Felix Salmon

There are two stories often told of hedge fund managers, and they’re pretty much diametrically opposed. In the popular imagination, such managers are risk junkies, putting on massive bets in the hope that they’ll have huge payoffs, making a fortune for their investors and even more so for themselves. But that’s not the story told to — and bought by — big institutional pension funds and insurance companies and endowments, who lap up stories of state-of-the-art risk management, carefully-calibrated hedges, aggressively maximized Sharpe ratios, and returns which not only beat the stock market but do so with significantly lower volatility along the way.

So which is true? Read Lawrence Delevingne’s account of how Michael Geismar gambled away his time at the SALT conference in Las Vegas, and it’s pretty clear that the hedge fund manager of popular imagination is a very real creature indeed. He throws $1,000 tips around like confetti, he books a $20,000 private jet home on a whim, he wins and then he loses $70,000 and then he just keeps on playing, and ends the conference up $710,000 or so.

“He was jumping into the pit screaming ‘we’re going to need more chips over here!’” O’Leary recalls, laughing. “It was insane.”

The young dealer was visibly sweating with tens of thousands of dollars now being bet on every round of cards. A small crowd had formed around the table. At one point a casino pit boss came over, worrying that the players Geismar was backing up weren’t actually betting their own money. The table quickly convinced the man they were, and play resumed. The pit boss conferred with a superior, who O’Leary recalls saying “We’re never going to win our money back, but screw it, let’s let it roll.”

Well, yes. This is why SALT will always be in Vegas, and why Vegas will always welcome SALT with open arms. I’m sure the casinos made very good money on SALT even after accounting for Geismar’s winnings, and they’ll probably make money from Geismar too, on net, over time. If nobody ever won big money, no one would gamble at all. But in the end, the house always wins — and all of these hedge-fund managers are smart enough to know that. And still, left to their own devices, what they do is gamble, and they even layer on silly “risk management” techniques which don’t reduce risk at all — in this case, after a losing hand, Geismar would bet a little less, reckoning that somehow “laws of averages” would help him as a result.

Delevingne’s story makes for great reading, but it’s also pretty much impossible to imagine why anybody would invest in hedge funds in general, or Geismar’s hedge fund in particular, after reading it. SALT is the brainchild of our old friend Anthony Scaramucci, of course — and while I’ve definitely met people who like Scaramucci, or are charmed by him, I haven’t met anybody who thinks that Scaramucci’s fund-of-funds is near the top of any list of the best places to invest money. Whatever you think of gladhanding and gambling, they’re not really the kind of behaviors you’re primarily looking for in a fiduciary.

All of which brings me, inevitably, to JP Morgan’s Chief Investment Office, which, the WSJ reports, has been making all manner of highly-risky bets, including bets on LightSquared. There’s lots of hair-splitting in the story about whether or not the bets are funded with excess deposits, but ultimately money is fungible, and in any case the reason that JP Morgan can fund this Special Investments Group so cheaply is just that it’s a big commercial bank which is too big to fail. And if it’s entirely right and proper to look askew at hedge funds exhibiting symptoms of gambling addiction, we certainly shouldn’t stand for JP Morgan Chase to be engaging in anything like that behavior.

This is a Volcker Rule question, of course, but it’s not only a Volcker Rule question. There’s a much deeper issue here as well — which is whether big commercial banks should have hotshot trading desks staffed by the likes of Achilles Macris and Bruno Iksil at all. Both Peter Eavis and Jonathan Weil have new columns decrying the opacity of JP Morgan’s public disclosures: the bank seems to make it as difficult as possible for its owners to find out just how much risk it’s taking and where. And not just its owners, either: the owners’ representatives on the board, JP Morgan’s risk committee, is deliberately staffed by muppets.

There’s a good reason for that, of course: hedge funds need to operate in secrecy, because if the market can work out what their positions are, it will move sharply against them. JP Morgan’s CIO is a hedge fund in all respects except the fees it charges, and clearly the CIO (and the CEO) want its activities to be effectively unsupervised. That’s almost certainly the reason that the CIO is effectively based in London: it’s largely outside the scope of US regulators, there, while UK regulators tend not to care too much about the actions of foreign banks, when those actions don’t present a big risk to the UK economy.

So here’s another principle, which might be helpful alongside the Volcker Rule, in any principles-based regulatory regime: if you’re a too-big-to-fail commercial bank, you shouldn’t have any desk which needs to operate in secrecy in order to do its job effectively. In practice, as Sheila Bair says, that means that JP Morgan should be broken up. If hedge funds want to gamble, fine, let them do that. But not when they have an implicit US government guarantee.

Many thanks to Ben Walsh for putting this chart together for me. What you’re seeing is JP Morgan’s excess deposits — the size of the bank’s deposit base, minus the amount of its loans — both in absolute terms and as a ratio. Either way, it’s going up and to the right.

JP Morgan clearly has a certain amount of control over the amount of deposits it takes in. What you’re looking at here isn’t entirely a flight-to-quality trade: JP Morgan’s total deposits actually fell in the two years following the financial crisis. They were just over $1 trillion at the end of 2008, they dropped to $940 billion at the end of 2009, and then they fell again to $930 billion at the end of 2010.

But then, in 2011, they shot straight back up — and now they’re at a record high of $1.13 trillion, with JP Morgan having failed to lend out more than $400 billion of that amount. That’s a record not only in absolute terms but also in relative terms: for every dollar that JP Morgan has on deposit, it has managed to lend out just 64 cents.

To put it another way, JP Morgan has $9,900 on deposit per US household — and of that, $3,600 per US household is “excess deposits” which are mostly being farmed off to London rather than being invested in helping US individuals and businesses grow.

The ostensible purpose of JP Morgan’s Chief Investment Office is to take the bank’s excess deposits and invest them in a way which manages to hedge the rest of the bank’s exposures. But if you’re spending 57 cents on hedging operations for every dollar you’re making in original loans, which is the case here, then something’s clearly very wrong. JP Morgan’s loan book isn’t that risky, or difficult to hedge. And if it is, JP Morgan needs some new loan officers.

The real story here, of course, has nothing to do with the difficulty of hedging JP Morgan’s loan exposures. Rather, the hotshot CIO traders in London were managing to get a higher return on their “hedging” operations than the loan officers were getting on their bread-and-butter loans. And so Jamie Dimon started taking in all the deposits he could find, and sending them straight to London, where they could be “hedged” to the tune of billions of dollars a year in profits.

It’s easy for JP Morgan to bring in huge amounts of deposits, of course: corporate balance sheets are bloated with cash, and those corporations want to deposit their funds with a too-big-to-fail institution. But if those deposits are being attracted by JP Morgan’s implicit government backstop, then it’s incumbent upon JP Morgan to lend them out into the US economy, to get it moving again. Rather than sending them off to London to be gambled away by the likes of Bruno Iksil, even as JP Morgan’s total loan base remains lower today than it was in 2008.

You want proof that JP Morgan was — is — using its Chief Investment Office to gamble with taxpayer-backstopped funds?

The CIO unit also had a lower cost of capital than other parts of the bank, an artificial advantage that gave it an incentive to take more risk and behave in a less disciplined way, people familiar with the unit said.

“It was very large, but was never very transparent, and it wasn’t clear that they had an appropriate funding cost,” said the source with direct knowledge of the CIO.

In any unit of any bank, one of the key drivers of profit and loss is the internal cost of funds. If you’re paying 1% for your funds and earning 3%, then you can claim profits of the difference, 2%. But if your cost of funds is increased to 2%, then your profit is halved at a stroke. For someone like Ina Drew, who was charged with turning hedges into profitable trades, the easiest way to do that would always have been to simply get Jamie Dimon to decrease the CIO’s cost of funds.

And at JP Morgan, just like at any other bank, the cheapest cost of funds is always deposits. JP Morgan has hundreds of billions of dollars in excess deposits just because it’s too big to fail, and has an implicit government backstop. It’s bonkers that it should then be able to take the resulting ultra-low cost of funds, and turn it into eight-figure bonuses to people like Drew, all for taking that money and playing on derivatives indices in London.

As John Macaskill points out, the CIO, by its own faulty measurements, had for the past two quarters more money at risk than JP Morgan’s entire investment bank — and that was with a more lenient risk measurement and with a lower cost of capital. In reality, the CIO’s risk levels were vastly greater than those at the investment bank, as we discovered after the blow-up.

If JP Morgan wants the CIO to be taking that kind of risk, it has to significantly increase the CIO’s internal cost of funds. The CIO is at heart a hedge fund (it’s designed to put on hedges), and JP Morgan should extend it billions on the same kind of terms that it would extend money to top prime-brokerage clients. The CIO’s secret weapon, all these years, has been its artificially low cost of funds. If that number were more realistic, maybe JP Morgan wouldn’t have ended up parking such an insanely enormous amount of money there.

The size of the run on Greek banks is not at all clear: while it seems that something on the order of €1 billion has left the banks of late, it’s less obvious whether that was over the course of one day, three days, or two weeks. The big picture, though, is unambiguous:

What you’re seeing here is Greece down to its last €165 billion or so in deposits, and at the margin the rate of decrease is probably accelerating, despite the fact that most sensible Greeks will have already stashed their hard-earned euros safely outside the country a long time ago. I don’t know what the minimum amount is that Greeks need on deposit just to serve their near-term liquidity requirements, but we’re not there yet: Greece’s total population is only 11 million. So there’s a long way further this number can fall — especially since the Greek banking system isn’t receiving the support it needs from the ECB.

The more realistic constraint is simply that many Greeks lack the education and sophistication and language skills needed to move their money out of the country. This, for instance, is telling:

A 60-year-old textiles store owner who gave his name only as Nasos said he had transferred 10,000 euros over the phone to a bank in fellow euro zone state Cyprus on Tuesday afternoon.

If Greece exits the euro, there’s no doubt that there will be a massive banking crisis in Cyprus — it’s pretty much the least safe haven conceivable for someone looking to move their money from Greece. The only reason to move money to Cyprus rather than, say, Luxembourg is that they speak Greek there, and the logistics of moving money to Cyprus are easier than the logistics of moving money to any other country.

Meanwhile, in the rest of the eurozone periphery, foreigners are already pulling their deposits from Italian banks, while the Spanish banking system is only getting increasingly precarious:

All of which is to say that the causal relationship between sovereign crises and banking crises is rather more complicated than one causing the other: in reality, they cause each other, in a vicious cycle which clearly isn’t close to being broken in any of the southern European states. Greece is further along in the cycle than Spain or Portugal or Italy, but they’re all still moving in the wrong direction.

Greece’s banks, remember, are the mechanism by which the rest of Europe will force Grexit. Banks are the circulatory system of any economy: if they stop pumping money, the country dies. And so, in extremis, Greece will need to do a complete blood transfusion, replacing all euros with drachmas, if the only alternative is to see the flow of euros dry up entirely.

In the meantime, however, expect to see deposits continue to leave Greece — and the rest of the European periphery as well. Even if your euros are reasonably safe in a big Italian bank, they’re surely safer in a big German bank. And the first thing that all depositors want is safety. Now that questions have been raised about the solvency of various southern European banking systems, it’s going to be very hard to reconstitute the eurozone in a robust fashion. The Eurozone was never designed to cope with millions of Spaniards moving their money out of the country, behaving like middle-class Venezuelans with offshore accounts in Miami. And it also was never designed to cope with capital controls. But increasingly, it looks like we’re going to end up with one or the other. Or both.

Ina Drew — the JP Morgan executive who famously “loves crises” — is out; it seems the buck for the $2 billion trading loss in her unit has stopped with her. And slowly, a few shapes are beginning to emerge from the fog of what exactly happened here.

For one thing, it’s becoming increasingly obvious that Drew got paid her eight-figure salary in return for being able to pull off a very neat trick: turning hedging operations into a profit center.

Drew’s Chief Investment Office quadrupled in size between 2006 and 2011, reaching $356 billion in total, and it’s easy to see how that happened. On the one hand, it was incredibly profitable, with the London team alone, which oversaw some $200 billion, making $5 billion of profit in 2010, more than 25% of JP Morgan’s net income for the year. At the same time JP Morgan accumulated enormous new deposits in the wake of the financial crisis, both by acquiring banks and by attracting big new clients wanting the safety of a too-big-to-fail bank. Historically, JP Morgan has served big corporations by lending them money, but nowadays, as the cash balances on corporate balance sheets get ever more enormous, the main thing these companies want from JP Morgan is a simple checking account — one where they can be sure that their money is safe.

With lots of deposits coming in, and little corporate demand for loans, it was easy for all that money to find its way to the Chief Investment Office, which could take any amount of liabilities (deposits are liabilities, for a bank) and turn them into assets generating billions of dollars in profits.

But the CIO does much more than just provide profits for JP Morgan. In contrast to the bank’s lending book, the CIO is nimble. Loans, as a rule, have to be held to maturity: that’s the essence of relationship banking. Investments, by contrast, can be sold at any time. Of course, an investment which can be sold at any time has another name: it’s a trade. Thus did the CIO become home to big traders, making huge bets and huge bonuses.

In the past couple of years, of course, that raised its own set of problems: how could this group of traders possibly be Volcker-compliant? The answer lay in Drew’s love of crises: her incredibly valuable ability to prevent losses and even make profits when the world is falling apart. In that sense, the CIO was one big hedge, and in a narrower sense the CIO was the go-to office whenever JP Morgan saw a risk which needed hedging.

Mark Dow has an intriguing thesis this morning:

We know that over the last 2-3 quarters of 2011 we were gripped by the fear of a European financial meltdown and a second recession in the US.

We know that that the Fed’s swap lines and the ECB’s LTRO reversed this market view and crushed credit spreads lower, hurting those who had been buying protection in the previous months.

Against this backdrop, it seems likely to me that the aggressive selling of protection we heard about in April 2012 was actually the unwinding of the hedge that had been accumulated in 2011 and was by then deeply underwater.

In other words, Jamie Dimon, like everybody else, was worried about a Europe-induced financial crisis at the end of 2011, and so he told Drew to put on positions which would protect against such a crisis. She did so — only this time around, the crisis never happened, and Drew’s positions had to be unwound.

That’s where things seem to have gone very, very wrong. Drew prided herself on turning every hedge into a profit center — having her cake and eating it too, basically. We’re deep in the realm of speculation, here, but it’s entirely possible that Drew positioned the CIO, at the end of 2011, to profit from a European meltdown. When that meltdown didn’t happen, simply selling those positions would involve realizing a substantial loss. And so rather than selling the positions, Drew decided to put on new, profitable positions which would offset the old hedge. Enter Bruno Iksil, the London Whale, and his enormous trade.

Iksil’s trade was fundamentally bullish, which would make sense for a trade designed to offset a fundamentally bearish hedge. Of course it wasn’t a perfect offset — there’s no such thing as a perfect hedge. Traders making multi-million-dollar bonuses don’t get paid to design perfect hedges, in any case. Iksil was being paid to put on a trade which would make money for the CIO, even as it was also hedging existing positions.

As with all imperfect hedges, however, especially when they’re big and public, the market can always move against you in exactly the way you don’t want. We don’t know the details of Iksil’s trade, but let’s say that the big underlying position was a bearish position in cash bonds, while Iksil’s trade involved a bullish position in the CDS market. In April, the cash and CDS markets stopped mirroring each other, and started behaving very oddly — you’d see bullish moves in cash bonds, combined with bearish moves in the CDS market. That combination, it seems, turned out to be the one thing that JP Morgan wasn’t hedged against, and the losses in the CIO started mounting rapidly.

How did Iksil’s trade go so horribly, massively, wrong? Partly it’s because his position was so big and so public. When hedge funds worked out what he was doing, they managed to get the word out, using stories in Bloomberg and the WSJ. And then it was just a matter of watching the market do what it always does, when it smells blood: I’m told that Boaz Weinstein’s Saba, for one, made a lot of money taking the other side of Iksil’s trade.

Taking a much bigger-picture view, however, what was really going on here was that JP Morgan had hundreds of billions of dollars in excess deposits, thanks to its too-big-to-fail status. And rather than lending out that money and boosting the economy, Jamie Dimon decided to simply play with it in financial markets, just as a hedge fund would. Here’s Bloomberg:

Dimon pushed Drew’s unit, which invests deposits the bank hasn’t loaned, to seek profit by speculating on higher-yielding assets such as credit derivatives, according to five former executives. The CEO suggested positions, a current executive said.

It’s always dangerous when a CEO suggests positions for an internal hedge fund to take, because the CEO by definition has no risk manager with enough authority to effectively constrain him. Dimon is powerful and secure enough that he’s not going to lose his job over this. But he probably should. Partly because the bank’s risk-management procedures were so weak that a $2 billion loss could suddenly appear out of nowhere. Partly because Dimon became too cocky, and started thinking that his job was to trade the bank’s billions for profit. But mainly because he’s lost sight of what JP Morgan has to be, in a post-crisis world.

Those excess deposits weren’t gifted to Dimon on a plate so that he could gamble them on the CDX NA IG 9. Rather, Dimon’s job is to take those deposits and lend them productively into the real economy. Every extra dollar in the CIO is a sign of his failure to do that. And the $2 billion loss is really just a symptom of what happens when banks get too much money, and don’t really know what to do with it all.

I’m not sure if it was the biggest quarterly loss of all time, but Merrill Lynch’s $16 billion loss in the fourth quarter of 2008 certainly ranks very high up there in the annals of investment-bank blowups. It happened after the bank had already been taken over by Bank of America, and it was in the middle of the financial crisis, so it didn’t get nearly the amount of attention it deserved. But it was not simply a case of assets plunging in value. Instead, it was, in very large part, a basis trade blowup.

The basis trade is an arbitrage, basically. There are two different ways the market measures credit risk: by looking at credit spreads — the yield on a certain issuer’s bonds, relative to the risk-free rate — or by looking at CDS spreads, which are basically the same thing but set in the derivatives market rather than the cash bond market. Most of the time, CDS spreads and cash spreads are tightly coupled. But sometimes they’re not. And at Merrill, a huge part of that $16 billion loss was reportedly due to a bad basis bet: the basis on many credits became very large and very negative during the financial crisis.

This time around, the basis-trade disaster has happened at JP Morgan, where the famous London Whale seems to have contrived to lose $2 billion on what was meant to be a hedging operation. And once again, although the details are still very murky, the culprit seems to be the CDS-cash basis.

I’ve been meaning to write a post about the CDS-cash basis for a few days now, which is why I happen to have this chart handy, showing the basis for various European banks as of Tuesday May 8.

These are very big numbers, for very big banks: UBS is at 75bp, Deutsche is at 83bp, Natixis is at 116bp, and IKB is at a whopping 392bp. And this is just the banks — other corporates have seen similar price action. The cost of protection has gone up sharply, while the cash bonds are still trading at very low spreads.

Bruno Iksil, the London Whale, had a massive long position on corporate CDS in general, and the CDX.NA.IG.9 index in particular. He was selling protection, betting that credit spreads would go down, rather than up. The position was meant to be a hedge, although it’s a bit unclear how JP Morgan could have some massive short position in corporate debt that it was hedging against. In any case, CDS spreads went up — and credit spreads, in the cash market, didn’t.

Cue a $2 billion loss.

Rarely has a position been as widely publicized as Iksil’s, and I wouldn’t be at all surprised to learn that the credits with the highest basis were precisely the credits CDX.NA.IG.9 index. Whenever a trader has a large and known position, the market is almost certain to move violently against that trader — and that seems to be exactly what happened here. On the conference call, when asked what he should have been watching more closely, Dimon said “trading losses — and newspapers”. It wasn’t a joke. Once your positions become public knowledge, the market will smell blood.

Of course, this loss only goes to show how weak the Volcker Rule is: Dimon is adamant, and probably correct, in saying that Iksil’s bets were Volcker-compliant, despite the fact that they clearly violate the spirit of the rule. Now that we’ve entered election season, Congress isn’t going to step in to tighten things up — but maybe the SEC will pay more attention to Occupy’s letter, now. JP Morgan more or less invented risk management. If they can’t do it, no bank can. And no sensible regulator can ever trust the banks to self-regulate.

David Barstow’s explosive 7,600-word investigation of corruption at Wal-Mart is required reading this weekend. I’m not going to attempt to summarize the whole thing, but basically Eduardo Castro-Wright, currently Wal-Mart’s vice-chairman, oversaw a culture of bribery when he was CEO of Walmex. And when a key player in that bribery scheme blew the whistle, Walmart in Bentonville buried the investigation, and didn’t report anything to the authorities in either Mexico or the US.

All of this looks like a slam-dunk case under Foreign Corrupt Practices Act, and I’m quite sure that multiple extremely senior heads are going to roll in the wake of this NYT exposé. As always in such cases, the crime was bad; the cover-up was worse.

One name, however, is conspicuous by its absence in Barstow’s report: Banco Wal-Mart, the huge bank which is a wholly-owned subsidiary of Walmex. It’s a serious player in the Mexican banking industry — it opened its millionth account over a year ago — and thanks to a quirk of international banking-regulation protocols, it lacks a lot of the regulation that its competitors have.

Banks like Banco Wal-Mart which are subsidiaries of foreign corporations are meant to be regulated by the bank regulators in the parent’s country. But because regulators in the US have consistently refused to allow Wal-Mart to become a bank here, bank regulators in the US don’t regulate Wal-Mart at all — let alone its Mexican subsidiary. (There is a Wal-Mart-branded prepaid debit card, but that’s run by Green Dot, not Wal-Mart.)

Barstow’s report shows that corruption is marbled throughout Walmart’s international operations, not only in Mexico but also in Asia, where reports of bribery were coming in to Bentonville HQ at the rate of five per month just from Asia alone. There’s nothing in the NYT which suggests that Banco Wal-mart was doing anything suspect at all — but at the same time, all parts of Castro-Wright’s empire should be under suspicion now, given the kind of illegal activity which peaked under his leadership. And Banco Wal-mart was one of the jewels in Castro-Wright’s crown.

All US corporations are held to high standards under the FCPA, but banks are even more important, given the way in which they’re regularly used by criminals for money laundering. After reading the NYT this weekend, I have no faith at all that Wal-mart has done an effective job of ensuring that Banco Walmart is corruption-free. And given its regulatory status, I also have no faith at all that if there were corruption at the bank, its regulators would have found it.

If I were the Mexican banking authorities, then, I’d start asking some very pointed questions indeed in the wake of this news — and I might even start thinking about revoking Banco Walmart’s license entirely. Certainly there’s no indication at all that Wal-Mart cares about stamping out corruption in Mexico — quite the opposite. And if a foreign-owned bank is operating in your country, you want to be sure that its parent is particularly assiduous in such matters.

I’ve historically supported the idea that Wal-mart should get a banking license: I think, in principle, that such a bank would provide healthy competition for existing banks, and that it would help to reduce the rolls of the unbanked. But in the wake of this news, the chances of Wal-Mart getting such a license are surely more remote than ever. And the Mexican authorities must be wondering whether US banking regulators didn’t have the right idea after all.

Google’s announcement yesterday that it was buying a company called TxVia was a bit like Barack Obama’s announcement that he was nominating Jim Yong Kim as World Bank president: it caused a very large number of journalists to say “who?” and rush to find out what on earth TxVia was. It wasn’t easy: they were likely to find a lot of meaningless jargon about “platform as a service”. And the Google post certainly wasn’t much help.

So while we know that Google bought TxVia to beef up its Google Wallet offering, it’s less clear why TxVia would help on that front. Sean Sposito had a good attempt in American Banker, saying that Google was worried about the security of Google Wallet and that TxVia has a very secure platform. That’s true. But there’s more here than just a question of security.

Go back to one of the smartest things ever written about Google, Daniel Soar’s essay It knows in the LRB. Essentially, Google is insatiable in its desire for as much information as it can possibly get. TxVia is a company which powers roughly 100 million prepaid debit cards. And here’s the thing: the amount of data that TxVia collects from every single one of its prepaid debit cards simply dwarfs the amount of data that banks collect with normal debit cards linked directly to a bank account.

I learned this yesterday over the course of a fascinating conversation with Josh Reich and Shamir Karkal of Simple. When you open an account with Simple (if you open an account with Simple — there’s a monster waiting list, and right now it’s only working for people with iPhones, and it’s still pretty much in friends-and-family mode for the time being), the main thing you get is the Simple Visa card. And the Simple Visa card, it turns out, is actually a prepaid card built on TxVia.

Now you get a bank account too, with your name on it, insured up to $250,000 by the FDIC. Prepaid cards are clever things, but they can’t fully replace a bank account. But what they can do is provide Simple with vastly more information about transactions than any normal debit card.

The reason is basically just one of historical accident: when banks first introduced debit cards, they didn’t need any information beyond just the name of the merchant and the amount being debited, so they ignored and discarded everything else. More recently, when TxVia introduced a prepaid-card platform, data storage and manipulation was much cheaper, so they kept all the data they could find instead of throwing it away.

And more generally, prepaid-card operators think in real time, about money coming in and going out over the course of the day. Whereas banks, to this day, still batch-process most of their transactions: they accumulate a pile of them, and then put them all through at the end of the day. That transaction-oriented mindset makes gathering rich data — even really basic stuff like the zip code of the merchant — something no bank is set up to do.

At Simple, they’re taking the steps which have already been made by TxVia with its prepaid operators, and adding lots of custom special sauce on top, mostly around the mobile-banking functionality in their iPhone and Android apps. What’s more, the Simple card is in an important sense not a prepaid card: your account balance always remains in the bank, rather than on the card, and the card itself always has a zero balance. In that respect, it’s a bit like an old-fashioned American Express charge card, which gets paid off daily rather than monthly. And because all Simple customers will have gone through the process of opening a bank account, which is a lot more laborious than simply buying a prepaid debit card, Simple knows those customers well and can allow them to spend much more money on their cards than most prepaid cards allow.

What I’m not clear on is how much of the information about my Simple transactions will now be available to Google, if only in some kind of aggregated and anonymized form. It’s possible that if I somehow link my Simple account to my Google account — or if, as is certainly possible, Google ends up buying Simple — then Google will have access to a very great deal of my very private financial information. That could allow it to provide me with incredibly well personalized services — and would almost certainly cause a firestorm from privacy advocates at the same time.

But for the time being, I want my bank to know lots of information about me, because that enables the sophisticated and data-rich applications that Simple is rolling out. The difference between private banking and the service that the rest of us get is, at heart, simply personalization. If Simple, TxVia, and Google can provide that kind of personalization on a mass scale, that’s surely something to welcome.

Maybe it’s a function of the Durbin act, which explicitly excluded prepaid debit cards from the massive decrease in debit interchange fees that it imposed on all other debit cards. But whatever the reason, prepaid debit cards are huge right now. One panel at today’s conference — a panel which wasn’t even meant to be about prepaid debit, but rather much more broadly about “Ensuring Consumer Access to the Payments System in the Connected Age” — had four people sitting next to each other, three of whom talked with great excitement about their prepaid debit cards.

One of them, Green Dot, was understandable — prepaid is what Green Dot does. The second, US Bank, was more interesting. Banks tend not to go in for prepaid debit cards very much: they’re not as profitable as checking accounts, and they’re worried about cannibalization. But US Bank’s Convenient Cash card is a notable development in the world of prepaid debit cards, because it’s very easy, if you’re near a US Bank branch, to reload the card for free.

Nearly all prepaid debit cards allow people to top it up using direct deposit — but of course we all end up with money from various different sources, not just the place which sends us a regular paycheck. And if you want to put some cash onto, say, Suze Orman’s Approved Card, then that’ll cost you upwards of $3.50 a pop. (And that’s a charge, by the way, which doesn’t appear anywhere on the card’s official list of fees.)

If you’re looking to get a prepaid debit card as a checking-account replacement, then, and you regularly deposit money into your checking account, then the US Bank offering is particularly attractive. The monthly fees for prepaid debit cards are usually very obvious; the amount you’re likely to end up spending just by reloading it, by contrast, is less clear ex ante.

So it’s encouraging to me that US Bank is offering a product where you can just walk into any branch and reload your card for free, just as you could your checking account. This, it seems to me, is a significant competitive advantage — so it’s weird that the feature isn’t mentioned anywhere, as far as I can tell, on the card’s website. As a result, I don’t know whether you need to go to a teller during bank opening hours to take advantage of this feature, or whether you can use any US Bank ATM which accepts deposits 24 hours a day. In any case, I’m quite sure that other banks are going to follow suit and issue other free-to-reload cards, which should in turn add some healthy competition to the space.

Most exciting of all, however, was the revelation that the US Treasury has been quietly running a pilot program where it issues tax refunds in the form of a reloadable prepaid debit card. It’s called My Account Card, and is a great step forwards in comparison to the non-reloadable cards used for things like benefits payments. Treasury has tried My Account Card in various permutations, and it’s clear that the one with no monthly fee is the most popular. What’s more, you can elect to get not only your tax refund but also your benefits payments on the same card — which means there’s no need at all for any other card.

If Treasury starts sending tax refunds and benefits payments straight to prepaid debit cards around the country, that will be a huge boost to the reputation of an industry which is still often dismissed as the kiddy slopes of banking.

And then, at some point, Simple will start sending its cards out en masse — and the world will see just how powerful and fully-featured such things can really be. Simple’s sales pitch is aligned with that of prepaid debit cards: no surprising fees, lots of predictability. And it’s aimed at a decidedly affluent demographic: you’re not even allowed to join if you don’t have an iPhone or Android phone. The web interface is state-of-the-art, and the card will allow you to do things that other prepaid debit cards don’t even dream of, like peer-to-peer payments and international wire transfers.

You won’t find the word “prepaid” anywhere on Simple’s website: the company is positioning the card as a fully-featured bank account, not as a gussied-up prepaid debit card. But increasingly it’s a distinction without a difference. I just wonder how much those cash reloads deposits are going to cost.

Sheila Bair has put her finger on the fundamental weakness of this week’s stress tests with a single statement:

“No distribution should have been approved that would bring the leverage ratio below 4 percent,” Bair, the former chairman of the Federal Deposit Insurance Corp., said yesterday in an interview. “With leverage of 25-to-1, during a crisis, these banks would likely suffer a run.”

Essentially, the stress tests model what might happen to bank balance sheets in the event of a major crisis — one which includes a peak unemployment rate of 13 percent, a 50 percent drop in equity prices, and a 21 percent decline in housing prices. The Fed wanted to make sure that all big banks would still have a capital base of at least 5% of their assets in that scenario, which is why it barred Citigroup from returning capital to shareholders. Citi comes out at 5.9% “assuming no capital actions after Q1 2012″, but that number drops to 4.9% “with all proposed capital actions through Q4 2013″.

But capital levels are only half of the equation; the other half is leverage. And look at the Tier 1 leverage ratio for the different banks under the stressed scenario, on page 27 of the PDF. Citigroup plunges from 7.0% now to just 2.9% after the stress, while Bank of America is much more robust, dropping from 7.1% to 5.3%. And here’s the scary thing: of all the big banks, it’s the ones with investment banking arms which fare the worst. There are 19 different banks listed; seven of them end up with a leverage ratio under 5% in a stressed scenario. Citi’s one; the others include Goldman Sachs (4.5%), Morgan Stanley (4.5%) and JP Morgan Chase (4.0%), its “fortress balance sheet” notwithstanding.

Now, picture yourself in the kind of crisis where stocks are down 50% and unemployment is up to 13%. And imagine that you discover that the counterparty you use for all your financial transactions is levered 25-to-1. You will change your counterparty. That’s known as a run on the bank, and it’s fatal.

In other words, banks don’t need to just survive the stress test; they need to be able to keep their customers in a stressed situation as well. If a bank comes near to insolvency, it will go bust, as its customers rush for the exits.

As Bair says, bank counterparties don’t look at sophisticated risk-based metrics in a crisis: they look at headline numbers like the leverage ratio.

“This underscores another weakness of the tests: They didn’t really stress liquidity,” said Bair, now a senior adviser at Pew Charitable Trusts, a Washington-based nonprofit. “The investment banks are particularly vulnerable to liquidity failures because they don’t have a large, core deposit base.”

Investment-bank counterparties can flee in a matter of hours; old-fashioned deposit runs tend to take a lot longer. Which means that investment banks should be held to a higher standard than commercial banks when it comes to the stress tests. Instead, they just need to show a liquidity ratio of more than 3%. That number’s too low.

Frank Partnoy makes a great point: the word “client” has been over-used by investment banks so much that by this point it “has become Orwellian doublespeak”. But the problem is much deeper than one of semantics. When all counterparties are considered clients, then that creates a corporate culture where all clients are considered little more than counterparties. And that, in turn, can be evil and poisonous.

Partnoy says that “the firm’s salespeople know who is a client and who is a mere a counterparty”, and to a certain degree he’s right. A sovereign wealth fund dealing with the equity derivatives desk is a counterparty; a private individual whose money is being managed by Goldman Sachs Asset Management is a genuine client. If you’re paying Goldman fees, you’re quite unlikely to be called a “muppet”, and no one in the firm is going to try to “rip your eyes out”.

But that doesn’t mean that Goldman will always be acting in your own best interest, rather than its own. Stockbrokers, famously, receive substantial fees from their clients, but don’t have a legal fiduciary duty to those clients, and do have a demonstrated tendency to steer their clients into the investments which end up paying them the highest commissions.

And even companies paying for M&A advice are sometimes victims of Goldman’s conflicts.

In other words, no one can complacently assume that they’re a favored client of Goldman Sachs and that therefore Goldman will be ripping off others on their behalf, rather than ripping off its own client. Not even people writing large checks to Goldman every quarter.

I’ve been talking to bankers in the days since Greg Smith’s op-ed came out, and there’s a pretty much unanimous feeling that bankers’ loyalty to clients, at least at Goldman and other big investment banks, has been declining across all aspects of the business, for many years.

Greg Smith was in equity derivatives — an area where it’s incredibly easy for salespeople to hide fees if they’re inclined to do so. In fact, it’s so much easier for a bank to build its fee into the pricing of complex bespoke products than it is to charge that fee directly, all banks do exactly that. It’s like buying “commission-free” currency when you go on holiday: you know full well that the bureau de change is still making money; it’s just making that money by giving you a bad price for your dollars, rather than by charging you a high commission.

But in a business devoted to making ever-increasing sums of money, it’s very easy for those hidden fees to get bigger and bigger over time. I talked to one former equity derivatives executive a couple of days ago, who said with surprising vehemence that in his day, the big clients were God: you built in fees, yes, but you never ripped them off or tried to steer them into something which was not in their best interest. Now of course what he was saying was self-serving, but I think it had an element of truth to it, too.

There’s been a lot of talk in the past couple of days about how Smith was not much of a star at Goldman: he was the sole person trading US equity derivatives in London, which is always going to be a marginal job at best, and he hadn’t risen very far up the greasy pole given how long he worked at the firm. Certainly it’s a bit of a stretch to call him an “executive” at Goldman, as that term is generally understood: he didn’t even have any employees. But at the same time, his relatively lowly position in the company is entirely consistent with a tale of a smart but ethical professional who didn’t make as much money for the firm as his peers did, just because he didn’t rip off his clients to the degree that they did.

All of which is to say that it’s worth taking Floyd Norris’s concerns seriously about the latest spate of deregulation in the securities markets. I think that there’s a lot to like in the JOBS act, especially the idea that we should stop forcing companies to go public just because they have 500 shareholders, including employees. Companies should be encouraged to give out equity to their employees, without worrying that if they do so, they’re on some kind of IPO train which can’t be derailed.

At the same time, however, there’s a lot of deregulation in the JOBS act which seems aimed primarily at giving banks a greater opportunity to make money, largely at the expense of investors in the primary markets. Mary Schapiro has some strong and important points: the primary markets are rife with information asymmetries, and someone needs to protect the interests of investors, rather than allowing banks to rip them off with legislated impunity.

All big banks are public companies. Public companies are always under a lot of pressure, from their own shareholders, to grow. But as a country, we have a public interest in seeing those banks shrink. The tension is clear. And if regulators try to get banks to shrink, the banks in turn are going to make even greater efforts to extract the highest profits possible from the businesses they retain. Which is another way of saying that they’re going to rip off their clients even more. So let’s be assiduous when it comes to regulation, because neither banks nor their boards are going to lift a finger to protect client interests. Not when they’re trying to maintain and maximize their own profitability.

James Saft has a very smart take on Greg Smith today:

Goldman was able to make long-term greedy work because, in the view of those working there at the time, that was the best kind of greedy they could get their hands on. Burning clients wasn’t so much wrong as stupid…

Careers in banking are wasting assets; someone will only get so many bites at the apple, and is far less likely to be at the same firm than they were in Gus Levy’s time. The industry too, it is important to understand, is also a wasting asset; it is shrinking and may well shrink substantially from here. Ironically, that may well mean it is even more rational for bankers to burn clients.

It’s notable that Smith’s lament appeared as Citigroup’s Vikram Pandit scrambled to get back onto his feet after his plan to return capital to shareholders was knocked down by shareholders.

Pandit wants to return capital to shareholders because they clearly value that capital much more highly in their own hands than they do in his. Each of my dollars is worth $1. Each of Citigroup’s dollars, by contrast, is worth just 58 cents: that’s the price-to-book ratio that Citi’s trading at right now.

As a general rule, when banks are worth much more than their book value, long-term greedy makes a fair amount of sense: each dollar you make for the company becomes worth much more than that when looked at through the lens of the present value of the franchise value that dollar represents. When banks are trading at a substantial discount to book value, on the other hand, it makes just as much sense for employees to extract as much money from them as they can, as quickly as possible. And shareholders too, for that matter. That’s why Vikram wanted to give them their money back.

This mindset is indicative of a broken system, as Anat Admati explains:

If a strong bank retains its earnings and invests prudently, shareholders are still entitled to the profits from these investments, as long as debts are paid. Many successful companies do not pay dividends for extended periods of time, and their stock prices reflect their good investments. When banks distribute profits to shareholders and continue to borrow, they create more risk. This pollutes the interconnected financial system by increasing its fragility. If banks do not want to invest the profits, they can use them to pay down some of their debts.

What this says to me is that the entire banking system, from Citi to Goldman (which itself is trading at just 0.92 times book value), is locked into a vicious cycle of short-term greed, where everybody from traders to shareholders is trying to get their money out as quickly as possible, and regulators are fighting a rear-guard action trying to prevent them from doing so. It’s fundamentally dysfunctional and adversarial, with bankers pitted against both regulators and their own clients. And yet at least at the biggest banks, like Citi and Goldman, it might ultimately help to shrink them down to less dangerous size.

What regulators should be doing, I think, is encouraging the likes of Citi to give back capital to shareholders — just so long as the bank’s capital ratios go up at the same time. In a word, deleveraging. The lesson of the 2008 bailouts is very much that no matter how much capital you inject into banks, they won’t lend it out in the real economy. So let’s allow that capital to leave the banks, return to shareholders, and get invested in the economy some other way. Just so long as when that happens, the big banks shrink commensurately.

It’s that time of year — think February to March — when bonus checks have cleared and voluntary departures from investment banks spike. So it’s obvious why Greg Smith quit now. The question is, why decide to quit in as public and destructive a manner as possible?

When Smith joined, Goldman was transitioning from a partnership model to being publicly-traded. And I suppose it’s possible that Smith has such deep nostalgia for the partnership he never really knew that he’s willing to hurt his entire current team — everybody who helped him make his millions — in an attempt to goad Goldman into returning to those halcyon days.

But it certainly doesn’t seem that way. Smith says that Goldman is currently “toxic and destructive”. He goes on to say that “It makes me ill how callously people talk about ripping their clients off,” and that “the morally bankrupt people” need to be weeded out — how, he doesn’t say — by the board of directors. It’s much easier to see the disgruntled ex-employee here, quitting in a huff, than it is to see someone genuinely trying to do his part to reconstitute the Goldman Sachs of Gus Levy and John Whitehead.

To a certain extent, time will tell. If Smith ends up founding or joining a rival company, his decision to harm Goldman as deeply as possible will end up looking rather self-serving. On the other hand, if he goes to, say, join his former colleague Gary Gensler at the CFTC, working to regulate all investment banks from the outside and to try to level the playing field between the buy-side and the sell-side as much as possible, then we might start taking him a bit more seriously. Smith has declared a serious moral purpose today; that’s not something you can wear for just one news cycle before moving on to the next thing, and so I hope and trust that he’s going to spend the proceeds of his ill-gotten final bonus check in the service of that moral purpose. After all, it was the work of those morally bankrupt traders in the ripping-eyeballs-out business which got him all that money in the first place.

Which is not to say that Smith doesn’t make important points. He’s in the equity-derivatives business, which is also where Andrew Clavell came from. Clavell’s blog is down, now, but these words are immortal:

If you claim you do know where the fees are, banks want you as a customer. You don’t know. Really, you don’t. Hang on, I hear you shouting that you’re actually smarter than that, so you do know. Read carefully: Listen. Buster. You. Don’t. Know.

Smith’s clients thought they knew where Goldman was making its money when it sold them equity derivatives. Nine times out of ten, they were wrong. I can guarantee you that every single one of the clients referred to as “muppets” within Goldman considers themselves to be a sophisticated investor. Mainly because they have Goldman employees phoning them up on a regular basis and flattering them with tales of how sophisticated they are.

Clients know in principle that every time they do a trade with Goldman, Goldman makes money. But they don’t know how much money Goldman makes on those trades. And Goldman is extremely good at structuring deals which can’t easily be replicated by combining various liquid derivatives. In turn, that gives Goldman pricing power — so much power, indeed, that in some instances the bank will go so far as to insist that if the client attempts to get independent pricing for the contract in question, then the whole deal is off.

Smith has been in this business for 12 years, and he’s done extremely well by it. And to a certain extent, if the people who work for him are constantly asking how good a deal is for Goldman, rather than how good the deal is for Goldman’s clients, then that’s because of the example he set. What’s missing in his op-ed is any sense of mea culpa, any sense that he was at all part of the problem.

There’s a strong smell of faux-naive coming from Smith’s op-ed. “Leadership used to be about ideas, setting an example and doing the right thing,” he writes. “Today, if you make enough money for the firm (and are not currently an ax murderer) you will be promoted into a position of influence.” Here’s a question for him: back when he made videos for Goldman urging candidates to join the company, were the people who got promoted those who had ideas and did the right thing? Or were they the ones who made lots of money for the firm? To ask the question is to answer it.

So let’s not pretend to be shocked that the most successful bankers are the ones who make the most money off their clients. And let’s not try to imply that the solution to this problem lies at the Goldman Sachs board level. It doesn’t. The real muppets, in this story, are Goldman’s board members, who have never had any real control over how the company is run. And, frankly, never will. The most remunerative skill, at Goldman, is the ability to flatter someone into believing that they’re incredibly important and clever and sophisticated, even as you’re getting that person to do exactly what’s in your own best interest. No one rises to lead Goldman Sachs who doesn’t have that skill. And you can be sure that Lloyd Blankfein uses it on the board every time he meets with them.

Why would clients like El Paso ever hire Goldman Sachs if Goldman Sachs is always working in its own best interest rather than that of the clients? My hypothesis, yesterday, was some kind of mysterious Goldman magic. Which, admittedly, is not particularly falsifiable or compelling. So many thanks to a loyal reader, who doesn’t want to be named, for giving me some very good reasons why clients hire conflicted investment banks, especially in the M&A field. It turns out that there are good reasons why “the most conflicted bankers are often the most sought after by clients”. Take it away, loyal reader:

A few points from your post on Goldman today.

You and many other commentators seem to have some misconceptions about what exactly large, sophisticated clients such as El Paso’s board hire investment bankers to do.

Its always funny how, in the minds of pundits everywhere, those conniving and all-powerful one-percenters who sit on corporate boards become impotent and completely incapable of independent decision-making once an investment banker walks into the room.

El Paso’s directors were well aware that Goldman was conflicted and in fact displayed a healthy skepticism of Goldman’s impartiality by its decision to “exclude Goldman from tactical discussions about how to respond to Kinder Morgan from September 15, 2011 onwards”.

At the end of the day the board, not Goldman or any other advisor, made the decision of how to proceed at each major step in the process and while Goldman may have been consulted on some of these decisions (along with MS and probably 2 or more sophisticated law firms), the sophisticated directors of El Paso’s board knew full well that the decision was their’s to make and that Goldman’s advice should be taken with a grain (or block) of salt.

So contrary to your claims I would posit that Goldman’s clients do not in fact trust Goldman to provide “impartial advice in their own best interest” and that Goldman’s ability to “snow clients and get them to do whatever Goldman wants” is highly overrated (and likely non-existent).

So why do clients hire potentially conflicted investment bankers?

The tempting answer – and the one implied by your final paragraph – is that Goldman’s clients are all irrational idiots getting unwittingly screwed by a giant squid. However, it’s important to remember that pretty much every PE fund out there hires Goldman or one of its competitors to perform either buy-side (sometimes) or sell-side (nearly always) advisory work on all of their transactions. Surely, the masters of the universe running multi-billion dollar PE funds aren’t getting “snowed” by their comparatively poorer and less-well-regarded friends working on the sell-side.

When sophisticated clients (management teams, company boards, PE funds, etc) hire M&A bankers, they typically hire them for two main reasons (in addition to the legally required shams referred to as “fairness opinions”): Execution and Connections.

The execution part is obvious – M&A processes require a lot of (sometimes specialized) work that most companies are not well-staffed for since these events come around relatively rarely. While execution work represents the bulk of the person-hours devoted to a deal, the work is simple enough that if execution work were the primary value-add provided by bankers you would see much lower fees since the work itself is fairly commoditizable.

It’s the connections that bring in the big bucks for bankers. From making sure that the book lands on the desk of a potential buyer’s CEO rather than a lowly corp dev intern to massaging egos on both sides after a particularly harsh negotiation call, the value the banker provides is his/her ability to act as a conduit between the seller and potential buyers. This obviously means that the most sought-after bankers are those with the best connections to (and deepest relationships with) potential buyers. Since it’s basically impossible for a banker to develop strong relationships with a buyer without having some sort of conflict (say having formerly worked for potential buyer in a previous engagement), we shouldn’t be at all surprised that the most conflicted bankers are often the most sought after by clients.

A few personal examples:

• Back in my private equity days our firm was looking to sell a smaller company to one of a handful of larger potential strategic buyers. Our criteria for selecting a banker basically came down to two metrics: (a) how many times had that banker worked for any of the buyers and (b) how many times had the banker sold a company to one of the buyers. We weren’t looking for impartiality and “strategic advice”, we were looking for connections and relationships – “conflicts”, you might say. It’s the job of the principal (whether a PE fund or a company’s board) to make all of the hard decisions of when to sell and for how much. The advisor is simply paid labor to help throughout the process.
• Back in my days as an M&A banker, we had just wrapped up the sale of a mid-sized company (“Company A”) to a private equity firm when a larger firm (“Company B”) that owned a non-core subsidiary that was one of Company A’s direct competitors called us up because it wanted to sell the non-core subsidiary. The CEO of Company B hired us without the traditional “bake-off” process in part because the CEO of Company A (whom Company B’s CEO was friendly with after meeting at various industry events) had been impressed with our work. More importantly, though, CEO B knew that the PE fund that had recently purchased Company A was executing a roll-up strategy in the industry and was one of the most likely buyers of his subsidiary. At this point it’s worth mentioning that our firm’s relationship with the PE fund involved extended far beyond having recently sold Company A to them. The PE fund was one of our firm’s top relationships, and we regularly both sold companies to this PE firm and sold this PE firm’s portfolio companies to other buyers when they were ready to exit. Further, several of our firm’s MD’s, including the lead banker on the deals in question here, were LP’s in several of the PE firm’s funds, including the current fund that had bought Company A and would look to buy the subsidiary of Company B. Both CEO A and CEO B knew of our deep relationships with the PE firm before they hired us. Point being, if CEO B had tried to find a more conflicted banker to sell his subsidiary, he couldn’t have found one (and if he could have he would have hired them instead). He hired us on the spot because he knew all of our “conflicts” meant that we had the best relationships – and that’s exactly what he was buying.

It’s a well known principle of economics and game theory that “repeated game” negotiations lead to more efficient outcomes for both parties than one-off negotiations because of the reciprocity and trust built through repeated games. What clients are buying from bankers is access to this type of trust that can only be gained through repeated transactions between parties. Viewed in isolation, any one instance of “reciprocity” may look like an instance of conflicting interests – and in many cases, it might very well be. But the sophisticated clients of Goldman and other banks know that it’s exactly this reciprocity that they are buying – after all they could have easily hired the lower-priced and conflict-free banker who didn’t have any relevant tombstones in the back of his pitch deck.

Looked at from this view, it shouldn’t be at all surprising that sophisticated clients keep paying the a premium Goldman’s “strategic advisory services” when Goldman has a reputation for being the most conflicted bank on the street. These clients aren’t hiring Goldman despite its many conflicts of interest. They are hiring Goldman specifically because of these numerous conflicts and the numerous deep relationships they represent.

None of this is to excuse the Goldman MD for not revealing his holdings in Kinder or to say that Goldman is always above board with all of its clients. Nor is it to pretend that there aren’t often principal-agent issues between boards, management teams, advisors and shareholders, especially in large public companies.

But we should at least acknowledge that conflicts of interest are a core piece of an M&A banker’s value proposition to its clients and that almost all of these clients are extremely sophisticated individuals who know exactly what they’re paying for.

Update: Matt Levine has a great response.

Andrew Ross Sorkin weighs in today on Goldman’s conflicts in the takeover of El Paso Corporation by Kinder Morgan, as laid bare in a blistering opinion by Delaware Chancellor Leo Strine. Steven Davidoff has described the decision as demonstrating that “Chancellor Strine is a bold judge, one who is brilliant and willing to make waves” — and so it’s worth extracting some of the more Rakoffian bits of Strine prose.

While Sorkin leads his column with the script that Goldman CEO Lloyd Blankfein was given when he called El Paso CEO Doug Foshee, for instance, he omits the gloss that Strine provides on that script:

Certain Chancery staff have experienced a troubling side effect to reading this evidence: Lionel Richie’s 1980’s treacle, “Hello,” came to mind and is stuck in their heads. See LIONEL RICHIE, Hello, on CAN’T SLOW DOWN (Motown Records 1983) (“Hello!/Is it me you’re looking for?/I can see it in your eyes/I can see it in your smile/You’re all I’ve ever wanted/And my arms are open wide …./And I want to tell you so much I love you ….”).

Similarly, while Foshee officially says that he has “acted at all times in a manner consistent with our values of stewardship and integrity, and always conducted myself in the best interests of El Paso, its employees, and its shareholders”, that has to be read in the context of the way in which Strine utterly skewered him:

At a time when Foshee’s and the Board’s duty was to squeeze the last drop of the lemon out for El Paso’s stockholders, Foshee had a motive to keep juice in the lemon that he could use to make a financial Collins for himself and his fellow managers interested in pursuing an MBO of the E&P business. The defendants defend this by calling Foshee’s actions and motivations immaterial and frivolous.

It may turn out after trial that Foshee is the type of person who entertains and then dismisses multi-billion dollar transactions at whim. Perhaps his interest in an MBO was really more of a passing fancy, a casual thought that he could have mentioned to Kinder over canapés and forgotten about the next day.

It could be.

Strine saves his most acid commentary for Goldman.

The defendants begrudgingly concede that El Paso’s long- standing financial advisor, Goldman, had a “potential conflict” because: (1) it owned approximately 19%, or $4 billion worth, of Kinder Morgan stock; (2) it controlled two of Kinder Morgan’s board seats; (3) it had placed two senior Goldman principals on the Kinder Morgan board who thus owed Kinder Morgan fiduciary duties; and (4) the lead Goldman banker working for El Paso, Steve Daniel, personally owned approximately $340,000 of Kinder Morgan stock.

The phrase “potential conflict” is footnoted; Strine notes drily that “Goldman’s answering brief used the phrase ‘potential conflict’ to describe its position fifteen times.” In fact, as Strine says, this wasn’t a potential conflict at all: instead, the conflict was “actual and potent”.

Goldman’s position — beautifully demolished by Strine — is that it had Chinese walls in place, and that its M&A team was blissfully ignorant of the enormous stake that Goldman had in Kinder Morgan getting El Paso on the cheap. (Never mind the fact that Goldman’s M&A team was led by someone who personally had a $340,000 stake in Kinder. As Foshee himself put it, that’s a conflict “between one person’s brain”.)

But here’s the thing: as Francesco Guerrera points out, if Goldman’s only interest here was getting a nice check for its M&A team, there was an easy and non-conflicted way for them to do that.

This unruly mess wouldn’t have happened had Goldman resigned from El Paso right after the Kinder Morgan approach. Goldman would have probably been hired by Kinder Morgan, earned similar fees and avoided uncomfortable questions about divided loyalties.

Which definitely makes it seem as though the only reason for Goldman to stay on as an El Paso adviser was to ensure that El Paso and Forshee sold themselves for a modest sum to Goldman and its fellow owners of Kinder.

Guerrera adds that “what Goldman did isn’t illegal, just inappropriate in an age in which Wall Street’s morals and behavior are under the public microscope”. But Strine actually goes further than that — he says quite clearly that “the plaintiffs have a reasonable probability of success on a claim that the Merger is tainted by breaches of fiduciary duty”. And Davidoff notes that “Goldman Sachs’s engagement letter with El Paso probably limits its liabilities to no more than $20 million”. It’s entirely possible that Goldman’s actions in this case were both inappropriate and actionable; what’s more, Goldman will probably end up settling the case at some point, for a multi-million-dollar sum.

All of this comes as Nick Dunbar of Bloomberg reports on the numbers involved in Goldman’s shenanigans in Greece.

On the day the 2001 deal was struck, the government owed the bank about 600 million euros ($793 million) more than the 2.8 billion euros it borrowed, said Spyros Papanicolaou, who took over the country’s debt-management agency in 2005. By then, the price of the transaction, a derivative that disguised the loan and that Goldman Sachs persuaded Greece not to test with competitors, had almost doubled to 5.1 billion euros, he said.

The question at this point is surely why any client would ever trust Goldman on anything. Goldman seems to have a habit, here: it recommends a certain course of action, involving a deal which the client is barred from testing in the market. (El Paso wasn’t allowed to shop itself to anybody other than Kinder; Greece wasn’t allowed to check the market price of the swaps which Goldman was selling it, because Goldman said that if Greece did that, the whole deal would be off.)

This is surely the most magical and mysterious aspect of Goldman Sachs: that despite mountains of evidence that its actions are always orchestrated to result in the best possible outcome for Goldman Sachs, its clients still seem to trust it to give excellent and impartial advice in their own best interest. Maybe that’s the key skill that Goldman investment bankers are hired for. Not analytical or strategic expertise, but rather the ability to snow clients and get them to do whatever Goldman wants.