“It’s pretty self-explanatory, sir”–a Goldman executive to Senator Ted Kaufman.
(After spending well over three hours on Tuesday listening to the proceedings of the Senate hearing on Goldman Sach’s role in the financial crisis, I could not help but be overcome by the atmosphere of redundancy that was brought upon by the increasing tension between both parties)–My overall impression
The Securities and Exchange Commission (SEC), once labeled as incompetent, due to its lack of oversight on the financial industry and especially, on Bernie Madoff’s enterprise, is now on an upward climb towards redemption. The agency’s bold agenda to create accountability for the ongoing financial crisis, by implicating Goldman Sachs and one of its executives, is not only positive news to all the affected victims of the mortgage crisis, but also, it is the impetus that Democrats are seeking to progress with a financial reform bill by the end of the year, despite Republican opposition.
I was mostly impressed with the questions posed by Senators Ted Kaufman and Carl Levin, in relation to Goldman’s market making and market manipulating roles. Previous allegations of Goldman’s and other banks’ ability to manipulate spreads and engage in self-interest deals are now resurfacing and after hearing the testimonies of several Goldman executives, it became more apparent to me why Goldman Sachs would want to further distance itself from Fabrice Tourre, the only named executive in the lawsuit. It is a known fact that Goldman Sachs was involved in securitizing stated income loans (borrowers simply stated their unverified income to qualify for loans). It is also a known fact that Goldman engaged in the practice of “bar-belling” (packaging low-rated debt with high-rated debt in a high-rated security package). With these factors and others I did not mention, it can be inferred that Goldman Sachs engaged in the business of advising some of its clients towards vast potential losses for its benefit and that of John Paulson’s hedge fund, specifically with the Abacus CDO.
Not to focus on one firm ex post facto, however, I do believe now is the time for a financial reform bill. The two areas that reform should be focused on are:
1) Ratings agencies
2) Glass-Steagall Act
Firstly, a model in which firms pay ratings agencies to rate their securities is an easy case of moral hazard and a potential conflict of interest, especially when ratings agencies compete with each other to win a firm’s business. Lastly, during the Great Depression, the Glass-Steagall Act of 1933 was established to regulate the financial markets and financial institutions, and it specifically separated the functions of an investment bank from that of a bank, to name a few of its features. After the Act was repealed in 1999, M&A activity increased in the financial sector and financial firms became further intertwined and shared almost the same risks, which is why some large firms are sometimes called “too big to fail”. For the benefit of the financial system and to prevent a near system failure such as that of 2008 from ever occurring again, the Glass-Steagall Act should be reinstated, at least for the large money-center banks.