Thoughts on the Goldman Fraud Charges
In addition to the charges from the SEC, Goldman is now facing charges in Britain and additional scrutiny in Germany. With all of this going down while we await the passing of new hedge fund legislation in both the E.U. and the U.S., we have to ask ourselves, if the AIFM directive passes and if the Volcker rule goes through will it even make a difference? Would more financial oversight be able to prevent these losses? Will any kind of regulatory structure be able to eliminate this kind of conduct on the part of hedge funds?
I honestly don’t know. These sort of back-room deals done with a handshake and a wink and a smile by the a couple of “old boys club” guys in $5,000 suits are notoriously hard to police. Sure, we can attempt to limit compensation and cut big banks out of hedge fund activity and proprietary trading. We can require hedge funds to register with the SEC or with some regulatory body abroad, monitor their risk exposure and the amount of leverage they can take on, restrict who they can employ in third party roles, try to force them to increase transparency… but, honestly, there are nearly 15,000 single-strategy hedge funds globally… somehow I feel that, even with the most dedicated and brightest of staff (and the SEC is apparently looking to hire experienced hedge funders now so they will have insight into the inner workings of hedge funds in order to properly monitor them), the highly intelligent minds running those hedge funds will be able to find loopholes in whatever laws the government comes up with– or just disregard the laws entirely and conceal whatever devious designs they have to make a fast buck. There will always be loopholes—and sometimes, making money isn’t pretty. In fact, greed can be downright ugly, as we have seen here with the Goldman fraud charges. The only real solution I can see is to minimize the opportunities for such insider deals by pushing as many transactions as possible onto central clearinghouses and exchanges in order to increase transparency– and that’s not really a solution. People will still find ways around it.
Ever since Lehman collapsed in 2008 and America has really been feeling the financial strain (not that our economy was exactly setting records prior to that), there has been public outcry that something be done. Big banks are not making themselves look good. Hedge funds are not helping themselves out here either, despite the fact that official reports looking into the financial crisis — such as the British government-commissioned Turner Review, published in March — assigned such funds only a marginal role in the melee. But most politicians are quick to blame, the public is easily convinced of their guilt, and they’re an easy scapegoat. It looks really bad when America finds out that they’re the ones largely behind all of this mess… nevermind the fact that there were only a select few jackasses behind the plan to create the CDOs that Paulson would later bet against and Goldman would conveniently forget to tell its investors Paulson had a hand in creating and picking… now both industries will be blamed. And the big paydays for bank and hedge fund heads look really bad when 10 percent of the nation is unemployed and close to 17 percent is underemployed thanks to the mess they helped (in part) to create. I mean, the current state of the economy is hardly entirely Goldman’s fault (or Lehman’s or any one other entity’s), but they certainly didn’t help matters.
So it’s little wonder that Obama and et al., along with most of Europe (with the notable exception of Britain, which is trying to push for softer hedge fund regulation) are clamoring for financial reform, with the U.S. trying to corral the commercial banks and the E.U. seeking to reign in hedge funds. Right now, big banks are a frickin’ jack of all trades. In this case, Goldman was creator, trader, hedger and seller of the CDOs. It reminds me of a Homer Simpson quote: “Television: teacher, mother, secret lover.” Not quite the same, but my brain is wired a little funny, and I have loose associations, so indulge me. My point is, maybe banks have their fingers in too many pies and their sticky fingers are creating quite a mess… at least such is the thinking behind the proposed legislation. If we were to restrict the number of functions they could perform, we could also eliminate some of the conflicts of interest. Maybe.
But the banks are fighting hard against the legislation designed to weaken their market power, despite the fact that their actions continue to erode public trust in the markets. It’s a real blow to the financial system as it struggles to rebuild public confidence. And as long as this lack of trust and uncertainty persists, markets might charge a higher systematic risk premium. A new breakdown in trust could also undermine efforts to revitalize the battered financial industry, possibly increasing concerns about transparency, due diligence and complexity.
It’s unlikely that the timing of the charge brought against Goldman is coincidental: Obama is probably going to use it politically to bolster his argument that America seriously needs the financial reform he is proposing– most likely, as the Washington Post put it, “as a cudgel to persuade Republicans to line up behind the bill.” I already thought that the odds of the legislation being passed were high, but now I’m all but certain of it. The public wants greater oversight. They want the big banks to stop screwing them over and taking them under when they bet big and lose.
The SEC’s allegations against Goldman are hardly shocking, and I expect that in the coming weeks/months we will see more charges against other firms involved in similar investment schemes. A headhunt was all but inevitable—it’s just took a little longer than I personally thought it would. But, again, maybe Obama was biding his time, waiting to announce it so that it coincided with the near-passage of his proposed financial reform legislation. Just a pet theory.
The sad truth is that there is a solid chance that Goldman may get away with this, despite the public desire to see heads roll. The reality of the situation is that there has been a lot of deregulation in recent years (see the Commodities Futures Modernization Act of 2000, for example)—maybe too much deregulation for Goldman to be found guilty, and maybe too much for these charges to even stick. You’ve got to know Goldman has it’s legal team working overtime to find a way out of this, and fast– before its stock sinks any lower. It’s entirely possible that Goldman’s conduct may be ruled distasteful and unethical, but technically legal… Unbelievable as that may seem, it’s entirely possible. Only time will tell.
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