All the Devils Are Here [212]
Late July saw the German government bail out IKB. In early August, American Home Mortgage Investment Corporation, which was unable to sell its commercial paper, filed for bankruptcy. A few weeks later, Countrywide had to draw down that line of credit, signaling it was in trouble. On August 21, an auction of four-week Treasury bills nearly failed because the demand was so massive it overwhelmed the dealers. In mid-September, the British bank Northern Rock had to be rescued by the Bank of England.
The banks were all announcing huge write-downs while frantically trying to raise additional capital—something Paulson was pushing them to do. But the new capital was quickly overwhelmed by yet more losses. The SIVs that some banks had all used to off-load debt and lower their capital requirements were foundering as the money market funds began dumping their commercial paper. Treasury came up with a plan to create a “super SIV,” which the banks would fund, that would buy the assets from the individual SIVs. The plan fell through. Citi—which had been the most promiscuous user of SIVs—had to put the SIV assets back on its balance sheet, at exactly the wrong time, and they eventually contributed to its many billions of dollars in write-downs. Paulson and his staff were frantically busy, trying to come up with solutions and stave off disaster. His restless energy went into overdrive. Today’s idea wasn’t necessarily consistent with yesterday’s idea, but then, the problems were unprecedented. There was no manual for what to do when you’re the Treasury secretary trying to prevent a financial crisis. As the year wore on, he and his small team at Treasury began to joke that they felt like Butch Cassidy and the Sundance Kid: they were being pursued and cornered, and even though they’d come out with guns blazing, they couldn’t ever seem to get out in front of the problem.
Though he was a Bush appointee, Paulson had no patience for the White House’s “holy war”—his words—against the GSEs. Yes, they were flawed institutions that were far too big and, quite possibly, posed systemic risk. But Paulson was a pragmatist. He dealt with things as they were. Fannie and Freddie weren’t going away; they were a problem that needed to be managed. Besides, the GSEs were only partly to blame for the monsters they’d become. “This was created by Congress,” he’d say.
When he did focus on Fannie and Freddie, he didn’t gnash his teeth at the moral hazard they posed. Rather, he worked to reduce that moral hazard. One step was to get Fannie and Freddie a new regulator. It was no secret that OFHEO was outmatched; practically from the moment he was named Treasury secretary, Paulson had worked to push through legislation to create a new regulator that would have real authority to set capital requirements, conduct serious audits, and even—if it came to that—wind down the GSEs. To get such legislation, he had to compromise with Democrats. Paulson had no problem with that, but it was anathema to the White House staff. Paulson was perfectly willing to override them and go to President Bush directly, which he did. In 2006, he began working with the Democrats to get legislation that would create a better, tougher regulator. The effort ran into congressional roadblocks. Fannie’s enemies—including its White House enemies—started speculating that Paulson was in the tank for Fannie because it was a big client of Goldman’s. (Actually, it was a big client of every firm on Wall Street.) Goldman Sachs board member Jim Johnson, a typical charge went, had been the chair of the compensation committee when Paulson was CEO and had helped set his pay. And so on.
The second step Paulson took was to urge the GSEs to raise capital, the same way he was urging all the big firms to raise capital. He liked to say that he’d never seen a CEO of a financial institution get fired for having too much capital. And indeed, the GSEs did raise additional capital, selling a combined $13 billion in equity and preferred stock.