Bloomberg is reporting that the US is considering a conservatorship for AIG. Their story will follow. If you’re in a rush to get the news, however, you can read our version from three hours ago.

UPDATE: Bloomberg’s story is now up.

UPDATE: CNBC is reporting that there are doubts at Treasury about the legal authority of placing AIG into a conservatorship, as we reported in our original story.

(Image via Barry.)

Institutional buyers have no more appetite for the debt or preferred equity of financial companies, the manager of the world’s biggest bond fund said in an interview with CNBC’s Erin Burnett. Bill Gross, who manages the $130 billion Pimco Total Return Bond Fund, added that he didn’t expect retail investors had very many funds left to make further investments either.

After the interview Jim Cramer and Burnett speculated that Gross was trying to force the hand of Hank Paulson, who was authorized by Congress to use federal money to bail out government chartered mortgage giants Fannie Mae and Freddie Mac but has held back. If Fannie, Freddie and other financial institutions find themselves unable to raise money, the Treasury may believe it has to begin the bailout.

Gross this morning called for an even broader bailout of the housing market, calling on the Treasury to use funds to bail out mortgages as well as financial companies. And he seems to be betting on that bailout, saying that Pimco finds distressed mortgages an attractive investment.

Combined with word from HSBC that wealthy individuals are moving into cash and away from both stocks and bonds, this could put enormous pressure on the Treasury to act. Paulson colorfully explained that the authority to bail out Fannie and Freddie could be enough to forestall their collapse by saying that if you carry a pistol you might have to use it but if you carry a bazooka you probably won’t.

Gross seems to be saying that it’s time to take out that bazooka.

So what’s going on between the Treasury Department and the GSEs? This morning Barron’s said that a government bailout of Fannie Mae and Freddie Mac was becoming more likely, in part because the mortgage giants were unlikely to be able to raise enough money in the open markets. The Treasury kinda-sorta put down the idea, saying it had “no plans” to use the authority lawmakers gave it to rescue Fannie and Freddie.

“As the secretary said many times before, we have no plans to use the authority that we’ve been given, so I’m not going to comment on any speculation,” Treasury resident hottie spokeswoman Jennifer Zuccarelli told a news briefing on Monday.

Those with memories that stretch back beyond the current crisis will recall that five days before Paulson was named Treasury Secretary, President George Bush responded to questions about the rumor resignation of John Snow, Paulson’s predecessor, by saying he knew of “no plans” for Snow to step down.

Of course, the Treasury’s denials are almost entirely besides the point. No one is asserting that the Treasury has current plans—like a schedule—to inject new capital or loans into Fannie and Freddie. Rather, Barron’s was analyzing the likelihood that the government will need to do so to keep them afloat. We suspect that the Fed was sending a subtle message that it didn’t necessary disagree with Barron’s by issuing this half denial.

Interestingly, speculation began to increase today that the Treasury may ultimately try to split apart Fannie. The idea would be to build a “Good Bank” of a securitizing Fannie that could continue as an independent entity borrowing at market costs without an implicit guarantee, and a “Bad Bank” loaded up with Fannie’s awful portfolio and ill-advised loan guarantees.

Last week we learned that the Treasury Department, shortly after receiving authority to help shore up Fannie Mae and Freddie Mac, hired Morgan Stanley to advise it on the rescue plan. While the Treasury is only paying Morgan Stanley a $94,000 fee for the transaction, Morgan’s role here still raises serious questions. First and foremost: why was Morgan Stanley hired?

We hear that Treasury Department spoke with a variety of Wall Street firms to discuss the advisory role. Presumably, Morgan Stanley got the mandate because it was willing to give up certain market positions that would have created conflicts of interest with its advisory role. (Goldman, which thrives at the nexus of conflicted interest, probably wanted nothing to do with this.)

But the very idea of hiring a Wall Street firm to provide “market analysis and financial expertise” in connection with Fannie and Freddie is strange. No one on Wall Street has the requisite experience for reforming or rescuing government sponsored entities that are now explicitly backed by a bailout package. What’s more, the small size of the advisory fee and its structure provides no incentives for Morgan Stanley to provide advice that will keep Fannie and Freddie out of trouble in the future. Indeed, their client relationships and ties to the securitization and mortgage market may well create incentives for them to push Fannie and Freddie right back into the mortgage bubble inflating business.

We’re sure the people at Morgan Stanley, however, are bright enough and perhaps even honest enough to resist these incentives. But the first thing this deal obviously does is remove accountability for a future failure of Fannie or Freddie. Morgan Stanley’s low fee means that they probably can’t be penalized for giving bad advice. Politicians and regulators, the folks who ordinarily would be held accountable for the collapse of government sponsored entities, will be able to point to Morgan Stanley . In other words, everyone’s ass is covered.

This looks, in short, like a way to free Fannie and Freddie from oversight rather than to provide it. Government guarantees already have freed the companies from market oversight—they simply cannot fail. Now outsourcing the reform has largely freed them from political oversight. Fannie and Freddie may be more autonomous after all this is done than they ever have been before. And once Hank Paulson and his crew—who are genuinely pro-market skeptics with an appetite for reigning in Fannie and Freddie—have passed from the scene, the checks on them may well be removed.

The special Federal Reserve borrowing facility for Wall Street securities firms is only temporary, a top Treasury official said Wednesday. Robert Steel, US Treasury undersecretary for domestic finance, stressed the word “temporary” in his remarks on the facility to the Wall Street Journal’s dealmaking conference on Wednesday.

The new discount window that allows securities firms to borrow from the Federal Reserve, a privilege reserved for depository commercial banks in normal times, was opened amidst the collapse of Bear Stearns. It has somewhat calmed fears that another large Wall Street firm could collapse in the fashion of Bear Stearns, but lately Fed officials seem to have been indicating that the window poses serious “moral hazard” threats.

Much of the discussion on Wall Street and in the media has centered around the likely regulation that would accompany any continuation of the window beyond September. Indeed, much of the coverage of Steel’s remarks concentrated on this issue. But this seems to overlook the very real possibility that the window will be shut permanently.

When asked if the window would remain open beyond its schedule September expiration, Mr Steel said, “I stressed the word temporary.” The interviewer then pointed out that the word temporary was not used in Merrill Lynch CEO John Thain’s discussion of the window earlier in the conference. Steel reiterated: “Notice I used it twice.”

With government officials stressing the dangers of the window and its temporary nature, it’s a wonder that Wall Street continues to widely believe that the window is permanent. The mainstream financial media is also stuck in this story line. Not one wire story or newspaper report on Steel’s remarks even used the word “temporary.” How many times does Steel have to say “temporary” before the message gets through?

Just one day after Merrill Lynch chief John Thain urged that the Federal Reserve borrowing facility for securities firms be made permanent, a treasury official sounded the warning that this new investment banking borrowing window may be closed when it ends its initial run in September.

Under Secretary Robert Steel, whose bailiwick covers the domestic financial system, seemed to have crafted his remarks as a response to Thain’s. Yesterday Thain told attendees at a Wall Street Journal dealmakers conference in midtown Manhattan that he hoped the facility would be continued after its scheduled expiration. Speaking a the same conference today, Steel went out of his way to emphasize that the facility is temporary.

After he referred to the facility as the “temporary borrowing facility for primary broker-dealers,” Steel added: “Notice the first word in that phrase is temporary.”

When the moderator pointed out that Thain hadn’t used the word “temporary” when discussing the facility the day prior, Steel acknowledged that his remarks diverged from Thain’s.

“Notice I just used the word twice,” he said.

Steel left open the possibility that the window could remain open after expiration, adding that the regulatory framework for institutions permitted to borrow from the window remains unclear. The major commercial banks—including, most recently, Bank of America CEO Ken Lewis speaking to the conference this morning—have urged that investment banks be subject to the same regulations that restrict commercial banking. Yesterday Thain said he thought a less restrictive regulatory framework was more appropriate.

Treasury Secretary Hank Paulson’s “blueprint” for revamping the financial regulatory system is already coming under fire from powerful agency heads. As early as Friday, even before the details of the plan were widely-known, the plan was lambasted by John Reich, the director of the Office of Thrift Supervision, which oversees the savings and loan industry. Immediately after Paulson’s speech this morning, Commodity Futures Trading Commission big shot Bart Chilton released a colorful and blisteringly critical statement describing the plan as “moving boxes around in Washington DC.”

Paulson’s plan would combine the Securities and Exchange Commission, which regulates equities and debt markets, with the Commodity Futures Trading Commission, which that regulates the exchanges trading commodities and financial futures. The two commissions have very different regulatory approaches, with the SEC favoring direct regulation and a rules-based approach and the CFTC favoring a principles based approach that relies heavily on self-regulation by commodities and futures exchanges. SEC head Chris Cox has been described as being disposed to supporting the plan.

After the jump, we delve into the dirty, metaphor-strewn past of the CFTC commissioner.

It’s often been said that we’re in the worst financial crisis since the 1930s. So perhaps its no surprise that we seem on the verge of the biggest financial regulatory overhaul since the Great Depression. But we certainly didn’t expect anything this sweeping to come out of the Bush administration. We clearly underestimated these guys. Talk about shock and awe.

But we’re getting ahead of ourselves. Over the weekend Treasury Secretary Hank Paulson released the outline of his controversial and sweeping a plan to overhaul financial regulation. He would eliminate thed SEC, FDIC, CFTC, OTS and OCC. And after dumping out this bowl of alphabet soup, he would fill it right back up again with the Prudential Financial Regulatory Agency , the Conduct of Business Regulatory Agency, the Federal Insurance Guarantee Corporation and the Corporate Finance Regulator. It’s going to take some time to digest these changes.

Later this morning, Paulson will give a speech about this plan. In the meantime, the plan is already coming under criticism. Barney Frank worries that the plan may take too much power away from states, particularly (from what we’ve been lead to understand) in the area of regulating insurance. Larry Ribstein worries that the new, more concentrated structure of regulation could result in losing significant flexibility in financial innovation.

“On this latter point, consider that the CFTC’s replacement, CBRA is likely to be less accommodating,” Ribstein writes. He adds that “with one regulatory agency we’re likely to get fewer new financial products.”

We’re going to hold back for now, as we attempt to work through what’s known about the plan. Let’s see what Paulson has to say. More later today.

Paulson Plan Begins Battle Over How To Police Market
Paulson’s big bang [Ideoblog]

The Treasury’s Entity is seen as a Citigroup bailout by lot of people for the very simple reason that it is a Citigroup bailout. That might not be the only thing it is, but stupid is as stupid does, and one thing this stupid thing does (or will do, if it ever gets off the ground) is bailout Citigroup, which is reportedly on the hook for as much as $80 billion from it’s four mammoth SIVs. Since the fund could buy Citigroup’s SIVs, it would reduce the amount that Citigroup would need to write off. And reducing write-offs is something Citi desperately wants to do right now.

There’s at least a fair amount of quiet clapping about the Treasury Department’s role in creating the Entity. Citigroup, some say, is too big to fail, and the Treasury Department should step in to prevent the kind of financial market disorder that would come from the toppling of the towering financial giant.

But this kind of logic has some rethinking the wisdom of the financial regulatory reforms that allowed banks such as Citi to grow so large in the first place. When lawmakers reformed depression era laws that stood in the way of these financial super-markets, they tended to sound libertarian notes about allowing financial innovation and the operation of the free market to control the size and scope of Wall Street firms. The era of government planning was over. So the Glass-Steagall Act of 1933, which had separated investment houses from commercial banks—most famously requiring JP Morgan to part from Morgan Stanley—was changed to permit the growth of the universal banks.

Many now think that the universal bank is a failed strategy. From Citi to Merrill to Bear Stearns, there are calls for Wall Street firms to slim down, break-up and concentrate on the core businesses that made them wealthy and famous to begin with. But was it a failure? If growing into financial giants allowed them to unilaterally acquire a secret—and nearly costless—government insurance policy, it seems like a great gamble. The executives and shareholders get the upside, while the broader public insures against failure.

“What a scam that is,” writes William Greider in The Nation.

And it’s a scam the Greider thinks is over. Banking regulation will inevitably make a big comeback, he predicts.

“At least the unambiguous truth about ‘financial modernization’ is now on the table for all to see,” he writes. “That should keep the Wall Street guys from whining for a while about the oppressive nature of bank regulation. The next reform era, when it does finally arrive, will head in the opposite direction—restoring public protections for the little guys against the greedy excesses of big hogs.”

What Greider doesn’t mention is that this era of new regulations might be coming too late. Or, rather, right on time, depending on your point of view. Resistance to a new wave of banking regulation requiring bank breakups and dividing Wall Street according to regulatory fiats rather than market demand is likely to be weak in an era when many think the financial supermarket model has failed and should be abandoned. No-one expends much time, money or energy defending a right to do something they don’t want to do anyway. What’s more, there will be plenty of money made by investment bankers spinning-off, selling and acquiring the fragments they are shoring up against the ruins of the toppled giants. Some of these people may actually be the same ones who made fortunes building the giants.

And we’ll all raise a glass to the only saloon in town where it’s never last call: the Wall Street punch bowl.

Citibank: Too Big to Fail? [The Nation]

The government cannot effectively regulate the hedge fund industry and it’s a good thing too, Robert Steel said yesterday. The setting was a Manhattan Institute conference. Steel, a former Goldman Sachs executive who is now the Treasury Department’s top domestic finance official, raised two original arguments against hedge fund registration and regulation. Since this is something we talk about a lot around here we found ourselves a bit surprised that we hadn’t heard these ideas before.

Steel, the Treasury undersecretary for domestic finance, also said it would be costly and impossible to train enough people to keep tabs on some 8,000 hedge funds.

“I don’t like the moral hazard of communicating a government all-clear,” Steel said at a conference hosted by the Manhattan Institute in New York today. The risk is that regulation “communicates confidence in a product that is riskier than normal investors should get involved in,” he said.

Both points are the sort of thing that are so obvious—once they’re raised. You instantly feel like you’ve known them all along.

Steel Says Hedge-Fund Regulation Risks ‘Moral Hazard’ [Bloomberg]

Duncan,

I’m starting to get what you’re saying about these damn jabronis. Viva la hybrids!

Best,
H

We were getting a bit worried that the apparent silence coming from US officials in the face of calls by various Europeans for international hedge fund regulation was a sign of acquiescence to the terrible idea. Fortunately, Henry Paulson swatted down the talk of hedge funds and private equity as “locusts” in need of international regulations and policing.

U.S. Treasury Secretary Henry Paulson made clear on Saturday that he thinks any risks posed by lightly regulated hedge funds can be handled through market discipline without adding heavy government regulators.

“Market discipline, focusing on the risk management of regulated counterparties, is the most effective way to address potential systemic risk concerns,” Paulson told a news conference at the close of a two-day Group of Seven finance minister’s meeting in the German industrial city of Essen.

He said a thriving global hedge fund industry “is in the U.S. interest” and adds liquidity to financial markets.

Paulson makes case for tougher enforcement of securities laws

Paulson says need to apply business rules lightly

Just as long as those guys in Washington are giving the market clear signals.

Speaking of Hank Paulson, has anybody seen the new Paulson twenties yet? Last month we noted that the first bills bearing the new Treasury Secretary’s signatures were rolling off the presses and into circulation. And we announced a contest: the first person sending in a photo of themselves holding up a Paulson twenty wins a drink with DealBreaker’s Bess Levin. (Sadly, it will not be unsupervised. John Carney will tag along as a chaperone.) So get those pictures in asap. Email to tips(at)dealbreaker(dot)com (subject line “Paulson Twenties.”)

Our heads are still aching from drinking one (okay, three or four) too many margaritas in honor of Jeff Skilling, the guy at the helm when Enron hit the iceberg of its financial gambles who yesterday got hit with a sentence of 24-years or life (whichever comes first). So it is comforting this morning to know that it’s not just us tequila-quaffing kids who are skeptical about increasing the risk of criminal liability for American corporate executives.

U.S. Treasury Secretary Henry Paulson said he is considering recommending changes to the 2002 Sarbanes-Oxley corporate governance law because its restrictions have overwhelmed some American companies. While the “net result” of stricter reporting standards for executives has been positive, Sarbanes-Oxley has also contributed to “an atmosphere that has made it more burdensome for companies to operate,” Paulson said in an interview today from Washington.

“We’re going to need to look at how we can address some of these issues,” Paulson said. “This is something we’re giving a lot of thought to.”

Paulson’s comments come as business groups press the Bush administration to loosen the Sarbanes-Oxley restrictions. The U.S. Chamber of Commerce and other groups say the law stifles innovation and puts corporate officials, who must certify the accuracy of their financial results, at risk of prison terms.

“We as a country do as good a job as any nation of shining a light on a problem when a problem occurs,” Paulson said in the interview. “Oftentimes the pendulum will swing too far.”

If he keeps this up, we’re going to start feeling bad about the whole “tree-hugger” thing.


Paulson Says Sarbanes-Oxley Adds to Companies’ Burden [Bloomberg]

Hank Paulson got a pretty sweet leaving package when he stepped down from running Goldman Sachs to take the job as George Bush’s Treasury Secretary. And now his move down to Washington, DC is looking even sweeter. Eight million dollars sweeter.

U.S. Treasury Secretary Henry Paulson, the former chief executive officer of Goldman Sachs Group Inc., sold his 50th floor condominium near Manhattan’s Lincoln Center for almost $8 million, according to public records.

Paulson paid a total of $2.88 million for two apartments he bought and combined on West 67th Street, one in 1996 and the other in 1998. Tax on the re-sale was about $112,000, according to the New York City Register.

U.S. Treasury’s Paulson Sells New York Condo for $8 Million [Bloomberg]

It’s all Goldman Sachs all the time at the Treasury Department these days. Former Goldman CEO Hank Paulson is bringing Goldman senior director Robert Steel on board the good ship Treasury as undersecretary for domestic finance.

Steel started in the equities division at Goldman, and eventually rose to run the group. He was served on the management committee for years with Paulson. He rose close to the pinnacle of power at the firm as vice chairman. We’ve heard that he was one of those who pushed for changes at the NYSE to permit buy and sell orders for the most heavily traded stocks to pair up electronically, eliminating the middlemen of specialists and floor brokers. At the time, he was said to have urged Paulson to combat then NYSE chief Dick Grasso’s resistance to these changes.

Bush to nominate Goldman’s Steel to Treasury post [Reuters]

A transcript of Hank Paulson’s talk with Maria Bartiromo was published in The Wall Street Journal. Looking back on our morning of bourbon bets and liveblogging, we think we did a damn good job of conveying the spirit of Paulson’s words.

But if you absolutely have to know exactly what our Treasury Secretary said, feel free to click the link below.

Transcript of Treasury Secretary Henry Paulson on CNBC [Wall Street Journal]

Senators Charles Schumer and Lindsey Graham are long-time China hawks, and most recently have been threatening China with tariff sanctions if it won’t adopt a flexible exhange rate for its currency. Today they are meeting with Treasury Secretary Hank Paulson, who is viewed as friendly toward China. Or, to revert to more typical DealBreaker parlance, Hank’s a China-Hugger.

Presumably, Paulson will ask the Senators to give him more time to negotiate with his Chinese counter-parts.

US senators to meet Paulson on China yuan concern [Reuters]

Yesterday we learned that a federal grand jury in the Eastern District of Missouri had returned indicted 11 individuals and four corporations connected with the online gambling business on various charges of racketeering, conspiracy and fraud. The founder of BetonSports.com, Gary Stephen Kaplan, was dramatically arrested while changing flights on a trip from the UK to Costa Rica.

Today some in the online gambling industry are wondering whether they might have a friend or ally in the Bush Administration, namely Treasury Secretary Hank Paulson. During his time at the top of Goldman Sachs the investment bank reportedly made investments in online gambling, including Betonsports. So will Paulson back his boys now that he is in the second highest ranking cabinet level post?

Uhm, don’t bet on it.

U.S. Treasury secretary Henry Paulson a friend to online gambling? [Gambling911.Com]