A REPORTER AT LARGE EIGHT DAYS The battles save the Aieriean aancial systems, BY JAMES B. STEWAITud Bath Repadces and Demmcerat. [actrations by tan irtsen, FRIDAY, SEPTEMBER I2 Lets don’t be alarmist "Times inorant werk in Ames financial history since the Great Depression beg idayin the middle of September last year. Uhave pieced together this account of i frum scorts af interviews with participants: observers. Many of the p 10 be interviewed, including Henry Pa: sony who was Secretary of the Treasury, Bea Bemanke, the chairman of the Hed: eral Reserve System; and Timoehy Geith- nef, who was president of the New York Federal Reserve. AAs time has passed, ‘meritcries inevitably uave been colated by hindsight and efforss ro shade the tut twas blame anu claim credit bu Treasury official told me, referring 10 hisnself and his colle or better er worse, were the ones responsible. The sit accurately the story is told, the bee ter ourpolicies willbe ceived” ‘As Bernanke burried to the Depart mentof the Treasury farhis weekly beeak- fast with Secree Lehman Brothers Holdings Ine.,2gbal fin a dygoodsstorein 1 baal neial-services firm that started cart a5, faced imminent icy. Its collapse could be cata struphic, and a solution hadl 20 be foun rman of Monday. Paulson, a former ch the powerful investment bank Gold Sachs, is tall, excitable, gamnous, and s prcinely self confident Reaed as Chris tian Scientist in the affluent Chicage uch of Barringvon Hills he was an Eagle Scoutin high school and faocbll player at Dartmouth bef ness School, Paukon di md tends to ask rapid in a distinctive, ra Heencetold acolleaguc,“I didi scharm gene.” -aduating fr! ly did Bemanke, a soft spoken former prafessor of econor ‘House officals ist incerviewedt for the post af Fed chairman, quiet they worted thar he lacked, 2s-one Plu it, “assertiveness.” He grew up in a small own in South Carolina, played: swophone in the marching band, verote an unpublished now Harvard summa and earned a Ph.D, in econom THE NEW YORKER. Serterenen 21 2007 59MLLT. He is an expert in the economic history of the Great Depression. Both men were appointed by Presi~ dent George W. Bush, but, unlike the ‘Administrations fee-market absolutss, they, along with Geithner, considered themsehes pragmatists proponents of government action when markets fail The twocamps had long coexisted among Republicans, sometimes uneasily, but during the Bush Administration, with ts anti-regulation thetoric and cuts in mar ginal tax rates, free-market proponents seemed to bein their element, Bemanke's predecessor at the Fed, Alan Greenspan, [rept interest rates exceptionally low. Reg~ ulators at the Securities and Exchange ‘Commission tolerated high leverage atin- vestment banks, and the Ped and the Pod- tal Deposit Insurance Corporation toler- ated lax real-estate lending standards, “Housing prices shot up. In October, 2007, the Dow Jones Industrial Average reached peak of 14,093. Unheeded by Bemanke, Paulson, orjust about anyone in aposiion cofauthority, an asset bubbled grown to petilous and historic proportions. “That year, the bubble had begun to deflate. Defanlts among subprime-mort- age borrowers rose, and then the elabo~ rate infrastructure of mortgage-backed securities started to erode. In an attempt to contain the damage, Paulson and Bemanke presided over what many com sidered the greatest governmen sion into markets and finance since the nineteen-thirtes, Tn March, 2008, the government ush- cred the fling investment bank Bear Stearns into a merger with JPMorgan Case, a deal that was made possible ‘by $29 billion of government financing for Bear Steams’ troubled assets. In easly September, the Treasury rexcued the gov: cemment-backed private mortgage agen- cies Fannie Mae and Freddie Mac, pledg- ing up to $200 billion in capital, Such interventions put taxpayer money at risk and made a mockery of the notion of “ynoral hazard,” a guiding principle of cconomies which posits that unless actors bear the consequences of their actions they will act recklessly. Public citicsm of Paulson and Ber- nanke was scathing. The bailouts had ‘brought into rare alignment the Republi- can right wing, averse to aay tampering with the free market, and the Democratic {eft outraged by the government rescue of 6 THE NEW YOSREN, SEPTEMBER 21, 2009 ‘Wall Streets overpaid dle, Senator Jim Bunning, Republican of Kentucky, called forthe two men to resign, anclargued that the bailouts were “a calamity for out free market system.” He stated, “Simply put, is socialism,” and told a Bloomberg, journalist that Paulson was “acting ike the ‘minister of finance in China.” Nouriel Roubini, an economics professor at New ‘York University’s Stern School of Busi- ness, who had wamed about the housing bubble back in 2004, declared that “socal~ ism is indeed alive and well in America,” ‘but with a twist: “This is socialism forthe rich, the well connected, and Wall Szeet.” Ts previous afternoon, Septem ber 11th, Timothy Geithner, atthe New York Fed, ad told Paulsom and Bernanke that Lehman was unlikely to be able to open for business on Monday. Since its origins, in cotton trading, Leh~ ‘man had underwritten countless stock ‘and bond offerings, had beoome force in mergers and acquisitions, and was per- haps best known for its bond index, the equivalent of the Dow Jones Industrial “Average for stocks. In 2005 and 2006, it was the largest underwriter of subprime- mortgage-backed securities ‘As recently as 2007, Lehman had re~ ported record profit, thanks largely to ts leverage of thirty to one, meaning that for every dollar of tangible capital it had thirty dollars of debt. Most of its assets were funded by borrowed money, and now, given the steep decline in mortgage- backed securities, no one believed thatthe assets were worth their nominal value of $640 billion; Lehman's share price was down ninety-four per cent from the pre- vious year. A run on its asets was already under way, its iquidity was vanishing, and its stock price had fllen by forty-two per cent just the previous day; it couldn't sur- vive the weekend. Global markets and the financial system were far more fragile than they had been in March, when Bear Stearns faltered, and Geithner, waning that the consequences ofa Lehrman bank- ruptcy would be quite bad, acgued that an alternative had tobe found. Otherwise, he said, the damage almost certainly would not be contained. Bernanke, coming from a different perspective, had arrived at much the sare position. As a scholar of the Depression, hie had argued that the collapse of banks and other financial institutions at the time hhad made the Depression mach worse by constricting credit. He had become a pro- ponent of intervening to provide liquidity and encourage lending. He argued that the risks ofinsufficientaction—lack of ac tion had led Japan into a prolonged slump inthe nineteen-nineties—were fa greater than those of overdoing it. Paulson had headed Goldman's in~ vvestment-banking operations, including, mergers and acquisitions. AAs its chief executive, he had first opposed, then ‘embraced, the firm's decision, in 1999, to go public, showing both flexibility and decisiveness. ‘Butas Paulson and Bernanke sat down, ‘on September 12th the morning news in- daded reportsin which anonymous Tres sury officials appeared to say that Paulson was ruling out the possibility of any gov- cemment financial assistance to Lehman, Paulson acknowledged to Bernanke thathe bad authorized the comments, He ‘was under intense political pressure from the White House and Capitol Hill to ‘curb the furor over the rescue of Fannie Mac and Freddie Mac the previous week end, aswell continuing resentment over Bear Steaens. More important, every pri- vate business he had spoken with about ‘acquiring Lebman was insisting on some kind of govemment funding. Neverthe- less, Paulson assured Bernanke, he was committed to finding a buyer. ‘All suumer, Paison had been press- ing Lehman's chairman and chief execu- tive, Richard S. Fald, Jr, to find a buyer (ora major investor for the firm, Fuld, at sixty-two, was intensely aggressive. He joined Lehman Brothers in 1969, as a trader, and had subsequently driven Leb- ‘mais ambitious expansion. But Fuld had been slow to grasp the severity of the fires plight, and Paulson was frustrated that Fuld kepr insisting, on what Paulson deemed unrealistic terms, including too high a price. (Fuld lawyer did not reply to requests for comment for this acount.) ‘As a result, Paulson had taken it upon himself to find a buyer, and he had come up with two serious candidates: Bank of ‘America and Barclays, one of the kegest banks in the U.K. Bernanke, 100, had talked to Kenneth Lewis, the chairman and C.E.O. of Bank of America. Lewis, a native of Walnut Grove, Mississippi, and a graduate of Georgia State, had joined a smal regional bank, North Carolina National, in 1969,