The villain in a dumbed-down morality play
The SEC’s lawsuit against Goldman Sachs will only let politicians off the hook for the state of the economy.
The media is in a frenzy over Goldman Sachs. Last Friday, the US Securities and Exchange Commission (SEC) charged Goldman Sachs with securities fraud in a civil lawsuit. The SEC claims that the Wall Street giant deceived clients by selling them a subprime mortgage investment product that was intended to fail.
The story is being hyped up as a court case that might define the financial crisis era. Yet, in one sense, it is hard to see just what the fuss is about. Consider the information we know about the case itself:
- The investment vehicle created by Goldman Sachs, called Abacus 2007-ACI, was a collateralised debt obligation (CDO). As an incisive Wall Street Journal editorial notes: ‘By definition, such a CDO transaction is a bet for and against securities backed by subprime mortgages. The existence of a short bet wasn’t Goldman’s dark secret. It was the very premise of the transaction.’ In other words, a CDO will have investors on both sides: those taking long positions (betting it will increase in value) and those taking short positions (betting it will decline). The fact that it was a ‘synthetic’ CDO – which means no cash investment was made in the securities themselves, just a bet on how they would move in value – indicates how it was designed for pure speculation.
- The investors who took long positions – America’s ACA and the German bank IKB – were what are referred to as ‘sophisticated investors’ – that is, big boys who should know that ‘buyer beware’ applies everywhere in investment. They knew what mortgage securities they were betting on. As William Cohan wrote in a New York Times op-ed piece: ‘No one forced them to buy Abacus.’
- At the time the investments were made, there was no certainty that the funds would fall in value. Many were still bullish on the subprime market. And if the assets had risen in value, would the SEC be charging Goldman today?
- The claim against Goldman is that it did not reveal that hedge-fund manager John Paulson helped to select the securities. But at that time, Paulson was a virtual nobody (he became famous later as he made billions by betting against the housing market). As John Tamny notes in Real Clear Markets: ‘Back then, Paulson was not taken seriously, and if his role had been known, it’s a fair bet that client demand for Abacus would have been even greater.’ So why did Goldman have, as the SEC asserts, the obligation to inform potential investors that he was on the other side? Yes, Paulson identified the securities he wanted to bet against, but not all were ultimately selected, as he did not have authority to make the final selections; ACA’s management had the final word, as even the SEC admits. Paulson could not get all the assets he wanted in the package, as there needed to be those on the other side of the trade who would agree to buy.
- The media are excited about the ‘billions’ involved. In fact, Paulson made about $1billion. Which, in the world of investment banking and toxic assets, is akin to Dr Evil’s ransom claim in the movie Austin Powers for ‘one… million… dollars’.
- Goldman itself lost money on the deal ($90million), making it a fraud to deceive… itself?
- It appears that only one Goldman executive, Fabrice Tourre (who referred to himself as ‘Fabulous Fab’), was involved, with no connection to the top executive team.
- The case might drag on for months, if not years, and since this is a civil (rather than criminal) case, the most likely outcome is that Goldman, if found guilty, would face a fine that would probably represent a tiny portion of its assets.
So, it is not clear-cut whatsoever that Goldman broke the law, but if it did, the offence will not be a major one, nor will the company face a devastating penalty. Goldman’s reputation would be damaged. But, overall, not much will have objectively changed, whatever the verdict.
Yet, while the facts of the case don’t worry the headlines, there are clear reasons why the story is deemed newsworthy. The first reason has to do with short-term political expediency. The Obama administration, Senator Chris Dodd and other Democrats have jumped on the Goldman case to try to push through their financial reform legislation. Never mind that the reforms do not address the issue at stake in the Goldman case.
The award for rank political opportunism, however, must go to British prime minister Gordon Brown. In the midst of the UK’s General Election and with his party trailing in third place in some recent polls, Brown took the opportunity to complain about Goldman, even though his government has only an indirect connection to Goldman and the case (the bailed-out Royal Bank of Scotland inherited a loss of $841million after acquiring ABN Amro, which made the brilliant decision to insure the securities). As Brown told the BBC: ‘We need a global financial levy for the banks. We have to quash remuneration packages, such as Goldman Sachs. I cannot allow this to continue.’ Note the multiple non-sequiturs: a ‘global financial levy’ has nothing to do with preventing Goldman from creating CDOs or disclose who bets on them; ‘remuneration packages’ reminds people that bankers get big bonuses, but the SEC is not charging Goldman with being overpaid; and the reference to ‘I cannot allow this…’ is just bizarre, as if Brown himself was going to bring Goldman Sachs to justice.
But the real driving force behind the rush to condemn Goldman – even more than short-term politics – is the desire to put a face to a simplistic, conspiratorial version of the financial crisis story. The authorities are presenting us with a morality tale, and Goldman has now been chosen as the big, bad villain. It is as if, unless we find an evil-doer committing a crime, we haven’t really got to the bottom of the financial crisis.
For example, a New York Times leader declared: ‘We urge everyone to keep a close eye on this case. If it is handled correctly, it should finally answer the question of whether malfeasance – and not merely greed, incompetence and weak regulation – was also responsible for the financial meltdown.’ Great: first we were told bankers were greedy; now we’re being told they’re crooks, too. What a tremendous advancement in our understanding of economics!
Deals like the one Goldman is accused of arranging did not cause the financial panic. More generally, Goldman and other investment banks were not the only ones implicated in the financial crisis either. The problem of an imbalanced economy skewed towards an overgrown financial sector was (and remains) systemic, the result of both an underperforming non-financial sector as well as an expanding financial sector. And, most importantly in political terms, a proper reckoning would recognise the role that the political class played in facilitating the financial blow-up. Targeting Goldman as the deceptive mastermind has the huge advantage for politicians of diverting attention and blame away from themselves.
The Goldman case will be a big deal, but not because it deserves to be.
Sean Collins is a writer based in New York. Visit his new blog, The American Situation, here.
Previously on spiked
Rob Lyons attacked Darling’s decision to bash bankers at Labour’s Autumn conference. Sean Collins explored the true story behind the battle to save Wall Street. Brendan O’Neill explained that the attack on Fred Goodwin’s home was the result of an elite blame game. Daniel Ben-Ami argued that blaming bankers glosses over long-term economic decline. Tim Black attacked those who wanted to scapegoat the spivs. Or read more at spiked issues Economy and USA.