Of Gold Sacks and Garbage
So Goldman Sachs (Gold Sacks to those of us who have watched its operations with ever-increasing horror) is finally getting spanked by the SEC. GS created and marketed a junk-stuffed synthetic CDO at the request of and with the advice of hedge funder John Paulson. No legal problem there. GS disclosed to the CDO buyers that Paulson was investing in the CDO. No legal problem there. Except that GS left out these teeny-tiny details: Paulson was betting against the CDO, he had picked the CDO content so he could bet against it, and GS sold him his bet. Oops. Hence the SEC action.
What happens now? That depends to a great extent on GS. Remember that GS is a publicly traded company, so it is required to make certain disclosures, and its disclosures (required or not) are heavily regulated. And for the last week, GS has been digging itself deeper with every disclosure. GS apparently received a Wells notice (the tap on the shoulder the SEC gives a company before it files an enforcement action), and the general counsel determined that wasn't a material event requiring disclosure (Translation: We insiders know the stock is about to tank, and we want an opportunity to dump our shares before the public finds out. That's called insider trading kids. I wish I made his salary for giving that kind of advice.). Then GS issued a statement claiming the SEC complaint had no basis in law or fact, a statement that will be classified as a material misstatement in a disclosure should there prove to actually be a basis to the complaint (and it will so prove). And GS has kept swinging from there. The stupid, it burns.
GS could start getting smart and try to resolve this thing, which everyone expects it to do. The question there is whether the SEC is ready to deal or if it wants a pound of flesh and doesn't care about Portia's collateral damage arguments. GS may find itself in a box and try to get out using the nuclear option of showing the SEC just how deep the rabbit hole goes, disclosing other deals and other players. And then the fun will spread, because the markets will not be able to ignore a mess like that the way they've ignored economic reality the last year.
Of course there's a "Happy Happy Joy Joy" crowd that thinks nothing will come of this, it's just political, GS didn't do anything wrong. Fareed Zakaria, CNN's alleged financial genius talking head, says this morning that the SEC case is weak because it's based on the CDO going bad, which just happens and isn't illegal. Excuse me Fareed, but you're exactly wrong. The complaint is based on material nondisclosure, and you just showed the world you've been drinking deeply from Alan Greenspan's "No One Could Have Known" Kool-Aid jug. That sound you hear is whatever respect I had for Zakaria running over the hill with its hair on fire.
So what's next? Well, the markets are going to have to stop their exuberant climb, which was based on nothing anyway. And the Too Big To Fails will find that failure is an option because their revenue is based on destructive practices that need terminated. These changes are necessary if our economy is to survive, and they will be painful. Just not so much to those of us who are mere mortals and do not live in such rarefied air. Let's face it, how many of us have seen any return from the market run-up this last year? How many of us get financing from the likes of GS? Not that many. Jobs are scarce and shaky. Our customers are scared and aren't buying. The little banks that finance us and our customers are still failing at a record pace (and the Bigs are taking the rake, so any clampdown on them is a plus for us), and financing will only get tighter as an even bigger tsunami of ARMs resets over the next two years (which will also result in more foreclosures and more real estate deflation). We're in a mess that will take years to sort out, and what comes out the end will be a completely different animal than what went in.
Just do yourselves a favor. Introduce yourselves to your neighbors and local businesses. They're the people you're going to be depending on for the next several years.