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

There was no time to savor our legislative victory. At home TARP’s passage failed to console the market: the Dow dropped 157 points, for a total of 818 points lost over the week.

Late on Friday, as I sat in my office, I told Michele Davis, “To put it mildly, I don’t feel ecstatic.” If anything, I believed we were still almost as vulnerable as when we first submitted TARP. The markets, after all, were much worse.

Acting on Michele’s advice, I emphasized in my public comments that it would take time to put a comprehensive plan together and that we would still need to use the combined powers of all the regulators.

I needed time to think in a quiet setting, so Wendy and I had decided to get away for the weekend—my first respite in weeks. Before I left Treasury, I asked Neel to figure out how soon we could begin to buy the banks’ toxic assets. And I made sure to tell Dan Jester and the rest of the team: “Figure out a way we can put equity in these companies.”

I flew out of Washington Friday at 4:00 p.m. for a weekend break, knowing only too well that the legislation signed by President Bush at 2:30 p.m. that afternoon had bought us little time. If anything, the financial markets and the economy were in worse shape than they had been before TARP’s passage.

Congress and the markets expected immediate results, but it was going to take weeks to launch a program to buy toxic assets from banks. Since Monday, world financial markets had taken a drastic turn downward. European banks were teetering, the credit markets remained frozen—with the vital commercial paper business all but shut down—and stock prices had fallen sharply. The SEC’s ban on short selling would expire in a few days. I had directed my team to craft a plan to provide capital to banks, but we didn’t yet know how such a program might work.

No doubt about it, this would be a working weekend. But at least I would be working on Little St. Simons Island, one of my favorite places on earth. For 27 years Wendy and I, and our family, had come regularly to this narrow stretch of land off Georgia’s Atlantic coast. It had changed little in that time. Never developed, its beautiful forests and marshes were blessed with an abundance of wildlife.

We touched down on neighboring St. Simons Island and drove five miles to the marina. Most folks traveled to Little St. Simons Island by motorboat—you can’t reach it by car—but Wendy and I preferred to kayak, and we left Washington’s concerns behind for an hour as we paddled the three and a half miles to the island, arriving just in time to see the sunset. Walking to our lodge through the refreshing salt air, Wendy assured me that I would sleep well that night, and I began to unclench a little. If nothing else, I had made it to the weekend.

Saturday, October 4–Sunday, October 5, 2008

The next morning at dawn I headed out with my fly rod and fishing gear to Bass Creek to catch some redfish. Standing in warm, knee-deep water, surrounded by shorebirds, I caught and released half a dozen redfish on a clouser minnow fly. I felt like myself for the first time in a long while—just Hank Paulson, out fishing.

But I was soon back to business. Tim Geithner called after I returned to the lodge and told me that we needed to make a strong, unequivocal public statement backing our financial institutions.

I agreed. But how could we do so in terms that the market would believe? The President’s Working Group gave us an excellent platform, we decided. The Treasury, Federal Reserve, FDIC, and SEC could stand together and commit themselves to coordinated action in the crisis.

Tim and I set Treasury and New York Fed staff to work. We wanted to outline clearly the powerful tools that government agencies now possessed to deal with the crisis, specifically highlighting the broad authorities—and deep pockets—granted Treasury by the TARP legislation, as well as the FDIC’s ability to protect depositors and guarantee liabilities by invoking systemic risk, as it had with Wachovia.

All weekend, drafts of a statement moved back and forth. I managed to wedge in a little more fishing, but I spent three or four hours at a crack on calls with Ben Bernanke and Tim, and my team at Treasury.

I also kept a wary eye on the Citigroup–Wachovia–Wells Fargo triangle, discussing the increasingly complicated situation with Ben and Tim. Citi was demanding that Wells Fargo drop its $15.1 billion offer for Wachovia, claiming it breached Citi’s own deal. News reports quoted Citi CEO Vikram Pandit as calling the deal illegal, so I assumed a lawsuit was forthcoming.

On the plus side, Wachovia, despite its abundant problems, had attracted two major banks and would be saved from failure. But one of those banks, Citi, had troubles of its own, having written down $19 billion of bad assets in the first six months of the year. We were concerned that Citi might be hurt if its deal with Wachovia disintegrated—and this time the institution under attack would be one of the biggest financial services companies in the world.

I flew back to Washington Sunday evening and got on a conference call with my staff about 7:00 p.m. Among other things, Dave McCormick filled us in on developments in Europe, and it was clear we needed to move fast on the PWG statement as well as on our capital and illiquid asset purchase programs.

Over the weekend, French president Nicolas Sarkozy’s summit of European leaders had failed to produce the desired unity that would calm the markets. Quite the contrary: participants squabbled publicly over how far they should go to support their most important financial institutions. Then on Sunday night, continental time, while Germany arranged a $68 billion rescue for troubled lender Hypo Real Estate, Chancellor Angela Merkel had said her country would guarantee personal savings accounts, a proposal that by some calculations would have affected $1 trillion of savings.

Dave had been talking to his counterparts overseas, trying to get a grasp on the German situation. We hoped that Merkel’s comment was just a “moral guarantee” intended to reassure her markets, not a hard, two-year guarantee like the one the Irish parliament had approved the previous week.

“This is going to move quick and force us to do some things we may or may not want to do,” I said.

Usually when I got to Treasury in the morning, I stopped in the Markets Room. On Monday, though, I went straight to McCormick’s office to check on Europe.

“Things are in complete disarray,” he told me.

The U.K. was fuming. The British press was reporting that the country’s financial officials were upset that Merkel had given no indication of her plans. The U.K. feared Merkel’s “beggar thy neighbor” policy could cause a domino effect, potentially destabilizing banking systems across Europe as each country enacted its own guarantees to prevent money from leaving to seek safer havens. It wouldn’t be long before we had to follow suit.

President Bush’s deputy chief of staff Joel Kaplan echoed Dave’s concerns when I spoke to him later that morning.

“Hank, it seems to me we’re going to have to do something to match the Europeans,” he said.

“You’re probably right,” I said.

That morning we released the PWG statement. We affirmed our commitment to coordinated forceful action, vowing to move with “substantial force on a number of fronts.” Alluding to the FDIC authorities on Wachovia, we asserted that we would stand behind our systemically important institutions. Though the statement was intended to reassure the markets, it fell flat.

However, I’m not sure any statement would have made a difference that day. Asian and European markets plummeted in reaction to European banks’ problems and concerns that TARP would not provide a quick enough fix in the U.S. Once our markets opened, the reports were equally frightening: the Dow fell sharply—in little more than an hour it was off 578 points, or 5.6 percent. The LIBOR-OIS spread would hit a near all-time high of 288 basis points before contracting slightly; a month earlier, it had stood at 81 basis points.