Three Men And a Bailout
By KAREN TUMULTY, Massimo Calabresi
The largest government bailout in U.S. history was born before dawn on Sept. 17, when Federal Reserve Chairman Ben Bernanke woke up at 6 a.m., checked his BlackBerry and saw the very thing he had dreaded: the futures market in free fall. Bernanke, Treasury Secretary Henry Paulson and New York Fed president Timothy Geithner had spent the past year staving off one disaster after another, for the most part working behind the scenes. Earlier in the month, they had let investment bank Lehman Brothers slide into oblivion and then ushered another, Merrill Lynch, into the arms of Bank of America. Just the night before, the trio had wrapped up a deal to rescue insurance giant American International Group and gone to bed praying it would halt the panic and worrying it wouldn't.
It didn't. On Sept. 17, the Dow plunged more than 400 points, and all three were picking up signs of an even bigger nightmare, one that most Americans were yet unaware of: the whole financial system was seizing up, from formerly rock-solid banks and money-market funds to the esoteric but vital market for foreign-exchange swaps. Credit--the access to cash that keeps the U.S. and other economies oiled--was simply drying up. Banks stopped lending to other banks, out of fear they would not get the money back. Big companies were having trouble raising cash on the overnight commercial-paper markets. If left unchecked, it would be only a matter of days, maybe less, before businesses would be unable to get the cash they needed to make purchases and meet payrolls.
And after that? Think the unthinkable. On Sept. 18, Paulson and Bernanke laid out the dark scenario for stunned-silent congressional leaders: a stock-market crash, businesses going under, unemployment soaring, consumers unable to get so much as a car loan, banks failing so fast that they would quickly drain the federal deposit insurance fund--and with it, countless people's life savings. And unlike the chain reaction that came over the course of weeks and months in 1929, this one would happen in a matter of days, if not faster. "The chain reaction," said Paulson, "is quicker than in the past."
And so Paulson and Bernanke asked for the world--and warned lawmakers they had only a few days to deliver it. Treasury needed $700 billion to buy up Wall Street's toxic mortgage-backed assets, which the government would eventually repackage and sell when the real estate market recovers, and a crisis might be averted. The proposal was simple, only three pages long. "Ben, Tim and I had talked for months about how there might be a need to do something like this, discussed the various plans," Paulson told TIME on Sept. 24. "The one thing we knew was that we couldn't or shouldn't go to Congress until we absolutely needed to, because the worst thing would be to go to Congress, ask for it and not get it."
The notion that a massive, unprecedented intervention in the financial markets should be the final economic act of a Republican President was made all the more stunning by the sight of no less a free-marketeer than Vice President Dick Cheney being dispatched to the Hill to sell it to furious Republicans. But Congress is coming late to this crisis. Paulson, Bernanke and Geithner--whose conference calls can number more than half a dozen a day--have been quietly trying to keep the ship in the channel for months. Treasury Secretary Paulson, 62, was one of Wall Street's toughest dealmakers as CEO of Goldman Sachs. Fed chief Bernanke, 54, is a quiet academic who was the chairman of Princeton's economics department and is one of the foremost scholars of the Great Depression and other economic catastrophes. Least known of the three is Geithner, 47, whose years at Treasury in the 1990s and position at the Fed's pivotal New York City office make him the trio's eyes and ears on Wall Street. There is some speculation that Geithner himself might be Treasury Secretary someday in a Democratic Administration. "A very unusually talented young man," said Paulson. "He understands government and understands markets."
The three didn't know one another well when the dawning foreclosure crisis threw them together in August 2007. They bring contrasting--and sometimes contentious--styles to their countless strategy sessions, all-nighters and weekends spent away from their families. Paulson is profane and direct and talks in anecdotes. He is also the bearer of bad news, having been the one to let Lehman Brothers' chiefs know they were going down without a helping hand. Checking in from his tomblike suite of offices at the Federal Reserve on Constitution Avenue, where he monitors two computers and a TV while chewing on Necco Wafers, Bernanke is calmer, quieter and prone to offering up a fourth option when three are on the table. Paulson called him "pragmatic, intellectually curious--a courageous guy." Geithner, working from the New York Fed's imposing Manhattan headquarters on Liberty Street, often serves as the bridge between the other two back in Washington. "There isn't anything spoken in anger, but certainly these are men with ideas and can be forceful in how they express them," says one person familiar with their calls. "If there's a sense that someone was miffed or something, then there's a private call right afterward, and then the next call is fine."
Who does what depends on which agency has the most authority for the task at hand. Paulson was the primary mover last fall in getting banks and mortgage companies to ease up on homeowners who faced foreclosure, while Bernanke dropped billions into jittery credit markets with a surprise rate cut. Geithner engineered the rescue in March of the investment bank Bear Stearns. In the summer, Paulson horsed Congress into giving him broad authority to seize troubled lenders Fannie Mae and Freddie Mac--which he ended up having to use two months later. And when the three have run into interference from conservatives in the White House who didn't much care for their intervention in free markets--including, at times, aides in the Vice President's office--President Bush has told them, To hell with the flak--just get it done.
But asking Congress for $700 billion overnight when lawmakers have been unable for years to find funds for all sorts of other national priorities provoked a bitter and bipartisan backlash. "Paulson confused venture-capital behavior with leading a free society," says former House Speaker Newt Gingrich. "I don't know why Bernanke thinks a problem largely created by the Fed and the Treasury is something that only the Fed and the Treasury are smart enough to fix." Others went further: "It's financial socialism," Senator Jim Bunning of Kentucky told Paulson and Bernanke at a stormy Senate Banking Committee hearing, "and it's un-American." Bunning, a conservative, was echoed by Senator Chris Dodd, a Connecticut liberal: "After reading this proposal, I can only conclude that it is not just our economy that is at risk, but our Constitution as well."
Nor could anyone guarantee that $700 billion, as staggering a figure as that is, would be enough to get the job done. After all, the people who would be brought in to do the deals would come from some of the very Wall Street firms that caused this problem in the first place. But as unpalatable as it is to bail out the wealthy financiers whose greed got the economy into this mess--and to do it, no less, in an election year when voters are already furious--the trio maintained that not doing it would be even worse. "We just haven't communicated as well as we need to. The average American looks at this as being about Wall Street. They're angry, and I'm angry too," Paulson said. "But the average American doesn't understand the implications this has for them."
Ultimately Paulson, Bernanke and Geithner must convince the public that fixing the financial mess requires a dramatic expansion of government power--and in particular, the power of their respective offices. That may be a tough sell, in part because the disaster was as much a failure of the political system as of the financial one. Over the past decade, politicians, scooping up campaign contributions from Wall Street, took down the guardrails that had existed since the Depression. And few were better connected in the corridors of power--or more successful at deflecting proposals for tighter government supervision--than mortgage giants Fannie Mae and Freddie Mac.
So lawmakers looked the other way as financial firms grew and morphed and created financial instruments no one understood well enough to oversee. When housing prices caught fire, the big financial players jumped in with borrowed money that they in turn lent out to home buyers who didn't have the means to keep up with the payments. Then the banks sliced and diced those loans and sold them as exotic new securities. All of that left everyone naked and exposed when the market crashed.
Congressional critics of the Paulson-Bernanke bailout have demanded to rewrite the plan before approving it, clamoring for aid to struggling homeowners, limits on executive pay at firms getting federal help, perhaps even requiring Treasury to get an equity stake in a firm in exchange for its subpar assets. In the interview with Time on Sept. 24, Paulson said, "I believe that we're going to get a bill that works and a clean bill. It certainly won't be exactly what we asked for--it never is--but it's got to be sufficient to let us do the job."
But the bailout is just the beginning. Even if it works, that still leaves the job of making sure it never happens again. Congress needs to remake the 1930s-era patchwork of various federal agencies that oversee banks and financial institutions. "There's so much that needs to be done, so much work," Paulson said. "Some people want to say there's too little regulation. It's not that. It's just outdated, outmoded, ineffective. The architecture was put in place in a different era, and it hasn't kept pace with the evolving financial markets."
And as Paulson pondered the work before himself, Bernanke and Geithner, it was hard not to notice that, for the first time, he sounded like a very tired man.
More Paulson Read the full transcript of our interview with Hank Paulson at time.com/paulson