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.
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.
Interesting but I would like to call you on
“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), ”
“Bankers” ordinarily includes the worthies who handle the ordinary business of mortgage lending, provision of working capital to small business, electronic payments, international transfers and the like that ANZ, CBA, NAB & WBC all do in an aspirational but essential humdrum way of providing essential features of the financial system we can’t do without.
If you mean “investment [or merchant] bankers” – and the absence of any qualification suggests you are just mouthing a prejudice rather than thinking about the subject – then you would have a more interesting task because you would have to recognise that there is need for specialists in raising money for industry and governments and for providing suitable investment vehicles for that recently rediscovered person the private saver. So how do you calculate the contribution so as to find it negative without giving excessive prominence to some bad years – some about 1994 and some recently but also intermittently over the centuries as irrational exuberance overtook some employed in the banking industry and some of those exploited by some in the banking industry who were harder headed? Mightn’t it be the case that most of the time investment banks have been allowing the wheels of industry and commerce to turn and grow even if not often doing something as spectacular as financing the purchase of 40 per cent of the Suez Canal stock (Rothschilds and the British government)?
Rufus. the comment was referring to the net contribution of bankers. Do some bankers contribute to the efficient allocation of capital? No doubt. But to bankers in their entirety contribute in a positive sense given the significant ‘leakage’ of money to them – absolutely not.
It was the poor practies of bankers (retail and investment) in the US and Ireland which caused their house bubbles and subsequent busts. These mistakes required the general public (read: taxpayers) to pay for bankers’ mistakes.
The dot.com bubble was largely spurred by conflicted investment banks.
Behind every misallocation of capital in history, lies a set of bankers who have sought to enrich themselves at others’ expense.
Yuk. Goldmans were performing a service… is it any different from an estate agent…. yuk yuk yuk, sick to my stomach.
Yes its different from an estate agent and yes the company is at heart the responsible party here. All the members of this ugly greedy world are tainted, please don’t try to let GS off so lightly, its really nauseating.
And the only reason they didn’t go down like the rest of them is because of a) Warren Buffett and b) taxpayer money.
Yuk. I need a shower after reading this.
Thanks for the reply Adam. Because I read your stuff in Crikey allow me to try a bit more nitpicking to spur you on to rigorous heights of explanation.
I was well aware of your writing about the “net” contribution of bankers. It was in fact because you were implicitly balancing the negative against the positive that I asked for more detail.
Although you don’t take up my point that you could be taken to refer to all kinds of bankers including those performing functions which it is difficult to see us doing without (and you might even have been referring to central bankers if taken literally) I presume you are writing about investment or merchant bankers. ** No one can be enthusiastic about the performance of Wall Street when given opportunities by regulatory, legislative and policy failure to profit from the petty fraud and gullibility manifest throughout not only the USA but foreign banks which should have known better. And there have been merchant banking stuff ups from time to time over centuries. But how do you put a price/value on the negatives and on the positives so as to get your assured negatives?
You don’t seem to give credit for the essential function for the working of modern capitalism of aggregating capital for investment in projects, plant and equipement, speculative exploration and development of innovations etc. and seem to dismiss its contribution with the remarkably absolutist statement that “Behind every misallocation of capital in history, lies a set of bankers who have sought to enrich themselves at others’ expense.” Whether or not you are right in attributing most of the tech bubble to bankers – which I doubt without being willing to assign a precise weight to typical cyclical excesses of folly and irrational exuberance and the competitive pretence of mutual fund managers that they could beat the market – your generalisation would be hard to uphold if one looked at the bubbles in Australia – right up to the 1968 to 1970 mining boom – which preceded the existence of merchant banks in Australia (though I remember borrowing money from a subsidiary of a major bank for investment and trading purposes in those days, but that was on my initiative). The South Sea Bubble and the Tulip Mania had little to do with devious bankers. Experienced people in the financial markets, and some of them only will be bankers, can certainly expect to cash in on the rashness and emotionalism of the neophytes and amateurs.
** I see that you may not have been confining your strictures to merchant/investment banks since you specifically mentioned the Irish banks (and what about Iceland?! – and what about Gordon Brown using anti-terrorist laws to heavy the Icelanders in aid of greedy British investors – or simple minded folk who thought a high interest rate from a “bank” must be a sure thing)? But it is hard to regard the entrepreneurial follies of the Fannie Maes, Freddy Macs and Irish banks funding a real estate bubble as a mainstream banking failure more than it is a failure of government in its executive and legislative branches. And you would have to factor in (as I am reminded by just having read about the fraught relations between partners in Goldman Sachs in the 90s before its IPO) the effects of limited liability and, in particular, having a lot of powerless mostly passive shareholders when listed on the stock exchange.
The chances of the law and regulators providing a remedy for human greed and folly in any set of circumstances are always doubtful and it will no doubt always be the case that the law will be behind the action (sometimes even contributing to the disasters as in the repeal of Glass-Steagall) but it shouldn’t be too difficult to generalise restrictions on heads-I-win-tails-you-lose commercial situations even if only by weighty and insistent warnings.
I confess to having bought into what seemed to be a Goldman Sachs Global Alpha hedge fund because of the reputation of the firm for making profits and the fact (and it seems to have been fact) that a lot of GS people had their own money in the fund. I was agreeing to the managers taking a 20 per cent cut of profits above a benchmark and, if my assumption had been right that I was going to benefit from the expertise of the top professionals I would have been justified even though the managers of the fund suffered no penalty for underperformance.
That brings me to a somewhat different situation on which we would probably agree. That is the ability of executives of publicly listed companies to “earn” huge salaries and bonuses without fear of corresponding losses or penalties at the expense of shareholders, and sometimes creditors, and in sharp contrast to the pre IPO situation of Goldman Sachs partners whose capital was being diminished month by month during 1994 as trading losses mounted.
Still, it is hard to argue that Goldman’s, and all the partnerships which preceded it in floating to the public should have been prevented from escaping the dangers to stability of the partnership structure or the limitations on size – unless one is willing to make a case that the total activity of such “banks” is inevitably net negative. In making a case for or against the entrepreneurial financial sector one of the activities that needs to be weighed in the balance is the largely zero-sum business of bond, share and above all derivative trading. The possible positives include the maintenance of liquidity in financial markets (more an Anglo-American thing than traditional European Continental) and it might even be argued that the smart guys who win the zero-sum games will probably be the best people to invest money productively, at least better than the mug punter. A more respectable rationale applies to speculation generally. The existence of speculative markets akin to gambling raises money for speculative purposes some of which will pay off bigtime for everyone, investors and consumers alike, and does it cost effectively because it takes part of the money from those who get a reward from the fact that they actually enjoy the gamble. Whether the merits of that argument do much for banks is another matter.
Further to picking up on your precise reference to “misallocation of resources” Adam I have been reflecting on a number of cases and the Asian crisis of 1997 (Russia and LTCM was 1998 wasn’t it?) does exhibit banking in its broadest sense up to its knees (if not armpits) in misallocation of resources and one could certainly say of a lot of those SE Asian bankers, in particular, even when just doing what everyone was doing and feeding the property developers’ desire for cheap finance, that their contributions may well have been net negative even in long careers. Bankers can be blamed perhaps for desperately but improvidently seeking profitable ways to use flows of cash – petrodollars then (i.e. at least one of the Latin American disasters), Greenspan’s excessively low interest rates in the aftermath of 2001 events and the Quantitative Easing now (though it seems that it is now difficult to get them to lend) but without more fundamental analysis as I suggest below I don’t think bankers being net negative contributors is the most accurate or useful description.
By contrast the tech bubble, whether or not you attribute much of it to bankers or the banking system, probably didn’t involve much of a misallocation of resources from an overall public benefit point of view. Building hotels and apartment buildings which are never occupied, even in cheap labour countries, is unambiguously waste of resources but building the tech revolution with its huge spin-offs (when, for example, Costello could rightly note as Australian Treasurer, that Australia – partly by the practical benefits its banks were getting and providing from tech developments which mostly took place in the US – was one of the big gainers from the tech bubble as it later could be seen to be in stock market terms) was probably not a misallocation of resources any more than the throwing of money at all sorts of blue sky hopefuls during Australia’s mining booms was, in the end, a serious misallocation of resources. (Anyway, a misallocation compared to what? Rex Connor calling the shots?)
My objection to your “net negative” assessment of bankers’ contributions is not so much its inaccuracy (which can no doubt be cured by special definitions) but its logical tendency to suggest that someone – and who else but politicians or world statesmen/bureaucrats in Brussels, Washington DC or wherever – should supplant banking as the provider of the services it provides and claims or tries to provide. True one way of achieving that is hyper regulation but why would that be better?
I would be inclined to start along one line of analysis with a wide description of what are generally regarded as banking functions and look for logically defective parts of the design and its implementation. Particularly since the dropping of the gold standard effectually administered from London there has obviously been a need for institutions devoted to functions such as maintaining some sort of stability amongst currencies and one has to consider whether the people running them should be regarded as bankers though that is not central to proper analysis of the way the system runs and should run. Then there are obvious markett-failure mechanisms such as the World Bank which might be regarded perhaps as a political positive (because necessary) but an economic negative in practice.
Another line would be to examine the big changes affecting banking since the great days when – give or take one or two earlier Baring collapses – the world’s bankers greatly assisted the original industrial revolution truly revolutionise the pre-Malthusian world of the 18th century. Look for the largely unforseen, and certainly unintended, consequences of e.g. dropping the gold standard altogether. Then one might learn what is needed to curb animal spirits, whether fired by irrational exuberance, greed, excessive generosity/grandiosity or plain foolishness, when those in the banking world are presented with new opportunities or dumb excesses of free market dogma leading to excessive or misguided deregulation. But, by the way, I don’t think this should lead to the view that you can’t blame private businessmen for simply taking advantage of the chances they were offered. That would be like condoning the use of “bottom of the harbour” tax avoidance schemes merely because you might be able to get away with it legally.
My criticisms of GS would include (assuming some of the facts now alleged are correct) that they dudded some clients even if the clients were supposed to be “sophisticated” so that GS could get away with it legally; that their shareholders were treated simply as a convenient source of safe extra leverage for their more far out money grabs (not as bad as Lehman Bros of course) and that they don’t seem to have had either the nous or sense of public responsibility to make SEC, Fed Reserve and Treasury understand what needed to be done. But then, like a lot of people who make money, they were probably much closer to being lucky idiots than it is easy to imagine. After all very few people saw the GFC coming except in the most general fortune-teller’s terms that grandma could emulate and those that did it best can be seen to have got plenty of other predictions wrong. (Curious isn’t it that those who rightly point to inadequacies in climate modeling can’t see that being an economic modeler confronts equal or greater problems of complexity with the huge additional complexifier that there are millions of people doing their best to provide undpredictable feedback, as if there were thousands of wilful volcanos about just waiting to bu**er up the best of climate predictions).