A Skeptical Outsider Becomes Bush's 'Wartime General'

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Paulson: Preserve Flexibility in Bailout

Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke waged a stout defense on Capitol Hill Tuesday of their management of a $700 billion financial bailout.

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That uproar has already started. Yesterday, during a hearing on Capitol Hill, Paulson endured a barrage of criticism, mainly from Democratic congressmen, for repeatedly shifting directions on how the bailout billions will be used and for refusing to spend any of it on struggling homeowners or the ailing auto industry.

Treasury secretary is "fundamentally a lonely job," said a former senior Treasury official who advises Paulson. "It's very hard for anybody to know what goes into these kinds of judgments, and I'm sure he's dramatically changed by that. He has to live with all that second-guessing all the time."

Paulson said he always has tried to define his job expansively and plans to encourage his successor to do the same.

Senior government officials said Paulson helped craft rescue programs for financial firms, though he was not sure he had an unquestionable legal basis for the initiatives, including the bailouts of the failing investment bank Bear Stearns in March and the wounded insurance giant American International Group in September.

One senior official said similar legal doubts also applied to the Treasury's decision in September to grant a tax break to banks to help stabilize the financial system by encouraging them to merge. Treasury officials have said publicly that the tax-policy change is legal.

Paulson also supported the Federal Reserve Bank of New York in organizing the market for complex financial derivatives known as credit-default swaps. Some familiar with the effort said officials from the Fed and Treasury never knew whether they had the legal authority to interfere with the market for such derivatives but did so anyway because the opaque trading threatened the wider financial system.

At the same time, Paulson has muscled independent regulatory agencies to adopt his ideas. Several regulators said he often applied enormous pressure to get them to fall in line, for instance pushing the Securities and Exchange Commission to adopt a temporary ban on short selling and the Federal Deposit Insurance Corp. to introduce a new program to guarantee debt issued by banks. Paulson himself acknowledged that he had been the driving force behind a guidance document released this month by four regulatory agencies urging banks to use bailout money to increase their lending.

"Hank has taken his leadership role seriously," one of the regulators said. "And if he thinks he knows the right answer for a bank regulator, particularly for the Office of Thrift Supervision or the Office of the Comptroller of the Currency or Fannie and Freddie, he will not hesitate to express his views. To that extent, he's the benevolent dictator. He wants an answer, and he wants it yesterday."

Paulson said times forced him to take that role. Every major call in confronting the financial crisis, Paulson said, was his. No other regulator had the authority or will to do it, he said.

When the investment bank Lehman Brothers released disastrous second-quarter earnings this summer, shortly before it went bankrupt, Paulson asked its chief executive, Richard S. Fuld Jr., what the next quarter would look like. Fuld said it might be worse. Paulson demanded that he find a buyer for the company.

Fuld balked, looking for other ways to save the firm. So Paulson moved ahead himself and tried, ultimately unsuccessfully, to engineer a deal.

"I was the only guy who drove that," Paulson said. "I called two banks when none of them were interested. I tried to get them interested. I urged them to do it. . . . That's what a Treasury Secretary needs to do when you are in a war."