naked capitalism

As readers may know, the Senate Permanent Subcommittee on Investigations just issued another report, Wall Street and the Financial Crisis. This is a far more focused and damning document than the Financial Crisis Inquiry Commission report, which was produced at considerably more expense and was undermined by dissent among its commissioners (which in fairness appears to have been by design).

I confess to having only gotten partway through the document and plan to issue a more thorough discussion in the next few days. However, some things are clear at this juncture. The committee took the approach of drilling into certain practices and players they regarded as key to see where that took them. On the one hand, that serves to provide far more concrete proof of the extent and nature of certain practices believed to be widespread that industry players have either denied or argued were based only on anecdotal evidence and were therefore simply isolated examples. It serves to demonstrate that the degree of institutional failure and fraud were widespread and played a direct and significant role in the crisis. On the other hand, it is not and cannot be a comprehensive account, and therefore misses other key elements which this writer along with other industry participants believe were serious and insufficiently examined drivers of the crisis (in particular collusive relationships among major players that were presented as independent). Thus it does not in the end do more to explain the crisis (all its research focused on issue, such as rating agency bad behavior and regulatory incompetence) that are widely accepted by the public and virtually all analysts of the crisis not operating on behalf of the financial services industry, but provides more support and color around some of the major issues. However, I suspect that some of its supporting evidence, which the subcommission also released, will point to issues that the report did not stress.

The report looks at WaMu (considered heretofore to be one of the better subprime lenders), the Office of Thrift Supervision (among other things, the hapless supervisor of AIG’s holding company) rating agencies, and Goldman’s and Deutsche Bank’s behavior in the RMBS and CDO markets. One presumes Goldman and Deutsche were put int the spotlight due to their role as innovators in the CDO market, particularly in developing credit default swaps on asset backed securities, and having the largest synthetic CDO programs (Goldman’s was called Abacus, Deutsche’s was named Start).

Senator Carl Levin, in releasing the report, took aim at Goldman’s truthiness in its testimony before Congress and called on Federal prosecutors to examine whether Goldman committed perjury. Two issues are at stake. First it the Goldman claim that it lost money on its housing bets and was not net short housing (or at least not for long). Second is the notion that the firm was acting merely as a market marker, which basically means caveat emptor, if clients made bad bets, Goldman was merely acting as a neutral middleman.

While Goldman made the usual pious denials, the evidence in the report supports the Levin charges. It notes:

Overall in 2007, its net short position produced record profits totaling $3.7
billion for Goldman’s Structured Products Group, which when combined with other mortgage
losses, produced record net revenues of $1.2 billion for the Mortgage Department as a whole.

2007 was the critical year when the market turned decisively south and all dealers were dumping mortgage-related inventory. Goldman had been further ahead in the process and appears to be the only firm to put on very sizeable short positions. The magnitude of the profits on the short side lend credence to the charge that Goldman was substantially and successfully net short.

The second major charge, that Goldman was merely a market maker, never passed the common sense test. The report delineates the aggressive measures the firm took to unload CDOs, with e-mails showing an aggressive, full bore sales push, including salesmen relying on their credibility with clients to get them to buy doggy deals and demanding extra sales credits in return.

This is contrary to the role of a market maker, which intermediates client orders. Goldman was acting in the role of a placement agent, and the case law in this area calls on the firm to disclose all material conflicts of interest. Since the three year statue of limitations for civil litigation under the securities law has passed, we are unlikely to see any new litigation, but Goldman’s statements about its role look to be gross misrepresentations.

But will the generally craven and bank-friendly Obama administration charge Goldman with perjury? Almost certainly not, and that will sadly serve to cement the notion that we have a two-tier standard of law in the US, one for banks, and one for the rest of us. And now with the industry populated by too big to fail banks, all operating at the same low level of conduct, large investors who trade in large sizes and therefore work with major players can’t effectively vote with their feet either. The crisis has cemented the role of a diseased oligopoly at the center of the global economy, and it looks certain to continue its looting until the next crisis creates another window of opportunity to bring it to heel. One can only hope that investigations like the Levin report will help stiffen the spines of the officialdom and the non-banking plutocrats next time around.