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

Lockhart went first. He took Fannie Mae through a long, detailed presentation, citing one regulatory infraction after another. Most didn't amount to much, frankly; they were more like parking tickets in the scheme of things. He was a little nervous and hesitant, but he brought his speech around to the key point: his examiners had concluded there was a capital deficiency, the company was operating in an unsafe and unsound manner, and FHFA had decided to put it into conservatorship. He said that we all hoped they would agree to do this voluntarily; if not, we would seize control. We had already selected a new CEO and had teams ready to move in.

As he spoke I watched the Fannie Mae delegation. They were furious. Mudd was alternately scowling or sneering. Once he put his head between his hands and shook it. In truth, I felt a good bit of sympathy for him. He had been dealt a tough hand. Fannie could be arrogant, even pompous, but Mudd had become CEO after a messy accounting scandal and had been reasonably cooperative as he tried to clean things up.

I followed Lockhart and laid out my argument as simply as I could. Jim, I said, had described a serious capital deficiency. I agreed with his analysis, but added that although I'd been authorized by Congress to do so, I had decided that I was not prepared to put any capital into Fannie in its current form. I told them that I felt Fannie Mae had done a better job than Freddie Mac; they had raised $7.4 billion earlier in the year, while Freddie had delayed and had a bigger capital hole. Now, however, neither could raise any private money. The markets simply did not differentiate between Fannie and Freddie. We would not, either. I recommended conservatorship and said that Mudd would have to go. Only under those conditions would we be prepared to put in capital.

"If you acquiesce," I concluded, "I will make clear to all I am not blaming management. You didn't create the business model you have, and it's flawed. You didn't create the regulatory model, and it is equally flawed."

I left unspoken what I would say publicly if they didn't acquiesce.

Ben Bernanke followed and made a very strong speech. He said he was very supportive of the proposed actions. Because of the capital deficiency, the safety and soundness of Fannie Mae was at risk, and that in turn imperiled the stability of the financial system. It was in the best interests of the country to do this, he concluded.

Though stunned and angry, the Fannie team was quick to raise issues. Mudd clearly thought Fannie was being treated with great injustice. He and his team were eager to put space between their company and Freddie, and the truth was they had done a better job. But I said that for investors it was a distinction without a difference -- investors in both companies were looking to their congressional charters and implicit guarantees from the United States of America. The market perceived them as indistinguishable. And that was it. The Fannie executives asked how much equity capital we planned to put in. How would we structure it? We wouldn't say. We weren't eager to give many details at all, because we didn't want to read about it in the press.

"Dan's too gracious a man to raise this," said Beth Wilkinson. "But we're a unified management team. How come he is the only one being fired, and why are you replacing him?"

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