Yesterday I had Chinese food for lunch and at the end of my meal, I broke open my “fortune cookie” to see what the factory who made it had dreamed up for my future. There were two fortunes in there! The first one predicted, “You have an important new business development shaping up.” The second warned, “A liar is not believed even though he tells the truth.” That started me thinking about what these two things had in common with the state of our current world and that, in turn, led to the following conclusions. Just a few days ago, the Securities and Exchange Commission accused Goldman-Sachs executives of engaging in outright fraud during the recent “financial crisis.” Besides predatory lending (which should be a crime, but isn’t) there was massive misrepresentation of risks (actually it was great big lies clothed as neutral third party evaluations of “Collateralized Debt Obligations” – but more about that later on). In short, we the consumers were lured into taking out complex, expensive loans* that most of us just didn't understand. (*the infamous “sub-prime mortgages,” that, after they failed, became known by the even more insidious euphemism “toxic assets”).
The Bush administration’s regulators both failed to call attention to, much less stop, this abusive lending and prevented states from doing it as well. To compound the issue (no pun intended), subprime lenders didn’t retain the loans they made, but sold them to investors, whose insatiable demand was responsible, at least in part, for the expansion of the “creative lending practices” at the root of this whole mess. What is more, while knowing that future losses were virtually certain and neglecting to inform the people buying those loans of this fact, the lenders sold them anyway. This wasn’t strictly illegal either, even if it was unethical and immoral behavior. Then, brokerage firms packaged and marketed securities backed by these bad loans while betting that such securities would tank, thus netting themselves even more profits. Shades of Gordon Gekko indeed though, unlike the movie, people really got hurt.
Now, the S.E.C. is charging that Goldman Sachs created, marketed, and sold securities that were deliberately designed to fail, so that forwarned “important clients” could profit from that failure. And Goldman isn’t the only financial firm accused of doing this. It appears that several banks helped market similar securities for a major hedge fund that profited immensely from that failure according to ProPublica, a website devoted to “journalism in the public interest.” In addition, ProPublica reports that Merrill Lynch is now suspected of similar transgressions.
So what role did fraud play in the financial crisis?
Predatory lending and selling of mortgages based on lies did not, in themselves, cause the recent crisis. However, by inflating the housing bubble and creating a miasma of “toxic assets,” these practices definitely made it much worse than it should ever have been. Further, the creation of investments designed to fail significantly increased bank losses and that led to an economy-wide catastrophe once the housing bubble burst.
Remember “neutral third party evaluation of these Collateralized Debt Obligations (CDOs)?” When investors asked for what they believed to be impartial, objective assessments of risk, Goldman Sachs is charged with passing off their “designed to fail” structure as a neutral evaluation! That’s outright fraud, and it means that Goldman considered their customers as little more than “marks” or targets for fraudulent gain.
In addition, many of the synthetic CDOs designed by Goldman Sachs carried “risk-free” or “nearly risk-free” ratings from both private and government agencies. Former Goldman CDO traders have been quoted as saying that, “the ratings agencies didn’t understand these instruments,” and that, “the investment banks would offer their (Goldman's) models for the agencies to use in assigning ratings.” Without these high agency ratings, investors might have looked more closely at these packages and realized what they really were. Representations made to the ratings agencies by banks allied with Goldman Sachs are also fraud and should, in my opinion, become the focus of a continuing SEC investigation.
Would financial reform of the kind now before the congress have prevented the fraud that flourished over the past decade?
What the current senate bill could do:
* An independent consumer protection bureau could limit predatory lending.
* Requiring that lenders retain five percent of the value of loans they make, could limit the practice of making bad loans and quickly packaging and selling them to unwary investors.
* While it might not prevent abuses of the type alleged to have been committed by Goldman Sachs, requiring that financial instruments like “credit default swaps” be traded openly and transparently could prevent insurers like A.I.G. from backing theses abuses and needing a federal bailout to prevent its total collapse.
In addition to these provisions, the financial reform bill must stop the creation of instruments like “synthetic C.D.O.’s,” that let investors gamble on assets without actually owning them.
In the final analysis, reform can only go so far. In my mind, what is urgently needed is a fundamental change to the way Wall Street does business. Financial-industry lobbyists, through the Republican politicians they have bought and paid for, would have us believe that all will be well if the federal government simply pledges to stop all bailouts. That is patently absurd; the truth is that the financial industry has become a sham in which an elite cadre receive huge bonuses based on their ability to mislead and exploit consumers, investors, and their own customers. This sytem must change, so bailouts are not needed, much less contemplated.
No wonder the Tea-Party folks are angry – they lost more individual freedoms during the Bush-Cheney years than when King George instituted the stamp act, and now the private sector, of which they mistakenly believed they were part, has destroyed their dreams of retirement and taken away their homes. Like the fortunes in my cookie, another dichotomy fraught with sinister implications.
