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A Conversion in 'This Storm'
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In reflecting on his term, which comes to an end in January, Paulson said his biggest regret was not seeing the extent of the financial crisis as it developed. But he defended every major action he took.
"We were always behind. We saw the problem, but it took us a while to see the severity of the problem," he said. "But even if we had been more clairvoyant, we wouldn't have been able to do much differently that what we have done."
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Paulson had long believed that free markets work only if companies, no matter how big or vital to the financial system, could pay for their mistakes by failing. Nothing is as powerful a motivator as the possibility of a collapse, he would say.
He articulated this philosophy in a July speech in London and continued to maintain this viewpoint in public even as troubled Wall Street giant Lehman Brothers edged toward the brink in September. In interviews at the time, he warned of the dangers of repeatedly offering government guarantees to companies. Just three days before Lehman failed, Paulson reinforced the point, telling reporters and Wall Street executives that no government money would be used to save the 158-year-old investment bank.
But behind the scenes, Paulson had already shifted his position. He communicated a different message to executives at Barclays, a British bank that he had recruited to buy Lehman and save it from collapse.
"I said, 'There wouldn't be government support,' " Paulson said. "They said they wouldn't buy it without government support."
"Then I said, 'Well, give us your best deal with government support, and let me try to figure out how to make it work.' " Though he had concluded that the Treasury Department did not have the authority to give Lehman money, he was willing to see whether the Federal Reserve would help bail out the bank, much as the Fed had provided crucial guarantees for the sale of the ailing investment bank Bear Stearns in March.
In the end, Barclays's British regulator blocked the Lehman deal. The Fed, in turn, refused to prop up a company without a buyer from private industry.
Ultimately, Lehman failed, not because of Paulson's convictions about how free markets should work but because he could not arrange a deal to save the firm, even with taxpayer money.
The fallout from Lehman's bankruptcy filing Sept. 15 was severe. The firm had relationships with a wide range of hedge funds and financial firms. Some could not get their money back. Suddenly, investors on Wall Street could no longer be assured that their money was safe in any investment bank.
Just a day later, Paulson dropped publicly any pretense that large firms would be allowed to fail. Along with Timothy F. Geithner, president of the Federal Reserve Bank of New York, Paulson put together an $85 billion loan for the insurance titan American International Group. Before the end of the week, Paulson headed to Capitol Hill to ask for the authority to spend $700 billion on an unlimited number of banks and financial firms whose troubles could put the entire financial system in jeopardy.
