All the Devils Are Here [218]
But even if that hadn’t been the case, the government’s priority wasn’t the shareholders. It was preventing the housing market from collapsing. For decades, Fannie and Freddie had worked to maximize profits at the expense of its government mission. Now that mission was paramount. The shareholders would have to fend for themselves. Fannie and Freddie’s stocks continued to plummet.
Even after everything that had happened, getting the bill passed required Fannie and Freddie’s support. Fannie got language inserted saying that the government could use its bazooka and inject equity only if Fannie approved. But Fannie executives didn’t bother to fight the provision about consenting to conservatorship, because they thought that “consent” would require a negotiation. In which case Fannie thought it had a trump card: it could always threaten to shrink the company’s balance sheet and stop supporting the mortgage market. And maybe there was a little hubris at work, too. “I used to say that if two accounting scandals, a Republican Congress and White House couldn’t kill us, how could you kill us ever?” says a former executive.
The legislation was signed at the end of July. Immediately Paulson brought in bank examiners to comb through the GSEs’ books. Just before heading off to Beijing for the summer Olympics—and just before Fannie and Freddie announced that they had lost a combined $3 billion in the first half of 2008—Paulson also hired Morgan Stanley to analyze the companies. He wanted to get an idea of how much money the GSEs could lose on mortgages they owned or guaranteed. He also wanted to get a feel for their ongoing liquidity—whether they would be able to continue to finance their operations. “Hank was very concerned with the overhang of this unraveling, and with $5 trillion, you don’t wait for the razor’s edge,” says one person who was involved.
Three weeks later, on August 19, the Morgan Stanley team told Paulson it thought Fannie and Freddie could lose as much as $50 billion. It was a staggering number, far worse than Fannie’s worst estimates. The examiners from the Fed were similarly horrified when they looked closely at the loans that made up the GSEs’ Alt-A books. Fannie and Freddie may not have called them subprime, but they sure looked that way to the examiners.
At that moment, upon finally learning how deep Fannie and Freddie’s problems were, Paulson decided the government had to take over the companies. “I started to race against the clock,” Paulson later recounted. He knew that Lehman Brothers’ third-quarter results were going to be disastrous. He was worried that Lehman’s problems would spread to the GSEs and trigger a run. He met with Bernanke, who agreed. For the sake of the housing market, the government needed to step in and nationalize the companies. “We had no choice,” Paulson would later say. Simply injecting capital—the original heart of the bazooka plan—would be a political disaster for the Treasury, given the Republicans’ feelings. Nor, Paulson believed, would it bring back investor confidence. “Why would any sane investor put money into these companies without knowing what the ultimate disposition would be?” Paulson would ask.
On August 26, from the Situation Room on the ground floor of the West Wing, Paulson briefed President Bush, who was at his ranch in Crawford, Texas. He briefed the president a second time on September 4. “Do they know it’s coming, Hank?” Bush asked.
“Mr. President,” Paulson replied, according to his memoir, “we’re going to move quickly and take them by surprise. The first sound they’ll hear is their heads hitting the floor.”
Even at