Hank's Book - My Take

If the financial history of the globe is a topic of interest to you Hank Paulson’s new book, On The Brink
is a must read. Tim Geithner and Ben Bernanke were central parts of
that part of our history, but after reading this book you come away
with the conclusion that it was Paulson who was pulling the strings
every inch of the way.

There were some aspects of the book that I found to be not credible;
there was one critical section that I thought the facts were a bit
distorted. I think there was one part of the story that was omitted. As
a result I was left questioning how many other aspects of this story
were ‘skewed’.

Start with what I think is an indisputable fact. Hank Paulson is one of
the smartest financial guys in the world. He is one of the top
investment bankers; he knows debt and corporate finance as well as
anyone. Throughout his book Hank demonstrates his knowledge and
establishes the fact that he knows everyone in the game on a first name
basis.

Given that as a backdrop I have issues with the credibility of the following sections of the book:

I) What did he know (suspect) and when did he know it?

On August 17, 2006 the newly appointed TSec. Met in Camp David with
president Bush and his economic team. At that meeting Paulson said


“If you look at recent history, there is a disturbance in the capital markets every four to eight years”.

Hank added in the book, “I was convinced we were due for another disruption”.

Hank was a very much a hands on CEO at GS before becoming TSec. He was
a big risk taker, but he was very measured in his bets. I think it is
important to look at GS’s record in the years preceding 2006 as a clue
to Paulson’s thinking.

In the 2003-2006 periods Wall Street was coining money in
originating/packaging and distributing Sub Prime and Alt-A mortgages.
In those same years GS consistently ranked last or next to last on the
league tables of how much of this business was done. If GS wanted to be
#1 in this business they could have been. They had the brains, the
balance sheet and the moxie. So for me this is a sign that the senior
management at GS took a hard look at a big money making operation and
said, “This one is going to stink, let’s keep a low profile”.

I think that Paulson was a big factor in steering GS away from the junk
mortgage pitfall that ended up killing the competition. He had made up
his mind on this issue years before the August 06 Camp David meeting.
He saw on a daily basis the absolute junk that was coming from Wall
Street. I maintain that when he spoke he knew in the back of his mind
that the source of the “next financial crisis” he was warning about was
going to be bad mortgages.

If in 2006 Hank had sounded the alarm bell as he had inside of GS there
would have been a different outcome in 08 and 09. There were plenty of
people (including myself) who were looking at the debt that was being
created from the junk and saying, “This is just getting silly”. Paulson
was too smart and too connected to have not seen this. He does not
acknowledge this in his book. He claimed that he smelled trouble, but
did not know where it would come from. I find that hard to believe.


II) The TARP debt for equity Flip Flop

Anyone who knows corporate finance knows that equity is worth 10X’s
more than debt. Paulson knows this from forty years ago. With this in
mind the time line of how the TARP program was shifted to one of buying
distressed assets to buying the equity in the banks is important.

The TARP program was sold to the public and to Congress as a program to
buy toxic assets that were “clogging” the system. Congress agreed to
the $700b program on October 2, 2008. It contained a provision whereby
Treasury could use the funds to acquire equity if necessary, but the
expectations by all were that Treasury would be buying toxic assets and
not common or preferred shares. Ten days later on October 12th Paulson
changed the game and switched from buying trouble mortgages to buying
equity in the banks.

In the book Paulson gives credit to two unlikely sources for the change
in his thinking. Warren Buffet and Ben Bernanke. I think he just used
those two as the basis for the change in plans. They just confirmed
what he wanted do all along. Paulson makes reference to a discussion on
September 30th 2008 with Bernanke:

“Ben Bernanke told me that he thought that solving the crisis
would demand more than illiquid asset purchases”. In Bernanke’s view,
“we would have to inject equity capital into financial institutions”.

So it was Ben that planted the seed for the massive flip flop on the
use of TARP funds. I think the seed was already there and Hank used Ben
to support what he had already concluded.

Nine days after TARP was passed (October 11) Paulson had a phone
conversation with Warren Buffett. During that call Buffett urged
Paulson to consider investing the TARP money in low coupon preferred
stock in the banks as an alternative to buying assets. Paulson
describes this as a ‘eureka’ moment. The point where he became
convinced that this was the right way to use the money. He said of this
phone call, “I was convinced Warren’s was the best way to make a capital purchase program attractive to banks”.

For me, this version of history does not pass the smell test. I believe
that Paulson was well aware of the leverage that could be obtained by
investing in equity versus debt. He describes in the book how $70b of
equity could cover $700b in debt at a bank. Hank knew the value of
equity. I maintain that his plan was all along to acquire equity, but
he knew he could not sell that plan to Congress, so he masked his plans
with a debt buyback. That the TARP legislation was drafted to give him
the ability to buy equity was not a mistake of history, it was a part
of a plan that Paulson had considered from the very beginning.

After the decision had been made to change the use of Funds and the
money had been committed, Paulson continued to have Neel Kashkari
(visibly) chasing after a methodology to implement an asset purchase
program. This was done as a smoke screen to Congress to demonstrate
that the original intent of the legislation, to buy troubled assets,
was being pursued. No TARP money was ever used to buy the assets it was
intended for.


The James Lockhart, OFHEO/FHFA Connection

A significant part of the book is spent relaying the facts leading up
to the conservatorship of the GSEs, Fannie and Freddie. I think there
was a significant misrepresentation of the facts in the book. On page 6
Paulson says:

“I had spent much of August working with Lockhart. A friend of
the president’s since their prep school days. Jim understood the
gravity of the situation, but his people, who had said recently that
Fannie and Freddie were adequately capitalized, feared for their
reputations”.

This is not factually correct. It was not ‘some of Lockhart’s people’
who made the statement that F/F were adequately capitalized. It was
Lockhart himself. In the days that followed, both Paulson and the
president* repeated Lockhart’s words. Headlines and links on this:

Link: Here

Link: Here

The fact that the president*, the TSec. and the chief regulator of the
GSE’s all made misleading public statements regarding the health of the
GSEs just months before they were put into conservatorship is an
important part of this history. We now know, both from the book and
other information, that there was a very high level of concern
regarding the Agencies at exactly the time that these statements were
made. These were listed companies with a big stock float; misleading
information on their health was made public. Our highest officials
repeated that information.

This aspect of the story was not put in the proper perspective. The
implications of Lockhart’s words along with Paulson’s and the
president’s role were glossed over. It is my opinion that a mistake was
made with these statements. Paulson did not acknowledge that. This puts
a taint on the entire narrative. If I can’t trust this aspect of the
story, I have trouble believing in the rest of the information as well.

A Missing Link?

In numerous sections Paulson makes clear that as TSec he actually did
not have much power to commit money toward fixing problems. He had no
Bazooka and he wanted/needed one. To do anything,  he had to have the
prior permission of Congress. TARP ultimately became his congressional
bazooka. Hank and his staff knew early on that they needed the ability
to act decisively and without the consent of Congress. They looked
endlessly for ways to fight the battles without having to go to the
Hill. They even used the 1934 Exchange Stabilization Fund to guaranty
the money market funds. This step was effective; it showed how
resourceful they were. It showed how far they were willing to push the
envelope.

One unused arrow in Treasury’s quiver was the Federal Financing Bank
("FFB"). This is a doghouse bank owned by Treasury. It finances
government agencies like HUD and the Post Office. It makes long-term
loans to rural electrics, it provides financing for foreign arms sales.
The FFB has made big loans to the FDIC in the past. It has a mandated
ceiling on its balance sheet of $500 billion. In 2008 it had assets of
only $50b, it had $450b of buying bower. So this bank had to have been
considered as a tool for Hank to use. He left no other stone unturned.
I, for one, can’t believe that he did not consider FFB when he was
looking for a bazooka and he didn’t want to ask congress for a new one.
There is no mention of the FFB in the book. I found that odd.

The following is not based on facts that I can deliver to you. Therefore treat it as such. **

I wrote a piece sometime ago on the FFB. Later on someone who claimed
to have the minutes of the FFB May 2008 Board minutes contacted me.
(The minutes are not public) I did not review this; portions of it were
read to me on the phone. There was one comment that struck me. I do not
recall the exact language. The essence was that in the minutes there
was a reference to a meeting that took place outside of the Board
Meeting and at that meeting there was some discussion of using FFB to
acquire significant quantities of mortgage related assets. No details
of that meeting were included in the minutes. As TSec. Hank Paulson was
the Chairman of the Board of the FFB, he had to be part of those
discussions. FFB was his “baby”.

My thinking on this has always been that the idea of using FFB to
acquire assets was a continuation of the ‘Break the Glass’ plan that
was developed by Treasury in February/March of 2008. This was the blue
print for TARP. The missing link to the break the glass plan was where
does the money come from? FFB was a possible candidate given that it
was controlled and run by Treasury and had the capacity to buy a lot of
assets. FFB was not designed to do this. My assumption was that it was
looked at and it was determined that there were legal (political?)
restrictions on FFB that would not allow it to be the bazooka that Hank
wanted. (Note: FFB did go on to buy $400mm of worthless Hope Now bonds.
So it was used as a popgun not a bazooka.)

There is another more speculative side to this. What mortgage assets
were being considered for purchase? The toxic ones or was there
consideration back in May of 2008 to acquire the MBS of Fannie Mae,
Freddie Mac and Ginnie Mae. We will never know. There is no discussion
of this in the book and the details of that meeting back in May of 08
will remain a mystery.

In the Author’s Note, Paulson says, “I have been blessed with a good memory”. I wonder why his memory is not so good on this aspect of the story.

Notes:

*On July 10, 2008 I was asked to draft a question re: the GSEs that
would be posed to President Bush by a FOX business reporter. I did
that, and the question was asked. Bush totally dodged my question and
responded, “Their (F/F’s) regulator (James Lockhart, his childhood
friend) has said, ‘they are adequately capitalized’”. End of interview.
I don't have a clip of this, but Roger Ailes at FOX does. Someday it
will be re-aired as part of this history.

**I write to government agencies all the time. I ask them questions.
They often say, ‘Buzz off”. Sometimes they say, “Here’s the info you
wanted.” It is rare that I do not get a response. I didn’t get any from
these:

12/3/2009 to FFB
Hello, I am a journalist. I write about financial matters.


Can you provide me with the Email link that has the minutes of May 2008 FFB board meeting?

12/14/2009 to FFB
Hello again. I am disappointed at the lack of response on my request. Possibly I should put some cards on the table.


I have reviewed the May 2008 board minutes. I took notes but do not
have a copy. I know that you have given this link to other journalists.
I learned of this from them. They contacted me to help with a story on
this. I know that there is a reference in the minutes to a secret
meeting. I know that the topic of this secret meeting was a discussion
as to the feasibility of the FFB acquiring Mortgage Bonds. This meeting
is an important part of that history. I would like to know more about
it. I believe my readers (2mm this year) would also like to know about
it.


Please reconsider my request. Thank you.

Comments

[bchbum]

Don't forget traitor.

[Fat Bob]

+1

[Rainman]

Nice fact checking, Bruce. This book represents Volume 1 in a series of ass-covering fictional characterizations of what lead to Great Depression II.

I sure hope you didn't have to PAY for the book. I'm a firm believer in starving off the bookwriting proceeds of present/former politicial beasts. 

[JohnXXX]

He's a liar, Bruce. That's all you need to know. End off. Period. Full stop.

[Careless Whisper]

Max Keiser said the book should be titled; Steal This Book And I'll Collect Triple On The Insurance

I think Paulson is a lyin' piece of shit and besides Goldman is really a taxpayer backed hedge fund, isn't it!?