The Reasoned Review

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Fraud Didn’t End With Goldman Sachs

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Hats off to ProPublica for their phenomenal follow-ups to the SEC case against Goldman Sachs, and for revealing that what might have been a genuine move against corruption now merely seems like a politically motivated slap on the wrist, a show-trial, essentially, where big bad Goldman Sachs gets forced to pay a pittance of a fine and the rest of their compatriots who indulged in the exact same practices go off scot-free. Let’s not forget that they paid only 1% of their 2009 profits in taxes, so whatever restitution the SEC squeezes out of them won’t begin to cover their debt to the US Government.

For those of you who haven’t been following the byzantine hearings regarding the Goldman case, with their alphabet soup of acronyms and stern avocations from our media that these are “complex financial instruments” we’re dealing with – well, who can blame you? But the gist of the case is relatively easy to follow, and while Goldman may have been a particularly egregious offender, almost every investment bank bigger than a mom-and-pop outfit traded in Collateralized Debt Obligations (CDOs), the “complex instruments” that lie at the center of this case. Earlier this month ProPublica ran an extensive look at Magnetar, a hedge fund that traded exclusively in CDOs, and just a few days ago it revealed that Merril Lynch engaged in identical practices to the ones that got Goldman Sachs sued by the Securities and Exchange Commission.

CDOs are basically a bet that a given asset will perform well or perform poorly. In the Goldman Sachs case, Goldman put together securities (assets) that it knew would fail (the SEC hopes to show that a Goldman trader specifically picked the components of the securities for their especial toxicity), sold those securities to gullible investors, then secretly took out a collateralized debt obligation against that same security, betting, in essence, that its value would go to zero, which of course they knew would happen because they picked it specifically to do so. When, sure enough, the security did become worthless, Goldman hit paydirt.

This is called fraud, and it’s a pretty grievous sin in the world of finance (at least it was, once upon a time). So on one hand, it’s absolutely just for Goldman Sachs to come under the SEC’s gun, get its reputation tarnished a bit, and, with luck, get a few of its executives fired, where they can live the rest of their days in their Park Avenue penthouses, counting their ill-gotten gains. But on the other hand, what is the use of this symbolic prosecution if it doesn’t engender a shift in practices from the financial community?

The case of John Paulson and Goldman Sachs identified in the SEC indictment was neither the biggest nor the most blatant case of securities fraud during the run-up to the crisis. For the SEC to suddenly regain its regulatory muscle, and for them to focus on this one case to the exclusion of all else stinks of politics. President Obama’s approval ratings are dropping fast, and prior to this there had been no prosecutions of financial fraud at all. I could easily see President Obama instructing the SEC to move forward on the Goldman case so he could have something to show by November, especially since Goldman is the most visible and most reviled of all the Wall Street slimeball firms.

Finally, this case brings to light just how important the financial reform being discussed in the Senate is to prevent future such fraud. Currently most of the discussion seems to center around the politically popular “consumer protection”, but while overdraft fees and adjustable rate mortgages were pernicious side effects of the crisis, the real engine behind the financial meltdown was the widespread sale of over-the-counter (unregulated) derivatives like the CDOs mentioned in this case.

“Financial Reform” means nothing if not the outright ban of derivatives trading – or failing that, the erection of a structured derivatives exchange where fraudulent trades like the Goldman Sachs deal would be visible to the public and to investors. Without that, we’re literally back where we started.

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Written by pavanvan

April 23, 2010 at 2:54 pm

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