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The Real Wolves of Wall Street

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of what "too big to jail" is all about: 

THE GOLDMAN SACHS CASEPart III: "Jokers to My Right"James S. Henry

 

Well, la gente Americano may not know the difference between a synthetic CDO and a snow shovel,  but the masses are clearly frothing for a  taste of banquero al la brasa, fresh from the spit.

"Financial reform," whatever that means, is now far more popular than "health care reform."  And it has only recently  become even more so, in the wake of all the recent investigations and prosecutions -- Warren Buffett  might say "persecutions" -- of the "demon bank" Goldman Sachs.     

Evidently the masses' appetite for banker blood was  only slightly sated by the SEC's April 16th civil charges against Goldman, Senator Levin's  11-hour show-trial  of senior Goldman officials on April  27, and the "entirely coincidental"  announcement on April 30th that the US Justice Department --   which is under  strong political pressure  to bring more fraud cases to trial, but also tends to screw them up -- has launched a criminal investigation into Goldman's mortgage trading.

INSIDE BASEBALL

In the wake of this populist uprising, Senate Republicans have suddenly adopted "financial reform" as their cause too,  allowing the Senate to commence debate this week on Senator Dodd's 1600-page reform bill. 

However, this promises to be a lengthy process.  While reform proponents like US PIRG and Americans for Financial Reform were hoping for final action as early as this week,  Senator Reid  now  expects to have a Senate bill by Memorial Day at the earliest, and Obama only expects to be able to sign a bill by September. 

That's just two months ahead of the fall 2010 elections, so there's not much room for error.  But the beleaguered Democrats may just be figuring  that they'd rather bash banks than run on their rather mixed track record on health care reform,  unemployment, climate change,  and offshore drilling, let alone -- Wodin forbid --  immigration reform.     

In any case,  Senator Dodd's  bill has now been through more permutations than a Greek budget forecast.  The latest one  discards the $50 billion bank restructuring fund as well as new reporting requirements  that would helped to spot abusive lending practices.

These concessions apparently were part of retiring Senator Chris Dodd's Grail-like quest for that elusive 60th (Republican) vote -- rumored to be hidden away and  guarded by an ancient secret order known as "Maine Republicans."  

A GOAT RODEO

Meanwhile, behind the scenes, leading Republicans, aided by several Democrats from big-bank states like New York, California, and Illinois, and countless lobbyists,  have been trying to weaken other key provisions in the bill, which was already pretty tame to begin with. 

The most important  measures at issue pertain to derivatives and proprietary trading, the power of the new Consumer Financial Products Bureau (especially, according to Senator Shelby, the Federal Reserve's shameless power grab over orthodontists),  the regulation of large "non-banks,"  and (interestingly, from a states' rights perspective)  the power of states to preempt federal regulation. 

On the other hand,  the bill has also inspired dozens of amendments  from a cross-section of Senators who appear to be genuinely concerned  -- even apart from the opportunities for grandstanding  -- that the Dodd bill isn't nearly hard-hitting enough.

Some of these amendments are purely populist anger-management devices that don't really have much to do with preventing future financial crises. 

These include Senator Sanders' proposals to revive usury laws and audit the Federal Reserve, a proposal by Senators Barbara Boxer and Jim Webb  for a one-time  surtax on bank bonuses, Senator Mark Udall's proposal for free credit reports, and Senator Tom Harkin's proposal to cap ATM fees.

The very first amendment adopted was also in this performative utterance  category: Senator Barbara Boxer's bold declaration that "no taxpayer funds shall be used" to prevent the liquidation of any financial company in "receivership." 

Cynics were quick to point out that in any real banking crisis, this kind of broad promise would be unenforceable, since it would also be among the very first measures to be repealed. 

STRUCTURAL REFORM?

Other proposed amendments sound like more serious attempts at structural reform.

These include  the Brown-Kaufman amendment that tries to limit the number of "too big to fail" institutions by placing upper limits on the share of system-wide insured deposits and other liabilities held by any one bank holding company, and the Merkley-Levin amendment, which  attempts to  "ban" proprietary trading and hedge fund investments by US banks, and also  defines tougher fiduciary standards for market-makers.  

But so far neither of these measures has received the imprimatur of the Senate Banking Committee, let alone Senator  Reid.  This means that for all practical purposes they are may amount to escape valves for venting popular steam,  but little more. 

This is especially true, given the delayed schedule that Reid, Dodd, and the Obama Administration seem to have accepted, which will relieve the pressure for such reforms.

Furthermore,  upon closer inspection, both proposals leave much to be desired.  Indeed, one gets the distinct impression that they dreamed up by Hill staffers on the midnight shift to appease the  latest  cause célèbre,

For example, the Brown-Kaufman amendment,   highly touted by  chic  liberal "banking experts" like Simon Johnson, doesn't mandate the seizure and breakup of any particular large-scale financial institutions directly.  Nor does empower the FTC to set tougher standards for competition in this industry, as it might have done, or even specify what kind of industry structure would be desirable from the standpoint of avoiding banking crises. 

To a large extent that simply reflects the paucity of knowledge about the relationship between structure and behavior in financial services. As a bootstrap, the amendment  specifies arbitrary caps on bank activities that may or may not be related to actual misbehavior -- for example, the share of "insured deposits" managed by any one bank holding company (≤ 10%), and the ratio of "non-deposit liabilities to US GDP" (≤ 2%).

This has arbitrary consequences. Under the limits in the amendment,  for example, Wells Fargo and Citigroup, the # 4 and #1 banks in the country by asset size, would  nearly avoid any breakup, while JPMorgan and BankAmerica would feel much more pressure. 

Meanwhile, evil Goldman Sachs' minimal .3% shares under both limits would leave it plenty of room to grow -- perhaps even by acquiring the extra share that the "Big Four" would have to spin off.

Furthermore,  even the largest US institutions might be able to avoid  the caps by devoting more attention to  large-scale private banking customers, whose deposits and other investments would avoid these regulations,  or by conducting more of their risky business through offshore banking centers.

Indeed, this also suggests a key problem with the Merkley-Levin amendment as well: it is a  US  solo act. It  completely ignores the fact that  even our largest banks, and the US financial system as a whole, are part  of a competitive global financial market.

As  this week's Greco-European financial crisis has underscored, to be effective,  bank regulation and structural reform must be conducted on a coordinated international basis. Unilateral initiatives only drive bad behavior to the myriad of under-regulated offshore and onshore financial centers.

From this perspective, I'm  surprised that  Senator Levin,  a long-time critic of offshore financial centers, has proceed in such a ham-handed way  with this.  This  was his year to finally round up global support to crack down on offshore centers -- a precondition for effective global bank regulation.  Instead he decided to  target Goldman and pursue this wayward, sloppy attempt  at unilateral reform -- as if  the Isle of Man, Guernsey, Jersey, Bermuda, and the Cayman Islands, let alone London and Zurich and Singapore and Hong Kong, are not waiting in the wings. 

WHAT HAVE WE LEARNED?   

If we step back from this political goat rodeo, what have we learned about the political economy of financiali reform? 
 

CONSOLIDATION (UNDER BOTH PARTIES)

First, as shown in the above chart, the US banking industry has indeed undergone a major structural transformation, especially December 1992. The following 15 years became the era of Wild West banking, when all the lessons that should have been learned from the Third World debt crisis were forgotten.  It became an era of rampant deregulation, rising US public and private debt levels, and asset speculation.

The impacts on financial structure were far reaching and rapid. Back in December 1992,  there were more than 13,500 banks, and the top four US banks accounted for less than 10 percent of the sector's jobs. 

Already by 1998, there was a decided increase in this concentration level, to more than 20 percent.  Today there are fewer than 8000 banks. The top 4 alone  -- Citigroup, JPMorganChase, Bank of America, and Wells Fargo -- now employ more than 800,000 people, over 40 percent of the US total. Indeed, together with the failed banks they acquired, the top four banks have accounted for almost all the sector's employment growth;  the rest of the sector has shrunk.

Tiny Goldman has also been growing, but it now only accounts for about 18,900, less than 10 percent of any one of the top four.  

 

This growing concentration is also reflected in most key US banking markets, especially the markets for deposits, overall bank loans, real estate loans in general, home mortgages, and credit derivatives. As indicated, in each of these markets, the market share commanded by top four banks  has increased from less than 10 percent in 1992 to 40-50 percent or more by 2010. In the case of the credit derivatives market, the share now approaches 90 percent.

Nor has this increasing concentration been accounted for by superior performance. Indeed, the "big four" also now account for more than 78 percent of all bad home mortgages -- behind in payments, or suspended entirely. While some of that is accounted for by the acquisition of failing institutions, most of it is not.   

THE ECONOMICS OF GOLDMAN BASHING

Third, once again, for the sake of Goldman bashers in the audience, as indicated above, its share of each of these key market indicators is trivial. Even in credit derivatives, the segment for which Goldman has taken such a beating, its market share today is just 8 percent, compared to the "Big Four's" commanding 88 percent. And Goldman's share of real estate loans, home loans, insured and uninsured bank deposits, and bad home mortgages are even lower.

Just to pick one example: today the "top 4" banks have more than $204 billion of bad home loans, compared with Goldman's $0.0 of such loans.  

From this standpoint, the Levin hearings were a stellar example of  completely ignoring industry economics. They singled out a smaller,  more successful,  widely-envied target for political scapegoating, while ignoring the much more economically  much more important financial giants. 

THE MORTGAGE-INDUSTRIAL COMPLEX

The  key driver on the domestic side of all these developments is a political-economy complex that in the long run has had perhaps as profound an influence on our nation's political and economic system as the  legendary "military industrial" complex.  This is  what we've called (in the first chart above) the "US mortgage-industrial complex," including financial institutions, real estate firms, and insurance companies. From 1992 to 2010, in comparable $2010, this industry spent an average of $2793 per day per US Senator and Congressman on federal campaign contributions and lobbying -- far more than the corresponding levels in the 1970s and 1980s.  

Except for the insurance industry -- where health care reform efforts by Clinton and Obama tilted the giving -- Democrats and Republicans have more or less divided this kitty pretty evenly. It is also important to note that more than 71 percent of total federal spending by these industries  from 1990 to 2010  was on lobbyists, not campaign contributions. While  cases like the recent Citizens United decision may affect this balance,

  

Furthermore, within the financial services industry, the top four US  banks alone have accounted for at least 20 percent of all spending on federal lobbying and campaign contributions (in comparable $2010) from 1992 to 2010. Investment banks as a group -- including Goldman, Lehman Brothers, Bear Stearns, Morgan Stanley, UBS, Credit Suisse, and their key predecessors, especially Paine Webber and Dean Witter -- added another 8 percent.   But once again, by comparison, and contrary to its reputation as the premier political operator in Washington,   Goldman Sach's share of total "real" spending on lobbying and contributions was relatively small -- just 2.2 percent. 

This was just 40 percent of what Citigroup spent, and less than 60 percent of what JPMorganChase spent during  this same period.  

C'mon guys -- Is it any really wonder that Jamie Dimon gets invited to the Obama White House for dinner while Lloyd Blankfein gets served for dinner on a spit up on the Hill?  

Ironically,  if it were just a question of a given institution's loyalty to the Democratic Party, Goldman -- and indeed Lehman Brothers and Bear Stearns as well -- would have clearly had the inside edge. As shown below,  these investment firms clearly preferred Democrats over the long haul.
 
Ironically, to paraphrase Senator Levin, especially in Goldman's case the Democratic Party appears at least so far to have "put its own interests and profits" first, basically turning a blind eye  -- at least so far -- to the substantially much larger potential misbehavior of the "big four."

Meanwhile, when President Obama traveled to New York two weeks ago to give a speech on the urgent need for financial reform, the peripatetic Mr. Dimon could be found in Chicago.  He was rumored to have met with CME and/or Board of Trade executives to prepare to invest in an exciting new "derivatives exchange," should JPMorgan need to transfer its substantial share of that business -- several times Goldman's market share, even in credit derivatives -- to an open exchange. 

JOKERS TO MY RIGHT 

So all this concentration of political and economic power in US financial markets would appear to make a strong prima facie case for a serious structural reform, perhaps even along the lines of the Brown-Kaufman amendment,  n'est pas?  Unfortunately, no.

As we argued earlier, that amendment sets very crude targets that bear little immediate relationship to bank misbehavior or even political influence. At worst, the caps might just force bad behavior like risky derivatives and hedge fund investing offshore. And the bill's  current caps would, at best, just force banks like Cit, JPM, and BankAmerica to shed less than 10 percent of their market shares, setting them back to -- say -- 2005 levels.

In other words, they're not a substitute for effective regulation. But that puts us back in the chicken-egg problem with "regulatory capture."

My own particular solution to these dilemmas is suggested by the following chart -- although it also suggests
that the most opportune time to implement it has already come and gone.  In terms of the current  banal  American political  discourse,   it would be probably be  quickly dismissed as  'socialist,"  although that term is such a catch-all that it has really become virtually useless, except as a device for red-baiting timid liberals.  

THE CHILEAN MODEL

So don't take my word for it; let's ask the ghost of Chile's General Pinochet, whom I'm quite certain no one ever accused of being a "socialist," at least not to his face. For years he was best known among economists as one of the key political proponents of Milton Friedman's so-called "Chicago School" of ultra-free market economics.  But in February 1983, during a severe crisis when all the banks in Chile failed, Pinochet showed that he could be quite pragmatic -- with a little arm-twisting from from leading US banks, which threatened to cut off his trade lines if he didn't nationalize the banks' debts.

So, after swearing up and down that private debts and private banks would never be nationalized, Pinochet's government did so. Three to six years later, after restructuring the banks and cleaning them up,  and privatizing their substantial investments in other companies, they were sold back to the Chilean people and the private sector -- for a nice profit. (Similar policies were also followed by "socialist" Sweden in the case of a 1990s banking crisis, but the Pinochet example provides a more instructive example for so-called conservatives. Much earlier, General Douglas MacArthur, a lifelong Republican,  also employed similar pragmatic tactics in restructuring Japanese banks in the early 1950s.) 

Now this is the plan that the US Treasury (under Paulson and then Geithner) might have adopted in the Fall 2008 - Spring 2010, if only it had not been so hide-bound -- and in the case of the Obama Administration, so wary of being termed a "socialist." 

In hindsight, the economics of such a pragmatic temporary government takeover and reprivatization would have been compelling. At its market low in March 2009, the  combined "market cap" of the "big four" banks was just $120 billion -- including $5 billion for Citi and $15 billion for Bank of American.  This was a mere fraction of the capital and loans that were ultimately provided to them. (At that point Goldman's market cap had fallen to $37 billion from $80 billion a year earlier -- not as steep a decline as the giants, but clearly no picnic for its shareholders, either.)

Only a year later, while the "demon bank" Goldman has recovered to more or less where it was in June 2008, before the crisis, the market cap of the "top four"  US banks is now nearly six times higher than its low in March 2009, and, indeed, at an all time high -- well above both previous peaks.

Too bad the US taxpayers have only captured a small fraction of that $500 billion industry gain.

Too bad the US Treasury hasn't exercized strong "socialist" control over these institutions, changing the way they behavior directly, and restructuring them in the interests of the economy as a whole before selling them back to the private sector.

Too bad that "big four" lobbyists are now back in force on the ground in Washington DC, influencing the fine print of the "financial reform" bill in ways that we will probably only understand years hence. Despite its woes, undoubtedly this will be a bumper year for political spending by the  financial services industry.  

Of course, President Obama  IS now being widely demonized as a "socialist"  -- anyway.

***

(c)JSH, SubmergingMarkets, 2010

       

   

   

 

THE GOLDMAN SACHS CASEPart II: "The Crucible"James S. Henry

Whatever the ultimate legal merits of the SEC's case against Goldman Sachs -- and those appear to me to be questionable at best --  its most important contributions are being made right now. They are not judicial, but political. 

'Lord knows I've been about as critical as one can possibly be of Wall Street banks, as well as of unfettered free marktets. (See, for example, a, b, and c.)

However, after listing to today's  showdown hearings before  US Senator Carl M. Levin's Permanent Investigations Subcommittee,  I'm convinced that:

(1) If anyone needs the benefit of the new "financial literacy" program proposed  by S.3217, Senator Dodd's proposed financial reform bill, it is the US Senate. Many  members of the Senate -- and by extension, the House -- don't  seem to understand very basic things about  the structure and role of private capital markets, finance, and business economics, let alone global competition. In the world's largest capitalist economy, this level of ignorance  on behalf of our political elite is really mind-boggling.

(2) After 18 months of intensive investigation, the US Senate's Permanent Subcommittee on Investigations  and the SEC have not so far been able to find anything that is clearly illegal to pin on Goldman Sachs.

(3) On the other hand, on the secondary trading side of Goldman's  business, Goldman traders  clearly have "market maker" ethics, not investment adviser ethics. They've grown accustomed simply to  providing market liquidity for whatever securities clients  happen to want -- or can be persuaded to want, even if Goldman is taking opposite positions at the very same time in the very same securities. 

For example, regardless of what Goldman's own sales people  felt about the terrible quality of the synthetic CDOs they were selling in 2007  -- including many securities packaged out of  "stated income" mortgages --  they continued to sell anything for which there was a current price.  

Goldman's trader culture simply  doesn't  buy the notion that market makers  have any "duty to serve the best interests of their clients. In competitive world, this amoral culture may well be essential to being a successful "market  maker,"  and Goldman is one of the most successful secondary traders in the world  However, if we expect some higher standard of behavior toward clients, this is likely to require new rules; Goldman will never get there on its own.

Of course, in a highly competitive global market,  any such rnew ules might just cause  this entire business to move offshore, to London, Hong Kong, Singapore, or any number of other offshore financial centers.

(4) With great respect to Michael Lewis, the notion that Goldman Sachs engaged in a hugely profitable "big short" in 2007-2008, in the sense of secretly betting systematically against the same securities that it was underwriting for its clients, is easily overstated. Goldman's investment portfolio in mortgage securities turned negative in early 2007,  was net short all year long in 2007, and at times had up to $13 billion of gross shorts, the bank's net profits from all this shorting that year was $500 mllion to $1 billion. The following year, 2008, its mortgage portfolio lost $1.8 billion 

(5) There appears to be enormous pent-up rage and ressentiment in the country at large, right now, driven by the financial crisis, the slow recovery, high unemployment, and the loss of homes and pensions, on the one hand, and the widespread perception that banks not only created the crisis, but have also profited immensely from it.  Most people may not know a CDO from a dustpan, but there is a very disturbing tendency to seek scapegoats, dividing the world into villains and victims. Ironically,  the most obvious targets include companies like Goldman Sachs, one of our most successful, better-managed, if trader-ridden  companies.

(6) Compared to other major US banks, Goldman Sachs' role in the credit derivatives market, the mortgage market, and bank lending in general, as well as in the roots of the most recent crisis, was minor at best. Indeed, compared with the more than $240 billion of past due/non-performing mortgage loans now on the books of the "big four" banks,  the sums involved even in Goldman's most questionable deals were trivial. Why the US Senate and the SEC decided to focus so heavily on Goldman, as compared with Citi, Bank of America, JP Morgan, and Wells Fargo, is an interesting political-economic puzzle.  

(7) On the other hand, these other major  private banks, plus Lehman  Brothers and Bear Stearns, were by far the largest players in the private mortgage market. If they  had followed Goldman's risk management, accounting, disclosure, and leverage practices, the worst of this crisis might well have been avoided.  Indeed, it appears that one reason these generally much larger firms did not adopt such practices was because -- unlike Goldman -- they genuinely believed they were "too big to fail."  

(8) Going forward, the real problem with Goldman market was not, by and large,  illegal behavior, but an excess of perfectly legal behavior that may well be socially unproductive and way under-regulated.  Especially in a world where other countries have fallen behind in the move to  update their financial regulations, dealing with this problem will require much more than lawsuits and investigative hearings.  

IN THE DARK TRUNKS...

Today's hearings probably came as close to fireworks  as investment banking and "structured finance"  ever gets.  In one corner there was Goldman Sach's slightly shaken,  but still-unbent  CEO Lloyd C. Blankfein (Harvard '75/ HLS '78).

 

There was also Blankfein's articulate, amiable  life-time Goldman employee David Viniar  (HBS '80); the now-notorious, side-lined 31-year old Goldman VP Fabrice P. (aka "fabulous Fab") Tourre (Stanford M.S. '01),  architect of the particular "synthetic CDO" at the heart of the SEC case;  and several other  past and present stars from the "devil bank's" specialists in mortgage banking.  

Apparently not pressent was Goldman's President and COO,  Gary D. Cohn (American U, 'whenever)  (aka "Aeolus,"). Perhaps he had flown to Athens to arrange more  cosmetic "dirty debt swaps"  for Greece,   

Ring-side support for the Goldman front line  was  provided by a hand-picked team of  very high-priced trainer/coaches.  This included former Democratic House Speaker Richard Gephardt,  former Reagan Chief of Staff Ken Duberstein, and Janice O'Connell (aka "Puerta Giratoria"), a former key aid to Senator Dodd.

 Senator Dodd, the retiring Chair of the Senate Banking Committee, has been working since November on  S.3217, an epic 1600-page bill that Senate Republicans (with perhaps a little help from Fed staffers who opposed the bill) have  just prevented from coming to a vote. 

Of course Goldman has also hired Obama's own former chief counsel Gregory Craig as a key member of its defense team.

Once taken seriously as a "liberal" Democratic Presidential candidate, Gephardt has gone the way of all flesh, and is now  completely preoccupied with serving such worthy clients as Peabody Energy, the world's largest private coal company; NAPEO, an association of "professional employer organizations" that is trying to dis-intermediate what little remains of labor rights for outsourced workers; UnitedHealthCare, a stalwart opponent of the "public option" in health care reform; and of course, Goldman Sachs, which has also employed the  prosaic Missourian to pitch the (really insidious) idea of "infrastructure privatization"  all over the country to cash-strapped state and local governments.

IN THE WHITE TRUNKS.. 

In the other corner is the aging  heavyweight champion from Michigan. Senator Levin (Harvard Law '59), is a low-key but tenacious warrior, with a mean-right hook; Goldman would do well not to underestimate him.   He's a  veteran critic, investigator, and opponent  of  global financial chicanery, dirty banks, and tax havens -- except perhaps when it comes to GM's captive leasing shells and re-insurance companies in the Cayman Islands and Bermuda (Heh, even a Dem's  gotta eat!)  

Sen. Levin is backed up by several knowledgeable, tough cross-examiners, especially Democratic Sen. Kaufman of Delaware and Republican Senator Collins of Maine. On the other hand, Republican Senators McCain and Sen Tom Coburn  were a bit more  "understanding" of Goldman's basic amoral attitude toward market-making. 

FIRST ROUND

In handicapping this contest, some observers predicted that the best and brightest from our nation's leading  investment bank  would basically roll over the "old folks" from the Senate.

In the first few hours, however, it quickly became clear that the bankers were a little under-prepared for the Senators' often-times impatient, hard-nosed tone, especially from former Prosecutor Levin, Collins, and Kaufman.

Nor were they prepared for the widespread, if perhaps naive and even "Midwestern" view  that there was just something fundamentally wrong with the lines Goldman drew between pure "market-making" and providing investment advice.

LEVIN DOG

For example, Sen. Levin  was a real rat terrier  on the question  of whether it was ethical for Goldman market-makers in 2007 to  be aggressively pushing clients like Bear Stearns  to buy a CDO security called "Timberwolf" that Goldman's own internal analysts had called  "shitty."  Meanwhile, Goldman's ABS group was shorting Bear by buying puts.  The panel of five present or former Goldman executives had trouble recognizing that there was any problem at all -- given the fact that, from a legal standpoint, Goldman had fully informed these clients about the risks they were taking.

For another $2 billion "Hudson" CDO deal that Goldman sold from its inventory, the firm's own sales people characterized the product as "junk," and indicated that more sophisticated customers might not buy it.  Yet, according to Senator Levin,  Goldman's selling documents for a portion of the sale characterized  the deal as one where Goldman's interests and the client's interests were "aligned" because Goldman retained an equity interest in the Hudson package. In Senator Levin's view, this  "retention" was misleading, simply because Goldman took time to sell down its position.

On the question of the Abacus transaction at the core of the SEC law suit,  Sen. Levin was able to establish that the  Goldman's  Tourre never told the German bank that invested in the deal that  John Paulson, the hedge fund manager who helped choose the portfolio, although he claimed to have told portfolio selection manager ACA.  Oddly enough, from what we heard about other "raw deals" today for the first time, this now appears to have been perhaps the weakest deal for SEC to attack.

Similarly, Senator Collins pressed a group of Goldman securities "market-makers"  very hard about whether  or not they felt they had a "duty" to work in the "best interests of their clients." The responses she received indicated that these Goldman executives, while insisting on the organization's high ethical standards, also simply "did not get" the point that there might be some higher ethical, let alone legal,  duties to clients, for pure market makers, beyond just providing them with legally-required disclosure.

CONTEXT

Senator Levin claimed that these hearings have been in the works for more than a year. He says that it is just sheer coincidence that they are occurring soon after the SEC decided to file its case by a narrow 3-2 party lines vote, and right when Senator Dodd's reform bill just happens to be on the verge of being introduced. 

Other sources indicate that Levin's investigation had been scheduled to continue through May, and that it was abruptly rescheduled after the SEC vote.

Furthermore, for someone who is supposedly holding hearings to gather facts and find out what was really went on,  Senator Levin had already formed quite a few strong opinions prior to hearing from any witnesses -- as shown in his latest press release.  

 But so what?  Even if  he's was a little simplistic, filled with anti-bank animus, and eager to portray the financial crisis as a kind of morality play,  and even if there's no big payoff other than the theatrics, it was definitely kind of fun to  watch the "show trial" -- finally  see someone  asking  big bankers tough questions under oath.  After all,  regardless of what  "caused" the financial crisis and its interminable aftermath,  it is pretty clear who is paying for it -- and it is certainly  was neither these Senators nor the bankers in the dock. 

( Stay tuned for Part III, which takes a closer look the Goldman Sachs case in light of these hearings, and consider the broader question of other "big bank" roles in the crisis.)

***

(c) JSHenry, SubmergingMarkets (2010)

THE GOLDMAN SACHS CASEPart I: "Clowns to the Left of Me" James S. Henry

Article PDF

Goldman Defense PDF

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 an MSNBC host's denunciation of Goldman for refusing to appear on his show -- his show ! There was also a plea from Madame Ariana for criminal charges.

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."  

THE RECKONING

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 Commission look 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!

Now of course Prof. Johnson hails from the UK.

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. 

MATERIAL OMISSIONS

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.

One of only nine "former IMF Chief Economists" who still walk amongst us,  Prof. Johnson may have only served in that post briefly,  from March 2007 until September 2008. 

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.

He may also be able to instruct the jury on the fine arts of concealing what one really believes  in order to reconcile the divergent interests of multiple clients. 

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. 

CONSOLATIONS

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.