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

I left the White House and walked back to Treasury, where we had to script what we would say to the two mortgage agencies the following day. We wanted to be sure we had the strongest case possible in the event they chose to fi ght. But even now, at the 11th hour, we still had concerns that FHFA had not effectively documented the severity of Fannie's and Freddie's capital shortfall and the case for immediate conservatorship. The cooperation among the federal agencies had generally been superb, but although Treasury, the Fed, and the Office of the Comptroller of the Currency (OCC) agreed, FHFA had been balky all along. That was a big problem because only FHFA had the statutory power to put Fannie and Freddie into conservatorship. We had to convince its people that this was the right thing to do, while making sure to let them feel they were still in charge.

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. The president himself wouldn't intervene because it was inappropriate for him to talk with a regulator, though he was sure Lockhart would come through in the end. In any event, I invoked the president's name repeatedly. "Jim," I'd say, "you don't want to trigger a meltdown and ruin your friend's presidency, do you?"

The day before I'd gone to the White House, I spoke with Lockhart by phone at least four times: at 9:45 a.m., 3:45 p.m., 4:30 p.m., and then again later that night. "Jim, it has to be this weekend. We've got to know," I insisted.

Part of FHFA's reluctance had to do with history. It had only come into existence in July, as part of hard-won reform legislation. FHFA and its predecessor, the Office of Federal Housing Enterprise Oversight, which Lockhart had also led, were weak regulators, underresourced and outmatched by the companies they were meant to oversee, and constrained by a narrow view of their charters and authorities. FHFA's people were conditioned by their history to judge Fannie and Freddie by their statutory capital requirements, not, as we did, by the much greater amounts of capital that were necessary to satisfy the market. They relied on the companies' own analyses because they lacked the resources and ability to make independent evaluations as the Fed and OCC could. FHFA preferred to take the agencies to task for regulatory infractions and seek consent orders to force change. That approach wasn't nearly enough and would have taken time, which we did not have.

Complicating matters, FHFA had recently given the two companies clean bills of health based on their compliance with those weak statutory capital requirements. Lockhart was concerned -- and Bob Hoyt, Treasury's general counsel, agreed -- that it would be suicide if we attempted to take control of Fannie and Freddie and they went to court only to have it emerge that the FHFA had said, in effect, that there were no problems.

We had been working hard to convince FHFA to take a much more realistic view of the capital problems and had sent in teams of Fed and OCC examiners to help them understand and itemize the problems down to the last dollar. The Fed and the OCC saw a huge capital hole in Fannie and Freddie; we needed to get FHFA examiners to see the hole.

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