A Conflict of Interest is Not a Conflict of Interest If It Involves Goldman

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The “all animals are created equal, but some are more equal than others” logic appears to operate in full force as far as Goldman is concerned. Violations of normal rules of conduct are not merely tolerated, but are asserted to be acceptable.

Now admittedly, the latest news tidbit, of former Goldman co-chairman Steven Friedman staying on as chairman of the New York Fed after Goldman became a bank holding company, isn’t as troubling as when current Goldman chief Lloyd Blankfein was the only Wall Street denizen to meet with Hank Paulson when the Treasury was deciding what to do about AIG. Readers may recall that Goldman had the biggest exposure to AIG and thus had the most to benefit from a course of action that would be generous to counterparties (who had chosen of their own cognizance to enter into contracts with the big insurer).

What is disturbing about the Wall Street Journal is the moral blindness of too many of the key actors, namely Friedman himself and some Fed officials. Let’s parse some of the key bits of the Wall Street Journal story:

The Federal Reserve Bank of New York shaped Washington’s response to the financial crisis late last year, which buoyed Goldman Sachs Group Inc. and other Wall Street firms. Goldman received speedy approval to become a bank holding company in September and a $10 billion capital injection soon after.

During that time, the New York Fed’s chairman, Stephen Friedman, sat on Goldman’s board and had a large holding in Goldman stock, which because of Goldman’s new status as a bank holding company was a violation of Federal Reserve policy.

The New York Fed asked for a waiver, which, after about 2½ months, the Fed granted. While it was weighing the request, Mr. Friedman bought 37,300 more Goldman shares in December. They’ve since risen $1.7 million in value.

Yves here. It’s bad enough that Friedman owned Goldman shares while involved in policy discussions that would affect the bank. The fact that he went and bought more shares is breathtaking. Of course, this shows a huge deficiency in Fed procedures. Directors should be barred from trading stocks in any institution regulated by the Fed. While it is technically not inside information (you need to be an insider of the company in question, that is, have a fiduciary duty to its shareholders), it certainly raises the specter of trading on privileged information.

It would be a scandal if someone on the FOMC were to be found to be trading interest rate futures. Being party to discussions about regulatory policy (as in having advance knowledge of how things are likely to play out) means one similarly has advance knowledge of facts that investors would find important.

Yet we get this comment from Friedman:

Last week, following questions from The Wall Street Journal, Mr. Friedman, 71 years old, disclosed he would step down from the New York Fed at year end. In an interview, he said he made the decision because the waiver letting him own Goldman stock and be a Goldman director expires at the end of the year. He added: “I see no conflict whatsoever in owning shares.”

Yves here. So we get the Big Lie. A conflict is not a conflict. The Journal does find someone to take issue with this view:

Jerry Jordan, a former president of the Fed bank in Cleveland, says Mr. Friedman should have stepped down once Goldman became a bank holding company in September and thus fell under the Fed policy barring stock ownership by certain directors of Fed banks. “Any kind of financial transaction at all by any of the directors is always a problem,” Mr. Jordan said. “He should have resigned.”

Yves again. But we then get the Fed’s defense:

New York Fed officials say that to have forced Mr. Friedman off the board while it sought a Geithner successor would have deprived it of two leaders at a crucial time.

“Steve Friedman is a very capable chairman,” said Tom Baxter, the New York Fed’s general counsel, “and was the kind of person who we needed to head the search” for someone to succeed Mr. Geithner.

In Washington, the Fed’s general counsel, Scott Alvarez, also says Mr. Friedman was needed during the New York Fed’s transition.

Yves here. While I have trouble with that notion, there appears to have been no consideration of a compromise, say having Friedman head the search committee and recuse himself from discussions and decisions that could benefit Goldman.

The article provides more detail on normal Fed procedures:

The Federal Reserve Act bars directors representing the public interest from owning bank stocks or being bank directors or officers. Because Goldman had always been an investment bank, Mr. Friedman’s board membership there and his ownership of about 46,000 Goldman shares, at that time, hadn’t run afoul of this rule. Now it did.

The regional Fed banks have three classes of directors: Class A, elected by member banks and representing them; Class B, elected by banks but representing the public; and Class C, representing the public but picked by the Fed. Under law, directors in Class C, including Mr. Friedman, and Class B can’t be officers or directors of banks, and Class C directors like Mr. Friedman also can’t own shares of banks. This means not of bank holding companies, either, by the Fed’s interpretation of the 1913 law.

Mr. Baxter, the New York Fed general counsel, realized that the bank’s chairman was now in violation of the Fed rules. But the institution had just lost another director, Richard Fuld Jr., a few days before the September collapse of the firm he led, Lehman Brothers Holdings Inc. So on Oct. 6, at the urging of New York Fed lawyers, Mr. Geithner asked the Federal Reserve Board for a waiver enabling Mr. Friedman to continue owning Goldman stock and serving on Goldman’s board.

While Fed officials in Washington weighed the request, Mr. Baxter stayed in touch with a senior lawyer there, pushing for a decision, says a New York Fed official. This official says that in conversations with Mr. Friedman, who began voicing concern about the delays in December, Mr. Baxter suggested that the Fed policy should be considered to be in abeyance until the waiver came through.

Mr. Friedman’s role grew more prominent in November after Mr. Geithner became the pick for Treasury secretary…

Mr. Friedman saw that Goldman’s battered stock was trading below book value, or assets minus liabilities. On Dec. 17, he bought 37,300 Goldman shares at an average price of $80.78, a $3 million purchase, according to regulatory filings

Yves here. Recall that in the waning days of the Bush Administration, it wasn’t clear how bank friendly the new Administration would be. Even thought Geithner was Treasury secretary designate, there was some discussion in the press as to the divergent views within the Obama economic policy team, and whether that would create creative friction or conflict. Conflict (or having Volcker, who is not a fan of innovative finance, have a strong voice) could have kept bank valuations at bay.

Thus while Goldman’s stock was arguably cheap, cheap stocks can get cheaper. One of the important inputs to the wisdom of going long would be knowing how bank friendly the new Administration’s policies would be. To think that Friedman didn’t have some insight into that question by virtue of his advantaged position is naive.

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17 comments

  1. Sam

    Glad you picked up on this Yves. This is just blatant and outrageous, even by ’09 standards. We have become so desensitized by all this cronyism that this too shall become a mere footnote soon.

  2. Jesus

    The beat goes on and the corruption is absolute. I think it will take another year before most Obama voters (sadly, I am one of them) catch on completely. If things have not turned around by that time, I would expect folks like this to be either in Argentina or hanging from an oak tree.

  3. kxmoore

    The pig men at Goldman Sachs have been bailed-out big time by cronies in government on at least 3 occasions, The Peso “crisis”, the Asian currency “crisis”, and the recent Wall Street fiasco. Had it not been for their political influence GS would be out of business, game over. These banksters should be treated as pariahs but are instead given more and more power to formulate policy that is destroying our economic base.

  4. skippy

    Wake me, when the citizens of the US really wish to change them selves and the country. Until then its all just wishful thinking, cranky verbalization or hair pulling to no end.

    Insufficient mass until people see their toil is for naught, just lining of entitled INDIVIDUALS bank accounts.

    Skippy…Doc H read me a nice bed time story please and no cereal in the bed.

  5. bob

    “Violations of normal rules of conduct are not merely tolerated, but are asserted to be acceptable.”

    I would change the last word to beneficial, in my perfectly cynical banker speak. You couldn’t possibly estimate the value of the experience that Mr. Friedman has.

    This should have been how it was played.

    Having him actually acknowledge the question is a good first step.

  6. attempter

    Yves again. But we then get the Fed’s defense:

    New York Fed officials say that to have forced Mr. Friedman off the board while it sought a Geithner successor would have deprived it of two leaders at a crucial time.

    “Steve Friedman is a very capable chairman,” said Tom Baxter, the New York Fed’s general counsel, “and was the kind of person who we needed to head the search” for someone to succeed Mr. Geithner.

    In Washington, the Fed’s general counsel, Scott Alvarez, also says Mr. Friedman was needed during the New York Fed’s transition.Here’s another example of the “talent” ideology’s Big Lie.

    I don’t believe for a second that apparatchiks like this are ever indispensable. On the contrary, as we’ve seen they’re a dime a dozen, right on up to the likes of Greenspan.

    I imagine any reasonable intelligent and wise person would’nt need too arduous a tutorial to get up to speed on the knowledge required here.

    What’s really valued here is not knowledge/training but ideology. Otherwise mediocre specimens like Geithner or Friedman are valued because they are either compliant waterboys (Geithner) and/or ethical nihilists (Friedman), in either case the sort who will be ready and eager to obey all antisocial orders.

    What is clearly the most precious commodity is wisdom itself.

  7. DownSouth

    Jesus said…”I would expect folks like this to be either in Argentina or hanging from an oak tree.”

    Unfortunately, that’s probably what it’s going to have to come to:

    Beginning with the idea that social injustice could be resisted by purely ethical, rational and emotional forces (truth-force and soul-force in the narrower sense of the term), he (Gandhi) came finally to realise the necessity of some type of physical coercion upon the foes of his people’s freedom, as every politcal leader must. “In my humble opinion,” he declared, “the ordinary methods of agitation by way of petitions, deputations, and the like is no longer a remedy for moving to repentance a government so hopelessly indifferent to the welfare of its charge…”~

    –Reinhold Niebuhr, Moral Man & Immoral Society

  8. Independent Accountant

    Attempter:
    Charles DeGaulle said, “The world’s cemeteries are full of indispensable men”.

    YS:
    I read this one too. A CPA cannot own shares in any company he audits. Why should the NY Fed not be subject to the same rules CPAs are. The conduct of these clowns is appalling.

  9. Scott Frew

    “While it is technically not inside information (you need to be an insider of the company in question, that is, have a fiduciary duty to its shareholders), it certainly raises the specter of trading on privileged information.”

    Yves, maybe you’re being too subtle for me in the quotation above. But Steve Friedman as a director is most certainly a Goldman insider. And if he traded on the basis of material (““Material.” Information has been defined as “material” for purposes of U.S. securities laws in
    circumstances where: (i) there is a “substantial likelihood” that a “reasonable investor” would
    consider the information important in making an investment decision; (ii) the disclosure of the
    information would be “viewed by the reasonable investor as having significantly altered the ‘total
    mix’ of information made available;”9 or (iii) the disclosure of the information is “reasonably
    certain to have a substantial effect on the market price of the security.”) non-public information, that sounds an awful lot like insider trading to me.

    Oh, wait a second, reading through the regs, I see a little-remarked-upon footnote, the “Goldman exclusion.”

    Never mind.

  10. gpp

    These are the guys in charge of the dollar.

    I see the gold standard making a comeback.

  11. An80sReaganite

    To me, the crux of the matter is this recurring theme so far in this administration:

    “New York Fed officials say that to have forced Mr. Friedman off the board while it sought a Geithner successor would have deprived it of two leaders at a crucial time.“Steve Friedman is a very capable chairman,” said Tom Baxter, the New York Fed’s general counsel, “and was the kind of person who we needed to head the search” for someone to succeed Mr. Geithner.

    In Washington, the Fed’s general counsel, Scott Alvarez, also says Mr. Friedman was needed during the New York Fed’s transition.” – The banks where “to big” and “too important” to fail.
    – Geithner was “too important” to the bank nationalization to let $40,000 in back taxes keep him from such an important post.
    – Mr. Friedman was “too important” an asset at such a crucial time for the rules to apply to him. Everything & everyone is too important for the rules to apply to them.
    The rules are for us “little people” who aren’t so crucial to the “system”.

  12. Richard

    Simon Johnson wrote that the big New York banks have established an oligarchy. I think it might be more accurate to say that Goldman Sachs has established the Oligarchy because through both administrations, the the answer to any policy question is “Goldman Sachs wins.” It is breathtaking that this guy, and the whole crew at the Fed and the Treasury, see nothing wrong with this guy using his inside position to enrich himself (even though he is probably already as rich as Croseus – as the Scorpion told the Frog, I cannot help myself, it is my nature.)

  13. Hugh

    “While it is technically not inside information”

    It’s called crony capitalism. It’s like Goldman alumnus Liddy at AIG. It’s like Summers getting millions from a hedge fund for doing nothing. It’s like Paulson risking the whole financial system to settle whatever vendetta or ill-feelings he had toward Lehman while making sure no matter what happened Goldman was taken care of. It’s how Madoff made off with billions for so long. It is how a system that has completely failed can act as if it only has a PR “confidence” problem.

    “Steve Friedman is a very capable chairman,” said Tom Baxter, the New York Fed’s general counsel”

    This reminds me of the obligatory interview the media do with the neighbors of axe murderers: “He was such a nice man when he wasn’t chopping people up. Very quiet.”

  14. Jim T

    How do you not get disheartened when you read stories like this and you realize that a huge percentage (if not all) of your politicians and corporate leaders really deserve to be put in jail. It’s just horrific when you think about what all of these SOBs get away with on a daily basis. They all seem to find their own ways to extort money from the system!

    This guy with his insider trading, Nancy Pelosi with her TUNA/Samoa connection, Chris Dodd and his Country Wide Loans, George Bush and his $100 million in Library Donations (Nobody liked him? Somebody did!) You could go on for days listing their sins!

    When does it go from disheartened sheep to Civil Unrest and hanging them from an oak tree?

  15. bondinvestor

    this is absurd.

    I work for a large fund manager with multiple investment operations. I have transactional authority and am considered a covered person under SEC regulations. my assistant, my junior analysts, hell, even my wife, can’t buy or sell any security (equity or fixed income) for which there are open buy/sell orders in any part of the company in any part of the world. in fact, they can’t place orders for any security that has been discussed on an investment call in any part of the company.

    now you’re telling me that the Chair of the NY Fed is free to buy shares in a firm that is under his supervision upon which he is a member of the board – with no pre-clearance from compliance?

    unbelievable.

  16. dunkinrussia

    “Mr. Baxter, the New York Fed general counsel, realized that the bank’s chairman was now in violation of the Fed rules. But the institution had just lost another director, Richard Fuld Jr., a few days before the September collapse of the firm he led, Lehman Brothers Holdings Inc. So on Oct. 6, at the urging of New York Fed lawyers, Mr. Geithner asked the Federal Reserve Board for a waiver enabling Mr. Friedman to continue owning Goldman stock and serving on Goldman’s board.”

    What what what? Am I reading this correctly- Richard Fuld was on the f-ing board of the Fed at the same time as he served as chairman of Lehman?

    That cannot be legal. The chairman of one of the country’s largest financial firms can not possibly be allowed to serve as one of the country’s chief regulators at the same time.

    I am either reading this incorrectly, or I am hopelessly naive about the strength of incestuous ties between the public and private sector. Please, please, please tell me that it is the former.

  17. Francois

    “In Washington, the Fed’s general counsel, Scott Alvarez, also says Mr. Friedman was needed during the New York Fed’s transition.

    Yves here. While I have trouble with that notion…”

    That makes three of us. General deGaulle once said: “Cemeteries are full of indispensable men.”

    The arrogance of the financial elite doesn’t seem to know any limit whasoever.

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