dotCommonweal

A blog by the magazine's editors and contributors

.

Is this a felony?

Gretchen Morgenson, my favorite Times' business reporter since Joe Nocerra went on leave, has a fascinating story in Sunday's paper suggesting that Goldman Sachs not only reaped the benefits of the financial meltdown but that it may have had a bigger hand in bringing it on than we knew."A.I.G. had long insured complex mortgage securities owned by Goldman and other firms against possible defaults. With the housing crisis deepening, A.I.G., once the worlds biggest insurer, had already paid Goldman $2 billion to cover losses the bank said it might suffer."A.I.G. executives wanted some of its money back, insisting that Goldman like a homeowner overestimating the damages in a storm to get a bigger insurance payment had inflated the potential losses. Goldman countered that it was owed even more, while also resisting consulting with third parties to help estimate a value for the securities."http://www.nytimes.com/2010/02/07/business/07goldman.html?hpWould the investment, bond, and/or insurance gurus comment on the ins and outs of the story? I'd like to fully understand what went on here.UPDATE: And on Monday morning, we have another data set about how the regulation business is going. "In a Message to Democrats, Wall St. Sends Cash to G.O.P.""This year Chases political action committee is sending the Democrats a pointed message. While it has contributed to some individual Democrats and state organizations, it [Chase] has rebuffed solicitations from the national Democratic House and Senate campaign committees. Instead, it gave $30,000 to their Republican counterparts.http://www.nytimes.com/2010/02/08/us/politics/08lobby.html?hpUPDATE: NOT ANOTHER FELONY! Andrew Ross Sorkin has this gem today about an investor group paying itself a hefty dividend from a hospital corporation deeply in debt. Should we assume they were hoping for health-care reform and now think it's dead? Or????http://www.nytimes.com/2010/02/09/business/09sorkin.html?ref=business

Comments

Commenting Guidelines

Do you really think this is a matter of a greedy rogue corporation and not the default mode of our capitalist system? We will be even more stuck if criminal charges are filed since it will then be seen as the fault of certain individuals.

Margaret--It's not often that we agree, but I think in this instance there is much overlap in our thinking. I liked Gretchen Morgenson's work when she was with Forbes magazine, many years ago. The fact that she could thrive there and at the NYT speaks well of her work. Unfortunately, I don't know if we'll ever fully understand what went on here, but something doesn't smell quite right. Saying anything more than that wouldn't be prudent.Hal Holbrook had a memorable line in the movie Wall Street:"Man looks in the abyss, there's nothing staring back at him. At that moment man finds his character. And that is what keeps him out of the abyss."We all stare into the abyss at some point in our lives. I wonder if some people in this situation let the abyss swallow them.

What is intriguing (and perhaps perfectly legitimate in our capitalist system) is that two of the GS traders cited in the story were betting against the derivatives while GS was collecting insurance on the declining value of same. As the story points out these derivatives (or some of them ) have now come back and GS has profited. Just or not, it seems monumentally corrupt.It is probably true that criminal charges would get us nowhere, but then something else has to happen. Regulation? The too-big-to-fails are allowed to fail next time? Not clear to me that when there is a next time (which it sounds like there could be), we are not going to face the same dilemmas.

On the broad picture, see review of Stiglitz's book in the book review.Criminal charges? Will Spitzer work with NY DA White collar crime bureau on this?Would be interesting to know on the inside.

On the inside: Morgenson cites e-mails, conversations, and interviews of people involved; perhaps they've been laid off from GS, or gotten a conscience.

MargaretAs much Goldman's influence within the Wall Street/Federal Govt. nexus has been extremely damaging to the economy, in this particular case they are unlikely to be guilty of any misbehavior.The transactions in question are Credit Default Swaps (CDS). These are contracts in which one party (in this case AIG) promises to pay another party (Goldman) an agreed amount if the bonds or debt instruments specified in the contract default on payment. For example,let us assume that Goldman in 2006 bought $10.0 million of General Motors bonds, but as time passed they became concerned that General Motors might default and not pay the debt, so to protect themselves they would enter into a contract with someone like AIG that called for AIG to pay Goldman what they might lose in the event of GM's default. The contract would have called for Goldman to make sizeable premium payments-say $1.0 million- most of which would have been paid up front. And while the CDS contract issued by AIG (or any other counterparty) might look like an insurance contract, both parties know that it is not an insurance contract, because it is issued outside of the regulated insurance business and therefor without the protections provided by regulation. The most important of these protections is the requirement for reserves to back up the issuers (AIG) obligation to pay. Since both parties know that the contract is inherently without substance, the contracts generally call for the issuer(AIG) to post collateral (usually cash) if one of two events occur. The first event is a decline in the issuers credit rating-an event which calls into question the issuers ability to make good on its promise. The second event is a deline in the subject bond's credit worthiness-making it more likely that a default could occur.In the case of the Goldman/AIG relationship referenced in the NYT article, both events occurred. The credit rating of AIG declined,and credit worthiness of the "insured" mortgage securities fell off the cliff. In this case Goldman was well within its legal and moral rights in demanding substantial cash collateral or payments. The real bad boy in this case is AIG because it committed itself to such an enormous CDS liability that there was there was not the slightest possibility that they could honor even a small percentage of it. That said, in a very real sense, there is a degree of culpability surrounding the entire business of CDS trading that involves not only Goldman, AIG and the banks, but also the Federal Reserve , the Clinton and Bush administrations, and Congress: and that is the failure to regulate this activity when presented the opportunity in the late '90's.

Itis greed. When the government intervenes it is called interference. When it does not it is irresponsible. Goldman may not be let off the hook even tho the government did not do its job. AIG should not have been given a bailout and Goldman should take its losses which too much risk caved in AIG. Sure AIG should not have insured Goldman. But at that point too many insiders are involved.Further, the real issue is human greed. Just as baseball players were essentially greedy in using steroids (to make more money and fame). It is time to stop letting the Banks off the hook by saying they operate on the profit motive. The profit motive is fine. But when you take down so many it is no longer justified.

Years ago, a U.S. attorney explained securities fraud to me for what it is - just another form of cheating. If Goldman Sachs knowingly committed fraud in its claims to AIG, its executives are vulnerable. It would get very interesting if any of those insiders were pressured to open up to federal investigators about whether there was a plot to manipulate the market.

I hate to be defender of Goldman,but in in this instance there was no fraud. The confusion and the dispute between AIG and Goldman had to do with valuations. AIG's position was that the notional value of the underlying securities was higher than what Goldman had calculated. There is a great deal of subjectivity in these calculations because they incorporate predictions of future economic behavior. The test is what actually happened as the future unfolded; and as we now know, Goldman's valuations were actually too optimistic. The valuations should have been much lower and AIG's cash payments should have been much higher. Moreover, any attempt to assign the fall of these valuations to Goldman's market manipulations misses the point, because the default rates and market value of these and all other mortgage securities is, in reality, turned out to be far worse than anyone could have predicted in 2007 or 2008.As for greed, Bill could not be more correct. The fundamental problem is that we have allowed our economy to be captive to a system whereby individuals are free to take extraordinary risks with other people's money in the expectation of huge financial rewards (the "bonuses"), but with no personal risk, no downside and no accountability. This is moral hazard in the extreme, and I am afraid that no amount of regulation will cure it. Probably the only way to stop this trainwreck is to restore highly progressive income tax rates as existed before the 1980's. This would cut off the rewards and put an end to the practice. And contrary to what you may hear, this would not disincentivise small business so long as the top marginal rates do not apply to income under $1.0 million and capital gains rates are left alone.

Thanks for those clarifications. So let me raise some additional question that were not in the Times's story. I have read elsewhere that at the same time that GS was selling its own positions in these derivatives, it was encouraging its clients to buy more of them. Not illegal? And further afield: there has been much brouhaha, but not much clarity, about the fact that the NY Fed (Timothy Geithner, head) made AIG pay full value for the contracts it had with GS and others rather than say n%. Presumably this is not illegal either, but it must have had some impact on the final bail-out that AIG needed. Prudential judgment? Self-interest? Double-dealing?

MargaretTrading in opposition to what you are recommending to your clients certainly is problematic and in some cases can be illegal. Goldman is known to have pretty good internal controls so I would doubt that they crossed the line into illegality-but, of course anything is possible. As for treasury (through the AIG bailout) paying face value for underwater credit default swaps, well that is completely inexplicable. Once again it falls back to a matter of valuations. and as defensible and businesslike as were Goldman's earlier actions vis-a vis AIG , the Treasury's actions were precisely the opposite. Their payments without reference to valuations cannot be defended.I honestly do not understand what in the world they could have been thinking of.

It is notable that Chase has decided to play hardball with the Democratic National leadership. How will the Tea party react to that one? Will the public rally to Obama in his conflict with the big banks? Or will Obama wink to the banks and say he is just kidding. Some serious decisions or changes are possible. Bears watching. One might say that greed is as human as food and sex. A good example is when one calls 911 reporting an illness. The Fire dept., Police dept. along with the mandatory ambulance show up. Clearly there is no need for both the Police and Fire departments. The scene, by the way, ends up as very comical. But both are vying for this job, as it were, since they get funding and are able to hire more personell and buy more supplies. Build the empire sort of thing. Sex and food are more necessary and honorable than Greed. But greed makes ample use of both those essentials to screw up the entire human race.

Bill Mazzella: Speaking of Bears (or a certain kind of bears), did you notice that William Daly, brother of Mayor Daly, was in the forefront of doling out money to the G.O.P?CL: Thanks again for your comments. It is unlikely that criminal indictments will come of this (unless Elliot Spitzers runs again for NYS attorney general), but if we are to avoid another meltdown of this sort, what regulatory mechanisms have to be in place?

No matter whether Republicans or Democrats are in charge, these guys continue to drift between the Treasury and the Fed and Goldman - and back again, and so it seems that what's good for Goldman Sachs is good for America.

I thought I'd put a plug in for Fr. Jim Martin's podcast on the big bonuses over at america blog this week -comes right out and talks about morality/ethics not the same as what was 'legal."

Share

About the Author

Margaret O'Brien Steinfels, a former editor of Commonweal, writes frequently in these pages and blogs at dotCommonweal.