By Scott Lanman
Oct. 16 (Bloomberg) -- When nine U.S. bank chieftains gathered this week in a Treasury conference room to hear the government's plans to invest in their firms, they faced Washington's frontline crisis-response team: Henry Paulson, Ben S. Bernanke, Timothy Geithner -- and Kevin Warsh.
When Warsh was appointed to the Federal Reserve Board at age 35 in 2006, he was best known as the son-in-law of cosmetics billionaire Ronald Lauder. Little more than two years later, he has emerged as an inside player, working alongside Treasury Secretary Paulson, Fed Chairman Bernanke and New York Fed President Geithner as the government scrambles to prevent the financial crisis from bringing down the U.S. economy.
Warsh, a former Morgan Stanley investment banker and White House aide, was an architect of the terms the Treasury dictated to the nine banks in return for its $125 billion injection of new capital. Earlier, he played a central role in negotiating the sale of the ailing Wachovia Corp., mediating a takeover fight that erupted between Citigroup Inc. and Wells Fargo & Co.
Warsh has ``almost an intuitive understanding of financial markets and credit markets,'' said Allan Hubbard, who was Warsh's boss as director of the White House National Economic Council in 2005. ``That's been very important in helping Ben work through this.''
Liaison
Besides being the board's youngest member, and its wealthiest, Warsh is also the only one of its five members with financial-markets experience -- an especially valuable quality in a Fed run by Bernanke, a career academic. Bernanke has used Warsh largely behind the scenes as one of his main liaisons with Wall Street.
That isn't a role many envisioned for Warsh when President George W. Bush nominated him to the Fed in January 2006. Back then, Warsh -- who earned a Harvard law degree but never practiced -- was derided as a lightweight.
``Kevin Warsh is not a good idea,'' the late Fed Vice Chairman Preston Martin said then. After praising Warsh's co- nominee, Randall Kroszner, as a ``distinguished academic,'' the late Fed board member Edward Gramlich, added: ``The other one, Kevin, I don't know.''
Some of the commentary then focused on Warsh's marriage to heiress Jane Lauder. The couple's assets, with a value of at least $62 million in 2006, make them wealthier than the four other Fed governors combined, according to the Financial Markets Center, a researcher based in Howardsville, Virginia.
In-Law's Connections
Warsh's father-in-law was U.S. ambassador to Austria under President Ronald Reagan and has donated about $500,000 to Republicans and their candidates over the past two decades, according to the Center for Responsive Politics.
Ronald Lauder also funded two referenda establishing term limits for New York City elected officials. He said Oct. 8 that he would support Mayor Michael Bloomberg's effort to change the law so he can run for re-election to a third term. Bloomberg is founder and majority owner of Bloomberg LP, parent of Bloomberg News.
Warsh's seat at the table at Treasury's Oct. 13 meeting with the nine bank leaders marked the culmination of weeks of work after Bernanke assigned him to find a way to inject government funds to recapitalize banks while protecting taxpayers and keeping shareholders from fleeing.
Fed officials privately advocated the cash-injection approach as the best way to unfreeze credit, while Paulson preferred to purchase distressed assets.
Paulson's About-Face
Paulson changed his mind, and the result was the senior preferred shares that Treasury will purchase using the first $250 billion of $700 billion of funds authorized under Congress's Oct. 3 rescue legislation. The shares will pay a dividend of 5 percent for the first five years and 9 percent after that.
At the same time, Warsh was the point man on the Fed's efforts to deal with Wachovia, which faced possible failure last month.
Warsh first returned to his role as investment banker, trying unsuccessfully over the last weekend of September to find a private buyer for Wachovia, the fourth-biggest U.S. bank. Instead, the Federal Deposit Insurance Corp. had to step in to take on potential losses and let Citigroup acquire Wachovia's banking operations.
When Wells Fargo offered days later to buy Wachovia, Warsh mediated a litigation standstill, speaking frequently with Kovacevich and Citigroup executives reporting to Chief Executive Officer Vikram Pandit, a colleague of Warsh's from Morgan Stanley.
Filled Gaps
Warsh has ``filled two gaps'' at the Fed, bringing direct experience and contacts in financial markets as well as political know-how, said Vincent Reinhart, who was the Fed's director of monetary affairs until 2007.
Reinhart said those same qualities make him a potential candidate to succeed Geithner, a former Treasury undersecretary who may become secretary should Barack Obama win the presidential election.
``To his credit, he didn't try to take part in discussions in which he didn't think he had a lot to add,'' Reinhart said of Warsh's approach to Federal Open Market Committee meetings. ``He contributed to the discussions where he did.''
That fits what Warsh described as his approach to success in public service and standing out from the other smart, ambitious types who head to Washington.
``My own experience on Wall Street at least gave me some area of comparative advantage, some area of competence,'' Warsh told conferees at Stanford University, his alma mater, in 2005. ``Once you're there and you establish your knowledge in a very narrow area, it's a lot easier to move up vertically and move around horizontally.''
To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net
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