When wealth accumulates in the collective hands of a few individuals, it can lead to a nexus of concentrated power that can be easily abused, regardless of which industry and economy you operate in.
And Goldman Sachs, with close to $1 trillion in assets, knows this better than anyone else. With top financial institutions including JP Morgan and Bank of America that continue to be embroiled in controversy and are charged fines in the range of billions of dollars that hardly make a dent in their earnings, this article about Goldman is a pertinent one to remember.
Reference: If not specifically noted as my personal views, the following information is presented to you as an excerpt from “How They Got Away With It: White Collar Criminals and the Financial Meltdown” edited by Susan Will, Stephen Hanelman and David C. Brotherton (Columbia University Press).
Brief Background on Investment Banking
Investment banks are prestigious and powerful financial institutions, with high-level executives who are richly compensated. They present themselves as central players in the creation of wealth in capitalist societies who put the interests of their clients first. Specifically, the wages for the investment banking industry for the period from 1980 to 2000 amounted to a staggering $500 billion, with shareholders and customers subsidizing a vast proportion of this payout (Augar 2005, 62). Since 2000, payouts increased even more dramatically (Johnson and Kwak 2010; Morris 2008; Prins 2009).
By simultaneously advising both buyers and sellers in merger transactions, investment banking institutions are obviously involved in a conflict of interest. Indeed, they aggressively promote mergers—even when such mergers impose great costs or losses on investors, employees, and consumers—because they generate huge fees for investment banks. They allocate hot initial public offering (IPO) shares to top executives of corporations, expecting that in return these executives will steer lucrative corporate business to the investment banking houses.
Major investment banks were deeply implicated in the corporate scandals involving Enron, WorldCom, and other corporations that vastly misrepresented their finances (Augar 2005; Sale 2004). They were accused of either inadequately overseeing huge loans to such corporations or being directly complicit in fraudulent applications of these loans. Among other things, they had helped structure controversial and sometimes illegal off-balance-sheet partnerships.
My personal note about Wall Street: New York City, or rather, Wall Street is heralded as the financial capital of the world. But it took a series of volatile events to attain that status. Post the casualties of the Civil War, American economy emerged with a national banking system, dominated by a surge of investment banks whose massive underwriting and financing activities set the stage for the Industrial Revolution. Even during this period, many individuals pointed fingers at the massive concentration of wealth in the hands of bankers, still visible today. Post WWI, many of the City’s banks surged into the global market by lending to clients abroad. Unfortunately, a great sum of the bank’s own investments came directly from the deposits of customers. When clients failed to pay back their loans, it led to the stock market crash of 1929, signalling the ills of misusing investment banking that can lead to grave economic recession in the absence of sound financial regulation. The crash was followed by the Great Depression. These successive events prompted the New Deal and the landmark Glass-Steagall Act of 1933. The latter made it mandatory that commercial banking be kept separate from investment banking. Post WWII, commercial banks, in general, played a significant role in development of their communities by attracting customers with better rates and services, which is still visible in our present day economy. There was again another period of downturn and doubts about the strength of the American financial system during the 1970s which was a cumulative effect of the unfavorable Vietnam War and the oil crisis. Post 1980s upheaval, banks transformed into bigger institutions with high risk securities due to great deregulation and started to locate their headquarters in a consolidated area of Manhattan. The effects of this politically motivated deregulation and the stake of multiple corporations (including insurance giant AIG) in complex derivatives and mortgage-backed securities was evident in 2008 financial crisis, whose impact created unprecedented ripples in the world economy.
Gold-digging Goldman Sachs
Goldman Sachs has been widely recognized as an iconic American investment bank. Two recent Treasury secretaries came from the firm. In the spring of 2010, Goldman Sachs received a great deal of unwanted attention following the civil fraud filing against it by the Securities and Exchange Commission (SEC), reports of an ongoing criminal fraud investigation by the Department of Justice, and a high-profile Senate hearing (Story 2010; Story and Morgenson 2010; Taibbi 2010).
Goldman’s Involvement in the 2008 Financial Crisis
Among other forms of wrong-doing, Goldman Sachs was accused of selling to investors “synthetic collateralized debt obligations [CDOs]” that were designed to fail and then betting against these opaque investments (Gandel 2010a). In July 2010, Goldman Sachs agreed to pay $550 million to settle the SEC complaint (Chan and Story 2010). In that same month, an arbitration panel ordered Goldman Sachs to pay more than $20 million to investors defrauded by the Bayou Group, a hedge fund from which Goldman earned millions of dollars of fees for clearing trades (Craig 2010). In the United States, Goldman Sachs created CDOs that were ultimately repackaged as structured investment vehicles [SIVs]- all highly complex financial instruments- and sold to many American municipalities and counties, leading to huge losses when the housing market collapsed (Gandel 2010b). As a consequence, vital services had to be cut and fees imposed on residents of these municipalities and counties. Journalist Matt Taibbi (2009) demonstrated that Goldman Sachs played a central role, over much of the course of the past century, in major manipulations of the financial markets, profiting very richly while complicit in the “high gas prices, rising consumer-credit rates, half-eaten pension funds, mass layoffs, future taxes to pay off bailouts,” and other immense costs to the American citizenry.
To get further insight on the 2008 credit crisis, here is brilliant, animated video that breaks down tricky concepts such as sub-prime mortgages and CDOs for a lay man who has no inkling of financial terminology.
Goldman and the Greek Economy Collapse
During this period [US Financial Crisis], the meltdown of the Greek Economy and the resulting impact on the European Union was also a big story. Goldman Sachs was shown to have collected hundreds of millions of dollars in fees over a period of years for helping Greece conceal its mounting debt and then to have made more money betting on the failure of the Greek economy (Schwartz and Dash 2010).
My personal note: I was intrigued about Goldman when my Finance Professor at Rutgers mentioned Goldman’s involvement in the Greek debt mess. As a quick intro, Greece joined the European Union in 1981 (followed by other present-day debt ridden nations — Spain and Portugal in 1986). Goldman played a significant role in helping Greece hide their national debt for over a decade (1999-2010). When the Credit Default Swap that Goldman created for Greece in 2009 matured in 2010, its debt was exposed, leading to the collapse of the Greek economy.
The EU sets the guidelines on the desired stipulations for those interested in joining the Union as well as maintaining membership. Many countries have employed a number of tactics to conceal their debt (with the help of powerful investment banking institutions) so as to enjoy the trade and commerce benefits the EU has to offer, dominated by the strength of the German economy under Merkel. When the swaps matured and its debt was exposed, Greece had no strategy or market planning to pay down those debts. (Anyone who tries to compare the wonderful Greek lifestyle in comparison to their country back home- it comes at a great price, my friend. To you and to future generations.)
Quite a number of EU member nations are struggling with the onus of their debt and require austerity measures to pay it down gradually, much to the ire of their citizens. Mind you, industrialized developing nations with lesser degree of debt are well accustomed to the 70+ hour per week workdays.
Here are my final two euros on the matter: To Ireland, Portugal, Italy, Spain and any other European nation that believes it does not need government austerity measures and it is fiscally sound without them—I have four words for you- That’s what Greece said 😉
Goldman and the Oil Market
According to Taibbi (2009), Goldman Sachs also played a central role in the manipulation of the oil market, which led to a dramatic rise in the cost of gas at the pump, not traceable to a shortage of supply or an increase in demand.
Goldman and Food Shortage
Starting in 1991, Goldman Sachs invested heavily in the food commodities market, in effect profiting greatly by “gaming” this market, with the ultimate consequence of an estimated one billion more people worldwide left hungry or even starving (Kaufman 2010). The worldwide price of food rose some 80% between 2005 and 2008, with millions of American households bearing a heavy burden from this rise.
Tactics employed by Goldman
According to this analysis, Goldman Sachs was involved in a vast “investment pyramid” or “pump-and-dump” scheme, persuading ordinary investors to purchase investments that the bank knew to be defective and that would decline greatly in future value. Traditional guidelines for underwriting companies were abandoned, and stocks in new companies with extremely doubtful prospects were increasingly sold to investors. Goldman engaged in “laddering,” the practice of manipulating share prices in new offerings, and “spinning,” the practice of offering executives in new public companies shares at exceptionally low prices, in return for promised future business. Practices such as these contributed to the creation of a huge internet bubble, which wiped out some $5 trillion of wealth on the NASDAQ alone. Penalties imposed on firms such as Goldman Sachs for wrongful practices were so small relative to the profits that they could not be said to act as any deterrent.
Goldman Sachs has continued to pay billions of dollars of compensation in the midst of the devastating financial meltdown to which it contributed, and it has continued to benefit hugely from “bailout” initiatives due to its contacts at the highest levels of government. Moreover, it has positioned itself to profit immensely from a proposed, emerging carbon credits market. Throughout most of its history, Goldman Sachs has epitomized ultra-respectability and has enjoyed a high level of trust. If the preceding critique is accurate, however, it should more properly be regarded as a form of organized crime. And if some of its key activities over the years were fraudulent, then they need to be legislatively defined as such and therefore classified as criminal.
p.s. Special note for attorneys like Preet Bharara who have the courage and willpower to prosecute some of the biggest criminals in insider trading and scams in the financial sector (Raj Rajaratnam and Rajat Gupta to name a few.) Here is a must read speech by the man himself at 2013 Columbia Law School Commencement.