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Paulson Memo Warned Banks to Take Aid or Be ‘Exposed’

by Elliot Blair Smith

May 14 (Bloomberg) — Former Treasury Secretary Henry Paulson, describing nine U.S. banks as “central to any solution” of the credit crisis, told their leaders to take government aid or be forced to by regulators, according to a memo his staff prepared for a private meeting in October.

“If a capital infusion is not appealing, you should be aware that your regulator will require it in any circumstance,” Paulson’s one-page list of talking points for the session with the banks’ chief executive officers said.

“We don’t believe it is tenable to opt out because doing so would leave you vulnerable and exposed,” the memo said.

Investing $125 billion in the financial institutions was a shift for the Bush administration, which had proposed buying troubled assets with $700 billion Congress approved 10 days earlier. The memo is among newly released Treasury Department documents containing details about the Oct. 13 meeting.

“Most Americans are going to be uncomfortable with the government forcing the banks into this arrangement,” said Tom Fitton, president of Judicial Watch, a nonprofit research group in Washington that obtained the documents under a Freedom of Information Act request.

Andrew Williams, a spokesman for the Treasury, didn’t return calls seeking comment.

Banks worldwide have taken $1.45 trillion in writedowns and losses during the worst credit crisis since the Great Depression.

Preferred Stock

In his memo, Paulson said the government would buy preferred stock in the banks, which he called “a significant part of our financial system” and “central to any solution.”

Three and a half hours after the meeting was scheduled to begin, Paulson had obtained the bankers’ signatures on half-page forms along with the handwritten amount of the federal government’s investment, according to the documents. He announced the actions publicly the next day.

“Government owning a stake in any private U.S. company is objectionable to most Americans — me included,” Paulson said Oct. 14. “Yet the alternative of leaving businesses and consumers without access to financing is totally unacceptable.”

Paulson said the Treasury would make up to $250 billion available to U.S. institutions in exchange for restrictions on executive compensation and other concessions by the lenders.

‘Little Off Track’

“It was the moment when the financial rescue went a little off track,” said Douglas Holtz-Eakin, the president of DHE Consulting LLC in Washington, who at the time was an adviser to Republican Arizona Sen. John McCain’s presidential campaign.

Minutes after the Oct. 13 meeting broke up, Joel Kaplan, White House deputy chief of staff, wrote an e-mail saying he had briefed Holtz-Eakin on the meeting, according to the documents. The McCain advisor replied that “he had succeeded in backing down the ‘they are nationalizing the banks’ crowd … for now.”

Holtz-Eakin said in an interview today that the release of the Treasury documents revealed that Paulson’s directive to the bankers’ “was tougher even than I appreciated.”

With the presidential election less than a month away, Paulson had called both McCain and Democratic candidate Barack Obama, according to another e-mail. He spoke with Obama and was “waiting to hear back” from McCain.

In releasing the documents yesterday, Judicial Watch said the Treasury initially responded that it had no records about the meeting. It didn’t release a transcript of the discussions between government officials and bankers.

Nine Bankers

The CEOs who attended were Kenneth Lewis of Bank of America Corp., Vikram Pandit of Citigroup Inc., Lloyd Blankfein of Goldman Sachs Group Inc., Jamie Dimon of JPMorgan Chase & Co., John Thain of Merrill Lynch & Co., now part of Bank of America;Robert Kelly of Bank of New York Mellon Corp., Ronald Logue of State Street Corp., John Mack of Morgan Stanley and Richard Kovacevich of Wells Fargo & Co.

Accompanying Paulson were Federal Reserve Chairman Ben Bernanke, Federal Deposit Insurance Corp. Chairman Sheila Bair and New York Federal Reserve Bank President Timothy Geithner, who succeeded Paulson as Treasury secretary.

The Monday meeting came after Paulson had huddled with Geithner, Bair and Treasury aides Sunday afternoon and then placed calls that evening to each CEO except Blankfein, according to the secretary’s daily log.

The Treasury has invested $199.1 billion in the bank preferred share program, with $1.2 billion since returned by 12 institutions, according to government data.

Paulson succeeded at stabilizing the financial services industry, said J.P. O’Sullivan an SNL Financial bank analyst in Charlottesville, Virginia.

“It was a calming mechanism,” O’Sullivan said.

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