Comments 2 | Comment on this article
This week will see one of the most remarkable tests of whether that “deficit” truly exists with the appearance of senior members of Goldman Sachs, up to and including the chairman and chief executive, Lloyd Blankfein, before a Congressional committee in Washington. The committee, under the gimlet eye of Senator Carl Levin, is investigating America’s sub-prime mortgage market and the role banks played in creating the conditions for the financial crisis of 2008.
At the heart of the questioning by Senator Levin and his political colleagues will be the Abacus debt investment vehicle which has become, somewhat hurriedly, shorthand for all that was wrong in the market ahead of the spectacular crash nearly two years ago.
Abacus was a synthetic collateralised debt obligation – a vehicle which allowed investors with differing views of the sub-prime housing market to bet against one another on the direction prices would go. On the short side was Paulson, the hedge fund which made billions of dollars betting on a collapse, and on the long side were ACA Management, an independent “collateral manager”, and IKB, a German bank with, it must be said, a pretty poor record in “picking winners”.
Paulson won and made $1bn. ACA and IKB lost and suffered the monetary consequences.
At the centre was Goldman, the market maker, that created the product and managed the deal. It was also positioned on the long side and therefore lost a considerable chunk of money.
Ten days ago, to the widespread sound of jaws dropping onto floors across Wall Street, the Securities and Exchange Commission announced that it was bringing a “securities fraud action” against Goldman and the main director responsible for Abacus, Fabrice Tourre. The SEC claims that ACA and IKB were misled about Paulson’s involvement on the short side of the deal and the hedge fund’s role in helping to find appropriate packages of mortgages to follow.
Goldman denies all the allegations and says the SEC is wrong in “both fact and law”. But, despite the protests, much approbrium has been heaped upon them. The great vampire squid was at it again, the critics said, attempting to funnel up money with its monumental suckers whatever anyone else’s misfortune.
Ten days on, and ahead of the committee hearings, the situation is somewhat clearer and the position for Goldman far stronger than it first appeared.
That is for three reasons. First, during the week it was revealed that Paolo Pellegrini, a senior executive at Paulson, had met ACA representative Laura Schwartz to explain the hedge fund’s position ahead of the deal being closed in April 2007. Ms Schwartz appears to claim she was still unclear which side of the deal Paulson would be sitting, but it is surely incumbent on a professional investment organisation to ensure it is clear on the status of the players in the deal.
Also, is it really for the SEC to “hold the hand” of professional investors attempting to make a buck on a rackety housing market and sadly being on the wrong side of a deal? Caveat emptor is surely an essential part of the market process.
Second, there is now increasingly compelling evidence – put together by the bank and revealed in millions of pages of emails and statements to the committee – that Goldman itself was riven by division on the direction the housing market would go in 2006 and 2007, the time at which Abacus was put together.
Although Mr Tourre, who even Goldman colleagues admit was something of a boaster, was writing in emails that the “monstrous” sub prime market was about to implode, evidence before the committee reveals that many other senior executives within the bank were on the other side of the debate and emploring Goldman to take long positions in order to make money.
This goes to the heart of the allegation that Goldman knew the housing market was about to collapse but kept taking investors’ money on rising prices.
Well, it may not be comfortable for Goldman but their argument is that, whisper it, the bank was as much in the dark as everyone else about what was about to happen.
The third element in Goldman’s strengthening case is the report by David Kotz, the SEC’s inspector general, which reveals that while the financial crisis was creeping up on a slumbering world many of the Commission’s most senior staff were busy surfing the internet on company time, looking for pornography.
A senior executive, one among more than 30 caught up in “porngate”, has apparently admitted to spending up to eight hours a day looking at inappropriate material. One assumes he didn’t have a great deal of time for much real work after such exertions. This from the Commission that failed to spot the $65bn Bernard Madoff ponzi fraud.
Why is it important in this case? Surely a few people surfing pornographic channels doesn’t have a link to the Goldman issue?
This is where the politics comes in. Goldman and the rest of Wall Street were somewhat surprised at the suddenness of the fraud announcement and by the fact, rare in such high-profile cases, that the committee making the decision to go ahead was split 3-2 along Democratic/Republican lines. Senior Goldman figures now believe that Mary Shapiro, the head of the SEC appointed by President Barack Obama, was so rattled by the findings of the Kotz report that she rushed out the Goldman fraud charges to show that the SEC was at least getting some things right.
Senior SEC officials will be appearing before Senator Levin’s inquiry and, without some red Goldman meat to wave, they feared that they would be taken apart.
Of course, Goldman is nowhere near out of the political woods and the news today that George Osborne, the shadow chancellor, is announcing another raft of finance sector crackdowns, shows that banking is seen, at least by politicians, as still the enemy. But in a world where even small victories are welcome for the Bad Boys of Wall Street, Goldman has, at least, managed to claw back some ground.