Busting the Rating Agency

Frat Party

Yo everybody 5-0! 5-0!  The cops are here!

The US Justice Department filed a lawsuit yesterday against Standard & Poors, for its role in over-rating mortgage bonds, CDOs, and other securities in the years 2004 to 2007, securities which later proved to be weapons of mass financial destruction – the initial catalysts of the Great Credit Crunch.

When I read the story this morning, I suffered an involuntary eye-roll, the type I discourage in my daughters.

If a fraud was committed in those years, the rating agencies, frankly, are not the prime suspects here.

If the Wall Street mortgage bond market was the greatest financial frat party of all time, in the years 2002 to 2008, the rating agencies were the freshman pledges.  We needed them for continuity, and because they provided a reason to host a party.  But look, nobody really respected them.  They did what Wall Street told them.[1]

But then the party went horribly awry.  Somehow the upperclassmen frat brothers are way too smart to still be at the scene.

Now, with the frat house furniture stolen, the neighbor’s cat shaved and duct-taped, the Dean’s house toilet-papered, and the entire kitchen and basement burned black, the police have shown up and seized all the stupid pledges they found passed out in the back garden.

Yes, the pledges were at the party.  And yes, they kind of knew it could all go wrong somehow,[2] but not really.  They weren’t really in on it.  They didn’t have the upside that the Wall Street firms had.  They were just trying to appeal to the big frat brothers, who might someday invite them to be part of the inner circle.[3]

So, I rolled my eyes this morning because the cops can definitely bust Standard & Poors, but it begs the question of “Why?”



[1] Who paid their fees?  Oh, Wall Street firms did?  ‘nuff said.

[2] The US Justice Department has damning emails from S&P employees saying things like 1. ““Let’s hope we are all wealthy and retired by the time this house of card falters.” And 2. ““We rate every deal. It could be structured by cows and we would rate it.”  Hey guys?  I know you have that personal opinion, but seriously, never write that shit down.

[3] Michael Lewis makes the great point in The Big Short that the rating agency folks generally didn’t have the educational pedigree of the Wall Street in-crowd, but many hoped one day to join the firms themselves.  This “next-job” focus often leads to conflicted professional behavior and may help explain why the rating agencies acted like pledges at the frat party.

 

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Book Review: Black Swan – The Impact Of The Highly Improbable

The “Black Swan,” of Nicholas Nassim Taleb’s title, describes an event that occurs completely outside expectations, has an enormous impact on future developments, and can be explained only in hindsight as predictable. Further, Taleb argues that despite the fact that we are blind to their imminent arrival ahead of time, Black Swans drive the world more than the visible, predictable patterns around which we typically organize ourselves.

Examples of Black Swans would include the European ‘discovery’ of the American continents, Eduardo Severin’s $20,000 Facebook investment becoming $2 Billion, the rise of modern weaponry for war, the 9/11 attacks, and the Great Credit Crunch of 2008[1]

But instead of looking for Black Swans, we seem to be hardwired to search for predictable patterns to understand our world.  The typical forward-looking models we create to make sense of the world tend to assume inertia and normal distributions.  We expect the future to remain within an expected range of previously observable or predictable outcomes.  Black Swans, however, all too often overwhelm our expectation for continuity, acting like a tsunami that wipes out all our careful planning.

If you find the Black Swan view of the world compelling, how would you then organize your life and organize your investments?

Taleb’s suggested approach to both is dominated by what he calls empirical skepticism, which may be otherwise understood as doubting everything, and trying your darndest to deal with the fact that what you should be worrying most about is the thing you haven’t yet conceived of.

What you should not do, however, is trust too deeply in established patterns, impressive-seeming back-ward looking models, or anything that depends on normally-distributed bell curves.

I founded my investment fund[2] in 2004 with a compelling investment thesis, based on observable phenomenon and solid experience.  From my mortgage bond sales seat at Goldman Sachs I could see clearly that we, and thousands of our colleagues and competitors, were engaged in a headlong rush to underwrite and securitize as much consumer debt as we could possibly create on a daily, weekly, and monthly basis.  A good portion of this debt inevitably would go bad, creating huge opportunities for distressed investors who knew how to find and profit from the distress of financial institutions.

I knew something about the default and recovery rates on this type of debt, and I knew about the profitability of purchasing debt when it became distressed. In sum, I knew that we were headed for a debt reckoning, and I knew I had to set up my fund and achieve scale in time to take advantage of that reckoning.  So far, so good.  My fund grew until 2008.

The Black Swan of 2008 made it clear that instead of focusing on what I knew, I should have profitably focused on what I didn’t know.  Fund of Fund Managers can have their capital wiped out in July 2008 and demand a 100% redemption, for reasons entirely unrelated to my fund.

Let’s just say the Black Swan of 2008 swatted aside all the things I thought I knew about distressed debt investing.  It was all the things I didn’t know that killed the fund.  Taleb would argue that I focused on all the wrong risks, and I have to say, in hindsight, he was right.

Market participants could contemplate a single large broker dealer like Bear Stearns going under in March 2008.  That’s not a Black Swan.  What was harder to contemplate and therefore qualifies for Black Swan status was the simultaneous insolvency in one week in September 2008 of Lehman, AIG, Fannie Mae, and Freddie Mac, followed within weeks by the likely insolvency of money market funds and every other major financial firm.

I know I’ve already written before that I don’t like ‘How To Invest’ books, preferring instead the ‘How Not To Invest,’ book as more profitable in the long run.  Most of Black Swan may be profitably read as a ‘How Not To Invest,’ as Taleb implicitly blows up the status quo investment approaches embraced by the mainstream Financial Infotainment Industrial Complex.

However, I would be remiss if I failed to mention Taleb’s interesting investing career, which practice closely reflects his Black Swan philosophy.  He co-founded and continues to consult with a fund called Universa.  Universa purchases ‘volatility’ and ‘tail risk,’ via a long options strategy.  In plainer English his fund traditionally purchases deep out-of-the-money calls and puts, resulting in a portfolio that loses a little bit of money in most years but makes a killing when the rest of the investment world blows up due to some unforeseen, volatile, Black Swan event.

A word of caution if you’ve never read Taleb:  His personality determines his writing style more than most authors.  In his first, well-known book, Fooled By Randomness, Taleb nearly undermines his key financial and philosophical points with his abrasive style.  He slashes through ideas and people he considers lazy or wrong, never lowering the decibel level on his critique.  He improved the tone in Black Swan to the level of merely an irascible professor, making him more readable than his debut effort.

 

Please also see my review of Nassim Taleb’s Fooled by Randomness.

Please see related post: All Bankers Anonymous Book Reviews in one place.


[1] Which of course occurred after the publication of Black Swan and did more than anything to cement the value of Taleb’s skeptical empiricism approach.  Black Swan is more readable but probably less profound than his earlier book Fooled by Randomness, which I’ve reviewed here.  His latest book Antifragile, Things That Gain From Disorder is on hold at my local library.

[2] Misleadingly labeled a ‘hedge fund’

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In Praise of SIGTARP Part II – We blew it on the repayment of TARP funds by the largest financial institutions

See related post In Praise of SIGTARP Part I here

We are now at the four year mark on the deepest part of the Great Credit Crunch and Great Recession, so I’m moved to ask:

When it comes to avoiding the next financial blowup and bailout we need to ask “Are our bank protections better off now than they were four years ago?”

A Congressionally-mandated investigative entity, SIGTARP[1], AKA the Norse God of Financial Accountability, does not think so.

We know the United States government leaped into bailout frenzy throughout 2008, attempting virtually every permutation of intervention to keep the country’s largest financial institutions – and by extension – the world economy – from complete collapse.  The US government used mergers, direct investments, shotgun marriages, bankruptcy, receivership, loan guarantees, voluntary asset sales, forced asset sales – the whole toolkit.

While the bailout process could best be described as ad-hoc, we hope that the delicate unwinding of the government safety net for Too Big to Fail institutions will be more thoughtful, and less chaotic.

We hope, however, in vain.

According to the SIGTARP report the bank’s exit from government protection has been quite ad-hoc as well.  Worse, we[2] let weak TBTF banks pay back public funds before they were really steady on their feet with enough capital.  The same banks – Citibank, Bank of America, Wells Fargo – remain weakly capitalized.  This matters a whole lot because taxpayers continue to silently subsidize the safety net for TBTF banks.

SIGTARP’s report on repayments by the TBTF banks raises and answers key questions, such as

  1. Why did banks want to repay TARP money so quickly, before they were fully ‘ready’ to access private markets for their funding?
  2. How do we know the process was ad-hoc and rushed?

The answer to question number one is simple.  Bank executives said it was to remove the shame and stigma of continuing to receive public bailout funds from TARP.  I think anyone who has spent time around finance executives, however, knows that shame could not possibly weigh as heavily on them as did the TARP restrictions on executive compensation. [3]

The answer to question number two forms the bulk of SIGTARPs report from September 29, 2011, and the details are fascinating.[4]

To get the full gist of the issue, we need some background first, which SIGTARP nicely provides.

The authority to directly invest in TBTF banks[5] via preferred shares came with a sensible proviso that banks could not repay TARP money for 3 years, but Congress reversed course a few months later in early 2009 with a new law[6]  that allowed banks to repay the borrowed capital more quickly.  Although TARP money came from Treasury, the Federal Reserve Board headed up the regulatory team[7] charged with setting criteria for repayment.

Nine reasonably well-capitalized banks[8] repaid TARP funds in June 2009, while another eight – including 3 of the 4 largest banks in the country(Citigroup, Bank of America, and Wells Fargo) – failed a bank stress test.  Among the criteria developed then for the weaker banks was a requirement that they raise a significant amount of TARP repayment funds – specifically 50% of the cash required for repayment — through common stock issuance.[9]

When push came to shove, however, we learn from SIGTARP’s report that regulators stretched, pulled, waived, and disagreed with one another about whether to make banks comply with the rules they had just put in place.  Treasury’s rush to encourage repayment, it turns out, trumped the regulatory need for strong banks.  And if you suspect large banks get better treatment than small banks, here’s your evidence.

Bank of America, for example, raised capital partly through preferred shares issuance, a less regulated type of capital.  Citigroup, as well, fell short of its required 50% issuance of common stock.  Wells Fargo attempted multiple times to wriggle out of the need for a fully dilutive equity issuance but ultimately raised the required amount at the end of 2009.  Regulators, nevertheless, signed off on all three banks’ 2009 repayment plans, waiving their own requirements mere months after setting them.

FDIC’s then Chairman Sheila Bair, however, stands out as a vocal critic of the regulatory cave-in to the combined Treasury and bank-executive pressure.

Treasury, FRB and OCC officials apparently claimed that private markets were too weak to support the admittedly massive equity issuance needed for the banks.  Paradoxically, at the same time Treasury, FRB and OCC implied the direct opposite, that banks were strong enough to pay back public funds.

As FDIC Chief Sheila Bair points out,

“The argument [FRB and OCC] used against us – which frustrated me to no end – is that [Bank of America] can’t use the 2-for-1[10] because they’re not strong enough to raise 2-for-1.  That just mystified me.  The point was if they’re not strong enough, they shouldn’t have been exiting TARP.”

Sheila Bair called out the impossible double-speak coming from Treasury, the Federal Reserve and the Office of the Comptroller of the Currency.

It makes sense to me that you can’t be both too weak for private capital markets but plenty strong enough to leave public protection.  Regulators blew it by letting the banks out of TARP too early.

As a result of the rush to re-privatize we missed the chance to control, from a regulatory standpoint, the destiny of TBTF institutions and our public exposure to the next big crisis.

SIGTARP’s September 2011 report has a ‘remains to be seen’ conclusion on whether banks are now strong enough to absorb future financial shocks.  That’s a pretty interesting negative-report from within the government, significantly doubting whether regulators have properly done their job.

Also, there’s this, from SIGTARP:

“Unless and until such institutions, either on their own accord or through regulatory pressure or

requirements, are restructured, simplified, and maintain adequate capital to absorb

their own losses, they will pose a grave threat to the entire financial system.”

That’s a compelling and scary argument right now, with Bank of America stock down 50% and Citigroup down 30% from when they repaid TARP in November 2009.

 

Also, please see In Praise of SIGTARP Part I here

SIGTARP Part III- The Citigroup Bailout

SIGTARP Part IV – Which Small Banks are Going Under Next?

and SIGTARP Part V – The AIG Bailout



[1] AKA Special Inspector General of the Troubled Asset Relief Fund.

[2] And by “we” I really mean primarily the US Treasury Department.

[3] When explaining bank executive behavior, always assume personal compensation comes first, until proven otherwise.  It’s just a rule I follow and it’s never steered me wrong.  Bankers feeling shame at receiving public funding to save their bacon?  Please don’t insult me.

[4] All of this is assuming you find financial regulatory reviews fun reading, as I do.

[5] Through the Emergency Economic Stabilization Act of 2008 of October 2008

[6] Through the American Recovery and Investment Act of February 2009

[7] Generally the Federal Deposit Insurance Corporation (FDIC) and Office of the Comptroller of the Currency (OCC)

[8] GS, MS, JPM, US Bancorp, Capital One, Amex, BB&T, BONY/Mellon, State Street

[9] Regulators like common stock issuance because it improves a bank’s ability to absorb future losses, ie. it’s ‘capital ratios.”  Bank executives dislike stock issuance because it dilutes value for shareholders, including themselves.

[10] “2-for1” is the regulatory short-hand language to indicate that 50% of TARP repayment money must be raised as new common equity

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When Geithner Goes to Goldman

Just an FYI: I plan to walk out my front door to punch the neighbor’s cat in the face, toward the end of this year, when US Treasury Secretary Geithner finally announces he’s joining Goldman, Sachs & Co as senior advisor and Managing Director.

While he’s indicated his intention of leaving his post as Treasury Secretary soon, Intrade gives Geithner a 37% chance of leaving before the end of Obama’s first term.  The departure of two top Geithner aides to Goldman Sachs in the past 4 months has increased the chatter that Geithner will soon be headed that way as well.

To be clear, I believe punching Mr. Biggins on his cute little cat nose will accurately reflect the combination of surreal injustice and rage that I will feel.  Consider it a measured, senseless act of violence and random mean-spiritedness to match the public mood that should accompany Geithner’s inevitable sell-out move.  What else can I do?  What else can any of us do?

While my act will be appropriately senseless, I want to be careful in how I explain my feelings.

I hold no particular grudges towards those who, in the spirit of providing a better life for their families, seek employment in the private sector following a long career in public service, like Timothy Geithner.

I won’t blame Goldman for offering Geithner the job, either, as it’s clearly in their interest to hire such a key player in shaping the current financial architecture.

I also hold no specific animus toward Geithner himself, who appears to have executed admirably on his difficult professional assignments.

Geithner’s resume deserves respectful review and appreciation.  The man served as Under Secretary of the Treasury under Larry Summers when the latter signed our dollar bills as Treasury Secretary.[1]  He moved up to President of the Federal Reserve Bank of New York in 2003.

Some FRB-NY Presidents have served in that position, easily the second most powerful seat at the Federal Reserve, in relative obscurity.  But not Geithner.  He had the interesting fortune to be on the FRB-NY President hot seat during the Great Credit Crunch in 2008[2], thereby putting his imprint on every major decision made about Wall Street from 2007 to 2009.

When Bear Stearns teetered on the edge of Bankruptcy and the FRB-NY offered a $25 Billion loan to tide Bear over, Geithner was there.  When the FRB-NY subsequently rescinded its offer to Bear, ensuring its immediate demise, Geithner was also there.

JPMorgan Chase then bought Bear Stearns for a song, and the FRB-NY provided up to a $30 Billion non-recourse loan to get the deal done.[3]  Geithner was there too.[4]

When the FRB combined with the US Treasury to lend up to $182 Billion to prop up AIG, a bailout understood at the time to be, and a bailout that actually was[5], a back-door bailout of the largest financial firms in the world, Geithner was there.[6] [7]

When the Federal Reserve and US Treasury made available to Bank of American $20 Billion in additional TARP funds[8] and an extra $118 Billion in asset guarantees[9]  to ensure that it followed through to purchase Merrill Lynch in December 2008, Geithner was there too.[10]

Obama took office in January 2009 and Geithner received a promotion from the FRB-NY President to US Treasury Secretary, a logical move to ensure continuity at a very dicey time in financial markets.  I’ve written in an earlier post about the tight circle of government officials running financial policy, and the trade-offs between continuity and stagnation.  It was not crazy for Obama to promote Geithner.

In the light of Geithner’s impending employment by Goldman Sachs, however, it’s interesting to review how Geithner has not “been there” on a number of issues.

When AIG paid bonuses to its executives after its $170 Billion bailout, the largest financial failure/bailout of all time,[11] Geithner as US Treasury Secretary did not force a clawback of those AIG bonus payments.  Under what authority could Geithner influence bonus payments?  The US government owned 92% of AIG at that time.  But Geithner somehow wasn’t there.

After Ken Lewis destroyed a perfectly healthy Bank of America in 2008 through his devestating purchases of Countrywide and Merrill Lynch, forcing the extraordinary Treasury and FRB-NY bailouts to stabilize the bank, Lewis departed in 2009 with an estimated $125 million retirement package.  Under what authority could the US Treasury Secretary influence executive payments?  Well, for starters, Bank of America owed $45 Billion at the time to the US Treasury.  But Geithner wasn’t there to claw back Lewis’ compensation.

While Too Big to Fail (TBTF) banks continue to this day to operate as large hedge funds, and continue to compensate their executives accordingly, under an implied government guaranty of safety, Geithner is not taking a public stance against this.

While I review the FRB-NY and US Treasury bailouts in some detail I want to be careful not to blame Geithner exclusively for mistakes that were made.  I don’t endorse every decision made by Paulson and him, but I acknowledge the battlefield conditions under which they labored.  I know the issues are complex; they weighed financial stability against moral hazard, justice against political feasibility.  I get it.  This stuff is hard.

But at no point in his tenure as FRB-NY President or US Treasury Secretary did we witness Timothy Geithner take a principled, unpopular stance – in the face of egregious moral hazard – to come down hard on Wall Street’s surviving behemoths.

I’m not a paranoid person by nature, and I believe Geithner’s actions to be defensible without accusing him of sucking up to his future employers.[12]

Clearly one analogy here is a powerful Congressman[13] who leaves office, moves down to K-street, and sets up a profitable lobbying shop influence peddling on his access to decision-makers.  We have some, albeit too few, restrictions on this type of brazen move.  Even that comparison, however, misses the magnitude of Geithner’s influence in recent years over $Billions in compensation and investment returns.

As an ex-banker I – oddly enough – still believe in the system.  I assume a basic decency tempers all but a few bad actors.  I’m still shocked by corruption.  I still can be disappointed by greed and influence peddling, and I believe the United States still boasts the least corrupt financial center in the world.[14]

More than any other single financial leader Geithner has argued within the administration for stabilizing and buttressing TBTF banks above all other factors, and seemingly has resisted efforts to extract proportionate commitments from the salvaged banks in the name of systemic reform or limitations on executive compensation.  Geithner’s heroic efforts on behalf of the TBTF banks have been worth billions of dollars to them, and he’s become the face of moral hazard within the Obama administration.[15]

Geithner’s move to become a Goldman Managing Director later this year – rightly or wrongly – will signal to journalists, Wall Street, SEC regulators, investors, you, and me, that all is for sale.  The move will signal that private gain trumps public good, every time.

But back to cat-punching for a moment.  If we have no way of preventing Geithner’s move to Goldman, then we have no reason (except sheer naiveté) to ever expect tough decisions to rein in Too Big to Fail banks.  I for one cannot stand to have my neighbor’s cat live peacefully in that kind of world.  Consider yourself warned, Mr. Biggins.



[1] One of my closest friends served under Larry Summers at Treasury.  I’ve shaken Larry’s hand a couple of times.  I’m not breaking any news here to say that Larry is not a super fun guy to spend your working day with.  Let’s agree to award Geithner a Bronze Star for that portion of his professional career.

[3] The $30 Billion non-recourse loan arranged by Geithner’s FRNNY  in this transaction was simply awesome for JP Morgan Chase.  Non-recourse means that only Bear Stearns collateral backed the loan, so if it turned out its portfolio was worthless, JP Morgan could walk away with only the first 3% of losses.  What that means is that the Federal Reserve agreed to absorb up to $29 Billion in losses on JP Morgan Chase’s purchase of Bear’s $30 Billion asset portfolio.  It’s kind of like being given a million dollar house by the Federal Reserve, but if you decide you don’t want it later you just owe 30K, and they can’t go after you for the other $970K.  Like I said, so awesome.  Jamie Dimon, you owe free drinks to Geithner for the rest of his drinking life.  We would all love the option to walk away from 97% of a $30 Billion loan.   We should seriously all try to get one of these loans from the FRB-NY.

[4] Bear Stearns initially got sold to JP Morgan Chase for $2/share, just 7% of what Bear Stearns had been worth 2 days before, before the FRB-NY rescinded its loan offer.  Later, sort of out of pity and to avoid further litigation, Paulson allowed an upward revision of JPMorgan Chase’s purchase price to $10/share, still an extremely low price.

[5] If you have a taste for wonkiness and financial history like yours truly, I highly recommend this link.  But for the rest of you let me summarize the key point of page 24.  The size of the bailout for each firm you’ve heard of, via the AIG loans from FRB-NY, were as follows: Societe Generale: $16.5B, Goldman $22.5B, Deutsche Bank: $8.5B, Merrill Lynch $6.2B, and UBS $3.8B.

[6] To briefly review the history of this particular bailout: AIG got taken out by a series of lightly-collateralized credit default swap trades done with some of the largest Wall Street firms.  The trades were meant to be, from AIG’s point of view, a nearly riskless cash-flow stream based on insuring the credit of a large portfolio of high quality companies, as well as some highly rated but ultimately dodgy mortgage securities.  When the unexpected mortgage downturn happened, and some high-quality companies got downgraded, AIG’s Wall Street counterparts asked AIG to provide additional collateral to reflect a change in value of the trades.  The portfolios themselves did not necessarily suffer outright losses, but the collateral requirements to Wall Street meant they had to come up with many $billions in cash very quickly.  If AIG had failed to post collateral, suddenly many major Wall Street firms would have suffered immediate life-threatening cash shortages, at the worst point in the crisis, September 2008.  When the FRB-NY (along with Treasury) provided essentially unlimited funds to AIG, the rest of Wall Street got their collateral and bought themselves a bit more breathing room.

[7] When the FRB-NY went back in November 2008 to ask, you know, if maybe Wall Street would give some of that AIG money back because it kinda looked bad at the time, Wall Street told FRB-NY, essentially, to go fuck themselves.  The whole report of Wall Street’s response is in the link in the main text above, but, linked to again here for your convenience.

[8] This $20 Billion exceeded the $25 Billion already invested by the US Treasury to shore up Bank of America in October 2008, and the extra $20 Billion legally could not be offered without creating an entire special work-around program just for Bank for America, called the Targeted Investment Program (TIP).  Bank of America said, “thanks for the TIP.”  See what I just did there?

[9] Again, these latter guarantees were non-recourse to Bank of America, and the Federal Reserve pledged to absorb 90% of losses after the first $10 Billion write-down.  Again, non-recourse meant Bank of America could default on loans from the government without any negative hit to their credit.  It also meant that the Federal Reserve, again under Geithner’s leadership, took on (up to) a theoretical additional $100 Billion liability so that Bank of America would complete its purchase of Merrill Lynch, all in the name of bank stability.

[10] Details and a review of the rationale behind this move are here, starting on page 23.

[11] Incidentally, isn’t a bonus an optional reward for a job well done? I’m just going to go out on a limb here and say that AIG executives, more than ANY other financial executives who kept their jobs through the Crisis, should not have been rewarded for ‘a job well done.’  Were there any forced clawbacks of bonuses at AIG?  Nope.  Not one.  To steal a phrase from my favorite sports writer, I will now douse myself with kerosene and light a match.

[12] However, I will note that Geithner’s longtime financial benefit to Goldman Sachs and a few other surviving banks far exceeds by multiple billions of dollars the comparatively miniscule compensation of a few million dollars he’ll receive as a new GS Managing Director.  It’s really the very least Goldman could do, to put him on the payroll for a few years.

[13] Or more commonly, his senior staff members.  Wall Street has long considered the SEC a joke for this reason, as the only way to get well compensated as an SEC executive is to cash in on your position for a senior role at a Wall Street firm after a stint supposedly regulating the Street.

[14] Ok, I know you’re all groaning out there at my sudden earnest patriotism.  But I stand by my statement and it’s not based in patriotism.  Why does the dollar, despite our weakened government credit, continue its role as the dominant reserve currency?  Why do M&A transactions worldwide get done by US-based law firms, and financial litigation gets fought in US-based courts?  Because we are the least corrupt place in the world for financial transactions, that’s why.

[15] Paul Krugman lays out Geithner’s role within the Obama Adminsitration in his review of recent books on economic policy “…it is Tim Geithner, Obama’s treasury secretary, who appears, even more than Obama, as the decider in this saga. In contrast to Summers, whom [one of the authors] Scheiber portrays as a flexible, reformist Rubinite, willing to alter his views in the face of evidence, believing in particular that shareholders of bailed-out banks could and should pay more to taxpayers, Geithner is described as a doctrinaire Rubinite who viewed his primary task as one of restoring financial market confidence, which in his mind meant doing nothing that might upset Wall Street.”

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Book Review: Money and Power – How Goldman Sachs Came To Rule The World


The book cover – featuring a view of planet Earth presumably from a heavenly vantage point – offers the first hint that William D. Cohan’s plan here is not critical thinking but rather hyperbolic imagery.  Inside he writes a survey not of Goldman, Sachs & Co.’s overall history but rather of historical points selected for potential embarrassment to the firm.

As the consensus choice for the Wall Street firm that escaped the least scathed financially from the credit crunch, paradoxically, Goldman Sachs’ reputation became the most tarnished by its role throughout the 2007/2009 crisis and the years leading up to it.  After a calamity like the Great Credit Crunch, the general public and its commentators need a villain.  And it stands to reason, goes their thinking, that the Wall Street folks who broke even or came out ahead must have been the same ones who both caused the crisis and set themselves up ahead of time to benefit from it.

Cohan and his publisher clearly sought to benefit from this demand for a scapegoat.  Unfortunately Cohan seems determined to find a scapegoat more than he tries to put recent financial events into context that helps explain them.

If you’re looking to save time, skip to the final quarter of the book.  Cohan features Goldman’s mortgage department traders and some of their most successful trades in 2007 and 2008.  Cohan managed to get Josh Birnbaum, a key part of Goldman’s ‘Big Short’ trading team throughout 2007, to speak on the record and in depth about who did what, when, and to whom.  Now, it should be acknowledged here that Michael Lewis’ book about this period and the traders who got the The Big Short right is about five times more interesting than Money and Power, but crucially Lewis could not get Goldman’s employees to speak to him.  Lewis settled for a Deutche Bank trader and other more obscure hedge fund traders.  Cohan gets the journalistic prize of landing the insiders of Goldman, the firm that the public cares the most about.

The first three-quarters of Money and Power, however, did not need to be written, and certainly don’t have to be read.    The majority of Money and Power follows the rise and reign of Goldman’s leaders throughout its history.  He clearly interviewed a wide number of leaders and partners of the firm.  Less impressively, a majority of his chapters rely almost entirely on secondary sources such as earlier books, newspaper coverage of scandals, and feature pieces in industry magazines.  Lawsuits and SEC investigations provide the rare primary source document.

Cohan highlights a few gossipy items of interest, in particular clashes between the firm’s leaders throughout the years.  Given the recent collapse of MF Global, Jon Corzine’s massive risk appetite and his trading losses in 1994 seem particularly relevant.  Also relevant is Corzine’s long-time alliance with Chris Flowers, who installed him as head of MF Global, and earlier became an uncomfortable catalyst of conflict between Goldman’s leaders Corzine and Hank Paulson in the lead-up to the firm’s IPO in 1999.

Paulson clearly provided extraordinary access to Cohan and manages to come out looking the best among Goldman’s modern leaders, a trick Paulson also pulled off with journalist Andrew Ross Sorkin in Too Big to Fail.

If you need an illustration of how Cohan chose headlines over substance, look no further than his Prologue.

The Prologue describes in detail Senator Carl Levin’s (D-Michigan) cross-examination of executives in the Goldman mortgage department in front of his investigatory committee in 2010.  The hearing highlights Levin’s blustering unwillingness to listen to the testimony he’s asking for.  Levin repeatedly cuts off answers, refuses to acknowledge complexity, and grandstands for the cable news networks.

As Cohan tells it, Levin makes the point at the end of his Congressional cross-examination that as a lawyer, Levin knows not to represent both sides of a deal.  To do so, Levin lectures, would introduce undeniable conflicts of interest that would harm his client, his firm’s reputation, and the ethics of law practice.  Levin points out that as a broker working both sides of a CDO transaction, Goldman has badly served its clients and wrapped itself in a web rife with conflicts of interest.

It’s a fine-sounding point, and we can imagine a number of cable news hosts at the time pursing their lips in prim agreement with the venerable Senator’s analogy.

Levin clearly doesn’t get, however, or will not admit to getting, what a broker-dealer does all day.  By definition, a financial broker-client relationship is not an attorney-client relationship.  Attorneys always, or most properly, represent one side of a deal, but financial brokers do not.  There are almost always two sides to the client transaction, and the broker buys from one client and sells to the other client.  Cohan should know this, as does anyone who has ever worked in the securities business, but he doesn’t bother to point out the obvious flaw in Levin’s analogy.

Next Cohan describes the SEC actions against Goldman’s CDO structuring desk, built on the evidence of a pair of emails, one from a senior manager who describes relief at the end of a ‘a shitty deal’-  and the other in which a relatively junior CDO structurer worries to his girlfriend about the end of a financial window for selling his product.  The ‘smoking gun’ found by the SEC was only an empty water pistol, but that did not stop Cohan from describing the actions as if they are solid evidence of wrong-doing and moral breakdown.

Cohan concludes his Prologue with what’s meant to be a shocker about selling shares in Facebook in 2011.  For this, Cohan needs to be quoted in full:

“How could Goldman get comfortable, in January 2011, with offering its wealthy clients as much as $1.5 billion in illiquid stock of the privately held social-networking company Facebook – valued for the purpose at $50 billion – while at the same time telling them it might sell, or hedge, at any time its own $375 million stake without telling them that its own private-equity fund manager, Richard A. Friedman, had rejected the potential investment as too risky for the fund’s investors?”

Now here again, Cohan could prove that he knows how broker-dealers work – but he fails to give the obvious answers to his rhetorical question. First, the investment management arms of broker-dealers do not always, or even often, purchase the same investments as their clients.  Second, broker-dealers frequently have widely different valuations for assets than their clients.  Third, Goldman’s wealthy clients are allowed to, and often do, make purchases that differ, in important ways, from the purchases made by Richard A. Friedman for the firm.

I get the sense that Cohan did a Google search of Goldman just before sending his final book edits to his publisher in early 2011 and decided on one final zinger against the firm.  He should have restrained himself.  The Facebook example is the point where Cohan loses credibility as a financial journalist and becomes an author trying to capitalize on public anger by ignoring his own experience.  It’s too bad for Cohan that the point occurs in the Prologue.

How did Goldman Sachs come to “rule the world?”  It’s a great question, and a book that answered it would be a great book to read.  Unfortunately, Cohan provides almost no analysis to support his title.  Instead he presents Goldman’s history since at least 1929 as a series of scandals, bad behavior, and influence-peddling.

Is Goldman Sachs the real villain of the Credit Crunch?  Cohan effectively surveyed the popular mood and surfed the firm’s history for anecdotes to support this idea.  But there’s almost no comparative discussion in the book of Goldman’s role vs. the role of other Wall Street firms.  There’s also very little in the way of weighing evidence for Goldman’s centrality to the crisis vs. other important actors or explanations.  What we are left with instead is a survey of headlines throughout the firm’s history, and an unwillingness to explain what they mean.  The intelligent but non-insider audience will believe whatever they believed before picking up the book, and that’s a missed opportunity.

We need a book that leads the interested public through the complex issue of who is responsible for the Great Credit Crunch and the Great Recession, but Cohan’s Money and Power is not it.

Please see related post: All Bankers Anonymous Book Reviews in one place.

 

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