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Hank Paulson Launched The Big Lie Campaign On September 15, 2008

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Hank Paulson Launched The Big Lie Campaign On September 15, 2008

February 9, 2016 at 8:28 am, No comments
It wasn't apparent at the time. But today we can look back and observe how The Big Lie campaign-- promoting the meme that Fannie Mae, Freddie Mac and U.S housing policy caused the financial crisis--was launched just after 1:42 p.m. on September 15, 2008, exactly twelve hours after Lehman Brothers filed for bankruptcy. At the White House, Treasury Secretary Henry Paulson came forward to address an anxious nation and financial leaders.
Like most doublespeak artists, he couched his message with empty platitudes and vague insinuations. He was never so blunt as the Steve Carell character in The Big Short, who prophesized that, "the banks will blame poor people and immigrants." Paulson's message, conveyed in coded references, was precisely that. His agenda was to reassign the failures of private label securitizations on to affordable housing goals and the GSEs.

At first blush, his answers seemed to go off on tangents. Or maybe they were non sequiturs. To finance ministers across the globe, he must have sounded utterly clueless, if not mendacious. With hindsight, it seems obvious that Paulson wanted to leave the press corps with two big fat lies.

Many remember the more famous one, since it made a good soundbite. "I never once considered that it was appropriate to put taxpayer money on the line in resolving Lehman Brothers," he said. Scores of professionals at Britain's Financial Services Administration, at Bank of America, at Barclays, at Treasury and at the New York Fed must have wondered if Paulson had been struck with amnesia. The other falsehood, about the "root cause" of increasingly fragile credit markets, was more oblique.

Bear in mind, that everybody knew what was going on at the time. Here's what I wrote six days afterward, on September 21st. (The correct date of the piece is here.)

Paulson keeps referring to a "root cause" that has nothing to do with Wall Street turmoil.

Paulson repeated the same false meme five times during his 12-minute press briefing. His technique was encapsulated by one exchange with a reporter who asked a very astute and cogent question:

Q: Mr. Secretary, it seems like your policy right now is that of a triaging some of the investment banks and hoping that that will solve the situation. Nevertheless, there are a lot of commercial banks that have their investment banking also probably exposed in many of the debt that is represented by the investment houses. Isn't the problem really much bigger than simply the investment banks? And isn't it really impossible to try and bail out that? And that if you go in that direction for the commercial banks, that you're still going to be facing the same problems in spite of what you do today?
This reporter nailed it. The securities and trading arms of Citigroup and JPMorgan and Bank of America, set to acquire Merrill, had the exact same problems that afflicted Bear Stearns and Lehman and would soon threaten Morgan Stanley. The problem was much bigger than Lehman, which, by the way, had limited exposure to CDOs. Yet Paulson's response was utterly disconnected from the problems afflicting Wall Street:

SECRETARY PAULSON: Let me -- your question says, "Where is the root of the problem?" And I think I've consistently said that when we looked at our financial institutions the root of the problem lies in this housing correction. And until we stem the housing correction, until the biggest part of that is behind us and we have more stability in housing prices, we're going to continue to have turmoil in the financial markets.
And that is why the actions with respect to Freddie Mac and Fannie Mae are so extraordinarily important, not only to our capital markets, but to making sure we have plenty of financing in housing, because that, in my judgment, is going to be the key to turning the corner here.

False. The turmoil was not caused by mortgages or by the housing correction; it was caused by private label mortgage securitizations, more specifically, the deeply subordinated tranches of private label securitizations, which were at the heart of The Big Short. Those bonds, which were mostly repackaged into CDOs totalling about $640 billion, were a tiny sliver of the $11 trillion mortgage market, and a very small percentage of the total risk exposures held by Citigroup, AIG, UBS, AMBAC, MBIA, Merrill, and others. But these subordinated bonds were very toxic because they could get wiped out in a heartbeat. Moreover, these CDO risk exposures were highly concentrated among a relative handful of global institutions. By September 2008, almost all of those deeply subordinated bonds were worthless. A housing recovery would never save those CDOs.

Put another way, the turmoil had nothing to do with Fannie and Freddie, except for the fact that these two mortgage behemoths stabilized the mortgage markets that were frozen because fraud had gone viral among mortgage originators and private label securitizers.

Here is my executive summary of the financial crisis, written a few weeks ago.

An Executive Summary of Financial Crisis: Here’s what really happened.

In the summer of 2007, almost immediately after the rating agencies began assigning long-overdue downgrades to subprime bonds, the market for private label residential mortgage-backed securitizations shut down. Trading in cash RMBS bonds almost ceased. Over the subsequent 14 months, a number of entities holding significant exposure to private label RMBS faced liquidity crises. Many of those entities collapsed. First it was some hedge funds. Then it was the $400 billion market for SIVs (structured investment vehicles). Then it was some banks in Germany. Then it was the broader ABCP (asset backed commercial paper) market. Then it was Bear Stearns. Then it was Lehman. Then it was AIG. The near-collapse of all these institutions was exacerbated by the inconvenient truth about modern credit markets; credit default swaps have undermined, if not eliminated, transparency.

Mortgage loans did not cause the crisis. Mortgage securities caused the crisis. Specifically private label RMBS caused the crisis. Why? Because, as I’ve written before, the non-triple-A-rated tranches, which were subordinated to 95% of a 100% debt-financed capital structure, can get wiped out overnight. That’s not my opinion, that’s just math.

Also, by September 2008, virtually all of those subordinated tranches had already been wiped out. Those tranches may not have yet experienced a payment default, because no principal was due and payable prior to the 30-year final maturity date. But the net present values of those tranches, under any plausible scenarios, showed that principal recovery was zilch.

Moreover, those deeply subordinated tranches were not distributed broadly throughout the vast universe of institutional investors. There was a huge concentration of that toxic risk exposure held by a relative handful of global institutions. AIG, Citigroup, UBS, Merrill Lynch, MBIA and AMBAC all faced the specter of insolvency because their collective risk exposure to subprime CDOs exceeded $250 billion. The ripple effects were huge.

(It’s certainly true that mortgage loans did in Wachovia and Washington Mutual; though the law and, precedent set a clear path for the government takeovers of those banks.)

The foregoing summary is not my interpretation of events. That’s what happened. Anyone who says otherwise—anyone who says that New Century, or Bear Stearns, or the SIV market, or the ABCP market, or Lehman Brothers, or AIG, or Merrill Lynch, or Citigroup, or MBIA, or AMBAC faced collapse because of anything related to Fannie’s or Freddie’s business model—is lying. All of those companies faced collapse because of their exposure to private label RMBS. The September 2008 meltdown was not caused by mortgages; it was caused by private label mortgage securities. Anyone who fails to make that critical distinction is either ignorant or disingenuous.

Moreover, the GSEs never faced any kind of liquidity crisis. They continually had unfettered access to the unsecured debt markets, and their mortgage securitizations were continually sold without disruption. Anyone who says otherwise is lying.

Paulson's Remarks On September 15, 2008

Which is why saying that the GSEs were the root cause of Lehman's collapse or of the fragility throughout the system was flat out false. But Paulson kept repeating this point over and over. He mentioned Fannie and Freddie five times over 12 minutes. He uttered thev word,"Lehman," thrice.

Below is the entire transcript of Paulson's remarks given just after 1:42 p.m. on September 15, 2008. The references to housing policy and the GSEs are in bold, and my comments are highlighted in yellow.

1:42 P.M. EDT

MS. PERINO: Good afternoon. Obviously, one of the biggest stories of the day is what's happening in our financial market. Secretary Paulson has graciously given us some of his time today -- he doesn't have an endless supply of it, so please keep that in mind, and we'll try to let him answer as many questions as he can before he needs to go. And then I'll come back up and finish up the briefing.

SECRETARY PAULSON: Good afternoon, everyone. And I hope you all had an enjoyable weekend. (Laughter.)

Well, as you know, we're working through a difficult period in our financial markets right now as we work off some of the past excesses. But the American people can remain confident in the soundness and the resilience of our financial system.

I commend the SEC and the Fed for their work over the weekend, convening leaders of financial institutions from around the world to meet the current challenges and put measures in place to reduce market stresses. I'm particularly pleased that these major market participants were willing to make extraordinary commitments to market stability as we manage through this turmoil.

Their actions will complement the important steps taken by the Fed and the SEC that will help to minimize disruptions to our markets and to our broader economy. As you've heard me say before, the strength and stability of our financial markets is important to every American, to their household budget, to their ability to find affordable financing for a home, a car, a college tuition and to finance small business expansion.

Let me step back a bit and provide a little perspective. As I've long said, the housing correction is at the root of the challenges facing our markets and our financial institutions. I believe that we've taken very important steps with respect to Fannie Mae and Freddie Mac, and they're amongst the most important actions we can take to work through this turmoil.

Lastly, I'm committed to working with regulators here and abroad, as well as policymakers in Congress, to take additional necessary steps to maintain the stability and orderliness of our financial markets.

Thank you, all -- now let me take your questions.

Q Thank you, sir. Can you talk about what the federal role should be going forward? And are we likely to see any more federal involvement in rescues, like you did with Fannie, Freddie and Bear Stearns?

SECRETARY PAULSON: Well, the federal role is obviously very important, because as you've heard me say, nothing is more important right now than the stability of our capital markets. And so I think it's important that regulators remain very vigilant. We're very vigilant, but we do not take, and I don't take, lightly ever putting the taxpayer on the line to support an institution.

Q Should we read that as no more?

SECRETARY PAULSON: Don't read it as no more; read it as that it's important, I think, for us to maintain the stability and orderliness of our financial system. Moral hazard is something I don't take lightly. The other thing I think I'd like to focus you on is the way our financial system came together, those institutional leaders coming together to do things to support the markets. And that's what I'd like to see continue to happen here.

Q Mr. Secretary, could you just put aside for a second the specifics of AIG or Merrill or Lehman Brothers and can you just tell us how this happened and how did we get there? I mean, beyond housing correction, take us back and explain to the American people, how did we get here?

SECRETARY PAULSON: Okay. I would say, first of all, we have excesses, and excesses that have built up for a long period of time, number one. Number two, we have an archaic financial regulatory structure that came in place a long time, after the Depression; it really needs to be rebuilt. And then there are certain things like, for instance, Fannie and Freddie. The roots of that, they're -- what we're doing is really living up to our responsibilities, which were rooted in congressional charters that go back decades and that have been perpetuated by Washington.

He doesn't quite say it but leaves the impression that New Deal reforms and Fannie and Freddie were the cause of current market turmoil, when in fact it was the hollowing out of New Deal reforms--the Private Securities Litigation Act of 1995, the Commodity Modernization Act of 2000, a litany of Supreme Court decisions undermining the 1934 SEC Act, along with the Bush Administration's refusal to enforce laws against mortgage fraud--that removed transparency and integrity from the markets and led to the financial turmoil of 2008.

But again, what we're focused on right now I think is the future, and the future is stability, orderliness in our financial markets, and working through this period, and that's what we're doing.

Q And specifically, a future with what kind of regulation?

SECRETARY PAULSON: Well, I think there's got to be a balance between regulation and market discipline. You can't rely on one to solve the problem, but it's going to have to be streamlined and more effective regulation. And there's major changes that we need, and we also need major authorities to wind down financial institutions that aren't banks, aren't deposit -- aren't federal institutions with deposit insurance. We need resolutions and authorities to let us deal with situations like Lehman Brothers.

Q How concerned are you about commercial banks? And what reassurance can you offer the American people who may be concerned about their savings account and their checking account?

SECRETARY PAULSON: Well, I've got to say our banking system is a safe and a sound one. And since the days when we've had federal deposit insurance in place, we haven't had a depositor who's got less than $100,000 in an account lose a penny. So the American people can be very, very confident about their accounts in our banking system.

Q And when you talk about the future --

SECRETARY PAULSON: Excuse me, let me just make sure -- yes.

Q Sure. I'd like to ask two things if I can. Could you explain a little bit more about the additional authorities that you think might be needed? Is there going to be additional regulation or additional legislation?

SECRETARY PAULSON: Well, let me say, in the intermediate and longer term, clearly we need a -- we're going to need major regulatory changes, and I've spoken a lot about that. And we could use additional authorities to deal with non-bank financial institutions. But again, that's going to take longer for Congress to do. And right now we're working with the tools we have, and what you're finding is that the Fed, the SEC, Treasury, the FDIC -- we're all working together and we're going to do what's necessary to protect this system with the tools we have.

Q Mr. Secretary, this morning in speeches, Senator McCain promised in regards to the economy, "We will never put America in this position again." His running mate, Sarah Palin, said, "Washington, when it comes to the economy, has been asleep at the switch and ineffective." What blame should the Bush administration take for the current economic situation in the United States, and have you been asleep at the switch and ineffective?

SECRETARY PAULSON: Let me say, we're in the middle of a presidential campaign and we're going to let the campaigns fight it out, make their cases to the American people. I'm not focused on politics right now. I'm not looking back, I'm looking forward. This President is very committed to the stability of the financial system, to its importance to the economy, and that's where I'm focused.

Q But don't you accept some of the blame, sir? You've taken steps and the economy hasn't gotten better; the situation is getting worse.

SECRETARY PAULSON: Well, I would say this: I'm playing the hand that was dealt me. A lot of what I'm dealing with, you know, I'm dealing with the consequences of things that were done, often many years ago -- as I said with the case to Freddie and Fannie, that's congressional charters going back decades, that's what Washington has put in place. What we're dealing with there, for instance, is living up to our responsibilities; in other cases we're dealing with, again, the situation as we see it. And again, I'm focused on the stability of the markets and the importance to the American people.

Again, he's saying it was the consequences of the GSEs congressional charters--not credit default swaps, nor newly invented credit default swap indices, such as the ABX, nor the originate-to-distribute model of private label RMBS, which allowed mortgage fraud to go viral, nor the Bush Administration's refusal to actively police mortgage fraud--that created the crisis.

Q Why did you agree to support the bailout of Bear Stearns but not Lehman?

SECRETARY PAULSON: The situation in March and the situation and the facts around Bear Stearns were very, very different to the situation we are looking at here in September. And I never once considered that it was appropriate to put taxpayer money on the line in resolving Lehman Brothers.

The facts are different in that, by September 2008 the markets were far less stable, the interconnectedness of Lehman was far greater than it was for Bear, plus Lehman collapsed how it did, when it did, because of an ultimatum given by Paulson at 6:00 p.m. on September 12, 2008.

And here, again, I want to commend the financial institutions from around the world for coming together and really taking some very constructive, positive steps to make our market work here. And that's how I'm going to leave that one.

Q What impact will the problems in the capital markets have on rebuilding efforts along the Gulf Coast, where they're going to need a big infusion of capital to rebuild?

SECRETARY PAULSON: Well, I've got to say our capital markets, our response have a big impact on our economy overall, that's why they're important. It's important, as I said in my remarks to the American people, to the growth in our economy, to jobs. And so the capital markets have a big role to play there and so that's why it's so important that we maintain stability there.

Q Is the rebuilding effort being made more difficult by this?

SECRETARY PAULSON: What we're going through in the short term doesn't make anything easier. But in the longer term it's going to make things better because we've got excesses we need to work through and we need to work through them as quickly as possible. And I think we're making progress.

Q Mr. Secretary, you said you're playing the hand that was dealt you. The President has been in office for six years longer than you have. Is the administration playing the hand that it was dealt, or is it to blame in any way for what's happening today?

SECRETARY PAULSON: I've got to tell you, the President has been a great boss as we worked through here. He's been focused on the right thing. I strongly support his economic policies. He knows how important stability in the capital markets are. He's encouraging me to do the right things. And I'm going to leave history to the historians and focus on what we need to do today.

Q Mr. Secretary, it seems like your policy right now is that of a triaging some of the investment banks and hoping that that will solve the situation. Nevertheless, there are a lot of commercial banks that have their investment banking also probably exposed in many of the debt that is represented by the investment houses. Isn't the problem really much bigger than simply the investment banks? And isn't it really impossible to try and bail out that? And that if you go in that direction for the commercial banks, that you're still going to be facing the same problems in spite of what you do today?

SECRETARY PAULSON: Let me -- your question says, "Where is the root of the problem?" And I think I've consistently said that when we looked at our financial institutions the root of the problem lies in this housing correction. And until we stem the housing correction, until the biggest part of that is behind us and we have more stability in housing prices, we're going to continue to have turmoil in the financial markets.

And that is why the actions with respect to Freddie Mac and Fannie Mae are so extraordinarily important, not only to our capital markets, but to making sure we have plenty of financing in housing, because that, in my judgment, is going to be the key to turning the corner here.

Paulson seems to insinuate that, since the government takeover, Fannie and Freddie are now in a position to provide liquidity to the mortgage markets. Except Fannie and Freddie were in a position to do precisely that before the takeover. And the root of the problem was not housing, but dodgy mortgage-backed securities, which made Paulson and his friends rich.

Q -- Federal Reserve giving AIG a bridge loan?

SECRETARY PAULSON: Let me say, what is going on right now in New York has got nothing to do with any bridge loan from the government. What's going on in New York is a private sector effort, again focused on dealing with an important issue that is, I think, important that the financial system work on right now. And there's not more I can say than that.

Q Mr. Secretary, when are we going to see the bottom of this? Where are we in the process overall?

SECRETARY PAULSON: Where are we in the process overall? I want to remind you of one thing, which is, when I look around the world and look at the long-term economic fundamentals we have in this country I think they compare favorably with what I see in any major developed country in the world. So we've got a strong basis in terms of where we are, in terms of working through this.

I think we've got to go back to the housing correction and where are we in the housing correction. And I believe that there is a reasonable chance that the biggest part of that housing correction can be behind us in a number of months. I'm not saying two or three months, but in months as opposed to years. I think we're going to have housing issues in this country for -- and mortgage issues for years, but in terms of getting by the biggest part of this correction, if we can make this Fannie Mae-Freddie Mac effort work the way I would like to see it work, I think we'll make real progress here.

There never ever was any such thing as a short-term housing cycle. No housing correction ever lasted less than a few years. And anyone who thought that the takeover of Fannie and Freddie would forestall liquidity crises at AIG or at other big firms was delusional. Paulson acts like he is clueless.

I've got time for one more question -- the woman in the middle there.

Q Secretary Paulson, despite the injection of $70 billion in overnight repos this morning and the extension of the credit lending facilities you still saw Fed funds rate spike to two or three times the target today. What does that spike tell you about the health of the banking system today?

SECRETARY PAULSON: Well, again, I don't look at any one day, any one indicator, any one week. As I've said, we're not going to move through this in a straight line. There are going to be some real rough spots along the road, but I believe we're making progress. And when I look at the way the markets are performing today, I think it's a testament to the way the financial industry has come together because they're dealing with an extraordinary set of circumstances and they're dealing in a way we should all be proud of.

Thank you very much.