A Subprime Bet for Paulson?

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The Center for Responsible Lending will coordinate with another nonprofit, the National Association of Consumer Advocates, to manage the money and distribute it to community groups across the country.

Stanley Brand, founder of the Brand Law Group in Washington, says that the arrangement seems to pass ethical scrutiny both under tax rules and under the new federal lobbying disclosure laws passed this year. As long as the Center for Responsible Lending keeps clear accounts of what the $15 million contribution is financing, he says, it can continue to lobby on Capitol Hill without registering as a lobbyist for the hedge fund or jeopardizing its nonprofit tax status. "There are loopholes in the law, and people find ways to exploit them," Brand says.

Shorting Subprime

Scott Talbott, a lobbyist for the Financial Services Roundtable, a trade association that counts among its members Citigroup (C), JPMorgan Chase (JPM), and American Express (AXP), complains that Paulson is making money on the backs of painful home foreclosures: "The firm has bet that Americans will lose their homes. If the bankruptcy bill is enacted, [Paulson] stands to make large profits."

New York-based Paulson, which has about $20 billion under management, has seen its coffers more than double this year, largely by taking a significant short position on the subprime market, correctly betting that defaults would increase dramatically. Traders familiar with Paulson's strategy told BusinessWeek earlier this year that the hedge fund made a massive, leveraged short bet (BusinessWeek.com, 3/8/07) on the ABX subprime index dropping. The fund reportedly scored a paper profit of hundreds of millions of dollars when the ABX index crashed, according to people familiar with the fund. The ABX subprime index measures the cost of insuring against defaults on subprime bonds.

Aside from the contribution to the nonprofit, Paulson is working to develop a broad coalition of consumer groups to advocate passage of the bankruptcy bill, Day says. The Center for Responsible Lending has been asked to join that group, but has not yet decided whether to do so, she says. Asked whether there was a quid pro quo in taking Paulson's $15 million and joining its coalition, Day says, "You'd have to ask them if they think it is—we don't think it is, and it hasn't been presented like that."

Paulson's Waldorf calls the idea of a quid pro quo "outrageous."

Javers is BusinessWeek's Capitol Hill correspondent. With Dawn Kopecki in Washington.