Sachs and pillages

Wall street's latest scandal is just what the Obama administration needs to push through its reforms of the financial industry

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by L. IAN MacDONALD
The Gazette, Wednesday, April 21, 2010

There being no accidents of timing in politics, it is hardly seen as coincidental that the U.S. government launched a securities fraud suit against Goldman Sachs, the Wall Street investment banking giant, just days before a financial-regulation reform bill reaches the floor of the Senate.

These lawsuits are usually settled out of court, but in this case neither side is likely to settle on the courthouse steps. The government, through the Securities and Exchange Commission, wants to make a point that there's a new sheriff in Dodge, while Goldman will spare neither effort nor expense to defend its iconic brand.

The accusations are stunning: Goldman is accused of bundling bad mortgage securities to clients, in the knowledge that another client, hedge fund manager John Paulson, would bet against these toxic assets by shorting them. Goldman may be too big to fail, but this fund was built to fail.

While other Goldman clients lost $1 billion, Paulson made $1 billion betting against a mortgage fund that had been put together in the expectation it would fail. Except the other suckers weren't given a "buyer-beware" heads-up by Goldman, which is accused of playing both sides of the street. This is a firm that paid $20 billion in bonuses last year, on the heels of the $700-billion bailout of Wall Street, a source of rage on Main Street.

On the news of the lawsuit, significantly filed as markets were open rather than after the close last Friday, Goldman's richly priced shares dropped more than $23, or 13 per cent of their market capitalization, for a staggering loss of $12 billion in a single session.

By the end of the weekend, British Prime Minister Gordon Brown, in the midst of a tough election campaign, jumped on the anti-Goldman bandwagon, promising an investigation in Britain and calling for an end to rich compensation packages for investment banks. For good measure, he called Goldman "morally bankrupt." Brown then jumped on his favourite hobby horse, repeating a call for a tax on banks, or as he called it "a global financial levy," which is staunchly opposed by most of Britain's G8 partners, including the U.S. and Canada.

Finance Minister Jim Flaherty, in Washington for meetings ahead of the G8 and G20, will certainly be carrying the message that Canadian banks should not be made to pay for their success of managing through the financial crisis, without ever accepting a nickel of standby credit made available by Ottawa, which did not have to bail out Bay Street.

Meanwhile, the U.S. Senate will begin debating a 1,400-page financial-reform bill that covers the waterfront and would, among other provisions, establish a derivatives exchange - not unlike Montreal's - as a central clearing house so that investors know who's buying and who's selling.

Goldman knew to whom they were selling the bad mortgages in a fund called Abacus, but the buyers weren't aware the assets were designed to fail, and they certainly wouldn't have known that Goldman was putting them together so that another client could bet against them. At least, that's what the SEC is alleging.

The financial bubble burst partly because of the commoditization of products, such as derivatives, that no one really understood and the spreading of risk by banks and financial institutions selling them to one another. When one fell, they all fell, like dominos.

There was a time when financial services comprised four discrete pillars - commercial banks, investment banks, brokerages, and insurance companies. Then came the Big Bang of 1986 - Margaret Thatcher's deregulation of British financial services that announced the globalization of the industry. Thus, a quarter century later, the Royal Bank of Scotland had significant losses because of its holding in the bad Goldman fund. RBS was bailed out by the British government during the financial crisis.

Does the Goldman suit give the Obama administration leverage over the Senate, where the Democrats have lost their filibuster-proof majority? For the moment, all 41 Republicans in the 100-seat Senate oppose the financial reform bill. But this isn't health care. Any Tea Party movement on Main Street will be driven by revulsion and disgust at Wall Street. Nobody wants to be seen defending Wall Street, not even the Republicans.

Besides, Barack Obama is feeling pretty frisky after his big win on health care, when he used the presidential bully pulpit with enormous success.

By no coincidence, Obama is hitting the road tomorrow with a major speech on financial reform right in New York.

Meanwhile, Goldman put out its first quarter numbers yesterday: a profit of $3.3 billion, or $5.59 per share, easily beating the whisper number of $4.01. Interestingly, its stock got no bounce out of the news, and in the last hour of trading was actually down more than $2, right where it was last Friday, meaning the market has larger concerns than earnings, namely the integrity of the brand.

 
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