It seems like everyone in the financial media and blogosphere has something to say about the Friday bombshell from the SEC, which charged Goldman Sachs (GS) and Goldman VP Fabrice Tourre with securities fraud. Read the full complaint here.
Among the first to post on Seeking Alpha were, Felix Salmon and this analyst. Both articles emphasized the charges against Goldman and not the defense. Although links were provided to Goldman Sachs statements (in my article and comment stream), the thrust of both articles was to the nature of the SEC complaint.
In the following I will discuss what those have to say who seemed to be aligned, at least partially, with defense of Goldman in one section and summarize what the themes seem to be with Goldman detractors following sections. Finally, some questions that remain, at least in my mind, will be put on the table in a concluding section.
Statements for the Defense
This section most appropriately leads off with two statements issued Friday by Goldman Sachs. The first statement, issued a few hours after the SEC charges were made public, contained a single sentence related to the suit:
The SEC’s charges are completely unfounded in law and in fact and we will vigorously contest them and defend the firm and its reputation.
A few hours after the first statement, GS issued a second statement with a more specific response to the SEC action:
We want to emphasize the following four critical points which were missing from the SEC’s complaint.
• Goldman Sachs Lost Money On The Transaction. Goldman Sachs, itself, lost more than $90 million. Our fee was $15 million. We were subject to losses and we did not structure a portfolio that was designed to lose money.
• Extensive Disclosure Was Provided. IKB, a large German Bank and sophisticated CDO market participant and ACA Capital Management, the two investors, were provided extensive information about the underlying mortgage securities. The risk associated with the securities was known to these investors, who were among the most sophisticated mortgage investors in the world. These investors also understood that a synthetic CDO transaction necessarily included both a long and short side.
• ACA, the Largest Investor, Selected The Portfolio. The portfolio of mortgage backed securities in this investment was selected by an independent and experienced portfolio selection agent after a series of discussions, including with Paulson & Co., which were entirely typical of these types of transactions. ACA had the largest exposure to the transaction, investing $951 million. It had an obligation and every incentive to select appropriate securities.
• Goldman Sachs Never Represented to ACA That Paulson Was Going To Be A Long Investor. The SEC’s complaint accuses the firm of fraud because it didn’t disclose to one party of the transaction who was on the other side of that transaction. As normal business practice, market makers do not disclose the identities of a buyer to a seller and vice versa. Goldman Sachs never represented to ACA that Paulson was going to be a long investor.
Others Who Have Spoken in Defense of Goldman
One of the first I heard was Jim Cramer on CNBC who gave a report during the afternoon about information from anonymous reliable sources that had told him Goldman was confident of its innocence because it had lost money on the transaction cited in the SEC complaint. In the evening he had a discourse (video here) which, among other things, gave the following opinions:
- Cramer does not see anything illegal, immoral or unethical in what Goldman did.
- John Paulson, who made the request that CDOs (collateralized debt obligations) be structured with CDSs (credit default swaps) on the weakest MBS (mortgage backed securities), was not a big name back then. His bet could have gone against him instead of against the buyers of the long position and he could have lost millions.
- Goldman lost $90 million on the securities deal.
- The client bank buying the securities made a bad bet and paid the price.
- The name of John Paulson could not have been divulged to buyers of the CDOs. In essence, Cramer says Paulson was the seller and it is illegal for a securities intermediary to divulge the name of the seller to the buyer and vice versa.
Cramer has furthered his argument with a short piece at TheStreet.com.
A second defender is Henry Blodget, a former top-ranked Wall Street analyst, who says the allegations against GS are very weak; he says charges against Tourre, though weak, may be stronger. Writing Friday at Clusterstock Business Insider, Blodgett makes a strong case for the defense of Goldman, but less so for Tourre. Blodget is an "insider" expert on securities business sanctions. The following is a quote from his bio profile at The Business Insider:
From 1994-2001, Henry worked on Wall Street at Prudential Securities, Oppenheimer & Co., and Merrill Lynch. He ran Merrill's global Internet research practice and was ranked the No. 1 Internet and eCommerce analyst on Wall Street by Institutional Investor and Greenwich Associates. He was later keelhauled by then-Attorney General Eliot Spitzer over conflicts of interest between research and banking and booted out of the industry.
W.C. Varones has pointed out that Blodget also thought Martha Stewart would not be convicted (here). And, of course, Blodget was on the “wrong side of the trade” with Eliot Spitzer in his own case.
Andrew Bary, in a feature article in Barron’s, says that even if the SEC charges stick, the market reaction on Friday was overblown. Bary feels that GS has far more resources than necessary to ride this out and put it behind them. He says the stock is undervalued. Seeking Alpha’s Trader Mark expresses a similar opinion.
Attack Dogs
As might be expected, there are a lot of rather strongly worded statements that are on the side of the claimant. Note: I did not use the word “prosecution” because the SEC has filed a civil complaint, not a criminal one.
No surprise, Matt Taibbi, Goldman critic and frequent contributor to Rolling Stone, has a brief post at True Slant entitled "Goldman Sachs Busted".
John Taplin at TPMCafe called this “the greatest short scam of the last decade.”
David Goldman (Seeking Alpha) says this opens Pandora’s box for financial firms and stocks.
Option Monster (Seeking Alpha) wonders if this situation might extend to additional deals at Goldman (and other firms). Of so, might the eventual result be that AIG (and hence the government) get restitution from Goldman (and others).
Joe Sudbay at Americablog called for criminal charges.
Tony Czuczka (Business Week) reports Germany may take legal action against Goldman Sachs.
Ben Sills and Ben Moshinsky (Bloomberg/ Business Week) report that the EU investigation of Goldman will be “profound and thorough,”according to EU Monetary Affairs Commissioner Olli Rehn.
There are other articles and posts out there, but this should give you enough of an idea about the “attack dog” reactions.
Others Speaking Mostly on the SEC Side
Prof. Lynne A. Stout (UCLA) faults the 2000 Commodities Futures Modernization Act. Prof. Stout says that the legislation did away with the constraint that at least one side of any derivatives trade must have a hedging interest. With the new law, moral hazard was introduced. Since then the equivalent of buying insurance on a neighbor’s house and then committing arson became legal (from the New York Times.)
Prof. Michael Greenberger, Univ. of Maryland and former director of trading and markets at the Commodity Futures Trading Commission, raises the question: How can misuse of power be prevented when an intermediary is able to sell two evenly matched, but highly conflicting, investments. Greenberger implies (but never asks) the question: What is the responsibility of the intermediary to make full disclosure equally to both clients? He does ask: What is the accountability standard that should apply to the intermediary? (From the New York Times.)
Nicole Gelinas feels that this case is further evidence that opacity in markets is the problem. Gelinas, contributing editor to the Manhattan Institute’s City Journal and author of “After the Fall: Saving Capitalism from Wall Street — and Washington” had this to say:
Congress should direct regulators to impose trading, disclosure and capital rules consistently across financial firms and instruments — so that markets can smash the repositories for secrets that imperil the economy. (From the New York Times.)
Yves Smith, of Naked Capitalism, writes the following:
No matter what happens to this particular lawsuit, it’s critical not to lose sight of the fact that immoral, destructive behavior has become deeply entrenched on Wall Street, and it will take concerted action to root it out.
Smith’s discourse implies the following question: What will it take to make markets safe from misrepresentation to investors? (From the New York Times.)
Naomi Prins, a senior fellow at Demos and author of “It Takes a Pillage: Behind the Bailouts, Bonuses and Backroom Deals from Washington to Wall Street” and “Other People’s Money: The Corporate Mugging of America” writes:
In our current regulatory framework, any issuing bank can act on all sides of a C.D.O. (or other complex security) — as creator, trader, hedger and seller. This inevitably means there will be conflicts of interest because the bank in the middle gets paid (handsomely) for all its services, no matter what the outcome of the deal’s performance. Plus, it has the benefit of insider knowledge.
Prins is well qualified to question the potential conflicts if interest in this case and similar situations; She is a former managing director at Goldman Sachs. (From the New York Times.)
Edward Harrison asks if there is ant political motivation in the timing of the SEC filing. He wonders if it is fuel for engendering support for financial reform. He does think there are some positives, however:
Since at least 2004, when the FBI warned of a mortgage fraud “epidemic,” it has been clear that deception, predatory lending and outright fraud have been rampant in the financial services industry. Yet regulators did nothing. Therefore, my initial reaction to the fraud charges against Goldman Sachs for misleading clients is largely positive. I have long felt that the government was treading lightly against large U.S. banks, perhaps for fear of our economy’s fragile state.
Harrison is a banking and finance specialist at the economic consultancy Global Macro Advisors. He is also the principal contributor to the financial Web site Credit Writedowns and a leading contributor here at Seeking Alpha. (From the New York Times.)
Douglas Elliot, of the Brookings Institute, also wonders if the SEC action will support the passage of financial reform. (From the New York Times.)
Megan McCardle, business and finance editor for The Atlantic, doesn’t directly ask the question, but it is clearly implied: Is this the case that reveals the extent to which investment markets are rigged?
McCardle writes (from the New York Times):
One side of the transaction had dramatically more information than the other — a situation which most market regulation is supposed to prevent. If the S.E.C. is correct, this isn’t merely evidence of a crime, but of a distressingly cavalier attitude toward basic rules of market conduct.
Critics have long accused the bulge-bracket banks of using their market position to self-deal at the expense of ordinary investors. But these charges suggest that heavy-handed use of market muscle may have slipped over the line into outright fraud.
William Black, professor at the University of Missouri Kansas City and a former top federal financial regulator, wonders why the allegations are so tame, why no management higher-ups have been named and why there are no criminal charges. Black wrote (from the New York Times):
The S.E.C. complaint says that Goldman defrauded its own customers by representing to them that the C.D.O. was “selected by ACA Management.” ACA was supposed to be an independent group of experts that would “select” nonprime loans “most likely to succeed” rather than “most likely to fail.” The SEC complaint alleges that the representations about ACA were false.
The question is: did John Paulson and ACA know that Goldman was making these false disclosures to the C.D.O. purchasers? Did they aid in what the S.E.C. alleges was Goldman’s fraud? Why have there been no criminal charges? Why did the S.E.C. only name a relatively low-level Goldman officer in its complaint?
Some Questions I Haven’t Heard Others Asking
- Is there such a thing as a loss leader in investment banking? Goldman claims it lost $90 million on the Abacus deal. (Abacus was the name of the CDO offering in question.) First, I haven’t heard that there has been an independent accounting of the $90 million. Is it real? Secondly, everything is related to everything else. How much did Goldman make on related deals? Did they give a napkin away to attract a buyer for an expensive china place setting?
- What about criminal charges? Richard Blumenthal, Connecticut AG is starting an evaluation of criminal charges. But I have heard nothing from New York. Is AG Andrew Cuomo too preoccupied with his run for governor to look into this?
- Why hasn’t anyone suggested that John Paulson was guilty of insider trading? I’ll answer my own question: It’s probably because insider trading rules apply only to publicly traded securities. Doesn’t that make a case for requiring all securities and derivatives to be publicly traded and subject to all the rules and regulations that apply there?
- What should be the fiduciary standard for investment banking intermediation? I have written before (here and here) about the problem that FINRA (Financial Industry Regulatory Authority, an industry self-regulation organization for broker-dealers) has resisted the attempts to establish fiduciary responsibility for registered reps at retail broker dealers. Obviously, if that is resisted at the level of contact with individual investors, the financial sector is a long way from considering fiduciary responsibility for more complex dealings with presumably more sophisticated entities.
- Doesn’t capitalism have the basic concept of a fair market (or a free market) that includes transactions at “an arm’s length”? How does intermediation where all parties are not equally informed by the intermediary satisfy one of the basic tenets of capitalism?
The best thing that can happen here is for this case to go to trial. Goldman reportedly has declined to try to settle for a fine and a reprimand, but they could be maneuvering to do just that later. This case should go to trial and every minute should be televised. There are two reasons I say this. (1) The discovery phase of the trial will be very educational for the public. (2) The shortcomings of existing law will be itemized in detail with every denied objection from both sides.
Note: After completing this piece, I came across a post by Mish (Mike Shedlock) here that discusses some of my questions. Mike is a Seeking Alpha contributor and this article may show up here. It had not been posted at the time I wrote this.
Disclosure: No positions.
