Reassessing Hank Paulson
Imagining that Henry Paulson would threaten Bank of America CEO Ken Lewis into completing the Merrill Lynch acquisition late last year never required a huge mental leap. “I intended to deliver a strong message,” Paulson anticlimactically acknowledged in congressional testimony.
This is the same treasury secretary, after all, who last October summoned the CEOs of the nation’s nine largest banks to Washington and told them that it wasn’t in their financial self interest to refuse government capital infusions. And if the executives happened to disagree with Uncle Sam’s assessment, regulators would force the money on them anyway. Consider it another “strong message” delivered. Yup, the former football lineman makes for an awfully persuasive tough guy.
The drilldown on BofA-Merrill, however, is a transitory issue. And Paulson surely realizes this. He started his testimony before the House Committee on Oversight and Government Reform with a broad defense of his role in the government’s handling of the 2008 financial crisis. Today was legacy enhancing time for Paulson. And the former Goldman Sachs CEO gave a convenient standard by which economic historians and second guessers everywhere could judge him: “Having had the benefit of some time to reflect, and to consider views expressed by others, I am confident that our responses were substantially correct and that they saved this nation from great peril.”
OK, then, were Paulson’s efforts to deal with the horrific collapse of the twin housing and credit market bubbles “substantially correct”? Refusing to support the suspension of mark-to-market accounting may have been Paulson’s biggest mistake. (Accounting forbearance is letting the banks hold on to the “toxic assets,” rake in the cashflows, and muddle their way back to health so as to avoid a market-eviscerating nationalization.)
But there were other mistakes as well, such as saving the unsecured creditors at Bear Stearns and helping set up false expectations of government salvation when Lehman started to implode. Or the repeated assurances that Fannie and Freddie were solvent.
Then there’s Lehman. Letting the investment bank go down often gets cited as Paulson’s biggest blunder. But Treasury officials seem to believe a) they had no authority to save it, and b) they had given management and the markets plenty of warning that no federal help was coming.
Anyway, “event” analysis of interest rate spreads (serving as risk indicators) by Stanford University economist John Taylor, provides strong evidence that Lehman’s failure was merely another milestone in an ongoing credit freeze. But Taylor does blame Paulson in the poor public communication efforts surrounding TARP that made the program seem like a rushed and panicky response to the crisis. The bad-mouthing of the economy that Paulson and Ben Bernanke undertook to get Congress to fund TARP also unnerved markets and American consumers.
Then with markets quickly deteriorating, Paulson decided to use TARP to inject capital into banks rather than buying bank assets. Taylor concludes: “At a minimum a great deal of uncertainty about what the government would do to aid financial institutions, and under what circumstances, was revealed and thereby added to business and investment decisions at that time.”
Of course, Paulson and Bernanke could have skipped TARP altogether, letting a combination of accounting changes, bank bond and money market guarantees, and Fed lending facilities do the heavy lifting. Former Treasury official Phillip Swagel, though, rejects that counterfactual approach in a recent paper: “With financial institutions beyond Lehman weakening as asset performance deteriorated, it seems likely that the lockup would have taken place, and perhaps sooner than later.”
Perhaps, but TARP has also served to give government an unhealthy foothold into America’s capital allocation system and furthered the costly bailout fever (and accompanying moral hazard) that hopefully may have finally broken with the government’s decision to not save CIT Group.
Yet any errors must be placed in the context of a fast-evolving financial crisis. It would have taken a cool hand indeed (as well as a strong stomach) to have not attempted something like a $700 billion toxic asset buy. Hey, had that silver-bullet plan had enough time to be put into effect, Uncle Sam could be sitting on some potentially quite profitable assets today.
In the end, however, if the U.S. economy avoids both bank nationalization and a long period of economic stagnation following the double bubble trouble, Paulson may well be judged “substantially correct.”