I finally got around to reading Phillip Swagel's account of the financial crisis from inside the Bush Treasury department--Swagel was assistant secretary for economic policy from late 2006 till the clock ran out this January. It's a pretty interesting document--slightly self-serving in the ways you'd expect (most, though not all, of the mistakes Swagel concedes fall into the category of "we didn't do a good enough job explaining ourselves"), but overall a pretty illuminating look at what Treasury was thinking and doing as the world melted down.

Anyway, reading it reminded me that whatever mistakes Hank Paulson may have made, we were pretty lucky to have a Treasury secretary who wasn't too proud or stubborn to change course when doing so brought him a lot of personal embarrassment and political blowback from Congress. It's not at all clear that your average high-ranking official is capable of this. Certainly not your average high-ranking Bush official.

In fact, it wasn't just one reversal but two, with the second being possibly more important--and courageous. The first, as most people probably recall, came during the second and third week of October, when Paulson set aside his plan to buy toxic assets and instead used TARP money to inject capital directly into banks. (Paulson began the injections in a famous meeting with the CEOs of the nine biggest banks on Monday, October 13.)

The second reversal came in late October. According to Swagel, Treasury was on the verge of returning to Paulson's original plan, using about $200 billion in remaining TARP money to buy up toxic assets. There seemed to be two goals at this point, one substantive and the other political. The substantive goal was to revive the market in mortgage-related assets. The political goal was to save face with Congress. Or, as Swagel says of a scaled-back version of the idea: "In even a modest size, this activity would have allowed the Secretary to say that he was fulfilling his initial promise to buy toxic assets."

But it didn't happen. Here's Swagel's account of why:

We had reverse auctions to buy MBS [mortgage-backed securities] essentially ready to go by late October 2008—including a pricing mechanism—but faced a decision as to whether we had the resources left in the TARP to implement them. We figured that at least $200 billion had to be devoted to purchasing assets for the program to make a difference. With credit markets still in worse shape than before the TARP had been proposed, it seemed more important to reserve TARP resources for future capital injections, including having the ability to act in the face of further AIG-like situations. Another factor in the decision to cancel the reverse auctions was simply time: the first reverse auction to buy mortgage-backed securities might have taken place in early December but would have been small—perhaps a few hundred million—while we became comfortable with the systems. The auctions would have ramped up in size, but still would likely have remained at $5 or 10 billion dollars per month, meaning that it could take two or more years to deploy the TARP resources in this way. ...

Estimates by the New York Fed of bank losses and capital raised suggested that banks faced a capital hole above and beyond the initial $250 billion CPP [the initial capital injections, begun on October 13] of perhaps as much as $100 billion in the case of a moderate recession and perhaps $250 billion or more additional capital in the case of a severe recession. These would be in addition to hundreds of billions of dollars of losses among U.S. non-bank financial firms such as hedge funds and insurance companies. The decision to cancel the asset purchases was made on October 26 with this in mind. ...

Secretary Paulson formally announced that he would not be using TARP to buy assets at a November 12 speech to the assembled press. Secretary Paulson fully understood that cancelling the auctions would make it seem as if he was switching course yet again—first in changing from asset purchases to capital injections and then in cancelling the asset purchases altogether.

He was willing to take the criticism—it was essential to keep the resources available for more capital injections.

Again, probably a little self-serving, but it basically jibes with what we know. And it was almost certainly the right decision, since it gave the Obama administration the flexibility to respond as the situation deteriorated, and since the two years it would have taken to buy up assets under the original Paulson plan made it almost useless as a practical matter.

--Noam Scheiber