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

I called Obama right away. He said that he would try to be as constructive as possible but that the Democrats were doing their part and I had better keep in touch with McCain. The president was scheduled to give a major speech that evening making the case for TARP, but news of McCain’s decision to suspend his campaign dominated the rest of the afternoon. After the House hearing, I walked over to the Senate side of the Capitol to answer questions from the Senate Democratic Caucus. They were meeting in the Lyndon Baines Johnson Room, a huge room with a tiled floor and an imposing ceiling fresco, where LBJ had once reigned as majority leader. Harry Reid and the Democrats were waiting for me, but before I went inside, Joe Lieberman approached me.

“You’re doing great, Hank,” the Connecticut senator said, confiding that the Democrats wanted to exclude him from this meeting because he was supporting McCain. “I’m going to walk beside you, because they won’t throw me out if I go in with you.”

Ben was already there, and upon my arrival (Lieberman had already disappeared into the crowd), Reid went to the podium and told the group that we would answer questions. The first person to speak was John Kerry of Massachusetts, whom I had found to be consistently on the right side of the issues about the financial crisis. He said he was unsure that he wanted Ben and me there because there was a political element to everything, and suggested that the group first meet alone. But Reid refused, saying that questions needed to be answered. From the look of it, the entire caucus was there, though some seemed no more eager to vote TARP through than were House Republicans. Many were unhappy. At least a third were irate that the crisis was happening and were unwilling to agree to anything unless there were major modifications to the bill. One after another they spoke, occasionally asking a question but usually just attacking our proposal. I felt fortunate that Chris Dodd was chairing the Banking Committee because many of these senators liked and trusted him. But he had his work cut out for him.

Halfway through the session, I hit the wall. I had been going for days with little sleep and no exercise, hustling from one difficult meeting or conversation to another, and I ran out of gas. I realized I was going to get the dry heaves, and if I did that in front of people it would make for a bad news story, to say the least. So I made a poor joke.

“Excuse me,” I announced, standing at the podium. “I have to go get rid of some Diet Cokes.”

I rushed out of the room and into a bathroom stall, had a short bout of dry heaves, then returned to the meeting. Again, no one seemed to notice anything amiss, and I returned as Ben was responding to another irate senator.

Afterward Hillary Clinton told me to stick with Schumer if I wanted to get things done. I told her I would, but the fact was, Chuck and I had a serious disagreement about how the $700 billion should be allocated. I wanted Treasury to have access to the total amount right from the start, but Schumer wanted it doled out in tranches. I suspected he wanted to reserve part of the money for the next administration.

Before I went to bed that night, I watched President Bush address the nation from the State Floor at the White House. “Our entire economy is in danger,” he said, carefully explaining how we had gotten to that point: foreign investment in the U.S., easy credit, a housing boom, irresponsible lending and borrowing. It was his most substantive address yet on the financial crisis, and it was well delivered, but the last thought I had before I fell asleep was that even a speech by the president wouldn’t be able to sway the House Republicans.

We’d devised TARP to save the financial system. Now it had become all about politics—presidential politics. The president, the leaders of both parties, and both candidates were scheduled to meet around 4:00 p.m. Thursday. I wondered what McCain could have been thinking. Calling a meeting like this when we didn’t have a deal was playing with dynamite.

Democrats, I later learned, had moved into high gear to devise a strategy to ensure that they emerged as the winners from McCain’s maneuver. They didn’t want to take the blame for TARP’s failure—and they didn’t want McCain to be able to claim credit for its success.

By midmorning, Democrats and Republicans from both houses were haggling over the bill’s provisions. Over the course of two hours or so, in the Foreign Relations Room, located below the vice president’s office on the Senate side, the negotiators agreed on several big items, including setting the size of TARP at $700 billion. TARP funds would not be immediately available to the administration but could be drawn down in tranches. Senate and House negotiators agreed on the need to place restrictions on executive compensation and to give Treasury warrants to purchase equity in companies participating in the program so that taxpayers could share in any possible gains they made.

Enough tentative progress had been achieved for Utah Republican senator Bob Bennett to get caught up in the moment as he emerged from the negotiation sessions around midday. He grabbed a microphone and told the press, “I now expect we will, indeed, have a plan that can pass the House, pass the Senate, be signed by the president, and bring a sense of certainty to this crisis that is still roiling in the markets.” Chris Dodd told reporters that he, too, was confident.

But there were problems with this scenario. It was a big stretch to say these negotiators had reached an actual agreement. And, in any case, House Republicans were not on board, and without them TARP was going nowhere. The math was simple. We would need 218 votes for House passage. Though the Democrats, with 236 members, held a clear majority, we weren’t going to get 100 percent of their votes, so we had to have some Republicans. But the only House Republican attending the morning negotiating session had been Spencer Bachus, the ranking Republican on the House Financial Services Committee. Afterward, he allowed that progress had been made. But he wasn’t in a position to deliver his colleagues.

Hour by hour the need for the legislation was becoming more urgent. The noose continued to tighten on the nation’s credit markets: by the close of trading, LIBOR-OIS spreads had widened to nearly 200 basis points, up 30 basis points from the day before. By comparison, they had been about half that level just after Lehman failed.

Then Washington Mutual went down—the biggest failure in U.S. banking history. While the legislators were negotiating, Sheila Bair called me around 11:00 a.m. to break the news that the FDIC was going to seize the bank, and that JPMorgan would pay the government $1.9 billion for the company, which had $307 billion in assets.

WaMu’s demise wasn’t a surprise. It had been struggling for months and had taken a catastrophic turn for the worse: Its CDS rates, already shocking at 2,742 on September 15, had nearly doubled to 5,266 on Wednesday, September 24, as the bank was hit by a run on deposits. Customers had withdrawn $16.7 billion over the preceding ten days.

Back in March, JPMorgan had wanted to buy WaMu, but its regulator, the Office of Thrift Supervision (OTS), and management had opted instead for a $7 billion capital investment from a group led by the private-equity firm TPG. This decision proved to be a mistake: an acquisition by JPMorgan would have stabilized the bank. Still, I had kept in close touch with Sheila and Ben Bernanke on WaMu and periodically talked with JPMorgan CEO Jamie Dimon.

Unfortunately, the WaMu solution wasn’t perfect, although it was handled smoothly using the normal FDIC process. JPMorgan’s purchase cost taxpayers nothing and no depositors lost money, but the deal gave senior WaMu debt holders about 55 cents on the dollar, roughly equal to what the securities had been trading for. In retrospect, I see that, in the middle of a panic, this was a mistake. WaMu, the sixth-biggest bank in the country, was systemically important. Crushing the owners of preferred and subordinated debt and clipping senior debt holders only unsettled the debt holders in other institutions, adding to the market’s uncertainty about government action. Banks were even less willing to lend to one another. In the future, I concluded, we were going to need to go beyond the standard FDIC resolution process for a failing bank.