Hank Paulson: ‘I think it’s pretty likely we will see a recession’
The former US Treasury secretary on why the banking crisis isn’t over — and why the US-China relationship ‘is on the brink’
I have arrived in Barrington, Illinois, an hour early for my lunch with Hank Paulson. The cloudless prairie sky is as big as the town is small. Although just 40 miles north-west of Chicago, Barrington betrays no shadow of its soaring urban neighbour. The main street even has a kiosk where you can deposit your “retired flags” for sacred disposal — a custom that is pretty much confined to small-town America.
This is the place where Paulson — the US Treasury secretary during the 2008 financial crisis — was raised and retains his primary residence. We are to meet at the town’s obligatory Italian restaurant, a meatball-serving family establishment that is somewhat incongruously called Ciao Baby!
Having scouted the main street and crossed the railway tracks, I show up 10 minutes early. “Mr Paulson is waiting for you,” says a lady who is clearly on the lookout. She ushers me to an airy room at the back. Paulson, 77, who still has the strapping gait he had as a high-school wrestler and a lineman on his college’s American football team, greets me with an iron handshake. “I’m glad we got to do this,” he says.
Setting up this lunch took a little preparation. I approached Paulson during last month’s meltdown of Silicon Valley Bank and Signature Bank — a mini financial panic that the markets are calling “March madness”, with the implication that it is already over. Paulson believes that is wishful thinking.
As the man who in 2007 and 2008 served as George W Bush’s point person for what history abbreviates to the GFC — the global financial crisis — few are better placed to take the temperature. Paulson’s tenure was far more significant than the two years it spanned. The first year he spent helping to reset a Bush presidency that had gone badly awry.
This earned Paulson the kind of trust that enabled Bush to delegate all the big calls to him during the second year, when the financial crash was engulfing the western world. His and the Federal Reserve’s big-bazooka response to the meltdown saved the US economy yet also helped spawn the populist Tea Party backlash that followed. It is notable that Paulson, a life-long Republican, endorsed Hillary Clinton over Donald Trump in 2016.
Although Paulson talks frequently to Janet Yellen, today’s Treasury secretary, and Jeff Zients, Joe Biden’s chief of staff, he tends to turn down interviews. “As someone who sat in the seat and had people shoot at you from the outside, I know what it’s like,” he says. He has decided to make an exception today because there are things he wants to say. These boil down to two themes: the dangerous state of US-China relations, and the fragility of America and Europe’s financial systems. I consider it my duty not to let the conversation get too hemmed in.
I begin by asking about the town where he grew up. Since Paulson is a Christian Scientist and teetotaller, I know better than to press a glass of wine on him. He orders an Arnold Palmer — an iced tea and lemonade mix named after a US golfer. I get a Diet Coke. Both are continuously refilled. We agree to split an antipasti salad. One salad turns out to be far too big for two: the smaller the town, the larger the portion.
Paulson talks of how he built a home next to his parents’ here in the early 1970s, after he had started to make money at Goldman Sachs, where he was later to become chief executive. His mother died two years ago at 99.
“We are surrounded by thousands of acres of forest preserve and I can get to O’Hare [Chicago’s biggest airport] quickly because I travel a lot,” he says. The main office of the Paulson Institute, his “think and do tank”, is in downtown Chicago, where he also keeps an apartment. The institute focuses primarily on carbon and green finance and China, where it also has staff.
Great powers don’t look to go to war: they stumble into it . . . the last thing Xi needs is a war for Taiwan
Though he has been to China more than 100 times, next week he will fly to Beijing for the first time since the start of the Covid pandemic. He knows all its leaders well, including Xi Jinping and his predecessor Hu Jintao. “This is a very different China to even a few years ago,” says Paulson. “The US-China relationship is on the brink. Communications have ground to a halt. There’s a lot going on in the world that’s troubling but to me it’s the US-China relationship that is the most worrying.”
I ask who is to blame. “What we’re seeing right now is Biden waiting to have a sorely needed call with Xi and meanwhile Xi’s everything-but-America strategy is a whirlwind of activity,” Paulson says. “Xi is playing the global statesman, meeting with heads of state around the world and in China. The Chinese are arguing that the US is trying to contain them and the Chinese people definitely believe that. They’re putting out to the world, and to American CEOs, that China is open for business again. If America goes too far in curtailing trade and investment with China and we go far beyond what our allies and partners want to do, the result will be to isolate the US.”
I observe how radically things have changed since Paulson was in Washington, when he set up a routine dialogue between the US and China that died under Donald Trump. In those days, American businesses would lobby vigorously for more engagement with China, since it contributed such a large share of their bottom line. Today, business is conspicuous by its silence. “People are quiet because if you’re a CEO and you have business in China, and you look at what’s acceptable to say in China and what’s acceptable to say in America and you draw a Venn diagram, there’s very little white space,” he says.
“This is a dangerous situation. I strongly believe that Biden would like to stabilise the China relationship but both Republicans and Democrats in Congress have staked out a very strong line which complicates things for Biden. I have a concern that Congress is underestimating the relative power of China, the permanence of China, and China’s relationship with so many other countries.”
Paulson caused a stir earlier this year when he wrote an essay in Foreign Affairs magazine with the headline “America’s China policy is not working”. Along with just a handful of other senior US statesmen — notably Henry Kissinger, who will turn 100 next month, and Michael Bloomberg, the former mayor of New York, who is 81 — Paulson is going against the grain of America’s hawkish consensus. Perhaps that is why he is pressing his point so hard. Whatever modest dent has been made in our salad is almost entirely down to me.
I ask whether there is any precedent in history for two big powers to rub along peacefully. “This is a very dangerous period,” he says. “Great powers don’t look to go to war: they stumble into it through some combination of miscalculation or misjudgment or accident. So I think it’s important that we tone down the rhetoric on Taiwan. Despite what you read, the last thing that Xi needs is a war for Taiwan.” Next year will be a momentous one, he adds. Not only is there a US presidential election in 2024, there is also one in Taiwan earlier in the year.
So what would it take for the two giants to live and let live, I press. “When I asked a Chinese leader a number of years ago if he could think of a situation where you have an existing power and a rising power coexisting stably, this man, who is very wise, said, ‘I can’t think of any, but we are going to do it this time because if we don’t the result is going to be catastrophic.’” So failure is not an option? “Correct.”
I know Paulson has said what he wanted to say on China. But I want to know what responsibility he thinks China bears for today’s worsening impasse. I point out that Xi essentially closed down Hong Kong’s “one country, two systems” arrangement in 2020, which sent a pretty stark signal to Taiwan that the carrot is off the table. All that seems to remain is the stick. Moreover, there is no space in today’s China for Chinese Paulsons and Kissingers and Bloombergs to contest Xi’s line. Who are Paulson’s Chinese counterparts?
“I never defend the actions I’ve seen China has taken. I abhor them,” Paulson says. “But what I say is we need to be smart and tough and do things in a realistic way that will work. I am interested in results. Our ‘One China policy’ [under which the US recognises the People’s Republic of China as the sole legal government of China but only acknowledges Beijing’s position that Taiwan is part of China] has served us very well over the years and it’s very important that we stick to it. If we stick to One China and have a deterrent in the region, war is not inevitable.”
We have long since abandoned the one salad policy. Our separate main courses arrive. Paulson gets the house ravioli in marinara sauce. I have flouted common sense by going for the four-cheese baked pasta. “Would you like parmesan on that?” the waitress asks. I think I have enough cheese for the time being, I reply.
It is also time to change topic. Is the banking panic over, I ask. “No,” says Paulson. Please walk me through why. “Some things we know and some things we don’t know,” Paulson replies. “What we know is that if you’re running a small or regional bank right now, you wouldn’t be lending. The capital markets shut down for two or three weeks. Now they’re opening but not to the extent they were. So I think it’s pretty likely we will see a recession if you look at what’s happening to credit.” When will that hit, I ask. “It will take a while to manifest itself.”
He goes on. “Another thing we are almost certain to see is credit provision moving outside the regulated banking sector. This is different to the extent that the panic moves quicker when you have social media, and Twitter, and who knows where it’s going to crop up again. There will be a lot of focus on Europe, where financial institutions aren’t as strong or as well capitalised as they are here.”
Just to be sure I understand you, I say, the crisis will show up in two ways — in recession and in more small bank failures? “In the last couple of weeks you’ve had $300bn in deposits move out of the banking system, maybe a trillion since the beginning of the year. These deposits have gone to money markets, and have also moved from regional to big banks. There’s a lot of turmoil.”
So more regional banks will go under as depositors flee? “I’ve been around long enough to not predict anything. There is uncertainty and more to come.”
I ask if Paulson is happy with the fact that the US government is now essentially guaranteeing every deposit in the land. Isn’t that getting close to having a socialist banking system? “It’s been a real wake-up call. Confidence has been shaken. The risks are still out there. There was a theory that in the midst of a systemic crisis, the government could wind down a failing institution and stop a panic without damaging the economy. That should have been disproved by Covid. In early March, the failure of two banks, which had just over 1 per cent of US banking assets, threatened to destroy the regional banking system, and the Biden administration came with a very quick response to stop that. There shouldn’t be a myth that ‘too big to fail’ has been solved, because it hasn’t.”
Paulson then sets out in some detail why Congress needs to give US regulators broader emergency powers to solve future systemic crises. “We can never abolish financial crises,” he concludes. “They will always happen.”
Did he have trouble sleeping when he was in charge in 2008? I ask because I can never forget the dark rings under Paulson’s eyes as he wearily stepped in front of the cameras after yet another institution had gone under. “I would say there’s nothing worse than feeling a great sense of responsibility and not having all the authority you need,” he replies. “I did have trouble sleeping. But the fact that it moved so fast and we’re playing offence the whole time helped me through it.”
I remind him of the famous moment in the 2008 election when John McCain, the Republican candidate, announced that he was suspending his campaign to return to Washington and solve the crisis. This forced Bush to summon McCain and his opponent, Barack Obama, as well as leaders from Congress, to thrash out a common line to stem the panic. Paulson smiles at the memory. “For good or for bad that’s an enduring image,” he says.
The White House meeting quickly degenerated into a shouting match and the Democrats retreated from the cabinet room to the Roosevelt Room down the corridor. Paulson followed them. “They were in a huddle around Obama and they were outraged and turned to shout at me. In a moment of levity, I dropped to one knee, and Nancy Pelosi [the Speaker] said, ‘Hank, I didn’t know you were a Catholic.’ It broke the ice. I said, ‘I don’t want you to blow this up,’ and someone said, ‘We’re not the ones blowing this up.’”
How did it feel to have the famous actor William Hurt play you in the subsequent movie, Too Big to Fail? “People that know me said Hurt was so laid-back and calm that he sure didn’t capture you,” replies Paulson. “My kids said, ‘You should be happy because he’s the nicer version of you.’”
How do you respond to people who say that, no matter what happens, the rich always get bailed out? “Yup. It’s unfortunate, because that’s what happens. The actions you need to take to protect everyone cause the equity markets to go up, and those that own the equities benefit more.”
I start on another question but Paulson suddenly looks concerned and says he fears that he is “dumping all over the messages I want to get out” because we have been ranging too widely. I assure him that I will faithfully convey what we have discussed. I sense, however, that it is time to wrap up. Also, I have a flight to catch back to DC.
Another small-town truism: the bill is as modest as the portions were large. Paulson and I walk around the corner to a private parking lot where he left his car. It is no longer there. “I’ve been towed,” he says, with a hint of panic. “I didn’t expect that.”
What can I do to help, I ask. “No, no, you must catch your flight,” he insists. I feel a twinge of guilt glancing back at a stranded Paulson as I am being driven off in my Uber. He will have to bail himself out. I feel partly responsible for his unexpected misfortune.