In a New York Times op-ed late last year, Bill Black, Frank Partnoy, and Eliot Spitzer called for an open source investigation:
we know where the answers are. They are in the trove of e-mail messages still backed up on A.I.G. servers, as well as in the key internal accounting documents and financial models generated by A.I.G. during the past decade. Before releasing its regulatory clutches, the government should insist that the company immediately make these materials public. By putting the evidence online, the government could establish a new form of “open source” investigation.
Once the documents are available for everyone to inspect, a thousand journalistic flowers can bloom, as reporters, victims and angry citizens have a chance to piece together the story. In past cases of financial fraud — from the complex swaps that Bankers Trust sold to Procter & Gamble in the early 1990s to the I.P.O. kickback schemes of the late 1990s to the fall of Enron — e-mail messages and internal documents became the central exhibits in our collective understanding of what happened, and why.
Now it is worth noting that the emphasis in the Black/Partnoy/Spitzer argument was to get a lot of eyeballs on a large stash of source material that is presumably pretty accessible to the public, namely, e-mails.
But there is a second line of potential open-source inquiry that would be at least as valuable: getting people who have expertise in certain types of documentation to look probe transaction documentation for deals that were deceptive or had significant negative outcomes. Even with more and more investigators of various sorts getting their noses into various suspect-looking activities, a lot of the destructive behavior took place in the form of transactions that industry participants at the time would argue fell within normal, accepted practice. Understanding what was deficient about prevailing practice is therefore key to developing durable reforms.
For instance, one of the requirements in the FDIC’s proposed securitization reforms is to have the participants disclose their motivations and intentions as well as their fees. That means that parties like Goldman and Deutschebank, who teed up CDOs for the purpose of them taking a short position would have had to disclose that objective under the proposed regulations.
Reader Nick has provided a link to one of the now-infamous Goldman-Greek government swaps, which served to camouflage the magnitude of its fiscal deficits from the EU. His comments:
I came across the prospectus for the 5.1bn Euro Titlos PLC Asset Backed Notes which Goldman arranged for Greece in 2008.
This was the restructuring of a controversal 2005 swap, which, in turn, related to the infamous
“Aeolos” deal in 2001. Aeolos was the SPV which GS and the “Hellenic Civil Aviation Authority” used
to enable the Greeks to hide its borrowing and enter the EU under false pretenses.
See page 47 of the pdf file (page 43 of the document) under “Use of Proceeds”. I’m curious that no mention of Greece’s real motivation to do this deal — or previous ones — is mentioned. (Maybe it’s in the doc, but I sure couldn’t find it.)
Will the final net result of these derivative trades be a transfer from German and French taxpayers to Greece along with $300mm or so to GS?
Yves here. Per the remarks above on the FDIC, I’m not surprised at all regarding the lack of disclosure. And Nick’s comment raises a more basic point: how the use of forms and mechanisms from regulated markets have served to lull investors and issuers into a false sense of security.
Now here, Greece presumably knew exactly what it was doing. The whole point of this deal was to allow it to hide its failure to live up to its Maasricht obligations.
But even though I have looked at various types of deal documents for decades, something that should have been blindingly obvious occurred to me only tonight. This document, like all of its cousins, says very clearly that the securities (in this case, notes) will not be registered with the SEC, but will be listed on the Luxembourg stock exchange. So this one at least is subject to certain disclosure requirements. But as Nick points out, you sure couldn’t tell what the real motivation for the note deal was from this prospectus (as in the stated aim, while not necessarily untrue, was not the real driver).
But investors have over the course of decades come to expect that documents like this make a full and fair disclosure. The use of this particular form of presentation conveys the message (among others) that everything you need to know to invest is here. It may be somewhat obscured by clever lawyering or the relegation of key facts to financial footnotes, but the belief surrounding documents like this is that the investors have been told what they needed to know.
But we now know they weren’t. The SEC has a key notion in its disclosure rules, that failure to state a material fact is a no-no. It isn’t just that what a prospectus says has to be accurate, it also must not omit to state any material fact that would make the statements in the disclosure documents false or misleading.
And where did the chicanery that led to the crisis take place? Not in areas subject to the full force of SEC regulations, but areas completely outside its reach (derivatives) or where much weaker rules were operative (the rule 3a-7 exemption for asset backed securities).
In case readers think I am making overmuch of this process, consider: propaganda similarly suborns existing channels, in this case, the media. Most people believe that the press and TV tell them what they need to know, both in the sense that what they say is accurate, and anything they fail to cover must not be newsworthy. And even though we have had some stark evidence to the contrary, that the media can be used by the state for its own ends (witness the Creel Commission in World War I, as well as the run-up to the Iraq war) as well as influenced by powerful private interests, the conditioning, which is to trust the media, remains very much intact.
So as much as I welcome and encourage reader comments on the document that Nick pointed out, I’d also welcome reader input on where they think disclosure fell short, and why.