Is Goldman Sachs the new Anthem Blue Cross?
In early February, Anthem Blue Cross announced that it would be raising its insurance premiums by 39%. The resulting uproar returned the nation’s attention to health care reform and offered a perfect example of why real action was needed. President Obama immediately announced a summit of Congressional leaders on this issue with the goal of “rescuing” the health care legislation. Of course, this ultimately proved successful, with Obama signing the historic reform into law in March.
Congress is now focusing on another monumental task: reforming financial regulation. The need for action is clear – you would have to be living under a rock for the past few years to have missed the collapse of several Wall Street titans, plummeting retirement funds, countless foreclosures, and hundreds of bank failures, all of which can be directly attributed to a lack of effective regulation.
Reform of financial regulation may seem like a done deal to any logical person (who would not want to reign these ridiculous practices?!?), but the reality is unfortunately more complicated. As was the case in the health care reform battle, money is pouring in from the corporate world. Contributions from firms in finance, real estate, and insurance totaled a whopping $455,414,072 in 2009. This sector also employed 2,597 lobbyists, or roughly 6 per member of Congress. Being the recipients of this absurd sum of money, it comes as no surprise that many in Congress are reluctant to do much.
So, despite the House having passed a comprehensive bill in December 2009, the probability that reform would be signed into law by President Obama has recently been less than certain. However, that was before Friday, April 16.
On that day, the SEC released a simple statement indicating that it was charging Goldman Sachs, the king of Wall Street and alleged blood sucking vampire squid, with fraud. This stunning (and apolitical) announcement could very likely provide the catalyst needed for this legislation to become law. In other words, this allegation of fraud could have the same impact on financial regulatory reform that Anthem’s rate hikes had on the health care legislation.
The exact allegations could prove damning if shown to be true. Apparently Goldman Sachs constructed a synthetic collateralized debt obligation (CDO) in September 2007 with the direct input of billionaire hedge fund manager John Paulson. He wanted to short this instrument as a way to bet against the building housing bubble. The foundation of the CDO was a series of mortgage-backed securities (MBS) that were hand-picked to fail. Obviously, Paulson had a pretty good bet.
On the other hand, one of Goldman Sachs’ clients, ACA Management, was not quite so lucky. Goldman marketed the long position of this built-to-blow-up CDO to ACA, who agreed to purchase it. You may be asking how ACA could be so foolish? Well, apparently they weren’t: the SEC says that Goldman neglected to properly disclose how the CDO was initially created. Of course, if ACA knew that the CDO was created by Paulson, a famously savvy investor, and was composed of such poor MBS, it would have clearly not purchased it.
Although this is an unfortunate event for ACA and its clients, proponents of reform have to feel blessed that this news literally fell into their lap at such a crucial time. This is a perfect example of why reform is needed. Advanced financial instruments, commonly known as derivatives, are shrouded in a world of secrecy and free of any effective regulation. Nonetheless, they have the power to destroy entire financial institutions (see: Lehman, Brothers).
Fortunately, the Senate is moving forward with legislation that would reign in the $450 trillion derivatives market. If passed, it would enhance derivatives’ supervision and limiting their use by depository institutions. Let’s hope this momentum continues, comprehensive legislation is soon passed, and this unfortunate incident is ultimately remembered as the catalyst for much needed reform.
