Terry Connelly is dean of the Ageno School of Business at Golden Gate University and is frequently quoted on business, financial, and economic issues by Bay Area local, as well as national, news media.
Let’s try this:
1) Does the SEC have a good case against Goldman Sachs/ Better than a lot of commentators think. Of course sophisticated private buyers knew that short sellers were on the other side of the trade, and GS was not an underwriter but just a placement agent; BUT GS should have disclosed that the securities were picked from deck supplied by a known short-seller — that looks like an omission of a material fact, because that information would have made a difference to a reasonable buyer at least on PRICE, if not on the decision whether to buy at all.
2) Is Goldman’s (or any other investment bank’s) basic business model as a financial intermediary unethical because they don’t “put the client first”? NO: by definition, a financial intermediary has two clients — one a buyer and one a seller– GS has an obligation to deal with them each fairly and above board, but how can they pick just one to “put first’” — you can’t be a fiduciary for both sides of a trade. And remember some clients want to take risks. One of the long-taught lessons to apprentice investment bankers is — “if the client wants a red suit, sell them a red suit” … and in 2007, a whole lot of folks wanted to go long the mortgage markets, because they didn’t perceive it was a “red suit” waiting to happen. Goldman apparently did perceive that, but if it had refused to sell the mortgage products then and there, the business would have just gone someplace else (say Bear Stearns, and the risk profile of the financial industry (and the US taxpayer) would have wound up the same.
3) BUT what about when Goldman trades for it’s own account against the interests of its customers? Well, here it gets interesting. Sometime a firm like GS will take a position for itself just because it likes the bet — it has a view of the market informed by its day-to-day experience. But other times it takes a position onto its own book to accommodate a client or to facilitate making a market, like after an IPO, which means its taking a risk on that security, and if it hedges that risk, it is in a real sense protecting its “own account”. The proposed “Volcker rule” says that a deposit-taking institution can’t just trade for its own account because it puts taxpayers at risk, but where do you draw the line for the situation just mentioned where it starts with accommodating a client?
4) What about derivatives: if they are “instruments of mass financial destruction” or whatever Warren Buffet called them why does he use them and ask Congress to exempt his from the new rules? Well, derivatives have legitimate uses (airlines hedging the price of jet fuel; farmers hedging their crop return) the clearly should be bought and sold through a “clearing” house, which would mean that both sides would have to put up enough collateral to be sure they can pay off. Banks are really trying to fight off another step which would require them to be traded through a public exchange (most of them would be done in Obama’s hometown Chicago companies)…this would make their pricing transparent, and banks have been making a boatload of money on derivatives precisely by keeping the trades private and this not transparent, so only they know the true market price.
5) What’s really going on here: Look, we are in the middle of a fight about proposed legislation which will set the framework for the financial industry for the next two or three decades at least. There is a lot at stake, and the lobbying is fierce, and firms like Goldman have a lot of lobbying power at their disposal (and a lot of friendly media, too. Obama has been quite clear about wanting the banks to call off their dogs in this fight, and it would be that the case vs. Goldman and leaks about Justice Department investigations are what we know if baseball a s “brush-back” pitch in the Ninth Inning of a close World Series seventh game. If I’m right, the folks who think Obama is a “weak sister” who can’t play hardball have got another think coming: and remember that Goldman definitely knows how to play hardball. So maybe all that’s really going on is a process of evening up the odds. The contra view, of course, is that Obama is clearly playing hardball just to push some of Wall Street’s business over to Chicago!
6) Why don’t we have a “product recall’ practice for Wall Street securities that go sour just like we have for Toyota’s and Tylenol? NOW There’s a Good Idea! We do have some securities Act provisions about recession, but they are cumbersome and not used: but would the earth stop spinning for a moment if some investment bank one day admitted to the buyers what it tells itself in e-mails — namely, that this deal we did stinks to high heaven, and we’re going to recall it, and fix it or eat it ourselves! Maybe then, Goldman Sachs would rate as high as Johnson & Johnson in public respect, and even keep its stock price up, too.
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