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Paulson's Cover Slips

Source Reveals Plot Against Fannie, Freddie
Wayne Jett © November 30, 2011
    Another ray of light just fell on former Treasury secretary Henry Paulson Jr.’s role in the financial destruction of 2008, otherwise known as “the eight-months-long October Surprise.” Bloomberg News reports Paulson convened a secret meeting (undisclosed to President George W. Bush, or the public, or mentioned by Paulson in his recent book) on July 21, 2008, the very day Fannie Mae and Freddie Mac gained shelter from illegal naked short selling under an emergency order of the Securities &  Exchange Commission. The meeting of about a dozen major hedge fund managers was held in the Manhattan offices of a hedge fund, and Paulson told those attending something extraordinary.
‘Da Plan, ‘Da Plan
     In the meeting, a source in attendance told Bloomberg News, Paulson described a scenario in which the U. S. Treasury would seize control of the two largest privately owned mortgage companies in the world, Fannie Mae and Freddie Mac, and drive their share prices to zero (“wiped out”). The source said Paulson left “little doubt that the Treasury Department would carry out the plan” as he described it.
    Paulson spent July 20-21, 2008, in New York City, purportedly to respond to any “concerns” the financial sector had about Fannie and Freddie. On July 20, Paulson’s televised interview on CNBC gave no clue he was plotting to wipe out shareholder equity of Fannie and Freddie. Nor did Paulson intimate he intended to disclose his scheme to the most rabid short-side financiers – nearly half of them his former partners when he was CEO of Goldman Sachs.
    During his interview with Maria Bartiromo, spouse of a notable financier at Wisdom Tree Investments,   however, Henry (his friends call him “Hank”) Paulson called himself a “capitalist … who believes in short selling.” Beyond doubt, as former CEO of Goldman Sachs only two years removed, he was expert in every technique suited to a “big short” on the enormous scale of Fannie and Freddie.
    His knowledge of tactics included naked short selling, which Paulson called illegal in his interview of July 20. He must have known also of “married puts” given wings by the SEC’s “Madoff exemption,” which authorized option market-makers to sell shares naked short as a hedge to any option sold.
     In a “married put” transaction, an investor buys “put” options from a market-maker promising the right to sell, say, 100,000 shares of XYZ at $10. The market-maker immediately sells naked short (counterfeits) 100,000 shares of XYZ (as a hedge of its risk in selling the “put”) and sells those shares to the same investor at an agreed price. The investor would then be free to dump the 100,000 fake shares on the market, dropping the share price and driving the market price of the “put” options higher.

Innocents in the Dark
    Having laid out his design for destruction of shareholder investments in Fannie and Freddie for edification of the Wall Street wolf-pack on July 21, 2008, Paulson did not inform President Bush of his intentions until the first week in September. By then, Paulson’s plan was honed to military precision with aid of a team of Morgan Stanley financiers put together by CEO John Mack of Pequot Capital infamy.
    Bush wrote in his book Decision Points (p. 454) that he asked Paulson whether the executives at Fannie and Freddie knew what was coming, and Paulson told him “the first sound they’ll hear is their heads hitting the floor.” Close coordination with his Wall Street cronies had been Paulson’s order of the day, but not with the U. S. president or with executives responsible for managing the giant mortgage firms. Neither did executives at American Funds, the largest family of mutual funds in the country and the largest shareholders of Fannie and Freddie, get an invitation to Paulson’s meeting of July 21, 2008, we presume.
    In the dangerous aftermath of Paulson’s handiwork, a financial firm wrote anonymously that an estimated $500 billion in private capital had been looted through trading in U. S. financial markets during the bear attack on Fannie Mae and Freddie Mac. An initially classified report obtained by the Pentagon estimated $13 trillion was looted from U. S. financial markets by financial terrorists, either domestic or foreign, in 2008.
Just Being Helpful?
    What possible motives might Paulson have had for such conduct? Did a desire to save taxpayers money and risk drive him to do it? This concept seems to rank right up there with “Brer Rabbit and the Briar Patch” as a fairy tale material. Billions in illicit gains for those in the know on the “Kill Fannie and Freddie” plan must have been on the table, at least in the minds of those around it. But what was in it for Paulson?
    Wall Street has a carefully crafted reputation for rewarding public officials who deliver as benefactors of the Street. The public cannot learn what, if any, considerations Paulson gained before, during or after his term as Treasury secretary from Goldman Sachs or from anyone else. This is true, most certainly, if no one with subpoena power investigates.
    But additional possible motives exist for Paulson’s extensively orchestrated seizure of the two biggest owners of home mortgages. Motives over and above the gigantic rip-off of shareholder capital and untold billions more in taxpayer funds used to pay off credit default swaps bought by those betting the two F’s would fail? Yes, other motives exist. Let’s examine one or two.
Those “Toxic” Assets
    Paulson said in his July 20 interview that he was telling Wall Street financiers to be diligent in marking asset values to current market value according to the new “mark-to-market” GAAP Rule 157. Rule 157 was newly instituted in 2007 after being abandoned in 1938, and it played a pivotal role in the bear attacks on Bear Stearns, IndyMac, Fannie, Freddie and other major financial firms in 2008. Paulson was pressing write-down of asset values according to such measures as the highly suspect ABX-HE index of sub-prime mortgage backed securities.
    Is it possible that the enormous write-downs in value of financial assets required by Rule 157 were unwarranted and the trillions in mortgages owned by Fannie and Freddie are not actually “toxic?” That has been true of financial assets owned by other firms hit by the storm of 2008, and it may well be true in the case of Fannie and Freddie.
     In that eventuality, much of the financial play on those assets is still to come. Expect public discourse to regard those assets as toxic until they are sold to private bidders, and expect the winning bids to be Wall Street players. Then they will own the U. S. mortgage industry as they coveted before 2007. Will Paulson or his colleagues be in the mix? Almost surely, you may count on it.
Crime and Non-punishment
    Bloomberg News reported unnamed “law professors” advising that Paulson “broke no law by disclosing what amounted to inside information” in his July 21 meeting with hedge fund managers. Does this mean a federal cabinet officer, especially one called an “economic czar,” is immune from prosecution for such crimes as murder, rape or bank robbery? Or, is this immunity applicable only to violations of federal securities laws?
  Recall that Paulson was placed under allegedly strict ethical guidelines governing such matters as communications with his former employer Goldman Sachs when he became Treasury secretary. Did these ethical restraints apply, or were they violated or waived, with respect to his July 21 meeting in Manhattan?  If that meeting could occur with the substantive discussions alleged and be proper and lawful, then ethical and statutory boundaries have no meaning.
    Immunity seems likely to be the basis for the “broke no law” conclusion. How else may a federal official disclose major market-moving information to aggressive and powerful market participants without violating laws against insider trading?
    On second thought, perhaps the law professors presumed that Paulson received no consideration for his actions and had no motive for wrong-doing. That’s the nature of presumption often allowed an “economic czar.” ~