While zapping the channels in my modest “headquarters” in Turkey, I came across CNN’s Fareed Zakaria who sounded more like a PR frontperson for the company telling the masses not to demonize Goldman Sachs (GS). I'm not demonizing anybody. I just think the SEC complaint is extremely serious.
Yet a lot of people have been making the point that the SEC case is weak. Let me try to summarize this argument briefly:
"This is how Wall Street works. There is always another side to a trade. Goldman Sachs, acting as an intermediary, had no duty to inform investors about who the other side is. In fact, Goldman had a fiduciary duty to keep all of its clients’ confidentiality regarding these matters.
Furthermore, all investors in this deal were “highly sophisticated institutions” and they had the resources as well as the capability to form their own opinions. These sophisticated investors also knew that someone had to be taking the other side of the trade, and the fact that Paulson was taking a short bet against the housing market would not have been material information."
Sounds like the perfect defense, but it is not the right one. The SEC charges are a lot more sophisticated than who lost or made money in the housing market or who knew who took what side of the trade.
I’ve read the SEC complaint, Goldman defense letters that have been made public, and what has been available online from major media outlets as well as blogs. Here’s a brief bullet point summary of my thoughts regarding this case:
- SEC has a very strong case. In fact, some portions of it are slam-dunk.
- Top management at Goldman, along with its representative lawyers, made a gross error in judgment in letting this SEC lawsuit see the light of day.
- This case is political, and the fact that it is political compounds the strength of the case as opposed to weakening it.
- The culture of arrogance instilled by Goldman CEO along with a general feeling of infallibility led the firm to severely underestimate the repercussions of this suit.
- The stronger the arrogance, the bigger the downfall. In other words, the longer Goldman versus SEC showdown lasts, the more vulnerable the firm becomes.
- This case will be a game changer in financial markets, and it is indicative of a series of judicial and legislative procedures that will unfold for U.S. government (as well as other governments) to reign on Wall Street.
Why Are People Saying SEC Case Is Weak?
Maybe because Goldman exudes so much arrogance, I mean self confidence, that people are mesmerized into believing in their invincibility without actually taking an objective look at the facts presented by the case. Or perhaps it is the number of ex-alumni working at all levels of U.S. government that rightfully perpetuates this view.
It may be that they have not read the SEC complaint. Or that they read it but do not understand the structure of a synthetic CDO well enough to appreciate the charges. Perhaps they think it will just come to one person who left behind an unfortunate trail of self-incriminating emails. Or they believe the case depends on what words like “material” or “fraud” really mean. Perhaps they believe a fraud does not count as a fraud if others are doing it as well.
What Do You Think Are the Repercussions of Such a Suit Exactly?
We are already seeking some. British and European politicians, prosecutors, US investors, and possibly the Justice Department will see new reasons and fresh perspectives to pursue their own lawsuits against Goldman Sachs and maybe others. On top of everything, it will lead to more investigation into the firm’s practices and new fact-finding that may lead to criminal charges.
If I were in charge of Goldman Sachs, I would be doing everything to try to settle as opposed wheeling the PR machine to discredit the SEC. American public could not think less of the SEC as a watchdog, so fanning the flames in the media on Sanford sham or “porn” will not cause the public to feel more empathy towards Goldman. If anything, this kind of news may provide reasons to root for the underdog and cause the agency to fight for its reputation with a greater resolve and as a tougher adversary.
The very fact that this lawsuit has been brought to court by the SEC as opposed to being contained as an out-of-court settlement by Goldman Sachs has shown that the firm does not know when and how to take a loss. Ironic for a firm that prides itself for its superior risk management skills. Maybe the top crew did not get the memo that informs them about the idea that risk comes in many forms, be it legal or political, as opposed to being purely financial.
But they should know. As a matter of fact, they have consistently benefited from the upside of such risks in the past, by having been the beneficiary of many political and legal favors.
Perhaps the powers that be are thinking it’s time to stop the house that got too powerful mostly due to political wrangling and influence in the first place. Let me kindly try to give some perspective on that by saying that the fate of such folk would be a lot less luminous in countries like Russia or Turkey.
A black swan event should be considered seriously, but that’s far from being the only scenario that could unfold even if the U.S. government in tandem with SEC decides to fight back on all cylinders in a drawn-out legal and/or political battle. Yet the case certainly gives the government a different image than its traditional role as the bail-out guy.
This case gives U.S. people “hope” that the U.S. government will no longer be a willing and complicit partner in the scandals and financial crimes that have become commonplace in the financial sector. In fact, politicians around the world have predictably jumped on the populist bandwagon.
From a non-US perspective, this case gives the impression that America has decided to fight back against those who have hijacked the economy and cost homeowners and rest of the taxpayers billions of dollars. This is why British and European governments have reacted a lot more strongly to this case than may have been predicted.
World governments have been waiting for leadership from the U.S. government to put an end to their own bailouts, which have created a never-ending cycle of moral hazards that have caused unethical and criminal behavior in the past and in the conceivable future. Financial sector bailouts worldwide have amplified the ballooning sovereign debt of the developed world.
The much talked-about derivatives overhaul goes hand-in-hand with this case and it brings into focus urgent issues of disclosure as well as standardization that are necessary to contain what Warren Buffet has famously called financial weapons of mass destruction.
A Goldman civil (and possibly criminal) probe, possibly along with other firms is good news for the long run not only for taxpayers, but for financial markets as well. These instruments, along with its designers and profiteers, have contributed to the market crash and amplified difficulties in the ailing mortgage market that ultimately threatened the stability of the global financial system.
Because a possible criminal probe brings to mind the possibility of a collapse and a systemic shake-down, how such a development would be handled by U.S. government and/or Justice Department would be another interesting point. However, a less severe and gradual implosion of Goldman is a lot more probable than a Lehman-style collapse.
A gradual contraction or split of the Goldman Sachs monopoly, among others, is a necessary process needed to direct the talent and energy wasted in concocting the next gambling instrument into more productive venues to serve the “real” economy and to produce something good for society as a whole.
U.S. government needs to send a clear message that adding these enormous bailouts to its ballooning debt ad infinitum is no longer acceptable. The downsizing of the financial sector is currently an ongoing process. The mortgage bubble has imploded, but the financial sector bubble exists thanks to the world governments’ coordinated bailouts as well as special pandering for certain firms of the sector.
If this severe dysfunctionality of the so-called free marketplace is not dealt with in an adequate fashion, the next big short trade will be the sovereign debt issues of the developed governments (i.e., the bailout guys) themselves. I believe this is the main cause of the hard-line behavior we are seeing from the legislative venues of the U.S. government as well as its legal enforcement agencies (SEC) today.
If the U.S. government is unable to contain the financial sector, it can expect to be the next casualty of the markets along with fellow bail-out governments.
Therefore, unless the SEC case against Goldman marks the beginning of a very serious phase where sector-wide wrong-doing is punished and necessary reforms and regulations are instituted, I maintain my pessimistic stance on the sovereign debt of certain developed nations.
This is a big picture view of repercussions of the case as I see it. The next article will contain a detailed analysis of the Goldman defense that has been made public thus far and argue about its strengths and weaknesses in the light of the SEC complaint as well as other documents that have been made public that I could find.
Disclosure: No positions
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