Henry Paulson - On the Brink - Inside the Race to Stop the Collapse of the Global Financial System

In addition, the mechanics of securitization impeded speedy modifications: homeowners no longer dealt with a single lender. Their mortgages had been sliced and diced and sold to investors around the world, making the modification process much more difficult.

I asked special assistant Neel Kashkari to take on the foreclosure effort. He promptly set up a series of meetings that included lenders, subprime servicers, counseling agencies, and industry advocacy groups like the American Securitization Forum (ASF) and the Mortgage Bankers Association, with the goal of getting the parties to improve communication and coordinate their actions to avoid preventable foreclosures. I told my team that I didn’t want to hear of a single family being foreclosed on if they could be saved with a modification.

On October 10, HUD and Treasury unveiled the result of Neel’s efforts: the HOPE Now Alliance, created to reach out to struggling borrowers and encourage them to work with counselors and their mortgage servicers. This sounded simple, but it had never been tried before. Notably, the program would not require any government funding.

We felt a sense of urgency. As bad as things were, we knew they would get a lot worse. We calculated that about 1.8 million subprime ARMs would reset from 2008 to 2010.

To deal with this problem, Neel worked with the ASF and the big lenders on ways to speed up loan modifications. Surprisingly, the servicers contended that resets were not the critical issue. Rather, a good number of borrowers had other circumstances that drove them into foreclosure; many were overextended with other debts—auto loans or credit cards, for example. As Treasury’s chief economist Phill Swagel looked into the loans, he saw that often the original underwriting was not the sole cause of foreclosures. As he would put it, “Too many borrowers were in the wrong house, not the wrong mortgage.”

Still, resets remained a concern, and we pushed the industry for faster loan modifications. Given the volume of problem mortgages, lenders could no longer take a loan-by-loan approach; we needed a streamlined solution. FDIC chairman Sheila Bair, who deserves credit for identifying the foreclosure debacle early, had proposed freezing rates. Treasury worked with the HOPE Now Alliance and the ASF to come up with a workable plan, and on December 6, 2007, I announced that thanks to this effort, up to two-thirds of the subprime loans scheduled to reset in 2008 and 2009 would be eligible for fast-tracking into affordable refinanced or modified mortgages.

My announcement was part of a bigger presentation that day at the White House in which President Bush laid out a program that would freeze interest rates for five years for those people who had the basic means to stay in their homes. The president also explained our outreach program, but this did not go off without a hitch: When it came time to announce the counseling hotline, instead of saying, “1-888-995-HOPE,” he said, “1-800-995-HOPE,” which turned out to be the number of a Texas-based group that provided Christian homeschooling material.

Despite this inauspicious start, many people called the hotline and were able to get help and keep their homes. But after all of our concerns about resets, interest rates ended up not being an issue once the Fed began to cut rates. By the end of January 2008, the central bank had slashed the Fed funds rate to 3 percent from 5.25 percent in mid-August.

HOPE Now received criticism from all sides of the political spectrum. Conservatives didn’t like the idea of bailing out homeowners, even though HOPE Now gave out no public money. Many Democrats and housing advocates complained that we weren’t doing enough, but much of this (from lawmakers, anyway) was posturing—until late 2008, there was no congressional support to spend money to prevent foreclosures.

HOPE Now wasn’t perfect, but I think it was an overall success. Government action was essential because even a few foreclosures could blight an entire community, depressing the property values of homeowners who were current on their payments, destroying jobs, and setting off a downward spiral. The program helped a great many homeowners get loan modifications or refinance into fixed-rate mortgages—almost 700,000 in just the last three months of 2008 alone, more than half of them subprime borrowers. The Alliance grew to include servicers that handled 90 percent of subprime mortgages.

But the hard fact was that we could not help people with larger financial issues—those who had lost their jobs, for example. And as the credit crisis continued, I became concerned that a slowdown in consumer lending could lead to full-fledged recession. After investors stopped buying asset-backed commercial paper in the wake of August’s credit meltdown, it was harder for people to get all kinds of loans—credit cards or loans for cars and college. The banks, forced to put on their balance sheets loans previously financed by asset-backed commercial paper, suddenly became stingy with new credits.

Throughout the fall of 2007, the markets remained tight and unpredictable. In mid-September, British mortgage lender Northern Rock sought emergency support from the Bank of England, sparking a run on deposits. Coincidentally, I had scheduled a trip to France and the U.K. just a couple of days later, flying first to Paris on September 16 to meet with President Nicolas Sarkozy and his finance minister, Christine Lagarde. I noted how the French leader took a political approach to the financial markets. In his view, political leaders needed to take decisive action to revive public confidence—and he wanted to scapegoat the rating agencies.

I disagreed. “The rating agencies have made a lot of mistakes,” I told him. “But it’s hard to say that all of this should be blamed on them.”

Still, I had to give Sarkozy credit: he understood the growing public resentment and the need for government to take aggressive actions to satisfy it. And the rating agencies did need to be reformed.

Overall, I found the French president to be engaging, with a biting sense of humor. He joked with me about the many Goldman Sachs leaders who had worked for the government. Perhaps he should look for a job at Goldman in a few years, he said. I can only wonder what he might think today.

I had become more worried over the summer about the dangers posed by the hidden leverage of major U.S. banks. Though entities like SIVs ostensibly operated off balance sheets, the banks frequently remained connected to them through, among other things, backup lines of credit. Starved for funding, the SIVs would have to turn to their sponsoring banks for help or liquidate their holdings at bargain prices, devastating a wide range of market participants.

I asked Bob Steel, Tony Ryan, and Karthik Ramanathan to figure out a private-sector solution. They presented me with a plan for what we would dub the Master Liquidity Enhancement Conduit, or MLEC. (Because this was a mouthful, the press ended up calling it the Super SIV.)

The idea was simple. Private-sector banks would set up an investment fund to buy the high-rated but illiquid assets from the SIVs. With the explicit backing of the biggest banks, and Treasury’s encouragement, the MLEC would be able to finance itself by issuing commercial paper. With secure financing to hold securities longer-term, it would avert panic selling, help set more rational prices in the market, allow existing SIVs to wind down in orderly fashion, and restore liquidity to the short-term market. We just needed to get everyone on board.

Industry leaders had a mixed response to the plan. Finally, on October 15, 2007, a month after the first meeting, JPMorgan, Bank of America, and Citi announced that they and other banks would put in upward of $75 billion to fund MLEC, but the announcement met with skepticism in the press. Critics predicted that the industry would never go along with the plan, and in the end, they were right. Banks dealt with the problem assets themselves by taking them onto their balance sheets or selling them.