A 650-page report released yesterday by a bipartisan US Senate Committee was scathing of Wall Street investment banks, with the report’s co-author, Senator Carl Levin, stating Wall Street is a “financial snake pit rife with greed, conflicts of interest, and wrongdoing”. Leading investment global bank Goldman Sachs received the brunt of the criticism, with the report recommending criminal charges be laid, including charges against Goldman Sachs chairman and CEO Lloyd Blankfein.
Last year Goldman paid $550 million to settle civil charges brought by the Securities and Exchange Commission, relating to what was known as the “Abacus” transaction. The charges occurred after the investment bank had allegedly sold synthetic Collateralised Debt Obligations (CDOs) to clients without telling them that the instruments had been constructed by hedge fund investor John Paulson, as a means to “short” the US housing market.
The accusations made by the Senate Report are far more serious though — with the report alleging Goldmans systematically profited from “shorting” the mortgage security market, while also profiting from selling mortgage securities to clients. In the earlier (settled) SEC claim, it was Paulson, not Goldman, which was alleged to have made the trading profits.
The ramifications from the Senate report appear to be far more serious than the earlier SEC charge. Not only are Goldman Sachs accused of misleading clients, but Blankfein (who was paid more than $100 million over 2006 and 2007 and more than $18 million in 2010), may face personal criminal charges after he was accused of misleading Congress. Thus proving the cover-up is almost always worse than the crime.
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In a press conference, Senator Levin was especially critical of Goldmans (and also Deutsch Bank), stating: “Why would Goldman deny what is so obvious, that they were engaged in a huge short? … Because they gained at the expense of their clients, and they used abusive practices to do it.”
While many practices of investment banks are abhorrent, and the remuneration received by employees for contributing virtually nothing to society is obscene (in fact, the contribution by bankers is almost certainly a negative one), the criticism of Goldmans appears unwarranted. Clients of investment banks, and especially clients of Goldmans, are fully aware the bank not only sells securities, but also takes its own “proprietary” interest in trades. A “two minute scan of Goldman’s Annual Reports indicates would have indicated the extent of its profits from proprietary trading, especially in the lead-up to the global financial crisis.
Further, the entities purchasing the securities sold by Goldmans are allegedly large, sophisticated institutions, themselves being paid substantial amounts by clients to invest on their behalf. Many institutions were especially critical of the small minority of investors who were effectively “shorting” the US property and mortgage debt market. They were confident of their views, and were happy to effectively sell “insurance” on mortgage debt in exchange for a slightly higher yield.
Were Goldmans’ hands completely clean? Almost certainly not. One part of the bank was clearly telling one thing to investors, and making the complete opposite trade itself. But is that any different from a real estate agent selling their own house, while at the same time, enticing bidders to bid on another property? Or a senior executive selling shares in the company they runs?
Goldmans was performing a service to clients. Those clients wanted to buy mortgage debt securities. Goldmans facilitated that service. Further, the people selling the debt were not the same people as the prop traders who were taking a “short position” against the mortgage market. (Incidentally, Goldman was also very bullish about the property market up until late 2006, with the bank switching from a net “long” position of US$6 billion to a “short” position of US$10 billion by February 2007.)
Senator Levin was especially critical of Blankfein in his press conference, effectively accusing the Goldmans CEO of perjury in Senate testimony in April 2010. Levin stated that “Goldman clearly misled their clients and they misled the Congress” after Blankfein told Congress that “we didn’t have a massive short against the housing market and we certainly did not bet against our clients … Rather, we believe that we managed our risk as our shareholders and our regulators would expect.”
While Goldman is not without fault, it is far to suggest the ultimate collapse of poorly managed investment banks like Bear Sterns, Lehman Brothers and Merrill Lynch (and the oft-forgotten taxpayer bailout of Citigroup) were far more damaging than Goldman’s duplicity. Those banks paid their executives billions, only to wipe out not only their own shareholders, but require trillions of dollars in taxpayer assistance to try to rescue the global economy from collapse.
The report was also critical of Deutsch Bank, whose star trader, Greg Lippman, effectively created the market to allow hedge funds like John Paulsen to “short” the mortgage sector through synthetic collateralised debt obligations. Deutsch was accused by Levin of engaging in “disturbing activities”. This assessment appears unfair, given Lippman was effectively a pariah and hated within Deutsch for his publicly negative views on the property sector (Deutsch ended up losing more than US$10 billion on its own “long” positions).
After release of the report, Goldman Sachs shares fell by 2.7% in after-hours trading.