Paulson’s Itchy Finger, on the Trigger of a Bazooka
“If you’ve got a bazooka, and people know you’ve got it, you may not have to take it out.”
That’s what Treasury Secretary Henry M. Paulson Jr. told a Congressional panel in July about his plans to stabilize Fannie Mae and Freddie Mac and, with them, the financial markets.
The bazooka in question was his new authority to seize the two mortgage finance giants if things went horribly wrong. The thinking was, if the markets knew that Mr. Paulson was packing heat, the markets would back off and confidence would be restored. He might save Fannie and Freddie without firing a shot — sort of a Wall Street version of the theory of deterrence.
And yet the moment Mr. Paulson uttered that line, it was all over for Fannie and Freddie. Once he mentioned that bazooka — that is, the possibility that the Bush administration might take over the two companies — he virtually guaranteed that that was exactly what would happen. On Sunday, his bazooka went off, and the shot is still reverberating around the world.
The rest was just theater. For the last two months, Fannie and Freddie ran around Wall Street searching for a savior. Private equity? Sovereign wealth funds? Anyone?
But Wall Street was never really sure what Mr. Paulson would do — and that was a problem. “He never laid out a roadmap and how he would use the power. Because of the uncertainty nobody was willing to put in money” into Fannie or Freddie, said Doug A. Dachille, the chief executive of First Principles Capital Management.
The companies also never got the chance to tap people who already owned their stock for additional cash. “We will never know whether existing shareholders would have put in money,” Mr. Dachille said.
Meanwhile, the companies’ bankers — Goldman Sachs, JPMorgan Chase and others — jockeyed for positions of influence, and yes, fees. (Morgan Stanley, which had been working for Freddie — and was at one point demoted, according to company executives — jumped ship and found a more prestigious, pro bono role advising Mr. Paulson and the government.)
But the real question is, did things have to end this way? The answer, many on Wall Street believe, is yes. But maybe not when nor the way it did.
Many people in financial circles can’t quite figure out why Mr. Paulson, the former chairman of Goldman Sachs, pulled the trigger when he did. He insisted politics had nothing to do with it. Never mind that the news broke just after the Democratic and Republican conventions, but as far away as possible from the November election.
But as of last week, Fannie and Freddie, for all their troubles, seemed to be bumbling along O.K. Both were able to roll over their enormous debts in the capital markets. Sure, Wall Street was nervous about those debt auctions, but the sales were running efficiently, in part because Mr. Paulson’s promise — or threat, depending on your view — showed that the government would stand behind the companies in the end.
What’s more, Fannie had made good on its promise to raise $5.5 billion last spring, before Mr. Paulson asked Congress for his bazooka. By most analysts’ accounts, Fannie had enough wiggle room to stay in business for a while longer, if not find a way out of the mess down the road.
“We are surprised that such measures are deemed necessary at this time,” Bradley Ball, a research analyst at Citigroup, wrote in a research report on Sunday night.
Freddie — long considered the more troubled of the two — was capitalized enough to keep going through 2009, many analysts believe. “Even if neither raises another dollar of capital over the next year, we estimate that both companies will likely remain above their statutory minimum requirements,” Bruce W. Harting, an analyst at Lehman Brothers wrote.
Neither company is blameless. Freddie seemingly refused to raise new money while it still could, in part, for fear of diluting its shareholders and selling too low. Freddie was convinced it could recover first; the power of optimism is a dangerous force. Indeed, it was Freddie’s balance sheet that had Mr. Paulson most worried, at least in the immediate term.
Could Mr. Paulson have put Freddie into a conservatorship without bringing Fannie in too? Probably not. It would have just put more pressure on Fannie.
In the end, Mr. Paulson’s decision seems to have been a philosophical one, rather than one forced by imminent crisis. Of course, for stagecraft purposes, it was played as impending disaster.
His decision will either go down as a masterstroke — or a horrible mistake.
He appeared to want to take care of the problem himself — perhaps guaranteeing him a lasting legacy — during his time in the Bush administration. This way, had either Fannie or Freddie run into problems in the next administration, nobody could point the finger at him. For that reason, perhaps we should give credit to Mr. Paulson for jumping in ahead of more problems instead of looking back and playing Washington’s blame game after the fact.
There’s something very Wall Street about the decision: firms often write down their bad investments in one year, so they can start the next year fresh.
All of us will bear the cost, of course. The scariest part of Mr. Paulson’s economic acrobatics is that we won’t know for years just how much this will cost us. On CNBC on Monday morning, when asked about how big the bill might be, Mr. Paulson replied, “We didn’t sit there and figure this out with a calculator.” Apparently, he wasn’t joking.
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Sorkin, Andrew R. “Paulson’s Itchy Finger, on the Trigger of a Bazooka.” NY Times. 8 Sept. 2008.The New York Times.9 Sept. 2008 <http://www.nytimes.com/2008/09/09/business/09sorkin.html?ex=1378699200&en=4774a26c31dca726&ei=5124&partner=facebook&exprod=facebook>.
