Frank Partnoy, derivatives salesman turned law professor, took an ill fated star turn in the Financial Times today. In a comment titled, “Goldman is wrong target for official censure,” he writes (among other things): “Goldman is not to blame for the financial crisis,” a straw man if I ever saw one.
I hate to say it, because I like and admire Partnoy, but this piece is the writing equivalent of a bad hair day. It’s hard to understand how this article came about, since Partnoy has been a long-standing critic of both the dubious products and sales techniques that have become widespread in the financial services industry. He is also normally a scrupulous, diligent researcher; his book Infectious Greed, for instance, provides a detailed, compelling account, not only of numerous financial services industry scandals in the 1990s, but also the successful efforts to stymie reforms.
But Partnoy, despite his keen insights, has some peculiar blind spots. He has argued that even though Enron engaged in transactions to flatter their financial statements, Enron nevertheless was a highly profitable derivatives bank. He contends it collapsed not because it was a house of cards, but its creditors did not understand how much risk it was taking, and went into run on the bank mode when they realized how levered it really was. Pretty much everyone I know who knows Enron reasonably well disagrees vehemently with Partnoy’s thesis.
Let’s turn to Partnoy’s current piece. Strip it to its core, it comes dangerously close to the sort of argument you’d reject if it came from your six year old: “It isn’t fair that the teacher punished me. Johnny was doing even worse stuff.”
If Goldman engaged in criminal conduct, or violated securities laws, it should be punished. And other securities firms should be investigated and if the facts warrant, punished as well. But Partnoy goes off on the rather odd assumption that Goldman is somehow being unfairly picked on by the government. He forgets that the SEC took action because it got a referral from a private party, which we had reason to believe was IKB. Unless Partnoy can tell us that there are other referrals for complaints that the SEC or the Justice Department is not taking as seriously as the Abacus case, it’s hard to see how this “Goldman as victim” argument stands.
Now it is fair to say that the MEDIA focus on Goldman has been consistent and pointed, with the Matt Taibbi famous “vampire squid” article as centerpiece. But that stems from several causes. First, when former high fliers suffer a decline in fortune, be they ones on an eventual terminal downslide like Enron, or ones who are merely not longer darlings, like Cisco in the dot bomb era, the press can overshoot on the downside much as it did on the upside. Second, Goldman’s seemingly untouchable standing as “Government Sachs”, in combination with some events that did not pass the smell test (Hank Paulson’s discussions with Blankfein over AIG when Goldman was the investment bank with the most extensive involvement in AIG’s toxic CDOs), resentment within the industry for suspected front-running, and arrogance that was an outlier even by securities industry standards made it a very juicy target for journalistic salvos. Its ham-handed responses (will Lloyd Blankfein ever live down his “doing Gods’ work” remark?) keeping the outrage going.
Goldman had come to epitomize what was wrong with Wall Street – arrogance, lack of remorse, phony capitalist posturing, and presumed predatory conduct – yet its cultivation of friends in powerful places seemed to assure that they would be never called to account. So it isn’t surprising that the media and the public would respond so strongly to the news of the SEC’s lawsuit. And it therefore isn’t unreasonable for the Permanent Subcommittee on Investigations to focus on Goldman in light of the SEC case, as in this gave them a concrete example they could probe deeply..
Partnoy did have the bad luck to have the government disprove his contention that Goldman was being “singled out” by a leak of an investigation of Morgan Stanley hitting the wires within hours of his article going live. But it illustrates what I would have argued regardless: that his “Goldman is being singled out” argument is sheer conjecture. The fact that action against Goldman is now visible does NOT mean that other investigations are not proceeding apace.
Many of his arguments are bizarre:
Of the banks that dominated the market a few years ago, why would the government target the only one to survive the crisis financially intact?
Yves here. Huh? First, “financially intact” is inaccurate. All major capital markets firms around the world needed government assistance to make it through 2009. Per former derivatives traderRoger Ehrenberg:
Goldman is a great firm with a stellar culture, and in most circumstances it’s risk management and funding practices have been second to none. Except when the crisis hit. It stood with the rest of Wall Street as a firm with longer-dated, less liquid assets funded with extremely short-dated liabilities…..
There is not a Wall Street derivatives trader on the planet that would have done the US Government deal on an arms-length basis. Nothing remotely close. Goldman’s equity could have done a digital, dis-continuous move towards zero if it couldn’t finance its balance sheet overnight. Remember Bear Stearns? Lehman Brothers? These things happened. Goldman, though clearly a stronger institution, was facing a crisis of confidence that pervaded the market. Lenders weren’t discriminating back in November 2008. If you didn’t have term credit, you certainly weren’t getting any new lines or getting any rolls, either. So what is the cost of an option to insure a $1 trillion balance sheet and hundreds of billions in off-balance sheet liabilities teetering on the brink? Let’s just say that it is a tad north of $1.1 billion in premium. And the $10 billion TARP figure? It’s a joke. Take into account the AIG payments, the FDIC guarantees and the value of the markets knowing that the US Government won’t let you go down under any circumstances. $1.1 billion in option premium? How about 20x that, perhaps more. But no, this is not the way it went down….
Yves here. Remarkably, Partnoy uses the bogus argument that Goldman did not need a bailout to contend that the firm was being prudent in going net short and that “it was not a scheme to bet against a client”.
There are so many things wrong with that construction that it takes some unpacking.
First, the question of the ethics or legality of Goldman’s conduct is separate from the results. The “it was good for Goldman to go net short, therefore this Abacus trade was OK” is tantamount to saying ends justify the means. Moreover, not just this section, but the ENTIRE PIECE ignores the central charge in the SEC’s complaint: that Goldman made a material misrepresentation in not letting investors in the deal know that the CDO had been significantly influenced by someone who wanted to create a short position, John Paulson.
Note also that the common defense, “there had to be someone on the short side in a synthetic CDO” is also bogus. First, synthetics were sold to investors as being economically equivalent to cash CDOs, so dealers played down the role of the buyers of CDS protection that went into the CDO. Second, there was no reason for an investor to assume that the CDS buyers were putting on a short position; they could be hedgers (a lot of players in the mortgage industry would partially or fully hedge exposures of various sorts). Third and most important, it would NOT occur to investors that the equity investor (who was in theory taking the most risk and hence was given some say over the deal) was a Trojan horse for a bigger short position. Even if it is found to be legal, that was deception.
His argument about Magnetar v. Goldman is similarly questionable:
According to a recent report from ProPublica, there were 26 deals in which Magnetar, a hedge fund, both sponsored CDOs and bet against them. (Magnetar says these deals were perfectly legal.) They were arranged by Citigroup, Credit Agricole, Deutsche Bank, JPMorgan Chase, Lehman Brothers, Merrill Lynch, UBS and others (not Goldman). There are hundreds of non-Goldman CDOs that no one has yet investigated.
Yves here. Goldman got its Wells notice in September 2009. The SEC must have received its referral prior to that; it take some time to investigate a complaint. By contrast, ECONNED broke the Magnetar story in March 2010, and it did not get considerable attention until ProPublica released its own report six weeks later. Magnetar went to some length to stay under the radar; there were two books published on subprime short and neither mentioned Magnetar. Moreover, even the full extent of Magnetar’s deals is not yet known; our deal list has two more transactions than ProPublica’s and we are told there may be as many as 20 more. So it is far too early to criticize the officialdom for inaction on Magnetar.
Similarly, the issue is not “other CDOs” at this juncture (although we have raised issues about other types of market manipulation that we feel merit attention” but the role of synthetic or heavily synthetic CDOs. The Magnetar program and its imitators were the biggest of the bunch. There were not as many pure synthetic programs: Goldman’s Abacus program was one; DeutscheBank had a program, START, which we have noised about here and wish someone would probe (we have not been able to find their transactions) plus the smaller Morgan Stanley program now under investigation, one by Citi called Franklin, and seven pure synthetic CDOs launched by the hedge fund Tricadia.
The final point is that, as we have discussed before in this blog, is that there has been almost no litigation of structured finance deals, which are underwritten under rule 144a. The SEC may want to proceed cautiously and file suits where it thinks it has a particularly strong case to see what grounds will be well received in court before widening its frame of action. Admittedly, the Administration is now pressuring Goldman and the SEC to settle the case, but the SEC had to assume it might wind up in court.
The piece goes on to offer more dubious arguments:
The Securities and Exchange Commission advertises itself as the “investor’s advocate”. Yet the investors in Goldman’s Abacus 2007-AC1 deal were two large European banks, one of which, it is alleged in a separate private lawsuit, defrauded US pension funds by selling them similar subprime mortgage-backed investments. Why would the SEC advocate on behalf of a European bank against Goldman Sachs instead of on behalf of American investors against a European bank?
Yves here. Read that argument a second time. This is stunning. Because one bank foreign and is ALLEGED (meaning the case has not been tried yet) to have defrauded US investors by a PRIVATE party, the SEC should not take action. So if you get sued, the SEC should forget about you. In other words, the US should not offer equal protection under the law, anyone who is stupid enough to be sued, no matter how frivolous, must be assumed to be unworthy of protection. And the US capital markets should be made safe only for US players, if you are foreign, you are fair game for fraudsters and crooks.
And then we get this:
Another explanation is that Goldman is the healthiest, most profitable remaining target. Some banks are dead; others might not survive government attack. Politicians who need to throw a bank under the bus might pick the one most likely to live through the rumble. The easiest and safest scapegoat is the one with the highest salaries and profits.
Yves here. Huh? What firms were big in the CDO game? Merrill (now BofA), Deutsche, Calyon, SocGen. Bear (now JPMorgan), Citi, UBS, Morgan Stanley and others were also significant. Think any of them can’t handle a major private suit? No, in fact Fannie and Freddie are demanding that Citi, BofA, Wells, JPMorgan buy back mortgage securities that these banks misrepresented, with 2009 losses among the four totaling $5 billion and 2010 losses expected to reach $7 billion. But Partnoy would have us believe that the “government” is socking it to Goldman only because it is particularly profitable. And as Eliot Spitzer showed, criminal charges against a corporation, particularly a financial firm, are a sword of Damocles, they are assumed not to be able to survive a successful prosecution. So any of the big firms would survive a private suit by the SEC (they can afford to grovel, settle, and pay a big fine) and any firm, wealthy or not, would have trouble surviving a successful criminal prosecution.
I sincerely hope Partnoy returns to his usual impressive form. This piece verges on intellectual dishonesty. I can’t fathom what about the spectacle of Goldman in the stocks in the town square elicited such an off-kilter reaction from a normally sound commentator.