Hank Paulsen, the Goldman Sachs Men, & Insider Information
I have said before that President Bush was ill-served by former Treasury Secretary Hank Paulsen. This news about mass insider trading on government information by members of Congress and other officials detailed in Peter Schweitzer's new book "Throw Them All Out" is merely the latest example of the degree of reform that is needed in Washington and the incredible influence that Goldman Sachs seems to have with administration after administration.
For readers not familiar with insider trading you can read up on it HERE. Make no mistake. If you or I had engaged in this behavior it could very well result in incarceration.
How Paulson Gave Hedge Funds Advance Word
Treasury Secretary Henry Paulson stepped off the elevator into the Third Avenue offices of hedge fund Eton Park Capital Management LP in Manhattan. It was July 21, 2008, and market fears were mounting. Four months earlier, Bear Stearns Cos. had sold itself for just $10 a share to JPMorgan Chase & Co. (JPM)
Now, amid tumbling home prices and near-record foreclosures, attention was focused on a new source of contagion: Fannie Mae (FNMA) and Freddie Mac, which together had more than $5 trillion in mortgage-backed securities and other debt outstanding, Bloomberg Markets reports in its January issue.
Paulson had been pushing a plan in Congress to open lines of credit to the two struggling firms and to grant authority for the Treasury Department to buy equity in them. Yet he had told reporters on July 13 that the firms must remain shareholder owned and had testified at a Senate hearing two days later that giving the government new power to intervene made actual intervention improbable.
“If you have a bazooka, and people know you have it, you’re not likely to take it out,” he said.
On the morning of July 21, before the Eton Park meeting, Paulson had spoken to New York Times reporters and editors, according to his Treasury Department schedule. A Times article the next day said the Federal Reserve and the Office of the Comptroller of the Currency were inspecting Fannie and Freddie’s books and cited Paulson as saying he expected their examination would give a signal of confidence to the markets.
A Different Message
At the Eton Park meeting, he sent a different message, according to a fund manager who attended. Over sandwiches and pasta salad, he delivered that information to a group of men capable of profiting from any disclosure.
Around the conference room table were a dozen or so hedge- fund managers and other Wall Street executives -- at least five of them alumni of Goldman Sachs Group Inc. (GS), of which Paulson was chief executive officer and chairman from 1999 to 2006. In addition to Eton Park founder Eric Mindich, they included such boldface names as Lone Pine Capital LLC founder Stephen Mandel, Dinakar Singh of TPG-Axon Capital Management LP and Daniel Och of Och-Ziff Capital Management Group LLC.
After a perfunctory discussion of the market turmoil, the fund manager says, the discussion turned to Fannie Mae and Freddie Mac. Paulson said he had erred by not punishing Bear Stearns shareholders more severely. The secretary, then 62, went on to describe a possible scenario for placing Fannie and Freddie into “conservatorship” -- a government seizure designed to allow the firms to continue operations despite heavy losses in the mortgage markets.
Stock Wipeout
Paulson explained that under this scenario, the common stock of the two government-sponsored enterprises, or GSEs, would be effectively wiped out. So too would the various classes of preferred stock, he said.
The fund manager says he was shocked that Paulson would furnish such specific information -- to his mind, leaving little doubt that the Treasury Department would carry out the plan. The managers attending the meeting were thus given a choice opportunity to trade on that information.
There’s no evidence that they did so after the meeting; tracking firm-specific short stock sales isn’t possible using public documents.
And law professors say that Paulson himself broke no law by disclosing what amounted to inside information.
Rampant Rumors
At the time, rumors about Fannie and Freddie were tearing through the markets. The government-chartered firms’ mandate, which continues today, is to buy mortgages from banks and repackage them into securities either for their own portfolios or to sell to others. The banks can then use the proceeds from those transactions to write new mortgages.
By mid-2008, delinquencies and foreclosures were soaring, and the GSEs set aside billions of dollars against future losses. In the first six months of 2008, they racked up net losses of $5.46 billion as they slashed dividends and marked down the values of their huge inventories of mortgage-backed securities.
On Wall Street, confusion reigned. UBS AG analyst Eric Wasserstrom on July 10 cut his share price target on Freddie to $10 from $28. The next day, Citigroup Inc. (C) analyst Bradley Ball reiterated a “buy” recommendation on the two GSEs. On July 12, the Times of London, without citing a source, reported that Paulson was contemplating a $15 billion capital injection into the firms.
Shares Rally
At the time Paulson privately addressed the fund managers at Eton Park, he had given the market some positive signals -- and the GSEs’ shares were rallying, with Fannie Mae’s nearly doubling in four days.
William Black, associate professor of economics and law at the University of Missouri-Kansas City, can’t understand why Paulson felt impelled to share the Treasury Department’s plan with the fund managers.
“You just never ever do that as a government regulator -- transmit nonpublic market information to market participants,” says Black, who’s a former general counsel at the Federal Home Loan Bank of San Francisco. “There were no legitimate reasons for those disclosures.”
Janet Tavakoli, founder of Chicago-based financial consulting firm Tavakoli Structured Finance Inc., says the meeting fits a pattern.
“What is this but crony capitalism?” she asks. “Most people have had their fill of it.”
If you can stomach it, you may read the rest at Bloomberg News.