On the Brink
Copyright
Copyright © 2010 by Henry M. Paulson, Jr.
All rights reserved. Except as permitted under the U.S. Copyright Act of 1976, no part of this publication may be reproduced, distributed, or transmitted in any form or by any means, or stored in a database or retrieval system, without the prior written permission of the publisher.
Business Plus
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First eBook Edition: February 2010
ISBN: 978-0-446-56567-7
Contents
Copyright
Main Cast of Characters
Author’s Note
Chapter 1
Chapter 2
Chapter 3
Chapter 4
Chapter 5
Chapter 6
Chapter 7
Chapter 8
Chapter 9
Chapter 10
Chapter 11
Chapter 12
Chapter 13
Chapter 14
Chapter 15
Chapter 16
Illustrations
Afterword
Acronyms Used in the Text
Acknowledgments
About the Author
For Wendy
MAIN CAST OF CHARACTERS
(in Alphabetical Order)
CONGRESS
REP. SPENCER BACHUS (R-Alabama), ranking Republican on the House Committee on Financial Services
SEN. MAX BAUCUS (D-Montana), chairman of the Senate Committee on Finance
REP. ROY BLUNT (R-Missouri), House minority whip
REP. JOHN BOEHNER (R-Ohio), House minority leader
SEN. JIM BUNNING (R-Kentucky), member of the Senate Committee on Banking, Housing, and Urban Affairs
SEN. HILLARY RODHAM CLINTON (D–New York)
SEN. CHRISTOPHER DODD (D-Connecticut), chairman of the Senate Committee on Banking, Housing, and Urban Affairs
REP. RAHM EMANUEL (D-Illinois), chairman of the House Democratic Caucus; later chosen as chief of staff by President-elect Barack Obama
REP. BARNEY FRANK (D-Massachusetts), chairman of the House Committee on Financial Services
SEN. LINDSEY GRAHAM (R–South Carolina), national campaign co-chairman for Sen. John McCain
SEN. JUDD GREGG (R–New Hampshire), ranking Republican on the Senate Committee on the Budget
SEN. MITCH MCCONNELL (R-Kentucky), Senate minority leader
REP. NANCY PELOSI (D-California), Speaker of the House
SEN. HARRY REID (D-Nevada), Senate majority leader
SEN. CHARLES SCHUMER (D–New York), vice chairman of the Senate Democratic Conference
SEN. RICHARD SHELBY (R-Alabama), ranking Republican on the Senate Committee on Banking, Housing, and Urban Affairs
FINANCIAL LEADERS AND THEIR ADVISERS
JOSEF ACKERMANN, chairman of the management board and CEO of Deutsche Bank
HERBERT ALLISON, JR., chairman and CEO of TIAA-CREF; later president and CEO of Fannie Mae
LLOYD BLANKFEIN, chairman and CEO of Goldman Sachs
WARREN BUFFETT, chairman and CEO of Berkshire Hathaway
H. RODGIN COHEN, chairman of Sullivan & Cromwell
MERVYN DAVIES, chairman of Standard Chartered Bank
JAMES DIMON, chairman and CEO of JPMorgan Chase
J. CHRISTOPHER FLOWERS, CEO of J.C. Flowers & Company
RICHARD FULD, chairman and CEO of Lehman Brothers
EDWARD HERLIHY, co-chairman of the executive committee of Wachtell, Lipton, Rosen & Katz
JEFFREY IMMELT, chairman and CEO of General Electric
ROBERT KELLY, chairman and CEO of Bank of New York Mellon
RICHARD KOVACEVICH, chairman of Wells Fargo
KENNETH LEWIS, chairman and CEO of Bank of America
EDWARD LIDDY, chairman and CEO of AIG
JOHN MACK, chairman and CEO of Morgan Stanley
HERBERT (BART) MCDADE III, president of Lehman Brothers
DANIEL MUDD, president and CEO of Fannie Mae
VIKRAM PANDIT, CEO of Citigroup
ROBERT RUBIN, former secretary of the Treasury; director and senior counselor of Citigroup
ALAN SCHWARTZ, CEO of Bear Stearns
ROBERT SCULLY, vice chairman of Morgan Stanley
LAWRENCE SUMMERS, former secretary of the Treasury; chosen as director of the National Economic Council by President-elect Barack Obama
RICHARD SYRON, chairman and CEO of Freddie Mac
JOHN THAIN, chairman and CEO of Merrill Lynch
ROBERT WILLUMSTAD, CEO of AIG
FINANCIAL REGULATORS
SHEILA BAIR, chairman of the Federal Deposit Insurance Corporation
BEN BERNANKE, chairman of the Federal Reserve Board
CHRISTOPHER COX, chairman of the Securities and Exchange Commission
JOHN DUGAN, comptroller of the currency
TIMOTHY GEITHNER, president of the Federal Reserve Bank of New York; later nominated for secretary of the Treasury by President-elect Barack Obama
DONALD KOHN, vice chairman of the Federal Reserve Board
JAMES LOCKHART, director of the Federal Housing Finance Agency
CALLUM MCCARTHY, chairman of the Financial Services Authority (United Kingdom)
KEVIN WARSH, governor of the Federal Reserve Board
INTERNATIONAL LEADERS
ALISTAIR DARLING, chancellor of the Exchequer of the United Kingdom
HU JINTAO, president of the People’s Republic of China
MERVYN KING, governor of the Bank of England
ALEXEI KUDRIN, finance minister of Russia
CHRISTINE LAGARDE, finance minister of France
ANGELA MERKEL, chancellor of Germany
VLADIMIR PUTIN, prime minister of Russia
NICOLAS SARKOZY, president of France
JEAN-CLAUDE TRICHET, president of the European Central Bank
WANG QISHAN, vice premier of the State Council of the People’s Republic of China
WU YI, vice premier of the State Council of the People’s Republic of China
ZHOU XIAOCHUAN, governor of the central bank of the People’s Republic of China
PRESIDENTIAL CANDIDATES AND THEIR RUNNING MATES
SEN. JOSEPH BIDEN, JR. (D-Delaware), vice presidential candidate for the Democratic Party; later elected 47th vice president of the United States
SEN. JOHN MCCAIN (R-Arizona), presidential candidate for the Republican Party
SEN. BARACK OBAMA (D-Illinois), presidential candidate for the Democratic Party; later elected 44th president of the United States
GOV. SARAH PALIN (R-Alaska), vice presidential candidate for the Republican Party
TREASURY DEPARTMENT
MICHELE DAVIS, assistant secretary for public affairs and director of policy planning
KEVIN FROMER, assistant secretary for legislative affairs
ROBERT HOYT, general counsel
DAN JESTER, contractor
NEEL KASHKARI, assistant secretary for international economics and development and interim assistant secretary for financial stability
JAMES LAMBRIGHT, chief investment officer of TARP
CLAY LOWERY, acting undersecretary for international affairs
JEB MASON, deputy assistant secretary for business affairs
DAVID MCCORMICK, undersecretary for international affairs
DAVID NASON, assistant secretary for financial institutions
JEREMIAH NORTON, deputy assistant secretar
y for financial institutions policy
KARTHIK RAMANATHAN, director of the Office of Debt Management
ANTHONY RYAN, assistant secretary for financial markets
STEVEN SHAFRAN, senior adviser to the secretary of the Treasury
ROBERT STEEL, undersecretary for domestic finance; later president and CEO of Wachovia
PHILLIP SWAGEL, assistant secretary for economic policy
JAMES WILKINSON, chief of staff
KENDRICK WILSON, contractor
WHITE HOUSE
JOSHUA BOLTEN, chief of staff
GEORGE W. BUSH, 43rd president of the United States
RICHARD CHENEY, 46th vice president of the United States
EDWARD GILLESPIE, counselor to the president
STEPHEN HADLEY, national security adviser
KEITH HENNESSEY, assistant to the president for economic policy; later director of the National Economic Council
JOEL KAPLAN, deputy chief of staff for policy
EDWARD LAZEAR, chairman of the Council of Economic Advisers
DANIEL MEYER, assistant to the president for legislative affairs
AUTHOR’S NOTE
The pace of events during the financial crisis of 2008 was truly breathtaking. In this book, I have done my best to describe my actions and the thinking behind them during that time, and to convey the breakneck speed at which events were happening all around us.
I believe the most important part of this story is the way Ben Bernanke, Tim Geithner, and I worked as a team through the worst financial crisis since the Great Depression. There can’t be many other examples of economic leaders managing a crisis who had as much trust in one another as we did. Our partnership proved to be an enormous asset during an incredibly difficult period. But at the same time, this is my story, and as hard as I have tried to reflect the contributions made by everyone involved, it is primarily about my work and that of my talented and dedicated team at Treasury.
I have been blessed with a good memory, so I have almost never needed to take notes. I don’t use e-mail. I rarely take papers to meetings. I frustrated my Treasury staff by seldom using briefing memos. Much of my work was done on the phone, but there is no official record of many of the calls. My phone log has inaccuracies and omissions. To write this book, I called on the memories of many of the people who were with me during these events. Still, given the high degree of stress during this time and the extraordinary number of problems I was juggling in a single day, and often in a single hour, I am sure there are many details I will never recall.
I’m a candid person by nature and I’ve attempted to give the unbridled truth. I call it the way I see it.
In Washington, congressional and executive branch leaders are underappreciated for their work ethic and for the talents they apply to difficult jobs. As a result, this book has many heroes.
I’ve also tried to tell this story so that it could be readily understood by readers of widely varying degrees of financial expertise. That said, I am sure it is overly simplified in some places and too complex in others. Throughout the narrative, I cite changes in stock prices and credit default swap rates, not because those numbers matter in and of themselves, but because they are the most effective way to represent the plummeting confidence and rising sense of crisis in our financial markets and our economy during this period.
I now have heightened respect for anyone who has ever written a book. Even with a great deal of help from others, I have found the process to be most challenging.
There is no question that these were extraordinary and tumultuous times. Here is my story.
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 your shareholders?” 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 official 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.
I explained that we had teams of lawyers, bank examiners, computer specialists, and others on standby, ready to roll into the companies’ offices and secure their premises, trading floors, books and records, and so forth. We had already picked replacement chief executives. David Moffett, a former chief financial officer from U.S. Bancorp, one of the few nearly pristine big banks in the country, was on board for Freddie Mac. For Fannie Mae we’d selected former TIAA-CREF chief executive and chairman Herb Allison. (He was vacationing in the Caribbean, and when I reached him later and twisted his arm to come to Washington the next day, he’d initially protested: “Hank, I’m in my flip-flops. I don’t even have a suit down here.” But he’d agreed to come.)