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Miles Mogulescu

Miles Mogulescu

Posted: April 28, 2010 12:07 PM

Comparing Goldman Sachs to a Casino Is an Insult to Casinos

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As Goldman Sachs CEO Lloyd ("We're Doing God's Work") Blankfein, Fabrice "Fabulous Fab" Toure, and other bank executives paraded before the Senate Permanent Subcommitee on Investigations to proclaim that their honor is as pure as the driven snow, even Nevada's Republican Senator John Ensign--who had an affair with his Chief of Staff's wife and then paid the couple off to keep it quiet--took moral offense when several Senators compared Wall Street banks to Vegas casinos, telling the Committee, "In Las Vegas, most people know the odds are stacked against them. On Wall Street, they manipulate the odds while you're playing the game."

He had a right to be offended. Vegas casinos and bordellos run more honest businesses than Wall Street megabanks.

Running a gambling casino is actually a pretty simple, straightforward and honest business. You're closely regulated by the state gambling commission who would throw you in prison if you were caught loading the dice, stacking the deck or making side bets for your own account against your customers. All your customers know that you skew the odds slightly in favor of the house, so that cumulatively the house always wins and you make healthy profits on the margin by which the odds are slightly skewed in your favor.

But if you're Goldman Sachs (and the other Wall Street megabanks) creating and selling toxic packages of synthetic derivatives, you can load the dice, stack the deck, and trade for your own account against your clients with impunity and then get bailed out by the government if you lose your bets. Any self-respecting casino owner would be insulted if you accused him of similar behavior.

If Goldman (and the other Wall Street megabanks engaging in similar practices) were a casino, it would look something like the old Robert Redford-Paul Newman movie The Sting: First they'd allow one of their heavy roller clients (in this case John Paulson) to pick the cards for its blackjack table, stacking the deck so some other drunk heavy rollers from Germany would almost certainly lose. Next they'd pay a supposedly independent private consumer rating company--something like Consumer Reports, but in this case called Moody's or Standard and Poors--to certify to the Germans that the blackjack table was on the level. Then they'd make money selling the Germans lots of liquor to be sure they would bet heavily, while taking a cut of the table when they lost. Next they would make more fees by letting its other client, Paulson, bet against the Germans, taking a cut of that table too. Finally, they would make the really big score by using their own money (proprietary trading) to make side bets with other gamblers (like AIG) that customers playing at the stacked blackjack table would lose. And when this last group of gamblers (the AIG ones) lost their bets and had to pay up--but couldn't because they weren't legally required to have enough money to cover the bets in the first place--they'd threaten financial Armageddon if the taxpayers didn't cover their bets and bail them out. And it wasn't just Goldman running this kind of sting operation. It was other Too Big To Fail Banks like JP Morgan Chase and Morgan Stanley.

Part of the reason that this kind of activity would get a casino owner thrown in jail and would get a bankster a taxpayer-funded bailout is that in 1999, Bill Clinton signed a bipartisan bill prohibiting derivatives from being regulated in any form--as gambling, insurance or securities--after being advised to do so by his Treasury Secretaries Bob Rubin and Larry Summers (now Obama's chief economic advisor).

So under current law, it may not be illegal for a bank to put together a package of toxic synthetic derivatives, knowing all the while that they're likely to blow up and lose their clients' money. It may not be illegal to simultaneously sell another client short bets that the toxic derivatives will blow up. And it may not be illegal to use the bank's own money, collected from federally insured depositors, to bet that the entire subprime mortgage market, of which those derivatives are a part, will melt down. (Well there's at least a theory that it's illegal. It's possible that this scheme may have broken general laws against fraud, or conspiracy to commit fraud; but so far no branch of the Federal government or state governments have tried to bring charges on those grounds. Let's hope that the Justice Department and/or some state Attorneys General seriously pursue this angle--putting a few banksters in jail may do as much to deter future irresponsible behavior as regulations, particularly if the banks continue to capture the regulators.)

So far, the only law that Goldman has been accused of breaking in this scheme is the requirement that securities underwriters provide their buyers with all "material" information about the securities in question. The narrow legal issue in the SEC's civil (not criminal) suit against Goldman is whether it was "material" to have told its clients, who were buying the synthetic derivatives long, that another client--John Paulson--helped pick the securities in the package because he was taking a short position that would make money if the package blew up. Goldman's defense--and it may be a winning defense--is that almost no one at the time knew who Paulson was, so telling the long investors that Paulson was helping pick the securities would not have affected their decision to buy the securities and thus was not "material." The government's case will likely be that Goldman had a duty to tell its buyers, not only Paulson's name, but that he was one of the people both picking the securities and betting against them to fail, and this information was thus "material." Most lawyers will tell you that this case could go either way.

More important than who will win the Goldman suit is whether negative publicity from the Goldman charges will spur Congress to do more to make it clearly illegal for Goldman and other megabanks to engage in this kind of activity in the future. At this point, the financial reform bills before Congress don't do nearly enough. Blanche Lincoln's Agriculture Committee amendment, which the Democrats have now incorporated into their bill, at least requires most derivatives to be traded in public on exchanges, and forces banks to spin-off their divisions which engage in proprietary trading of derivatives into separate companies. There's a good chance, however, that this will be watered down in the final bill by Republicans and corporate-friendly Democrats.

The legislation currently does nothing about ratings agencies that are paid by banks to give toxic assets AAA ratings, when both the banks and the ratings agencies know, or should know, that the assets are toxic. It does nothing to require that banks have a fiduciary duty to their investment clients, to treat their clients' money as carefully as they would treat their own money, and to not be allowed to construct and sell securities packages that the banks have good reason to believe are toxic. It does nothing to restrict the sale of "synthetic" derivatives where neither the buyer nor seller actually owns anything, which securities were at the heart of AIG's collapse and bailout.

If the Senate doesn't amend the financial reform bill to unequivocally outlaw these practices--which did so much to create the financial meltdown and led to millions of Americans losing their jobs and houses--then banks will keep engaging in them and future booms, busts and bailouts are likely. We'll continue to hear that giant sucking sound of the megabanks scooping up the wealth of middle class Americans and redistributing it upwards (instead of playing their proper role of allocating savings and capital where it's most useful to make the economy more productive and create jobs.) And running a gambling casino will continue to be a more honest businesses then running a Wall Street Bank.