The Great Read-cession, Part IV

On the BrinkWelcome to Part IV of our eleven-part breakdown of the books of the financial crisis. Having trouble keeping up? Then check out this page for all previous and future posts in the series.

On the Brink: Inside the Race to Stop the Collapse of the Global Financial System

by Henry Paulson 2010


The unifying element of the first four books was pessimism: Whether it was Ritholtz’s scorn for those in power, Morgenson’s search for someone to blame, Lewis’s tragic tale, or Sorkin’s narrative of disaster, all four books had decidedly bleak outlooks on the events. Since there is only so much despair one person can read about, I wanted to read the account of someone who would be sympathetic to the policy-makers and CEOs who everyone else blamed.

Henry Paulson was perfect. If the financial panic of 2008 has a face, it’s Paulson’s. As Treasury Secretary during the collapse, he was the one who told Congress of the dangers of Fannie and Freddie (in his infamous squirt gun analogy), who proposed TARP, and who ultimately dispensed the bailouts. And unlike the other figures prominently involved—Geithner, Bernanke—he faded from public view almost immediately after the disaster passed.

Reading Paulson’s book, though, it is hard to dislike him. His prose is straightforward and he comes across as an upstanding, diligent worker with integrity. He’s honest, but polite and gracious to a fault—despite presiding over what many would describe as a complete disaster, he has nothing but kind words for almost everyone involved.* He worked for Presidents Nixon and Bush—two of the least popular Presidents of the last 50 years, if not ever—but says nothing negative about either. He clashed with another prominent public figure, Jon Corzine, for the top spot at Goldman Sachs, but all he says about that is “frankly, the pairing was never right.”

*One notable exception is Sarah Palin. Paulson’s description of a conversation with her (then John McCain’s new running mate) is the closest he gets to snide: “Governor Palin immediately made her presence felt. Right away she started calling me Hank. Now, everyone calls me Hank. My assistant calls me Hank. Everyone on my staff, from top to bottom, calls me Hank. It’s what I like. But for some reason, the way she said it over the phone like that, even though we’d never met, rubbed me the wrong way.” Given Paulson’s generous descriptions of everyone else, he might as well have called her the C-word.

Some would probably accuse Paulson of being coy, but his matter-of-fact style is merely an extension of his personality. Paulson is a Midwesterner with a traditional belief in a Protestant work ethic: He goes to bed early (9:30 PM every night, or so he says), he doesn’t take long vacations (part of what bothered him about his former colleague John Thain was Thain’s insistence on taking two weeks off at Christmas every year), and he doesn’t complain about other people. In other words, he comes off as a likable guy.

With that said, it’s really hard to defend the job he did as Treasury Secretary. I wanted to present some kind of counterintuitive pro-Paulson narrative, especially after I started to like him, but there just isn’t enough to justify it. The best that can be said about Paulson is that, under more stable conditions, he could have been a great Treasury Secretary. He recognized the need for key reforms, was skilled at building consensus, and had a lot of credibility on Wall Street and in international markets.

But the same traits that benefited Paulson as the head of Goldman Sachs and could have served him well in calmer times ended up hurting him during this crisis. His intimate ties to Wall Street, for example, call into question his objectivity. He had close relationships with several CEOs and companies that he was tasked with bailing out. It’s unfair and likely inaccurate to say that he intentionally favored some over others (though many critics like to point out how his decisions benefited Goldman Sachs), but it’s disingenuous to think that personal relationships would play no role at all in his decisions.

He’s honest, for example, about not particularly liking Lehman’s Dick Fuld. Though his refusal to bail out Lehman was not motivated by animus, Paulson’s dismissive attitude towards Fuld and his firm might have led the Secretary to underestimate Lehman’s systemic importance.

More importantly, though, Paulson’s close relationships with the rest of Wall Street and intimate knowledge of banks shaped his overall perspective on the crisis. When AIG was about to fail, for example, he had to have immediately known how adversely this would affect Goldman Sachs and other Wall Street banks. Even if he wasn’t consciously trying to help his old firm (or his friends at other banks), this certainly influenced his conclusion that AIG was “systemically important.”

The result of this was that almost all of Paulson’s relief efforts were designed to stabilize the markets. He speaks in passing about the Bush Administration’s efforts to help homeowners, and his desire to reform Fannie Mae and Freddie Mac, but the bulk of his actions were designed to merely stop the bleeding at Wall Street banks, particularly after the failure of Lehman.

Even prior to that, though, he was thinking primarily of investors. When he sought power to bail out the GSEs with that squirt gun analogy, he was essentially making an argument about investor confidence, not the health of the housing markets: “If you’ve got a squirt gun in your pocket, you may have to take it out. If you’ve got a bazooka, and people know you’ve got it, you may not have to take it out. By having something that is unspecified, it will increase confidence.” Of course, doing so put American taxpayers on the hook for Wall Street’s investments, but that was secondary to Paulson’s concerns for stability.*

*Paulson maintains that this benefited homeowners, calling his decision to place Fannie and Freddie under conservatorship “by far the single most important step taken to counter the price declines in housing.”

Similarly, Paulson’s Midwestern belief in the virtue of getting things done led to the ad hoc approach to the crisis. Each time an institution teetered on the verge of failure, Paulson sprung into action. Sometimes that action was simply encouraging CEOs to raise capital, other times it was engineering mergers.* But in each case, Paulson felt like he should respond.

*TIMEOUT: It’s worth pausing here to consider the strange implications of the Treasury Secretary telling bank CEOs to raise money. Paulson freely admits telling Dick Fuld to raise capital multiple times; but what does it mean to a CEO when a government official says so? Is that an order? Is it friendly advice from a former colleague? Is it a subtle hint from someone who knows the state of other banks and institutions? The distinctions here are not academic: Sorkin’s book quotes Fuld as saying on multiple occasions that Lehman Bros. had “a great profile with Treasury.” Is that because Fuld, having raised a modicum of capital at Paulson’s behest, felt that the government owed him? Did Fuld think those messages from Paulson implied that the government was invested in Lehman’s success?

In other words, for all the talk about “government takeovers” of industries and the impending creep of “socialism” in America, the current relationship between private industry and the government is downright incestuous. It’s no wonder Wall Street banks routinely break the law—it’s virtually impossible to tell what messages from the government are laws and what are “suggestions.”

The problem with responding to each specific problem is that it prevents you from coming up with a comprehensive response to the imminent disaster. Paulson spent his time trying to plug the holes in the dyke instead of drawing up an evacuation plan for the inevitable flood.

The result was an unpredictable government response that at times exacerbated the crisis. Paulson’s book presents such an erratic and inconsistent response that it borders on hypocrisy. When detailing the Bear Sterns rescue, for example, Paulson is adamant that “If there’s any chance of avoiding this failure, we need to take it.” When Jamie Dimon called him to back out, Paulson told him, “[W]e need to figure out under what terms you would do this.” In other words, when the buyer was ready to back out, Paulson offered federal money.

When discussing Lehman, however, Paulson insists that there was no way to bail them out: “There had been no legal basis to bail out Lehman… There was, in fact, no deal to put money into.” But this is only true because Bank of America backed out when Paulson refused to offer the same federal assistance he gave Dimon. If Paulson had offered the same deal again, it’s more than likely that Lehman could have been saved.

Similarly, Paulson’s rationale for bailing out AIG changes throughout the book. Initially, he insists that “we were dealing with a liquidity, not a capital, problem.” Later, though, Paulson admits that there was a capital problem, but that now “AIG was systemically important and could not be allowed to fail.”

There is simply no legal or ideological consistency to Paulson’s actions. What role should government aid play? Is it to bail out “systemically important” banks? Other institutions? Is it to help temporary liquidity problems? Can it orchestrate deals, or only assist ones that are already in place? Not only were the answers to these questions never clear to the public, but I don’t think they were ever clear to Paulson.

Of course, these questions are incredibly complicated, and there’s no way of knowing what the right answers are. But I think any answers would have been better than none at all. If Paulson had simply said, “No government money,” then Bear Stearns would have failed, and possibly Lehman too, but other banks would have raised capital and moral hazard might have been avoided. If, on the other hand, Paulson had offered money to everyone, then Lehman would not have failed and the crisis would have possibly not been as severe. At the very least, a definitive policy would have at least offered some insight into the advisability of that policy. As it stands now, it’s not clear if Paulson’s mistake was too much government, or not enough.

It’s not clear that any Treasury Secretary could have prevented the crisis of 2008—the seeds of that began long before Paulson took the job. Nevertheless, Paulson’s results are not impressive. Paulson’s honesty and work-ethic are admirable, and his book is good, but that doesn’t let him off the hook. At the end of his book, Paulson declares proudly that, “it was clear that our actions had prevented a meltdown.” This kind of statement is either hilarious or tragic. If that wasn’t a meltdown, then what was it? Five years later, the ramifications of that non-meltdown are still being felt by ordinary Americans.

The Greatest Trade EverThe Greatest Trade Ever: The Behind-The-Scenes Story of How John Paulson Defied Wall Street and Made Financial History

by Gregory Zuckerman 2009


My search for optimism led me to another account of the few winners in crash of 2008. Like The Big Short, Zuckerman’s book focuses on a few different hedge funds that bet against the housing market early, and made fortunes in the process. Zuckerman focuses primarily on John Paulson (no relation to Hank), who famously made almost $4 billion on a single trade, though he mentions many others, including Burry.

Unlike the heroes of The Big Short, who were portrayed as brilliant outsiders or righteous crusaders, Paulson comes off as relatively mundane. Zuckerman tries to present him as an outsider, but this rings hollow: Paulson began his career as a consultant, and bounced around Wall Street after that. He worked at Bear Stearns and a number of merger-arbitration firms before starting his own hedge fund in 1994. Throughout the 1990s, Paulson’s fund wasn’t very impressive, by his own admission. Zuckerman seems to equate this lack of success with being an “outsider,” but mediocrity does not a renegade make.

To Paulson’s credit, he went looking for ways that conventional wisdom was wrong: “Where’s there a bubble we can short?” he asked a colleague. He found that bubble in the same housing market that Burry and Eisman shorted, and he did it the same way—by buying CDS contracts on those bonds. Like the other people who delved into this trade, Paulson (along with his deputy, Paolo Pelligrini) didn’t really understand the market for housing bonds initially.* At first, he bet against subprime mortgages that were given too early—by the time the interest rates on those loans started to reset, the homes had appreciated enough that the borrowers could simply refinance their mortgages.

*A recurring theme in these success stories is that the people who most understood the instruments being used kept seeing reasons why they couldn’t fail; those who were new to them only saw reasons they couldn’t possibly succeed.

Again, to Paulson’s credit, he and Pellgrini caught the error and, rather than being dissuaded, jumped right back in. Still, Paulson does not come off as exceptionally brilliant in Zuckerman’s telling. Of course, Paulson did some things nobody else did—he was able to raise more capital from investors, he waited until the market had truly hit its nadir before selling, etc.*—which enabled him to make billions on the trade, but he doesn’t stand out the way others who made similar bets do.

*Paulson, of course, is most infamous for his role in the Abacus deal that led to an SEC investigation of Goldman Sachs. Paulson has been vilified for selecting the worst mortgages to bet against. While none of the books I read went into great detail on that particular deal, it seems obvious to me that Paulson did nothing wrong—he should by all means try to get the best deal possible for himself. It’s not as if he were intentionally giving out bad loans to bet against. Goldman Sachs, on the other hand, probably misled investors on the other side of the deal about the quality of the investments.

Zuckerman further undercuts Paulson’s uniqueness by including a slew of other traders who made similar bets. By the end of the book, in fact, it becomes hard to keep track of all the characters involved, and the stories begin to sound repetitive: Someone noticed there was a housing bubble, figured out a way to bet against it, raised some money, and made a fortune.

In many ways, Zuckerman’s book has a happier ending than Lewis’s similar one: Paulson made a fortune and got a ton of recognition from Wall Street. The other investors all made money as well, and there isn’t the sense of injustice that hangs over the stories of Burry and Eisman.

But Zuckerman’s is probably a more depressing book. The heroes of The Big Short seemed like truly exceptional people, but Zuckerman’s “heroes” just seem lucky: They are reasonably intelligent people who happened to notice something most people didn’t. If they could see it, then why couldn’t the rest of Wall Street? In fact, it seemed so obvious to them that it appears as if many on Wall Street were willfully ignoring the evidence.

Finally, the attitude of those who profited off the crash seems to be almost unanimous regarding the crash’s effects: Nothing has changed. There have been no meaningful reforms, and no real lessons learned. After the crash, Pellegrini tried to offer advice to Congress—he was rudely rebuffed. Whether or not you believe a hedge fund manager could offer meaningful reforms of the housing market, he at least seems like someone worth talking to. Unless you’re intent to learn nothing and continue with the status quo…

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