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

Dave had been working with Japanese finance officials to try to move the Mitsubishi UFJ deal along. The Japanese bank appeared to be pulling back from its agreement. The U.S. bank’s shares had fallen so far that Mitsubishi UFJ was worried that if it invested, the U.S. government might step in and wipe out its position.

“I know it may not be the most dignified thing in the world,” Dave said, “but you’re going to have to lean on them. The market doesn’t think this deal is going to close.”

The G-7 ministers were arriving in Washington as we spoke, and, as was customary, I had a bilateral meeting with the Japanese finance minister, Shoichi Nakagawa. It was scheduled for noon, and I told Dave I would broach the Morgan Stanley issue then.

The session in my small conference room with Finance Minister Nakagawa dealt mainly with the major issues we were confronting; among other things, he strongly believed that the U.S. should inject capital into our banks, as Japan had done in the 1990s.

Then I turned the conversation to Mitsubishi UFJ’s agreement with Morgan Stanley. “We believe,” I said, “that this transaction is very important to the stability of the capital markets.”

Friendly and dynamic, Nakagawa was Japan’s fourth finance minister in two years, and like all of us he carried a heavy load. He didn’t commit to pushing the Mitsubishi UFJ deal along, but he agreed to focus on the issue, and that was the most I had hoped for.

The G-7 ministerial meeting began at 2:00 p.m. that afternoon. We gathered in the Cash Room, which was adorned with the flags of our respective countries. Ben and I sat side by side facing our counterparts from the world’s major economies. They were arrayed around a huge rectangle of tables: central bank head Masaaki Shirakawa and Finance Minister Nakagawa from Japan, Axel Weber and Peer Steinbrück from Germany, Christian Noyer and Christine Lagarde from France, Mario Draghi and Giulio Tremonti from Italy, Mark Carney and Jim Flaherty from Canada, Mervyn King and Alistair Darling from Britain. Jean-Claude Trichet from the European Central Bank was also there, along with World Bank president Bob Zoellick and Dominique Strauss-Kahn, managing director of the IMF. As a group we had wrestled with difficult challenges, but the stakes had never been so high, nor our collective mood so dark.

Before the meeting both Ben and Dave McCormick had warned me that the Europeans were angry about Lehman Brothers; many attributed their deepening problems to its failure. Nonetheless, I was surprised to see Trichet pass out a one-page graph that illustrated the dramatic increase in LIBOR-OIS spreads post-Lehman. Then, using uncharacteristically forceful language, he said that U.S. officials had made a terrible mistake in letting Lehman fail, triggering the global financial crisis.

Trichet was not alone in his sentiments—other ministers, including Nakagawa and Tremonti, pointed to the problems caused by Lehman in their opening remarks. It was the first time, though far from the last, that I heard global political leaders use this sort of rhetoric to blame the U.S. government for their financial systems’ failings as well as our own. It was obvious to me that AIG and some other financial institutions had been on their own paths to failure, independent of Lehman. So, too, were banks in the U.K., Ireland, Belgium, and France. Lehman’s collapse hadn’t created their problems, but everyone likes a simple, easy-to-understand story, and there was no doubt that Lehman’s failure had made things worse.

Not wanting to seem defensive, I kept my response simple. My goal was not to justify our actions, but to be sure we left this meeting unified in our desire for a coordinated global response to our problems.

“Lehman,” I said, “was a symptom of a larger problem.” I noted that the U.S. had not had the ability to put capital into Lehman and that there had been no buyer for the firm. Now, with TARP, I pointed out, we had the power to act.

Mervyn King would pick up on this theme, reminding the ministers that “Lehman is the proximate cause, but it’s not the fundamental cause” of the current market crisis. Mervyn was as keen, I think, as I was to move from pointing fingers to linking hands to get out of the mess we were in.

During our discussions, Mervyn and some of the others suggested that to help give the market confidence we should do something different and more forceful with the communiqué. Business as usual would not create the impact we wanted.

Mervyn thought that the draft communiqué lacked punch and that we should shoot for something much briefer that could fit on one page. I agreed.

As the speakers went on, I watched Dave McCormick, who was sitting next to me, scribble out a new draft communiqué. He handed it to a staff member, who quickly brought back a typed version that I thought was just right. I suggested to my colleagues that we try this shortened version, and they agreed. Dave disappeared with his fellow deputies, returning in less than half an hour with a new draft.

The deputies had drawn up a concise, powerful statement—so concise and powerful that it went through only one round of changes by the ministers. In a few brief sentences including five bullet points, we showed our resolve:

The G-7 agrees today that the current situation calls for urgent and exceptional action. We commit to continue working together to stabilize financial markets and restore the flow of credit, to support global economic growth. We agree to: 1. Take decisive action and use all available tools to support systemically important financial institutions and prevent their failure. 2. Take all necessary steps to unfreeze credit and money markets and ensure that banks and other financial institutions have broad access to liquidity and funding. 3. Ensure that our banks and other major financial intermediaries, as needed, can raise capital from public as well as private sources, in sufficient amounts to re-establish confidence and permit them to continue lending to households and businesses. 4. Ensure that our respective national deposit insurance and guarantee programs are robust and consistent so that our retail depositors will continue to have confidence in the safety of their deposits. 5. Take action, where appropriate, to restart the secondary markets for mortgages and other securitized assets. Accurate valuation and transparent disclosure of assets and consistent implementation of high quality accounting standards are necessary.

Once we had the five-point plan, the group’s mood changed. We’d started out with gloominess and finger pointing, but suddenly we felt ready for action. This handful of words solidified our resolve and set the stage for our future moves.

Energized, we walked out onto the steps of the Treasury’s Bell entrance, facing the White House visitor center, for our customary “class photo.” It was midafternoon, the sun was shining, and even the sound of a group of demonstrators chanting “Arrest Paulson!” couldn’t dim my mood. Peer Steinbrück leaned over and said to me, “It sounds like we’re in Germany.”

As if to underscore the importance of our meetings, Friday was astonishingly volatile in the markets. The Dow plunged 8 percent, or 680 points, to below 8,000 in the first seven minutes of trading, then rebounded by 631 points in the next 40 minutes. After slumping again, it roared up 853 points to 8,890 just after 3:30 p.m. before plummeting to 8,451, for an overall loss of 128 points on the day. It was the culmination of a terrible week: the Dow and S&P 500 both closed down 18 percent, while the NASDAQ fell 15 percent. It was the worst week for stocks since 1933.

In the credit market, the LIBOR-OIS spread had reached a shocking 364 basis points, and investors fled once more to safe Treasuries. Morgan Stanley ended the day in single digits, at $9.68, with its CDS topping the 1,300 mark.