The Meltdown According to Hank Paulson

On the Brink:
Inside the Race to Stop the Collapse
of the Global Financial System
By Henry M. Paulson, Jr.
Hachette; $28.99

Henry Paulson recalls dining with some of Wall Street's most powerful bankers on June 26, 2007, not long before the credit bubble burst. "All were concerned with excessive risk taking in the markets and appalled by the erosion of underwriting standards," he writes in his penetrating memoir, On the Brink. Yet they felt forced by competitive pressure to make loans they didn't like, the former U.S. Treasury Secretary says.

"Isn't there something you can do to order us not to take all of these risks?" was the gist of a question posed by Chuck Prince, who was still running Citigroup (C) as the bank bumbled toward disaster.

That comment encapsulates the bizarre situation that enveloped Paulson as he struggled along with Federal Reserve Chairman Ben Bernanke and New York Fed chief Timothy Geithner to save the free-market system from itself. Banks, hedge funds, and other financial institutions were playing a game of chicken, the economic equivalent of the Cuban Missile Crisis. Paulson's mission was to prevent mutually assured destruction.

No one can argue that Paulson, a former chief executive of Goldman Sachs (GS), didn't work hard enough. This day-by-day narrative—written with the help of former Institutional Investor editor Michael Carroll—reminds us of his punishing schedule. We see Paulson's shiny-headed blur of nonstop phone calls, his late-night meetings, his tossing and turning at night (in boxers and T-shirt). In the middle of the meltdown, George W. Bush pulled a Paulson adviser aside. "Tell Hank to calm down and get some sleep," the President said by this account.

A devout Christian Scientist, Paulson got so worn out that he was tempted to take a pill to sleep. Instead, he flushed the drugs down the toilet. Another night, he managed to fall into a deep sleep, only to get a call from the world's most famous value investor. "Hank, this is Warren," said the voice on the phone. In his grogginess, Paulson says he wondered why his mother's handyman, Warren Hansen, was calling. It was, of course, Warren Buffett.

The big question is whether Paulson's indomitable resolve helped or hurt during the crisis. Though On the Brink won't settle the matter, it does lay out Paulson's rationale for taking actions that were repugnant to his own free-market beliefs.

The narrative goes behind closed doors as Paulson and his team endeavored to prop up the wobbling dominos—Fannie Mae (FNM) and Freddie Mac (FRE), Bear Stearns, Lehman Brothers, American International Group, and on and on. We get a persuasive portrait of a man caught between markets, taxpayers, and politicians. Paulson worried about what his "old friends" in Beijing would think; the Chinese, after all, held hundreds of billions of dollars in U.S. debt. Yet his biggest opponent was the global collective of investors. "The market was determined to call our bluff," he says in describing Bear Stearns' shotgun marriage to JPMorgan Chase (JPM).

Each bailout upped the ante. As Lehman tottered, Paulson and Geithner were prepared to consider a "Bear Stearns-style rescue," he writes. Yet Paulson told Street bankers ranging from JPMorgan's Jamie Dimon to Morgan Stanley's (MS) John Mack that there could be no federal money in a Lehman lifeline. Why? "I knew that unless I explicitly said this, some of them might think that Good Old Hank would come to the rescue."

Time and again, Paulson admits his mistakes—including intemperate remarks and underestimation of public outrage over taxpayer-funded bailouts—and concedes that he risked distorting markets. While you don't have to accept his arguments, it's useful to know the logic and legal constraints that motivated all those ad hoc decisions. Paulson also works hard to polish George Bush's image. By this account, Bush didn't go AWOL during the crisis; he was "all business, engaged and focused," courageously backing market meddling for the good of the country.

Yet Bush wasn't really up to speed. During one meeting in August 2006, Paulson found himself giving the President "a quick primer on hedging." By then, the bottom was falling out of the subprime-mortgage market.

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