Paulson feared run on dollar and collapse of Goldman Sachs

'Everything that Could Go Bad, Did Not'

By Krishna Guha
Financial Times, London
Sunday, January 31, 2010

http://www.ft.com/cms/s/0/772748d6-0e94-11df-bd79-00144feabdc0.html?ncli...

Hank Paulson feared there would be a run on the dollar during the early phase of the financial crisis when global concerns were focused on the US, the former Treasury secretary has told the Financial Times.

"It was a real concern," Mr Paulson said in an interview ahead of the release on Monday of his memoir, "On the Brink." A dollar collapse "would have been catastrophic," he said. "Everything that could go bad did not go bad. We never had the big dislocation of the dollar."

When the crisis escalated and went global with the failure of Lehman Brothers in September 2008, the dollar rallied -- but Mr Paulson had to grapple with a firestorm of financial failures.

He feared that Goldman Sachs and Morgan Stanley would go down along with Washington Mutual and Wachovia.

Lloyd Blankfein, Goldman Sachs chairman, told him that Goldman would be "next" if speculators succeeded in bringing down Morgan Stanley, the former Treasury secretary said.

"If they go, we're next," Mr Blankfein told Mr Paulson, a former Goldman chairman who had recused himself from decisions relating to his former company.

US officials explored the possibility of mergers between JPMorgan and Morgan Stanley, Goldman and Citigroup, or Goldman and Wachovia, before settling on turning Morgan Stanley and Goldman into banks with access to central bank loans.

Even then Morgan Stanley was not safe until the US Treasury helped seal an investment by Japan's Mitsubishi UFJ, Mr Paulson writes.

The frenzied manoeuvring came in the three-week period between the failure of Lehman on September 15, 2008, and Columbus Day weekend in early October, when the global financial system was on the verge of meltdown.

"Banks were going down like flies," Mr Paulson told the FT. As his book details, he was scrambling to secure Tarp bailout funds from Congress. "The timing could not have been worse since we were months or weeks from the election, so you had the collision of markets and politics.”

Although a Republican, Mr Paulson found it harder to deal with John McCain than Barack Obama -- raising the interesting (and unanswered) question of which candidate Mr Paulson voted for.

Mr Paulson said that the turning point in the crisis came when -- armed at last with Tarp equity -- the US joined other Group of Seven nations to announce comprehensive interventions to guarantee bank funding and access to capital on October 10.

Three days later Mr Paulson pressured nine top US financial institutions into accepting $125 billion in Tarp capital. "I do think it was the defining act," Mr Paulson said.

Mr Paulson said the US authorities lacked essential tools to deal with a crisis -- above all a controlled bankruptcy regime for non-bank financial companies.

He hopes his book conveys "the pace at which things were moving and the number of decisions that had to be made in very short time frames."

He said he was surprised by the vehemence of the public reaction against bailouts. He told the FT there was "a disconnect" between the way policymakers saw their actions and the way the public perceived them.

"We knew -- I knew -- that when the markets froze there was going to be a painful impact on the economy a number of weeks out."

Mr Paulson is frustrated that people do not pay more attention to disasters averted by timely actions -- including the move to seize control of Fannie Mae and Freddie Mac.

Instead, most debate centers on the failure to stop Lehman from collapsing, and the decision to rescue insurance giant AIG.

Critics say the Treasury should have deployed its sole pre-Tarp source of capital, the Exchange Stabilisation Fund, to backstop a rescue. However, Mr Paulson said Treasury lawyers had been through this during the Bear Stearns crisis six months earlier and concluded that it would not be lawful.

Others fault top US officials for not doing a better job of preparing for a Lehman collapse.

Mr Paulson said the US was taken by surprise by the UK bankruptcy administrator's decision to seize hedge fund assets held by Lehman -- a move he said was "devastating."

He also admitted: "I did not see the money markets moving as quickly as they did" after the Lehman collapse. But he said there were limits to what could have been done in general to mitigate a Lehman failure without precipitating its immediate collapse.

On AIG, Mr Paulson said he had nothing to do with the controversial decision to pay counterparties at par -- and found out about it only in December when AIG made a public disclosure.

"The decision to rescue AIG was a Fed authority, a Fed decision, and the Fed was responsible for administering that loan," he told the FT.

His book hints that the Treasury was less than enthusiastic about supporting the original Federal Reserve loan with later Tarp equity -- but Mr Paulson refused to discuss AIG further.

Looking back, Mr Paulson is confident that -- notwithstanding criticism -- the big calls were the right ones.

"This Monday morning quarter-backing misses the point -- that, guess what, we did take the important actions that it took to stop the system from collapsing."

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