Q&A: Secretary of Treasury Henry Paulson

Are you going to get this done this week? And how clean is this going to look?

We're right in the period where the sausage is being made. I clearly believe we are going to get it done this week; we need to get it done this week. And I believe we're going to get a bill that works and a clean bill. It certainly won't be exactly what we asked for, it never is. But it's got to be sufficient to let us do the job.

$700 billion— one big question is what made that the magic number, and why should people have confidence that that's going to do it?

First of all, that is a number which we think is big enough to calm the markets. We think it—in terms of the assets outstanding—it's enough to do the job. And again, here we're not talking about using all of the $700 billion, and it would be paced out over a period of time. And remember this is not a spending program. This is purchasing assets, holding those assets, reselling those assets, and the money coming back to the government.

Do you have a sense of what the net outlay might be?

It's impossible to know, because it depends on the pace of recovery in the housing market and the economy. But if things go well, the actual cost could be far less than the money spent on the assets.

Did you, may I ask, play any role in bringing Buffett into Goldman Sachs. Did the Treasury Department?

Absolutely not. Again, the point that I've made is, this is about the American taxpayer and as much as I don't want to be here asking for this, it pains me to do this, we believe that this is much less costly than the alternative. Because the taxpayer is already on the hook for the impact on the economy if our financial markets don't work the way they need to work.

Do you think we're out of the woods in terms of the credit scare?

These markets are still very fragile and the conditions in the credit markets are very tight. This is in many ways about just not—it's about the illiquid assets in the financial institutions and it's about confidence.

Are you worried about reactions in the markets to ongoing negotiations on the hill?

That obviously impacts the market, and the markets are watching what's going on, and this is a situation where as Ben [Bernanke], Tim [Geithner] and I had talked for months about, there might be a need to do something like this. We discussed the various plans. We've never seen anything like it. There's no model for anything that's been done in the past that would work here.

But the one thing we knew was that we couldn't or shouldn't go to Congress until we absolutely needed to. Because the worst thing would be to go to Congress, ask for it and not get it. And so it wasn't until last week when the markets were literally coming unglued that we needed to take a number of other emergency short-term actions, that we knew that we had to do something to get at the heart of that problem which was the housing correction and the illiquid assets.

Can I ask you about the dynamic between the three of you? It's an odd and surprising grouping of people—you're very much the deal maker, Bernanke is professorial, and Geithner is something of a mix between the two, but certainly younger. How have those conference calls gone, how have you learned to deal with each other? What's the dynamic?

We started working closely together from the day I arrived. I chair something called the President's Working Group on Financial Markets, and although we weren't predicting this, we certainly knew we were bound to have stress and turmoil in the capital markets. It had been a long time, you have to go back to '98 since we'd had the last serious bout, and so we've worked very closely together for over two years now. And we work very well.

I mean Tim was a senior official here at Treasury, earlier, he knows the Treasury Department well; he actually helped me get acclimated and think about my job. I'd known him when I was in New York.

Was he at Goldman at the same time you were there?

No, no, he was just at the New York Fed. He was president of the New York Fed for at least a year, maybe two years, when I was at Goldman Sachs. And he's a very, very, unusually talented young man. And so he understands government and understands markets. And Ben is, although he's got an academic background, very pragmatic, intellectually curious, a courageous guy. And he has—these steps we've taken have been with the Fed authorities, we don't have the authorities here to do some of the things we've done.

If this plan goes through, there's a lot more work to be done after that, figuring out how to do the asset sales. But also, figuring out how to fix the system so this doesn't happen again. Those two are going to be here after January.

They'll have a big role, but I think the next administration, the next Congress—there's so much that needs to be done, so much work. We have a regulatory system some people want to say there's too little regulation. It's not that, it's just outdated, outmoded, ineffective, the architecture was put in place in a different era and it hasn't kept pace with the evolving financial markets.

We have institutions that have been allowed to become too big to fail because we had all kinds of flaws in our financial infrastructure, in the whole way over-the-counter derivatives work. We don't have the necessary laws or powers to deal with failing non-bank institutions. If they're a big bank, the depositor has deposit insurance and the regulators can wind them down without throwing them into bankruptcy.

All the problems of the shadow banking system.

Yeah. We have a system that needs to be fixed, but the thing that we just haven't communicated as well as we need to is the average American looks at this as being about Wall Street. And they're angry. And I'm angry too.

And there have been huge excesses and flaws in the system. But the average American doesn't understand the implications this has for them, because if money doesn't flow through the system the way it needs to—money needs to flow throughout the system so that every American business virtually every day can operate the way it needs to.

Can you paint the picture? Nothing would be more powerful.

But every American business from the biggest companies to small hardware companies need money to flow through the system not only to create new jobs but to sustain existing jobs. Most people when they think of businesses, they think of parts or supplies, they don't recognize they need short term funds to meet the payroll, to pay for inventories, and people understand the way credit cards work, and we have a lot of credit in the system, and if someone couldn't use their credit card they could understand the impact on businesses.

But we're talking about loans to farmers to small businesses, we're talking about peoples retirement savings; the system needs to work and I'm not trying to scare people, because I have real confidence we'll get through this, we always do. But we have to come together as a democracy and rise. This is a real test of our system.

We need to come together. Can we react quickly enough to deal with the modern world and the rapidly changing— saying it another way, there's so much complexity, actually over-complexity, in the financial system and the speed with which money and information moves has increased. And so when these events, the chain reaction surrounding these events is quicker than in the past.

So for instance we had to make a decision on Thursday to use our exchange stabilization fund here to guarantee money market funds because money was starting to flee those funds, and if it fled those funds it was going to get to the financing of American businesses who rely on them for $1.7 trillion in short-term borrowings.

Can I ask you a direct question? As head of Goldman Sachs you played a very central role in building up and operating within this shadow banking system, including placing a fair amount of housing debt from Fannie Mae.

I would just say, Fannie Mae and Freddie Mac, so you'll get it from me — I look at that totally different than any of the rest of this. Those charters were set up a long time ago by Congress with the ambiguities and the obligations around that. This was living up to our responsibilities as the United States of America. There was $5.4 trillion of debt, mortgage-backed securities and debt here and around the world, $3.7 trillion in the U.S.

That was a situation where thank goodness that I had the powers from Congress and we were able to move quickly and stabilize the situation before we got into last week and mortgage rates have remained calm. Yeah, I and everyone else placed Fannie and Freddie debt. We didn't create this system and this was a mess that had to be cleaned up. And that is something that I'm proud of, Ben Bernanke's proud of, Jim Lockhardt, the regulator — not proud that the situation happened, but proud that we were able to move quickly enough to use the powers given to us by Congress to stabilize the system.

There are plenty who are happy to have someone who knows that market as well as you do in the center the storm. One further along this line, though, you did also place Jim Johnson on the board of Goldman Sachs and made him chairman of your compensation committee. Is that correct?

Jim Johnson was on our board. I don't make him Chairman of the Compensation Committee, the CEO doesn't do that, but Jim Johnson was on our board.