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Henry Paulson

Goldman Sachs and United States Treasury Department
B.A. English – Dartmouth; MBA – Harvard

Henry Paulson played a major role in having the “net capital rule” changed.  The net capital rule limited the amount of leverage Wall Street firms could employ.  However, it was believed by Paulson and others that computers made the leverage limits defined by the net capital rule passé and too conservative.  Because of the testimony of Paulson and others, William Donaldson (#17) – the chair of the Securities and Exchange Commission (SEC) – authorized changes to the net capital rule in 2004 that allowed investment banks to use more leverage.  Within a little over four years, two of the banks that qualified for the new, more liberal, leverage limits – Bear Stearns and Lehman Brothers – had vanished from the face of the earth.  Amazingly, in his post-crisis memoir, On the Brink, Paulson bemoaned the enormous increase in leverage and the considerable contribution this leverage had in causing the crisis, but never mentioned his considerable role in providing the banks the regulatory permission to take on more leverage!

As disastrous as the changes to the net capital rule were, Paulson’s role in having these changes enacted is not Paulson’s largest contribution to the financial crisis.  Instead, Paulson’s largest contribution to the financial crisis was the influence he exerted over Wall Street pay practices. After a brief stint in the Nixon White House, Paulson began working on Wall Street with Goldman Sachs.  Henry Paulson recalls being impressed with both Steve Friedman (#12) and Robert Rubin (#41) when he first started working for Goldman in 1974.  Of Friedman and Rubin, Paulson stated, “My time in government taught me that whom you work with is as important as what you do.”  Suffice it to say, Paulson’s judgement was lousy when he starting working on Wall Street and it only got worse.  Paulson rose to become Goldman CEO and the highlight of his Wall Street career must be May 4, 1999.  On that day, Paulson took Goldman Sachs public.

Outside of the Federal Reserve’s disastrous monetary policies, a major reason Wall Street pay has risen so much in the past twenty years is the large investment banks are now public corporations instead of private firms.  When the big Wall Street banks were private firms, the partners were risking their own money.  As a result, they were relatively cautious in using leverage.  For example, as late as 1979, Salomon Brothers – the largest bond trader on Wall Street – assiduously kept track of its working capital with a hand-written ledger that was maintained outside a partner’s office!  When the firms became publicly traded corporations it was the stockholders money that was at risk, and it is a lot easier to risk other people’s money.

By simply having the good fortune of being CEO when Goldman went public, Paulson was able to “monetize” – a classic Wall Street term – hundreds of millions of dollars of Goldman Sachs equity that had been built up over decades.  In other words, Paulson along with other senior Goldman executives in the late 1990s who were simply running Goldman when it went public – and who had relatively small roles in building the enterprise value of Goldman and the Goldman name – essentially paid themselves billions of dollars for the hard work of other people.  (The huge increase in value of investment banks generally was a direct consequence of the Federal Reserve’s disastrous monetary policies since 1971 and Paulson had no role in this either.)  

After paying himself hundreds of millions of dollars to run a business that other people had founded and built, during the financial crisis Paulson would then have the supreme gall to criticize the pay practices of other Wall Street banks.  A little discussed reason for the wild, speculative business practices on Wall Street was the desire of young investment bankers to make as much money as their bank’s management had when the various investment banks went public.  Not without some justification, many of these young investment bankers believed they had been cheated out of their share of the bank’s value as a public company when the bank’s senior management took the lion’s share for themselves.    

Paulson’s influence on Wall Street pay practices goes well beyond the huge amounts of money he paid himself after Goldman went public.  After paying himself so much money, Paulson apparently realized he needed to come up with a reason to explain why he deserved so much money.  The reason that Paulson seized on - which on Wall Street is not so much a reasoned belief as it is a reflexive, Pavlovian response – was Wall Street banks must pay high salaries to attract the rare talent required in investment banking.  

During the negotiations over his Troubled Asset Relief Program (TARP), where Paulson originally hoped to have the Treasury department purchase toxic assets from banks to shore up their capital, legislators were reluctant to go along without some limits on Wall Street pay.  Paulson fought these pay limits with the following rationale,  

“I would continue to resist pressure on compensation restrictions for several days.  I was appalled as anyone at Wall Street’s pay practices, particularly the flawed incentive structures, which we had tried to avoid at Goldman Sachs.  When I was CEO, I did my best to align incentives with long-term performance.  I knew compensation was too high industry –wide, but I couldn’t change that.  We needed to be competitive if we were going to have the best people.”

The enormous stupidity in Paulson’s statement that the “best people” work on Wall Street – coming as it did in the aftermath of an enormous crisis that these “best people” labored hard to bring about – should be self-evident.  For the discussion here, the primary issue is Paulson admits high salaries are among the chief – if not the only - motivating factor needed to entice people to work on Wall Street.  The Bible warns, “For where your treasure is, there will your heart be also.”  Given this admonition and the obvious avarice that exists throughout Wall Street, should anyone then be surprised that Wall Street is distinguished by so much unprofessional, borderline criminal conduct, or that the focal point of so much of this unprofessional, borderline criminal conduct during the housing crisis was Paulson’s former firm – Goldman Sachs?      

However, the most damaging part of the Wall Street salary structure and Paulson’s active endorsement of it as a mere reflection of the singular talents working on Wall Street are the society eroding forces that accompany the Wall Street salary structure.  There is a German saying which states, “Wenn jeder vor seiner Türe fegt, ist die ganze Stadt sauber.”  (When everyone cleans in front of his own door, the whole town is clean.)  This saying succinctly captures what should be the obvious notion that a society requires contributions from all its members to move forward.  Charles Dickens said much the same thing while providing insight into one of the founding principles of capitalism – the division of labor.  Dickens – through his Doctor Marigold - stated, “No one is useless in this world who lightens the burden of it for anyone else.”  

In part, because of the enormous salaries on Wall Street – and elsewhere - many people have lost their connection to any sort of larger sense of community or how they fit into the nation’s economic life.  After all, if someone like Henry Paulson can earn hundreds of millions of dollars on Wall Street and claim that this prodigious salary is a mere reflection of his equally prodigious talent, then why would the average person making perhaps $50,000 per year think they have any responsibility or influence on the larger society?  

Writing decades ago, the great Wilhelm Röpke presciently predicted what the Henry Paulson’s of the world – along with the political establishment, Hollywood, the mainstream media elite and Ivy League faculties - would unleash on society with their outrageous salaries and insatiable quests for power and influence;

“This feeling for the meaning and dignity of one’s profession and for the place of work in society, whatever work it may be (emphasis added), is today lost to a shockingly large number of people.  To revive this feeling is one of the pressing tasks of our times.” More recently, in 2011 a committee comprised of the Vatican and the chief rabbinate of Israel concluded similarly, “our modern world is substantially bereft of a sense of belonging, meaning and purpose.”  

Obviously, Henry Paulson is not solely responsible for the society eroding forces unleashed by the enormous concentration of wealth among the super-rich or the corrosive nature of today’s popular, political and media cultures.  Nevertheless, Paulson’s defense of Wall Street’s salary structure- and the enormous enrichment that he helped himself to when Goldman went public – exposes Paulson to enormous and justified criticism.  As such, and like every other Goldman Sachs CEO since 1990, Henry Paulson has a well-earned place on the list of 50-people most responsible for the financial crisis of 2008.      

Additional Information:

See William Donaldson (#17) for more information on the net capital rule.  See Lloyd Blankfein (#4), Jon Corzine (#13), Steve Friedman (#22) and Robert Rubin (#41) for the other Goldman Sachs CEOs on this list.