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Paulson Delivered Inside Information on GSEs to Cronies

Bloomberg News, quickly becoming the leading muckraker of the financial markets, has another blockbuster story today, on the heels of its release of information about Federal Reserve bailouts. Here they have former Treasury Secretary Henry Paulson essentially aiding and abetting an insider trading scheme while in office, as far as I can tell:

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 […] 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 […]

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.

Paulson told the dozen hedge fund managers in attendance – in a nice detail, Bloomberg mentions that at least five of them previously worked at Goldman Sachs, where Paulson was the longtime CEO – that he wanted to put Fannie and Freddie into conservatorship, which is what ended up happening in September. He even detailed how the common stock would get wiped out. These were 12 of the most likely people to profit from this disclosure, several weeks before it happened, on the advice of the Tresaury Secretary himself.

Bloomberg could not dig up any evidence of acting on trades, though there was all kinds of short action on the GSEs throughout this period. While Bloomberg tries to soft-pedal the crime committed, finding law professors to say that nothing illegal transpired, it’s pretty obvious that what happened was at least unethical, and a clear example of crony capitalism at work. The bigger problems is how hard it is to determine what’s actually legal:

“The bottom line is that senior-level people in Washington, in the name of keeping in touch with their stakeholders, are tipping their hands,” says Adam Zagorin, a senior fellow at the Project on Government Oversight, a Washington watchdog group. “You can’t prosecute them for insider trading if they didn’t trade the shares. You may not be able to even reprimand them. What the hell are the rules?”

Paulson’s spokeswoman referred Bloomberg to Paulson’s book about the financial crisis, which makes no mention of the meeting. And that’s probably where it ends. It takes a journalist outlet to uncover these sordid details, rather than an investigative entity. The flurry of insider trading prosecutions apparently do not extend to a former Treasury Secretary allowing hedge fund cronies to steal from the government.

This is tied into the burgeoning questions around insider trading in Congress, which also doesn’t have a whole lot of restrictions attached. Now that 60 Minutes has told a (somewhat poorly rendered) story about it, Congress has leapt to action to protect its reputation. Even Spencer Bachus, accused of insider trading in the report, scheduled a hearing on the legislation. There’s a more populist sentiment against this kind of behavior in Washington. It remains to be seen whether that will extend to Paulson.

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David Dayen

David Dayen