Our Pecora Moment
by Simon Johnson
We have waited long and patiently for our Ferdinand Pecora moment – a modern equivalent of the episode when a tough prosecutor from New York seized the imagination of the country in the early 1930s and, over a series of congressional hearings: laid bare the wrong-doings of Wall Street in simple and vivid terms that everyone could understand, and created the groundswell of public support necessary for comprehensive reregulation. On Friday, that moment finally arrived.
There is fraud at the heart of Wall Street, according to the Securities and Exchange Commission. Pecora took on National City Bank and J.P. Morgan (the younger); these were the supposedly untouchable titans of their day. The SEC is taking on Goldman Sachs; no firm is more powerful.
Pecora exposed the ways in which leading banks mistreated their customers – typically, retail investors. The SEC alleges, with credible detail, that Goldman essentially set up some trusting clients and deliberately misled them – to the tune of effectively transferring $1 billion from them to a particular unscrupulous investor.
Pecora had the drama of the congressional hearing room and used his skills as an interrogator to batter the bastions of Wall Street, day-after-day, with gruesome and convincing detail. We don’t know where and when, but the SEC action points in one direction only: Lloyd Blankfein (CEO of Goldman) in the witness box, while John Paulson (unindicted co-conspirator) waits in the on-deck circle.
Either Blankfein knew what was going on – and is therefore liable before the law – or he was clueless and therefore incompetent. Either way, the much vaunted risk management and control systems of Goldman, i.e., what is supposed to prevent this kind of thing from happening, are exposed to be what we have long here claimed: bunk (as I argued with Gerry Corrigan, former head of the NY Fed and long-time Goldman executive, before the Senate Banking Committee when we both testified on the Volcker Rules in February).
Read the rest here
And then there's this from TickerGuy Karl:
Goldman, by the way, while a convenient whipping boy, is not alone. The real problem is with these so-called "complex securities" that are in fact nothing more than a gambling contract designed and constructed in such a fashion as to make proper due diligence impossible. Some of these synthetics had literally 100,000 pages of referenced documentation related to them - how can anyone reasonably expect to read and understand that sort of paperwork?
Further, as I have written previously, these "Synthetics" are an inherently abusive construct in the first instance. They come into existence only because someone believes that the reference security or securities in question will decline in value to the point that a "credit event" will occur. In addition, under the claims made by the "intermediaries" the buyer of these synthetics is not entitled to know who the real party at interest is on the other side of the transaction.
This claim comes from the general view in the options and futures market. If I buy a PUT contract (betting that a stock will decline in price) I do not know who sold me that contract; ditto for futures (e.g. if I am long or short corn or oil, for example.)
But in these cases the security in question does not come into existence only because someone wanted to place a bet on the destruction of the underlying collateral.
In the case of these "synthetics" this in fact is very likely the case!
When a company goes public or issues a bond, thereby creating a security, the real party at interest and their intentions are known to everyone. When GE issues a bond for 10 years, as an example, we all know that the real party at interest is General Electric and they intend to use the money to fund their operations. You, as a buyer of that security at original issue, know that GE intends to pay and are acquiring to the capital for their operations.
Likewise, when a company issues an IPO, at original issue the securities are issued into the market (and sold to market participants) for the purpose of general working capital to further the enterprise.
Note that in both cases the real party at interest, and what their interest is, has been identified to the buyer of those securities.
We should not tolerate anything less for these so-called "synthetics"!
There is a huge difference between the secondary trading of a security once issued and its creation. Knowing who sold me the 5,000 shares of IBM I bought is not material to the transaction - we simply have a difference of opinion on the future of the company. I think the stock will be worth more tomorrow, the seller thinks it will be worth less. That's all.
But when a security is created the real parties at interest and their economic position - that is, who they are and their motivation in getting involved in the transaction - is not only material to the transaction it is part of the essence of the transaction!
Hiding such information thus must always be prohibited as the only reason to hide such information is to commit a fraud upon the buyer or seller on the other side.
The reason the banks don't like such rules is that if the real party at interest (in this case alleged to be the John Paulson hedge fund) and the essential purpose of the creation of the synthetic CDO(to place a bet on the detonation of the reference securities) were disclosed nobody would have bought it.
If that's not the definition of fraud I don't know what is.
In the 1990s investment banks brought literally hundreds ofIPOs to market in which they had no reasonable expectation of business success, relying on the "brand integrity" - that is, the "good name" of the particular book-runners and offering managers, to get people to buy.Millions of investors bought predicated on ridiculous and outrageously-inflated expectations, all based on the imprimatur of these "investment banks", andultimately lost everything. These scams wereuncovered during the .COM blowup when it came to light that the investment banks knew they were pumping garbage securities - emails and other communications came to light where the bankers were calling particular companies they were representing "trash", "vomit" and other similar adjectives.
Yet very few went to prison.
That refusal to prosecute after the 2000 crash- a uniquely government failing - was in large part responsible for why we got into trouble this time. The bubble in housing and the markets, both stock and creditgenerally could not have inflated without these very same bankers creating all this "liquidity" by creating and selling securities that were once again, in many cases, described as "vomit" - in private.
If the SEC action taken yesterday remains a solely civil one, then we will not fix a damn thing. Fines will be paid and chuckles will ensue around the boardroom table.
These acts demand, as they did in 2000,criminal investigation and prosecution, including where appropriate charging the company, not just specific actors within the firm. Such charges should, if proved, result in the effective dissolution of the firms involvedvia the revocation of banking and securities licenses.
We cannot have a fair and free market economy, most particularly in the securities realm, unless those who invest and trade have good cause to believe they're not being swindled. This confidence has been lost, and the blatant and outrageous refusal to clamp down after the debacle in 2000 was directly responsible for the depths of the latest collapse.
Ironically, it is also related to the huge stock market rally, as was demonstrated yesterday. When Goldman Sachs has their stock decline by $23.00, a 13% drop in one day, as a consequence of being potentially tagged for unlawful behavior in a civil venue, it tells you that much of the rise that has occurred in these firms' stock prices happened because investors believe that their conduct would not be exposed and stopped.
That's the sort of "market" that one has in a Banana Republic, not a nation governed by the rule of law.
......Read the rest here.