The torrent of speculation surrounding the SEC’s chances of succeeding with its attempts to nail the “giant vampire squid” (a.k.a. Goldman Sachs) over alleged fraudulence in its Abacus 2007-AC1 collateralized debt obligation seems to have obscured the true import of what happened last Friday.
For Goldman Sachs, traditionally the most successful and powerful investment bank on Wall Street, to be charged with fraud by the leading regulator in its home country is actually quite astonishing. Whether the case is won or lost, the mere fact of the charges and their tangible effect on Goldman’s reputation, will come to be seen as a seminal event in the power struggle between unfettered free markets, globalization, and governments around the world.
The fact the SEC pressed charges on Goldman last Friday for defrauding its own clients—and specifically for keeping “long” investors in the dark about the identity of the (short-selling) group selecting the group debt parcels that were thrown into the hideously opaque CDO, speaks volumes about the changed mood in Washington right now.
Gone is the cozy situation whereby a bank’s chief exec could simultaneously sit on the board of the regulator. Gone are the days when what was good for Goldman Sachs was deemed to be good for America.
Gone are the days when the investment bank could rely on a sympathetic ear in the White House and the Treasury and when former Treasury secretary Hank Paulson could favor his former Goldman colleagues. Gone are the days when Goldman could rely on its many alumni in senior government roles and in global institutions such as the IMF to ensure that policy mirrored its interests, irrespective of whether this was good for Main Street (i.e. American voters).
Blind faith in the efficient market hypothesis, which has pretty much driven Anglo-Saxon governments’ thinking about financial services since the 1980s, took some severe knocks as a result of the multiple financial and economic train wrecks of 2007-09. The theory is now as discredited as was communism after the Fall of the Berlin Wall (according to Professor Joseph Stiglitz at least).
If the market always knew best and if banks were predisposed to behaving responsibly (which was what powerful figures such as former Federal Reserve governor Alan Greenspan and prime minister Gordon Brown actually believed prior to the crisis) the blow-outs could not have occurred.
Given such ideological shifts—coupled with Wall Street’s lack of contrition and seeming ingratitude for the taxpayer-funded bailouts of 2008 and 2009, it was only a matter of time before government responded to people’s wrath and lost patience with over-mighty firms such as Goldman.
The current SEC action and the concomitant action by the Financial Services Authority in London, suggests the gloves are off. Governments have woken up to the danger that, left to their own devices, institutions like Goldman Sachs can become virtual “rogue states” that allow financiers to rig the capital markets in their own favor.
We’re unlikely to be headed back to the days of exchange controls or the gold standard any time soon. But with healthcare under his belt, Obama is now deadly serious about reforming finance, both through additional taxation and through structural changes as outlined in the Volcker Rule and Senator Chris Dodd’s financial reform bill.
I believe that last Monday will probably go down in history as the day when the financiers were kicked off the “commanding heights” of the economy. The “masters of the universe” will take a while to adjust to their new lowland habitat. But, if it does nothing else, the Abacus debacle will teach them that a business should exist to serve society and the wider economy, not the other way around.
Who knows, investment bankers might even be persuaded to start valuing concepts like fairness and transparency rather than always looking to make the fastest buck.
Further reading on the Goldman Sachs fraud allegations
- Viewpoint: Bill Hambrecht, Bringing Trust Back to Wall Street
- Volcker’s right: Prop trading was at heart of crisis, by Ian Fraser
- US Financial Regulation: A Hopeless Tangle, or Complexity for a Purpose? by Lawrence J White
Tags: Abacus 2007-AC1 , banking , collateralized debt obligation , financial crisis , Goldman Sachs , regulation , trading , transparency