Professor Mark J. Perry's Blog for Economics and Finance
"In the end, we learn a lot from this latest SEC fiasco. The agency that cannot detect a Madoff fraud can conjure up a Goldman fraud out of thin air. At this point, some fundamental reform is in order. Forget the fancy stuff. Either the SEC should master its primary fraud prevention mission, or it should shut down altogether."
Dr. Mark J. Perry is a professor of economics and finance in the School of Management at the Flint campus of the University of Michigan. Perry holds two graduate degrees in economics (M.A. and Ph.D.) from George Mason University near Washington, D.C. In addition, he holds an MBA degree in finance from the Curtis L. Carlson School of Management at the University of Minnesota. In addition to a faculty appointment at the University of Michigan-Flint, Perry is also a visiting scholar at The American Enterprise Institute in Washington, D.C.
26 Comments:
Greg Mankiw also highlights this quote from David Brooks:
The premise of the current financial regulatory reform is that the establishment missed the last bubble and, therefore, more power should be vested in the establishment to foresee and prevent the next one.
http://gregmankiw.blogspot.com/2010/04/great-sentence.html
Gee! Epstein almost gets it...
Maybe the SEC people were to busy doing something else...
Now it seems that the SEC is playing at cover up...
At its core the issue that goldman ducked yesterday is a good one, what is its responsibility to its customers? Should it be selling items that it is shorting for its own account at the same time? Most on the panel thought it unethical, although the Goldman folks thought it ok. This does suggest the fundamental conflict of interest where a broker makes markets and trades for its own accounts.
One simple way is for Goldman to state on every trade document that it may take any position on the security sold short or long, and require their salesmen to disclose that as well when they call. Here one is back to the fundamental principal of the New Deal legislation transparency.
But as to Collins comment its that the establishment bought the rational market hypothesis hook line and sinker. The market is rational except when it is not. In Oct 2008 it was in a state of panic which by definition is not rational. We just need to recognize that markets are done by human beings who still have an animal at their core and sometimes animal spirits come in play both good and bad.
Note the following from Professor Bainbridge: Who Would be Empowered by Obama's Corporate Governance Ideas?
The last paragraph: As documented elsewhere in this series of posts, the beneficiaries of Obama-Dodd-Frank financial reform will not be retail investors. Nor will it be institutional investors (such as pension or mutual funds). Instead, the prime beneficiary will the firms that provide proxy voting advice. Since RiskMetrics Group dominates that select group, it will be the main beneficiary of reform. But, as we've asked before, who holds RiskMetrics accountable?...
Lyle, when an investment bank hedges its bets and at the same time sells a product to an investor to go long, it's not a conflict of interest. Each portfolio is different.
I stated before, Congress will go way beyond the moral hazard of too-big-to-fail, and it has with over a 1,300 page bill.
Also, Democrats wants to debate "their" bill to score political points and promote "taxpayer" anger.
It's very divisive, similar to Obama's recent speech:
Obama's goal:
"reconnecting" with the voters who voted for the first time in 2008, but who may not plan to vote in the lower-profile Congressional elections this year.
Obama speaks with unusual demographic frankness about his coalition in his appeal to "young people, African-Americans, Latinos, and women who powered our victory in 2008 to stand together once again."
SEC officials should have been penalized for missing the Bernie Madoff fraud.
A primary notion of the Securities laws of 1933 and 1934 was:
"People who sell and trade securities – brokers, dealers, and exchanges – must treat investors fairly and honestly, putting investors' interests first.
Goldman Sachs is both an investment bank and trader. GS should have a transparent way of notifying investors in the securities it sells of opposite trades GS takes (ie. short selling via puts).
Here is article by Felix Salmon that diagrams the Credit-Linked Note Structure that Goldman sold as an investment. Mr. Salmon points out, in this very complicated deal, where the problem for GS is.
Marketing tremendously complicated deals may hide critical details that don't put "investor's interests first". A hidden critical detail may also be the premise for the issueor placing a trade opposite the overall investment.
The selling of investments and trading opposite (not insurance) seems to be the primary issue.
lyle-
if i go to goldman and ask to buy 100,000 of dogfood.com or whatever, first off, it's not their responsibility to make sure i am making a good trade, that's my responsibility. their responsibility is to get me the best price. that's what a market maker does.
second, if they short me the first 20,000 shares to get me going, they are doing me a favor, not betting against me.
this whole bias against shorting is based on lack of understanding. shorting enhances liquidity, it does not jeopardize markets. further, it helps me get the best price when i buy. if i want to buy an instrument and goldman can get someone else who wants to short it, i get a better price as GS can lay off its exposure. if they can't, my price goes WAY up as they have to make a directional bet.
if you go to your bookie and bet on the giants to beat the dodgers, is your bookie shorting the giants? if he then takes someone else's bet on the dodgers to win, why is there a conflict of interest?
different people have different opinions. if i want to buy IBM and you want to sell it and we both trade with goldman, it's their job to put us together. that's what a market maker does. they match buyers and sellers.
every single trade in the world works this way.
every transaction has a buyer and a seller.
if you want to sell your house and an agent finds you a buyer, he's done a good job, not developed a conflict of interest.
why is it people can see this obvious fact in almost every instance, but as soon as you add an investment bank, they see perfidy?
>"Now it seems that the SEC is playing at cover up..."
That is just too rich! Now the SEC has detected fraud at.....the SEC!
>"One simple way is for Goldman to state on every trade document that it may take any position on the security sold short or long, and require their salesmen to disclose that as well when they call."
Please don't ask for MORE government regulation. Isn't it obvious that we have too much already?
First, what PeakTrader said at 09:56.
Second, none of the parties involved in this story are innocent babes in the woods. They all understand the business they are involved in, or they shouldn't be in it. What you suggest disclosing, is already well known to the parties involved.
There are no victims here, except perhaps the SEC, which has called into question the need for its own existence. And of course, as always, we taxpayers.
Morganovich:
It does make a difference if Goldman is the underwriter of dogfood.com (not a bad idea for a company, btw, sell hi-end dogfood).
If Goldman represents the underwritten stocks or bonds in dogfood.com in a certain way, it must be earnest about those representations.
More bailouts:
Roubini sees 'significantly rising' risk that European monetary union will rip apart
April 27, 2010
Greece’s financial woes -- and more important, the deepening fiscal problems of its European neighbors Portugal and Spain -- could batter global credit markets, disrupt the economic recovery and potentially tear apart the 11-year-old European monetary union.
Greece last week formally asked for a $60-billion bailout from the rest of Europe and the International Monetary Fund.
Investors dumped bonds of Greece, Portugal, Spain and Ireland on Tuesday, driving yields up. European stock markets were hammered, and the selling spread to the U.S..
Here is the pitch from Golman Sachs: ABACUS 2007-AC1 Ltd. (a Cayman Islands SPV).
Triple-A securities are highlighed but were they really traditional triple-A or influenced to be rated AAA?
benny-
you are correct about underwriting requiring adequate disclosure, but there is ZERO evidence that goldman did not do so. the documentation on this instrument ran to over 100,000 pages.
further, the mortgages were selected by the buyer and put into an instrument that copied one from DB. goldman didn't issue the mortgages nor backstop them in any way, they just allowed their customer, at his own request, to bet on them in a certain way.
this is more like a basket trade than an IPO.
there was nothing inherently flawed about the instrument. it behaved precisely as it should. the customer just made a bad directional bet. if the housing market had done well, they would have cleaned up.
the simple fact is the customer made a bad bet. you can't regulate away bad investment theses, nor should anyone want to.
getting-
the securities were chosen by the customer, not goldman.
why would goldman bear any responsibility for their quality?
that's like arguing that they should not have let me buy IBM because they were going to miss their numbers a year from now.
morganovich stated: "the securities were chosen by the customer, not goldman.
why would goldman bear any responsibility for their quality?"
There seems to be a mix of different bundles of securities being marketed as one. The pitch from Goldman states:
"The proceeds of the notes will be invested in senior, floating -rate. triple-A structured product securities (the collateral securities)." This is complicated stuff so, maybe I am missing something or misconstruing this statement.
Morganovich:
Perhaps I am splitting hairs, but there is a diff between adequate disclosure and being earnest.
We all know there are IPOs, bonds, follow-on registered offerings that have followed the letter of the law, and include boilerplate to the effect that everything could tank.
What concerns me is that GS seemed to know that this collection of RMBS was extremely dubious (as revealed by internal e-mails).
It reminds me of the situation in the late 1990s when many major brokerages were hustling dot.com IPOs to market, which internal e-mails revealed they considered to be extremely dubious ideas (indeed, even bulge bracket firms were advising institutional clients to sell their allocated IPO shares into the frenzy, while advising retail clients to buy).
A brokerage should be earnest in its advice and prospectuses.
That said, it may not be an ideal that can be regulated or legislated.
I am puzzled that the market does not punish such behavior. It may be GS in general does an excellent job, or that they have gotten so big they are few alternatives, or that everybody involved makes money on the transactions, while the ultimate loser--those who actually own the RMBS--is left holding the bag with little recourse.
But I would not so casually blow this off. If investors lose faith in capital markets, the consequences are severe. Investors need to be continually assured that capital markets are transparent, fair, and stiffly policed.
All the other financial disasters don't exist only Government Sachs does.Now we know why they didn't kill them off in the crash. It was so they could make an example of them so they would look like they are doing something coming up to an election. Lap it up loonies you are being had.
If you read the offering document (it alone is 128 pages) it says that during the offering period the company can go short or long to make an market for the securities. All I would have had goldman add is
"From the time of the offering of the securities the Underwriter may for its own purposes and at any time take a long or a short position in the securities, buy or sell a credit default swap or other derivative based upon the securities" If they had had that in the offering document than yesterday they could have said, its in the offering document.
It seems to me that Goldman could have put that in to cover its rear end easily.
But as the big short says the sophisticated investor is not really that it suggests that a lot of the prospectuses in the mortgage bond market were never read thoroughly because when someone did they found the holes. The big short discusses the fellows from Dusseldorf who would buy the junk when offered, due to greed, which combined with the desire to get rich quick where at the root cause of the debacle. (Greenspan observed that on CNBC's House of Cards about the greed). All of which is more evidence as the Nova last night on Behavioral Economics points out the economic profession has fallen into an ideological trap with the efficient market hypothesis.
benny-
this was a custom product sold to a customer who asked for it. to even be allowed to have a conversation like that with GS you need billions of dollars and to be a very sophisticated investor. this wasn't some ETF marketed to etraders.
GS served its customers, some of whom wanted to bet on and some against a market. everyone involved knew exactly what they were doing. note that none of the actual customers sued or failed to perform.
it's only the SEC that is too unsophisticated to be at the table.
this was the capital markets working. the only reason to lose faith is because of this sort of SEC show trial brought by an agency that clearly does not understand either the instrument traded or what happened, and worse, doesn't care. if you can be publicly pilloried for doing what is legal, ethical, and common practice, that's something to worry about.
make a bad bet and lose, and that's stain on you, but to get attacked for serving your clients, that's chilling.
GR-
this instrument was a pool of mortgages. it's valued as one instrument based on their aggregate performance (just as a mutual fund is based on the NAV of its stocks).
the customer chose the bundle, goldman was just an aggregator..
blaming them for this is like blaming an architect that followed his customer's wishes for building an ugly house. if the customer asked for a pink fountain in the living room and then finds it makes the house difficult to sell later, whose fault is that?
It turns out the offereing document said what I thought it should say
"
"Goldman Sachs does not make any representation, recommendation or warranty, express or implied, regarding the accuracy, adequacy, reasonableness or completeness of the information contained herein or in any further information, notice or other document which may at any time be supplied in connection with the Transaction and accepts no responsibility or liability therefore. Goldman Sachs is currently and may be from time to time in the future an active participant on both sides of the market and have long or short positions in, or buy and sell, securities, commodities, futures, options or other derivatives identical or related to those mentioned herein. Goldman Sachs may have potential conflicts of interest due to present or future relationships between Goldman Sachs and any Collateral, the issuer thereof, any Reference Entity or any obligation of any Reference Entity."
source: http://www.nakedcapitalism.com/2010/04/leaked-goldman-presentation-on-abacus-trade.html"
So then the question is why did not the Goldman people throw this back to the Senators. I would have then said we said this in the prospectus, we assume as we say in all our materials that securities are offered only by the prospectus, if the client did not read it well.... Then all the salesmen need to say is read the offering document/prospectus and they have covered themselves. This is then a spectacularly bad piece of PR work on behalf of the Goldman folks. (It suggests they don't read their own documents, part of a major problem that we have the same issue as do you read everything at a real estate closing)
also note:
GS was a LONG investor in this deal.
their prop desk owned this and lost money on it.
so how is betting WITH a client fleecing them? if this instrument was so toxic and they knew it, why did they buy some for themselves?
'nough said
Could someone give me a definition of fairly that would stick to anything.Wouldn't one mans view of the word, be different to anothers. Didn't Bernie Madoff treat his victims fairly because he robbed them all equally and fair and square.
I think that the "Goldman fraud" is politically driven.
What a coincidence that the hearings are being held a) 6 months before the election and b) while the Senate is trying to pass legislation to prevent the next big financial failure.
The real frauds are the congresspersons who are grandstanding to their constituents about how they manhandled GS at the hearing and that GS was the blame for the financial collapse instead of themselves.
GS magically becomes the root of all evil instead of the very sorry morons in Congress, particularly the Senate that contributed to the near-collapse of the economy.
Transference, duplicity and posturing.
For the record, with all the campaign contributions GS has made to the Democratic party, there is no way in heck the financial regulation bill will serve the best interest of Americans, but it sure as heck will meet GS's and the financial industry's needs.
It took a while, but that's where both Brooks and Epstein have it right.
"SEC officials should have been penalized for missing the Bernie Madoff fraud"...
Why? The SEC keeps missing the FDR/federal government ponzi scam every year...
Madoff is a minor amateur in comparison...
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