The Problem With Paulson

As the department did its work, along came the mortgage and credit mess. Paulson never anticipated the crisis that has come to dominate his tenure as Treasury secretary. To be fair, it also caught other smart people unawares, but Paulson has seemed particularly clueless at times, as in April 2007, during a speech to the Committee of 100-a Chinese American business group-when he predicted that the trouble in the housing market and with subprime loans wouldn't amount to much. "I don't see it imposing a serious problem. I think it's going to be largely contained," he declared.

Yes, Paulson has worked with the Fed to bring more liquidity into the market, but it was the Federal Reserve's New York bank that ultimately engineered the J.P. Morgan Chase-Bear Stearns deal, even though Paulson was on the phone that weekend too. Paulson has also worked with mortgage providers to renegotiate terms for beleaguered borrowers (but only those with good credit histories) and on expanding Fannie Mae's role in solving problems in the home-lending market. He hasn't been sitting on his hands.

But after he faced the greatest financial crisis to hit the U.S. since the Depression, the vaunted Paulson's biggest response was the regulatory blueprint that he unveiled in March. It was as if Paulson had gone ahead with his original plan for deregulation, oblivious to the housing crisis. The blueprint does little to mitigate the subprime woes-the predatory lending, undercapitalization, and other dubious practices that brought us to where we are now-and it doesn't take on the Wild West of hedge funds, derivatives, and financial innovations that's crying out for more government oversight. It just rearranges the agencies already in charge-cutting some, augmenting others-and it provides for no new regulatory authority, save for a kind of SWAT team that could open fire if it felt that the whole financial system was under siege. "The Fed has been much more creative than Treasury," said the Wall Street executive I spoke to, pointing out the Bear deal and the Fed's other efforts to rescue an economy in peril.

Beyond the credit problems, perhaps Paulson's biggest failure has been his policy toward China. When Paulson took office, much was made of the more than 70 trips he took there while he was at Goldman. He was hailed as the man who could sway Beijing to move on its currency, the yuan, the value of which has remained artificially and stubbornly low against the dollar, making Chinese goods cheaper than they would be if Beijing didn't limit its fluctuation and allowed it to float upward. With Chinese merchandise so cheap, the U.S. trade deficit with China continues to expand. Under Paulson, the yuan has indeed risen, but far less against the dollar than free-floating currencies like the euro. And the Chinese, much to Paulson's public dismay, aren't unpegging. "He has been doing this for, what, two years, and there don't seem to be any appreciable results," says Clyde Presto�witz, a trade hawk who served in the Reagan administration and is now head of the Economic Strategy Institute. "Maybe what's happening is that the Chinese listen politely, give him tea, and then they do what they damn well please."

How does Paulson deal with defeat? To his credit, friends and allies say the All-Ivy football star dusts himself off and does what he can. That's been the case with controlling entitlement-program spending, one of the top priorities he set during his confirmation hearing before the Senate Finance Committee in June 2006. Since he took office, spending on Social Security and Medicare has continued to soar. Meanwhile, the administration's ideas, such as creating private Social Security accounts, have gone nowhere since Congress balked in 2005. In the wake of this setback, Paulson did help promulgate reports about the nation's fiscal woes and tried to revive interest in Bush's moribund Social Security plan. "He worked with all the stakeholders," says Maya MacGuineas, president of the Committee for a Responsible Federal Budget. "He talked to everyone."

But as David Walker, a former comptroller general of the U.S., says, "Even though Paulson had a sincere desire and ended up spending a significant amount of time and effort to try to revive Social Security reform, he wasn't able to do it."

I've scratched my head as to why Paulson's record has been so spare. Even the basics of the job-talking up the economy-seem to have eluded him. Tongue-tied, he's never been able to soothe the markets with Rubinesque grace. But because Paulson is good at massaging Washington's erogenous zones, he continues to get good press while the economy staggers. He's our Andrew Mellon-except the press and Washington eventually turned on the famed financier. If things keep getting worse, the same fate may befall Hank Paulson.

-- Additional reporting by Jessica Liebman

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