Goldman Sachs reported monster earnings this past week. First-quarter profit was up 91% year-on-year, to a whopping $3.46 billion.
The growing consensus seems to be that the SEC fraud charge is not that big a deal... that Goldman will likely pay some kind of fine, probably less than $100 million, and then it will be back to "business as usual."
The investment bank has its defenders too -- some of whom are
Taipan Daily readers. Goldman apologist Robert W. weighs in:
It's too bad that JL doesn't mention that GS lost 90 million in the deal and that ACA picked its own on what to put in the CDO. Goldman more than held up their part in showing both sides what was going on. That's why it took 3 years and is a civil case not criminal. Notice the 2 democratic members (puppets) of the SEC and OBAMA went right after GS. Politics should keep their nose where it belongs and let the SEC do their job.
Okay, Robert, where to start. How about that supposed $90 million loss.
"Subject to Losses" -- Yeah Right
"We were subject to losses and we did not structure a portfolio that was designed to lose money," Goldman said on Friday. That reported loss was in the ballpark of $90 million -- the between-the-lines statement being,
Hey, we lost money too, how can we be the bad guys here?
Except "loss" is a very slippery term in this case.
Imagine that you and I go into business together, and decide to buy a warehouse full of widgets. You put up 90% of the capital for the deal; I put up 10%. Then I go out and buy fire insurance on the side without you knowing about it.
When the warehouse burns down, I make a killing on the insurance policy I bought. The sliver of capital I "lost" due to the fire -- the 10% I put up -- is dwarfed by my gigantic gains made on the insurance side.
And if you decide to question my motives, I can claim innocence because I was, ahem, "subject to losses" just like you.
The above describes exactly what Goldman Sachs did. How do we know? Because the top brass had bought into the bearish subprime case BEFORE the Abacus deal was finalized. As
The New York Times reports, "
Goldman's top ranks changed its stance on housing in December 2006"...
The Abacus deal lost more than a billion dollars. The $90 million or so that Goldman "lost" was a tiny sliver of that total, dwarfed by the money they raked in shorting the daylights out of the entire subprime complex. (They actually BRAGGED about that shorting campaign too -- remember all that guff about how GS was such a great risk manager, having protected itself from the fallout created by its
own products, while all the other banks were too dumb to do this?)
Plausible Deniability
As for the idea that ACA "picked on its own what to go into the CDO," that's just fantasy, pure and simple. This is the kind of bait and switch that can be handled with a simple phone call.
Why is it, do you think, that mafia bosses never give orders over the telephone? Two words: "Plausible deniability."
And we know the Abacus deal was hand-crafted by Goldman's client -- Paulson & Co. -- because not one but TWO other sources were rejected first.
Paulson & Co. tried to set up a similar deal through Wells Fargo, but decided not to because Wells Fargo wouldn't play ball. They wouldn't go trashy enough, insisting on higher quality offerings in the mix. That would have made the shorting profile less attractive.
And then there was Bear Stearns (the bank that got swallowed up by JPMorgan).
Paulson & Co. originally approached Goldman Sachs, Bear Stearns and Deutsche Bank with the idea of creating CDOs that they could bet against.
Bear Stearns said no on the grounds of ethics.
According to Bear Stearns trader Scott Eichel (as told to
WSJ reporter Greg Zuckerman):
"It didn't pass our ethics standards; it was a reputation issue, and it didn't pass our moral compass."
Ironic, that. Before going under, Bear was known for being one of the toughest, most brass-knuckled, take-no-prisoners players on the Street. And yet even they said no.
After walking away from Wells and Bear, and coming to Goldman with a keenly focused objective in mind, the idea that Paulson didn't have full control over the Abacus deal is ludicrous. They wanted toxic garbage, and they got it.
Hurdles and Political Witch Hunts
As for why the case is "civil and not criminal," that's because the government learned its lesson with the criminal prosecution of two Bear Stearns fund managers, Ralph Cioffi and Matthew Tannin.
The burden of proof is much higher in a criminal case. After Cioffi and Tannin were judged not guilty on all criminal charges, the government changed its strategy. Pursuing a civil action against Goldman, rather than criminal, means there is higher likelihood of making something stick.
The political witch hunt aspect is definitely real. Once again, Democrats and Republicans showed their true colors in this mess -- the Dems by using the charge to try and score points just before banking reform legislation hits, and the Republicans in blindly defending the investment banking complex.
As for letting "the SEC do their job"... the SEC has NEVER done its job. Two words: Bernie Madoff. Two more words: Allen Stanford. If the SEC were to actually start doing its job now, that would be a first.
The Thin End of a Wedge
At the end of the day, Washington is still run by clowns and the SEC is still a bunch of keystone cops. They may well screw up the case, especially when matched up against Goldman's superlawyers.
Especially because, as reader Robert W. shows, there are all kinds of "plausible" means of arguing Goldman's innocence -- defenses that will sound very powerful in the capable hands of a highly paid legal team. Those arguments may well be garbage from a commonsense standpoint, but they could easily be enough to beat back the SEC in court. It's always hard to pin down a savvy defendant, especially one with very deep pockets.
Here's the thing though.
Even if Goldman Sachs beats the SEC, the troubles are just beginning to mount. The fraud charge is the thin end of a very big wedge. To understand why, consider the following:
- Goldman has more than a legal problem. It has a public relations problem.
- That public relations problem is now Godzilla-sized.
- Even if the SEC case goes away, countless NEW lawsuits are coming.
- In the eyes of the public, a strong pattern of deceit has been established.
- All the clients who got burned by subprime are now pondering just how badly Wall Street made fools of them... and what they should do about it.
In your editor's point of view, David Kotok of Cumberland Advisors has it right:
In Cumberland's view, the GS news is big and is not a one-off event. Since the announcement of the SEC suit, we have been polling everyone we talk to about GS. They are universally despised. The alleged wrongdoings have intensified an already large anger. GS arrogance has created a perception problem, and now GS has a reality problem. It could quickly become a criminal action. One lawyer said "just wait until we hear from Andrew Cuomo."
We expect that there are a lot more charges coming and they will impact GS and many other firms. And we will soon see state attorneys general piling on. The plaintiff law firms are already preparing class-action suits. Germany and the U.K. are launching their own investigations. These types of allegations are not going to be confined to SEC vs. GOLDMAN SACHS & CO. and FABRICE TOURRE. The allegations will not be limited to a single security series known as Abacus 2007.
Hitting Them in the Wallet
The real problem here is that Wall Street has lost control of the narrative. "Fraud" is a very, very ugly word. And now the public has a blueprint for seeing and understanding, in a relatively simple and not-hard-to-understand way, how Wall Street managed to rip off a bunch of gullible clients, in service to the interests of a handful of sophisticated ones.
Nor is this trouble limited to Goldman Sachs. What Goldman did was merely a template. As the
WSJ reports, the SEC is already investigating other instances of the same maneuver, in which sharp clients benefited and gullible clients got burned.
Consider, too, the perspective of the typical investment banking client. For every atypical client that made a killing on subprime, like Paulson & Co., there were dozens, if not hundreds, of those who got killed on the other side.
All those burned clients now have to be asking themselves,
"Does Goldman Sachs (or whoever, fill in the blank) really have my best interests at heart... or am I just a sacrificial lamb? Am I really an 'important client' to these guys -- or just cannon fodder?"
Con men have an old saying: "You can shear a sheep many times, but you can only skin him once."
Whether or not the sheep who got skinned rise up in anger against Goldman Sachs now (and other i-banks of the same ilk), they won't be as easy to shear from here on out. And that means a coming drop in revenues.
Meanwhile, as a backdrop to all this, we are headed straight into the teeth of a rising interest rate cycle, an increasingly hostile regulatory environment, and a stalling out of the unsustainable "mad money" consumer spending binge... all with a stock market that is by some measures more than 25% overvalued.
The bulls can try to ignore the weight of the Goldman fraud charges in the short term. But from a bigger-picture perspective, this could prove to be a perception-altering sea change event that will not be denied.
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