All the Devils Are Here [217]
Debt investors around the world owned a staggering $1.7 trillion in either mortgage-backed securities guaranteed by the GSEs or GSE debt, according to the study by Jason Thomas. Suddenly, for the first time in memory, they were net sellers of that debt, unloading some $66 billion in Fannie and Freddie debt securities in July and August. Fannie and Freddie had literally billions of dollars in debt that they would need to roll over in the coming months.
Now Paulson was obsessively focused on Fannie and Freddie. He still didn’t know the extent of the credit risk on their books. Indeed, their regulator was still saying they were in good shape, and Paulson had no way of judging for himself whether that assessment was right or wrong. And Fannie and Freddie were every bit as vulnerable to a run on the bank as Bear Stearns—maybe even more vulnerable, because their capital cushion was so small. It really wouldn’t take much to put them over the edge.
If panicked investors around the globe started dumping Fannie and Freddie debt, the government would be helpless to do anything about it. That’s the only thing Paulson really knew. “I had no power, and the regulator had no power, no responsibility, and no authority,” Paulson later said. The would-be reformers had long clamored for a way to wind down a failing GSE. But Paulson had already failed to push through legislation that might accomplish that.
Paulson’s instinct—as it always was when faced with a problem—was to take control and do something. “Hank wanted to fire anyone who said the GSEs were OFHEO’s problem,” recalls a Treasury official. “He said, ‘We own this problem. It’s ours to solve.’” But how? The staff worked all weekend to come up with a plan: get Congress to give Treasury “emergency powers,” to use Paulson’s phrase, that would allow the government to put money into Fannie and Freddie. At the same time, the logjam surrounding the creation of a new regulator had finally broken. And so the bill that finally, at this desperate late date, passed Congress did a few things all at once. It created a new regulator for the GSEs (though it was really the old regulator with a new name). It gave the Federal Reserve power to look at the GSEs, so the Treasury staff didn’t have to rely on OFHEO’s judgment of their health. It made it easier for the government to take over the companies through conservatorship should they fail—it included, among other things, a provision that if their boards consented to a takeover, shareholders couldn’t sue. And it gave Treasury the unlimited ability to use and increase those long-standing $2.25 billion lines of credit that Fannie and Freddie had. At that point, Paulson never intended to use it.
“If you’ve got a bazooka, and people know you’ve got it, you may not have to take it out,” as Paulson explained it to Congress.
Less than two weeks later, Tim Geithner had a dinner party at the New York Fed, as he often did so the Treasury secretary could talk with Wall Street’s chiefs. Paulson explained to the assembled CEOs why his actions on the GSEs should be reassuring to the market. Lloyd Blankfein raised his hand. “Hank, I don’t mean to be disrespectful,” he said. “But this is a strange market, one that’s driven by fear. Stop and think.” Blankfein paused before delivering his punch line. “Fannie and Freddie are the U.S. government’s SIVs.” He finished, “Hank, how long did it take before Citigroup had to step up to its SIVs and put them on its balance sheet?”
“I had to change the subject because the moment he said it, I knew he was right,” Paulson later said.
The news of the bazooka did not turn the tide. The irony was powerful. For decades investors had bought Fannie’s and Freddie’s stocks, happy in the knowledge that the GSEs were backed by an implicit government guarantee. It had always been one of the most attractive things about owning the stock. But now that the government was saying, quite explicitly, that it would back Fannie and Freddie, investors