An exclusive group of powerful Wall Street insiders, many of them alumni of Goldman Sachs, got an advance heads-up from then Secretary of Treasury Henry Paulson that Fannie Mae and Freddie Mac could be going into government conservatorship.
The trade implications were obvious: Freddie and Fannie’s shares would be going down the toilet in such a scenario.
Paulson was head of Goldman Sachs before becoming Treasury Secretary.
The day you and I found out that Freddie and Fannie were going into a government bankruptcy was September 6th, a Saturday.
The day he told his little gathering of Wall Street heavyweights of this very possibility was July 21st.
On September 8th, the Monday following this announcement, which took most of Wall Street by surprise, Fannie’s stock price dropped from $14.13 to under $1. Freddie’s price dropped from $8.75 to under $1 too.
I remember that Monday with good reason. I had invested in Freddie’s “B” shares. They lost around 85% of their value. I can see now what my main problem was. I wasn’t invited to Paulson’s meeting in mid-July. If I knew what everybody in that meeting was told, I would never have invested in Freddie’s preferred shares.
But I didn’t know. Like other investors, all I had to go on was Paulson’s public pronouncements, which were in tone and substance positive about the outcome facing Freddie and Fannie.
Why would Paulson say one thing in public and quite another in private? And why would he share this “inside information” with investors in the position to trade on such information?
Only Paulson himself can answer those questions.
But for the thousands of shareholders of Freddie and Fannie, the idea that a “privileged” few knew what the government was contemplating weeks before it happened while giving opposite signals to the general public is a serious breach in ethics.
It should also be a crime for which you can go to jail. It isn’t. There is no law against sharing material nonpublic information. Legally, the key point is that Paulson himself did not trade on this knowledge.
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.
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.
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.
There’s no other way of putting this. What Paulson did stinks of crony capitalism. Now that it has come to light, we at least know of this one meeting between Paulson and a bunch of his buddies.
But how many other took place that we don’t know about?
Whatever the number, you can be sure it’s too high. Let’s pass a law that would make Paulson’s loose lips a crime in the future. This kind of behavior should not stand.
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