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Wall Street's Double-Dippers


Some of the finance outfits being tapped by Washington to clean up the mess are the same ones that helped cause it

Here's another development sure to outrage some observers of the mortgage crisis: Some members of the financial brain trust being tapped by Washington to clean up the mess worked at firms wrapped up in the subprime debacle.

Treasury Secretary Henry Paulson has yet to choose the companies that will value and manage all the toxic assets as part of his proposed bailout. But everyone in finance is angling for a piece of the government's proposed $700billion kitty, which could bring in hefty fees. If the recent rescues of American International Group (AIG), Fannie Mae (FNM), and Freddie Mac (FRE) are any indication, some new recipients of Washington largesse will have been big participants in the lending and securitization bacchanal that precipitated the credit crisis. "There really should be a no-crony clause," says James K. Galbraith, a professor at the University of Texas. In congressional hearings, Paulson said: "We've been very conscious of [conflicts]. When we've dealt with advisers before, we've been very careful about how we do it."

Perhaps no example underscores the irony more than the Federal Deposit Insurance Corp.'s dealings with IndyMac Bancorp, the bank seized by the regulator in July. Days later, the FDIC turned to investment bank Lehman Brothers for advice on how to dispose of the lender's $200billion mortgage portfolio and other assets—even as Lehman's share price was plunging on doubts it could stay in business. When Lehman filed for bankruptcy on Sept. 15, the FDIC had to push back the IndyMac auction, slated for the same day. Now the FBI is inquiring whether securities fraud took place at Lehman during its final months.

Goldman Cronies

Treasury, too, has tapped some Wall Street stars—not surprising given Paulson's 32 years at Goldman Sachs (GS) and the history of the firm's luminaries at Treasury. Ken Wilson, a former top banker at Goldman, started advising Paulson for free in August. Wilson consulted on some of the past decade's biggest mergers, including UBS's (UBS) 2000 marriage to PaineWebber. He also worked on one of the worst, the 2004 hookup of HSBC (HBC) and Household Finance, a subprime lending business that dragged down its parent.

Another Goldman alum, Robert K. Steel, a former vice-chairman, joined Treasury in 2006 as Paulson's lead adviser on domestic finance, a bailiwick that grew to include the subprime mess. (This summer, Steel took the CEO job at Wachovia (WB).) Current executives at Goldman, which securitized tens of billions of dollars worth of home loans, helped come up with solutions for AIG. Goldman declined to comment.

Paulson also has sought the counsel of Morgan Stanley (MS), which has notched $15.7billion in losses since last summer. A team from the firm, led by Vice-Chairman Robert W. Scully and top banker Ruth Porat, counseled on the Fannie Mae and Freddie Mac rescue, receiving a token $95,000 for the task. A few weeks later, the Federal Reserve asked Morgan Stanley to figure out how deeply insurer AIG was enmeshed in the financial system. Morgan declined to comment.

The Most Competent

Not all of the firms stocking Washington's cleanup team were deeply involved in the subprime fiasco. When it came time to bail out troubled Bear Stearns, the Fed tapped JPMorgan Chase (JPM), which has largely sidestepped the mess so far. A 50-person team headed by the bank also analyzed a possible private-sector solution to AIG's problems on behalf of the Fed and Treasury. And Paulson is calling on JPMorgan in crafting his bailout plan.

Likewise, money manager BlackRock (BLK), which advised the government on Bear Stearns, is in discussions to manage part of that $700billion pie. Bond giant Pimco may be trying to get a piece as well. Neither has been sullied by the subprime crisis. "Mistakes have been made, but it would be a gross simplification to say that the whole industry is not to be trusted," says a JPMorgan executive who is consulting with Treasury.

Paulson's choices are understandable. After all, the universe of people who understand the complexities of this crisis is small. Conflicts arose and were addressed after the Resolution Trust Corp. was created to deal with the insolvent assets from the savings and loan crisis of the late 1980s. Law firms, for example, weren't allowed to advise the RTC on deals involving insolvent firms with which they had a previous relationship. They could, however, consult on other bank sales. Says Michael S. Gambro, a securities lawyer at Cadwalader, Wickersham & Taft: "What's the cost of hiring people who are less competent to do the job?"

Even so, it doesn't necessarily look good to outsiders that some architects of the misery may be lining up to profit a second time. "The taxpayers saved [the firms'] bacon," says Dan Seiver, a professor at San Diego State University. "[But] Paulson is trying to keep the profits on Wall Street."

Der Hovanesian is Banking editor for BusinessWeek in New York. Francis is a writer in BusinessWeek's Washington bureau. Silver-Greenberg is a reporter for BusinessWeek.com.

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