Fighting the Financial Crisis, One Challenge at a Time, by Henry Paulson, Commentary, NY Times: We are going through a financial crisis more severe and unpredictable than any in our lifetimes. We have seen the failures, or the equivalent of failures, of Bear Stearns, IndyMac, Lehman Brothers, Washington Mutual, Wachovia, Fannie Mae, Freddie Mac and the American International Group. Each of these failures would be tremendously consequential in its own right. But we faced them in succession…
By September, the government faced a systemwide crisis. After months of making the most of the authority we already had, we asked Congress for a comprehensive rescue package so we could stabilize our financial system and minimize further damage to our economy.
By the time the legislation had passed on Oct. 3, the global market crisis was so broad and so severe that we needed to move quickly and take powerful steps to stabilize our financial system… Our initial intent was to strengthen the banking system by purchasing illiquid mortgages and mortgage-related securities. But the severity and magnitude of the situation had worsened to such an extent that an asset purchase program would not be effective enough, quickly enough. Therefore, exercising the authority granted by Congress in this legislation, we quickly deployed a $250 billion capital injection program, fully anticipating we would follow that with a program for buying troubled assets.
There is no playbook for responding to turmoil we have never faced. We adjusted our strategy to reflect the facts of a severe market crisis, always keeping focused on our goal: to stabilize a financial system… By mid-October, our actions … helped us to accomplish the first major priority, which was to immediately stabilize the financial system. …
I have always said that the decline in the housing market is at the root of the economic downturn and our financial market stress. And the economy, as it slows further, threatens to prolong this decline, as well as the stress on our financial institutions and financial markets.
A troubled-asset purchase program, to be effective, would require a huge commitment of money. In mid-September, before economic conditions worsened, $700 billion in troubled asset purchases would have had a significant impact. But half of that sum, in a worse economy, simply isn’t enough firepower. …
The current $250 billion capital purchase program is strong medicine for our financial institutions. More capital enables banks to take losses as they write down or sell troubled assets. And stronger capitalization is essential to increasing lending, which is vital to economic recovery.
Recently I’ve been asked two questions. First, Congress gave you the authority you requested, and the economy has only become worse. What went wrong? Second, if housing and mortgages are at the root of our economic difficulties, why aren’t you addressing those problems?
The answer to the first question is that the … the financial rescue legislation … is not a panacea for all our economic difficulties. … But recovery will happen much, much faster than it would have had we not used TARP to stabilize our system. …
The answer to the second question is that more access to lower-cost mortgage lending is the No. 1 thing we can do to slow the decline in the housing market and reduce the number of foreclosures. Together with our bank capital program, the moves we have made to stabilize and strengthen Fannie Mae and Freddie Mac … will promote mortgage lending. We are also working with the Department of Housing and Urban Development, the F.D.I.C. and others to reduce preventable foreclosures.
I am very proud of the decisive actions by the Treasury Department, the Federal Reserve and the F.D.I.C. to stabilize our financial system. We have done what was necessary as facts and conditions … have changed, adjusting our strategy to most effectively address the crisis. We have preserved the flexibility of President-elect Barack Obama and the new secretary of the Treasury to address the challenges in the economy and capital markets they will face.
As policymakers face the difficult challenges ahead, they will begin with two considerable advantages: a significantly more stable banking system…; and the resources, authority and potential programs available to deal with the future capital and liquidity needs of credit providers. … I am confident of success, because our economy is flexible and resilient, rooted in the entrepreneurial spirit and productivity of the American people.
I see it a bit different. The financial bailout was necessary, but the initial rollout was botched badly and it created a huge backlash against the bailout program by the public. That didn’t have to happen, and it has made it much more difficult to do what is needed.
But that is another problem, getting the Treasury to understand what is needed, and then do it. I think the toxic asset removal program might have worked – a year ago – but they waited too long to do anything and it won’t work now. Buying the assets months ago when they were at a higher value would have, essentially, recapitalized the banks and helped them to avoid insolvency. (But it also means that the government would have probably taken losses on these assets. I think the losses would have been less than they will be now when you include the deterioration in the overall economy, but taking the losses would have likely created a public backlash. Demanding a share of future profits in return for removing the toxic assets might have helped on this front.)
For the most part – in every case I can think of – Paulson generally waited until he was forced to act. After dealing with a series of problems with individual financial intermediaries that were on the brink of failure, then making a big mistake by letting Lehman fail, things got so bad he was convinced we were close to, or at the meltdown point. Given that, he had no choice but to ask for a massive bailout.
Paulson now claims the problem is too large to do anything about now, or even on October 3 when the plan was passed, though the toxic asset removal plan would of worked a couple of weeks earlier in mid September. However, as he admits, the plans weren’t ready then, it took them until now to have the asset removal plans ready to go, so how could he have put the plan in place by October 3 even if congress had approved it the day he asked for it?
Instead of having plans ready, plans that that had been thought through enough so they could explain how they were supposed to work, they fiddled around with various ideas while bank balance sheets deteriorated. That left banks with a insolvency problem that needed to be addressed, but again Treasury was slow to do anything about it. They only acted when they were forced into this step and led by the nose by the British (and Paulson is now taking credit for doing this).
This financial crisis has been going on a long, long time, and they should have been planning long ago about how to deal with various contingencies. Plans should have been on the shelf and ready to go. Even now, they don’t have an agreed upon plan to address the foreclosure problem, something Paulson says he has believed all along is the key to stopping the deterioration. Then why don’t we have a plan? It has been in the planning stages for who knows how long, and the plans are now being abandoned since the clock has run out. It’s hard not to wonder if the delaying tactics are ideologically based and intentional. Hem and haw long enough so that nothing gets done.
A committed and competent Treasury could have done a lot to help the situation, but unfortunately, that is not what we got. Let’s hope the next administration makes better choices.
Originally published at the Economist’s View and reproduced here with the author’s permission.