When he arrived in Washington as Secretary of the Treasury in the summer of 2006, Henry M. (Hank) Paulson Jr.'s top priority was to make certain that his department would have independence and clout. If he was giving up the top job at Goldman Sachs, he wasn't doing it for a sinecure.
Mission accomplished. Mission overaccomplished.
"I've always said I don't want to be irrelevant," Paulson said during an interview in mid-December, his 6-ft. 1-in. frame folded into a big chair in the corner of the office where such legends as Andrew Mellon and Henry Morgenthau once worked and where he has presided over some of the most momentous Treasury meetings ever. "But, boy, I do not want to be this relevant."
Paulson, 62, has come to play a historic role at a historic time. A lame-duck President has given him nearly complete control over the country's economic policy in the midst of an epic financial collapse. Congress has given him close to $1 trillion to repair the financial system. Along with his partners in panic, Federal Reserve Chairman Ben Bernanke and Federal Reserve Bank of New York president Tim Geithner who will take over at Treasury in January Paulson has led a government economic intervention on a scale never before seen in the U.S., except perhaps during World War II.
For a brief period in late summer, before the collapse of Lehman Brothers brought the crisis into a new and much more dire phase, Paulson's new clout was greeted by widespread acclaim. He was hailed on magazine covers as KING HENRY and PAULSON TO THE RESCUE. Congressional leaders of both parties (but especially the Democrats) sang his praises. If anybody could lead us through the crisis, it would be the hard-charging former Dartmouth College football star known as the Hammer.
You don't hear that kind of talk anymore. Paulson has become an unpopular, controversial figure, the target of harsh criticism on Capitol Hill and in the media. If there is a face to this financial debacle, it is now his exuding an air of perpetual embattlement.
What does Paulson think about this change in his fortunes? "I just haven't had time to focus on it," he said near the beginning of a long conversation, during which he made clear that he had focused on the criticism and saw most of it as unfair. "I don't think we've made mistakes on the major decisions," he argued. "We've done the right things."
Is that true? As Paulson said in another context, "I think five years from now it will be a lot easier to put all of this in perspective." Today the facts point toward two conclusions:
1) Given the political and economic realities he faced, there is no obviously better path Paulson could have followed.
2) Paulson is really bad at explaining why he made the choices he did.
To arrive at the first conclusion, you have to believe that we were on the brink of disaster in late September and early October. "The alternative we were looking at was a cascade of failing institutions," Paulson said. "We were looking at a downward spiral or a free fall." This fear was widely shared by economists and financial-market participants. What we've ended up with instead an ailing financial system, a deep recession and a few trillion taxpayer dollars at risk is vastly preferable to that. Give the man a little credit.
O.K., we will: "He's smart. He listens to all the right arguments. He's decisive at a time when few people have been willing to make decisions," says Glenn Hubbard, dean of the Columbia Business School and a top first-term Bush economic adviser. "I can't think of somebody I would have rather had doing that."
Yet Hubbard has been a frequent critic of the "lurching from crisis to crisis" that has characterized the government response ever since markets began behaving strangely in August 2007. This can't all be pinned on Paulson. In late 2007 and early 2008, most of the lurching was done by Bernanke and Geithner, and everyone in government has been hobbled by what Paulson calls an "outdated and outmoded set of regulatory policies and authorities" that kept a tight rein on commercial banks but encouraged the growth of a vast shadow banking system. The investment banks that dominated this second system spewed forth unfathomable amounts of securitized paper, like the now infamous collateralized debt obligations, over which regulators had far less control.
All this came to a head in March, when the investment firm Bear Stearns imploded. The Fed intervened, backstopping JPMorgan Chase's shotgun acquisition with a $29 billion guarantee. The Fed could do this because it doesn't have to ask Congress for money it can effectively print its own. But if the Fed simply issued more currency to patch every hole in the U.S. financial system, the dollar would eventually lose all credibility.
And so after Bear Stearns, a consensus developed at the Fed and Treasury that if more bailouts were called for, they should be done by Treasury, with congressional approval. That's when Paulson took command. He identified mortgage giants Fannie Mae and Freddie Mac as the shoes likely to drop next and decided that with $5.2 trillion in debt securities that were seen by investors worldwide as implicitly guaranteed by the U.S. government the companies couldn't be allowed to fail.
Paulson outmaneuvered a recalcitrant White House economic team and got approval directly from President Bush, then held a Sunday-morning press conference to announce that he was seeking major new powers and asking Congress for hundreds of billions of dollars to backstop the two firms. Within a couple of weeks, Paulson got what he had asked for. It was a bravura performance by a man who had risen to the top of the investment-banking profession on his ability to make deals happen.
At Goldman, Paulson had always been known more as a doer than a chin-stroking thinker. "He is like a heat-seeking missile going to problems," says Goldman board member and former Medtronic CEO William George, who has known Paulson for 30 years. And as he tried to articulate his philosophy at Treasury, Paulson talked himself into a bind. He drew a seeming line in the sand after Fannie and Freddie, making the case in speeches and interviews that some big firms had to fail. "You need that market discipline," he told me in July.
In mid-September, Paulson followed that hard line and let Lehman Brothers go under. "I never once considered it appropriate to put taxpayer money on the line in resolving Lehman Brothers," he told reporters the day the investment firm declared bankruptcy. He also said the government wasn't considering a loan to struggling insurance giant AIG.
Within days, the market's panicked reaction had changed Paulson's tune on AIG, which the Fed saved with a loan aided by Treasury. And now he says the issue with Lehman was that Treasury didn't have the power to do anything and the circumstances that allowed for the JPMorgan-Bear Stearns deal (a willing buyer and collateral that the Fed could lend against) weren't present.
This may be true, but it wasn't what Paulson said at the time, and these mixed signals confused markets and the public. When Paulson then headed to Capitol Hill to secure $700 billion in what became known as the Troubled Asset Relief Program (TARP), the signals got even more confused. At first, Paulson argued that the money should be used to buy distressed mortgage securities rather than to take direct stakes in financial institutions. "Putting capital into institutions is about failure," he said. "This is about success." Within weeks, he had switched course and committed almost half the $700 billion to direct investments.
This was almost certainly the right decision, but it was more evidence that the transition from dealmaker, which requires pragmatism, to policymaker, which favors consistency, was proving difficult for Paulson. Ask him what his philosophy of financial regulation is, and he begins, "My basic philosophy is hardly extreme. I believe in markets." A few sentences later he tacks back: "I've never been antiregulation. I've always believed that raw, unregulated capitalism doesn't work." Then another turn: What's needed, he says, is a regulatory setup in which financial institutions can fail without endangering the system. And another: Since we don't have that, he and the Fed have had to intervene to save financial institutions, because history teaches that the longer you wait to intervene, "the more economic havoc is wreaked." But wait: Interventions also distort markets.
It is as if he is circling the question, testing out every possible answer. His staffers at Treasury say this is how he makes decisions chewing over all the arguments and facts, then quickly making his call and not looking back. It's a pragmatic, flexible approach. It also means that with slight changes in the arguments or the facts, Paulson is capable of making the diametrically opposite decision. The result is a communications challenge for Treasury but also something of a quandary for those who would demonize Paulson.
"He's been criticized for two things," quips House Financial Services Committee chairman Barney Frank. "Preventing companies from going under and not preventing companies from going under." And so Frank, while he has battled with Treasury over the use of TARP funds, continues to look to Paulson to get things done. So does the rest of Washington.
When the city's focus turned from banks to the auto industry, Paulson at first avoided involvement. "There's something bizarre about Congress not voting to do something with the autos and then whispering in my ear, 'Use the TARP and don't tell us,'" he said on Dec. 10. "You know, 'Here's the revolver go do it for the good of the regiment. And then I'll criticize you after the fact.'" Two days later, after auto-rescue legislation crashed in the Senate, Paulson was hard at work trying to craft another bailout.