Kevin O. Woghiren

The timing is impeccable. Not only is the U.S. Government ready to fully give up on its Goldman Sachs criminal fraud investigation, but it is also preparing to implement the imminent Dodd-Frank Act in order to mitigate systemic risk and prevent another financial crisis. Although there are multiple points that I can pursue for both events, however, I will only focus on two key points, one from each event.

The Securities and Exchange Commission and Goldman Sachs recently agreed on a half a billion dollar fine in order to settle the ongoing fraud investigation against Goldman. Not only did the U.S. Government prove that some firms are too big to fail, but also that some firms are too big to be fully prosecuted. For one, the fraud charge against Goldman Sachs was for about $1 billion dollars, but Goldman Sachs was only fined for about half of that in an attempt to “sweep the case under the rug” as the media switches its attention to the new bill. This action only proves of Goldman Sachs influence on the U.S. Government and the impunity of certain firms and their indifference to Main Street.

The Dodd-Frank Act, named after the two leading proponents of the bill, is the intended moniker for the recently passed financial overhaul bill after it is signed by President Obama. The bill expands the U.S. Government’s oversight on the financial industry but it fails in its attempt to lessen systemic risk. The bill is not clearly defined at times and loopholes are prevalent. For example, the bill states that proprietary trading will be curtailed at large bank holding firms and that banks are able to invest a certain percentage of their tangible common equity in institutions such as hedge funds but it doesn’t clearly define its interpretation of proprietary trading nor does it call for a proportionate increase in capital requirements. The bill also creates several new institutions such as a consumer protection agency to “improve financial literacy” among American consumers and an oversight council that will “monitors systemic risk” and reports to the Federal Reserve. Both of these new institutions are examples of a more bureaucratic and ever expanding government that will continue to be one step behind the Bernie Madoffs of this world. This bill, once signed, will put American financial firms at a slight disadvantage against international competitors and its simply bad for business.

“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.

The past two decades have been marred with political unrest, violence, and scandals, but then again, that has been the story of the human experience. It would be faulty and absurd to think that the upcoming decade will be any different. However,  it would be premature and unfair to negatively categorize the upcoming decade with its past peers, so my positive theme for the upcoming decade: Green!

Despite the collapse of the politically-charged climate change summit in Copenhagen, there is still hope for the future of our environment. The Green Revolution is the new economy and it will be as revolutionary as the Internet was in the 1990s. Although carbon emissions taxes and carbon trading can be influential tools in reducing society’s carbon footprint, they are a barrier to economic growth, especially during an economic recession. There is clearly a market demand for energy efficiency and businesses and individual entrepreneurs are willing to act on this demand as long as the infrastructure and stimuli are provided by the government. If the environmental crisis is treated as a true crisis, then a significant stimulus should be planned, with OECD countries and cash-rich developing countries leading the way.

The other option is to wait for the political process to take its slow course. Specifically in the United States, politics has been a barrier to the alternative energy industry. The US government enacts alternative energy incentives on a temporary basis, which is very unattractive to long term investors and hurts the industry more than it spurs growth. Alternative energy can create jobs to both developed and developing countries and can be key in reducing conflict over other countries’ natural resources such as oil. A Green Revolution supported by stimuli is a feasible public venture and is necessary in order to bring the world out of an economic recession.