I had gone to bed modestly optimistic about our chances of saving Lehman. The Barclays bid was proceeding, and Diamond had a board meeting scheduled for early that morning in London.

Tim spoke with Diamond after the Barclays board meeting, at 7:15 a.m. New York time, and Bob warned him that Barclays was having problems with its regulators. Forty-five minutes later, I joined Tim in his office to talk with Diamond and Varley, who told us that the FSA (Financial Services Authority of the U.K.) had declined to approve the deal. I could hear frustration, bordering on anger, in Diamond’s voice.

We were beside ourselves. This was the first time we were hearing that the FSA might not support the deal. Barclays had assured us that they were keeping the regulators posted on the transaction. Now they were saying that they didn’t understand the FSA’s stance. At 10 a.m., we met with the bank chiefs again, and I told them we had run into some regulatory issues with Barclays but were committed to working through them. The CEOs presented us with a term sheet for the deal. They had agreed to put up more than $30 billion to save their rival. If Barclays had committed to the deal, we would have had industry financing in place.

At 11 a.m., I went back upstairs, and soon got on the phone with (British Finance Minister) Alistair Darling, who wanted a report on Lehman. I told him we were stunned to learn that the FSA was refusing to approve the Barclays’ transaction.

He made it clear, without a hint of apology in his voice, that there was no way Barclays would buy Lehman. He offered no specifics, other than to say that we were asking the British government to take on too big a risk, and he was not willing to have us unload our problems on the British taxpayer.

It was shortly before 1 p.m. when Tim, (Security and Exchange Commission Chairman) Chris (Cox) and I addressed the CEOs again. I was completely candid. Barclays had dropped out, and we had no buyer for Lehman.

“The British screwed us,” I blurted out, more in frustration than anger. I’m sure the FSA had very good reasons for their stance, and it would have been more proper and responsible for me to have said we had been surprised and disappointed to learn of the UK regulator’s decision, but I was caught up in the emotion of the moment.

Back in my temporary office on the 13th floor, a jolt of fear suddenly overcame me as I thought of what lay ahead of us. Lehman was as good as dead, and AIG’s problems were spiraling out of control. With the U.S. sinking deeper into recession, the failure of a large financial institution would reverberate throughout the country—and far beyond our shores. It would take years for us to dig ourselves out from under such a disaster.

All weekend I’d been wearing my crisis armor, but now I felt my guard slipping. I knew I had to call my wife, but I didn’t want to do it from the landline in my office because other people were there. So I walked around the corner to a spot near some windows. Wendy had just returned from church. I told her about Lehman’s unavoidable bankruptcy and the looming problems with AIG.

“What if the system collapses?” I asked her. “Everybody is looking to me, and I don’t have the answer. I am really scared.”

I asked her to pray for me, and for the country, and to help me cope with this sudden onslaught of fear. She immediately quoted from the Second Book of Timothy, verse 1:7—”For God hath not given us the spirit of fear, but of power, and of love, and of a sound mind.”

read more here from WSJ

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)

The dollar and the euro are engaged in an ugly contest.

In a long slide since 2000, the dollar has lost 41% against the euro. After a brief rebound as investors sought safety during the worst of the financial crisis, the greenback again weakened through 2009. But that could change this year.

That might seem odd as, on the face of it, there is little to recommend the dollar. A fed-funds target rate hovering at around zero, quantitative easing and ballooning deficits all serve to undermine the currency. Economic data, especially in consumer-sensitive areas like housing and employment, remain weak.

Ugly as that is, Europe is no model of perfection either. Greece, the obvious blemish, points to a deeper malaise. As Brown Brothers Harriman & Co. says, incomplete political union leaves the euro zone without effective mechanisms to enforce fiscal discipline in member states.

Other countries—like Greece—have lost competitiveness over the past decade but could not devalue, and relied on fiscal expansion instead. If Greece calls for a bail-out, countries like Germany will have to weigh the risks of raising moral hazard versus the risks of destabilizing markets by standing firm—an unpalatably Lehman-like quandary. The need for more rigorous fiscal policing by definition suggests further erosion of member-state sovereignty will be required, setting the stage for protracted political wrangling.

China’s artificially low renminbi may be compounding the euro zone’s problems. Lombard Street Research reckons European businesses bear the brunt in terms of loss of market share in international trade.

China’s recent moves to tighten monetary policy might suggest some relief on this front. But the more pertinent effect, from a currency perspective, is to raise anxieties in financial markets—as observed in recent stock sell-offs and the jump in volatility measures like the VIX index. As the experience of late 2008 showed, if things turn ugly, investors tend to close their eyes and embrace the dollar.