Back in the summer of 2008, as the financial system teetered on the edge of collapse, no one knew what would happen to the debt-laden mortgage giants Fannie Mae and Freddie Mac—would they be allowed to go under, or would the government come to their rescue? What would become of the shareholders? Trillions rested on the answers to those questions. Oh wait, someone did know. Treasury Secretary Hank Paulson. And he told his hedge fund pals and former Goldman Sachs colleagues. He just didn't tell you. Because, really—who the fuck are you?

Bloomberg Markets has the amazing, jaw-dropping, rage-fomenting story of how, during a casual July 2008 lunch with some hedge fund oligarchs at the Manhattan offices of Eton Park Capital Management, Hank Paulson explained to them precisely how the U.S. government was going to ease Fannie Mae and Freddie Mac into conservatorship, seven weeks before it did so:

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.
Stock Wipeout

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.

The fund manager who told Bloomberg about the meeting was so taken aback that he actually called his lawyer to see if it was safe to attempt to profit from what Paulson had just told him. The answer: "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."

That's right—Hank Paulson just randomly told his bros something so sensitive that even a hedge fund manager's lawyer didn't want to touch it.

It's not clear whether the other assembled Masters of the Universe—who included at least five former employees of Paulson's alma mater Goldman Sachs, among them Eton Park founder Eric Mindich, Lone Pine Capital's Stephen Mandel, and Och-Ziff Capital Management Group's Daniel Och—profited from the information, because "tracking firm-specific short stock sales isn't possible using public documents." But overall, Bloomberg's Richard Teitelbaum reports, bets that Fannie and Freddie would fail skyrocketed in July, spiking from 86.3 million shares on July 9, 2008 to 262 million on July 24, three days after Paulson clued in the hedge funds.

What was Paulson saying publicly about Fannie and Freddie at the time?

Paulson had been pushing a plan in Congress to open lines of credit to the two struggling firms and to grant authority for the Treasury Department to buy equity in them. Yet he had told reporters on July 13 that the firms must remain shareholder owned and had testified at a Senate hearing two days later that giving the government new power to intervene made actual intervention improbable.

"If you have a bazooka, and people know you have it, you're not likely to take it out," he said.

On the morning of July 21, before the Eton Park meeting, Paulson had spoken to New York Times reporters and editors, according to his Treasury Department schedule. A Times article the next day said the Federal Reserve and the Office of the Comptroller of the Currency were inspecting Fannie and Freddie's books and cited Paulson as saying he expected their examination would give a signal of confidence to the markets.

As a result, shares in the firms were actually rallying in July 2008. At the very moment Paulson was—"over sandwiches and pasta salad"—telling his insider friends that he was going to wipe out Fannie and Freddie's shareholders, some fucking idiot civilian rube was buying shares in the companies. Ha! Dumbasses.

And it's all perfectly legal, as long as your the Treasury Secretary. If you're an investor, not so much.

[Image via Getty]