Bring Back Bush's Treasury Chief

Paul O’Neill may be retired, but he’s got plenty of ideas about how Wall Street should be reformed to avoid another recession. He tells Michael Hirsh that Obama is getting it all wrong.

09.20.10 10:42 PM ET

Paul O’Neill may be retired but he’s got plenty of ideas about how Wall Street needs to be reformed to avoid another recession. He tells Michael Hirsh that Obama is getting it all wrong. His new book, Capital Offense, is out now.

Paul O’Neill has a better idea, as he will be the first to tell you.

Consider the giant financial-reform law that President Obama signed with so much fanfare over the summer. Why spend 2,000 pages writing a bill when all you ever needed was two? O’Neill said in a recent interview.

If he’d had his way, says George W. Bush’s former Treasury secretary, the first page of his law would have required would-be home owners to put 20 percent equity down on every mortgage. The second page would have added a “parallel” requirement for all financial institutions, forcing them to stake 20 percent of their own capital on every loan and investment. That simple dual approach would have instantly restored sanity both on the borrower and lender side, O’Neill says, “so that people aren’t leveraging up the system without a personal interest.” For both banks and borrowers, there would be no more high-risk gambling and reckless speculation with the nation’s  future. The “Restoring American Financial Stability Act,” while it added a lot of new rules on capital and debt, didn’t go nearly that far.

In O’Neill’s view, such dramatic new restraints on leverage—the financial sector’s great profitability engine—might also rebalance the economy so that America’s best brains, currently working as “quants” on Wall Street, are motivated to rejoin the “real” economy of goods and services. The financial engineers of yesteryear, in other words, might seek to become the real engineers of tomorrow, lifting us out of our slow-growth future. End of systemic problem. Why didn’t the Obama administration and the Congress take this approach? “They don’t seem to have the courage to do what ought to be done,” snaps O’Neill. But was it practical? “Most of what I believe should be done is impractical but it ought to be done anyway.”  

Capital Offense: How Washington’s Wise Men Turned America’s Future Over to Wall Street. By Michael Hirsh. 352 pages. Wiley. $26.95.

Paul O’Neill, now 74, is clearly a relic of another era, but he does have a certain retro appeal. One of the things people didn’t like about O’Neill when he became Treasury secretary in early 2001, you may recall, was that he was no Robert Rubin. O'Neill wasn’t a smooth talker, and he didn’t defer automatically to Wall Street. Looking and sounding like a real-life Mr. Magoo, he openly scoffed that he didn’t need to consult the bond traders sanctified by Rubin and the other Clintonites. “I probably shouldn’t have said it,” O’Neill later recalled. “Someone said, ‘Aren’t you going to talk to people on Wall Street?’ And I said, ‘Why would I talk to people sitting in front of flickering green screens?’ But it’s true. Why would I?” O’Neill often seemed to reflect the bias of an earlier period—what is looking now very much like a golden era—when Wall Street investment banks were handmaidens to big business, not their taskmasters. And when they answered to the regulators in Washington. “I had spent 15 years at the center of government thinking 24 hours a day about public-policy matters across the Office of Management and Budget,” he said. “I was pretty confident that nobody in Wall Street thought about things that I had.” 

O’Neill also ran into trouble with his boss, President Bush, by speaking truth to power about tax cuts. Here again, O’Neill proved to be something of a relic of an earlier time, when the debate within the Republican Party was fairly balanced between tax cutters and budget balancers (the Reagan era, believe it or not).

In the spring of 2002, O’Neill had the temerity to suggest that perhaps another tax cut was not a great idea. “I believed there was still prospect of another 9/11,” he told me later. “The first one cost us $100 billion-$200 billion,” he said. “We needed money to fix Social Security and Medicare.” Constantly talking out of turn, O’Neill committed one of his biggest errors when he frankly admitted that Clinton had left things in good shape. “The Clinton administration pursued a really responsible fiscal policy,” he told me later. “It’s true the economy was limping from the evaporation of the dot-com nonsense, but as we were going through 2001 the economy was not terrible. Interestingly enough, much to consternation of the economic types, even after 9/11 we didn’t take as big a shot as people thought.” Things got especially rough after the 2002 midterms, which the Republicans won handily. O’Neill’s old friend—and, he thought, ideological ally—Dick Cheney pushed relentlessly for more tax cuts. When O’Neill worried aloud in a meeting about the rising deficit, Cheney infamously barked that “Reagan proved deficits don’t matter.”

Even when O’Neill looked over his shoulder for the one supporter he felt sure would be behind him—his old pal Alan Greenspan, the fiscal schoolmarm of the Clinton years—he found that the Fed chief wasn’t there either. O’Neill and Greenspan had known each other since 1968, and the two worked closely during the Ford administration, when O’Neill had been at the OMB and Greenspan had been chairman of the Council of Economic Advisers. But Greenspan left O’Neill swinging in the ill wind of the Bush team’s tax-cut fervor. Greenspan, who had campaigned so effectively for reining in the deficit during the Clinton years, suddenly decided he didn’t want to be seen as holding out against the latest wave of supply-side economics. “When I was making my arguments about the right and not-right things to do about tax policies, he was quiet,” O’Neill said. 

Today, with President Obama trying to negotiate what seems an impossible middle course between the demands of fiscal conservatives and the desires of progressives who advocate more aggressive government spending and attacks on Wall Street, Paul O’Neill may be worth listening to once again. Obama’s economic team seems to be in mid-disintegration, and the president’s appointment of his old campaign economic adviser, Austan Goolsbee, to replace Christina Romer as chairman of the Council of Economic Advisers smacks of Band-Aid politics rather anything like a permanent fix for the still-festering (if officially ended) recession. Goolsbee, while a very smart left-of-center economist, is basically part of the same Wall Street-centered orthodoxy that produced Larry Summers and Tim Geithner. (Rumor is that Summers, who nudged Goolsbee aside at the beginning of the administration, will be the next Obama-ite to go after Romer and Peter Orszag, perhaps by the end of the year.)  

O’Neill was always an odd duck, out of touch with his times, but in what now looks like a very a reassuring way. He’s like the financial equivalent of a Norman Rockwell painting. An honest fiscal conservative from Pittsburgh, O’Neill first came to Washington in the 1960s and then served as deputy director of Office of Management and Budget under President Ford. After Ford lost the 1976 election to Jimmy Carter, O’Neill left Washington to embark on a brilliant corporate career, first at International Paper and then, from 1988 on, as chairman of Alcoa. Rooted in downtown Pittsburgh, he resisted the era of deregulated finance that gave Wall Street the whip hand over the economy.  

“From the kinds of things that investment bankers were saying to me, I thought they were all lunacy.”

As Alcoa’s CEO, O’Neill had insisted that his company stay out of the reckless use of derivatives after reading a 1986 book on the “new financial world” by Henry Kaufman, the Salomon Brothers economist then known as Dr. Doom. Kaufman wondered somberly—and far earlier than most—how regulators would be to stay on top of a global financial system in which the role of banks had waned and new credit instruments, including then-exotic derivatives, were taking over. “When I first started being concerned about broad patterns developing in financial markets, it was in the early 1990s. Henry Kaufman’s book rang true to me. From the kinds of things that investment bankers were saying to me, I thought they were all lunacy. So I wouldn’t let our financial functionaries at Alcoa do any of that exotic stuff, the third- and fourth-order derivatives.”

It wasn’t that O’Neill got everything right, either in the corporate world or in Washington. By the end of his tenure as Treasury secretary, somewhat desperately trying to echo Cheney’s view of deficits, O’Neill dismissed the U.S. current-account imbalances as “meaningless” in the face of America’s attractiveness as a source of investment. That was close to being economically illiterate: In fact, the vast amounts of capital flowing into the United States—into asset-backed securities, among other things—were arriving because Americans were consuming and borrowing, not because there were great investments here.  

The end came quickly for him. When O’Neill was dumped unceremoniously at the end of 2002 for daring to express public doubts about Bush’s tax-cut-and-spend approach to government, almost no one mourned his departure. He had dug his own hole, most people felt.  

Today, however, O’Neill looks more like a canary in the mine—the guy who divined early on that Wall Street was out of control and paid the ultimate career price for it. And he’s refused to keep quiet. By 2007, long out of power, O’Neill had begun to pitch people on his idea for a double-20 percent requirement of borrowers and banks. In June 2007, he called one of the businessmen he’d gotten to know over the years, Angelo Mozilo of Countrywide Financial, and told him he was really worried. O’Neill said he was “prepared to make some phone calls,” he recalled. “I think we need to get the Treasury and Fed to create huge liquidity pool, making it available to people like you to call back securitized debt obligations out there, and sort the underlying mortgages into legitimate single As, double As, and so on.… I’m worried you’re going to have to call back these things. Angelo said, ‘Can’t do it, it’s too complicated, Paul.’ I said if we don’t do something like that, then I think we’re going to be in position where all that stuff ends up being valued zero. He said, ‘We just can’t do it.’” 

Mozilo, Countrywide's former CEO, is facing civil charges brought by the Securities and Exchange Commission that he misled investors about risks tied to subprime lending.  

As for O’Neill, he’s still in restless retirement back in Pittsburgh, and he fears that the financial fixes have been too meager. The recent Basel agreement raising bank capital requirements to 7 percent is worthwhile, he says, but not nearly enough. The Federal Housing Administration is still only requiring 3.5 percent down on mortgages in some cases, which he says “is crazy. We’re asking for it again.” O’Neill says he wants a reasonable course that restrains Wall Street without overregulating, so that “we have a financial structure in place that can weather economic cycles. We need no more regulation than is absolutely required, but they have to be clear bright-line requirements.” Maybe retro is the way to go.  

Adapted from Capital Offense: How Washington’s Wise Men Turned America’s Future Over to Wall Street (Wiley & Sons, Hoboken, September 2010)