EXCERPT: Henry M. Paulson Jr.'s: 'On the Brink'

The president and his advisers were well informed of the seriousness of the situation. Less than two weeks before, I had gotten on a secure videoconference line in the West Wing to brief the president at his ranch in Crawford, Texas, and explained my thinking. Like him, I am a fi rm believer in free markets, and I certainly hadn't come to Washington planning to do anything to inject the government into the private sector. But Fannie and Freddie were congressionally chartered companies that already relied heavily on implicit government support, and in August, along with Bernanke, I'd come to the conclusion that taking them over was the best way to avert a meltdown, keep mortgage fi nancing available, stabilize markets, and protect the taxpayer. The president had agreed.

It is hard to exaggerate how central Fannie and Freddie were to U.S. markets. Between them they owned or guaranteed more than $5 trillion in residential mortgages and mortgage-backed securities -- about half of all those in the country. To finance operations, they were among the biggest issuers of debt in the world: a total of about $1.7 trillion for the pair. They were in the markets constantly, borrowing more than $20 billion a week at times.

But investors were losing faith in them -- for good reason. Combined, they already had $5.5 billion in net losses for the year to date. Their common share prices had plunged -- to $7.32 for Fannie the day before from $66 one year earlier. The previous month, Standard & Poor's, the rating agency, had twice downgraded the preferred stock of both companies. Investors were shying away from their auctions, raising the cost of their borrowings and making existing debt holders increasingly nervous. By the end of August, neither could raise equity capital from private investors or in the public markets.

Moreover, the financial system was increasingly shaky. Commercial and investment bank stocks were under pressure, and we were nervously monitoring the health of several ailing institutions, including Wachovia Corporation, Washington Mutual, and Lehman Brothers. We had seen what happened in March when Bear Stearns's counterparties -- the other banks and investment houses that lent it money or bought its securities—abruptly turned away. We had survived that, but the collapse of Fannie and Freddie would be catastrophic. Seemingly everyone in the world -- little banks, big banks, foreign central banks, money market funds -- owned their paper or was a counterparty. Investors would lose tens of billions; foreigners would lose confi dence in the U.S. It might cause a run on the dollar.

The president, in suit coat and tie as always, was all business, engaged and focused on our tactics. He leaned forward in his blue-and-yellow-striped armchair. I sat in the armchair to his right; the others were crowded on facing sofas. I told the president we planned to summon the top management of Fannie and Freddie to meet with Bernanke, Lockhart, and me the following afternoon. We'd lay out our decision and then present it to their boards on Saturday: we would put $100 billion of capital behind each, with hundreds of billions of dollars more available beyond that, and assure both companies of ample credit lines from the government. Obviously we preferred that they voluntarily acquiesce. But if they did not, we would seize them.

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