The Paulson Crisis
One issue that I don’t think has been adequately explored yet is the extent to which our current predicament is attributable to Hank Paulson’s mismanagement of the situation ten days ago. After underreacting to problems at Lehman Brothers and bringing us close to brink, Paulson abruptly reversed months of (false) reassurance that everything was fine and decided that dramatic action was needed. The smart thing to do would have been to privately alert key congressional leaders that he thought the ad hoc approach wasn’t sustainable and they and their staffs should expect to spend the weekend in sequestered talks with him and Ben Bernanke to work something out. They could have announced to the public that bipartisan discussions were underway to think out a comprehensive approach to problems in the financial system. I bet something could have been worked out.
Instead, Paulson unilaterally unveiled a plan that, in its initial form, was completely unacceptable to legislative leaders in either party. And then, in a misguided effort to ramrod a bad bill through congress, he did the equivalent of strapping a bomb to the entire US economy by dramatically announcing that the entire banking system was on the verge of imminent failure.
Naturally, this had the effect of taking whatever real problems were growing and making them much more severe by creating a sense of panic. It did not, however, have the effect of transforming an unacceptable plan into an acceptable one. So congressional leaders wound up needing to meet privately and negotiate with Paulson anyway. Which is what he should have done in the first place. But in the interim, justified criticism of Paulson’s initial plan helped poison opinion against the (better) bill that eventually emerged. Had Paulson proceeded in a more reasonable manner from the get-go, I think it’s very possible that we wouldn’t be in this situation.
37 Responses to “The Paulson Crisis”
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September 30th, 2008 at 9:33 am
I have no desire to exculpate Paulson in any way, but still, he does work for the Bush Jr administration, and he handled this situation exactly as Bush / Cheney like to do things. Including an over-the-top ballsy arrogance that may have been what helped doom the bill (for now). That’s not a coincidence in my view.
September 30th, 2008 at 9:34 am
Matt,
Well said.
September 30th, 2008 at 9:38 am
Management by panic is all Mr Paulson knows. I doubt he saw the problem until it was too late and then freaked out.
September 30th, 2008 at 9:39 am
I think Matt has the politics right, but I am not sure about the economics. My sense is that the initial economic reaction to Paulson’s plan was positive in that it did in fact calm down the credit markets a bit. Of course now people are indeed starting to panic again as uncertainty about the bailout increases, but I’m not sure it is obvious that panic is worse than it would have been anyway.
September 30th, 2008 at 9:52 am
I agree with DTM, Matthew has the politics correct, which is really unfortunate. This has so little to do with the Treasury Secretary and far more to do with the regulatory environment (read good and bad regulations as well as no regulations) that preceded his tenure. Fannie and Freddie, Sarbanes Oxley, CRA, bad loans, greedy banks, stupid politicians. This all has more to do with the problems were facing right now.
Give Paulson some credit…what people don’t realize is that the guy had been sounding the trumpet (in the background) before all of this broke.
September 30th, 2008 at 9:55 am
Whatever the reaction to the plan was does not negate the fact that he greatly exacerbated the DOW slide by declaring that if his plan is not adopted, there will be economic catastrophe.
September 30th, 2008 at 9:58 am
And then, in a misguided effort to ramrod a bad bill through congress, he did the equivalent of strapping a bomb to the entire US economy by dramatically announcing that the entire banking system was on the verge of imminent failure.
You have this completely bass-ackwards.
On Thursday the 18th, four days after Lehman failed and Merrill was sold, two days after AIG was bailed out, the markets were on the brink of complete collapse. Morgan Stanley and Goldman Sachs were heading towards bankruptcy or firesale by week’s end. A deal was not in place at that time for WaMu or Wachovia and either could have been forced to declare bankruptcy. The entire banking system was on the verge of imminent failure. Everyone involved in financial markets knew it, but the public at large did not. In order to get political support, he needed to trumpet the cause. Apparently he needs a bigger trumpet.
Paulson also needed to loudly announce a bold plan immediately to keep the stock market from crashing and the credit markets from seizing up that Thursday (both of which are now happening). Of course his plan had foolish aspects, but it was the directness and boldness with which he announced his intention to fix the situation that calmed the markets for the last ten days.
September 30th, 2008 at 10:09 am
Evidence for this claim? Every economics blog I have read since he came into power in July 2006 has been relentless in pointing out how naive he has been. See Dean Baker for more.
Maybe you are confusing Paulson with Roubini.
September 30th, 2008 at 10:13 am
Heck-of-a-job, Paulsie.
September 30th, 2008 at 10:14 am
This seems pretty much right to me. I’m angrier in retrospect that Paulson and Co. made such a big deal over getting a clean bill. Now of course this was probably a Republican-saving effort, but I think it turns out that dissenting Republicans either opposed the whole idea from Day One when Paulson put out his original plan or opposed the bill yesterday because Pelosi made them cry- neither of which have much to do with the tinkering done over the weekend. So it turns out that declaring the crisis to be of such magnitude sorta precludes the ability to drive much of a bargain. Indeed, Paulson should’ve lowered his horizons from the beginning.
But as has been stated many times before, this White House just doesn’t know how to work with Congress… even when their party ran it.
September 30th, 2008 at 10:18 am
second to right’s comment. paulson didn’t necessarily handle this correctly (as someone else said, he is part of the bush administration), but it’s not talking that made the problem worse: the problem got way worse in the aftermath of the lehman bankruptcy.
and i’m sorry if that sounds like “counterproductive sneering” to point out that matthew simply has this wrong and needs to understand the circumstances better before he carries on implying that the problem we have is a problem of talking and not of finance.
September 30th, 2008 at 10:25 am
Paulson certainly made a hash of this in a number of ways, but “right” is correct that he had to announce the bailout publicly. The crisis was moving way too quickly two weeks ago to wait until a bill was in final agreed form–a public signal was required.
What he should have done, in my view, is instead of leaking a proposed bill leak a description of the underlying crisis that conveyed the nature of the risks we are dealing with (i.e., why this matters on “main street”) along with a description of how he thought the proposal would work to alleviate the crisis. He should never have gotten into specific legislative language–that should have all been negotiated behind closed doors.
September 30th, 2008 at 10:34 am
Today’s GOP is all about the swagger, the manly-man hero that steps in to save the day. If there’s no crisis, there’s no ability to play that role. So you do what you have to do to make sure there is a crisis.
September 30th, 2008 at 10:40 am
Yes, if only Paulson had been Treasury Secretary before Lehman failed. With his keen vision and well-polished trumpet, he could have sounded the alarm about the danger to the credit markets in allowing them to fail.
September 30th, 2008 at 10:52 am
It’s really too bad we don’t have the sober judgment and sound policy of a Matt Yglesias at the helm of the Treasury at times like this…
Seriously, this post is total crap. Of course, Matt would have made all the right decisions as to which firms to bail out and which to cut loose. Matt would have acted decisively, and in real time, making all the right decisions in a totally unprecedented financial environment. Matt would have known to call on the Congress at exactly the right time: not too early, so that he’d be called a Chicken Little, nor too late, after the meltdown had spread throughout the economy.
This is the worst sort of content-free amateur hour blogging.
September 30th, 2008 at 11:18 am
Paulson is one thing, what about the media, Matt? What could the media have done to better serve the viewing public? (Notice I say viewing, not reading.)
1. Explain clearly the linkage between (1) bad mortgages, (2)a collapsing banking sector, and (3) the sky falling on America’s economy. Right now, most people how (1) leads to (3).
2. Explain clearly how the bill before Congress proposed to address the problem. How does $700 potentially get spent? How would this calm things down? How does it address the concerns of fairness and equity?
More frustrating than Paulson’s imperious proposal and Congress’ populist demagoguery is the fact that responsible elements in our government who want to fix things CAN’T GET THE MESSAGE OUT.
Journalists and their editors have failed to serve in the public interest, preferring to peddle stories of rich speculators collecting the taxpayers money. Time to shoot the messenger?
September 30th, 2008 at 12:15 pm
Given a three page “plan”, congressional leaders should have summoned Paulson and read him the riot act. Instead they released this on the public and pretended that it could be taken seriously. Then they held two days of hearings. Two days of hearings to explain a three page plan.
Paulson may be a moron for producing the original, but it should have never seen the light of day.
September 30th, 2008 at 12:26 pm
Paulson’s real incompetence showed not ten days ago but in the months before that, when everyone was warning of a crisis and he did nothing. Why was he not conducting quiet negotiations with Congress all along, to have something ready in case of catastrophe? Why wait until the very last minute to announce to them his plan?
I believe that there is a potential crisis. I believe that something has to be done. Politically I even understand why Paulson’s bill has to be the basis for what Congress is trying to do. But as a matter of policy, it seems insane to me that the guys who stuck their fingers in their ears and sang “LALALALALALA” for the last year should be trusted to set everything straight. Why should anyone believe that they know what the fuck they’re doing?
September 30th, 2008 at 12:37 pm
The doctors’ bill
The article referenced gives good financial background to the situation and also delineates the timeline for the ongoing breakdown in the financial sector. Note in particular that Bernanke and Paulson were not completely taken by surprise at the recent events but had been thinking about them since early August. It appears to be simply a case that they brainstormed the “worst case” but didn’t think it would happen … then, it did.
I am not one of those who believe that anyone whose politics I don’t like is ipso facto stupid. Which appears to be the thought process for a lot of opponents of the “bailout.” Meanwhile, my investments (401k) and my credit prospects in the near term continue to decline. And, is there anybody on the Left who actually cares? They seem to be a distinct (and decidedly not vocal) minority.
Thanks.
mp
September 30th, 2008 at 12:57 pm
I like the word “ramrod,” but I don’t think this is proper usage. And the only proper usage is the Boss’s usage.
September 30th, 2008 at 12:58 pm
Excuse me, but wasn’t the White House responsible for the politics of this bill? Paulson is in the cabinet, but the White House is responsible for working out the politics with Congress, not the Treasury Dept. What does the White House staff get paid to do? They should have worked with Paulson on something that worked politically. Instead, they let Paulson go out there by himself and screw it up.
September 30th, 2008 at 1:52 pm
If Paulson is putting a plan as dramatic and sweeping as he proposed to fix the situation I don’t think there is little choice but to be alarmist. What else it Paulson to do, mention that there might be a small problem with the economy and then say we need $700 billion to fix it? Just because someone from the administration says something does not make it untrue. (But it might increase the odds.)On the whole I would say Paulson saw eminent and catastrophic risk and the only way to deal with that risk is to treat it as such.
September 30th, 2008 at 2:35 pm
I agree with Matt on Paulson’s handling of this. Add that to the fact that 1. most Americans don’t understand the complexity and interconnectedness of the financial system; 2. the fact that they felt so rushed; and 3. the extreme “everything is OK” and then “the sky is going to fall” talk. I don’t know if I consider the fact that it failed to be that much of a surprise.
October 1st, 2008 at 12:57 am
A lot of the defenses of Paulson here seem to be forgetting something: his 3 page plan was substantively, not just politically, bad. It was, at that point, moral hazard writ large, a no-bid contract. You’d think this never occurred to Paulson: that as the country tries to save itself from Wall Street recklessness, the high rollers would need to make common cause, perhaps sacrifice (equity? upside? regulation?) as well. No, I don’t think it occurred to him.
That doesn’t cut it for a position of “public trust”.
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