Saturday, May 1, 2010

Enron On The Hudson: The Goldman Defense (part 3 of a series)

This was a rough week for The Great Vampire Squid.

No sooner were they hit by the SEC lawsuit but they
were hauled before the Senate Permanent Subcommittee
on Investigations to answer questions they would
prefer not be asked, especially in light of the pending
SEC enforcement action.

And in listening to the proceedings on C-SPAN, I couldn't
help but wonder if the participants were all on the same

The Senators, all interested in appearing to be "on top"
of the causes of the financial collapse before a confused
and angry public, berated Chief Squid Lloyd Blankfein
and his lieutenants, Chief Risk Officer Craig Broderick
and CFO David Viniar about the "sh***y" deals they
foisted on their unsuspecting clients.

But Blankfein and his fellow mollusks didn't bat an
eye or even twitch a tentacle.

And, in their responses to the committee, they in fact
outlined what will no doubt be their defenses to the
SEC charges.

Now, I'm not an attorney, so I'm not going to get into
the particulars about "affirmative defenses" and the
finer points of both case and regulatory law that Goldman
will no doubt raise. In fact, Goldman's attorneys have yet
to file their legal response to the SEC charges, which will
cover all of these matters in minute detail. When they do,
we will cover the response.

But to me, there appear to be three things that will make up
Goldman's defense:

1) "We were a Market Maker, not an Originator, in this transaction".
This is perhaps the most plausible defense that Goldman has. In
modern finance, institutional buyers and sellers often approach
investment banks to put together packages of securities to
either "Go Long" (hold in expectation of a profit), "Go Short" (sell
short to profit from a decline) or to "Hedge" ( buy or sell securities
to mitigate risk on an unrelated transaction).

In the Abacus transaction, Goldman put together a
package of securities for its client Paulson & Co. that
reflected Paulson's desires - Paulson believed that the
housing market would collapse, and wanted to go short
on a package of existing mortgage-backed securities likely
to fail in that instance. Goldman, as market maker,
put together such a package.

Now, it takes two sides to make a transaction or a market,
and if Paulson was going to short the package, Goldman
had to find someone willing to take the other side. It found
three such parties - ACA Capital (then a subsidiary
of soon-to-fail Bear Stearns), ACA's client ABN Amro, and
IKB, a mid-range German bank. It even engaged ACA Capital
to be the selection agent for the deal - to pick out the very
securities going into the package. Thus, at one stroke, Goldman
made a market for its client, bringing both sides of a transaction
together, and pocketing a nice $15 million fee for its trouble.

In conclusion, then Goldman was, according to its lights,
both market maker and honest broker - doing something
it has done thousands of times before, in bonds, commodities,
equities and derivatives, according to the normal rules and
procedures that govern such transactions. Was it obliged to
tell ACA and the others that if they bought long, that a
particular party was going to sell short? Absolutely not;
in fact, doing so might have been a larger violation
of other SEC rules governing confidentiality and due
diligence. However, that will be a matter for the court
to decide.

2) "We've been unfairly singled out - everyone was doing this".
Point conceded. As the events of the past year and a half have
borne out, everyone on Wall Street was doing this kind of
dubious "business" - and, in point of fact, Goldman wasn't even
the largest player. That unsought-for distinction can be shared
by JP Morgan, Deutsche Bank, and the late-and-unlamented
Bear Stearns and Lehman Bros. Even Merrill Lynch, Bank of
America and Citicorp were heavily involved.

But, few of these institutions sought out this kind of
business with the naked aggressiveness of Goldman Sachs,
and its institutional willingness to skirt regulations and
bend the rules brought it huge notoriety along with huge
profits. Not for nothing did muckraking journalist Matt Taibbi
name Goldman "The Great Vampire Squid" - an unflattering
sobriquet that is now commonly used by the mainstream
media to describe Goldman and its attitude toward the
minimalist sense of morality and ethics that prevail on
Wall Street.

3) "We will completely prevail on the narrow points of law and fact".
A very troubling set of circumstances that just might happen. In
fact, due to its undue influence with lawmakers and regulators,
Goldman has done more to undermine what little remains of
a rule of law on Wall Street than any other institution.
As Simon Johnson points out in his book 13 Bankers, the
deregulation and unfettered "innovation" that made the
collapse of 2008 all but inevitable owes much to former
Goldman Chairman and CEO Robert Rubin and his total
domination of both Treasury and the regulatory
community during the Clinton Administration. And
the anti-regulatory zeal was brought to fever pitch by
former Goldman CEO Hank Paulson during his tenure
as Treasury Secretary in the second Bush Administration.

And where was Congress when all this was happening?
Busy lapping up campaign contributions and other favors
from Goldman's and the others' lobbyists. Small wonder
than when it came time to clamp down on the Wall Street
casino, these worthies were nowhere to be found.

But now, these folks may have seen the light. Stung by
the overflowing anger of the public, they may now be
shamed into reforming the "casino capitalism" of
Wall Street. But I'm not going to hold my breath
waiting for it to happen.

In fact, I'll make this prediction - if Goldman walks,
or gets away with a tap-on-the-wrist small fine by
copping a plea to violating an obscure rule or two,
neither the Army nor the police will be able to
contain the torch-and-pitchfork-wielding crowds
that will descend like locusts on both Wall Street
and Washington.

We want Calamari- and we'll take it either fried
or broiled.

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