When Hank Paulson agreed to become Treasury Secretary in May of 2006, he found himself in a bit of a pickle. You see, he owned about $500 million in Goldman Sachs stock, from his days as CEO of the firm.

So to avoid any appearance of a conflict of interest, government rules forced Mr. Paulson to sell all that stock. Phew, looks like we dodged a bullet there…

Mr. Paulson’s conflict of interest also brought a very unique benefit: He didn’t have to pay any capital gains taxes on the sale of that stock — zero. The Economist estimated his tax savings to be $200m. That’s not bad compensation for less than 3 years of work at a “public service” gig. He also got a nice salary and generous benefits. For more on the intimate relationship between Goldman and Government, see this post.

The ethics rules that forced Paulson to sell his GS shares were designed so that rich executives aren’t dissuaded from entering public service due to tax issues. But they seem to have the opposite effect. It encourages these guys to move to Washington after they’ve made their fortunes. Getting a government job with conflicted interest turns out to be a fantastic tax dodge. Not to mention all the good you can do while in office (for your buddies, high-five!). Sorry, I’ve been watching too much Borat/Ali-G lately.

As most people know, Paulson went on to orchestrate the largest corporate bailout in history. Some banks failed, some will prosper in a thinned field of competitors. One of the major beneficiaries was the firm he formerly headed, Goldman Sachs. They received $10b in direct aid, plus another $12b indirectly, via the AIG bailout. Goldman argues that even if AIG wasn’t bailed out, they would have collected most of their $12b. They may be correct, but I am skeptical. To be clear, I am not accusing Goldman or anyone else of illegal activity or fraud. But things seem very fishy.

Goldman is also a major government contractor, which means the Treasury Department pays Goldman millions for their expert advice on financial matters. And Edward Liddy, who was appointed by Paulson to head up AIG, is a former director at Goldman. How much more conflicted can the entire situation get? Mr. Liddy was officially only paid a $1 salary for his time at AIG, but he still owned roughly $3 million in Goldman Sachs stock.

This story is not a new one, by any means. But most people I mention the “conflict of interest” tax-loophole to haven’t heard of it. And I think it’s especially interesting in light of everything that’s happened since. When you consider Goldman’s continued dominance in Washington, it’s downright disturbing. Lloyd Blankfein for Treasury, anyone? Geithner seems doomed to be fired soon, and he’s earned it in my opinion. It only seems logical that they’d select a new face from the same crowd to replace him.

Slightly off-topic rant

I really hope Obama wakes up and realizes that his economic team is a disaster. These shenanigans and revolving doors between government and financial companies has to end. And it needs to happen soon. Obama’s current team is trying to reflate and revive the bubble. Tim Geithner, Larry Summers, and Ben Bernanke will not save us from this crisis. They are exacerbating it, and played a major role in causing it. One of Mr. Bernanke’s central tenants is that a “savings glut” is the major cause of our problems. Yes, that’s right. He actually believes that savings, not debt, are at the root of the problem.

The administration’s economic beliefs have been discredited. They obviously favor big banks over taxpayers and savers. The inflation they are stoking now could be disastrous in a few years. And the moral hazards are incalculable. They are encouraging even more risk-taking and reckless lending, which will negatively affect our economy for decades. But for now, banks can rest assured that they’ll be bailed out in the future, regardless of risks they take and the bonuses they grant.

Personally, I am starting to regret not voting for Ron Paul. He’s not for everyone, and I don’t agree with some of his positions. But at least he would have shook things up, and made hard choices. I’m sure of that. But now he’s probably too old to run again, and looks sad in the recent interviews I’ve seen. That sucks. The guy fought against reckless monetary policy for 30+ years. Some people would be gloating, chanting I told you so in delight. But Ron Paul isn’t gloating, he seems to think his efforts weren’t enough, that he failed. That’s a damn shame. Maybe he will run again in 2012, I hope he does. He still seems sharp.

I still have some hope for Obama, whom I voted for and donated to. But I’m becoming disillusioned fast. Geithner, Bernanke, Emanuel, and Larry Summers have got to go, ASAP. Those guys are not economic change, no matter how you spin it.