Henry Paulson’s Magic Eight Ball has been hard at work. For those of you unfamiliar with Mattel’s fortune telling toy, a fellow named Al Carter of Abale Crafts invented it back in the forties. Unlike the Treasury Secretary’s version, the classic toy with the icosahedral die floating in a liquid made of alcohol and blue dye was based loosely on another device invented by his mother Mary called the Sycho Seer.

The problem with that original device, a version that held two separate dice suspended in molasses that according to Tim Walsh who wrote Timeless Toys (Andrews McMeel Publishing, October 1, 2005), was the time it took for the answer to appear. As we explore the twenty possible answers floating inside the current version on Hank’s desk, keep in mind that the answers provided by this curious toy are eerily similar to the outlook given by the Treasury Department over the last several months.

It is hard to imagine Ben Bernanke and Henry Paulson as having a very good relationship. One, an academic left with a mess of an economy far beyond any previous Fed chairman’s experience and the other, former CEO of Goldman Sachs and all-around financial guy whose claim to fame was running a company with a pristine balance sheet. One sees the mess for what it is; the other wants to see less regulation in the marketplace and a much freer market driven, European style economy.

But talk they must. As Mr. Paulson pushed for less regulation, I imagine he received numerous phone calls from the Fed chairman. “Something is happening in the financial markets with mortgages,” he must have begun, “that is not right. Don’t you agree?” Although Mr. Paulson does not need to shake the ball, he does anyway. “As I see it, yes” the answer floats to the clear window as he turns it over.

“But” Ben continues worriedly, “those mortgage market problems are hidden by clever manipulation and we have no idea how, or even who owns what. This can’t be good.” The eight ball offers Hank his answer and tells the Mr. Bernanke, unsure as of July of 2007 whether this is more than simply a Main Street issue suggests that Ben “ask again later”.

On August 16, 2007, Mr. Paulson sits down for an interview with the Wall Street Journal. He understands the importance of this interview and what it means to his old firm Goldman Sachs. Although Goldman is technically an investment bank, it has gradually shifted its risk over the course of the last year or two and now resembles a hedge fund. Other banks are envious and attempt to emulate not only the positions but the risks as well. Hank knows that decisions made in haste could unwind several very profitable positions taken by his firm. He suggests in that interview that some firms are doomed to fail simply because the market – the less regulated markets under Bernanke, Cox and Paulson – are not as vigilant as they could or should be. When prompted to offer a few names he simply replies: “Better not tell you now”.

Yet, within five months, things had begun to unravel. While neither men are necessarily political in nature, the situation they were facing is beginning to demand the same talking points that most of Washington has cloaked themselves in leading up to this point. They now understand the importance of being on the same page.

Relying on his desktop fortuneteller Mr. Paulson continues to field questions. “Will the markets have difficulty in the coming months because of the mortgage mess?” “Don't count on it,” he replies offering his best long range forecast of how strong the markets are.

“So you are saying…” and he quickly turns the ball over, not waiting for the ten seconds that the manufacturer instructs. The “outlook good” he replies hastily in clipped eight ball language dropping the needed structure the sentence should have had. “No problems?” the reporter asks somewhat incredulously as he remembers how many foreclosures have already taken place and recalls hearing somewhere that there were more mortgage interest rate loan adjustments in the very near future. This would add add to the defaulted loans already on the books, a number that was not even known as of yet. “Without a doubt,” the Treasury Secretary quips.

But Ben has begun to worry even more than usual. His research has uncovered a much deeper problem and wonders if they should begin to formulate a better, more viable solution than the current sit-and-wait-tell-them-everything-is-fine position they seemed to have adopted. Mr. Bernanke knows that he has rates where they are, not because he is comfortable with them at these levels but because he worries that any increases now, even as he thinks about inflationary pressures, will spur on additional turmoil. Mr. Paulson, in his interview with the Washington Post was presented with just those kinds of concerns. In his judgment he tells the paper that things are “closer to the end of market turmoil than the beginning.” Adding quickly that “it is certain.”

Fannie Mae’s problems prompt Mr. Paulson to step in at the beginning of September. He believes that the other financial institutions are still rock solid even as the mortgage giant along with Freddie Mac are taken-over by the federal government in an effort to quell the general public’s concern over whether the two largest mortgage companies will fail. Each question begets an answer that can only be due to the impatience that Mr. Paulson brings to the job. He is, as they say, a get-it-done kind of a guy and this is not getting it done.

To queries such as: “is the rest of Wall Street essentially okay?” “Signs point to yes” “Will the government intervene in case they turn out not to be?” “My sources say no.” “How important is the existence of Fannie Mae and Freddie Mac?” “Concentrate and ask again.” “Does the government have any plans in the short-term about dealing with these mortgage backed securities?” Because Mr. Paulson still believes that the end result of all of this turmoil will turn out for the best, he offers: “Yes” but only after he shakes the ball again when it offers a much more middle of the road reply, “cannot predict now.”

When Lehman Brothers decides to throw itself to the mercy of Bernanke and Paulson, they answer, “My reply is no.” But two days later, AIG is knocking on the teller’s glass asking for help. At first, Paulson answers the request with “Reply hazy, try again” but his staff offers some him some additional if-it-fails scenarios. He then realizes that the world’s largest insurer of risk cannot falter and although each time he turns the ball over “outlook not so good” and again “very doubtful” he keeps asking until the answer is more acceptable. Eventually it answers: “It is decidedly so.” He responds with $85 billion to which AIG suggests now they may not need.

He agreed when he was asked if the crisis was based on irresponsible lending and borrowing with “most likely” as he attempted to explain why Lehman was allowed to fail, AIG was not and whether or not they were really the problem.

The Monday morning September 22nd markets are greeted with Morgan Stanley and Goldman Sachs assuming a new identity as a holding bank (and in the case of Goldman, less shareholder value in the quarters and years to come) even as the Treasury conceded that even they do not now know the depth or breadth of the financial crisis.

What we do know Mr. Paulson as much as said is that even though the consequences are still unknown, $700 billion, possibly more may be needed to restore the trust of the global marketplace. Perhaps as Joe Nocera of the New York Times points out, the biggest problem isn’t the plan itself but the “utter lack of confidence” by the plan’s architects.

But will the government need to create another layer of regulation to handle this ongoing problem? “Yes – definitely.”

And while the halting of short-selling on stocks related to financial institutions may on the surface seem like a good thing and shoring up the net asset value of money market funds was of utmost importance, it still doesn’t answer the question of how long this will go on, who will lend and be willing to take the risk, and more importantly, who will borrow. “Is this the end of the financial world as we know it?” To which Mr. Paulson turns the ball over yet again. Drifting to the top of the upside down globe is the answer everyone knows and no one wants to hear: “You may rely on it.”