In April, the multibillion-dollar hedge fund Paulson & Co. was cited in a blockbuster Securities and Exchange Commission civil fraud suit against Wall Street investment bank Goldman Sachs. The SEC complaint alleged that Paulson helped build investment vehicles predicated on rising real-estate prices — and then bet against them, making more than $1 billion on the collapse of the subprime market and the nationwide housing market decline.
[Congress1] Now, Rep. Darrell Issa (R-Calif.), the ranking Republican on the House Oversight Committee, has opened an investigation into whether Paulson did much the same — blowing up the subprime bubble while standing to reap hundreds of millions when it burst — via a large donation to a nonprofit group.
In a May 26 letter to John Paulson, the head of Paulson & Co., Issa asks for documents relating to the firm’s $15 million July 2007 donation to the Center for Responsible Lending, an advocacy group that runs community banks to provide loans to low-income Americans, lobbies for stronger consumer protections on Capitol Hill and offers legal aid to victims of predatory lending, among other activities. The Issa letter implies that Paulson donated to the CRL to stoke the housing bubble and thereby increase its returns. (Ben White first posted the letter at Politico.)
The allegations in the Issa letter stem not from a congressional investigation or think tank report — but from Americans for Prosperity, the Koch family-funded conservative advocacy group famed for supporting the Tea Parties and rallying against health care and financial regulatory reform. CRL contends that AFP’s investigation misconstrues the way its lending programs work, and Paulson pushes back against the idea that it used charitable donations for business ends.
“According to reports,” the Issa letter reads, “CRL was involved in a strategy to ‘shake down and harass banks into making bad loans to unqualified borrowers.’ Central to CRL’s strategy were loans made under the Community Reinvestment Act, legislation designed to encourage banks to make loans to low-income borrowers using loosened underwriting standards.”
But the “reports” cited by Issa come from Americans for Prosperity. The quotation comes not from any independent study, but from a FoxNews.com op-ed by Phil Kerpen, the head of AFP. And the Issa letter is a product of AFP’s months-long grassroots campaign to convince Washington lawmakers to investigate the ties between Paulson, CRL and the Obama administration, alleging that Paulson used the CRL to stoke and then pop the property bubble and criticizing the “revolving door” between CRL and the administration.
AFP faults the CRL and other community lenders that do not require high down payments or take on borrowers with bad credit for blowing up the housing bubble. It also alleges that the CRL “harasses” big banks into making bad loans, by accusing them of redlining when they do not penetrate low-income or minority communities, for instance.
It makes sense, Kerpen told TWI, that Paulson would donate to CRL to help it fund bad loans or to convince it to make more of them — and then collect a profit once the bubble collapsed. In his op-ed, he argues that the CRL donation and the Goldman Sachs deal were two sides of the same coin.
“Paulson paid Goldman Sachs … $15 million to design collateralized-debt obligations comprised of specific subprime mortgages that he selected,” he wrote. “This bucket of investments may have included loans that he knew were unsound and were made only because banks were strong-armed by the CRL. Until there is a full investigation, we won’t know for sure, but it appears Paulson’s $30 million — split between the CRL and Goldman Sachs — financed a scheme that netted his fund a cool $1 billion dollars.”
Of course, Paulson & Co.’s true motivations are opaque. But the firm hit back against allegations that the donation had any business motivation whatsoever, saying the funds helped create an institute to provide legal assistance to homeowners, not to originate subprime loans.
“Paulson & Co’s donation was used exclusively to provide legal assistance to people facing foreclosure to help them stay in their homes,” the company’s spokesperson, Armel Leslie, wrote in an email. “The program has provided legal assistance to thousands of people facing foreclosure. It has distributed $10 million to 34 legal service organizations in 30 states through multi-year grants. [And the] CRL estimates that the program has saved more than 1,300 homes.”
Paulson himself has argued the same. In 2008, the hedge fund manager told the House Oversight Committee that he made the donation in the hope of slowing the foreclosure crisis, not stoking it. “As we saw the difficulty homeowners were having in making mortgage payments, in July 2007, prior to the initiation of any government support programs, Paulson & Co. made a $15 million charitable contribution,” Paulson said in November 2008. “The institute supports local groups across the country providing legal representation to families facing foreclosure.”
Michael Waldorf, a vice president at Paulson, has also defended the donation. “We decided to make a positive contribution in addressing a serious economic problem. People are being thrown out of their homes,” Waldorf told BusinessWeek’s Eamon Javers. “And if they don’t have enough money to pay their mortgages, then they don’t have enough money to pay a lawyer.”
(A person familiar with the hedge fund’s business also noted that the donation to CRL came at the end of Paulson’s property-bubble strategy, not the beginning or middle. The subprime bubble had already burst, with lenders declaring bankruptcy and foreclosures spiking, by the summer of 2007. Paulson’s millions had for the most part already been made.)
The CRL says that Paulson’s donation did not go to capitalize its community banking arm, and therefore never funded subprime loans. CRL spokesperson Kathleen Day says that while the CRL does originate subprime mortgages, it provides vanilla 30-year mortgages. The organization expects higher-than-average default rates because of its low-income lending mission. Additionally, she notes that the CRL itself takes on losses from loans it repackages or originates.
“Every bit of that money went to help people facing foreclosure try to save their homes,” she says. “I’ll say it over and over and over again. It led to fewer foreclosures. If anything, it would have cost Paulson money by easing [the foreclosure crisis]. And the CRL, since 1999, has been arguing for changes to the regulatory and bankruptcy laws to prevent the foreclosure crisis.”
Still, Kerpen and the Issa letter fault the CRL for stoking the housing bubble through low-income mortgage lending. And Kerpen wants a broader investigation into the CRL and its lending, advocacy and lobbying practices. He wrote in his opinion piece that the CRL has “[escaped] the spotlight of investigation, but under [Sen. Chris Dodd's (D-Conn.) financial regulatory reform bill] the CRL is poised to accomplish most of its longtime goals and achieve sweeping new powers.” (The Dodd bill does not give consumer advocates new powers beyond creating, in the form of a new Consumer Financial Protection Agency, a new rule-making entity to consider their concerns.)
And on Friday, Kerpen reiterated the broad concern behind his argument about the Paulson donation to CRL. “We think that the financial crisis is being used as a pretext for vast new regulations that have nothing to do with what went wrong,” he told TWI. “We’re particularly concerned that the Consumer Financial Protection Act was attached to the Dodd bill, and CRL was the advocacy group that was responsible for making that happen.”
The CRL argues that it advocates only for the interests of those afflicted by predatory lending and underserved low-income and minority communities — and that its political mission is sound. “These are all the same charges that have been dredged up for the past two and a half years by organizations that are against reform,” said Day. “It’s the payday lenders and financial services industry groups and others getting fronts to oppose us and bringing up bogus charges. [This is part of] an effort to try to torpedo legislation that will benefit consumers.”
On Friday, Kerpen said that he does not know Paulson’s motivations, but is happy that the government is finally investigating. “It is possible it was a coincidence. And it is possible that [Paulson made the donation] to assuage his guilt about the Goldman deal,” Kerpen says. “But it is also possible that [Paulson and the CRL] were sharing information.”