Why Paulson?

Today’s announcement that Goldman Sachs’ CEO Hank Paulson will become the next Treasury Secretary comes as a surprise. While it is no mystery why the White House would want Paulson, it eludes reason why Paulson would take the job.

The president is looking for a respected Wall Street executive to convince the world that the US economy is in great shape thanks to the administration’s economic policies. Paulson is certainly a respected Wall Street executive.

As to why Paulson would accept the job. Three reasons come to mind:

• This is what’s done at Goldman Sachs. Many Goldman Sachs executives – Robert Rubin (who was Clinton’s Treasury Secretary and Stephen Friedman (who was Bush’s head of the

National Economic Council) -- have left the top post to take an important role in government. Such a move is good for the Firm – since it can’t hurt Goldman’s business to have a former executive steering government business to Wall Street;

He wants to outdo Robert Rubin. Robert Rubin is clearly the most highly regarded former Goldman Sachs executive who moved to Washington. Clinton called Rubin the best US Treasury Secretary since Alexander Hamilton. Paulson would no doubt enjoy being remembered more fondly than Rubin; and

He wants to save the world from the coming financial crisis. The challenge is that if the global economy keeps chugging along as is Paulson will not be able to distinguish himself. The only way to do that would be to save the global financial markets from a crisis on the order of the Mexican financial crisis or the Russian financial meltdown in 1998. Recently appointed Fed Chairman Ben Bernanke, while academically brilliant, has yet to demonstrate that he has the real world experience to manage such a crisis. And his discussion of a “data driven” approach to interest rate policy seems to have unsettled the financial markets. Paulson’s experience and network of global contacts would help him make the right decisions.

Is such a crisis imminent? Cheap Foreign Capital Harks Back to '90s Crisis in this morning’s Wall Street Journal [subscription required] suggests that developing countries are becoming increasingly dependent on our cheap capital but that we are providing that capital with insufficient awareness of the risks. If developing country stock markets tumble too far too fast, these risks could become all too apparent. This would lead to a rapid withdrawal of the cheap capital – leading to a global growth slowdown.

This is just the kind of financial crisis that could test Paulson’s skills and put him in the history books.