We had decided to focus the fourth meeting of the Strategic Economic Dialogue on sustainable economic growth, and when we met in June 2008, the theme could hardly have been more appropriate. Oil prices were soaring. At $138 per barrel, crude sold for twice what it had a year earlier. Rising fuel and fertilizer costs, combined with local droughts, had hiked the tab for food, especially staples, while shortages sparked deadly riots in some poor parts of the world. The price spikes reflected in part the ever-greater demands that the rapid growth of developing countries was placing on scarce natural resources. China’s success alone had lifted hundreds of millions out of poverty. Now the country’s challenge was to maintain that progress without upsetting its domestic stability or causing a global calamity.
By the time we gathered at the U.S. Naval Academy in Annapolis, Maryland, for SED IV, the United States was being buffeted by the deepening financial crisis that would engulf the financial world. Much has been written about this dark period in our nation’s recent history. Less well known to Americans is how profoundly the crisis would shape Chinese attitudes and policies. It exposed China’s overdependence on exports and confirmed the need to rebalance its economy toward domestic consumption. Measures that China would take to withstand the worst of the crisis—particularly a massive fiscal spending program—would halt needed structural reforms and leave the country with a costly legacy of bad debts that it continues to suffer from today. China would play a stalwart, responsible role in helping us contend with rapidly multiplying problems. But the nature of the relationship between our two countries began to shift noticeably as the U.S.’s troubles brought doubt and discredit to our system in some quarters and boosted China’s self-confidence.
This was brought home clearly to me along the sidelines of the SED, during a break in the proceedings, when I was pulled aside by Wang Qishan, who had moved from his post as mayor of Beijing to succeed Wu Yi as my SED counterpart. Qishan, who had been named vice premier in March, wanted me to know that the financial crisis in the U.S. had affected the way he and others in the senior ranks of the Party saw us.
“You were my teacher, but now here I am in my teacher’s domain, and look at your system, Hank. We aren’t sure we should be learning from you anymore.”
The crisis was a humbling experience, and this was one of its most humbling moments.
I’d known Wang Qishan for nearly 15 years now and had worked closely with him on several pressure-packed occasions. He’d become a friend and confidant. He was charming and cheerful, and though he could be quite diplomatic, he was generally direct and no-nonsense with me. I appreciated that quality, and his comments, earnest and animated, did not offend me in the slightest. Instead, coming from a man who had spent the past three decades pushing for reforms at home, they told me how difficult the climate for such change had become in China. The Western financial crisis had toughened internal resistance to opening the country’s capital markets.
“We’ve made plenty of mistakes, but you can learn from them,” I responded. Our problems, I said, shouldn’t lead China to conclude that it didn’t need to continue to develop open, competitive markets. In any case, I added, “we are determined to do what it takes to fix our markets and protect our economy.”
Still, there could be little doubt our system was under great—and increasing—stress. In March the crisis had claimed its most prominent U.S. victim to date in the investment bank Bear Stearns, an outsize player in the mortgage-backed securities markets. As housing unraveled, Bear lost the confidence of the market and fell victim to an all-out run. It would have failed had the Treasury, the Federal Reserve, and the Federal Reserve Bank of New York, working together over a frenzied mid-March weekend, not found a buyer for it in JPMorgan Chase and had the Federal Reserve not provided financial assistance.
As I have related in On the Brink, my previously published account of the financial crisis, Bear’s collapse sent a shock wave around the world. The fallout was felt deeply in China, whose state-owned investment company, CITIC Securities, had previously agreed to buy a 6 percent stake in Bear for $1 billion; it hastily retreated as Bear fell apart. Separately, China’s sovereign wealth fund, China Investment Corporation (CIC), had made high-profile investments in 2007 in Blackstone Group and Morgan Stanley, giving the country’s leaders a keen interest in Wall Street’s imperiled health. Moreover, China was beginning to feel the reverberations of the crisis. Though the country’s banks had been spared, the downdraft in global stocks had contributed to a 45 percent drop in the Shanghai Stock Exchange Composite Index since its October 2007 peak. GDP growth was moderating, and the slowdown in economic activity in the U.S. and elsewhere threatened to reduce demand for the country’s vital exports.
I had gotten a taste of China’s concerns firsthand in April, when I had been in Beijing to plan for SED IV. Hu Jintao, Wen Jiabao, and Wang Qishan had all peppered me with questions about the U.S. economy, the health of our banks, and their country’s money-losing investments in Morgan Stanley and Blackstone. I assured them that the U.S. responses had been swift. The Federal Reserve was providing liquidity to stressed financial markets, while the $150 billion stimulus program I had negotiated with the Democratic-controlled Congress on behalf of the Bush administration would soon put money in the hands of consumers. I noted, too, that many forecasters expected the economy to rebound in the second half.
How wrong they were!
The Chinese appreciated how openly we were communicating with them. After the Bear Stearns rescue, Neel Kashkari, a senior Treasury adviser, had led a call with officials from the Chinese Ministry of Finance. We would increase the frequency and depth of contact as the crisis escalated over the coming months. The broad-based constant communications fostered by the SED, coupled with my long-standing relationships with Wang and Zhou Xiaochuan, would prove enormously valuable in helping us manage the economic relationship with the second-biggest foreign investor in U.S. securities during this fraught period.
I had let the Chinese know during my April visit that Treasury was on high alert for more problems. It turned out, of course, that we were right to be vigilant, as one financial institution after another felt the wrath of investors suddenly worried about toxic assets, weak balance sheets, and the banks’ hesitance to lend to one another. I stressed the need for more capital and greater liquidity cushions to Wall Street and banking CEOs, repeatedly encouraging Lehman Brothers CEO Richard Fuld through the spring and summer of 2008 to gird his firm for the tough times ahead by finding a deep-pocketed strategic investor or, eventually, a merger partner.
Bad news accumulated. As U.S. share prices drifted down from their record highs in October 2007, the economy continued to lose steam and unemployment climbed. At 5.6 percent in June, it was up a full percentage point from the previous year. Though checks from the federal stimulus reached U.S. citizens in record time, they barely covered the higher cost of gasoline.
China-bashing grew louder through the presidential primaries. In May the Democratic rivals, Senators Hillary Clinton and Barack Obama, endorsed legislation that would have allowed punitive duties on Chinese goods in response to currency manipulation. I spent hours on Capitol Hill with Al Holmer, Treasury’s special envoy for China and the SED, trying to deflect such knee-jerk protectionism. We pointed to the progress we had made on currency valuation—the renminbi was up nearly 14 percent since July 2005—and noted that the SED was yielding tangible results, from the open-skies agreement to enhanced product safety, that we risked losing if we took a punitive turn.
I had cautioned Wang Qishan shortly before his arrival in the States in June that the mood in Congress had grown far darker and more volatile than it had been when Wu Yi had visited the previous spring. If Democrats pushed anti-China legislation, Republicans wouldn’t vote against it.
“Anything could set off a cascade,” I warned.
Still, I figured that if anybody in China had the charm to soothe irritated legislators, it was the vice premier. Wang Qishan was as different as yin and yang from Wu Yi, a tenacious negotiator who stuck to debating points and stayed on message. Wang Qishan held just as firmly to his country’s positions, but his approach was at once expansive and subtle, intellectual but leavened by a dry sense of humor. A real people person, he welcomed almost any meeting. When asked tough questions, he relished giving as good as he got.
Wang Qishan was scheduled to meet the Capitol Hill leadership, but I’d also invited a handful of senators and members of the House to meet China’s new SED leadership team for breakfast in Treasury’s Cash Room. It was a magnificent, gold-trimmed palazzo-style space on the second floor of the Treasury building, where the government had once transacted such financial business as redeeming gold and silver certificates and supplying local commercial banks with coins and currency from the Treasury’s vaults. Seven lawmakers attended, including Senators Norm Coleman (R-MN) and Maria Cantwell (D-WA) and House members Sandy Levin (D-MI) and Don Manzullo (R-IL). At one point, one of the lawmakers challenged the vice premier on China’s lack of commitment to combating climate change.
Wang Qishan surveyed the table for a moment as if he were thinking through his response or wondering whether the guests were up to following him. Then he headed off on a lengthy discourse that touched on economics, social policy, and personal responsibility. China might have the third-biggest economy in the world, he pointed out, but it was still a poor country; by GDP per person it was ranked 125th—below Namibia. This was a standard Chinese talking point, but Wang Qishan turned it in a less familiar way.
On the one hand, he noted, some in the U.S. were criticizing China for wasting resources, damaging the environment, and contributing to global warming. On the other hand, many claimed the Chinese were hurting the U.S. by exporting too cheaply, and they were pushing China to rebalance its economy to encourage even more domestic consumption. How was China to pursue both increased consumption and sustainability?
“Here we are,” he said. “It’s a hot summer day, but it’s cold in your offices because you’ve got the air-conditioning on. In the winter you’ve got the heat blasting out. For exercise you work out in air-conditioned gyms, then take hot showers, then get into air-conditioned cars. This is America! In China, we don’t live that way. We can’t afford to. I tell my colleagues: conservation with personal conduct! For exercise, ride your bikes to and from work.”
It was quite a show. What had been meant to be a Q&A session turned into a tour de force disquisition that laid out the paradox of sustainable development for his country without a hint of the reflexive defensiveness that often colored, and weakened, Chinese arguments. I knew that Wang Qishan, as a reformer and conservationist (he had served with me on the Nature Conservancy’s Asia-Pacific Council), was committed to finding solutions. In pointing out the inherent difficulties of China’s situation, he was not so much lecturing U.S. lawmakers as trying to illuminate for them a thorny problem, just as he had for me a few months earlier when we met in Beijing to discuss the energy and environmental initiative of the SED.
“The world simply does not have enough resources to support another billion Chinese living the Western lifestyle,” he had noted. “We have to find a new model.”
I frankly thought he was right. As he spoke, I remembered that long-ago February meeting at Zhongnanhai during which I’d spied Zhu Rongji’s long underwear sticking out under his pant cuffs—a precaution against the cold that our pampered leaders would never have to take.
For the June 17 and 18 SED IV, we met on the pristine grounds of the U.S. Naval Academy, which was established in 1845 where the Severn River meets the Chesapeake Bay in Annapolis, Maryland, about a half hour east of Washington. Its distance from the District was one of its attractions; we wanted to keep members of our delegation away from their offices and concentrated on SED business. But even for me, it wasn’t easy to focus. A little more than a week before the meetings began, Lehman Brothers had released second-quarter earnings in a vain attempt to reassure investors. Its shares kept falling, and behind the scenes, no buyers or major strategic investors had emerged. My team at Treasury and the staff at the Fed continued to look for ways to prevent a Lehman failure. At the same time, we were becoming preoccupied with the mortgage titans Fannie Mae and Freddie Mac, which had come under intense market pressure as legislation to reform them stalled in Congress.
Just about every break was consumed with phone calls, but I made a point of not ducking out of the SED meetings and asked my fellow Cabinet members to do the same. At one point I had to negotiate with the White House about who would attend an emergency meeting President Bush had called to deal with widespread flooding in the Midwest that demanded the administration’s attention. The president’s meeting was vital, but I was determined to respect the SED process as much as the Chinese did. I believed that our dedication to the SED would pay dividends.
I tried to address the fragile state of the markets head-on in my SED remarks. I explained the Bush administration’s efforts to stabilize the financial system and the economy and noted that flexible, market-based prices serve as automatic stabilizers in the ups and downs of economic cycles. I also made the point that the market turmoil was no excuse for halting financial sector reform and development in China.
Most important, we signed the Ten-Year Framework for Cooperation on Energy and Environment, committing the U.S. and China to work together for the next decade on clean, sustainable energy development. The agreement, which we had begun working on during SED III, increased the likelihood that our efforts would carry over to the next administration.
Currency issues continued to give me grief. In September 2007 Dominique Strauss-Kahn, the former French Finance minister and presidential hopeful, had become head of the IMF and sought our backing to make some much-needed changes, including a plan to sell some of the Fund’s gold reserves. I made clear that our support was contingent upon the IMF’s citing China for currency manipulation. The undervalued renminbi was a global concern, and the IMF was the proper forum to address it. Frankly, I was also tired of the U.S.’s always having to lead on this issue.
DSK agreed that the IMF would cite China, but afterward he indulged in some backdoor maneuvering that sparked the protestations of my friend Zhou Xiaochuan, China’s central bank chief. Zhou came up to me during one of the breaks in Annapolis and said, “Hank, Strauss-Kahn says he doesn’t want to cite us. He wants to give us more time to make progress, but you are insisting that he act now. If the IMF acts now, it will make it harder for us to move the currency because our people will think we’re bowing to outside pressure.”
China was eager to avoid public criticism from a credible and independent multilateral institution, but as always, Zhou was measured and reasonable. I was a bit irritated that DSK had used me, albeit accurately, as his excuse for getting tough with China, but I didn’t let on to my friend.
“The IMF needs to do its job,” I told Zhou. “And if you show more flexibility with your currency, there will be no need to cite China.”
Though I wished DSK had not told Zhou Xiaochuan about our agreement, I realized the Frenchman’s transparency was just part of his pragmatic, straightforward nature. I always found him easy to deal with, and when he later was convinced by Zhou Xiaochuan that the Chinese needed more time, I just asked him to move as soon as reasonably possible.
As it happened, our world was about to change dramatically, and China’s currency would soon become the least of our worries.
The financial crisis had deeply wounded Fannie Mae and Freddie Mac. These government-sponsored enterprises, or GSEs, owned or guaranteed $4.4 trillion in U.S. mortgages, including a big chunk of subprime loans. They were bloated, undercapitalized, poorly managed—and politically all but untouchable. Because they had been established and were regulated by the U.S. government, many investors assumed their securities were backed by the full faith and credit of the United States. They were not. Fannie and Freddie were shareholder-owned private corporations, but their perceived government backing gave them access to cheap funding and led them to take on enormous risk. I’d come to the Treasury Department determined to reform this untenable business model, which privatized profit while socializing risk. But lawmakers resisted changes; the two companies had wrapped themselves in the “American dream of home ownership” and were past masters of public relations and lobbying.
By early July Fannie Mae and Freddie Mac had come under intense pressure. We had to ensure that they got through the mortgage crisis without triggering a full-scale financial panic that could spread quickly across our borders. Many of the GSEs’ biggest investors were foreign central banks. Of the $5.4 trillion in Fannie and Freddie securities outstanding, $1.7 trillion was held by foreigners.
On July 7 speculation that the two GSEs needed up to $75 billion in capital spurred investors to flee the stocks. Shares plunged again on July 9. Hoping to calm the markets, I stood on the steps of the Treasury Department on July 13 and announced that I would ask Congress to give me temporary emergency authority to increase Fannie’s and Freddie’s lines of credit with the Treasury and to allow us to buy equity in the GSEs if I deemed it necessary.
Two days later I was in the hot seat on Capitol Hill as members of the Senate Banking Committee pounded me over my request. I had to perform a delicate balancing act: convince skeptical lawmakers that the situation with Fannie and Freddie was so dire that it warranted government intervention without panicking nervous investors about the fragility of those institutions. Reaching for what I hoped would be a helpful analogy, I used words that made sense to me at the time but would come back to bite me.
“If you’ve got a squirt gun in your pocket, you may have to take it out,” I said. “If you’ve got a bazooka and people know you’ve got it, you may not have to take it out.”
Anyone listening to the rancorous Banking Committee response would have assumed that the GSEs, and their investors, might be abandoned by fed-up lawmakers. Worried foreign governments began calling for guidance, and I summoned David McCormick, the department’s undersecretary for international affairs, to my office. A West Point graduate who had served in the first Gulf War, Dave had worked at the White House as deputy national security adviser for international economic affairs. I admired and trusted him and knew he could help me with a touchy undertaking.
We put together a list of the top 15 holders of GSE debt, and I asked Dave to work with me to reassure major foreign investors about our commitment to the agencies. This group included finance ministers and central bankers from countries like Brazil, Russia, Japan, and Kuwait. I would talk with finance ministers and central bank governors as needed, while Dave communicated with a range of government officials in many nations. One of the most important of Dave’s group was Madam Hu Xiaolian, administrator of China’s State Administration of Foreign Exchange, the investing arm of the central bank, which oversaw $1.8 trillion in foreign reserves. Just under $1.1 trillion were in U.S. Treasuries and agency paper. It was crucial that the countries hold on to their positions and not sell into an already weak market.
“Make sure they understand what we’re doing,” I said. “Let them know that, as much as possible, our government will stand behind Fannie and Freddie. Give them some confidence.”
Dave kept in constant touch with the investors. He quickly discovered that although the technocrats in the ministries and central banks understood that the GSE paper they owned was only implicitly backed by the U.S. government, their bosses believed they owned the equivalent of Treasury bonds, but with higher yields. In some cases, these bosses didn’t fully understand the difference between equity and debt, so when they saw the terrible headlines about GSE shares, they thought their investments were in trouble and pressured the technocrats to reduce their positions.
I called many government officials, including Wang Qishan and Zhou Xiaochuan, to reassure them.
“We’re watching this carefully,” Wang said. “We want to make sure you are going to protect our financial interests.”
I tried to explain the contentious congressional debate to my Chinese friend. “This is political theater,” I told him. “In the U.S. we always do what we need to do, and I am confident Congress is going to support Fannie and Freddie.”
I only wish I’d been as confident as I sounded.
Congress finally granted Treasury 18-month emergency authority on July 30. In the first week of August, Fannie and Freddie announced awful second-quarter earnings. Combined, they had lost more than $3 billion. The calls with foreign investors became more frequent and urgent.
I decided that we had to be as open as possible in explaining the situation. David Loevinger, minister counselor for financial affairs at the U.S. Embassy in Beijing and Treasury’s senior representative in China, launched a series of weekly conference calls with staffers from Treasury—and sometimes the Fed and the SEC—to post Chinese officials on any developments. The Chinese asked very pointed questions focused on protecting their assets. How could we make sure they weren’t at risk? The Chinese assured us that they would not sell, but they would also not start buying again until they saw others buying as well.
On August 7 I flew to Beijing with my family for the Olympic Games, a commitment I’d made a year before that fortunately fit into a brief hiatus while the regulators evaluated the financial condition of Fannie and Freddie. Though the crisis at home was much on my mind and I had a number of official meetings, this was technically a vacation with Wendy, our children, Merritt and Amanda, and their families. I was not a part of the presidential delegation.
When we reached our hotel, the Westin Beijing Chaoyang, we found that Wendy and I had been given a suite, while Amanda, her husband, Josh, and our 14-month-old granddaughter, Willa, had been assigned to a smaller room. At Wendy’s suggestion we decided, much to the consternation of the hotel’s front desk, to switch rooms to give the kids more space. I didn’t see what the fuss was at first, and then it dawned on me. I may have been on vacation, but to the Chinese it was business as usual, and our original room was no doubt equipped with listening devices. Once we switched, it was too late to bug our new room, because my Secret Service detachment was standing guard all of the time. Wendy and I had a good laugh at the thought of the Chinese listening to Amanda reading Goodnight Moon to Willa.
Wendy, the family, and I had fun watching the Olympic Games and seeing the sights—even though I gouged my head at the Great Wall when I neglected to duck for a too-low ceiling in one of the guard towers. I bled so heavily (and yelled so loudly) that the Chinese still remind me about it. But the whole time—watching the U.S. men’s basketball team beat China, practicing tai chi in a park with my wife and the kids, giving interviews to the American press—I worried about the situation back home and found it increasingly hard to sleep. Just before I had left Washington, Ben Bernanke told me that his people at the Fed had found some troubling things as they inspected the GSEs’ books. Ben said the review was only in the preliminary stage, and he didn’t want to spoil my trip, but of course he had. I was itching to know more, but I didn’t want to call him up and ask for the gory details, fearing the worst and not wanting the Chinese, listening in, to learn how bad the situation was.
While in Beijing, I received some disturbing news: I was told that Russian officials had made a top-level approach to the Chinese with the suggestion that together they might sell some of their GSE securities to force the U.S. to use its emergency authorities to support the companies. I didn’t know how serious the Russians were about their proposal, which could have hurt the GSEs and the capital markets, but the thought that they might test us added to the restlessness of my sleepless nights. The Chinese had declined to go along with the plan and would show admirable resolve in cooperating with our government and in maintaining their holdings of U.S. securities throughout the crisis.
Most days I exercised in a nearby park, and one morning, I was walking briskly, mulling things over, when I stopped and pulled aside Taiya Smith. She was in Beijing negotiating with her Chinese counterparts for the December SED. “I’ve been thinking about Fannie and Freddie and the financial markets back home,” I said. “As much as it kills me, I have to honestly say I’m not going to be able to focus on the SED. I need you to run the show and only come and get me if you’ve got a big problem.”
I had complete confidence in Taiya, whose bright smile belied a steely determination and resourcefulness. She had worked as special assistant to Deputy Secretary of State Robert Zoellick as his policy adviser for Africa, Europe, and political/military affairs. She had been the State Department’s point person on Darfur before that. I trusted her judgment and her ability to read the Chinese. Her job as SED coordinator could be painful and thankless: she had to organize the efforts of the entire U.S. government, managing Cabinet-level egos and occasionally explaining why some people’s pet projects were not big priorities. She had to overcome similar challenges in China, where teamwork did not come naturally. In between SED sessions Taiya and her team spent weeks in China going back and forth among different Chinese ministries that didn’t naturally work together. I kidded Taiya that she was not only running our interagency operations but those of the Chinese as well.
I returned to a full-blown crisis in Washington on August 15. That weekend, in an article titled “The Endgame Nears for Fannie and Freddie,” Barron’s predicted that the U.S. government would take over the GSEs and wipe out common shareholders. Their shares subsequently plunged to 18-year lows that Monday. The report was prescient. Examiners from the Federal Reserve and the Office of the Comptroller of the Currency, aided by outside advisers, had found huge unrecognized losses and poor-quality capital on the GSE books. With no access to the markets, the companies were doomed, and we had no choice but to take control of them, something I had not anticipated weeks earlier.
On Saturday, September 6, I took the unpleasant but necessary step of seizing Fannie and Freddie, replacing their CEOs, and putting them in conservatorship under the Federal Housing Finance Agency. The government would provide up to $100 billion to each company to backstop any capital shortfalls, and Treasury would set up new secured lending facilities for both agencies. Common shareholders would be hard-hit by the rescue, but bondholders were protected.
The following day, Sunday, I announced the actions publicly, taking care to explain why what we had done with these enormous but—to most Americans—obscure institutions was so important. I described conservatorship as a temporary “time-out” while the government decided what further steps to take. The failures of these companies, I said, would have affected “the ability of Americans to get home loans, auto loans, and other consumer credit and business finance… and would be harmful to economic growth and job creation.”
I believed then—and continue to believe today—that the failure of the GSEs would have led to a global financial meltdown.
Later that day I got on the phone to walk Zhou Xiaochuan and Wang Qishan through our decision. From the start of the crisis, we had decided to be frank about any problems, and they had trusted us and helped to steady markets at a fraught time.
“I think we’ve put out the fire,” I told Wang Qishan. “I believe this will stop the panic.”
He assured me that the Chinese would continue to hold their positions and congratulated me on our moves, but he cautioned me: “I know you think this will end all of your problems, but it may not be over yet.”
As we spoke, I reflected on how much Wang and I had reversed roles from a decade before, when Guangdong Enterprises ran aground. Like the GSEs, though on a smaller scale, Guangdong Enterprises had embraced an unsustainable business model in which investors thought they had Chinese government guarantees when they did not. In passing, I reminded the vice premier that Steve Shafran, who had led the Guangdong restructuring, was now a critical member of the team advising me at Treasury. Wang respected Steve enormously for his work and never failed to ask after him.
“Your investments are in good hands,” I told Wang.
When I look back on that gloomy summer and fall, I recall few bright moments. One came in late August, as we prepared to seize control of the two GSEs, when Chinese activist Yang Jianli came to see me at Treasury with his wife and two young children. He wanted to thank me personally for helping to secure his release from China and return to the U.S. a year before. Though barred from China, he had remained active in human rights efforts, leading the Foundation for China in the 21st Century, a pro-democracy group he’d founded in California in 1990.
I didn’t go into a lot of detail about my efforts on his behalf, simply crediting the SED for providing me with a vehicle for pressing for his release.
However, it turned out he had heard plenty—not about my jobs at Goldman Sachs or Treasury but about my work in conservation.
“I read about what you were doing in Yunnan when I was in prison,” he said.
And in a gesture that struck me profoundly, Yang made a point of thanking me not just for his release but for the work we had been doing with the environment. Here was a prominent dissident thanking me for the same things, and in much the same way, as had the very leaders he protested against. His words drove home to me yet again how important it was to find common ground and identify issues that mattered to the Chinese. Showing my genuine concern for China, the well-being of its environment and its citizens, had made a big difference to people in very different walks of life there.
To my discomfort, markets weakened further even after we seized Fannie and Freddie. Unable to find new capital or a strategic partner, Lehman Brothers deteriorated sharply as nervous creditors cut their dealings with the strapped institution. Finally, after an emergency meeting in New York of the world’s leading investment banks failed to devise a rescue, the storied bank, whose roots stretched back to 1847, filed for bankruptcy. Try as we could, without a buyer or a capital partner, we could find no government authority that would allow us to save an insolvent investment bank. That same weekend we learned that another major investment bank, Merrill Lynch, was also faltering. Worse, the gigantic insurer American International Group was in dire straits, weighed down by credit default swaps tied to bad mortgage investments.
Lehman’s fall set off a near panic, and financial shares—led by AIG’s—plunged on Monday, September 15. (Fortunately, Bank of America had agreed to acquire Merrill, averting an even bigger disaster than Lehman.) Funding sources began to dry up, hurting banks and big companies alike. Major industrial companies like Procter & Gamble and Coca-Cola began to have trouble selling commercial paper. Often bought by money funds looking for a little extra yield compared with government bills, commercial paper was a crucial short-term financing source for many companies.
A nonstop series of explosions kept detonating within the larger unfolding disaster. On Tuesday, September 16, we learned that AIG would need an $85 billion Fed loan that day to avoid bankruptcy. Lehman’s assets had been frozen in London, causing hedge funds to pull back from dealing with even apparently healthy investment banks. A riled-up John Mack called me to report that short sellers were attacking Morgan Stanley, where he was chairman and CEO. A respected name and a stout balance sheet were no longer enough. Mack was desperate to raise capital for his firm, and he logically thought of China Investment Corporation, which managed a part of China’s foreign reserves and had purchased 9.9 percent of Morgan Stanley in December 2007, after the Wall Street firm had posted its first quarterly loss ever. John knew I was close to Wang Qishan and asked me to see if I could talk to him and get the Chinese to increase their investment.
“All the signals we get are that they’d like some reassurance and encouragement from you,” the Morgan Stanley CEO said.
I promised to do what I could.
The interconnectedness of markets caused problems to spread rapidly from one sector to another. The trouble with money market funds began when a few funds were hurt by their holdings in now worthless Lehman paper. Fear that they would “break the buck,” or fail to pay investors 100 cents on the dollar, triggered a deluge of redemptions. This shrank their coffers, reducing the money available to invest in the commercial paper market, which soon froze up. Spooked investors shifted to safe Treasuries, creating such demand that banks and investors soon refused to lend government bonds to one another, slamming shut the doors of another crucial venue for short-term funds, the so-called Treasury repurchase market. Only an emergency guarantee the Treasury Department devised for the money market funds would prevent a catastrophic run that could take down industrial companies of all sizes and quickly spread the crisis from Wall Street to Main Street.
As all of this was unspooling, Dave McCormick rushed into my office to declare, “I’ve got really bad news. The Chinese are moving their money.”
After one of the big money funds, the Reserve Primary Fund, had broken the buck, Dave had begun hearing from Wall Street sources that nervous Chinese banks were withdrawing large sums from the money market. We’d heard, too, that the Chinese were pulling back on secured overnight lending, afraid of counterparty risk. And they had begun shortening the maturities of their GSE holdings.
We didn’t know quite what to make of this, though the implications were ominous, since the Chinese were such big investors. In my chats with Wang Qishan, he had emphasized that while China would not purchase more U.S. government and agency paper, it would also not be a seller. I asked Dave to find out what was going on. He called Chinese leaders, including Zhou Xiaochuan and Finance Minister Xie Xuren.
“You may not be giving the advice that they sell,” he told Zhou, “but somewhere in the bureaucracy these decisions are being made.”
Zhou said he was unaware of what Dave was describing but promised to find out. True to his word, Zhou called the next day to confirm the substance of the reports we’d gotten, but he assured Dave that none of the sales had been coordinated.
“People are making what they think are smart choices,” Zhou said. “We’re going to give some guidance particularly about the overnight lending and the pullback from the Reserve Fund.”
Shortly afterward, nervous Chinese institutions reversed course. The irony was that Chinese banks were supposed to make independent decisions: that was what the reform and restructuring process had been about, after all. We didn’t expect Zhou Xiaochuan to prevent the banks from taking measures to protect themselves, but he could point out the dangerous consequences of their actions. The truth was that the Chinese banks remained very much under the thumb of the State Council. Though they had public shareholders, they were owned by the state, and their CEOs ultimately took their orders from the government. As a result, the “guidance” given by the Chinese government stemmed some of the panic in the markets. And the financial world ought to be grateful for that.
On the evening of September 19, John Mack called me again to report that he had not made much progress with China Investment Corporation.
“The Chinese need to know that the U.S. government thinks it is important to find a solution,” he said.
“I’ll talk to Wang Qishan,” I told him, adding that I was prepared to ask President Bush to contact President Hu if it would help. Morgan Stanley was much bigger than Lehman, and its failure would have brought down other institutions and might have caused the collapse of our entire financial system, triggering another Great Depression.
The next day I alerted the president to be ready in case he was needed to speak to President Hu. That would happen only if CIC appeared more interested in increasing its stake in Morgan Stanley. The approach would have to be careful and indirect, because the president couldn’t very well ask a foreign government to invest in a U.S. company. But President Bush could thank Hu for his country’s cooperation in helping us deal with problems in the capital markets to signal how important Morgan Stanley was to the financial system. My staff would make it clear to Hu’s people that the thank-you concerned Morgan Stanley. President Bush asked me to work with National Security Adviser Steve Hadley on this.
That night I spoke to Wang Qishan. After the disagreement over the joint venture investment bank formed by Morgan Stanley and China Construction Bank in the 1990s, he and John Mack had become good friends, and he had a high regard for Morgan Stanley. But friendship went only so far. I concluded as we spoke that the Chinese were not quite as enthusiastic about investing as John Mack had hoped. As a matter of fact, Wang didn’t seem very interested at all. It was clear he was concerned with the safety of any investment the Chinese might make. And because I couldn’t give him the assurances I knew he was looking for, I moved on to the next topic. I knew there would be no need for President Bush to talk to Hu.
I wasn’t surprised because I understood the Chinese concerns. They didn’t want to lose any more money on Morgan Stanley. The stakes were simply too high. Our troubles had given new energy to Chinese opponents of reform, who were denouncing the U.S. and stoking nationalist sentiments. The government had been taking a public relations beating for months over its money-losing investments in Blackstone and Morgan Stanley, which were tracked meticulously every day by an army of online bloggers. If China had suffered losses on its vast holdings of Fannie or Freddie securities, there could have been a huge political problem and a loss of confidence in the government.
Morgan Stanley would end up finding a partner in a Japanese firm, Mitsubishi UFJ—which agreed to invest after some encouragement and assurances from the Treasury Department—and I certainly don’t blame China for not wanting to risk putting good money after bad. Overall, its leaders were very supportive, despite frightening headlines, breathtaking market plunges, and the outright failures of major institutions. It was, as I’ve said, in their interest to stay the course. Though unnerved, they held firm—just as they had during the Asian financial crisis, when it was their region on the brink of collapse. Now it was the U.S. and Europe that were faltering, and China’s strength of purpose and resolve would play a big role in helping the West survive and emerge from the worst of the crisis.
In my view, the relationships I had built in China, at Goldman and through the painstaking efforts of the SED, had paid off. True, I can’t draw a straight line from the personal trust and frequent informal communications fostered by the SED discussions to China’s restraint during the financial crisis, but there’s not a doubt in my mind that there was a connection. This achievement may have fallen outside the list of deliverables, but its importance during a dire period for the United States is impossible to overstate.
Meanwhile, it had become clear to anyone with eyes to see that we were not going to be able to keep holding the financial system together with ad hoc measures. We would have to ask Congress to grant us extraordinary powers to deal with the worst American economic catastrophe since the Great Depression. This conclusion led us, in consultation with Congress, to craft the $700 billion Troubled Assets Relief Program, which authorized the government to buy toxic assets from financial institutions to help clean up their balance sheets.
As I remember only too well, the passage of TARP was a nail-biter; the House of Representatives rejected it initially, triggering a week of market chaos. TARP’s eventual passage—on Friday, October 3—failed to steady the markets, in part because the pervasive, global nature of the problems was becoming clearer. The following Monday, Asian, European, and U.S. shares plunged as investors worried that a squabbling Europe would be unable to fix its banks and that TARP might not be enough. The situation had worsened significantly during the two weeks we had been working with Congress to get TARP authority, and we realized that TARP’s asset-buying program would not be enough. We needed something that would work more quickly to restore confidence in the markets and be more powerful. My team at Treasury began to work on a sweeping plan to inject equity and recapitalize more than 700 banks.
British prime minister Gordon Brown, whose government would unveil an $875 billion bank bailout of its own, suggested to President Bush that he call a meeting of the G20 leaders. Inside the administration we debated the merits of the idea. Though I was concerned that such a gathering could lead to a political brouhaha that might destabilize markets further, we needed a global approach to a global problem, and I advocated holding a meeting as soon as possible after the U.S. presidential election on November 4.
First, we wanted to make sure we had a productive meeting of the G7 finance ministers, who were to gather on Friday, October 10, during the annual World Bank/IMF meeting. The usual G7 format was highly scripted, with ministers reciting talking points to one another and then the group releasing highly technical communiqués understandable only to a small group of insiders and members of the press. This time we needed to come together in a serious, substantive way to communicate our resolve to the public and the markets. We got off to a bumpy start as one central banker after another rose to blame the U.S. for the global mess, tracing their countries’ problems to Lehman’s collapse. In truth, Europe’s overleveraged and undercapitalized banks had been on the road to disaster long before Lehman fell. Still, the venting helped. In the end, the group issued a strong, clear communiqué, long on substance and short on jargon, committing us all to decisive action in dealing with the crisis.
The outcome inspired the White House to press ahead with a global leaders’ summit. I pushed for inviting the G20, as did a number of the president’s advisers—including chief of staff Josh Bolten, National Security Adviser Steve Hadley, and Dan Price, who wore two hats as deputy national security adviser for international economic affairs and assistant to the president for international economic affairs. The G20’s Finance ministers and central bankers met regularly, but its heads of state had never convened. I thought that should change; taken together, emerging G20 powerhouses like Brazil, India, and China represented not just the present but also the future.
Not everyone was enthusiastic. Some in the U.S. government felt 20 countries was too many to be effective and that the participation of countries like Argentina, with its populist president, Cristina Fernández de Kirchner, who we believed had a history of taking irrational, irresponsible, and anti-U.S. economic positions, might undermine the group’s effectiveness. But we all saw eye to eye on one thing: if the Chinese were willing to exert a leadership role at the G20—and if the biggest developed nation and the biggest developing nation were in agreement on the issues—the G20 would be a success. Before moving ahead with our plans for the gathering, President Bush authorized me to call Wang Qishan and get a quick answer from President Hu.
We knew there was a very small risk of being rebuffed—the Chinese were still smarting over a U.S. decision to sell $6 billion in arms to Taiwan in early October—but we got a strong yes within 24 hours from an eager Hu. The Chinese leader surely realized that this emergency gathering would be an ideal showcase for China in its new role as a global power. With the Chinese on board, President Bush decided to move forward with the G20 leaders’ summit.
With the exception of Gordon Brown, the Europeans resisted a group that size, fearing their influence would be diluted. In a concession, we agreed to invite Spain and the Netherlands, which belonged to neither the G8 (the G7 plus Russia) nor the G20. After much back-and-forth, a summit of G20 leaders was scheduled for November 14–15 in Washington. Dave McCormick worked with Dan Price to coordinate the effort.
China also was beginning to feel its share of pain. Its equity and real estate markets were off sharply, while export and investment growth were declining. On November 9, less than a week before the G20 leaders were to arrive in Washington, the PRC announced a large $586 billion two-year stimulus program, chiefly to build infrastructure. It was the biggest such plan the country had ever attempted. The government also eased credit and would encourage a massive $1 trillion–plus lending campaign by state-owned banks the following year. How ironic, I thought, that the very banks whose weakness had endangered China five years before were now helping to pull the country’s economy—and the world’s—out of the ditch.
On November 15 the G20’s leaders gathered in Washington at the Great Hall of the National Building Museum, a vast space with soaring Corinthian columns that had originally been designed to house the Civil War pension bureau. An enormous square table had been set up in the hall to accommodate the large group. As I surveyed the room, I saw a vivid illustration of how the order of things was changing—for the better. Joining such European leaders as French president Nicolas Sarkozy, Germany’s Angela Merkel, and Italy’s Silvio Berlusconi were China’s Hu Jintao, Brazilian president Luiz Inácio Lula da Silva, and Indian prime minister Manmohan Singh.
As Hu’s eagerness to attend had demonstrated, China was stepping up as a major participant in the global community. This was not the scenario I had hoped for—China’s emergence on the international stage being driven by a global financial disaster centered in the U.S. and Europe—but the Chinese, too, had a stake in global economic stability, and I was glad to see them playing a leading role in working to restore confidence.
During a break in the proceedings, I had an opportunity to visit briefly with Hu Jintao and Wang Qishan. We talked for a bit, and Hu said, “I bet you’re glad we didn’t move the currency faster than we did. I hope you now understand why. Some of the things you wanted us to do would have been dangerous. Now we’re stable and can stimulate the economy, and that’s helping us and the whole world.”
I thanked President Hu and told him I thought the steps China had taken to begin reforming its currency had been beneficial. “It’s important that you keep your economy growing,” I said, adding, “but I believe that it is your fiscal spending, and not your currency policies, that has bolstered this growth.”
Throughout the meeting the Chinese were accommodating on just about everything, with one notable exception: they didn’t want the final communiqué to use the word “imbalances,” which they viewed as shorthand for China’s oversaving and the U.S.’s overborrowing. The subject had been a thorny issue for years. Citing imbalances as a cause of financial excesses leading to the crisis was the same, to the Chinese, as faulting them for something that was our doing. I had always held that imbalances worked both ways: the U.S.’s huge debts and low savings were as much a cause of the parlous state of the global economy as China’s excessive savings. But the Chinese were very sensitive to any hint of blame, and Wang Qishan had cautioned me about publicly addressing the subject of China’s imbalances in connection to the financial crisis.
“If you talk about this, it looks like you’re pointing the finger at us,” he said. “And we haven’t pointed the finger at you.”
Going into the G20, I’d been concerned that our efforts to deal with the financial crisis might get bogged down in petty protectionism and recrimination. But I could not have been more wrong. The developed economies apologized for their role in the current disaster, but instead of blaming the freewheeling Western financial system, the smaller economies expressed concern about overreaction. All the countries rejected protectionism and agreed that reforms would only be successful with a commitment to free-market principles. The communiqué the group released affirmed that the 20 nations would implement reforms to strengthen the global financial system and noted the importance of international cooperation.
Three weeks after the G20 leaders’ summit, in early December, I flew to Beijing for what would be my last SED meeting. When the group reconvened in July 2009, president-elect Barack Obama’s new team would be in place. The U.S. government transition, truly a marvel of our democracy, was under way, but markets remained tense, and we were still contending with an unrelenting series of crises. General Motors and Chrysler were teetering on the verge of failure (and would require a government loan from TARP funds to be saved). In late November we had had to rescue U.S. banking giant Citigroup with a combination of capital injections and guarantees. Citi was the largest U.S. bank, with assets of $2 trillion—and another $1.2 trillion assets off balance sheet, half of which were related to mortgages. It had begun to wobble under the weight of toxic assets and speculative attacks in the stock market. We were forced to act to prevent its failing, which would have had catastrophic consequences.
Given these persistent problems, Vice President Dick Cheney suggested that I stay home. “The president is relying on you to protect our financial system and economy,” he told me on the sidelines of our weekly Wednesday lunch with the Bush administration’s economic team. “This is equivalent to leaving the country at a time of war.”
I argued that it would look worse if I didn’t make the trip. The markets would surely see my cancellation as a sign that the situation in the U.S. was truly disastrous. “If I don’t go to Beijing, or if I call off the SED, everybody will really think we’re in deep trouble,” I said.
The vice president was a low-key guy, and he didn’t push the issue, but I could tell he was uncomfortable with my leaving the country. Despite his strong conservative principles, he never wavered in his support for TARP or any of the ugly capital markets interventions we were forced to make during the financial crisis. He was also supportive of the SED and our two-way economic relationship with the Chinese.
SED V brought home to me the value of two and a half years of effort, as issues our teams had been diligently working on bore fruit: the U.S. affirmed that it welcomed investment from China. We made sure to emphasize the link between foreign direct investment and well-paying American jobs. We didn’t want anyone thinking we were trying to sell precious U.S. assets to the Chinese—or to anyone—at fire-sale prices. Our analysis showed that foreign investment had led to 5 million U.S. jobs; these paid, on average, 30 percent more than the going rate nationally.
At SED V we also signed the EcoPartnerships agreement as part of the Ten-Year Framework, ensuring that local institutions would work together to address environmental issues. We built upon the successes of past SEDs by organizing technical training to promote food and product safety and improving our ability to jointly deal with emergencies. To critics of the SED, some of these achievements—from increasing and expediting the number of Chinese tourists visiting the U.S. to agreeing to work together to combat illegal logging—might have seemed less than spectacular. But there were hundreds of them, they added up to a lot of progress, and they would not have been achieved without the SED. I saw each one as a brick in a strong structure that we were building—a structure that would withstand the winds of future tensions and crises.
At the first SED, back in December 2006, Wu Yi had used her opening speech to underscore the extent to which Americans failed to understand China. In her view, China was a developing country not respected by the world powers, which failed to treat it as a strategic partner. Now, two years later, our countries were committed to working hard together. There was plenty we disagreed about, but we both valued the dialogue that allowed us to defuse crises and make progress on those areas where we could agree.
In my first days as Treasury secretary, we had drawn up plans for the SED with three overarching goals: to advance the economic relationship between the U.S. and China, to help bring about market reforms in China, and to encourage its emergence as a responsible global citizen. Our economic relationship with China was now on a stronger footing, buttressed by joint efforts to achieve environmentally sustainable economic growth. We had not gotten the market reforms we wanted—as I write this, China still hasn’t lifted its cap on foreign investment in its financial companies, though I believe our work in this area will bear fruit—but we had won a broader latitude for U.S. firms to operate in China as well as a stronger renminbi, without destructive U.S. protectionist legislation. Finally, elevating the status of the G20 had provided the Chinese an opportunity to play a responsible leadership role in supporting the economic system from which they had benefited so much. Over time, I hoped, they would learn to do just that, because their commitment to solving problems is crucial to global stability.
As a young investment banker, I learned that the key to success was building relationships, between you and your client, between your firm and his or hers. As Treasury secretary, I had worked to build lasting relationships, this time between countries. Personalities came and went—I wouldn’t be Treasury secretary much longer, and the Chinese leadership would also change. But with the SED we had created a forum for relations between our countries that would carry on after us. Indeed, the Obama administration would embrace the SED approach, while broadening it to include foreign policy and national security as the renamed Strategic and Economic Dialogue. In November 2014, building on the platform of the Ten-Year Framework, the U.S. and China reached a breakthrough agreement to limit greenhouse gas emissions, fulfilling my vision of increased collaboration to combat climate change.
I learned something else as a young investment banker: never take no for an answer. You almost never got what you asked for the first time around, especially with new clients. You had to work hard to understand their needs and frame your proposals to appeal to their best interests. Then you had to push and push, and keep asking for the same thing. With enough time and effort, the answer might just change to yes. I certainly employed that approach in China. How many times did I hear “no” or “not yet” or “not so fast” in response to my requests for the Chinese to open their markets or move their currency? Even when we didn’t get the answer we wanted, we managed to wedge the door open a little further, and the next time we’d push a little more. In a country where so many people weighed in on so many issues, we were, at a minimum, helping them build a consensus for change.
As was the custom, after the rest of the U.S. delegation had met with President Hu in a formal setting, I shared a private chat with him. The Chinese leader and I sat side by side on a cushioned bench in a screened alcove behind the elaborate meeting room in the Great Hall of the People. I let him know that I remained concerned about problems in the U.S. economy, and I reminded him that the new administration would be feeling its way for a while and not to expect too much too soon.
“There’s still significant anti-China sentiment in the U.S.,” I noted, cautioning him that U.S.-Chinese relations would suffer if his country stopped or slowed down reform. I urged him to stay committed to the kind of engagement with the world he had demonstrated during the G20.
This was my closing official advice to China’s president, and his final words to me as Treasury secretary were meant to be reassuring.
“We may not go as fast as you like,” Hu said. “But the direction is always going to be forward. Our reform process is irreversible.”
I certainly hoped so. In a short while I would leave Treasury, just as I had left Goldman Sachs, behind me. I had no idea what I would do next, but even as Hu spoke I knew that one way or another, I would continue to push my Chinese friends to speed up their reforms, for the simple reason that doing so would be good for China, good for the U.S., and good for the world.