the dollar.

The president, in suit coat and tie as always, was all business, engaged and focused on our tactics. He leaned forward in his blue-and-yellow-striped armchair. I sat in the armchair to his right; the others were crowded on facing sofas.

I told the president we planned to summon the top management of Fannie and Freddie to meet with Bernanke, Lockhart, and me the following afternoon. We'd lay out our decision and then present it to their boards on Saturday: we would put $100 billion of capital behind each, with hundreds of billions of dollars more available beyond that, and assure both companies of ample credit lines from the government. Obviously we preferred that they voluntarily acquiesce. But if they did not, we would seize them

Reprinted from On the Brink: Inside the Race to Stop the Collapse of the Global Financial System by Henry M. Paulson. Copyright 2010 by Henry M. Paulson. Used with permission of the publisher, Hachette Book Group.

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