New York Times Editorial: Wall Street Casino

New York Times Editorial: Wall Street Casino
Copyright by The New York Times
Published: April 27, 2010
http://www.nytimes.com/2010/04/28/opinion/28wed1.html?th&emc=th


Congressional Republicans have concluded that screaming foul about the banking bailout and blocking financial reform is a clever strategy for the fall elections.

This approach ignores some pretty basic history: that the banks imploded while Republicans held Congress and the White House; that President George W. Bush started the rescue; that many Republicans voted for the bailouts; and that they stabilized a financial system that was perilously close to collapse.

More important, it’s a distraction from the very real reasons the nation needs to tighten the rules governing finance. They were on vivid display on Tuesday in a hearing room just down the hall from the Senate floor where Republicans voted the day before to block debate on a Democratic financial reform bill.

Current and former Goldman Sachs officials tried to defend their practice of trading incomprehensible mortgage-based investments of little demonstrable economic value and enormous destructive capacity. Instead, they underscored why much of this work should be curtailed.

The Securities and Exchange Commission has accused Goldman of defrauding clients by selling them a complex instrument without telling them it was designed so another client could bet against it. Testifying before the Senate subcommittee on investigations, Goldman executives denied withholding information. They insisted there was nothing wrong with selling mortgage-backed products while placing bets against them.

They called it “risk management.” Most people call it stacking the deck.

We do not know whether Goldman broke the law, but we know this gambling is too dangerous. Banks like Goldman turned the financial system into a casino. Like gambling, the transactions mostly just shifted money around. Unlike gambling, they packed an enormous capacity for economic destruction — hobbling banks that made bad bets, freezing credit and economic activity. Society — not the bankers — bore the cost.

That’s why objecting to financial regulation overhaul on the grounds that it might allow future bailouts is such a specious argument.

The bailouts, which many Republicans acknowledged were necessary at the time, cost taxpayers about $87 billion, or 1 percent of gross domestic product. The crisis cost more. Falling tax revenues, unemployment insurance for millions of jobless workers and a fiscal stimulus to stop the economy’s slide is projected to boost the federal debt to more than 65 percent of G.D.P. next year.

Financial reform is needed to try to ensure such a crisis never happens again, and the bill cobbled together by Senate Democrats is reasonably tough. It would ban many — unfortunately not all — of the private, custom-made derivatives at the center of the financial meltdown and force most derivative trading onto open exchanges. Banks trading in custom-made products would have to build larger cushions of capital to protect themselves.

The bill would establish a consumer protection agency to stop predatory lending, impose new oversight on hedge funds and make it possible for regulators to dismantle big banks that were deemed to pose an imminent risk of failure. And it would create a $50 billion fund, by the nation’s largest banks, to cover commitments of a failing institution that was being wound down.

Whatever Republican campaign mailings may say, the fund was designed to avoid bailouts. The bill’s failing is not that it’s too weak. It’s that it could be stronger.


The Goldman E-mails, or How to Sell Junk
By Chris V. Nicholson
Copyright by The New York Times
April 28, 2010, 4:33 AM
http://dealbook.blogs.nytimes.com/2010/04/28/the-goldman-e-mails-or-how-to-sell-junk/?hpw

Evidence released Tuesday by Senator Carl Levin, the Michigan Democrat in charge of the Permanent Subcommittee on Investigations, includes a series of e-mails sent by executives at Goldman Sachs as the bank attempted to shed mortgage-related assets in the run-up to the subprime crisis of 2007.

The e-mails support one of the most important criticisms of the bank — that it served itself at the expense of its clients — and illustrate the conflicts of interest that arise when banks’ proprietary trading overlaps with customer sales.

The panel put it simply:

After Goldman Sachs decided to reduce its mortgage holdings, the sales force was instructed to try to sell some of its mortgage related assets, and the risks associated with them, to Goldman Sachs clients. In response, Goldman Sachs personnel issued and sold to clients RMBS and CDO securities containing or referencing high risk assets that Goldman Sachs wanted to get off its books.

While Goldman has insisted that the deals that have been making headlines recently involved only institutional investors — a client base often termed sophisticated — clearly there is sophisticated, and then there is sophisticated.

On the one hand, there were hedge funds that lined up with Goldman to short the subprime-based securities, as illustrated by this e-mail from Fabrice P. Tourre, the midlevel trader cited in the recent charges of securities fraud made by the Securities and Exchange Commission.

[T]his list might be a little skewed towards sophisticated hedge funds with which we should not expect to make too much money since (a) most of the time they will be on the same side of the trade as we will, and (b) they know exactly how things work and will not let us work for too much $$$….

One the other were the clients who wanted to make money on subprime, depended on Goldman’s advice, and ended up losing big, exemplified by this e-mail to Daniel Sparks, former head of the mortgage trading desk at Goldman.

Real bad feeling across European sales about some of the trades we did with clients. The damage this has done to our franchise is very significant. Aggregate loss of our clients on just these 5 trades along is 1bln+. In addition team feels that recognition (sales credits and otherwise) they received for getting this business done was not consistent at all with money it ended making/saving the firm.

And while Goldman, as one might reasonably expect, does everything to turn a profit and protect itself from risk, certain of its employees (like the one writing this message to Lloyd C. Blankfein) justify keeping clients even if those businesses are not profiting, or avoiding risk, as successfully as they deal with the bank.

I met with 10+ individual prospects and clients … since earnings were announced. The institutions don’t and I wouldn’t expect them to, make any comments like UT good at making money for urself but not us. The individuals do sometimes, but while it requires the utmost humility from us in response I feel very strongly it binds clients even closer to the firm, because the alternative of take ur money to a finn who is an under performer and not the best, just isn’t reasonable. Clients ultimately believe association with the best is good for them in the long run.
They are being compensated in prestige, apparently, but that always doesn’t translate well to the balance sheet.

In an e-mail from Daniel Sparks to other Goldman executives, Mr. Sparks outlines a plan to reduce the bank’s subprime risk:

Follow-ups:
1. Reduce exposure, sell more ABX index outright, basis trade of index vs CDS too large
2. Distribute as much as possible on bonds created from new loan securitizations and clean previous positions
Even at a disadvantage, not all clients were easy to convince. Goldman e-mails show how the bank backed up its salespeople as they sought to unload bets they thought might one day go sour.

In one exchange, one Goldman employee refers to one e-mail as “as a way to distribute junk that nobody was dumb enough to take first time around.” The response of Jonathon Egol, a colleague of Mr. Tourre’s who designed some of the mortgage trades, was “LDL,” or “let’s discuss live,” effectively moving the discussion off record.

Another e-mail refers to a firm as “too smart to buy this junk.”

The investigation into the causes of the financial crisis, which began in November 2008, has over the past year and a half amassed evidence based on millions of documents and hundreds of interviews, Mr. Levin said.

“Historically, investment banks helped raise capital for business,” the report says; today, as the e-mails make clear, they also help diminish it.