Financial Advisors

Paulson Justifies "Terrible" Choices

Henry Paulson confessed that one his lowest moments as Treasury Secretary came as he was about to deliver a speech just as Citigroup was starting to unravel in late 2008.

Paulson, who'd already worked to rescue Lehman, AIG, Fannie, Freddie, and Bear Stearns with the highly unpopular TARP bail-out funds, badly wanted to address Citigroup's problems, but knew if he did not appear for the scheduled speech, it would read by the markets as a sign of more trouble.

He noted the irony of his presence in the Reagan Library: "I was in the temple of free markets and I was an interventionist."

In an anecdote studded Q&A Wednesday morning at the Schwab IMPACT 2010 Conference in Boston, Paulson discussed how he rescued the financial system and saved the country from economic ruin.

To hear Paulson tell it in person, while he was an interventionist, he was a highly reluctant one. But you do things you don't like when are living from catastrophe to catastrophe whose depths you do not want to discover. "These were terrible things we did, but consider the alternative," he said.

As Treasury Secretary, Paulson said he enjoyed a year of essential relationship building before the crisis hit and knew there were problems in housing and mortgage markets. He and many others simply did not appreciate that the problems could lead to collapse of America's premier institutions and eventually the entire financial system.

"A number of us thought [the residential real-estate problems] were contained... and that mortgages were safe investments," he told Liz Ann Sonders, Schwab Chief Investment Strategist. "No one assumed there would be a really steep decline. That was missed. A lot of people pointed out the problems, but there were no solutions." 

Once he understood the gravity of the credit crisis, he asked both Congress and President George W. Bush for unprecedented authority as Treasury Secretary. Advisers warned him if he asked for unlimited authority, he would not get it. So he asked and got it under a different name, "unspecified authority."

Paulson, self-described as a "straight shooter" and "decisive," quickly showed how he would wield his "unspecified" power in his famous "bazooka" quote: "If you have a bazooka in your pocket and people know it, you probably won't have to use it."

Asked if he regretted such bravado, Paulson never answered the question, but it's clear he didn't. Once he realized the "capital hole" at Fannie and Freddie, he used the bazooka and more powerful weaponry, metaphorically speaking.

"I really had to take the bazooka out. I actually out took a big bomb out and we did what we needed to do," he said.

Stabilizing private and quasi public institutions, he reasoned, would "comfort" the markets. And he wrote the rules as he went, given regulatory authority was badly outdated and inadequate to deal with non-bank financial institutions.

"Housing policy was over stimulated. [Fannie and Freddie] held almost $5.4 trillion in mortgage securities with almost no regulation," he said. He complained no one regulator had a comprehensive view of the financial system and that there was "overlap" between agencies. And there was little transparency in the financial markets.

He gave a gripping account of his bargaining for the TARP bail-out funds, which were hugely unpopular with the American public in a presidential election year. During one acrimonious TARP negotiation between Democrats and Republicans that became known as the "circus meeting," he got down on one knee to "break the tension" and begged House Speaker Nancy Pelosi "not to blow this thing (TARP) up."

"Republicans were a difficult lot to me," he said in noting that they compared TARP to a stick in the eye. "Ninety percent of Americans were against TARP and 60% are against torture,' he said.

He said several times that managing in government was much more difficult than in the private sector. He described this chapter in American financial history as a "collision between market and political forces."

Asked why Bear Stearns, Merrill Lynch and other institutions were saved and Lehman Brothers wasn't, his answer was simple: no buyer could be found for Lehman despite intense negotiations with Barclays' Bank fell apart after Paulson grew frustrated with British regulators in holding up the deal. "They would not say no, but they just would not say yes."

In a lighter vein, Paulson said he was asked three times by President Bush to take the Treasury job before he accepted. After all, his wife was a good friend and Wellesley classmate of Hillary Clinton's and his left-leaning mother told him should be "ashamed of himself' going to work for Bush, who Paulson came to like.

"I did not want to look back and say I did not serve my country."

Sonders concluded the hour long Q&A by asking how Paulson thinks history will judge him. "I'll leave history to the historians," he answered. "I did the best I could to prevent the collapse of the financial system."

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