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

We couldn’t keep using duct tape and baling wire to try to hold the system together. This was a national crisis and both the executive and the legislative branches of government needed to be involved. Although I was determined to get new powers, I knew how hard it would be to win them and how difficult it would be to hold the system together while we were trying. We would have to choose carefully the authorities we requested, while honing our approach to Congress. It was Treasury’s most crucial legislative undertaking since the Great Depression. The stakes were incalculably high: the cost of asking for powers and failing to get them might be bigger than not asking at all.

Chris raised the issue of a short-selling ban. Tim and Ben joined me in expressing support for a ban, which gave Chris the backing he needed to go to the rest of the commissioners for approval. We went through the need to guarantee the money market funds. I admitted that we still didn’t know exactly how the program would work. The complexities were enough to make your head spin, but I was firm: “We’ve got to go with this.”

Almost everyone liked the idea, but some were concerned that we were moving too fast. But frankly we had no choice but to fly by the seat of our pants, making it up as we went along. The alternative, waiting till we had figured out every angle, was untenable.

Before going to the White House, I called Ben and told him that the president was going to want to press him on the extent of his authorities, because the thought of being totally dependent on Congress was anathema to the administration. The president would want to know what the Fed could do if Congress didn’t grant us the powers we needed. I encouraged Ben to think expansively. “If the market thinks Congress is our last line of defense, and they turn us down, it will be fatal,” I said.

On my way to the White House, Nancy Pelosi called to ask about the market. She had wanted me to come up the following morning with Ben to brief the Democratic leadership. I related just how bad things were and told her we would have to go to the Hill that night to ask for emergency powers. She asked why it couldn’t wait until the morning, and I replied it might be too late by then.

“We need legislation passed quickly,” I said. “We need to send a strong signal to the market now.”

The Speaker immediately pushed to put stimulus spending into any bill. “Nancy, we’re racing to prevent a collapse of the financial markets,” I told her. “This isn’t the time for stimulus.”

A large group gathered in the Roosevelt Room at 3:30 p.m. to meet with the president. Ben, Chris, and Fed governor Kevin Warsh were there, along with a hefty contingent of White House and Treasury staff. Joel Kaplan had warned the president ahead of time that Ben and I were on edge.

I began by telling the president that the Fed and Treasury were preparing to take some extraordinary steps and that we were going to need to get special powers from Congress.

“Mr. President, we are witnessing a financial panic,” Ben put in. He vividly described what we were seeing in the markets, from the travails of commercial paper issuers to the difficulties in secured lending, and where this all might lead if we didn’t find a way to stop its spread now.

“Is this the worst crisis since the Great Depression?” the president asked.

“Yes,” Ben replied. “In terms of the financial system, we’ve not seen anything like this since the 1930s, and it could get worse.”

Individuals and companies were in imminent danger, I told the president: “Money market funds are on the verge of breaking. Companies are taking drastic measures to preserve their finances—not just the big banks, but also companies like General Electric and Ford.”

We had been dealing with these crises one at a time, on an ad hoc basis. But now we needed to take a more systematic approach before we bled to death. We all knew that the root cause lay in the housing market collapse that had clogged bank balance sheets with toxic mortgage assets that made them unwilling to lend. We were going to need to buy those bad assets where necessary, actions that required new powers from Congress and a massive appropriation of funds. In asking for this, we would be bailing out Wall Street. And that would look just plain bad to everyone from free-market devotees to populist demagogues. But not doing this would be disastrous for Main Street and ordinary citizens.

President Bush was very concerned about the money market funds and commercial paper markets because of how deeply they affected the average American’s daily life. As he said, “You’ve got to protect the guy in Midland, Texas, who wants to take $10,000 out of his money market fund to buy something.”

The president listened intently as we briefed him on the actions we planned to roll out: Treasury’s money fund guarantees and the Fed’s liquidity facility for asset-backed commercial paper. Although he had a genuine contempt for Wall Street and its minions, he did not let that stand in the way of what he thought had to be done. Just as he had swallowed hard to win Fannie and Freddie reform legislation in July, he now pushed his personal feelings aside.

“If we’re in the midst of a financial meltdown, all I’m asking is whether it will work,” President Bush said. He noted that we didn’t have time to worry about politics. We had to figure out the right thing to do and let Congress know that it needed to act.

“Tell the Hill we’re fixing to have a meltdown,” he said. “We just need to tell them that this is our strategy and be firm.”

I then asked Ben what the Fed could do if Congress refused to grant the powers we needed. I asked this because I knew that the president needed to hear the answer.

Ben insisted that, legally, there was nothing more that the Fed could do. The central bank had already strained its resources and pushed the limits of its powers. The situation called for fiscal policy, and Congress needed to make the judgment. President Bush pushed him, but he held firm.

“We are past the point of what the Fed and Treasury can do on their own,” Ben said.

President Bush had never wavered in backing us, but that day he was exceptionally reassuring. He promised that his entire team would work with us to get congressional action as quickly as possible. After the meeting began to break up, he walked around the Roosevelt Room patting people on their shoulders.

“We’re going to get through this,” he told us. “We have to get through this.”

I later learned that he took Michele Davis aside and said, “Tell Hank to calm down and get some sleep, because he’s got to be well rested.”

Leaving the meeting, I was more convinced than ever that we had to move fast on the money market guarantee. It was a step that we could take unilaterally. As soon as I returned to Treasury, I stopped by David Nason’s office and told him I wanted the guarantee announced in the morning, even if it couldn’t be finalized for weeks: we had to make clear right away what we were doing. I instructed David to work closely with Steve Shafran and make this his top priority.

The markets had gotten a badly needed shot of good news just before we went into the White House, when CNBC reported that Treasury was considering taking action to buy illiquid assets from the banks. The report also said that New York senator Chuck Schumer indicated that we would be announcing our plan later in the day. Stocks soared. In the last hour of trading, while we were in the White House, the Dow, down more than 200 points, surged 617 points to gain 410 points, or 3.9 percent, on the day.

Morgan Stanley’s shares were particularly volatile, closing at $22.55, up 80 cents, after having fallen by as much as 46 percent during the day. But credit markets continued to weaken. Morgan Stanley’s CDS were trading at 866 basis points, while its excess liquidity continued to drain away.