Thursday, April 22, 2010
THE GOLDMAN SACHS CASE Part I: "Clowns to the Left of Me" James S. Henry
Well, we no longer have to worry only about corrupt bankers in Kyrgystan. Ever since the Goldman Sachs case erupted last week, there's been plenty of fresh banker blood in the water right here at home, with scores of financial pundits, professors-cum-prosecutors, and political piranha swirling around the wounded giants in the banking industry as if they were a herd of cattle crossing a tributary on the upper Rio Negro.
This feeding frenzy was precipitated by last Friday's surprising SEC announcement of civil fraud charges against Goldman Sachs -- heretofore by far the most profitable, highly-respected, and, indeed, public-spirited US investment bank.
Despite -- or more likely because of -- Goldman Sach's relatively clean track record and illustrious credentials, many commentators have assumed a certain Madame Defarge pose, reigning down censure and derision from the penultimate rungs of
their mobile moral pedestals.
Over the weekend, for example, Huffington featured a
half dozen vituperative columns on the subject, including a Vanity Fair contributing editor's feverish claim that the whole affair was somehow
deeply connected to one high-level
Wall Street marriage, and
host's denunciation of Goldman for refusing to appear on his show --
his show ! There was also a plea from Madame Ariana for criminal
In fact, this is a case where, as we'll see in Part III, the SEC's civil charges against Goldman Sachs are not only highly debatable, but largely beside the point.
Meanwhile, Bob Kuttner, another Huffy perennial, and one of our most prolific popularizers of conventional liberal dogma, asserted that Goldman demonstrates conclusively that Wall Street en tout is nothing but an on-going criminal enterprise, up to its eyeballs in outright fraud.
In a lurch toward financial Ludditism, Bob figuratively placed his hands on his hips, stomped his feet, and demanded nothing less than a "radical simplification of the
financial system" -- leaving it to the reader's imagination to determine just what the hell that means.
Will we still be permitted to use ATMs, checking accounts and paper currency, or will we all soon have to return to wampum beads and n-party barter?
Elsewhere, the Daily Beast published a de facto job application from Harvard Law's Prof. Alan Dershowitz -- otherwise well known in the legal profession as "He whose key clients are either fabulously wealthy or innocent."
Prof. Dershowitz argues -- quite rightly -- that Goldman' behavior, while no doubt
morally reprehensible, was also by no means clearly illegal. On the other hand, he also says the law is so vague that hedge fund investor Paulson might even be charged with conspiracy to commit fraud.
Well, ok -- except for the article's faint suggestion that for a modest fee, our country's finest criminal lawyer may just be available to help explain all this to a judge -- and also to argue that "only a tiny fraction of investment bankers who abuse their clients actually commit murder."
Finally, there is the omni-present, virtually unavoidable Simon Johnson, a Peterson Institute Fellow, MIT B-school prof, book author, "public intellectual," and "contributing business editor" at Huffington.
This week has been Prof. Johnson's heure de gloire, and he is living it to the fullest.
All week long he could be found at all hours on nearly every cable news channel and web site, pitching his own increasingly Puritanical, if not neo-Manichean views of the banking crisis and Goldman's role in it.
At first, Prof. Johnson merely expressed
delight that the US had finally reached its "Pecora moment" --
referring to the 1933-34 US
Senate investigation of Wall Street that, indeed, makes the modest
$8 million Angelides
like a California '68 love-in.
But by mid-week he'd had moved on to a much harsher assessment.
Not only is Goldman guilty as sin, but hedge fund investor John Paulson, one of the key parties to the Goldman transaction, deserves to be "banned for life" from the securities industry. If necessary, Johnson says, the US Congress should even pass an ex post facto bill of attainder!
He may therefore not be aware that the US Constitution (Article 1, Section 9) has explicitly prohibited both ex post facto laws and bills of attainder (legislative decrees that punish a single individual or group without trial) ever since 1788.
Just this month, a US federal district court in New York struck down Congressional sanctions that singled out ACORN, the community organizing group on precisely these grounds. The case is now on appeal.
Indeed, even in the UK, there have been no bills of attainder since 1798.
Despite Prof. Johnson's limited grasp of US or even UK law, and his Draconian appetites, I've actually grown rather fond of him lately -- or at least more understanding.
This is partly because since he left
the IMF in September 2008, he's apparently had a kind of road-to-Damacus epiphany.
He now realizes, as if for the first time, the enormous carnage that has been inflicted by a comparative handful of giant global banks, as well as the huge potential rewards of decrying these outrages from the roof tops.
But that 1+ year was more than enough time for him to leave a lasting impression at the IMF.
He is still fondly remembered at the IMF not
only for having entirely
missed the 2007-08 mortgage crisis even as it was unfolding, but also for deciding in
July 2008, less than 3 months before the entire global financial system nearly collapsed, to sharply increase
the IMF's growth forecast for both 2008 and 2009.
That was just one month before the otherwise-feckless Bush SEC initiated the 18-month investigation of Goldman Sachs that ultimately led to last week's charges.
If and when the Goldman Sachs case ever comes to trial, therefore, it may be interesting for Goldman's attorneys -- perhaps Prof. Dershowitz -- to consider calling Prof. Johnson as a witness for the defense.
After all, he probably qualifies as an expert on the heart-rending experience of just how difficult it was even for highly-trained experts to have clear peripheral vision, much less perfect foresight, back in the heady days of the real estate boom.
In Prof. Johnson's case, these included IMF senior management, executive directors, and a myriad of country officials who were all pressuring the IMF to inflate its forecasts back in 2008, just as housing markets and financial markets were beginning to crumble.
In July 2008, on Prof. Johnson's watch, they temporarily prevailed.
From this angle, the IMF Chief Economist's role might even be compared to that of a certain young Goldman Sachs VP.
Even in the dark days ahead, therefore, Goldman Sachs execs have at least a few consolations.
First, they can remind themselves that there were very damn few heroes in this sordid tale -- journalists, politicians, public intellectuals, and economists included.
Indeed, Brooklyn-born investor John Paulson may turn out to have been, if not quite a "hero," at least one of the few relatively straightforward and consistent players in the lot.
At least in his own investing, he consistently opposed the systematic distortions about the housing miracle and the exaggerate forecasts -- dare one say frauds? -- that institutions the US Treasury, the Federal Reserve, and Prof. Johnson's own IMF employed in the final stage of the real estate bubble, in a failed attempt to achieve a 'soft landing.'
Second, while it may be hard for us to imagine, things might actually have turned out a whole lot worse.
Goldman Sachs might well have relied on Prof.
Johnson's sophisticated, bullish forecasts rather than on John Paulson's intuitive short-side skepticism.
How much money would Goldman's clients, investors, and the rest of us have lost then?
© JSH, SubmergingMarkets, 2010.
April 22, 2010 at 06:43 AM | Permalink
OK. The punitive background on Johnson is interesting. Question is, did or did not Goldie Sucks' alleged collaboration with Johnson, damage or not the people who had shares in the Funds (large institutional) which bought Goldie's derivatives-of-derivatives-of-junk mortgages - aka "synthetic CDOs". Cording to what I read, Goldie's upper mgrs maintain nuthin was hidden from the sophisticated investor-buyers of the super-Derivs, e.g. what specifically was bundled into the underlying derivative(s). Were the individual sub-prime and Alt-A mortgages detailed? I am interested, cause my former house help's IndyMac Mtg was sold to Deutsche, who made a CDO out of it. Now Deutsche won't allow a Ln Modification, cause the buyers of the CDO(s) don't want to lose money on their investments, despite the govt $s being made available to cover - 90%? - of the investors loss.
Am I confused, or is their nothing at all in the SEC's civil case against Goldie? The British regulator is lso going after Deutsche for the same little profit-seeking double-Deriv. No? Yes?
Posted by: Evan Rotner at Apr 22, 2010 2:21:51 PM
Thanks for your comment, Evan. We'll get deeper into the details in Part II, but the short answer is that these were synthetic CDOs, designed in part to satisfy the hedge fund manager Paulson, and then intermediated via an "independent" transaction manager, ACA, which invested its own money, insured most of that with Abn Amro (later acquired by RBS), and also got a German bank to invest $150 mm in the deal. The SEC suit basically charges Goldman with not fully disclosing or indeed misrepresenting Paulson's role in selecting the portfolio AND the character of his interests to ACA and its investor. I will look into the DB case you describe, but it sounds a little different: not clear a professional shorter was involved. The closest case I'm aware of involved a Chicago hedge fund called Magnetar, which did a bunch of similar deals with banks like JPM and UBS.
Posted by: james s. henry at Apr 22, 2010 6:26:21 PM
Why no photo of a vampire squid?
Posted by: nicholas shaxson at Apr 23, 2010 5:10:42 AM