The Great Debate

The following is a guest post by Dana Radcliffe, a senior lecturer of business ethics at the Johnson Graduate School of Management at Cornell University. The opinions expressed are his own.

The day after the Securities and Exchange Commission announced its $550 million settlement with Goldman Sachs, three noted business journalists appeared on a popular current affairs TV show. They concurred that the deal was a win for Goldman since the dollar amount was surprisingly low — equal to what the firm earns in just a few weeks. They felt the SEC’s case was weak and that, legally, Goldman had done nothing wrong and would have prevailed in court.

They also agreed that people were understandably appalled by some of the firm’s conduct in the subprime mortgage crisis in light of the flood of emails and other internal company documents released by Congress and Goldman. Grasping for a way to express what was repellent about such actions, one of the writers described them as “icky.” Another airily noted that they might be seen as wrong “in some ethical, moral, or philosophical sense.”

What is remarkable is while all three pundits shared the common view that Goldman had behaved offensively, they would not say that Goldman’s behavior was “unethical” or “morally wrong.”

This reminded me of the most notorious article ever published in the Harvard Business Review — a 1968 piece by Albert Carr, a former advisor to President Truman. In it, Carr argued that business is akin to poker, where bluffing is often legal and expected. While allowing that deception in one’s personal life violates “private morality,” Carr contended that business and poker are strategic competitions whose rules permit participants to profit from misrepresentations. Indeed, he wrote, being a skilled practitioner in either endeavor requires occasional bluffing.

John Kemp is a Reuters market analyst. The views expressed are his own

Goldman Sachs cut the amount of risk it staked on commodity trading during Q2 2010 by almost 35 percent, part of a broad-based reduction in risk across the bank’s trading book. Value-at-risk (VaR) linked to commodity prices fell to an average of just $32 million per day between April and June, down from $49 million in the prior quarter and $40 million in the same period a year earlier, according to the firm’s earnings release. Cuts in VaR allocated to commodities were in line with reductions elsewhere, including interest rate risk (down just over 20 percent) and equities (down just over 30 percent). Only currency trading saw a slight increase in risk taking (up 3 percent). Commodity VaR was reduced to its lowest level since the three months ended September 2009, and before that November 2007.

Goldman has been reducing firm-wide VaR (net of diversification) since the middle of 2009 — shortly after the firm converted to Bank Holding Company (BHC) status regulated by the Federal Reserve, subsequently changed to Financial Holding Company (FHC) status, rather than its previous incarnation as a securities firm. Gross VaR (excluding diversification) started dropping after Q3 2009 (when it peaked at a massive $416 million). Gross VaR now stands at a more modest $272 million (down 35 percent). The firm’s massive interest rate risk (which peaked at $218 million in Q1 2009) has been cut to less than half that ($87 million in Q2 2010). But the April-June quarter was the first time the de-risking process had extending to commodities.To some extent, VaR is endogenous. Unless position limits are changed to offset it, VaR naturally rises and falls with market volatility. But firms can always over-ride fixed limits to keep VaR “budgets” unchanged despite changes in volatility if managers decide it is worthwhile.

What is notable is that market volatility rose during Q2 2010 in most asset classes (including commodities) after a quiet Q1. Yet Goldman’s VaR measures declined almost across the board, suggesting a deliberate policy to cut risk. Opportunities to generate revenue by taking market risk appear to be declining across the company’s trading operations. One crude measure of the firm’s “trading efficiency” is the amount of dollars it generates in net revenue for every $1 put at risk (VaR). Trading efficiency peaked at $46 for every $1 risked at the start of 2007 and has never recovered to the same level. Efficiency in Q2 2010 was just 24:1, down from 32:1 in the prior quarter, and less than half the peak (Charts 4 and 5).

— Charles K. Whitehead is an Associate Professor of Law at Cornell Law School.  He practiced in the United States, Europe, and Asia as outside counsel and general counsel of several multinational financial institutions, including as an associate in a law firm representing Goldman, Sachs & Co.  The opinions expressed are his own —

The civil action brought by the SEC against Goldman, Sachs & Co. has placed it squarely in the cross-hairs of those who argue, in the debate over new financial regulation, that Wall Street needs a new moral compass.  But it’s important, I think, to separate our frustration with Wall Street from the strength of the SEC’s case.  The case for reform is relatively easy to make.  After all, who needs smoke when we have just put out the fire?  The case against Goldman Sachs, I argue, is not nearly as convincing.  And, while there is – and, no doubt, will continue to be – a he-said, she-said quality to some important facts, it may be useful to consider the core case the SEC has brought.

The SEC’s charge, if proved, is fairly straightforward:  Goldman Sachs defrauded investors in notes whose value was based on a portfolio of assets selected by a hedge fund, Paulson & Co., first, by failing to disclose Paulson’s involvement in the selection process, and second, knowing that Paulson had placed bets on the portfolio declining in value.  To prevail, the SEC must show a substantial likelihood that the failure to disclose Paulson’s involvement and its short position was significant to a reasonable investor, considered within the total mix of information available at the time the purchase was made.  That may be difficult to do in light of what was being sold.

– Ed Mierzwinski is the longtime consumer program director of U.S. PIRG, the federation of state Public Interest Research Groups. U.S. PIRG is a founding member of Americans for Financial Reform, an unprecedented coalition of over 250 labor, senior, civil rights, community and consumer organizations. –

Over 18 months ago, U.S. taxpayers bailed out the reckless Wall Street banks. Yet, despite widespread and overwhelmingly public support for Wall Street reform and dramatic House action in December, efforts to move a Wall Street bill through the Senate have been stalled for months by a phalanx of powerful Wall Street lobbyists. While we cannot count them out, because they’ve increased their lobby and campaign spending as we move toward the endgame, Banking Committee Chairman Chris Dodd’s (D-CT) coup in moving a strong bill closer to floor action gave us some wind in our sails.

Then, several events last week put an even bigger whirlwind behind our reform efforts.

If you want less of something, tax it.

That truism is often used as an argument against a tax on profits, or health benefits, or employment, but in the case of the rents extracted from the economy by the financial services industry here’s hoping it proves more of a promise than a threat.

The International Monetary Fund has put forward two new taxes on banks to pay the costs of future rescues, one of which is a fairly conventional “Financial Stability Contribution,” with an initial flat levy on all banks, to be refined later into something with more precise institutional and systemic risk adjustments.

More interestingly, the IMF is also proposing a “Financial Activities Tax,” (FAT) a tax on bank pay and profits which, if correctly designed, could serve as a tax on rents — the unwarranted spoils — of the financial sector.

So remind me, why will clients continue to do business with Goldman Sachs?

I know, it is a stupid question; investors and corporations will continue to do business with Goldman even after the bank has been charged with an alleged fraud for the same reasons they always have: because they hope, like every gambler, to beat stacked odds and because they flatter themselves that they are not the sucker at the table.
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- Laurence Copeland is a professor of finance at Cardiff University Business School and a co-author of “Verdict on the Crash” published by the Institute of Economic Affairs. The opinions expressed are his own. -

In a previous blog, I expressed the fear that in the aftermath of the financial crisis we were going to see either the innocent punished or guilty men convicted of the wrong crimes, or maybe both.

A topical case is Goldman Sachs, an investment bank which weathered the crisis better than most, only taking Fed money when all the other dominos had already fallen, repaying it extremely quickly, and facing accusations ever since of having been too clever for its own good.

– John Kemp is a Reuters columnist. The views expressed are his own –

It is now virtually certain financial reform legislation will go sailing through the Senate, following the complaint filed against Goldman Sachs  and an employee in the U.S. District Court for the Southern District of New York by the Securities and Exchange Commission this afternoon.

Filing a complaint is not the same as proving it. Goldman Sachs has already stated that “The SEC’s charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation”.

Goldman Sachs has a lot to be thankful for – huge bonuses, massive taxpayer subsidies, unrivalled political influence – but in Greece they have finally found nirvana: a highly profitable business partner who can also credibly serve as the villain in the piece.

Goldman is widely reported to have arranged a swap transaction for Greece early in the last decade structured in such a way as to provide the country with $1 billion upfront in exchange for higher payments much later.

That later bit is key – it helped to mask over-borrowing by Greece from the euro zone’s budget watchdogs in Brussels, not to mention from Greek taxpayers and the buyers of Greek debt, all of whom have a right to fully understand the risks of a country incurring liabilities which perhaps it may struggle to repay.

Tim Geithner's appearance in front of Congress today was another embarrassment, perhaps more for the people's representatives than the Treasury Secretary. Still, Geithner offered a clumsy defense for paying out 100¢ on the dollar to AIG's counterparties, which included more than Goldman Sachs.

What they lacked in knowledge and nuance, Congress made up for in volume and OUTRAGE. The worst moment I saw was the utterly bogus comparison by Rep. Stephen Lynch between AIG's payout to Goldman (100¢ on the dollar!) and the bailout offer for Bear Stearns shareholders (only $2 per share). 100 is a bigger number than 2, you see.

Geithner was lucky to be doing battle with such an unprepared, unimpressive group.