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The Nation

Profiting from the Inside? Friedmanism at the Fed

Greg Kaufmann

(Image: Karen Caldicott)

Ongoing Congressional investigations into the AIG bailout have put the
incestuous and murky relationship between the Federal Reserve and Wall
Street in the spotlight--and put Treasury Secretary Timothy Geithner and
Fed chair Ben Bernanke in the hot seat. Calls for Geithner's resignation
regularly reverberate inside the Capitol, and Bernanke's recent
reappointment was opposed by thirty senators, including Republican John
McCain and independent Bernie Sanders. Critics from both sides of the
aisle fault Geithner and Bernanke for mismanagement, unnecessary secrecy
and undermining Congressional oversight. But neither of them has been
the target of questions about gaming the system for personal financial

That distinction belongs to Stephen Friedman, the former chairman of the
board of the New York Federal Reserve Bank and a member of the board of
directors of Goldman Sachs. Through those two posts, Friedman may have
had access to privileged information about the extent of Goldman's
exposure to AIG and the opportunity to profit from the Fed's bailout of
the beleaguered insurance giant. While he was serving on both boards,
Friedman purchased 52,600 shares of Goldman stock, more than doubling
the number of shares he owned. These purchases have since risen millions
of dollars in value--and raised allegations of insider trading.

Friedman's purchases were exposed by the Wall Street Journal in
early May 2009, and within days he resigned as chair of the New York
Fed. His resignation letter claimed that although he had acted "in
compliance with the rules," the suggestion of impropriety had become a
"distraction" from the important work of the Federal Reserve. In a press
release, New York Fed executive vice president and general counsel
Thomas Baxter also said that Friedman's acquisition of Goldman shares
"did not violate any Federal Reserve statute, rule or policy."

But if Friedman and Baxter were hoping to extinguish scrutiny over
Friedman's Goldman buy and limit any collateral damage to the Fed, it
looks like they are out of luck. In late January, House Oversight
Committee chair Edolphus Towns called in Geithner, former Treasury
Secretary Henry Paulson, Baxter and Friedman to testify about the AIG
bailout. Friedman's Goldman deal was a significant line of inquiry.

And now, at least one member of the committee, Massachusetts
Representative Stephen Lynch, is calling not just for continued
Congressional investigation but for other enforcement agencies to look
into possible insider trading and other matters surrounding the AIG
bailout. In an interview with The Nation, Lynch said that he
intends to meet with the SEC to see "whether or not they might be
helpful with this." Lynch also suggested that the Justice Department's
Financial Fraud Enforcement Task Force should be investigating
Friedman's Goldman purchases as well.

A full investigation would not only determine if Friedman violated the
Fed's rules; it would also shed light on the arcane regulations and
conflicts of interest that riddle the Federal Reserve system, an
important public service, since Congress is debating whether the Fed
should serve as the leading regulator of systemic risk in our economy.
Indeed, what we already know suggests that even if Friedman acted "in
compliance with the rules," the rules were inadequate and easily
subverted and therefore did little to guarantee transparency and

That Friedman was simultaneously chair of the New York Fed and a board
member of Goldman Sachs was itself a violation of Fed policy. As a
"Class C" director who is on the New York Fed board to represent the
public, Friedman was barred from being on the board of a bank holding
company or even owning stock in a bank holding company. This policy came
into play in September 2008, when Goldman converted from an investment
bank to a bank holding company (the policy did not apply to investment
banks). Friedman was not only on the board of Goldman but also held
46,000 shares in the company. So he had to make a choice: resign from
the Fed or resign from Goldman Sachs and sell the shares he owned.

But Friedman did neither. Instead, to allow him to maintain his roles at
the Fed and Goldman, New York Fed officials, led by then-president
Geithner, asked the Federal Reserve board of governors in Washington for
a waiver, which was granted on January 21, 2009.

In the meantime, the New York Fed made its now-infamous decision--on
November 9, 2008--to pay AIG counterparties like Goldman Sachs, Bank of
America and Merrill Lynch full value for insurance on mortgage-backed
securities that had tanked when the housing bubble burst. It was a $62
billion deal, and Goldman was the greatest domestic beneficiary,
receiving an estimated $13 billion. Goldman had been locked in a dispute
with AIG since 2007 over the value of those securities--a dispute New
York Times
reporters Gretchen Morgenson and Louise Story described
as "one of the most momentous in Wall Street history"--until the Fed
stepped in and sided with Goldman.

Despite demands from Congress and the media, neither the Fed nor AIG
disclosed the names of the banks or the amount of money each had
received through the bailout until March 15, 2009, when AIG finally did
so. While the public was left in the dark, Friedman nearly doubled his
Goldman holdings by purchasing 37,300 shares for about $3 million.
Friedman made that purchase on December 17, 2008, just over a month
after the Fed decided to pay Goldman and the other banks full value for
the insurance on mortgage-backed securities. Since he had yet to receive
the waiver, his purchase of additional shares occurred at a moment when
he was still prohibited from owning the shares he already possessed and
was thus out of compliance with Fed policy.

On January 22, 2009--just one day after the Federal Reserve granted
Friedman the waiver--he purchased another 15,300 shares of Goldman.
According to the Wall Street Journal, the "million-dollar
purchase brought his holdings to 98,600 shares." On March 16, 2009--one
day after the public was finally told the identities of the banks and
the amount of money each had received from the Fed--Goldman was trading
at approximately $94 per share. A week later the stock price had risen
to just under $112. As of late February Friedman had gains of
approximately $4.2 million on those post-bailout stock purchases.

The fact that Friedman's actions augmented rather than diminished the
conflict of interest was not lost on members of the House Oversight
Committee. "At a time when Mr. Friedman was prohibited from owning
Goldman Sachs stock, he proceeded to buy 37,000 more shares of it
anyway," says committee chair Edolphus Towns. "That strikes many
Americans as unjust, unwise and unfair."

At the hearing, Representative Lynch also homed in on that fact. "Here's
the problem," said Lynch. "As a member of the board of governors you're
making decisions on matters that directly affect Goldman Sachs, and
you're a former shareholder, current shareholder, and then you buy
37,000 more shares of that company that you're overseeing?"

"Yeah," replied Friedman.

After the hearing Lynch told me that Friedman was "obviously in a
position of extreme conflict and was given full opportunity for inside


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"I mean, think about it," Lynch said. "He asks for a waiver; he knows
there's a conflict. Then he gets the information that the Fed is going
to pump this money into AIG and the positions are going to be covered
100 cents on the dollar. And so with that information, what would you
do? Buy another 37,000 shares, baby."

Various spokespeople and others close to Friedman insist that everything
he did was aboveboard and that he is a victim of a media frenzy and
politicians with their own agendas. None of these people allowed their
names to be used for this article. Friedman did not respond to an offer
for an interview.

Friedman testified that he had consulted with Goldman counsel before the
purchase in accordance with the firm's policy. He also said he was
informed by New York Fed officials that "the rules were in abeyance"
while the waiver was pending, so he could continue "chairing the board."
But Friedman never informed the New York Fed of his intention to buy
more Goldman shares, only of his existing ones. Fed officials there were
surprised by both stock purchases as well as the size of the
transactions, according to sources familiar with the matter.

An attorney for Friedman said he met any reasonable standard one could
expect from an investor and that any financial impact from AIG payments
to counterparties was reflected in Goldman's fourth-quarter earnings
report, issued December 16, 2008. But that report does not disclose the
amount of money Goldman received from the Fed. Moreover, Goldman has
said repeatedly that the payments from AIG were "immaterial" because the
firm had purchased insurance to cover any losses arising from an AIG
default. But at a time when the financial system was on the verge of
collapse, the value of that insurance could not have been certain.

"Goldman might have been fully hedged, but how good is that hedge if the
counterparty in those hedges was not solvent or fully hedged and so on?"
asks James Cox, a securities law expert and professor at Duke Law
School. One of the parties must have been exposed, he says. "So would
not knowledge that the first domino would not fall be inside

Perhaps most significant, an attorney for Friedman confirmed that
Friedman and other Goldman board members were briefed regularly in late
2007 and early 2008 regarding how much money AIG owed Goldman. This is
an important piece of information because Friedman can't claim complete
ignorance about how much money was at stake when AIG collapsed and thus
how much the Fed's intervention would benefit Goldman. One question that
Friedman still needs to answer under oath is: What exactly did you know
about Goldman's exposure to AIG when you purchased 37,300 shares in
December 2008 and another 15,300 shares in January 2009?

Goldman Sachs declined to comment when asked this very question.
According to a Fed spokesperson, Friedman did not have access to
confidential information regarding AIG stemming from his tenure on the
New York Fed's board of directors. An attorney for Friedman wrote in an
e-mail: "The facts demonstrate that Steve Friedman was not aware of any
undisclosed material information relating to Goldman's exposure to AIG
on December 17, 2008, when he purchased Goldman shares."

Another spokesperson directed me to Friedman's written Congressional
testimony, in which he attempts to make the case that when he made his
purchases, the public knew that Goldman had been paid full value on its
contracts with AIG and that it was a good time to buy Goldman. He points
to newspaper articles speculating that Goldman was one of AIG's
counterparties and on the amount of exposure Goldman had to AIG. He
cites financial analysts who rated Goldman stock a "buy." He quotes
Goldman Sachs CFO David Viniar on public earnings calls in the third and
fourth quarters of 2008 describing the firm's exposure to AIG as
"immaterial" because of "risk management with appropriate hedging

Friedman's testimony reads: "At the time of my purchases, it was widely
known and reported--through various public statements by Goldman Sachs
officials, in numerous contemporaneous newspaper articles, in multiple
investment analysts' reports, and in the November 10 Federal Reserve
Board and AIG press releases...that Goldman Sachs was a counterparty to
AIG and had been repaid at par on November 10."

But Friedman's claim--that newspaper articles, ratings from individual
analysts and public statements from Goldman's CFO are the equivalent of
being briefed on what Goldman said it was owed by AIG--rings hollow. The
Fed and AIG press releases issued in November didn't reveal that the
banks were paid full value. That information wasn't disclosed until SEC
filings were released in December, and the identity of the banks and how
much each received wasn't disclosed until March 2009.

And what of the Fed's role in all of this? If Goldman really was fully
protected by hedging instruments--so that it had no exposure whatsoever
to AIG--then why did the Fed pay full value on those securities?

"Friedman's explanation does raise questions about the full-payment
justifications offered by Secretary Geithner and others," says Cox.
"Namely, that to pay less would have caused losses throughout the system
and create havoc."

"These [securities] are in the vortex--these are at ground zero of all
this," says Lynch. "They've got huge positions. And what happens to
Goldman if AIG is allowed to go into bankruptcy? The market was pricing
those derivatives at 50 percent of value, yet they were paid 100 cents
on the dollar. There's just no way in hell they would have received that
in the bankruptcy process. So here's someone sitting here with this
great inside knowledge and capitalizing on it. Maybe it's just too

The government was so intertwined with Friedman's stock purchases, one
can imagine there is significant pressure to move past any questions
about insider trading. That's why it's so critical that the Oversight
Committee continue its investigation.

Finally, it's worth noting that before Friedman resigned, he finished
his job as chair of the search committee charged with finding a
replacement for Timothy Geithner at the New York Federal Reserve Bank:
William Dudley, another Goldman alum.

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