Thursday, December 1, 2011

Former Bush Secretary of the Treasury Henry Paulson May Have Given Inside Information on Fannie Mae and Freddie Mac to Hedge Fund Managers

That’s Why They Can Make Money in the Market and You Cannot

President George W. Bush selected Goldman Sachs CEO Henry Paulson to be his Secretary of the Treasury before the financial crisis hit in 2008.  Mr. Paulson took the job in part because there was a tremendous tax advantage for him to do so.  He had huge gains in his stock in Goldman Sachs, which he had to sell to join the government.  But a provision in the law allowed him to postpone capital gains tax, possisbly forever,  if he put the proceeds in Treasury securities. 

It turns out Mr. Paulson had another reason to join the government.  Bloomberg News is reporting that Mr. Paulson met with his old buddies on Wall Street and told them that Fannie Mae and Freddie Mac, two private companies at the time, were going to be taken over by the government. 

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.

This would do the following for them.  Knowing that the equity of the two companies would go to zero, the hedge fund managers could short the stock and make a profit equal to whatever they received for the stock. 

There’s no evidence that they did so after the meeting; tracking firm-specific short stock sales isn’t possible using public documents. . . .
The fund manager who described the meeting left after coffee and called his lawyer. The attorney’s quick conclusion: Paulson’s talk was material nonpublic information, and his client should immediately stop trading the shares of Washington- based Fannie and McLean, Virginia-based Freddie.

And what was Mr. Paulson telling the public at this time?

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.

As for the legality of what Mr. Paulson was doing

And law professors say that Paulson himself broke no law by disclosing what amounted to inside information.

Of course not, that’s not what laws are for are they.

As for Mr. Paulson, we now find him

Paulson is now a distinguished senior fellow at the University of Chicago, where he’s starting the Paulson Institute, a think tank focused on U.S.-Chinese relations.

The University of Chicago, in case anyone is not aware, is the home of laissez-faire economics, and its economics department is the home of the strongest “government regulation is evil, the free enterprise system unencumbered by any rules is the best of all possible worlds” thinking (?) in the nation.  Any institution with basic principles would now be embarrassed to have Mr. Paulson associated with it.  The University of Chicago probably could not be prouder.

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