Goldman Accused of Fraud

Good day, I’ll start the week off with a piece of good news regarding Chuck… His surgery went well on Friday, and he got to go home from the hospital on Saturday. I exchanged several emails with him yesterday, and he said the pain is dramatically better and he was able to make it through Sunday without the help of pain medication. The doctors want him to rest for a while, but the prognosis sounds good. Thanks again to everyone for all the emails of support, your prayers and words of encouragement are appreciated.

The SEC dropped a bomb on the markets Friday with the announcement of a civil suit accusing Goldman Sachs of fraud. The suit is based on complicated CDOs (Collateralized Debt Obligations) that were created and sold by Goldman. According to the SEC, Goldman allowed a large hedge fund investor who wanted to bet against the mortgage market to select securities to be included in a series of CDOs, which were then packaged and sold to investors. The investors (in this case some very large foreign banks) lost billions and the hedge fund investor gained. Goldman made money on both sides of the transaction, as they always do. It isn’t much of a stretch to believe Goldman didn’t give ‘full disclosure’ to the buyers of these CDOs, but I was a bit surprised the SEC decided to bring the suit.

This opens up a huge can of worms for Wall Street, as anyone who lost money on instruments sold by the big banks are going to come knocking on the door to regain some of their losses. While I am not a big backer of Goldman and their greedy manipulative ways, I question if the SEC will be able to win the case. Most of these investors were supposedly sophisticated enough to understand the products they were purchasing, and if not they shouldn’t have bought them. These are ‘big boys’ and made the investments into these CDOs knowing that someone was taking the other side of the trade; that is what makes markets. The bankers pocketed their billions, and now the lawyers are going to swoop in to get theirs. None of this can be good for the economic recovery of the US, as the lawyers just aren’t a big enough driver of economic growth in this country.

Goldman’s stock sold off dramatically, dragging down the broader market throughout Friday’s trading day. Currency investors sold all of the high yielders and moved money back into the ‘safe havens’ of the yen (JPY) and US dollar. The move back into the US dollar could prove to be temporary, as the charges brought against Goldman are predicted to keep the FOMC from pushing rates higher in the near term. Currency traders had started pricing in an earlier boost for US rates after positive economic data showed the US economy continues to recover. But new worries over the health of the banking system and Wall Street will force the Fed to keep rates lower longer.

Data released on Friday here in the US were mixed, with disappointing housing starts but building permits surprising the markets with an increase of 7.5% over the previous month. Andrew Murray, a Vice President in our mortgage area, sends me a daily update of the mortgage markets and explained this apparent contradiction: “Permits are not usually affected by weather so they are a more reliable indicator. Bad weather may delay actual housing starts, but the weather is always the same standing in line at the city offices where you get your building permit. Permits have climbed to their highest level since October 2008.” Andrew goes on to say this is a good sign for the future of the housing recovery.

This will be a fairly slow week for data, with the leading indicators today, followed by ABC Consumer Confidence tomorrow, and MBA mortgage apps on Wednesday. Thursday will be the big day for data with the release of PPI along with the weekly jobs numbers and existing home sales. Friday will end the week with durable goods and new home sales for March.

The euro (EUR) came under renewed selling pressure after the Greek Prime Minister called for talks with the IMF and EU. Prime Minister Papandreou is facing mounting public protests over the austerity measures that have been put into place to try and bring the deficits back into line. And if the Greek citizens are upset over the existing cuts to their public subsidies, just wait until the IMF demands become public. EU finance ministers told Greece to brace itself for the IMF conditions which will be discussed during talks originally scheduled to begin today, but now delayed until April 21st. Greece needs to raise almost 12 billion euros to cover bonds maturing on May 19, and the country’s financing costs remain at levels Papandreou calls ‘unsustainable’. The EU has pledged up to 30 billion euros and the IMF as much as 15 billion euros to help Greece cover these obligations. Papandreou will have to decide whether or not to tap these loans in the next couple weeks, with the decision hinging on the level of demand for new Greek debt.

If Greece’s unions follow through on strikes and a ‘social storm’, the euro will come under more selling pressure. On the flip side, if Papandreou can continue his austerity measures without inciting social unrest, the euro could move back to its recent highs of 1.38. The next few weeks will tell us a lot about the future of the euro and Greece’s ability to remain part of the common currency.

India’s central bank may look to raise interest rates for a second time in a month in order to quell inflation. Consumer prices paid by industrial workers in India rose 14.9% in February from a year earlier. The nation’s wholesale price inflation rate held at a 17-month high of just below 10% in March. The central bank will likely push interest rates higher in order to slow their economy and try to bring inflation lower. India’s economy is predicted to grow at a 7.5% pace in 2010, second only to China among major economies.

Higher rates should be good news for investors in India’s rupee (INR). The currency has gained about 4.5% since the beginning of the year, almost as much as it gained during the entire 2009 year. Higher rates and a torrid pace of growth will push the rupee higher still. The biggest question is just how high the Indian government will let the rupee rise. If they continue to stay on the sidelines, the rupee could become one of the leading currencies for 2010.

Volatility in the markets increased dramatically over the past few months. The Greek financial crisis continued to cause investor concern while the SEC’s lawsuit against Goldman Sachs created new questions regarding the future of the big Wall Street firms. When volatility is high, investors start looking for a stable place to seek refuge, and precious metals provide a solid place to ride out the storm.

Chris Gaffney
for The Daily Reckoning