The Great Debate

The credit rating agency, Standard & Poors, announced Monday that it was the target of a civil lawsuit by the Justice Department for its actions in rating the complex securities that played a major role in the 2008-2009 financial collapse.  The company also said that it had not been apprised of the details.  It is interesting that the other two major rating agencies, Moody’s and Fitch made no announcements.

There is much that all the agencies should worry about.  What is publicly known — and it is a great deal — was laid out in the two-year Senate investigation led by Senator Carl Levin (D-Mich.), which ended with the release of a final report in spring, 2011.

The committee staff laid out a formidable case. As early as 2004 and 2005, and increasingly by 2006, the email chatter among the rating agency staffs suggested they were expecting a crisis.  One email said: “This is frightening. It wreaks of greed, unregulated brokers and ‘not so prudent’ lenders.” Staff analysts asked why the regulatory agencies hadn’t “come down harder on these guys.”  One wrote worriedly about the possibility of “another banking crisis.”

One damning sequence occurred in spring, 2007.  Early that year, it became clear that the subprime mortgage market was in serious trouble. Two major subprime issuers failed in December 2006, and in the first quarter of the new year, another 20 failed, including the giant New Century. This was also the period, as we now know, that Goldman Sachs embarked on an aggressive internal clearing of its inventory, or “The Big Short” as it was called, which was largely accomplished by selling to greater fools.

But for the most part, Wall Street and the credit agencies shrugged off the worries and carried on with business as usual. The agencies issued triple-A ratings even on booby traps like the security that Goldman devised for the hedge fund manager John Paulson, so he would have a $1 billion plus security that he could bet against with confidence in its shakiness.

Londoners are greeting the Olympics with all the enthusiasm of a child awaiting a root canal. The government has warned those unable to book coinciding holidays not to travel anywhere beyond walking distance of home as Communist-style “Olympic lanes” whisk dignitaries past the interminable traffic the Games cause. During the Olympics, London will be run under a curious kind of corporate martial law. Thousands of troops will handle security to make up for private contractor G4S’s staffing “shambles”; missiles have been placed atop public housing; an Orwellian “brand police” is sweeping the city to ensure no businesses other than 11 official sponsors use words like “gold,” “silver,” “bronze” and even “London.”

Putting up with this misery is supposedly justified by the commercial windfall, tourist bonanza and enhanced prestige the Olympics create. One Tube station poster depicts a man who, having identified alternative transport routes, is jauntily reading a newspaper as he whizzes past an escalator logjammed with athletes: The headline is “London 2012 Games a huge success, save British economy.”

But as Wednesday’s woeful economic data confirmed Britain’s slide into a double-dip recession, it’s worth questioning whether hosting the Olympics is worth the $14.5 billion cost. In strict financial terms none ever actually make money. Some host cities have turned profits since Los Angeles was the first to do so in 1984, escaping the crippling public debt incurred by cities like Montreal and Vancouver. But, as a recent report by Goldman Sachs points out, “most countries … have treated the cost of constructing facilities and infrastructure, together with security and other ancillary costs, as being separate from the cost of running the Games themselves.”

Goldman Sachs can’t seem to stay out of the wrong spotlight these days. With reports about executive layoffs and high numbers of senior people leaving, Goldman is losing its once-untouchable luster as analysts scrutinize its performance through a new lens.

The oceanic rift between average Wall Street salaries and those of everybody else has been measured by both public and private facilities. The New York State Comptroller’s office released a report last October showing that while total profits at Wall Street’s major brokerage houses declined during the first half of 2011, employee compensation, which accounts for about 60 percent of expenses for the firms, increased by 18.7 percent compared with the same period the year before.

The report showed the average salary in the securities industry was $361,330 in 2010. The national average wage that year was $45,230, according to the Bureau of Labor Statistics. A big difference was that while many suffered unemployment and pay freezes during the recessionary years, finance firms rewarded employees with raises. According to a survey by eFinancialCareers.com that polled 2,860 financial professionals, 54 percent were offered higher salaries in 2011.

The average Goldman Sachs employee earns in excess of $350,000 per year, and we’re assured Greg Smith, who most visibly quit his job there last week, was paid substantially more.

And, in leaving his long-time employer, Smith didn’t abandon just a fat salary. To regain his career freedom, he knowingly forfeited a considerable sum in deferred compensation as well.

Most people in the world, of course, can only dream of being so highly paid for their work, so it’s a good assumption that a very large percentage of the working population has summarily judged Smith’s resignation as an act of complete insanity.

Greg Smith doesn’t have any new criticism of Goldman Sachs in his New York Times op-ed today. Nor are his points as detailed and documented as the SEC’s allegations in the ABACUS case.

Instead, Smith is selling a warm, self-congratulatory glow to anyone who thinks that Wall Street used to be great. In some halcyon era, according to this view, Wall Street’s success was great news for employees, for customers and of course for the economy as a whole. And it was great because it was built of great things: “teamwork, integrity, a spirit of humility, and always doing right by our clients … It wasn’t just about making money.”

In Smith’s moralistic telling, Goldman’s success was the result of its culture. And as TED has pointed out, that’s a vision of its business that has been sold for a long time, at least since the days of Sidney Weinberg.

1. Crash Winners

Here’s a new entry for the lists of winners and losers that get published this time of year: The ten lawyers, bankers, consultants or accountants who reaped the most from the financial disaster of the last three years.

The poster-boy would likely be Irving Picard, a partner at the Cleveland-based international law firm of Baker & Hostetler. Picard is the court-appointed trustee responsible for recovering money for Bernie Madoff’s victims. From the sketchy clips I’ve seen, it appears that Picard and his firm have already received more than $200 million in fees for their work from the court overseeing the cases. Is that true?

Then there are the lawyers involved in bringing and defending all those multi-hundred million-dollar and billion-dollar claims against the banks that packaged and re-sold troubled mortgages and other securities. Or the accountants, lawyers and bankers sorting out the assets and liabilities in the wake of the Lehman Brothers bankruptcy and and other implosions.

By Katrina Pugh
The opinions expressed are her own.

In the jitteriness over the stock market’s worst quarter in two years, a racing volatility index, and protests spreading across the nation’s major cities, all bank leadership (and perhaps all corporate leadership) needs to ask a fundamentally new question: “What blindspots are dogging us?”  This hardly seems like a radical question. After all, most arbitrators make their money off of other people’s blindspots by seeing around corners where others can’t.

But often, leaders are unaware of blindspots in their own organizations.  And they are unaware that they are unaware.

At UBS, blindspots led to $2.3 billion in undetected rogue trading losses, and the ouster of CEO Oswald Gruebel. Analysts have widely criticized UBS’s lax accountability, and oblique, easily-gamed bank systems.  Corporate insider Sergio Ermotti brings a strong track record to UBS’s post of interim CEO. Entering this maelstrom, however, will put his leadership to the test.

Could the dreaded R word come back to haunt the developing world? A study by Goldman Sachs shows how differently financial markets and surveys are assessing the possibility of a recession in emerging markets.
One part of the Goldman study comprising survey-based leading indicators saw the probability of recession as very low across central and eastern Europe, Middle East and Africa. These give a picture of where each economy currently stands in the cycle. This model found risks to be highest in Turkey and South Africa, with a 38-40 percent possibility of recession in these countries.
On the other hand, financial markets, which have sold off sharply over the past month, signalled a more pessimistic outcome. Goldman says these indicators forecast a 67 percent probability of recession in the Czech Republic and 58 percent in Israel, followed by Poland and Turkey. Unlike the survey, financial data were more positive on South Africa than the others, seeing a relatively low 32 percent recession risk.
Goldman analysts say the recession probabilities signalled by the survey-based indicator jell with its own forecasts of a soft patch followed by a broad sustained recovery for CEEMEA economies.
"The slowdown signalled by the financial indicators appears to go beyond the ‘soft patch’ that we are currently forecasting," Goldman says, adding: "The key question now is whether or not the market has gone too far in pricing in a more serious economic downturn."

Jim O'Neill, the new Goldman Sachs Asset Management chairman who is famous for coining the term BRICs for the world's new emerging economic giants, reckons he knows why Germany might not be rushing to bail out all the euro zone debt that is under pressure. Europe is not as important to Berlin as it was.

Speaking at the Reuters 2011 Investment Outlook Summit being held in London and New York, O'Neill pointed out that in the not very distant future Germany will have more trade with China than it does with France.

"It's a different global environment. That's why maybe Germany (ties)  itself to a rules-based game with the rest of Europe because economically it doesn't mean so much to them now. What goes on in China is more important than what goes on in France and that's puts a different economic (spin) on the situation for the Germans."

It is beginning to look like financial markets cannot handle more than three risks. First we have, as MacroScope reported earlier,  Barclays Wealth worrying about U.S. consumers, euro zone debt and Asian overheating.

Now comes Jim O'Neill and his economic team at Goldman Sachs, with three slightly different notions about risks in the second half, this time in the form of questions. To whit:

1) How deep will the U.S. economic slowdown be and what will  the policy response be? (That's two questions, actually, but let's not nitpick).