Guns smoke after they have been fired from. But before brushes and forests catch fire they could smoke. The smolders also do after the conflagration. In this crisis it could be confusing for those caught up in its effects to figure out the smokes from the fires. Only those causing them know, but it is often part of the grand larceny and arson to not reveal the fire setters. The rumors around Washington these days are that Larry Summers, the President’s Director of the National Economic Council (NEC) is smoking. The economic metaphor is increasingly becoming clear whatever may be his smoking habits (inhalation notwithstanding).
On the pretext of financial regulatory reform, the Securities and Exchange Commission (SEC) has charged Goldman Sachs with securities fraud. The allegation is that Goldman manipulated the derivatives market to profit from the crisis for causing which it is responsible in part. Alleging market manipulation in the unregulated markets, the Democrats are seizing political leverage to force financial regulatory through. In the melee no one is questioning why the crisis was caused to begin with.
The same political leverage that is being gained by the Democrats to force the financial regulatory reform of their liking (in spite of better advice) through the flimsy lawsuit against Goldman Sachs may also have been gained by causing the crisis in a timely manner before the 2008 elections (to get Hillary Clinton elected president, a continuing aspiration) and just after the Federal Reserve had finished raising rates in the summer of 2007. The Democrats started the fire, engendered the grand larceny with the arson and are now trying to douse it on their terms after the looting by those in the Gucci loafers.
The government’s primary motive in suing Goldman Sachs appears to be to force cooperation from the major investment banks on regulatory reform, the secondary motive being collecting settlement revenues for causing the crisis to pay back the tax payers and to assuage public angst about the crisis. The government will succeed in both and it quite appropriately should, the arson to be paid for by the president’s men with their jobs. So, the SEC must expand its defendants list on Wall Street beyond Goldman Sachs. Given the lack of solid legal ground to prove intent of fraud by the investment banks, the SEC can force a settlement on the grounds of incompetence. This is necessary to humble the self-proclaimed masters of the universe on Wall Street and is long overdue.
Still, the current debate over financial regulatory reform seems to be to say a lot without doing much. The Treasury and the Federal Deposit Insurance Corporation (FDIC) tussling over when to collect fees from financial firms is moot.
The Treasury exposing the government’s balance sheet to financial failures first, after a crisis, to recover the funds later through penalties is poor management of the nation’s books. The FDIC wanting to levy higher insurance charges up front demonstrates a lack of understanding of the dynamics of the shadow financial markets.
In this crisis commercial banks were not affected and were served well by existing deposit insurance rules. Further, deposit insurance payouts will be triggered only in the event of a run on the commercial banking operations of large bank and financial holding companies. The Volcker Rule that is currently under consideration for financial regulatory reform intends to at least logically separate commercial deposits from the more risky activities of financial institutions. In this context, FDIC attempting to regulate risk through higher fees on commercial bank deposit insurance may be irrelevant.
The probability, even without higher FDIC fees, of a crisis in non-commercial banking functions to cascade into a commercial bank run is low. It is best to regulate risk in non-commercial banking in a manner that makes the markets appropriately price the risk while saving for a rainy day. The FDIC is jumping the gun on deposit insurance changes for the large banks.
The trouble with this government charade (without accusing the SEC of not understanding what they are prosecuting) seems to be not whether the SEC understands the various financial instruments. The more important distinction here is between the derivatives market where Goldman Sachs was operating and the hedge funds market. Derivatives are bought and sold in the derivatives market, whereas hedge fund investors rarely take interest on owning the underlyings but bet on the movements in their values.
Even if Goldman Sachs helped others in the hedge fund industry realize their bets by influencing the market sentiment, given that Goldman appears to have held a large portfolio of the instruments in question, it is indeed market manipulation but not covered by current law, unless the SEC can prove that the market movements in the unregulated markets affected the movements of other financial instruments it oversees, by Goldman’s intent, and that Goldman Sachs benefited from those also with or without colluding with others. The case of Greece ought to be of interest to the United Kingdom and Germany which are reportedly working together with the SEC on the Goldman matter because the potential Greek sovereign debt default nakedly connects the types of securities that SEC regulates and the derivatives which it does not.
The death of a shadow should not kill the person. But in this case, a failure in the derivatives market killed the economy. Then it is not a shadow. And therefore, must be treated as a person and the Goldman case’s purpose then becomes establishing the process by which the unregulated markets can be regulated for fraud, given the fungibility of the myriad transactions with money that crisscrosses the standardized financial instruments and the yet to be regulated financial instruments which are cooked up faster than a chef can make a meal in a Manhattan restaurant by a multitude of underlings with MBAs, eager for large annual bonuses, unbeknownst to the best minds in finance, such as Robert Rubin per his own confessions.
SEC v. Goldman Sachs can help unravel the de facto economic machinations of the very wealthy in the shadow markets to influence governments through markets. The case could help reestablish the checks and balances between the markets and the government.