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

On Saturday evening, after dinner, we gathered in a small room in the main lodge that doubled as a natural history museum—complete with mounted ducks and tarpon, turtle shells, and the skeletons of alligators and dolphins—to hash out the policy and political considerations. My political advisers—Jim, Kevin, and Michele—explained how difficult it would be for Congress to give us the last $350 billion. I wouldn’t take no for an answer; the danger of being unprepared was too great. The questions were: What would it take for us to get it? And what commitments would we have to make to demonstrate a credible plan for using the money so that we could bring Congress on board?

Everyone agreed we would need to offer a plan for foreclosure relief. Partnering with the Fed on TALF was a top priority, but the idea had not yet been unveiled, was difficult to explain, and would be seen as a change in our strategy. We also took a hard look at our plan to buy illiquid assets, which was proving more difficult to develop and taking longer than any of us wanted. Kevin, Jim, and Jeb argued that the criticism would be severe if we backed away from asset purchases. But Michele countered that if we announced a program we couldn’t execute effectively, we’d eventually take even more heat.

We were entering a period in which anything I said would be viewed through the prism of election-year politics. So we decided that I should avoid making public comments until after November 4, even though this meant I could not lay the groundwork for any future change in strategy.

I left the island leaning toward developing targeted programs dealing with asset-backed consumer loans, foreclosures, and the troubled monoline insurers, as well as illiquid assets. And I wanted to move as soon as possible after the election to ask Congress to release the last tranche.

I knew how hard this would be, but I was convinced we would need all the TARP funds, despite how much the American people and their elected representatives loathed bailouts. I would spend much of the next two months debating with my colleagues and inside my own head exactly when to ask Congress for the money, and how to do it.

We flew back to Washington on Sunday afternoon and went straight to the office. At 8:00 p.m. I met in my large conference room with senior staff and White House deputy chief of staff Joel Kaplan. We wanted to compare our notes from the weekend and make a decision about how to proceed.

Steve Shafran reported on the consumer lending program he was working on. One challenge was that he and the New York Fed agreed on a different approach than the Washington Fed, but he expected a solution would be found. Dan Jester and David Nason said they had been working throughout the weekend to finalize the equity deals with the nine big banks and expected to complete them soon. (The paperwork was finished just after midnight.) Neel reported that 20 additional banks had applied for the capital program, including such important names as Capital One and Northern Trust.

Neel and his team had spent Sunday at Bank of New York Mellon. Under our reverse auction plan, Treasury would determine a specific amount of TARP money to spend on illiquid assets, then hold an auction in which financial institutions would bid to sell their assets to Treasury. The government would buy the assets at the lowest price, helping to improve liquidity and create a market, which private-sector buyers had been unwilling to do.

That was how it was meant to work, anyway. Right after TARP passed, Treasury had asked potential custodians to submit proposals, and they indicated they would be able to start auctions quickly. But after discussing with Bank of New York Mellon the unique requirements of the legislation—allowing thousands of firms to register to sell their assets and making sure they had signed off on executive compensation restrictions, for example—Neel learned that it could take two months, not two weeks, to set up an auction. And because the auctions would have to start small to allow for any necessary adjustments, we might be able to buy only about $5 billion of assets by the end of the year.

“It’s just too small in terms of the volumes that we need to move,” Neel explained.

There was another problem. A bank owning a small amount of a security might decide to unload it at any price, no matter how low, just to be rid of it. But that could trigger big write-downs at other banks that owned a lot of the same security.

We didn’t have time to ramp up the reverse auctions, so I told Neel to concentrate on a different idea we had for moving the assets: hiring professional money managers and giving them each a certain sum of money to buy eligible assets in the market.

Though it was getting late, and everyone was tired, we had a lively discussion, and as usual nobody held back. We debated whether we should go ahead with the direct purchase of illiquid assets, the program most visibly associated with TARP. Neel, Jim Wilkinson, and Jeb Mason argued in favor of staying the course, with Jeb making the case that we should focus on buying whole mortgages, as TARP allowed, instead of the more complex securitized mortgages. David Nason and Dan Jester thought we should focus on executing our $250 billion capital purchase program and that the regulators should assess the health of the banks before proceeding with a new program. Both Dan and David believed we should consider expanding the CPP to insurance companies. And everyone agreed we would need to designate a big portion of the last $350 billion for future capital programs.

Shafran said we had to include a foreclosure program in TARP; otherwise we would be on the wrong side of history—and of politics.

“You’ll live to regret it if you don’t,” he said.

I told him all I needed was to see a program that would succeed.

As the clock ticked toward 10:00 p.m., I began to seriously doubt that our asset-buying program could work. This pained me, as I had sincerely promoted the purchases to Congress and the public as the best solution. But in addition to the problems Neel had outlined, it appeared the magnitude of the crisis was outstripping our ability to deal with it by directly buying troubled assets, even with the last $350 billion. Housing prices continued to decline, while mortgage troubles had spread beyond subprime to prime residential loans and, more recently, to commercial real estate. Problems were mounting in the market for asset-backed consumer loans, as the deepening recession crimped individuals’ ability to repay debt.

Still, I held off making a final decision, hoping that we could devise a plan that would work faster than the reverse auctions. I concluded that any new capital program should wait until our existing program was further along. I gave the go-ahead to look into buying whole loans and to continue to work on foreclosure relief plans. I also wanted to address the troubled monoline insurers, if only to separate their viable municipal finance business from the failed structured finance business so that state and local governments would be able to tap the public markets for desperately needed funds.

But the big question was whether we would have enough TARP money to deal with unforeseen emergencies—like AIG.

In fact, no recipient of government aid had caused more public ire than AIG—and it once again stood on the brink of failure. I needed someone to manage the situation, but everyone seemed to shy away from it. It was a thankless task that came at an awkward time, at the end of the administration, when people were already searching for new jobs. Some told me point-blank that they didn’t want to do it.

As it happened, though, I had just the right person on staff in Jim Lambright, who had arrived just days before—on October 22—to manage TARP’s investments. Still in his 30s, Jim had been appointed by President Bush to be chairman of the Export-Import Bank in 2005. I’d met him while working on the Strategic Economic Dialogue with China. Now I asked Jim to work with the Fed to structure what would become Treasury’s TARP investment in AIG. I could tell that the former Golden Gloves boxer had the fortitude and capability to handle the problem.