It's Not Speculation, It's a Sure Thing: When the Treasury Secretary is in charge of inside information

The financiers of Wall Street believe fervently in Social Darwinism.  They make so much money (watch out for those January 2012 bonuses) because they are better.  [Circular reasoning: also, they are better because they make so much money.]  Not that they’re lucky.  Or that they have a sure thing in a rigged game.

Take Goldman Sachs.  It can’t resist dividing up the world into winners and suckers.  In the late aughts GS had John Paulson, the notorious hedge fund manager enriched by shorting subprime mortgage market, choose a portfolio of lousy mortgage backed securities to create a synthetic collateralized debt obligation (CDO).  Then he bet against it. He made $1 billion on this one transaction.  GS got a $15 million fee.  It promoted the CDO as a great investment, telling buyers that an independent third party chose the portfolio.  If an investor got a whiff of Paulson’s hand in the mix, the CDO would’ve been toast.  So GS made out on the front and the back end, telling one story to its clients/suckers while enriching itself with the other.

After years of FOIA filings, Bloomberg News got the inside dope on similar Goldman Sachs double-dealing, which went all the way to the top.  On the same day that Treasury Secretary Henry Paulson told the New York Times that Fannie Mae and Freddie Mac were being vetted by the Federal Reserve and the Office of the Comptroller of the Currency and the results would cheer the market, he told a group of hedge fund managers at a meeting at the office of the hedge fund Eton Park in NYC that Fannie and Freddie were hemorrhaging losses, they’d be put into a structure called a conservatorship where the government would pump them with money to replace the heavy losses they were suffering from mortgage defaults, and their equity would be wiped out.  (Fannie Mae and Freddie Mac were private corporations with implicit government backing.  They bought and guaranteed 50% of the mortgages in the U.S. but they didn’t control the lax underwriting standards of the securitization daisy chain.)

The short version:

July 21, 2008 am--Paulson told the New York Times that Fannie/Freddie would be just fine

July 21, 2008 pm--Paulson told hand-picked hedge fund managers, many former GS employees, that Fannie/Freddie would tank.

July 21, 2008--Fannie Mae share price = $14.13; Freddie Mac share price = $8.75

September 6, 2008--Fannie/Freddie go into conservatorship; stock worthless.

Before Paulson was Bush’s Treasury Secretary, he was CEO and Chairman of Goldman Sachs (1999-2006).

Paulson gave his buddies a gift of insider information, defined as “material, non-public information”.  Straight from the horse’s mouth.  In essence the Treasury Secretary told a select group of people to short the hell out of Fan/Fred and walk away with wheelbarrows of money.  Their activity would have been buried within the plethora of investors shorting Fan/Fred anyway.

Records show that many investors were betting against Fannie Mae and Freddie Mac at the time.  According to Data Explorers Ltd., a London-based research firm, short interest in Fannie Mae shares rose sharply in July, from 86.3 million shares on July 9 to 163 million shares on July 14.  Short interest continued to rise, to 240 million shares, on the day of the Eton Park meeting: it hit 262 million on July 24, its high for the year.  Freddie Mac’s short interest showed a similar trajectory.

Isn’t what Hank Paulson did illegal?  Well, no.  As far as anyone can prove, he didn’t profit financially.  And “the rules for what can or cannot be disclosed by government officials are often either unclear or nonexistent.”  As Adam Zagorin, a senior fellow at the Project on Government Oversight, a Washington watchdog group, says:

”You can’t prosecute them for insider trading if they didn’t trade the shares.  You may not even be able to reprimand them.  What the hell are the rules?”

Paulson consulted with his Wall Street buddies many times during his tenure.

The question is: how brilliant do you have to be to make a bundle when the Treasury Secretary is spoon feeding insider information?