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

Around 8:30 a.m. I gathered my team in the large conference room. I told them we needed to figure out a way to get ahead of the markets and stabilize the system before other institutions went down. I told them Ben had made it clear that we couldn’t rely on the Fed alone to solve the problem for us.

“This is our moment of truth,” I said. “We’ve been dealing with one-off firefights, and we need to break the back of this crisis now.”

I laid down two principles for my team to follow as we worked on solutions. First, any policies would have to be simple and easily understood by the markets. Second, our actions had to be decisive and overwhelming—I learned this lesson back in July during the Fannie and Freddie crisis.

With an eye toward managing the workload and spurring creativity, my team had already divided into groups to handle different aspects of the crisis. One team of Treasury staff, led by Steve Shafran, had begun working the previous evening with Fed staff in Washington and New York to develop solutions for the credit markets. A second group, headed by Neel Kashkari, would focus on ways to purchase the toxic assets clogging bank balance sheets. Dave McCormick and Ken Wilson would head a third team, working with the SEC on policy issues such as short selling.

I’d long since learned that you couldn’t get anything done in Washington without a crisis. Well, this was an ongoing series of crises coming at us from all directions, all at once. At Goldman Sachs I had prided myself on my ability to handle many different issues simultaneously, but at Treasury I faced a different challenge. Each of the issues confronting me was enormously important—a wrong decision would hurt not just one client or one firm but the entire financial system and many millions of people in the U.S. and around the world.

Just after 1:00 p.m., John Mack called me in alarm. Morgan Stanley was under siege. Its shares had fallen below $20, and its CDS rates were way up—they were trading at around 800 basis points. To put that in perspective, Lehman had topped off at 707 basis points the Friday before—and it had gone belly-up. Short sellers were laying Mack’s bank low. “We need some action,” he said.

But John and his team weren’t about to go down without a fight. He said Morgan Stanley was looking to raise capital from strategic investors, and that the Chinese were a strong possibility. China Investment Corporation, the country’s sovereign wealth fund, already owned 9.9 percent of his firm.

“All the signals we get are that they’d like some reassurance and encouragement from you,” Mack said.

He asked if I’d be willing to talk to my old friend Wang Qishan, China’s vice premier in charge of economic and financial matters. I told John he could count on our support, and that Dave McCormick would follow up with him.

Shortly after that, Hillary Clinton called me on behalf of Mickey Kantor, who had served as Commerce secretary in the Clinton administration and now represented a group of Middle Eastern investors. These investors, Hillary said, wanted to buy AIG. “Maybe the government doesn’t have to do anything,” she said.

I explained to her that this was impossible unless the investors had a big balance sheet and the wherewithal to guarantee all of AIG’s liabilities.

Her call stands out in my mind because it reflected the general sentiment about AIG—that it was a good company with many interested buyers. The market believed that its problem was liquidity, not capital.

When I finally had a few minutes to deal with the Morgan Stanley situation, I called Chris Cox to discuss market manipulation. The investment bank’s falling stock price and widening CDS appeared to be driven by hedge funds and speculators. I wanted the SEC to investigate what looked to me to be predatory, collusive behavior as our banks were being attacked one by one.

Chris was considering various steps the SEC could take, including a temporary ban on short selling, but his board was divided. He wanted Tim, Ben, and me to support him on the need for a ban.

The short-selling debate was another of those issues where I found myself forced to do the opposite of what I had believed for my entire career. Short selling is a crucial element in price discovery and transparency—after all, David Einhorn, the hedge fund manager who shorted Lehman, had ultimately been proved right. I had long compared banning short selling to burning books, but now I recognized short selling as a big problem. I concluded that even though an outright ban would lead to all sorts of unintended consequences, it couldn’t be worse than what we were experiencing just then. We needed to do something.

Wednesday afternoon I was cleared to fight all the fires we faced. I had sold my shares in Goldman Sachs and severed ties with the firm when I became Treasury secretary. I had also signed an ethics agreement that precluded me from being involved in any government transaction “particular to Goldman Sachs.” With the two remaining investment banks on the edge, Tim Geithner argued that my role as Treasury secretary demanded that I get involved. We were in a national emergency, and I knew he was right. I obtained clearance from the White House counsel’s office and the career designated agency ethics officer at Treasury.

We had set up a 3:00 p.m. call to review the progress of our three workstreams and to prepare for another long night of work. My office filled with people as we reviewed the state of play. The markets were in near chaos. Stocks were plunging—the Dow was on its way to a drop of 449 points, or 4.1 percent. The credit markets were locked up.

The turmoil was going global. Russia had suspended trading for an hour on Tuesday, and its stock market shut down again on Wednesday. Karthik Ramanathan was fielding panicky calls from central bank reserve managers begging us to improve liquidity in the Treasury market. Some even wanted Treasury to pay for securities that the banks’ counterparties could not return.

At one point, Ben brought up the need to go to Congress. I couldn’t have agreed more, but I was so preoccupied with the steps involved in getting emergency powers that I didn’t respond. I was caught up in thinking of all that would have to be done, not least getting the White House on board. The president, I was sure, would support us, but we would need to get his press office, policy people, and legislative affairs staff involved in a course of action that we all knew was going to be very difficult and that some doubted could be successful. We needed to craft a winning strategy for the Hill and find a way to hold the financial system together while waiting for Congress to act.

We started to map out a comprehensive plan to deal with all the elements of the crisis that kept popping up. We had to tackle each problem as it arose and simultaneously devise a more far-reaching solution that we could present to the House and Senate.

The members of the three teams we’d set up earlier cranked away on their assignments: credit markets, asset purchases, policy. Periodically they would gather in my office to touch base and get direction, then they would go back to work for a few more hours. The credit markets team had been tasked with our most pressing issue: finding ways to add liquidity to the money markets and help the asset-backed commercial paper market before it pulled down companies like GE. Working with the SEC, the policy team investigated a wide range of issues: among them, whether regulators should reinstate the rule allowing short selling only on a stock’s uptick and whether fair-value accounting rules should be adjusted regarding bank mergers. The team working on illiquid asset purchases hashed out three questions: what assets to buy, whom to buy them from, and how to buy them. As a starting point, we turned to Neel Kashkari and Phill Swagel’s “Break the Glass” plan from the previous spring, which had outlined possibilities for recapitalizing the banks.