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Kris Sayce from Money Morning Australia reckons the frauds for which Goldman Sachs are being charged are the almost inevitable result of so-called “financial engineers” playing with the counterfeit capital created out of thin air by the banking system… You may have seen the news reports over the weekend. As the US Securities and Exchange Commission puts it on its own website:
“SEC Charges Goldman Sachs With Fraud.”This comes as no surprise to your editor. In our opinion the entire banking system – including the central bankers – should be up before the beak on fraud charges.
According to the SEC charge:
“Undisclosed in the marketing materials and unbeknownst to investors, a large hedge fund, Paulson & Co. Inc. (’Paulson’), with economic interests directly adverse to investors in the ABACUS 2007-AC1 CDO, played a significant role in the portfolio selection process. After participating in the selection of the reference portfolio, Paulson effectively shorted the RMBS portfolio it helped select by entering into credit default swaps (’CDS’) with GS&Co to buy protection on specific layers of the ABACUS 2007-AC1 capital structure.”In other words, Goldman’s structured a product to sell to investors. The firm Goldman’s relied upon to structure the CDO – Paulson & Co – shorted the fund by buying a CDS.
Buying the CDS means Paulson & Co was betting that the CDOs in the portfolio would fail. It was betting against the performance of the investment product it had designed!
The architect of the deal was Fabrice Toure, who worked for Goldman Sachs in Paris. But before I go on, you shouldn’t think this is some kind of rogue trader, acting alone. There’s little doubt in my mind that this is how the majority of investment banking deals are structured.
And furthermore, you shouldn’t think Australian banks are any different. It’s just that they use different products – the property market. But more on that later…
After spending the weekend reading over the news and watching clips from the so-called financial news channels, three points about this story stand out:
- The blasé reaction from fund managers – fund managers who are either customers of or suppliers to Goldman Sachs
- The ‘assets’ on the US Federal Reserve balance sheet
- And, how are Goldman’s actions any different to other banks and the central banks?
We were stunned when we watched this video. The reaction of the fund managers left us speechless.
In a nutshell their general response is, “So what? Goldman Sachs will survive, they’ll pay a fine and move on. This looks like a good time to buy Goldman Sachs stock.”
In one sense they could be right. The litigation will go on for ages and eventually when everyone has almost forgotten about it they’ll settle out of court with Goldman’s neither admitting nor denying any wrong doing but paying a fine of $X million.
But the fund manager reaction goes to show what we’ve being saying all along. You can’t trust anyone else to look after your money for you. Let me just make something clear, Goldman Sachs is being charged with fraud.
Fraud. Er, last time we checked the legal dictionary that was a pretty serious charge.
Although it’s only a civil action and not a criminal action, in our mind there’s little difference. Fraud is fraud. The fact that these fund managers couldn’t care less, and see the 12% price drop of Goldman’s as a buying opportunity shows you they know which side their bread is buttered on.
Clearly they’re more concerned about maintaining their relationship with Goldman Sachs than they are with speaking out about the disgraceful business practices of the former investment bank.
These fund managers are more interested in making sure they get access to Goldman research, Goldman investment deals, and invites to the next Goldman cocktail party than they are about how client money is being invested.
But it also brings us back to something we wrote a couple of weeks ago on April Fool’s Day, “Deals Lovingly Crafted by a Caring and Responsible Investment Banker.”
In the article we wrote how the US Federal Reserve had finally published details of the assets and liabilities it held on its balance sheet following the collapse of Bear Stearns. There are thousands of them. As far as we can see, they’re all crap.
They’re assets which the Fed paid par value despite the market pricing them at mere cents on the dollar. A great deal for the US taxpayer, not!
As we pointed out:
“But the way we see it, much of the cause of the excesses in financial markets is due to financial engineers having too much access to investor’s cash, too much access to bank-created credit, and too much of an incentive to get create new products and investments for the sake of earning a fee rather than because it’s a good investment for the punters.”And then we read the following extract from the SEC charge sheet. The SEC is quoting from an email sent by Goldman Sachs employee and financial engineer extraordinaire, Fabrice Toure:
“More and more leverage in the system, The whole building is about to collapse anytime now…Only potential survivor, the fabulous Fab[rice Tourre]…standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstrosities!!!”In another email he wrote:
“[T]he cdo biz is dead we don’t have a lot of time left.”He’s telling the truth. These guys don’t have any idea what they’re doing. They’ve got no idea about the implications of the investments or even what they are. All they know is how to package something up and sell it off to suckers.
Then it’s in the hands of the traders. And they know even less.
There’s a general misconception in the financial markets that these trader dudes at the big banks and broking firms are the brightest sparks ever to walk the earth. The reality is they aren’t. Despite all the fancy screens and expensive software they use, the facts are they may just as well have two big buy and sell buttons in front of them which they can bash alternatively like a two year old playing with a Fisher Price toy.
Again, as we’ve pointed out before, the guys that were trading CDOs and CDSs were the same guys trading energy contracts for Enron and before that they were trading tech stocks during the tech boom, and before that they were trading interest rates for Long Term Capital Management.
Broker: “Buy, Sell, Buy, Buy, Sell, Buy, Sell, Sell, Sell, Oops! What’s next? Box Office Futures? I’m in Mr. DeMille. Which is my best side? Buy or Sell?”
Mr. DeMille: “The opposite of what you tell your client to do. Ha, ha… more champagne?”
If the market and the fund managers really think this is an isolated case then they’re living in a dream world. Every single investment product crafted by the investment bankers, whether it’s Goldman Sachs, JPMorgan or Macquarie Group, is crafted for the benefit of a select group of people…
The firm that created them and their buddies in the business. Not their clients.
Bankers don’t earn millions of dollars by sitting on their thumbs. They’ve got to come up with the next great investment product that the brokers (salespeople) can flog to the clients.
And each product has to be better than the last. The salespeople don’t care what’s in the product because they wouldn’t understand it even if they did know.
And as Fabrice Toure admits in his emails, he didn’t “necessarily understanding all of the implications of those monstrosities!!!”
Finally, there’s the third aspect of this. Let’s refresh your memory. Goldman Sachs invited hedge fund manager John Paulson (no relation to ex-Treasury Secretary Hank “Hank” Paulson) to select a bunch of CDOs that it could stick into a fund and then market to Goldman Sachs’ clients.
Not surprisingly, Paulson chose the CDOs he thought were most likely to collapse considering that he was already short selling the CDO market and would also short sell these particular CDOs as well using a CDS contract.
The thing that gets us is, how is this any different to the actions of central bankers? OK, you may think we’re drawing a long bow here, but in our opinion the comparison is valid.
In the case of Paulson and Goldman it was selling to investors assets that would lose value – knowingly if we go by what we’ve seen so far.
It seems to us that this is exactly the same charge that could be levelled against the central bank and retail banks. It issues money which it knows will lose value. Not that it openly tells you that.
The bankers talk up the strong economy and increasing asset values and how Australians’ wealth has improved. Yet all the while the banks reside over an ever devalued currency. A currency which has lost around 90% of its value in the last forty years.
Isn’t that fraud? Telling you one thing while the opposite is actually the case. Sounds like fraud to me.
But whatever, the fact is, the banking system is broke and this is further proof of it. But also remember that the ultimate fault for this fraud doesn’t lie with Goldman’s. The ultimate crime is committed by the central bankers and governments who allow the initial fraud to take place.
The initial fraud being the creation of money from thin air. Money that is then given to the banks which they then use to weave their magic on unsuspecting investors and clients.
Even so, we’re sure the shills in the mainstream Australian media and analysts will spruik that the Australian banks are different and that they wouldn’t dream of doing the same sort of thing as Goldman’s.
Oh yeah? No one could accuse the banks of encouraging individuals to buy into a sky-high asset class – housing – when anyone with an ounce of grey-matter could tell you it’s massively over-valued and on the verge of collapse.
Goldman’s are being charged with fraud for misleading clients. The Australian banks should be charged with fraud for misleading property buyers into thinking the Australian housing house of cards will never crash.
The important point to remember is that the mainstream press and commentators only ever warn about asset bubbles after they’ve burst. Until then they spruik and cheer about rising prices and increased wealth. And if they do mention bubbles they’re quick to call on anti-bubble ‘experts’ who tell them not to worry.
Only when the stinking and putrid building collapses do they take note about the dangers of boom and bust economies. But that doesn’t last long, because as we’ve seen over the last year or so, everything is forgotten and they’re out there cheering on the next bubble.
Make no mistake, the Australian banking system and Australia’s banks stink just as much as Goldman Sachs. You shouldn’t for a moment believe that the actions of our banks are any nobler than those in the US.
The only difference – if there is one – is the US banks were shafting individuals using CDOs and subprime loans, whereas the Aussie banks are shafting individuals by baiting them with cheap money to buy overpriced real estate…
Same proverbial, different shovel.
Cheers,
Kris.
UPDATE 1: The estimable Doug Reich at The Rational Capitalist disagrees vehemently with the the claim that this was fraud.
"[T]his case is not about fraud. This case is a publicity stunt engineered by the Democrats to bolster their case for the upcoming financial "reform" bill being written by Sen. Dodd and others. To a public ignorant of the details of the fraud case and mired in altruism, such a case relies on a knee-jerk contempt for the 'fat cats' on Wall Street and wariness of any profit seeking business.Read Goldman!! "Two Minutes Hate"
UPDATE 2: From The Cody Word: What Goldman's accused of, in plain English:
"Today’s WSJ has a fantastic, plain English explanation of what this whole John Paulson, Goldman fraud fiasco is about. Here’s my even more plain-er English explanation of their explanation:
- Paulson and Goldman team up with ACA to create worthless mortgage securities to sell to other investors.
- Paulson buys worthless insurance from Goldman.
- Goldman buys worthless insurance from ACA.
- ACA buys worthless insurance from RBS.
- RBS got $45 billion from UK taxpayer in bailouts of which about $1BB apparently went to ACA to give to GS to give to Paulson.
"This is the exact same scenario that I’ve long been railing about- the US taxpayer gave AIG $160 billion of which it gave $13 billion to Goldman...."
5 comments:
There is nothing wrong with financial engineering. There is something wrong with those interpreting the results to advise policy makers. It has been also reported that some of the policymakers were advised by financial engineers about the risks that emerged leading to disasters in the past, but only to be ignored.
I disagree vehemently with the the claim that this was fraud. I blogged about this here:
http://dougreich.blogspot.com/2010/04/goldman-two-minutes-hate.html
Claiming that this was a fraud is tantamount to claiming that every stock purchase by anyone is a fraud because:
1) A counterparty has chosen to sell you the stock, i.e., they have "selected" the stock to sell you
2) The name of the counterparty (the person selling it to you) remains undisclosed
Both sides of this transaction were fully aware of the securities in the portfolio and either could have profited as is the case in any transaction.
I will grant the larger premise that it is the counterfeit operations of the central banks coupled with policies which encourage home ownership that gave rise to price inflation and that, indeed, is the larger fraud, however, it is far from clear that these transactions were "fraudulent" in the legal sense.
AFAIK, basic derivative instruments/trading (such as options) have been in existence since the time of Jesus Christ or even earlier than that. There were no advanced CDO derivatives during Jesus’ time as we have today. There were no banking systems either. The existence of derivative financial instruments weren't the cause of the problems. The assignment or evaluation of risks were the problems, because they were under/misevaluated. Ok, there were legislation & government interference to be blamed, but even some risk-evaluators had spotted the problems (with no mathematical models being used at all) just before the crisis happened. Those spotters gained or perhaps had minimal loss during the financial tsunami.
I know that the Libz had argued that they're against compulsory food labelling in the supermarket & also policing the (unsupported) claims by supplement manufacturers about the magic medicinal values of their vitamin pills and such via legislation. In other words, this is to simply say, buyer beware. The buyer must do the research him/herself before buying those products in the first place. They (buyers/consumers) must also do the risk evaluations. To me, this is how it should be. Take personal responsibilities. Profits/Losses rest primarily on the shoulders of consumers/buyers.
In finance, it is no difference. The buyers were not forced to buy those CDOs, unless some of those investors were forced with a gun (by the sellers/fund managers) into buying those derivative financial products. The investors solely failed in their own duties to themselves (via advisors, DIY, relatives, etc...) to properly evaluate the risks.
Don’t blame the trading instruments or financial engineers. Blame people & the decision-makers.
This may be of interest to this thread.
1st draft of Open Letter to Soros
Dear Mr. Soros,
As the members of the so-called Econo-Physics community, we are heartened to learn your initiative of “Institute of New Economic Thinking”. As you may know already, about a couple hundreds of physicists since more than ten years have been trying to crack into the field of finance in particular, socioeconomic phenomena in general, and we feel this trend is unstoppable as economy is too important to leave to economists alone.
We decided to write to you directly as we see this as an important milestone, that your initiative as a call for multi-disciplinary research to dethrone the moribund Neoclassical Paradigm, finally to replace with something new. Some of us have heard your Budapest lectures in 2009 and we believe that human endeavors must be treated differently than “hard sciences”, and reflexivity idea you’ve been advocating must be an important element in the New Paradigm that may emerge.
But we are so far frustrated that the forthcoming inaugural event at Cambridge is dominated by the mainstream economists and few outsiders are represented. In particular, no representatives from the Econo-Physics community are invited, despite our initial contact with the organization.
Mainstream economists, even the very progressive ones that will be massively present at the Cambridge meeting, are still deeply rooted in the old paradigm, despite many are very critical of the current economic outcomes and complaining about the dominant theory. The stakes are too high for the highly acclaimed economists who spent most of their careers with the neoclassical methodology (utilities, maximization etc), it’s unrealistic to expect radically different approaches can originate from the stakeholders. To take but one example, in their recent book “Animal Spirits”, Akerlof and Shiller (who otherwise command our highest esteem for their pioneering work like information asymmetry and behavioral finance) blamed the subprime crisis squarely on the “crazy & greedy” speculators. Since Adam Smith’s time we know that bankers are by profession must be greedy, if the market fails system wide, it’s the regulator who deserves the blame (Greenspan was “shocked to learned” that that bankers were so much for selfish gain in his Senator hearings).
The highly acclaimed economists at the end of their glorious careers are not particularly apt to learn new tools and switch to “new thinking”, even as progressive thinkers they tend to strongly to differ with market fundamentalism and their good social conscience often urges them to defend public interests. However if we look at their core work we may have the impression that often their innovative work is piecemeal repair work of the mainstream economics, of those present at Cambridge across them there five new economics textbooks, invariably still heavily rooted in the Neoclassical Paradigm. We can understand the reluctance to go back to the drawing board to start with a clean slate.
As physicists by training we know better the pitfalls of mechanic-analogy, it is especially misleading to mimic 19th century physics to human endeavors. The under-signed have been probing various social-economic phenomena, though nothing yet earth shaking come from our community, but initial efforts start to bear fruits. Our methodology is varied, and models are more rooted in empirics, high theory has less space than understanding forces behind.
We firmly believe that we can make significant contribution in your new initiative and our community, having no stake in the mainstream profession, can act as a independent balance for the multi-disciplinary challenge.
The open letter draft to Soros that I posted above was lifted from a blog post at the econophysics forum. The first part of the post is shown below, which may be of interest to readers here.
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Worrying signs of "new thinking"
During the spectacular financial market crashes and the resulted recession, there has been a renewed assault on the Efficient Market Hypothesis (EMH) and its theoretical basis—mainstream economics. George Soros announced in Oct. 2009 that he will put 50 million dollars over ten years to establish an "Institute for New Economic Thinking". We remember that in 2003 he has committed 3-5 millions to try to get George Bush not elected. Soros the financier probably knows that the effort to dethrone the dominance of the mainstream economics would be a much harder challenge. Despite being discredited many times over the past century, mainstream economics still prevails in most leading economics departments around the world. Soros the philosopher’s new battle will have little chance of success if the allies and opponents are not identified. For our small community of scientists working on economic and financial problems, Soros's gesture is a much welcome signal as there is chance that fresh ideas and methodologies may get attention and we may feel emboldened to take on the root causes of the current old economic paradigm.
However, our initial enthusiasm is quickly disenchanted as the INET board members and speakers list are set up, they are the most prominent members of the establishment, though most have a progressive bend but their methodology is deeply rooted in the neoclassical theory. The first event of INET was to launch the initiative in Cambridge over the past weekend with much fanfare and press coverage. Given the majors players of the INET, the event may look comic—as if in the last years of Soviet Union, Gorbachev knowing the rotten dogma couldn’t continue any longer, set up a committee with the mission to overthrow the old paradigm, but invited mostly politburo members and Red army generals! Can we seriously believe they have any interest to study the ways how they’d be buried? The same thing now with INET, by inviting mostly the multiple decorated economists are we serious to dethrone the Old Thinking and replace it with a New Thinking?! Indeed, as Paul Ormerod (author of Death of Economics) blogged on this forum, precisely the old thinking dominated the Cambridge meeting, as we feared.
In the blog section, readers will find some feedback from attendees (they were not invited to speak) of the Cambridge meeting, below I posted also the first draft of our open letter. For a more polite, politically correct open letter please see the special section where some sample work is posted as well.
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It was lifted from here:
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