By Simon Johnson
Last week, Senator Ted Kaufman (D., DE) gave a devastating speech in the Senate on “too big to fail” and all it entails. A long public silence from our political class was broken – and to great effect. Today’s Dodd reform proposals stand in pale comparison to the principles outlined by Senator Kaufman. And yes, DE stands for Delaware – corporate America has finally decided that its largest financial offspring are way out of line and must be reined in.
Today, the Senator has gone one better, putting many private criticisms of the financial sector – the kind you hear whispered with conviction on the Upper East Side and in Midtown – firmly and articulately on the public record in a Senate floor speech to be delivered (this link is to the press release; the speech is in a pdf attached to that – update: direct link to speech, which will be given tomorrow). He pulls no punches:
“fraud and potential criminal conduct were at the heart of the financial crisis”
He goes after Lehman – with its infamous Repo 105 – as well as the other entities potentially implicated in those transactions, including Ernst and Young (Lehman’s auditors). This is the low hanging fruit – but have you heard even a squeak from the White House or anyone else in the country’s putative leadership on this issue?
And then he goes for the twin jugulars of Wall Street as it still stands: The idea that we saved something, at great expense in 2008-09, that was actually worth saving; and Goldman Sachs.
“[T]his is not about retribution. This is about addressing the continuum of behavior that took place – some of it fraudulent and illegal – and in the process addressing what Wall Street and the legal and regulatory system underlying its behavior have become.”
Our system has long been imperfect, but it used to work much better:
“When crimes happened in the past (as in the case of Enron, when aided and abetted by, among others, Merrill Lynch, and not prevented by the supposed gatekeepers at Arthur Andersen), there were criminal convictions.”
Here’s the most intriguing bit – he challenges the moral authority of those who think they are doing “God’s work” in finance.
“If we uncover bad behavior that was nonetheless lawful, or that we cannot prove to be unlawful (as may be exemplified by the recent reports of actions by Goldman Sachs with respect to the debt of Greece), then we should review our legal rules in the US and perhaps change them so that certain misleading behavior cannot go unpunished again.”
But that’s not all – he actually lays out the parameters of what should be, if our legal institutions still functioned, a compelling case against Goldman.
“Following these transactions, Goldman Sachs and other investment banks underwrote billions of Euros in bonds for Greece. The questions being raised include whether some of these bond offering documents disclosed the true nature of these swaps to investors, and, if not, whether the failure to do so was material.”
“These bonds were issued under Greek law, and there is nothing necessarily illegal about not disclosing this information to bond investors in Europe. At least some of these bonds, however, were likely sold to American investors, so they may therefore still be subject to applicable U.S. securities law. While “qualified institutional buyers” (QIBs) in the U.S. are able to purchase bonds (like the ones issued by Greece) and other securities not registered with the SEC under Securities Act of 1933, the sale of these bonds would still be governed by other requirements of U.S. law. Specifically, they presumably would be subject to the prohibition against the sale of securities to U.S. investors while deliberately withholding material adverse information.”
This sounds like a potential violation of Rule 10b-5 – you are simply not allowed to sell securities in the United States while withholding material adverse information, i.e., what any reasonable investor would want to know (like the true indebtedness of a government, when you are being pitched on a sovereign debt issue). In fact, such actions are frequently considered serious fraud – at least when the people involved aren’t as powerful as Goldman Sachs.
And after having just spent a considerable amount of time with Hank Paulson’s memoir, On the Brink, I have to ask: What did Hank Paulson know (as CEO of Goldman at the time), and when did he know it – regarding the potential misleading sale of Greek government securities to US entities? Goldman reportedly netted $300m from its Greek “swaps” and presumably more from managing subsequent Greek debt issues; this is the same order of magnitude as Mr. Paulson’s payout when he left Goldman (around $500m, tax-free).
Who is Senator Kaufman and what power does he have in this situation? He is not a member of the Senate Banking Committee – and if you think this is a regulatory issue, that reduces the weight of his voice.
But he is a member of the Senate Judiciary Committee and we are discussing here potential crimes – or what should be crimes if the legal system still functioned. He was also a cosponsor of the Fraud Enforcement and Recovery Act (FERA) – which was right on topic – and is an experienced Capitol Hill insider who has studied these issues long and hard. He has also worked closely, over many years, with Vice President Biden.
The tide is turning, but not primarily through the actions of Senator Dodd and his Banking colleagues. Rather the biggest and most unruly players in our financial system have behaved in such an egregious manner that they will be brought down by the law – either that, or they will further bring down the law.