The Tainted Money Managers Who Might Run the Bailout

Treasury Secretary Henry Paulson found little support for his $700 billion Wall Street bailout while testifying before the Senate Banking Committee on Tuesday, but the varied concerns expressed by committee members did not include Paulson’s plan to turn over implementation of the bailout to private asset managers.

It would be a serious mistake for Congress to assume, as does Paulson, that only experts from the private sector could carry out the purchase of massive quantities of “troubled” assets. The entire bailout proposal is highly dubious, but letting for-profit firms handle the transactions would make a bad plan much worse.

I’ve been writing about the theoretical conflicts of interest that such an arrangement would create, especially if some of the banks getting bailed out also get chosen to help manage the asset purchases. The ethical issues, however, are not entirely in the realm of the hypothetical. While we don’t know exactly which firms would be chosen by Treasury, the overall money management industry has a track record that is far from unblemished.

Yesterday, as Paulson testified along with Federal Reserve Chairman Ben Bernanke and Securities and Exchange Commission Chairman Christopher Cox, Cox’s agency put out a press release announcing that it filed an enforcement action against AmSouth Bank and AmSouth Asset Management “for defrauding AmSouth mutual funds by secretly using a portion of administration fees paid by fund shareholder for marketing and other unrelated expenses that should have been paid by AmSouth itself.” AmSouth, now part of Regions Bank, agreed to pay $11 million to settle the charges.

This case is hardly unique. The SEC’s archive of litigation releases includes a multitude of enforcement actions against small and large money managers and investment advisers. In one of those cases, Stephen J. Treadway, who had been a top executive at PIMCO, agreed in 2006 to pay $572,000 to settle charges of fraud, breaching fiduciary duty and other violations of securities laws. PIMCO is reported to be a leading contender for a bailout money management slot.

Money management firms, which can also function as securities dealers, have also come under fire from state regulators. Earlier this year, the financial giants Citigroup, Merrill Lynch and UBS were pressured by those regulators to buy back some $40 billion in volatile auction-rate securities they had pressed on unsuspecting customers. As the magazine Bloomberg Markets reported last January, state and local governments themselves have often been the victims of unscrupulous money managers who pressured them to invest public funds in extremely risky securities.

Given the discussion by Paulson of using a technique called reverse auctions to purchase toxic assets from banks, it is interesting to note that in 2006 a prominent money manager, Mario Gabelli, agreed to pay $130 million to settle charges that he defrauded the Federal Communications Commission during the auction of cell-phone licenses in the late 1990s.

And these are the kind of firms we are going to put in charge of $700 billion worth of transactions using taxpayer money? That may make sense to a 30-year Wall Street veteran such as Paulson, but Congress should know better.