Profile | Henry Paulson, Treasury secretary

WASHINGTON — When Henry Paulson took the helm of the Treasury Department 16 months ago, he spoke in soaring terms about shaping America's competitive destiny. At his confirmation hearing, not a single question focused on the housing market or the mortgage industry.

But just under the surface, a lending crisis was about to burst into full boil.

Now, as crises in the mortgage and financial markets raise fears of a recession, he has moved forcefully to try to prevent the worst outcomes.

Using the skills he developed during three decades at Goldman Sachs, he persuaded banking executives to create a private fund that could buy up investment instruments so that their collapse would not infect the broader economy. His staff is developing policies to stem the flood of foreclosures anticipated in the coming months. His legacy as Treasury secretary is likely to be that of crisis manager.

Paulson, 61, has won praise from Congress for being flexible and creative in responding to the problems. He has also drawn criticism: from the left, for not acting on a housing meltdown that affected millions of Americans until it threatened big banks; from the right, for assenting too readily to new regulation of the financial system.

"I think we're working our way through this," Paulson said last month. "But I also recognize that it's going to take longer for these markets to operate the way they should be, and until they are, there's a certain amount of" — he paused for a moment, as if searching for words that would not fuel further panic — "fragility in the system."

In a domestic financial crisis, there are limits to a Treasury secretary's powers. He cannot force markets to calm down. He cannot cut interest rates, which is the purview of the Federal Reserve.

"There's not a whole lot of magical buttons over there to push," said Robert Nichols, president of the Financial Services Forum and a former Treasury official.

So, as markets for a wide range of debt products went haywire in late July and August, Paulson took little visible action. Publicly, he said that damage in the mortgage sector appeared "largely contained." Privately, he was furiously gathering information — mostly by working the phones incessantly.

Paulson drew on more than 30 years of high-level contacts. He called James Dimon, chief executive of J.P. Morgan Chase, to educate himself about the market for mortgages. He called American Express CEO Kenneth Chenault to learn whether businesses and consumers were reducing their spending. (They weren't, at that point.) He called James Owens, chief executive of the construction-equipment company Caterpillar, to ask how the problems were affecting industrial firms. After his normal 12-hour days in the Treasury Department building, he spent evenings making more calls from his Washington, D.C., home.

Series of meetings

In September, as the damage mounted, he invited senior executives from Citigroup, J.P. Morgan Chase and a dozen other major banks to a series of meetings at Treasury to discuss a kind of self-bailout. Some of the banks were facing serious problems with what are known as structured investment vehicles, or SIVs.

These off-the-balance-sheet funds had invested heavily in the market for subprime mortgages, which are made to borrowers with shaky credit histories. If these funds collapsed, major banks might have to cut back dramatically on loans to preserve cash.

The banks agreed to create a $75 billion fund that would stand ready to buy up or lend against securities from those troubled structured investment vehicles. Paulson described his Treasury team's role as one of getting private companies to do a deal that was in their mutual interest, and noted that no taxpayer money would go into the fund.

In October, Paulson called for an overhaul of the Byzantine system for regulating banks. He also indicated openness to national standards for mortgage brokers, and other regulatory steps that have traditionally been more popular with Democratic than Republican administrations.

"I believe in markets. I don't believe in unregulated markets," Paulson said last month.

Dems' complaints

Democrats still complained that not enough was being done for homeowners threatened with foreclosure. Sen. Charles Schumer, D-N.Y., chairman of Congress' Joint Economic Committee, said: "The feeling I have is that Paulson would do some of these on his own but is being a good soldier within the administration."

Paulson had originally been reluctant to take the Treasury job. His predecessors' experiences were not encouraging. President Bush's first Treasury secretary, Paul O'Neill, was edged out of major decisions and then fired. His second, John Snow, was widely viewed as more a spokesman for the administration than a powerful decision maker.

Accepting the nomination, Paulson described his mission in lofty language, referring to the "competitive zeal of the American people," staking out a broad role overseeing global relationships and trying to ensure America's place in the 21st-century economy.

But among his first actions as Treasury secretary were steps to prepare the department for a financial crisis.

Market monitored

Snow had shut down a "markets monitoring room" to save money. Paulson re-opened the space, where five staff members now analyze data on the stock, bond and currency markets all day, and notify senior Treasury officials when they behave oddly.

The President's Working Group on Financial Markets, created after the 1987 stock-market crash to coordinate response to a financial crisis, had rarely been meeting.

Paulson scheduled quarterly meetings of its lead members, including himself and the directors of the Federal Reserve, Securities and Exchange Commission, and Commodity Futures Trading Commission.

The group conducted "tabletop exercises," which essentially were financial war games, going through the mechanics of how each agency might act in the event of, say, a 1,000-point one-day drop in the Dow Jones industrial average.

Staffers traded cellphone numbers, set up conference call lines and figured out how to get announcements to the media.

The system got its first test Feb. 27, after the Chinese stock market tanked and the Dow appeared to fall 546 points.

Using the new communication system, the agencies involved rapidly found out that part of the decline was caused by a computer glitch, so the damage was not as severe as it looked. Panic averted.

The system tested that day has been in near constant use in the past four months, keeping key decision makers in touch through the roller-coaster ride in financial markets.

"All of my training was to look at facts," Paulson said. "I didn't have political training because facts aren't political. Facts are facts."

But he has adapted. "The best idea in the world, if you can't sell it, you can't persuade people, it isn't any good."

Washington Post staff researcher Richard Drezen contributed to this report.