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

“Stay close to Lindsey,” he said. “Just keep talking to him, keep that as a bridge to McCain.”

The uncertainty caused by Republican disenchantment with TARP helped drive the Dow down 373 points, wiping out Friday’s gains. Shares of Washington Mutual and Wachovia dropped sharply. On the plus side, Morgan Stanley’s and Goldman’s CDS spreads had narrowed considerably, indicating that the plan to turn them into bank holding companies had given them a little breathing room. It helped, too, that Mitsubishi UFJ had announced its intention to buy 20 percent of Morgan Stanley.

Still, we needed to sell TARP hard. As Treasury staff negotiated with congressional Democrats on the particulars, we felt we could not show any doubts about our approach or any openness to other ideas. Whenever anyone on the Hill asked the Treasury team if they had any other plans, the response was: “This is the plan.” If we had entertained other options, the process would have bogged down.

Executive compensation remained a sticking point. That evening when I met with my team—Kevin Fromer, Michele Davis, Jim Wilkinson, Neel Kashkari, and Bob Hoyt—to review the issue, we discussed the increasingly strident tone of the election campaign: “You hear what people are saying on the campaign trail. You listen to the candidates,” Michele said. “To get the votes, we’re going to need executive compensation restrictions.”

I told them I believed that we should take very tough positions with top executives of failing companies, as we had when we fired the CEOs of the GSEs and AIG. But to my mind, restricting pay could put us on a slippery slope with Congress. The whole idea of TARP was to encourage the maximum number of institutions to participate in our auctions and sell their bad assets. Those taking part would clean their balance sheets and attract new capital from private investors.

As we walked out of our meeting, Kevin Fromer warned me, “This is going to be tricky.”

I replied, “I would rather get nothing at all than get something that ties my hands so I know it won’t work.”

I held out for a few days, refusing to compromise and angering many on the Hill. But doing so allowed us to agree on a set of restrictions that the market accepted. Congress would make them much tougher after I’d left.

Ben Bernanke, Chris Cox, Jim Lockhart, and I were scheduled to appear before the Senate Banking Committee at 9:30 a.m. We knew it wasn’t going to be an easy session, and we knew we had to be prepared. Ben called me two hours before that to say he was concerned that we hadn’t been doing a good enough job of explaining what we needed. He wanted to make sure I was comfortable with the statement he planned to give.

Going into the hearing, I knew I had to choose my words carefully. We faced a real dilemma: To get Congress to act we needed to make dire predictions about what would happen to the economy if they didn’t give us the authorities we wanted. But doing so could backfire. Frightened consumers might stop spending and start saving, which was the last thing we needed right then. Investors could lose the final shred of the confidence that was keeping the markets from crashing.

I described the roots of the crisis, the bad lending practices that had hurt homeowners and financial institutions and caused a chain reaction that had spread to Main Street, where nonfinancial companies were having trouble funding their daily operations. I stressed the need for swift action, but I resisted when I was asked to describe what a meltdown would look like and to provide details on what it would mean to lose a retirement account or a job.

Ben was less hesitant to present an alarming scenario. “The financial markets are in a quite fragile condition, and I think absent a plan they will get worse,” he told the panel. “I believe if the credit markets are not functioning, that jobs will be lost, that our credit rates will rise, more houses will be foreclosed upon, GDP will contract, that the economy will just not be able to recover in a normal, healthy way.”

The Senate is more civilized than the House, but this was a long, difficult session. I didn’t get to speak until 90 minutes or so into the hearing, after the committee members had made their statements.

Over the course of the nationally televised, five-hour hearing, the senators expressed big concerns about moving too fast, about taxpayer protection, and about the broad powers I was requesting. This was understandable: we were asking for a lot—on short notice, and just weeks before Election Day. They fired questions at us, and the senatorial rhetoric blew hot and heavy. Jim Bunning denounced TARP as “financial socialism” and “un-American.” Richard Shelby criticized our ad hoc approach and our rush. And these, nominally, were our Republican friends.

As for the Democrats, Chris Dodd, whose advice we’d followed in sending up a bare-bones outline of legislation, took the opportunity to say, “This proposal is stunning and unprecedented in its scope and lack of detail…. It is not just our economy at risk, but our Constitution as well.”

Still, Chris was helpful in some ways. Reading the bill closely, he noted, “There’s nothing in here that would prohibit you from using the flexible notions and thoughts out there on how a better approach might work—an equity infusion, for instance.”

I responded, “Mr. Chairman,… you said it better than I did. I didn’t want to find myself in the position of being here, asking for these authorities. But under the circumstances, I think they’re better than the alternative…. Our whole objective here is going to be to minimize the ultimate cost to the taxpayer.”

To that point, we had put equity only in the GSEs and AIG, and we’d basically killed the shareholders of those companies. We didn’t want to give a whiff of support to speculation that we would inject equity, because we feared that such speculation would only drive bank share prices to zero before Congress had had a chance to vote on TARP. I left the hearing room knowing that we were still a long way from getting something done.

Senator Obama called afterward to touch base. I told him that it had been a tough hearing. He noted that the American people were not happy to see big compensation packages for an industry needing government help, and he warned me that I had to stay on top of my party if we wanted to make sure TARP passed. The Democrats, he said, were more inclined to support the legislation.

Meanwhile, I was getting reports from my people that the bill that was being worked on in the House and the Senate was getting longer and longer—and we hadn’t yet seen any resolution on the major issues: executive compensation, taxpayer protection, and oversight.

One of my worries lifted Tuesday when Goldman Sachs—which had overnight Sunday become the fourth-biggest U.S. bank holding company—had finally found its strategic investor. And they’d found the most credible investor in the world, Warren Buffett, who announced that he would invest $5 billion in perpetual preferred shares yielding 10 percent, with warrants to buy $5 billion worth of common shares. What cemented his decision was the prospect of TARP’s being passed. As he would say in an interview on CNBC the next day, “If I didn’t think the government was going to act, I would not be doing anything this week.”

But the markets were not as easily assuaged: stocks took another fall as the trading day closed, and the Dow finished down 162 points, at 10,854, as credit spreads continued to widen.

With investors like Buffett counting on TARP, we pressed ahead on our sales efforts. At 6:15 p.m. I sat down in John Boehner’s office with House Republican leaders. They disliked TARP but knew something needed to be done, and they kept trying to come up with an alternative. Boehner had already warned me that things were not going well in the GOP caucus. About a third of the House Republicans were facing tough elections and worried about losing their seats. Another third were so ideologically driven that they would never vote for TARP.