Is Treasury Secretary Paulson Trying To Drive Bank Stocks Down?

The markets are reeling because of fears that Freddie Mac and Fannie Mae are about to go under.

This is the lead summary this weekend from CNBC:

Analysts say hurdles for the stock market in the coming week include continued uncertainty about the financial sector—specifically mortgage giants Fannie Mae and Freddie Mac...

Here's MarketWatch this weekend:

It's an uncertain week ahead for U.S. stock markets, as IndyMac bank falls and jitters slam Fannie Mae and Freddie Mac.

You would really have to be an idiot not to get the fact that two quasi-government organizations with over $5 TRILLION in liabilities might be a concern to Wall Street. Generally, at times like this, government officials step up to the plate with statements to calm the markets. Stuff like: "We will do what is necessary to maintain the integrity of the market.", "We stand by to do whatever is necessary."

So what did Treasury Secretary Henry Paulson do yesterday as Fannie Mae and Freddie Mac stock were crashing? He issued a statement that began:

Today our primary focus is supporting Fannie Mae and Freddie Mac in their current form...

Say what? The present form of Freddie Mac and Fanne Mae is crash mode. Why would Paulson issue such a market scaring statement?

We have no objections to the government staying out of markets, but it is a very curious time for Hank Paulson to get this religion, since only weeks ago he planned to bring the financial sector under tighter regulatory control. But, Paulson getting free market religion yesterday can only spook markets and spook shareholders in any banks stocks.

So let's back up a little and get some perspective.

Back in April, I attended a luncheon where Carlyle Group managing director Randal Quarles spoke. Who is Quarles? Before Carlyle, he worked for Paulson at the Treasury and, according to his Carlye profile he was(our emphasis):

Under Secretary of the U.S. Treasury, where he led the Department’s activities in financial sector and capital markets policy, including coordination of the President’s Working Group on Financial Markets, development of administration policy on hedge funds and derivatives, regulatory reform of Fannie Mae and Freddie Mac...

Of the luncheon, itself, I reported at the time:

Quarles spoke at a luncheon meeting... His topic: “Restructuring Financial Regulation”. Quarles told the luncheon group that he chose the topic in January. Hmmm. Didn’t Treasury Paulson just make the proposal to restructure the financial regulatory agencies last week? How did Quarles pick this topic back in January? Short-answer, Quarles is a major insider and his comments should be monitored to get a sense for what insiders are thinking.

In his talk, Quarles said that estimates go into the hundreds of billions in terms of capital that will be required by the financial industry because of losses sustained as a result of the current crisis. He said there will be more financial institutions that will go under in coming months.

He said that public markets will not supply the necessary funds because they don’t have the capabilities to study in detail the risks and potential rewards of the complex financials of financial institutions. He said private equity firms have the capabilities to do so and to supply the necessary funds. (N.B. Carlyle Group is a private equity firm).

So Quarles, who worked under Paulson knows in January to choose financial regulatory reforms as his topic, in April he knows that more banks are going to fail and proposes that regulations be changed so that private equity firms can aggressively by banks stocks. In late June, we learn that someone from Carlyle, probably Quarles, is talking to the Fed to make it easier for private equity to buy into bank stocks.

So enough on Quarles, for the minute. You get the picture. Now, another point.

Curiously there is a report out of Reuters late Friday after the market closes that:

Fed Chairman Bernanke told Freddie Mac chief Richard Syron that his company and Fannie Mae could take advantage of the emergency discount window...The source said that Bernanke and Syron spoke by phone Thursday afternoon and the central bank chief said in that call he intended the discount window to be opened if necessary to the two largest U.S. mortgage finance companies.

Again, this is not free market news, but it is in line with the way Bernanke has been approaching the crisis, and it is market calming news. So what happens on Saturday morning, less than 24 hours since the market calming news breaks? The Fed kills the market calming news. From WSJ:

Federal Reserve officials haven’t discussed discount-window access with government-sponsored enterprises Fannie Mae and Freddie Mac, a Fed spokeswoman said Friday.

“Federal Reserve officials are following the situation closely, but there have been no discussions with the GSEs about access to the discount window,” Fed spokeswoman Michelle Smith said when asked about a report that Fed Chairman Ben Bernanke had told Freddie Mac’s chief executive that the GSEs were eligible to use the facility.

Was the Reuters reporter making the initial report up? Extremely unlikely. Something unusual is going on here. Market calming news is killed and Paulson comes out with a statement that does the opposite of calming the markets. All this is just going to continue to kill the financial sector, to kill bank stocks. Meanwhile, Quarles, with probably the strongest insider credentials I have ever come across, is paddling like crazy to do everything he can to change bank regs, including writing an WSJ Op-Ed calling for the changes to make it easier for his firm, Carlyle Group, to buy huge chunks of bank stocks.

So let's add up the pieces here. The Federal Reserve kills a market calming story. Treasury Paulson issues a statement that states it is "supporting Fannie Mae and Freddie Mac in their current form..." Which is crash mode. Thus, banks stocks are crashing. At the same time the ultimate insider Quarles, former Undersecretary, former coordinator at the Treasury for President’s Working Group on Financial Markets (aka, The Plunge Protection Team) and former developer for the Bush Administration "regulatory reform of Fannie Mae and Freddie Mac", is using every avenue possible to change regs so Carlyle Group can aggressively buy banks stocks.

Here's the final equation: Treasury Secretary Paulson issues statements driving banks stocks down + other government operatives kill market calming news = Carlyle Group buying bank stocks cheap, real cheap.