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Why Bad Publicity Never Hurts Goldman Sachs

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My last posting focused on the widely-publicized research conducted by Stéphane Côté, PhD, Associate Professor of Organizational Behavior at the University of Toronto’s Rotman School of Management, who worked with a team of four psychologists from the University of California at Berkeley to conduct seven studies on a rather timely subject.  Their article, “Higher social class predicts increased unethical behavior” was published in the February 27 issue of the Proceedings of the National Academy of Sciences (PNAS).  The following excerpt from the abstract of their paper provides the general theme of what their efforts revealed:

.   .   .  investigation revealed upper-class individuals were more likely to exhibit unethical decision-making tendencies (study 3), take valued goods from others (study 4), lie in a negotiation (study 5), cheat to increase their chances of winning a prize (study 6), and endorse unethical behavior at work (study 7) than were lower-class individuals.

I began my discussion of that paper by looking back at a Washington Post opinion piece entitled, “Angry about inequality?  Don’t blame the rich”.  The essay was written last January by James Q. Wilson (who passed away on March 2).  On March 4, William K. Black took a deeper look at the legacy of James Q. Wilson, which provided a better understanding of why Wilson would champion the “Don’t blame the rich” rationale.  As Bill Black pointed out, Wilson was a political scientist, known best for his theory called “broken windows” – a metaphor based on a vacant building with a few broken windows, which quickly has all of its windows broken because petty criminals feel emboldened to damage a building so neglected by its owners.  Bill Black emphasized that Wilson was exclusively preoccupied with minor, “blue collar” crimes.  Black noted that in a book entitled, Thinking About Crime, Wilson expressed tolerance for “some forms of civic corruption” while presenting an argument that criminology “should focus overwhelmingly on low-status blue collar criminals”.  Bill Black went on to explain how Wilson’s blindness to the relevance of the “broken windows” concept, as it related to “white collar” crime, resulted in a missed opportunity to attenuate the criminogenic milieu which led to the 2008 financial crisis:

Wilson emphasized that it was the willingness of society to tolerate relatively minor blue collar crimes that led to social disintegration and epidemics of severe blue collar crimes, but he engaged in the same willingness to tolerate and excuse less severe white collar crimes.  He predicted in his work on “broken windows” that tolerating widespread smaller crimes would lead to epidemic levels of larger crimes because it undermined community and social restraints.  The epidemics of elite white collar crime that have driven our recurrent, intensifying financial crises have proven this point.  Similarly, corruption that is excused and tolerated by elites is unlikely to remain at the level of “a few deals.”  Corruption is likely to spread in incidence and severity precisely because it undermines community and the rule of law and it is likely to grow more pervasive and harmful the more we “tolera[te]” it.

*   *   *

Taking Wilson’s “broken windows” reasoning seriously in the elite white collar crime context would require us to take a series of prophylactic measures to restore integrity and strengthen peer pressures against misconduct.  Indeed, we have implicitly tested the applicability of “broken windows” reasoning in that context by adopting policies that acted directly contrary to Wilson’s reasoning.  We have adopted executive and professional compensation systems that are exceptionally criminogenic.

*   *   *

Fiduciary duties are critical means of preventing broken windows from occurring and making it likely that any broken windows in corporate governance will soon be remedied, yet we have steadily weakened fiduciary duties.  For example, Delaware now allows the elimination of the fiduciary duty of care as long as the shareholders approve.  Court decisions have increasingly weakened the fiduciary duties of loyalty and care.  The Chamber of Commerce’s most recent priorities have been to weaken Sarbanes-Oxley and the Foreign Corrupt Practices Act.  We have made it exceptionally difficult for shareholders who are victims of securities fraud to bring civil suits against the officers and entities that led or aided and abetted the securities fraud.

*   *   *

In the elite white collar crime context we have been following the opposite strategy of that recommended under “broken windows” theory.  We have been breaking windows. We have excused those who break the windows.  Indeed, we have praised them and their misconduct.  The problem with allowing broken windows is far greater in the elite white collar crime context than the blue collar crime context.

To find a “poster child” example for the type of errant fiduciary behavior which owes its existence to Wilson’s misapplication of the “broken windows” doctrine, one need look no further than Matt Taibbi’s favorite “vampire squid”:  Goldman Sachs.  One would think that after Taibbi’s groundbreaking, 2009 tour de force about Goldman’s involvement in the events which led to the financial crisis . . .  and after the April 2010 Senate Permanent Subcommittee on Investigations hearing, wherein Goldman’s “Fab Four” testified about selling their customers the Abacus CDO and that “shitty” Timberwolf deal, the firm would at least try to keep a lower profile these days.  Naaaaw!

Goldman Sachs has now found itself in the crosshairs of a man, formerly accused of carrying water for the firm – Andrew Ross Sorkin.  Sorkin’s March 5 DealBook article for The New York Times upbraided Goldman for its flagrant conflict of interest in a deal where the firm served as an adviser to an oil (and natural gas) pipeline company, El Paso, which was being sold to Houston-based Kinder Morgan for $21.1 billion.  Goldman owned a 19.1 percent stake in Kinder Morgan at the time.  Andrew Ross Sorkin quoted from the script which Goldman CEO, Lloyd Blankfein read to El Paso’s CEO, Douglas Foshee, wherein Blankfein confirmed that Foshee was aware of Goldman’s investment in Kinder Morgan.  It was refreshing to see a bit of righteous indignation in Sorkin’s discussion of the dirty details behind this transaction:

When the deal was announced, buried at the end of the news release was a list of Wall Street banks that had advised on the deal, including Goldman Sachs.  Goldman received a $20 million fee for playing matchmaker for El Paso.  The fee, of course, was not disclosed, nor was the Kinder Morgan stake owned by Goldman Sachs’s private equity arm, worth some $4 billion.  Nor did the release disclose that the Goldman banker who advised El Paso to accept Kinder Morgan’s bid owned $340,000 worth of Kinder Morgan stock.

Now, however, a court ruling in a shareholder lawsuit has laid bare the truth:  Goldman was on every conceivable side of the deal.  As a result, El Paso may have unwittingly sold itself far too cheaply.  Mr. Blankfein may have said he was “very sensitive to the appearance of conflict,” but the judge’s order ruling “reluctantly” against a motion to block the merger made it clear that Goldman’s conflicts went far beyond mere appearances.

Here’s just one example:  In an effort to help mitigate its clear conflict, Goldman Sachs recommended that El Paso hire an additional adviser so that El Paso would be able to say that it had received completely impartial advice.  Goldman did not say it would step down, and lose its fee, it simply suggested that El Paso hire one more bank – in this case, Morgan Stanley.

After explaining that Goldman included a provision in the deal that Morgan Stanley would get paid only if El Paso agreed to the sale to Kinder Morgan, Sorkin expressed this reaction:

Goldman’s brazenness in this deal is nothing short of breathtaking.

Goldman’s conflict of interest in the El Paso deal was also the subject of an article by Matthew Philips of Bloomberg BusinessWeek.  Mr. Philips reminded us of whom we have to thank for “helping Greece dupe regulators by disguising billions of dollars’ worth of sovereign debt”:

New details have also emerged about Goldman’s role in helping Greece hide its debt so it could qualify for membership in the European Union.  In a Bloomberg News story out this week, Greek officials talk about how they didn’t truly understand the complex swaps contracts they were buying from Goldman bankers from 2001 to 2005, and that each time Goldman restructured the deal, things got worse for Greece.

The story reads like a cautionary tale of a homeowner who keeps returning to the same contractor to repair the damage done by the previous fix-it job.  At one point, Goldman prohibited Greece’s debt manager, Christoforos Sardelis, from seeking outside price quotes on the complicated derivatives Goldman was selling to Greece.

*   *   *

Yet Goldman’s sullied reputation doesn’t appear to be negatively impacting its business.  In fact, Goldman is outpacing its Wall Street competition recently in key areas of business.  In 2011, Goldman was the top adviser for both global M&A and equity IPOs.  A Bloomberg survey of traders, investors, and analysts last May showed that while 54 percent of respondents had an unfavorable opinion of Goldman, 78 percent believed that allegations it duped clients and misled Congress would have no material effect on its business.

In other words:  Goldman Sachs keeps breaking windows and nobody cares.  Thanks for nothing, James Q. Wilson!


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Banking Lobby Tools In Senate Subvert Reform

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May 20. 2010

The financial pseudo-reform bill is being exposed as a farce.  Thanks to its tools in the Senate, the banking lobby is on the way toward defeating any significant financial reform.  Although Democrats in the Senate (and the President himself) have been posing as reformers who stand up to those “fat cat bankers”, their actions are speaking much louder than their words.  What follows is a list of the Senate Democrats who voted against both the Kaufman – Brown amendment (to prevent financial institutions from being “too big to fail”) as well as the amendment calling for more Federal Reserve transparency (sponsored by Republican David Vitter to comport with Congressman Ron Paul’s original “Audit the Fed” proposal – H.R. 1207 – which was replaced by the watered-down S. 3217 ):

Akaka (D-HI), Baucus (D-MT), Bayh (D-IN), Bennet (D-CO), Carper (D-DE), Conrad (D-ND), Dodd (D-CT), Feinstein (D-CA), Gillibrand (D-NY), Hagan (D-NC), Inouye (D-HI), Johnson (D-SD), Kerry (D-MA), Klobuchar (D-MN), Kohl (D-WI), Landrieu (D-LA), Lautenberg (D-NJ), Lieberman (ID-CT), McCaskill (D-MO), Menendez (D-NJ), Nelson (D-FL), Nelson (D-NE), Reed (D-RI), Schumer (D-NY), Shaheen (D-NH), Tester (D-MT), Udall (D-CO) and Mark Warner (D-VA).

I wasn’t surprised to see Senator Chuck Schumer on this list because, after all, Wall Street is located in his state.  But how about Senator Claire McCaskill?  Remember her performance at the April 27 hearing before the Senate Permanent Subcommittee on Investigations?   She really went after those banksters – didn’t she?  Why would she suddenly turn around and support the banks in opposing those two amendments?   I suppose the securities and investment industry is entitled to a little payback, after having given her campaign committee $265,750.

I was quite disappointed to see Senator Amy Klobuchar on that list.  Back on June 19, 2008, I included her in a piece entitled “Women to Watch”.  Now, almost exactly two years later, we are watching her serve as a tool for the securities and investment industry, which has given her campaign committee $224,325.  On the other hand, another female Senator whom I discussed in that same piece, Maria Cantwell of Washington, has been standing firm in opposing attempts to leave some giant loopholes in Senator Blanche Lincoln’s amendment concerning derivatives trading reform.  The Huffington Post described how Harry Reid attempted to use cloture to push the financial reform bill to a vote before any further amendments could have been added to strengthen the bill.  Notice how “the usual suspects” – Reid, Chuck Schumer and “Countrywide Chris” Dodd tried to close in on Cantwell and force her capitulation to the will of the kleptocracy:

There were some unusually Johnsonian moments of wrangling on the floor during the nearly hour-long vote.  Reid pressed his case hard on Snowe, the lone holdout vote present, with Bob Corker and Mitch McConnell at her side.  After finding Brown, he put his arm around him and shook his head, then found Cantwell seated alone at the opposite end of the floor.  He and New York’s Chuck Schumer encircled her, Reid leaning over her with his right arm on the back of her chair and Schumer leaning in with his left hand on her desk.  Cantwell stared straight ahead, not looking at the men even as she spoke.  Schumer called in Chris Dodd, who was unable to sway her.  Feingold hadn’t stuck around.  Cantwell, according to a spokesman, wanted a guarantee on an amendment that would fix a gaping hole in the derivatives section of the bill, which requires the trades to be cleared, but applies no penalty to trades that aren’t, making Blanche Lincoln’s reform package little better than a list of suggestions.

*   *   *

“I don’t think it’s a good idea to cut off good consumer amendments because of cloture,” said Cantwell on Tuesday night.

Other amendments offered by Democrats would ban banks from proprietary trading, cap ATM fees at 50 cents, impose new limits on the payday lending industry, prohibit naked credit default swaps and reinstate Glass-Steagall regulations that prohibit banks from owning investment firms.

“We need to eliminate the risk posed to our economy by ‘too big to fail’ financial firms and to reinstate the protective firewalls between Main Street banks and Wall Street firms,” said Feingold in a statement after the vote.  Feingold supported the amendment to reinstate Glass-Steagall, among others.

“Unfortunately, these key reforms are not included in the bill,” he said.  “The test for this legislation is a simple one — whether it will prevent another financial crisis.  As the bill stands, it fails that test.  Ending debate on the bill is finishing before the job is done.”

Russ Feingold’s criticisms of the bill were consistent with those voiced by economist Nouriel Roubini (often referred to as “Doctor Doom” because he was one of the few economists to anticipate the scale of the financial crisis).  Barbara Stcherbatcheff of CNBC began her report on Dr. Roubini’s May 18 speech with this statement:

Current efforts to reform financial regulation are “cosmetic” and won’t prevent another crisis, economist Nouriel Roubini told an audience on Tuesday at the London School of Economics.

The current mid-term primary battles have fueled a never-ending stream of commentary following the same narrative:  The wrath of the anti-incumbency movement shall be felt in Washington.  Nevertheless, Dylan Ratigan seems to be the only television commentator willing to include “opposition to financial reform” as a political liability for Congressional incumbents.  Yves Smith raised the issue on her Naked Capitalism website with an interesting essay focused on this theme:

Why have political commentators been hesitant to connect the dots between the “no incumbent left standing” movement and the lack of meaningful financial reform?

Her must-read analysis of the “head fakes” going on within the financial reform wrangling concludes with this thought:

So despite the theatrics in Washington, I recommend lowering your expectations greatly for the result of financial reform efforts.  There have been a few wins (for instance, the partial success of the Audit the Fed push), but other measures have for the most part been announced with fanfare and later blunted or excised.  Even though the firestorm of Goldman-related press stiffened the spines of some Senators and produced a late-in-process flurry of amendments, don’t let a blip distract you from the trend line, that as the legislative process proceeds apace, the banks will be able to achieve an outcome that leaves their dubious business models and most important, the rich pay to industry incumbents, largely intact.

As always, it’s up to the voting public with the short memory to unseat those tools of the banking lobby.  Our only alternative is to prepare for the next financial crisis.



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Too Cute By Half

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April 29, 2010

On April 15, I discussed the disappointing performance of the Financial Crisis Inquiry Commission (FCIC).  The vapid FCIC hearings have featured softball questions with no follow-up to the self-serving answers provided by the CEOs of those too-big–to-fail financial institutions.

In stark contrast to the FCIC hearings, Tuesday brought us the bipartisan assault on Goldman Sachs by the Senate Permanent Subcommittee on Investigations.  Goldman’s most memorable representatives from that event were the four men described by Steven Pearlstein of The Washington Post as “The Fab Four”, apparently because the group’s most notorious member, Fabrice “Fabulous Fab” Tourre, has become the central focus of the SEC’s fraud suit against Goldman.   Tourre’s fellow panel members were Daniel Sparks (former partner in charge of the mortgage department), Joshua Birnbaum (former managing director of Structured Products Group trading) and Michael Swenson (current managing director of Structured Products Group trading).  The panel members were obviously over-prepared by their attorneys.  Their obvious efforts at obfuscation turned the hearing into a public relations disaster for Goldman, destined to become a Saturday Night Live sketch.  Although these guys were proud of their evasiveness, most commentators considered them too cute by half.  The viewing public could not have been favorably impressed.  Both The Washington Post’s Steven Pearlstein as well as Tunku Varadarajan of The Daily Beast provided negative critiques of the group’s testimony.  On the other hand, it was a pleasure to see the Senators on the Subcommittee doing their job so well, cross-examining the hell out of those guys and not letting them get away with their rehearsed non-answers.

A frequently-repeated theme from all the Goldman witnesses who testified on Tuesday (including CEO Lloyd Bankfiend and CFO David Viniar) was that Goldman had been acting only as a “market maker” and therefore had no duty to inform its customers that Goldman had short positions on its own products, such as the Abacus-2007AC1 CDO.  This assertion is completely disingenuous.  When Goldman creates a product and sells it to its own customers, its role is not limited to that of  “market-maker”.  The “market-maker defense” was apparently created last summer, when Goldman was defending its “high-frequency trading” (HFT) activities on stock exchanges.  In those situations, Goldman would be paid a small “rebate” (approximately one-half cent per trade) by the exchanges themselves to buy and sell stocks.  The purpose of paying Goldman to make such trades (often selling a stock for the same price they paid for it) was to provide liquidity for the markets.  As a result, retail (Ma and Pa) investors would not have to worry about getting stuck in a “roach motel” – not being able to get out once they got in – after buying a stock.  That type of market-making bears no resemblance to the situations which were the focus of Tuesday’s hearing.

Coincidentally, Goldman’s involvement in high-frequency trading resulted in allegations that the firm was “front-running” its own customers.   It was claimed that when a Goldman customer would send out a limit order, Goldman’s proprietary trading desk would buy the stock first, then resell it to the client at the high limit of the order.  (Of course, Goldman denied front-running its clients.)  The Zero Hedge website focused on the language of the disclaimer Goldman posted on its “GS360” portal.  Zero Hedge found some language in the GS360 disclaimer which could arguably have been exploited to support an argument that the customer consented to Goldman’s front-running of the customer’s orders.

At Tuesday’s hearing, the Goldman witnesses were repeatedly questioned as to what, if any, duty the firm owed its clients who bought synthetic CDOs, such as Abacus.  Alistair Barr of MarketWatch contended that the contradictory answers provided by the witnesses on that issue exposed internal disagreement at Goldman as to what duty the firm owed its customers.  Kurt Brouwer of MarketWatch looked at the problem this way :

This distinction is of fundamental importance to anyone who is a client of a Wall Street firm.  These are often very large and diverse financial services firms that have — wittingly or unwittingly — blurred the distinction between the standard of responsibility a firm has as a broker versus the requirements of an investment advisor.  These firms like to tout their brilliant and objective advisory capabilities in marketing brochures, but when pressed in a hearing, they tend to fall back on the much looser standards required of a brokerage firm, which could be expressed like this:

Well, the firm made money and the traders made money.  Two out of three ain’t bad, right?

The third party referred to indirectly would be the clients who, all too frequently, are left out of the equation.

A more useful approach could involve looking at the language of the brokerage agreements in effect between Goldman and its clients.  How did those contracts define Goldman’s duty to its own customers who purchased the synthetic CDOs that Goldman itself created?  The answer to that question could reveal that Goldman Sachs might have more lawsuits to fear than the one brought by the SEC.



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