L. Randall Wray, GOLDMAN SACHS VAMPIRE SQUID GETS HANDCUFFED, KC economics
blog, SATURDAY, APRIL 17, 2010, http://neweconomicperspectives.blogspot.com/
In a startling turn of events, the SEC announced a civil fraud
lawsuit against Goldman Sachs. I use the word startling because
a) the SEC has done virtually nothing in the way of enforcement for years, managing to sleep through every bubble and bust in recent memory, and
b) Government Sachs has been presumed to be above the law since it took over Washington during the Clinton years.
Of course, there is nothing startling about bad
behavior at Goldman - that is its business model. The only thing that
separates Goldman on that score from all other Wall Street financial
institutions is its audacity to claim that it channels God as it screws its
customers. But when the government is your handmaiden, why not be audacious?
The details of the SEC's case will be familiar to anyone who
knows about Magnetar. This hedge fund sought the very worst subprime
mortgage backed securities (MBS) to package as collateralized debt
obligations (CDO). The firm nearly single-handedly kept the subprime market
afloat after investors started to worry about Liar and NINJA loans, since
Magnetar was offering to take the very worst tranches - making it possible to
sell the higher-rated tranches to other more skittish buyers. And Magnetar
was quite good at identifying trash: According to an analysis commissioned
by ProPublica, 96% of the CDO deals arranged by Magnetar were in default by
the end of 2008 (versus "only" 68% of comparable CDOs). The CDOs were then
sold-on to investors, who ultimately lost big time. Meanwhile, Magnetar used
credit default swaps (CDS) to bet that the garbage CDOs they were selling
would go bad. Actually, that is not a bet. If you can manage to put together
deals that go bad 96% of the time, betting on bad is as close to a sure
thing as a financial market will ever find. So, in reality, it was just pick
pocketing customers - in other words, a looting.
Well, Magnetar was a hedge fund, and as they say, the clients of
hedge funds are "big boys" who are supposed to be sophisticated and
sufficiently rich that they can afford to lose. Goldman Sachs, by contrast,
is a 140 year old firm that operates a revolving door to keep the US
Treasury and the NY Fed well-stocked with its alumni. As Matt Taibi has
argued, Goldman has been behind virtually every financial crisis the US has
experienced since the Civil War. In John Kenneth Galbraith's "The Great
Crash", a chapter that documents Goldman's contributions to the Great
Depression is titled "In Goldman We Trust". As the instigator of crises, it
has truly earned its reputation. And it has been publicly traded since
1999 - an unusual hedge fund, indeed. Furthermore, Treasury Secretary Geithner
handed it a bank charter to ensure it would have cheap access to funds
during the financial crisis. This gave it added respectability and
profitability - one of the chosen few anointed by government to speculate with
Treasury funds. So, why did Goldman use its venerable reputation to loot its
customers?
Before 1999, Goldman (like the other investment banks) was a
partnership - run by future Treasury Secretary Hank Paulson. The trouble with
that arrangement is that it is impossible to directly benefit from a run-up
of the stock market. Sure, Goldman could earn fees by arranging initial
public offerings for Pets-Dot-Com start-ups, and it could trade stocks for
others or for its own account. This did offer the opportunity to exploit
inside information, or to monkey around with the timing of trades, or to
push the dogs onto clients. But in the euphoric irrational exuberance of the
late 1990s that looked like chump change. How could Goldman's management get
a bigger share of the action?
Flashback to the 1929 stock market boom, when Goldman faced the
same dilemma. Since the famous firms like Goldman Sachs were partnerships,
they did not issue stock; hence they put together investment trusts that
would purport to hold valuable equities in other firms (often in other
affiliates, which sometimes held no stocks other than those in Wall Street
trusts) and then sell shares in these trusts to a gullible public.
Effectively, trusts were an early form of mutual fund, with the "mother"
investment house investing a small amount of capital in their offspring,
highly leveraged using other people's money. Goldman and others would then
whip up a speculative fever in shares, reaping capital gains through the
magic of leverage. However, trust investments amounted to little more than
pyramid schemes - there was very little in the way of real production or
income associated with all this trading in paper. Indeed, the "real" economy
was already long past its peak - there were no "fundamentals" to drive the
Wall Street boom. It was just a Charles Ponzi-Bernie Madoff scam.
Inevitably, Goldman's gambit collapsed and a "debt deflation" began as
everyone tried to sell out of their positions in stocks - causing prices to
collapse. Spending on the "real economy" suffered and we were off to the
Great Depression. Sound familiar?
So in 1999 Goldman and the other partnerships went public to
enjoy the advantages of stock issue in a boom. Top management was rewarded
with stocks - leading to the same pump-and-dump incentives that drove the 1929
boom. To be sure, traders like Robert Rubin (another Treasury secretary) had
already come to dominate firms like Goldman. Traders necessarily take a
short view - you are only as good as your last trade. More importantly,
traders take a zero-sum view of deals: there will be a winner and a loser,
with Goldman pocketing fees for bringing the two sides together. Better yet,
Goldman would take one of the two sides - the winning side, of course--and
pocket the fees and collect the winnings. You might wonder why anyone would
voluntarily become Goldman's client, knowing that the deal was ultimately
zero-sum and that Goldman would have the winning hand? No doubt there were
some clients with an outsized view of their own competence or luck; but most
customers were wrongly swayed by Goldman's reputation that was being
exploited by hired management. The purpose of a good reputation is to
exploit it. That is what my colleague, Bill Black, calls control fraud.
Note that before it went public, only 28% of Goldman's revenues
came from trading and investing activities. That is now about 80% of
revenue. While many think of Goldman as a bank, it is really just a huge
hedge fund, albeit a very special one that happens to hold a Timmy
Geithner-granted bank charter - giving it access to the Fed's discount window
and to FDIC insurance. That, in turn, lets it borrow at near-zero interest
rates. Indeed, in 2009 it spent only a little over $5 billion to borrow,
versus $26 billion in interest expenses in 2008 - a $21 billion subsidy thanks
to Goldman's understudy, Treasury Secretary Geithner. It was (until Friday)
also widely believed to be "backstopped" by the government - under no
circumstances would it be allowed to fail, nor would it be restrained or
prosecuted - keeping its stock price up. That is now somewhat in doubt,
causing prices to plummet. Of course, the FDIC subsidy is only a small part
of the funding provided by government - we also need to include the $12.9
billion it got from the AIG bail-out, and a government guarantee of $30
billion of its debt. Oh, and Goldman's new $2 billion headquarters in
Manhattan? Financed by $1.65 billion of tax free Liberty Bonds (interest
savings of $175 million) plus $66 million of employment and energy
subsidies. And it helps to have your people run three successive
administrations, of course. Unprecedented and unprecedentedly useful if one
needs to maintain reputation in order to run a control fraud.
In the particular case prosecuted by the SEC, Goldman created
synthetic CDOs that placed bets on toxic waste MBSs. A synthetic CDO does
not actually hold any mortgage securities - it is simply a pure bet on a bunch
of MBSs. The purchaser is betting that those MBSs will not go bad, but there
is an embedded CDS that allows the other side to bet that the MBSs will fall
in value, in which case the CDS "insurance" pays off. Note that the
underlying mortgages do not need to go into default or even fall into
delinquency. To make sure that those who "short" the CDO (those holding the
CDS) get paid sooner rather than later, all that is required is a downgrade
by credit rating agencies. The trick, then, is to find a bunch of MBSs that
appear to be over-rated and place a bet they will be downgraded. Synergies
abound! The propensity of credit raters to give high ratings to junk assets
is well-known, indeed assured by paying them to do so. Since the underlying
junk is actually, well, junk, downgrades are also assured. Betting against
the worst junk you can find is a good deal - if you can find a sucker to take
the bet.
The theory behind shorting is that it lets you hedge risky
assets in your portfolio, and it aids in price discovery. The first requires
that you've actually got the asset you are shorting, the second relies on
the now thoroughly discredited belief in the efficacy of markets. In truth,
these markets are highly manipulated by insiders, subject to speculative
fever, and mostly over-the-counter. That means that initial prices are set
by sellers. Even in the case of MBSs - that actually have mortgages as
collateral - buyers usually do not have access to essential data on the loans
that will provide income flows. Once we get to tranches of MBSs, to CDOs,
squared and cubed, and on to synthetic CDOs we have leveraged and layered
those underlying mortgages to a degree that it is pure fantasy to believe
that markets can efficiently price them. Indeed, that was the reason for
credit ratings, monoline insurance, and credit default swaps. CDSs that
allow bets on synthetics that are themselves bets on MBSs held by others
serve no social purpose whatsoever - they are neither hedges nor price
discovery mechanisms.
The most famous shorter of MBSs is John Paulson, who approached
Goldman to see if the firm could create some toxic synthetic CDOs that he
could bet against. Of course, that would require that Goldman could find
chump clients willing to buy junk CDOs - a task for which Goldman was
well-placed. According to the SEC, Goldman allowed Paulson to increase the
probability of success by allowing him to suggest particularly trashy
securities to include in the CDOs. Goldman arranged 25 such deals, named
Abacus, totaling about $11 billion. Out of 500 CDOs analyzed by UBS, only
two did worse than Goldman's Abacus. Just how toxic were these CDOs? Only 5
months after creating one of these Abacus CDOs, the ratings of 84% of the
underlying mortgages had been downgraded. By betting against them, Goldman
and Paulson won - Paulson pocketed $1 billion on the Abacus deals; he made a
total of $5.7 billion shorting mortgage-based instruments in a span of two
years. This is not genius work - 84% to 96% of CDOs that are designed to fail
will fail.
Paulson has not been accused of fraud - while he is accused of
helping to select the toxic waste, he has not been accused of misleading
investors in the CDOs he bet against. Goldman, on the other hand, never told
investors that the firm was creating these CDOs specifically to meet the
demands of Paulson for an instrument to allow him to bet them. The truly
surprising thing is that Goldman's patsies actually met with Paulson as the
deals were assembled - but Goldman never informed them that Paulson was the
shorter of the CDOs they were buying! The contempt that Goldman shows for
clients truly knows no bounds. Goldman's defense so far amounts to little
more than the argument that a) these were big boys; and b) Goldman also lost
money on the deals because it held a lot of the Abacus CDOs. In other words,
Goldman is not only dishonest, but it is also incompetent. If that is not
exploitation of reputation by Goldman's management, I do not know what would
qualify.
By the way, remember the AIG bail-out, of which $12.9 billion
was passed-through to Goldman? AIG provided the CDSs that allowed Goldman
and Paulson to short Abacus CDOs. So AIG was also duped, as was Uncle
Sam - although that "sting" required the help of the New York Fed's Timmy
Geithner. I would not take Goldman's claim that it lost money on these deals
too seriously. It must be remembered that when Hank Paulson ran Goldman, it
was bullish on real estate; through 2006 it was accumulating MBSs and
CDOs - including early Abacus CDOs. It then slowly dawned on Goldman that it
was horribly exposed to toxic waste. At that point it started shorting the
market, including the Abacus CDOs it held and was still creating. Thus,
while it might be true that Goldman could not completely hedge its positions
so that it got caught holding junk, that was not for lack of trying to push
all risks onto its clients. The market crashed before Goldman found a
sufficient supply of suckers to allow it to short everything it held. Even
vampire squids get caught holding garbage.
Some have argued that the SEC's case is weak. It needs to show
not only that Goldman misled investors, but also that this was materially
significant in creating their losses. Would they have forgone the deals if
they had known that Paulson was shorting their asset? We do not know - the SEC
will have to make the case. Besides, Goldman does this to all its clients - so
the SEC will have to make the case that clients could have been misled,
whilst knowing that Goldman screws all its clients. After all, Goldman hid
Greece's debt, then bet against the debt - another fairly certain bet since
debt ratings would fall if the hidden debt was ever discovered. Goldman took
on US states as clients (including California and New Jersey and 9 other
states), earning fees for placing their debts, and then encouraged other
clients to bet against state debt - using its knowledge of the precariousness
of state finances to market the instruments that facilitated the shorts. Did
Goldman do anything illegal? We do not yet know. Reprehensible? Yes. Normal
business practice.
To be fair, Goldman is not alone - all of this appears to be
normal business procedure. In early spring 2010 a court-appointed
investigator issued his report on the failure of Lehman. Lehman engaged in a
variety of "actionable" practices (potentially prosecutable as crimes).
Interestingly, it hid debt using practices similar to those employed by
Goldman to hide Greek debt. The investigator also showed how the prices by
Lehman on its assets were set - and subject to rather arbitrary procedures
that could result in widely varying values. But most importantly, the top
management as well as Lehman's accounting firm (Ernst&Young) signed off on
what the investigator said was "materially misleading" accounting. That is a
go-to-jail crime if proven. The question is why would a top accounting firm
as well as Lehman's CEO, Richard Fuld, risk prison in the post-Enron era
(similar accounting fraud brought down Enron's accounting firm, and resulted
in Sarbanes-Oxley legislation that requires a company's CEO to sign off on
company accounts)? There are two answers. First, it is possible that fraud
is so wide-spread that no accounting firm could retain top clients without
agreeing to overlook it. Second, fraud may be so pervasive and enforcement
and prosecution thought to be so lax that CEOs and accounting firms have no
fear. I think that both answers are correct.
To determine whether Goldman and other firms engaged in fraud
will require close examination of the books, internal documents, and emails.
Perhaps the SEC has finally fired the first shot at the Wall Street firms
that aided and abetted the creation of the conditions that led up to the
financial collapse. More importantly, that first shot might have driven a
bit of fear into the financial institutions that have been trying to
carry-on with business as usual. And, finally, perhaps the SEC might induce
the Obama administration to stand-up to Goldman.
It is probably not too early for Goldman management and alumni
to begin packing bags for extended stays in our nation's finest
penitentiaries. More than 1000 top management at thrifts served real jail
time in the aftermath of the Savings and Loan fiasco. This current scandal
is many orders of magnitude greater - probably tens of thousands of managers
and traders and government officials were involved in fraud. We may need
dozens of new prisons to contain them.
Meanwhile, the Obama administration should immediately revoke
Goldman's bank charter. Even if the firm is completely cleared of illegal
activities, it is not a bank. There is no justification for provision of
deposit insurance for a firm that specializes in betting against its
clients. Its business model is at best based on deception, if not outright
fraud. It serves no useful purpose; it does not do God's work.
[ “Call him what you will. He is, he says, just a banker "doing God’s work" “ ]
Government
should also relieve itself of all Goldman alumni - no administration that is
full of Goldman's people can retain the trust of the American public.
President Obama should start his house cleaning with the Treasury
department. Yes, Rubin and his hired hand Summers and protégé Geithner (and
his hired hand Mark Patterson, Goldman's lobbyist who became chief of staff
of the Treasury) and Hank Paulson must be banned from Washington; and
Rattner (former NYTimes reporter who tried to bribe pensions funds when he
worked for the Quadrangle Group - who served as Obama's "car czar" and is now
likely to face lawsuits), and Lewis Sachs (senior advisor to Treasury, who
helped Tricadia to make bets identical to those made by Magnetar and
Goldman), and Stephen Friedman (Goldman senior partner who served as
chairman of the NYFed), and NY Fed president Dudley (former chief US
economist at Goldman) must all be sent home. Actually, anyone who ever
worked for a financial institution must be banned from Washington until we
can reform and downsize and drive a stake through the heart of Wall Street's
vampires.
And why not use the powers of eminent domain to take back
Goldman's shiny new government-subsidized headquarters to serve as the
offices for 6000 newly hired federal government white collar criminologists
tasked with the mission to pursue Wall Street's fraud from the Manhattan
citadel of the mighty vampire squid? If Obama is serious about reform, that
would be a first step.
POSTED BY ECONOMIC PERSPECTIVES FROM KANSAS CITY AT 5:46 PM
Wall Street Journal
November 9, 2009, 10:00 AM ET
The Times of London’s mammoth 6,900-word piece on Goldman Sachs over the weekend contains plenty of fodder for those that see the investment bank as Wall Street’s top dog, as well as those that see it as a creepy, conspiratorial vampire squid of finance.
But the key quote that’s getting attention comes in Goldman Chief Executive Lloyd Blankfein’s exchange with a reporter after a question on whether there should be limits to compensation:
Is it possible to make too much money? “Is it possible to have too much ambition? Is it possible to be too successful?” Blankfein shoots back. “I don’t want people in this firm to think that they have accomplished as much for themselves as they can and go on vacation. As the guardian of the interests of the shareholders and, by the way, for the purposes of society, I’d like them to continue to do what they are doing. I don’t want to put a cap on their ambition. It’s hard for me to argue for a cap on their compensation.”
So, it’s business as usual, then, regardless of whether it makes most people howl at the moon with rage? Goldman Sachs, this pillar of the free market, breeder of super-citizens, object of envy and awe will go on raking it in, getting richer than God? An impish grin spreads across Blankfein’s face. Call him a fat cat who mocks the public. Call him wicked. Call him what you will. He is, he says, just a banker “doing God’s work”
Even if you have serious questions about whether investment banks actually perform a useful societal function, there’s no reason to get all bent out of shape about Blankfein’s comments. The “impish grin,” that seems to go along with the abbreviated quote makes it clear that the head Goldmanite just can’t resist winding us all up a bit.
At the same time, there does seem to be a strange uptick in religious rhetoric from bankers lately, as they strive to counter an upsurge in anti-banker sentiment. For example, Time Magazine’s Justin Fox writes:
In a discussion about morality and markets at St. Paul’s Cathedral in London, Goldman Sachs international vice chairman Brian Griffiths, a former adviser to Margaret Thatcher, described giant paychecks for bankers as an economic necessity. “We have to tolerate the inequality as a way to achieve greater prosperity and opportunity for all,” he said.
And the New York Times recently quoted John Varley, of Barclays, telling an audience at London’s St. Martin-in-the-Fields that ”profit is not satanic.”
Blankfein’s wry comment that he’s “doing god’s work” seems almost to be a veiled jab at this sort of religio-public relations push, which to a serious banker of Blankfein’s stature, must seem somewhat silly.
Blankfein clearly knows who he works for. After all, God couldn’t afford him.