The Persecution of Goldman Sachs

If a person wants to buy a home, should he not do so because of the very fact that the seller wants to sell and therefore most "know something" to make it a bad purchase?

If someone wants to make an investment, such as in stocks, bonds, or a certificate of deposit, should she not do so because the seller wants to sell and therefore buying the investment is too risky?

If you think these are ludicrous perspectives on commonplace transactions, you are right.

But fundamentally, that is the essence of the SEC's allegations against Goldman Sachs it in the Abacus transaction involving subprime mortgages.

The Abacus deal required some parties to be "long" the deal (meaning they think the investment will increase in value) and others to be "short" the deal (meaning they think the investment will decrease in value). The SEC alleges that Goldman Sachs didn't disclose material information by not disclosing the name of the investor who was "short" the deal.

The "long" investors specialized in mortgage investments, managing billions of dollars, and as Warren Buffet said about the incident, knowing who the "short" is in the deal is irrelevant to making a proper investment decision.

Putting it another way, if you buy (taking the "long" position) a stock through your broker, you never know who the seller (analogous to taking the "short" position) is. Does that mean you shouldn't buy the stock until you know the name of the seller? Why would that matter? Clearly, the SEC doesn't think that is important since billions of shares a day are traded in the United States without the buyer knowing the identity of the seller.

This reflects a fundamental fact about economic transactions: the buyer and seller have different views on the items being bought/sold, and transact with one another to allow each to have their own view realized. Differences of opinions are fundamental to many economic transactions, particularly financial ones.

Even Bill Clinton concluded that Goldman Sachs broke no laws in the Abacus deal.

Moreover, it is worth noting how unusual the SEC's process was in deciding to bring the case. Goldman Sachs last spoke to the SEC in September 2009, and next heard from the SEC in April 2010 when the lawsuit was announced. Normally, the SEC notifies a party of its intent to sue them and then tries to negotiate a settlement before publicly disclosing the case.

Adding to the unusual nature of the case, the SEC's commissioner voted 3-2 to commence the lawsuit, with the three Democratic commissioners voting in favor of the suit and the two Republican commissioner opposing it. Again, such a partisan split isn't the norm for such prominent SEC suits.

If the SEC lawsuit against Goldman is so baseless, and was pursued in such an unusual manner, what might have motivated the agency to bring the case as it did?

First, one of the relatively unreported aspects of the matter - and a scandal of first order in its own right - is that on the same day the SEC announced its suit against Goldman, the SEC posted to its website, buried in a hard-to-reach link, an investigative report in its handling of the Bernie Madoff ponzi scheme.

The report revealed that the SEC's investigative arm had recommended that its enforcement arm pursue Madoff for orchestrating a ponzi scheme, but the enforcement division declined to do so because it preferred easier to win cases against more prominent firms. Literally, the SEC's shocking negligence cots investors many billions of dollars in a real, unambiguous fraud.

But that story got lost due to the sensational charges against Goldman Sachs. So the case against Goldman allowed attention to be deflected from the SEC's failure.

In addition, the partisan nature of the commissioners' vote highlights that the suit against Goldman serves a useful purpose for Democrats seeking to pass their financial services regulatory bill.

The SEC's gambit worked. It hid the Madoff report and whipped up the frenzy against Wall Street to help secure Senate approval of the new regulatory bill.

Only a small thing like justice got trampled in the process.

Weak Presidents

The nuclear deal that Turkey and Brazil negotiated with Iran demonstrates what happens when the world perceives America, and its president, as weak.

Turkey and Brazil both aspire to play a larger role in world affairs. Turkey is a powerful and relatively modern Muslim nation, and under its Islamic-oriented government has changed its foreign policy course decisively in the past few years. Turkey had been a reliable ally of America and had developed an important strategic relationship with Israel, cooperating on various defense and security matters.

Turkey now sees Iran as likely to become the regionally dominant power, once it obtains nuclear weapons, so naturally wishes to develop good relations with Iran to minimize tensions with a powerful neighbor.

Brazil has a growing trading relationship with Iran and currently runs a $1 billion trade surplus, so maintaining good relations with Iran is important. Moreover, Brazil wants America's role in the world in general, and Latin America in particular, to be reduced so Brazil can be the local power of significance.

And in fairness to both nations, if America is going to allow Iran to develop nuclear weapons, why shouldn't Turkey and Brazil try to win some diplomatic points in helping Iran and securing "peace"?

Herein lies the problem with Obama's appeasement of Iran, Hugo Chavez's Venezuela, Putin's Russia, and other thuggish regimes: if America won't stand up to oppose these bad actors, other nations aren't powerful enough to do so on their own or in concert with others - so they will accommodate the thugs too in their own way.

The price America is paying for electing Barack Obama president is incalculable. The end result will either be utter appeasement of a multitude of enemies (which is well underway) or war to escape the consequences of such appeasement - a war fought from a weaker position and fewer allies scared off by previous appeasement.

Political Capital

The Wall Street Journal reports on the efforts to save ShoreBank, a Chicago-based bank that is on the verge of being taken over by the FDIC due to bad loans it made. ShoreBank lends to poor communities.

Remarkably, Goldman Sachs, Citigroup, JP Morgan, and Bank of America have tentatively agreed to invest money as part of a $125 million capital raising process to stave off insolvency.

A person involved in the process to save the bank said: "Sometimes a bank like ShoreBank has to rely on karma, and the planets seem to have aligned to provide some karma with respect to this particular deal."

And here I thought that capital raising was about providing attractive returns for shareholders, and not about karma.

In reality, this is about Wall Street firms, facing intense government and PR scrutiny, looking to appease a politically-connected bank and score points with the Obama administration and Democrats.

It takes the phrase "political capital" to a disturbing, new level.

Crime and Punishment

The New York Times notes that New York City police stopped and frisked minorities nine times more often than whites in 2009 despite having similar arrest rates after being stopped and frisked.

The article implies the police are doing something wrong by stopping minorities so often, but the opposite appears true: if their stop and frisk approach leads to similar arrest rates, then the police are able to gauge a similar degree of criminality across the population.

This also sheds some interesting information on the current controversy with Arizona's law on allowing the police to stop people to see if they are illegal immigrants. The U.S. Supreme Court, in Terry v. Ohio, allowed police to detain someone briefly under a "reasonable suspicion" standard, rather than the more stringent "probable cause" standard. New York City is currently stopping over 570,000 people per year and arresting about 6% of them.

That is a large number of people being stopped, with a fairly small percentage being arrested. If such a tactic is appropriate to deal with New York's crime problem, I wonder if the courts will overturn Arizona's attempt to deal with its illegal immigration challenge?

Where's the Outrage II?

Coming Oon the heels of Freddie Mac asking for another $10.6 billion from the federal government to cover its first quarter losses, Fannie Mae has requested another $8.4 billion.

Since the Obama administration is using Fannie and Freddie to prop up the housing market while keeping their liabilities off the balance sheet of the U.S. government, Obama will continue to fund their losses without looking to reduce taxpayer losses.

The financial "reform" legislation that Obama and the Democrats want to pass has no reforms of Fannie and Freddie, despite their seminal role in the financial crisis and their staggering losses.

Where's the Outrage?

Freddie Mac, one of the two government-sponsored mortgage companies that played a central role in creating the financial crisis by spurring lending in lower credit quality mortgages, announced another $6.7 billion loss and asked the government for another $10.6 billion.

If this were Citigroup, Goldman Sachs, or any other private company, it would be a major news story and lead to cries of outrage directed against Wall Street, the company, and management.

So why is the story on the back pages of the Wall Street Journal and the New York Times?

Here's a hint. Precisely because it was created by the government to spur mortgage lending; precisely because Democrats blocked regulatory reform of Freddie Mac and its related company Fannie Mae; and precisely because blaming Wall Street helps avert attention from the government's role in the financial crisis, the press doesn't want to make a big deal about the catastrophic losses Freddie and Fannie have experienced.

Freddie and Fannie have cost taxpayers $136 billion, with more losses projected. Meanwhile, TARP funds invested in Wall Street banks will likely turn a profit.

Inconvenient Facts

Barack Obama has said he wants America's exports to double over the next five years.

That's certainly a laudable goal, but it is instructive to review the categories of products which were America's top exports in February 2010.

Pharmaceuticals were America's number 1 export that month, and medical products were the seventh highest.

It is ironic that ObamaCare, which will lead to restrictions on the development and growth of the pharmaceutical and medical device industries over time, will hurt important parts of our export industries.

On the other hand, the auto industry, which received unprecedented government assistance that will never be fully repaid, is no where to be seen.

So Obama attacks some of our most successful industries and assists some of our least successful ones. While that is a terrible investment strategy, it is consistent with government intervention in the economy, which seeks to aid troubled industries and hurts successful ones.

The proper government policy is one which plays no favorites, maintaining a level playing where success and failure are earned in the marketplace.