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

“Isn’t there something we can do without this?” Vice President Cheney asked. Though a free-market advocate and highly skeptical of government intervention, he had understood from day one how essential our actions were. He was not content to sit back and watch the economic devastation that might result from congressional inaction. “Doesn’t the Fed have some power? Don’t we have some power?”

“No, we don’t,” I said.

“We’ll figure out how to get it,” the president said.

Josh Bolten took me aside and reassured me once more: “We’ll get this done.”

Before I returned to my office, I stepped out onto the White House lawn and spoke to the press. For once, I was less concerned about reassuring the markets than about delivering a strong message to Congress. “We’ve got much work to do,” I said. “This is much too important to simply let fail.”

My stomach sank when I returned to my office and looked at the Bloomberg terminal behind my desk. Stocks had begun the trading session down sharply, then gone into free fall as the vote mounted against TARP. The Dow had posted its largest one-day point decline ever, almost 778 points, or 7 percent, while the S&P 500 suffered an 8.8 percent drop, for its worst day since the October 1987 crash. Overall, more than $1 trillion in stock market value was wiped out—a jarring one-day record.

Though I often focused on what many people might consider the esoteric aspects of finance—commercial paper funding, credit default swap rates, or the triparty repo market—I cared deeply about the loss of value in the equity markets. It meant so much to the average citizens—to their retirement security and to their sense of confidence.

Credit market functions are crucial but somewhat abstract to most Americans. How often does anyone hear about LIBOR-OIS spreads on the evening news? But if credit stopped flowing, businesses would shut down across America and many, many jobs would be lost. It’s like clogging the arteries of a human body. Soon critical functions become impaired, and then, with a heart attack, they cease suddenly.

That afternoon and evening, I talked with a number of people whose positive attitudes helped to buck me up. Lindsey Graham was particularly inspiring. “Hank,” he said, “you have both presidential candidates supporting you in an election year. You have the support of the leadership in Congress. All you need is 13 more votes in the House. You need to project confidence publicly and privately.”

That night I spoke again to Josh Bolten, who was already thinking of new approaches. “Hank, you’ve done what you can do,” he told me. “Give me the ball for a few days, and let’s see if we can corral the votes.”

September 30 marked the Jewish holiday of Rosh Hashanah and the markets were open, but Congress was not in session. I woke up early and went to the gym for the first time since the day after Lehman fell. I felt out of shape, and as I attempted to follow my routine I tried hard not to dwell on the House defeat.

The markets were in great distress Tuesday. Overnight, LIBOR had jumped to 6.8 percent, more than double the week before and the highest level in years. The crisis was spreading rapidly through Europe. That morning the French-Belgian bank Dexia had become the fifth big European financial institution to succumb to a bailout or nationalization in the past two days. Governments around the world, from France to India and South Korea, were taking action to stabilize, and in some cases to prop up, their weakened financial institutions. Ireland said it would guarantee payments on as much as 400 billion euros ($574 billion) in bank debt. The figure guaranteed nearly the entire Irish banking system and amounted to twice the country’s gross domestic product.

Almost every hour I got an update from Josh Bolten or Joel Kaplan about TARP’s progress. They were feeling optimistic again. Rahm Emanuel had helped concoct a strategy with Harry Reid to push the legislation through the Senate first. Senate Republicans were more secure in their seats than their House counterparts and more sympathetic. Prepared to move boldly and quickly, Reid said he could schedule the vote as soon as the next day.

There were two options for getting TARP through the House on a second try. One was to assume that the Republicans would never sufficiently support the legislation and therefore try to win over as many Democratic votes as possible. And one way to get those votes might be to offer a second stimulus spending plan, as Pelosi had once suggested. But doing that would drive away the Senate Republicans.

A second option was to try to gain broader support and attract Republicans by combining TARP with energy-related tax credits that were set to expire and a patch on the Alternative Minimum Tax, the unpopular levy that perennially had to be adjusted to protect the middle class from a tax increase. Other sweeteners included raising FDIC deposit insurance limits and addressing mark-to-market accounting in some way.

The leadership chose the second route and included these provisions. But, as Josh Bolten pointed out, one big reason some Republicans were proving more receptive was that they had gone home to find their constituents upset that TARP’s failure had wiped out 10 percent of their retirement accounts—and they were blaming Congress for it. As a result, Monday’s stock slide meant a lot more cooperation.

During this difficult time, Ben Bernanke told me that he thought that solving the crisis would demand more than the illiquid asset purchases we had asked for. In his view, we would have to inject equity capital into financial institutions. Dan Jester and Jeremiah Norton came to see me and made the same point. I agreed that they were probably right, but we had no plan in place, and the concept made me uncomfortable, even though we had been careful to make sure that TARP’s language allowed it as an option. I was philosophically opposed to any action that might smack of nationalization—government interventions always come with some undesirable influence or control—and I also knew that we would sabotage our efforts with Congress if we raised our hands midstream and said we might need to inject equity. I believed that illiquid asset purchases would be the biggest part of whatever we did, and told Ben this.

Still, I had also talked with a number of investors I trusted, and they all told me the same thing: the system’s problems were too big and immediate to be fixed by anything other than capital injections. I asked Dan, Jeremiah, and David Nason to give this some thought.

We had a meeting Tuesday morning and then a conference call to discuss raising the FDIC cap on insured deposits from $100,000 to $250,000 per account as part of the TARP sweeteners. We turned to another key issue—guaranteeing all bank transactional accounts—and picked it up again that afternoon in a conference call with Ben Bernanke, Tim Geithner, Kevin Warsh, Joel Kaplan, and David Nason.

This idea was being pushed by Larry Lindsey, a former economic adviser to the president and onetime Fed governor. To pay their bills, companies routinely kept sums of cash in their checking accounts that far exceeded the $100,000 FDIC insurance limit. That left them prone to pulling their money at the first sign of danger and, as with Wachovia, thereby fueling bank runs. We discussed the idea of unlimited guarantees to stabilize these accounts, but we worried that in the midst of a panic, foreign depositors would move their money to the U.S. to take advantage of this new protection, sparking retaliatory actions by other countries and weakening the global financial system.

None of us liked Lindsey’s idea, and Tim, in particular, was concerned. He rightly noted that it could lead to all kinds of distortions. No one wanted to incite a harmful round of global “beggar thy neighbor” policies.