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    Report: Henry Paulson Tipped Hedge Funds About Fannie, Freddie Takeover

    We've been following the reporting Bloomberg Markets Magazine has been putting out over the past few days. They've gotten a load of documents through Freedom of Information Act requests and found that the U.S. Federal Reserve had committed $7.7 trillion to rescuing big banks in 2009.

    Today, the magazine dropped another big story: Henry Paulson, who served as secretary of the Treasury under President George W. Bush, gave hedge funds advance notice that the government was getting ready to put Fannie Mae and Freddie Mac under conservatorship.

    Here's how the magazine describes what happened:

    "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."

    We'll let you click over to read Bloomberg's extraordinary reporting. But Paulson, the magazine found, did not break any laws. If traders had used that information to sell stocks, they would have broken the law, but Bloomberg points out that it's impossible to tell from public records whether insider trading happened.

    Paulson did not respond to Bloomberg's request for comment. In the blogosphere, the reaction has been swift and harsh. Take what Mike Shedlock, a well-read economics blogger, had to say:

    "How many people were suckered into buying Fannie and Freddie while hedge funds were told in advance to dump shares?

    "What Paulson did may not have been illegal (acting on the information would have been), which makes the comment by William Poole, a former president of the Federal Reserve Bank of St. Louis seem downright bizarre.

    "Said Poole ... 'It seems to me, you've got to cut the guy some slack, even if he tipped his hand. How do you prepare the market for the fact that policy has changed without triggering the very crisis that you're trying to avoid? What is he supposed to say without misleading these people?'

    ...

    "Poole's idea of preparing the market means telling the big boys how to make billions, while screwing the little guy. Poole is another player deserving your contempt and scorn."

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