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

“There are a lot of bank deposits that aren’t insured,” she said. “And they can now go to the money market funds.”

Sheila had a good solution to prevent this from happening: insure only the customer balances that were in the money market funds on or before that day, September 19. I said that I liked her idea and that I would ask David Nason to work closely with her and her staff to implement it.

The truth is, we had to move quickly as the crisis mounted, and occasionally we stumbled. We grappled with this hard fact every time we worked on a new idea: often our fixes led to unattractive consequences. Whenever government came in—as with the guarantee program—we risked causing massive distortions in the markets. The risk of a misstep was greater the faster we had to move and the less time we had to think through every possible outcome. As a result, we had to be nimble, and flexible, enough to make midcourse corrections as needed.

The money market guarantee was an extraordinary improvisation on the part of Nason and Shafran. They had raced through the night to sketch its outlines and make the plan work. In time, funds participating in the guarantee would pay fees into a reserve that supplemented the ESF, which would not expend a single dollar on the program.

Treasury was operating so much on the fly that Nason drafted staff from the Terrorism Risk Insurance Program, which he oversaw, to help formulate the agreements and pricing schemes of the guarantee. It was announced on September 19, opened ten days later, and was, I believe, the single most powerful and important action taken to hold the system together before Congress acted. (The guarantee was intended to be a temporary program, and Congress has since ended it.)

Initially we worried about industry acceptance of the plan. Nason and Shafran had canvassed everyone from executives at Charles Schwab and Vanguard Group to the Investment Company Institute, the industry’s trade association, and found that many were concerned about having to pay to insure what was already a low-margin product. But in the end we had virtually 100 percent market participation and collected over $1 billion in premiums.

That morning, the U.S. government unveiled a package of new programs to boost liquidity and calm the markets. The SEC issued an order prohibiting the short selling of 799 financial stocks for 10 business days (the order could be extended to 30 days). My efforts to round up Tim’s and Ben’s support had given Chris Cox the backing he needed, and after our meeting with Hill leaders the previous night, SEC commissioners had approved the ban in an emergency session. The announcement did not go off without a hitch, however. A number of major companies, including GE and Credit Suisse, had been omitted from the list, which Chris later had to expand.

At 8:30 a.m., the Federal Reserve unveiled its Asset-Backed Commercial Paper Money Market Fund Liquidity Facility, better known as AMLF. Under this program, the Fed would extend nonrecourse loans to U.S. depository institutions and bank holding companies to finance their purchases of high-quality asset-backed commercial paper from money market mutual funds. In a separate action to boost liquidity, the Fed said it would buy short-term debt from Fannie Mae and Freddie Mac.

This raft of programs, coupled with news reports that we had gone up to the Hill to get new legislation, acted like a tonic to the markets. Led by financial shares, stocks rallied right from the opening. By 9:42 a.m., the Dow was already up 275 points, on its way to a full-day gain of 369 points. Morgan Stanley’s shares jumped 33 percent in the first few minutes of trading.

As my staff labored on upcoming White House and congressional presentations, my phone pulled me every which way. Goldman CEO Lloyd Blankfein called to express his concern for Morgan Stanley and what its troubles might mean—for the market and for his firm. The market was losing confidence in investment banks, he said, and although Goldman had a strong balance sheet, counterparties and funding sources were scared.

“I’ve never rooted so hard for a competitor,” he said. “If they go, we’re next.”

Dick Fuld also called, and although I didn’t really have time to talk, I stayed on the line with him for 20 minutes. Like our conversation a few days earlier, I found it very sad. He was afraid he would spend years in court. He asked if I could please tell others how hard he had tried and what he’d done. I told him I knew that he’d made a big effort to save Lehman, but the crisis we faced was unprecedented. It was the last time I spoke with him.

The Treasury press office stayed busy that day. At 10:00 a.m., I issued a statement that explained our reasons for going to Congress—how illiquid assets were clogging the financial system and threatening Americans’ personal savings and the entire economy. I said I would work with Congress over the weekend to get the legislation in place for the next week. And I took the opportunity to push for the regulatory reforms I had long advocated.

Forty-five minutes later Ben, Chris, and I stood in the White House Rose Garden with President Bush, who outlined the actions we were taking and announced that we had briefed Congress on the need for swift legislation granting the government authority to step in and buy troubled assets. “These measures will act as grease for the gears of our financial system, which were at risk of grinding to a halt,” he said.

There was much still to be done. Treasury staff took the lead, representing the administration, in working with the House and Senate financial services committees to outline what would become the Troubled Assets Relief Program. I pushed our team to ask for the most expansive authorities, with as few limitations as possible, because I knew we had only one chance to get this from Congress.

In the afternoon, Kevin Fromer took me aside and said, “If you believe there is a possibility $500 billion won’t be enough, we should request more.”

“You’re absolutely right,” I said. I did want a bigger number, and I knew the market would, too. But I didn’t want to run the risk of asking for too much, then getting turned down. “What’s the most you think we can get?”

“The public and Congress will hate $500 billion,” he said. “It’s already unthinkable. But I’m not sure they will hate $700 billion any more. If you get any higher, closer to a trillion, we will have a problem.”

Our choice of the $700 billion figure wasn’t just a political judgment. There was a market calculation as well: back of the envelope, we knew there were roughly $11 trillion of residential mortgages in the country, most of them good. We would need to buy only a small amount of them to provide transparency and energize the markets. And we believed that $700 billion was enough to make a difference.

Still, the $700 billion figure shocked many Americans—and Congress. Maybe my failure to anticipate this reaction showed how inured I was becoming to the extraordinary numbers associated with the prospect of an all-out financial meltdown. I was constantly being confronted by shocking figures. Friday, as the equity markets rallied, the credit markets remained tight, and investors’ flight- to-quality kept demand unbelievably high for Treasuries. Fails to deliver rose to $285 billion that day, a jaw-dropping increase from $20 billion one week before.

We had raced the clock on Bear Stearns, then again on Fannie and Freddie, Lehman, and AIG. Now we were rushing to develop the outline of TARP, even as I feared we could lose four giant financial institutions—Washington Mutual, Wachovia, Morgan Stanley, and Goldman Sachs—in the next few days.

Congressional leaders had advised us not to present them with a finished document but to work with them, so we prepared a short, bare-bones proposal with open-ended language, knowing that members would add provisions that would make the legislation their own. At about 9:00 p.m. on Friday, Chris Dodd called to ask where our proposal was. “My staff’s been waiting since 5:00 p.m.,” he said, reminding us to be cooperative.