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Can Hank Paulson Defuse This Crisis?
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As the Bush administration’s third Treasury secretary, Henry M. Paulson Jr. has faced a brutal series of crises on Wall Street and in Washington that have sparked fiercely partisan debates.


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By STEVEN R. WEISMAN and JENNY ANDERSON
Published: July 27, 2008

IF Henry M. Paulson Jr. hadn’t left Wall Street for Washington to become Treasury secretary in 2006, he would still be making tens of millions of dollars a year as the chairman of Goldman Sachs. He would be comfortably zipping around the globe on a corporate jet. He would be presiding over the only big Wall Street firm that hasn’t lost billions on bad debt.


Ed Quinn

In 1994, Henry Paulson, left, and Jon Corzine, right, served under Stephen Friedman at Goldman Sachs.

He wouldn’t be answering rounds of questions at meandering Congressional hearings. He wouldn’t be at the center of the Bush administration’s struggle to contain a potential financial meltdown the likes of which the world hasn’t seen since the Great Depression.

And he certainly wouldn’t be openly (and with a grin) comparing himself to Job, the Bible’s best-known punching bag.

Still, he insists that he doesn’t regret leaving his perch atop Goldman Sachs when the president called.

“I don’t look back,” he told New York Times editors and reporters in a meeting last Monday. “It wasn’t my first choice, ever. I enjoyed what I was doing. I thought it was the right thing to do.”

Whether Mr. Paulson has actually done the right things during his two uneven years in office has been a matter of intense debate in financial and political circles. That debate reached a boiling point last week as Congress moved toward approval of a taxpayer-financed rescue package that Mr. Paulson advocated for Fannie Mae and Freddie Mac, the government-sponsored mortgage giants that appear to be powder kegs.

Even Mr. Paulson, for all his Wall Street experience and market savvy, occasionally appears flummoxed by the scale and complexity of the current crisis.

“When I talk to people, there are a whole lot of them that say: ‘I don’t like this,’ ‘I don’t like that,’ ‘I don’t like the other thing,’ ” he said in the Times meeting. “I say: ‘Neither do I. What idea do you have? What do you think we should do?’ ”

Mr. Paulson is leading the Bush administration’s struggle to contain an economic contagion stemming from a disintegrating housing sector, volatile financial markets and frozen credit, skyrocketing energy and food prices, widening job losses, and a precipitous fall in the dollar.

As he scrambles to find solutions to these myriad and interconnected challenges he has earned plaudits for how quickly he has recently marshaled federal resources. Yet he’s also been roundly criticized as having not grasped the threat and severity of the crisis when it began to snowball about 18 months ago.

Moreover, a Treasury secretary who initially preached against “excessive regulation” of the financial sector is presiding over a sweeping government intervention in the economy, one that conceivably marks the end of a federal deregulatory push that began in the late 1970s and accelerated in subsequent decades.

And an administration that has rarely had conflicts with its allies in Congress discovered that the Fannie and Freddie legislation is opposed by most Republicans in the House of Representatives, some of whom claim it smacked of socialism.

Critics on the right also accuse Mr. Paulson and Ben S. Bernanke, the Federal Reserve chairman, of panicking and over-reaching, keeping interest rates low, which they say has fanned inflation and caused the dollar to skid.

Facing the possibility of even worse economic news in the months to come, Mr. Paulson — whose nickname “The Hammer” comes from his days as an offensive lineman on the Dartmouth football team in the ’60s — has won praise on Wall Street and Capitol Hill, particularly among Democrats, for his role in fashioning solutions to economic difficulties this year.

“He has handled this crisis extremely well,” said Representative Barney Frank, the acerbic Massachusetts Democrat who is chairman of the House Financial Services Committee and customarily a scathing critic of the Bush administration. “It’s fair to say that he and almost everybody else failed to anticipate some of these problems. We all underestimated it. What I give him credit for is how rapidly he adapted.”

But other observers say they still aren’t convinced that Mr. Paulson’s overall performance has been up to speed, seeing it as overly reactive rather than proactive.

“I’m afraid there’s much more Treasury could have done much earlier in this process,” says Thomas H. Stanton, an author and expert on mortgage finance. “Once the financial markets showed signs of panic, Treasury had to act.”

And, Mr. Stanton adds, “it’s almost as if Treasury was panicked as well.”

Still, say others, Mr. Paulson and his Treasury team can’t shoulder all of the criticism aimed at the federal government over its handling of the financial crisis.

It wasn’t just the Treasury; it was a problem throughout the federal government that everyone was asleep at the wheel,” said Nouriel Roubini, an economics professor at the Stern School of Business at New York University. “They let the subprime market and housing bubble expand without any controls. They believed in risk-management models,” he said, thinking that “market discipline would be better than regulation. But the lesson we have learned is that self-regulation means no regulation.”
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Mr. Paulson left Wall Street to become President Bush’s third Treasury secretary, on July 10, 2006.
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Critics say policies of Mr. Paulson, at back, and Ben S. Bernanke, the Federal Reserve chairman, have contributed to inflation and the dollar’s slide.

WHEN Mr. Paulson accepted the Treasury job, he sought advice from Robert E. Rubin, another former Goldman Sachs chief, who served as Treasury secretary in the Clinton administration. The two sat together in the library of Mr. Rubin’s Manhattan home as Mr. Paulson peppered him with questions about how Washington works.

“Some people from business or law go down to Washington and they go with the view that they’ve done very well in whatever they’ve done and they can take that same way of functioning and apply it in Washington,” says Mr. Rubin. “Very often that doesn’t work. Others say, ‘I’ve had a lot of experience, but this world operates in different ways and I have to learn how this world works.’ That’s a much more effective approach, and that’s my impression of what Hank has done.”

In Washington, where politicians and policy wonks can feel in their bones when a Cabinet member does or doesn’t have clout, Mr. Paulson’s stock is riding high.

It was the Treasury chief, for example, who persuaded Mr. Bush to go along with a $168 billion economic stimulus package in cooperation with Democrats early this year. As markets fell precipitously in March, he worked with Federal Reserve officials to orchestrate the fire sale of Bear Stearns to JPMorgan Chase, encouraging the Fed to financially back the deal and open its coffers to other ailing investment firms.

Bear Stearns complained that it was being forced to accept a low-ball price for its ailing shares; Mr. Paulson demanded a rock-bottom price so the public didn’t have the impression that Bear’s shareholders were getting a life raft paid for by Main Street taxpayers.

And this month, as Mr. Paulson helped hammer out emergency legislation authorizing the federal government to potentially inject hundreds of billions of dollars into Fannie and Freddie if the government-sponsored mortgage makers weaken further, he spent long hours with lawmakers of both parties.

Although the White House made clear its distaste for parts of the legislation, especially increased federal spending for homeowners, it said that Mr. Bush was taking the Treasury secretary’s advice not to veto the bill.

The House speaker, Nancy Pelosi, a California Democrat and a critic of the White House, praised Mr. Paulson for changing Mr. Bush’s mind. Senator Christopher J. Dodd, the Connecticut Democrat who is chairman of the Senate banking committee, is also singing “Kumbaya.”

“I’ve watched him grow in the last year, not in terms of intellectual capacity but in his appreciation of how this town works,” says Mr. Dodd.

Then again, in an environment where financiers and public-policy makers have temporarily tried to forge a bipartisan front to address the most severe economic tempest in a generation, few people are willing to speak critically of Mr. Paulson for attribution — recognizing, they say, a need for a nervous public and queasy financial markets to believe that the federal government is in charge, is capable, and knows exactly how to confront the downturn.

“There’s reluctance to be critical because they understand that to be critical would further erode investor confidence and therefore cause the markets to dive deeper,” says James D. Cox, a corporate law professor at the Duke University School of Law. “We are at a point where it’s difficult to determine how much of this is being driven downward by psychology or the excesses of the past working themselves out. Most people think it’s excesses of the past, but they hope no one else realizes that.”

Moreover, Mr. Paulson has especially endeared himself to the denizens of Wall Street by using federal power and the public purse to rescue the financial industry from its own, outsize mistakes and prevent the meltdown from getting out of control.

“He’s saved their bacon,” Mr. Cox says.

Truth be told, Mr. Paulson is not an easy person to stage manage anyway. Colleagues and acquaintances say he can be forceful and candid in his arguments, even if he is sometimes hot-tempered and prone to impulsive table-pounding.

While Mr. Paulson’s weak communication skills make him a notoriously hobbled public speaker, in private he still can be a good listener. “He lacks the fluidity of a Bob Rubin, but he can be very persuasive,” Mr. Dodd says.

For his part, Mr. Paulson has the confidence and self-awareness to cop to some of these faults.

“I’m not an inspirational leader,” he told the Dartmouth Alumni Magazine in 2003. “I’m just not.”

IF Mr. Paulson, 62, has been something of a fish out of water in Washington, he was sometimes that way on Wall Street as well.

(Page 3 of 5)

At Goldman Sachs he didn’t golf or drink, and he often left dinners with senior executives at 8:45 p.m. so he could go to bed. He shunned the Hamptons scene, spending free weekends in Barrington, Ill., where he and his wife, Wendy, built a house in 1974, down the road from his mother, Marianna.
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He has impeccable Republican credentials and raised funds for George W. Bush. Friends are quick to point out that both he and Wendy, a Democrat, are ardent bird watchers and environmentalists. (Mr. Paulson, who wanted to be a forest ranger before he chose a financial career, was chairman of the Nature Conservancy until he took the Treasury job.)

He shuns the trappings of great wealth in other ways as well. He donated $100 million of his Goldman stock to a family foundation dedicated to conservation and environmental education and has said he would give the remainder of his fortune, which stood at about $500 million in 2006, to charity when he dies. He told one reporter that he loved his children too much to leave them money.

MR. PAULSON was raised as a Christian Scientist in Barrington, studied English at Dartmouth, landed a Pentagon job, and then worked in the Nixon administration as a liaison to the Treasury and the Commerce Department. After that, he attended Harvard Business School and joined Goldman’s Chicago office as an investment banker after graduating.

He made an early impression.

“He was very smart, he had the best people in corporate finance working on his team — they recognized his talent — and when I went on client visits, the most important business people in Chicago looked to him personally for his advice,” said Stephen Friedman, a former Goldman Sachs chairman who was President Bush’s top economic adviser from 2002 to 2005.

Inside Goldman, Mr. Paulson was known for his bulldog intensity and direct manner. “He used to say that he runs fastest toward problems, and it was true,” said Eric Schwartz, a former Goldman executive who worked closely with Mr. Paulson. “Instead of avoiding conflicts — which is what a lot of managers do — he goes headlong into them.”

In 1999, he snared Goldman’s top job after leading a palace coup to push out Jon Corzine, his co-senior partner. (Mr. Corzine, a Democrat, is now the governor of New Jersey.)

Mr. Paulson presided over Goldman as it successfully made the transition to public company, expanded aggressively into international markets, and shifted from a more advisory-focused business to one that takes more principal risk in trading and investing.

He also defied conventional wisdom among critics and competitors who thought the firm was too small to go it alone. After the repeal of federal laws separating commercial and investment banking in 1999, it was widely accepted that new, sprawling megabanks like Citigroup would crush smaller firms like Goldman.

But Mr. Paulson repositioned the business as one built on superior brainpower and the generation of heady profits through judicious risk-taking. Today, Goldman stands alone as the only bank that has yet to take huge write-downs in the credit crisis.

Goldman, however, was also an integral part of a money-hungry Wall Street culture that helped build, oil and maintain the securitization and derivatives machinery underlying the current mortgage-fueled problems.

Mr. Paulson’s tenure wasn’t without scars. His bluntness — or “brain-to-mouth,” as he has described it — has been a liability at times. In 2002, at an investment conference, he said that 15 percent to 20 percent of the people in each of Goldman’s businesses added 80 percent of the value. It violated Goldman’s cultlike approach to team work. He immediately apologized to all the firm’s employees.

He was also deeply embroiled in the 2003 ouster of the former New York Stock Exchange chairman Richard A. Grasso over complaints about Mr. Grasso’s compensation. And Mr. Paulson sat at Goldman’s helm during the excesses of the dot-com bubble, selling vast numbers of subpar companies that promptly crashed with the market. Goldman wasn’t the worst of the offenders, but it wasn’t an exception either.

WHEN Mr. Bush struggled to right his listing administration in 2006, his chief of staff, Joshua B. Bolten, a former executive at Goldman Sachs, recruited Mr. Paulson to replace John W. Snow at Treasury.

Neither Mr. Snow nor his immediate predecessor, Paul H. O’Neill, was viewed in Washington as having much clout in the Bush administration — Mr. O’Neill went embarrassingly public with his criticisms after he left office — and Mr. Paulson demanded that he be given the authority they lacked if he were to take the job.

According to administration officials and others close to Mr. Paulson, he asked to be named as the administration’s chief economic official and that he have a direct line to Mr. Bush.

Upon taking office, Mr. Paulson had something of a rude awakening. He said he intended to direct a bipartisan effort to overhaul Social Security and Medicare, but Democrats balked. He tried to improve economic relations with China but met with limited success. Although the Chinese let their currency appreciate in value, they continued to resist opening their markets to American goods, services and investments.

Meanwhile, the financial crisis has swirled around the White House in ever more violent waves. But each sign of economic trouble brought assurances from regulators, Mr. Paulson and others in the Bush administration that the housing sector was experiencing a “correction” or a “repricing of risk” that would work its way through the system without throwing the economy into a steep downturn. Each assurance soon ran aground as more bad economic news poured in.
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At the same time, Mr. Paulson began echoing the line of many in the financial industry that the real problem facing Wall Street was a welter of cumbersome regulations.

Warning that private equity firms and others were raising capital in markets outside the United States, Mr. Paulson said in November 2006 that although he had no wish to lift regulations altogether, “excessive regulation slows innovation, imposes needless costs on investors and stifles competitiveness and job creation.”

Accordingly, Mr. Paulson set up a presidential working group to come up with a new regulatory blueprint that would simplify if not lift government regulations. What he didn’t anticipate was that the financial crisis would redefine that mandate.

Last fall, he declared that “the ongoing housing correction is not ending as quickly as it might have appeared late last year.” He repeatedly said that the problem wasn’t bad credit but market fears, so he encouraged banks to raise more capital and recommended other forms of financial engineering that didn’t gain traction.

Most notably, he advocated bundling bad loans into off-balance-sheet entities that theoretically would allow banks to improve their financial standing. The plan was a total flop and yet another signal that Mr. Paulson underestimated the severity of the problem.

Another initiative from Mr. Paulson was a program called the Hope Now Alliance, which the administration says has helped hundreds of thousands of homeowners stay in their homes through voluntary renegotiations with banks of mortgage payments.

But the markets weren’t reassured. And then came the heart-stopping events this year, beginning with Bear Stearns and mushrooming into the Fannie and Freddie messes. Treasury has been “reactive and not proactive,” said George Soros, the financier and philanthropist. “You can see it on the compromise on Fannie Mae — it’s a halfway house. It remains part of the problem instead of becoming part of the solution.”

Some associates of Mr. Paulson say he is handicapped by a lack of a strong bench at Treasury, although government analysts consider the caliber of the midlevel professionals there to be high.

Mr. Paulson wound up relying more in the current crisis on Robert K. Steel, a former Goldman executive who left Treasury abruptly earlier this month to become chief executive at Wachovia Bank.

Although there has been speculation that Mr. Steel’s departure hinged on a failure to grasp the problems at Fannie and Freddie and keep Mr. Paulson more fully apprised, people close to the situation at Treasury strongly deny that. Rather, they say, Mr. Steel left in part because he realized he wasn’t going to be promoted to a deputy position at Treasury.

Mr. Steel says that he and Mr. Paulson foresaw the economic and housing problems much earlier than they are given credit for, and that they made early forays to reform Fannie and Freddie.

“When Hank came to Washington, he went to the president and said we’d had a long period of time with no disruptions in the marketplace, and that there was a lot of dry tinder out there,” Mr. Steel recalls in an interview. “I think it’s pretty amazing that in August of ’06, he began to prepare for financial challenges.” Executives close to Mr. Paulson say the administration, including Mr. Steel, were stunned by the magnitude of Fannie’s and Freddie’s internal financial problems.

Mr. Paulson says he was not late to the game. “I’ve had a number of people say to me, ‘You should have pushed this harder earlier.’ And I almost don’t get it. Because I came down here and from the day I showed up in Washington I looked at that problem; there is no doubt there is systemic risk,” he said when speaking at The New York Times last week. “The idea of working hard to get a regulator with powers to address some of these systemic issues is important.”
Page 5 of 5)

Nonetheless, earlier this year Mr. Paulson’s hopes for reform consisted mostly of enhanced oversight of Fannie and Freddie. That effort also ran into Congressional opposition and demands that the two agencies expand their lending activities.
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Mr. Paulson’s associates say that he has also been frustrated at how hard it has been to convince the White House and other parts of the administration that quick action was essential in the Bear Stearns and Fannie and Freddie debacles.

The Bear Stearns crisis happened so fast that Mr. Paulson didn’t bother following inter-agency protocols and simply briefed Mr. Bush and two top aides on the matter.

The Treasury chief has also tried to avoid overstating or understating the dangers ahead.

“I think we’ll be dealing with the housing issue in one way or another for months, maybe years after I’ve left,” he said at The Times. But he added that the “biggest part” of the crisis will be “largely over by year-end” and that progress “isn’t in a straight line.”

Mr. Paulson has quietly tried to tell members of Congress that the whole world is watching how America deals with its housing problems, including Fannie and Freddie. Even so, he is quick to say how uncomfortable he is overseeing a huge, government-led intervention in the financial industry.

“I would rather not be in the position of asking for extraordinary authorities to support” Fannie and Freddie, Mr. Paulson said during a speech at the New York Public Library. “But I am playing the hand that I have been dealt.”

Some on Wall Street welcome his response. “He’s done a spectacular job balancing free-market ideology with strong government actions,” said Thomas Nides, chief administrative officer at Morgan Stanley and a Washington veteran. “And as a Democrat that’s not an easy thing to say. He’s a Republican and a free market guy — but he’s not making decisions based purely on ideology.”

All of which is why Mr. Paulson has been working overtime to try to contain the financial mess. What the White House isn’t publicly emphasizing is that overseas governments and investors hold a considerable amount of securities guaranteed by Fannie and Freddie. If they sell off those securities it could spark a huge market disruption.

To that end, backing up Fannie and Freddie is imperative, says Mr. Paulson.

“The credit facility is like a lender of last resort and what I believe Congress wants to do — will want to do — is to increase the confidence in our capital markets and in these organizations,” he said at the Times meeting, discussing the proposed rescue package for the mortgage giants. “It will be used as a last resort and it will be used to protect the taxpayer.”