viernes, 14 de septiembre de 2018

viernes, septiembre 14, 2018

Hank Paulson Still Remembers the 'Terror-Filled Nights' of the Financial Crisis

By William D. Cohan

U.S. Secretary of the Treasury Henry Paulson is shown in 2007
U.S. Secretary of the Treasury Henry Paulson is shown in 2007 Photo: Daniel Acker/Bloomberg


If Hollywood decides to produce a movie about a government official who finds himself mired in the middle of a once-in-a-lifetime crisis, Hank Paulson could easily be cast in the lead role.

He’s tall, bespectacled, ruggedly handsome, and still has pretty much the same athletic physique he had when he started 50 years ago on the varsity football team at Dartmouth. (His nickname was “Hank the Hammer.”)

He is also the former CEO of Goldman Sachs and of course was the Treasury secretary, under President George W. Bush, during the 2008 financial crisis. 

These days, Paulson, now 72, runs the Paulson Institute, a non-partisan “think and do” tank with offices in Chicago, Washington, and Beijing that is devoted to strengthening the economic ties between the U.S. and China, with an emphasis on environmental sustainability and conservation.

Paulson had recently returned from an environmental adventure vacation in Brazil when we spoke by phone to get his perspective on the financial crisis, 10 years later.

Barron’s: When did you first become aware that there was an unusual amount of trouble that might be brewing in the fi nancial markets? There are a couple of dates that appear to me, whether it was the crack in the ABX index of subprime mortgage securities in February 2007, the crack in the Bear Stearns hedge funds April-May 2007, or some other point. Was it as early as the beginning of 2007 that you began to see it?

Hank Paulson: The events you cite, those two events, were flashing yellow lights but as far as I was concerned the financial crisis arrived in force in early August 2007, when BNP Paribas halted redemptions on their three investment funds. And that’s what really began to freeze liquidity and we went into high gear. And I was really fortunate to have had a year to build strong working relationships with President Bush, Ben Bernanke, Tim Geithner, and members of Congress before the crisis hit. ….

It was in the spring of 2008 when we began to believe a rescue of the financial system might be necessary and we began doing contingency planning for that.

You mean after Bear?

I can’t pinpoint it exactly but we were working on some things when Bear went down. Let’s just say it was in the spring and it was intensified after Bear.

It’s very frustrating to feel a great sense of responsibility to act and not have the emergency powers you need, and to know that you can’t get them from Congress. For a long time we knew that if we went to Congress and tried to get emergency powers and failed we would precipitate the crisis we were trying to prevent.

In terms of your question about Bear, no advance planning really prepares you for the real thing. The markets were dynamic, and we were operating in uncharted waters which were rapidly changing.

So the kind of planning you might have done before the financial crisis started, or in early days, wouldn’t be that relevant as the situation worsened.

At that moment you thought we’ve got to do what we need to do to save Bear because –

Yeah, we said “Anything we can do we need to do. We don’t know how bad it is but there’s a significant risk it will be bad.” That was the mindset. We didn’t have much time for debate.

While Bear Stearns’ failure in normal markets would not hurt the U.S. economy, we believed that the system was too fragile and fear-driven to take a Bear Stearns bankruptcy. To those who argue that Bear Stearns created moral hazard and contributed to the Lehman failure, I believe just the opposite—that it allowed us to dodge a bullet and avoid a devastating chain reaction.

If Bear had failed, the hedge funds would have turned on Lehman with a vengeance. Lehman would have failed almost immediately and the result would have been much worse than Lehman’s September failure, which occurred after we had stabilized Fannie Mae and Freddie Mac and Bank of Americaacquired Merrill Lynch. I would hate to imagine what would have happened if this whole thing started before we’d stabilized Fannie and Freddie.

So if Bear had actually gone bankrupt, what do you think of this idea that Dick Fuld of Lehman would have gotten religion and said “Oh, boy, I’m bigger than Bear Stearns?”

Lehman would have gone bankrupt very soon thereafter

The inter-bank lending market was freezing. All the conversations I had with international finance ministers after the Bear rescue was, “Why should we feel good? Why should we be doing business with any of your investment banks?” There was a lot of fear.

After the summer did you think the worst had been averted? Bear rescued, Freddie and Fannie shored up, or did you suspect that another step down was likely?  
Bear Stearns was a huge wake-up call for us and reinforced our anxiety about the likelihood of another step down and not having the necessary tools to deal with it. Despite what all the lawyers said to me beforehand that we didn’t have tools to guarantee liabilities or put capital in a non-bank, I just couldn’t believe there wasn’t an authority somewhere that would allow us to do it.

So we went to the Justice Department, we went everywhere we could and we learned we didn’t have the necessary power to rescue a failing nonbank without a buyer. Ben and I consulted with Barney Frank about not having the authority to manage a failure of a non-bank like Lehman.

Barney understood and confirmed what we feared. He said we couldn’t get Congress to act unless they were convinced Lehman was going to fail and that its failure would seriously harm our economy. Of course, sounding that alarm would have led to the firm’s immediate failure. I used Bear Stearns to get both Fannie and Freddie to commit to raise equity and used it to jump start the Fannie/Freddie legislation in the Senate at a meeting in early April with Sen. Richard Shelby and Sen. Chris Dodd who had been reluctant to come to a compromise to move the legislation.

Afterwards, Tim and I began actively trying to convince Dick Fuld to attract a strategic equity investor or sell his company. We went into high gear and we did a lot contingency planning, none of which gave us any comfort.

So let’s then turn to the umpteenth time: Why didn’t the government rescue Lehman?

An interview with Tim Geithner on this topic was done recently at the Yale School of Management and he speaks much more authoritatively on the limits of the Fed powers than I, but here goes. While our responses may have looked inconsistent, Ben, Tim, and I were united in our commitment to prevent the failure of any systemically important financial institution.

But we had a balkanized, outdated regulatory system without sufficient oversight or visibility into a large part of the modern financial system and without the necessary emergency powers to inject capital, guarantee liabilities, or wind down a non-banking institution. So we did whatever we could on a case-by-case basis.

We dealt with four failing investment non-banks before getting the TARP legislation from Congress: Bear Stearns, Merrill Lynch, Lehman, and AIG. One of them, Merrill Lynch, didn’t take government support because it found a buyer. With Bear we were fortunate to have a well-capitalized buyer in JPMorgan that, importantly, was willing to guarantee the Bear liabilities during the pendency of the shareholder vote.

For Lehman, we had no buyer and we needed one with the willingness and capacity to guarantee its liabilities. Without one, a permissible Fed loan would not have been sufficient or effective to stop a run. To do that, the Fed would have had to inject capital or guarantee liabilities and they had no power to do so. Now, here’s the point that I think a lot of people miss: In the midst of a panic, market participants make their own judgments and a Fed loan to meet a liquidity shortfall wouldn’t prevent a failure if they believed Lehman wasn’t viable or solvent. And no one believed they were.

But a Fed loan was able to prevent an AIG failure and avoid catastrophe because AIG had a portfolio of insurance companies, and these were insurance companies with independent credit ratings, which both the Fed and the market believed had sufficient value to secure a loan and ensure that AIG was viable after receiving a loan to cover a huge liquidity shortfall at the holding company.

Then a couple of months later, after AIG’s losses mounted, it took government capital to restructure and to satisfy the rating agencies that the company was viable and fortunately at the time we had capital.

At the end of the day we got lucky with AIG. If it had failed it would have been an order of magnitude worse than Lehman and the government funds that were put in AIG all came back with a big profit. So it worked out well, but it is really an ugly story.

AIG is a cautionary tale. We should not have let our financial regulatory system fail to keep up with modern financial markets. No single regulator had oversight visibility or adequate powers to deal with AIG. Its insurance companies were regulated at the state level, its holding company was like a giant hedge fund sitting on top of the insurance companies, and it was regulated by the ineffective Office of Thrift Supervision, which also regulated—get this—Countrywide, WaMu, IndyMac, GE Capital. They all selected their regulator. So you get the picture, it’s regulatory arbitrage.

And let’s talk about you personally. The lowest moment for you and how you got through it emotionally and physically, and what support you got from your family?

There were so many “Oh boys.” I can’t distinguish. I mean, Lehman going down; narrowly avoiding the implosion of $3.5 trillion of money market funds with 30 million investors which were a primary source of commercial paper financing for many businesses; the House voting the TARP down the first time; the weekend in November after I thought we’d stabilized the banking system when Citi almost failed and needed a second rescue, or near the end of 2008, when I learned that Merrill Lynch had a huge quarterly loss and Bank of America had to be pushed to make good on its deal to acquire Merrill.

During the days, I was too busy to be fearful, but I had to deal with raw fear when I woke up at night and big problems seemed insurmountable. I had a number of terror-filled nights when I looked into the abyss and saw food lines and Great Depression-like scenarios, wondering how we could ever put our concentrated, complex financial system back together again if one other institution went down and precipitated a string of serial failures. How would we put Humpty Dumpty back together again?

I had great support from President Bush, a calm, strong leader, always willing to make tough, unpopular decisions. He bucked me up when I repeatedly brought him bad news. I can only imagine what I might have said if I had a Treasury secretary who kept coming back with bad news. I had two of the best partners imaginable in Ben and Tim, and that working relationship and trust in each other helped immeasurably.

I had a terrific core team at Treasury who worked around the clock, and time after time they came through for us. Then, as you said, my wife Wendy was a calming and reassuring presence at home. It just made all the difference, and we relied very heavily on prayer. Prayer is a big part of my life and looking to a higher power, a divine mind as a source of strength, courage, wisdom, and creativity.

Given your connection to China, do you ever wonder if the next crisis could be started in China?  

It’s impossible to predict, but the world is becoming smaller and more interconnected and interdependent every day so it’s quite likely that the next financial crisis will begin outside the United States.  
Do you think we’re on the precipice of another financial crisis, as I do? Or are you thinking that will be years away? Or is it, as ever, just very difficult to know? Do you think financial crises are inevitable given human nature and the DNA of our banking system?

The timing, cause, and severity of the next financial crisis are impossible to predict. Of course someone will get it right and will be credited with doing so, but he or she won’t spot the next one. But future crises are a certainty, they’re inevitable. As long as we have banking systems, as long as we have fragile banking and financial markets, no matter what the political system, government policies will be imperfect and flawed, and they’ll lead to excesses, which will manifest themselves in the financial system.

So the best we can hope for is to maintain our economic competitiveness so that we’re more resilient to the economic shocks when they come, and deal with the excesses before they are too great, and have the right people equipped with the necessary tools to mitigate the harm to the U.S. economy.

And I’m concerned that some of the tools we effectively used to stave off disaster have now been eliminated by Congress. These include the ability of Treasury to use its exchange stabilization fund to guarantee the money market funds, the emergency lending authority the Fed used to avoid the failure of Bear and AIG, and the FDIC’s guarantee of bank liabilities on a systemwide basis, which was critical.

Importantly, we now have the ability to wind down a failing non- bank on an orderly basis. We wish we had this for Lehman, but the presumption is for it to be used without any government money, which may not be effective in a crisis unless it is used in a manner that is inconsistent with Congressional intent.

Ten years later, what stands out to you most about the crisis and what do you think you learned most about human nature, Wall Street, politics, American society and culture? What would you have done differently if you could and where does that experience rank in your life experiences, which have all been pretty remarkable?

Wow that’s a lot to unpack. The crisis exposed the worst attributes of human behavior, particularly greed. It exposed some big shortcomings in our regulatory system. It exposed a political system where it takes a crisis to get Congress to act on something that’s controversial or unpopular. But what I’m most grateful for is the way the crisis ultimately brought out the best in our government, which allowed us in the fall of 2008 to avoid catastrophe.

So twice Republicans and Democrats in Congress came together on a bipartisan basis to give Treasury unprecedented powers. First for Fannie and Freddie, and then for the TARP. These are the last two times Congress has done something that was consequential and controversial on a bipartisan basis. There was also an unusual level of teamwork across government agencies and great policy continuity from the Bush to the Obama administration.

The Bush administration as first responders developed capital market stabilization programs and put in most of the capital. The Obama administration then adapted the programs where necessary, managed them very well, initiated stress tests, and implemented a massive fiscal stimulus program. President Obama selecting Tim as his Treasury secretary and Ben continuing as chairman of the Fed were critically important to the transition.

We made plenty of mistakes. We didn’t predict the troubled mortgage market as a trigger for the crisis. We didn’t predict the problems in the shadow banking markets. I was unsuccessful at communicating to the American people that the rescues of big banks were not done in the interest of helping Wall Street. They were intended to protect the hard-earned savings and homes of our citizens.

Fortunately, my biggest mistakes during the crisis were quickly corrected by reversing course right on the battlefield. First with Fannie and Freddie, when we sought and received the emergency powers from Congress. I didn’t believe I’d have to use it to nationalize these institutions. If I had, I would have been transparent and we might not have received the Congressional authorization we so desperately needed, so that mistake actually worked in our favor.

I can only imagine how bad it might have been if Fannie and Freddie had not been stabilized before Lehman failed. And just imagine that, and how much further home prices would have declined. Many more homeowners would have lost their homes if we didn’t have Fannie and Freddie as the only source of mortgage financing during the crisis. This is one of the most consequential actions that we took. ....

We faced an epic crisis with an outdated regulatory system and authorities and without a playbook. And rather than having regrets about the big mistakes, we got the big things right.

Where does serving as Treasury secretary rank in my life experiences? The opportunity to serve my country during a time of crisis and to have helped us get out of the crisis is the honor of my life. It’s just as simple as that.

Did you ever think that 10 years later, the stock markets basically have never been higher, the unemployment rate has basically never been lower. Is the proof in the pudding?

We’ve got a lot to be grateful for. And I’m particularly grateful that Ben had the courage to pursue extraordinary monetary policy in the face of withering criticism and for Tim’s creativity and equanimity. But I’m mindful of the fact that the crisis put a very heavy burden on millions of Americans, particularly those who were least able to bear it.

So we must make sure our regulatory system and authorities are sufficient to mitigate the next crisis. Now is the time to do just that. We can and we should do better.

And now that our economy is strong, it is important to begin to address a fiscal deficit that threatens our long-term economic security. It’s also important to deal with some of the other perverse economic problems that predated the crisis and contributed to it, particularly the plight of so many Americans that are being left behind and are not fully benefitting from our economic success. This income disparity, driven by automation and globalization, is increasing and threatens our democracy.

The economic policies that have served us well for years aren’t working as well as they should in today’s America. Just like our regulatory system, which was put in place decades before the crisis, didn’t serve us well during the crisis.

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