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What Hank Paulson had feared

Excerpts from Hank Paulson's memoir, "ON the Brink".  The former Treasury Secretary feared a total collapse of US dollar; going down of both Morgan Stanley and Goldman Sachs. He also blamed UK authority for failing to let Barclay take over Lehman Brothers, then triggered a free fall of the market in Oct. 2008. Reports FT:

Hank Paulson feared there would be a run on the dollar during the early phase of the financial crisis when global concerns were focused on the US, the former Treasury secretary has told the Financial Times.

"It was a real concern," Mr Paulson said in an interview ahead of the release today of his memoir On the Brink . A dollar collapse "would have been catastrophic," he said. "Everything that could go bad did not go bad. We never had the big dislocation of the dollar."

When the crisis escalated and went global with the failure of Lehman Brothers in September 2008, the dollar rallied – but Mr Paulson had to grapple with a firestorm of financial failures.

He feared Goldman Sachs and Morgan Stanley would go down along with Washington Mutual and Wachovia.

Lloyd Blankfein, Goldman Sachs chairman, told him that Goldman would be "next" if speculators succeeded in bringing down Morgan Stanley, the former Treasury secretary said.

US officials explored the possibility of mergers between JPMorgan and Morgan Stanley, Goldman and Citigroup, or Goldman and Wachovia, before settling on a "plan B" to turn Morgan Stanley and Goldman into banks with access to central bank loans.

Even then, Morgan Stanley was not safe until the US Treasury helped seal an investment by Japan's Mitsubishi UFJ, Mr Paulson writes.

The frenzied manoeuvring came in the three-week period between the failure of Lehman on September 15, 2008, and Columbus Day weekend in early October, when the global financial system was on the verge of meltdown.

"Banks were going down like flies," Mr Paulson told the FT. As his book details, he was desperately scrambling to secure Tarp bail-out funds from Congress.

"The timing could not have been worse since we were months or weeks from the election so you had the collision of markets and politics."

Although a Republican, Mr Paulson found it harder to deal with John McCain than Barack Obama – raising the interesting (and unanswered) question of which candidate Mr Paulson voted for.

Mr Paulson said that the turning point in the crisis came when – armed at last with Tarp equity – the US joined other Group of Seven nations to announce comprehensive interventions to guarantee bank funding and access to capital on Friday, October 10.

Three days later, Mr Paulson pressured nine top US financial institutions into accepting $125bn in Tarp capital. "I do think it was the defining act," Mr Paulson said.

Before that weekend, he said: "We were always running behind this. It was always bigger than we were".

Mr Paulson said the US authorities lacked essential tools to deal with a crisis – above all a controlled bankruptcy regime for non-bank financial firms.

He hopes his book conveys "the pace at which things were moving and the number of decisions that had to be made in very short time-frames".

Mr Paulson was surprised by the vehemence of the public reaction against bail-outs. He told the FT there was "a disconnect" between the way policymakers saw their actions and the way the public perceived them.

"We knew, I knew that when the markets froze there was going to be a painful impact on the economy a number of weeks out."

Mr Paulson is frustrated that people do not pay more attention to disasters averted by timely actions – including the move to seize control of Fannie Mae and Freddie Mac.

Instead, most debate centres on the failure to stop Lehman from collapsing, and the decision to rescue insurance giant AIG. Mr Paulson said Lehman was "like a slow-motion car crash".

Critics say the Treasury should have deployed its sole pre-Tarp source of capital, the Exchange Stabilisation Fund, to backstop a rescue. However, Mr Paulson said Treasury lawyers had been through this during the Bear Stearns crisis six months earlier and concluded that it would not be lawful.

Others fault top US officials for not doing a better job of preparing for a Lehman collapse.

Mr Paulson said the US was taken by surprise by the UK bankruptcy administrator's decision to seize hedge fund assets held by Lehman – a move he said was "devastating".

He also admitted "I did not see the money markets moving as quickly as they did" after the Lehman collapse. But he said there were limits to what could have been done in general to mitigate a Lehman failure without precipitating its immediate collapse.

On AIG, Mr Paulson said he had nothing to do with the controversial decision to pay counterparties at par – and found out about it only in December when AIG made a public disclosure.

His book hints that the Treasury was less than enthusiastic about supporting the original Federal Reserve loan with later Tarp equity – but Mr Paulson refused to discuss AIG further.

Looking back, Mr Paulson is confident that – notwithstanding criticism – the big calls were the right ones.

"This Monday morning quarter-backing misses the point – that guess what, we did take the important actions that it took to stop the system from collapsing."

Trust placed in a 'Higher Power'

"I left the New York Fed before 9pm, optimistic about the prospects for a deal. The industry was doing its part to come up with funding, and I had reason to believe we would find a solution to Barclays' need for a shareholder vote.

"Anticipating another sleep-deprived night, I arrived back at the hotel exhausted. I went into the bathroom of my room and pulled out a bottle of sleeping pills I'd been given. As a Christian scientist, I don't take medication, but that night I desperately needed rest.

"I stood under the harsh bathroom lights, staring at the small pill in the palm of my hand. Then I flushed it – and the contents of the entire bottle – down the toilet. I longed for a good night's rest. For that, I decided, I would rely on prayer, placing my trust in a Higher Power."

Excerpt from On the Brink, Saturday September 13 2008 (during the Lehman Brothers crisis weekend)

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