The timing of fraud charges against Goldman Sachs
[Update: The WSJ note that, intentionally or otherwise, the Goldman charges served to bury the larger story of the SEC’s utter failure to stop Alan Stanford’s multi-year multi-billion-dollar fraud.]
On Friday, the Securities and Exchange Commission filed fraud charges against Goldman Sachs, not-so-affectionately known by those of us who object to a private firm essentially running our nation’s fiscal policy as Government Sachs.
[Don’t forget…it was a Goldman-dominated Treasury which repaid AIG 100 cents on the dollar for contracts whose fair market value was probably about 30 cents on the dollar, thus allowing AIG to funnel $13 billion to Goldman. In other words, Goldman was the recipient of $10 billion stolen from taxpayers. In most places, receipt of stolen property is a crime, but not at the US Treasury.]
The charges against Goldman basically go like this:
A big hedge fund manager named John Paulson wanted to bet against the housing market in 2008. Paulson asked Goldman to create a type of bond portfolio containing housing-related bonds but Paulson’s intent…apparently known by Goldman at the time…was to short the bonds, i.e. bet on their going down, not up, rather than buy them.
Goldman got a nominally independent company involved in selecting which bonds would be in the portfolio but convinced the company to allow Paulson to help with that selection; Paulson indicated to the company that he would be a buyer of the bonds and therefore that his interests and the selection company’s interests were in line. But it was a lie and Paulson chose bonds that he thought were vulnerable to collapse. Paulson was right, of course, and shorting these bonds along with others he made betting against housing helped him make several billion dollars in the past few years. (Paulson is not related to former Goldman CEO & Treasury Secretary Hank Paulson.)
[A quick lesson on “shorting": Shorting is a way to make a profit by the decline in price of a trade-able asset. Let’s say a trader thinks stock XYZ will decline in price. (It doesn’t have to be a stock. It could be any asset where this same process is possible.) The trader borrows some XYZ from someone who owns it, usually paying the lender a small fee. The trader sells XYZ in the market, let’s say for $20/share. Let’s imagine a trader who did this with 1,000 shares of stock, he he now deposits $20,000 in his account, but he owes the stock lender the shares. Then XYZ drops to $19/share. The trader buys 1000 shares for $19,000, returns the shares to the lender, and keeps the $1,000 in profit (less commissions). The fee to the lender and the interest earned on the $20,000 also play into the equation but those numbers are usually small compared to the profit or loss due to the movement in the stock price.]
As that lesson makes clear, for someone to “go short", someone else needs to own the asset in question so it can be borrowed, and someone else must be around to buy the asset from the short seller. So, the charge against Goldman is essentially that they sold bonds to investors which they knew or should have known were designed to fail.
On first glance, the SEC’s case appears fairly strong although how bad the behavior really was may be overstated. Jim Cramer doesn’t think the case is strong. (Cramer worked at Goldman, so might not be completely objective.) [UPDATE: The Wall Street Journal suggests the case against Goldman is weak and also that the most interesting thing about the past couple of years is “how little villainy was found."] But such cases usually do appear strong on first glance. Most likely, Goldman will end up settling and repaying some money to investors who lost in those bonds. It will be interesting to see how they arrive at a compensation amount because such an enormous percentage of mortgage securities lost much or most of their value. In other words, even a non-fraudulently created bond would probably have been a substantial loser for those investors.
Interestingly, Goldman said that they lost $90 million on the transaction. If they bought the bonds themselves, it’s a decent defense for them. However, it’s very easy to buy one thing and hedge somewhere else so that the combination was profitable. And that hedge will be extremely difficult for the SEC to find within the complex maze of Goldman’s total portfolio.
Is it any coincidence that the SEC charges were filed just as Democrats are trying to get even one Republican to vote for their hyper-partisan and poorly-conceived financial reform bill? It’s a measure which retains the worst features of “too big to fail” despite the rhetoric to the contrary. It punishes big firms just for being big. And it seems to give government the authority to break up a big firm just on a hunch that the firm might pose “systemic risk". (It should be noted that the failure of Lehman Brothers, a firm which many might have thought to pose such risk, was handled with barely a hiccup by the markets.) All in all, the bill seems to allow or even encourage government to play favorites among banks, precisely what we don’t need after seeing how government pressure on banks (to make loans to less-than-creditworthy borrowers) was the single biggest cause of the financial meltdown.
Is the SEC acting as part of the Obama propaganda machine, bringing fraud charges against a major firm as part of a strategy to get public support for their “reform” bill? I wouldn’t put it past anyone who works for this government to behave in that manner and for that reason, especially if the SEC is feeling threatened by their utter failure in the Madoff, Petters, and Stanford cases. Could someone at the SEC be trying to curry favor with Obama and congressional Democrats with the timing of these charges? I’d like to think the answer is “no"…but I think the answer is “yes".
Particularly now, there is no such thing as a coincidence inside the Beltway.
Goldman is probably guilty of these charges – or at least guilty of very shoddy business practices and oversight – and heaven knows that many people including myself would like to see them taken off their pedestal…not because I oppose success but because I oppose the way the firm uses government to direct our money into their bank accounts.
But if the timing of these charges is not coincidental with the Democrats’ push to add more government control of the financial industry, then the SEC’s actions should be an even bigger scandal than Goldman’s.
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