Paulson’s Complaint

Hank Paulson, former master of the universe, sits in a nondescript office in northwest Washington, D.C. He is trying to work on his memoirs, but he is struggling. He doesn't seem like the onetime All-Ivy tackle at Dartmouth, the Harvard M.B.A. who ran Goldman Sachs, the prince of Wall Street who went on to be come secretary of the Treasury. He comes across more like an athlete who has lost a game and can't stop talking about the dropped pass, the missed shot. He is trying to explain the weekend last September when Lehman Brothers went down—and the financial world collapsed.

The conventional wisdom, he admits, congealed quickly: it was a mistake for the government to let Lehman die, and the blame rested squarely with Hank Paulson. On the day that Lehman filed for bankruptcy, Paulson had tried to get out ahead of the story. If Lehman couldn't save itself, he told reporters, then he wasn't about to ask the taxpayers to step up. "I never once considered it appropriate to put taxpayer money on the line," he said. The message was that the government would no longer bail out failing companies—that would just invite more foolish risk-taking. It would create a "moral hazard."

But of course, in the weeks and months since the fall of Lehman Brothers, the government has gone on to bail out banks and other financial firms to the tune of hundreds of billions of dollars. So why didn't it save Lehman? If only the government had rescued Lehman, a financial panic could have been averted. Or so the story goes. The narrative was set from the beginning by Paulson's moralizing tone, followed by a market crash—and, as the once mighty bankers crawled out of the wreckage, the anguished testimony before Congress of Dick Fuld, the CEO of Lehman, who portrayed Paulson as a backstabbing Judas. "Until they put me in the ground," Fuld said, leaning into the microphone and baring his teeth, "I will wonder."

Paulson insists that he did not turn his back on Lehman. "There's no company that I spent more time with and worked harder to save. That's sort of the irony of the narrative that we wanted them to go under," he told NEWSWEEK in one of his first extended interviews since leaving office. He also dismisses the argument that the fall of Lehman provoked a panic. "It is absolutely a fiction that Lehman was anything more than a symptom." He says a perfect storm of other near failures caused the financial crisis—the troubles at Fannie and Freddie, the news that AIG faced huge liabilities from its financial insurance gambles, the teetering of giant mortgage lender Washington Mutual on the edge.

All this is true enough, but it doesn't mean that Paulson knew what he was doing when Lehman went down. The panicked scenes that played out between bankers and policymakers during Leh-man's last days were recounted in the newspapers in the weeks that followed. But now, more than half a year later, and with the most acute moments of the financial crisis behind us, the key players are better able to reflect on the decisions they made. Perhaps no one has spent more time reconstructing the events than Paulson. In retrospect, it appears that Paulson was not the callous titan of Wall Street, but rather an earnest, sometimes bewildered man caught in a whirlwind he could not tame or even fully understand. He did the best he could, reaching, sometimes lurching for answers, but in the end he was rescued by the sort of nerdy professor type who might have been devoured on the trading floors of Wall Street. To the extent that there was a hero during those weeks, it was arguably Ben Bernanke, the quiet, shy chairman of the Federal Reserve, whose problem-solving and salesmanship before a skeptical Congress were critical to avoiding financial disaster.

Paulson was known as "the Hammer" as a 6-foot-1, 200-pound tackle on the Dartmouth football team because he seemed to explode at the snap of the ball. Tenacity and drive, more than brainpower, have distinguished his career. He has been a champion arm-twister and shrewd enough: when he rescued Goldman's IPO in the wake of the Russian financial crash in 1998 he made hundreds of millions for his partners and shortly thereafter became their leader. Yet Paulson can be oddly inarticulate for such a powerful man. He is not a Wall Street smoothie: no trophy wife (he remains married to his college sweetheart), and at Goldman he was known for wearing penny loafers, not handmade Italian shoes. He's an avid bird watcher. A nonsmoking, nondrinking Christian Scientist, he did not head for the Hamptons on the weekend but visited his mother in Barrington, Ill. Yet, physically imposing, radiating a confident forcefulness, he came to stand for the dominating Goldman brand. In the Wall Street hierarchy, Goldman is the smartest and most confident of them all: the firm makes bets, but only ones it feels sure to win.

The Lords of Goldman, who tend to come from Ivy League schools, looked down on the hustlers at lower-ranked firms like Lehman, who came out of state schools and the trading pits. Lehman was an old firm, but its modern incarnation was built in the image of its scrappy CEO, Fuld, who came from the trading floor and liked to make big, risky bets. Fuld was called "the Gorilla," a nickname some might have resented. Fuld kept a toy gorilla in his office. His ethos was us (the public-school guys—Fuld went to the University of Colorado) against them (the Harvard know-it-alls like Paulson of Goldman Sachs). Paulson and Fuld have known each other for years. For the record, as well as in private, Paulson describes Fuld as a "good guy" and even as a "friend." (Fuld declined to speak to NEWSWEEK). But knowledgeable Wall Streeters and government officials who asked to remain anonymous in order to speak more freely say that Paulson regarded Fuld as a gambler who lost sight of reality.

Paulson began having his doubts about Fuld—and the future of Lehman—as early as October 2007, when Lehman made a big bet on commercial real estate even though there were signs the deal was unwise. Paulson remained dubious about Leh-man's rosy earnings reports for the first half of 2008, and when the red ink began to show in June, he began urging Fuld to scale back Lehman's leverage and find a buyer or a fresh infusion of capital. He was frustrated, say these knowledgeable sources, when Fuld stubbornly demanded terms that were too favorable to Lehman to attract any buyers or investors.

Fuld's 31st-floor midtown office had sweeping views of the Hudson River and the New York City skyscrapers. In early September, the executive suite of Lehman Brothers became a kind of war room; day and night, Fuld's lieutenants padded about, munching M&M's and chugging Diet Cokes, as they searched, with growing desperation, for a solution. A South Korean bank had seemed interested in investing, then backed off. Fuld and his men tried to stay hopeful. Six months earlier, in March, JPMorgan had rescued the failing investment bank Bear Stearns—with the help of a loan from the federal government. In early September, the Feds seized control of Fannie Mae and Freddie Mac, the two mortgage giants sucked down by the collapsing real-estate market. Surely, the Lehman team believed, the Feds would step in to help—if Lehman could only find a buyer.

Paulson does not seem to have grasped the urgency of the looming disaster. Although top financial experts were warning about the housing bubble back in 2006, Paulson—by his own admission—was not paying much attention to the way banks were slicing and dicing mortgages and selling them as complex securities. "I didn't understand the retail market; I just wasn't close to it," he told NEWSWEEK. But while he was at Goldman, he had lobbied Congress—successfully—for new rules allowing investment houses to at least double the amount of leverage they could carry.