It is incredible how this financial crisis is throwing up the accumulated dirt in Wall Street. You can hear my own cries of anguish in some of the articles I have written in this blog. What always bothered me was the entrenched corruption and the blatant disregard for the well-being of the larger society exhibited by these very pillars of our capitalist society. Why am I writing this again? Because, just today, SEC decided to charge the mighty Goldman Sachs for committing fraud in their structuring of Collaterlized Debt Obligations (CDOs) in at least one specific case. This, I feel, is only the beginning of what could be a long summer of more instances of clear violation of ethics by these famed institutions.
Without getting too technical about it, here is what happened (Read this for more): One of the CDO managers, working for Goldman Sachs (I believe a 31-yr old man who called himself “fabulous fab”), structured a CDO, (a derivative instrument made up of different tranches of residential mortgage-backed-securities (RMBSs) of various risk levels), wherein the securities were hand-picked by a hedge fund manager who in turn “shorted” them by purchasing credit default swaps (CDS, a form of insurance against the default of underlying bonds, in this case the securities within the CDO). So, while Goldman was selling the CDOs to all those customers who trusted their products, behind their backs Goldman was selecting rotten securities so that a hedge fund manager could short them. A serious violation of trust. There is nothing more to be said.
Now we know that John Paulson, made famous by WSJ’s Greg Zuckerman’s book “Greatest Trade Ever”, was the hedge fund manager behind this deal. Mr. Paulson made more than $2 billion in 2007 for himself and nearly $15 billion for his firm. I don’t think SEC has charged him. But, the point is, it looks like deals like this were quite commonplace in those days. Those who had the vision to short the subprime market made billions, but what is stunning here is, those who were creating these CDO products were aware of the “crumbling towers” they were building for their customers. Yet, they were driven by self-interest of the worst kind. There are more cases like this discussed in Michael Lewis’ book “The Big Short.” What is abominable is the fact that Goldman was making money on both ends—selling CDOs to the customers on one end and selling CDSs to the shorts on the other end. By the way, this is lot more complex than what I have described here. The worst part is, Goldman wasn’t even responsible for paying the CDS-holders in the event of CDO defaults, as they had investors on the other side of the CDS transactions who received the CDS premium while Goldman took a cut. Believe me, the kind of financial legerdemain evidenced here belongs to the world of Harry Houdini. Despite the complexity and conspicuous greed behind such esoteric products, there was nothing illegal about most of these actions, I think. This is a clear case of violation of trust.
That is why there is so much cynicism in the Main street when it comes to Wall Street. Of course, most of the employees of these big institutions are honest workers who work very hard to earn their above average rewards. However, it is the greed, dishonesty and incompetence of few who really hold the levers of power who are responsible for this huge crisis that has destroyed the trust of people in these institutions.
I am sure Goldman will fight these charges to safeguard its reputation. And, despite all the bad news there may be no consequences except few bad players getting thrown out of the game for good. Longer term, if this culture of greed and excesses is not changed, it is inevitable that we will be faced with another crisis. Through all this, ordinary, hard working people will suffer for no fault of theirs. Financial crisis invariably results in economic crisis and that in turn impacts people of all walks of life. It hurts them as they lose jobs, lose equity in their homes, their nest eggs deplete, children’s education suffers…the list is very big and depressing. Entire humanity pays a huge price for the action of few. What bothers me is, despite such irresponsible behavior, the central bank has allowed these big banks to have access to easy money (at the expense of tax payers), so that these banks can make billions by trading (it’s like a casino!) esoteric products and pump up the equity markets and at the end of the day have a party and giveaway huge bonuses while people in the main street continue to suffer the consequences of the actions of these big banks.
I have nothing against these institutions. I know that they play an important role in this economy. Being a finance guy myself, I have lot of respect for those who run these institutions. But somewhere, especially, in those areas where the actions of these institutions impact the larger society, things do need to change. In order to win the trust of the main street the Wall Street has to shed greedy excesses; they have to identify the bad apples early. Instead of waiting for government regulations, they should resort to self-regulation. Greedy behavior has to be checked by creating a better incentive system. While fierce competition among these Wall Street firms require them to play the game everybody plays, any evidence of ethics violation by one firm need not be a de facto industry standard or a license for everyone to do the same. Instead, such actions should be immediately brought to the attention of regulators as opposed to waiting for the regulators to catch the thief. One honest action will lead to another and will become the reason for saving the entire system.
I guess, I am naive. Yet, is it too much to expect honest and able leadership from at least some of the leaders who head these institutions? Don’t they feel like questioning the system when there is obvious wrongs being committed that have larger implications? I certainly hope so.
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