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Tuesday, April 20, 2010

It's Springtime for Goldman Sachs

This whole Goldman Sachs derivatives fraud thing is complicated. So complicated that the news media has been struggling to explain it. Last night on The Daily Show, Jon Stewart went looking for some good explanation from the media and found instead clumsy metaphors and inapt analogies.

I think I found a clip that explains the whole thing pretty well. Here's Gene Wilder and Zero Mostel explaining Goldman Sachs' scheme:



So the short version of Goldman Sachs' fraud; they were selling Springtime for Hitler to unwitting investors. The details are a little different, but that's the broader idea.





See Goldman set up something they called ABACUS 2007-AC1, which was basically a big pile of sub-prime loans. They sold shares in Abacus, with the idea that investors would get paid back (with interest) when the mortgages were paid off.

Except that wasn't the idea. It's just what told these investors.

The real idea was that Abacus was crap. Goldman told investors that Abacus had been chosen as a good investment by ACA Management LLC. In reality, it was a bomb. Here's where things get ugly.

"The Securities and Exchange Commission says this is where Goldman lied," reports Arthur Delaney for the Huffington Post. "According to the [Securities and Exchange Commission's] complaint, the underlying portfolio was put together by John Paulson, a hedge fund manager who hand-picked the worst possible assets in hopes that they would default. He rightly anticipated that the housing market would soon crash, and that people put into mortgages they couldn't afford would default when they lost the ability to simply refinance based on rising home values."

So, like Springtime for Hitler, Abacus was designed to fail. And, unlike Springtime for Hitler, it served its intended purpose wonderfully. Paulson cleaned up by buying credit default swaps, which are basically insurance that pays if the mortgages default.

"[Goldman Sachs] arranged a transaction at Paulson's request in which Paulson heavily influenced the selection of the portfolio to suit its economic interests," the SEC charged, "but failed to disclose to investors, as part of the description of the portfolio selection process contained in the marketing materials used to promote the transaction, Paulson's role in the portfolio selection process or its adverse economic interests."

So basically, Paulson and Goldman created a big economic and financial fire bomb -- complete with investors -- for the sole purpose of collecting the insurance. Metaphorical arson to collect on a failing business. Paulson paid Goldman $15 million to create Abacus, for the sole purpose of watching it go down. It'd take more than a few of the marks with it and a good chunk of the global economy, but so what? This is business and it's a dog eat dog world out there. It's eat or be eaten, except these dogs were already incredibly well fed.

It's at about this time that we ought to be enjoying a little lesson in the nature of reality. Conservatives and Libertarians like to talk about the "invisible hand of the market," which is a self-correcting mechanism driven by the "enlightened self-interest" of guys like John Paulson. The moneyed elite would never screw things up this badly, because then they'd get screwed too.

But what all this pie-in-the-sky economic fantasizing overlooks is that a lot of people suck and that no one commits a crime with the intention of getting caught. People commit crimes because they think they can get away with them. Had Goldman's and Paulson's scheme gone off as planned, no one would ever be the wiser and they'd be a little bit more insanely wealthy than they already are. "Enlightened" and "self-interest" don't necessarily go hand in hand and the "invisible hand of the market" just slapped us upside the head.

Some are accusing the Security and Exchange Commission of politically motivated timing in charging Goldman Sachs with fraud. The charge is that the White House is using this as a way to drum up support for reforming Wall Street. But, like the "invisible hand of the market" idea, this argument is fatally flawed:

-Goldman and Paulson did this and they did it on their own schedule, not the SEC's or the White House's.

-If the timing is politically motivated, how badly would Wall Street need reform then? By this argument, you can just run out and find a case of massive fraud any time it's convenient for you -- it's all over the damned place. It would have to be near-constant. Critics of reform are basically arguing that things are even worse than the White House is saying and that's why we shouldn't do anything. That's not the most persuasive case in the world.


Our choices seem pretty clear here. We can either reform the way Wall Street works or we can sit through Springtime for Hitler again and again and again. Republicans and Wall Street will bring the popcorn.

-Wisco


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