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Inside the Seizure of Fannie and Freddie

Book review: "On the Brink: Inside the Race to Stop the Collapse of the Global Financial System"

Feb. 15, 2010

By staff

President George W. Bush's former Treasury secretary has provided a behind-the-scenes look at the seizure of Fannie Mae and Freddie Mac.

In his book On the Brink: Inside the Race to Stop the Collapse of the Global Financial System, Henry M. Paulson, secretary of the U.S. Department of the Treasury during the tumultuous financial crisis in 2008, said that left to die, the two firms -- which own or manage more than $5 trillion in mortgages combined -- would have taken down the global financial system.

Paulson explained Bush's opinion of the two firms.

"He had a deep disdain for entities like Fannie and Freddie, which he saw as part of a permanent Washington elite, detached from the heartland, with former government officials and lobbyists cycling through their ranks endlessly while companies minted money, thanks, in effect, to a federal entitlement," Paulson wrote.

buy On the Brink
The author noted that it was imperative regulators move quickly before the two firms had time to mobilize their powerful political machine on Capitol Hill.

But the Federal Housing Finance Agency, the two companies' regulator and the only agency with the authority to throw both companies in conservatorship, was resisting their seizures. People at the agency had already used data fed to them by Fannie and Freddie to support public statements that the two firms were adequately capitalized.

Paulson handled the resistance by sending in teams of examiners from the Federal Reserve and the Office of the Comptroller of the Currency to help FHFA staff see that there was actually a "huge capital hole" at the two companies. In addition, Federal Deposit Insurance Corporation Chairman Sheila Bair sent over her "best person to help write a case."

The director of FHFA was James B. Lockhart III -- a prep school friend of Bush. Lockhart now works for billionaire Wilbur Ross.

Paulson noted that Lockhart had either "worn those examiners down or they had come to realize that immediate conservatorship was the best way for them to resolve this dangerous situation with their reputations intact."

FHFA summoned both companies to its offices to advise them of their fate.

Fannie's chief executive officer Daniel Mudd was joined by its chairman, general counsel and outside counsel. In addition to Lockhart, Fed Chairman Ban Bernanke, Paulson and regulatory staff were present on behalf of the United States.

Fannie initially resisted, explaining that it had done a much better job than Freddie of addressing a capital shortfall. But the government countered that the markets were not distinguishing between the two firms.

Paulson said that as Lockhart told Fannie about the decision to place it in conservatorship,"Mudd was alternately scowling or sneering." But he acknowledged that Mudd, who took the helm at the Washington, D.C.-based organization only after a "messy accounting scandal," had been cooperative during his tenure. 

The former cabinet member said Freddie's CEO, Richard Syron, was "relaxed, seemingly relieved" when informed of the government's decision.

Paulson wrote that such drastic moves by the government required the replacement of the CEOs despite their performance.

He indicated that among several calls with members of Congress about the seizure was one with then presidential candidate and U.S. Senator Barack Obama, whom he described as "well informed, well briefed and self-confident" and noted "was quick to grasp why we thought the two agencies were so critical to stabilizing the markets." Another discussion with running mate Joe Biden prompted Paulson to write that the senator was "on top of the issue" and "understood the nature of the problem."

In a call with Sen. John McCain and then governor Sarah Palin, McCain had little to say while an annoying Palin was quick -- like Obama -- to grasp the political significance of firing the CEOs. But Paulson added that he wasn't "sure she grasped the full dimensions of the situation I had sketched out."

Given the heavy Chinese position in agency debt, Paulson personally briefed Zhou Xiaochuan, the head of the central bank of China, about the seizure. He also spoke with Wang Qishan, vice premier in charge of China's financial economic affairs -- who had some prophetic words.

"I know you think this may end all of your problems, but it may not be over yet," Qishan reportedly said.

Paulson said he felt relieved after the seizure, noting that "we had just pulled off perhaps the biggest financial rescue in history."

The author, himself, prefers that Fannie and Freddie operate like utilities.

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