第3章 SECTION I. BEGINNING

CHAPTER 1: I DON'T KNOW WHAT I'M DOING

MAY 2007

As the speechwriter, I wasn't an expert in anything, yet was expected to write expertly about everything.

From outlines, talking points, notes or summaries, I wrote drafts that were changed, edited, revised and then changed again. Economics and finance may not be topics of multilateral interest (multilateral is a favorite Treasury word), but I liked them. My right brain, the creative side, wooed the left, the mathematical side, and on my most productive days they danced. In between were days when I chewed erasers off pencils and the inside of my cheek until it was raw. I smoked too much and swore I would quit, tomorrow.

Then, the speech was finished or the opinion piece was published and the words were quoted around the world. That was very cool.

Secretary Paulson had been Chairman and CEO of the investment bank Goldman Sachs, the whitest of all the white-shoe Wall Street firms, legendary for its deals, profits and talent. During college, he had been the all-Ivy, all-East, all-New England offensive lineman of his Dartmouth football team. He was also, quite unexpectedly, the all-star, besieged, offensive lineman during the last year of the Bush Administration.

Although in formal reference the Secretary preferred Henry M. Paulson, Jr., in daily life he didn't want to be called "The Secretary" or "Mr. Paulson" or "Secretary Paulson." He wanted us to call him by his name, Hank.

He was President Bush's third and final Treasury Secretary. When his nomination was announced May 20, 2006, a rare editorial agreement emerged. The New York Times called it a "master stroke" and The Wall Street Journal said Hank was a "financial heavyweight." The Senate approved his appointment on June 28, 2006 with nary a voice of dissent.

But as is always the case with politics, the minute someone puts you on a pedestal someone else tries to knock you off. A band of folks on the far right mistrusted Hank because he was a committed environmentalist who appreciated, as he often said in speeches, "wild beautiful places," and had been Chairman of the left-leaning Nature Conservancy. A band on the far left criticized his work at the Nature Conservancy as a conflict of interest with his work at Goldman. A Los Angeles Times headline named him "The Bird-watching Businessman."

An early profile in Fortune said Hank had "unmatched credibility on Wall Street, in the White House and on both sides of the aisle in Congress." That credibility was desperately needed and sorely tested when it collided with financial crisis in the fall of 2008.

When he was at Goldman, Hank didn't give many speeches. He spoke off-the-cuff from outlines and didn't have to worry that a misspoken word might disrupt the $14 trillion U.S. economy. When he gave speeches as Secretary, he gripped the sides of a podium, pushed his hips back and his shoulders forward as if looking under the hood of a car. Staff more senior than I reminded him to stand up straight; he grumbled, but did.

Hank believed in free, but not reckless, markets, and that bad choices should have consequences. Early on, he told President Bush that we were due for capital markets turmoil because it occurs every five to ten years. And the President's Working Group on Financial Markets began to examine how to "mitigate … risk in the event of turmoil or—even worse, a financial crisis."

Before he took the job Hank also made sure that he'd have wide latitude in policy and answer directly to the President, not his minions.

In his Senate confirmation hearings, Hank said that he would focus on achieving "a stronger and more competitive U.S. economy." That included reforming the tax code, Social Security and Medicare, and fostering "an entrepreneurial spirit and culture" that expanded opportunities and raised living standards to "keep America the economic envy of the world."

This ambitious agenda was derailed when Republicans lost control of Congress in the November 2006 elections. But Hank wasn't about to retreat; he told Fortune, "If I don't succeed, it won't be for lack of trying."

In the final days before President Obama took the oath of office, he was still trying and we were still writing. Hank's last speech on January 7, 2009, laid out possible treatments for ailing mortgage giants Fannie Mae and Freddie Mac, treatments that we wouldn't be around to administer. The country had grown a little tired of Hank Paulson, George Bush and most all of us Republicans.

It was an inauspicious end to what had been an inauspicious beginning, for me anyway, because I was almost fired within my first two weeks on the job.

My first day, I wore a black linen dress and carried a photo of Eva, my 11-year-old Labrador retriever, into my office on Treasury's third floor. I arranged the pencils and the pens, and had no idea what to do next. My predecessor, Ed, left a list of who to contact about what issues, a few folders with drafts of old speeches and a copy of "Paulson's Principles"—Hank's philosophy for leadership and success. Ed said the pace was pretty slow; he'd worked on some speeches for a month at a time. My first project would be to write an editorial in favor of open economies and looming on the horizon was Hank's June commencement speech at his alma mater, Dartmouth. Before I even started work I spent an hour on the phone taking notes as Hank talked about the speech. In policy speeches he rarely strayed from black and white facts; for Dartmouth he wanted to be wise, foreseeing and funny.

Ed left Treasury to go to law school; I think he also wanted to avoid writing the Dartmouth speech.

During my interview, Hank seemed a little perturbed at my lack of speechwriting experience. He asked Brookly and Denise, who were sitting in, if anyone had read my writing samples. I sat on the couch in his office and sweat, for good reason—I'd given them two speeches, two of the five I'd ever written. One was about computer recycling programs, the other about commodity futures. I understood recycling; to this day I can hardly explain futures—not commodities, not my own.

But I have always written: journals, stories, rhymes and letters. After my first month at UCLA, I told my dad that I wanted to be a writer.

"You'll starve," he said. "Get a real job and write in your spare time."

I like food, and so that may have been wise advice. I will never know. I do know that it was a major edit that changed the style and substance of my life because I accepted it.

After graduating from college, I spent 25 years in business and politics. As my high-heels clicked up the career ladder I lived a secret life writing stories and novels.

In 2006, I was 46 and made a lousy decision. After five years earning lots of money peddling other people's agendas as a lobbyist, I thought I could swear off politics and Washington forever. I returned to my first career as a banker and became the Chief Operating Officer at a start-up business bank in Durham, North Carolina. After six months I realized it was an extreme makeover gone horribly wrong. I drove to work with a pit in my stomach and dissolved the pit at the end of the day in a bottle of wine.

As I tried to decide where to relocate my proverbial mobile home, I listened to The Purpose Driven Life. In the seventh chapter, Rick Warren told me "each of us was uniquely designed by God with talents, gifts, skills, and abilities." And 1 Peter 4:10–11 says that we must "manage them well so that God's generosity can flow through …" I knew instantly that my talent has always been words—writing, reading and worrying about where to put the comma.

I hadn't grown up on faith; my parents had tasted organized religion and found it sour. They taught my two brothers and me right from wrong, good versus evil and we thanked God with a prayer before dinner, but they wanted us to find our own way. It took me 42 years. I was baptized at St. Paul's Episcopal Church in Alexandria, Virginia, the only candidate not in diapers and worried about the water smearing her mascara. The years since have been hard, confusing and full of a peace I've never known before.

So in 2006, I prayed and moved from Durham back to Washington. I used my savings to buy a townhouse near the Potomac River and decided I would figure out how to both write and avoid starvation.

Along life's way, I had gotten this stellar credential called a Stanford MBA, for the mere sum of $40,000 in student loans, and a good friend named Matt. By now it was early 2007, and Matt was a freelance business speechwriter with more work than he could manage. I wrote two speeches for Matt's clients and then he called to say that the current Treasury speechwriter was leaving and asked if he should recommend me for the job. Why yes, please, I said, and thought, wow, God is generous.

I got the job and then, like Robert Redford in the closing scene of The Candidate, asked, "What now?"

Hank, the great new career, the issues—even the Treasury building intimidated me. It is four stories of granite and towering columns, next door and within strong spitting distance to the White House. Look at a handy $10 bill; you'll see a picture of Treasury on the back. It's historic and prestigious; it deserved a speechwriter with some real experience, didn't it?

I wrote my oldest brother Mark many emails complaining of anxiety and insomnia. Then I wrote that what I lacked in experience I'd make up with persistence and good grammar. He finally told me to stop whining.

"For crying out loud," Mark wrote, "How scary can a guy be when he wants you to call him Hank?"

Over six feet tall and lanky, Hank often walked alone down Treasury's wide, marble halls and dropped into people's offices. He came into my boss's office and, if we were having a staff meeting, apologized for interrupting and excused himself. But he didn't like to wait or to be kept waiting and if you told him something he already knew, he interrupted and waited for you to tell him something he didn't.

My first week he reviewed one of my drafts and told me, quite brusquely, to drop "very" from a sentence. "No modifiers," he said. Okay, easy enough, I thought: he subscribes to the Hemingway theory that less is more.

I wasn't completely wrong. First, Hank is a plainspoken Midwesterner who rejected what he called "cheerleader words." Second, he had already learned that modifiers can move markets. He had been quoted as "looking closely at" an issue. A few days later he said he was "looking very closely at" the same issue. The Dow dropped.

Near the end of my interview, Hank asked a question I would hear throughout the next 18 months, "What does Michele think?"

Michele Davis returned to Treasury as Assistant Secretary for Public Affairs and Director of Policy Planning when Hank came in the summer of 2006. Although I had the title of Speechwriter to the Secretary, in truth, Michele was not only my boss, she approved every word and wrote quite a few of them, too. Michele and I had both worked for the House of Representatives many years earlier, but not closely. In the intervening years, while I bounced from job to job, she had moved up steadily with success.

On paper, I looked like a success—I had an MBA, I'd had big titles and big jobs—but I didn't feel like one. As my friend Eric once wrote, I was "treading lightly on the tripwire of midlife." I carried the wisdom and regrets that come from walking outside every morning and choosing to either catch the bus, or let it pass. I had no children and had been married once to a husband who found his perfect wife, two years after he married me.

After my divorce in 1991, I defined myself by work. Now, after sixteen years using ambition to quell loneliness, I had stopped wanting to rule the world. I wanted to make a success of my blessings, to be what I had wanted to be since I wrote my first story about Tina the Tiny in the third grade. I wanted to find strength "in quietness and in confidence," as written in Isaiah 30:15.

Some think that speechwriters are ventriloquists orchestrating the voices of the powerful, shaping world events through our words. Sometimes, speechwriters even hint that myth is true. Few speeches are the burst of one, creative genius. They are cobbled together through constant revision and scrutiny, and every day the writer dies the death of a thousand edits.

At Treasury, the lead writer was called the person "with the pen." It's a quaint notion in a time when we rarely use pens for more than signing a credit card receipt, but I became Hank's pen: not his muse, not his adviser, not his whisperer. I needed to be quiet and to be confident. And I needed to do my job.

But I didn't when it came to the Dartmouth speech. My first day, Michele, Jim Wilkinson, Chief of Staff, and I spent another two hours with Hank to talk more about the speech. I turned the meeting notes into an outline, read his previous commencement speeches, but didn't write a single word.

Two weeks later, Hank wanted to read the first draft. I told Michele that I hadn't had time; I was working on the five other remarks he would give before Dartmouth. And besides, I was flying to California to spend Mother's Day with my mom; I'd work on it as soon as I got back. I had totally missed the point—what was a priority for Hank should be the priority for me.

Hank was angry; actually, Michele said on Friday afternoon, "You have no idea how angry he is. He wants a draft by Sunday morning." It wasn't a request or a question; it was "it shall be done."

I had expected to spend leisurely hours researching, contemplating and writing about great financial theories. What a bonehead. From the day I started until almost the last day, there was at least one speech or op-ed in progress at any one time, and sometimes there were three or four.

I canceled my trip to California and finished the first draft on Saturday. I used Paulson's Principles and my notes as a guide. I called Ed for help; I got sympathetic laughter. I had no idea if the draft was good or bad, if it was in Hank's voice or mine; it was an air ball. If there hadn't been a draft there would have been a new speechwriter. If it hadn't been a good draft, I don't know what would have happened.

That was the first of many vacations I would cancel because of work; it was the last time I missed a deadline.

Good commencement speeches are personal; I had been on the job two weeks and knew very little about Hank. In the end, he, his wife and his daughter, also a Dartmouth alum, pretty much wrote that speech and I offered suggestions. At the beginning, he quoted a student who told The Daily D newspaper he was disappointed at the choice of Hank as the commencement speaker "because I really have no idea who he is at all." In a little over a year, financial crisis would make Henry Paulson a household name.

The speech ended with a sentiment that haunts me, still, given all that's happened. Hank talked about the difficult decision to end his 32-year career at Goldman Sachs, and his desire to serve at Treasury:

Many people counseled me against … it, pointing to the fact that few who go to Washington leave with their reputations enhanced.

That spring and the early summer of 2007, Hank spoke about the need for lower corporate tax rates, smarter regulations, and accurate financial reporting. We hosted the largest-ever delegation of Chinese officials for the second meeting of the U.S.–China Strategic Economic Dialogue.

What I knew about China I'd learned in books, movies and my first job as a hostess at Bill Lee's Bamboo Chopsticks in Bakersfield, California. Mrs. Lee, a squat woman who wore the same flowered dress every day, sat on a stool at the cash register and yelled at me in Chinese. I vaguely recalled Nixon going to China and something about ping-pong.

I have heard that Tony Snow, who was a speechwriter for the first President Bush, had "walk in privileges" to sit in on any of the President's meetings and learn the issues first-hand. If Hank had other speechwriters, I probably could have done more of that. But the vast office of speechwriting was a 10' by 12' cubbyhole with one window and one occupant: me. I realized quickly I wouldn't have time to sit in on lots of meetings and also write, so I went only to the meetings that helped me learn.

Status in Washington is often measured by whether or not you were "in the meeting." In my old careers, I made sure I was in every one. Now, I wanted to learn to be the quiet rather than what C.S. Lewis called the Big Noise. I wanted to walk closer to God. To do this, I needed to practice humility. It was really hard.

I have two concepts of humility. One is from the movie The Nun's Story. In the convent, the Mistress of the Postulants tells the nuns-in-training, "When we walk the halls and corridors, we practice humility by walking close to the walls."

I practiced this at Treasury, wandering along the third floor, reading drafts. Sometimes, though, by walking close to the walls and reading at the same time, I ran into things.

My other notion of humility comes from Mere Christianity, when Lewis talks about its opposite, the great sin of pride:

The point is that each person's pride is in competition with every one else's pride. It is because I wanted to be the big noise at the party that I am so annoyed at someone else being the big noise.

When Hank held roundtables with outside experts, lots of people wanted to be the Big Noise. My job was to listen—not talk—but still my ego screamed, "I want to be the Big Noise, too." Then I heard Rick Warren's voice at the very beginning of The Purpose Driven Life: It's not all about you.

So I kept practicing. I sat in the back row, listening and learning, writing down Hank's responses as if he was dictating.

And how he responded was invaluable. In the fall of 2006, President Bush and China's President Hu Jintao created The Strategic Economic Dialogue (SED) to better coordinate the U.S.–China economic relationship. Hank led the SED and its biannual meetings. At the Brookings Institution before the May 2007 SED, scholars discussed a familiar topic: the pace of economic change in China. The Chinese needed to appreciate their currency, liberalize trade and financial markets and develop social safety nets for their people.

At one point Hank put his hands on the table, leaned forward and said, "People are impatient; they want results." From that, I wrote this for his May SED opening statement:

Americans have many virtues—we are a hard-working, innovative people—but we are also impatient.

That sentence was the key news bite in the Dow Jones wire, the AP and in Time magazine's "Verbatim" column. I would never have captured that sentiment if I hadn't listened differently—for Hank's thoughts in a seemingly throwaway phrase. Impatience was his thought, not mine; I just gave it context.

To listen differently and learn became my mantra. And there was so much I didn't know. That riff about China's economic issues? I didn't learn that at Bamboo Chopsticks.

In mid-2007, we were still optimistic. People were working, buying houses, getting raises. But there were signs of trouble. Housing prices had been falling or flat for over a year; the housing bubble was slowly popping. And home lenders who specialized in subprime mortgages were going out of business, little failures here and there.

But the world economy was strong and our big concern was U.S. competitiveness—a difficult, five-syllable word that I shuddered at including in a speech—how we stacked up against the rest of the world in investment, capital markets, innovation, productivity and ease of doing business.

We were especially worried about losing our competitive advantage to the Europeans and the Chinese. On May 10, the White House issued a policy statement on Open Economies, saying that we needed to overcome national security worries and again welcome foreign investors and foreign trade.

Americans are both easy and uneasy with trade; the word "foreign" is as threatening as it is seductive. Trade brings competition and can tear down the picket fences that bound the American front yard. Every industry wants to be protected against competition, yet protectionism (one of the many -isms I would come to know and love) is rarely a good idea. It is always answered—we protect our industries, other countries protect theirs and before you know it, we have a trade war. That leads to fewer jobs and slower economic growth, the opposite of what was intended. I wave at people driving cars with "War is not the Answer" bumper stickers, certain that they are fellow free-traders.

Since the 9/11 terrorist attacks, we had become almost hysterical about foreign investment in our companies or on our soil. Hank was to echo the May 10 White House statement with a balance of patriotism and pragmatism.

We wrote an editorial and called America a "bold and self-confident nation, committed to political and economic freedom." We talked about the wider choices and lower prices that come from trade and healthy competition, like fresh oranges in the dead of winter and smaller, more efficient cars.

Hank recalled the 1980s when the Japanese bought Rockefeller Center and Pebble Beach and how we were afraid they would own every American landmark and we'd eat more sushi than hamburgers. We were as afraid of the Japanese then as we are of the Chinese now. In both cases, the fear is silly. The Secretary of the Treasury can't say silly, so instead we called it [profoundly mistaken].

The editorial was rejected by every paper but The Sacramento Bee. Not that the Bee isn't a fine paper but I thought anything with the Treasury Secretary's byline would be printed wherever and whenever we wanted. I did a lot of assuming, still do, and it's never useful.

Four days later, the Financial Times did publish Hank's editorial on a capital markets competitiveness plan. Treasury had held a conference of luminaries in March 2007 to talk about keeping the United States the financial capital of the world. The conference was held when financial markets were working as they should, amid howls that regulatory constraints threatened U.S. financial and economic leadership.

Especially loud were the cries that the 2002 Sarbanes-Oxley Act (enacted in a state of political trauma after Enron and other nefarious corporate wrongdoings) was wasting millions of business dollars and giving London an edge over New York for initial public offerings of company stocks, called "IPOs" in the lingo.

The editorial was on the need for a robust (another favorite Treasury word) accounting industry. Hank talked about a notion that means as much to markets as it does to love: trust.

Last November, I spoke about the importance of strong capital markets, pointing out that capital markets rely on trust. That trust is based on financial information presumed to be accurate and to reflect economic reality.

While markets may be measured with numbers and statistics, they can frown, pout and throw fits as well as any teenage drama queen. Emotion affects markets far more than I ever realized, stitching everything together or tearing it all apart. Even the words of the financial crisis that was to come were emotional: fear, panic, crisis, anxiety, shock.

Who knew that 15 months later lack of trust and confidence would push us to the brink of financial meltdown? As the U.S. housing bubble popped and foreclosures rose, no one trusted the value of the mortgage-backed securities, the "MBS" that financial wizards had sold to banks and investors all over the country and the world.

In the olden days, you scrimped for years to save a 20% down payment to buy a house. Then you went to your local bank and got a 30-year fixed-rate mortgage. You sent your payments to the bank, which held the loan as an asset and it was one of their overall portfolio of loans. Your bank "originated and held" the loan.

In the 1980s, this originate-to-hold model changed to originate-to-distribute. Banks and mortgage brokers originated mortgage loans and then distributed (sold) them to Wall Street financial wizards. The wizards then packaged or "securitized" the mortgages and resold them to investors. These packages are a main character in our story; they are (Eureka! mortgage-backed securities [MBS]).

MBS are also the troubled assets that have since been nicknamed toxic, which if I were an asset would trouble me even more (Eureka! toxic assets).

To borrow Forrest Gump's analogy, an MBS is like a box of chocolates and you never know what you're going to get. Each chocolate is a mortgage. The nougat center is the principal owed on mortgages with different amounts and terms made to homebuyers with different financial situations. The chocolate coating is the interest payment on the mortgage.

Some mortgages are made to credit-worthy "prime" borrowers, people with stable income, assets and a high credit score. Some are to "subprime" borrowers, people with a checkered credit history and fewer assets who couldn't make a down payment. Many of them could only afford the house because of a low, "teaser" initial interest rate that would eventually rise much higher.

To create a basic MBS, the financial wizards put chocolates of similar types—the prime with the prime, the subprime with the subprime—into boxes and turned them into new financial instruments, mortgage-backed securities. Investors bought the interest and principal payment streams, and the risk that the loan might not be repaid.

The wizards also peeled the chocolates apart and created even more complex, fancy concoctions. They put the nougat, the principal payments, in one MBS box, and the chocolate coatings, the interest payments, in another. Sometimes they sliced and diced the nougat and coatings even more, creating securities where investors received payments in different amounts and by different priorities. These were called (Eureka! collateralized mortgage obligations [CMOs]). And, wait, there's more! They also created (Eureka! collateralized debt obligations [CDOs]) another variation of slicing and dicing debt and risk.

These MBS, CMOs and CDOs were called "structured credit products" sort of like Cheez Whiz is called a "processed cheese food."

In the summer of 2007, there were about $6 trillion of MBS. That's a lot of chocolate when you compare it to the total $8 trillion of U.S. residential mortgages and the U.S. economy, the largest in the world, at $14 trillion. Yet, chocolate is a basic food group (at least it is for me) and people want chocolate right? People will pay their mortgage rather than lose their home, right? Or so we thought.

When housing prices were steady or rising and people were making their payments, all was well. When the housing market slowdown began in 2006—what Hank called the "inevitable housing correction"—more people couldn't make escalating payments under subprime loan terms, and even prime borrowers started to have trouble. The originate-to-distribute model began to fall apart. By mid-2007, nobody knew what was inside each MBS box, if it was edible or valuable. We had a chocolate mess.

Then confidence dropped, fear rose and the U.S. housing market troubles spread to the financial markets and then to the entire economy.

Those problems were yet to come, though, and during those first weeks at Treasury I didn't know MBS from BS. I tried to figure who was who and who did what. I learned the Byzantine clearance process for speech drafts—sending them out to names on a list, people who also sat behind closed doors silently communicating through email.

I wasn't quite an island, but almost. I would eventually write about every issue Treasury touched, yet I wouldn't ever be wholly a part of anything except the words. Sometimes I was as much a translator as a writer, trying to turn policy wonkese, the dense language of experts, into understandable English.

JUNE 2007

In between China and Dartmouth, Hank gave a speech on stopping terrorist finance. I admire derring-do, intrigue and men in uniform, and writing about national security was an unexpected bonus.

For years, Treasury has helped fight the war on illegal drugs by cutting off the drug kingpins and cartels from using the banking system as if they are as legitimate as the neighborhood grocer. Based on evidence, Treasury designates suspects, puts them on a potent list, sort of like the Most Wanted Financial List and it's illegal for U.S banks to do business with them anymore. Because we are the banker to the world, once you get blocked from the U.S. financial system, it's a lot harder to move money around to support your evil business. The Colombian drug cartels said the list was like enduring "muerte civil" or civil death. Cocaine Charlie gets fewer wire transfers and has a hard time clearing checks.

Twelve days after 9/11, President Bush issued an Executive Order that gave Treasury similar authority to stop terrorists' financing. That helps keep our men and women in uniform safe, because al Qaida has to find some other way to transfer money to buy bomb-making equipment or pay the families of suicide bombers. In 2005, the President issued another Executive Order targeting weapons proliferators and their support networks. The prime example of proliferators would be North Korea and Iran, who need to transfer and spend money to buy the ingredients necessary for a nuclear cocktail.

Learning about the surreal world of international terrorist finance was, frankly, terrifying. Treasury's Office of Terrorism and Financial Intelligence (TFI) helps protect us without dropping a single bomb or shedding an ounce of blood. It also proves the great axiom: follow the money. Former Secretary of the Treasury John Snow liked to call it blood money. As Hank said in his speech, stopping terrorist finance may not be the "knock-out punch" but it is a great step forward to keep "dangerous weapons out of the hands of dangerous people."

The weather was beautiful that June and I wrote at home, with the windows open. I spent a lot of time on the phone with Stuart Levey, the Under Secretary for TFI, and asked him many questions, including whether to spell al Qaida with an "e" or an "i": everyone spelled it differently. These are the odd things writers worry about. As I shouted the question over the static on his cell phone, I realized my neighbors might wonder just what was going on in #130 and closed the windows.

The first draft was over 6,000 words, 45 minutes long. Nobody wants to sit through a 45-minute speech. We cut out the TFI history and rhetoric Stuart called trite, like equating credit cards to box cutters as weapons of terror. We showed an early draft to Hank, which he didn't like, and we worked for a week on a new draft which was almost okay. Hank edited line by line. He changed words, moved phrases, wanted to say the same thing in a different way, and present a strong case against Iran. In this and every speech, Hank decided what was said and how.

That was the first time I learned how hard it is to find the right nuance without being too provocative. We left that to the politicians and the pundits who often repeated the same [profoundly mistaken] statistics and phrases in nightly newscasts.

JULY 2007

One thing I did know something about was taxes. I was thrilled that we were going to have a Business Tax Competitiveness Conference in July. How scary is that? While the President's speechwriters wrote about freedom and democracy, I wrote about financial restatements and international accounting standards, shallow soil for literary flourish.

Taxes, though, are about freedom and justice. I wanted to soar with lofty rhetoric, call the weak to arms in favor of a simpler, fairer tax code and make men weep over the inevitability of taxes and death. In the end, I settled for quoting the saint of lower taxes, Ronald Reagan.

On July 19, 2007, right before the tax conference, The Wall Street Journal published Hank's editorial, "Our Broken Corporate Tax Code." We used a 1985 Reagan quote about the "old jalopy of our tax system" and said it was "clogging the U.S. economic highway yet again." The editorial included one of my favorite sentences:

At a time when markets change rapidly, requiring businesses to be ever more flexible and swift, they are burdened with a business tax code complicated by parochial political interests.

That was a polite way to rail against the tax breaks Congress gives to special interests. Just like individuals, companies want to minimize their tax bills. It's okay when we use the mortgage deduction to pay lower taxes, but when a company uses congressionally created deductions Congress acts shocked and calls them loopholes.

The basic issue in the editorial was this:

The Reagan tax reforms set the stage for 20 years of remarkable economic performance in the U.S. and around the world … "The American Miracle."

Twenty years later, after much of the world has followed our lead, the U.S. is once again a high corporate tax country. We now have, on average, the second-highest statutory corporate tax rate (including state corporate taxes), 39%, compared with an average rate of 31% for our top competitors…

There are a few unwritten rules about what Treasury Secretaries should and should not say. Hank, like those before him, always said he believed in a strong dollar. Hank did not say, ever, that corporations don't pay taxes. They do pay taxes; they also pass the cost of those taxes to consumers as higher prices or to their employees through lower wages. He also didn't say that far from being evil creatures, corporations (whether multinational oil companies or that friendly neighborhood grocer) employ most Americans, create the profits that mean higher wages and stock prices, turn medical research into life-saving drugs, and make, sell and service the stuff that gives America the highest standard of living in the world.

The editorial also had a principle that was later smacked down by the financial meltdown:

Government should not pick economic winners or losers; the marketplace has proven itself more than able for that task.

Although we worried about high tax rates and competing with China and London, we weren't too worried—the economic reports were mostly positive. First quarter economic growth had been slow, but roared back in the second. The Dow Jones Industrial Average (more commonly referred to as "the Dow" or "the stock market") reached 13,000 for the first time on April 25, 2007 and 14,000 for the first time on July 19.

Over the prior 12 months, the United States had created two million new jobs and 8 million total new jobs since 2003. Real wages were up and unemployment was at 4.5%, which is near full employment because either by choice or misfortune there will always be people out of work. The price of oil had been creeping up, but gas prices weren't in the footnotes, let alone the headlines. Food prices were rising too because as living standards increased around the world demand couldn't match supply. Americans continued to spend, spend, spend and we talked about transitioning to a "sustainable growth path."

Treasury was working on recommendations to reduce risk across the financial system (Eureka! systemic risk), and modernize outdated, inefficient financial regulation. We watched the housing market and thought it would bottom out soon. We expected to speed down the economic highway for the foreseeable future, and the August recess waved like a good friend with a beach house and a boat drink. It was time to relax, rejuvenate and I was going to spend time with my niece who was in Washington for a summer internship.

The 2008 presidential campaign was already underway. The nation was angry about the ongoing Iraq war and fascinated by the antics of buxom, living starlets (like Brittany Spears) and buxom, dead starlets (like Anna Nicole Smith).

All in all, things seemed pretty normal.

But they weren't.

Not only were home prices falling and home mortgage lenders going out of business, two Bear Stearns subprime mortgage hedge funds were about to go bankrupt. Overseas, the German government led a $15 billion rescue of IKB Deutsche Industriebank, which had invested heavily in the U.S. subprime mortgage market.

Until that summer, a worldwide economic boom and low interest rates had set the world floating on a sea of money and easy credit (Eureka! liquidity) yearning for yield and high rates of return. Imagine, there was an estimated $150 trillion trying to invest in a world economy of $52 trillion. Much of that was invested in U.S. stock markets, companies and mortgages because we are the safest and soundest economy in the world. But there was too much money chasing too few opportunities, and eventually more and more money was invested in ever more risky products like those MBS, CMOs and CDOs.

When our houses, the assets underlying those fancy concoctions, kept losing value, the money waters began to recede and left behind a credit market squeeze. The Federal Reserve lowered its economic forecasts because of housing market troubles. Housing inventory, the number of unsold homes, was higher at the end of July than at any point in the last sixteen years.

Hank and the financial wizards gauged market health by specific vital signs, one of which was credit spreads, the difference between interest rates charged on safe versus more risky types of debt (Eureka! credit spreads). Low spreads are typical; wide spreads are a sign of trouble.

A funny thing called the TED spread, the difference between the three-month Treasury bill rate and LIBOR, (Eureka! TED spread) is a major barometer and is a bit like my hips—narrow or lean (less than 0.50%) when I'm happy in good economic times and wider or fat (above 1.0%) when I eat too much during economic stress.

The TED Spread had been rising all year, a signal that confidence in a never-ending boom was ending. As of July 31, the Dow had dropped almost 800 points from its 14,000 high and those two Bear Stearns hedge funds did go bankrupt.

In that wide lens of the review mirror, it looks like we were zipping along the economic highway and missed the 18-wheeler barreling down on our bumper.

CHAPTER 2: SHAKEN, STIRRED AND SQUEEZED

AUGUST 2007

The 18-wheeler carried a heavy load of uncertainty and fear, and scraped our bumper for the first time this August. Instead of summer boat drinks, the cocktail of the month was Pepto-Bismol.

Like most of official Washington, Hank had few public events and a planned vacation.

But as the credit squeeze kept squeezing, vacations were interrupted and all hands were back at Treasury. In a sure sign of market fear, our friend the TED spread ballooned to 2.4%, over four times its normal level. For the first time since right after 9/11, the Federal Reserve cut interest rates outside a scheduled meeting. Central banks throughout Europe spewed money into the world's financial systems to restore liquidity. The largest U.S. mortgage lender barely escaped bankruptcy; another big lender did not, and housing prices continued to fall, hurting Americans all across the land.

Early in the month, Hank went to Billings, Montana, for a community jobs forum with Senate Finance Committee Chairman Max Baucus. As promised when he became Secretary, Hank focused on how to keep our economy strong and he made the case for lower corporate tax rates, foreign investment and free-trade agreements.

After Montana he joined Secretary of the Interior Dirk Kempthorne in Boise to release the Idaho state quarter. An image of the peregrine falcon was on the backside of the quarter and Hank was invited because he had helped preserve the peregrine falcon in his pre-Treasury days.

Hank was passionate about wilderness and birds; he also likes snakes. In his office, framed photos showed him hiking with his family along a mountain crest, on a riverbed holding a big fish and, in one that was a little unnerving, Hank grinning for the camera with a huge snake wrapped around his arm.

Boise was a brief respite and a non-Treasury-Secretarial sort of day. The program included a singing cowboy and scores of children. His remarks included a word he wouldn't use again: fun.

It is fun for me to talk with you today about these two successful, cooperative public and governmental efforts—the U.S. Mint's 50 State Quarters Program, and the restoration of the peregrine falcon. I look forward to the rest of today's program and, remember, spend your Idaho quarters wisely.

Even as the cowboy sang, markets were "reassessing and re-pricing risk" and credit markets were being squeezed. At the heart of the squeeze was first, the housing correction (a fancy word for falling home prices) and second, the uncertainty about MBS values because of the housing correction.

So what is a credit market and what was being squeezed?

Imagine that a credit market is like a supermarket for loans; call it Cred-Mart instead of Wal-Mart. It's a serious place, no greeters and no yellow smiley faces, either. The Cred-Mart shelves are filled with contracts to borrow through lines of credit, mortgages, home equity lines, term loans, bonds, commercial paper, repurchase agreements, mortgage and asset-backed securities. Companies borrow, consumers borrow and banks borrow from one another, too. Cred-Mart price tags are interest rates charged to lend the money, and vary based on perceived risk of not getting paid back. Riskier borrowers usually pay a higher price.

Cred-Mart is as important as it is serious; without safe and sound banks to supply Cred-Mart our economy would fail. But that danger was not imagined, yet.

Until the summer of 2007, there was almost limitless credit choice, all types, terms, sizes and flavors, just like the soda aisle at Wal-Mart. But with housing prices and confidence falling, it became harder to get credit and borrowing prices for everything, risky or not, went up (Eureka! credit squeeze).

The United States has had credit squeezes since we've had a national currency, and some particularly tight squeezes in the late 20th century. The economy goes in cycles, as you know; after four years of strong growth, it was natural for things to slow down a little. With time and fresh liquidity from the Federal Reserve, we thought Cred-Mart would return to normal.

Hank talked to the Fed, talked to banks and companies to find out, as they say, conditions on the ground. President Bush met with his economic team on August 8 and then Hank went out as chief economic salesman to reassure markets, the press and, most importantly, you, because you were starting to worry more about the economy than anything else.

The stacks and stacks of MBS, those "toxic assets" in the Cred-Mart warehouse were complicating what otherwise might have been a difficult, but manageable, housing downturn.

Why?

The Cred-Mart suppliers—the banks, investment banks, hedge funds and government-sponsored enterprises (we'll learn more about these creatures in a moment)—held about $6 trillion of MBS inventory. But because of the imploding subprime mortgage market, nobody was quite sure what those MBS were really worth.

This was not good news for banks. Banks must keep a certain amount of capital on reserve as a cushion against bad loans or in case you, the persnickety customer close your account and want your money back (Eureka! capital requirements). Uncertain and dropping MBS values reduced that cushion. Banks either had to raise new capital or conserve what they had.

So Cred-Mart suppliers became cautious and it was harder to get a mortgage. Fewer mortgages meant it was harder to buy or sell a house. And without normal buying and selling, the housing correction kept correcting.

Housing prices were falling and foreclosures were rising because it was harder to get a mortgage or refinance. Or it was harder to get a mortgage or refinance because housing prices were falling and foreclosures were rising. The problem was not which came first, the chicken or the egg; the problem was both the chicken and the egg.

So when American Home Mortgage, the nation's 10th largest home mortgage lender, laid off all its employees and said it was going to close its doors the Dow dropped almost 300 points at the news. American Home Mortgage specialized in Alt-A mortgages, for borrowers better than subprime but not quite prime, and raised new fear that the not-paying-the-mortgage-problem was spreading.

Charles Dickens wrote a book called Great Expectations; an economist might have titled it Dismal Expectations. When talking to the press that August, Hank tried Rational Expectations.

He pointed out that our economy was fundamentally strong. What we called the "real economy"—producing, selling and buying of goods and services—was working just fine, thank you, not yet overwhelmed by the problems at Cred-Mart.

Hank was not talking up the economy falsely, but he wouldn't talk it down falsely, either. It was always about balance, about rational response even in the face of irrational events.

Some pointed out that the entire subprime mortgage market was too small—about seven million of almost 50 million U.S. mortgages—to ruin the economy. Roughly one million subprime borrowers were either delinquent or in foreclosure, but that was only a slight increase over 2006.

So what were they worried about down at Cred-Mart? The future.

About two million more subprime mortgages were going to reset to higher interest rates over the next two years. Could the borrowers pay the higher monthly payment? Would more subprime, Alt-A and, heaven forbid, prime borrowers go into foreclosure? Then what would happen to the values of those MBS mixed up in the chocolate boxes?

Investors had relied on credit ratings to set the MBS' values but now those ratings were suspect (more about that later). Markets feared that nobody knew what was inside those chocolate boxes, and that the trillions of dollars of MBS had turned to mush.

The squeeze hit European Cred-Marts earlier than it hit the United States. On August 9, the European Central Bank injected more money into its banking system since the terror attacks of 9/11 squeezed credit markets.

Meanwhile, over here in America, Countrywide Mortgage, the nation's largest mortgage lender, borrowed $11.5 billion to stave off bankruptcy.

Although August was rather slow for the vast office of speechwriting, it wasn't slow for Hank or the Domestic Finance office as the fun, or not so much fun, had begun.

Hank held a weekly staff meeting in the Secretary's large conference room. The room was painted a deep peach; frames filled with historic currencies hung on the walls and sideboards were engraved with dollar signs. The career staff and political appointees who collected the taxes, interpreted tax laws, printed the money and paid the U.S. debt gathered for 20 minutes on Thursday mornings. Hank would sit at the center of the 24-foot long conference table, say a bit about current issues, sometimes tell a funny story, and then go around the table. Each person would either speak up or say "pass" if they had nothing to report.

I often thought these meetings were more for us than for Hank. If he wanted to talk to you, he was relentless and didn't wait for no stinking meeting. And he met with his key senior staff almost every morning, when much of the real planning was done.

The weekly topics began to change, though, to discussion of spreads, housing and resurrecting the "markets room," where staff would watch national and international markets day and night, track movements and changes and look for signs of danger or relief.

On August 10th, the Federal Reserve and other world central banks injected over $300 billion into financial markets. The Fed said it was "providing liquidity to facilitate the orderly functioning of financial markets" because of "dislocations in money and credit markets," i.e. fancy words for trying to ease a credit squeeze.

Countries as big as the United States and as small as the nation island of Comoros have central banks like our Federal Reserve that are "the lender of last resort," which means they lend when regular banks can't and an economy falters. But that's in the bad times. In normal times, a central bank's main job is to control inflation through adjusting the money supply. The best central banks are independent and decide policy based on their facts, statistics and models; imagine if we let the politicians decide how much money to print (Eureka! central banks).

A week later the Fed cut the discount rate, the rate it charges when banks borrow at the discount window, which is a special Cred-Mart between the Fed and regulated banks. They also expanded the type of collateral they'd take for loans and said "downside risks to growth have increased appreciably." This was another step to ease the squeeze, to restore liquidity that was evaporating because of uncertainty and fear.

It was the first time since six days after 9/11 that the Fed cut interest rates outside its regular meetings. Of course financial losses are nothing compared to the loss of human life but like 9/11 it seemed that subprime losses were a sudden and unexpected attack, yet in both cases the trouble had been brewing for years.

In real estate, you care about location, location, location; in markets we need confidence, confidence, confidence. I needed confidence, too, as the issues became more complex and harder to understand. I found solace in my small office, leaning into God for strength, to help what my friend Catherine called "my big Stanford brain" learn all I needed to learn in order to write well.

Hank would say that the credit squeeze was the aftermath of "benign markets," years of easy money and easy credit. President Bush said "Wall Street got drunk." Main Street hoisted a few, too. I can say that because I was right there at the bar with you. We were feeling the hangover after a long party, drinking financial concoctions that made millions of crazy mortgages possible for people who "bought more home than they could ever hope to afford."

Hank assigned Neel Kashkari, a rocket scientist and MBA who had worked for Goldman's San Francisco office, the job of figuring out how to reduce foreclosures. Neel would later become briefly famous and unfairly infamous as counselor to troubled (also known as toxic) assets. Intelligent and intense, he always struck me as a man glad to have a purpose, and this summer his purpose was foreclosures.

The housing correction was "inevitable" and getting through it as quickly as possible was Hank's goal. You hear about markets finding a bottom; that was the goal in housing, too. Find the bottom and then recovery will follow. He spoke of "carefully choosing policies that minimize the impact of—but do not slow—the housing correction."

Neel and the Domestic Finance office met with the mortgage industry often. Bank vice presidents and lending managers sat around the conference room table debating processes and standards, not entirely confident they were prepared for an onslaught of delinquencies and foreclosures.

I didn't understand, really, what this might mean for the future. Like most Americans, my life went on as usual. I had a job. I paid my mortgage on time. My investment account was flush. My brilliant and beautiful niece Caitlin, who wants to save some corner of the world, was in town for a summer internship. I liked being the city-and-career-wise aunt and wished her Godspeed to follow her dream.

On the last day of August, President Bush held a press conference on the White House portico, across the driveway from Treasury. With Hank and HUD Secretary Alphonso Jackson by his side, he announced steps "to help American Families keep their homes and Reform the Mortgage Finance System."

He announced a new program called FHASecure and asked Congress to pass FHA reform that had been languishing since April 2006; both were needed to help lower-income homeowners. He also asked for a change in the tax code so those who lost their home in foreclosure didn't have to pay income tax on the canceled mortgage debt. He publicly tasked Treasury and HUD to do the work we'd already started to minimize foreclosures, and wanted improved mortgage standards so the binge drinking wouldn't start again once the hangover wore off.

The President also created a financial literacy council because a big part of the problem was, and is, ignorance of basic economics and finance. When we understand how the economy works, the role of banks and financial markets, and about credit, savings and interest rates hopefully we'll say no to crazy mortgages and to cures that are worse than the disease. We'll also know more than many pundits and politicians, and make decisions based on knowledge rather than emotion.

We may also realize that only we can protect ourselves from ourselves. As Hank said in an interview with NPR on August 31:

I don't think it's my job or the government's job to tell anybody how much money they can borrow, what asset they should borrow against. People will from time to time make mistakes. We can't protect everyone against losses.

After this first summer of upheaval, Hank started to call markets fragile. I envisioned porcelain dolls sitting on a high shelf; if the shaking, stirring and squeezing continued, they could fall off and shatter.

SEPTEMBER 2007

The liquidity bathtub stayed pretty full after the central banks turned on the money spigot in August. There was still angst down at Cred-Mart; we lost about 100,000 jobs this summer, but even TED was settling down. However, reporters were already saying the R-word as in, "Are we in a recession?"

That was a little [profoundly mistaken] because the "output of goods and services produced by labor and property in the United States" (Eureka! gross domestic product [GDP]) had grown 4% by the time the second quarter ended in June. Reporters, like economists, have predicted 12 of the last 8 recessions. The technical definition of recession is two consecutive quarters when GDP shrinks. Economists call it "negative GDP growth," which, like much policy wonkese, is more complicated than it needs to be.

Despite the turmoil and credit squeeze, GDP grew another 4% from July through September. Even so, we knew we had problems. Housing prices weren't stabilizing as expected. Energy and food prices continued to rise, which had nothing to do with housing but was making life more expensive and consumers more gloomy.

The main attraction of the month remained the subprime mortgage market. As Hank said repeatedly, "The housing correction poses the biggest risk to our economy."

On September 12, he invited the press and a dozen or so mortgage lenders to the conference room to show that he was working on solutions, which he was. It was the first and only time I saw the now fairly famous Countrywide Mortgage CEO, Angelo Mozilo. He was hard not to miss, with his white hair and supernatural tan. I'd had a Countrywide mortgage once, although not through his Friends of Angelo special-lending-rate program. The rest of the group was distinguished men-in-ties, all promising support and action to help homeowners.

In his public remarks, Hank said that lenders needed to try to refinance at-risk homeowners into something they could afford quickly, not wait for them to fall behind on payments. But in the midst of a credit squeeze and falling housing prices, there was less money and less appetite to finance mortgages. And since the subprime mortgages helped cause the problem in the first place, should lenders repeat the mistakes all over again? The problem remained both the chicken and the egg. Hank also added the rational point of view:

But the other point which I think is significant here is this is all happening against the backdrop of a strong economy … this turbulence wasn't precipitated by problems in the real economy. This came about as a result of some bad lending practices.

This same day, the large UK bank Northern Rock almost collapsed because of exposure to the U.S. subprime market. Fearful Brits stood in queues (what we Americans call lines) and withdrew about ￡1 billion in a modern-day bank run. Northern Rock survived, but would be the second major casualty of the subprime mortgage fiasco.

On September 18, the Federal Reserve again tried to ease the squeeze and lowered the federal funds rate; they would cut it two more times before the end of the year.

The federal funds rate is kind of complicated, but bear with me because you hear about the Fed lowering interest rates all the time, right? If I translate properly, you'll soon be able to convince your family and friends that you, too, could be a financial wizard.

To balance their books everyday some banks need to borrow; some have excess money to lend. The Fed acts as a clearinghouse and sets a target rate for banks to charge one another as they lend or borrow overnight (Eureka! federal funds rate).

This is important because I bet your mortgage and credit card rates are based on something called the prime rate, which is the fed funds rate plus about 3%. When the Fed lowers or raises the fed funds rate, the prime rate adjusts, too. It's not some theoretical event; it's money in or out of your pocket. Lower interest rates spur spending because they lower costs.

And lower interest rates meant that the base for adjustable rate mortgages dropped, helping some homeowners afford their new payments. The Fed was using a broad market approach to help homeowners simultaneously and equally.

Whew, I'm fed up with Fed-speak for now. Let's talk about something more colorful and less logical: Congress.

House Committee on Financial Services Chairman Barney Frank came back to work from his August recess, almost as tan a man as Angelo. On September 20, Hank, Fed Chairman Ben Bernanke and HUD Secretary Alphonso Jackson testified about "Legislative and Regulatory Options for Minimizing and Mitigating Mortgage Foreclosures."

Barney Frank is indeed one of Congress's more colorful characters. He has a barbed tongue, lashing wit and is unabashedly liberal. Although Hank and Barney fundamentally disagreed on most issues, there was mutual respect and both men liked to get things done. Committee Chairmen are muy importante in the making of law, which is one of the reasons why control of Congress is, and should be, akin to mortal combat.

The most senior committee member from the party-not-in-control is called the Ranking Member; in the House Financial Services Committee this was the southern-spoken Alabama Congressman Spencer Bachus.

Anyway, Hank, Ben, Alphonso, Barney, Spencer and the committee had a pretty civil discussion compared to future hearings. The Committee members sat on the raised dais looking down on Hank, Ben and Al. Disagreements about how best to help homeowners were polite, and pretty much along party lines. The mortgage industry meetings gave some meaty factoids for Hank's opening statement:

First, it is clear that while adjustable rate subprime mortgages are the most at risk, some prime borrowers with solid credit histories are also struggling.

Second, we learned that lenders are proactively contacting homeowners facing an interest-rate reset that they likely cannot afford. Yet those calls often go unreturned because many homeowners mistakenly think that their lender wants to repossess their home in foreclosure. In fact, the opposite is true.

Finally, we learned that 50 percent of foreclosures occur without borrowers ever talking to their lender. When borrowers don't seek solutions until after they have missed payments, they will have far fewer financing options.

A significant part of the hearing was about the role of the GSEs. Geez, who?

This was the first time I wrote the term GSE—or government-sponsored enterprise—and delved into the morass of housing finance. Oh, if only it had been the last. After another year, I never wanted to hear the terms GSE, Fannie Mae or Freddie Mac again. In fact, I don't even want to write about them now, but it's such a key part of the story I have to write it and you have to read it.

Housing finance is painful because the system is complex and described in jargon. We who hold mortgages only see the surface and, like so much that contributed to our crisis, there were tangles and gnarls and a big fat mess underneath. These are the weeds of public policy that both bore and confuse. It keeps few people awake at night, but in the case of the GSEs Fannie and Freddie, we should have night sweats. As Hank summarized in his opening statement:

The GSEs are an unusual construct—they answer to shareholders and have a congressionally mandated mission. As we consider any changes to their role, we must always balance these imperatives:

The temporary needs of today's market;

The legitimate public policy question of how much of the mortgage market should be directly or indirectly influenced by GSEs, which are misperceived as being backed by the federal government;

Issues of size, systemic risk and longer-term market distortions that will occur by inserting perceived government-backed intervention.

The GSE history begins in the bleak days of the Great Depression.

When President Franklin D. Roosevelt took office in 1933, almost 10% of U.S. homes were in foreclosure and a collapsing banking system wasn't offering many new mortgage loans. So, one goal of the New Deal was to revive housing and housing finance.

Before FDR arrived, Congress had created the Federal Home Loan Bank system, the first government-sponsored enterprise to support housing (Eureka! GSE). The FHLB replicates (it still exists today) the buildings and loans, like Bailey's in It's a Wonderful Life, which had been a big source of mortgages until a wave of failures in the early 1930's (Eureka! FHLB).

In 1934, Congress created the Federal Housing Administration (Eureka! FHA). FHA offered government insurance to lenders so they'd make more and more affordable mortgages. If the borrower didn't pay, the government would. The FHA still exists today and provides a lot of finance for low income and first-time homebuyers.

Then, in 1938 Congress created the Federal National Mortgage Association (Eureka! Fannie Mae) in a further quest for more and more affordable mortgages. Fannie Mae could issue bonds, and use the money raised to purchase the FHA mortgages from the original lenders, creating what's called a secondary market.

It was an ingenious use of government power. The FHA offered federal insurance to encourage banks and thrifts to make mortgage loans, and once they made the loans they sold them to Fannie Mae. More people could buy houses because mortgages were more affordable, and lenders could lend more because they'd sell their FHA loan to Fannie Mae, get their money back and use it to make more FHA loans.

For the next 30 years, the mortgages Fannie Mae bought were held on the U.S. government's balance sheet. Then in 1968 Congress split Fannie Mae in two. They created the Government National Mortgage Association (Eureka! Ginnie Mae), which continues to purchase government-insured loans like the original Fannie Mae.

The other action Congress took is what many say started the big fat mess and blurred to no good end the distinction between public purpose and private profit.

Fannie Mae was recreated as a government-sponsored enterprise and became a publicly held company owned by shareholders, like a General Electric or an AT&T. Congress also expanded Fannie's mission so it could buy mortgage loans made by private banks, not just FHA, in the secondary market.

In 1970, Congress enlarged the family and created another GSE to compete with Fannie Mae, the Federal Home Loan Mortgage Corporation (Eureka! Freddie Mac). Ginnie Mae still had a room down the housing finance hall. Ta da! The full slate of GSEs: FHLB, Ginnie Mae, Fannie Mae and Freddie Mac.

Ginnie created the first box of chocolates in 1970 by pooling its mortgages and selling them as an MBS.

In 1980, Freddie Mac introduced those collateralized mortgage obligations (CMOs) that separated the mortgages into strips carrying different maturities and credit risk—the first of the MBS chocolate boxes with a mix of nougats, crèmes and coatings.

The overall effect of this Congressional legislative wizardry was lots of money for mortgages and more people owning homes, which had been the purpose all along.

But not so fast, Buster.

Fannie and Freddie were private companies, now, with the same pressure to earn profits as any other shareholder-owned company. But they were also a government invention, so they weren't like other companies at all and had distinct government-sponsored advantages. Hank politely called them an "unusual construct;" in my drafts I referred to them as "mutant."

Fannie and Freddie had some limits, too. Their primary mission was to support affordable housing, so Congress limited the size, type and total amount of loans they could buy.

Fannie and Freddie's advantages were exemption from state and local taxes, a line of credit at the Treasury Department and investors' belief that the securities and pools of MBS they held or sold—a special brand called Agency MBS or GSE MBS (Eureka! GSE MBS)—had U.S. government backing.

Investors thought the GSE MBS were as risk-free as you could get in a risk-based system. So investors liked to deal with Fannie and Freddie, and they held, packaged and sold MBS, or offered a guarantee to others who did, and everybody made nice profits along the way.

Since late 1999, Fannie and Freddie had been easing credit requirements and moving firmly into subprime territory. The New York Times was a bit prescient in a September 30, 1999 article:

In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980's.

Join me in saying ?ay! caramba; this 1999 prediction came true in 2008. When the housing correction and uncertainty hit, Fannie and Freddie had about $5.4 trillion of obligations. And remember those capital requirements for banks? The GSEs had those, too, but they were miniscule and, turns out, much of what they said was capital was accounting hocus-pocus. There was, and still is, a special regulator just for the GSEs, but Congress had limited its power.

The government-concoction of Fannie Mae and Freddie Mac anchored U.S. housing finance; they held MBS in their own portfolios and sold their GSE MBS to banks and investors in the U.S. and all over the world.

Hank said this in his last speech on January 7, 2009:

The inherent conflict in this structure is obvious—the GSEs served both a public mission and private shareholders—they received public support but operated for private shareholder gain. While policymakers of every ideological stripe have acknowledged the risks created by this conflict, entrenched debate, often with little recognition of market realities, prevented reform.

So when mortgages were squeezed along with everything else at Cred-Mart, it was no surprise that Chairman Frank, a fervent supporter of the GSEs, and others in Congress wanted to expand Fannie and Freddie's role.

Since 2001, the Bush Administration and every Treasury Secretary had argued that we needed legislation to reform Fannie and Freddie. The blurry line between public mission and private profit, the implicit U.S. government backing of trillions of dollars of obligations, weak capital requirements and a weak regulator were an inevitable wreck on the economic highway.

But sadly, the government usually just clears the debris after a wreck and drives on. The blame game for Fannie and Freddie started long before Hank arrived and will continue long into the future. The truth is, Republicans didn't fix it, Democrats didn't fix it and we've yet to produce the political progeny who can muster the gumption, find the solution and actually get it done.

That was the debate at this hearing and throughout the next year—should the fundamentally flawed Fannie and Freddie play an expanded role to help us through the credit squeeze and housing correction? If they didn't, who would? Chairman Frank wanted bigger GSEs and Hank continued to object unless Congress, at the very least, also created a stronger regulator.

To be fair, Chairman Frank had ushered a GSE Reform bill through the House, but the Senate Banking Committee Chairman, Chris Dodd, hadn't moved anything in the Senate and wouldn't until spring of 2008. When a bill was passed in July of 2008, Fannie and Freddie were already insolvent.

This "What if" could be endlessly debated. If the Senate had acted in 2007 or sooner, would we have been able to fix the problems instead of having to take over Fannie and Freddie and offer $400 billion in credit lines to boot? It was probably already too late in 2007. It wasn't a question of if, but when.

As we kvetched with Congress over Fannie and Freddie, Hank put on his environmental hat again and spoke at the "Major Economies Meeting," the effort launched by President Bush to supplement the UN effort to combat global warming. I was ambivalent about global warming, not sure that it was true or if it was, that it was man-made. I also disliked saving the planet because I had to write pandering statements of the obvious:

Globalization and interdependence are here to stay, so we all have a role to play protecting our environment for our own children and the children of the world.

CHAPTER 3: THIS IS NOT MY BEAUTIFUL HOUSE

OCTOBER 2007

If writing about saving the planet was pandering and writing jargon about housing finance was painful, writing about home foreclosures was depressing. I imagined abandoned houses with broken windows and family dogs left behind digging through trash for food. Although we talked about risk and statistics, we knew the housing downturn was about real people.

Millions of homeowners were stuck. Among those most stuck were the most vulnerable, those who didn't ask, didn't understand or didn't care what was going to happen over the life of their mortgage. Also stuck were the middle class who borrowed to build swimming pools and gourmet kitchens. Like Scarlett O'Hara, they would think about paying tomorrow, for after all tomorrow is another day. Tomorrow came; rates adjusted up, they couldn't afford the payment, couldn't refinance and couldn't sell.

While much of the nation watched the major league baseball playoffs (the Red Sox would eventually sweep the Rockies in a four-game World Series), Treasury's focus was mostly bricks, mortar and foreclosure rates this October. In every housing downturn in the last three decades, GDP dropped. But GDP was still growing. Hank started to talk about limiting "spillover," containing housing and Cred-Mart troubles before they spilled over to the rest of the economy.

On October 9, mind you, the Dow hit an all time high of 14,165. Since the majority of Americans own stock directly or through retirement plans, the market can make us happy or sad. It was making me pretty happy, then. I celebrated in the spirit of free trade by buying Italian shoes.

On October 10, Hank, Alphonso of HUD and mortgage servicers, representing 60 percent of all U.S. mortgages, announced the HOPE NOW Alliance. The private sector was going to coordinate and scale efforts to help homeowners and Treasury was going to watch and measure their results. At this point adjustable subprime mortgages were the big concern, and HOPE NOW would be the centerpiece of our early efforts to fight rising foreclosures.

On the 16th, Hank gave the first of many speeches on housing, this one at the Georgetown Law Center. Since most law students don't have mortgages, I wondered about the venue. Cleverly, we told the students why they would be interested, even if they weren't:

As students of law, business and public policy, you have an interest in real life case studies that combine financial markets and policy issues. Current developments in the housing and mortgage markets provide such an example.

This speech was rather dismal. Hank never wanted to be overly optimistic but Bob Steel, the Under Secretary of Domestic Finance who had worked with Hank at Goldman, argued that we were swinging too far to the pessimistic. In the end, I drafted based on the economists' facts. In October 2007, the facts were:

The ongoing housing correction is not ending as quickly as it might have appeared late last year. And it now looks like it will continue to adversely impact our economy, our capital markets, and many homeowners for some time yet. Even so, I believe we have a healthy, diversified economy that will continue to grow.

Hank gave a grim account of our national housing spree …

The housing correction has its roots in an eight-year period of exceptional home price appreciation which was fueled by an increased demand for, and an abundant supply of easy credit. Speculation also played a significant role, as the share of buying activity by investors or individuals buying second homes more than doubled from 2000 to 2005. Homebuilders responded to the extraordinary demand for more and larger homes as if it would last forever.

As mortgage lenders and investors reached for higher returns this "demand" pressure, coupled with our fragmented mortgage origination process, led to a decline in underwriting standards and a sharp increase in the issuance of riskier mortgage products. As demand for housing began to slow in 2004, originators, eager to maintain high mortgage origination volumes, further lowered their underwriting standards.

… and how we were feeling only the point of a knife that would cut much deeper:

This decline in lending standards was not limited to, but was most pronounced, in the case of subprime lending, which grew from only about 2 percent of mortgages in 1998 to nearly 14 percent in mid-2007…

Of the approximately 50 million outstanding mortgages in the U.S. today, approximately 10 million are subprime loans. Many have cited the statistic that 2 million of those subprime mortgages will reset to higher rates in the next 18 months. That statistic is true, relevant, and troubling, but it is not the complete picture of the risk going forward … the number of homeowners having trouble making payments on prime mortgages is also increasing.

He talked about the originate-to-distribute mortgage model and our toxic friends, the MBS:

Gone are the days when a homebuyer only went to the corner bank to take out a mortgage. Today, the mortgage process is disaggregated and less personal. A mortgage loan is likely to be originated, serviced, and owned by three different entities. Originators often sell mortgages to securitizers who package them into mortgage-backed securities, which are then divided and sold again to a global network of investors.

The money that made these mortgages possible came from the worldwide liquidity flood and a fancy word: securitization, done by securitizers who securitized.

We learned in Chapter 1 about mortgage-backed securities, MBS. These were created by packaging mortgages and selling them to investors, that process is (Eureka! securitization). The wizards also securitized other cash payment streams, like credit card and auto loan debt.

And we also learned that they also sliced the MBS further into CMOs and CDOs. The banks either moved these securities into "Special Purpose Vehicles" off their balance sheet, or sold them to U.S. and international investors. This slicing and dicing meant few "whole loans" existed anymore and that complicated mortgage modifications.

In my stalwart American Heritage Dictionary, which got me through college, business school and multiple creative writing classes, security is a noun that describes "written evidence of ownership." Financial wizardry had turned security into a verb.

Language evolves; that same dictionary has the noun googol, which is the number 1 followed by 100 zeroes. If I were to buy a new dictionary, I suppose it would have securitization, Google the proper noun and google the verb, as in "I googled him," which I suppose makes me a googlizer who practices googlization.

Banks and mortgage brokers made loans, even ones destined to go bad, and then sold them off. Mortgage brokers have long fallen through the regulatory cracks, and since they were originating a mortgage only to sell it, what did they care if it could never be repaid? And since the wizards were going to slice, dice and sell it again, Wall Street didn't care much, either. People who never thought they could own a home suddenly could. It was some party.

All seemed fine and dandy until what went up had to come down. Except for Peter Pan and upturned collars on preppie polo shirts, nothing defies gravity, not the U.S. economy or our housing market. Hank would refer to this principle of economic gravity often.

The last part of the October 16 speech asked the question that will be endlessly debated: What is the proper role for government?

Hank raised the issue of moral hazard, a term I looked up to make sure I knew what it meant. Basically, it's the hazard that after government bails a company or industry out of its mistakes, they make the same mistakes again because they assume the government will bail them out later, too (Eureka! moral hazard). That seemed more like immoral than moral hazard to me.

A year later when we were rescuing or bailing-out—pick your verb—the banks, there were nods of concern about moral hazard, but the hazard of the moment overwhelmed the possible moral, or immoral, hazard of the future.

In this speech Hank also said, "I have no interest in bailing out lenders or property speculators."

He didn't have any interest in that a year later, either, but when going eyeball-to-eyeball with a potential financial collapse he had to blink. Before then, Hank stuck to his guns that risk must bring success and failure. Those guns would have hit the target in a man-to-man shootout, but not in the O.K. corral.

The speech also laid out solutions to the problems that had contributed to the mess: lack of disclosure, lax regulations on mortgage originators and predatory lending.

In speeches and remarks throughout October, November and December, Hank outlined Treasury and HUD's efforts to minimize foreclosures. In a December 7 Wall Street Journal op-ed entitled "Our Plan to Help Homeowners," he further explained the mission and purpose of the HOPE NOW Alliance:

In the next two years, we will face a rising volume of subprime mortgage resets, and we expect a dramatic increase in the number of borrowers who will struggle to make their payments at these higher rates. Investors and mortgage industry participants recognize that their traditional process will be overwhelmed and unable to handle the higher volume of borrowers seeking assistance.

In such a diffuse industry, no single firm could convene all investors to streamline the current cumbersome, loan-by-loan process. This suggested a role for government, to bring the private-sector participants together so they could develop solutions they could not reach acting individually. By convening a large group of servicers and mortgage investors, we facilitated their work to improve their outreach and develop an industry-wide, streamlined response to struggling borrowers.

HOPE NOW was a market-based solution to a private sector problem. The industry had crafted a framework to solve problems more quickly, to put homeowners in categories—don't need help, need help now, need help tomorrow and, unfortunately, can't be helped at all. Hank urged industry to standardize, streamline and be snappy about it. If someone could be helped, we didn't want them to go into foreclosure just because the mortgage guys couldn't get to them soon enough.

It was cajoling, rather than mandating. We didn't tell them what they had to change or to break private contracts; once the government starts interfering with legal contracts entered into freely that is a sure step away from democratic capitalism. It was the first of many sharp philosophical debates about how to "solve" the housing crisis.

With the economy still relatively strong, and interest rates down thanks to two more rate cuts by the Fed in October and December, the HOPE NOW plan seemed like a feasible solution. It was hailed by The New York Times in November because it was forcing lenders to act and criticized by The Wall Street Journal in December over concern that it would force lenders to act. Go figure.

HOPE NOW was as practical as it was ideologically consistent. Since the mortgage servicers "serviced" (collected the payments and managed the mortgage terms) for MBS investors, they knew what homeowners were going to face a big payment jump and could talk to them about refinancing their mortgage. And then, reduced foreclosure rates would shore up MBS values, loosen the Cred-Mart squeeze and get us back onto a smoother highway.

But it was never so simple. Since so many mortgages had been sliced and diced and the pieces put into many different boxes, multiple investors had to agree to any change in loan terms. And then, in the glorious tradition of modern American jurisprudence, the servicers had to worry about getting sued. The question of who was liable for what slowed everything down.

If someone was afraid to talk directly to the mortgage servicer, they could talk to the friendly mortgage counselors, like NeighborWorks, which were also a part of HOPE NOW.

Ah, but many scoffed, claiming that the banks that made these profitable loans would be the last ones to fix them. That is so [profoundly mistaken]. It's cheaper for a lender to refinance, if possible, than to foreclose.

We hoped, pun intended, HOPE NOW would do the trick. Hank also said, "The problems we are facing in the mortgage market are complex and unprecedented, and there is no perfect way to deal with them."

It was going to be a lot of work, and would take years, to clean up after a reckless party of greed on Wall Street, Main Street and both ends of Pennsylvania Avenue.

Wall Street was greedy for profits, and their reckless risk fueled and met market demand for more credit.

Main Street was greedy to own a new car, a swimming pool and a bigger house in a better neighborhood, and borrowed recklessly to get what it wanted. That's harsh, but if you look out your window, you'll see me living next door.

Politicians, greedy for votes and popularity, turned homeownership into an entitlement and propped up the GSEs to finance the housing spree.

Decades of policies distorted the means and the end of the American dream, which I had been taught was the freedom to succeed or fail, no matter your race, gender or pedigree so long as you did honest, hard work. Hank referred to homeownership as "a cherished part of the American dream," not the whole dream itself. We're not a great country because we own houses. We're a great country because we have the freedom to earn the money to buy a house if we choose.

While housing problems were discussed but far from solved, I worked on the first of three speeches the China team had planned to preview at the December SED meeting in Beijing. Problem was, after Hank gave the first speech on October 23, he'd said basically all there was to say and we still had two more to go.

I disliked writing China speeches for reasons that had nothing to do with the Chinese people. They had given me my first job, after all. I disliked writing about China because the China team was spread out over three floors and three different offices; they didn't get along and negotiated policy through the speeches. There was also a fellow on loan from a think-tank who kept trying to be the lead writer. He said the issues were very complex and sophisticated, hinting that I couldn't understand them. He also said that the wrong modifier might destroy the entire U.S.–China relationship. Who knew it was so fragile?

After the first insult, I was resentful; after repeated insults I was openly hostile. I wanted to walk closer to God; I didn't think that meant being trampled by man. I asked through clenched jaw if he would kindly knock it off.

My clenching was compounded by the schedule; Hank had five speeches within four weeks. The vast office of speechwriting was overwhelmed. After the housing and China speeches, he was going to India. He was making a major speech on the Indian economy to the Council on Foreign Relations (CFR) the day after the first China speech, and then a second speech in Mumbai.

I've never been to India, although I saw Gandhi and have eaten tandoori and naan at the Bombay Club. It took 23 drafts to finish a speech titled "The Economic Power and Promise of India."

The speech was, as the title said, about India's potential, including making Mumbai an international financial center. How optimistic we were then, how unaware of what was to come. But in Mumbai in October 2007 and slightly adjusted in Cape Town one month later, Hank made the same case:

Properly-regulated and well-functioning financial markets are critical for balanced development and strong, inclusive growth. … Efficient markets link capital with ideas and ambition—they are the economic lifeblood through which people find the means to rise out of poverty. This is true in India, in the United States and around the world.

While in India, Hank was going to visit the home of Rabindarath Tagore, the Nobel-prize winning Indian poet, and the CFR speech included this:

The great Indian poet Tagore wrote that he had become his own version of an optimist. He said, "If I can't make it through one door, I'll go through another door—or I'll make a door."

Hank's first speechwriter, Ed, said he couldn't believe Hank quoted someone else in his speech, let alone a poet. I got lucky once, and although Hank would quote Alan Greenspan and Warren Buffett in the future, he never quoted a poet again.

Hank would never be accused of being a polished or even an engaging speechmaker. His voice is scratchy and halting and he didn't like to tell stories about himself or warm the crowd with "a funny thing happened on the way…" He scrubbed every last word of every speech, but rarely practiced reading aloud. On those rare occasions when he did, he had a keen ear for what was good and what was bad. He stopped once when practicing a speech with Ed and said, "I'm going to put myself to sleep."

For the CFR India speech, he agreed to practice but moved the time up from 3 p.m. to 10 a.m. and the speech wasn't ready. Michele, Jim and I sat around the table in his small conference room. This was Hank's room for private meetings, where he prepped for testimony and hosted Fed Chairman Ben Bernanke (we'll spend a lot of time with him, soon, so I think we can call him Ben from now on) for a weekly breakfast. Gold swags pulled heavy green velvet drapes back from windows with a view of the White House and Hamilton's silver tea set sat atop a credenza. Hank stood behind a podium brought in for the practice.

I gave him his reading copy and said, "It needs to be shortened." The speech was in what I called the "bloat" phase. Facts and arguments had been added piecemeal and in policy wonkese; I had planned to use the day to revise and tighten it. Hank wanted to practice anyway. At the third page he stopped and said, "I'm even boring myself."

Over the next hours I cut 1,000 words and 10 minutes out of the speech. When we met again for practice that evening he was almost as relieved as I was that it was better—not perfect, but closer to final.

The second Indian speech was about investing in physical infrastructure in order to build India's economy and lift her people out of poverty through jobs. The developing world needs the same roads, power plants, electrical grids and pipelines that the United States has had for a century. They need infrastructure to start and run businesses, almost as much as they need medicine and peace. They might have more of the latter if they had more of the former. As is usually the case with the good and generous nation of the United States, Hank did more than lecture; he offered American money and minds to help. If you want to be conspiratorial, you could say there's a sinister motive, like we want more Indian and African consumers to buy Coke and Pepsi. I never saw that; we helped because we could and knew we should.

While India got the infrastructure pep talk, U.S. and world Cred-Marts were still squeezing and banks looking worse. Citigroup announced third quarter profits down almost 60% from the prior year, Merrill Lynch announced a $2 billion loss and a new CEO named John Thain, and Morgan Stanley cut almost 1,000 jobs.

On October 27, the optimist Bob Steel announced that Treasury was working on the liquidity squeeze in one of those Cheez-Whiz-like structured credit products known as a Special Investment Vehicle, or an SIV. SIVs are another wizard creation, a package of asset-backed securities (ABS) or asset-backed commercial paper, sometimes MBS or sometimes not (yes, all this BS is confounding) that banks held off their balance sheets. Uncertainty was squeezing this market, too, and fear might cause one to fail, and then we'd have a "disorderly wind-down" that is, a tangled mess. The idea was to create a super SIV, separating good assets from bad, freeing up capital to help the economy and the banks. It was, like HOPE NOW, a valiant attempt at a market-based solution. The problem here was the same as everywhere else; nobody was confident about the market price for the assets. The SIVs sat lonely and unloved and were liquidated by the banks over the next year.

Back to these asset-backed securities: What are they? During our economic party we securitized lots of stuff, and it was all now part of the Cred-Mart squeeze. Just as the financial wizards expanded home lending through securitizing mortgages, in the mid-1980s they expanded consumer credit by securitizing auto loans, student loans and credit card receivables (Eureka! asset-backed securities [ABS]). For example, when you financed a car through Ford Motor Credit, the finance arm of Ford Motor Company, they'd pool your auto loan with others, package and sell the pool and they could lend more money, cheaper and more often.

This type of non-bank lending is called the "shadow banking system;" at its peak, it supported as much if not more consumer lending than the banks. The (Eureka! shadow banking system) and ABS would matter much more a year later, when the credit squeeze turned into a freeze. For now, let's say that we like securitization when done right. But housing was still the heart of the problem. It was, as Hank kept saying, "The greatest downside risk to our economy."

NOVEMBER 2007

As I drafted Hank's speeches about the housing market, I realized I'd not only been securitized, my house was being corrected, too. I checked with my realtor about my house value. Gadzooks! I was almost underwater: My house was worth barely more than my mortgage. Although I wasn't a subprime borrower, I did have an interest-only ARM. In essence I was renting and my landlord, JPMorgan Chase, had my hefty 20% down payment as a rental deposit.

In the 1940s, my Grandma Bessie was a widow who raised three kids on the wages she earned as a telephone operator in Salt Lake City. When I knew her, Grandma drove a sky blue Ford Fairlane and liked a highball and a Kool cigarette at the end of the day. She fondly called her grandchildren "little shits." My mother grew up constantly moving to new apartments in the middle of the night, sometimes just across the street. The family lore was that Grandma was a gypsy at heart and with three kids in tow she satisfied her wanderlust by renting new apartments.

My Uncle listened to these stories for years and finally guessed that Grandma probably wasn't so much a gypsy as she was skipping out on rent she couldn't afford.

For years, as I moved from city to city and from house to house within the same city, I said that I was channeling my gypsy grandmother. At 34 I became an owner instead of a renter, but I kept moving. Why did I have to own a home? Because I wanted the freedom to paint the kitchen red (which I never did), I wanted the tax deduction and, like Scarlett, I looked for some stability in the red earth of Tara. When home prices were rising, I made some tidy profits buying and selling; I also paid huge transaction fees. By the time I calculated the renovations, taxes, titles, escrow and commission costs, I didn't make so much money after all. It was more like a forced savings plan.

As I wrote about all these people living above their means, stuck in a house they couldn't sell and couldn't afford, I learned more about humility. I was in the same predicament and felt pretty dumb for someone who always thought I was so smart.

On November 8, Hank gave the second of the three-China-speech-death-march. This one was better than the first. It was mainly about shared responsibility for open, healthy, environmentally responsible economies.

The next week he left for Africa and made a speech at the U.S.–Africa Business council in Cape Town, "The Remarkable Change and Progress in Africa's Economic Development." And there were signs of remarkable change because of the worldwide economic boom:

Improved fiscal and monetary policies, combined with favorable global conditions and strong commodity prices, have had dramatic consequences across the continent: annual GDP growth has exceeded 5 percent for half a decade, inflation rates have dramatically declined, debt levels are more sustainable and the IMF projects that, this year, foreign exchange reserves will reach record levels.

Private investment was increasing, although it was still miniscule compared to other parts of the world, and Africa now had 200 million mobile phones, up from zero a few years before. That's important not just for the African teenager who wants to text, but telephones help businesses start and operate, which creates jobs that lift people out of poverty.

The fall was a whirlwind of trips and speeches. I never traveled with Hank. Michele or her deputy, Brookly McLaughlin, went along to handle the press, and there were always a few policy staff that went, too. While they were traveling and speaking to the world I was home with my dog working on the next speech. The vast office of speechwriting wished she had known to insist on some trips when she was hired.

But I had been to Africa once, and since 2001 had helped support a boy and a girl in Uganda through Compassion International. We exchanged letters, prayers and photographs. For the small amount of money I sent each month, they bought shoes, clothes and goats, and one Christmas Ruth and her family bought a cow. They sent me a picture; I've never seen such a beautiful beast. I liked learning about pockets of joy on a continent we often hear is only violent and corrupt.

Forgetting that Tagore had been a lucky literary flourish, my earliest draft of the Africa speech had excerpts from Cry, the Beloved Country and Things Fall Apart. They are two of my favorite books; they hold the scent and sense of Africa on every page. The first draft I so foolishly circulated had this:

One way in which Africa is unlike any other place is, of course, in its land—the quiet citizen that lies beneath every farm, village and city. Future generations will be able to rely upon Africa's land and natural resources, if they are used carefully today. In Cry, the Beloved Country Alan Paton wrote this about South Africa's land: "Keep it, guard it, care for it, for it keeps men, guards men, cares for men."

An international economist read the draft and asked, "How is Africa unlike any other place?" I have found that economists are pretty smart, but not big on imagination. But I was being pretentious—Look at me! I read literature! The quotes didn't fit, weren't relevant and I deleted them.

Meanwhile, on November 15 in a galaxy far, far from Africa, the supreme council of accountants dropped the FAS 157 bomb. The official weapon was called "A Statement on Fair Value Measurements," in slang we call it mark to market, and some say it contributed as much to our financial crisis as all the MBS, ABS and BS.

How on earth could a mere statement by some accountants do this? And who are these guys anyway?

FASB is the Financial Accounting Standards Board, a private-sector gang of accountants based in Connecticut that set the rules for, you guessed it, financial accounting standards (FAS)—like how to value an asset on a balance sheet, and what is an allowable expense on an income statement. The SEC requires that all publicly held companies follow the FASB standards. This is good, because standards mean when you compare company financial statements and profits you're comparing apples to apples. And as was so eloquently pointed out in Hank's May op-ed about the accounting industry, market trust is "based on financial information presumed to be accurate and to reflect economic reality."

But what is economic reality? Put on your 3-D glasses.

FAS 157 meant a sea change for how companies accounted for thinly traded or hard-to-value securities including those trillions of dollars of MBS. Up until this time, banks, investment banks and hedge funds often used mathematical models to value the MBS (some called this mark to myth). As the housing market tanked, some hedge funds and banks had to sell MBS to meet margin calls, or as in the case with those two Bear Stearns subprime funds in July, liquidate entire portfolios. Once FAS 157 took effect after November 2007, banks and funds had to mark these assets to the market price. This meant their balance sheets would have to reflect the actual, lower MBS prices, whether they were selling them or not.

An MBS pool valued at $5 billion had to be written down to say, $3 billion, reflecting what the market price was for a similar asset someone had sold recently, often under duress. That $2 billion write-down came out of their capital requirements and a bank can lose only so much capital before trouble looms. Write-downs like this can also flow through to the income statement and hurt profits, too.

Accountants will make a good point here that regulatory capital requirements and financial accounting standards can differ, and FAS 157 allowed for "judgment" in valuing these assets. But in the presence of a trial lawyer, judgment is often taken as an invitation to a lawsuit.

The public debate over FAS 157 was spirited, to say the least. Some said (in loud voices some might call screams) that it was ridiculous to apply short-term prices to long-term assets, especially a short-term price reflecting current fear, or write down an asset you didn't intend to sell right now. Others argued that reality is today's value, whether you like it or not, and nobody had complained about marking-to-market when the values were high.

My first car was a Chevy Vega that cost $1,000 in 1976. I left Mrs. Lee behind at Bamboo Chopsticks and drove my Vega to a part-time job at McDonald's. Thanks to evidence of incredible exploding gas tanks, my Vega became worth about 200 bucks. I wasn't going to sell it; I needed it to get to McD's, but if I marked-to-market my personal assets would drop from $1,000 to $200. I wasn't selling my Vega, so what did it matter what someone else said it was worth? I might have beaten my accountant with a filet o' fish.

On the other hand, how could I say that the Vega was worth $1,000 if nobody was willing to pay more than $200?

That's a simplifed attempt at explaining the mark-to-market arguments. By the way, my Vega was gold with a white racing stripe and it never exploded.

While the accounting and financial wizards debated and Hank walked the fertile fields of Africa, I fell briefly for a real man in uniform, an Army Colonel. I mention this not because this is going to turn into a love story (you should be so lucky; we've got much more to wizardry to learn). I mention it because after I conjured him as the perfect blend of Mr. Darcy, James Bond and Indiana Jones, I couldn't let go of the fantasy. I pretended he was a romantic action figure who would some day want me. What he really wanted was an economic debating society. Throughout the crisis he was like my personal Rush Limbaugh, sending furious messages about how Treasury and the government were ruining the economy. It was quite irritating, because at times I had doubts of my own.

I am incredibly blessed and, like millions of other single people, I have not yet found a true companion. I wonder sometimes if I don't have enough faith in God's plan or if in fact this is His plan: me, alone. In the BBC series Cranford, Miss Matty Jenkyns summed up how I often feel, "It is not the despair that hurts me; it is the hope." I don't know that it's wise to argue with God (He's always going to win) but I have tried, telling him what He already knows, that I get lonely and it's time He got with my program. Thankfully, when you're insolent to a divine being, He always forgives.

November ended with more bad news for housing, Cred-Mart and banks. Freddie Mac announced a $2 billion loss due to mortgage defaults and credit losses, and complained that those pesky capital requirements—even though they were far less than was required of banks—meant that they'd have to raise more capital at a high price. Bear Stearns cut more jobs, they'd cut a total of around 1,500, more than 10% of their workforce. Oil went over $88 a barrel, up over $30 since January. Food and commodity prices were spiking, too. A Goldman Sachs economist forecast that bank losses due to subprime MBS could hit $400 billion. By December of 2008, losses were well over $1 trillion.

But 94,000 new jobs were created in November, and the bigger economy was sheltered from the housing and Cred-Mart problems. So far.

DECEMBER 2007

But growth slowed in December and the unemployment rate rose to 5%. Moody's began to cut credit ratings on the MBS and other securities it had rated AAA, another punch to the belly of confidence.

A word here about credit ratings agencies: they were like my friend April, who set me up on a blind date. She assured me that the guy was great, really, or at least he seemed to be during the few times she'd met him. Her intentions were good, her information incomplete. He turned out to be a closet psycho killer. Okay, maybe not a killer but a bit of a psycho. But then, when I kept dating him, whose fault was that?

For years, credit ratings agencies did a similar thing. There are three big agencies—Moody's, Standard & Poor's and Fitch—and they get paid to classify investments by risk. They tell investors that a security or bond has a low risk of credit default and give it a good rating, like AAA, or if it's more risky, say B-1 (Eureka! credit ratings). Investors rely on credit ratings when deciding to invest, so the wizards needed credit ratings to sell those "structured products" like MBS and CDOs. If investors had been told these products were more like a potential psycho (killer), they may not have bought them.

From this paragraph in a speech Hank gave in March 2008 you can glean what the credit ratings agencies didn't always do:

The credit rating process needs to clearly differentiate between structured products ratings and ratings for corporate and municipal securities. And agencies should require securitized credit issuers to perform robust due diligence of originators of assets that are securitized or used as collateral for structured credit products.

Yes, being the sleuths that we are, we can tell that the credit ratings agencies didn't account for the difference between a relatively simple security and the fancy, structured concoctions. They didn't look at the details of the layers that had been sliced, diced and then thrown back together. They gave ratings anyway, usually pretty good ones and so investors bought the securities.

About this time, in what would be a traditional British understatement, the UK Financial Services Authority said to prepare for the credit crunch to get much worse.

Hank spoke at the Office of Thrift Supervision on December 3, outlining both what the Administration had done so far to help stop foreclosures, and what Congress needed to do. There was a lot of talk but not a lot of action in those vaulted halls on Capitol Hill. This speech included the sentiment that some people criticized, and was hard-fought internally because it was brutally honest: that some who owned houses that they couldn't afford "will become renters again."

He repeated President Bush's request for Congress to pass FHA reform to help about 200,000 families refinance into more affordable loans, to pass the mortgage debt tax relief bill and complete work on GSE reform to create a strong, independent regulator for Fannie and Freddie. Congress did pass the mortgage tax relief bill this month; the others they wouldn't get around to for awhile.

In talking about rising foreclosures Hank again said, "We face a difficult problem for which there is no perfect solution." Another understatement.

Treasury and the acronym soup of finance and housing agencies (HUD, FDIC, OCC, OFHEO, OTS) announced a streamlined HOPE NOW framework to try to help troubled subprime loans before they went delinquent. It was criticized from the left as insufficient and from the right as Paulson's Dangerous Precedent. Go figure.

HOPE NOW launched an outreach campaign and toll-free number, and for Hank's remarks I seized the opportunity for a literary flourish. My draft included friendly language like "call for hope," and "spread the word that hope is but a phone call away." A cast of thousands, including David Nason, the housing finance guru —aka Assistant Secretary for Financial Institutions—met to edit the draft.

The rocket scientist Neel asked me, "Why are you saying hope so many times?"

Before I could answer, David said, "It's called a literary device."

"Yes!" I almost screamed. It was a device, the poor cousin of a flourish, but when the subject was systematic evaluation methods for foreclosure mitigation, it was the best I could do.

As we battled the incoming wave of foreclosures and the receding wave of confidence, the Federal Reserve took more action. They established a Term Auction Facility (TAF), another special Cred-Mart program to boost banks' liquidity. The Fed widened both the type of collateral and the institutions that could borrow "longer-term," which meant about 28 days, versus the normal overnight borrowings (Eureka! TAF). The Fed press release said, "This facility could help promote the efficient dissemination of liquidity when the unsecured interbank markets are under stress." The Fed also injected more money into world markets through $24 billion of currency swap agreements.

Still, banks reported more losses and write-downs, mostly related to mortgage assets.

Bear Stearns announced its first ever loss quarter after writing down almost $2 billion in subprime securities. This was bad news for Bear and the top executives who got goose eggs for year-end bonuses. Recall that Bear had been the leading edge of the credit squeeze with two subprime hedge fund bankruptcies in July; it was a lead that would eventually cost them dearly.

A few banks raised capital to offset the losses, but fear had seeped deep. Many shorter-term business loans are priced off the London Interbank Offered Rate: the interest rate banks charge one another for unsecured loans, sort of a very private bank-only Cred-Mart (Eureka! LIBOR). Recall this is the denominator of the TED spread we met in Chapter 1. The hundreds of billions pumped into world financial markets should have lowered LIBOR. But the fear of a bank failure kept LIBOR high, and the squeeze which began during the warm days of summer continued squeezing the cold days of winter.

Hank went on the road in mid-December for housing town hall meetings in Florida, Missouri and California. He heard a whole lot of trouble and frustration, and that the economy was slowing significantly. Former Treasury Secretary Larry Summers called for tax cuts and a spending package to stave off a deep recession and while we didn't talk about it publicly, planning for something was already underway.

Hank ended the trip at a trade forum in Long Beach with my old boss, California Governor Arnold Schwarzenegger. Hank was more comfortable in forums with back and forth discussion than he was standing behind a podium, especially when talking about trade, which he fervently supported. And who couldn't be comfortable sharing the limelight with the tan man (is there a pattern here?) named Arnold?

Even though I've lived outside of my home state of California since 1993, I was born, raised and educated there and in my heart I remain a Californian. When Arnold became Governor in late 2003, I raised my hand and said, "I want to help." For the next year, I ran his DC office and was California's chief lobbyist in Washington, DC. Every phone call I made was returned, every meeting I asked for was accepted; but it wasn't me that Washington wanted to see, I was basking in the reflected glow that was Arnold. He was new in office, learning his way around the federal acronyms and the morass of who controlled what federal money—since California then, as always, needed money. I didn't talk to him often, but when I did it seemed to me he picked up on the game faster than most. He was serious and intent on doing a good job, and with a cigar and questions would sift to the core of a matter.

He was human too, as California's ongoing troubles show.

We the pilot fish of his staff sat behind him during one of the tedious National Governor's Association forums, and watched him talk, drink, think, even cross a leg over his knee. Between the hem of an expensive suit and the sole of expensive shoes he was wearing white tube socks. When we giggled he turned around and said, "I forgot to pack my good ones."

It had been a long few months for all of us at Treasury, not as long as the months to come, but, to use a Hank metaphor, everybody was in the boat, rowing to reach shore. I had found my rhythm, too, and had grown more confident that I was, in fact, a writer. I still hated all the editing, though.

After the trade event Hank's assistant called, would I hold on until she got Hank on the phone? He wanted to talk to me. My first thought was that I'd messed up; it was the opposite. He called to say thank you, that he knew how hard I worked, and that he really appreciated the quality of his remarks and speeches. I listened, my grin spreading outside my face until even my hair smiled. Afterward I did the happy dance and called everyone I knew to repeat what Hank had said. I had recovered after my near fatal start. I was loyal because he had given me my first shot at being a paid writer, and after that call I would be even more loyal because he had taken the time to say thank you when it wasn't necessary.

In my first eight months, between May and December of 2007, Hank had been a speaking and I had been a writing machine. He'd given 11 major speeches, about 40 additional remarks and we'd written six op-eds. When the sacred Christmas season arrived, everyone was supposed to go on vacation. Since we'd missed boat drinks in August, we hoped for egg nog in December.

Dare to dream. There wouldn't be a break again until we handed the keys over to the Obama Administration in January 2009.

On Sunday, December 23, my Blackberry light blinked red and Michele emailed that Hank would give a housing and capital markets speech on January 7. He had learned a lot on his December trips and there was a growing consensus that the economy was in trouble. Hank wanted to lay the groundwork for an economic stimulus package as soon as the holidays were over.

Michele forwarded a bunch of background information from Domestic Finance and said Hank wanted a draft the day after Christmas. Since I had vowed to never miss another deadline, no matter how onerous (you do the math—a draft the day after Christmas meant writing through Christmas), I sat down to my computer to work. In reality, it wasn't so bad. I get melancholy over the holidays, even though I try to remember that Christmas is about God's love, not parties and tinsel. I felt God's love but was a little lonely, so I was glad to have something to do.

As I drafted, I drew parallels between the faltering U.S. economy and my faltering love life; I was still disappointed about the Colonel. My earliest speech draft had this: The U.S. economy is resilient, but you must remain vigilant. Before investing your heart's gold, beware: what comes, goes. I also tried to fit in "weenie," but it's not an economic term.

I sent out the first draft at 10 p.m. on Christmas night. I was being petty and wanted everyone know that while they were feasting with family, I had been working. We hashed through many versions of this speech over the next week, including a conference call on December 31. Hank said that he knew he would be attacked from the left and the right, and was resigned more than happy about it. He wanted to be clear about his view of the government's role in the housing downturn: to coax the industry and competitors to work together and stop things from spinning out of control.

I got off that call and onto another one with the International Affairs (IA) office about draft remarks for Davos, also scheduled for January.

Every year, the world's political and business titans, even movie stars and supermodels, travel to Davos, Switzerland, for the World Economic Forum. Hank didn't go the first year he was Treasury Secretary, but the plan was for him to talk in January 2008 about the need for change in the international financial institutions.

The international financial institutions, known as the IFIs or "If-ees" are the World Bank and the International Monetary Fund. What do they do? You got me. Why do they need to change? You got me on that one, too.

During the call, the IA staff discussed the IFIs, multipolarity and central bank coordination, and the general structure of international financial cooperation set out at Bretton Woods, New Hampshire, after World War II.

As they discussed multipolarity, I thought about a woman who used to work for me, who was bipolar. One day she would be scary-nice, the next day scary-aggressive. When my thoughts stopped wandering, I interrupted and asked an IA expert to explain multipolarity.

He said that multipolarity is the dispersion of economic power beyond the U.S. and Europe.

"Just what I thought," I said (I wasn't thinking that at all).

Over the next 24 hours, IA put together an outline based on "mega trends" in the world economy and how the IFIs needed to evolve. Part of the speech would deal with reform of the G dialogues—the G7, G10, G13, and G20. These are the groups of 7, 10, 13 and 20 country finance ministers who meet a couple times each year for "dialogues." A dialogue is the same thing as a meeting. If two people are having a dialogue, it's a bilat (a bilateral discussion). If more than two, then it's multilateral or a multilat.

It was probably best that I didn't have a strong a view on bilats or multipolarity, although it felt okay to fear bipolarity. Yet, I always needed to read a lot of stuff to understand the issues and write a coherent draft. Those were the extra-credit hours; the evenings spent following link after link in Google as if scaling down to the third Dewey decimal. For the Davos speech, I read about Bretton Woods, post-World War II Europe, the European Development Reconstruction Bank, and diagrammed the membership and evolution of the G dialogues.

At the very least, the research made me smarter. It also would have made me a good dinner party guest if I ever became a Big Noise. At the very best, I found a thread to tie a speech together.

Then the Davos trip was canceled.

I spent New Year's Eve drinking champagne and watching movies with my friend Ginny. I walked home in the black cold of the first night of 2008 and prayed that I would learn more about patience and about love. It didn't occur to me to pray for the Dow to stay above 8,000. It had closed the year at 13,264.