04/19/10 Laguna Beach, California – If you shine a light on a cluster of cockroaches, they scatter and hide. But when you shine a light on a cluster of investment banking con men, they simply stare back and reply, “The SEC’s charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation.”
As the entire investing world knows by now, Goldman Sachs is the latest cockroach to scuttle under the spotlight. Last Friday, the Securities and Exchange Commission accused Goldman of defrauding investors out of $1 billion.
The details of the SEC’s complaint allege that Goldman failed to disclose “vital information” about a mortgage-back security called Abacus. The SEC said: “Unbeknownst to investors, Paulson & Co. [a hedge fund]…which was posed to benefit if the [securities in Abacus] defaulted, played a significant role in selecting which [securities] should make up the portfolio…In sum, Goldman Sachs arranged a transaction at Paulson’s request in which Paulson heavily influenced the selection of the portfolio to suit its economic interests.”
Goldman responded in classic fashion – crying “Foul!” and claiming that it is the victim of a gross misunderstanding. Does anyone really believe them? To rephrase the question, does anyone really believe that this single instance of alleged fraud is the only such instance?
This question reminds us of another truism about cockroaches: There’s never just one. Any financial firm that is capable of committing a fraud as egregious and flagrant as the one the SEC’s complaint describes is certainly capable of committing a second fraud…and maybe even a third or a fourth…or a fortieth.
The fraud the SEC identifies in its complaint against Goldman is not a mere “Oops!” It is a fraud that every licensed stockbroker in the land would recognize as a career-ending no-no.
“The product was new and complex,” explained Robert Khuzami, a director from the SEC’s Division of Enforcement, “but the deception and conflicts were old and simple.”
In other words, a lie is a lie.
Nevertheless, your editor is content to let due process run its course…and to wait as long as necessary for the guilty verdict to arrive.
Whatever the ultimate verdict, Goldman is already “guilty by association” in the eyes of most Americans. It is guilty by its close association with the practices that precipitated the financial crisis of 2008. It is also guilty by its close association with the powers in Washington who decided which firms would receive billions of dollars of emergency assistance (i.e. Goldman Sachs) and which would be allowed to fail (i.e., Lehman Bros.). And most of all, it is guilty by its close association with the obscene sense of entitlement that characterizes Wall Street pay practices.
In short, America hates Goldman Sachs.
So the fact that Goldman may have actually committed a large-scale fraud is a very big deal. Suddenly, the Goldman-haters are carrying loaded weapons…and the ensuing firefight might produce some significant volatility in the financial markets.
For starters, this event might produce a very convenient excuse for a very pronounced selloff. But Goldman is not merely an excuse for a stock market selloff; Goldman is the stock market…and it is also the commodity market and the Treasury market. Goldman is the biggest market maker in the US stock market and among the biggest players in every major commodity market. Goldman is also one of the largest primary dealers of Treasury Securities.
So maybe it is no fluke that most commodities tumbled Friday, right along with the stock market. Gold and crude oil both tumbled more than 2%. And as this new week begins, Goldman’s troubles are mounting.
Citing Goldman’s “moral bankruptcy,” Britain’s Prime Minister Gordon Brown called for a full inquiry by Britain’s Financial Services Authority in conjunction with the SEC. Germany also said it would ask for detailed information about the case. Both governments had to bail out banks that lost hundreds of millions of dollars on investments marketed by Goldman.
None of this will be good news for the stock markets of the world. And yet, none of this is really a surprise either. Nearly two years ago, in a column entitled, “The Goldman Sachs Phenomenon,” your California editor remarked, “The American financial system still possesses too much talent and creativity to operate prudently… Consider yourselves forewarned!”
Just two months before this column first appeared, JP Morgan Chase had acquired the failing Bear Stearns. As part of the deal the Federal Reserve took responsibility for $29 billion in toxic assets from the Bear Stearns portfolio – effectively handing a $29 billion subsidy to JP Morgan, and establishing a precedent for the hundred-billion-dollar subsidies that would flow to Wall Street’s largest firms just six months later.
We smelled a rat back then…and the rat doesn’t smell any better now…
Eric Fry
for The Daily Reckoning
Eric Fry
Eric J. Fry, Agora Financial’s Editorial Director, has been a specialist in international equities for nearly two decades. He was a professional portfolio manager for more than 10 years, specializing in international investment strategies and short-selling. Following his successes in professional money management, Mr. Fry joined the Wall Street-based publishing operations of James Grant, editor of the prestigious Grant's Interest Rate Observer. Working alongside Grant, Mr. Fry produced Grant's International and Apogee Research — institutional research products dedicated to international investment opportunities and short selling.
Mr. Fry subsequently joined Agora Inc., as Editorial Director. In this role, Mr. Fry supervises the editorial and research processes of numerous investment letters and services. Mr. Fry also publishes investment insights and commentary under his own byline as Editor of The Daily Reckoning. Mr. Fry authored the first comprehensive guide to investing internationally with American Depository Receipts. His views and investment insights have appeared in numerous publications including Time, Barron's, Wall Street Journal, International Herald Tribune, Business Week, USA Today, Los Angeles Times and Money.
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“The product was new and complex,”….
Sounds like a bit of “Greenspaneze”
It will be interesting to see if the SEC has grown a pair, or is just as “limp wristed” as usual.
How far does the rot spread????