Paulson to defend bailout response to crisis

Former Treasury Secretary Henry Paulson is the lone witness at a House hearing today on how a private deal – the merger of Bank of America and Wall Street giant Merrill Lynch – turned into a $20 billion public bailout.

It’s his first public opportunity to answer critics on the Bush administration’s response to the financial crisis – and his own role in shaping that policy. According to prepared testimony, Mr. Paulson will argue that the programs “we put in place at the height of the turmoil continue to provide critical support to our financial markets.”

At issue: Did Paulson cross a line when he warned Bank of America CEO Kenneth Lewis on Dec. 21 that he and the Bank of America board would be fired if they backed out of the deal?

It’s a question directed at the Bush administration’s actions. But for House Democrats, it’s also a shot across the bow for the Obama administration’s emerging strategy on issues ranging from bailouts to a proposal to give new powers to the Federal Reserve.

Before Congress acts on President Obama’s financial services reform proposal, it needs to have a “thorough understanding” of what caused the current financial crisis and how the federal government responded, said Rep. Edolphus Towns (D) of New York, who chairs the House Committee on Oversight and Government Reform, at a June 25 hearing.

For House Republicans, Thursday’s hearing will speak to the larger issue of “unprecedented government intervention” in the market started by President Bush and accelerated by Mr. Obama.

“The Bush-Obama policies of bailout and nationalization are a threat to the free market and individual liberty and, as such, merit a thorough debate in the public square,” said a Republican staff memorandum Wednesday.

At an earlier hearing on this issue, CEO Lewis said that the merger and the $20 billion bailout “made sense for the stability of markets.”

“Committed people of good intentions, in both the private sector and the government, worked desperately hard in late 2008 to prevent a collapse of the global financial system that would have resonated throughout the global economy,” he said at a June 11 hearing. “Even six months later, it is easy to forget just how close to the brink our system came.”

Paulson is expected to say Thursday that the words he used to pressure Mr. Lewis “were my own.”

But Paulson also says in prepared testimony that he was confident the Federal Reserve also believed that for Bank of America to pull out of the deal, as it had threatened to do, was “not a legally reasonable option.”

“All public officials involved, including [Federal Reserve Chairman] Bernanke and me, believed that the failure to consummate the merger would likely create immediate financial market instability, would threaten the viability of both firms, and would call into serious question the judgment of Bank of America’s leadership,” Paulson says in his prepared testimony.

Mr. Bernanke had said at an earlier hearing that the central bank now has the authority to “make changes or recommend changes in management.”

“These actions were taken under highly unusual circumstances in the face of grave threats to our financial system and our economy,” he told the committee June 25.

But, citing internal e-mails obtained from the Federal Reserve, top Democrats on the panel say that in threatening to pull out of the Merrill Lynch merger, the Bank of America may have been angling for more federal funds.

“Was Bank of America forced to go through with the deal, or was this just an old fashioned shakedown?” says Chairman Towns.