Monday, April 19, 2010

Krugman On The Fraud

Paul Krugman writes:
Most discussion of the role of fraud in the crisis has focused on two forms of deception: predatory lending and misrepresentation of risks. Clearly, some borrowers were lured into taking out complex, expensive loans they didn’t understand — a process facilitated by Bush-era federal regulators, who both failed to curb abusive lending and prevented states from taking action on their own. And for the most part, subprime lenders didn’t hold on to the loans they made. Instead, they sold off the loans to investors, in some cases surely knowing that the potential for future losses was greater than the people buying those loans (or securities backed by the loans) realized.

This only really makes sense if you think people are stupid. Dopey borrowers were lured into complex and expensive loans that they didn't understand means they were stupid. Likewise, the lenders sold the loans to investors, who didn't understand the fully understand the underlying risk of the loans. Again, stupid.

FLG is far more sympathetic to the idea that taking advantage of the stupidity of retail investors is bad and perhaps even fraud. Nevertheless, FLG not only signed his loan docs, where the closing attorney explained the Truth-in-Lending in detail, but also, back in the day, programmed the logic that printed out those numbers. He knows that the nature of the loan is explicitly and relatively simply explained. Come on, you're taking out a loan for hundreds of thousands of dollars. You have some responsibility as an adult to understand what you are getting into. Then again, FLG does feel bad for the Grandmas who mortgage brokers talked into refinancing their 30-year fixed into 3-year ARMs. The hear their mortgage payment can be cut in half or more and they're on a fixed income. FLG gets it. It's wrong. So, on the retail customer side, ie regular people, FLG is somewhat sympathetic to the idea that people were duped. People can be stupid when it comes to money.

But this concern doesn't apply so much to the investors Krugman writes about. Let me put it this way. If your job is to invest other people's money and you don't know what type of assets you are buying, then you are negligent, not the seller. IT'S YOUR FUCKING JOB! FLG doesn't care that everybody else wasn't paying attention and was just buying and selling. Just because everybody else is shitty at their job or interested in making a quick buck before the music stops doesn't mean it's okay for you to do it and then blame somebody else when you are left without a chair.

What we’re now seeing are accusations of a third form of fraud.

We’ve known for some time that Goldman Sachs and other firms marketed mortgage-backed securities even as they sought to make profits by betting that such securities would plunge in value. This practice, however, while arguably reprehensible, wasn’t illegal. But now the S.E.C. is charging that Goldman created and marketed securities that were deliberately designed to fail, so that an important client could make money off that failure. That’s what I would call looting.

If FLG remembers correctly, Goldman sold these to ABN Amro, ie another financial firm. Again, cry me a river because the firm was too fucking incompetent or stupid to ask what was in the bag they were fucking buying. These are big boys in the big game. Stop fucking whining.

In fairness, The Ancient did point me to a post that does raise some concerns:
The problem is that the marketing documents claimed that the securities were selected by ACA Management, a third-party CDO manager, when in fact the selection decisions were influenced by Paulson’s fund. Goldman had a duty to disclose that influence, especially since Paulson was simultaneously shorting the CDO. (According to paragraph 2 of the complain, he bought the credit default swaps from Goldman itself. I used to wonder about this; if he bought the CDS from another bank, then Goldman could claim it didn’t know he was shorting the CDO, implausible as that claim might be. But in this case Goldman must have known.)

It seems like the key will be proving that Paulson influenced the selection of securities enough that it should have been in the marketing documents. Paragraphs 25-35 include quotations from emails showing that Paulson was effectively negotiating with ACA over the composition of the CDO, so it’s pretty clear he had influence. The defense will presumably be that ACA had final signoff on the securities, and Paulson was just providing advice, so Paulson’s role did not need to be disclosed. (I don’t know what kind of standard will be applied here.)

The complaint also alleges that Goldman misled ACA into thinking that Paulson had a long position in the CDO via the equity tranche, while in fact Goldman knew all along that he would short the debt tranches. It seems pretty clear that that’s what ACA believed. The implication is that had ACA realized that Paulson was shorting the CDO, they would not have gone along with the deal.

FLG doesn't know, legally, how much Goldman had to disclose, but he's of the opinion that Goldman didn't get to where it is by flaunting flouting disclosure laws. Therefore, he's pretty confident that this met the letter of the law. Did Goldman have a responsibility to disclose to the customers it was selling the CDO that Paulson influenced the creation? FLG could see an ethical case for that. Did Goldman or Paulson have the responsibility to tell ACA that Paulson was going to short the CDO? Perhaps.

But let's step back a bit. If ACA is putting this thing together and it can't tell that Paulson is trying to get stinkers put into it, then what the fuck are they doing all day? Sniffing fucking glue? If some guy kept calling FLG about putting loans into a security that FLG was creating and all the loans were pieces of shit, then FLG would probably figure out what is going on. Why? Because FLG doesn't sniff fucking glue at work. Likewise, the supposedly professional investors who bought the damn thing ought to ask themselves what they were doing. You get paid to make investment decisions. Presumably well-paid.

Much is being made about how Goldman supposedly screwed over its clients. FLG read this article, which is behind a pay-wall and FLG can't find a non-pay one, on how investment bank salespeople choose what information to share with clients:
Salespeople, like traders, are also managed. However, this management serves only to support the prioritising of the accounts which generate the greatest turnover, and therefore both the highest profit and the highest level of market information. In many markets, this favours hedge funds. One manager of an emerging market  trading business within an investment bank outlined the strategy for determining which accounts to cover.23 A small group, ‘maybe three or four’, has to be treated well because they are important for business elsewhere in the firm. Apart from these, the first criteria is ‘is it a big enough client that can move market prices in this asset class? And then we need to speak to them.’ This is hardly surprising, but it is important to note a near universal characteristic of hedge funds: leverage.

Hedge funds borrow money to increase the volume of their investments, in order to maximise returns. Among the implications of this borrowing is that if a hedge fund and an investment fund that does not borrow (usually termed a ‘real money’ account in financial markets) have the same amount of funds under management,
the hedge fund, thanks to its leverage, will invest more; it is more likely to be ‘big enough’ to warrant priority coverage from investment banks. Investors that transact the highest volume of business are likely to receive greater amounts of timely information, and those investors are more likely to be hedge funds.

So, Goldman Sachs, a Wall Street investment bank, prioritizes its clients based on their ability to bring in revenue to the firm. FLG is shocked. In this case, this means that Paulson & Co, a powerful and rich hedge fund that presumably trades a lot, was a favorite client and Goldman put together the trade. In the process it, if you take the worst of the accusations to be true, committed fraud against other people whose jobs are not to be suckered.

You know, the more FLG learns about Wall Street and Goldman Sachs, the more he thinks it's kinda like the Special Forces. The Special Forces often say they aren't that great; everybody else sucks. That seems to apply on Wall Street. It's not that Goldman is so smart, it's just that everybody else is lazy. Intellectually lazy people who are supposedly professional investors who are well-paid.

Krugman sums up his article thusly:
For the fact is that much of the financial industry has become a racket — a game in which a handful of people are lavishly paid to mislead and exploit consumers and investors. And if we don’t lower the boom on these practices, the racket will just go on.

Again, this only holds if people are stupid. FLG is willing to entertain the idea that retail investors are financially stupid. He just fears that a consumer protection agency will end up making things worse through unintended consequences, mostly because the people who are so pro-consumer protection agency have an overly broad idea about what misleading and exploitation mean. But FLG is completely unwilling to entertain the idea that professional and institutional investors are stupid patsies, and that's what you have to believe to get all outraged by this Goldman thing.

Maybe FLG ought to start sniffing glue. Maybe then he can get a high-paying job on Wall Street.


The Ancient said...

"Stupid" is a fun word, and I am much more willing to entertain it than you are.*

But if you go back over your post and replace "stupid" with "cattle" you might wind up with something on which everyone might agree.

(In which case, Goldman might be thought of as the most efficient and profitable abattoir ever devised.)

((At the slaughterhouse, it really doesn't matter much if one animal is smarter than the rest.))
*Krugman seems to have reached a point in life where he thinks everyone who disagrees with him is "stupid" or "venal" or "dishonest."

FLG said...

"In which case, Goldman might be thought of as the most efficient and profitable abattoir ever devised."

I can agree with that, and I like the use of the French word. But it still stands that Goldman, since it doesn't have a retail division (omitting private wealth management, which doesn't really count), the cattle are supposed to be highly skilled professionals.

The Ancient said...

The "stupid" word is definitely going around ...

I was talking recently with a friend of mine who was seriously hurt financially by these past two years. He’s a guy who’s also been in the investment business (very successfully) for a long time. When things around him started to collapse, like Bear and then Lehman and then Merrill, and AIG, and WaMu, etc., even he was shocked by the information that was surfacing.

Now two years later, still trying to piece it all together for himself, “to make sense of it,” he told me he discovered a lot of the people in charge, running these big pools of money were “actually stupid.” He was still dumfounded to have realized this. He repeated the words, as if let it sink in: “actually stupid.”

(On balance, I prefer "stupid cattle.")

FLG said...

The Ancient:

I guess the thing that bugs me most is that I knew the mortgage-backed securities business was a problem back in 2003. None of it made any sense. Now, I sit here and think, you guys were idiots, it wasn't fraud.

I'm also less sympathetic than most to the idea that mortgage borrowers with flexible rate ARMs didn't understand their payments could go up. I think the vast majority knew. They just thought prices would keep going up and they'd refi. But I'm more sympathetic to that than people who are paid to invest money, presumably because of their expertise in investments, crying foul because what they bought ended up worthless.

The point I'm trying to make here is that I have no insider information and have never worked on Wall St, but for self-perception and mystique on Wall Street about how smart they are and how the talent level is so high and how difficult it is to get a job in an I-Bank, they seem pretty clueless. All except GS. And even then, I will say flat out that the people whom I know personally who got jobs at Goldman, are less intelligent than I am.

Now, this isn't jealousy. I'm not really somebody who wants to work that much, and I don't particularly care how much money they make. What pisses me off is the pretension, self-congratulation, and intellectual bankruptcy of it all.

Shit. I'd like a financial sector where super smart people allocated capital super efficiently and were handsomely rewarded. The issue we have is that the MBAs are largely mediocre minds who don't know enough math to understand what the quants are doing, but even more importantly because of the culture surrounding B-school and Wall Street don't know they're mediocre. And then you have quants, who are certainly smart mathematically, but lack some fundamental insights about people and behavoir.

FLG said...

Just FYI. My previous comment was written while you were posting, so I didn't see it and largely agree obviously.

The Ancient said...


FLG said...

I'm not reading a Matt Taibbi article about finance. I just don't have the necessary stomach lining anymore because he's upset me so much previously.

The Ancient said...

And here I thought you'd be cutting him some slack for all that fine writing in eXile about object sex and piracy.

Ralf the Wise and Powerful said...


Change "flaunting" to "flouting" in the 7th graf:

FLG doesn't know, legally, how much Goldman had to disclose, but he's of the opinion that Goldman didn't get to where it is by flaunting disclosure laws.

FLG said...



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