Paulson Likes What He Sees in Overhaul
“The one thing you’re not going to get me to do is speculate.”
That is what Henry M. Paulson Jr., the former secretary of the Treasury, told me when I called him last week and posed this question: If the Dodd-Frank Wall Street Reform and Consumer Protection Act had been in place during his tenure, would the financial crisis — and the ensuing recession — have happened?
Given that President Obama is expected to sign the bill into law soon — the deadline keeps slipping — it seemed timely to ask the central government actor during the panic of 2008 what he made of the legislation and whether he thought, in practice, it would help us avoid another crisis.
Mr. Paulson, who was speaking by phone from his longtime home in Barrington, Ill. — he recently put his home in Washington up for sale — was initially reluctant to weigh in. He said he had not read all 2,000 pages of the legislation. But as he began talking, despite his insistence that he didn’t want to answer my question, he did exactly that.
“We would have loved to have something like this for Lehman Brothers. There’s no doubt about it,” Mr. Paulson declared about midway into our conversation.
He was referring to a provision of the bill known as resolution authority, which would enable the government to unwind a failing investment bank or insurance company in an orderly way without forcing it into bankruptcy, thus avoiding the unintended consequences that a bankruptcy might create. Mr. Paulson had spoken publicly about the need for resolution authority in June 2008, three months before Lehman’s failure, but did not believe it was politically viable to ask Congress for such powers.
As he recalled those sleepless days in September, he suggested that had he had resolution authority, he would have been able to take over Lehman Brothers and the American International Group without the financial system crumbling. (Of course, there remains a running debate about why Mr. Paulson didn’t seek to have the government bail out Lehman Brothers; he says he didn’t have the powers.)
I followed up by asking whether he believed he would have used the power to take over Morgan Stanley and then, perhaps, even Goldman Sachs . Would he have taken them over, too?
He said that he believed that if the government had had the authority to take over Lehman and A.I.G., it would have stopped the panic endangering other firms.
“It’s hard to believe that winding down Lehman in an orderly way would have put more pressure on Morgan Stanley than what happened,” he said.
But Mr. Paulson said that even more than the resolution authority, he saw the legislation’s creation of a systemic risk council as perhaps the most important aspect of the bill and crucial to preventing the next crisis. The council would give the various parts of government insight into what was going on elsewhere and the power to shut firms down or change practices that might put the system at risk.
“Some things would hopefully have been identified earlier,” he said. While his critics have contended that regulators missed warning signs about impending problems, he said he had little visibility into certain businesses, like A.I.G., until it was too late.
“I doubt that there is any regulator that had all the information that would have allowed something like what was happening at the A.I.G. holding company to have occurred,” he said.
But to fully prevent the crisis of 2008, he said, the Dodd-Frank act would have needed to have been in place not just before September 2008, but years earlier. He suggested it would have had to have been in place even before he joined the administration in 2006 to have had any effect.
“We’d have needed the systemic risk regulator up and running by 2005 or so, to recognize the dangers of ever more lax underwriting and intervene,” he said. His critics might say that his suggestions are a bit too convenient, but Mr. Paulson earnestly said that he and the Bush administration were blindsided by the development of the market for collateralized debt obligations and the importance of “repos,” or repurchase agreements, that kept investment banks afloat, often literally on a overnight basis.
Still, he said he was frustrated that the legislation had focused little on policy, specifically housing policy. “The root causes of all this are housing policies — not just Fannie and Freddie,” he said, referring to the giant mortgage companies. “That hasn’t been dealt with.”
But he did not seem surprised by that development — or lack of. “There’s plenty of blame to go around — the banks, investors, rating agencies, regulators. But let’s not forget policy makers,” he said.
One policy that Mr. Paulson was not so sure of was the so-called Volcker rule, which would largely prohibit banks from investing with their own capital and being in the business of hedge funds and private equity.
“Proprietary trading during the crisis that I dealt with wasn’t what created the problems at WaMu or Countrywide or Wachovia or Lehman Brothers or A.I.G.,” he said. “We were dealing with another set of issues.”
In the end, though, Mr. Paulson said that regulation on its own would not be enough to prevent another crisis. No, that will come down to people.
“As I’ve thought about it, this is very people-driven,” he said. “A lot of this is about the people who have the responsibility for the regulation when there isn’t a crisis and the people who have the responsibility during a crisis. Unless you believe that the big financial institutions were intentionally trying to blow themselves up, they were unable to spot a number of the issues.”
He continued: “I think it is asking a lot for regulators to be perfect — because they won’t be. But what you have here is a mechanism that gives regulation a much greater chance to be successful.”