The bailout: Why did Paulson do it? Why didn't he wait?

The members of the permanent government of the United States -- the CEOs, the Congress, the next president, etc. -- all agree, so it must be true: Henry Paulson Had No Other Choice. He had to take over Fannie and Freddie to stop financial chaos.

What if they're wrong? What if the bailout, as conceived and executed by the Treasury secretary (pictured) in two moments of grand theater this summer, was the wrong thing to do? The question is worth asking and it is posed in a thoughtful and provocative column by Andrew Ross Sorkin of the New York Times.

Remember, the Paulson bailout consisted of two bold actions: first demanding that Congress give him unlimited powers, and money, to take over Fannie and Freddie, and then exercising those powers. Sorkin questions the timing of both moves, particularly the second:

Many people in financial circles can’t quite figure out why Mr. Paulson, the former chairman of Goldman Sachs, pulled the trigger when he did. He insisted politics had nothing to do with it. Never mind that the news broke just after the Democratic and Republican conventions, but as far away as possible from the November election.

But as of last week, Fannie and Freddie, for all their troubles, seemed to be bumbling along O.K. Both were able to roll over their enormous debts in the capital markets. Sure, Wall Street was nervous about those debt auctions, but the sales were running efficiently, in part because Mr. Paulson’s promise — or threat, depending on your view — showed that the government would stand behind the companies in the end.

Strong stuff. Anybody want to explain why it happened the way it did, and why it Paulson pulled the trigger when he did?

-- Peter Viles

Photo: Getty Images

Comments

[Maggie Knowles]

I think Mike Morgan has some interesting ideas regarding Paulson, here's an excerpt:
http://realestateandhousing2.blogspot.com/
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
It Gets Stinkier - Paulson has put together a scheme that can linger on and on and on, like the Energizer Bunny, providing his Pals with many opportunities to suck up billions. But . . . and this is one of those big BUTs. I'm hearing from a few of my friends that wear Kevlar and only come out at night, that neither McCain or Obama is going to honor the crap that Paulson just doled out to his buddies. No matter who gets in, they are going to re-structure the Paulson Giveaway. In fact, you can bank on that. It will be their opportunity to dump on the prior administration and the opportunity to put their own stamp on things.

P.S. - Before I forget. The same friends that only come out at night are telling me the lobbyists are taking numbers in Washington. These include the auto industry lobbyists looking for their bailout and the airline industry lobbyists and the trucking industry lobbyists and a few more that are taking numbers just in case. Stinky Rewards - My friends in hiding also tell me that their will be Stinky Rewards. These will be the huge rewards guys like Bill Gross will reap when they sell back the piles of paper they just bought. They will start selling them back to the Fed ASAP, and when the next Administration changes the rules, they will buy them back again at lower prices. Sounds nutty, huh?

[Chris]

From SLATE

"The bailout of Fannie Mae and Freddie Mac is mostly meant to shore up our damaged international financial standing, preserving leadership and making sure the U.S. Treasury Secretary doesn't get tarred and feathered at the next G-8 meeting. "

Not from SLATE -

If other countries stop buying T-bills we are screwed and the Republicans will not win the election.

[Nick]

My take:

Although I posted before about the lack of an immediate problem as long as IB's could borrow from the Fed to buy the GSE debt (and make 17% on their money), there was probably still some stuff behind the scenes which was bad. In particular, Paulson remarked that their capital position was much worse than they had thought once they looked at their books. Remember, their capital was deteriorating with the market; even though they could roll it over, their financial situation was getting worse by the day, with no end in sight. I'm sure they were shopping for investments, but nobody wanted to touch them (and for good reason).

My speculation is that they were going to have to take some drastic action on their next filing date, and they told the regulators as much. They needed to do something before then, or risk everybody dumping their bonds as well as their stock, or worse. Remember, the GSE's were technically bankrupt as of last quarter ($5 billion in the hole, iirc), and this quarter would have likely been far worse, especially with even close to plausible accounting. Imagine what would happen if they filed for bankruptcy... every bank and IB with exposure to mortgages in the country (most of them) would be forced to write down all their GSE-backed assets (stock and bonds), and beinstantly insolvent. In the words of Dr. Egon Spengler, "it would be bad."

Paulson seemed to "get it" in the interview, saying that the GSE's were a disaster created by Congress years ago, made worse recently, and this is just the regrettable inevitable outcome of their charter. The best thing the government could do now is run them off, and try to prevent Congress from making the same mistakes. However, they certainly couldn't get Congress to do that currently, so determining their fate falls to the next administration.

[The original RZ]

My conspiracy theory based on pure speculation:

The Bush administration is trying to do some "cleaning up" before it's too late. Dubya wants to have some positives in the review of his presidency, which many will remember for the ongoing problems in Iraq, rapidly inflating gas prices, FEMA screw-ups after Hurricane Katrina, etc. This housing mess may or may not be his administration's fault, but it did happen on his watch. So with two months to go, and after McCain's nomination is secure, his administration begins moving to do some clean up and make sure things end in a way that makes it *seem* that problems came to an end on this president's watch. He announces a plan to withdraw 8,000 troops from Iraq - which gives him clout to argue that the operation was a success based on the fact that U.S. troops are leaving - and has Paulson take on Fannie Mae/Freddie Mac as a way of flexing government muscle and showing that his administration is "on it" when it comes to the economy.

[Anon.]

Chris,

T-bills are not going to decide this election.

[Chris]

Hey Maggie

That Mike Morgan stuff is fantastic. Completely hilarious, informative and spot on. Everyone should read it, enjoy a good laugh, and learn how to short financial stocks.....

[alvin]

enough with the conspiracy theories. you guys are making this WAY more complicated than it really is.

congress thought it had the perfect little plan to shave a few bips off mortgage rates and make housing more "affordable" for everyone - create a couple government "sponsered" entities that would issue debt with an "implicit" backing of uncle sam, and use that cheap money to buy mortgages, thus driving rates lower.

this may have worked as intended when they were small, manageable portfolios. but congress then let them grow (despite warnings from the Fed and others) into a $5.2 trillion debacle. As losses at FNM and FRE started piling up and they began depleting capital faster than they could raise it, a bailout out (which is really just making the "implicit" guarantee "explicit") became inevitable.

sorry, but you can't let 5.2 TRILLION dollars of US government sponsored debt default without the utter collapse of the world's financial system as we know it.

[registered investment advisor]

The US of America is becoming a socialist country, slowly but surely. Paulson just took the free out of free market. Now everybody know the free market in the US will stay free until it is not.

[TrojanDLA]

Ironically, the creation of the GSEs was to facilitate "free market" participation of investors in mortgage backed securities, no?