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

“China stands to gain more than anyone in the world by freeing up trade, and it stands to lose more than anyone by backsliding,” I said.

“We didn’t move as fast in a number of areas as you wanted us to,” Hu said. “But we don’t vacillate, and we will continue with reform and opening up.”

I left Beijing pleased with the success of the SED, but I was returning to an increasingly troubled economy. On December 5, the government reported November job losses of 533,000, for a total of almost 2 million jobs lost in the past year. The unemployment rate stood at 6.7 percent, versus 4.7 percent a year before. And the latest news from the auto industry was bleak. That morning, United Auto Workers president Ron Gettelfinger testified before Congress that “GM could run out of funds by the end of the year, and Chrysler soon thereafter.”

Wendy and I spent a restful day together on Saturday and attended the Kennedy Center Honors the next evening. A reception in the East Room of the White House preceded the event, and there I ran into Nancy Pelosi. I told her that circumstances might force us to notify Congress that we needed to draw down the last TARP tranche, perhaps over the holidays. She took my hand, which she always did when she was trying to charm.

“Please don’t,” she told me. “We don’t have the votes.”

While Nancy and I were chatting, I was surprised to see Clint Eastwood walking toward us. The actor, a friend of Nancy’s, would be speaking on behalf of honoree and fellow actor Morgan Freeman, and he said, “I don’t know what she’s talking to you about, but she’s stronger than you, Mr. Treasury Secretary. I suggest you do whatever she wants.”

I chuckled appreciatively. By then, no one understood Nancy Pelosi’s power better than I did.

I wanted a chance to talk through the auto situation in a small setting, so Joel Kaplan and I had lunch alone with the president on December 11. The day before, the House had approved an emergency plan to speed $14 billion to the car companies without dipping into the TARP funds, but the administration-approved measure faced serious opposition among Senate Republicans. Vice President Cheney had joined a group of White House staff led by Josh Bolten that tried to persuade them to help the automakers. He said the GOP risked being labeled the party of Herbert Hoover if it allowed the companies to fail. But they refused to budge.

This would be one of our last lunches together. As usual, we ate in the president’s private dining room off the Oval Office. In my two and a half years at Treasury, I had noted how little these lunches varied. I normally ordered soup and either a chicken- or a tuna-salad sandwich. The president always ate the same thing: a little bundle of carrots, a chopped apple, and a hot dog in a bun. Wendy frequently accused me of inhaling my food, saying she had never seen anybody eat faster than I did. Then again, she had never eaten alone with the president—his food would be gone in five minutes. Sometimes we’d have low-fat soft frozen yogurt for dessert; other times the president would take out a cigar and chew on it.

For President Bush, an auto bailout was a bitter pill to swallow, especially as the last major economic decision of his administration. He disliked bailouts, and he disdained Detroit for not making cars people wanted to buy. But we were in the midst of a financial crisis and a deepening recession, and he recognized that if the giant companies were to declare bankruptcy, they would be doing so without advance planning or adequate financing for an orderly restructuring. The consequences for the economy would be devastating. It would create more panic, and it would crush auto suppliers and other carmakers—not just Chrysler and Ford, but also Honda’s and Toyota’s U.S. operations. Although the president didn’t explicitly say he would jump in to save the automakers, I knew he recognized—once again—the need for quick, decisive action.

Senator Bob Corker had tried to make legislation palatable to Senate Republicans but his efforts fell apart that night, largely because the auto unions refused the wage cuts that he proposed. When Democrats and Republicans failed to reach agreement, they went home for Christmas break having done nothing to bolster either automaker. Harry Reid was quoted as saying on the Senate floor, “I dread looking at Wall Street tomorrow. It’s not going to be a pleasant sight.”

He didn’t have to wait for Wall Street. Asian markets opened first and were sharply down: Japan’s Nikkei index fell more than 7 percent in midday trading, as did Hong Kong’s Hang Seng.

I had just arrived at the office at 7:00 a.m. the following morning when Joel called me. President Bush had decided to announce that he would consider using TARP funds to help the car companies. He was flying to Texas on Air Force One , and he wanted to get his statement out immediately, well before the U.S. markets opened. The statement had already been written; Joel wanted to make sure I was comfortable with it. I had just a few minutes to read it over, and I quickly said it was okay.

The statement did calm the markets, giving the White House some time to debate the next steps. Josh told me that the White House would control the process but that Treasury should run the negotiations with carmakers. I assigned Dan Jester, Steve Shafran, and Jim Lambright to develop the terms for the loans to GM and Chrysler. I encouraged the White House to make a quick decision. Since Congress had failed to act, TARP was the only tool we had before the companies ran out of funds, and there was nothing to be gained from dragging the process on.

Another big problem erupted early in the afternoon on December 17, when Ken Lewis called to tell me that Bank of America’s board had concerns about whether to go ahead with its $50 billion deal to buy Merrill Lynch. He said he had recently learned that Merrill Lynch’s fourth-quarter losses were expected to run to about $18 billion, pretax—way out of line with what he or anyone had expected. As a result, his board was considering invoking the material adverse change (MAC) clause to get out of the deal with Merrill Lynch. Common in merger arrangements, a MAC allows the buyer to break the agreement under extraordinary circumstances. But I knew that shareholders from both companies had already approved the deal, and I had never heard of a buyer successfully invoking a MAC after a shareholder vote. Moreover, this MAC clause was unusually favorable to Merrill Lynch in that it could not be invoked for a general deterioration in market conditions.

While I understood that December was shaping up as a bad month for banks, the $18 billion number shocked me. “This is a very serious matter,” I told Ken. “You need to come to Washington and meet with the Fed immediately.”

“I sure hope you’ll be there,” he told me.

We set up a meeting for 6:00 p.m. that evening at the Fed. Bob Hoyt, Jim Lambright, Jeremiah Norton, and I arrived early and conferred with Ben Bernanke, Don Kohn, and general counsel Scott Alvarez in Ben’s conference room. Surrounded by the portraits of former Fed chairmen that lined the walls, I learned that the Fed knew nothing about the expected size of Merrill Lynch’s losses but was aware that BofA was expecting to lose money in the fourth quarter and had a weak capital ratio. Ben and I agreed that we should take a tough line on the MAC, asking BofA for its legal justification. I shared my concerns about the market reaction to an $18 billion pretax Merrill Lynch loss for one quarter. If Merrill’s losses were truly of this magnitude, we faced a serious problem.

Ken Lewis arrived promptly at 6:00 p.m. with his chief financial officer, Joe Price, and newly minted general counsel, Brian Moynihan. Ken explained that BofA had recently learned that Merrill was expected to lose $18 billion in the fourth quarter and raised the possibility of invoking the MAC. Ben strongly pushed back on that, saying that doing so might lead to a run on the bank. Ken asked if he was talking about Merrill Lynch, and Ben replied, “No, both Merrill and Bank of America—out of a loss of confidence in management for putting themselves in this position.”