- The Washington Times - Tuesday, February 4, 2014

Henry M. Paulson Jr., the financial firefighter stationed at the epicenter of the biggest financial crisis since the Great Depression, worries that the nation is headed for another crisis because political leaders failed to learn critical lessons from the last one in 2008.

In an exclusive interview with The Washington Times, Mr. Paulson, former President George W. Bush’s last secretary of the Treasury, said the most serious lapse may be Congress’ failure to reform mortgage giants Fannie Mae and Freddie Mac in a way that would revive the private market for mortgages, which has all but disappeared since the crisis.

He insisted that vigorous, bipartisan action is needed to ensure that housing never again turns from the American dream into an American nightmare for middle-class homeowners.

“We don’t want to have to replay this movie. We need to learn from our mistakes and clean up our messes,” he said, emphasizing that worries about Washington’s failure to reform Fannie and Freddie are what prompted him to make a documentary being released in theaters this week that chronicles his central role in the government response to the monumental financial collapse.

He points out that the mortgage giants owned or guaranteed about half of the nation’s mortgages before the crisis but have dramatically increased their dominance ever since. Along with the Federal Housing Administration, they guarantee nearly every new mortgage in the U.S., which enables the government to essentially dictate the price and terms of home financing and suffocate any hope that the market will return to normal, he said.

“That’s ultimately a recipe for disaster,” he said, adding that reforming the mortgage guarantors — which remain in a government custodianship that he engineered in September 2008 — will be much harder now that they are profitable again and their profits are being transferred to the Treasury each quarter to help pay down bloated U.S. budget deficits.

Mr. Paulson is also concerned that the nation’s biggest Wall Street firms and megabanks remain “too big to fail” and could cause another financial disaster, although he said Congress and regulators have made progress reining them in with measures enacted in the Dodd-Frank banking reform law.

‘Mr. Bailout’

A figure reviled in some circles, Mr. Paulson acknowledges his own role in making those banks bigger by arranging during the height of the financial crisis the merger of such giants as J.P. Morgan and Bear Stearns, Bank of America and Merrill Lynch, all in a desperate effort to prevent the kind of nosedive into financial chaos that ultimately happened anyway with the spectacular failure and bankruptcy of Lehman Brothers in September 2008.

He jokingly suggests that he may be best remembered as “Mr. Bailout” for having engineered taxpayer-funded rescues for a long list of American financial and corporate behemoths in the 10 months before President Bush left office in January 2009, including Fannie and Freddie, General Motors, Bank of America, American International Group and Citibank. But he defends the moves as “absolutely necessary” and credits them with preventing an even bigger economic catastrophe that could have driven U.S. unemployment to 25 percent instead of the 10 percent level where it topped out in 2009.

Like the Americans who were traumatized by the crisis and ensuing deep recession, which threw more than 8 million people out of work and millions out of their homes, Mr. Paulson keeps returning to the subject and mulling over what happened, seeking to find those kernels of truth that reveal the meaning.

His latest effort, the documentary collaboration between Bloomberg BusinessWeek Films and award-winning director Joe Berlinger, recounts the dramatic and fast-paced events as the debacle deepened and Mr. Paulson led the effort to soften and prevent the nation’s head-spinning downward economic spiral.

As “Hank: Five Years From the Brink” vividly recalls, Mr. Paulson repeatedly confronted and coerced the nation’s top bank chieftains as one after another of the megabanks was engulfed by the financial superstorm that ultimately erased more than half the value of the U.S. stock market and completely wiped out large parts of the U.S. bond market.

He fears that many of those banks, which have grown even larger since the crisis, with the top five owning nearly half of all U.S. banking assets, remain “too big to fail,” threatening to drag the nation and taxpayers into future bailouts if their failures threaten to bring down the financial system.

Regulators are moving in the right direction following Dodd-Frank mandates requiring the banks to have big capital cushions, ample liquidity and other safeguards, he said. “The biggest banks are better managed and much better regulated now,” but he still worries that the nation has not gone far enough to defuse a crisis.

“It’s obviously unacceptable for any bank to be too big to fail,” he said. Regulators still need to reform the shadowy “repo” market where big banks get much of their funding, and ensure in laying out procedures for liquidating large banks in the future that the banks are not allowed to continue operating in the same form that led them to the brink of collapse.

‘Horror show’

Still, while the banking leviathans continue to pose risk to the system, he said, it is the question of Fannie and Freddie that most concerns him. Political leaders and the public have not focused as much on their critical role in the housing debacle, perhaps because he stepped in and took control over the goliaths before a crisis occurred, in what he views as his single biggest move to stem the crisis.

“We took action before they started to unravel, before there was a failed auction. The public never saw that horror show,” he said. “People never focused on what their failure or near-failure would have done,” he said, suggesting the ensuing crisis would have been much bigger than the financial collapse in the wake of the Lehman bankruptcy. “They were collectively nine times bigger than Lehman Brothers” and the massive damage to the housing and mortgage markets could have been many times worse.

“It perplexes me that nothing has been done” and both parties seem content to just allow the housing market to drift through yet another era of government dependence and dominance that potentially is creating even bigger market distortions, he said. “Every financial crisis has its roots in flawed government policies that lead to excesses in the markets that build up and build up, and then you get a bubble and it bursts.”

As with so much of Washington, gridlock and powerful vested interests in the housing industry have frozen housing policy, he said.

Deep disagreements over the role Fannie and Freddie played in the crisis seems to prevent any compromise over their future role.

Conservative Republicans blame Fannie and Freddie for generating the crisis by encouraging lenders to make easy-money loans to increase homeownership among disadvantaged groups and borrowers.

Mr. Paulson called that view “oversimplification,” noting that unethical mortgage brokers and dealers on Wall Street who knowingly sold risky instruments to unwary borrowers and investors were as much at fault, while homeowners contributed to the crisis by getting too deeply into debt as they sought to finance unsustainable lifestyles and spending habits they adopted during the bubble years.

“I don’t like oversimplifications. The crisis we dealt with was a once-in-75-year crisis where excesses had been building for a long time.” Among the problems that contributed to the crisis was the “incredible complexity” of the subprime mortgage securities engineered by Wall Street, which ultimately blew up and triggered the downward spiral in financial markets.

The blame within the government rests not just with the fair-housing mandates given to Fannie and Freddie, but also with government policies in place since World War II that include generous tax deductions for homeowners and low down-payment lending programs for farmers and veterans, all of which have encouraged homeownership at almost any cost and heavily favor borrowing over saving, he said.

“It doesn’t make sense for everybody to own a home,” he said. “These policies encouraged Americans to put everything in their homes” and get over their heads in debt, yet they succeeded only in nudging up the homeownership rate from around 64 percent before the housing bubble to 69 percent when it peaked, he said.

Congress and the administration need to find a compromise that realistically addresses the role Fannie and Freddie played in the crisis and prevents them from making the same mistakes in the future, while paring back their role in the market to allow private lending to re-emerge, he said.

Bipartisan legislation drafted by Sen. Bob Corker, Tennessee Republican, and Sen. Mark R. Warner, Virginia Democrat, which preserves a residual role for the government providing a last-resort backstop in the mortgage market, would be a good starting point, he said.

“I have no doubt that if you do this properly, you’ll have a private market” for mortgages again, he said.

• Patrice Hill can be reached at phill@washingtontimes.com.

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