The Taming of the Squid


Today the Securities Exchange Commission charged with fraud the "great vampire squid wrapped around the face of humanity." The scheme Goldman Sachs is said to have been involved in isn't too dissimilar to race-track shenanigans: basically, during the heights of the housing bubble, the now legendary hedge fund manager John Paulson (no relation to Hank) decided he wanted to short subprime mortgages  (i.e. bet that they would lose value) and asked Goldman to create Collateral Debt Obligations (CDO) for this purpose -- which it did and, according the SEC, even allowed Paulson himself to select some really sub subprime mortgages that the firm proceeded to bundle into a ticking time-bomb security. A CDO (like a derivative or option) has no inherent value; it's a contract. That means that if Paulson, or anyone, wants to short something through such instruments, he needs a willing participant on the other end of the trade -- something Goldman again was able to provide by making recourse to its large pool of gullible investors, who dutifully bought up all the securitized garbage.

Put simply, Paulson wins, the investors lose, and Goldman Sachs collects the fees. (Goldman always wins.)   

I'll reserve judgment on whether any of this really happened or not. I certainly wouldn't put it past either party.   

But I think it's highly unlikely that Goldman will be served with anything other than a slap on the wrist -- some small fine in the hundreds of millions. After a parade of Goldman boys was shuttled through the Treasury during the Hank Paulson years, the Vampire Squid put an exclamation point on its friendship with the Obama administration last October by having a former Goldman vice president, a 29-year-old pimply faced kid named Adeam Storch, named chief operating officer of the SEC. The notion that Storch is going to take down his former bosses is highly doubtful.   

And beyond the presence of Storch, the SEC is in no position to wave its finger at anyone. These are the guys who missed the Maddof scandal, even though independent voices like Harry Markopolus were banging the table about it for a decade and even though in 2005 the commission received memos with headings like, "The World's Largest Hedge Fund Is a Fraud." The fact that SEC compliance official Eric Swanson was dating Madoff's niece, Shana -- and eventually married the woman -- certainly gave the impression that a great conviviality had arisen between regulator and regulatee...   

This aside, there's much about this latest story that strikes me as a Washington-engineered distraction. (I say this in no way as a defense of Goldman, which I wish had been liquidated in 2008 along with the rest of the investments banks.) It's almost as if the government wants to put someone on trial for ruining everyone's 401K plans in 2008. Greenspan was a probably a candidate for being the scapegoat, but he was deemed too closely connected with the government; the universally loathed investment bank fit the bill. Needless to say, Freddie and Fannie, or the Fed itself, won't be held to account for inflating the housing bubble, even though these institutions were indispensable components of the crisis. Goldman, jackal-like, made money off the corrupt system, just as it'd make money off any system; but its alleged collusion with short sellers most certainly could not have caused the 2008 crash.     

I've recently started reading The Big Short by Michael Lewis (he of The Blind Side fame.) In this account (meant for Barnes-and-Noble, mainstream consumption), the people who shorted the mortgage market, most prominently Steve Eisman, are depicted as free-thinking heroes. Eismann is called "the financial market's first socialist" (that's a good thing in this book), his crucial insight on the housing market deriving from his conviction that Wall Street is always out to screw the poor.  

I admire those who foresaw the crisis, particularly those ballsy enough to make big contrarian bets. (I wish I had done that.) But the idea that they were doing something wonderful for humanity is just as wrong as the idea that they caused the crisis itself. At any rate, news that short sellers might have been in bed with Goldman certainly upsets Lewis's version of events...