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

In our previous efforts with Congress—the 2008 stimulus bill and GSE reform—we’d had weeks to come up with plans and prep lawmakers. Now, facing a much more severe situation, we no longer had that luxury. Treasury staff worked straight through the night to Thursday morning. Most people broke for an hour around 5:00 a.m. or 6:00 a.m. to go home, shower, and change their clothes, then came straight back to the office. Others, like Neel Kashkari, showered in the gym at Treasury and slept in their offices. All learned to get by on little sleep and bad food.

Looking at my team’s tired faces, I remembered the lectures I used to give at Goldman on the need to balance one’s work and life. But back then I never foresaw a situation like this, with multiple crises demanding solutions, and the entire economy on the brink.

Early Thursday morning, members of my staff began to stream in and out of my office, briefing me, listening in on my phone calls. Weary but alert, most had worked through the night on one of the three crisis teams we had set up to look into policy issues, asset purchases, and credit markets. Another grinding day stretched out before us. The U.K. and Ireland were readying restrictions on short selling. Russia had suspended stock trading for a third straight day.

Just before 9:00 a.m. I took an unexpected call from Bob Scully, the Morgan Stanley vice chairman, who had played such a critical role in August in helping Treasury prepare to place Fannie Mae and Freddie Mac into conservatorship. A consummate banker, he had never spoken about his own firm during that period. But now he was calling to tell me that speculators and short sellers were not only driving Morgan Stanley’s shares down but also undermining confidence in the investment bank. As nervous counterparties shied from the firm, its liquidity was declining rapidly. He didn’t know what I could do, but he said he felt obliged to tell me, point-blank, that he was not sure Morgan Stanley was going to make it.

Coming from Bob, always calm and levelheaded, this was an alarming message. I alerted Tim Geithner and then called Chris Cox to urge him again to do something to end abusive short selling. I had been pressing Chris with increasing intensity since Monday. We’d spoken seven times Wednesday and would speak just as frequently Thursday on the subject. I implored him not to sit idly by while our financial system was destroyed by speculators. Any other time, I would have argued strongly against a ban, but my reasoning now was pragmatic: our short-selling rules hadn’t been written for these conditions, and whatever we chose to do couldn’t be worse than the panic we were now seeing. Chris worried about unintended consequences to the market.

“If you wait any longer,” I said, “there won’t be a market left to regulate.”

Chris also faced opposition from within his own agency and from his fellow commissioners. He reiterated that he needed the clear public backing of Ben Bernanke, Tim, and me. Tim had concerns that a ban might inhibit risk taking and be destabilizing—the trading strategies of many highly leveraged hedge funds depended on shorting.

Not long after that, I spoke to the president, who had canceled a fund-raising trip to Alabama and Florida to focus on the financial emergency. He was joined by Deputy Chief of Staff Joel Kaplan. I told them that the crisis had reached the point where we were going to have to take dramatic actions, including going to Congress for sweeping fiscal authorities. The president seemed supportive but asked that I make sure to fully brief his whole team. It was essential that everyone in the executive branch work together, because we all knew it would be difficult to get Congress to act.

At 9:30 a.m. my staff and I got on a conference call with Tim, Ben, Chris, and their people. The Fed was working hard to ease liquidity pressures in global markets. At 3:00 a.m. New York time—8:00 a.m. in London—it had announced a dramatic $180 billion expansion of its swap lines, which made dollars available to other central banks for the needs of their commercial banks.

I was particularly worried about the money market funds. Treasury’s Steve Shafran and his group, who had been working with the Fed people all night, had put together a list of ideas to improve liquidity. One idea would have had the Fed provide long-term financing to the investment banks in addition to the short-term money they already had access to. Another would have let the money funds borrow directly from the Fed.

“That won’t stop a run,” I said. If anything, a money fund borrowing from the Fed would be stigmatized and suffer even more withdrawals. “What would you do if you wanted to be more decisive than that?”

Steve threw out another suggestion: “Well, we could use the Exchange Stabilization Fund to guarantee the money market funds.”

I slapped my desk. It was exactly what I was looking for—the strong step the situation required: something dramatic that would prevent an impending implosion of $3.5 trillion in money market funds.

“That’s what I want to do,” I told him. “Go make that happen.”

Guaranteeing the money markets was an inspired idea; the problem was how to do it. Shafran’s insight was crucial. Treasury had next to no funding power—with one exception. The Gold Reserve Act of 1934 had created the Exchange Stabilization Fund (ESF) to allow Treasury to intervene in the foreign exchange market to stabilize the dollar. The ESF had been used very selectively over the years, most controversially when President Bill Clinton tapped it in 1995 to extend up to $20 billion in loans to Mexico. Now money market funds were being hit by massive redemptions, some of them from skittish overseas investors. A collapse of the money fund industry could easily lead to a run on the dollar. If the president approved, we could use the ESF, which totaled about $50 billion, to fund the money market guarantee initially.

David Nason had put off his decision to leave Treasury to help us at this critical time, and I asked him to work with Steve. David had been at the SEC, and I knew that he had a long list of contacts in the money market industry as well as the technical expertise to design a temporary guarantee program. Even as they faced a rash of redemptions, money funds were choking on asset-backed commercial paper that they couldn’t sell. Fed staffers were working on ways to purchase this paper from the money funds.

“Hank, are you willing to go to the Hill and get fiscal authority?” Bernanke asked.

“Ben, Ben, Ben,” I interrupted, realizing I hadn’t had time to update him on my just-concluded call with the president. “You and I will be going to the White House.”

After the call, I asked my team to prepare a short presentation for the president. Joel Kaplan had wisely suggested that the most efficient way to brief the key White House staff was for them to sit in on our meetings at Treasury. By 1:30 p.m., Joel, Ed Lazear, Keith Hennessey, and Dan Meyer had come over to Treasury. They would spend many hours over the next few weeks with us, and I could tell they were taken aback by the atmosphere. There were probably 15 people in my office at all times, huddled in clusters and holding separate meetings, talking at a hundred miles an hour, as I sat at my desk in the center of the whirlwind. There was virtually a running conference call with Tim and Ben, with people getting off the line and getting back on. I’d be talking to someone else on my phone, always trying to speed things along.

Now the White House crew crowded into my office with Treasury staff for a scheduled call with Ben, Tim, and Chris. I did much of the talking.

“This is the economic equivalent of war,” I said. “The market is ready to collapse.”