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The power of Paulson

He came to Washington reluctantly. His job was almost a backwater. Today his task is momentous, wrestling down the greatest financial crisis of our time.

By Marc Gunther, senior writer
September 16, 2008: 9:57 AM EDT

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Treasury Secretary Hank Paulson
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Paulson as a Dartmouth lineman, 1968
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Paulson fishing on Assateague Island near the Maryland/Virginia state line, 1973
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Paulson with daughter Amanda at the Berlin Wall, 1990

(Fortune magazine) -- On the first Saturday in September, tropical storm Hanna dumped torrential rains on Washington, D.C., keeping most of the city's residents indoors. One of them was a weary Henry "Hank" Paulson, Secretary of the Treasury, who arrived at his office at 7 a.m. Paulson had been working long hours without a day off for weeks, and the night before he'd been awakened by a phone call just after settling into bed. "I don't know how he got my number," Paulson says cheerfully, "but Barack Obama woke me up at 10:30, and I was on with him for about an hour." There had been plenty to talk about.

By then Paulson had put the finishing touches on his plan for a takeover of Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500) - the most sweeping government intervention in the financial markets in years. Paulson and his team had fired the CEOs of the once-formidable mortgage giants and recruited replacements. All that was left was to summon their boards to ratify the deal. As rain pounded on the skylights of the 139-year-old Treasury building, Paulson worked the phones, as he often does, lining up support. He had a long talk with John McCain and Sarah Palin, another with Nancy Pelosi, explaining the takeover. Twice he spoke with President Bush, giving him progress reports.

That evening Paulson had planned to celebrate his 39th wedding anniversary with his wife, Wendy. "We were going to go out to dinner, but we were too tired," he says. "She cooked me an omelet."

Such is the grueling, not-so-glamorous life of the former CEO of Goldman Sachs (GS, Fortune 500), whose biggest worry, before accepting the job of Treasury Secretary in 2006, was that he would not be able to make much of a difference. Boy, was he wrong about that.

This past weekend, Paulson summoned Wall Street CEOs to meetings in New York as Lehman Brothers hurtled towards bankruptcy - only to inform potential suitors that, this time, Treasury would not step in, and no taxpayer money would be made available to smooth a bailout. That killed Lehman, with unforeseen consequences.

Lehman, Paulson said, was different from Bear Stearns. He argued that Lehman had been spiraling downwards for months, and that the investment bank, its creditors and investors had time to prepare for a shock, reducing the likelihood of what he calls "systemic risk." Paulson said at a White House briefing on Monday: "I never once thought it was appropriate to put taxpayer money on the line when it comes to Lehman Brothers." But he did not rule out future interventions, should the financial markets as a whole need stabilizing.

As President Bush's third treasury secretary, Paulson was slow to get his footing and recognize the severity of the financial crisis that has frozen credit markets and threatens the American economy. But lately, against long odds - remember, he's working for an unpopular, lame-duck President and a Congress run by Democrats that is reluctant to take risks during an election year - Paulson has seized the initiative. He brokered the compromise between Congress and the White House that produced this year's $168 billion economic-stimulus package. He was point man for the Bush administration during the rescue of Bear Stearns. His bailout of Fannie and Freddie, which hold or guarantee $5.4 trillion in mortgages, has put the U.S. government at least temporarily in charge of providing financing to America's troubled housing market, at an ultimate cost to taxpayers that no one can predict. And he has laid out a blueprint to modernize regulation of the financial markets.

The financial crisis isn't over, not by a long shot, and Paulson has said it won't be until the housing market - which is at the heart of today's troubles - stabilizes.The financial-services industry has posted losses of $476 billion since July 2007, while average U.S. home prices have fallen 15%, yet each federal rescue mission has brought only a temporary respite from the waves of anxiety sweeping through the financial system. Other big institutions - AIG (AIG, Fortune 500), Wachovia (WB, Fortune 500) and Washington Mutual (WM, Fortune 500), the largest U.S. thrift - have become the newest players in a financial version of "Deal or No Deal."

As the drama's protagonist, Paulson has taken on the role of Washington economic czar just as his old Goldman colleague Robert Rubin did a decade ago as the velvet-voiced statesman of the Clinton years. Paulson has established himself as a man of action, the tenacious firefighter working alongside Federal Reserve chairman Ben Bernanke to prevent an outright meltdown of the markets or, worse, the economy. "By far the biggest priority has been to get through this period with as little spillover into the real economy as possible," he told Fortune. That's a tough job under ideal circumstances, and tougher still in the polarized, distrustful political culture of Washington in 2008. Aside from his knowledge of capital markets, Paulson's most valuable asset has been his zealous pragmatism, which has enabled him to cut through the partisanship and build strong relationships across party lines. Put another way, Paulson has done what George Bush said he would do - but didn't - and what Barack Obama and John McCain are both now promising: He has brought people together to get things done.

As a crisis manager, Paulson has wide support. President Bush calls him "my wartime general." While Obama and McCain don't agree on much these days, both supported the stimulus plan, the Bear Stearns deal, and the takeover of Fannie and Freddie. Other Paulson fans range from Barney Frank, the Massachusetts Democrat who chairs the House Financial Services Committee, to John Castellani, CEO of the Business Roundtable. That tells you something. "He's genuine, and you feel he's shooting straight and trying to do his best," says Jim McCrery of Louisiana, the ranking Republican on the House Ways and Means Committee.

Still, the full impact of Paulson's activism won't be felt until long after he leaves office in January. "Each of his interventions is controversial, and economists will be talking about them for years," says Glenn Hubbard, the former chairman of President Bush's Council of Economic Advisors and dean of the business school at Columbia. "But he has been extraordinarily effective. I can't imagine someone I would have rather had in the job."

Paulson's critics tend to be strong believers in unfettered markets who say that the Treasury Secretary has overreacted, lurching from crisis to crisis without considering the consequences of government's expanded role. To these people the very qualities that enable him to have an impact - his pragmatism, his nonpartisan instincts, his bias for action - look like a willingness to be infinitely flexible. "I'm quite disappointed," says Peter Wallison, a former Reagan administration Treasury official and an expert on Fannie and Freddie. "He certainly isn't a believer in free markets." Others go further: "America is more communist than China right now," declared maverick investor Jim Rogers. "This is welfare for the rich."

Paulson disputed such charges in two expansive interviews with Fortune, the second on the day after he unveiled the Fannie-Freddie rescue plan. (By then he was sufficiently relaxed that he had his feet up on his antique desk.) "I believe in markets," he says. "I also believe there is a role for government." More than anyone, he has exhorted the White House and Congress to think seriously about finding the right balance between the two. But in the meantime he's been scrambling to ensure support for his interventions and letting the second-guessing roll off his back. As Paulson told Fortune, "Rather than trying to revise history afterward, I'm going to make it and get something done. It may not be perfect."

***

If we were to grade Hank Paulson's work at Treasury by asking whether he has done what he said he was going to do when he came to Washington, we'd give him a gentleman's C. At his confirmation hearing in June 2006, he listed his priorities as restoring the long-term financial stability of Social Security and Medicare (nope), keeping taxes low and simplifying the tax system (not really), expanding trade agreements so that American workers, business, and farmers could compete globally (well, there's Peru), and enhancing the flexibility of financial markets by preventing "creeping regulatory expansion" (oops). While those are the sorts of bromides that Republican cabinet nominees serve up at confirmation hearings, Paulson did make an effort. He published reports on Social Security and Medicare and tried to get a conversation going, but couldn't find anyone who wanted to talk about it. He worked to expand trade but was thwarted by Democrats in Congress.

Although Paulson was a major Bush fundraiser, anyone looking closely would have seen a man unbound by ideology. Paulson, who gave few speeches at Goldman Sachs (and still appears uncomfortable behind a bank of microphones), delivered a rare public-policy address back in 2002 at the National Press Club, where, in the wake of the Enron scandal, he called for stronger regulation to restore investor confidence in big business. He's an environmentalist, the former chair of the Nature Conservancy. And in his first major speech as Treasury Secretary, he cited income inequality as a worthy concern, sounding a bit like his Dartmouth '68 classmate and former Labor Secretary Robert Reich. Said Paulson: "Amid this country's strong economic expansion, many Americans simply aren't feeling the benefits."

Paulson had never planned a return to Washington, where he'd worked in the early 1970s at the Pentagon and the Nixon White House. When Josh Bolten, President Bush's chief of staff and another Goldman alumnus, first offered him the Treasury post, he balked. Paulson's predecessors, former Alcoa CEO Paul O'Neill and John Snow, who'd run railroad giant CSX, had been ineffective, and Bush's presidency had just two and a half years to run. "I didn't want to be Treasury Secretary just to be Treasury Secretary," he says. He wanted to have an impact, he told the President, who assured him in writing that he would be equal in stature with the Secretaries of State and Defense, as well as chief spokesman on all economic issues. After mulling things over some more, Paulson realized that he was also worried about failing and what that would mean for him. "Who has left this administration with a better reputation than when they came in?" he wondered. That, he decided, was not a good enough reason to turn down a call to serve his country. (One fringe benefit was the capital gains tax exemption given to federal appointees who have to sell holdings before they take office: When Paulson sold his $500 million of Goldman Sachs stock, he saved tens of millions of dollars.)

***

Did you know that Hank Paulson was an Eagle Scout? Paulson, 62, grew up in Barrington Hills, a Chicago suburb, and he still comes across as a straight-shooting, down-to-earth Midwesterner, an image he does nothing to dispel. (Look for his cheap sports watch the next time he is on TV.) A Christian Scientist, he doesn't smoke or drink, and he's more likely to spend a Saturday night grilling hamburgers with friends at home than holding forth at a Georgetown salon. (When they came to Washington, Hank and Wendy Paulson sold their Manhattan condo and bought a $4.3 million home in northwestern D.C.; their son, Merritt, owns minor-league hockey and baseball teams in Portland, Ore., and daughter Amanda is a staff writer at the Christian Science Monitor.) Since Paulson has been working so many weekends lately, he tries to get away for a couple of hours in the middle of the afternoon to take a bike ride with Wendy in Rock Creek Park.

Right from the get-go at Treasury, Paulson laid out a set of principles. One was accessibility. In his first few weeks on the job he held 48 individual meetings with members of Congress in their offices, and he makes it a point to return calls promptly from lawmakers, even the backbenchers. Such gestures matter in our nation's capital. A second goal was to avoid politics. Paulson stopped raising money and chose not to campaign for Republicans in 2006 or to attend the GOP national convention this year. His patience is tested when Democrats make snide remarks to him about the President, but he won't push back. "You never get angry," he says. "You don't personalize things." The result is that Paulson has developed close ties to lawmakers on both sides of the aisle, among them Republicans John Boehner and Mitch McConnell and Democrats Nancy Pelosi and Charlie Rangel. "We had Harry Reid and his wife over for dinner, and Wendy cooked for them," Paulson says. Then there's the brilliant but caustic Barney Frank, who has unexpectedly become one of Paulson's closest collaborators. Frank's take on the Treasury chief: "Here's the problem. We are reaping the fruits of deregulation run rampant, some of which he supported. But given the situation he inherited, he's done very well."

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