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DAVID SKORTON: Well, good afternoon, everyone, or perhaps we should say good evening. I'm just delighted that we have such a terrific turnout for the Hatfield Address. It's a great honor and a pleasure to welcome Cornell's 29th Hatfield Fellow, Henry M. Paulson Jr., former US Secretary of the Treasury and former chair and chief executive officer of Goldman Sachs.
For almost three decades now, the Robert S. Hatfield Fund for Economic Education has brought the most influential corporate leaders to Cornell to serve as Hatfield Fellows. The fund, established in 1980, by the Continental Group Foundation honors the late Robert S. Hatfield, who was a Cornell trustee, member of the Cornell class of 1937, and former president, chair, and CEO of the Continental Group.
Selection as a Hatfield Fellow is the highest distinction Cornell bestows upon corporate leaders. And the Hatfield address, our premier corporate event, is intended to serve as a major platform for the exchange of ideas between the academic and corporate communities. We are very fortunate to have with us here today two of Robert Hatfield's daughters, who, like their father, are good friends of Cornell. Please join me with a warm welcome for Suzanne Hatfield and Molly Hatfield DuPree.
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And I believe Wendy is not here today. Is that correct? She is. Oh. Well, please, allow me to also welcome a very dedicated friend of Cornell, Mrs. Wendy Paulson, a noted conservationist. Forgive me. I had heard at the last minute you weren't going to be here. And a devoted member of the administrative board of Cornell's Lab of Ornithology. Please.
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Hank Paulson served as secretary of the treasury during what was surely one of the most difficult times to play that role in all of American history. He took office under president George W. Bush in July of '06 and, within a year, found himself leading the struggle to manage the nation's credit crisis and alleviate the deepening recession in an economy plagued by housing foreclosures, bank failures, volatile financial markets, and mounting job losses. Before leaving office in January of '09, he had played a central role in several unprecedented actions, including the government takeover of Fannie Mae and Freddie Mac and the rescue of American International Group with an $85 billion in government funds.
He relates his experiences during this time in an engaging book that I commend to you published earlier this year titled On the Brink: Inside the Race to Stop the Collapse of the Global Financial System. Mr. Paulson came to the treasury with 32 years of experience and increasing authority at Goldman Sachs. He served as chair and CEO from 1999 to 2006.
Since leaving government, Mr. Paulson has continued his longtime interest in conservation and environmental issues, a passion he shares with his wife, Wendy. Hank has served as chair of the Peregrine Fund Incorporated as well as chair of the board of directors for the Nature Conservancy. He has also helped to establish parks in Tierra del Fuego and in China's Yunnan province.
As secretary of the treasury, he designed a 10-year framework for cooperation on energy and environment with China. Mr. Paulson has graciously agreed to enter into a dialogue with me today, after which we'll open the floor for questions. And, Hank, would you join me on stage? Please join me in welcoming Secretary Hank Paulson.
[APPLAUSE]
Let me put words to that applause by thanking you before we begin the interrogation to thank you for the enormous effort in what you did and what you tried to do for the American people. Thank you, Hank Paulson.
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OK. Well, we're going to go back and forth for about 20 minutes, and then we'll open it up to all the slings and arrows that you heard about before. Hank, you were tapped by President Bush to become Secretary of the Treasury in May of '06. Can you describe whatever it is that led you to accept this invitation?
HANK PAULSON: [LAUGHS] Well, it wasn't an easy decision then, because the members of my family did not want me to do it. As I relate in the book, my mother cried. When I told her I'd made the decision, she said, you started with Richard Nixon, and you're ending up with George Bush. Aren't you proud of yourself? So it was--
[LAUGHTER]
And I had turned it down twice. But frankly, I think I just decided I didn't want to look back 5 or 10 years and say I had been asked to serve my country, and I'd said no. And the other thing that it hit me-- and it hit me rather belatedly-- was I'd gone around talking to student groups like this and others and said, embrace change. Don't be afraid to try something new. And I realized that it occurred to me that very few people went to Washington and came away with a reputation that was enhanced. And I was wondering whether I was going to be able to be successful.
And once I realized that maybe it was fear of failure that was causing me to turn it down, I quickly reversed myself and accepted and made the decision.
DAVID SKORTON: Very interesting. Well, let's fast-forward to your first few months in Washington in this role. Had your perspective on world markets and economies changed at all as you moved from the vantage point of a CEO of Goldman Sachs to the vantage point of treasury secretary?
HANK PAULSON: Well, I would say this, David. As I relate in the book, in the very first meeting with the president, I changed the topic for the economic team in July of 2006 and said I thought we were overdue for a credit crisis. There are a lot of excesses in the system. I didn't predict something of the magnitude we'd had.
And I know he asked me at the time and said, well, Hank, what would cause it? I said, I don't know. But afterwards, it'll be obvious. You know, I didn't see the Russian default coming in '98.
But I think the biggest perspective-- the change that hit me was when I started getting groups of regulators together. And I took a look at the overall regulatory system, financial regulatory system, for the first time, a comprehensive quick look. And I was just blown away with how outdated, outmoded, dysfunctional the various problems. And also took a look at Fannie and Freddie, Fannie Mae and Freddie Mac. And I started a study, which we released a blueprint for changing the financial-- the regulatory system in March of 2008. So I started those looks.
So obviously when you leave the corporate sector and become treasury secretary, you're representing the United States of America. And so that clearly was a change. But also taking a look at what we had to work with. And I was actually a little bit surprised at how outmoded a lot of the regulatory structure was and the authorities were.
DAVID SKORTON: You know, in the little corner of the world that we inhabit here, we found out during the crisis of some weaknesses that we had in our systems.
HANK PAULSON: Yeah.
DAVID SKORTON: But it seemed like very few people-- just like here, very few people saw or at least acknowledged the systemic flaws leading up to the crisis. Why did so few people see these warning signs? We've asked ourselves that question again and again here. Why did so few people see warning signs at the national level?
HANK PAULSON: I think there were a lot of people that saw excesses. Now, to step back, what I didn't see, OK, was that residential housing and residential mortgages would have the impact they'd have. And I think the reason that was the case is you just have to look at modern history in the US, that in modern history ever since World War II, there have been a lot of real estate problems. But they've been commercial. And residential housing prices have more or less gone up. There had been never a significant nationwide decline.
So mortgages were considered to be safe investments. If you bought a mortgage and invested in it, the biggest risk you had wasn't that you were going to get paid back. The biggest risk is you'd get paid back too soon. And so none of the models had that baked in.
I would say in terms of the-- I'm still not sure when you say what are the causes, you know, what are the problems-- the banks made a lot of mistakes, and there's a lot of blame to go there. But you have the rating agencies. You have investors. You have regulators.
And then the thing I talk about a lot, because if we don't focus on this, we'll be right back here again is you have the policies. So when you look at the root causes of the crisis, there were housing policies that overstimulated homeownership. You can have too much of a good thing. And if you look at Fannie Mae, Freddie Mac, the FHA programs, the federal home loan bank programs, state programs, even the mortgage interest rate reduction-- if your mortgage is a million dollars, you get an interest rate deduction.
And so you look at that and then these huge global imbalances that you're reading about right now with the G20. And of course, those stem from the fact that we as a nation save very little. And we spend a lot. And that's rooted not just in the American people. It's the policies. It's the government policies that drive it. Our tax system, there's-- look at our policies.
And then other nations have these structural problems-- China, for instance-- where they save a lot and consume little. And that's rooted in their structure. So again, like so many things, there's not just one simple answer. But I think the thing we all missed-- at least everyone I talked with there-- was that not that there could be a problem in subprime mortgages, but that you could have the kind of nationwide decline in home prices that we've had of the magnitude which had the impact it's had.
DAVID SKORTON: Yeah, it's been breathtaking and just unbelievable.
HANK PAULSON: I'd say the other thing, David, which is interesting-- if I had, as I've said to people-- and this isn't to be defensive. If I'd been totally omniscient, there's not a single thing I could have done about it at that time, because by luck or whatever, I'd started working immediately on getting there on the reform of the regulatory system and on getting legislation on Fannie Mae and Freddie Mac. So I didn't know the extent of the problem, but that's where I started working with Barney Frank right away.
And as hard as we worked, it literally took the system on the verge of melting down, Freddie Mac and Fannie Mae with $5.4 trillion in securities outstanding getting ready to implode, to get Congress to act in July of 2008. So in our system, it seems to take a crisis to get action, legislative action, on something big and difficult and controversial or structural.
DAVID SKORTON: Very, very dramatic. You mentioned Barney Frank and thinking about the very complex problems and the teamwork that's necessary. In the book, which I commend everyone for the human aspects of it as well as the interesting discussion of the finances, you describe the relationship that you and Ben Bernanke and Tim Geithner developed. Share a little bit more of that with us about how you got under this tremendous amount of pressure to trust each other. Who did what? What were the roles of dealing with this immense, unhandleable problem?
HANK PAULSON: Well, I'll step back and just simply say, one of the things I learned and I say to all the students here today, no matter how smart you are or how good your ideas are, if you can't work with others or persuade others, you won't be effective. And so to begin with, when I came down, I had an agreement from George Bush that I would have great access and be the primary advisor and spokesman on domestic and international economic issues. And I knew it would be meaningless unless I was able to develop a relationship with the president. If I didn't, it would be my fault, not his.
I had an agreement with him I wouldn't engage in political activities. So I wasn't going to participate in the 2006 elections. I wasn't going to do things that other treasury secretaries had done. So I started working immediately to develop relationships with Barney Frank and Nancy Pelosi and Harry Reid and so on.
Now, with Ben and Tim-- Ben Bernanke and Tim Geithner-- we were very, very fortunate, because we became good friends. And we had skills that complemented each other. And we started working, because even though we didn't know what was coming, I convened regular meetings of the president's working group on financial markets. And of course, with Ben, you have just a world-class mind, world-class economist and with all of the great academic experience and just articulate as can be verbally and in writing. And with Tim, you had someone who was a career public servant, and he knew treasury actually better than I did, because he'd been Bob Rubin's undersecretary. And I'd known him at the New York Fed.
And I knew financial markets. But the other thing was I had experience-- I'm decisive and action-oriented. And so we got to know each other. And we trusted each other and worked very closely together.
And once we got to the point where we needed to go to Congress, I had had an opportunity to also have worked with Nancy Pelosi and others on the first stimulus bill in 2008. So I had some experience. And Barney and I had been working on reform of Fannie and Freddie since 2006. And so that just-- it just made a big difference.
DAVID SKORTON: Well, the teamwork part of the book is very, very interesting. And along that same line, following the same tack, also in the book you note that there was an unusual amount of bipartisanship finally in dealing with this crisis. And elaborate a little bit more about that if you could. It's such-- in everybody's mind right now after the midterm elections.
HANK PAULSON: Well, I would just simply say, it's-- of course, partisanship is the enemy of all of us up there and just people taking extreme positions. I had a boss during the last 2 and 1/2 years who basically took the position that we were going to have to be bipartisan to get things done. So for instance, on the stimulus, when we worked on, rather than sending something up and saying this is my proposal, I, George Bush, he, with a lot of leeway, set me up with some firm guidelines to negotiate something with the Democrats and the Republicans and work on that.
In terms of the crisis, I can just-- he really saw, I think, the best of our country twice. People will argue and say that, well, the house voted down the TARP the first time. But the fact was I think everyone that voted for the TARP knew they were making a very unpopular vote. They knew it, and they had the courage to do it.
They didn't know it would be as unpopular as it was. I was talking with a Democrat leader up there right now today, and we were reminiscing about the fact that when I left office in '93, 93% of the Americans opposed the TARP, and 60% opposed torture. So I mean, that just shows you that we never made-- we were never able to convince the American people that we were doing this to stave off disaster.
And he was saying to me, well, people-- all the money's coming back. I said, yeah, but that's-- it was still very unpopular. And I think the-- when I went up with Ben on September 18 to ask for those authorities, we knew because the financial markets had frozen that $3.8 trillion of commercial-- of really money market funds were getting ready to melt down. The commercial paper market had shut down. So we knew that the economy was going to turn way down in six to eight weeks. But members of Congress didn't know it yet. The American people didn't know it, because it was a delayed reaction.
We also knew that we were on the brink so that if we hadn't come up with the idea of how to-- figured out how to guarantee the money markets, you would have just had a catastrophe. But when we were talking to Congress-- my book in many ways, David, is about the collision of politics and markets, because it took place six weeks before a national election. And if either Barack Obama or John McCain had opposed the TARP, it wouldn't have passed, and we would have been defenseless. If they had spoken out and said negative things about the actions we were taking, we would have had trouble doing it. So I was talking to each of them daily all the way through this.
So we got up to Congress. And when we explained-- we were essentially saying, you know what? If we don't get these authorities, we're going to be in deep doo-doo. And then I remember explaining that the economy was going to turn down anyway, but if we did this, we would avoid disaster. And Barney explained to me at the time, Hank, the American people will never understand. We have to do this. You can never prove a counterfactual.
And he was right, because what happened was we got the authorities. We prevented collapse. But to the American people, we were in deep doo-doo. So they-- it didn't work in their mind because the economy is turned down. And you'll never get credit for avoiding a disaster that didn't happen.
DAVID SKORTON: Fascinating. It's a fascinating part of the book. I want to change gears just a little bit before we open it up and touch on a couple of other issues. Thinking about President Obama's trip overseas and thinking about your work in China and so on, I wanted to ask you this. You advocate for open trade and against protectionism. Why is that, that you promote that in this climate?
HANK PAULSON: Well, because this country has benefited as much as any country in the world from open trade and open markets and free and fair trade. We have a-- it's been a huge benefit. And I believe it's helped us economically, and it's created jobs in the United States.
And I think that much of what makes people unhappy really is not-- and some of the problems we're dealing with right now, it's not fair to blame on trade, OK? For instance-- and these numbers, I haven't looked-- done this analysis recently. But they're generally right. When I last looked at, for instance, manufacturing-- and people say, why don't we have any real manufacturing jobs in the United States? When I looked at them some time ago, in 1950, we had 16 million manufacturing jobs in the United States. Very recently, we had 16 million, a much smaller portion of the economy.
But we had eight or nine times the output for those jobs. And we were the largest manufacturer in the world. But what has driven that change is productivity. And I remember going through a Caterpillar tractor facilities in Peoria when I first started working with Caterpillar in the '70s, and I saw people all over those plants. You go through a plant today, you don't see people. You see robotics, and you see technology.
And it's very hard to be against technology. Who's against technology and innovation? But we've got very serious issues to deal with, structural issues. And I think the way you need to deal with them is not through isolationism. And we could talk-- and this is probably off topic here-- about how to deal with some of those issues.
But China, for instance, you know, I fought very hard and I think pretty successful to get China to move their currency, to do other things. But currency is a symbol. And China needs over time a market-determined currency if they're going to continue to reform their economy. But the truth is, most of the products we import from China, they're not taking jobs away from the United States. If we didn't the import them from China, we'd import them from elsewhere. We run a trade deficit with virtually every nation in the world. And that stems from the fact that we don't save.
And the issues-- I think the things that China needs to do are structural changes that won't be solved just by currency alone. They save because they don't have safety nets. They don't have good retirement programs or health care programs. They have to over save because the individual in China, they don't have adequate capital markets. They put money in banks, and they get 2% on their deposits. And inflation is a multiple of that.
And so those are the kinds of structural changes we need. But all those that want to make China the enemy here, we'll find out how wrong. they are if the Chinese economy starts growing-- stops growing and has problems, because my own view is we need to solve our own problems. And if we don't solve them, it won't be because of China. Matter of fact, they're going to be harder to solve if China sputters and has economic problems.
Now, that doesn't mean that I'm not-- wasn't fighting all the time. And I would tell my Chinese counterparts, listen, I believe in free trade, and I think we benefit-- I think we benefit from imports from China. I think it keeps inflation down. I think it creates choices for a lot of Americans, particularly those on low incomes and fixed income. And it's pretty positive.
But let me tell you, it's going to be a lot easier for me to work to keep our markets open for you if you keep opening your markets for us. And you might as well start by eliminating all tariffs on environmental goods and services, because that's not economically wrong. That's morally wrong.
DAVID SKORTON: Two quick questions, the first one derivative-- or last two questions. First one derivative from your comments about rank and file in the factories and also about people on lower, fixed incomes. I worry a lot about Social Security and Medicare, and I'm sure you do too. Do you think workers and folks in the audience here who are in their 40s and 50s, their most productive years, good citizens, working in a wide variety of pay levels, paying into this system-- is that system going to be there for them when their time comes?
HANK PAULSON: Well, I don't think it will without change. And, David, here's the way I see it. This is not just about economics. It's about morality, and it's about generational equity or fairness. People, you and I, we have kids that are in the workforce. And we would like it if our children and our grandchildren had the same opportunities we have. But we are a very selfish generation, because the-- and many Western democracies are. We vote we want benefits, but we don't want to pay for them.
And if you look at many of the pension funds, state and municipal funds, not just Social Security and Medicare, it's a house of cards. They're built on-- I won't say it's fraudulent, because it's legal. But it's fictional accounting. And the money won't be there. And so I have no doubt that we will solve this fiscal crisis, and we will deal with the entitlement programs. But the longer we wait to deal with it, if it's a crisis, the less flexibility we have, and the worse deal it will be for future generations.
I've watched-- I have a friend who is a United Airlines pilot. And he retired. He expected to have a very-- maybe, probably a very big retirement, $120,000 a year. And his retirement is now $30,000 a year because the company failed, and the pension plan wasn't adequately funded. But so this is something that I think it's about fairness.
DAVID SKORTON: Last quick question-- in honor of the fact that Wendy's here today and has been such a advocate and a visionary person on environmental issues, you may know that we just got this honor of a very, very substantial $80 million endowment gift for our now Atkinson Center for a Sustainable Future . 220 of the faculty here-- 220 faculty out of 1,600 are involved in this. Give us a short, one single environmental issue that keeps you up at night. I know there's many, but which one really keeps you up at night?
HANK PAULSON: Well, the-- my interest and my passion is saving wild, beautiful places and ecological diversity. But what keeps me awake at night is obviously the climate issues. And all those that say they're not real are putting their heads in the sand. And when you've got 100% evidence on anything, it's too late, and you're looking in the rear-view mirror. And the only way you can solve this problem is having developing countries participate also, the major economies. And the only way you're going to have them participate is to have the development and deployment in scale of cost-effective, clean energy, low carbon technologies.
And so I'm optimistic they can be developed, that there's some that aren't that far away. But they're going to have to be developed and deployed. It would sure help if we had a price signal, if we put a price on carbon to do that. But I think that's really is a challenge in front of the world. And no matter what we do in the United States, we're not going to be successful unless we get China and India and other countries.
And that's why I think it's so important that there not be-- as was I explained to many of these countries when they said, well, you polluted when you were developing, you know? It's our turn. They're not really saying it quite that way now. And you just say, yeah, but right now we know how bad it is, and we've got the technologies. And on top of that, how do you justify, how does anybody justify having a tariff on environmental goods and services? And so there's a lot that can be done, and it needs to be done.
DAVID SKORTON: OK, I had 10 more questions on how much harder it is to be a university president than a treasury secretary, but we'll pass on those for right now. So we'll turn the lights up, please, and let's have questions from the audience. He's laughing because he knows it's much harder to be a university president.
HANK PAULSON: I know it is.
DAVID SKORTON: Much harder. Much harder.
HANK PAULSON: Let me tell you something-- none of these jobs are easy.
DAVID SKORTON: OK, so let's start out over here please.
AUDIENCE: Secretary Paulson, thank you so much for coming. I just wanted to ask your opinion. Given the Fed's quantitative easing right now in its prospect, do you think we're in a liquidity trap in the US? And the second stage is, how do you think we can grow, innovate, and create jobs in this country? What keeps you awake at night that we should be doing, but we're not doing?
HANK PAULSON: Well, those are two great questions. And I'd say the following. When I was treasury secretary, I stayed out of monetary policy. As a retired treasury secretary, I probably should stay out of it other than to say I have a very high regard for Ben Bernanke and his judgments. You know, he's I think been on record as saying the central bank can't be asked to do everything. The executive branch and the legislative branch have got to do things. It's clear that there's not much more being done. We're still not growing.
I think deflation is unlikely, but it's a small but deep hole. And I have no doubt that his motive is to get the economy growing. It certainly isn't to weaken the dollar. And so I'm a big supporter of Ben's.
Now, I think your question is really the $64,000 question, the second one. How do you get the economy growing, and how do you create jobs? Now, one thing is going to happen automatically, which is you've got $2 trillion of corporate cash that isn't being spent. I don't agree with businesspeople that say it's not being spent because the president said some bad things about us, or it's all the government regulation.
I think that when business starts to see the turn and feel better about the economy, they'll spend. And I'm starting to see some signs already. And so I would be more optimistic over the next year that you'll see business growth. But I think employment will be slow to follow.
And I think the only way we're going to deal with the employment problem, the fact that one out of-- you know, 20% of men between the ages of 20 and 50 are unemployed right now-- is with significant structural changes. For instance, take taxes. I think we ask the wrong question, no matter which side you're on, about should the Bush tax cuts for the highest earning Americans expire or not. That's not the right question.
The right question is, what form of tax will give us the revenues we need and let us create jobs and grow and be competitive? Because we need taxes. So the question is, what should they be? Should they be 18, 19, 21, 22% of GDP? Whatever they should be.
Then you know taxes are going to be a drag on growth. So what form is going to let us be competitive? And we have a tax system that's out of step with the rest of the world and particularly a corporate tax system, but overall a tax system that doesn't encourage savings and encourages-- you know, it also encourages consumption.
There is a whole series of things to be competitive in terms of training. You know, I'd be a big believer that there should be-- it may be unpopular to say it in this group, young people, but I think every young person owes the United States of America service, if not in the military, in the Peace Corps, teaching, or whatever.
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And getting training there and then having some form of a GI Bill where there's skills training and technical training to give people the skills they need for the jobs of the future. How are we going to be competitive without an immigration policy that's comprehensive and makes sense?
And so unfortunately, you can't expect the head of the central bank to do something on monetary policy that's going to solve all of those. And there's no major economy in the world that has got-- that doesn't have more problems than we have. We're the richest country in the world. But we need to make structural changes.
So I think the question for all of us to ask is, do we have a form of government today-- and I've always been a real patriot. We say we have an imperfect government, but it's better than any other. But the question really for us is, is our government going to be able to make the structural changes we need to create the jobs and be competitive?
AUDIENCE: Thank you.
DAVID SKORTON: Fabulous interchange. Please.
AUDIENCE: Hi. My name is Jose [INAUDIBLE]. Do you have it?
DAVID SKORTON: You're OK. Just get as close to it as you can.
AUDIENCE: Thank you. My name is Jose [INAUDIBLE]. And I have a tough question for you, sir. Formerly, I was on the Royal Bank of Scotland Greenwich Capital market's global macro proprietary desk. I remember in fall 2007, OIS-Libor spreads blew out to 58. I had a conversation with somebody that night, and I said, you mean 5.8. He said, no, 58. The end of the world was coming, and everybody felt it.
Ben Bernanke was basically out of ammunition by January or February 2008, and he was essentially pleading for fiscal stimulus. My question is, do you think that we should be rethinking the Federal Reserve Act and essentially merge the Federal Reserve in with treasury to bridge this communication gap that we had? Because there was a huge delay, and the ship was sinking.
HANK PAULSON: There was-- no, I don't think you should do that. And there was no communication gap. We did everything we could to pool our powers, met regularly, talked all the time. The problem we had was this. The Fed had more powers than the treasury did. The only way you could get treasury powers, fiscal powers, which we needed, was to go to Congress and get them.
And we had a situation where it was impossible to get them from Congress, that in the middle of this crisis, we still had members of Congress trying to push Fannie and Freddie to buy subprime mortgages. We had them debating over piddly little housing reform and mortgage reform issues. I was getting a lot of flak because I got the private sector together, mortgage servicers, originators, lenders to figure out how to modify mortgages and change some accounting rules and legal rules to do that.
So we couldn't-- working on Fannie or Freddie, it took a-- so Ben and I and our two teams developed a plan. And we called it a break the glass plan. So we developed a plan to go to Congress with authorities to buy illiquid assets in size. But we couldn't have got-- to go and say there's an emergency and not be able to get these authorities would have been worse than nothing at all.
And so what we did was we went as soon as we possibly felt we could do. I don't think we could have gotten anything on Fannie or Freddy a bit earlier. And the TARP got voted down the first time in the middle of a crisis. And so the problem we had was a lot of what needed to be done had to be done with fiscal powers. Treasury didn't have the powers. You can't-- none of us had powers to guarantee mortgages or to guarantee borrowings or liabilities or to put capital into the system or to wind down a failing nonbank. There were no emergency powers for that.
So that was-- and today-- so now we look forward say, what do we have today going forward? We have a regulatory system that makes a lot more sense. All the big financial institutions are going to have at least the Fed as a regulator. There are going to be better capital rules and liquidity rules. There's going to be a systemic risk function.
And most importantly, there are emergency authorities that now work for nonbanks. But you'd have a Constitutional crisis if you tried to get more from Congress. And the Congress-- I used the Exchange Stabilization Fund and got a good legal opinion, but it was a stretch to guarantee the money market funds. And when Congress passed the TARP, they put it in legislation, don't ever do that again.
So I think it's just the way our system works. And we don't like-- the American public does not like bailouts. And in our system, the feeling is if you reap the benefits of risk-taking, you should pay for the losses. And so that's why I think these wind-down authorities, resolution authorities, are so important so that it's not that any-- no bank is too big to fail, but they're too big to liquidate quickly. And so we have those authorities now.
DAVID SKORTON: Over here, please.
AUDIENCE: Thank you. Hi, my name's Alex Boris. I want to thank you, Secretary, for coming. My question is, is Goldman Sachs currently too big to fail? And would you support splitting it into smaller parts?
HANK PAULSON: Well, I would say-- to not deal specifically with Goldman Sachs, let's talk about the size of financial institutions. One of the problems we have when we deal with-- to just give you a magnitude and why your question is perceptive-- in 1990, the 10 largest financial institutions had 10% of the financial assets in this country. Today, they're over 60%. Now, we made it worse in the crisis. But there is this huge concentration.
So then the question comes up with size, OK? And should there be-- what should be the limits on size? And what I had recommended was with very-- because you're going to need big-- with a $14 trillion US economy and $60 trillion global economy, you're going to need institutions to help others manage risk that are big institutions.
So the question is how do you regulate them, and how do you make sure that if they fail, that they're not too big to fail, OK? How do you make sure of that? And first of all, you need tough regulation where a regulator can step in and prevent any type of activity or have them divest one activity or another.
I think even more importantly, what you need-- and then the second thing you need is they can't be too interconnected to fail. So you need-- what we're going to have going forward is a derivatives market where there's more-- much more transparency and much more standardization. And so where derivatives that are standard trade on exchanges, and if they're more complex, on centralized clearinghouses, but that they've got big capital charges against complexity, because complexity is an enemy. And you have to fix the secured lending market.
But then the most important thing we need is what I was trying to get to with the other gentleman when I was talking about-- is what we need is a system that doesn't rely just on regulation, because no matter how good regulation is, you won't find all the problems. Unless you thought the banks were trying to blow themselves up, the banks didn't find the problems themselves. So you need a situation where every big bank, there is-- if they fail that they're allowed to fail and allowed to fail in a way in which it doesn't take the system down with us. And that's why you need these emergency resolution authorities.
And what the regulators are now doing are going to the banks and saying-- and it's something I'd recommended-- we need a living will just like all of you will need a will someday. Every major complicated financial institution has got to say, here is a plan of liquidation. Here's a will. If I fail, here's how I'm going to be broken up. And so I think that's the right way to deal with it. But it's, I think, a very important and fundamental question.
And I think the other question is complexity is our enemy. It really is. And a lot of the leverage was in complex instruments, which were hard to understand. And it's hard to regulate against complexity or legislate. But if you have big capital charges that go with complexity, I think you'll get a lot more standardization, and the system will make more sense.
DAVID SKORTON: I just want to check. Do we have a microphone upstairs? I guess we don't. But nobody's up there right now. OK. Take one.
AUDIENCE: There is.
DAVID SKORTON: Oh, there is one. OK, please.
AUDIENCE: Hello. Looking forward, what do you think the government should do about Fannie Mae and Freddie Mac? And do you believe that owning a home is a right or a privilege?
HANK PAULSON: I believe it's a privilege. And I don't think it's even fair to talk about it as being a right, because I think that someone doesn't have a-- you're not doing them a favor if you put them in a home they can't afford to own. And matter of fact, one of the things we might ask ourselves is, why are we so unfair to renters? Why does it make sense that if I want a million dollar mortgage, the interest is tax deductible, but if I want to rent a home, you know, I get no benefit?
So now, in terms of Fannie and Freddie, I think what you need to do is first of all say, what do you want housing policy to be in the United States? And so you need to look at this at the same time you're looking at all the other programs, FHA programs. You look at the mortgage interest rate deduction. So you look at all housing policies.
But what I would do at a minimum is I would first of all-- and for those of you who don't really know what Fannie or Freddie Mae are, this may be a little bit too much detail. But to keep it simple, they have an implicit government guarantee. I would make that guarantee explicit. And I'd have them pay for it. OK? Number one.
Number two is, does it make sense to have government support and private profit? So you should make them utilities. You can-- then what you should do-- they shouldn't have portfolios. And again, part of the reason they got in trouble was they had the low interest rate from the government support, and then they bought not just the mortgages they guaranteed, but they bought and held a lot to live off the carry. And so they shouldn't be allowed to do that.
And then I would really shrink their mission. I'd merge them, and I'd shrink their mission and limit what they do either by the size of mortgages guaranteed or the income of the borrower or something like that. And then you leave room for the private sector if they have to pay the right amount for the government guarantee.
But I think all those-- you know, this is a good example of what I don't like about Washington. I got to Washington, and it didn't take a rocket scientist to see that these were an odd construct. How would you ever-- the elephant-- even if you like the original construct, the elephant was much too big for the tent. This was a huge risk. And on top of that, by law, they had poor regulation and razor thin capital margins.
So what you had was you had people on each side of the issue. And nothing was getting done. There was one side that said, we shouldn't have them. Let's just drive them into the Potomac. Makes no sense. And the other side was, you know, we've got to have more and make more loans. And nothing was being done.
And one of the arguments I made to George Bush, and he accepted-- in 2006, I said, listen, I happen to think on this one, Mr. President, your administration-- our administration is right in terms of the position on Fannie and Freddie. But unless we compromise, we're going to leave here, and nothing is going to be done. So please give me the permission-- I think half a loaf is better than a whole loaf-- and give me the permission to go up and negotiate and work out something with Barney Frank. And in a minute, he said, yes, go do that.
Well, so I think right now it's unrealistic to say that Fannie and Freddie-- first of all, today we desperately need them. The mortgage market is still sick. And I think the most effective form of stimulus we did during the crisis and the most effective thing we did was in essence nationalizing them, because without financing for homes, can you imagine what home prices would be? And so that's been there. And we still need that.
But we need to figure out how to scale them back and reform them so we're ready to go when we no longer need this massive subsidy. And I think it's unrealistic all those that say, well, let's just make them totally private entities, because it's not-- whether it should or not, it's not going to happen. So we need to think about how to manage it and make sure we don't have this problem again.
DAVID SKORTON: Let's quickly sneak in one last question please.
AUDIENCE: Secretary Paulson and President Skorton, thank you very much for your conversation this evening. You touched on this a little bit on a specific level handling crisis in Washington and how tough that can be. And I kind of want to take that a bit more meta. When the financial crisis hit, we just barely managed to get some reform in for Fannie Mae and Freddie Mac, but still they desperately need reform. We managed to get a financial regulatory bill, but still there are gaps. And that just squeaked through after deal-making with Senator Brown. Are we losing our ability to handle crises in this country, and are we losing our ability to handle crises before they happen?
HANK PAULSON: The answer to the second one is yes. And I think the lesson that I took regrettably away from Washington is that it takes a crisis to get something big and difficult and controversial done. And in a system, a political system that's been corrupted by gerrymandering and redistricting, by cable television and all the money that comes into politics-- and so you just go from one election to another. It seems to be very difficult to get something done.
So you know, it's funny. I look back at it now. At the time, I was very, very frustrated that we couldn't get some of the powers we needed earlier. And we had the regulatory system. I now look at it, and I'm grateful that twice before the very worst happened with Fannie or Freddie, I went to Congress, and I-- they were so big, I couldn't-- I needed unlimited authority. And my political advisors said, you couldn't ask for unlimited, so I asked for unspecified.
[LAUGHTER]
And we-- you know, I would like to have got it earlier, but we got it. And we got very broad authorities with TARP. But that was the easiest thing, because that was preventing a-- stabilizing the financial system, preventing a meltdown. The kinds of structural-- you know, when you read the newspapers, think about it this way. When you're thinking about China, Japan, the US, Europe, the issues and the fiscal problems you see talked about are one of the structural issues. But the issues we have are structural issues.
And they're always going to be unpopular for the reason I mentioned earlier, because we're a selfish people. We seem to be. I hate to say it. Individually, we're not. We're the most generous people in the world in terms of doing things all around the world or charitable giving. But somehow or other, the political process brings out the worst in us. And people vote with their pocketbook and don't want to make the kinds of sacrifices, or we're afraid of change.
And there certainly are-- when you look at-- just take something in regulation. Anybody that knows something about financial markets, why would you regulate the futures market separately from the cash market? We have the CFTC and the SEC. You know why? There's two different congressional committees. And neither one wants to give it up. You've got vested interests.
And you could just look at all kinds of things in Washington that just needed to structurally change, and it's going to take tough leadership. So that's really the question. I think we will solve all of these issues. We will deal with them eventually. But the longer they wait, the more expensive it'll be, and the bigger the price all of us will pay and particularly future generations.
DAVID SKORTON: Please join me over here and allow us to thank you for this--
[APPLAUSE]
I want to thank you on behalf of all of us, not only for the very straightforward and honest answers, but for everything that you did in public service. And this is a special Steuben glass that was created for the Hatfield lecturers. It's in two pieces, and our staff wants me to make sure you know it's in two pieces, because if you drop it, I own it. So it's from us to you. Thank you very much.
HANK PAULSON: David, thank you. And let me--
[APPLAUSE]
Let me say one last thing, because-- what a great school. What a beautiful campus. And I hope I wasn't too negative about the future, because I will tell you, this has got to be-- you know, anyone graduating in the next several years, what an interesting time to come out into the world.
[LAUGHTER]
There's all these-- no, there's-- I got to tell you, there's no job today that isn't more fun and more interesting than when I graduated from college in 1968. And it's people like you that are going to make the difference. And I tell you, the time I've spent on college campuses, it gives you just great, great hope for our country. But it's going to take change, and it's going to take leaders like you to help bring about that change. So again, thank you very much.
[APPLAUSE]
DAVID SKORTON: Thank you.
HANK PAULSON: Thank you.
Former U.S. Secretary of the Treasury Henry Paulson reviewed some of the conditions preceding the 2008 financial crisis and the steps he took to try to avert it during the 29th annual Hatfield Address, a conversation with President David Skorton, Nov. 11 in Bailey Hall.
Paulson, who was chairman and CEO of Goldman Sachs from 1999 to 2006, took office as Treasury secretary in July 2006. Before leaving office in January 2009 he had played a central role in several unprecedented actions including the takeover of Fannie Mae and Freddie Mac, and the rescue of AIG.
The Robert S. Hatfield Fund in Economic Education was established in 1980 by the Continental Group Foundation to honor retiring chairman, president and CEO Robert S. Hatfield '37. The Hatfield Fellows Program is a platform for the exchange of ideas between the academic and corporate communities.
