I generally prefer systemic explanations for events, but it is obviously worthwhile to complement this with a careful study of key individuals. And in the current crisis, no individual is as interesting or as puzzling as Hank Paulson.
The big question must be: How could a person with so much market experience be repeatedly at the center of such major misunderstandings regarding the markets, and how could his team – stuffed full of people like him – struggle so much to communicate what they were doing and why?
Hank Paulson’s exit interview with the Financial Times contains some potential answers but also generates at least some new puzzles.
Paulson argues that he lacked the legal powers and resources necessary to intervene decisively and early on in the crisis, and this may account for some of his actions through mid-September. Still, the Fed has plenty of powers and essentially unlimited resources in a crisis, and it’s not clear why Paulson and Bernanke, acting together, couldn’t have done more – for example, after Bear Stearns revealed (to most observers, private and official, and presumably to them) the depth of the systemic problems. It’s odd that Paulson feels the severity of the crisis was only apparent after the intervention in Fannie Mae and Freddie Mac.
The greatest puzzle, of course, is why Lehman was not saved. Paulson essentially says that letting Lehman fail was not his idea, and the well-informed FT article implies it was definitely not due to Geithner. Yet it’s not plausible that Bernanke would have taken such a stand. So who did it?
(The excellent recent WSJ article on that critical weekend – link here, but subscription required – also jumps that key moment; it’s as if there is a cone of silence on this point. Perhaps Geithner’s upcoming confirmation hearing will reveal more.)
But there is also a more analytical puzzle. In his interview, Paulson stresses the role of capital flows and the so-called “global savings glut” in driving down risk premia and encouraging a system full of bad decisions (and the FT rightly regarded this as an important statement, and put it on the front page). Paulson also implies that more urgent multilateral action on this dimension would have helped.
Yet Paulson himself was instrumental in blocking, or not taking forward (and that’s close to the same thing), the deal brokered in the Multilateral Consultation between the world’s major trading areas. This was a major opportunity to advance policies both in the US and elsewhere that would have exactly addressed what Paulson now says was an evident first-order system problem.
Of course, the idea of de-emphasizing any kind of multilateral approach might have come from the Bush White House, but this level of detail is almost always delegated to the Treasury. And there is every indication that Mr. Bush trusted completely and listened carefully to Paulson at every stage, including throughout this fall’s downward spiral.
Corroborating evidence for the idea that Paulson did not want to work in a multilateral fashion comes from the fact that in fall 2007 he called for sharp spending cuts at the IMF (see his IMFC statement, near the top of the last page). The US Treasury continued to push for these cuts in the ensuing months, despite the obvious onset of a serious worldwide financial crisis – about which they, of all people, surely had the most inside knowledge. In fact, despite the current series of urgent crises, the IMF still finds itself constrained by the roughly 20% budget cut that the US insisted upon. Quite why these limits on spending were not immediately relaxed after September – which would have been easy to do under G7 or G20 leadership – is yet another mystery that can presumably be traced back to the attitude of the US authorities, although the crisis-deniers in Europe probably also played a supportive role.
In any case, Paulson was entitled to choose a strategy to address global imbalances other than that of the Multilateral Consultation. But what was his global strategy.? No one has yet been able to explain that to me, but please do make suggestions in comments on this post.
Other posts in this occasional series.
Originally published at the Baseline Scenario and reproduced here with the author’s permission.