• HIGHLIGHTS
• Bailing out Bear Stearns, but not Lehman
• The sudden surprise: AIG
• Paulson's infamous three-page bill
• "Dumbstruck" as House rejects bailout
• Lewis couldn't back out of the Merrill deal

Tell me about Hank Paulson. Who is he? How does he find himself in that job?

He had said no to the job once, and then realized when you get called on to serve your country, it was something you should do and come down here and see if you can make a difference. Certainly didn't foresee what was going to happen afterward, but [at] the first meeting of the economic team with the president, after he was in office, he said: "We have to plan for a crisis. These things kind of come in every six or eight years. It's been a while, so let's get some planning and look at different scenarios," never dreaming that we'd see sort of a once-in-a-lifetime event that we saw last fall.

What's your relationship with him?

You mean, when did I meet him? Only when he came down to be Treasury secretary. So I didn't know him before that. He wanted me to come work there, and he's very persuasive. So he talked me into it. ...

I had been at Treasury before. I did the same job for Secretary [from 2001 to 2002 Paul] O'Neill, and it had not been the smoothest of sailing. And so I said to him, "I've done this before with a CEO from outside Washington, ... and it didn't go so well, and I really don't know why I would want to go through that again."

He made the point that having run an investment bank is just a different animal than running a different kind of company, because your whole job at an investment bank is making deals happen and serving clients instead of just running a firm. And I think that ability of his to sort of make connections, build relationships with people from all different walks of life was critical to getting through the period last year.

He came in and ... was kind of the new kid on the block. And he spent the first probably six months just having dinners and breakfasts and lunches with his fellow Cabinet secretaries, with Republicans and Democrats in the House and the Senate, and just building relationships with everyone that Treasury would have natural interaction with.

That definitely came to our advantage later when push came to shove. People really knew each other already and kind of knew what each other felt was important and how to get it done.

[What's he like?]

His personality just definitely takes over a room, yeah. He's just got a very forceful personality. He always wants to look around the corner. ... Even in the heights of last fall when things were happening 100 miles an hour, he would always be asking the next question, like: "What's going to happen next? What else do we need to get ready for?" You know, not afraid to run toward a problem.

I think the situation we found ourselves in was one where you could easily have just been overwhelmed. So many unpredictable things happened all at once. And yet he just, you know, always charging ahead, always positive, always, "OK, what are we going to get done today?" And that was an enormously helpful leadership quality to the people in the building and across the government who were all exhausted by what we were going through. And yet he had the energy to keep looking ahead, and that gave everyone else the energy to do it.

[Former Treasury Secretaries] O'Neill [and John] Snow both complained a lot about the White House really running economic policy from the West Wing. It's been reported that Paulson basically said, "If I'm going to take the job, I want to run it."

Yeah, that's right. When he agreed to be nominated for secretary, he said, "I will be the lead economic spokesman, the lead economic policy-maker, the lead adviser to the president on all economic policy." There are a lot of things that can be said or drawn into an org chart. He knew he had to go establish the relationships to make that happen.

He, from day one, worked on making sure he became a trusted adviser to the president and was right at the table with all of his colleagues across the administration on every economic policy issue, Treasury-centered or not, whether a tax issue that's right up Treasury's alley or energy policy, which clearly has an economic impact. He was at the table on all kinds of issues and working with his colleagues, and really fulfilling that role that he had signed up for as the president's lead economic adviser.

What was your title? How much access did you have to him? And what did you see?

My title was assistant secretary for public affairs and director of policy planning. I think I spent every waking moment with him most of the time. We were very much connected at the hip. ...

He makes decisions by talking. So he had a small group of people around him that he always wanted to talk things through with, and that's sort of how he would arrive at decisions. He wanted people around him to point out the flaws or point out the minefield, whether it was political or financial or what the minefield might be. That's how he would usually arrive at a decision. It was a fun process to be a part of.

... When did you know that it's going to be more challenging than just inter-Washington politics, that it's a big thing that you're going to be at the center of?

I'm sure I'm going to get the dates wrong, but sometime in the summer of 2007, maybe it was maybe spring of 2007 when you started seeing mortgage default rates going up and hearing about foreclosure rates and real problems in the subprime market and housing prices starting to turn down, I think that's when everyone sort of thought, OK, this is going to turn serious.

But we were no more of a perfect forecaster than anyone else out there. I don't think anyone realized how serious it was going to be at that point. But we knew we had to dig in and really learn a lot about the subprime market, learn a lot about the process for keeping people in their homes. That's something that has never been a Treasury issue. ... Preventing foreclosures was an issue for bank regulators and the Department of Housing and Urban Development, other policy-makers.

And so that summer, we really started to do a deep dive into the whole mortgage market, the secondary market, who's holding all these things, what's the process that people go through when they find themselves unable to pay their mortgage. That was the beginning, that summer.

Did a shudder ever go through the group? Did you ever occasionally look down into what was an abyss rather than just a deep hole?

The analogy I'm sure that everyone uses is the frog in the boiling water. The temperature just keeps getting a little bit higher, and you don't realize it's boiling until it is. It was pretty gradual ratcheting up, I would say, until probably September 2008. That was when everybody went, "Wow, this is unbelievable." Nobody ever would have predicted we'd be in this boat.

The two Bear [Stearns] funds crater in the summer of '07. ... [Was that the first sign of big trouble?]

There had been a lot of discussion about hedge funds, and aren't they systemic risk? And the focus was really on the ones that were independent and not connected to banks. And I think what kind of everyone learned going through those next few months was that a lot of the regulating institutions had these kinds of funds, too, and that even if they weren't legally and technically exposed to the financial risk, they were reputationally exposed to what happened to those funds. And that ended up being a factor that no one had really counted on.

Does Bear in March surprise Paulson? How does he hear about it?

It was definitely a surprise, I think to everyone. Early that week was the first time I remember hearing about it with him. There were some signs that people were nervous, people at the FCC [Federal Communications Commission] were a little bit nervous, but projections that, "Oh, but they'll be OK for maybe 30 days or so."

That was Monday or Tuesday of that week, and Hank [was] saying: "These things turn into runs really fast. They may think they're sitting on 30 days' worth of time, but once people get nervous, the liquidity dries up really fast." And that's exactly what we saw happen over the next three or four days. It was like a classic run on the bank.

... Was it, like, this is just a confidence problem? How much of it felt like a fundamentals problem?

I think at the time even then, the feeling was that it was a problem at that institution. Bear was always a little more exposed to mortgages than the other investment banks. So I think while nobody thought the rest of the market was great, it really felt at that particular weekend like, "This is one institution that got a little too deep in this stuff, and it's only in this institution that it's going to reach this extreme state."

And the idea of some kind of a bailout [for Bear], $29 billion, a loan or whatever, where does that come from? ...

I think there were a lot of conference calls between the Fed and Treasury. The situation came upon people so quickly, and the question was really just raised of, "Given that the market is sort of fragile, do we feel like we can take the risk of letting it go, or do we want to facilitate this purchase?"

I think they all looked at each other and just said, "I'm not ready to take that risk given the situation in the rest of the market." It was sort of a gut-check moment. People were aware of the potential. It happens too quickly to really do the thorough analysis of what would be the impact, or to in any way prepare for the impact. And because of that, everyone felt like it's an unknown consequence. And the fear of the unknown was enough to say, "Let's do this loan."

Tell me about Tim Geithner's role in this.

[Federal Reserve Board] Chairman [Ben] Bernanke and then-New York Fed President Geithner and Hank, the three of them worked together on all of this. They all trusted each other's assessments and looked to each other for ideas, and they were all one team.

Not a lot of daylight in terms of differences of opinion about strategy or ideas or anything like that between the three?

No. Definitely not. They all actually drew on each other's ideas, and it was very much a cooperative process, always.

People putting in long hours?

Yeah, phone calls well into the night, yeah, and before the sun came up in the morning. ...

[During the week that Bear fell,] there was a 4:00-in-the-morning call to Ben Bernanke from Geithner, who says: "My guys are inside the building [looking at Bear's books,] and they don't like what they see. They see systemic risk." Were you hearing about those things, too?

Hearing about them, yeah. But because it was going to be a Fed loan, it was the Fed that was kind of on the front line, looking at where the actual financial picture was.

What was the secretary thinking about it?

I think just worried about the impact on the system, just going back and forth between, on the one hand, these guys, this institution got itself in trouble. On the other hand, if you can make a loan that facilitates a purchase and it's a well-collateralized loan, that's not the government taking a lot of risk for the taxpayers. And it prevents the unknown, which could have been a big downside.

When does he first talk about moral hazard? Or is that just in the air?

I think it was always in the air. I mean, he gave a speech in November of his first year, so November 2006, where he talked about regulation in general and how you always have to find a balance between market stability and moral hazard, market discipline. That was sort of his general philosophy from day one, before any of this ever became reality, that you needed both, that a market worked best if you had both moral hazard and a regulatory system that ensured stability, and that when the market is more fragile, clearly you have to be more looking out for market stability. ...

And so Bear is saved. It's then the summer. The story that we keep hearing over and over again is the secretary knows that there are kind of bull's-eyes potentially on Lehman [Brothers] and Merrill [Lynch], all the way even to [Goldman Sachs], his former company. What are you guys doing about it, worrying about that?

... It was really clear after that weekend that had there not been JPMorgan there ready to purchase, we would have had no solutions. We would have been left just empty-handed and watching Bear Stearns fail and trying to deal with the consequences as they happened.

So he and Chairman Bernanke both started talking about the need for some sort of resolution authority for the federal government. If you're a commercial bank and you're insured by the FDIC [Federal Deposit Insurance Corp.], and you run into trouble, the FDIC comes in, takes over. We've all seen the clips of Friday night, the bank shuts down and the FDIC staff show up, and the bank reopens on Monday morning because the FDIC is there and in charge, and everything goes in an orderly way.

There's no such authority like that to deal with non-FDIC-insured banks. So immediately, like you said, the headlines right after were, "Is Lehman next?" And we were realizing, well, we don't know if Lehman is next yet. But if it is, if there's not a purchaser, what are we going to do?

So there's a couple of speeches that the secretary made. There's congressional testimony when he and Chairman Bernanke were there, sitting in front of the House Financial Services Committee, talking about: "We do not have the tools to deal with this, and knock on wood, God forbid, hopefully it won't happen again. The American people expect the federal government to have the authority to prevent a disaster when they can see it coming, and we don't have that authority."

They didn't want to stand up and blast that message from the rooftops every day, because it would just scare people. But they made it very clear and looked for whatever authority that we could find, and the Fed or Treasury had no authority whatsoever to intervene with a bank or with an investment bank or any financial institution.

The Fed has a few more things. They opened the window to primary dealers. They kept looking for ways to provide liquidity backstops, but also did not have the authority to jump in and prevent a failure. And we all realized that.

We also all knew it was June, July of an election year. Congress does things in two-year cycles. There was not much realistic chance of actually somehow enacting new authorities before the end of that Congress. All we could do was look at the authorities we had and try to figure out what we could use.

And how frightening was that? ...

There was a ton of work going on, a ton of lawyers at the Fed, lawyers at Treasury, all examining every power that anybody could find and, "How has this been used?" And you saw it over and over again, how many news stories that say, "And the Fed did such-and-such today for the first time in 70 years," because all we could do was work cooperatively and try to figure out ways to use existing authority to provide more confidence.

And the secretary is doing the one thing that he can do, which is call in [Lehman CEO Dick] Fuld and saying, "Sell your company."

I think Dick Fuld knew. He didn't have to be told that he had a problem. He was well aware of it. And he tried to find solutions. They just didn't materialize. Or solutions that were satisfactory to him, he couldn't find them.

Are the stories of Paulson picking up the phone and talking to Fuld with some regularity true?

It was largely the other way around. Fuld called quite often to talk about the situation he was [facing], talk about what options he was thinking about. He called a lot, which was welcome. When a bank is in that kind of situation, you want to know what the thinking is.

What was his thinking? What was he hoping for? Was he hoping the secretary and the government could do something ... to bail him out?

No. Most of his calls were about the investors he was looking for or solutions within the bank, with different options that they were looking at for themselves. ...

What's Bernanke like? And what were they like together?

They were as different as can be, I think, but in a way that worked really, really well as a team, you know, Hank being the hard-charging, "Let's act now," bias toward action all the time, "What are we going to do now? Let's get it done," and very pragmatic, "What's our next step?"; and the chairman very much wanting to think it through, coming up with broader policy ideas and the broader sense of "Where do we want to be down the road?," and a much more tempered approach to discussing an issue.

I can't speak for Chairman Bernanke, but I know Hank just thinks the world of him and how much he valued the way they worked, almost bounced things off of each other. You know, one coming from an academic background and one coming from the market were able to kind of combine two very, very different ways of thinking about things to come up with a lot of very creative ideas.

Where did you see weakness in that relationship?

There was never a time through this whole period where I could imagine a better team of people. Because they knew each other and trusted each other so well, they almost knew what each other was going to think before they picked up the phone and called each other. They would team up to get things done, whatever it was. ... Whether it was going to the Hill or talking to the investment banks or talking to any audience, they would join forces and do it together and be stronger because they were together.

How did they communicate? Are they e-mailers?

No, telephone. Yeah, Hank is -- I call him a serial dialer. He's always on the phone. He would have one conversation with someone and immediately pick up the phone and call the five people who needed to know whatever he just learned. That's the way he worked, and it's the way he had always worked. From what the Goldman people would say, that's exactly the same as how he always was.

He believes in communication and overcommunication, and so you'd get phone calls sometimes every 10 minutes, getting an update on what he just learned. But in the end that paid off, because you had enough informed people in the room making decisions that everybody could benefit from knowing what was going on.

What's his workday? Early to rise?

Early to rise.

Come in around when?

Come in around 7:00, but already have been up and read all the papers and whatnot, and been on the phone if necessary. And just nonstop. I mean, if there was a 15-minute window on his schedule, his first thought would be: "Who should I be calling? Who should I be calling to know what's going on in the market? Who should I be calling on the Hill to see what the latest is up there that I need to know about?" He just was constantly in motion.

Unless it was a crisis type of day, he wouldn't stick around late at night, but again, would just go home and just be on the phone all night long. So it was not unusual for me to get phone calls from him at 10:00 at night, just a download on everything he had been doing since he left the office at 7:00.

Then you guys enter what has got to be the most hellish -- I don't know, let's say whenever the conservatorship of Fannie [Mae (Federal National Mortgage Association)] and Freddie [Mac (Federal Home Loan Mortgage Corp.)] is, late August through the election. It must just be a blur.

Yeah, middle of August till the weekend before Thanksgiving, I think everybody worked all weekend, every weekend, basically 24/7, never saw the sun shine. It's a blur of activity. We all lived in the building and lived in our offices and scavenged for whatever stale crackers somebody might have in their desk drawer, whatever it was, because it just did not stop.

And it just kept getting weirder and worse, right?

It would just be a new twist, you know? The whole issue of conservatorship for Fannie and Freddie was at least something that we had time to plan and to execute it in a very orderly way. That situation evolved over the course of the month of August. You had time to sort of get the Fed and the FHFA [Federal Housing Finance Agency] and Treasury folks all together and look at: "OK, what are you seeing from your angle? What does this mean?"

We had hired Morgan Stanley in late July to kind of give us a better picture of their financial situations. So we had a month of information gathering, thinking through what are the options? What are the goals we're trying to achieve here? We're trying to get stability. We're trying to reassure the debt holders. We're trying to make sure that there's some mortgage finance going on, or otherwise it's really going to have an awful impact on the economy. ...

And what we came out with in the end was something that was a unique animal, this preferred-stock agreement where we basically are guaranteeing the net worth of the two companies so that you can make the bondholders feel secure and have them in conservatorship so there is a little tighter control over the risk they're taking, making sure they're doing their policy objective. It was a really complex set of government maneuvers that had to be put together the right way.

And we had time to do that. ... There was very little commotion in the market that Monday morning. ... You took a breath and thought, all right, we did that right. That's about all we had time for, was one breath of relief on that front. And all of a sudden, it was Lehman.

... It's the Labor Day weekend. Do you have an inkling that Lehman is fragile and brittle and something bad is going to happen, literally right around the corner? …

It had been in the news. This is not inside Treasury information. CNBC for the entire summer, it seemed like every day, would run some headline about Lehman. It was a constant background noise. Dick Fuld would be calling and giving an update to Hank on a regular basis. So it certainly was on our minds, and we were very aware of it. But it wasn't until that week that it was really an action-forcing event.

Was it déjà vu all over again, too? Did it feel a lot like Bear Stearns?

It did and it didn't. The sense that it had been building for a long time and that market participants had been well aware of it, had time to look at their positions and their exposure. ... But still, the suddenness of it -- you know, a confidence issue was a confidence issue. It happens very, very fast.

And it happens in real time on CNBC, doesn't it?

Yeah.

Are you guys sitting in your offices with CNBC on?

Yeah, it was on in my office all the time. Hank didn't have it on in his office, but yeah, I watched constantly. And you had to, because the things were happening so fast. I knew what was going on in our building, but I needed CNBC to tell me what was going on elsewhere.

... What is Paulson like? Is he intense?

Yeah, super-intense and super-focused and super-worried. He's a worrier. The calls he was getting were getting him really worried, not able to sleep, because, "What are we going to do about this?" And all of the discussions from June and July about how we didn't have authority to wind down a non-bank -- suddenly we're back, front and center. What is the solution here?

And you also had an enormous political backlash from Washington to the Bear Stearns financing that loan. So you had this outpouring of stuff from the Hill of, you know, "No bailouts, no government money, no nothing." The politics were -- as we get closer and closer to an election, I don't think you could have found a worse time in the political cycle to have a financial crisis. Every member of Congress ... by Labor Day of an election year, they're focused on the election. Policy-making is largely done, and they don't want to be having news events out of Washington at that stage in the game, because there's just so little time left in the calendar to do anything about it.

Barclays is in the game. Bank of America is in the game by the middle of the week. How much of a role did the secretary play in the courtship of Bank of America and Lehman?

He knew that the only reason we've been able to get through the Bear Stearns weekend was because someone was available and wanted to buy the firm. One of the things he did that week, as different CEOs were calling and worrying, was ask people and look for who would be an interested buyer. Definitely wanted to have an interested buyer around, and signed up if it became necessary. So he was actively talking to everyone who could be a feasible possibility.

And increasingly, they weren't interested?

I don't know. It was a tough time in the market for everybody. I don't know that people would have been interested at a different time and suddenly weren't. I think it was just that week, the only two that really expressed any interest were those two.

... Is he desperately worried about, "If Lehman goes, what's the systemic risk?"

Oh, yeah. Absolutely. And that's one of the things he was asking a lot of the CEOs as he was talking to them during the week: How exposed are you? You've known about this risk for a long time. How exposed do you think you are? Do you think people in the market have sort of reduced their exposure because they've seen all these headlines for four months now?

You mean, are people pulling their money out of Lehman, or have they done it already?

Right. And just trying to get a sense of what would the consequences be. The feedback generally speaking was: "Gosh, everyone has known about this problem for a long time. It's not like Bear Stearns. It's not suddenly upon us, and it's too late to do anything." So people should be well prepared for this, or at least, if not well prepared, semi-prepared for it.

So that's the hope inside. And really the reality is, nobody's showing each other their cards, how exposed they are.

Right, but here's the secretary of the Treasury. People tell him what's really going on. He definitely thought he was getting accurate information from people on what their impressions were.

And so is he calmer about the idea that maybe this might not be the conflagration?

No, no, not at all. No, I mean, if that had been the case, then he wouldn't have organized that meeting in New York on Friday. So no, absolutely not. It was not only, "What if Lehman goes?" It was also this domino effect that we were seeing. ...

As one got eaten up by the problem, there was a next weakest guy, and that was everyone's target. I mean, we all saw not only what happened, what the Lehman impact would be as a much larger institution than Bear Stearns, but also the next wave would be even larger. And he wanted to get everyone together that weekend and try to figure out how to stop that domino train.

What's the big idea there [at the Sept. 12 meeting with bank heads at the New York Fed]? What is the secretary hoping will happen?

Friday morning, they call them all and ask them to come. When he and Bernanke and Geithner planned for that meeting, their intent was, let's get these guys together, because they all are at risk. ... Not only do we have to figure out what to do about Lehman Brothers, but nobody wants to be next. So how do we stop this wave that's been developing?

And he wanted to get them all together and look for them to do what's probably unnatural: instead of watching the competitor go down, and trying to make sure that you grab market share, actually recognize their common interest in trying to stem this confidence problem.

By Friday night, there's still hope that Lehman can survive the weekend and open for business on Monday?

I was not there, so caveat that, but just talking to Hank many times during the course of the weekend, he basically presented them with what are -- I think they all knew they had to spend the weekend preparing for a failure if it happened. I don't think there were people in that room who thought, oh, we've got lots of time on our hands. ...

Saturday morning, all the major banks had their operations folks sitting in meetings together figuring out, what happens to all if Lehman goes down? How do you clear the market? How do you move things along? They gathered a lot of people together to try to prepare to the extent they could.

It sounds like Friday night was the night where they sort of said: "They're not going to make it. We've got to get ready for them not making it." Did something happen, or did they just kind of realize it when they were all together?

Most people had realized it by then, and they were getting together to look for a solution. And that wasn't the only solution. Hank talked to all of them about if there is a buyer, then the rest of the industry needs to come together and bridge that purchase somehow. If there's a bunch of bad assets that have to get left behind, then the rest of the industry should all pile in together and take care of that.

And he had started building some consensus on that front, too, that should there be someone who would buy the bulk of Lehman, the rest of the industry would help take care of the remainder.

I talked to [Bank of America CEO] Ken Lewis. He said that he had his deal team in, going through the books on Lehman on Thursday and Friday --

"This is worse than we had thought."

-- that he had called Hank and said: "Look, I can't do this. I know you want me to do this, but I can't do this without something like the Bear Stearns deal, and maybe at the $60 billion level." Do you remember hearing about the conversation?

Hearing about it, yeah, absolutely. The BofA people, every time they came back with a report, it was worse, that there was more of a hole, and it was pretty clear they were not eager to move forward.

The difference with this and Bear Stearns was in the Bear Stearns case, the assets that got left behind were actually enough to collateralize the entire loan from the Fed. So it was a fully secured loan based on the valuation at the time.

The assets that Bank of America or anyone else looking at Lehman didn't want had a big hole in it -- big hole. The assets weren't enough to fully collateralize a loan that would close the deal. And the Fed statutorily can only make loans that are collateralized to the satisfaction of the board. So it wasn't like Bear Stearns, where you had the full collateral to back it up. It would have been acknowledging that you were making a loan that the underlying value of the assets did not even come close to matching.

And that would have been up to the secretary to say to Ken Lewis, "We're not going to do it"?

No, not "up to" -- it was not an option. The Fed cannot make a loan that isn't collateralized.

So when Lewis asks, Paulson has to say --

He kept looking, kept talking to the Fed, kept trying to figure out -- look at the authorities, look at the statute. What can you do? What can't be done? Just like we'd been doing all along: stretch all the authorities that we had to fit the situation. But it kept coming back to, the Fed cannot make a loan that isn't collateralized. And there's not enough collateral here.

Was that hard for Paulson to hear? Was he disappointed? Presumably, at that moment, he wouldn't mind helping Lehman Brothers. He knows what the consequences are.

Oh, yeah. ... If there had been a solution on the table where the Fed could have done what they did in Bear Stearns and made a fully collateralized loan and facilitated a purchase, I have no doubt that everybody would have jumped for that solution.

Even in light of the arguments about moral hazard and maybe it's time we let one go?

He was certainly not saying that at that time. ... The weekend was about stabilizing the financial system and finding solutions to do that. ...

The way a lot of people tell us, Saturday morning, Paulson has a conversation with [Merrill Lynch CEO John] Thain ... [and] says, "You should call Ken Lewis."

I think that's right. At the Friday night meeting, ... as people talked about, "What about Lehman?," John Thain was quick to say, "If Lehman goes, I'm next." He recognized this domino effect and knew he needed to do something about it.

[How long have Paulson and Thain known each other?]

Worked together for many, many, many years, and good friends.

Like each other?

Yeah, absolutely. ...

So it's probably true that Paulson would have had a general interest in, "Let's save Merrill Lynch. If we can hook them up with Lewis, and Merrill Lynch isn't as toxic as Lehman, it would be a good thing to get the two of them together," and a personal thing in the sense that he knows Thain well enough that Thain would listen to him when Paulson says, "Make a call"?

Yeah. Thain was clear Friday night that he knew he'd be the next target and that he needed to do something about it. And Hank has very direct conversations with all kinds of people all the time. That's his nature.

So he was presumably happy when he heard that [Bank of America] is in due diligence ... and they're going through [Merrill's] books?

I think he probably would have been happier if they had bought Lehman. But once that wasn't an option, yeah, I mean, his stated goal for the weekend was to solve as many of these problems as we could.

So that's a good one, relatively speaking.

Yeah, relatively speaking, yeah.

Some people have described it as a potential bulwark for him. If you've got a Merrill-Bank of America deal to be able to announce Monday morning, it may help with the markets. It may help with the perception. If Lehman's going down, at least business is being done, and the next one in line has been taken off the --

Has been shored up, exactly; that you've stopped this domino effect. That was definitely why we thought it would be good news on Monday morning.

So Paulson would have believed that?

Like I said, that was the intent from Friday night on, was deal with Lehman and do something to stop the domino effect. And the Merrill purchase we hoped would stop the domino effect.

So it's Monday morning, Sept. 15. There's going to be the announcement at the Bank of America headquarters in New York, ... and Lehman has declared bankruptcy in the middle of the night, ... and the markets are starting to just tank. What's the reaction?

I don't want to say that everyone was surprised. ... Lehman's an enormous institution, and nobody thought that was going to be a big up day, that's for sure. So I think everyone expected it to be a negative day, just because of Lehman. Nobody expected the Merrill Lynch news to stop that. We just thought it was more that it would stop the contagion to other institutions.

How bad does it feel at the end of Monday? Does it feel worse than you'd expected?

At that point, we were all huddled on AIG [American International Group], which had been a relatively sudden surprise to everyone over the weekend.

When did that start to happen?

Saturday in New York, I don't remember who it was, but some of the AIG leadership wanted to talk to Tim Geithner and Hank, and they said they were having some trouble, but they thought they had some private investors lined up and it was all going to be OK. And then Sunday they asked for another meeting, and they said that those private investors had gone away.

So it's on that Sunday that it became really clear this company that was not regulated by the federal government -- there had been some headlines about some problems there, but there was no federal regulator who had been inside the institution in any way, shape or form. ...

When they come Saturday morning, do they come down to the Fed? They come into a meeting? Do they call?

I believe it was at the Fed.

They come, and they see him. They sit with Geithner and --

And Hank, yeah.

... How do you hear about it?

I don't think he told me about it till Sunday, because Saturday, they kind of had said they had a solution lined up and thought they were going to be OK.

So when he calls you Sunday, what does he tell you?

... [He] called me and told me Barclays has fallen through, called me and told me this AIG thing now looks like a problem. By Sunday afternoon/evening, as Lehman's getting ready to file and he was expecting the worst, he was telling us to prepare legislation because we may need emergency legislation of some sort. Dig up all the stuff we had done over the summer, and contingency plans -- you know, "There's more coming." ...

So Sunday night when you go to bed --

Kind of dreading the next day, yeah. Hank was still in New York on Monday morning and flew back Monday morning. He had gotten everyone up and running already by Sunday night: "If we have to go get legislation, what does it need to be? What do we need to be prepared for?" And so people were already very focused on Monday, both on what to do about AIG but also what to do more generally: "What are the tools we don't have that we may have to actually go ask Congress for?"

Tools you'd been asking for in the summer, but the political process --

Yeah, and I don't want to exaggerate the asking for. We didn't send up legislation. We were not trying to pressure Congress to do something at that time, but powers so that it would never happen again, so that we would be able to intervene and prevent some systemically important institution from failing.

So how does it come up that Bernanke and the Fed can give $80 billion to AIG? When do you hear the number? ...

It was definitely Monday night, Monday, like middle of the night, that it all kind of came together. But I don't remember where exactly the number came from.

You were working, or were you at home?

I had gone home. I knew that a bunch of our team was on a conference call with the Fed, and the next morning, find out the conference call went on till 2:00 in the morning because everyone was having to learn all about AIG in real time, learn about the institution at the same time that they're having to make decisions.

And to the extent that anybody said what had happened at AIG, how this had happened, did you know, or did you even care at that moment?

It almost didn't matter at that point. That was for later. It was the immediate "What's the impact of this institution?," and having a look at what is their credit default swap business, and how broad a spread is it? And not even having the time to figure out who the big counterparties are, because you're faced with, it's Monday night, and if you don't do something in 24 hours, you're going to see the consequences, and you're going to find out how bad they are. Again, just not a risk anybody felt we could take.

Especially because somebody's also discovering on Tuesday that Lehman is all about the paper market.

Yeah, the commercial paper market started to really freeze up. Money markets, funds that had held a lot of Lehman paper were suddenly having problems. The consequences were in every corner of the market.

So you have Lehman, and you've got AIG. I mean, you really do have a meltdown, yes?

That week was the perfect storm. Things that no one ever thought would happen -- a money market fund breaking the buck, I mean, that's never supposed to happen. All these things were happening at one time.

And Paulson throughout this, what's he doing? What's he thinking about? What is the eye of the storm like for him?

Those few days were just like triage. It felt like the emergency room at the hospital, one person running in and saying, "This is what's happening in the money market, and what are we going to do about it," and basically inventing a money market guarantee program in 36 hours to shore that up. And then AIG on another track, and then, what are we going to do legislatively? Confidence is only going to come from the government showing action, and we've used every tool we have, and it's not enough. We need more.

So, operating on all these different fronts, all at one time, basically all of us in his office all day long, moving from one topic to the next, doing more work, coming back and just working through every issue as fast as possible, and never feeling like it was fast enough.

In the midst of all of that, how many times does the president call?

Several. The president would call or Hank would call [White House Chief of Staff] Josh Bolten and give updates all the time. He wanted to know what was happening all the time. He was very concerned about it, as everybody was.

Were they micromanaging, or were they just wanting to know?

Just wanting to know.

So nobody was trying to run it from the West Wing?

No, not at all. It was much more just, you do what's got to be done. Legislation, obviously you need the White House; you need the president. It's not something that Treasury can just do on its own. So they're very involved in terms of, how do we go about approaching Congress and go up there and get this done as fast as we can? ...

So Thursday morning, the 18th, Paulson and Bernanke go to the White House. ... What are they going there to say? And what do they hope to get?

The president already knew about -- everyone knew what the plan was. It was just sort of a final meeting and a decision to go. The plan was to ask for legislation to be able to purchase troubled assets, purchase some of these illiquid assets, mostly mortgage-related, and to get the toxic stuff out of the system.

Whose idea was that?

There has been this long, collaborative process all since '07 on sort of, "What would you do if," with a collaborative between Treasury staff and the Fed staff. So I think the idea had many fathers. ... This was the one that everyone agreed was, at the time, the most likely to succeed.

Were you at that meeting at the White House?

Yeah.

What did it feel like?

I guess I've sat in a lot of meetings in the Roosevelt Room with the president. He clearly knew it was serious, and he knew he was ready to do whatever it took. He listened to Chairman Bernanke talk about the economic consequences if this situation was allowed to continue, and he listened to Hank talk about: "Here's the solution we want to ask for. We know the politics are awful." And he was the most reassuring guy in the room. I mean, he just said: "If this is what we need to do, then this is what we're going to do. We're going to organize and get it done."

And at the end of a lot of policy meetings with him, you know, meetings over decisions made, he kind of just gets up and goes back to the Oval Office for whatever is next on his schedule. But that meeting he hung around afterward, and I know he came over and put his hand on my shoulder and was like: "We're going to get through this. We're going to get this done." And he kind of did that around the room, just kind of, "OK, if this is what we have to do, then we're going to find a way to do it."

It was a different George Bush than you'd seen before?

No, not at all. That's the way he is, yeah -- make a decision, and whether it's going to be popular or not, if it's the right decision, that's the way it's going to go.

When Bernanke was talking to the president, what did he say the economic consequences were going to be if we did nothing at all?

He walked through what a deep recession would look like, and if credit markets froze and Main Street manufacturing companies couldn't get money in the commercial paper market to fund their inventories, and just how the economy would just come to a stop. Already just the events of that two weeks had had an enormous impact on businesses' ability to fund their businesses going forward, and what it would mean for employment and what it would mean in terms of bank failures.

It was a dark picture he painted?

Yeah, yeah.

How dark?

I wish I could remember exactly what he said, but I just don't. It was a continuing wave of bank failures and recession and a lot of job losses.

And then it's down to [Speaker of the House Nancy] Pelosi's [D-Calif.] office?

Yeah, I guess that Thursday night, the two of them went down, and she gathered the House and Senate leadership and the committee leadership, and they basically had the same discussion there. I wasn't there, but Chairman Bernanke walked through the consequences of what had already been happening and what he foresaw if it was allowed to continue. And Hank walked through with the proposed solution and how quickly it needed to happen.

The White House meeting: How uphill a battle did it seem that they would be able to get something through to Congress to buy the toxic assets of the magnitude that clearly was called for at that meeting? Did it feel like an uphill?

Oh, absolutely. You're talking about six days before an election asking for an enormous amount of taxpayer money to put into the banking system. No one in their right mind would have thought that that would be politically easy. But it was what had to be done. There was no choice in the matter. And we knew that the markets would never again [have] confidence unless the united government was working together to solve the problem. ...

The guys that we talked to that were in that meeting said: "Who does Hank Paulson think he is? He comes up here with a three-page bill, no oversight," no this, no that. Did you anticipate those complaints?

They, on Thursday night, said: "OK, send us something that is what you need. But send us an outline. Do not send us a final bill and expect us to just pass it without changing a comma. That's not going to happen. We need to put our imprint on this bill."

And so we sent a very short bid of legislation. Like, this is the heart of it: You guys do what you need to do. We were compliant of what they asked us to do, which was only send an outline and let them fill in around it. Other people who had not been in that room that night and didn't know that that was what was asked for misinterpreted it as: "This is it. Don't touch this." That wasn't what they asked us for, and that's not what the intention was.

When Paulson hears that, how does he react?

He shrugged [his] shoulders and said, "Politics -- I'm not surprised given the timing and the unpopularity of helping out banks." I don't know what we could have done to make it clear. I guess we could have written at the top, "Outline As Requested." (Laughs.) Maybe we should have put that at the top of the page.

Were he and Bernanke really scared, or was some of this theatrics?

No, they were very nervous. I can't speak of the chairman, but Hank was very nervous about the impact on the economy. He was getting calls from large manufacturing companies that were struggling because of the credit markets being frozen. Talking to people, this was beyond the banking system already. And the longer it went on, the more trouble the economy was going to be in.

So when it comes around to a vote in the Congress, and especially the conservative Republicans just beat the hell out of it, ... what are you guys doing? What is Paulson doing? Are you watching the vote?

We were watching it. I was watching it outside his office. And when [the] time was up, and there were more nos than yeas, that was -- I've worked on Capitol Hill for a long time in the leadership when Republicans had the majority, and we never brought anything to the floor unless we knew we had the vote. That was just the way it was. And you often had this situation where time expired and there were more nos than yeses. But until someone gavels it, it's not over. That's what the whips are for: They go out, and they go find the people who haven't voted yet and make it clear that, you know, it's up to you; you've got to get this through.

It really did not cross my mind that that wasn't exactly what was going to happen in this case. They brought this legislation to the floor; they must know they have the votes. There are just some guys waiting in the back of the room who really didn't want to have to vote. But they're going to get them to vote.

And so I walked into Hank's office, and we turned on CSPAN. And I said exactly that to him, like, "Oh, they wouldn't have brought this bill to the floor if they didn't think it could pass, if they didn't have the votes lined up somewhere." And so I was sort of shrugging it off. And he's staring at CSPAN watching the numbers. And then we saw the tally getting worse. And then it was getting more higher and higher as they just kind of gave up, and they gaveled it as failing. And we all just -- it was just silence. We just stood there staring at a TV screen, not believing what we had just seen. ...

What's the look on his face?

It's just sort of dumbstruck. I mean, this was the risk we knew we were taking when we said we needed legislation. We knew it was going to be hard. This was why we tried to do as much as we possibly could do without getting new authorities. It was almost like the worst of our fears happening. We knew the worst thing that would happen would be to ask Congress for something and not get it. But that would really destroy confidence. And we were sitting there watching our worst fears play out.

And so when does Hank Paulson, the football star, kick and say, "All right, let's go"?

Within minutes we all were back over at the White House huddling, having a meeting with the president and figuring out the next steps. That's how the whole rest of the afternoon was spent.

How's the president about the defeat?

Like I said, he's always the calmest one in the room. And he's always, "OK, this is what we have to deal with," and "What's the plan?," and just kind of [goes] over, "What can we do? How can we win this vote?," and just listening to the guys who had been on the Hill, talking to members, trying to figure out what needed to be done and looking for things we could do to change the legislation to get the votes.

... Was there ever a despair moment in there?

The way the calendar worked that week, that was a Monday, and that Tuesday was a Jewish holiday, so Congress was out of session. So I know personally that I dreaded going to work that day, that Tuesday, because we knew nothing was going to happen in Congress that day because they were in recess. And I could not imagine how long that day was going to feel of just kind of wallowing in the defeat in the House and not knowing what was going to happen next. And the uncertainty of that day was just hanging over all of our heads until Wednesday when the Senate passed the bill.

The market is also just tanking.

Oh, yes -- 700 points on Monday after the vote. I mean, in some ways, that made it real to people. A congressman who had been telling us, "Gosh, you know, the banks in my hometown say there's not a problem, so I don't see why I need to vote for this" -- the market dropping like that I think made it really clear to everybody this is not just about Wall Street; this is about the entire economy.

So on Friday the House passes the new bill, and very quickly there's this idea of capital injections; the buying of the toxic assets gets kind of sidestepped. Why? What's the conversation that happens?

During that period that Congress was considering the legislation -- and not just because of the fail, but it's the credit markets kept deteriorating; things kept getting worse -- everyone came to the conclusion that we needed something that was quick. And buying assets is not quick. As you've seen since then when Secretary Geithner announced the plan -- I mean, it was announce the plan, take six weeks to hire asset managers, get them up and running. It just doesn't happen quick. ... The only way to inject confidence would be to do something that you could implement instantly. Capital was clearly something that the system needed, and it would be much faster and have a much greater impact on confidence and on the stability of the system.

As we went through the legislative process, as the legislation was first being written, we had worked with the Congress to make sure there was as much flexibility as possible. We knew once this bill became law, they really would be going home for the rest of year or something close to it, and we didn't want to have to make them come back again. So we wanted as much flexibility in that legislation as we could get because we couldn't see around every corner. We didn't know what was coming next. ...

And that's when we run up to this moment where he has the banks all in.

Yeah, on Columbus Day.

What was the idea there? Whose idea was that? How did it get formulated? And who got invited, and why did they get invited?

Bernanke and Geithner and Hank were always kind of bouncing ideas off of each other. It was largely conversations they had, the three of them, or the three of them plus a bunch of staff from all the different agencies, just kind of collaboratively coming up with these ideas, and the lawyers looking at the legislation, see what we can do; the finance guys figuring out the right way to structure the program and looking at it and saying: "You don't want to call in whoever you think is the weakest bank and tell them that they have to take capital. That doesn't do any good. It just makes them look weak."

So the best strategy would be to bring in the largest of the financial institutions and have them all take capital at the same time for the benefit of the system, not because as an individual institution they particularly needed it, but because the system, overall, is undercapitalized. ... So that's who we invited, was the largest institutions, and made the cast to them that they, as the largest institutions, needed to take this money to support the system as a whole.

Quite a dramatic event?

Yeah. I don't think I'll ever sit through a meeting like that ever again.

Did you go?

Yeah.

Tell me about it. Is Hank anxious? Does it feel like a big, momentous, historical moment to him? Is he a guy who feels things that way?

If you were looking at it in the abstract, nobody, none of us ever wanted to be in a position where you had government ownership in a bank. That was just anathema to all of us, and so crossing that line was a very momentous decision in the first place.

And then having to make the case to this group, and knowing that it would only work if they all agreed to do it, yeah, it was something we did a lot of planning for, did a lot of work to try to do our best to make the atmosphere one that would be successful.

[What happened?]

It was a pretty straightforward presentation: Chairman Bernanke talking about the situation we were in; Tim Geithner talking about the position of all the financial institutions broadly, not anyone by name; Hank talking about the way the program was structured so that ... it's the most passive possible way of putting capital in.

And they rightly had some questions, as you would expect. But we had planned ahead of time, thinking that it would be a situation where we had to kind of present to them, answer some questions, leave the room and let them talk, and then come back.

So we had plans for multiple hours of being there. And in less than [one] hour -- I think it was only about 45 minutes of discussion -- and everyone was sort of like, "OK, where do I sign?," knowing that the situation was dire enough and that the dynamic was such that if they all stepped forward together, none of them would be singled out as a weak institution. ...

Huge moment for Paulson, isn't it? Wall Street guy comes to Washington -- it's not an exaggeration to say this is, as you said, an unbelievably historic moment to pass out $125 billion in a day, to be in business now with the banks. Did he talk about that? Did he ever talk to you about how important that felt to him?

Oh, yeah. The last thing I ever wanted to do was have the government owning a bank, that I see no other way at this point. And as the staff was designing the programs, it was absolutely critical that it be as passive as possible in terms of control. You don't want government making lending decisions, government making business decisions. That would be a disaster. And the Congress didn't want that either. They were very clear they did not want the government controlling these institutions. ...

Then there's the election, and Obama wins. ... How are all of you about [his] selection of Geithner [as Treasury secretary]?

Oh, very happy. Obviously he was part of all the decision making, so we knew that there would be a great amount of continuity. There ... wouldn't be a relearning to do.

[What was the transition process like?]

The two weekends before the election, we were there all weekend long because we thought our responsibility was to, you know, Wednesday morning, if the winner of the election wanted a briefing and wanted to lay out options and wanted to know, "What next?," we'd be prepared to do that. We thought our highest responsibility during the transition was a smooth transition, that market confidence would come from seeing the transition go as smoothly as possible, and that balls don't get dropped on Jan. 21. ...

And so we did that. We spent two weeks before the election going through all the options for, "OK, we've done this capital program. Of all the options for what to do, let's prioritize them in terms of impact. What's the most important thing to do to stabilize the system?" ... And so we had gone through a lot of options lists, prioritized them, and were prepared to talk to the transition about them whenever they wanted to talk to us.

I think people in our building who were new to Washington may have had greater expectations than some of us who have been around transitions before. There's a lot to do in a transition.

I think they engaged to the extent they could. We also ran into the auto company issues in December. The transition folks were very involved in that. A transition team is small. There just aren't that many people working on the transition. So to the extent they were working on autos with us, they couldn't be working on TARP [Troubled Asset Relief Program] stuff with us or financial industry with us, too. There was too much going on.

Hindsight is always 20/20, and there's a way that the transition could have been more efficient, I'm sure, on both sides. That's always the way when you look back. But I don't think any of us had any realistic expectations that somehow the Congress would come back and move that second $350 billion before the new team was in office. At best, we thought we should at least offer to make the request in early January so that the clock would run out and the money would be available when the new team took office. ...

In October and especially in November and early December, the Merrill-Bank of America deal starts to get ugly. ... What happened?

Ken Lewis called Hank. I don't know the exact date, but he called and said they were finding losses that were larger than they'd expected, and he wanted to talk about it. And Hank immediately suggested that he come up and get together at the Fed with Chairman Bernanke, too. So that's what they did the next day. The three of them met at the Fed and talked through the issues.

The Fed lawyers, in the meantime, looked at the contract, and they didn't see anything in the contract that could prevent the merger from going forward. By virtue of what was in the contract, the merger would have to be completed.

But what Hank repeated to Lewis and what he's said publicly over and over again: ... We had a G7 meeting sometime in October, and at the end of that G7 meeting, he and all the other finance ministers came out and said: "We're committed to making sure that no systemically important institution fails again. This will not happen." ... He reiterated that to Lewis. ...

And when Paulson heard about the fact that Lewis wanted to get out, ... what did he say? Was he worried about the consequences of it if it fell apart? Was it the kind of thing that would have worried him?

It would have if not for the legal opinion that it wasn't an option.

So how does the idea of giving them additional funds and the loan come forward? Is that a Fed-generated thing, or is that something out of Treasury?

Like I said, we had said since October we would not let any systemically important institution fail. We would use the TARP and in combination with authorities at the Fed and the FDIC to give, to stabilize any financial institution. And we had done that in November with Citi. And so in January, after the merger had closed and they had an accurate picture of the situation, they came to us, and we did a very similar transaction with them as the Citi transaction from November. ...

You talked about Paulson's views of Thain, his views of Lewis?

He always had the highest regard for Ken Lewis.

And they talked?

Yeah.

Regularly?

Yeah. Well before the fall of 2008, Hank made a point of talking to certain people across Wall Street and across other industries to know what was going on in the economy and to know what was going on in financial markets. I think Lewis was one of the people he talked to pretty frequently.

The big question of Paulson's legacy -- he's been hit pretty hard. Does he have regrets? Does he have worries over his legacy?

Yeah. I think the history books will write the story. He's proud of what he did. He thinks we all ran toward problems and did everything in our power to do what could be done to deal with a once-in-a-lifetime financial storm. ...

Now he's writing a book, so he has more of an opportunity to kind of look back on it all and consider it. So many of the things that we ended up doing were unprecedented things. Whether it was capital injections or the way we combined the TARP and the FDIC and Fed authorities to guarantee some bad assets at Citi or Bank of America, some of these new things that were done had to be created out of whole cloth. So you can look back and think, gosh, why didn't we think of X, Y or Z sooner, you know? But everyone was working at lightning speed around the clock and making the most of what we had in front of us. ...

There's a complaint by [Congressional Oversight Panel Chair] Elizabeth Warren, who is charged with the oversight of the TARP, who had a problem with Paulson sending a letter to her saying that the money paid to the banks was stated to be a fair deal on the money invested into the banks. She has come out recently saying that was a lie; that, in fact, the real result was it was more like 66 cents on the dollar, and there is money going to be lost from that money. What's your reaction?

When we designed the capital program, it was designed so that the taxpayers would be at minimal risk. ... Not only did we get preferred stock in exchange for the money, but we also got warrants in each of those firms. And those warrants are additional taxpayer protection, above and beyond what [the taxpayer] gets when the preferred stock is paid back. ...

When you view the plans that have come out now, do you see them as sort of a normal continuation of the foundation that you guys had set up, or do you see it as radically different in any way?

The programs we've seen in the new administration are embracing the same principles that we did: combine the powers of the TARP, leverage it with the authority of the Fed, the authority of the FDIC so you get the most bang for the buck, and both stabilize the system and try to get lending going again. A lot of creative ideas that were germinating in the fall and in November and December kind of came to fruition in the last couple of months. They've obviously put their own stamp on things, as they should. It's a new team.

But I think the market has some confidence from the basic continuity in terms of the principles that underlie what we're doing. ...