Henry Paulson Oral History

March 11, 2013

Russell L. Riley

Up and running. How do you prefer to be called?

Henry M. Paulson Jr.

Hank.

Riley

All right, may we call you Hank?

Paulson

Absolutely.

Riley

Terrific. This is the Henry Paulson interview, and thank you for agreeing to be here as a part of the George W. Bush Oral History Project. We've just talked about the ground rules before the record began.

Paulson

Yes.

Riley

One thing we have to do as an administrative matter is I need to get everybody to go around the table and say a few words, identify yourself, so that the transcriber will know who is speaking. I'm Russell Riley, the chair of the Oral History Program.

Peter Rodriguez

I'm Peter Rodriguez. I'm a professor at the Darden School of Business.

Rebecca Neale

I'm Rebecca Neale. I'm Mr. Paulson's chief of staff.

Robert Strong

Bob Strong. I'm a politics professor at Washington and Lee University, currently the provost.

Barbara A. Perry

I'm Barbara Perry. I'm a senior fellow here at the Miller Center, in the Presidential Oral History Program.

Riley

All right. We talked on the phone.

Paulson

Right.

Riley

And I told you that we'll try to keep the preliminaries to a minimum, but because this is a Presidential Oral History Program, and you have some experience at the White House before you get to the George W. Bush Presidency, I hope you'll indulge a few questions about your experience with President [Richard M.] Nixon. Can you tell us about your time in the Nixon administration?

Paulson

Yes. I joined the administration in April of 1972, six weeks before the Watergate break-in. I had been part of a team at the Defense Department, a small group, an analysis group. As a matter of fact, Steve Hadley, who was George Bush's National Security Advisor, had been in the same group. John Spratt, who was Chairman of the House Budget Committee, and three other guys who eventually became CEOs [chief executive officers] served with me. It was a group of young people.

I had worked on the Lockheed rescue—It was actually my first bailout, believe it or not, and so I worked on that project. I got to know John Connally when he was Secretary of the Treasury. Walt Minnick, who was a good friend of mine from the Pentagon, had gone over, so I'd had a chance to go to the White House. I worked for a guy named Lewis Engman and after the 1972 election, he became Chairman of the Federal Trade Commission and I received, for a young guy, a big promotion. I became the Assistant Director of the Domestic Council and I was the liaison with Treasury, when George Shultz was at Treasury. Ken Dam, who later became Paul O'Neill's deputy, when Paul was Treasury Secretary, was an assistant to Secretary Shultz.

Watergate became a big political scandal hitting the White House. In February of '73, Mel Laird came over to replace John Ehrlichman and I wanted to resign then, but I had known Laird from the Defense Department, and he asked me to stay. I stayed through the end of the year, when I went to Goldman Sachs. Ken Cole was Laird's deputy; I worked closest with him. I had, I thought, a pretty good relationship with Richard Nixon for a young person; I got along pretty well with him.

Perry

What lessons did you learn?

Paulson

I learned some terrific lessons. I had come to the conclusion before I went there that almost as important as what you do is who you do it with. I had worked for four or five senior people in the Pentagon and I noticed that I worked better with—and learned more from—some more than others. I didn't know what the word "mentor" was, but some were really good mentors, and I seemed to need a mentor.

In interviewing for a job in the White House, I found a boss I respected and I was confident I could learn from. He was Lew Engman. Lew didn't have a great job to offer me. He had someone else who was doing the tax policy work and was the liaison with Treasury, and I was initially given a job that wasn't too interesting to me, but I could just tell I would get along very well with him. He's from Grand Rapids, Michigan, he'd worked for a small law firm, and when I got to the White House he told me immediately that everything I did not only had to be ethical to the highest degree, but I had to ask myself how would it appear if every memo I wrote, every conversation I had, was on the front page of the New York Times or Washington Post.

Then, when I was there a short time, I still remember a very vivid conversation. I remember John Ehrlichman telling me not to work with Chuck Colson or members of his staff. I said, "Why wouldn't I do that?" The way the White House was organized, Ehrlichman was the top Domestic Policy Advisor, Henry Kissinger was National Security Advisor and Chuck Colson was responsible for dealing with outside interest groups. And he said, "Well, the guy is highly political and short on principle," and I said, "Then what's he doing on Richard Nixon's staff?" He said, "Richard Nixon is a very complicated guy. Henry Kissinger appeals to the President's intellectual side, Len Garment (another senior advisor) represents Nixon's liberal dimension," you know on and on. Then he said, "He's never had an easy election and he's a bit paranoid. He believes the election was stolen from him in Cook County in'60, and in '68, if the campaign had gone another few days, he would have lost to [Hubert] Humphrey, so he wants to always have a derringer strapped to his ankle and that derringer is Chuck Colson." John Ehrlichman really knew how to turn a phrase.

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I went to see Ehrlichman when [Harry Robbins] Haldeman's name was in the paper and said, "I don't know if he's innocent or guilty, but he's hurting the President and he should go." A week later, Ehrlichman's name was in the newspapers and he was gone shortly thereafter. I would say the only other thing I—Well, I'm not going to get into all my Richard Nixon stories; this is George Bush and we have a lot to cover.

Riley

Can I ask, just as a bridge, did that experience cause you to want to get out of politics?

Paulson

At the time, yes. But I always intended to leave government after a few years. I had been very interested in conservation and the environment, so it was just crazy the way some of these decisions were made. I had a conversation with the President about leaving and he said, "Is there anything that would keep you here?" I said, "Well, maybe if I could run the park service," and he said, "You should have asked me earlier, I gave that to Ron Walker." Well, Ron Walker was his advance man. I didn't think he knew a bird from a tree. Nixon asked if I would like to run the Fish and Game Department. I was 26 or 27 years old. I remember talking to a few people on the outside and they said, "Listen, if you go to the private sector now, they'll look at you as being a bright young guy who did some very interesting things in government. If you run the Fish and Game Department, they'll look at you the same way." I had very good opportunities to do a lot of different things, and I started at the bottom. I took the offer for the least amount of money and went somewhere where I would learn, while some of my friends who stayed in Washington, they just sort of bounced around. They were lobbyists, hoping to go back to another administration.

I had an opportunity to go back and work for Ronald Reagan, I think in '84, to be his Domestic Advisor. I had just become a partner at Goldman Sachs, so it didn't make sense for me to leave the private sector just as my career in investment banking was just beginning to take off. But no, what that White House experience did for me, being there, I had vivid memories of—There was a flip. Before Watergate, everything was energizing and fulfilling—and I say Watergate, Watergate being the time that Ehrlichman and Haldeman left and it all hit the fan. Before then, the power was in the White House, to the point of becoming almost embarrassing.

I was a kid and if George Shultz wanted to send a memo on tax reform or something to the White House, it would go to Ehrlichman, who would send it to me, I'd write a cover memo. The two of us would go in and talk to the President about it and no one from Treasury was even there. I always made sure that I just treated everyone at the Department of Treasury with the utmost respect. After Watergate, there was nothing done in the White House, literally I had nothing to do. The only work I had to do was the work that Shultz's staff let me do and kept me informed and treated me with respect so I have some pleasant memories of going across to the Treasury Department. Again, I really do not want to spend a lot of time doing this, because there's a lot of other things I want to cover.

Riley

Sure.

Paulson

I had been asked by the Bush administration several times to be Treasury Secretary, and I had turned them down. There was then a time, which I wrote about in my book, On the Brink, when I had agreed—Josh Bolten had persuaded me to have dinner with the President the night before Hu Jintao, the President of China, was to have a state lunch. I was asked to that lunch and so I was going to come in the night before and have dinner with the President. It finally dawned on me that I was not going to take the President's time and tell him no, and there's no way I was going to do this. So I called and canceled at the last minute.

So I showed up for this lunch and George Bush was polite but cool. [Richard B.] Cheney was cold too, and as I walked out of the East Wing—It was a beautiful spring day in April and there were cherry blossoms everywhere—I looked right across into Treasury and it evoked what it used to be like for me, walking out of that East Wing. I was very quiet, and Wendy [Paulson] said to me, "Are you sorry you turned it down?" I said, "Oh, don't worry about it," and she said, "Well, if you turned it down for me, Sweetie, I really didn't want you to do it—but if it was important enough to you, I would have accepted it."

When the White House unexpectedly came back to me again several weeks later—this time through James Baker, I accepted. Wendy was hurt and upset. I said, "I thought you had told me it was OK." So yes, I believe net-net, the Nixon White House was a positive experience for me. I really enjoyed my time down there, although it ended in an extraordinary and devastating way.

Riley

Sure. All right, Hank. When we talked on the phone, I said there would be a couple of preliminaries, and then you had indicated there were a lot of things you wanted to deal with, the first one being the financial crisis, right?

Paulson

Right.

Riley

Well, should I just open it up and let you tell us what you want to talk about?

Paulson

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Riley

Are you comfortable with us injecting questions?

Paulson

Any way you want to do it. I'll maybe give you an outline and then I think you should inject questions as you go along.

Riley

OK.

Paulson

I think to understand this, I'll talk a little bit about my relationship with the President. I knew Dick Cheney because for whatever reason we'd met—I've even forgotten how and when we'd met—but he had asked me to come down and periodically brief him in the West Wing. So I would show up at the West Wing every, I don't know, four or five months. I'd tell him what I thought was happening in the economy and what was happening in China. Scooter [Irve Lewis, Jr.] Libby was his Chief of Staff and we would go in and we would talk, he'd ask questions. It was all one-sided. He was very friendly and nice, but I didn't ask him questions, I just did that and left.

Riley

Did he know markets well?

Paulson

He sure did. He and I had a good relationship. When I was at Treasury, we had different views on some issues, but he was smart as a whip and he understood what was going on in the financial crisis. He never once was one of these Republicans who said, "no bailouts." As a matter of fact, he was very much the other way. But I didn't know George Bush, and I had concerns about working for him based upon what I'd read in the press, based upon Iraq, based upon where he was on environmental issues, based upon my family's view of him. I would meet him when we'd go to the Kennedy Center Honors or attend some event in the White House, or if I got asked to a lunch or a dinner in the White House, but I didn't really know him, and I had not known Josh Bolten well.

Josh had been at Goldman Sachs, and had responsibility for regulatory relations in Europe. If I had met him, I didn't remember it. He was supposed to move to New York and be in the executive offices, but at the last minute he had decided to go to work for the Bush campaign in Austin, Texas. When he was in the West Wing, I had developed a bit of a relationship with him. REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT

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In any event, if I had really understood how much a Treasury Secretary can accomplish every day and what a pleasure it would be to work for George Bush and with many of my colleagues at Treasury and the White House, I would have wanted to become Treasury Secretary and I would have accepted right away—and it wouldn't have been as good for me, because the fact that I initially had declined put me in a better bargaining position in terms of what I was able to ask for and get.

When Jim Baker was persuading me to accept the offer to be Treasury Secretary, he had given me advice. He said it's important to be the primary advisor and spokesman in all domestic and international economic issues. But I knew how powerful the White House was when I was there and that this White House was reputed to be the same REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT

So I had this list of requests. I wanted to not only have regular and easy access to the President, but I wanted to have the option to replace all of the political appointees at Treasury with people of my choosing, regardless of what party they were from. I didn't want to engage in political activities. I didn't want to have anything to do with any political campaign. I wanted to chair the weekly National Economic Council meetings, and I asked to have the meetings at Treasury and to have the pen and write the memos that went to the President on issues which were important to the Treasury Department. They agreed to all those things.

We had the first NEC [National Economic Council] lunch over at Treasury and then I realized it was totally inappropriate, because the Vice President attended, so I quickly suggested future meetings be held in the White House. These meetings were so informal with open and direct communication that the "chair" title proved to be meaningless. I found it was better to be coordinated than to have to do the coordinating yourself, so I quickly decided, unless it was something I really cared about, I didn't want our guys writing the memos.

One thing I did very well—I had spent 30 years working with CEOs and clients, and even when I ran Goldman Sachs, I advised a number of clients. So I was accustomed to giving advice to principals, where they were the decision maker. At Goldman Sachs, I had always said, "I don't care how smart you are, if you can't persuade a client, your idea is worthless." So I knew how to work with principals. Also, Goldman Sachs was a partnership, and I couldn't just order people around. I had many people at Goldman Sachs who thought they were smarter than I was, and a number of them were right, so I learned to persuade them rather than order if I wanted them to stay. It takes a very similar skill set to succeed in business as in Washington. It's just much more difficult in Washington, much, much more difficult, and so it takes a different mindset.

If you're Treasury Secretary, you can't be king. You can't do anything in Congress without persuading them. Regulators are independent; you have to persuade them. You have no power unless the President gives you power, so I knew when I went down to Washington that the agreement I worked out beforehand with President Bush was totally meaningless if I didn't develop a relationship with the President. And, if I didn't have a good working relationship with my boss, I would fail and that failure would be on me and not him.

[interruption]

Paulson

So if I didn't develop a relationship with the President, it wouldn't work. It would be my fault and not his. I had a year, basically, before the financial crisis hit, and if I hadn't had that year to develop that relationship with George Bush and with Ben Bernanke and Tim Geithner and all my other counterparts, it would have been a much different outcome.

The next point I would make is that when George Bush and I had the meeting in his office in the residence on the Saturday, which I wrote about in On the Brink, he talked about having me put together banking sanctions on Iran and North Korea. I told him that I also wanted to take charge of organizing the relationship with China. We talked about entitlements reform, which was to be a big, big thing.

When I was confirmed—and it seemed like an eternity, although it was I think record time and unanimous, but if it's happening to you—When the White House announces the intent to nominate before Congress has reviewed your taxes and done all the investigations, it was—I remember saying afterward, if I had understood that process, I might not have said yes, so I'm glad I didn't understand it.

Strong

People say in the American system, you're innocent until appointed.

Paulson

That's right. It just seemed like it lasted—When someone told me this is the fastest in modern times anybody has been approved, I said, "My God, that is hard to believe." So the President was getting his economic team together, and I wrote about that in On the Brink so I won't spend a lot of time on it. But when he got his economic team together at Camp David, the White House asked me if I would speak on entitlements reform and I said, "I would prefer to speak on financial crises. I think there's a lot of excesses in the system. We haven't had one in a while." You have financial market disruptions every eight to ten years—of course, not this huge thing we experienced. So I prepared material to talk about all the money sloshing around in the system, the hedge funds, and over-the-counter derivatives, the high levels of embedded leverage, the excesses.

I remember at the time being very impressed by the level of the President's questions—you could tell he'd gone to business school; he'd been in business. He asked the right things. He asked me a number of questions about over-the-counter derivatives, and I think he was surprised to understand the extent of the problem as I laid it out. He then asked what would cause a crisis, and I said I had no idea but, after the fact, it would be very obvious and a number of people would take credit for predicting it, but they would be unable to get the next one right. I said I didn't foresee the Russian default or the Asian financial crisis, but the key thing was to be prepared for it. That was July of 2006.

Riley

Hank, when you said to be prepared for it, did you mean that there needed to be some steps proactively taken?

Paulson

Yes, some steps proactively taken, which was where I was going to go.

Riley

OK, thank you.

Paulson

I had known Tim Geithner when he became president of the New York Fed [Federal Reserve Bank of New York] and I was at Goldman Sachs. We worked on this problem of the over-the-counter derivatives, where there was no transparency, there was no public market. It was six months, sometimes, before these trades were even documented, because they were entered into over the phone. It was a very hard thing to clean up, because one firm couldn't do it unilaterally. You couldn't move any faster than your counterparties moved. No one seemed to have the authority to deal with it.

Tim had been working on this issue in a highly professional way, so when I was nominated as Treasury Secretary, I tried to persuade Tim that he should be my deputy. He very nicely explained to me that he thought he could be more helpful where he was, and he actually was. I sought Tim's advice on how best to prepare and he told me about the President's Working Group on Financial Markets, which was chaired by the Treasury Secretary, and suggested that I use this as a vehicle to coordinate with the other regulators, including the Fed, the OCC [Office of the Comptroller of the Currency], the SEC [Securities and Exchange Commission], and the CFTC [Commodity Futures Trading Commission]. The New York Fed hadn't been a member of the President's Working Group on Financial Markets, so I then made Tim a member. He said, "You can just use it and run it like your own committee." And even though they're independent regulators, I pretty much ran it like the management committee at Goldman Sachs. I didn't give direct orders, but for the first time we scheduled meetings a year in advance, we had really detailed agendas, and we started focusing right away on preparing for a financial crisis.

Now, we weren't looking at mortgages, which I will get into in a minute. We were looking at hedge funds, and so we focused on their intersection with the major banks, and the risk that this posed for the major banks. We worked on over-the-counter derivatives. This group and its agenda helped us develop very good working relationships.

I also brought in a number of people from the outside government to work with me at Treasury, one of whom is a guy who is now the deputy mayor for Mayor [Michael] Bloomberg, Bob Steel, who is chairman of the board of Duke [University] and Aspen [Institute]. He had been a vice chairman at Goldman Sachs, had left like three or four years earlier. Bob understood markets. But the reason I picked him wasn't because he understood markets. He is one of the best people-persons I know. People loved working with him and he could work with anybody and get results.

One of the key things we had going for us during the crisis was that Ben Bernanke, Tim Geithner, and I had skills that complemented each other, and we liked and trusted each other, and that's important. Tim had explained to me that he worked with [Robert E.] Rubin and [Lawrence] Summers and [Alan] Greenspan and a bunch of other people who also worked well together, but the level of trust and organizational harmony we had was unique.

Rodriguez

Could you tell us where that came from? You were relatively new to Bernanke at least, I would suggest. Was that just an instant rapport or something like that?

Paulson

I'll get to that in a minute. Let me just finish this point first. Bob Steel did a superb job of working with the key staff members at the SEC, at the New York Fed, and at the Washington Fed, and the FDIC [Federal Deposit Insurance Corporation], which clearly helped bridge institutional differences and build cohesion.

Now, where did the trust come from? It's always hard to tell. I think first of all, I'm very good at developing trust. I have worked with a lot of different clients. I think Ben and Tim are also good at developing trust—and our skill sets complemented each other. I had working experience in the financial markets and in various countries around the world. Tim was really smart and had worked at Treasury and knew how government worked. He'd worked with Rubin at Treasury, been Under Secretary [of the Treasury] for International Affairs during the Asian financial crisis, so he just gave me a lot of help. The first economic speech I gave, I had Tim Geithner reviewing drafts and giving me comments. I didn't look at organizational boundaries; I'm not a great respecter of organizational structure. Ben is so smart and he's a superb economist and I'm not one, so I asked him a lot of questions. He had studied the Great Depression as a scholar and he was able to put that to great practical use. For whatever reason, it worked, and so we had our meetings with the President's Working Group, preparing for a crisis.

I'll say something about mortgages. None of the three of us—including most people at the time—saw the financial crisis coming through the mortgage route. Goldman Sachs had a mortgage unit, but at that time it wasn't a very important part of the business, and residential mortgages and subprime mortgages certainly weren't. I didn't know much about them, I didn't know much about that bubble when I was at Goldman, but when I got to Washington, as the subprime market heated up by the end of 2006, early the next year, we knew it, but didn't see it as posing a big threat to the US economy. Why? Because the subprime market in and of itself wasn't big enough to threaten the US economy and we didn't foresee the extent of the problem in the broader mortgage and housing market.

Since World War II the US had never experienced a national decline in housing prices. So when we had mortgage crises, they were on the commercial mortgage side, with commercial real estate, office buildings and so on, and that's what you had in the S&L [savings and loan] crisis. But there had never been a nationwide decline in housing prices.

Why? Because flawed government policies were very much at the root of a lot of this. The government subsidized home ownership through multiple programs ranging from Fannie [Mae] and Freddie [Mac] to the mortgage interest rate deduction, to the FHA [Federal Housing Administration] programs. In recent history going all the way back to World War II, housing prices just didn't fall nationally. If you bought a diversified pool of residential mortgages, the biggest risk you had was you would get your money back too soon, because when interest rates dropped, people prepaid their mortgage and you ended up with your money back and you had to reinvest it at a lower interest rate. That's what you were worried about, getting your money too soon. So the models, which were based on the last 60 years, didn't factor in a decline in home prices.

Nonetheless, another thing I had started focusing on in the early days—Two other things that sound prescient, but I didn't do them because I saw a crisis coming—I started working on Fannie and Freddie reform legislation right away. The reason I did was that at Goldman Sachs, I'd watched Fannie or Freddie—I hadn't thought a lot about them from a public policy standpoint, but they just struck me as being out of control, that they were so large. I remember saying, "The elephant is too big for the tent," because what I focused on was this: The way they made a lot of their money was taking the implicit federal guarantee and then buying in their own securities and holding them in their inventory. To do that, you have—and I don't want to get into technical stuff here, it's not going to be that helpful, but do you all know what duration risk is?

Rodriguez

Yes, they do.

Paulson

You know what duration risk is. Duration risk is you need a hedge, so you don't have exposure to interest rates moving up and down. And of course if you have a mortgage, even if it's a 30-year mortgage, the duration is going to be, I don't know, five or six years or whatever, because you get prepayments on interest, so you have to hedge. There would be some days when rates moved like ten basis points in a day and you'd find out that either Fannie or Freddie had a duration mismatch and they'd come in and quickly try to get things in order. I referred to them as the civil service of hedge funds, because if you're a hedge fund, you were worried about that all night and so on, but these guys would wake up, come into the office at 9:00 in the morning, "Oh, my God," and they'd start working and they were just so huge they disrupted the markets.

As I got into this when I got down there, what I found was what you typically find in Washington: there is a holy war. The Republicans, and Richard Shelby, the Chairman of the Senate Banking Committee, was the leader on this, basically said this is a bad construct, they're dangerous, they have all kinds of major risks associated with them and we want to drive them into the Potomac. They had a piece of legislation that was really good; it was actually the way I would have drafted the legislation. The Democrats, on the other hand, were in a different place. Now, both the Republicans and the Democrats, let me tell you, created and fed this beast, so the idea that the Democrats are the ones to blame is a bunch of hooey. But the legislation was going nowhere. There was no middle ground and I looked at it and I said that's just absurd. We're going to leave here and nothing's going to be done, and why wouldn't you want half a loaf rather than no loaf?

I wanted to negotiate with Barney Frank. I could not have had a more negative view of anybody from just what I'd read, so it seemed impossible. Bob Steel went up and developed a good relationship. Bob convinced me, based on recommendations he had received from Barney's staff, that I should spend some time with Barney, so I went up, and lo and behold, I really liked the guy, and then I learned that his reputation was one that you could trust him. You know, when he said something, he meant it. And Barney Frank ended up being right there with Judd Gregg, probably the closest professional relationship I developed when I was up at the Hill. I became a friend and admirer of his, and we worked together exceptionally well, particularly when we collaborated on legislation to stabilize the capital markets and prevent an economic catastrophe.

Then—as I wrote about, so I won't spend much time on it, I'll just note it; this was the first real problem I'd had with the White House staff. Basically, my relationship was very good, very smooth. Al Hubbard—who knows whether I would have been Treasury Secretary if Al Hubbard hadn't agreed to all the requests I made, some of which were unreasonable requests. I was just concerned with everything I'd heard about the White House. I'd had two or three people who worked in the administration tell me I was crazy to go there. REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT. So I just had an abundance of caution.

I said I was prepared to negotiate and find middle ground to reform the GSEs [government-sponsored enterprises], Fannie and Freddie, and I was prepared to give up a fair number of provisions in the Shelby plan if we could constrain the securities that they put in their inventories, and if we could get a real regulator with the normal powers that safety and soundness financial institution regulators have to make judgments about capital adequacy, because their capital was razor thin, and was defined by Congress and the regulator had no power to do anything other than accept the legislatively proscribed capital rules, inadequate though they were. There was no judgment associated with capital structure, it was formulaic, intangibles were even counted as capital. If you had come from the industry I had come from, you looked at it and it was beyond absurd. Now, maybe it made sense when they were set up initially, when they were just tiny little things or whatever.

So I had this principals meeting in the Roosevelt Room of the White House where all of the President's other economic, legislative, legal, and political advisors were sitting around the table, and literally every single person disagreed with my plan to reach a compromise with Barney Frank, the Ranking Member of the House Financial Services Committee. Harriet Miers, who was a general counsel at the time and who I thought was terrific on many things—you know she was the one who found my general counsel for me, gave me a guy, Bob Hoyt, who was superb, who was on her team, did all kinds of things to help me coming in—but she was just adamantly opposed to any compromise: This is what we've said, this is what the President said on this, this is what we've all said. I finally just had had it and said, "I disagree with all of you and I'm going to go to the President," and I wrote a memo.

Karl Rove was very helpful to me. We disagreed on some things, but he was as capable and professional as anyone I'd ever worked with: he understood policy, he understood politics, he was articulate. Karl did not favor my plan; he opposed it. So I wrote a memo, and the memo basically said this is where you all have been wrong on all these different things. I was very straightforward.

He called me over the Thanksgiving weekend and said, "Listen, take my advice and rewrite this memo. This is a foregone conclusion; you're going to win this. The reason has nothing to do with the merit. George Bush isn't going to go against his brand-new Secretary on the first thing you go to him with, so you've given the President no choice; he'll decide to do what you want to do. But please write the memo in a respectful way," and he had some very good suggestions as to how the world had changed and the Democrats were probably going to win the House, et cetera, et cetera.

So I wrote the memo the way he had suggested. I met with the President the Sunday after Thanksgiving—and if we have some time maybe at the very end of all of this, this was on Iraq, and he had had the National Security Council together in the Residence to talk about Iraq strategy. After that meeting, he gave me the memo back and said, "That's why I brought you down here, to make decisions like this. Go work with Barney." To make a very long story short, Barney and I had reached an agreement early on, well before Thanksgiving and the election, that if I was working with him in good faith, which I had been doing—I didn't have the permission yet from the White House to cut a deal, but I'd been up there negotiating and I told him what I wanted to do—that if after the election he was committee chair, he would stick with the deal, which he did.

Then after the midterm election, when the Democrats took control of the House of Representatives and Barney Frank became Chair of the House Financial Services Committee, the House passed our compromise bill to reform Fannie and Freddie and the Senate didn't do anything because Shelby didn't want to move it, and because [Christopher] Dodd, the Senate Banking Committee Chair, ran in Presidential primaries for a year, which also hindered us. Dodd essentially went to Iowa to focus on the upcoming caucus. But that early work with Barney Frank helped us build a relationship of trust, which proved to be critical to what we did later.

Rodriguez

Hank, can I ask a question? It sounds like you had identified in some ways the real vulnerabilities that were going on, the explosive rise in the repo [repurchase agreement] market, over-the-counter derivatives, problems with mortgages. No one knew the trigger, but it sounds like, early on, you had a sense of the big vulnerabilities. Do you ever wonder, or did anyone think at the time, or maybe during the crisis, that had we been able to achieve one of these early wins, perhaps some reform there, there would have been more substantial early—that it would have delayed or given more time?

Paulson

You know, it's funny. I've thought about that a lot and I'll give you another vulnerability I discovered and started working on right away too, but no. The excesses were already in the system because the credit bubble had been building for years, as had the housing bubble, and many of the worst mortgages were originated at the state level, under very inadequate state regulation, particularly in California and Florida. Even if we had been omniscient, the horse was already out of the barn; and as we will get to, we didn't have the authorities we needed to prevent the failure of nonbanks. And we couldn't have got the necessary authorities from Congress any earlier. Despite the fact that we started working on GSE reform in the fall of 2006, it took their near failure in June of 2008 to get the legislation we needed to stabilize them. And even in the darkest days of the crisis, after the Lehman [Brothers] failure, the House voted down the TARP [Troubled Assets Recovery Program] the first time. Beginning in 2007, I jawboned the banks publicly and privately to raise capital, but with only limited success because they viewed capital raising as a sign of economic weakness and vulnerability and came with a stigma because only the weakest banks were forced to raise capital to stave off failure, as Merrill Lynch, Citibank, and Morgan Stanley had done in late 2007.

If you look at the ten years before the crisis, '97 to 2007, the bubble years, median household income was flat, while household borrowing doubled. People were borrowing much more than they could sustain to maintain a standard of living they couldn't afford.

Every financial crisis from the beginning of time was created by flawed government policies. Banks always make a lot of mistakes, so the banks always get the blame, which is fine. Blame the banks. But what isn't fine is if you don't deal with the problems that got you there. The problem that got us there is we as a country and as a people borrow too much, save too little, and the incentives for doing that are built in our tax systems, et cetera. The fact was there were a number of flaws in our economic system and other governmental policies and programs. The biggest vulnerability I recognized early on—and I just hadn't been onto that when I was at Goldman Sachs—was the whole financial regulatory system.

Rodriguez

Do you mean the repo market and the OTCs [over-the-counter derivatives] not being regulated?

Paulson

That's one thing. I don't want to talk all day about the repo market, but in the repo market there's a huge problem that still hasn't gotten a lot of attention and it really fell outside of the regulatory system altogether, and it was really quite antiquated. BONY [Bank of New York] and J.P. Morgan administered the triparty repo system, but they really had no economic incentive to invest in it—to upgrade the technology—and they were doing this almost as a service. The government really didn't have oversight, and the practices were sloppy and it was a huge problem.

Now I was going to go to something much more basic: the architecture of our regulatory system. The structure was incredibly flawed and still is. We had five safety and soundness regulators, and financial institutions could often essentially pick their regulator. The Office of Thrift Supervision, which was at Treasury and very independent, was incompetent and AIG [American International Group, Inc.], GE [General Electric], IndyMac [Mortgage Services], Countrywide [Mortgage Organization], and WaMu [Washington Mutual], all were regulated by OTS [Office of Thrift Supervision]. Moreover, although there were emergency powers to prevent bankruptcies and disorderly failures of banks, no such authorities existed for failing nonbanks.

The cash markets were and still are regulated by one regulator, the SEC, the noncash markets, the futures or derivative markets, by another regulator, CFTC. The system essentially hadn't changed since the Great Depression, and the markets had grown dramatically. You don't have a problem if someone's got a bad idea, because it doesn't go anywhere. But securitization was a good idea, derivatives are a good idea, and they had grown so fast that the regulation and the system hadn't kept up with them. So good ideas created a huge problem within a flawed structure.

I don't remember exactly when it was, it was either the end of 2006 or beginning of 2007, but it was well before the financial crisis first manifested itself—I had persuaded David Nason to stay at Treasury, had promoted him to be an Assistant Secretary. He had worked with Bob Steel and with me, doing a study that we called "The Regulatory Blueprint." We basically said our regulatory system is all screwed up, here is our recommendation. That was published—roughly five years ago, on March 30th, a few weeks after Bear Stearns failed—this huge report, over a hundred pages, laying out the flaws in the regulatory system and making recommendations to fix it.

Again, that was another of the very rare instances when I had a problem with the White House staff. A number of my colleagues in the White House insisted we go to the President, because the Office of Management and Budget signs off on something like the Treasury's regulatory blueprint. Jim Nussle, the director of OMB, who is a very good guy, didn't like a number of the ideas we had and they also didn't like it just as a matter of policy process. How could Treasury put this out? I took the view that it wasn't going to be legislation, this is just our blueprint that we wanted to put out there for people to work from, and if OMB wanted to put one out, they should put one out. If Congress wanted to put one out, they would legislate. This was Treasury. But my White House colleagues said, "That's not the way it works in the administration."

We went to President Bush and he just basically said if any of you guys know as much about this topic as Hank Paulson, raise your hand. Otherwise, he's putting it out. And so we put it out there, and as Barney Frank writes in the foreword to the paperback edition of my book on the financial crisis, On the Brink, a number of those ideas were adopted in the Dodd/Frank regulatory reform legislation bill. I believe it was a very good piece of work.

But to get back to your question, I believe—and I'll say this now and then I'll say it at the end—I can be very hard on us for a lot of little mistakes, but the big things we did, we got right. I was as concerned as anybody down there about the crisis and I underestimated what we were dealing with every step of the way, right until we got the final authorities from Congress. But if I had been omniscient, there was not much I could have done that would have made a significant difference, because we couldn't have gotten the necessary powers to stem a once-in-75 year crisis a day earlier than we got them, and we didn't have the power to deal with a failing investment bank, or to fix Fannie or Freddie, or to recapitalize a highly leveraged banking system. The excesses were already in the system. There was a bubble; but of course, by definition the extent of the bubble is not fully understood until it bursts.

I made public remarks in June, and then a speech in July of 2008, saying that we needed resolution authorities to wind down a failing nonbank financial institution. I went up to the Hill with Ben Bernanke and told Barney Frank if Lehman goes, we have no way of handling this unless there is a private sector buyer, as there was for Bear Stearns. And Barney Frank said there's no way you can get these resolution authorities, emergency authorities, unless you stand up and say Lehman's going to go. And when it fails they will damage our economy. And of course Lehman would have gone the next day if we'd done that. It took [Barack] Obama many months, even after the crisis, to get this resolution authority for failing nonbanks. I mean, these are contentious issues.

Let me go through the crisis, sort of go through the outline very quickly. REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT

Riley

That's fine.

Paulson

I consider President George W. Bush a friend and I like and respect him immensely. That last weekend at Camp David, President and Laura Bush had Wendy and me and Condi there with the Bush family. I had a relationship with him the last year and a half, where I would have breakfasts and lunches alone, where we talked about a whole variety of things, where I gave advice on a whole variety of things and received advice and direction from him.

I'm very straightforward, so sometimes clients had a hard time initially, until they get used to me and know that I will always tell them exactly what I think in private, but there will never be any daylight between us publicly. I would say from Day One the President was terrific to me and I had my regular meetings. I quickly found out the normal private meetings really weren't private meetings, that private meetings just weren't Cabinet meetings. In the private meetings you'd have Dick Cheney and George Bush, and you would have Al Hubbard, and there'd be Josh and Joel Kaplan, who was absolutely fantastic and helped me all the way through the crisis, and two or three other people, and that was your private meeting.

Condi Rice said to me, "Hank, it's important to ask for and get regular private meetings over a meal." I had known Condi pretty well because, before the election, George Shultz sent her to see me. She basically said, "I'm a Russian expert. I didn't see the Russian default coming, because I don't understand economics. Can I go to work for Goldman Sachs and sit on your trading desk in London and/or New York?" I said, "I ran Goldman Sachs and I didn't see it coming, and people at our trading desk didn't see it coming, so don't think we can give you that kind of foresight—but yes, you can do that." She said, "Good, I'll get back to you in six months." And then in six months she called and said, "I'm going to join the Bush campaign." So she was unusually helpful to me and she told me, "Listen, just tell him you want to see him together and you want to see him alone."

The fact that Josh Bolten was White House Chief of Staff—Josh was a unique guy. I bet you there's never been a Chief of Staff like him. There's no ego there. All he did, he and Steve Hadley, the National Security Advisor, only supported the President. If I had been there with a different Chief of Staff, this thing might not have worked, but Josh encouraged me to spend time alone with the President and build a relationship. So when I said, "Hey, Josh, I don't like these big "private" meetings, how about me meeting with the President alone?" he began organizing them for me. Then I started having regular meetings either with the President alone or with the President and one other person—because I found it was sometimes better if you had someone else there who could remember what was going on and so on, so I'd ask for Josh or Joel to be there or whatever.

[Long redacted passage]

Paulson

OK, so the financial crisis. I've been through the regulatory blueprint. I've been through working with the President's Working Group. I was working very hard on the strategic dialogue with China, on free trade agreements, which I'll talk about later, on a whole series of things, while we were having the President's Working Group on Financial Markets do its work. I got deep into all this stuff. Although the markets looked frothy, I was starting to get even a little bit optimistic that maybe this crisis wouldn't come when I was in Washington, and I'd get out of Dodge before it came. Then, in July of 2007, it hit. I won't take you through all the different things—read On the Brink and you have it in terms of what happened.

What I would underscore was there clearly was a problem with mortgages. The President was away at his ranch in August and right up through Labor Day, so we worked around the clock at Treasury. Even though a lot of this should have come under HUD [Housing and Urban Development], we included the HUD Secretary, Alphonso Jackson, but I defined my job expansively, so Treasury did the work and came up with a series of initiatives that we thought would be important for the President to stand up and make an announcement right after he was back after Labor Day.

There was a bit of a hiccup with the White House staff, in that when Al Hubbard came back from vacation, it slowed us down. I would have done the same thing in his position; he wanted to understand it all. We were fortunate that during the financial crisis, we didn't have to spend hours talking with the White House staff and make sure everybody understood everything and take into account what their position was before we acted. But we did a lot of this before the President returned from his ranch. We announced two or three initiatives that we thought would be helpful.

Complexity was a huge problem. You had tranched mortgages; sometimes the most-risky pieces were put in tranches and they were very complex, and so rather than getting a mortgage from your neighborhood bank, these things were sliced and diced, put into packages, and sold to investors all around the world.

So how do you deal with minimizing defaults? You're always going to have six to seven hundred thousand defaults every year, because people's economic circumstances change and they can't afford to stay in their house. But when it makes sense, a bank will do a workout, and will let people stay in a house, because a default will be more costly to a bank. But the securities were so complex, the law was complex, the accounting was complex, lenders were spread out, investors all over the world. It turns out that if you had the most senior tranche, you might have one interest while someone who owns the riskiest tranche might have a different and conflicting interest, so how do you work your way through this?

Riley

And the ratings agencies were not helping on this.

Paulson

The rating agencies had given many of these complex mortgaged securities a AAA rating. They are sometimes cited as being the culprit. They're no more a culprit than many other market participants, because they used the same models, and the models just basically said you're not going to have a default. At the end I will tell you what I believe the flaws were in the system, and flawed government policies were the root causes of the crisis.

Riley

OK, great.

Paulson

The kinds of things we did early on were that we got a tax change through Congress that said if I reduce the principal on your mortgage, that's not a taxable gain to you. Otherwise, the guy has to pay a tax because debt forgiveness is a taxable event. And so we did that. If you are delinquent on your mortgage payment, if you get a warning letter from your bank, only 3 percent reply. People get scared and throw the notice away. If, on the other hand, you are contacted by a mortgage counselor, there's a much greater chance of responding. So we funded mortgage counselors and George Bush told everybody call this number, this is a hotline, and very famously, he was supposed to say 8-8-8 and he said 800, an 800 number, which was a Catholic charity, which was flooded by calls.

We did those things and we did a lot of others, and I did a lot of work with Sheila Bair at the FDIC on various programs on a voluntary basis to fast-track mortgage notifications, getting servicers and counselors and delinquent homeowners together to process mortgage workouts. We even had the SEC change accounting rules, and I described this as a Gordian knot, because it was just very hard to figure out how to untangle it, but we did a lot of work.

I was working with Ben Bernanke and Tim Geithner closely, meeting regularly. A lot of people think the crisis didn't start until Bear Stearns went under, but Bear Stearns went under almost ten months after the crisis began and the system was getting weaker and weaker and financial institutions increasingly stressed. Even more, you could just see how serious it was in Europe also. I knew the European banks had greater deficiencies than those in the US, although European regulators didn't recognize it, and so this thing just kept going on and on. We tried all sorts of private market solutions. I did a lot of work on something we called MLEC [Master Liquidity Enhancement Conduit], which was a private sector-generated vehicle, to try to provide liquidity in the securitization markets, because what happened was the mortgage problem was so concerning to people that pretty soon every complex financial instrument became illiquid. People became scared of mortgage securitizations.

Bob Steel, who worked with me, used a mad cow disease [bovine spongiform encephalopathy] analogy: it is not just a matter of price. You know, if there's a mad cow disease outbreak, you couldn't sell more hamburgers by simply reducing the price; people would stop buying beef, period. These complex securities were difficult to understand. There was no transparency, so they were all tainted in investors' eyes. They all became illiquid, so we worked very hard to find ways to bring price discovery and liquidity to the complex mortgage securitization market.

Things came to a head around mid-March, when Bear Stearns failed. I'm trying to hit the highlights, because on Bear Stearns you saw it; it's written about in On the Brink. But on a Thursday morning, Bob Steel came to see me and said that Rodgin Cohen, who was a Sullivan & Cromwell lawyer, had told him that Bear Stearns was having a liquidity issue.

I had learned how fast liquidity goes in an investment bank. Liquidity is really more important than capital. A liquidity cushion is essential. I had banks tell me all the time, we have a liquidity cushion and they didn't calculate liquidity the way we did at Goldman Sachs. The right way to view liquidity is assuming a worst-case scenario, where if everybody who can withdraw money does—and all those who can demand liquidity do—how much do you have left and how long does it last? Of course, under this scenario most institutions didn't have much excess liquidity. But most institutions' cushion calculations assumed their creditors would keep acting the way they had historically done under normal conditions. But this proved to be very wrong.

I thought that Bear was going to go quickly, and I was right. They called that night to say they were going to file for bankruptcy the next morning unless we assisted them. To make a long story short, we got very lucky and were able to save Bear Stearns because J.P. Morgan was a buyer and the New York Fed provided financial assistance. Although this was done with Fed authorities, I needed to be actively involved also because Ben Bernanke said early on, "Unless Treasury indemnifies us, I'm not going to make a loan." I said we'd indemnify the Fed because I figured we'd find a way to do it legally and I knew it would be horrific if Bear Stearns went down.

To step back even further, some people argue that the Bear Stearns rescue was a huge mistake. Some of the ideologues have said that we created a moral hazard, because the reason Lehman had the problem was that we said we'd bail out Bear Stearns. Quite the contrary. If Bear Stearns had gone, Lehman would have gone a few days later, and we weren't prepared. We hadn't even stabilized Fannie or Freddie, yet the market was so scared, Europeans were so scared, that even after rescuing Bear Stearns it took a lot of reassuring to convince the market that the other US investment banks were creditworthy. The other thing we learned was that a Fed loan, in and of itself, was insufficient to prevent the failure of an investment bank in the midst of a bank run. In a panic, customers, creditors, and counterparties don't stick around; they pull their money out and run.

After we announced the Fed loan to Bear Stearns through J.P. Morgan on a Friday, by the end of the day it was clear that Bear was going to fail by Monday unless we found a buyer. They had a capital shortfall problem and a liquidity problem. We were fortunate enough to find a buyer, because there was no legal authority for the Fed or any other government body to put capital in a nonbank and no authority to guarantee its liabilities. Our laws made no provision for emergency rescues or wind-downs of nonbanks. Fortunately we found a buyer in J.P. Morgan to provide the capital. J.P. Morgan not only had to agree to buy but had to agree to guarantee the trading book during the pendency of the shareholder vote, to prop Bear up while the merger was being completed. But we could only persuade J.P. Morgan to buy Bear if they received assistance from the government in the form of a nonrecourse loan against Bear's troubled mortgage portfolio. J.P. Morgan provided the permanent capital and a necessary guarantee to stop the panic, but the New York Fed needed to essentially make a nonrecourse loan secured by Bear's mortgage portfolio through an innovative use of their emergency lending powers.

Two other things happened here that were interesting. I had heard we didn't have authorities to deal with failing institutions that were not banks, but that didn't sound right to me. I just believed that there had to be some creative interpretation of some law we could use. I had been in England at the end of the year to visit Gordon Brown when he was Prime Minister and Alistair Darling was Chancellor, when Northern Rock was coming unglued. Gordon and Alistair asked if I would be on the stage with Alistair to divert some of the angst while he answered the questions about Northern Rock, and I agreed to do it. I saw how brutal the UK [United Kingdom] press was. He was arguing that the UK government didn't have the emergency powers they needed to deal with a failing savings bank like North Rock. Afterward, I said to my chief of staff, "What a bunch of bullshit," you know, "that her majesty's government doesn't have these powers somewhere. These guys are fumbling and bumbling." It turns out they didn't have the necessary powers and they did what they could. I tell this story because it helps me understand where the Lehman skeptics are coming from.

I assumed we could find some power we could creatively use, and on Sunday, my general counsel, Bob Hoyt, who was great through all of this, came back to me and said there were no powers for Treasury to have acted to save Bear or even to indemnify the Fed on their emergency loan as I had promised Ben and Tim. He had worked with the Justice Department, and undertaken an exhaustive review. So I had to call Ben and Tim and say there ain't no powers, and so I finally wrote an indemnification that I jokingly called the "all dollars are green" letter, saying that as Treasury Secretary, I recognize that if you guarantee this and lose money, we'll get less money in the Treasury. So, although we avoided disaster with Bear Stearns, we now recognized the extent of the vulnerability of Lehman Brothers, because Lehman had a weak balance sheet, was the next smallest investment bank, and was overexposed to real estate.

Sometime after the Bear failure, Ben Bernanke and I visited Barney Frank, who was the Chairman of the House Financial Services Committee, to tell him we needed some new emergency powers to wind down a failing investment bank outside of bankruptcy to protect our economy and we were worried that Lehman might be the next investment bank to fail.

Barney understood our problems, but said it would be impossible to get Congress to act unless we said Lehman is likely to fail and if they do, we will have an economic disaster on our hands without this authority. Of course, if we had done this, Lehman would have failed the next day. So we started doing a lot of contingency planning.

I would just say one other thing right now. My book on the financial crisis is about the collision of markets with politics, because this all happened weeks before a Presidential election. This is very much about the collision of politics and markets. The other thing the book is about is men and women who trusted each other, from different departments, agencies, or branches of government—from different political parties—working together, pooling their powers and authorities to deal with a crisis where we didn't have adequate authorities. But how we worked together as a team, to combine our authorities, skills, and experiences is a positive story. We started working together shortly after I arrived in DC. We'd been working together for some time when the crisis hit.

Riley

Hank, may I interrupt with a question?

Paulson

Yes.

Riley

I don't want you to lose your train of thought on this, but the question is a hypothetical: Could you walk us through what would have happened if you had let Bear Stearns go? I don't know practically what.

Paulson

I think we would have had a catastrophe that was at least as bad as the Great Depression, given the amount of concentration we have with a handful of big banks and investment banks controlling well over one-half of our banking assets. Look what happened when just Lehman failed. If Bear had failed, Lehman would have gone down immediately, and it would have ignited a fuse which would have set off a devastating chain of serial bank failures. I don't know how we would have put it back together. Bear Stearns, in and of itself, wasn't that big. In good times, they could have failed, and it could have been managed. But these were not normal times. The crisis had been building for some months, the system was overleveraged and fragile and we didn't have the necessary emergency powers to stop a panic. Bear was intertwined with the rest of the financial system, so it would have been a trigger point. The whole system was so weak, I think Lehman would have gone. And we had not yet stabilized Fannie or Freddie, which combined about $5.4 trillion of securities. I hate to even imagine it. There would have been more unemployment than we had after the Great Depression.

So after Ben Bernanke and I talked to Barney about Lehman, I made remarks in June about needing emergency resolution authorities for a failing nonbank. Then I made a speech in the UK in July, outlining the way these authorities should work. I didn't refer to Lehman for obvious reasons. The Fed put their examiners in the investment banks, and opened up their discount window to the investment banks, hoping that would inject confidence into the market. There was all kinds of work evaluating different scenarios, strategies for preventing or dealing with a Lehman failure. We successfully encouraged Lehman CEO Dick Fuld to sell equity twice, and tried unsuccessfully to get him to sell Lehman or find a strategic investor. I don't believe, even if Dick had been realistic, that it would have been easy for Lehman to find a buyer or a strategic investor, because the market knew Lehman had many bad assets and a big capital hole, because Fuld had gone all around the world looking for strategic capital or a way to unload Lehman's problem loans.

The big global investors who came in early on to help the weakest banks weather the crisis, CIC [China Investment Corporation] in China, the Saudis, the Kuwaitis, the Singaporeans, with investments in Morgan Stanley, Citi, and Merrill Lynch, all lost a lot of money. There weren't a lot of willing capital providers because the early rescuers had been burned by underestimating the severity of the crisis. As we were prodding Lehman to find a buyer to try to stave off disaster, Fannie and Freddie began to unravel. We had actually begun pushing then to raise capital over the weekend when we were rescuing Bear Stearns in order to try to create confidence in the market. On the Sunday of the Bear weekend, I had a conference call with Bob Steel; with Jim Lockhart, who was the Fannie and Freddie regulator; with [Richard] Syron and [Daniel] Mudd, who were the two CEOs, to get them to announce that they were going to raise capital. They both agreed they were going to raise capital. Fannie ended up raising it, Freddie didn't. So we started aggressively prodding the GSEs in mid-March.

Then after the Bear Stearns rescue, we had a meeting in Senator Chris Dodd's office, in which Dodd and Senator Richard Shelby, the Chairman and ranking member of the Senate Banking Committee, agreed with Mudd and Syron on a reform bill for Fannie or Freddie, and all parties stuck to our agreement, but legislation didn't move the way it was supposed to in Congress, because Congress was so divided over anything that looked like a bailout. And Fannie and Freddie legislation was by political necessity part of an overall housing bill that contained a provision that was actually quite modest to aid defaulting homeowners. This was vigorously opposed by most Republicans in the House who were against government funding for any mortgage relief or modifications as using dollars from prudent taxpayers to rescue imprudent ones who had overextended themselves, so the legislation really didn't go anywhere. It was too contentious and difficult. It was only sometime in late June when Fannie and Freddie started to fail that we were able to get Congress to act.

Let me talk about President Bush and my relationship with him, because he was, as I write about in On the Brink, going to be in New York the Friday on which we announced the bailout of Bear Stearns. He was going to be speaking at the Economic Club, doing a session with the editorial page of the Wall Street Journal. He had asked me to help him prepare and to give him some thoughts. He was putting in his speech a line that said, "we won't bail out a financial institution." I had said to him, before I'd heard about Bear Stearns's illiquidity, "I wouldn't say that. I don't want to do a bailout either and we won't call it a bailout. If it's a bailout, we'll call it a rescue. I don't think we'll have to do one, but I don't know for sure and why would you ever say that? Because you won't do it until you need to do it. You'll do a bailout if you have to do one. No one wants to do them." He said, "Well, I hear you, but I'm going to put this language in my speech anyway."

When I called him really early Friday morning after we had learned that Bear was failing—The great thing about him—You know the guy is an amazing guy, very disciplined. He was in his office at 7:00; I could always get him. I could go over and see him, walk right across the street, see him in his office, I could get him on the phone regularly. So when we did the Bear Stearns, as I wrote, I called him and I started off with a joke, "You can take that line out of your speech about no bailout." [laughter] He obviously did and he supported the Bear Stearns rescue.

He was an amazing leader during the crisis: quick on the uptake; understood markets; willing to support me in doing some unpopular, controversial, and unusual things. He also knew how to delegate. President Bush was a terrific example of leadership and true calm in crisis. Not only was he balancing all the stress of the financial crisis but he was also managing two wars. Yet, in the midst of what must have been grueling pressure, he was a rock. He said, "You're my wartime general. Keep me posted; come to me whenever you need to, but you do what you've got to do." He didn't make me go through the usual White House decision-making process. We made decisions at Treasury, kept the White House informed, and I stayed in regular contact with the President. He actually came over a couple of times and saw me at Treasury, and I saw him regularly in the Oval Office and talked with him frequently on the phone.

He was a great help to me because he could see the crisis was taking a strain on me. He would buck me up; he would tell me to sleep, to work out. He would say, "I would do more to help you with Congress, but it would hurt you if I tried to help you with the Democrats." He gave great advice, he understood the politics, and was a quick study on markets. If there's anybody who didn't want to be bailing out the Wall Street banks or GM and Chrysler, who had had a low opinion of Wall Street and the autos, it was George Bush. He was just absolutely determined to do what was right all the time. I could talk with him and have a conversation quicker with him on these market-related things than many others who I'm sure were very bright, much smarter than either he or I are in terms of IQ [intelligence quotient] or are policy whizzes. But on these things, gosh, he understood quickly and he would come back with analogies. When we were guaranteeing the money markets or the things we did, he had a feel for markets. I don't know, maybe it was from his days in the oil business in Texas, maybe because he just understood politics the way he did, and business. He had a Harvard MBA [master of business administration degree].

He didn't ask so many questions that it was painful, but he really knew how to ask the right ones, and we worked well together. If he hadn't been there, I don't know what would have happened. During one of the darkest days, when I thought Citibank might fail, he said, "Hank, you and I were very fortunate that we are here now." And I'm getting way ahead of myself, but he said, "You should be glad you're here. You should welcome this, because the country needs you and you've trained during your career for this. Just think what would happen if we had this crisis early in our administration, or at the beginning of an Obama administration, when a new President is just learning how to work with his Treasury Secretary. REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT. I have someone who knows what to do. I trust you, you trust me, we'll do what's best for the country. Who cares what the polls say?" And when I would come and give him bad news, he never shot the messenger. He just immediately was upbeat and would say, "OK, what do we do and how do we do it?" So anyway, he was a very strong leader.

Riley

Did he give you occasional redlines?

Paulson

No, never.

Riley

I actually owe you a break.

Paulson

Yes, I'll take one, yes.

Riley

Why don't we take five minutes then?

Paulson

He never once gave me a redline, but he didn't have to, because I checked with him. I knew who the boss was, so I did the work, but I never once took a major action or anything without going to him.

Riley

Right.

Paulson

I went to him. I'd go see him, I'd do it on the phone, on everything. The only time we really went through the White House staff and we went through the process was on autos, and on autos, Joel and I had lunch with him and decided it all before, but we went through the process.

Riley

All right, let's take five minutes and let you catch your breath.

[BREAK]

Paulson

I won't spend a lot of time on this, because you obviously know this, and because I'm sure everyone else has told you this, that there are two different George Bushes. If you're in a small meeting with him, he comes across the way he is: smart, knowledgeable, knowing what questions to ask, attributes of a good leader. Then you would watch him stand up publicly, when he gets that smirk on his face sometimes and so on, and you couldn't understand it. I had one experience with him early on, when he was getting together with a group of CEOs. I remember one of the guys was the CEO of Under Armour, Kevin Plank. And this is something I thought I did very well. I can sit down with a group of CEOs and ask questions, have a conversation about economic conditions, their opportunities, challenges, leadership, et cetera. In any event, he included me in his CEO round table and I was really impressed. I thought, By gosh, this guy hasn't run an investment bank, and he does this better than I do. He's really, really good. Then he said, "OK, everybody, let's bring the press in." So they brought the press in and I thought, My gosh, I'm a novice with the press, but I could do as well as he's doing. He wasn't natural, he wasn't articulate, he seemed a bit defensive.

Riley

Right.

Riley

How do you explain the two?

Paulson

I can't explain it, because he was a good politician, was great with people; he was good one on one. I watched him on a number of occasions where I just was in awe. REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT

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Riley

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Paulson

REDACTED TEXT REDACTED TEXT What was unusual was a disconnect when he talked with the press. I thought I'd just make that point—you all know that.

Riley

Well, we know it partly because we hear it. Barbara and I both, and maybe others of you, have had the privilege of being in small groups with the President, and have actually witnessed what you talked about, but it's still a puzzle and it's the kind of thing that if you're trying to communicate to generations down the road, something about—

Paulson

Josh Bolten would have to explain it. People explain different things to me and explain what happened when he first came in, you know when he tried working with the European leaders and they hit him with Kyoto and climate, and he got on the wrong side of some of that, and some of the experiences he had early on with the press or whatever. I can't explain it. But it was extraordinary to watch someone who could be so natural and powerful a communicator in private settings revert to a stiff recital of his talking points with the press.

Riley

Right.

Paulson

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Rodriguez

I think we sometimes learn things about Presidents that are 180 degrees wrong and yet they stick. Gerald Ford is not a clumsy person; he was an athlete, and probably the best athlete—

Paulson

President Bush was the best athlete in the White House.

Rodriguez

And Jimmy Carter was not indecisive. He had problems and they tended to be on the other side, being stubborn and sticking to things longer than he probably should have.

Paulson

And being incredibly naive.

Rodriguez

So the pictures that we think, people on the outside, are true about those individuals, are often wrong, and then once they're in place, almost impossible to remove.

Paulson

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REDACTED TEXT I am now, after Bear Stearns, posting the President regularly about various concerns, et cetera, and about how it's a tough situation and how bad the situation is in the capital markets. You can't see—When people look at the stock market, they don't look at the interbank funding market. They don't look at the different indices we were looking at or have the market intelligence I regularly received from a broad spectrum of market participants, but I saw that the system was stressed and fragile.

So then Fannie and Freddie started to unravel. The price of their securities declined, credit spreads blew out, their stock dropped, et cetera. There's a big misconception about Treasury. People think Treasury Secretaries have all kinds of power, but study it sometime. The Treasury Secretary has an important position and the power he has is what the President gives him. He doesn't have power over independent regulators. He has to go to Congress to get legislation or raise the debt ceiling. The President can delegate a lot, but—And Treasury did not have people, when I was there, who knew how to analyze and look at financial institutions, do risk analysis, or any with the investment banking or deal making or transaction structuring skills. The Treasury had really good policy people, economists, hardworking, smart, apolitical, never prone to leaks, but they didn't have practical financial analysis, financial engineering experience.

And we weren't Fannie and Freddie's regulator, that was OFHEO [Office of Federal Housing Enterprise Oversight]. Also, we didn't have access to the nonpublic information their regulator had. We only had public financials, which were insufficient. And then, on top of that, even OFHEO, their regulator, didn't understand the extent of the problem; they didn't have the capabilities or capacity. So when these institutions started to go down, I knew that I would need to go to Congress and get emergency powers. REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED

I briefed the President two or three times during the day on the Friday they began to unravel. I knew how much the White House was going to hate me going to Congress on behalf of Fannie and Freddie, because they'd been saying the government doesn't stand behind Fannie and Freddie. All over the world, the idea of trying to explain the difference between a government-sponsored entity and one where there was a hard guarantee was a very hard thing to do. There was $5.4 trillion of securities outstanding, $3.7 domestically, $1.7 overseas. There's been a lot written about the Chinese and the Japanese holding the securities. The Chinese did own a lot; they owned more, but not a lot more, than the Japanese or Europeans, but US investors owned by far the most. And those securities were rated AAA and treated by the regulators as if they were like treasuries.

On the one hand, the US government was saying there's no explicit support, and on the other, Fannie and Freddie's securities traded just like treasuries and were treated that way by the regulators. On a Sunday afternoon, I stood on the steps of the Treasury and I announced I was going to get emergency powers from Congress, after I had tried to consult with members of Congress beforehand.

I made a number of calls to congressional leaders beforehand. No one told me there's no way you're going to get the powers; no one was enthused. Chris Dodd, which was typical for him—Let me tell you, I was hard on him in some of what I wrote in On the Brink. But the farther I get away from it, the more positive I am about Chris Dodd. If Chris Dodd hadn't been there, we would have had a big problem, because his colleagues in the Senate trusted him, so we never had to worry about the Senate Democrats if we had Dodd's support, and ultimately he did what we needed him to do. But he was a very hard guy for me to deal with because he was an astute politician, always gauging public sentiment, and he ducked when I was trying to call him that weekend. It got to him what I was calling about, so the Chairman of the Senate Banking Committee never returned my call all weekend while he was considering his options. The first I heard from Chris Dodd was on Monday. Hours after I had committed myself in a Sunday speech, and after he made a public announcement he was scheduling hearings, I finally found him at his home in Connecticut.

My book tells the story of the various people I got to. I'd had quite a debate with my Treasury staff when I had said we needed to get unlimited powers. They said Congress will never give you unlimited powers, so I asked for unspecified powers. We figured we could get an unspecified authority, which was essentially unlimited. When I was testifying in front of Congress, I used an analogy to explain why I needed unspecified powers. It just came out of my mouth, I hadn't planned on saying it, but I said, "If you've got a squirt gun in your pocket and people know it, you'll have to take it out. If you've got a bazooka, you may not have to take it out," so I want a bazooka.

But the other thing I wanted, which I was told we couldn't get, and I had quite a fight with my Treasury staff who told me we couldn't get it, was I wanted emergency powers without a time limit because Fannie and Freddie had long-term securities and we needed to be able to guarantee mortgage-related securities with maturities of 30 years and longer. And the input we got from Congress was "The most you can get would be to go nine months into the next administration, extending only to the fall of 2009." I knew that would not work because there were hundreds of billions of dollars in long-term securities outstanding and it was important that there be funding for new mortgages with maturities that would extend well beyond October of 2009. But I accepted temporary emergency authorities and being able to get that from Congress as a huge success. But I knew we needed to figure out how to extend the guarantee. Ben Bernanke was very supportive, which was critical. We couldn't have succeeded without his strong support. But Treasury had to go up to Congress and negotiate the emergency authorities. I believed I had built a lot of trust on both sides of the aisle, so I took a deep breath and told the world we were going to get the support to save Fannie and Freddie and then we went up to the Hill and got the authority to do just that.

Richard Shelby was key. I had to tell Shelby that I'm a tough guy and if we find problems, I'll be severe in dealing with Fannie and Freddie, but I had no idea the extent of the problems. Maybe I was naive, but I really didn't have the facts, because the regulator and the companies were insisting that they were fine and had sufficient capital. I thought there was a very good chance that if the market knew we had the authority and the will to support Fannie and Freddie, it might be sufficient, particularly if we had a strong regulator who was given the authority to have them increase their capital over time, knowing that there was this emergency government backstop.

This was a very unpopular piece of legislation, because it was combined with Barney Frank's legislative authority to modify mortgages to help struggling homeowners. REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED Barney had talked a lot about it, the Republicans were very negative about it, and so they were fighting it. That was where the controversy was.

So when the President signed the bill in the Oval Office, in a private ceremony, he did not ask members of Congress up there. He basically said, "Paulson made me do it," because it was so unpopular with the Republicans and when we signed it in a private ceremony he joked, "I want to thank the members of Congress for being there on your side, and being here today," and our team had a laugh as he signed the legislation with a few staff from the Treasury and the White House present.

I breathed a sigh of relief. I went to New York and met with a group of hedge funds, to stabilize the market and convince them that our legislation was sufficient. I then met at the New York Fed with a group of large financial institutions, to take a victory lap, and it was there where my successor at Goldman Sachs said something that was very prescient. I was explaining how we had this bazooka, so the market would take it, and Lloyd Blankfein said, "Hank, let me ask you a question." Again, I'm being very technical, but a number of the banks, including Citibank, had these SIVs [structured investment vehicles] or conduits, which were vehicles that they sponsored but didn't guarantee to hold mortgages they originated, but the mortgages weren't on their balance sheet. The banks weren't even on the hook for them. But when Citibank announced that they were going to stand behind their SIV, the market immediately forced them to do so and assume the liabilities.

So he said to me, "You know in this market, it gets very quickly to where the most conservative investor or lender would be, and everybody gets there quickly, and that's what's going to happen here. Think about it for a minute. What happened with Citi? Fannie and Freddie are the government's SIV or conduit," and he was absolutely right and that's what happened to us.

But we got the emergency authorities to deal with Fannie and Freddie, which was no small accomplishment and this proved to be vitally important. The other thing we did that turned out to be wise was to insist that the Fed be a regulator along with OFHEO. Dodd opposed it and Barney Frank stuck with me. The compromise worked out among Chris Dodd, Barney Frank, and me was that the Fed would be a coregulator jointly with OFHEO, which became FHFA [Federal Housing Finance Agency], through October of 2009, the period that was as long as the emergency powers were in place.

That was early July of 2008 and that's when Bob Steel left to go run Wachovia. Tim Geithner urged, and I'm grateful that he advised me to do this, he said, "Hank, you'd better get some other people like Bob that you know and trust down here with the market and investment banking skills necessary to deal with Fannie and Freddie and the crisis."

In terms of the Goldman Sachs people that I get so much criticism for, there was a young guy named Neel Kashkari, who ultimately ran the TARP, who I didn't know when he was at Goldman Sachs. He was in our Palo Alto office. He'd been there three or four years; he was a high-tech banker. He had wanted to come to Washington and applied to be a White House fellow, and one of my partners who ran the office out there had said this is a good guy, would you write the letter of recommendation? I'd signed the letter of recommendation, but Neel was not selected.

Then, when I was nominated, Neel had called me and said he wanted to come and work with me and I said, "Listen, see me in a couple of months after I'm confirmed," but the next thing I knew he was literally knocking on my Washington hotel room door. I said, "OK, you can help with my confirmation and I'll give you a junior job at Treasury." Well, he performed very well; his work was superb. He wasn't the one who designed the programs we put together to stem the crisis, because I had other people who were more experienced financial engineers, but Neel had superb leadership skills, the organizational and management skills to put the people and processes in place to execute the TARP capital program, and the moxie and political courage to run the TARP, and I'll get to that in a minute.

Ken Wilson was a vice chairman of Goldman Sachs, had an office next to mine at Goldman, and was the premier investment banker to banks. He'd been in George Bush's business school class and they knew each other. I called him and said, "I need you to leave Goldman Sachs; you'll never be able to go back to Goldman Sachs again. I want you to resign and I want you to come and work for us," and we put the President on the phone, and Ken agreed to join us. And he was an invaluable advisor to me.

Earlier I told you about Dan Jester; he came up from Austin. Steve Shafran was an interesting case, because I'd worked closely with him in Asia. He was an expert at dealing with complex financial instruments and bankruptcies and workouts when he was at Goldman Sachs. He'd been a private equity investor, a very able man. He had left Goldman Sachs six years earlier, retired with his family to Sun Valley, Idaho. His wife, Janet, had very tragically gone down in a plane crash, left him with four young kids. He found it very hard to deal with all this, obviously. He had actually moved back to Washington because that's where he had met his wife, took his kids there to raise his family, bought Bill Frist's old house not far from me. I gave him a job at Treasury before the crisis, as an advisor. He got paid a dollar a year. He didn't work long hours because he wanted to spend time with his kids. When the crisis started, he was with us long hours every day. He was the one who came up with the money market guarantee and did a number of very important things.

Before Jester and Wilson arrived, we didn't have the investment banking skills, so we hired Morgan Stanley, which was extraordinarily hard to do. I had people at Treasury almost resign over it, because we expedited the normal bidding process you're supposed to go through to hire a consultant or contractor. Morgan Stanley worked for free and without indemnification, and gave us a strong team with a senior guy named Bob Scully and a financial market specialist, Ruth Porat—both real stars. Ken Wilson got Ed Herlihy, a superb lawyer from Wachtell, Lipton [Wachtell, Lipton, Rosen & Katz] to advise us. We had a really good team of Wachtell lawyers, led by Herlihy. People started doing work and I went to China for the Olympics. Just before I left, I got some inkling that it was worse than we thought, but was told there was much more work to do.

When I was in China, I heard this story—which I will briefly recount here, it's in On the Brink—from my Chinese friends, that the Russians had come and said, "Why don't we see if we can make this guy take the bazooka out of his pocket? You know, let's start selling Fannie and Freddie securities." Treasury people spent a lot of time dealing with foreign central banks. Dave McCormick, Neel Kashkari, and others reassured investors around the world. I'd learned, on Bear Stearns, that the market doesn't take ambiguity. I thought after Bear Stearns started to implode and it was going to go down—and the government stepped in and helped, made the loan to let J.P. Morgan complete the transaction—that the market would see that as a very strong signal. Instead they looked at it as By God, Bear Stearns has got these problems; all these other investment banks must have problems. Why should we do business with any of them?

When I called my counterparts a day later, in Germany, in France, to say, "Be sure and have your banks loan to our investment banks," there was no way they were going to comply. They were about to tell them to cut off credit to our investment banks, until I made that call. There was fear. People just don't take risks when you get into a crisis like that, so I had our people tell them the government is behind these entities, we're behind it, we're on the hook, don't worry. They still were nervous. And yet some smart well-meaning people believed bailing out Bear Stearns was a mistake and that we created a moral hazard that was largely responsible for Lehman's failure.

I got back from the Beijing Olympics and got the report on Fannie and Freddie and it was clear that they each have a big capital hole, but we didn't have the authority to put them under, only FHFA did. And they had just signed off and written a report saying that they had sufficient capital, so this created a big problem. I write about that in On the Brink, all we went through to get FHFA where they needed to be, which was extraordinarily difficult. If anything, my book understates the extent to which we needed to push FHFA. At the end, I even had Dan Jester over there working with the Fed and the regulator drafting the order.

We did a lot to get them there. I had to keep telling Lockhart, who ran the FHFA, because he cared about the nation and George Bush, and I had to keep saying there's going to be an economic disaster and it's going to be on your friend in the White House and it's going to forever mar his legacy and yours if you don't step up and do what you need to do. And Jim Lockhart voluntarily stepped up and had the courage and skill to push his examiners to reverse their recent letter that had said the GSEs were adequately capitalized. Ben Bernanke was an absolute hero. He sat in meetings at Treasury that went on for days including Saturdays and Sundays. He didn't have to say much. His presence spoke volumes. When we took Fannie and Freddie by surprise and put them into conservatorship, Ben was sitting right next to me, and that is an interesting story in and of itself. But before that, I want to just say one other thing.

Remember, we only had temporary powers. That wouldn't work. Dan Jester and Bob Scully and Ruth Porat at Morgan Stanley convinced me that we had to do more than that, and they came up with an ingenious solution. We had the power to put in as much preferred as we wanted, and the preferred could have any maturity we wanted. So we designed a keep-well, which basically said we were going to put in long-term Treasury preferred stock—and we set aside that preferred—to back any capital deficiency, which in essence was a long-term government guarantee. I actually thought there was a possibility I would be impeached for going against congressional intent when I announced that, because I had taken temporary power and turned it into a long-term guarantee. It's funny, how you could never guess with politicians how they would react. No one said a word about that. Maybe they didn't understand it or maybe they didn't want to understand it or they knew their constituents would not understand it. [laughter]

Riley

That sounds plausible.

Paulson

The things that the public and Congress reacted to, though, were the things for which we underestimated the adverse public reaction, which I will get to in a minute. And some of the things we did, like surprising Congress and putting Fannie and Freddie in conservatorship, created very few problems. I had never intended to do a receivership or conservatorship. I'm going to say some things that seem obvious now, but we hadn't figured it out, that Fannie and Freddie had so much power, and Congress was so supportive of them, that when we got the emergency authorities the legislation stipulated that we only had the ability to put in capital if Fannie or Freddie voluntarily supported it. We couldn't inject capital against their wishes.

I had thought in the worst case we'd put in a little bit of preferred, or we would put in some alongside the private sector or get the private sector to put some in. But we did not know the extent of the crisis at Fannie and Freddie. I had also not fully understood that the private sector would logically say, "Listen, why would we put money in here, unless we know what the ultimate outcome is going to be. The past construct wasn't likely to be acceptable. These entities aren't going to continue in their present form. How can we make an investment unless we know their ultimate form or go with some guarantee from the government or pari passu with the government?" And the government politically couldn't put money in where basically the taxpayers take all the losses and the private sector would come in and make a profit.

After the Fed and Morgan Stanley had done their analysis and we found out the level of the problem and then started thinking about what we could do, it became pretty clear that we had to seize them and put them in receivership. I'd never really considered or even heard of a conservatorship; I was thinking of a receivership and taking them by surprise. Because if you are Fannie's CEO, Dan Mudd, and I say, "I want you to agree to do something that's going to hurt your shareholders, maybe wipe them out," you, as Fannie's CEO, can't voluntarily accept it. I also knew, and I had to really press my own legal team and everyone else who was saying, "Gee, do we have a strong legal case?" you know, FHFA had just given the GSEs another letter saying their capital was adequate. I said, "Look, I know, having worked with boards, if you have the Secretary of the Treasury, the Chairman of the Fed, saying the government is prepared to seize your institution and put it in receivership unless you agree to voluntarily accept conservatorship, it is difficult to resist. I told the President that the first sound they're going to have to hear is when their head hits the floor. I later had an editor of my book say to me, "But, they can't hear once their head hits the floor." [laughter] We moved quickly and took them by surprise.

I had a very long conversation with Barack Obama. I think it probably went an hour and a half, it was a long time, that Friday night after we separately met with the two management teams taking them by surprise. He woke me up out of a sound sleep at 10:00 at night, at home, and we were on for a long time. I was impressed by how knowledgeable he seemed, how reasonable, how supportive he was going to be. At the end, he said, "I'm going to be President soon—I know I'm going to win this election—and I don't want to inherit an economic wasteland, so if there's ever a point when you think that the financial system is on the verge of collapse, and you want me to do something, get to me."

When I was writing my book, Christal West, who was my assistant, thought she remembered being on the phone for that conversation, and since she wasn't on the phone that night, I had trouble pinning down when the Obama conversation took place. As it turns out, what she remembered was me telling her about it. Christal is a dyed-in-the-wool Republican and was so offended when I recounted that conversation, it was indelibly imprinted on her brain, How dare this guy say that. Now I viewed it as very comforting, so I viewed it a different way than she had.

Riley

Sure.

Paulson

But when I was writing the book, I let Christal's recollection prevent me from placing Obama's conversation where I recalled it and I didn't know how I was going to get it in the book, because I knew I'd be criticized if I got anything wrong. But when I was writing about the 27th of September, when I was up at the Hill late on a Saturday night negotiating the TARP legislation, and I was so tired and I was so stressed, I didn't have a clear memory of that night, so I talked with those who were with me to get an accurate accounting of events. Neel Kashkari was one of those people and he recalled, "You were sitting in John Boehner's office and you were eating pizza. You called Barack Obama and you said to him, 'Barack, you asked to me to call you if the financial system was about to go down. Please tell Harry Reid we need him to come down here and help get something done, because the Democrats are blowing this up, and if we don't get the TARP, it's going to be a disaster for our country,'" et cetera.

And then Harry Reid arrived and things got done, et cetera, so I inserted the Obama conversation in the discussion of the night of September 27. What was the book that was a bestseller that came out about the Presidential election on Obama?

Perry

Game Change?

Paulson

Game Change, OK. When Game Change came out, it recounted that conversation as lasting two hours, and it was that Friday night before we nationalized Fannie and Freddie, as I had recalled. But Game Change came out after I had already gone to press with my book. But it confirmed Wendy's and my recollection of the conversation with Obama. So anyway, we had that conversation with him so then I had to call [John] McCain and McCain had Sarah Palin on. So we knew Biden was going to call next.

The story that had not been told before I wrote On the Brink—Too Big to Fail, Andrew Sorkin's book, is an accurate account, but its focus is on Wall Street—but the story that my book is about is mainly about Washington. All the way through this, if either Obama or McCain had come out against what we were doing, it would have been a terrible problem. I was continually talking to one or the other and Obama was very good, but he kept reminding me that if McCain went off the reservation, then he would too, because it was easier to oppose bailouts. At the time, I thought McCain was a loose cannon. He didn't seem to understand the economic issues. He was angry, rude on the phone, and seemed volatile. As I look back on it, I'm very grateful for John McCain's patriotism, because Obama had everything to gain from the financial crisis in terms of the election. McCain was hurt by it, and he could have demagogued it, but he didn't. And he voluntarily helped get some House Republicans on board. In any event, now back to my narrative.

Perry

Could you pause a moment to talk about the meeting at the White House?

Paulson

I'm going to get to that.

Perry

That's in the narrative?

Paulson

That is in the narrative. Then right after we rescued Fannie or Freddie, and I remember looking out of my Treasury office window at the Washington Monument saying, "We may have done it." I always had this running joke with George Bush: how much dynamite does it take to put this thing out?, you know, and he kept saying is this step going to be enough dynamite? We also had the Butch Cassidy and the Sundance Kid line, "Who are these guys who just keep coming?" [laughter] We were always just a dollar short and a day late, but it was like a billion dollars and a day late. So right after that, as I tell in the book, Lehman started to go down.

Riley

But you did feel like, occasionally, you were turning a corner?

Paulson

I did there. I thought maybe with this—If you want to be an optimist, you say, "By God, what a strong statement." You've put Fannie or Freddie into conservatorship, the government is behind $5.4 trillion in securities, all those securities rise in value, create value for all the financial institutions that hold it, la-di-la-di-la-di-da. But instead, what does the market say? The market says, "Holy moly, if Fannie or Freddie have those problems, what about Lehman?"

The other thing that I'm totally convinced was going on was that there was collusive, predatory behavior by hedge funds. Because the fact is, if it was just the market, all of the investment banks should have been under pressure simultaneously. But what happened was, it was like wolves singling out the weak elk in the herd, so you would find immediately the two trades they put on: the trade that blows out, the credit default swaps, you know, so their credit spreads dramatically widen, and then to short their stock, driving their stock down. And you drive the stock down, down, down, until it gets close to zero. Anyway, the focus turned on Lehman Brothers and it was—

Riley

So, predatory collusive behavior, rather than just open free market trades and keep it short?

Paulson

Well, there were a lot of open free market trades, but if it was just open free market trades, I believe a number of the investment banks would have been under pressure simultaneously. Instead there were sequential failures. I don't know this for sure; I can't prove this, I just believe it. Since I go into Lehman in so much detail in the book, I will just make the point that Ben, Tim, and I have repeatedly said, the Fed did not have the powers to save Lehman. They had powers to do certain things, but it wouldn't have saved Lehman. The Fed could have made a loan, they did make loans, and they made loans against collateral to wind Lehman down, but a loan when you have a bank run on an insolvent investment bank that is disintegrating won't do it. Lehman had a big capital problem, had a very big capital hole—it was insolvent—and a liquidity problem. Bear Stearns had a small capital problem, if any, and a liquidity problem. That's the first point I'll make.

I tried to set up a dynamic where we find a buyer, and where we would have a group of private sector banks, like was done to rescue Long-Term Capital [Management] in 1994, collectively try to help fund the buyer by assuming the bad loans and the assets with the biggest losses. And public messaging necessary to execute this strategy contributed to misperceptions about our approach to Lehman. Going into Lehman weekend we announced that the government wouldn't put money into Lehman. This was a strategy aimed at getting the banks to take on bad assets while we worked with the only two potential buyers, which were told to identify the assets they wanted to leave behind that would be assumed by others. But even then we could not find a buyer for Lehman.

But it turns out—as bad as Lehman's failure was, the alternative would have been even worse. During Lehman weekend we had three institutions going down at the same time—AIG, Lehman, and Merrill Lynch. And we had one buyer. If Bank of America had bought Lehman, Merrill would have failed, and Merrill was over twice as big. It would have been even more harmful. This failure really set up going to Congress. We had talked for some time about what we would need to go to Congress to get the authorities we needed to stem the crisis. Lehman's failure jolted the political system. That jolt underscored the need for Congress to act on TARP, which allowed us to recapitalize the US banking system and stave off an economic catastrophe that would have rivaled the Great Depression.

We get criticized by the free marketers for bailing out Bear Stearns, and creating a moral hazard. We get criticized for not bailing out Lehman Brothers and causing the whole problem, and I'll just tell you, no one who has criticized us has been able to identify an authority the Fed had that would have saved Lehman. People just assume what Ben, Tim, and I did to stretch one power or another to do extraordinary things meant that if we had wanted to rescue Lehman, we could have done so, which is not an unreasonable thing for people to conclude. But a Secretary of the Treasury can't spend money that isn't appropriated. It's against the law. There was no authority for the government or Fed to put capital in a nonbank, no authority to guarantee a nonbank's liability. Those are the powers necessary to stop a run on a failing nonbank in the midst of a crisis.

We also get criticized for not going to Congress earlier. But as you'll hear later, the TARP got voted down the first time during the darkest days of the crisis. It took over two years to get necessary reforms for Fannie and Freddie and even after Bear Stearns went down, when Dodd and Shelby were behind reform legislation, the Congress wouldn't pass Fannie or Freddie reforms over some silly little mortgage foreclosure mitigation provisions that was more optics than anything. So the idea that we could have gotten authorities from Congress earlier is wrong. Only the President could make the decision to go to Congress and he wasn't going to do it unless I went to him and said we have to do this. And there's nothing worse than going to Congress and saying we need emergency powers, and not getting them, and then having the whole system collapse.

After the Lehman failure, I went back to manage things in Washington. As soon as I got back to DC, I had to speak to the White House press corps. And, again, my communications contributed to the misperception that we didn't try to rescue Lehman. I didn't want to advertise the fact that the United States government had no power to prevent the failure of a disintegrating investment bank or to acknowledge the extent of our concerns about a Lehman failure because that would have exacerbated the panic and I believe this would have caused Morgan Stanley to fail immediately. I erred on the side of attempting to stabilize the markets by being cautiously optimistic about the Lehman failure and saying something about moral hazard. One last misconception on Lehman: its failure accelerated the crisis, damaged the system and hurt many people, but it wasn't responsible for the crisis or the other bank failures. It was a symptom, not a cause. Merrill, AIG, WaMu, Countrywide, the European banks didn't fail because they were holding Lehman paper. By the time Lehman failed, Merrill and AIG were going down simultaneously and a historic financial crisis that had been grinding on for over a year was taking its toll, and numerous institutions were approaching or on the brink of failure.

AIG had no modern financial controls. The holding company was like a hedge fund sitting on top of a number of insurance companies. We were able to save them with a Fed loan, because the market perception was there was no capital problem and only a liquidity problem at the holding company, and the Fed could make a loan secured by the insurance companies that were well capitalized. Well, six weeks later, when the rating agencies understood the extent of the problem and were going to downgrade AIG, it was clear there was a capital hole. Fortunately we now had the TARP money to put in to rescue AIG. The initial rescue was a Fed loan, but there's no way the Fed was going to do anything without Treasury's backing.

So I had to get out in front. I worked it with Tim; I got on the phone with Tim when we had to tell Bob Willumstad a condition of a Fed loan was his resignation. They were begging for a loan or they were going to go under. And so we just said the condition of a Fed loan necessary to prevent the failure of the company was his resignation.

The Fed had my strong support and I went up to Congress with Ben to explain why this extraordinary action was necessary. Then we had the scariest moment of all. This is where I'm going to get to what the world would have looked like if we had had a market collapse. There was $3.8 trillion in money market funds. Maybe some of you had money in money market funds then. Thirty million Americans did. Many people believed you have complete liquidity with a money market fund, which meant their NAV, net asset value, would always need to be protected. So if you put a dollar in, you could get a dollar out immediately whenever you wanted, just as if the fund were a federally insured bank deposit, and you got a yield that was more than you got if you put it in a bank.

Perry

Right.

Paulson

People thought it was better than a bank account. When Lehman went, the Reserve Fund had invested in Lehman's commercial paper, so they had to break the buck. But what was not generally known was virtually every other big money market fund called us to say they needed help, as they were going to have the same liquidity problem. The Northern Trust, BlackRock, Bank of New York, they all called Ken Wilson to say they didn't have the capital to put in to support their funds.

What then happened was that the commercial paper market, which major industrial companies use, dried up because the money market funds are the buyers of commercial paper. I had Muhtar Kent, who is the CEO of Coca-Cola, telling me that his CFO [chief financial officer] told him that they weren't going to have $800 million to pay their dividends at the end of the week. If this was drying up financing for a AAA credit like Coca-Cola, it would have quickly spread to middle-sized industrial companies, moving from Wall Street to Main Street. Every CFO would call their CEO and say, "Boss, we're going to have to cut back; we're not going to be able to fund our inventory. We can't pay our suppliers." This would have been an incredible vicious cycle where industrial companies had to fire people, and then it would just feed on itself. If the money market funds had imploded, we would have had a financial catastrophe.

The Fed was buying commercial paper to support the market, but that wasn't working. We learned a very important lesson. We learned that one thing that could prevent a meltdown in the midst of a crisis was a government guarantee. Well, as we were sitting around late in the day, in the middle of this, Steve Shafran said, "Why not guarantee the money market funds?" I said, "How can we guarantee them?" There was this Exchange Stabilization Fund at Treasury, which was to be used if we had to support the dollar in an emergency. I went to my general counsel and said, "Can you give me a legal opinion?" and he said, "Yes, we'll figure out how to give you an opinion," on the theory that if we went over the abyss, the dollar would have a big problem.

When we met with the President—to get his authorization to go to Congress to request emergency powers, I mentioned our plan to guarantee the money market funds. He immediately understood and he really hit that hard, because he had a very good market sense. Steve Shafran remembers me calling him on my Razr phone, walking back to Treasury from the meeting with the President in the Roosevelt Room saying, "Figure out how to announce this immediately." So we announced it, and the next morning Sheila Bair called and said, "Hank, you never talked with me about this." I said, "I didn't have time." And she said, "Well, you've screwed up, because a lot of the money is going to leave the banks and go to the money market funds, because you've given a guarantee." I said, "Good point, Sheila." We got our team together and we clarified our guarantee as only applying to the money in the funds as of September 19th, so if you weren't there by September 19th, you weren't guaranteed.

When we went up to Congress to ask for emergency powers to stem the crisis, Ben and I basically said the interbank lending market is frozen, it's been frozen for some time, this is a crisis, the economy is going to turn down no matter what we do in a couple of months, but if we don't get the emergency powers, we're going to have a much bigger problem. Barney then said, "You can't prove a counterfactual." It was late at night, and I said, "What's a counterfactual?" And he said, "You'll never get credit from the American people for preventing a disaster they never saw, so this is a very difficult vote." Later, when I was trying to make the case for Congress to vote for the legislation, I didn't want to scare the markets further and talk about how bad it was. Rahm Emanuel said, "You've got your market; we've got ours. You know you're going to have to speak right into the microphone and scare the living daylights out of people or we're not going to be able to vote for this."

I asked for authorities to purchase illiquid assets. The only bank capitalization programs I had ever witnessed or known about in crises, injected capital in them just before or after they failed and nationalized them. That's all anybody has ever done. That's what the Japanese did, the Swedes did, the Europeans did. Nationalizing failing banks is the normal thing to do. And it is costly for taxpayers and takes a long time for the banks to recover and operate as normal. I believed that the US banking system as a whole was undercapitalized. And, if the banks thought they were facing nationalization, which means very punitive terms, firing CEOs, and replacing the board of directors, every bank says, "I have no problem," right up until they do. When I tried to get Wachovia to raise capital, they say we only will issue preferred, because the only banks that issued common were the ones that had big problems like Merrill Lynch, Citi, and Morgan Stanley. So, we needed to figure out how to recapitalize the system. [beeping sound] Do you know what that is?

Rodriguez

That's outside.

Paulson

Our theory was that rather than nationalization, we should buy-in illiquid assets with the embedded losses, creating a market for them, causing the price of these securities to rise, thereby recapitalizing, but in which you're not nationalizing the banks. I really believed that would work, but by the time we got the TARP legislation from Congress, it was too late. In the two weeks we were negotiating with Congress, the market deteriorated, so we needed something that worked faster and was more powerful than asset purchases. So we went up to get TARP. You know the experience—I wrote about it in On the Brink—how difficult it was. Ben testified with me and was extremely helpful. He went to a meeting with me, with the House Republicans, which was very difficult and frustrating, but it was my Treasury team that had to negotiate with Congress over a two-week period.

Nancy Pelosi and I are on different sides politically and on a lot of issues, but I have a high regard for her ability. I worked with her first on the free trade agreements and again when we got the fiscal stimulus in January. George Bush asked me to handle those negotiations, just like we did for the TARP. It was Treasury's Legislative Affairs team, Treasury's press team. Treasury negotiated the stimulus completely and the White House was supportive. Ed Lazear was very helpful; Keith Hennessey was very helpful. The President was briefed every step of the way and set and approved the teams. But the stimulus negotiation gave me a good opportunity to work with Nancy before the TARP negotiations.

Riley

OK.

Paulson

When we finalized the TARP negotiations, Rahm Emanuel was very helpful, a number of people were helpful, but at the end of the day it was Nancy Pelosi who got people together and said, "We have to get this done." Judd Gregg, who represented the Republicans in the Senate, he understood this stuff from Day One, and was a very skillful negotiator and partner the night we negotiated the TARP, but I will go through the story now.

But before we get to the Saturday night when we concluded the TARP negotiations, I had spent a lot of time in nonpublic sessions with Republicans and Democrats in both the House and the Senate. At a private session with the Senate Republicans, I spent a long time explaining it to them, how serious the problem was and how important it was for them to act. I said, "Listen, I didn't want this job; I turned it down three times. I know more about this than any of you, and you have to trust me. If we don't get these powers, an incredible calamity is going to occur to this country. I'm not asking for these powers because I want to have the powers." It's actually a scary thing to have the powers, because when I go to use them I will be criticized.

Saxby [Clarence] Chambliss said that helped win over that group. But I believe the biggest reason for our success was that Judd Gregg, whom they all trusted, represented the Senate Republicans. Richard Shelby, the Senate Banking Committee Chairman, ducked and stepped aside so Judd could lead. Shelby's go-to move is to be against almost everything. In the crisis, he never said what he was for, while he opposed everything we recommended. The one exception was Fannie and Freddie, where he was very good, as I wrote in my book. He was head of the Senate Banking Committee, but Mitch [Addison] McConnell basically said to me, "Listen, he'll speak against giving you the TARP, but he knows something has to be done, so he won't work against you, and Judd Gregg will lead and speak for the Senate Banking Committee." Judd Gregg was one of the most able members the Senate. He is so smart, and he was critical in helping me negotiate this. He is a key negotiator on our side.

This now gets to McCain coming back. When I was at Congress testifying to get the TARP and when the committee took a break and we were at a recess, Josh Bolten called and said that McCain wanted to come back to help resolve the crisis in support of the House Republicans, and I said, "You can't let him come back; it will just blow everything up." He said, "We agree, but he's really given the President no choice." The President recommended against it, but McCain went and made an announcement that he was going to come back.

Now we fast-forward—McCain returned to DC and met with the Senate Republicans. Senator Lindsey Graham saved me repeatedly, because Lindsey Graham is close to McCain and a very reasonable guy. Lindsey was doing the best he could to keep John McCain under control. He would call me and let me know when he thought John was dangerous and going to say something wrong, and I would get on the phone and urge him not to.

Lindsey was clear that John was determined to come to DC. And when he did, John went into the Senate Republicans' weekly lunch. They'd been working and making progress, and they tried to brief him and he said, "You guys have got no business doing any of this without talking to me; I'm against you all," et cetera, and he lost his temper and walked out. Judd warned me that this had happened before we had the meeting in the White House, and so I got McCain on the phone on his way over to the White House for the meeting he had called to try to resolve the differences in Congress on the crisis.

I still remember vividly telling George Bush about my McCain conversation just before we had the meeting with the Republicans in the Oval Office. I was in the President's Dining Room, which is off of the Oval Office. There's a door going out into the Rose Garden from the dining room, and he was standing with a cigar in his mouth. It wasn't lit, but he was standing with a cigar in his mouth there, and he almost burst out laughing. I didn't think it was that funny at the time, but I told him that I'd called John McCain, and that he was yelling at me for doing these bailouts or whatever. I basically said, "Listen, you're a Presidential candidate, I'm just the Treasury Secretary, but if you come in and blow this up, I'm going to get on national television and tell the American people that you're the one who's hurting our economy, and I'll get Ben Bernanke to do it too." Well, I never said a word to Ben Bernanke. [laughter]

The next day, Ben Bernanke called me and said, "You know, McCain called me—He was very nice—I had a good conversation with him. He apologized and seemed very supportive." But in any event, as to the McCain meeting at the White House a day earlier, where John Boehner had this difficult group of Republican members who weren't supportive. He didn't have the votes. So we went in and the President turned to me and basically said, "Hank's our guy; we've got to do this." After I had given a brief summary, Barack Obama spoke first and the Democrats played this to the hilt politically. It was as if I was their best friend, you know, which just killed me with the Republicans. "Oh, I talk with Hank all the time and we're being supportive of whatever he wants to do and we have the votes." So the President went to McCain, "John, do you want to say something?" No. He said, "I'll defer." He didn't say anything.

So there was this big conversation where everybody had the votes from the caucus except for Boehner, and then I didn't handle it very well politically. Boehner threw out an idea that I thought was a dumb idea, and so I said it was a dumb idea. So then Boehner wouldn't—Boehner and I are on friendly terms, but he literally wouldn't talk to me for weeks after the TARP was done. He thought I put him in a difficult situation. He now says he wasn't aware then how serious it all was. He didn't fully understand the extent of the problem at the time; few people did.

Finally, at the end, when McCain had to speak, he picked a note card out of his pocket and read some innocuous comment and that was it. Then there was a shouting contest because Spencer Bachus said—Anyway, I won't go through the whole thing, but the meeting lost control. The one thing on which George Bush and I disagreed, he wrote in his book that he remembers saying, "I'm not going to let the White House be the source of this spectacle; the meeting is over." I remember him saying, "I've clearly lost control." Josh remembers it the way I do. They were all shouting. Vice President Cheney said he'd never seen anything like it.

Then I had that thing where I got down on my knees to Nancy Pelosi. Shelby had gone running out to the press with, "I have all these letters from all these economists saying the administration's plan won't work; this is a disaster," and the Democrats had all gone in the Roosevelt Room. They were all in there and I was afraid what they were going to say, so I just went in to talk with them. I'm naive, I think they're my buddies, I've been talking to them. All of a sudden they look at me—They're all huddled around Barack Obama—they look at me like, What are you doing here? [laughter] So I just—Trying to create a little levity, I thought I'd make a joke. I got down on my knees and so—But anyway, that was the scene.

Riley

On one page in your book, you're describing one of these meetings where you say that Shelby is replaced by Gregg and that Spencer Bachus has been replaced by somebody. My wife and I are both from Alabama, and I reported this to her last night and I said he clearly shows that progress is being made on the economy when the Alabamans were away.

Paulson

Well, they're very different guys, because Shelby was in the wrong place on the issue but was tough, really tough, and shrewd politically. Spencer was in the right place on the issue, but didn't have the support of his colleagues in the House. One story I will tell you, is he came to see me after I'd left Treasury, to explain why he had backtracked on the deal.

Riley

"He" being?

Paulson

Bachus. He brought an email that he had gotten from John Boehner, which said blow the turd up, you know. In other words, John Boehner knew his caucus would not support the TARP; and after Bachus had agreed to support the TARP, Boehner reined him in.

Riley

Sure.

Paulson

He's a nice, smart, and a well-meaning guy, but he didn't have the respect or backing of his caucus.

Riley

The House Republicans, did they just not understand the gravity of the circumstances?

Paulson

There were different situations. Some of them understood—many didn't, but they were free marketers.

Rodriguez

It just seems so—From an economic standpoint it's beyond chilling when you see [Jeff] Immelt can't get commercial paper sold, when you see all these things in the money market and mutual fund. It would be almost hard—I wonder what the position was like, because to explain the other side of this, I'm sure Bernanke could have eased the depression.

Paulson

Boehner probably had the best explanation when he explained to me, "Hank, one-third of my guys are knuckle draggers; the other third know they're going to lose their seats in a few weeks, but they hope they're going to win, so you're fishing in a very small pond." I will tell you, it took some courage to vote for the TARP. I think twice we got Congress to do extraordinary things to avoid disaster: what Congress did in terms of the TARP authorities that we were given, very broad, expansive authorities; and Barney Frank made sure that legislation was written in a way that gave us great flexibility.

Riley

OK, sure, sure.

[pause in recording]

Paulson

One other thing just occurred to me.

Riley

We're going to come back on. Now you were talking about the House Republicans.

Paulson

At the end of the day, I would tend to look at the more positive things, because basically we had both Presidential candidates—McCain has amnesia now, he doesn't remember it, but at the time he was supportive. You had a fair number of House Republicans who did ultimately vote for the TARP, and it was a very hard vote for them. And then there were those who couldn't get there. I use Michele Bachmann as an example, because Michele Bachmann, a conservative House member from Minnesota, just literally came right up after we met with the Republican caucus: "OK, you've got me, but how would I ever explain to my constituents" was basically what she said, "because I'm a free marketer?" One of the things that everyone underestimated—Every political person in the White House, if you talk to the most sophisticated members of the press that followed us, if you talk to everyone, they underestimated the amount of public hostility that would be aimed at the TARP.

When I left Washington in 2009, if you read polls the way I did, 90 percent of the American people were against the TARP and only 60 percent against torture. What politicians will tell you, if you talk to them they'll say, "If you give me 15 or 20 minutes, I can convince people that what we did made sense, but in a sound bite I can't." We Americans don't like bailouts. We think if you make money taking risk, that's great, but if you lose money, the government shouldn't be the one that comes in, and that's absolutely right.

It's hard to explain that we didn't do the bailouts for the banks, but to protect the economy for American people. Also people do not realize that the bank recapitalization programs worked. They not only prevented an economic catastrophe, but all the money put in the banks and insurance companies came back, plus almost $50 billion.

Part of the problem was that banks had to be propped up—We had no choice but to prop the banks up in their present form. There's no bank that's too big to liquidate, but there are plenty of banks that are too big to liquidate quickly, particularly during a financial crisis, when no bank of size can be liquidated quickly without harming the economy. We now have emergency resolution authorities to keep a failing nonbank financial institution like Lehman from damaging the economy. We've now got living wills and plans to break failing institutions up if need be, after they are rescued. I never was able to explain to the American people that we weren't doing this for my buddies at Wall Street; we were doing this to protect all Americans, because it was going to be a catastrophe if we didn't. The American people hated this. Members of Congress are in office because they understand what the people want, so they hate making an unpopular vote. The Democrats were the party in power, so this was on them. If they didn't act, they were going to get the blame, so the House Republicans sort of knew they could pull back.

Barney Frank gave me that great line I put in the book, or maybe I didn't, when after the House voted the TARP down on the first vote and I was despondent. I had two calls that really cheered me up: Lindsey Graham basically said, "You've got to be positive, Hank, you shouldn't be negative. You've got both Presidential candidates, you've got a majority of the Senate, you've got the Democrats in the House. All you have to get is the House Republicans, and you will get them, don't worry." Barney Frank cracked a joke to illustrate why he thought the House Republicans would return and vote for the TARP: "Sometimes when kids run away from home they have to get hungry before they come back." He had all these quips. [laughter]

The House Republicans voted no the first time the TARP came up, and it was just an absolutely terrible experience. Then it became pretty clear to me that purchasing illiquid assets might not be sufficient to stem the crisis. I didn't know that for sure, but in the two weeks we were up at the Hill working to get the vote, I could see the markets deteriorating in the US and in Europe. In the US, we had the two biggest banking failures in US history—WaMu and Wachovia—and Dan Jester just kept on me, saying, "Asset purchases aren't going to work. We're going to need to figure out how to put capital in the banks." The emergency authorities we got were broad authorities. If the Chairman of the Fed and the Treasury Secretary agreed, we could do pretty much what we wanted, but we only had the $800 billion. As I found out later, Citibank alone had over $200 billion of bad assets, so that $800 billion wasn't going to go very far unless we used it cleverly.

So we got TARP authorities from Congress, and after the vote, I was exhausted. I wasn't sleeping at night, so I went to our island off of Georgia, Little St. Simons Island, for a weekend. I did a little bit of fishing, but I was on the phone with Ben and Tim much of the time, and I had a team working on what we could do in terms of capital. We had six or seven countries in Europe that needed to step in and nationalize failing banks. That weekend, when I was at the island, it was clear we were going to have to do something much more than buy illiquid assets. The G7 [Group of 7] was coming to DC the following weekend, so we had a lot going on. I put people to work, thinking through capital programs, and we started working with Sheila Bair to come up with an FDIC guarantee for some of the bank's liabilities. We saw how well a guarantee worked with the money market funds. If we called something a guarantee, the market loved it.

As the week drew on, it was pretty clear to me we were going to need to put capital in the banks, and we designed something that people have never really given us credit for or really understood. Our capital program was different from any other capital program that's been done, because rather than dealing with bank failures as banks went down serially, one at a time, or just trying to single out those that were the weakest, we went out to recapitalize the whole banking system and did it with lightning speed.

When I told George Bush that we were going to be putting capital in the banks and not buying illiquid assets, he was a bit taken aback. He basically said, "You've told the whole world you were going to buy illiquid assets and now you are saying that won't work. This is a political problem, but obviously, we've got to do what we've got to do to save the economy and the financial system."

My own view on crisis decision making is when you're in a crisis, you can do a lot of things you can't do if there's not a crisis. Because oftentimes people either are afraid, so they'll take your idea, or if they don't have a better idea, they'll take your idea. And when you're dealing with a big, messy, ugly, complex problem, you're not going to find a neat, pretty, elegant solution. Every solution you have is going to have plenty of problems, but an imperfect solution is often better than doing nothing. You have to be prepared to act to prevent disaster. You need to have a debate and air all sides, and then you go with the information you have. But if and when the situation changes, you have to be prepared to change course. I am decisive by nature—not afraid to make a quick decision—and I have also always been willing to change course when I believe I've made a mistake.

I think the time we did the best work ever during the crisis was the time when we had the most to do, which was that weekend after we got the TARP. I had to deal with the G7; we also went a long way toward making the groundbreaking decision to go with the G20 leaders meeting. I will talk about that later. I had a team at Treasury that I was meeting with continually, working to come up with a whole set of measures, with a big emphasis on designing a capital program. I had been pressing Sheila Bair very hard to get the FDIC to guarantee liabilities of financial institutions. It was a big step for her to take, to decide to do the guarantee, because to use her fund, which was to protect depositors to guarantee the unsecured liabilities of bank holding companies or investment banks, that was a big reach. As we were all sitting around a big table at the Treasury that weekend reviewing our alternatives, and when the FDIC liability guarantee came up, Sheila Bair's lawyer stood up and said, "She doesn't have the legal authority," and I had to say, "Sit down and shut up; this is the United States of America you're talking about here." I was that serious.

Tim Geithner was fantastic. I had asked him to come down not as the head of the New York Fed, which he was, but to come down and work and act as my designee to manage the process to flesh out the alternatives we had to stem the crisis, because I was going from one meeting to another, the G7, the G20, this or that. Someone needed to convene staff and serve up the alternatives. He did that. When we went through the different measures we were taking, we knew that there were some things that were extraordinary and extreme. I thought that every bit as important as a capital program was the FDIC guarantee, but the capital program was essential because our banks were undercapitalized. There was no way Sheila was going to agree to the guarantee unless we put capital in the banks.

I'll do a diversion on Sheila. I'm very glad Sheila was there, because at the end of the day she made every decision we needed her to make. REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT

Anybody who was smart knew that it was politically perilous to work on an AIG or Citigroup 2 rescue, or whatever. Who would want to work on those things? If the institution fails, it's a disaster for the whole world; if it succeeds, you get investigated for the next two years because it's a politically toxic bailout. You are going to be unpopular with the public. You're going to be criticized. We were in a war, but no one was going to be a war hero. I had to keep going back over and over again to the same people, and anybody who was a politician or wanted to run for political office just didn't want to touch any of the crap we were dealing with. I had to keep relying on the same people over and over again, and in my judgment they were real heroes.

Sheila had a better political sense than any of us. When Tim would say to me, "Well, she leaks," I'd say, "What do you mean, 'she leaks'? The leakers do it surreptitiously. She just goes right to the press and puts her story out there REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT

During this weekend, I was constantly cajoling Sheila. She would say she was willing to have the FDIC guarantee then she said she wouldn't and I'd have to go meet with her alone. And when I met with her alone, I would just simply say, "Listen, if you don't use your fund to guarantee liabilities of bank holding companies, your fund will lose all its money, as your banks fail and the system will go under. If you do this, you're going to be a hero." And she did, and as far as I am concerned, she is a hero. We got through the weekend, but the hardest debate was the FDIC guarantee, because if you give a guarantee to bank paper, that disadvantages other institutions and borrowers that have to go the market without a guarantee. It's a bias that distorts the system.

I tell the story in my book about calling up Jeff Immelt, the GE CEO, to say that we were considering having the FDIC guarantee bank liabilities, but not the liabilities of GE Finance. He said, "Go ahead do it; if the whole system collapses it will be terrible for our economy and GE." That's what he said that day. Two days later he was pleading, "We need a guarantee also," because he had a company to run.

That weekend—and here I will just underscore, On the Brink tells the complete story—and what we got done at the G7, in coordinating and getting that group together, was important. Mervyn King, Governor of the Bank of England, was key at that meeting. Then what we got done that weekend—calling nine key bank CEOs, getting them to Treasury on 24 hours' notice, and persuading them to take capital on the spot—was important. We then moved to recapitalize the banking system. On the Sunday before Columbus Day, I said let's capitalize the banks tomorrow before the market opens. George Bush still talks about it. He said, "Paulson, I can't believe you did that."

It wasn't a problem, other than the Wells Fargo CEO, [Richard] Kovacevich, putting forward some objections, and he couldn't have been more wrong. He thought that we should have basically said all the other banks need capital, you don't, we give our seal of approval to Wells Fargo, despite the fact that they bought Wachovia, had all those option arms, and bad mortgages.

I'm going to be winding this down very quickly, because I can figure out how to summarize a lot of these things and leave time for your questions. But after we got the nine banks to agree to take capital, I then had another very tough call with John McCain. This was Columbus Day weekend; I remember it like it was yesterday. It was a beautiful, clear night, warm. [Silvio] Berlusconi was in DC and there was a state dinner in the White House. I was supposed to be at the dinner; Wendy was there. We had just finished putting capital in the banks and then we had to call political leaders and explain our actions. Barack Obama loved it. The Democrats loved it. They said we were right. Spencer Bachus loved it. He said, "I always said you should put capital in the banks," which he had. But we weren't nationalizing failing banks. We were recapitalizing the system.

I was worried about McCain, because if McCain came out against this program, there was no way the banks would finalize our agreements and accept the capital. I had called him first, but he was slow in returning my call. I remember waiting and waiting and waiting; I wasn't going to go anywhere until I talked with him. Finally, Wendy called and said, "The President wants you here." She told him that I liked the Jersey Boys and the Broadway cast was going to be singing Frankie Valle songs after dinner and the President asked that I come over for the dessert. So I was walking with the Secret Service detail, from Treasury to the White House, and fortunately my cell phone rang. It was Christal and she had John McCain. John McCain just let me have it—Gosh, again, you know—just ripping into me about what we were doing and he was going to come out against it.

I said, "John, do you realize what's happening? We're about ready to have another Great Depression, worse than the last one. Have you been reading the papers? Do you know what these European nations are doing? Do you know what we've done? If you come out against us, the banks won't take the capital and the financial system will collapse." He then stopped in his tracks and said, "Oh, OK, but you have to promise—Will I get my program for this and my program for that?" and I said yes, and then I went in and listened to the Jersey Boys.

I'm not going to take you through all of the various programs and what we did and how we did it. You have them in my book. I'm going to give you the summaries you need and then we can talk about Ben and Tim and Sheila and Chris Cox, and all those kinds of things.

Riley

We are going to break for lunch in about ten minutes.

Paulson

OK, to set up the lunch then, I will say the following, and this is the politics of this, which was phenomenal. Basically most of those who were close to the markets applauded it when we put capital in the banks. The banks applauded it, the market reacted favorably, as did the press. But it didn't take long for the public to turn negative. The American people were in a different place than the financial press was. Everybody underestimated the public reaction, and the first barometer of this was Chris Dodd.

I heard from Jamie Dimon, telling me that Chris Dodd was going to call the banks in for a hearing and demand that they lend out new capital and that they be careful with their compensation. All very reasonable suggestions, but this public hearing would have turned into a public flogging, stigmatized the banks, and causing them to back out. I had to say to Chris Dodd, "This capital program is off to a great start and will be successful. If you hold a hearing, if you put a stigma on this program, the banks won't take the capital that they've agreed to take. And they won't have to take it because the documentation isn't done. It will be your fault, Chris. You'll be the one who will personally blow this up and take down the financial system." So he reluctantly agreed not to go forward with the hearings. Today many people still don't understand why we didn't impose tougher conditions on the banks. If we had done traditional bank nationalizations like the Europeans did, we could have been very tough. But their banking system is still undercapitalized and very weak because only a few failing banks took capital and were nationalized. We needed attractive terms to make a voluntary recapitalization work.

We never demanded that the banks lend. How do you make banks lend? Even if you nationalize them, is the government going to get in and make banks lend? All of us wanted them to lend more, but lend more than what? More than they would have lent at the height of the bubble? Of course not. More than they would lend if they'd collapsed? Of course they will. We were trying to stabilize the system—increase market confidence. But we never, ever, asked the banks to lend. And all the people, like Elizabeth Warren, who said, "Oh, you're not reporting how they use their TARP money," it's just all baloney. It just was all politicians pandering to the public, because the banks report every quarter what their lending is. But to be able to trace a dollar, a dollar from a TARP equity infusion, in terms of how it somehow moves from capital to a loan? Any banker knows that's impossible.

There was that, and then there was the compensation: you should be tough on them on compensation. That was the biggest part of the negotiation with Congress, and we did things in prohibiting golden parachutes for CEOs. I wanted to be as tough as anybody. I was disgusted by the way banks gave out bonuses after receiving government capital. I can't tell you how strong my views were and are on that. But the fact is, if we put those kinds of requirements on TARP capital, then we're back to nationalizing banks, because no bank is going to sign up voluntarily; they would all be saying we're "healthy," right up until they failed. In our program, they were all taking capital together, holding hands—healthy and not-so-healthy banks.

This was a program that turned out, I think, to be an effective program—and I'll get into that later—after the fact. It worked much better than we even thought it would work. We would have put it in many, many more banks, and we would have had thousands of banks, rather than 700 banks, take it, but what happened was that the politics got ugly. Congress was going fine until the American people turned negative. The biggest benefit the banks got—even more valuable than the capital—was the FDIC guarantee. But the public didn't understand that. There was no flak that went with that, the FDIC guarantee. Taking capital quickly became a stigma.

Later, after I'd left, Dodd passed legislation that tightened up restrictions, but once the politics and the pushback came from this, then banks stopped taking capital. Otherwise, we would have had many more banks take capital. Now they wanted to pay it back quickly, which gave Tim and Ben a huge lever. That set up the Obama administration with a stress test. You weren't going to be able to pay the capital back until you'd passed a stress test, and we had a banking system that had been recapitalized. In three hours, we recapitalized nine banks holding half of the US banking assets and in another 90 days recapitalized 700 banks. And all the government money came back with almost a $50 billion profit. Meanwhile, the Europeans didn't do so well. Their banking system is still fragile—and so is their economy. And even the Brits, they were for injecting capital, but only Lloyds and RBS [Royal Bank of Scotland], on the brink of failure, accepted capital and nationalization and they still don't have sufficient capital in their banking system.

But the politics was such that the American people were outraged, and it just even got worse over the compensation. Part of this is because, to this day, most of the American people believe the banks are responsible for the whole problem. If only it were that simple. If you read the New York Times every day, if you pick up the New York Times today, you know there are two articles, both of which say again that the banks caused the whole problem. And it just plain isn't true. I'm not saying that as a former banker, but you go from the beginning of time, you go through every financial crisis, and the root cause is flawed government policies that create bubbles, which manifest themselves as excesses in the financial system.

The banks are at the center of the action, so there are all kinds of abuses and excesses when there is a bubble. In the old days, people literally used to kill the bankers. That's what happened in ancient China after banking crises. That is why so many overseas Chinese are successful entrepreneurs throughout the Pacific. Their forefathers were bankers fleeing for their lives. If you look at the story of Germany, what happened in the early 1900s, and then you look at [Adolph] Hitler. A lot of the anti-Semitism was blaming bankers. The cause of Germany's economic woes was terrible economic policies, but the Jewish bankers were the ones who Hitler blamed. And, of course, after the Great Depression, a number of prominent US banking CEO's went to jail, and perhaps deservedly so, but they didn't cause the Great Depression.

If you just look at the flawed policies we had that created this: The policies that inflated mortgages, both political parties supported them. We had homeownership near 70 percent in America. How is that fair to renters, letting someone buy an expensive home and deduct interest on a million-dollar mortgage to reduce their taxes? The Fannie Mae, Freddie Mac policies, the FHA policies, the Federal Home Loan Bank policies all subsidize homeownership, which is a good thing. But you can have too much of a good thing. So there was this huge political reaction.

Why don't we break for lunch? I've summarized our capital markets stabilization actions and programs. After lunch, I will tell you the points I want to make, which I think are the points that are important about the financial crisis, and I'll do those in under an hour.

Riley

OK.

Paulson

And then maybe you can ask questions about that and then we'll do other things.

Rodriguez

Just one brief question now. The administration was persistent in wanting you to be Treasury Secretary. At that time, you said people didn't foresee a housing crisis or the scale of things that were going to happen, but you and others were concerned about—It had been a while since the financial crisis; there were things going on that needed attention. Were they really thinking strategically, We need a strong Wall Street person in that position?

Paulson

You would have to ask Josh Bolten. What he said to me was they needed a Treasury Secretary with credibility. I think they may have felt—They weren't telling me they were concerned about a crisis, but I actually think they wanted to get some things done and thought I might have the credibility to do some things the last couple of years. They wanted to run to the end of President Bush's team. Josh Bolten led the effort to bring me on, Bob Gates, Michael Mukasey, and a new team, and the people I worked with in the White House there were extraordinarily able. Joel Kaplan, and Josh and Steve Hadley were top-notch professionals. The level of the staff, and the Vice President's staff—People like David Addington were also able people, and the decision-making process that the White House normally went through was also a very good one. You wrote memos, laid out both sides, you were there, you debated it and discussed it, the President heard the differences.

I don't know really why, but they went after me hard. I even suggested other candidates. As I said, if I'd known what it was like to work as President Bush's Treasury Secretary, I would have accepted the offer immediately. But I thought, With the President's approval rating at roughly 30 percent, why do I want to be there for the last two and a half years? I had underestimated the things you could do at Treasury, even without Congress. I set up the first environmental department at Treasury, set up a markets room, established the Strategic Economic Dialogue with China, helped secure congressional approval for several free trade agreements, reached a tax treaty with Canada, raised money to establish the clean technologies funds at the IFC [International Finance Corporation] at the World Bank. If you define the job expansively, even without a financial crisis, a Treasury Secretary can do a lot in two and a half years.

Riley

All right. Only one rule at lunch, and that is we can't talk about anything that needs to be on the tape.

Paulson

Good.

Riley

We'll be downstairs and we can talk about birds or something else.

Paulson

Good. Hopefully, we'll do it briefly then.

[BREAK]

[Long passage redacted]

Paulson

I would say this about looking back on the financial crisis. First of all, the root causes of the crisis were flawed government policies, all the policies that caused us, as a people and as a nation, to borrow too much, save too little; the tax policies; the structural imbalances that caused the United States to save too little and China and Germany to save too much. There were these billions of dollars flooding into and being intermediated by US financial institutions. The world was awash in capital, looking for yield, and taking on risks that it shouldn't have. The policies led to overstimulation of housing and all of the things I had mentioned before, everything from the federal home loan banks, Fannie, Freddie, to the FHA programs. Even take a look at mortgage interest rate deduction. It's just a spending program; it's an incentive for people to buy a house as opposed to rent, and it's unfair to everyone who's a renter. So all those things led to it.

Then you had a flawed regulatory system that hadn't kept up with the world, and as I said often, we didn't need more regulation, we needed better regulation and we needed a regulatory system with the proper powers. Regulators didn't have the tools they needed. The rating agencies had problems—We talked about that—and then complexity is the enemy here. You had huge amounts of complexity in terms of these very opaque, complex securitizations and derivatives, which weren't trading on public markets.

It's hard to regulate against complexity, but to me, what you do is you force trading on public exchanges or centralized clearinghouses. If they don't trade in the open, then institutions should have to hold extra amounts of capital against them for a capital cushion. You had very bad risk management practices by the banks. Of course there was fraud. That wasn't in my judgment the biggest problem. You're always going to have—In excesses like that, there will be fraud. I'm not making light of it, but it was overwhelmed by a lot of the mortgages that were originated in state programs, in states like California and Florida, where they had god-awful regulatory systems.

Investors made mistakes; the banks made huge mistakes. Plenty of homeowners bought mortgages where they intentionally lied, and just assumed the house price was going to go up and if it didn't, then they could walk away from it. So there were a lot of problems and lessons to be learned. In my judgment, you can never prevent financial crises— You're always going to have them—so the most you can do is to have a regulatory system that gives you the transparency you need, to try to uncover these things earlier, and have the tools you need to manage the crisis and limit the damage by acting early on with overwhelming force.

Only time will tell, but I think right now you have the resolution authorities to wind down banks if they fail, without propping them up in their current form or throwing them into bankruptcy, but it remains to be seen as to how people sitting in the seats, whether they will do the right things. We still have four safety and soundness regulators competing and falling all over themselves. We got rid of OTS, but multiple, competing regulators is a crazy way to run a system and it leads to a lot of confusion and uncertainty, with no clear accountability.

There's a positive that the Fed is the regulator for at least all of the big, complex, systemically important institutions. That's a good thing. Banks have more capital, which is our best defense. The banks have more liquidity, another big defense, since regulators will never find all the problems. Unless you think that the banks blew themselves up on purpose, it's hard to believe that a regulator is always going to find the problems that the banks can't find themselves. That's why you need market discipline. That's why people talk about moral hazard, and that's why I think it's so important, if it fails, that you don't prop an institution up in its current form.

Rodriguez

Hank, can I ask you for a reflection on a little bit of that? It seems like you're uniquely qualified, having come from Goldman, and then being the Treasury Secretary. In a post-LTCM [Long-Term Capital Management LP] world and all that, we learned about complexity. What do you think accounts for the inability to perhaps catch up to the need to regulate or offer more sunlight, or the need to catch up and recognize that the complexity perhaps might be beyond anyone's understanding?

Paulson

From the government's standpoint, just look at how much trouble Obama had in getting Dodd-Frank [the Dodd-Frank Wall Street Reform and Consumer Protection Act] done, and vested interests' resistance to change, and why we still have a CFTC to regulate futures and SEC to regulate cash markets? Why is the SEC still a safety and soundness regulator as opposed to focusing solely on investor protections? Then the banks—I'll tell you, big, complex financial institutions are hard to run. REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT

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There just was undue complexity. I've thought a lot about that, and where that comes from I don't know. The regulators didn't understand these securities. After I became Treasury Secretary, the regulators told me the banks were well capitalized and that when we had early meetings with the President's Working Group, it was "Oh, my gosh, look at all the capital—by historical standards the banks are well capitalized." That is what I heard. I had to explain that the leverage was embedded in opaque instruments that were hard to understand. The credit derivatives were another problem. Investors knew how many General Motors bonds were outstanding, but there was no way to determine how many credit derivative contracts were written against those bonds. And if General Motors failed, the contracts were written without a cash settlement option, so you actually had to have the bond to get the short protection you thought you had. There was a lot of really good work done before the crisis in terms of putting in protocols and rules, to make sure that the credit derivatives market would functioned as intended.

In the regulatory blueprint that the Bush Treasury put out in March of 2008, well before the darkest days of the crisis, was that we should ideally have one macro stability regulator—and we thought that should be the Fed—that could look throughout the whole market. If they found something that looked like it could endanger the whole system, they would have the ability to come in and study it and then the authority to take action, because before the crisis, there really was no one with the authority to take action for the repo market or the over-the-counter derivative market. There wasn't a regulator with broad market oversight responsibility. And we didn't get that out of Dodd-Frank, but we got something that might work. There's a committee chaired by Treasury, with some good people there with broad authority.

As a former banker, I don't want to sound like I'm making excuses for the banks. But if you just blame the banks and forget about the political decisions that put us in this box, you don't deal with the problem. The banks did many things wrong, things that sickened me and corrective actions were sorely needed, but there has been too little focus on fixing other flaws in our system.

Now, lessons. I get asked, "What did you do well? What didn't you do as well? What major mistakes did you make?" Looking back now, and I wasn't as sure of this when I left, but looking back now with 20/20 hindsight, I believe we faced something that was really unprecedented, a crisis of huge magnitude, with inadequate powers and authorities, and without a playbook. I think we came together, we pooled our authorities, and the major actions we took, with 20/20 hindsight, were right, and I'm going to talk about a couple of them. The things we normally get criticized for, which I'll talk about, are generally wrong. Then I'll talk about what the mistakes I think we made were.

What we got right was basically in every instance where there was a systemically important institution going down, we did our best to save them, and I think it was the right thing to do. We failed in only one case, which was Lehman. We get criticized for maybe not going and trying to get the authorities earlier. I disagree. I think what we got Congress to do twice on a bipartisan basis, just on Fannie and Freddie and then on the TARP, was extraordinary and unprecedented and we couldn't have gotten them earlier.

Twice we went to Congress and got broad powers, I think unprecedented. I was fortunate I had a year to build a relationship of trust with a number of Congressional leaders. You should read Barney Frank's foreword to the paperback edition of On the Brink, which talks about what Congress did and how we worked together and why Congress did what they did. He puts it in historical context and also puts in our ideas on regulatory reform and so on.

I think twice you can ask why didn't Congress act quicker, when we went up there for the TARP or Fannie or Freddie. But it's pretty amazing, frankly, if you look at getting the expansive TARP authorities we got in two weeks. That was something that we never could have gotten without Ben Bernanke's support, but that was something Treasury had to make the decision as to when to go to President Bush and then go up to the Hill and get it done. That was a positive.

We were lucky a number of times. We tried hard to get Bank of America to buy Lehman. But if B of A had bought Lehman, the outcome would have been worse, because Merrill would have gone down. We were lucky because I believed we were going to buy illiquid assets with the TARP funds as the best way to free up bank capital and get credit flowing again. But if I had gone to Congress and said we want to put capital in the banks, it would have been much more difficult to get the TARP. I was careful enough to make sure that we worked with members of Congress to get very broad authorities, including to inject capital in case we needed to nationalize a bank, and people who drafted that legislation drafted it very well, so we had broad authorities, but I didn't intend to put in capital in a broad-based program, but we switched and did so when it was necessary.

We were fortunate with Fannie or Freddie. It was the farthest thing from my mind that we would be putting them into receivership or conservatorship when I asked Congress for authorities to stabilize them. Imagine if I had gone to Congress and said, "How about nationalizing Fannie or Freddie?" We could only get our legislation with Mudd and Syron supporting us. That was in some ways lucky I didn't understand the full magnitude of the problem at that time. We were actually fortunate in these mistakes, but even more fortunate in our willingness to recognize them early on and correct them immediately.

The programs we put in place to stabilize the capital markets all worked. They were a combination of programs that were done either by Treasury or by Treasury and the Fed or Treasury and the FDIC, but the TALF [Term Asset-Backed Securities Loan Facility] program, which we did to bring back the securitization market, the Exchange Stabilization Fund guarantee, the bank and the insurance capital programs, which made a $46 billion profit.

On the capital programs, we were also very fortunate with Barack Obama and his Presidency, because what he did was he picked Tim Geithner and had the courage to do that, even though Geithner told him he'd brought the baggage of having been involved in creating a number of these unpopular programs. Tim was a key partner to Ben Bernanke and me who worked with us in taking the measures we took to keep more bank failures and to prevent a systemic collapse. When he became Treasury Secretary, here's a guy who had been working with me all the way through the crisis—the two and a half years I'd been there, the year and a half on the crisis—and then stepped into the seat.

He knew those programs intimately—He had helped create some of them—and he did a good job of working with the new administration to first of all convince the President not to change, because there was debate in that administration. Some of the President's advisors advocated nationalizing the banks, and when that got out, bank stocks dropped in price and that almost took the system down. The stocks of some of the major banks were trading down almost zero until Tim won that debate. Then Tim adapted the bank capital program and managed it in a very clever way, because it gave him the clout to use a stress test, right? Make sure all the banks are capitalized and stay capitalized, and so they did that.

The autos, I will give you a separate conversation, because that's worth it and it's an important part of George W. Bush's legacy. But to summarize, what the Bush administration did was to recapitalize, restructure, and rescue the financing affiliates of General Motors and Chrysler, without which they couldn't survive; and, of course, make an emergency loan to the autos to keep them alive, with a set of tough terms that they had to meet by March, which provided a blueprint for the Obama administration to restructure them. Then the Republicans, of course, are against all of this, so the Republicans criticized the auto rescue and the Obama administration takes full credit for it—And they should take a lot of credit because they did a good job—but I would argue that it was 75 percent done before Obama became President. But again, I'm sure the Obama team has a different view and there was great policy continuity between administrations.

The criticisms we get are severalfold. You didn't rescue Lehman, you were very unfair and arbitrary. I've answered that. I said the Fed did everything it could; we didn't have the powers, et cetera. You didn't see the problem in AIG in advance. I'd just tell you there wasn't regulatory oversight. AIG was regulated, to the extent it was regulated, by OTS. You get the Bear Stearns argument I made earlier, you created a moral hazard by bailing out Bear Stearns. I firmly believe if we hadn't, it would have really been a disaster before we caught the problem.

The thing I took the most heat on when I left, that I just took incredible heat on, was mortgage foreclosures: you didn't come up with a program to deal with that. Pure and simple, I was quite discouraged when I left because we couldn't find one that we believed would be effective and politically feasible. None of the Obama administration's programs worked. They were oversold and overstated at the outset and didn't work. We shared with them all of our ideas. It was impossible to prevent the wave of foreclosures unless the government was prepared to put a huge amount of money behind it, which no one in Congress was going to authorize. That was the most divisive single issue I saw up there, because someone who had lived within their means didn't want their tax dollars to go to their neighbor who had a boat and three cars and had too much debt on their home, or to the guy who bought three homes, or even to the struggling homeowner who was put in a home he couldn't afford by an unscrupulous realtor, mortgage broker, or lender who sold him a home he couldn't afford and a mortgage he didn't understand. A lot of the problem was you had people in the wrong house—They were in a house they couldn't afford; they should have been renters—and so we worked hard to come up with programs to fast-track mortgage modifications. We prevented many foreclosures, but most of the efforts didn't succeed because people who couldn't afford to live in a house often redefaulted after a modification and others walked away from mortgages when they were under water.

We worked so hard to solve the problem and took much grief and criticism. We tried very hard to come up with programs to help people keep their homes. We announced a number of them that made a difference. Then when we went to get the TARP, I was under enormous pressure from the Democrats to say we were going to use the money for foreclosure relief when we were working to get TARP legislation, and to write letters saying that when we got the TARP authority, we would use some of it for mortgage relief. I refused because the Republicans would not have supported that. I said that if we buy illiquid assets, we will then use our position with the banks to try to help. I had intended to find a way to buy illiquid assets, so when we put capital in the banks, over Columbus Day weekend, we'd said we're still going to buy-in illiquid assets.

Then, as we got closer to the election, no one wanted me to say anything publicly about this, because it might influence the national election. We had done a lot of work and we concluded we didn't have the capital in the TARP to finance the programs or to deal with the problems we were going to have to deal with if we bought illiquid assets.

I had come to the conclusion that we couldn't do this by purchasing illiquid assets, and I felt we had to announce that, because the market wasn't going to do anything with illiquid assets, in terms of trading, until they knew what we were going to do. We waited until after the election, when I announced that we weren't going to be buying them. The markets hated it. I got huge criticism from the Democrats, huge criticism for this. Then I worked very hard to come up with a program. The way the TARP was structured, you had to go back to Congress to take down the last tranche, and it was clear that a mortgage foreclosure program was necessary to take down the last tranche of the TARP. It was also clear to me that we didn't have enough money in the first two tranches to do a mortgage foreclosure program.

My view on foreclosure is we couldn't come up with a program that worked. What was much more successful than anything that was done in housing was nationalizing Fannie or Freddie. That kept the housing decline and mortgage crisis from being a lot worse than it was and prevented many foreclosures. I also believe the other programs we did to facilitate restructurings and workouts prevented foreclosures and no one came up with a really effective program.

I wish we had communicated better. I was never, ever, able to convince the American people that the things we did were not for Wall Street but were for them. I was never able to make that case. And, consequentially, it will be more difficult for policy makers to deal with a future crisis. Then there were other communications that could have been better. A classic example was we sent a two-page outline up to Congress for the TARP legislation. Chris Dodd had said to me, "Hank, don't steamroll us. Work with us on the legislation. We'll work together." So that's why we sent an outline. I should have explained that in a press conference. We got it up there at midnight, but someone said to me, "Well, you can't have a press conference at midnight." I said, "We had a few other late press conferences." I should have had a press conference at midnight and should have explained that. It looked arrogant and we took a lot of grief for that. That was something that could have been done better.

Some of the other communications problems, I don't know what I would have done differently. Right after Lehman went down, I wouldn't stand up and say we didn't have the necessary authorities, because I was worried that Morgan Stanley would go down if we said that.

The Goldman Sachs stuff is sort of interesting. I left Goldman Sachs and I totally severed my economic relationship with the firm. Despite all the stories about this big economic benefit you get not paying taxes, that's just baloney. The deal is you have to sell Goldman Sachs stock and you roll into a blind trust and you keep the same tax basis. The taxes are deferred, so when any of the new securities are sold, you pay the same capital gains you would pay if you held and sold the Goldman Sachs stock. My relationship with Goldman Sachs was severed. I don't even have a Goldman Sachs health care program after a 32-year career with the firm. As Treasury Secretary, the idea that I'm not looking to protect the whole financial system in the interest of Americans is malarkey. As Treasury Secretary during the crisis, I'm saying: "I am working for the United States of America and I don't want to be Andrew Mellon." Goldman Sachs is no more important than any other financial institution, and Goldman Sachs got treated—I didn't make the decision as to which banks the capital was going to go in. I made the decision to call the banks in and put capital in, but the regulators picked the specific banks, and the regulators chose the banks for a reason. I wasn't in that meeting; I wasn't in that discussion.

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Again, it's just one of those things. I came from where I came from and I did a bunch of rescues that prevented a catastrophic collapse of the banking system. That was my job. I was Treasury Secretary. I did it to save the American people and I was more disgusted than anyone when I got into some of these financial institutions. Bear Stearns, I got a lot of criticism because I didn't want their shareholders to make money because they would have gone under if the government hadn't come in. I felt the same way at AIG. I signed off on structuring the second deal using TARP money and we were tough on the shareholders. I felt the same way at Fannie and Freddie, in terms of what we did with the shareholders. If Goldman Sachs had failed and been bailed out, I would have been as militant there as anyone else, and I had no economic interest one way or the other. My concern was the American people and doing the right thing.

I haven't gone back to the banking industry. Today I work hard. I have a third career, but it is not-for-profit work. When I was at Goldman Sachs, I never sold one share of common for personal use. This includes the shares I received in compensation and when we went public. I had put $100 million of Goldman Sachs stock in my foundation to give away. Anyway, so that's that.

Rodriguez

Did others follow your example?

Paulson

What?

Rodriguez

Did others follow your example at Goldman, on that? You say that in the book, that you wanted to not sell stock, to keep a long-term—

Paulson

I think that was asking a lot from others. I wanted people to lock up a lot of their stock, but it could be counterproductive to lock all of it up. If they don't have any money outside of the firm and they're scared, it might cause them to leave the firm or what have you. You had to provide liquidity. I held all my stock because I was a CEO after going public, and my own view is this: They have all these windows in which CEOs can sell stock, right? I said I'd have to be a pretty bad CEO to not understand more than the public did at any time, so I don't care what the windows say; I don't know how I could sell. To me the nightmare would be I sell stock and then something after the fact comes out and it looks like I took advantage of inside information to advantage myself.

I'm helped by the fact that we have a pretty simple lifestyle and don't spend a lot of money on the personal side, and we didn't have debts. So I just didn't sell a share. But I remember thinking to myself when I was CEO after we went public, and it was the first time I thought that way, Boy, I'd have to be a pretty bad CEO—I don't care what the allowable window is for selling my shares—I know more about my business than the average investor. I have to have an advantage, so how do I pick a time when I sell?

Rodriguez

On the rescues, some had argued that—I know there was a lot of discussion about how much pain people were willing to take to get the rescues. Was there much discussion about bond holders also taking a haircut at that time?

Paulson

We were going to put them into receivership, which I thought was the right thing to do. Conservatorship hadn't occurred to me. Ed Herlihy came in from Wachtell, Lipton and did great work. He explained to me, in ways that I could easily understand, that if we went to the subordinated debt and if we went beyond the preferreds in terms of taking the pain, we would start getting into derivative contracts and that would be costly for Fannie or Freddie, because they had gains in the derivative contracts, plus it would create a huge uncertainty and there would be a big legal mess. I said that was the last thing we needed. I didn't want the taxpayers to have a bigger loss.

In terms of the other institutions, I don't think there was really much ability to deal with that, because, remember, we weren't using the resolution authorities. We were putting money in healthy banks, right? Our program—a historical first—didn't discriminate between healthy and sick banks, so it allowed us to put capital into 700 banks, essentially recapitalizing the entire US banking system, as opposed to doing what has traditionally been done—and what the Europeans did in 2008—nationalizing a few banks as they failed. But this meant it had to be voluntary and the terms attractive. So it was publicly unpopular but unusually effective.

Rodriguez

I see.

Paulson

OK? We didn't have the wind-down authorities, so that's part of the reason why we're—Now, people say a lot about moral hazard, and I think it's important, but anybody who thinks that the companies that failed, or were rescued somehow or other, would want to repeat the process, that the CEOs who got wiped out, lost their jobs, all the shareholders who lost money, et cetera—Again, I feel strongly that you need market discipline, but I also believe that some of what financial journalists write, and others, about moral hazard, is a little bit naive, because I will tell you, no employee or senior manager of any of the companies that failed would want to repeat the process. There is a strong feeling that more should have gone to jail. I'm not privy to the legal investigations. But it sure seemed to me that federal and state prosecutors were competing to put bankers in jail, so it just may be that it is possible to make big mistakes and even do bad things—and plenty of both were done—without breaking the laws.

I will say a few things about autos, because my book tells that in great detail, so I don't need to spend a lot of time other than saying the TARP was not intended for anything other than dealing with financial company failures. That was clearly the intent of the TARP, no doubt about it, number one. Number two, industrial companies don't pose the same systemic risk when they fail, and it's been proven time and time again. You have a bankruptcy process; the bankruptcy process works just fine for industrial companies.

We started off making a huge effort to get Congress to do what they needed to do, working with Democrats and Republicans. At one time, the Vice President actually went up and talked to the Senate Republicans and told them they were in danger of being the party of [Herbert] Hoover if they didn't step up and do something. This is not someone who liked bailouts, and he wanted Congress to act.

It was only after Congress didn't act that we were faced with a dilemma, and the thing that I explained to the President, and I did that at a lunch I had with Joel Kaplan—And let me just say, autos was the exception to all the other TARP stuff. The other TARP, the work was done at Treasury, the President delegated it and all the work was done at Treasury. Many in the White House staff—everyone including Ed Lazear to Keith Hennessey, you know—were all very supportive. It didn't square with their political or policy leanings, but they knew it was an emergency. They knew we had to do this; they were very supportive. Josh Bolten was very supportive, Joel Kaplan was like an ad hoc member of the team and he was there with us all the weekend that we put the capital in the banks. He came over all the time, I talked with him regularly. He offered constructive advice; he was helpful, so all the White House staff would know what was going on. Michele Davis talked with the press people at the White House so they would know what to say and do, the Legislative Affairs people.

I was really greatly relieved that the President and his staff saw autos as one decision that needed to be staffed by the White House and one that needed be made directly. Even though it was the TARP authority, it was outside of the financial system mandate we had requested and an auto rescue was going to inflame congressional Republicans. My guys, the team I had, were the ones that negotiated the deal. It was a very complicated deal that we did, with not just auto companies, but also with Chrysler finance and GMAC [General Motors Acceptance Corporation]. This was a very difficult thing to do. We restructured and recapitalized the two auto finance companies, without which the autos could not survive. With regard to the GM and Chrysler loan, the White House staff went through the normal decision-making process. The President signed off on all the other decisions we made. But on autos, the President not only signed off, he made this decision, in terms of exactly what alternative was selected. That decision was made by the President, and his key staff was Joel Kaplan and others.

In any event, Joel and I had lunch with the President, when I explained to him, which was critical to me, that even though bankruptcy normally works, it wasn't going to work in this case for two reasons, and this is in increasing order of importance. The first, General Motors had done no planning and done no work for it. They just had their head in the sand. They thought they were going to get a bailout or whatever, so they hadn't done the work, none of the planning work. I think we could have ignored that and it still somehow would have managed without TARP funds, if it hadn't been for the second.

The second was the financial system was so weak and the banks were barely hanging on themselves, so that there wasn't the traditional debtor-in-possession funding available that normally comes with a bankruptcy. They would have just disintegrated. And you can't sell cars, if you're General Motors, if you don't have the credit. People need to look at the underlying credit to back warranty. If you don't have a finance company, if you can't do the wholesale/floor plan financing, that would have taken them down. It would have taken down the auto suppliers, which were barely hanging on. It would have gutted the auto ecosystem and really hurt Ford. That is why even Alan Mulally, the Ford CEO, strongly supported the GM rescue.

Ed Lazear had done some work, and I think it could have been up to like two million people unemployed, and we'd have people in the streets. As Nancy Pelosi was saying to me, "You can make all the arguments to me, Hank, but how are you ever going to defend the fact to the American people that you bailed out the banks and not the autos?" Now, I didn't care as much about the political argument if we were right. We didn't look at politics that much; we did what we needed to do. If we thought at the end of the day General Motors could go bankrupt, that it would just be cleansing and they wouldn't disintegrate, we wouldn't have made the loan, but we knew their failure would have been a disaster, so I just gave the President my professional judgment that he didn't have any choice.

The things we debated were—You really had sort of three things you could debate. Number one, you could try to just leave a turd for the Obama administration and say that even though GM and Chrysler were going to go under, by hook or by crook, they will figure out how to get to Obama, you know? So you could hold your breath and assume they would hold on until Obama. The second alternative was what I cynically called—which I didn't want to do—"the bridge to Obama." We would give them a minimal amount of money to get them through late January or whatever, forcing Obama to deal with the autos immediately. The third was what I recommended and what the President decided to do, which is to give them enough money to get to the end of March, and put in a rigorous set of terms that they probably could only meet going through a bankruptcy or a restructuring that was equivalent to a bankruptcy. I told him that I thought Obama would do the right thing, because I had a high regard for Geithner and Larry Summers, who were going to be Obama's advisors. The President thought the new administration would be too beholden to the unions. We both were right. Obama did the right thing and restructured them, but put his hand on the scale to disproportionally benefit the unions relative to a normal bankruptcy, but it got done. I'm just trying to think if there's anything else.

Strong

I wanted to ask a quick question about the criticisms that were in the press, that were in the public. How were your actions regarded by the Finance Ministers around the world and by banking executives around the world? Was it a different set of opinions?

Paulson

We are the only country in the world that, at least before the crisis, had an abhorrence of bailouts and government ownership. When you look at state-owned enterprises and the history with them and with bailouts, our history is whenever you own something, whether it's Conrail or Lockheed or whatever, the day you buy it, you start thinking about how do you get the government out and privatize it. People around the world wanted only one thing, for us to take care of our mess. They wanted bailouts, so the biggest criticisms were over Lehman Brothers.

The Europeans were the most vocal, and to me it was totally on the one hand understandable. They publicly blamed the US for the crisis in general and the Lehman failure in particular. On the other they needed a scapegoat because their banks were undercapitalized, poorly run. And they continue to be undercapitalized and they dealt with it poorly. This has been a big problem and continues to be one. The Europeans have not yet adequately recapitalized their banks. The banks keep bailing out the government, which bails out the banks, which bail out the government. Lehman's failure accelerated and worsened the global crisis. It damaged the markets, hurt many people, but it was a symptom and not a cause. European banks didn't fail because they owned too much Lehman paper. Their crisis had its roots in a flawed European monetary union that let peripheral countries like Greece, Spain, and Italy borrow too much, impairing their own financial stability and that of their financial system.

European banks were highly levered and chocked full of bad loans: housing loans originated in Spain and southern Europe and the UK, and they had bad Eastern and Central European loans. The Germans would bail out their Landesbanks overnight on a weekend, and they would be saying, "You need more transparency in your system." I would say, "Well, what about the transparency in the Landesbanks?" They said, "There's plenty of transparency, but the Landesbanks just don't understand the problems!" Of course to the Germans, transparency was that they filled out forms and sent them in.

In terms of the worldview, I think confidence in America's system in particular and our economic system in general took a big hit. I do not want to underestimate the impact of that. In China, my principle counterpart during the crisis, Vice Premier Wang Qishan, said to me, "Hank, you were our teacher. But now our teacher does not seem so smart." But the immediate criticism was about Lehman, and I think that other nations all wanted a scapegoat. Sarkozy understood that early on. When I saw Sarkozy in December of 2007, before the crisis hit full force, he was already on it on the politics. He said, "Listen, you're a former banker. You're not going to want to blame the banks, but the public needs to blame someone." When he asked me what caused the crisis, I went through that lengthy explanation I gave you. He said, "That doesn't work with the public; you need someone to blame. If you don't want to blame it on the banks, blame it on the rating agencies. Get yourself a scapegoat."

So the crisis is a story of a collision between politics and markets, and at the end, markets always win.

Perry

I have a question. Back to your comments about communications. By total coincidence, last night C-SPAN [Cable-Satellite Public Affairs Network] ran FDR's [Franklin Delano Roosevelt] radio address, because it's the eightieth anniversary of the bank holiday and then the gradual reopening of the banks. As I was preparing for this, I thought, I'll listen to see what he says. Now, obviously these were commercial banks and he was speaking directly to the people about, I know you've seen runs on banks and I know you want your bank to open, and then he went through, in what I thought sounded like fairly technical language, but that people could understand, and that was how he said, "Now remember, we're not going to open all the banks at the same time, so if you live in a big city where there's a Federal Reserve Bank, those banks are going to open first." Just thinking about that, in light of what you said about communications, and back to something you said very early about President Bush and the problems of communication with the media because of perhaps how he saw them, or that he would become defensive. Do you think that was part of the problem as well, not you, but—

Paulson

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Riley

The same problem.

Paulson

But I will tell you, if you think this is easy communication, look at Barack Obama. He sure tried to communicate—and he's a pretty good communicator—and it's a hard communication to make. It is a complicated topic. It's easier to blame the banks; that's why people do it. You need to focus the anger somewhere. When people lose money, they're angry, so it's much easier, and that's essentially what Obama did, and he'd go too far, but by that time we had recapitalized and saved the banks. But I found it hard to save the bank and to punish them at the same time. The public wanted us to punish them and economic sanity means you need to save them, so it's just a very hard row to hoe. I didn't see the program you were talking about, but once the system has collapsed and you are explaining to the public about how and when the banks will open, it seems to me to be an easier sale than dealing with the problems we dealt with in an economy where we are trying to prevent a collapse, which was much more complex. But I freely admit I could have done better.

Oh, I want to talk about the transition, and that will get us back to FDR. Here's something that I think is quite important and I didn't write about directly in the book, although the book tells the story. This interim period between the election and when the new President takes over is almost barbaric. Other nations say, "How do you do a transition that quickly?" but when you look at going from November 7th to January 19th or whatever it is, more than six weeks—because you're there since there can only be one President, but no one's looking to your President anymore, so you really don't have the moral authority—it's just a really hard time, and this interregnum period was by far the most difficult thing for me.

At the time, I was very unhappy with the Obama administration, because I was naive. I look back on it now and I'm pleased with the way they operated during that period. My naivete came from this, and I wrote this in On the Brink. I saw this problem coming, so I went to both candidates and said, "Please tell us who you would like to run the TARP. We'll vet them for you, so we can nominate a new TARP head immediately and have a quick congressional confirmation. And you'll get a head start and your guy will be running the TARP." Obama didn't give me someone, but he said talk to Larry Summers, Bob Rubin, and they will recommend someone.

They suggested Lee [Lewis A.] Sachs, so we vetted Lee Sachs. Sachs ended up working for Treasury for an interim period after Obama was sworn in. But immediately after the election [Daniel K.] Tarullo came by to see me, and he said, "You won't be talking to the President anymore. Forget about it; those days are over; you communicate with me." And it was clear that they wanted to hear as little as possible from me, other than we weren't going to do anything major or new, and I thought, Well, I'm short on capital. If we have a run like we almost had on Citibank and a major bank goes down, I won't have the money to deal with the rest without going back to Congress, and I don't have any credibility left. It's shot. The Republicans were very unhappy after the election and they blamed the financial crisis for their problems and they had amnesia about having voted for the TARP; the Democrats were angry that we hadn't done more foreclosure relief. They didn't really understand this; the American people didn't like it; and George Bush was the one who just kept saying to me you should be grateful that we were here and we saved the economy.

I was sitting there without sufficient ammunition if we faced another major bank failure, and I was frustrated because I thought the Obama administration was going to have their TARP team in place, and they would help us take down the last $350 billion tranche, and they only asked us to notify Congress to take down the last tranche a few days before leaving, but we'd have the indignity of doing that, and then they took it down. And not only did we not get their team in, in advance, they had trouble getting their team in, so even after Obama was the President and I was no longer at Treasury, I had to lean on some of my former team to stay. And I got calls from people asking, "Boss, can we leave now?" and I said, "No, you have to be there and help Tim and the Obama administration," all the while the White House was publicly criticizing us, repeatedly.

But now, I look at it totally and completely differently. I look at what Roosevelt did with Hoover. But Bush wasn't Hoover; he was Roosevelt one. He stabilized the capital markets; 75 percent of the TARP capital was out the door before Obama arrived; and the programs that accounted for 95 percent of the TARP capital were already in place. But Obama was courageous and effective, because he picked Geithner and he kept all the programs in place. His team did the right thing in protecting the President during the time between the election and when he took office. President Bush and I, and our programs, were unpopular. He needed to distance himself from us publicly. But when you look at what was done during this interregnum, we did Citi 2, and kept a huge bank from going down, and Obama ended up doing Citi 3 later, converting preferred to common, which was the only bank capital program they initiated.

A few weeks before I left, Bank of America came to us to say that Merrill Lynch was going to have a $22 billion loss for one quarter, if you can imagine that. That would have taken down B of A, in my judgment, and Merrill, and so just a few days before we left, we injected capital into Bank of America. We rescued the autos a few days before I left. All that got done in the interregnum, and after I left I got very worried listening to the rhetoric coming out of the White House, but they kept our programs in place and they managed them flawlessly.

If you take a broader historical perspective and how the Bush administration behaved during the transition and compare that with the out-going Clinton staffers who destroyed the computers and the typewriters and all kinds of things in the White House, George Bush was so statesmanlike. We worked for months on the transition and everything we had done. We were told by the President to make it as easy as possible for the next guys. Every department, everybody, we just were planning, working on that transition. And boy, the management of the financial crisis was about as seamless a transition as you could have, so I'm pleased about that.

Riley

Hank, I want to go back and ask a question about the financial crisis period and your relationship with the President, in very general terms. To what extent, when you were meeting with the President, was he signing off on your recommendations out of trust in what you were doing, as opposed to the amount of time you had to spend convincing him?

Paulson

You should talk with him about this and let him explain it. It took very little time to convince him. He's told me repeatedly he trusted me, which made it easier for me, but the point I have made repeatedly and people are skeptical about, but I just will tell you is absolutely true—It wasn't blind trust, because he understood what the issues were better than anyone in the White House and most of the people in Treasury. He understood markets; he understood fear. He used analogies; he totally got it. He had a very good memory. He understood how to manage me, and that I needed bucking up and encouragement. I could not have done this—There's no way that we could have gotten through the crisis if we had not worked so well together. He delegated much to me—Told me and his staff that I was his "wartime general."

I will assure you that if I had had to go through a process where every single thing was vetted, where you prepared memos, where you let people debate and let the free-market people debate and whatever, we never would have gotten from here to there. He was able to figure out how to make it work and he knew how to ask the right questions. It was amazing to me, when I think back on it. I didn't think about it that much at the time, but I thought back on it—He would ask me three or four questions, and they were the perfect questions. Before Lehman Brothers weekend he'd said to me, "Listen, there is huge resistance from Capitol Hill and from the public and all kinds of people, to not bail them out, after what the Fed did for Bear Stearns." I said, "We're going to try to do a private sector solution," and he said to me, "If you're going to bail them out, come back and talk to me first."

I never worried for one second in terms of whether the President would approve it if we could put together an effective rescue for Lehman where there was Fed assistance. When I came back and told him, despite our efforts, we'd been unable to save Lehman, he immediately said—which was the obvious thing—"You're going to have to be prepared to explain someday how the Fed was able to rescue Bear Stearns but not Lehman." And I said, "It's very simple. We had a buyer for Bear Stearns to inject capital and not for Lehman," et cetera, and he said, "You will have to explain that."

On the illiquid assets, he understood the political ramifications; he understood the market stuff. He's not of Wall Street. He had a disdain for Wall Street, so that's another interesting question you'll have to ask him: why did he recruit me, coming from Wall Street, because there's no doubt he had an absolute disdain for Wall Street.

Riley

How did it manifest itself?

Paulson

He never told me directly, but those who knew him better than I, like Josh Bolten, told me, and I saw the disgust when I would come in and say, "By God, you're not going to believe what they found, sir, at AIG." REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED I said, "We're protecting the government the way it's structured, plus, we're doing this to protect the American people, because it will be disastrous for them if AIG goes down."

I would just say the analogy I would use was a wartime general, and he understood it was a war against a once-in-75-year financial upheaval and he understood that it was an extraordinary situation. REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT

And so the idea that his last act was going to be, while he was there, signing off on the auto bailout and a B of A bailout, that had to be tough—You know, there were people around him—The autos thing was hotly debated in the White House, hotly. I never lost one moment of sleep, because I knew where he'd be on it, but he let everybody have their say and his staff didn't want his last act to be an auto bailout. They would have preferred to leave it for Barack Obama or whatever. Well, it turns out that the Obama administration has taken full credit for the auto bailouts, so I guess the Bush White House staff doesn't have to worry anymore!

I think what I saw with George Bush was someone who had great confidence in what he knew, and he also knew what he didn't know. He knew he trusted me and others and he was prepared—regardless of the political consequences or what the polls showed or where the public was—to do what he thought was necessary. You can debate whether or not I would have found it so easy to work with the White House staff in the first term, I don't know, but I just know what I encountered when I was there.

Strong

In your conversations with him in this real crisis period, does he ever refer to conversations or advice he got from his father?

Paulson

No. He referred a couple of times to conversations he'd had with Jeb [John Ellis Bush Sr.], who had some involvement. I think Jeb had some relationship with Lehman Brothers and Jeb had told him that the Bear Stearns rescue, after the fact and just in passing, was important. Who knows what Jeb told him after Lehman went down? He did talk about conversations he'd had with various people, and I don't remember who they were. They were people who understood markets and they were for the most part very consistent with what we were doing.

I think he knew that I was always going to give him what he needed. I didn't talk to him all the time, but boy, as soon as I had a concern—and it was interesting because, for instance, I don't take notes. People didn't keep notes at Treasury. I didn't use email; I didn't work from memos, so when I was writing On the Brink, one place where I could get some help on some of these meetings were the notes, the Bush Presidential Library had people who took notes. I was actually amazed at how what was on my mind just came out, so when I was over talking to him about Fannie or Freddie early on in June, the first thing that came out was "I'm worried about Lehman, we don't have the powers on Lehman, what are we going to do," repeatedly.

When I talked to him down in Texas, in August of 2008 before he came back, the first thing that came out was Lehman, and then a whole lot of other things. I talked with him like I talk with you right now, about what was on my mind. I was just absolutely transparent. I didn't have to worry about process because I knew I could get to him any time, so it wasn't gee, you have to set up a meeting, just call, or I could go over and see him in the morning, or I could ask if he'd free up for lunch or whatever.

Riley

Did the NEC people or the Council of Economic Advisers people play any kind of role in this whatsoever?

Paulson

They are not market practitioners, but we were very fortunate to have Ed Lazear there. Ed is a superb economist; he's a labor economist. I would say he's more of a conservative Republican. He's a Milton Friedman disciple, but also of Gary Becker from the University of Chicago, so on policy matters he was really quite conservative, and I think also very good, a very strong thinker. He understood what we were doing and why. He wasn't involved in the details, but I think the fact that he was there and was as supportive as he was gave the President great comfort. Keith Hennessey, who ran the NEC, is, again, an ardent Republican, some people might say a partisan Republican. He's got his blog; he understands politics, understands finance and markets. Again, he was just terrific to have over there. They weren't part of what I was doing day to day but were supportive.

When we went to Congress on September 27, 2008, to negotiate the TARP, Keith Hennessey went up with me and my team. And Dan Meyer, who was the Legislative Affairs guy, accompanied us. As I write in the book, we negotiated the first deal ourselves at Treasury and the White House staff was there as observers and so they could understand what we were doing and they played a modest role. But after it got voted down, then the White House took over the second vote and did a superb job tactically. We switched and went through the Senate. So it passed the Senate before it went to the House, and I've gone over all that in On the Brink.

The top White House economic team, Hennessey and Ed Lazear, were supportive and allies, so I'm confident that when I wasn't there and when I was doing my thing, that they were telling the President, "This is the right team. They're doing the right things. We need to do these things." I don't know that; you would have to ask them.

Riley

Sure.

Paulson

I know Joel Kaplan. At one time, I asked Josh Bolten if Joel Kaplan could come over and work at Treasury full time. Could we borrow him? That didn't happen, but it almost did. He was there and I would say he and Hennessey were important architects of the auto transaction and my guys negotiated it, which was hard—Jester, Shafran, [James] Lambright, that whole team, so it was seamless. The Treasury people would come over and brief the President from time to time or be in the meetings. They were working with the White House staff.

Michele Davis was also a policy advisor to me and really good on the press issues, so don't blame her for the press failing. She would explain to me, "Hank, you can only get one or two major points across to the public and the press in every speech." So I gave my speech on November 14th—or whenever it was—that I'd been holding back on. I have multiple points in it, all these different things and all important: why we weren't going to go forward and buy illiquid assets; why we're not going to have mortgage foreclosure relief; explaining the Temporary Asset Liquid Fund. I get it all in and then the market is confused. But that's not my advisors; that's me. I just overruled them because I felt a need to disclose all this at once and I didn't want to have to do it in four or five different speeches. I felt uneasy that I couldn't say much in the two weeks before the election for fear of influencing it and I just threw it out there the best I could. The teams at the White House and at Treasury were seamless.

Riley

One of the characterizations that I don't think I've heard you use today is "too big to fail."

Paulson

I talked about it without using those words. No financial institution is too big to liquidate, but in the midst of a crisis, almost any financial institution of size is too big to liquidate quickly without seriously hurting the economy.

Riley

Right.

Paulson

In a crisis, where fear is governing, a financial failure of even a medium-sized bank can cause havoc. Drexel Burnham failed in a normal market, and that could be managed. The problem we had with Bear Stearns, which was maybe the smallest institution that had a bailout—but it was investment bank and people were looking at it as a proxy for other investment banks. But it was also the complexity, with all the derivatives and how intertwined it was with the whole global financial system. It was too big and too complex and too interconnected, given the magnitude of the crisis and fragility of other institutions.

Today regulators have the tools, including emergency resolution authority, to prevent another Lehman Brothers, but it will take political courage to use them properly to prevent damage to the economy. During a severe crisis, a failing bank will have to be rescued and temporarily propped up but it doesn't have to be—and shouldn't be—propped up and preserved in its current form indefinitely. It can be wholly or partially liquidated, but the initial rescue will be unpopular and run counter to congressional intent.

The way I think about too big to fail is as the first line of defense; make banks have plenty of capital and liquidity. All those who say that's going to slow down the economy don't realize what just happened to us again. You have to have plenty of capital, number one. Number two, to have a common regulator, common oversight for the big financial institutions. Number three, you have to have resolution authorities so you can wind down failing institutions over time without subjecting them to bankruptcy. The banks have living wills, which are contingency breakup plans that the regulators can use when they fail.

But the fact of the matter is we have a $60 trillion global economy; we have a $14 trillion US economy—I'm sure that's outdated now, I used that number a few years ago—but it takes big financial institutions. So I don't think there's a simple answer. It's an economic issue; it's a regulatory issue; and it's a political issue, and unfortunately, the solutions people have been talking about involve all three. So you necessarily have politicians trying to deal with economic and regulatory issues and these are easy issues to oversimplify and demagogue.

Strong

You talked a lot today about your staff, about how well they worked in the White House, with the Fed, with other regulators. In your book, there's another group of people who you keep coming back to that seemed to make a difference. All the connections you had on Wall Street, you would get a phone call from someone you knew to be calm, cool, and collected, who sounded panicked. That was a big cue to you. Or somebody would come to you with a spreadsheet on AIG, "Take a look at this." How important was that network of contacts?

Paulson

It was very important and it put me in harm's way after the fact, in that it generated a lot of criticism, but I couldn't have done my job as Treasury Secretary in a financial crisis without getting real-time market intelligence.

My contacts with market participants were valuable, not only to my team at Treasury but to Ben and Tim at the Fed also. You can't just look at market data or at your Bloomberg machine and know what was going on. I wasn't born yesterday, and so when I had conversations it wasn't "Let me tell you everything we're going to do and then get your view on it." It was "I'm the Treasury Secretary; I'm talking to you. You tell me what's going on; you tell me what you believe we should do." I understand self-interest. These were almost always one-way conversations.

When Warren Buffett called me and woke me up with a great idea on a capital program, I understood Warren Buffett has an equity ownership position in certain financial institutions and so on, but I also know he's a public-spirited individual and I know a good idea when I hear one. So when I'd come back to the Treasury team, I'd say, "This idea came from Warren Buffett." If Jeff Immelt had told me, when I called him before announcing it that the FDIC's TLGP, the Temporary Loan Guarantee Program, was going to be a complete disaster and lead GE to fail, we might have debated it another two hours before moving forward. I still don't know what else we might have done. But the fact that I knew and trusted Jeff and he said, "It ain't ideal for GE, but it's going to be worse if the whole system goes down and I think you have to do something like that. Go ahead and do what you need to do to save the economy and don't talk to me anymore."

I looked at hedge funds as the enemy, in terms of what they were doing, but when I looked at the impact they had on the markets, I knew I should talk with them, and when I did, I learned a lot. I had regulators telling me the banks have plenty of capital, et cetera, and I'd have the really smart, analytical hedge fund guys saying the banks are undercapitalized to the tune of X hundreds of billions of dollars. And there were a number of them whom I had known by reputation or personally to be smart, analytic, and honorable. Whenever I talked with them, I learned things. I also learned what their biases were and so on.

Ben and Tim were very supportive of me reaching out to Wall Street. They encouraged it.

Riley

I want to ask a general question that you just touched on a minute ago. You said one of your chief assets was your decisiveness. I can't think of a more vivid illustration of crisis leadership than what you had to go through, and I'm wondering if you could reflect a bit on your experience and maybe tell us what are the traits that served you best. And if you're trying to think about crisis leadership, what are the traits that you could identify as being crucial for somebody to succeed in a highly inflamed situation?

Paulson

What I'm going to say is not particularly insightful, but you'll get the picture. First of all, there's no big, ugly, difficult problem for which there's an easy solution. In Washington, there just aren't any easy solutions. It's either analytically complex or politically complex or both. During the crisis we dealt with many problems that were both. If you come from the business world, you learn that you never get all the information you'd like, ever, before you need to act, whether there's a crisis or not. If you get all the information you'd like, it's too late; you're looking in a rearview mirror.

Now, when you're in a crisis, things come much quicker, so you're always evaluating, weighing action against what the cost of no action is. If you look at no action as being very ugly and catastrophic, then you're looking at a number of imperfect steps you might take. Some people get scared because there's great uncertainty and you know that you're going to be—You know, anything that's imperfect, you're going to be criticized for after the fact.

It takes political courage. I attended a class with Stan McChrystal at Yale on crisis decision making and he tried to compare what we did with the Cuban Missile Crisis, and I said it's very different. We're not talking about dying; you're not landing on Omaha Beach. And of course, I'm not going to compare anything with nuclear war. The other thing is, if you fight a war and you do it well, you're a hero. Here, I think one of the things that we were dealing with was that my heroes were the guys who were willing to work on these capital markets stabilization measures, knowing that they were going to be criticized afterward and that they weren't going to go out being perceived as heroes.

Back to the decision making. The other thing you have to do is you have to be prepared to move quickly. But in my judgment, you can never ever move so quickly that you don't stop and say, "What are the things we haven't thought of? What are the consequences of doing nothing?" So you have to debate it. And then when you make the decision, you have to be ready to change it as you learn more or the facts become different. You can do a lot during a crisis, because other people are often either afraid to act or they don't have a better idea. You can ask, "OK, you don't like this, then fine, do you want the status quo? Do you support that, or what's your idea?" So you can usually force a decision. Often you are trading off unattractive consequences or risks of acting against even less-attractive consequences of doing nothing.

Now, I gave you part of the story on that weekend that we had the G7, where we put the capital in the banks and announced the comprehensive program. I had my chief of staff, Jim Wilkinson, come to me, I had Joel Kaplan come to me, and said you're driving too hard and fast. Because I felt a great sense of urgency and I am aggressive I was getting the working group together and pushing, saying, "We've got to do this. We've got to put capital in. We've got to do the guarantee. We're going to do this; we're going to do that," and they said these are huge consequential decisions and you look like you've already made up your mind. I said to them offline, "No, I haven't, but if I don't drive people hard now toward some specific proposals, we won't have anything to decide upon at the end of the weekend."

In other words, I had to push people toward some things that seemed like reasonable solutions, because if I said, "Go figure this out, but be careful." Or "I am concerned there could be a lot of risk with the Temporary Loan Guarantee Program, which could cause distortions in the markets and it's going to be difficult to put capital in the banks and we need to be careful here," all this kind of thing, we wouldn't get there.

I pushed toward a set of specific proposals, but then I said at the end we'll have a debate. For instance, for the Temporary Loan Guarantee Program, David Nason was given the assignment to present the case against this action, and there were plenty of concerns raised not the least by the FDIC's legal counsel, and then you say afterward, "What's your plan?" And the conclusion often is that an imperfect plan beats no plan.

To summarize, I think that you can't be afraid to make a decision, and you need to be decisive. You need to push an organization to the point of a decision, but then carefully evaluate the consequences the best you can. Then, after you've made a decision, be prepared to modify it as you get more facts.

Riley

Great. We owe you a break. Let's take it. Are you ready to go to China? Have we done everything we need to do on this?

Paulson

Yes, on this, although it feels perfect for China; I'm feeling jetlagged.

[BREAK]

Riley

Just sort of give us some prompts, and then we can pick up from there.

Paulson

You know I'm writing a book on China.

Riley

Yes. So we don't need to duplicate too much.

Paulson

And I've given you those draft chapters. They're not the finals; there's a lot more work still to be done.

Riley

Sure.

Paulson

There's more in there than will be in the final and there are things that will come out of there.

Riley

We're treating those also in confidence.

Paulson

You should.

Riley

I appreciate your sharing them with us.

Paulson

I had a long history; that's just the SED. Through good fortune, I had been involved, for years before going to Treasury, in the landmark capital markets transactions and reforms done in China, where I worked with past economic leaders and present ones, including the current ones, senior leaders of the country. I had known the present President and General Secretary of the party, Xi Jinping, well. I had worked on reforms of the banking system; the first public offering of the banking system; the first major public offering and reform of a state-owned enterprise, which is now called China Mobile. I had worked on the first reform of a big industrial company where the state broke the "iron rice bowl," which was PetroChina, the first managed bankruptcy. I had worked to set up the first national parks. I had had a long history, so I told President Bush that I'd like to put a process in place and have the primary responsibility for all economic relations with China.

Riley

I'm sorry, let me interrupt you and ask you what was the genesis of your personal interest there? Was it purely market based, looking at how many people they have, or was there something beyond that?

Paulson

I became cohead of investment banking at Goldman Sachs in 1990 when I was in Chicago—I didn't want to go to New York—My cohead said to me, "Why don't you take responsibility for Asia?" I first went to Hong Kong in 1992, when we had four or five people there, and we did no business in the PRC [People's Republic of China]. I met the President of China, Jiang Zemin and I watched what was going on. I thought there was a big opportunity; they were very serious about what they were doing. When I left, I think we had 1,200 people in greater China.

Riley

Wow.

Paulson

I spent a lot of time there. It was profitable business for Goldman Sachs. The CEO at a firm like Goldman Sachs needs to be strategic, so you work in those markets where you're trying to break in, where you're trying to brand your franchise. With me, it was spending time in Japan, the world's second largest economy, and where it's hard for a non-Japanese firm to break in; in China, which is a new but big market; and in Germany, the biggest country in Europe. Deutsche Bank was a tough competitor and I thought, Gee, if we can beat Deutsche Bank in Germany, it's going to be harder for them to make much headway in the United States.

I got very interested in China. They took advice very well. They looked for best practices everywhere in the world, tried to figure out how to adapt them to China. So I felt like my time was well spent. Because they didn't have a well-developed legal system or a good regulatory system, it's a country run by men more than laws, so relationships are important. If you build relationships there, relationships of trust, you get things done. Anyway, I had had a working relationship; I thought I knew how to get things done there. I thought I had proved I knew how to get things done and I wanted to put my experience to work representing my country.

Riley

So you go to the President, and he agrees with this?

Paulson

I had come to view the US relationship with China as the most important bilateral relationship in the world. Most major global challenges will be easier to meet if we are working in complimentary ways and very difficult if we aren't. I didn't believe the US government was working as effectively as it could and I had some ideas to fix it. There were two conversations. Obviously, there's initially, when I'm talking to the President about joining his administration, and I raised the issue with three or four sentences and he gave me a quick response. I took that as positive, but I certainly knew that that wasn't authority to do everything that I had wanted to do, the way I wanted to do it. The way we'd set it up was I didn't want to do this as Treasury Secretary. I wanted him to choose me to be his designee with responsibility for coordinating the Cabinet and prioritizing the economic issues we had with China, and to be responsible for pulling it all together in a coherent way, and prioritizing the issues in order to maximize the chances of getting a good result. I had wanted to manage our economic relationship writ large. I wanted to define economics to include environmental issues, energy issues, financial sanctions, et cetera.

Riley

OK.

Paulson

I think the mechanism put in place worked and I'll talk about just the political side. I think it worked because Josh Bolten agreed with it and, importantly, the National Security Advisor, Steve Hadley, understood what we wanted to do and agreed with the approach. Condi understood it and signed off. She said, "There can only be one Secretary of State." I assured her I that I knew that.

We designed a structure that helped us tremendously in the United States, in terms of prioritizing and not confusing the Chinese, but we designed a structure to interact with what I knew to be the way the Chinese made decisions. The Chinese are very diffuse decision makers; no one government leader could decide something, and a lot of people could kill it. Those who had the stated responsibility were important, but some who didn't have stated responsibility were also important. If you wanted to make progress on the currency, it wasn't just a matter of talking with the top central banker, Zhou Xiaochuan. It helped if other senior government officials were in the room when we discussed currency.

We also knew that the Chinese are not team players. They don't work well together, so you have to have a structure that makes it easier for them to do that, and then you need to build trust. It's all about trust and long-term trust building, so we wanted to have an organized structure to manage the relationship, which allows us to work on the most important long-term issues, but we also needed to have milestones along the way to show progress, so we needed to have deliverables that are short term. We put this in place.

I think it worked well, because after a while we had a number of Cabinet-level people who had relationships of trust, who could talk to their counterparts, so we made progress in some of the areas we prioritized, which I talk about in the book. We also were able to avert crises in other instances, because we could get our Chinese counterparts on the phone at a moment's notice, and there was sufficient trust that both sides were working in good faith.

I never would have the time or bandwidth to set up the SED had I come in during the financial crisis. I had a year before the crisis began in the summer of 2007 and that year working through the SED helped me tremendously in the financial crisis, in terms of managing the Chinese and the way they behaved, which was for the most part extraordinarily well and it made a big difference.

The Obama administration understandably wanted to differentiate themselves from the Bush administration, so they created the strategic and economic dialogue, which was a two-headed beast, dealing with both economic and security issues. You had Secretary of State Hillary [Clinton] and you had Treasury Secretary Tim Geithner heading it up, and designed it to fit the US government's organizational structure, as opposed to fitting China, because Hillary insisted on clawing back all the environmental issues. And Vice Premier Wang Qishan, who was Tim's counterpart on the economic side, was much more powerful than Dai Bingguo, who was the Secretary of State's counterpart. And when Hillary took responsibility for the environmental issues, she was talking with the wrong part of the Chinese government to make progress on the environment, because the Chinese viewed the environment as an economic issue and Wang Qishan, Tim Geithner's counterpart, was in a much better position to deal with environmental issues.

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Riley

Did you have trouble, particularly in the State Department? You said Condi had signed off on it, but was the Embassy helpful? Particularly the Bureau would be.

Paulson

Here's the thing. First of all, I never saw it. Sandy [Clark T., Jr.] Randt was very helpful, working with me on much of what we did in China. Early on, people tell me he initially didn't like the concept, and I heard that afterward, when I was writing the book—and I've left that out of my book.

John Negroponte, the Deputy Secretary of State, was just a delightful guy and a real professional. He had his senior dialogue with the Chinese that for whatever reason didn't get a lot of attention. He chose not to attend the SED and State sent Reuben Jeffery, State's Under Secretary for Economic Affairs, to the SED.

Condi Rice and I worked well together. She trusted me; she wanted to get things done. I was very respectful of her responsibilities, so I posted her before, afterward, when I veered into her areas of responsibility. I was transparent and kept everyone posted. Basically, Condi supported me at every step. Every time there was an interaction with a foreign leader in terms of how to work with the White House, in terms of sending over one of her key aides to be my chief of staff when I arrived, in terms of allowing me to keep Bob Kimmitt as Deputy Secretary of Treasury when she would have liked him to be Deputy Secretary of State. Over and over again, she helped me with advice on how to work in government, how to work with the President, and with more mundane things like protocol. I never knew where to stand and when to walk out, so she prompted me.

Riley

Well, some of that is an overlapping interest issue, isn't it? A piece of the agenda was environmental issues, and so parks.

Paulson

For sure. That was a big part of it, because if you care about the global ecosystem, what happens in China is very consequential.

The toughest issue I had initially was Sue Schwab, the US Trade Representative. She fought me really hard initially on this, and initially on the role I played in trade. But eventually, we became good colleagues and she liked the SED because she got meetings she never could have had. She got into all the meetings with the senior Chinese leaders, and I helped her with Congress. Initially, some people were more territorial than others. Sam Bodman, the Secretary of Energy, never really liked the SED, but his people did. Carlos Gutierrez loved it. [Michael O.] Leavitt, who ran HHS [Health and Human Services] was an active and effective participant in the SED, and it helped him do all kinds of things. It was a very good and very useful mechanism. The President was very supportive of it, as he saw it work, very supportive.

Riley

What are the usual protocols between a Treasury Secretary and the USTR, about territory?

Paulson

[Long passage redacted]

Now after passing the Peru FTA, Nancy Pelosi decided not to move the Colombia and Panama deals. And within six months the White House and Sue were urging me to try to get Nancy Pelosi to go pass these other two, and they were no longer concerned about the environmental and labor clauses that I had let the Democrats insert. It turns out the Colombia FTA was particularly problematic. No matter what Colombia was prepared to agree to, the Democrats were going to find it very difficult, because the unions particularly did not like the fact that so many Colombian labor leaders had been assassinated.

Although I got off on a wrong foot with Sue, ultimately we became close. At Treasury, we always tried to help USTR. I finally gave up on Colombia, because I went over to see John Sweeney—And again, I didn't announce this to people at the administration when I did this. I went over to see John Sweeney at the AFL-CIO [American Federation of Labor & Congress of Industrial Organizations] and said, "What can I do to get Colombia done?" Because Pelosi wasn't going to move without him. He said to me, "Nothing, Hank." I asked, "Would you go with me to Colombia; would you give Colombia a chance?" And he said there was nothing they could do. He said, "This almost cost me my job. The fact that I supported the last deal, the guys below me almost threw me out on the spot. There's not a single thing—And you're totally wasting your time, because there's not a single thing you can do to get our support."

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Rodriguez

Actually, I was going to talk about currency. I don't know if that's related.

Paulson

Yes, that's fine.

Rodriguez

One of the questions that comes up and dovetails nicely with the discussion of the crisis is just how concerned the Chinese were, given their strategic economic position, their desires to keep stability in the currency regime. This must have been front and center; you talk about it a little bit in the chapters.

Paulson

Of all the economic issues, currency was the biggest political one, because we had the trade imbalance. China had plenty of unfair practices the Chinese used, but currency manipulation was the biggest political issue, because it was a single issue that's easy for the public and Congress to understand. There are many countries that don't have market-determined currencies. It's impossible, I think, for a developing country at China's stage of development, without fully developed capital markets and an open capital account, to have a totally market-determined currency.

And currency wasn't the biggest problem we had, because the reason for the deficit was a structural reason. We borrowed too much and saved too little, and they saved too much. We had trade deficits with every major country in the world. Currency was important politically and it was important substantively, because the Chinese economy was never going to get where they needed to unless they moved toward a regime where they had a market-determined currency, and they moved toward appreciating it so they had a market signal and a currency that really reflect economic reality. They understood that.

The reason I pressed capital markets reform, and I think you'll see an op-ed from me soon on that topic; I've written one in China. I'm still pushing on it, because I think until you have competitive, world-class capital markets and an open capital account, you can't have a market=determined currency. I pressed them all the time, but I did it in a way they took it, because I never said, You need to do it because you're cheating us. I said, "You need to do it because it's in your best interest. Your currency policy tethers you to the dollar, which means you are importing our monetary policy. You don't have the tools you need to run your economy and to fight inflation. You're never going to make the transition you need to make higher-margin, value-added products. You're ripping off your citizens right now because the only place they can put their money is in banks, but you don't have well-developed capital markets, so your citizens put their money in savings accounts, and get a fraction of inflation as a return on their savings. Why do you think your people are over saving? You're ripping them off because the banks are then turning around and loaning the money to the state-owned enterprises at a subsidized rate." Those are the arguments I made.

We agreed, but we disagreed on pace and amount. I used to get a laugh when I was in China. I'd say, "We both agree, that you need to move the currency," and I'd say, "I think you need to move it this much, holding my hands far apart, in this period of time [bringing them close together], and the Chinese leaders want to move it this much [again holding them close together] in this period of time [now moving them far apart]. Other than that we agree." [laughter] They placed the biggest emphasis on stability; I argued that there was more danger in moving too slowly than in moving too fast, in terms of their stability.

Rodriguez

Did you face trouble in Congress as well, and other places, as Treasury Secretary?

Paulson

I had to manage Congress, that was important. I spent a lot of time in those chapters talking about what I had to do with Congress, and the time I spent with Max Baucus, when I visited him in Montana in the recess, and the time I spent always—The first SED, I got on the phone in December of 2006 and called [Charles] Schumer and Lindsey Graham and Baucus and Grassley. I knew the Chinese would be listening in. I told the Senators, the Chinese currency is undervalued and I am pushing them hard. And Schumer and Graham would say if they don't show more flexibility we will pass punitive currency legislation. Then the Chinese began moving the currency on an accelerated basis before our SED meetings, and when my plane would touch down, it would really begin appreciating. Pretty soon we got accelerated appreciation a week before and after. And I would report back to Congress, et cetera.

Rodriguez

That's interesting. It would also suggest that during the crisis, they were compelled to act or compelled not to take some of the advice you alluded to earlier, such as moving with the Russians, to try to force your hand a bit by selling Fannie Mae and Freddie Mac securities. It seems that it would have made it more difficult for them to have withdrawn support in that relationship.

Paulson

I think they would have been shooting themselves in the foot. But you could argue that both ways, because they could also have forced us earlier to do what we ultimately did, which is to stand behind Fannie and Freddie. There were a fair number of things they did that were very constructive.

You can never assume, particularly in a system like that, that everybody is going to act rationally. After Lehman Brothers, when they were selling positions in our money market funds and bank securities, we got to Zhou Xiaochuan, the Chinese Central Bank Governor, through David McCormick, and they stopped. The US government has a hard time calling a bunch of banks and saying don't do this or whatever. In China it is different. We worked very well through a number of tough situations and things that could have been much worse—like the food safety, product safety issues. There were a whole bunch of issues where we worked well together.

I'm not an apologist for China. There are a lot of things the Chinese do that I don't like. I just have the view that this is by far the most important bilateral relationship we have, because when one looks at the major global challenges, they're much more difficult or almost all impossible to solve without China working in complementary ways with us. They're more doable if you get the biggest developing nation and the biggest developed nation working together.

They are a strategic competitor. But they are not an enemy unless we make them one. They don't agree with our liberal Western values. They don't accept them as the basis for an international order, but they accept many of the elements of the preexisting order and the need for an international order. Of course, they want to shape it to benefit them, just as we do. But why isn't it in our national interest to try to find common ground, build trust, figure out a way to deal with the most difficult issues? But we need to be strong economically, militarily, and diplomatically. They understand strength. We also need to act in our self-interest because they sure will. Fortunately, we have many shared interests.

Again, all those who oppose the SED or engagement with China, it's a little bit like those who say, "Well, I wouldn't rescue the banks during the financial crisis because I don't like this aspect or that aspect of the program." Well fine, then, what would you do? So the reason why right now I have the Paulson Institute—it's a not-for-profit think and do tank, dedicated to strengthening the US relationship with China through programs and advocacy where the focus is sustainable economic growth and environmental protection. The reason that I spend a lot of my time and money working in China is that I'm concerned. I look at, for 40 years for your history, looking at it from eight different Presidents, there has been a view on the one hand that basically if we work to promote economic reform in China and bring them into a rule-based global governance system, it will be good for the United States.

That consensus has broken down among—forgetting about the public, it was never that popular with the public—policy leaders, thought leaders. It's broken down for a number of reasons. We had the problems of the financial crisis, and China initially came out on the surface looking relatively better, and that's put people on edge. Are they going to eat our lunch as a strategic competitor? Do they have a better economic system? Which they certainly don't. Make no mistake about it, they haven't developed a better form of capitalism.

The second reason is Chinese companies are now competing more directly with US companies. Today, it's not just sandals and toys; it's aircraft engines and it's higher-margin products. And, although there has been continued but slowing economic reform in China, there has been none of the promised opening up. In fact, US companies are finding it increasingly hard to do business in China. The World Trade Organization has won and will continue to win trade cases, but it is a weak organization without the teeth to enforce them. And, importantly, like a number of our global institutions, it needs to be reconstituted to meet the needs of today's world.

And then the third is the cybersecurity issues and the cyber theft you've heard about, where the Chinese are taking US technology. This is a huge problem and requires strong action on our part. And of course, the elephant, the military buildup of a strategic competitor on security issues where there are acute territorial tensions, particularly in the South China and East China Seas. And China is increasingly being viewed as an enabler of a rogue North Korean regime, which is developing a nuclear capability that is a threat to stability in Asia and has the potential to soon pose a threat to the continental US.

With regard to our economic relationship, we need to demand China protect intellectual property, not require US companies to transfer their technology to gain access to the Chinese market, and move much more quickly to open their market to foreign competition. There is no doubt that the US economic relationship with China is looking increasingly unbalanced and one-sided. But China will soon have the biggest economy in the world. It already is our fastest-growing export market, has the potential to be much more attractive, and also Chinese direct investment in the US is growing, creating jobs here and has the potential to create many more. But we need to be tougher with China and demand they move more quickly to open their markets to us if we are to keep ours open to them.

I look at it and say our economic performance in the US the first issue in terms of how we're performing is subject to self-help. Every one of our economic problems is going to be harder to solve if China is having problems. We have to solve them ourselves, and we're not going to have a strong, credible, foreign and national security policy unless we maintain a strong economy. All of our strength has to start with their economy. If we have an economy that's struggling and weak and we have big deficits, no one is going to want to emulate us, so we have to fix that to begin with.

We have to fight and exert leverage to force China to continue to open its markets to our companies and our products, perhaps even withholding access to our markets. And we have to continue to be the world's foremost military power and to project that power globally, including in Asia. But we also need an affirmative agenda where we come up with common interests and we build on those common interests, and it's not based upon naivete. I just don't know how it hurts the United States of America to do that. I believe that very strongly and I also believe that, although this basic philosophy is sound, we need to adapt our approach. We need fresh, new ideas. China has changed dramatically, we've changed, the world has changed, and I think on almost every major issue our approach should include some fresh thinking, at least start thinking about what we need to do. What kind of trade-offs can we make? But only if they are in our national interest.

And to do that, you have to understand what's going on inside China, because China has a whole set of challenges, and the leaders managing the change on that scale, they are doing it all under enormous pressure. With all the economic and political pressures, their biggest focus is still domestic—domestic security, domestic stability, and of course, domestic policies. For China's leaders, that comes down to keeping the Communist Party in control. They're learning how to be a global player and they're still feeling their way, but they are becoming more assertive in using their growing economic influence to assert their interests globally, and this will only increase. We can't expect them to automatically play by all the rules that the Western nations have set up, that we'd like them to play by, but they need to agree to play by some rules that we all agree on. And if we play our cards right, they will do so, because while they are a revisionist power, they are not a revolutionary one, and they have vested interests in global stability.

Again, I see this as a very important but increasingly difficult and stressed bilateral relationship. If we don't manage it better, it could devolve into debilitating competition causing our two nations to drift farther and farther apart and unnecessarily so. It's going to gradually get worse unless we have a more proactive thoughtful approach. We may become adversaries which would be bad for the US and the world. We don't need another Cold War. We need someone in the administration who really understands China, who is given the responsibility for handling it, because the pressures and the politics are taking you the other way.

Riley

Let me interject here, because you clearly have elaborated much more in your manuscript, and that book is going to be coming out before the transcript would.

Paulson

Good.

Riley

There's one item out of your original four that we haven't gotten to and I know that you're getting tired.

Paulson

Why don't you get to it?

Riley

All right. It's the sanctions, the Iran and Korea piece. I don't know whether we ought to talk about schedules for a second and see how you're feeling and wearing or what.

Paulson

I want to do three issues and then we can come back and do whatever tomorrow.

Riley

Does that work?

Neale

Yes.

Paulson

I want to get to stimulus. OK. I want to get to sanctions. I'll do sanctions first, then I'll do the stimulus, and then I'll do climate.

[Long passage redacted]

At the end of 2007, the crisis which had begun in late June was gaining momentum. There was big stress on the banks and the financial institutions. I was very concerned, I kept expressing alarm to everyone in the White House, everyone. They knew I was concerned, but you hadn't really seen the liquidity problems in the banks manifest itself to a significant extent in the economy.

But as the economy started to fall off near the end of 2007, it was the view of Al Hubbard, before he left the White House, it was the view of Keith Hennessey, it was the view of Ed Lazear, that we should consider some form of economic stimulus. The President then authorized me to reach out, because I'd been working well with Democrats and Republicans, to people on both sides of the aisle. First, to develop a clear view on the economy and a judgment on whether we should do something and then to consult with Congress. I and the other members of the President's economic team believed the economy was going to slow down significantly, so I had multiple conversations. I talked with, it must have been 15, 20 congressional leaders and on each side of the aisle and heard their ideas, got their views, and then I came back to the President in mid-January and said, "I believe we can get something done here. I believe everybody is concerned about the economy."

At the time, we were concerned about a dip in the economy around midyear and what we could do to mitigate it. I worked very closely with the White House staff and we agreed on policy but we had a tactical difference on the best way to work with Congress. There were some people on the White House staff who against my best judgment believed that the President should announce a program and then negotiate from there. I had heard from the Democrats that it would be much easier to get a deal, if, rather than announcing a Bush administration proposal, we worked collaboratively. Of course, the President had his own guidelines and red lines on what he would do or not, but I didn't want to put Congress in a box and set up a confrontation with Democrats by making a public announcement ahead of the negotiations.

This came to a culmination in a telephone conversation that the President had with Nancy Pelosi. I was sitting next to the President behind his desk in the Oval Office and Nancy was on the speakerphone. A large group of staff was sitting in front of the President and me. As I said, the internal debate was about were we going to send something up there or let me start negotiating from a set of principles established by the President. The President hadn't decided and then Nancy Pelosi said please don't send something up here, and I looked up and saw a whole phalanx of staff shaking their heads no at their President. I looked at him imploringly and he said—either he or I, I've forgotten who said it—but it was, "Obviously, we won't."

When I was heading back to the Treasury from the Oval Office, I called Nancy Pelosi and she said, "You won't be sorry you said that, we're going to get a deal done now." That strategy was a key to us obtaining the legislation and Nancy and I developed a good working relationship in the process. She and John Boehner and I negotiated it. The President proved he was not an ideologue because he really wanted to stimulate the economy. He realized that lower-income people needed the money the most and would spend it the quickest, so even though that wasn't typical Republican policy, we had a refundable tax credit as part of it. Ed Lazear and Keith Hennessey very much supported what we did. They wanted me to negotiate with really firm red lines which I did.

We got basically what we wanted, although, just as Pelosi, Boehner, and I were wrapping up the final deal ready to shake hands, Nancy Pelosi said she wanted to raise the lending limits for Fannie or Freddie but I held the line. And then, she and Boehner both started laughing and she handed me the note that Boehner sent her, which was, "Let's roll Hank on Fannie and Freddie." This ended up putting me in a very awkward position. I think that was part of the reason I had a big problem with Senator Richard Shelby, because I'd had an earlier meeting with the Senate Republicans where Shelby had said, "I heard you are going to raise the lending limits for Fannie and Freddie," and I said, "No, no, we're not going to do this." Well, that was until I got in the room for the final session with Pelosi and Boehner. We got there and I had no choice. Boehner explained it to him, as did Mitch McConnell after the fact, but Shelby was furious and thought I'd lied to him.

But the fact was, I got to establish a productive working relationship with Nancy Pelosi which was very important as the financial crisis worsened. And she is tough. Maybe other House leaders have been as tough, but boy could she whip her caucus into shape. She was effective and I was fortunate to have her as a partner during the crisis. I could get her any time. When she wanted to be available and she was working, you could get her on a cell at 7:00 in the morning, you could get her late at night.

When we worked out the stimulus deal, she knew one committee chairman wouldn't like it. When I was in her office, I heard her beating Charlie Rangel into submission in the adjoining conference room and he was practically crying as he protested. She was pounding him and telling him if he wanted to continue to be a chairman that he was going to have to go along with the stimulus bill as negotiated. She delayed the vote a day or two so he could actually have a hearing before the House vote. But Nancy was disciplined, she knew how to get things done, she cut that deal. I watched her on the TARP, late Saturday night drive toward a final deal. My Assistant Secretary for Legislative Affairs—equally importantly, Kevin Fromer got to work with all of her people. It got to the point that she was asking where Kevin was when we were doing the TARP and other things. In the Senate, Mitch McConnell was also a master of legislative tactics and amazingly effective—and Judd Gregg, who led the Senate negotiations on the TARP was the very best I worked with.

My point was I was fortunate that I didn't get hit with the financial crisis right away. Because before the crisis hit, I had a chance to get some things done because the President let me do so, rather than saying the White House is going to do this and you're going to be one of many people and we're going to have our Legislative Affairs staff do it. When we did the stimulus plan, Treasury negotiated it, my Legislative Affairs guys were the ones who supported me in the negotiations. But the President made every decision and his chairman of the Council of Economic Advisers and head of the NEC were a hundred percent behind it and I talked with them all regularly. So that's that story.

Riley

OK.

Paulson

I will do climate change and then I will do the Iran and financial sanctions.

Neale

We have an hour and a half tomorrow morning too, if you want to save anything.

Paulson

Yes.

Riley

Do you need a break?

Paulson

Why don't I take a real quick one?

Riley

Terrific.

[BREAK]

Paulson

You should also talk to Stuart Levey, because he worked with both administrations. He was Under Secretary of Treasury for Terrorism Finance. He had good people working for him at two different agencies: OFAC [Office of Foreign Assets Control] and TFI [Treasury Department's Office of Terrorism and Financial Intelligence]. Anyway, he had a very good team of people. I think you will see that this is an area in which the policies of the two administrations have been identical. They've carried over the policies, and a number of the things that were on the drawing board that hadn't been implemented yet, when I was at Treasury, they've implemented.

They've just taken the playbook and implemented it. I don't know whether sanctions will ultimately be successful, in that I think unilateral sanctions don't do nearly as much as multilateral, so building the support for multilateral is critical. The way you need to look at sanctions is like almost everything else you do that's big and difficult: they aren't a silver bullet, but going to war has to be a last resort. I think you need to ask, "What else has the ability to work?" Stuart played a very big role at Treasury in these programs.

One of the things I brought to the party was an understanding of big financial institutions. I could say, "I don't believe there are heads of Western big banks who want to fund weapons programs in Iran or help the enemy. I don't want to go on my hands and knees to the French government or the German government or the Swiss government asking them to rein in their banks. I want to go directly to the banks. I told my Treasury team we can go right in; we can see the heads of any big bank."

We initiated a program through which we worked with the intelligence community to declassify certain information. In one case this allowed us to go directly to the head of a big Swiss bank and explain these U-turn transactions, these—I guess the best way would be to say—"covert transactions," in which money could pass through a financial institution to fund an illicit activity in a way that they didn't detect it. You'd explain to them that the Iranian entities aren't going to come to you and say, "I want funding for a weapons program." They're going to say the bank is financing a rug company or whatever. You would go in and the bank would say, "Oh, this could never happen here," then you'd take them aside and say, "Well, we declassified this and guess again."

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I really was very enthusiastic about the program, did everything I could to support it, and then during the financial crisis, Bob Kimmitt played a very important role in working with Stuart on this.

What was the next thing I said I'd go over?

Neale

Climate change.

Strong

Climate.

Riley

Climate. Let me ask one question about sanctions while you're on the subject, before you move on. Cuba. Was there any discussion of doing something on Cuba?

Paulson

Yes. Treasury administered the Cuba sanctions and licensing. My own personal view was that there were other repressive regimes in the world that we didn't have those sanctions. I frankly thought that we had helped prop up [Fidel] Castro through those sanctions, that if we'd eliminated them, it would have been harder for him to keep that system in place and we could have put pressure on in other ways.

There are other people who thought about it more than I did. Secretary of Commerce Carlos Gutierrez was the face of our Cuba policy. There was never any serious debate when I was there. We had discussions about what would happen when Castro died, and the conclusion was there was really going to be no big difference because the oppressive regime was still going to be there and Fidel's brother was going to be there. Lula [da Silva], the President of Brazil, would talk to George Bush about the fact that ending sanctions would help the US in its Latin American relations. He could be helpful in terms of back channels. A number of people told the President they didn't think the sanctions made sense. We had review sessions where we talked about it. It's clearly a very corrupt regime, and it wasn't just going to fall when one guy went, because the corrupt elite were enabled by the current system, and they were ripping off the people and living very well.

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Riley

OK. Climate?

Paulson

I just wanted to say this for the record, in case the President doesn't take credit for it, but he deserves to take credit for it. Before the financial crisis hit, I tried hard to get the President to speak out and make a public speech on climate. He did work some language into his last State of the Union message. He never did make specific policy recommendations. It was a hard political challenge, because it would seem rather futile and feckless as he's going out the door.

There was no support in his party for getting anything done here. But those who say that it's only the Republicans who are against a cap-and-trade policy or a carbon tax are wrong. I know firsthand from all the times I went and talked with Democrats to see where they were on this issue, and whenever they assumed I shared the White House view, they said, "Oh, don't worry. I may make a public pronouncement, but we'll never do anything." There's 20-some-odd coal states, and when you combine the auto states with the coal, you could get a climate bill that would actually be worse than no bill at all in terms of giving special deals or carve-outs to coal. It's a political mess.

I did what I could. I established the first environmental group at Treasury, and there have been some terrific professionals in that job who are experts on climate change and on any environmental issue. I actually was going to work on carbon offset standards, because there are a lot of abuses in that area, but again, the crisis preoccupied me and prevented me from doing that.

The thing that was clear to all of us was that any effort to curb carbon emissions had to apply to the big developing nations. They didn't necessarily have to go as far as we did, but unless China and India acted, we weren't going to get anywhere. George Bush got a lot of grief for being against Kyoto [Protocol], but that was a treaty that was doomed to fail from the beginning. It was just mainly—You sign on for political reasons, right? You sign on to say we care about climate. You could argue about that one way or the other.

But the thing that the Bush administration came up with that I think was really good—I give Dan Price a lot of credit. I contributed to it and was supportive, but this was Dan Price, Josh Bolten, and, of course, the President—setting up this group of 18 major economies to tackle the issue. The premise here is that if the major economies agree, we achieve most of what we need, and the others will probably follow anyway. This was George Bush's initiative. President Obama adopted it and most people incorrectly believe it came out of his administration. We need new mechanisms for governance. The G20, which doesn't work perfectly, is one new mechanism. We may never again see a global trade round with the WTO [World Trade Organization], at least until the WTO is reconstituted to deal with today's world. I think it takes some imaginative new ways of doing things. It's the idea of saying that if you get these 18 nations together that are responsible for over 90 percent of the emissions, you have a better chance of doing something there. And of course, if you can get the United States and China, the two longest carbon emitters, to agree, that would be really impactful. That's why I worked to put that ten-year framework on energy and the environment together as part of the SED.

Riley

Sure.

Paulson

Or no one else may do so.

Perry

Could I ask a quick question? If you could have had the President speak on it, if you could have written the speech, what would you have wanted him to say?

Paulson

One of the things that the President and his White House team did is they brought in some good science advisors. Basically, he was told that the evidence was much more conclusive, and the scientific evidence was pretty clear, and there was a whole lot of discussion. There was a discussion about regulation of carbon emissions as a pollutant at the EPA [Environmental Protection Agency] after a court decision. As you know, Obama's EPA is now treating carbon emissions as an air pollutant and regulating it. Serious consideration was given to whether the Bush administration EPA should do some of this peremptorily, as opposed to waiting and letting Obama do it. There was a whole range of things we looked at under the rubric of energy security. We all had our suggestions.

And of course, none of us saw what was right under our noses, which is this fracking boom producing a huge supply of clean gas, which if done properly has the potential to make a big difference. I wanted the President to speak out forcefully, but he decided not to. I believe it was because if he had spoken out, it would have to be, "So what, why are you saying this at the last minute on your way out the door? What is the answer? What is it you're proposing? Are you going to propose a carbon tax? Are you going to propose a cap-and-trade? If so, what are the chances of getting it through Congress and why didn't you advocate it earlier?" Those are tough arguments to beat, because they have real merit.

I had worked on cap-and-trade. I left a few memos behind, as to how to do it, how to do it at the wholesale level, how to phase it in so it wouldn't make us uncompetitive in the global markets but would send a price signal. That was one area where I had major debates with the economic team at the White House. I even preferred a carbon tax. It's just a simpler, more effective way to put a price on carbon, and doing it in a way in which it wasn't a net tax increase, or regressive.

I believe if the President spoke, he would have had to say climate change is a fact and no matter what we do the Earth will warm. This poses a big economic risk as well as an environmental one. We need to prepare for the inevitable, so we need to adapt and become more resilient to reduce the damage from and the cost of the climate events that are almost certain to come. We need market-based solutions to mitigate and avoid the worst outcomes, so we need to put a price on carbon, and there are various ways to do that. The most adverse climate outcomes pose a huge risk to our planet and future generations, so we need to take out an insurance policy and lead other nations in a global effort. And my argument was a simple one as a businessman, that the science is clear and overwhelming, that if you ever wait until everybody agrees, it's too late.

Scientists are incredibly conservative. They don't want to be criticized and are risk averse, so in these international commissions, where they all come together for consensus, it gets dumbed down to the place where everybody can agree. I learned not to do that at Goldman Sachs after some of the earlier financial disruptions. When we relied on value at risk, we sometimes got extreme market moves—five- and six-standard-deviation moves—which shouldn't happen.

I believe we're in grave danger of underestimating the risks. And so far the Earth, particularly the oceans, is warming much faster than the models predicted, so we are in grave danger of not taking out an insurance policy to protect against a range of really bad outcomes that are a real possibility. We need to be risk managers for our planet and our children, grandchildren, and future generations. You want to avoid small but deep holes and, to do that, you need to figure out how to put some price on carbon. And if you do that, you don't need to send a large price signal initially. A more modest one initially begins to change behavior and promote innovation. And that leadership by the US government would make it easier to get things done internationally. Moreover, this ultimately strengthens our economy, because we become leaders in clean energy technologies, which are industries of the future. Over time this creates jobs and increases economic competitiveness, but in the short term there are winners and losers and some industries are hurt and jobs are lost. Additionally, we need to be smart and move to protect our economic security for the outcomes that are virtually certain to occur. This means businesses need to factor climate risk into their decision making. They need to harden their infrastructure and evaluate their supply chains for climate risk. That was my argument.

That was the one place where I didn't get a lot of traction. I was grateful for the things the President let me do and for the progress he made in climate. He could have made that speech—It wouldn't have led to much—but instead he quietly, under the radar, turned Dan Price loose, and convened the 18 major nations. It was tangible progress.

I thought of one other thing when I was talking.

Riley

Let me press you about climate, on one piece. You know the Chinese very well, and presumably you dealt with them on this issue too.

Paulson

All the time.

Riley

What do you expect to come from there?

Paulson

Well, first of all, the environment is a huge issue in China and the leaders are focused on it. One reason I spend much of my time and energy in China is because if you want to make a difference on global environmental issues, China's policies and practices have the potential to be the biggest difference maker. Urbanization is going to be one of the biggest economic and environmental events of the next 25 years in China. There's another 350 million people going to the cities. That's going to drive economic outcomes; that's going to drive environmental outcomes around the world. As one of their leaders said to me in 2008, "We have 1.3 billion Chinese who want to live the way you live. You've given us a bad model; there are not enough resources in the world to do that."

It's a huge, huge problem and they understand it, but the even more immediate, pressing problem is the ambient air pollution, which is killing people and a growing source of political unrest. And, for the most part, the measures to clean up the air also reduce carbon emissions. The Chinese don't debate the science. The problem they have is that as much as they've invested in new clean energy technologies, the benefits have been swept away by the rapid growth in hyperindustrialization in energy-intensive manufacturing and by the lack of regulatory enforcement. I spend a lot of time working with the Chinese on these issues. I write about this in Dealing with China.

In August of 2007, I went to the Qinghai Plateau. China's President Hu Jintao suggested I go up there. I went up with the top climate guy from China, and the top climate guy at the NSF [National Science Foundation]. This is the highest point in the world; it goes right across the Himalayas into India. It's a source of the jet streams, and the temperature changes there are changing the jet streams. It's the source of the seven big rivers of Asia. Climate change is leading to weird, extreme temperature events: 50 degrees below in Russia, people burning tires in Kuala Lumpur to stay warm, snow in Istanbul right now. The Chinese believe climate change is going to have profound effects on all of us—the way we live and our economic security.

They explained to me how the Himalayan glaciers were melting and would be gone in 25 years; the temperature is going up one-tenth of a degree a year. They understand it; I mean they're working on the impacts with an emphasis on adaptation. They have a hard time agreeing to emission targets because most targets they have in their five-year plan they meet, but they haven't been meeting their energy-efficiency targets. It is also easier to achieve a similar result in China by talking about energy efficiency as opposed to carbon emissions. But clearly air is a huge political issue in China right now. I emphasize a need to take a long-term view. All of us want to build long-term prosperity, and you can't get there with short-termism: What's the GDP [Gross Domestic Product] this quarter or this year. You have to have growth models that are going to be sustainable.

My own view is that our global ecosystem is at a tipping point and it's literally not just climate. The other thing that you should get from George Bush is what he did, and what Laura Bush led in the White House—or played a big role with her husband—in terms of the ocean parks they had set up.

Riley

Anybody else have any follow-ups, or shall we call it a day? We've run you pretty hard.

Paulson

I think the question I really have now is does it make sense—I'm here, I have it on my schedule.

Riley

Right.

Paulson

I could come back tomorrow and just answer any questions you have for an hour and a half if you'd like to, or I can take off. I'll do whatever you prefer.

Riley

Bob?

Strong

No, no, it's your call.

Riley

I think we'd like to come back and do that, let you get a good night's sleep so that you're rested.

Paulson

Yes, and I think what you might do is focus me on some of the things, you know, what are the big questions that I've missed?

Riley

Exactly.

Paulson

Maybe I'll have a few things that are coherent enough that I won't edit them out when you send me the transcript.

Riley

What almost always happens too is after you've had a good night's sleep after an episode like this—

Perry

A nice meal.

Riley

A nice meal and a night's sleep, then there will be some things that will come to you, that you wish you'd said. An hour and a half, as you'll see, will normally go by pretty quickly.

Paulson

It's not as much the things I wish I said, it's the things I wish I hadn't. [laughter]

I think it is quite important. As a matter of fact, I'm going to tell you two things. I'm going to tell you a story about entitlements reform. We can do this easily before dinner, and I'm going to deal with the deficit.

Riley

OK.

Paulson

[Long passage redacted]

Now on the deficit, we had a situation that was quite remarkable when I was at Treasury. Everyone says the Bush administration just kept increasing the deficits, how do you cut taxes when there are two wars going on, et cetera. I didn't understand it, but after I arrived we consistently monitored the deficit, which as a percentage of GDP, kept dropping, and it dropped to—I didn't bring the numbers here with me, but it just dropped all the way through 2006, through 2007. I think the deficit as a percentage of GDP dropped to like 1.9 percent or whatever, and maybe it was even smaller. Treasury's estimates were constantly wrong because the tax revenues just kept coming in at a level that exceeded all the expectations.

I also didn't believe that was because we cut taxes, as the White House argued. That was not my view, although the tax cuts almost certainly increase economic growth somewhat. My view on taxes very simply was we needed major tax reform to give us a system that let us raise more revenues while allowing us to be competitive and efficient and create jobs. We have a terribly outmoded tax system. I will talk with you about taxes tomorrow, that's one thing I won't talk about today. I will talk about it so we just get through it.

But the deficit—The numbers came in, but when we analyzed them, why are the tax revenues way ahead of forecast? I saw that they were coming in from New York and Connecticut, from big hedge funds, banks, and investment banks. I realized it was a huge unsustainable tax gift resulting from the precrisis bubble and excesses. There were large capital flows coming in from Asia that were being intermediated through our financial system. This made it easy to make money. You had hedge fund managers making a billion dollars or more, paying low taxes as a percentage of their income, but large amounts to the government. It was really just part of the bubble. This was not going to be permanent. It was not something we could count on, but it was hard to see and know that with any certainty at the time.

Josh Bolten or Rob Portman will give you the numbers when you talk with them. They will tell you that—Whatever it is, over the last 20 years—there've only been two Presidents who had more than X years where the deficit as a percentage of GDP was as low as it was for the Bush administration. So that was what was going on with the deficit.

We were sitting there looking at the deficits continuing to come down. I don't know what Dick Cheney was purported to say, that they don't matter or what have you, but I never heard him say it and I don't believe that was his view or believe when people were talking about the deficits, they were talking about them in the context of them dropping, and they did drop. Until they didn't. The Bush administration pointed out the problems with entitlements big time like no one else—and entitlements are the issue today. You can't solve our fiscal problems with taxes alone. The entitlements are growing faster than the economy and we need to rein the costs in, and to do that we need fundamental reform, which includes means testing. Why should I get Social Security or the same health care benefits as a low-income citizen?

So, the tax system. I looked at our tax system and it's hard to believe that it was ever structured this way. You look at the individual system: we tax capital and savings. We incentivize borrowing. There's all kinds of spending programs that are part of the tax system. The biggest one we came up with at Treasury was employer-provided health care. That cost $3.5 trillion over a ten-year period, and what that does is says if I work for a big company that's got a generous health care plan, the company gets a big advantage, they get a tax deduction on that. I don't pay income taxes on my benefit, and how is that fair to the waitress or the construction worker or the unemployed person who doesn't work for those companies? It just is a huge inequity. We talked with the President about it. I thought we should propose a tax credit for everyone. He said, "Well, that's what the Democrats will prefer; we can negotiate and get there but let's talk about a deduction first." It was George Bush, so they didn't want to talk about it. Politically even a proposal as reasonable as this didn't fly.

The tax system is just riddled with inefficiencies, inequities, and it is very hard to think about how to get out of it. I remember telling Barney Frank I didn't think there should be a deduction for mortgage interest payments. He said, "I don't either; it's not fair to renters. But I don't think it's fair to change it right now, because all these people bought their houses assuming there was going to be one." Good point, except how do you ever get yourself out of this mess and have a system that lets us be competitive? We're losing our competitiveness in the global economy.

The Bush administration had twice done tax cuts before I arrived. The last one looked more like tax reform, because of what was done with capital gains and dividends, but there was no way we were going to be able to really reform the system. When you reform the system, you have to do it when you're lowering rates, and we'd already done that. REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT REDACTED TEXT

So it was clear we weren't going to be able to touch individual tax reform, so I wanted to look at corporate taxes. As a matter of fact, right now our tax revenues maybe are at only about 17 percent of GDP. I'm not sure, but they were dropping as a percentage of GDP. Historically they'd been 18.5 percent, and we probably need higher taxes than that now. So we need a tax increase, and if you asked what revenues are the most expensive to raise in terms of hurting our competitiveness, it is our corporate tax revenues, because corporations are nothing more than a legal construction. They don't pay taxes. Economists can argue whether it's the workers, whether it's the investors—you know, the shareholders—or whether it's the customers, but it's some combination of those three that pay corporate taxes. And more and more you were finding economists saying it is the workers.

But I knew you couldn't eliminate corporate taxes. That doesn't work politically. You're not going to be able to stand up there and say, "I have this idea: let's eliminate corporate taxes." But we certainly have a corporate tax system that was a bad joke. It was out of step with the rest of the world because it was set up in a day when US companies had the strong competitive advantage, and so we have this crazy system. Almost every other country has some version of this territorial system, where you pay taxes in each country where you do business at the prevailing rate in that country. In the US, a corporation should pay US taxes and in China pay Chinese taxes, and so on. The US has a system that says after you have paid corporate taxes at the prevailing rate abroad, the US requires you to gross your taxes up so you are paying the full US tax rate if you want to bring any of your foreign earnings back to America. This hurts the competitiveness of US companies. Basically, the capital doesn't come back to the United States. Opponents say, "Well, if they bring it back, they'll just pay it out in dividends anyway." Now why is that all bad, to get it out in dividends in the United States? But, of course, some of it would go into job-creating investments in the United States.

It's a huge advantage to have global US companies headquartered here, and those that have the strongest operations overseas have the best platforms for export and pay the highest wages here, so it's in our interest to move to a territorial system. And then we should do away with the inequities, because different businesses have different tax preferences. No two industries pay the same rate. The industries that are the dying industries and the least competitive ones, those are the ones—the industries of the past—that often have the biggest tax benefits. It's exactly the last thing you would want to do.

So I started a competitiveness initiative at Treasury to look at corporate taxes. We had panels. This was before the financial crisis. We brought people together from all kinds of industries; we had Democrats, Republicans, to build consensus. But then it gets down to what are you going to do? Because if you lower the rates, then are you going to reduce the total tax revenues or are you going to do away with the distortions? If you do away with the distortions, that means certain companies are going to pay more and others are going to pay less. And the reason corporate tax reform is so difficult is that those who are against corporate tax reduction are unified, and those that want it—businesses—are united in their ambition, but when they get into the details, it's every company for themselves. When they get behind the closed doors, they're all fighting for their individual preferences, and every industry has them, and so we have this system that is terrible.

I don't believe we will restore our economy and our economic competitiveness until we do some things like reducing the cost of health care and entitlements, giving ourselves a tax system that lets us raise the revenues we need and be competitive, and doing three or four other things, because our competitiveness has been going down for a long time, through multiple administrations. Competitiveness means that the US companies can compete overseas and the standard of living goes up, not down. Competitiveness also means we are investing in our future, industries of the future, our young people's education, not behaving like a selfish older generation unwilling to make sacrifices for our children and grandchildren.

So I had an initiative on corporate taxes, talked a lot about it, but then we didn't have the support to put forward a proposal. My successor, Tim Geithner, made a similar attempt. It just is a very hard thing to do politically. And the individual tax system is also badly broken and even more difficult to reform in our political system. I think Erskine Bowles or [Alan] Simpson said when we eliminate these loopholes we are not really raising taxes but are cutting spending, because the tax code has all kinds of spending in it. And I agree. There's all kinds of spending for housing, for employer health care, for this and that. And once someone gets it, it is now their entitlement and it's their right.

Everybody says the same thing. Everybody says to me, I'm all for it, just don't touch my Social Security, or don't take away my this or my that. The big problem with democracies is voters want things they don't want to pay for, and it takes real leadership to get things done.

Strong

A lot of people would agree with that analysis of the tax code, but a reader of your book wouldn't come away thinking we have a Congress that's going to take on that kind of big project.

Riley

Ready? Day Two of the Hank Paulson interview. We had a good dinner last night. Let me start off with a couple of questions, the first being how do you think you did with respect to the financial crisis? How would you rate the programs that you put into effect in dealing with the crisis?

Paulson

First, let me acknowledge the obvious. The financial crisis did major damage to our economy and hurt many people. No one, certainly not me, should take victory laps. Second, we did our very best under difficult circumstances. And, looking back now, almost five years later, I have, I think, a better perspective. I believe our programs worked. We were dealing with an unprecedented crisis. We had inadequate powers. We had a flawed regulatory system. We didn't have a good playbook, but I think for the most part, the major decisions we made were the right ones. We were able to prevent a disastrous financial catastrophe for our nation.

Riley

Were there deficiencies?

Paulson

We obviously made plenty of mistakes. I believe our mistakes for the most part were communications errors: never convincing the American people, or helping the American people understand, that what we were doing wasn't done—We weren't doing it for Wall Street but for their benefit, to avoid a catastrophe. There were a number of mistakes I alluded to in On the Brink and talked about earlier in this interview. One of the ones that gets pointed out the most, and I think rightfully so, was sending a two-and-a-half-page outline to Congress when we went up to request TARP, and not explaining publicly that this was not "take it or leave it" and was not arrogance on our part. It was a starting point to begin negotiations with Congress.

As I've said frequently, when you're dealing with a big, ugly problem resulting from excesses that had been building up for many, many years, there's no way you're going to find elegant, perfect solutions. The things we did generated a lot of controversy. They were unpopular then, they're unpopular now, and they're unpopular for good reasons. The American people don't like and should never like propping up failed institutions in their current form. We didn't have the proper resolution authorities to deal with failing institutions, so we propped them up in their current form.

The political resistance and public resistance that were generated as a result of what we did was very divisive. That was very harmful. The public wanted us to punish the banks, but when we had to decide between public opinion and market stability, we came down on the side of stability. We did something that had never been done before, recapitalizing almost 700 banks. This benefited our nation greatly, but to do this, we needed to make the program voluntary and offer the banks attractive terms. This was very unpopular, and as a result, it will be even more difficult when we have another financial crisis for decision makers to do things that are unpopular. Hopefully now they have the tools, so that no institution will need to be permanently propped up in its current form to protect our economy when it fails.

Riley

Much of what you're dealing with is happening in a transitional period, from one Presidency to the next. How would you assess the relative contributions of the Bush Presidency and the Obama Presidency, in getting to a resolution of the crisis?

Paulson

That's a good question. President Bush and his team were the first responders and did the most difficult and unpopular things. But there is a very good story here of continuity and complementary policies. First of all, this crisis took place in many ways at what was absolutely the worst time, because it was a few months before a national election, and if either Presidential candidate had come out against what we were doing, we wouldn't have been successful, and it would have been catastrophic for the country. Neither McCain nor Obama came out against what we were doing, and Obama was quite positive and constructive. I talked with him regularly during the campaign; he was supportive. I talk about a couple of conversations with him in my book. There was one conversation where he said, "Hank, I expect to be President someday and I don't want to inherit an economic wasteland, so if there's ever anything that I can do if we're facing a financial collapse, please get in touch with me." And I did when I needed him, when I was up at the Hill negotiating the TARP and he called Harry Reid, who joined the negotiations on a Saturday night and the Democrats came through.

During the transition, I didn't talk with him. His people made it clear: there's only one President. But at least I felt, and I think the Bush administration felt, that we were supported in the things we did, and during the transition, we did some important things. We stepped in, in mid-November, to prevent a collapse of Citi. We stepped in to prevent a collapse of Bank of America, in the wake of the Merrill Lynch acquisition and big losses that Merrill Lynch was announcing. We rescued the auto manufacturers from failure.

Then, of course, President Obama picked Tim Geithner as his Treasury Secretary. Tim Geithner had been a key member of the team as the Bush administration worked to stabilize the markets and prevent the financial crisis from being much worse, so Tim was very knowledgeable. As I look at it, the capital market stabilization measures that were taken before Obama became President were effective. Geithner participated in putting them in place, understood them well, and I think then President Obama made a very important decision. I'm sure it was a difficult decision for him; it would be for any new President, to essentially stay with the program that was in place.

Looking at the capital market stabilization program and separating that from the Obama administration's stimulus—and I won't get into the relative contributions of the two—virtually all of the capital markets stabilization programs were either done, in place, or begun before Obama became President, and then the Obama administration and Tim Geithner did a terrific job in managing those programs, winding them down, adapting some of them to meet the changing circumstances. The programs were already in place before Obama came to office that accounted for 95 percent of the TARP funds that were ultimately invested or spent, and 75 percent of the money was out the door.

As I look at the capital market stabilization programs that were done before Obama assumed the Presidency, there's the Fannie, Freddie nationalization, putting them in conservatorship, which I think was as important as anything that was done and was the most important thing in dealing with the housing crisis and preventing a further collapse of the housing market. And in no particular order you have the Exchange Stabilization Fund commercial paper guarantee, which was very important. You have the October 2008 G7 meeting held at Treasury, which was the best example, at least in modern times, I can remember of Finance Ministers from around the world coming together and taking a coordinated global response.

You have the highly unpopular and highly successful TARP program. I think never in history has there been a program that's been at the same time so unpopular and so effective, but if you look at the bank capital and insurance capital portion of that, all of the money came back, plus almost $50 billion. You look at the auto rescues and you have GMAC, the financing arm of General Motors, successfully recapitalized, and restructured from the brink of failure, as was Chrysler finance. Then the Bush administration made loans to General Motors and Chrysler that matured, at the end of March, but with a set of terms the companies couldn't meet without going through a restructuring, so this made it easier for the Obama administration to put them through a restructuring, and difficult for them not to.

As to whether for the autos the relative contribution was 50 percent the Bush administration and 50 percent Obama, or more or less one way or the other? I happen to believe the hard part was the part that George Bush did. General Motors and Chrysler wouldn't have survived without the initial Bush administration rescue loan or without their finance companies, which would have failed without some deft financial engineering on our part. I think that was the hard part. Maybe the Obama administration has a different view; I'm sure they do, but I think the important thing is that our joint actions were complementary, and one was a continuation of the other.

I mentioned the Citi and the Bank of America rescue, but I'll talk a little bit about the Bear Stearns rescue, the FDIC's Temporary Loan Guarantee Program for banks, the TALF. The Term Asset-Backed Securities Loan Facility is one that doesn't get written about a lot by the financial press, but that was a very successful program to restore liquidity to the securitization market. That was a prime example of what you saw happen throughout the crisis, and that is, since we had inadequate powers, regulators worked together to pool their power and authorities. This was the New York Fed, the Washington Fed, and Treasury, working together to design this program. This was the case of a program in which there was a lot of work done. Most of the work was done before George Bush left office. We announced it in November. Steve Shafran, who was a key part of designing this, stayed on and worked in the Obama administration, as did Neel Kashkari, and that program was put into place and worked very well.

I'd say that another great example of how the Obama administration adapted the capital market stabilization programs that were put in place and made them work was the bank capital program. With Citi, they took it a step further, because Citi really needed pure equity capital, and they converted their preferreds to common stock. Then much more broadly, and very importantly, they took what I believe was a very important and uniquely structured bank capital program, which was designed to recapitalize the entire banking industry, as opposed to dealing with nationalizing failing banks. As I said, this is something that hadn't—And I can't find historical precedents for that. The Obama administration took that and used that and refined that through the stress test, which I think was very important. The capital program gave them great leverage to make sure that the banks were well capitalized and to be able to show the whole world that they were through the stress test.

Then, as I look at what additional things the Obama administration did, I think you would have to just say the stimulus plan was necessary and important. They did something called the PPIP, Public-Private Investment Program. It wasn't a big or a particularly consequential program. They made an attempt to limit foreclosures through a program to restructure or modify mortgages. We were criticized for failing to develop a plan that worked. I believe the Obama administration plan to reduce foreclosures also failed to meet even the minimal expectations. The most effective action to reduce the number of foreclosures was our Fannie/Freddie nationalization. In summary, I think that excesses preceding the crisis brought out the worst in behavior, which precipitated it. But the crisis also brought out the best I've seen in government behavior, because with regulators we were forced to—That's the wrong way to say it, because there was a real strong relationship of trust and cooperation among regulators as we pooled our authorities and worked together, Ben, Tim, and I, and the way regulatory agencies worked together to combat the crisis. And the TARP legislation is the last and the biggest and most important example of bipartisan Congressional action America has witnessed in a long time. As I look back, after the heat of battle, I think that these programs stabilized the capital markets and I think it's unusual to see the degree of continuity we had between the administrations.

The period between the election and when we left office I found to be sort of barbarically long and uncomfortable. It was a very difficult interregnum period. But as I look back at it now, with a little bit of hindsight, the programs continued. They went fairly seamlessly to the Obama administration, because a number of members of my team at Treasury stayed on. Tim Geithner, who was a key part of putting the earlier programs together, became Treasury Secretary. The reason I say "fairly seamlessly" is that I watched at the time, my heart in my throat, from the sidelines, as the Obama White House debated nationalizing a number of the biggest banks. I thought that almost put the banking system under for a while, you know, as the stocks of all dropped to almost zero.

And then President Obama made the difficult decision, because I think any new President wants to come in and say, "I have my own new set of programs." He made the difficult and the right decision to take unpopular programs that were in place and make them work, adapt them, get the autos done and move to the stress test, which were both the right decisions. The economy recovered, the capital markets were stable long before the economy recovered, so therefore I think it's not really right to talk about which was more important, the capital market stabilization program or stimulus. And, of course, the Fed's extraordinary monetary policy has been the most consequential driver of the recovery. You needed both, and the capital market stabilization programs worked and the economy is growing—not as fast as we'd like, but it's growing.

Riley

This is almost a uniquely American question, because in most systems, without established election dates, you call an election to deal with exactly the kind of crisis you're dealing with and then boom, one party is in, the other one's out, and the credit or blame is in some respects much easier.

Paulson

It's an interesting thing, because when you look back at the Great Depression, Franklin D. Roosevelt almost tried to make things worse during the transition period. And his predecessor, Herbert Hoover, got the blame, probably rightfully so, and then Roosevelt needed to first stabilize the markets and then lead the nation's recovery. I can remember when George Bush came to see me at Treasury after what we call Citi 2, the Citi rescue, around the 19th or 20th of November. This was during the transition. To me, that was the bleakest of times, because I had felt that our initial capital program was going to be sufficient. We announced it. I thought that it broke the back of this crisis, and the President and I had this sort of continual joke, sort of black humor. You know, "Is this enough dynamite to stop this thing?" Whenever we would take action, he would ask, "Is this enough dynamite?" And I'd say, "I don't know," or "I hope so" or whatever.

When he had asked the question after our Citi 2 rescue, I said that I really was quite concerned because Citi had over $2 trillion of assets that were off the balance sheet. They had $500 billion of deposits outside of the US that weren't covered by FDIC insurance. If that money had run and the bank failed, our entire financial system was at risk. We didn't have the last tranche of the TARP taken down, and we would have to have gone back to Congress at that time to get it. Even if we were successful in getting the remaining TARP funds, they might not have been sufficient, and it would have taken time. So when President Bush said to me, "Hank, you don't look like you've been sleeping," and I said, "I haven't been, sir." He said, "You don't look like you've been working out," and I said, "No, I haven't." Trying to buck me up, he said, "What are you so worried about?" And I said, "I don't want to be Andrew Mellon, Hoover's Treasury Secretary." After the President had a good laugh, I said, "A few people have heard of him, sir, but they've all heard of Hoover." [laughter]

That's when he said, "Well, you listen, don't even think about that for a minute. We're not Hoover, we're Roosevelt one. We're Roosevelt one and Obama is going to need to be Roosevelt two. We're very fortunate that you're here and that I'm here and that it's the end of a Presidency. No one's worried about polls and we don't have a new President trying to get used to a new Treasury Secretary, when they don't know each other, or how to make quick, difficult decisions. You should just feel very fortunate that this is happening now, because you've trained for this all your life and you and I have a close working relationship."

At the time I didn't feel very fortunate, and I was looking at the calendar and thinking, My goodness, there's another, whatever it was, month, until the new President is here. And it wasn't that I was trying to get out of Dodge, but I just felt unusually awkward being in the position with everyone looking to the new President, who wasn't reaching out a helping hand.

Riley

Sure.

Paulson

I felt I had real credibility with Congress, twice getting extraordinary powers we needed for Fannie or Freddie, getting extraordinary powers for TARP. The things we'd done now were very unpopular. I had lost my credibility with Congress and I'm sure with the American people. We didn't have the credibility to take down the last TARP tranche. People were highly critical of not doing a mortgage foreclosure program. We didn't have, I felt, the necessary funds to stanch another bout of financial instability without taking down the last tranche. We needed all the TARP funds we had already taken down to fund the programs to prevent collapse of the system, and I needed a little bit of extra firepower in reserve in case we had another collapse or another problem. So I was just saying, "How are we going to get out of here?" And it turns out I was worried about a few more unpleasant surprises, and we had them. We had B of A and the auto crisis before we left.

But when we left, I felt good about the programs that were there, and I believe they withstood the test of time. A big reason they withstood the test of time is the Obama administration adapted them and managed those programs. I'm not saying they did everything else properly, but I believe that in terms of the capital market stabilization programs, they managed them flawlessly, despite the criticism they got. They also have tried to take full credit for putting them in place.

Riley

Bob, you had some questions.

Strong

Oh, I have lots of questions. Let me just start with one that we like to do when we're in this final session, wrapping up. Your portrait of the President is different than some of the public criticism he's received. You described him as competent, you described him as engaged, you described him as courageous about taking hard decisions, and you say his interpersonal or his communication skills were great as long as the cameras weren't on.

Paulson

Right.

Strong

And that what a lot of people say about President Bush was wrong. So that's a story you've done well, but I want to ask—You weren't really going to the President for ordinary decisions. You were going to him when the pace of events and the scale of the risks being faced were so high that most of your interactions with him aren't typical of Presidential decision making.

Paulson

I'll begin by recounting what my experience was before joining the administration. I had spent two years in government, where I had worked for leaders in the Pentagon, watched people like David Packard and Melvin Laird and then in the Nixon White House; I'd spent 32 years at Goldman Sachs. I think the thing I did that was pretty unusual when I was at Goldman Sachs was that, throughout my career there, right up to and including the years when I ran the firm, I worked with clients, with CEOs and with heads of state in various countries around the world, particularly countries like China and Germany.

I had seen a lot of leaders, I had watched corporate decision-making processes, I had watched government decision-making processes, and I'd had a year in the Bush administration before the crisis. I'd had a year and a half before the crisis was so acute that it impacted decision making, the way the Bush administration ran the decision making. So I'd watched the way the Bush White House worked and I would say the following—and again this is my experience. I can't comment on the first term. I can comment on what it was like when Josh Bolten was Chief of Staff, Joel Kaplan was the Deputy, and the whole team that you know.

I thought it was an excellent decision-making process. And I went through that on various decisions—decisions that went my way, some that didn't go my way—in areas like talking about climate and energy. First of all, the staff was very bright, so the key people there compared with the smartest people I've worked with anywhere. There was a good culture. You knew what their views were on things because there was great transparency. Some people were more politically conservative than others, but the process was very open and the memos that went to the President were very objective and well written.

Coming into the administration, one of the things that I bargained for and got was the ability, as the President's top economic advisor, to write and have my staff write decision-making memos in areas that I thought were important or came under Treasury. After trying that for a month or two, I relinquished that. I said I found it easier to be coordinated than to do the coordinating, and I had great faith in the process and the objectivity of the process. It didn't go on endlessly; that's the thing that I liked. It was conclusive: everybody got a chance to look at the memo, to comment, their views were put in the memo, it went in to the President, and we had a meeting with him either in the Oval or the Roosevelt Room. He would sometimes make a decision on the spot; sometimes he would take a while to make the decision.

Now clearly, there is no administration, no decision-making process anywhere, where the President isn't going to have a few people that he's really going to listen to. There isn't any process where the President isn't going to have a few private conversations with someone, and I have to tell you, as a decision maker, I did. We had a management process at Goldman Sachs: we vetted important decisions with a 20-some-odd member management committee, got everybody's views, and I would often have two or three people with whom I really talked it over before I'd make a decision. I think George Bush did that too. He got information wherever he wanted, but then when he made a decision, you knew that he was behind you and he stuck with it. He wasn't wanting to make another decision the next day.

Once he made the decision, you didn't go through this process where someone whispered in his ear and said, "Oh, Mr. President, I didn't get to say this," and he'd call everybody together the next day and say, "Oops, let's go do it all over again." But when we needed to change—as I talked about crisis decision making—and I came back to him and said, "Guess what, I don't think buying illiquid assets is going to be something we should do here," he didn't say, "Oh, that's wonderful, do it." He said, "Let's talk about it a bit," and I told him the facts had changed, at least as we understood them, they changed. Then he said, "You've got to do what you've got to do to save our economy." That's what I found about the process.

Now, do I know that there are cases when I was there, of Cabinet members in some of the departments who didn't think they had the access they needed or that didn't feel that their views were always heard? Yes. But I blame them more than the decision-making process in the Bush White House. I had two or three of my fellow Cabinet members say, "You see the President whenever you want; would you make this case to him?" or that case or whatever, and I would very nicely tell him, "You're the Secretary, you run that department. You can ask to see the President, and in the decision-making process, you don't have to roll over. There's a decision-making process. Just insist that your views be there and speak up when you're there." In every administration there are people who are too cowed by power or by the White House staff, and I look at it and say those are people who shouldn't be in the Cabinet to begin with. I know I'm oversimplifying, but that's my view.

Based upon what I'd read in the newspapers, I was very concerned about going down to the Bush administration. I was concerned. One of the key things that got me to go was knowing that Josh Bolten was Chief of Staff, and trusting and looking at people like Steve Hadley, who I just had a very high opinion of, and so looking at the people that were there, looking at Al Hubbard and saying of course I can work with these people. But there was a disconnect. What I found surprised me to the upside, because the people who were there in the White House staff were determined to help me be successful. Offering up staff in the White House if I wanted them to come over and work with me, giving me advice at Treasury, working with me to be successful, that was my experience. I can't comment on others' experiences.

Strong

I wanted to ask, also, a speculative question. These are always unfair. You said it was important that the two Presidential candidates didn't misbehave or didn't demagogue the issues while you were making these difficult decisions. What would have happened had this crisis occurred when a sitting President was running for reelection?

Paulson

I don't know. I think it's a very, in some ways, similar situation, because if you stop and think about it—and this is maybe a poor analogy, but in many ways it was like Obama was a sitting President and McCain was someone challenging, because the financial crisis worked to Obama's political advantage.

As I went through the process and talked with candidate Obama and candidate McCain, I was always much more worried about candidate McCain, and those conversations were much, much tougher than they were with Obama. At the time, I looked at that differently than I do now, looking back on it. At the time, frankly, I was quite upset with John McCain, and I worried continually about what he might say or do, and not with Obama.

But as I look back on it, I am grateful for the way that John McCain conducted himself, because he was the one who was way behind, and this was working to his disadvantage. It would have been very easy for him to demagogue it and start running against the bailouts. I would say that candidate Obama was well aware of that and he said to me more than once, "I'm constructive, I'm going to continue to be so, but you'd better talk to your guy, McCain, because if McCain goes off the reservation and starts criticizing the bailouts," he implied, "I'll have to change my rhetoric."

I felt I was sitting on a powder keg and that if John McCain started referring to the rescues as the bailouts and criticizing us for it, I wouldn't have gotten the TARP legislation. Now, if George Bush had been running—If I was the Treasury Secretary and he was running for a second term, all I can tell you is my experience with him was that he would have made all the right decisions. I'm totally convinced he would have; you can never make me believe anything other than that.

Now the question is what would have happened with Congress and where would we have been with Congress and where would the Democrats have been? I think that would have been a more difficult piece of the puzzle and maybe the Republicans would have been an easier piece of the puzzle than they were, but I also believe whoever was in power in Congress, in one house or the other, feels great pressure to act. If you will read Barney Frank's foreword to the paperback edition of On the Brink, I think he explains that as well I've heard anybody, in terms of what that dynamic is in Congress when you're facing a crisis.

Rodriguez

When we look back on these monumental crises like the Great Depression that really change people's views about our understanding of markets or government or regulation, what's appropriate or what's not, I wonder, given the enormity of this event, if you look back on it and you had any change of view or any redefinition of your views about the extent to which markets operate effectively, even about things like compensation policies, which are criticized, or about the proper institutions we need in a world that is far more global in reach and seems to test the limits of human ability to understand the complexity of financial markets.

Paulson

My thinking has evolved so much it's hard for me even to remember where it once was. [laughter] The world is an increasingly small place. Looking at environmental issues and ecological and climate issues, looking at economic issues, looking at geopolitical issues, and at a time when global cooperation and coordination is more important than ever, our global governance mechanisms and institutions are very inadequate. They need to be reconstituted. And of course for every nation, their national policies are always going to trump some kind of global governance mechanism. But how major countries work together and coordinate and cooperate, whether it's harmonizing—Regulation is always going to be done on a national basis, but how financial regulation is harmonized and how economic policies are harmonized is extraordinarily important.

So as I look at the root causes of the crisis, as I said earlier, the public has always blamed the banks for every crisis from the beginning of the financial history. It's easy to do, because the banks are at the epicenter of the action when there's a crisis and that's where the excesses are manifested and many mistakes are made. They made mistakes and there was some very bad behavior during the excesses in the bubble years preceding the crisis, which need to be corrected. But the root cause is government policies. Here, I'd say some of them are global. You know, I would go to these G7 meetings and G20, and we'd write the communiqu? and we'd talk about economic imbalances and you'd write the language. The US doesn't save enough, borrows too much; China saves too much; Germany saves too much, et cetera, and all these structural problems. But I do believe that that and the Great Moderation—the world awash in liquidity, flowing from nations that oversaved, to the US that overborrowed—was a contributor to the excesses, in addition to our policies.

Then of course when you look at the financial institutions—I've talked a lot about regulation. We had a greatly flawed regulatory structure—inadequate, outdated, outmoded, without the necessary powers. It's better today. It's still flawed. To have four safety and soundness regulators falling all over each other, competing while they are trying to coordinate when it's not a crisis, is difficult. You've heard me say that the Volcker rule is very flawed, because how do you eliminate proprietary trading and define it so the banks can continue to do the market making that's so essential? So that's maybe an impossible line to draw, but you make it really difficult and confusing and uncertain when you have four regulators trying to agree on how to do that, and adding to the uncertainty and confusion in the marketplace. But we now have powers we didn't have before, to deal with failing institutions; we have a number of the other things I talked about. I think the banks are better regulated, better capitalized, have much bigger liquidity cushions.

Big financial institutions are hard to run. You've heard me explain how I believe that the biggest, most complicated institutions should have tough regulation. I thought we needed better regulation as opposed to more regulation, and I think we got some of both. I really do believe one of the things that regulators need to look at is size. If financial institutions show that they can't manage themselves properly, if they make mistakes, if they have any activity that threatens their health—and there are many activities that can threaten their health other than proprietary trading—if they show that they can't manage their risk, then I think regulators have to be prepared to limit size, force divestiture, cause them to eliminate certain parts of their business. But greater size doesn't necessarily mean greater risk. And, if we try to force all the risk out of the big banks through overregulation, these activities will move elsewhere in our financial system. Rather than going away, the risks may manifest themselves in markets or market participants where there is less transparency and oversight.

In terms of compensation: Compensation is a big issue politically. I'm not sure that compensation played the role that so many people think it did in causing the crisis, but there is no doubt in my mind that compensation is out of whack, both in terms of the amount and the form of compensation that was paid. I don't believe it's the job of government to set or try to regulate compensation. I believe, though, that with financial institutions, regulators have a very legitimate responsibility to talk about the form of compensation and compensation systems, and make sure that this doesn't induce bad behavior.

When I was Treasury Secretary, one of the things that I worked on very hard was getting all of the regulators to come together and write one of the initial memos that was written to financial institutions on the importance of the form of compensation and the compensation system. Things have evolved beyond that point, and I think that compensation systems are in a much better place today than they were a few years ago.

Compensation did play an enormously important role in turning the public against the banks in the wake of the crisis. After the government had done so much to save the banking system, some of the bonuses the banks paid were unseemly, showed an appalling lack of self-awareness, angered me, enraged the public, contributed to the unpopularity of our financial rescue and stabilization measures, and will make it more difficult for future regulators to take appropriate actions when there is another financial crisis.

Rodriguez

I have one sort of follow-up on that, and it's related. I wonder if it speaks to your prior experience at Goldman, but it seems that for a moment, looking in the rearview mirror, it's easy, but that markets and the institutions themselves really tolerated very thin levels of capital that seem illogical in the rearview mirror. Do you think that they were illogical, or do you have any explanation for why that tolerance rose?

Paulson

I think they were. I want to say one thing about my experience at Goldman, because at the risk of sounding defensive, I think it's illustrative of a point. Capital levels are very important. I don't mean to say they're not, but the nominal capital on a balance sheet can be very misleading.

Rodriguez

Sure.

Paulson

For instance, investment banks like Goldman had very different accounting than commercial banks. Investment banks had mark to market—They were forced to mark their assets and liabilities to market continually. If they'd had the same accounting that the banks had, I don't think there would have been—At least I know in Goldman's case, they would have been at least as well or better capitalized. But more importantly, and this is the point that I make, liquidity is hugely important because—

Well, even before I get to liquidity, let me talk about a balance sheet. One level of capital, a lower level of capital, could be more than sufficient if, on the balance sheet, all you are financing is US Treasuries, for instance, so a lot depends on how liquid assets are on the balance sheet and the risk properties of those assets on the balance sheet. And because it's so difficult to measure risk and to look at assets that are liquid today and could be illiquid tomorrow, at Goldman Sachs we placed a huge focus on liquidity. When I was at Goldman Sachs, we had at the lockbox at Bank of New York, unencumbered Treasuries, and this was an insurance policy. It was $40 billion, then $60 billion, and then after I left, during the crisis, I believe that the firm, I've heard, kept raising that level. That is the ultimate protection, because the way firms died or almost died during the crisis was a run on liquidity.

When I talked with many of the CEOs on Wall Street during the crisis, Bear Stearns or Lehman for instance, and I asked what their liquidity cushion was, I realized afterward that they didn't have the liquidity cushion and the policies that Goldman Sachs had; they didn't measure liquidity the same way. They calculated liquidity cushions assuming normal markets and normal behavior. For instance, they held complex securitizations and mortgage-related securities that they were financing in the repo market, at close to a hundred cents on the dollar, while these illiquid assets were trading at values much less than that if they needed to sell them, and assuming they could continue to repo them at 100 cents on the dollar. The only way to define liquidity is, in a crisis, how many days can you go if everyone who has a call on your liquidity, everyone who can draw down a loan, does so, and everyone who can withdraw money from your institution does so, how long will you last?

Here is a huge point I have to make, that not only is a liquidity cushion the most important measure of an institution's ability to get through a crisis, there are very few private institutions that can maintain a big enough liquidity cushion to see themselves through a hundred-year storm. It's very important to maintain a big liquidity cushion, but because none can maintain one sufficient to withstand a huge crisis while performing their necessary function in the marketplace and being competitive, I believe it is wrong for any private financial institution to have a AAA rating, unless it is a government-owned institution.

Rodriguez

Sure.

Paulson

I believe that a AAA rating caused problems, and I'll give you an example. Let's take AIG. AIG had a AAA rating on its senior debt, and that was an improper rating and created a moral hazard for both AIG and those that dealt with it, because a number of AIG counterparties entered into derivative transactions, swap transactions, where they didn't demand collateral, but there was a ratings trigger, so if there was a downgrade, they could demand collateral. If there wasn't a downgrade, and AIG maintained its rating, these counterparties relied on that AAA rating, and not collateral. It was a moral hazard for AIG, because they had the arrogance to ask, "We're a AAA, we don't need to give you collateral," and they didn't say, "What happens if we get downgraded and we have to come up with the collateral?" So they took advantage of those that entered into the contract without the collateral, and then of course when the downgrade came, what happened?

Rodriguez

Got it, thank you.

Strong

When many of these transcripts are available and finally open, lots of files in the White House, at the Presidential Library, will also be open. Whose files would you want to look through to tell the story of the financial crisis from the White House perspective?

Paulson

There isn't really any other than the President. Ed Lazear and Keith Hennessey and Joel Kaplan followed everything and knew everything we did. Most of the preliminary work really emanated from Treasury, with the exception of autos. On autos, I would think Kaplan and Hennessey. But what I don't know is who the notetakers were, OK?

Strong

OK.

Paulson

At Treasury, regrettably, I don't think we had any—The people who were really doing the work and were key, the people like—I won't name them because I named them in my book—but the half-dozen people who basically did the heavy lifting on everything we did didn't take notes, at least I don't believe they did. If they did, I never saw them. To write my book, it took a lot of conversations with multiple people who were there and were part of it, to make sure we got it right.

Perry

I have a general question: did you notice a change in your relations with the President and how you dealt with the President procedurally or otherwise, once Karl Rove left?

Paulson

No. When I showed up, Karl Rove wasn't Chief of Staff. Josh was clearly the Chief of Staff. My relationship with the President changed as I developed a relationship of trust with him. Everyone is different. I think he would tell you that I tend to be different from his other advisors and that I just have a different style. It's very much what you see is what you get, these are the facts, this is the way I see it. I think one of the things he needed to learn was something I told him from the beginning, that I had much experience over many years dealing with principals, and I knew he was a principal and he was a decision maker, and I would press him hard if I disagreed, but that once he made a decision, there wasn't going to be any daylight between us. So it was dealing with that.

My relationship with the President didn't change when Karl left. There was, however, a difference in working in the White House decision-making process, where I first, for a short time, breathed a sigh of relief, and then I missed having Karl. The difference was that he was a person who, on a number of occasions, had been on the other side from me, and I knew when he was on the other side, he would go toe to toe. He was very smart, he was very demanding, he was very persuasive, and it was more work, you know?

But with Karl Rove, once a decision was made, he was 100 percent behind it. Then in working to deal with a problem, if it was a communications problem, a political problem, a policy problem, he was fantastically good. I felt that he's just a very good guy to have on your side. He might be in a different place before a decision was made, but once a decision is made, he's on your side. And he supported a rigorous decision-making process

[Long passage redacted]

Strong

You've mentioned several times how careful you were to tell the story accurately in your book. Who, on the outside of the administration, has written the best things about the financial crisis?

Riley

Present company excluded.

Paulson

An interesting question, because Andrew Ross Sorkin, in Too Big to Fail, got a lot of it right as it related to the crisis and Wall Street, and had insights into a lot of things I didn't, as he takes you inside the boardroom with different companies and all of that. Given what he wrote about the government and us at Treasury and others, which was largely right, I have to believe the parts of his book that relate to Wall Street were largely right, and they square with what I saw. The biggest part of my book relates to what I call the collision between politics and markets, and what happened in Washington and with Congress and so on. I don't think anybody's written that, other than me, right or wrong.

[Long passage redacted]

Riley

We're fast approaching our appointed time. When you are approached by younger people in the investment community and people who are successful or want to be successful in the finance business, do you encourage them to do government service?

Paulson

Sure, very much so. But they have to want to do it. The advice I give them is very nuanced advice. There are some people who really want to do government service. They live in Washington and take one of two paths. They're either career government people who go to work for the State Department as a Foreign Service officer, or Treasury or whatever; they do that for a career. Those people seldom ask me for career advice.

Then there are others who want the political appointee positions at the White House, in Treasury, in State, wherever. For some of them, that that is their overriding interest. I do everything I can to encourage them, not to dissuade them, that this is something they should do because they eat, sleep, drink government and politics. From the time their President leaves office and they leave office, they often stay in DC waiting for another member of their party to be elected President. In the meantime, they sit on the sidelines taking jobs in DC, law, or consulting firms, become lobbyists, or work for think tanks, but are unhappy until they get back.

For those who are in the private sector and are interested in government service, I do my very best to be helpful. I believe it's easier to go to the government when you're young, early on. It's great training, and I don't just say it because I did it. It shows you how your government works, and the skills that it takes to be successful in the private sector are the same skills for government success. It takes a different mindset to be successful in government, because the issues and problems are more difficult—the management challenges greater. But whether it's the private or public sector, no matter how good your ideas are, they are not useful if you can't persuade someone else and if you can't work with others to put them into action. Everywhere you go, the problems are not analytical; they're people issues. It is all about people. It's about multitasking, communicating, listening most. Many people do a poor job at listening, understanding the other person's perspective. If you just talk at them and try to convince them that you're right, you don't get anywhere. You need to learn to compromise. So it's a wonderful experience from that standpoint, but it is very difficult to go back and forth between the private sector and the public sector.

The career Washington people talk about the private sector and the public sector, and for them, when they talk about the private sector, the private sector just means leaving government and doing something in DC, which is still part of the government ecosystem, to get by to earn a living until they can get back to government. In some respects, they have never left.

Riley

Two blocks away.

Paulson

I look at it all as the public sector, but to the career Washington people, this is private sector. "I am now going to the private sector," which means they're not on the government payroll, but they're still part of that ecosystem and that food chain. So if you're going to go to a real private sector company, like I did, you just don't—If you then come back, you really, really interrupt your career.

I'll give an example: I had an opportunity to go back, in a senior job, in the Reagan White House in 1984, just as my career was just taking off at Goldman Sachs. I had been a partner for two years, and I just couldn't. If I were a career government person, I would have run back there and I would have missed my whole Goldman Sachs career and I would have never been Treasury Secretary. So I think it's a great time early on and it's a good time later, but for those who say to me, "Gee, I want to be a Cabinet Secretary," I say, "Good luck." I mean, that's just serendipity. Are you qualified? Does a President or the people he's got around him at the time they come in know you and trust you? Is there going to be a good fit and are you going to have the right relationships? With me, who knows what it was, but I have to tell you, it was a point in time. In 2006, to be the head of a very successful global bank was a great credential to have. In 2009, it was the kiss of death.

Riley

Sure.

Paulson

Four years earlier, it wouldn't have been, and look at it now. My gosh, how long will it be until you have another head of a global financial institution come to Washington? I hope it won't be too long, because I believe banking is a noble profession and I believe it's great training, but it's been discredited.

Riley

As I was reading this book, I kept thinking back to another one on my shelf that was very popular years ago, called How the Irish Saved Civilization. Do you remember that book? I thought this was a good companion account to that, given how close we were to the brink, and your very vivid account of what we had to go through. So I suppose this is a benediction of sorts in saying thank you for your service, thank you for agreeing to come here and spend a couple of days with us. I hope you found the time well spent. It has created an extraordinarily rich document that once we get in a position where we can get it out and people will look at it, they will find it extraordinarily illuminating.

There's blue sky outside, unbelievably.

Paulson

Thank you.