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

World markets had responded enthusiastically. Japan’s Nikkei index soared by 14.2 percent, while the U.K.’s FTSE 100 rose 3.2 percent. In early trading, the Dow had jumped 4.1 percent to 9,794. Credit markets were stronger as well, as the LIBOR-OIS spread narrowed slightly to 345 basis points.

But no sooner had I returned to my office than one thorny issue I believed had been settled reared its head. Ken Lewis was on the phone, concerned about his deal with Merrill Lynch. With the markets stabilizing, the Bank of America CEO was worried that John Thain, who had sold Merrill only to prevent its failure, might now want to back out: after our weekend actions, Thain might have stopped believing that his firm’s survival depended on BofA. If that were the case, Ken wanted regulators to remember just how crucial to the country his decision to buy Merrill during the height of the crisis had been and to insist that Thain honor his contract.

“Ken,” I asked, “has John or anyone at Merrill indicated to you that they might want out?”

“No, I just have a concern.”

I heard him out and told him that I believed John would stay committed to the deal, but that I would pass his concerns on to Tim Geithner, and I did. I never mentioned them, however, to Thain.

In making critical decisions, finding the right mix of policy considerations, market needs, and political realities was always difficult. I tended to put politics last—sometimes to our detriment. To my mind, the bank capital program struck a perfect balance. It was designed to meet a market requirement, it addressed the problem of bank undercapitalization while safeguarding taxpayer interests, and it had been, I thought, brilliantly executed.

I expected the program to be politically unpopular, but the intensity of the backlash astonished me. Though the criticism from Republicans was muted, some conservatives, who had resisted TARP initially, felt betrayed, and their vocal dissatisfaction made me nervous. I knew that if the program turned into a political football and became an issue in the presidential campaign, the banks would get spooked and back away from the capital. Our efforts to strengthen the fragile system would collapse.

Fortunately, the candidates did not politicize the issue. On October 13, the night that the banks agreed to accept the money, I’d had a long phone conversation with an angry John McCain, who complained that we weren’t doing enough to deal with mortgages. He was also upset about the equity investments, but after we talked it out, I was confident he would not publicly attack our plans—and to his great credit, he did not, even though he was behind in the polls and might have been tempted to try to energize his campaign that way.

Democrats liked the program—some even took credit for it—but, joined by an ever-growing populist chorus, they began griping that banks were hoarding their new capital, not using it to increase lending. Before long it seemed that almost every member of Congress or business leader was directing his or her anger at the banks and their regulators. And this was before even one dollar of government money had landed on bank balance sheets.

John Thain didn’t help matters. Merrill reported a $5.1 billion third-quarter loss on Thursday, October 16. Referring to Merrill’s $10 billion government injection, he told analysts on a conference call that “at least for the next quarter, it’s just going to be a cushion.”

The day after he made his remarks, Nancy Pelosi and Barney Frank complained to me about Thain’s insensitivity. I got John on the phone, and I told him that although he was right in that Merrill wasn’t slated to get the capital until after its merger with BofA closed at year-end, he needed to be more politically aware. I asked that he clarify his statement publicly. He said he would look for an opportunity to do so, but would only comment if he was asked about it. I would have preferred a more proactive effort on Thain’s part. Then I heard that Chris Dodd planned to call the nine big-bank CEOs before the Senate Banking Committee to grill them about lending at an upcoming hearing. I managed to persuade him not to, arguing that if he did, he would so stigmatize and jeopardize the capital program that those first nine banks might back out.

I understood the need to get credit flowing again. In the Cash Room I had made sure to say that “the needs of our economy require that our financial institutions not take this new capital to hoard it, but to deploy it.” By requiring Treasury consent for share buybacks and increases in dividends, our program contained built-in incentives for the banks to retain capital, repair their balance sheets, and resume lending. But that would not happen overnight—after all, many businesses were reluctant to take out loans in an economic downturn. I didn’t think I could tell the banks how much to lend or to whom.

But politicians and the public became increasingly agitated in the midst of a hard-fought presidential campaign. They expected that our actions—meant to prevent bank failures—could also avert the recession and slow the wave of foreclosures already under way. Obama and McCain both denounced Wall Street’s greed as they traveled around the country. And no single issue inflamed people more than revelations of excessive executive pay—and perks. New York State attorney general Andrew Cuomo launched a high-profile probe of AIG’s corporate expenses, including a notorious post-bailout retreat for insurance agents at a California spa that generated a lot of fiery press coverage. People were outraged that banks that had received government aid were still planning to dole out lavish pay packages.

I empathized with their anger. People had seen the values of their homes and their 401(k)s plunge. We were in a deep recession, and many had lost jobs. Frankly, I felt the real problem ran deeper than CEO pay levels—to the skewed systems banks used that rewarded short-term profits in calculating bonuses. These had contributed to the excessive risk taking that had put the economy on the edge. I was convinced, for policy reasons and to quell public anger, that regulators needed to devise a comprehensive solution. I encouraged Ben, Tim, Sheila, and John Dugan to work on policy guidance for compensation, lending, foreclosures, and dividends that would apply to all banks, and not just those that took capital.

Jeff Immelt had come to my office on the 16th to make the case that the FDIC should guarantee GE Capital’s debt issues. He believed our new programs put GE at a huge disadvantage, making it difficult for the company to fund itself. Nonbanks like GE could tap the Fed’s Commercial Paper Funding Facility, but they weren’t eligible for TARP funds or the FDIC’s new debt guarantee, known as the Temporary Liquidity Guarantee Program. Why would investors buy GE debt when they could purchase the debt of other financial institutions with an FDIC guarantee?

“We are the ones out there making the loans that the banks aren’t, and we need help,” Immelt said. I knew he was right, and I said we would explore it with his finance team and the FDIC.

Following the success of the G-7 and the coordinated actions that had calmed the market, the White House revived plans for a summit at which President Bush could discuss the financial crisis with a broad range of leaders. I had made outreach to the developing world a priority and felt strongly, as did deputy secretary Bob Kimmitt, that if we were going to host a summit, it should include the members of the G-20. The president agreed. I asked Dave McCormick to work with the finance ministers to find common ground for the meeting, while the president put Dan Price in charge of preparations, including negotiating the summit communiqué with the other leaders’ representatives.