On the Brink (20 page)

After the long wait for Putin, we barely made the meeting with Medvedev, who was a couple of miles away in the Kremlin. Once more I had to endure some public gloating about the U.S. financial crisis, though he was more moderate and polite in front of the cameras than Putin. Behind closed doors Medvedev was very engaged, and as he peppered me with questions, he revealed a good understanding of markets. I was surprised not to be asked about Fannie Mae and Freddie Mac, because Kudrin had told me to be ready to talk about the GSEs, and Putin himself had raised the subject in 2007 with President Bush. I was soon to learn, though, that the Russians had been doing a lot of thinking about our GSEs’ securities.

Shortly after I returned from my trip, on Monday, July 7, the Federal Reserve and the SEC announced that they had finally signed a memo of understanding. The next day, speaking at an FDIC-sponsored forum on mortgage lending in Arlington, Virginia, Ben Bernanke signaled that the Fed was considering extending into 2009 the duration of the Primary Dealer Credit Facility and the Term Securities Lending Facility, its lending programs for primary government dealers.

But there was more bad news than good. The same day the Fed and the SEC announced their agreement, a report came out of Lehman Brothers, of all places, speculating that Fannie and Freddie might need as much as $75 billion in additional capital. It set off an investor stampede. Freddie’s stock dropped almost 18 percent, to $11.91, on July 7, while Fannie’s shares fell more than 16 percent, to $15.74. Both stocks rebounded somewhat the next day, as a result of assurances from their regulator, the Office of Federal Housing Enterprise Oversight, but they plunged again on July 9. I made two public statements myself that week in support of the GSEs. Each time, the market steadied for a while then resumed its downward tilt. Short sellers were becoming active. The press and investors in the U.S. and around the world were losing confidence in Fannie’s and Freddie’s viability. The GSEs went to the market almost as often as the U.S. government, with funding needs in the tens of billions of dollars every month. We couldn’t afford a failed auction of their securities.

Investment banks were sinking, too, and Lehman was hit hardest. Its shares dropped 31 percent that week, while its credit default swaps ballooned out to 360 basis points on Friday from 286 basis points on Monday.

I’d hoped that a combination of capital raising and reform would be enough to shore up the GSEs. Fannie had raised some equity, but Freddie had missed the opportunity, and Congress still had not acted on the proposed reforms. Now, we would need much more. For the first time, I seriously considered going to Congress for emergency powers on the GSEs. Before, with Democrats and Republicans at war, it had been impossible to get relatively modest things done without a crisis.

But now we had one—and we needed to act swiftly. I made a series of calls to alert key Hill leaders to the worsening situation and let them know, without being too specific, that we might need more authorities in the bill. Next, I needed to explain the urgency of this situation to the president and to request his permission to formally approach Congress. I knew he was always at work by about 6:45 a.m., so Friday morning I called Josh Bolten and asked to see President Bush. I walked over just after 7:00 a.m. and joined the president in the Oval Office, where I ran through my concerns about the capital markets, the vulnerability of Lehman, and the need to move on the GSEs. Later that morning, the president was to meet with his economic team at the Department of Energy to discuss oil prices, which hit a peak of $147.27 that day. I arranged to ride over with Josh and the president in his limo. I asked the president to publicly affirm the importance of the GSEs after his meeting.

“We’re probably going to have to take emergency action,” I said. “But you can help calm the markets in the meantime.”

The president understood the gravity of the moment. After the meeting, he called in the press, as was the custom, and made a point of emphasizing how important Fannie and Freddie were. I also gave a statement, noting that we were focused on supporting Fannie and Freddie “in their current form.” I hoped to calm market fears of a government takeover that would wipe out shareholders.

Later we had lunch in the president’s private dining room, adjacent to the Oval Office, with Vice President Cheney and Josh. I had come to ask for the authority to deal with Fannie and Freddie, but the first words out of my mouth were “I don’t believe there’s a buyer for Lehman.”

I mentioned that I’d spoken with former Fed chairman Alan Greenspan, who believed we should get authority to wind Lehman down, in case of failure.

Then I laid out the case for acting quickly on the GSEs, requesting permission to ask Congress for power to, among other things, invest in the mortgage giants. I didn’t provide a lot of details, because we were still debating what we would need. The president said it was unthinkable to let Fannie and Freddie fail—they would take down the capital markets and the dollar, and hurt the U.S. around the world. Although he disliked everything the GSEs represented, he understood that we needed them to provide housing finance or we weren’t going to get through the crisis. The first order of business, he said, was “save their ass.”

July 11 turned out to be a day for the books. The president and the Treasury secretary’s reassuring words about the GSEs failed to soothe the markets—Fannie’s shares fell 22 percent, to $10.25, while Freddie’s dropped 3.1 percent, to $7.75. Then, late in the afternoon, the Office of Thrift Supervision seized the teetering IndyMac Federal Bank, with more than $32 billion in assets, and turned it over to the FDIC. It was to that point the third-biggest bank failure in U.S. history.

The news reports of that day showed the first scenes of depositors lined up in the hot sun outside the failed thrift’s headquarters in Pasadena, California, desperate for their money. The government guaranteed deposits up to $100,000, but these citizens had lost faith in the system. This all-too-eerie reprise of the haunting images of the Great Depression was the last thing anyone needed just then.

C
HAPTER 7

Saturday, July 12, 2008

W
e needed congressional action to contain the deteriorating situation at Fannie Mae and Freddie Mac, so on Saturday, July 12, I tried calling Chris Dodd and Nancy Pelosi, but I couldn’t reach either of them during the day. Finally, Nancy returned my call from California at about 10:30 p.m. Normally, I’d have been fast asleep, but I was still up and working. When I told her we needed emergency powers to invest in the GSEs, she came right back at me, ready to start negotiating.

“This won’t be easy,” she said. “Will the president support our housing legislation?”

I told her I thought so. That is, with the exception of the block grants to state and local governments.

She rolled right past me. “We’re going to get the block grants,” she said.

That was a problem. House Republicans and the administration absolutely hated all of the Democrats’ proposed housing legislation but most especially the block grants. Barney Frank had explained to me how important they were to him and his colleagues, but his foremost objective was to get HOPE for Homeowners and GSE reform through. He had indicated that if the president made clear he would not accept the grants, they would be removed from the bill.

“I’ve got this deal with Barney,” I explained to Nancy. “If the president strongly objects to the grants, they’re going to come out.”

“Well, Barney didn’t talk to me. I don’t know how he can make deals like this without talking to me. I’m going to call him.”

Worried that I’d said too much, I decided I had better get to Barney before Nancy could. I reached him in Boston on his cell, but I could barely make out what he was saying over peals of laughter and a host of chattering voices in the background.

“Barney, can you hear me?” I said.

“I hear you, Hank,” he shouted, then paused, and with perfect timing quipped, “Can the president?”

I told him about my conversation with Nancy and that she hadn’t known about our understanding.

“That was just between the two of us, Hank,” he said, clearly annoyed. He said he would do his best, but that things had changed—given the dire circumstances, the threat of a presidential veto now seemed empty.

Block grants were just one of the political land mines we had to avoid. The weekend of July 12 and 13 was a blur of nonstop phone calls, meetings, and brainstorming sessions: Ben Bernanke, Tim Geithner, and Chris Cox. Chuck Schumer, Barney Frank, and John Boehner. Conference calls, one-on-one calls, still more meetings.

Though we did not have firsthand access to Fannie’s and Freddie’s financials, we knew we would need billions of taxpayer dollars to backstop the institutions from catastrophic failure and a strong regulator with powers to make subjective judgments about capital quality, just as other prudential regulators were able to do.

With this in mind, I had asked the Federal Reserve if it could provide discount-window funding for the GSEs. Ben Bernanke made clear that this was properly a fiscal matter, but indicated that the Fed Board of Governors would be willing to provide temporary support to the GSEs if I could assure them that Congress was likely to grant us the emergency legislation we would be seeking. I told him I would consult with congressional leaders and the GSEs and let him know for sure before his noon board meeting on Sunday.

I had very solid reasons for requesting additional powers: I was concerned that investors had lost faith in Fannie and Freddie. The mortgage giants had lost almost half of their value that week. This worried the debt holders, from U.S. pension funds to foreign governments, that held hundreds of billions of dollars of GSE paper, and raised red flags about the companies’ ability to fund themselves in future auctions.

Nonetheless, we faced the catch-22 of crisis policy making. There was always the chance that by asking for these powers we would confirm just how fragile the GSEs were and spook investors. Then, if Congress failed to come through, the markets would implode. The stakes were enormous: more than $5 trillion in debt either guaranteed or issued by Fannie and Freddie. Every time spreads grew—that is to say, the yields of these securities increased relative to Treasuries—investors lost billions of dollars. It was not my job to protect private investors. But a collapse of the GSEs would have drastic consequences for the economy and the financial system.

Fannie and Freddie needed to be brought on board, quickly. Without their support, legislation would go nowhere. On Saturday I called Dan Mudd and Dick Syron to get their cooperation. Mudd, the Fannie Mae CEO, wanted to save his company and asked a lot of questions. Syron, though, was compliant; he was looking for a way out. He was on a short leash and had had a difficult time working with his board. But the next morning, when I spoke with them at his request, his directors were supportive.

Then I huddled with my team at Treasury to review our options and nail down our proposed legislation. We were in an awkward position. The GSEs and their regulator, the Office of Federal Housing Enterprise Oversight, had said that the companies were adequately capitalized for regulatory purposes, but the market was skeptical. To know for sure, we would need experienced bank examiners to comb through their books. But we did not have the power to send in examiners.

Instead, we needed to get standby authority to deal with a potential liquidity problem, such as a failed auction of debt, and the authority to make an equity investment, if necessary. We didn’t want to put a dollar limit on this authority because that would imply that we had identified the size of the problem, which we had not. Having an unlimited capacity—we used the term
unspecified
—would be more reassuring to the markets. Asking for this was an extraordinary act—indeed, an unprecedented one—but my team agreed we had to try.

The difficulty came when I said that our powers should have no set expiration date. Fannie and Freddie guaranteed securities for up to 30 years, and I questioned whether temporary standby authorities would be enough to satisfy long-term investors. But after a tense conversation, Kevin Fromer and David Nason convinced me.

“Hank, if we’re going to sell this on the Hill, it needs to be temporary,” Kevin insisted.

We decided to ask for unlimited investment authority until the end of 2009, to give the incoming administration a year of protection.

From my calls, I knew there was a lack of enthusiasm on the Hill for what we wanted. At the same time, I had not gotten a single definitive
No way.
So on Sunday, July 13, I told Ben I thought we could get Congress to act. When the Federal Reserve Board met at noon, they agreed to provide a temporary backup to Fannie and Freddie through the New York Fed. Later that afternoon, I walked out onto the west steps of the Treasury Building, facing the White House and a group of reporters. The day had turned overcast. Storm clouds moved in, and the wind began to pick up as I spoke.

“Fannie Mae and Freddie Mac play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies,” I said, emphasizing that their “continued strength is important to maintaining confidence and stability in our financial system and our financial markets.”

I announced that President Bush had authorized me to work with Congress on a plan for immediate action, and that after consulting with other officials and congressional leaders, I would ask lawmakers for temporary authority to increase the GSEs’ $2.25 billion line of credit with Treasury and allow us to buy equity in the GSEs if we deemed it necessary.

We would also seek to give the Federal Reserve a role as a consultative regulator. Doing so, I knew, would give the Fed access to all financial information available to the GSEs’ new regulator, the soon-to-be-created Federal Housing Finance Agency, as well as a role in setting capital requirements. Crucially, the FHFA would have more flexibility to make judgments about capital adequacy and the power to place the GSEs in receivership. I had no sooner finished speaking than a downpour erupted.