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The Goldman Sachs Misdirection

Posted on April 29 2010 8:30 am
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The Goldman Sachs’ affair is filling up the news cycle. Compared to the year long health care battle, it seems trivial by comparison. But as a symbol for the absurdity of our times, it is informative. It most reminds me of the AIG compensation dust up about a year ago. Let’s take the least important issue among a list of enormous issues and make that the centerpiece of a political campaign.

There is plenty of crony capitalism to discuss and critique, but the Democrats, Carl Levin in particular, seem most shocked to have discovered that for every buyer there is a seller. The Republican Party doesn’t know quite what to make of this either. On the one hand, they don’t want to appear to be attacking free markets, whatever is left of them in our financial sector. But on the other, who wants to stand in support of a third string erstwhile “master of the universe” such as is 31 year old Fabrice Tourre? Republicans often have had the unfortunate habit of becoming strong free market supporters primarily in response to Democratic actions. But the AIG bail out and the TARP bill, sponsored by the Bush administration, were classic anti-free market policies.

I have no opinion on the specifics of this particular set of transactions referred to as Abacus that is under investigation by the SEC. The courts will decide if Goldman was fraudulent. I do have an opinion on what our Government’s priorities should be, however, and obsessing over this series of transactions is not one of them. These were deals transacted in 2006 and 2007. If Wall Street was so prescient, how did they manage to achieve $1 trillion of losses in the mortgage market (give or take $500 billion or so) during 2007 and 2008? Goldman may be sleazy, but they did not cause the mortgage crisis.

Which brings us to the main point, the so-called financial reform bill, a non sequitur sponsored by Senator Chris Dodd of Connecticut, which the Goldman indictment is supposed to make us support. The first question that comes to mind is how can Senator Dodd still be around? Dodd was the number one beneficiary of campaign contributions from bankrupt but bailed out mortgage entities, Fannie Mae and Freddie Mac. As late as the summer of 2008, Dodd was still insisting that two of the biggest buyers of sub prime mortgages were financially sound and fundamentally strong. Dodd’s conflict of interest was certainly greater than dopey Fabrice Tourre’s.

Do we really have to go over all of this again? Government policies at the state (California most among them with their restrictive land use laws and mortgage lending rules favoring borrowers) and federal level (for example, inconsistent and self contradictory capital rules, aggressive federal support for increased home ownership, etc.) led to what turned out to be a large housing bubble. When Wall Street discovered it had mortgage inventory it could not sell, their prices dropped precipitously.

The firm left holding the largest bag of mortgage “sh…..t”, a term which seems to appear in many Goldman e-mails, was insurance giant AIG. Firms like Goldman Sachs extended enormous amounts of credit to AIG, as the drop in mortgage prices led to a liquidity and solvency crisis for AIG. The liquidity crisis was made worse by Goldman and others insisting that AIG come up with cash immediately to “pay back” what AIG owed them from a series of price guarantees AIG made on many of these mortgages. (For a more complete analysis of this, please read my « Anatomy of a Bailout).

Since AIG could not pay, Goldman and others would take substantial losses for their stupid decision to expose themselves to such enormous credit risk to one company. Goldman alone was owed about $12 billion by AIG. But Goldman’s former Chairman, Henry Paulson, (no relation to the John Paulson involved in the current Goldman indictment), was George Bush’s Treasury Secretary. And in what may have been the biggest “untruth” mouthed by a government official in a long time, Paulson insisted that AIG be bailed out by the Government or there would be world wide calamity. AIG was bailed out but it did not prevent calamity at all, but rather enhanced it. Secretary Paulson somehow left out the part about the bailout money being used to pay for Goldman Sachs’ (and others) losses.

So now we have a “financial reform” bill that promises to make sure such financial travesties never happen again. Yet the two main components of the bill, like so much of what Government does, fails to address the main problem. The most ridiculous of the proposals is a pre-funded bailout “fund” that will supposedly be used the next time real estate prices drop 50% in California. The first thought that comes to mind is what will this “fund” invest its dollars in between now and the next financial crisis?

Like TARP’s bailout of GM, all beggars under the sun will have their hand out. Perhaps it can “invest” in “Green Projects”. Or Medicare. This fund is simply another Obama Rube Goldberg tax. Even if this were not the case, why encourage behavior that needs to be bailed out? The AIG and TARP bailouts should never have occurred and were a taxpayer rip-off. This proposed law simply codifies such bailouts in the future.

The second proposal in the bill is to eliminate the over-the-counter derivatives market by requiring a separate entity (a “clearinghouse” effectively owned by the banks) to be the counter party to all derivative trades. This would mimic what the current Futures Exchanges now do for standardized derivative contracts. But “derivatives” did not cause the financial meltdown. Bad credit policies by banks, inconsistent capital regulations, and government-sponsored housing incentives at the state and federal level did.

Supporters of financial reform feel they need to “do something”. The “something” they should do is guarantee that they will not bail out firms in the next crisis. Pretending Goldman’s Abacus deals had anything to do with the financial crisis is willful misdirection. Supporting Goldman Sachs in this affair is also beside the point. They and other so-called too-big-to-fail banks are direct beneficiaries of implied Government sponsored support. Eliminating this support should be the primary focus of conservatives, not diving into the weeds of a 4 year old CDO deal.

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