Decision Points Part 28

Almost exactly twenty-five years earlier, in October 1983, I was drinking coffee in Midland with a Harvard Business School friend, Tom Kaneb Tom Kaneb. We heard someone mention that a line was forming outside the doors of Midland's First National Bank. First National was Texas's largest independent bank. It had been a fixture in Midland for ninety-three years.

Recently, rumors had been flying about the bank's precarious financial position. First National had issued many of its loans when oil prices were rising. Then in the early 1980s, the price of crude dropped from almost forty dollars per barrel to under thirty dollars. The pace of drilling slowed. Loans defaulted. Depositors withdrew their cash. I transferred our exploration company's account to a big New York bank. I was not going to gamble on First National's solvency.

Tom and I hustled over to the bank. From the second-floor balcony, we watched people line up in the lobby to approach the tellers' windows. Some carried paper sacks. Amid the crowd was a prominent old rancher, Frank Cowden Frank Cowden. Like other West Texas ranchers, Mr. Cowden was fortunate that his land overlay a lot of oil. He was a large shareholder of First National. He was working the line, telling people that the federal government insured every deposit up to $100,000. The people just stared back at him. They wanted their money.

On October 14, 1983, the FDIC seized First National and sold it to First Republic in Dallas. The depositors were protected, but the shareholders were wiped out and a Midland inst.i.tution was gone. Mayor Thane Atkins Thane Atkins spoke for a lot of folks when he said, "I feel like hanging a black wreath on my door." spoke for a lot of folks when he said, "I feel like hanging a black wreath on my door."

I had read about the financial panics of 1893 and 1929. Now I had witnessed firsthand the bursting of a speculative bubble. First National, like all financial inst.i.tutions, depended on the confidence of its customers. Once that confidence was lost, the bank had no chance to survive.

Sixteen years later, I was running for president. By nearly all measures, the economy was booming. America's GDP had increased by more than $2.5 trillion since the recession that had cost Dad the election but ended before he left office. Fueled by new Internet stocks, the NASDAQ index had shot up from under 500 to over 4,000. Some economists argued that the Internet era had redefined the business cycle.

I wasn't so sure. "Sometimes economists are wrong," I said in a speech outlining my economic policy in December 1999. "I can remember recoveries that were supposed to end, but didn't, and recessions that weren't supposed to happen, but did. I hope for continued growth-but it is not guaranteed. A president must work for the best case, and prepare for the worst."

The centerpiece of my plan was an across-the-board tax cut. I believed government was taking too much of the people's money. By the end of 1999, taxes accounted for a higher percentage of GDP than they had at any point since World War II. The government was supposedly running a large surplus. I knew where that money would go: Government would find a way to spend it. After all, Congress Congress and President Clinton had agreed to increase nonsecurity discretionary spending by more than 16 percent in fiscal year 2001. and President Clinton had agreed to increase nonsecurity discretionary spending by more than 16 percent in fiscal year 2001.

I had another reason for supporting tax cuts tax cuts. I worried that we could be witnessing another bubble, this one in the technology sector. Larry Lindsey Larry Lindsey, my top economic adviser, believed the country was headed for a recession. If he was right, the tax cuts would act as a vital stimulus.

Sure enough, a recession officially began in March 2001. The New York Times New York Times considered the downturn a positive development for me. One article ran under the headline "For the President, a Perfect Time for a Recession." It sure didn't feel that way to me. I couldn't help but note a strange irony of history. In 1993, Dad had left behind an economy much better than the public realized. Now I had inherited one much worse. considered the downturn a positive development for me. One article ran under the headline "For the President, a Perfect Time for a Recession." It sure didn't feel that way to me. I couldn't help but note a strange irony of history. In 1993, Dad had left behind an economy much better than the public realized. Now I had inherited one much worse.

With the economy tanking, the tax cuts took on a new urgency. I pressed Congress to move quickly. In June 2001, I signed a $1.35 trillion tax cut, the largest since the one Ronald Reagan Ronald Reagan signed during his first term. The bill reduced marginal tax rates for every income taxpayer, including millions of small business owners; signed during his first term. The bill reduced marginal tax rates for every income taxpayer, including millions of small business owners;* doubled the child tax credit from $500 to $1,000; reduced the marriage penalty; and eliminated the lowest tax bracket, which removed five million low-income families from the tax rolls. The bill also phased out the death tax, a burden that was unfair to small business owners, farmers, and ranchers. I figured Americans had paid enough taxes while they were living; they shouldn't be taxed again when they died. doubled the child tax credit from $500 to $1,000; reduced the marriage penalty; and eliminated the lowest tax bracket, which removed five million low-income families from the tax rolls. The bill also phased out the death tax, a burden that was unfair to small business owners, farmers, and ranchers. I figured Americans had paid enough taxes while they were living; they shouldn't be taxed again when they died.

Signing the 2001 tax relief bill. White House/Paul Morse White House/Paul Morse I was optimistic that consumers and small businesses would spend their tax relief to help pull the economy out of the recession. But we were in for another ma.s.sive economic hit that no one expected.

The toll of 9/11 will always be measured by the 2,973 lives stolen and many others devastated. But the economic cost economic cost was shattering as well. The New York Stock Exchange shut down for four days, the longest suspension of trading since the Great Depression. When the markets reopened, the Dow Jones plunged 684 points, the biggest single-day drop in history-to that point. was shattering as well. The New York Stock Exchange shut down for four days, the longest suspension of trading since the Great Depression. When the markets reopened, the Dow Jones plunged 684 points, the biggest single-day drop in history-to that point.

The impact of the attacks rippled throughout the economy. Tourism plummeted. Several airlines filed for bankruptcy. Many restaurants sat virtually empty. Some hotels reported business being down as much as 90 percent. Manufacturers and small businesses laid off workers as skittish buyers canceled their orders. By the end of the year, more than a million Americans had lost their jobs. "The United States and the rest of the world are likely to experience a full-blown recession now," one economist predicted.

That was what the terrorists intended. "Al Qaeda spent $500,000 on the event," spent $500,000 on the event," Osama bin Laden Osama bin Laden later bragged, "while America...lost-according to the lowest estimate-$500 billion." He outlined what he called a "bleed-until-bankruptcy" strategy and said, "It is very important to concentrate on hitting the U.S. economy through all possible means." later bragged, "while America...lost-according to the lowest estimate-$500 billion." He outlined what he called a "bleed-until-bankruptcy" strategy and said, "It is very important to concentrate on hitting the U.S. economy through all possible means."

I saw it as my responsibility to encourage Americans to defy al Qaeda by keeping the economy moving. In late September 2001, I flew to Chicago's O'Hare Airport to promote the recovery of the airline industry. I walked onto a riser in front of 737s from American and United Airlines. With six thousand airline workers in the audience, I said, "One of the great goals of this nation's war is to restore public confidence in the airline industry. It's to tell the traveling public: Get on board. Do your business around the country."

Later, I would be mocked and criticized for telling Americans to "go shopping" after 9/11. I never actually used that phrase, but that's beside the point. In the threat-filled months after 9/11, traveling on airplanes, visiting tourist destinations, and, yes, going shopping, were acts of defiance and patriotism. They helped businesses rebound and hardworking Americans keep their jobs.

I was surprised by critics who suggested I should have asked for more sacrifice after 9/11. I suppose it's easy for some to forget, but people were making sacrifices. Record numbers of volunteers had stepped forward to help their neighbors. Even our youngest citizens pitched in. Students across the country donated $10 million-often one dollar at a time-to a fund we created to benefit Afghan children. In my 2002 State of the Union address, I launched a new national service initiative, USA Freedom Corps USA Freedom Corps, and called on all Americans to devote four thousand hours to serving others over the course of their lifetimes.

The bravest volunteers were those who risked their lives by joining or reenlisting in the military, FBI, or CIA. Hundreds of thousands made that n.o.ble choice in the years after 9/11. Many served multiple tours of duty away from their families. Thousands of our finest citizens gave their lives. To suggest that this country didn't sacrifice after 9/11 is offensive and wrong.

Short of a military draft-a step I strongly opposed-I'm not sure what more I could have done to encourage sacrifice. This was a different kind of war. We didn't need riveters or victory gardens like we had during World War II. We needed people to deny the enemy the panic they sought to create.

I've always believed that the critics who alleged I wasn't asking people to sacrifice were really complaining that I hadn't raised taxes. "Taxes are more than a device to raise revenue," one Was.h.i.+ngton Post Was.h.i.+ngton Post columnist wrote. "They are a statement of consensus on national purpose." I reject the premise that higher taxes would have led to stronger national purpose. I am convinced raising taxes after the devastation of 9/11 would have hurt our economy and had the opposite effect. columnist wrote. "They are a statement of consensus on national purpose." I reject the premise that higher taxes would have led to stronger national purpose. I am convinced raising taxes after the devastation of 9/11 would have hurt our economy and had the opposite effect.

September 11, 2001, changed American life; it also transformed the federal budget. The projected surplus of early 2001 had been based on bullish forecasts for strong economic growth. The bursting of the tech bubble and subsequent recession significantly lowered those projections. The economic damage caused by the terrorist attacks drove them down even more. Then we faced the essential cost of securing the country and fighting the war on terror. In November 2001, Mitch Daniels Mitch Daniels, a fiscal hawk from Indiana who ably led my Office of Management and Budget, delivered the official report: The so-called surplus had vanished in ten months.

For years, I listened to politicians from both sides of the aisle allege that I had squandered the ma.s.sive surplus I inherited. That never made sense. Much of the surplus was an illusion, based on the mistaken a.s.sumption that the 1990s boom would continue. Once the recession and 9/11 hit, there was little surplus left.

By the end of 2002, the recession was technically over, but the economy remained sluggish. In early January 2003, I called on Congress to accelerate the tax cuts tax cuts from 2001, which had not fully taken effect, and to pa.s.s further tax cuts that would encourage business investment and job creation. from 2001, which had not fully taken effect, and to pa.s.s further tax cuts that would encourage business investment and job creation.

While the 2001 tax cuts pa.s.sed with bipartisan majorities-as did a modest tax cut in 2002 focused on small businesses-the 2003 version ran into serious opposition. The left denounced the plan as "tax cuts for the rich." That charge was false. The Bush tax cuts, when fully implemented, actually increased increased the portion of the income tax burden that fell on the wealthiest Americans. the portion of the income tax burden that fell on the wealthiest Americans.**

Other critics opposed the tax cuts because they would drive up the deficit. It was true that tax cuts increase the deficit in the short term. But I believed the tax cuts, especially those on capital gains and dividends, would stimulate economic growth. The tax revenues from that growth, combined with spending restraint, would help lower the deficit.

The tax relief bill made it through the House by a vote of 231 to 200. The tally in the Senate was deadlocked at 50. d.i.c.k Cheney d.i.c.k Cheney went to Capitol Hill to break the tie in his const.i.tutional role as president of the Senate. Fortunately, he voted yes. He joked that he didn't get to cast many votes as vice president, but when he did he was always on the winning side. went to Capitol Hill to break the tie in his const.i.tutional role as president of the Senate. Fortunately, he voted yes. He joked that he didn't get to cast many votes as vice president, but when he did he was always on the winning side.

I signed the tax cuts into law in late May 2003. By September, the economy had started adding jobs again. It didn't stop for 46 consecutive months. After reaching a peak of 6.3 percent in June, the unemployment rate dropped for five of the next six months and averaged 5.3 percent during my presidency, lower than the averages of the 1970s, 1980s, and 1990s. Some argued that the timing of the recovery right after the tax cuts was a coincidence. I don't think so.

Amid the economic growth, I was mindful that the country was running deficits. I took my responsibility to be a good fiscal steward seriously. So did my four budget directors-Mitch Daniels, Josh Bolten Josh Bolten, Rob Portman Rob Portman, and Jim Nussle Jim Nussle. As a wartime president, I told them I had two priorities: protecting the homeland and supporting our troops, both in combat and as veterans. Beyond those areas, we submitted budgets that slowed the growth of discretionary spending every year of my presidency. For the last five years, my budgets held this spending growth below the rate of inflation-in real terms, a cut.

I worked closely with Congress to meet my spending targets-or, as I called it, the overall size of the pie. I didn't always agree with how Congress divvied up the pieces. I objected to wasteful earmarks inserted into spending bills. But I had no line-item veto to excise pork barrel spending projects. I had to either accept or reject the bills in full. So long as Congress met my bottom line, which it did year after year, I felt that I should hold up my end of the deal and sign the bills.

The results have been a subject of heated debate. Some on the left complain that tax cuts increased the deficits. Some on the right argue that I should not have signed the expensive Medicare prescription drug benefit. It is fair to debate those policy choices, but here are the facts: The combination of tight budgets and the rising tax revenues resulting from economic growth helped drive down the deficit from 3.5 percent of the GDP in 2004, to 2.6 percent in 2005, to 1.9 percent in 2006, to 1.2 percent in 2007.

The average deficit-to-GDP ratio during my administration was 2.0 percent, below the fifty-year average of 3.0 percent. My administration's ratios of spending-to-GDP, taxes-to-GDP, deficit-to-GDP, and debt-to-GDP are all lower than the averages of the past three decades-and, in most cases, below the averages of my recent predecessors. Despite the costs of two recessions, the costliest natural disaster in history, and a two-front war, our fiscal record was strong.

BUDGET COMPARISON TABLE***

At the same time, I knew I was leaving behind a serious long-term fiscal problem: the unsustainable growth in ent.i.tlement spending, which accounts for the vast majority of the future federal debt. I pushed hard to reform the funding formulas for Social Security and Medicare, but Democrats opposed my efforts and support in my own party was lukewarm.

Part of the problem was that the fiscal crisis seemed a long way off to the legislative branch while I was in office. In early 2008, the Congressional Budget Office estimated that the debt would not exceed 60 percent of GDP until 2023. But because of the financial crisis-and spending choices made after I left office-debt will exceed that level by the end of 2010. A fiscal crisis that many saw as distant is now upon us.

"Wall Street got drunk, and we got the hangover."

That was an admittedly simplistic way of describing the origins of origins of the greatest financial panic since the Great Depression. A more sophisticated explanation dates back to the boom of the 1990s. While the U.S. economy grew at an annual rate of 3.8 percent, developing Asian countries such as China, India, and South Korea averaged almost twice that. Many of these economies stockpiled large cash reserves. So did energy-producing nations, which benefited from a tenfold rise in oil prices between 1993 and 2008. the greatest financial panic since the Great Depression. A more sophisticated explanation dates back to the boom of the 1990s. While the U.S. economy grew at an annual rate of 3.8 percent, developing Asian countries such as China, India, and South Korea averaged almost twice that. Many of these economies stockpiled large cash reserves. So did energy-producing nations, which benefited from a tenfold rise in oil prices between 1993 and 2008. Ben Bernanke Ben Bernanke called this phenomenon a "global saving glut." Others deemed it a giant pool of money. called this phenomenon a "global saving glut." Others deemed it a giant pool of money.

A great deal of this foreign capital flowed back to the United States. America was viewed as an attractive place to invest, thanks to our strong capital markets, reliable legal system, and productive workforce. Foreign investors bought large numbers of U.S. Treasury bonds, which drove down their yield. Naturally, investors started looking for higher returns.

One prospect was the booming U.S. housing market. Between 1993 and 2007, the average American home price roughly doubled. Builders constructed homes at a rapid pace. Interest rates were low. Credit was easy. Lenders wrote mortgages for almost anyone-including "subprime" borrowers, whose low credit scores made them a higher risk.

Wall Street spotted an opportunity. Investment banks purchased large numbers of mortgages from lenders, sliced them up, repackaged them, and converted them into complex financial securities. Credit rating agencies, which received lucrative fees from investment banks, blessed many of these a.s.sets with AAA ratings. Financial firms sold huge numbers of credit default swaps, bets on whether the mortgages underlying the securities would default. Trading under fancy names such as collateralized debt obligations, the new mortgage-based products yielded the returns investors were seeking. Wall Street sold them aggressively.

Fannie Mae and Freddie Mac, private companies with congressional charters and lax regulation, fueled the market for mortgage-backed securities. The two government-sponsored enterprises bought up half the mortgages in the United States, securitized many of the loans, and sold them around the world. Investors bought voraciously because they believed Fannie and Freddie paper carried a U.S. government guarantee.

It wasn't just overseas investors who were attracted by higher returns. American banks borrowed large sums of money against their capital, a practice known as leverage, and loaded up on the mortgage-backed securities. Some of the most aggressive investors were giant new financial service companies. Many had taken advantage of the 1999 repeal of the Gla.s.s-Steagall Act of 1932, which prohibited commercial banks from engaging in the investment business.

At the height of the housing boom, homeowners.h.i.+p hit an all-time high of almost 70 percent. I had supported policies to expand homeowners.h.i.+p, including down-payment a.s.sistance for low-income and first-time buyers. I was pleased to see the owners.h.i.+p society grow. But the exuberance of the moment masked the underlying risk. Together, the global pool of cash, easy monetary policy, booming housing market, insatiable appet.i.te for mortgage-backed a.s.sets, complexity of Wall Street financial engineering, and leverage of financial inst.i.tutions created a house of cards. This precarious structure was fated to collapse as soon as the underlying card-the nonstop growth of housing prices-was pulled out. That was clear in retrospect. But very few saw it at the time, including me.

In May 2006, Josh Bolten Josh Bolten walked into the Treaty Room with a guest he was trying to recruit to the administration, Goldman Sachs CEO Henry Paulson. I hoped to persuade Hank to succeed Secretary of the Treasury walked into the Treaty Room with a guest he was trying to recruit to the administration, Goldman Sachs CEO Henry Paulson. I hoped to persuade Hank to succeed Secretary of the Treasury John Snow John Snow. John had been an effective advocate of my economic agenda, from tax cuts to Social Security reform to free trade. He had done a good job of managing the department and left it in better shape than he'd found it. He had been on the job for more than three years and both John and I felt it was time for a fresh face.

With John Snow. White House/Eric Draper White House/Eric Draper Josh told me Hank was a hard-charger-smart, energetic, and credible with the financial markets. Hank was slow to warm to the idea of joining my Cabinet. He had an exciting job on Wall Street and doubted he could accomplish much in the final years of my administration. He had a fine reputation and did not want his name dragged through the political mud. He was an avid conservationist who loved to fly-fish for tarpon and watch birds with his wife, Wendy-interests he might not be able to pursue. While Hank was a lifelong Republican, he was a party of one within his family. Wendy was a college friend and supporter of Hillary Clinton's. Their two children were disillusioned with the Republican Party. I later learned that Hank's mother cried when she first heard he was joining my Cabinet.

In his steady, low-key way, Josh eventually persuaded Hank to visit with me in the White House. Hank radiated energy and confidence. His hands moved as if he were conducting his own orchestra. He had a distinct way of speaking that could be hard to follow. Some said his brain was moving too fast for his mouth to keep up. That didn't bother me. People accused me of having the same problem.

Hank understood the globalization of finance, and his name commanded respect at home and abroad. When I a.s.sured him he would be my primary economic adviser and have unlimited access, he accepted the offer. I was grateful to Wendy and Hank's family for supporting him. At the time, none of us realized his tests as treasury secretary would rival those of Henry Morgenthau under FDR or Alexander Hamilton at the founding of the country.

When I took office, I became the fourth president to serve with Federal Reserve Federal Reserve Chairman Chairman Alan Greenspan Alan Greenspan. Created under President Woodrow Wilson Woodrow Wilson in 1913, the Fed sets America's monetary policy and coordinates with other central banks around the world. Its decisions have a wide-ranging impact, from the strength of the dollar to the interest rate on a local loan. While its chairman and board of governors are appointed by the president and confirmed by the Senate, the Fed sets monetary policy independently from the White House and Congress. That's the way it should be. An independent Fed is a crucial sign of stability to financial markets and investors around the globe. in 1913, the Fed sets America's monetary policy and coordinates with other central banks around the world. Its decisions have a wide-ranging impact, from the strength of the dollar to the interest rate on a local loan. While its chairman and board of governors are appointed by the president and confirmed by the Senate, the Fed sets monetary policy independently from the White House and Congress. That's the way it should be. An independent Fed is a crucial sign of stability to financial markets and investors around the globe.

I invited Greenspan to the White House for regular lunches. d.i.c.k Cheney, Andy Card Andy Card, and I would eat. Alan would not. He spent all his time answering our questions. His grasp of data was astounding. I would ask him where he saw the economy headed over the next few months. He would quote oil inventories, changes in freight miles in the railroad industry, and other interesting statistics. As he rattled off the figures, he slapped his left hand against his right fist, as if to jar more information loose. When his position came up for renewal in 2004, I never considered appointing anyone else.

With Alan Greenspan. White House/Eric Draper White House/Eric Draper When Alan sent word that he would retire in early 2006, we started the search for a successor. One name kept coming up: Ben Bernanke Ben Bernanke. Ben had served three years on the Fed board and joined my administration as chairman of the Council of Economic Advisers in June 2005. He was well respected by the staff and by me. Raised in a small South Carolina town, he was humble, down-to-earth, and plainspoken. Like me, he loved baseball. Unlike me, his team was the Boston Red Sox. He was able to distill complex topics into understandable terms. In contrast to some in Was.h.i.+ngton, the salt-and-pepper-bearded professor was not addicted to the sound of his own voice.

I liked to needle Ben, a sign of affection. "You're an economist, so every sentence starts with, 'On one hand...on the other hand,'" I said. "Thank goodness you don't have a third hand." One day in the Oval Office, I ribbed Ben for wearing tan socks with a dark suit. At our next meeting, the entire economic team economic team showed up wearing tan socks in solidarity. "Look at what they've done," I said to showed up wearing tan socks in solidarity. "Look at what they've done," I said to d.i.c.k Cheney d.i.c.k Cheney. The vice president slowly lifted the cuff of his pants. "Oh, no, not you, too!" I said.

What stood out most about Ben was his sense of history. He was a renowned academic expert on the Great Depression. Beneath his gentle demeanor was a fierce determination to avoid the mistakes of the 1930s. I hoped America would never face a scenario like that again. But if we did, I wanted Ben at the helm of the Federal Reserve.

As Fed chairman, Ben developed a close relations.h.i.+p with the other members of my economic team, especially Hank Paulson Hank Paulson. Ben and Hank were like the characters in The Odd Couple The Odd Couple. Hank was intense; Ben was calm. Hank was a decisive business leader; Ben was a thoughtful a.n.a.lyst who had spent much of his life in universities. Hank was a natural talker; Ben was comfortable listening.

Their opposing personalities could have produced tension. But Hank and Ben became perfect complements. In hindsight, putting a world-cla.s.s investment banker and an expert on the Great Depression in the nation's top two economic positions were among the most important decisions of my presidency.

With Ben Bernanke (left) and Hank Paulson. White House/Eric Draper White House/Eric Draper

I began my final year in office the same way I had started my first, concerned about a bursting bubble and pus.h.i.+ng for tax relief.

In mid-2007, home values had declined for the first time in thirteen years. Homeowners defaulted on their mortgages in increasing numbers, and financial companies wrote down billions of dollars in mortgage-related a.s.sets. Council of Economic Advisers Chairman Eddie Lazear Eddie Lazear, a brainy and respected Stanford professor, reported that the economy was slowing down. He and the economic team believed we might be able to mitigate the effects with well-timed tax relief.

In January 2008, I sent Hank Paulson to negotiate a bill with Speaker Nancy Pelosi Nancy Pelosi and House Minority Leader and House Minority Leader John Boehner John Boehner. They hammered out a plan to provide temporary tax incentives for businesses to create jobs and immediate tax rebates for families to boost consumer spending. Within a month, the legislation had pa.s.sed by a broad bipartisan majority. By May, checks of up to $1,200 per family were in the mail.

The economy showed some signs of resilience. Economic growth reports were positive, unemployment was 4.9 percent, exports had reached record highs, and inflation was under control. I was hopeful we could dodge a recession.

I was wrong. The foundation was weakening, and the house of cards was about to come tumbling down.

Early in the afternoon of Thursday, March 13, we learned that Bear Stearns Bear Stearns, one of America's largest investment banks, was facing a liquidity crisis. Like other Wall Street inst.i.tutions, Bear was heavily leveraged. For every dollar it held in capital, the firm had borrowed thirty-three dollars to invest, much of it in mortgage-backed securities. When the housing bubble popped, Bear was overexposed, and investors moved their accounts. Unlike the run on First National Bank in Midland, there were no paper sacks.

I was surprised by the sudden crisis. My focus had been kitchen-table economic issues like jobs and inflation. I a.s.sumed any major credit troubles would have been flagged by the regulators or rating agencies. After all, I had strengthened financial regulation by signing the Sarbanes-Oxley Act in response to the Enron accounting fraud and other corporate scandals. Nevertheless, Bear Stearns's poor investment decisions left it on the brink of collapse. In this case, the problem was not a lack of regulation by government; it was a lack of judgment by Bear executives.

My first instinct was not to save Bear. In a free market economy, firms that fail should go out of business. If the government stepped in, we would create a problem known as moral hazard moral hazard: Other firms would a.s.sume they would be bailed out, too, which would embolden them to take more risks.

Hank shared my strong inclination against government intervention. But he explained that a collapse of Bear Stearns would have widespread repercussions for a world financial system that had been under great stress since the housing crisis began in 2007. Bear had financial relations.h.i.+ps with hundreds of other banks, investors, and governments. If the firm suddenly failed, confidence in other financial inst.i.tutions would diminish. Bear could be the first domino in a series of failing firms. While I was concerned about creating moral hazard, I worried more about a financial collapse.

"Is there a buyer for Bear?" I asked Hank.

Early the next morning, we received our answer. Executives at JPMorgan Chase JPMorgan Chase were interested in acquiring Bear Stearns, but were concerned about inheriting Bear's portfolio of risky mortgage-backed securities. With Ben's approval, Hank and were interested in acquiring Bear Stearns, but were concerned about inheriting Bear's portfolio of risky mortgage-backed securities. With Ben's approval, Hank and Tim Geithner Tim Geithner, the president of the New York Fed, devised a plan to address JPMorgan's concerns. The Fed would lend $30 billion against Bear's undesirable mortgage holdings, which cleared the way for JPMorgan to purchase Bear Stearns for two dollars per share.****

Many in Was.h.i.+ngton denounced the move as a bailout. It probably didn't feel that way to the Bear employees who lost their jobs or the shareholders who saw their stock drop 97 percent in less than two weeks. Our objective was not to reward the bad decisions of Bear Stearns. It was to safeguard the American people from a severe economic hit. For five months, it looked like we had.

"Do they know it's coming, Hank?"

"Mr. President," he replied, "we're going to move quickly and take them by surprise. The first sound they'll hear is their heads. .h.i.tting the floor."

It was the first week of September 2008, and Hank Paulson Hank Paulson had just laid out a plan to place had just laid out a plan to place Fannie Mae and Freddie Mac Fannie Mae and Freddie Mac, the two giant government-sponsored enterprises, into government conservators.h.i.+p.

Of all the emergency actions the government had to take in 2008, none was more frustrating than the rescue of Fannie and Freddie. The problems at the two GSEs had been visible for years. Fannie and Freddie had expanded beyond their mission of promoting homeowners.h.i.+p. They had behaved like a hedge fund that raised huge amounts of money and took significant risks. In my first budget, I warned that Fannie and Freddie had grown so big that they presented "a potential problem" that could "cause strong repercussions in financial markets."

In 2003, I proposed a bill that would strengthen the GSEs' regulation. But it was blocked by their well-connected friends in Was.h.i.+ngton. Many Fannie and Freddie executives were former government officials. They had close ties in Congress, especially to influential Democrats like Congressman Barney Frank Barney Frank of Ma.s.sachusetts and Senator of Ma.s.sachusetts and Senator Chris Dodd Chris Dodd of Connecticut. "Fannie Mae and Freddie Mac are not facing any kind of financial crisis," Barney Frank said at the time. of Connecticut. "Fannie Mae and Freddie Mac are not facing any kind of financial crisis," Barney Frank said at the time.

That claim seemed more implausible as the years pa.s.sed. In my 2005 budget, I issued a more dire warning. "The GSEs are highly leveraged, holding much less capital in relation to their a.s.sets than similarly sized financial inst.i.tutions," the budget read. "...Given the very large size of each enterprise, even a small mistake by a GSE could have consequences throughout the economy."

That summer, we made another run at legislation. John Snow John Snow worked closely with Senate Banking Committee Chairman worked closely with Senate Banking Committee Chairman Richard Shelby Richard Shelby on a reform bill that would create a new regulator authorized to reduce the size of the GSEs' investment portfolios. Senator Shelby, a smart, tough legislator from Alabama, pushed the bill through his committee despite unanimous Democratic opposition. But Democrats blocked a vote on the Senate floor. I am always amazed when I hear Democrats say the financial crisis happened because Republicans pushed deregulation. on a reform bill that would create a new regulator authorized to reduce the size of the GSEs' investment portfolios. Senator Shelby, a smart, tough legislator from Alabama, pushed the bill through his committee despite unanimous Democratic opposition. But Democrats blocked a vote on the Senate floor. I am always amazed when I hear Democrats say the financial crisis happened because Republicans pushed deregulation.

By the summer of 2008, I had publicly called for GSE reform seventeen times. It turned out the eighteenth was the charm. All it took was the prospect of a global financial meltdown. In July, Congress pa.s.sed a reform bill granting a key element of what we had first proposed five years earlier: a strong regulator for the GSEs. The bill also gave the treasury secretary temporary authority to inject equity into Fannie and Freddie if their solvency came into question.

Shortly after the legislation pa.s.sed, the new regulatory agency, led by friend and businessman Jim Lockhart Jim Lockhart, took a fresh look at Fannie's and Freddie's books. With help from the Treasury Department, the examiners concluded the GSEs had nowhere near enough capital. In early August, both Freddie and Fannie announced huge quarterly losses.

The implications were startling. From small-town banks to major international investors like China and Russia, virtually everyone who owned GSE paper a.s.sumed it was backed by the U.S. government. If the GSEs defaulted, a global domino effect would follow and the credibility of our country would be shaken.

With Hank's strong advice, I decided that the only way to prevent a disaster was to take Fannie and Freddie into government conservators.h.i.+p. It was up to Hank and Jim to persuade the boards of Fannie and Freddie to swallow this medicine. I was skeptical that they could do so without provoking a raft of lawsuits. But on Sunday, September 7, Hank called me at the White House to tell me it had been done. The Asian markets rallied Sunday night, and the Dow Jones increased 289 points on Monday.

I spent the next weekend, September 13 and 14, managing the government's response to Hurricane Ike Hurricane Ike. The storm pounded Texas's Gulf Coast early Sat.u.r.day morning. The 110-mile-per-hour winds and 20-foot storm surge flooded Galveston, blew out windows in Houston, and killed more than 100 people. The worst storm to hit Texas since the Galveston Hurricane of 1900, Ike inflicted more than $24 billion in damage.

That same weekend, a different kind of storm was battering New York City. Like many inst.i.tutions on Wall Street, Lehman Brothers Lehman Brothers was heavily leveraged and highly exposed to the faltering housing market. On September 10 the firm had announced its worst-ever financial loss, $3.9 billion in a single quarter. Confidence in Lehman vanished. Short-sellers, traders seeking to profit from declining stock prices, had helped drive Lehman stock from $16.20 to $3.65 per share. There was no way the firm could survive the weekend. was heavily leveraged and highly exposed to the faltering housing market. On September 10 the firm had announced its worst-ever financial loss, $3.9 billion in a single quarter. Confidence in Lehman vanished. Short-sellers, traders seeking to profit from declining stock prices, had helped drive Lehman stock from $16.20 to $3.65 per share. There was no way the firm could survive the weekend.

The question was what role, if any, the government should play in keeping Lehman afloat. The best possible solution was to find a buyer for Lehman, as we had for Bear Stearns. We had two days.

Hank flew to New York to oversee negotiations. He told me there were two possible buyers: Bank of America Bank of America and and Barclays Barclays, a British bank. Neither firm was willing to take Lehman's problematic a.s.sets. Hank and Tim Geithner Tim Geithner devised a way to structure a deal without committing taxpayer dollars. They convinced major Wall Street CEOs to contribute to a fund that would absorb Lehman's toxic a.s.sets. Essentially, Lehman's rivals would save the firm from bankruptcy. Hank was hopeful that one of the buyers would close a deal. devised a way to structure a deal without committing taxpayer dollars. They convinced major Wall Street CEOs to contribute to a fund that would absorb Lehman's toxic a.s.sets. Essentially, Lehman's rivals would save the firm from bankruptcy. Hank was hopeful that one of the buyers would close a deal.