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On your knees & pledge allegiance

Based on the facts as I have come to understand them, I don't think the SEC has a case against Goldman. That’s not to say the SEC can’t make a boatload of trouble, or that they don’t have a specific agenda. They clearly do. It's also not to say that adverse facts might not show up. 

As far as I can tell, the identity of the securities in the portfolio was known to any investor who cared to look at the offering memo. The loan selection agent attested that it picked the reference loans (there was no cash product, this was synthetic). No one attested, as far as I know, that the loan selection agent did not select the loans. Everyone will attest that everyone had more opinions than fingers on each and every loan and tranche. Evidently, AIG liked some of them sufficiently well to write some CDS protection on them.

To do synthetics you need counterparties on both sides of the trade (and everyone, particularly institutional investors, knew this). Remember the old Venn diagram? The transaction takes place in the intersection of price, risk & liquidity views. This occurs in the private cash markets all the time, and is in fact necessary for complex and illiquid deals. When the rubber ultimately hit the road, everyone seems to have had access to the same information on the portfolio. 

Long is OK, short is NOT OK?

A sale is an expression of a view on price and risk with some liquidity preference baked in it. So is a purchase. The notion that a broker-dealer should not facilitate the expression of differing views of price or risk or liquidity preference leads to some very strange places. How is it that a broker-dealer whose mission is to service the needs of the putatively 'most sophisticated' investors in the world should be prohibited from:

  • the sale of any share of stock below the price at which they underwrote it?
  • the sale of a bond of any sovereign client at less than the original offering price? Or the forward sale of its currency below the current spot price?
  • the sale of any put option or futures contract on any bond or share of stock of any client whose securities they underwrote?
  • or any expression of a view of a future price or volatility of any loan, security, or derivative contract that is less than the current market or the originally underwritten price?

There may be more relevant facts as to the relationship between the loan selection agent than are currently visible, but as it stands now, I see defective business judgment in allowing Paulson effectively 'observation rights' at the front end of the underwriting process. This isn’t the Goldman of old, but again we note, the identity of the securities in the portfolio was known to any investor who cared to look.

There appears to be something else at work, and it starts with a revisionist view of how the mortgage market worked out.  Congress, of course, engineered & regulated the whole deal. You may remember the Community Reinvestment Act, Franklin Raines& Fannie, Freddie, Sallie, the Office of Federal Housing Enterprise Oversight (“OFHEO”), Barney Frank, Chris Dodd, and, oh, so many more!  Hmmm… we need a donkey on which to pin the tail and not just any donkey.

Call me old fashioned, but I thought the SEC used to try cases in court, not on TV or the front pages of the NY Times or the Wall Street Journal. If they've got a fraud case, put the hammer down and bust 'em. Otherwise this smells like regulatory & legislative manipulation.  Where’s my donkey?

It’s noteworthy that the SEC went after a Vice President…. a lowly, stinking Vice President? Seems they don’t have a case or won't or can’t bust senior people who can donate their way out of it.... that they just want to send a message to everyone that no matter what or who, and without regard for the processes and vetted market practice (and dare we say regulated?) at the time, we can retell the story to suit our needs. 

Don't get me wrong, this market stank.  And I am no friend of Goldman, but nowhere are we hearing that Congress set it up this way. Congress designed and mandated the regulatory framework & gave the rating agencies their monopoly power. The SEC, the FDIC, and the Fed presided over the failure of the control environment. The regulators knew it, and senior management ran the printing presses. This was all bought & paid for...and not by Vice Presidents at Goldman or junior auditing people. You need to ask: where did the originators of all this defective product get the juice? From whence the override on credit quality? The answer is Congress.

So, driven by the infinite wisdom of Congress, we created large concentrations of aggregated risk created by politically allocated capital; declare them unsafe after they’ve blown up; have the taxpayers underwrite the whole deal while allowing sovereign entities and foreign banks (the larger counterparties to AIG) to walk with no haircut whatsoever; and now propose to aggregate risks into larger, more concentrated pools of risk, and kick in $50 billion of contingent capital for grins.

Banks will become large zombies. Capital & risk will be allocated by political process and rent seeking behavior (green finance perhaps?). Think of large scale financial organizations who are protected from failure and whose creditors impose no discipline as they look to sovereign or semi-sovereign implied guarantees (GSA's anyone?). This, of course, creates organizations with the quality standards & acumen of General Motors. Innovative capital will try to move offshore, and taxpayers once again will pay the tab for any unpleasant long tailed risk that eventuates.

Oh, by the way, don’t even think about criticizing the financial reform bill.

This is how Alfred E. Newman manufactures six sigma events. Have you taken a look at municipal CDS spreads lately or perhaps state pensions?


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