On Our Rotten Financial System


On Our Rotten Financial System

Posted by Karl Denninger

So today Goldman will come before the Senate Permanent Committee on Investigations – with Lloyd himself, along with “Fabulous Fab” on the witness panel.

Blankfein’s prepared testimony makes some interesting claims:

“We didn’t have a massive short against the housing market, and we certainly did not bet against our clients,” Blankfein says in prepared remarks released by the company. “Rather, we believe that we managed our risk as our shareholders and our regulators would expect.”

Uh, Lloyd, are you sure?

Carl Levin, a Michigan Democrat who leads the Senate’s Permanent Subcommittee on Investigations, released documents that he said showed the company “put its own interest and profit ahead of the interests of its clients,” a conflict he called on Congress to end. Lloyd Blankfein, Goldman Sachs’s chairman and chief executive officer, will dispute that assertion and argue the firm was merely managing its own risk.


It’s amusing how Goldman claims it “lost money” on some of these deals.

So what?

The question is not whether there were residual pieces of trash that Goldman wound up (unwillingly) eating when they couldn’t sell them.  The question is whether or not Goldman (and everyone else) should have had the ability to put these deals together in the first place, and how it came to be that trillions of dollars of alleged “AAA” paper was better suited for use in the men’s bathroom stalls!

Levin said:

“This market is not free until it is free of self-dealing and until it is free of conflict of interest,” Levin, 75, said at a press briefing yesterday. “It is not free until it ends the gambling operation that results in gambling debts that the public ends up paying.”

That can’t happen until we see handcuffs Senator. 

“The SEC and the courts will resolve the legal question of whether Goldman’s actions broke the law,” Levin said. “The question for us is whether Goldman’s actions in 2007 were appropriate and whether we should act, legislatively, to bar similar actions in the future.”

17 pages Senator.  They’re called “Glass Steagall”, and that law absolutely barred the conduct that led to and caused this crisis.

Let’s be frank: Creating these sorts of toxic deals is, for these institutions, simply a reach for fees.  They don’t care if they perform so long as they don’t get stuck with the trash.  A particular transaction was even referenced as “one shi&&y deal” by Goldman employees, according to some internal emails:

“Boy that timberwo[l]f was one shi**y deal,” Montag, who is now Bank of America Corp.’s president of global banking and markets, said in a June 22, 2007, e-mail to Daniel Sparks, who ran Goldman Sachs’s mortgage business at the time, according to the panel’s statement. Within five months of Timberwolf’s debut, the CDO had lost 80 percent of its value, and it was liquidated in 2008, according to the panel.

The CDO was among securities that Goldman Sachs sold to clients after deciding the New York-based firm needed to reduce its mortgage holdings, Carl Levin, a Michigan Democrat who leads the panel, said in the statement. Chief Executive Officer Lloyd Blankfein and six other current and former executives will testify tomorrow in front of the panel about practices in mortgage securities markets before they collapsed.

And of course such conduct, and the people who commit it, aren’t fired.  Mr. Montag is now Bank of America’s president of Global Banking and Markets.  “Market discipline” doesn’t, it appears, extend to forcing people to eat their own cooking and when they sell things they know smell like dead fish to clients, it’s all ok.

Perhaps it is under the law, but whether it should be is another matter.

It is often argued that if we don’t permit this sort of “innovation” that our economy and businesses will suffer.  Really?  Who suffers?  Wall Street?  Can we reasonably have an economy where 1/3rd of all profits made in the nation are “earned” by asset-stripping other people?  That’s what even the good deals do – they turn over a part of the transactional flow of some business to the wall street banks, which then keep it for themselves. 

The bad deals, like this one referenced, are even worse in that they siphon off fees from someone who later loses all their money!

This is not restricted to Goldman, by the way.  Indeed, let’s examine another deal that the government was intimately involved in, this first reported by Zerohedge in the form of the Fannie Mae Preferred offering that was foisted on the market just weeks before the firm blew up.

The underwriters, who coincidentally received 3.15% of $2 billion, or $63 million bucks, include Merrill Lynch (now absorbed), Citibank (rescued), Morgan Stanley, UBS (who has a running spat with the IRS about assisting Americans in illegally evading taxes) and Wachovia (which collapsed in a ball of fire that was contained only by forced marriage to Wells Fargo.) 

Why was this deal so insanely toxic?  It was issued on May 19th of 2008, and paid exactly one coupon before Fannie was absorbed into conservatorship. 

And unlike the “sophisticated investors” who bought CDOs and other similar trash from the big banks, this deal was bought by literal widows and orphans, along with community banks.

I would argue that it should have never been brought to the market in the first place, as before it was offered I had opined (in public in fact) that Fannie and Freddie were both insolvent.

Indeed, on March 8th of 2008 I called out the games in a letter written to President Bush and others in which I said (among other things):

Mr. Bernanke and The Fed have lowered the Fed Funds Target from 5.25% to 3% over the last few months and the “slosh”, or free funds available in the Fed Banking System, has nearly doubled over that time. Yet this additional liquidity has done nothing to address the problem and won’t because the issue is not one of inadequate liquidity; rather it is a desperate move to hide the fact that a significant number of financial institutions in our nation are, if forced to mark all their paper to the market and recognize their exposure to off balance sheet vehicles, insolvent.

At the root of the matter, Mr. President, is a lack of trust caused by the intentional acts of these institutions, and lack of regulatory enforcement by both the Federal Reserve and other agencies such as the OTS and OCC.

We have fixed exactly nothing since then.  We have only papered over the insolvencies with government fiat currency, claiming they’re “loans” – and they are in a sense – they’re forced purchases of bankrupt companies by the taxpayer which we are now liable for.

Wall Street created this monster with the full knowledge and permission of the government. 

Despite laws prohibiting executives from signing off on fraudulent financial statements – that is, any financial statement that does not make a full and fair exposition of the firm’s financial position (Sarbanes-Oxley) these executives have not been prosecuted.  “I didn’t know” is not a defense under Sarbox – if you’re in the executive suite of a public firm you have an affirmative duty to know

So why have not the former CEOs of Bear Stearns and Lehman been indicted?  Why have not the CEOs of the other big banks that failed, all of whom proclaimed that everything was fine right up until they blew sky high? 

As for all these hinky deals that the big banks did, if this crisis has taught us one thing it is that if there’s a way to game a rule or regulation it will be gamed.  So long as these firms can find a way to play “heads we win, tails taxpayers lose” they will do so.  So long as they can effectively force companies to forfeit 30% of every dollar of GDP produced in this nation to them, they will do so.

So long as firms with access to federal assistance of any sort, whether it be The Fed window, overnight repo loans from or by firms with Fed Clearing access, or the privilege of deposit-taking and fractional loan-making exists, these firms will leverage government-provided backstops to their own benefit for the purpose of fee extraction. 

These fees do not benefit society as a whole.  They are in fact a tax on top of all other taxes that firms and thus individuals pay.  This burden is, today, roughly 30% of GDP, and our nation and its economy simply cannot afford to redirect this vast amount of wealth to a handful of rich and powerful people on Wall Street, whether their acts are founded in illegal conduct or not.

17 pages Senator.  That’s all it takes.

Reinstate Glass-Steagall and force all these banks to spin off the parts of their organizations that are in conflict.  All institutions that want access to any sort of public safety net, whether it be Fed Discount loans or FDIC insurance may not trade in or on the securities and insurance markets – OTC or otherwise – period.

Force all instruments onto a public exchange, including all CDS, without exception.  This immediately forces nightly margin supervision which prevents the sort of detonations that happened with AIG and others, and absolutely bars contagion, as no firm can maintain a position that it cannot back with capital.

It is often said that if we do this firms will “flee” to other nations that don’t have such restrictions.  No they won’t – not if we refuse to grant them access to our securities markets and the firms in them unless they comport with these rules worldwide no matter where they are headquartered

America is a vast economy.  Yes, China is growing, but we’re still a plurality of world GDP. 

Firms will threaten Senator, but if the law is crafted such that if they want access to our markets in any form or fashion they must comply worldwide with separation of function and exchange clearing, they will comply.

Yes, they’ll make “less money”, and that’s their argument against such changes. 

But let’s be frank – every dollar Wall Street “makes” it in fact extracts.  That is, Wall Street creates nothing.  It siphons off capital from other production – that’s all it can do, since it creates not one car, television, or cellular phone.  Indeed, every dollar of fees extracted by Wall Street and every dollar of interest paid to those firms is one dollar that cannot be returned to the economy in the form of innovation for the production of goods and services.

The essential functions of clearing payments and matching those who wish to loan capital with those who wish to borrow it is ministerial.  All the hinky deals alleged to “spread risk” have now been proved to do no such thing, but instead are complex simply so as to be difficult to understand and thus easy to intentionally misprice. 

That mispricing is fraud Senator, whether it can be legally labeled as such or not, and until we put a stop to it we will continue to have these bouts of crisis, each worse than the last.

Our government and society cannot withstand another banking system attack run, and it is imperative that The Senate, along with prosecutors, put a stop to it both through legislation and prosecution.

We have one last chance to stop it.  If we do not at this time do so, and another “market failure” occurs, our economy and even our political system – that is, our society and republican form of government – will fall.

Those are the stakes, and the question before you now is whether the bribery that is rampant in Washington (although we call it “lobbying”) will win, or whether you will rise to the occasion and uphold the oath of office that you, along with every other member of Congress, took before being seated.