The torrent of speculation surrounding the SEC’s attempt to nail the “giant vampire squid” (a.k.a. Goldman Sachs) over alleged fraudulence in its Abacus 2007-AC1 synthetic collateralised debt obligation (CDO) seems to have obscured the true import of what happened last Friday.
For Goldman Sachs, traditionally the most successful and most powerful investment bank on Wall Street, to be charged with fraud by the leading regulator in its home country is quite astonishing. Whether the case is won or lost, the mere fact of the charges were brought and their tangible effect on Goldman’s reputation, will come to be seen as a seminal event in the power struggle between unfettered free markets, globalisation, and governments around the world.
The fact the SEC pressed charges on Goldman and the architect of the toxic synthetic CDO, Fabrice “Fabulous Fab” Tourre, last Friday for defrauding their clients—and specifically for keeping “long” investors in the dark about the identity of the (short-selling) group selecting the group debt parcels that were thrown into the hideously opaque CDO, speaks volumes about the changed mood in Washington right now.
Gone is the cozy situation whereby a bank’s chief executive could simultaneously sit on the board of the regulator. Gone are the days when what was good for Goldman Sachs was deemed to be good for America.
Gone are the days when the investment bank could rely on a sympathetic ear in the White House and the US Treasury Department and when the former Treasury secretary Hank Paulson would favour his former Goldman colleagues. Gone are the days when Goldman could rely on its many alumni in senior government roles and in global institutions such as the IMF to ensure that policy mirrored its interests, irrespective of whether this was good for Main Street (i.e. American voters).
Faith in the efficient market hypothesis, which has pretty much driven Anglo-Saxon governments’ thinking about financial services since the 1980s, took some severe knocks as a result of the financial and economic train wrecks of 2007-09. The theory is now as discredited as was communism after the Fall of the Berlin Wall (according to Professor Joseph Stiglitz at least).
If the market always knew best and if banks were predisposed to behaving responsibly (which was what powerful figures such as former Federal Reserve governor Alan Greenspan and prime minister Gordon Brown believed prior to the crisis) the blow-outs could not have occurred.
Given such ideological shifts—coupled with Wall Street’s lack of contrition and seeming ingratitude for the taxpayer-funded bailouts of 2008 and 2009—it was only a matter of time before government responded to people’s wrath and lost patience with over-mighty firms such as Goldman.
The current SEC action and the concomitant action by the FSA in London, suggests the gloves are off. Governments have woken up to the danger that, left to their own devices, institutions like Goldman Sachs can become virtual “rogue states” that allow financiers to rig the capital markets in their own favour.
This blog post was published on Friday 23 April 2010. A longer version was published in Qfinance on the same day.