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You may remember that, earlier this week, Bloomberg reported that in June 2008, with the world’s financial system in the balance, then-Treasury Secretary (and Goldman Sachs alum) Hank Paulson (1) rode in an elevator and (2) upon disembarking from said elevator told a bunch of his friends who had WORKED AT GOLDMAN WITH HIM about how he was going to nationalize Fannie and Freddie (which he did about two months later) so his friends should short the hell out of the GSEs, which they then proceeded to do, or not do, since “The managers attending the meeting were thus given a choice opportunity to trade on that information. There’s no evidence that they did so after the meeting; tracking firm-specific short stock sales isn’t possible using public documents.”
So that happened. Fast forward to September 2011, when, with the world’s financial system in the balance, New York Fed president (and COINCIDENTALLY ALSO a Goldman Sachs alum) William Dudley met with some other hedge fund friends to ask them about what to do about Europe. And again about two months later, the Fed did some stuff about Europe. Very suspicious.
The Wall Street Journal reported on this meeting today and, while the article loses some points for not describing whether Dudley stepped off an elevator, jogged up a flight of stairs, or clambered in a window to arrive at the meeting, it’s actually remarkably fair in explaining how much you should freak out about this (not that much), as well as in foreshadowing how much people will freak out about it (quite a bit):
The Fed’s meetings with investors present a delicate situation for U.S. officials. They must balance the need for information from investors about the markets against the Fed’s internal policy discouraging employees from arranging meetings with investors that would confer a commercial advantage.
The Fed’s Mr. Dudley declined to comment. In a statement, Mr. Bacon defended the meetings, saying, “The Fed and Treasury canvass market opinions extensively through a variety of private-sector committees, contacts and trading desks in their task to fund the nation’s exploding debt load, stabilize markets and optimize economic outcomes.” …
There is no indication the meeting had any impact on the participants’ own investments. Minutes of the meeting obtained by The Wall Street Journal include notes taken by Fed staff members—but no record of comments by Mr. Dudley or any Fed officials at the meeting.
Mr. Dudley previously has said in a statement that he is in “listening mode” during the meetings and that he is careful not to provide “insights into our thinking” during meetings with investors.
He also said it is important the Fed understand investors’ thinking during periods of stress and that he filters out investors’ suggestions on policy that reflect their own interests. Committee members have said the questions asked by the Fed in advance of the meeting can give clues to the Fed’s thinking.
This is all sort of obvious but also touchy. If you are the Fed, part of your job really is to (1) figure out what will prevent the financial markets from melting down and then (2) trying to do that. (You can quibble with that being a goal, but really, you can’t.) Also if you are the Fed and you never talk to anyone who, y’know, owns any financial instruments, and instead only talk amongst yourselves, smart as yourselves are, your understanding of what will help/save/ruin the markets will be imperfect.
In my old job, one thing I did was tell companies what sort of rates they could expect to pay to issue securities. We didn’t know, really, but we got paid for being reasonably right based on judgment and math and previous experience and whatnot. And based on talking to people. We’d call up an investor and say “hey, do you like gold companies?” or whatever, and if he said yes we’d go to gold companies and say “investors are clamoring for issuance from gold companies, here’s where you can do a deal.”
We weren’t the Fed or anything, but Dudley’s efforts to not telegraph his plans, and to “filter out” self-interested ideas, sound pretty familiar. And quite hard to do. Because you don’t go around asking investors “do you like gold companies” unless you’re at least hoping, and have some reason to hope, to bring issuance from gold companies. (So we would not call up investors and say “hey, Company X is going to raise money and we want to pitch them, where do you care?,” because then we’d go to jail.) And because an investor, when asked about gold companies, has every incentive in the world to say “yes, we would buy billions of dollars of that, but here are nineteen reasons that you haven’t thought of for why has to be priced very cheap,” because all he wants is to get cheap paper.
Actually, sorry, that’s not all he wants. He also wants to have more conversations like this. Because just as underwriters want to know what investors think, investors want to know what underwriters are up to, even if the whole insider trading thing means that you can’t hear exactly what they’re up to. Knowing what other market participants think is what you do for a living. Talking to underwriters – hearing what questions they ask, and taking a crack at snowing them into bringing really cheap deals – helps investors do their jobs. And it helps underwriters do their jobs. And when things work out, the result is that companies do financing deals that help them expand their operations and create jobs and cure cancer or whatever, while also giving investors profitable investments and bankers profitable fees.
Similarly, when Paulson or Dudley meet with investors, those investors are not there just out of public-spiritedness. Their time is valuable, and they’re getting their money’s worth when they show up to a meeting with the Treasury Secretary or NY Fed president. They get value in the chance that Paulson or Dudley will reveal his intentions – by saying “we’re gonna nationalize Fannie and Freddie,” or by asking “should we nationalize Fannie and Freddie?” or “if you were nationalizing Fannie and Freddie how would you do it?” or “if you were to choose two entities beginning with the same letter to nationalize, what would that letter be?” – and in the chance that they’ll convince a regulator to do something that’s good for them, like I don’t know pay off AIG counterparties at par. And the regulators get value in that they learn what people in the markets think will help the markets. And when it works out, global financial systems get to not be blown up.
If you really like worrying about insider trading, you can worry that this is insider trading, which is kind of the upshot of Bloomberg’s Hank-Paulson-told-people-about-Fannie-and-Freddie thing. There, one of the money managers in the room didn’t trade on what Hank said because his lawyer told him that it would be illegal, which seems wrong to me but, whatever, not legal advice. If you really like worrying about corruption, you can worry that this is about logrolling among Goldman Sachs alumni who are trying to enrich each other, which is kind of an odd theory of human behavior but then I would say that wouldn’t I?
Or you can recognize that information about the hopes and dreams and needs and wants and plans and positions of market participants is valuable to other market participants. And that sharing that information can sometimes lead to positive-sum results – as, it must be said, it seems to have done here. And that when the Fed and Treasury do things like expand liquidity facilities or nationalize Fannie and Freddie, they are acting as market participants. And that the way for them to do well as market participants is to participate in information exchanging meetings that are asymmetric (those investors would probably meet with Dudley even if he said nothing at all, just to see his facial expression when they proposed ideas) but not entirely one-way.
These sorts of conversations look like corruption from the outside, since what hedge funds learn from the Fed and the Treasury can be translated into trades and profits, while what the Fed and Treasury learn from hedge funds gets translated into one input in a complex and political decision-making apparatus. But when you’re tasked with saving the world or whatever, all those inputs are valuable. And it’s probably a good thing that the Fed and the Treasury are competent at the whole information-trading game.