Customers (er… sometimes known as clients) are sold complex new financial instruments for their pension plans, investment portfolios, etc. that are difficult to understand, hard to value without serious expertise in a relatively new field, but are strongly recommended by a trusted stockbroker, investment advisor or financial expert working for a rock-solid financial institution with an apparently impeccable reputation. Add to that seeming powerful combination that imprimatur of seeming safety, the stellar credit rating from a stellar credit rating agency. Insert investor drool. Add big institutional investor drool – pension funds, university endowments, trust funds, hedge funds, etc.
Add a few more touches. The investment instrument is actually a bundle created by the same financial institution that is recommending the “buy,” and the broker/advisor tells you that they are investing in that asset as well. The safety? While individual loans and/or lines of credit may be risky, when these loans are bundled, you get “safety in numbers.” They even have some cool names for these bundled loans: collateralized debt obligations (CDOs) or mortgage backed securities or something like that. Derivatives – investment units based on the performance of some form of market trend or aggregation. Good investment the buyers are told.
What the investor/buyers were not told? Does the underlying institution have the same confidence in the market you are being sold that they are telling you? Are they protecting themselves in any way against failure that they aren’t letting you in on, because it would undermine your confidence in your decision to buy that new credit bundled derivative? Or do they have an advantage, once the market falls, that you do not? Maybe that the financial institution has taken out its own “insurance policy” (in the form of a credit default swap – CDS) against failure on their share of the investment… Or, how’s this for chutzpah, that same financial institution, famous for inventive minds constantly finding new bundles of complex financial assumption that can be traded as well, creates a new derivative that actually bets that the very instruments sold based on aggregated debt note above will fall in value. In “short,” the financial institution makes a bundle when your bundle of aggregated debt falls, and when your aggregated debt crashes and burns, the financial institution makes a “killing” in the rise of the value of their “bet” (or short) against your investment.
Some investment banks bet heavily on the credit bundles without the off-setting “hedge bet.” Bearn Stearns. Lehman Brothers. Etc. But the New York Times tells us of the story of how one rising star in the financial world protected his institution from the same fate: “In late October 2007, as the financial markets were starting to come unglued, a Goldman Sachs trader, Jonathan M. Egol, received very good news. At 37, he was named a managing director [the ultimate brass ring job, if you will] at the firm… Mr. Egol, a Princeton graduate, had risen to prominence inside the bank by creating mortgage-related securities, named Abacus, that were at first intended to protect Goldman from investment losses if the housing market collapsed. As the market soured, Goldman created even more of these securities, enabling it to pocket huge profits.”
Hey, I’d promote him too, but that Goldman prospered while those who trusted Goldman’s advice and bought the earlier CDOs… who were not informed of the need for an “Abacus” alternative investment when the market began to turn… and lost their investment shirts, so to speak, well there’s something pretty sinister about that in my opinion. “Pension funds and insurance companies lost billions of dollars on securities that they believed were solid investments, according to former Goldman employees with direct knowledge of the deals who asked not to be identified because they have confidentiality agreements with the firm.” The Times.
But clever “monkey-see-Wall Street-monkey-do” firms saw the light from Egol’s beam. “Goldman was not the only firm that peddled these complex securities — known as synthetic collateralized debt obligations, or C.D.O.’s — and then made financial bets against them, called selling short in Wall Street parlance. Others that created similar securities and then bet they would fail, according to Wall Street traders, include Deutsche Bank and Morgan Stanley, as well as smaller firms like Tricadia Inc., an investment company whose parent firm was overseen by Lewis A. Sachs, who this year became a special counselor to Treasury Secretary Timothy F. Geithner… ” The Times. That relationship between the government’s navigators through these roiling financial waters and such Wall Street insiders rears its ugly head, yet again. “Some [credit-backed] securities packaged by Goldman and Tricadia ended up being so vulnerable that they soured within months of being created.”
The same set of Wall Street monkeys who milked TARP money, slorpped near zero-rate fed funds for internal use (while small business were denied credit) and reveled in government-subsidized insurance proceeds from AIG… Those same financial institutions who now need rakes and wheelbarrows to dump bonus money onto the desks of their high-roller, revenue-generating “financial team”… the best and the brightest who always know how to protect the mother ship, even as those around her, those who trusted her advice, perished in flames. Are you getting steamed?
Congress and the Securities and Exchange Commission are beginning their investigations of his practice of betting against the very instruments sold to their clients. No matter the result, the message is clear: these financial institutions are “too big to continue” in their present form and “too big on their impact on the general economy” not to be seriously and tightly regulated. That part Glass–Steagall Act (the Banking Act of 1933) that prohibited commercial banks from engaging in speculative trading (thus separating investment and self-investing merchant banks from what we think of as traditional banks) was repealed in 1999 by a bill sponsored by Senator Phil Gramm (Republican of Texas) and signed into law by Democrat President Bill Clinton. The mega-merger frenzy that followed led to the situation we have today… conflicts of interest with legal sanction.
If we do not learn to curtail, corral and regulate these big financial institutions, if we continue to afford these mega-wealthy traders with legal rights, benefits and privileges that are not given to the general population, if we continue to cultivate greedy and self-indulgent special interests with their own “special access” to the highest reaches of government, we are sowing the seeds for the failure of the “government of the people, by the people and for the people” – as President Abraham Lincoln so eloquently spoke in his timeless Gettysburg Address.
I’m Peter Dekom, and I approve this message.
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