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According to the Collins English Dictionary 10th Edition fraud can be defined as: "deceit, trickery, sharp practice, or breach of confidence, perpetrated for profit or to gain some unfair or dishonest advantage".[1] In the broadest sense, a fraud is an intentional deception made for personal gain or to damage another individual; the related adjective is fraudulent. The specific legal definition varies by legal jurisdiction. Fraud is a crime, and also a civil law violation. Defrauding people or entities of money or valuables is a common purpose of fraud, but there have also been fraudulent "discoveries", e.g. in science, to gain prestige rather than immediate monetary gain
*As defined in Wikipedia

Friday, January 7, 2011

The Goldman Sachs Subsidy

You would think that Goldman Sachs would take a great deal of pleasure in showing just how well it can manage its affairs without government subsidy. That appears not to be the case. They have become so inured to their special status as a bank holding company with access to Fed discounts that they apparently can't even imagine going it alone. What pride is there in hanging onto the apron strings of the government? Why don't they just go it alone as an investment bank? Well, we know the answer to that. The article below from The New York Times writer, Simon Johnson, has some interesting things to say about Facebook and Goldman Sachs.

Why Are Taxpayers Subsidizing Facebook, and the Next Bubble?

Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author of “13 Bankers.”

Goldman Sachs is investing $450 million of its own money in Facebook, at a valuation that implies the social-networking company is now worth $50 billion. Goldman is also creating a fund that will offer its high-net-worth clients an opportunity to invest in Facebook.

On the face of it, this might seem just like what the financial sector is supposed to be doing – channeling money into productive enterprise. The Securities and Exchange Commission is reportedly looking at the way private investors will be involved, but there are more deeply unsettling factors at work here.

Remember that Goldman Sachs is now a bank-holding company – a status it received in September 2008, at the height of the financial crisis, in order to avoid collapse (see Andrew Ross Sorkin’s blow-by-blow account in “Too Big to Fail” for the details.)

This means that it has essentially unfettered access to the Federal Reserve’s discount window – that is, it can borrow against all kinds of assets in its portfolio, effectively ensuring it has government-provided liquidity at any time.

Any financial institution with such access to such government support is likely to take on excessive risk – this is the heart of what is commonly referred to as the problem of “moral hazard.” If you are fully insured against adverse events, you will be less careful.

Goldman Sachs is undoubtedly too big to fail – in the sense that if it were on the brink of failure now or in the near future, it would receive extraordinary government support and its creditors (at the very least) would be fully protected.

In all likelihood, under the current administration and its foreseeable successors, shareholders, executives, and traders would also receive generous help at the moment of duress. No one wants to experience another “Lehman moment.”

This means that Goldman Sachs’s cost of financing is cheaper than it would be otherwise – because creditors feel that they have substantial “downside protection” from the government.

How much cheaper is a matter of some debate, but estimates by my colleague James Kwak (in a paper presented at a Fordham Law School conference last February) put this at around 50 basis points (0.5 percentage points), for banks with more than $100 billion in total assets.

In private, I have suggested to leading members of the Obama administration and Congress that the “too big to fail” subsidy be studied and measured more officially and in a transparent manner that is open to public scrutiny – for example, as a key parameter to be monitored by the newly established Financial Stability Oversight Council.

Unfortunately, so far no one has taken up this approach.

However, there is consensus that the implicit government backing afforded to Fannie Mae and Freddie Mac in recent decades allowed them to borrow at least 25 basis points (0.25 percent) below what they would otherwise have had to pay – a significant difference in modern financial markets.

In “13 Bankers,” Mr. Kwak and I refuted the view that these government sponsored enterprises were the primary drivers of subprime lending and the 2007-8 financial crisis – that debacle was much more about extreme deregulation and private-sector financial institutions seeking to take on crazy risks.

Nonetheless, Fannie and Freddie were badly mismanaged – and followed the market in 2005-7 with bad bets based on excessive leverage – in large part because they had an implicit government subsidy. Those institutions should be euthanized as soon as possible.

Goldman Sachs now enjoys exactly the same kind of unfair, nontransparent and dangerous subsidy: it has effectively become a new form of government-sponsored enterprise. Goldman is not a venture capital fund or primarily an equity-financed investment fund. It is a highly leveraged bank, meaning that it borrows through the capital markets most of the money that it puts to work.

As Anat Admati of Stanford University and her colleagues tirelessly point out, the central vulnerability in our modern financial system is excessive reliance on borrowed money, particularly by the biggest players.

Goldman Sachs is a perfect example. Most of its operations could be funded with equity – after all, it is not in the retail deposit business. But issuing debt is attractive to shareholders because of the subsidies associated with debt financing for banks and to bank executives because their compensation is based on return on equity — as measured, that increases with leverage.

If banks have more debt relative to equity, this increases the potential upside for investors. It also increases the probability that the firm could fail — unless you believe, as the market does, that Goldman is too big to fail.

Social-networking companies should be able to attract risk capital and compete intensely. They do not need subsidies in the form of cheaper financing, or in any other form.

Social networking is a bubble in the sense that e-mail was a bubble. The technology will without doubt change forever how we communicate with each other, and this may have profound effects on the nature of our society. But investors will get carried away, valuations will become too high and some people will lose a lot of money.

If those losses are entirely equity-financed, there may be negative effects, but they are likely be small – in the revised data after the 2001 dot-com crash, there isn’t even a recession (there were not two consecutive negative quarters for gross domestic product).

But if the losses follow the broader Goldman Sachs structure and are largely debt-financed, then the American taxpayer will have helped create another major financial crisis.

And if you think that sophisticated investors at the heart of our financial system can’t get carried away and lose money on Internet-related investments, remember Webvan: “During the dot-com bubble, Goldman invested about $100 million in Webvan, the online grocer that never got off the ground and eventually collapsed in bankruptcy.”

Read the article here


Anonymous said...

For those of you out of the loop, you may not recall that the most powerful and destructive WMD that Boeing executives ever helped develop was the CDO, that’s a Collateralized Debt (Damage) Obligation. Do you remember that guy Edward Liddy? Liddy and Bill Daley were both Boeing board members, before Liddy temporarily moved to Goldman Sachs where he oversaw their Audit Committee. Liddy was the person who had the most knowledge of Goldman’s CDO exposure insured through, what was that company’s name?… Oh, AIG. Yeah, that was it. Then, Hank “Pentagon-Watergate-Goldman” Paulson unilaterally made Liddy the CEO of AIG, before teaming up with Tim “Kissinger-Rubin-Summers-IMF” Geithner to flush $183 billion tax dollars down the “too big to fail” drain. And then… after the government was finished pumping our tax dollars to financial terrorists through the AIG SPV, Liddy scurried back to the board of Boeing where he could have cocktails with his ole pal Billy-Boy Daley. Yep, Goldman, JP Morgan, Boeing and the destruction of the US economy, birds of a feather…

Anonymous said...

January 06, 2011
Hackers find new way to cheat on Wall Street -- to everyone's peril
Side-channel attack on high-frequency trading networks could net a hacker millions of dollars in seconds -- and leave everyone else much poorer

High-frequency trading networks, which complete stock market transactions in microseconds, are vulnerable to manipulation by hackers who can inject tiny amounts of latency into them. By doing so, they can subtly change the course of trading and pocket profits of millions of dollars in just a few seconds, says Rony Kay, a former IBM research fellow and founder of cPacket Networks, a Silicon Valley firm that develops chips and technologies for network monitoring and traffic analysis.

Kay, an Israeli-born computer scientist and one-time Intel engineering manager, says the root of the problem is the increasing speed of networks; as they get faster and faster, our ability to actually understand events taking place within them isn't keeping up. Network monitoring technology can detect perturbations in network traffic happening in milliseconds, but when changes occur in microseconds, they're not visible, he says.

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