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A Skeptical Outsider Becomes Bush's 'Wartime General'

By David Cho
Washington Post Staff Writer
Wednesday, November 19, 2008

Second of two articles

The pressure on Henry M. Paulson Jr. in early September was greater than at any other time during his tenure as Treasury secretary. As he pored over the books of mortgage giants Fannie Mae and Freddie Mac, he discovered that they were about to collapse and that the financial markets would experience what he called "a meltdown to end all meltdowns."

The federal government would have to seize the firms. But the law said their management would have to agree, and his own staff had reservations about whether Paulson had the legal authority to force them to surrender.

"Trust me," came Paulson's curt answer. "I'll get it done."

During his 28 months at the Treasury, Paulson has accumulated more power than nearly any of his predecessors and has wielded it boldly, even brazenly at times, in a bid to tame the financial crisis of a lifetime. He has burst through the customary boundaries that separate federal agencies, bent regulations to his will and pushed up against legal limits. As financial firms tumble and traditional oversight agencies prove impotent, Paulson has filled the void with his 6-foot-1 frame, summoning the rest of Washington and Wall Street to get in line.

"Even if you don't have the authorities -- and frankly I didn't have the authorities for anything -- if you take charge, people will follow," Paulson said in an interview. "Someone has to pull it all together."

He said regretfully that the financial upheaval has forced him to be a modern Robert Moses, the controversial 20th-century urban planner who acquired minor government posts and stretched their authority to reshape New York City as he saw fit. Though Moses never held elected office, he remade the landscape of New York through the cunning exercise of power.

Paulson had twice rebuffed the Bush administration by the time it offered him the post of Treasury secretary in April 2006. Paulson finally agreed but insisted on some terms. He would answer only to President Bush and not be subject to meddling by the president's economic policy advisers. And, Paulson recalled, he wanted it in writing.

The agreement laid the foundation. After the financial crisis erupted last year, Bush privately dubbed Paulson his "wartime general" on the economy, essentially telling him he would have White House backing for whatever measure he pursued, Paulson recalled in a series of interviews. That commitment endured even as Paulson steered the administration far from Republican orthodoxy on free markets.

Paulson used his influence within the administration to win even broader powers from Congress, allowing him to nationalize major financial institutions, either in part or entirely. The bills were sweeping in scope and gave him the latitude to spend hundreds of billions of dollars as he saw fit.

And Paulson unilaterally pushed his authority to craft initiatives even when, according a senior government official, he was not sure he had an airtight legal basis.

Confronted with the implosion of Fannie Mae and Freddie Mac, he didn't hesitate in identifying his course for the firms. He gave the companies' management just one day to review the Treasury's assessment of their situation, which revealed that each was on the verge of collapse. Then he summoned individually the two chief executives, Richard F. Syron of Freddie Mac and Daniel H. Mudd of Fannie Mae, to the third-floor conference room near his office in the Treasury building. Paulson sat across from them, along with Federal Reserve Chairman Ben S. Bernanke and the companies' regulator, James B. Lockhart III.

Paulson put it bluntly: "We are going to [take you over] and we want you to agree to it, and you will have a board meeting tomorrow and you are going to agree to it at your board meeting." Paulson never acknowledged that, under law, the companies had a choice in the matter.

Within days, Paulson had compelled them to agree that they would be nationalized.

"Not that I think it's a good thing; it should never work that way," he said. "But this was an extraordinary time period, and as much as I didn't want to do it . . . I knew what would happen if we didn't do it."

* * *

When President Bush first settled on a chairman of Goldman Sachs named Hank Paulson to be his new Treasury secretary, the administration couldn't seal the deal.

Nearly everyone Paulson talked to advised him not to do it. He spoke to family. He spoke to colleagues. They raised concerns about whether his reputation would be tarnished, as happened to Bush's first two Treasury secretaries, Paul H. O'Neill and John W. Snow. They proved ineffective, some political analysts said, because their authority had been undercut by the White House.

Even one of Bush's Cabinet secretaries counseled Paulson against coming to Washington, Paulson said. "Don't come down here; you can't trust them," he recalled being told. He declined to identify the Cabinet member.

Paulson was afraid of failing. "I will get down here and I won't be able to work with these people, and I'll leave with a bad reputation, and look at what people said about Snow and O'Neill," he said.

After the second time Paulson turned down the job offer, White House Chief of Staff Joshua B. Bolten, invited Paulson and his wife for lunch with Bush and President Hu Jintao of China. Paulson recalled feeling melancholy as he left the White House, reflecting on what he was about to pass up. He reconsidered.

Paulson sought out Allan B. Hubbard, director of the National Economic Council at the time, who guaranteed that the White House team would not undermine the Treasury Department.

Bolten said the toughest job was convincing Paulson that he could still accomplish important goals as Treasury secretary in the last years of the Bush administration. But giving Paulson written assurances that he would have broad authority at the Treasury was not hard for the White House.

"The real problem was getting Hank to be willing to do the job -- he was sitting on top of the world in early 2006," Bolten said. "He had heard that this is a very White House-centric operation, which in some respects it has been, and the secretary of Treasury did not have much authority and so on, and he wanted to be assured he would be leader of the economic team. To me that stuff was easy. The president would be in charge, but yes, you are the leader of the economic team."

The third time Paulson was asked, he accepted.

As turmoil in the financial markets escalated, Paulson's influence grew so great that he eclipsed the White House on economic policy. And when Paulson sought new authority from lawmakers to rescue the mortgage markets and financial companies, Bush told him he would "hang back" rather than risk that his poor popularity jeopardize Treasury's efforts on Capitol Hill, according to two sources familiar with the president's discussions with Paulson.

"I think the president of the United States was willing to defer to him and give him authority and liberate him from the constraints that the White House had forced on his predecessors," a senior government official said. "That was hugely important because it made him credible and able to negotiate with Congress."

In the summer, President Bush warned that he would block a landmark housing bill in Congress that in part would revamp the agency regulating Fannie Mae and Freddie Mac. That change was vital to Paulson. He persuaded the president to drop his veto threat, according to senior government officials.

"If you look at Paulson," said Rep. Barney Frank (D-Mass.), one of Paulson's key allies on Capitol Hill, "the one thing that's irreplaceable is his ability to bring George Bush along, and throughout this effort, the work . . . to persuade the president to do things that he otherwise would have resisted was important."

When Paulson went to Capitol Hill in September, asking for the authority to spend $700 billion to bail out financial firms, he said, he never worried that Bush would oppose him, though the plan was an unprecedented intrusion in the marketplace. The measure was initially defeated in the House of Representatives, primarily by Republican votes. But Bush never abandoned the proposal -- officially called the Troubled Asset Relief Program, or TARP, but better known around Washington as the Paulson plan -- instead intensifying lobbying efforts to get it passed.

"When the president stepped up big was when we lost the vote on the House," Paulson said. "He said, 'We will get it done, and we won't change one bit of your TARP. . . . the only thing we'll do is [think of] what sweetener do we have to add, and anything we add, will it gain more votes or lose more votes?' And the only thing he said is, 'We will run that process from the White House.' "

Under the plan, Paulson was granted sweeping discretion to decide how to use the $700 billion and which financial firms would get the money. He could hire firms to manage the program without having to obey the standard government rules for contractors. He could even decide how to place conditions on companies receiving government help, including limits on executive compensation.

In the end, Congress granted Paulson every authority he asked for.

* * *

Paulson acknowledges that such broad powers have a downside. It would be him -- not the White House -- who would be blamed if the emergency response to the crisis went awry.

"We may do things that are unpopular," Paulson said. "We may do things that we are forced to do. There may be things we have to do to respond to a systemic event, and there is no other authority to deal with it other than TARP. Then I will take one for the nation and take the criticism."

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."

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