Even as he defended his actions, Mr. Paulson said he was worried that some of the government’s moves could wind up haunting future Treasury secretaries. He pointed in particular to the decision to guarantee all bank deposits and interbank loans, something the United States did to keep pace with similar decisions in Europe. “We had to,” Mr. Paulson said. “Our banks would not have been able to compete.”
But the federal guarantees could create “moral hazard” and simply encourage banks to take on dangerous risk, he acknowledged. “This is the last thing I wanted to do,” he said.
Summer of Eroding Conditions
The subprime mortgage debacle began emerging in the summer of 2007, about a year after Mr. Paulson left his job as head of Goldman Sachs and joined the Bush administration. But the true depth and extent of the losses did not become clear until earlier this year, Mr. Paulson said.
“We thought there was a reasonable chance of getting through this,” he recalled.
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Then came the near failure in March of Bear Stearns, which was rescued in a takeover by JPMorgan Chase only after the Fed agreed to cover $29 billion in losses. That briefly lulled the markets into thinking the worst might be over. But during the summer, conditions deteriorated, and in early September the government was forced to take over Fannie Mae and Freddie Mac, the mortgage finance giants.
With increasing speed, other problems emerged, most notably Lehman and A.I.G., which was also burdened with bad mortgage-related investments. Both became the focus of intense meetings the weekend of Sept. 13-14.
Mr. Paulson, by then, had become frustrated with what he perceived as Mr. Fuld’s foot-dragging. “Lehman announced bad earnings around the middle of June, and we told Fuld that if he didn’t have a solution by the time he announced his third-quarter earnings, there would be a serious problem,” Mr. Paulson said. “We pressed him to get a buyer.”
Here the views of Mr. Paulson and his critics start to diverge, over what transpired in marathon meetings with Wall Street executives at the Federal Reserve Bank of New York that weekend.
Lehman officials said they believed the firm had not one but two potential buyers: Bank of America and Barclays, the big British bank. But both had conditions. Bank of America wanted the Fed to make a $65 billion loan to cover any exposure to Lehman’s bad assets, according to one person privy to the discussions who did not want to be identified because of their sensitive nature. Although this was more than double what the Fed had made available to facilitate the takeover of Bear Stearns by JPMorgan, Bank of America justified the request on the grounds that Lehman was larger.
Barclays also wanted a guarantee to protect against losses should Lehman’s business worsen before Barclays could compete its takeover.
The government initially was not clear in telling Bank of America and Barclays that no help would be forthcoming, participants said. The New York Fed president, Timothy F. Geithner, in particular, was uncomfortable about drawing a line in the sand against government support for a Lehman takeover. Participants said they were left with the impression from Mr. Paulson and Mr. Geithner that the government might well provide help for a serious buyer, with Mr. Paulson also trying to get Wall Street firms to create a $10 billion fund to absorb some of Lehman’s bad assets.
It remains unclear whether a more consistent message would have changed the outcome. But by Saturday, Bank of America, frustrated by the government’s unwillingness to commit to a deal, turned its attention to Merrill Lynch, which agreed to a takeover. Barclays, equally frustrated, walked away on Sunday, said the person with knowledge of the discussions.
Mr. Paulson said in the interview that Treasury was not at fault. The $10 billion industry fund had not worked because executives in the room realized that bailing out Lehman would not end the crisis. There were too many other firms that needed help. “I didn’t want to see Lehman go,” Mr. Paulson said. “I understood the consequences better than anybody.”
At a White House briefing on Sept. 15, Mr. Paulson shed no tears over Lehman’s failure. “I never once considered it appropriate to put taxpayer money on the line in resolving Lehman Brothers,” he told reporters.