Hank Paulson has said that he doesn’t plan to use remaining $350 billion of the bailout funds. He’s already a lame duck. It’s clear he’s gone into legacy mode, trying to shape the way history will view his tenure as Treasury Secretary.
The Washington Post runs the first tranche of a two part series on the Treasury Secretary. This one is built around the temptation and conversion of Paulson from free-marketeer investment banker to taxpayer money spending regulator. It’s almost a minature version, a synecdoche if you will, of both our recent transformations and the broader story of American history from the age of robber barons to the New Deal-Great Society-Compassionate Conservatism-Age of Hope.
A quick way of reading the conversion is to watch the revisionism around the failure of Lehman Brothers. Contemporaneous accounts portrayed Paulson and others as willing to let Lehman fail in order to ameliorate the moral hazard costs of earlier financial market bailouts. The idea was that the benefits of adding the risk of failure back to the markets outweighed the costs of failure.
Since then the decision to allow Lehman to fail has been widely criticised. The conventional wisdom seems largely built on post hoc, ergo propter hoc reasoning: turmoil in the credit markets got worse after Lehman’s failure, therefore the failure caused the turmoil. That’s obviously a fallacy in terms of logic, but it’s undoubtedly become the official story line.
Even Paulson himself now seems to buy it. According to the Post, Paulson wanted to rescue Lehman all along, even if it meant the government providing assistance. He was prevented from rescuing Lehman by vaguely described legal barriers that didn’t give him authority to mount a rescue. We never quite learn what those were. The moral of the story: Paulson was right all along; the political structure was just too broken to allow him enough power to rescue us.
Let’s go to the video tape Post’s story:
Paulson had long believed that free markets work only if companies, no matter how big or vital to the financial system, could pay for their mistakes by failing. Nothing is as powerful a motivator as the possibility of a collapse, he would say.
He articulated this philosophy in a July speech in London and continued to maintain this viewpoint in public even as troubled Wall Street giant Lehman Brothers edged toward the brink in September. In interviews at the time, he warned of the dangers of repeatedly offering government guarantees to companies. Just three days before Lehman failed, Paulson reinforced the point, telling reporters and Wall Street executives that no government money would be used to save the 158-year-old investment bank.
But behind the scenes, Paulson had already shifted his position. He communicated a different message to executives at Barclays, a British bank that he had recruited to buy Lehman and save it from collapse.
“I said, ‘There wouldn’t be government support,’ ” Paulson said. “They said they wouldn’t buy it without government support.”
“Then I said, ‘Well, give us your best deal with government support, and let me try to figure out how to make it work.’ ” Though he had concluded that the Treasury Department did not have the authority to give Lehman money, he was willing to see whether the Federal Reserve would help bail out the bank, much as the Fed had provided crucial guarantees for the sale of the ailing investment bank Bear Stearns in March.
In the end, Barclays’s British regulator blocked the Lehman deal. The Fed, in turn, refused to prop up a company without a buyer from private industry.
Ultimately, Lehman failed, not because of Paulson’s convictions about how free markets should work but because he could not arrange a deal to save the firm, even with taxpayer money.
The fallout from Lehman’s bankruptcy filing Sept. 15 was severe. The firm had relationships with a wide range of hedge funds and financial firms. Some could not get their money back. Suddenly, investors on Wall Street could no longer be assured that their money was safe in any investment bank.
Just a day later, Paulson dropped publicly any pretense that large firms would be allowed to fail.
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