Busting Out the Wall Street Casinos

I'm tempted to keep writing about Wall Street Fraud because the Stat Counter is going through the roof, and I'm aware of my public, you know. Just stick that in the label down below ("Wall Street Fraud," that is) and the world beats a path to your door. So I say hello to my new friends in India & France. I don't know any Hindi, but I can say bonjour. I suppose the citizens of the Earth have been waiting for the United States to begin, at least, the process of trying to clean up the mess that Wall Street has inflicted upon the civilized world at large, and the SEC complaint against Goldman Sachs, while barely a start, is a move in the right direction. I see where the brave and honorable Marcy Kaptur has even sent a letter to Eric Holder expressing her desire to see the Department of Justice use its criminal powers to come to the assistance of the SEC.

If Representative Kaptur's letter is delivered, that will at least offer some proof that we have an Attorney General. Mr. Holder certainly maintains a low profile. He was going to prosecute at least one case, against Khalid Sheikh Mohammed in District Court in New York, but now it seems virtually certain that he will turn even that prosecution, the biggest in his docket, over to the military. So it isn't as if he doesn't have time to take on Wall Street. What he should do is deputize Eliot Spitzer as a U.S. Attorney in charge of financial malfeasance and turn him loose. Eliot did a great job as the Sheriff of Wall Street, back in the day, which is why the Bush Administration, in cahoots with the Big Boyz, had to set him up for a fall. He understands how the game is played, how the big investment banks are making huge amounts of money by borrowing at a half percent and lending the money back to the government at 3%, while Congress sits still for it because these banks are so vital to the functioning of our economy. An economy which utterly sucks, but never mind. These things don't have to make sense, they just have to make money for the right people.

It's possible the SEC action is a rogue operation. It seems to violate one of Obama's key principles, ENSOL - the Eternal Now Statute of Limitations. Under this guideline, a predicate act cannot be prosecuted if it occurred in the past, because this is Looking Backward, Not Forward. Thus far, it has been applied mainly to war crimes and illegal wiretapping, but philosophically speaking a logical extension to Wall Street bankers, who are tantamount to government officials, could be made. We shouldn't forget that despite all those Obama email solicitations sent to us mere mortals (the "Morts" in Michael Lewis's phrase) for campaign money, his single biggest contributor was Goldman Sachs, and Obama's first overnight guest at the White House (as a way of saying thanks) was Lloyd Blankfein, the head guy at Goldman. Blankfein must be wondering right now: why don't I get the benefit of ENSOL? These things they're accusing us of, they all happened in the past, just like torture and wiretapping. It is a curious breach of professional courtesy, especially after the O-Man went out of his way to praise Lloyd and Jamie Dimon, the equally unscrupulous head guy at JP Morgan Chase, as "savvy businessmen," although that was after he called everyone on Wall Street a bunch of "fat cat bankers." Blankfein, Dimon, all the rest of them - they must be wondering what's up with this guy.

Meanwhile, I did catch Clinton's act on "This Week" Sunday where Bill admitted he made a mistake in agreeing to deregulate derivatives. Since derivatives were and remain the single biggest, efficient cause of the entire world economy going into a financial collapse, this seems like a minimal admission. No one admits error with quite the aplomb and gravitas of Bill Clinton. He never brags, but he's very effective at apologizing. I recall he also admitted that doing nothing during the Rwanda genocide was also a mistake, one that cost the lives of 800,000 Rwandans, or about 20% of the population. Some days nothing goes right. Bill's explanation, about derivatives, was that the "thinking" at the time, championed by Larry Summers, Bob Rubin and Alan Greenspan (and Summers is still on the job with Obama!), was that derivatives were the exclusive realm of the rich and sophisticated and thus needed no supervision. Thus, we allowed a company like AIG to make book on bets against all manner of derivative performance, such as subprime mortgage CDOs, and paid no attention to whether AIG had anything like the cash reserves necessary to make the bets good if the book went against them, on account of all the sophistication and resources of the people involved (like Joseph Cassano of AIG Financial Products division, who would write a credit default swap based on your bet about how many people would get off the 38 bus at the next stop). Yet when AIG crashed, due to its idiocy and lack of resources, the deregulation meant that the American public had to buy the company at enormous expense ($180 billion) so that it could make good on its bad bets with companies like Goldman Sachs (who took down $14 billion of that bailout), because the American financial system depends on these fraudulent investment banks in order to keep the gangster economy going, and anyway, if Geithner had not presided over that backdoor bailout, then what was all that largesse Blankfein was shoveling into the Obama campaign supposed to buy?

It's all definitely a pretty picture. Congress is so slow-witted that about three years after it became completely clear why the financial system was burning, the House and Senate are just now beginning to figure out exactly how we got had by Goldman, JP Morgan, Merrill Lynch, Lehman Brothers, Bear Stearns, Bank of America, Citigroup, Countrywide, New Century and a host of other scoundrels. Just in time, I'd say, because there are statutes of limitations involved, not the fanciful ENSOL either, but real ones. With guys like William Black, Frank Partnoy, Michael Lewis, Simon Johnson and many other learned commentators drawing them crystal-clear road maps, for literally years, Congress is just now positioning itself to do something about this mess. Which tends to demonstrate that they're only doing so, for the most part, because they really feel now they have absolutely no other choice. They'd really rather wait for another ten years and then "apologize" for not doing the right thing, but that is not going to play very well with a public even now sharpening the tines on their pitch forks.

I've got the horse right here, his name is Paul Revere

As a public service, I offer one or two comments on the legal framework relevant to an evaluation of the SEC's case against Goldman Sachs. I am moved to describe this framework by the highly undedifying spectacle of watching Maria Bartiromo on CNBC hysterically defend GS against the SEC's "unfair" allegations against this venerable den of financiers currently infesting Wall Street.

Maria wonders whether Goldman is being accused of "fraud" or of merely being "unethical." Further, she wonders whether it's fair to require the "seller" of a security to disclose the buyer and vice versa, something, she assures us, "has never been done." Her remarks tend to demonstrate that someone who has been chosen for her high profile position on the basis of the size of her eyes and her hairdo is not necessarily the best arbiter of the legal details involved, but does tend to prove that Goldman's PR flackery is effective insofar as it provides the talking heads with irrelevant gibberish to deflect public opinion away from the actual issue.

The gist of the SEC case is based (as in many, many cases of securities fraud) on the simple yet highly utile provisions of Rule 10b-5 of the Securities & Exchange Act of 1934, that Depression Era legislation which miraculously survived both Reaganism and Greenspan's tour of duty as Fed Chairman (Greenspan, like his heroine, Ayn Rand, thought the "market" should regulate fraud without government intereference). Rule 10b-5 (so named because of the subsection it occupies within the statutory enactment):

"Rule 10b-5: Employment of Manipulative and Deceptive Practices":

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

(a) To employ any device, scheme, or artifice to defraud,

(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,

in connection with the purchase or sale of any security."

That's it, the whole statute. Refreshingly pithy, direct, effective. Goldman is up against subsection (b) of the rule. It omitted "to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.

Here are the statements which Goldman made to the German bank and other investors in the Abacus CDO: okay, meine Freunden, here are some wonderful mortgage bonds for you to invest a billion dollars in, easy money, fixed income, and all secured by hard-working Americans religiously devoted to making timely payments, and also you should know that ACA, that big asset manager you like so much, played a role in choosing the specific collateral (American houses) in the portfolio.

So far so good. But you also need to avoid the omission of a statement necessary to make sense of the statements actually made, so that they're not misleading. Did Goldman omit to say anything? Well, yes. While it's true that the person "on the other side of the deal," in this case John Paulson, is not ordinarily disclosed, Paulson was somewhat more than just the person "on the other side of the deal" in this situation. Paulson was actually the guy choosing the collateral for the CDO, and he was choosing it not for its strong, Amerikanischer creditworthiness, but instead for its essential crappiness. Instead of those idealized Americans of the German fantasy with the picket fence and Priuses in the two-car garage, Paulson was looking for part-time lap dancers in over-limit status on their Discover Cards who claimed, on an unverified basis, that they made $200 k a year writhing and squirming in the Ultra Room of the Flamingo, and scored five houses to flip on just such credentials.

Details slightly exaggerated for effect; your parody may differ.

You see, Paulson wanted the short side of the bet, because he had a more realistic appreciation of his fellow Americans. But for a short side to work, you need a sucker on the long side. Just as a bookie who takes a bet on the Lakers, give the 6-1/2 points, Goldman needs to find someone who thinks the OK Thunder can beat the spread. This is what Goldman means by saying it acts as an "intermediary;" they're the tout, and their cut of the action was $15 million from Paulson to make this tanked game work.

What can we say? Paulson and Goldman had home court advantage. Pays to know the players before you start throwing a billion around, especially when you're relying on a shifty book like the one run by the fine "investment bankers" at Goldman Sachs. It's the oldest permanently established floating con game in New York.

Throw a little vampire calamari on the barbie

The title taken, of course, from Matt Taiibi's superb description of Goldman Sachs: A vampire squid wrapped around the face of humanity. The SEC, rousing itself from the persistent vegetative state which characterized its handling of the Bernie Madoff affair, is hacking away at GS's flailing tentacles in much the same way that Captain Nemo, in James Mason's protrayal in "20,000 Leagues Under the Sea," fought the giant squid trying to wreck the Nautilus.

I'm convinced that Goldman Sachs is guilty of security fraud. What convinces me is the character of its absolute rebuttal: their oft-quoted PR flack, Lucas Van Praag, meticulously and categorically denied everything the SEC alleged except for the one point that matters. A telling omission. Somewhere down at the bottom of the bowl of alphabet soup, the swirling RMBS and CDS and CDO, lies the answer, and it's not good for Goldman Sachs.

Goldman Sachs got too cozy with a big investor, John Paulson of Paulson & Co., who only a couple of years ago was the toast of Wall Street. Paulson devised ways of betting against the U.S. housing market through use of credit default swaps (CDS), which are essentially bets that a given asset or security will decline in value. I remember discussing Paulson's celebrity with my cousin Jim, at one of our breakfasts out on the wharf in Santa Cruz (those breakfasts, like the great American housing market, are gone forever). With Sinatra, as always, playing on the restaurant's stereo system, Jim chuckled in his inimitable way and noted that only in America could someone become a social hero by betting that America would go to hell in a hand basket. Paulson made billions with his CDS bets.

Now we see that Paulson, unlike the intrepid small guys described by Michael Lewis in The Big Short, had his finger on the spinning roulette wheel. He isn't such a hero after all. The fix was in, and he paid GS to rig the game. Paulson ponied up $15 million to Goldman to salt a collateralized debt obligation (CDO) with hand-picked residential mortgage backed securities (RMBS) culled by Paulson from a long list of such RMBS. Paulson specifically chose lousy credit risks - low FICO scores, zero down payment, adujstable rates, no wage documentation, zero equity. Loser loans, in other words. To Paulson's credit, he saw the housing bubble and put his money down.

Paulson's specific investment vehicle, we now know, was something called a synthetic CDO, which is (as described by Michael Lewis) a kind of mirror image of a real CDO built up from mortgages. The synthetic version is comprised of credit default swaps (CDS), and to Morgan Stanley, apparently, must go the honor of this great breakthrough in American financial engineering. The synthetic CDO allows short bettors to scale up their negative bets to the same level as the investors on the long side in MBS CDOs. In the case of the ABACUS CDO involved in the SEC complaint, here is what the SEC then accuses of Goldman of doing:

Undisclosed in the marketing materials and unbeknownst to investors, a large hedge fund, Paulson & Co. Inc. (“Paulson”), with economic interests directly adverse to investors in the ABACUS 2007-AC1 CDO, played a significant role in the portfolio selection process. After participating in the selection of the reference portfolio, Paulson effectively shorted the RMBS portfolio it helped select by entering into credit default swaps (“CDS”) with GS&Co to buy protection on specific layers of the ABACUS 2007-AC1 capital structure.

To beat the rap on a 10b-5 allegation, here is what the vampire squid would need to be able to say: We told the long-side investor (a German bank and others, including ACA) that the sack full of shit they were investing one billion dollars in had been assembled from turds specifically chosen by another investor, John Paulson, who selected those excremental pieces based upon their foul odor and disgusting appearance.

Here, however, is the squid ink excreted by Goldman in its defense:

Goldman Sachs Never Represented to ACA That Paulson Was Going To Be A Long Investor. The SEC's complaint accuses the firm of fraud because it didn't disclose to one party of the transaction who was on the other side of that transaction. As normal business practice, market makers do not disclose the identities of a buyer to a seller and vice versa. Goldman Sachs never represented to ACA that Paulson was going to be a long investor.

An artful dodge, which is very telling under these excruciating circumstances. The SEC complaint does not base its case on failing to "disclose to one party of the transaction who was on the other side of the that transaction." That would not have told ACA and the German bank much of anything, by itself. What Goldman Sachs did not tell the long-side investors, those redoubtable Germans who believed in the American mortgage-payer, was that the CDO they were buying had been hand-picked to fail by the short-side investor (Paulson), a right granted to Paulson because he greased the Squid's tentacles with fifteen million bucks. Now, if Lucas Van Praag could deny that explosive allegation, now would surely be the time to do so. But he doesn't. Goldman Sachs did not represent "to ACA that Paulson was going to be a long investor," of course, because Paulson was going to be no such thing. This is entirely beside the point.

Where things will really get fun for Goldman Sachs, as the SEC knows, is in the lawsuit that ACA and the German bank will surely file against Goldman Sachs and probably against Our Hero, John Paulson. Since fraud is involved, Goldman could be looking at punitive damages along with the billion in compensatory, humongous legal fees and other fun debit items.

Meanwhile, the American housing market continues its descent into the sink hole of deflation. At least, from time to time, we'll have the distraction of watching those (and GS won't be the last) who once profited from everyone else's misery take their turn in the dock. Too bad my cousin, who really believed in America, or at least in the America that used to be, can't be around to see the final act.