Paulson's actions in crisis questioned

Before he became President George W. Bush's Treasury secretary in 2006, Henry Paulson agreed to hold himself to a higher ethical standard than his predecessors. He sold all his holdings in Goldman Sachs, the investment bank he had run, and specifically said he would avoid any substantive interaction with Goldman executives for his entire term unless he first obtained an ethics waiver from the government.

But seven months after Paulson left office, questions are being asked about his part in decisions last fall to prop up the teetering financial system with tens of billions of taxpayer dollars, including aid that directly benefited his former firm. Testifying on Capitol Hill last month, he was grilled about his relationship with Goldman.

"Is it possible that there's so much conflict of interest here that all you folks don't even realize that you're helping people that you're associated with?" Rep. Cliff Stearns, R-Fla., asked Paulson July 16.

"I operated very consistently within the ethic guidelines I had as secretary of the Treasury," Paulson responded, adding that he had asked for an ethics waiver involving his interactions with his old firm "when it became clear that we had some very significant issues with Goldman Sachs."

Paulson did not say when he received a waiver, but copies of two waivers he received — from the White House counsel's office and the Treasury Department — show they were issued on the afternoon of Sept. 17, 2008.

Perilous week

That date was in the middle of the most perilous week of the financial crisis and a day after the government agreed to loan $85 billion to the American International Group (AIG), which used the money to pay off Goldman and other big banks financially threatened by AIG's potential collapse.

It is common for regulators to be in contact with market participants to gather valuable financial intelligence, and senior federal regulators had to scramble quickly last fall to address an unprecedented financial crisis. In those circumstances it would have been difficult for anyone to follow routine guidelines.

While Paulson spoke to many Wall Street executives during that period, he was in frequent contact with Lloyd Blankfein, Goldman's chief executive, according to a copy of Paulson's calendars acquired through a Freedom of Information Act request.

During the week of the AIG bailout, Paulson and Blankfein spoke 24 times, the calendars show, far more frequently than Paulson did with other Wall Street executives.

On Sept. 17, the day Paulson secured his waivers, he and Blankfein spoke five times. Two calls occurred before Paulson's waivers were granted.

Michele Davis, a spokeswoman for Paulson, said the former Treasury secretary was writing his memoirs and his publisher had barred him from granting interviews until his manuscript was done.

She said the ethics agreement Paulson agreed to when he joined the Treasury did not prevent him from talking to Goldman executives such as Blankfein to keep abreast of market developments.

Davis also said Federal Reserve officials, not Paulson, played the lead role in shaping and financing the AIG bailout.

But Paulson was closely involved in decisions to rescue AIG, according to two senior government officials who requested anonymity.

And government ethics specialists say the timing of Paulson's waivers and the circumstances surrounding it are troubling.

"I think that when you have a person in a high government position who has been with one of the major financial institutions, things like this have to happen more publicly and they have to happen more in the normal course of business rather than privately, quietly and on the fly," said Peter Bienstock, former executive director of the New York State Commission on Government Integrity and a partner at the law firm of Cohen Hennessey Bienstock & Rabin.

He went on: "If it can happen on a phone call and can happen without public scrutiny, it destroys the standard because then anything can happen in that fashion and any waiver can happen."

Lawyers' questions

In the weeks before Paulson obtained the waivers, Treasury lawyers raised questions about whether he had conflicts of interest, a senior government official said.

He helped decide the fates of a variety of financial companies, including two longtime Goldman rivals, Bear Stearns and Lehman Brothers, before his ethics waivers were granted. Ad hoc actions taken by Paulson and officials at the Federal Reserve, such as letting Lehman fail and compensating AIG's trading partners, continue to confound some market participants and members of Congress.

"I think it's clear he had a conflict of interest," Stearns, the congressman, said.

"He was covering himself with this waiver because he knew he had a conflict of interest with his telephone calls and with his actions. Even though he had no money in Goldman, he had a vested interest in Goldman's success, in terms of his own reputation and historical perspective."

Adding to questions about Paulson's role, critics say, is that Goldman Sachs was among a group of banks that received substantial government assistance during the turmoil.

Goldman received $13 billion in taxpayer money as a result of the AIG bailout and was given permission at the height of the crisis to convert from an investment firm to a national bank, giving it easier access to federal financing in the event it came under greater financial pressure.

Change of rules

Goldman also won federal debt guarantees and received $10 billion under the Troubled Asset Relief Program (TARP). It benefited further when the Securities and Exchange Commission (SEC) suddenly changed its rules governing stock trading, barring investors from being able to bet against Goldman's shares by selling them short.

Now that the company's crisis has passed, Goldman has rebounded more markedly than its rivals. It has paid back the $10 billion in government assistance, with interest, and exited the federal debt-guarantee program.

It recently reported second-quarter profit of $3.44 billion, putting its employees on track to earn record bonuses this year: about $700,000 each, on average.

Davis, the Paulson spokeswoman, said Goldman never received special treatment from the Treasury.

Paulson's calendars do not disclose any details about his conversations with Blankfein, and Davis said Paulson maintained a proper regulatory distance from his old firm.

A spokesman for Goldman, Lucas van Praag, said: "Lloyd Blankfein, like the CEOs of other major financial institutions, received calls from, and made calls to, Treasury to provide a market perspective on conditions and events as they were unfolding. Given what was happening in the world, it would have been shocking if such conversations hadn't taken place."

For investors, the days after the AIG rescue were perilous and uncertain; the Dow Jones industrial average fell 4 percent Sept. 17 as credit markets froze and investors absorbed the implications of the insurance giant's collapse. That day, Paulson and his colleagues at the Federal Reserve were scrambling to contain the damage.

Involvement disavowed

However, Paulson has disavowed any involvement in the decision to use taxpayer funds to make Goldman and AIG's trading partners whole. In his July testimony to the House, he said: "I want you to know that I had no role whatsoever in any of the Fed's decision regarding payments to any of AIG's creditors or counterparties."

Davis repeated this, saying Paulson's involvement in the AIG bailout was meant to forestall a collapse of the entire financial system and not to rescue any individual firms exposed to AIG, like Goldman. However, she said, federal officials were worried that Goldman and Morgan Stanley were in danger of failing later in the week, and it was in that context that Paulson received a waiver.

"The waiver was in anticipation of a need to rescue Goldman Sachs," Davis said, "not to bail out AIG."

Treasury Department lawyers said a waiver for Paulson regarding AIG was not necessary, Davis said, because the AIG rescue was conducted by the Federal Reserve. The Treasury had no power to rescue AIG, she said. Only the Fed could make such a loan.

But according to two senior government officials involved in the discussions about the AIG bailout and several other people who attended those meetings and requested anonymity, the government's decision to rescue AIG was made collectively by Paulson, officials from the Federal Reserve and other financial regulators in meetings at the New York Fed over the weekend of Sept. 13-14, 2008.

These people said Paulson played a major role in the AIG rescue discussions during that weekend and it was well-known among the participants that a loan to AIG would be used to pay Goldman and the insurer's other trading partners.

Since last September, the government's commitment to AIG has swelled to $173 billion.

A recent report from the Government Accountability Office questioned whether taxpayers would ever be repaid the money loaned to what was once the world's largest insurance company.