February 21, 2012

Goldman Sachs: The Master of Engineered [European] Crisis?

By David Smith at Economy Watch

The secret of Goldman Sachs’ power over the global financial system can be summed up in one word: Alumni. In his book, 13 Bankers, the former International Monetary Fund economist Simon Johnson argued that the relationship between Goldman Sachs and the US Government was so close in the run-up to the 2007 crisis, that the country was effectively “an oligarchy.”

Although European nations are not bought off by the banks in the same way as in the US, Johnson says that European financiers and politicians have formed alliances to perpetuate their mutual interests. Often, today’s European politicians have backgrounds in the financial sector, and more often than not connections to Goldman Sachs. The new prime ministers of Greece and Italy, for example, as well as the president of the European Central Bank, are all former investment bankers.
“This network of Goldman’s alumni power gives rise to far-fetched conspiracy theories,” said Suzanne McGee, author of Chasing Goldman Sachs. “But we don’t need conspiracy theories to speak about conflict of interest.”
“The bankers’ mindset is determined by their time on Wall Street so they don’t see the full range of options open to governments. They cannot envisage a world in which the banks are not vital to society and the economy. They are entrusted with policy because governments believe that to understand these giant and complex institutions, you have to have lived within the belly of the beast.”
The Bush administration, for instance, was dominated by Goldman graduates. The most powerful of them was the treasury secretary, Henry Paulson, a former Goldman CEO who became the architect of the bailout in his role. Paulson did nothing to hide his close relationship with his former employees despite blatant conflicts of interest. He even admitted to wanting to bring Wall Street and market regulators closer together so they were “seeing the same issues, the same problems and working toward the same solutions.”

Related Reading - How Goldman Sachs Became The Most Hated Bank on Earth

During the week of the bailout, according to the New York Times, Paulson spoke with the Goldman Sachs’ CEO, Lloyd Blankfein, 24 times. Thanks to his indoctrination with Goldman’s values, Paulson believed that what was good for the bank was good for the country.

As a result, Paulson’s bailout package greatly benefited his former paymasters and friends at Goldman Sachs. First, he elected not to save rival bank Lehman Brothers from collapse; second, he gave Goldman bailout money from the US government despite it coming out of the crisis better than any other bank; third, Paulson organized a massive rescue of AIG Group; all while in constant telephone contact with Goldman CEO Blankfein. AIG ultimately ended up using US$12.9 billion in taxpayers’ money to pay off all its debts to Goldman.
“Saving AIG is the perfect example of a naked conflict of interest,” said former bank regulator William K. Black. “Blankfein was invited to the meeting to determine AIG’s fate and asked for his views. But the Goldman CEO should never have been allowed in the room, much less listened to. He’s obviously going to say, yes, we really want the taxpayers to be on the hook for more money.”
Other Goldman alumni also did well in the bailout. Robert Rubin, Bill Clinton’s former Treasury secretary, spent 26 years at Goldman before becoming chairman of Citigroup — which received a US$300 billion bailout from Paulson. And John Thain, the chief of Merrill Lynch and a former Goldman banker, also earned a multi-billion-dollar handout when Paulson used public money to fund Bank of America’s rescue.

The democrat Barack Obama came to power with the pledge to “hold the big banks accountable”, but then he hired a team of Goldman-ites, and other former Wall Street bankers to help him run the economy. Conflicts of interest were especially apparent with Obama’s appointment of Larry Summers as National Economic Council chairman in 2009. Summers earned US$2.8 million in speaking fees from many of the major financial institutions including US$135,000 for a single speech to Goldman Sachs in 2008.
“It’s hard to understand the Democrat reasoning,” said William K. Black. “They had two choices – number one, blame the crisis on the people who caused it - my political opponents; or number two, make the crisis mine by taking the leading architects and making them my officials. They’ve just completely screwed up the world, but I will choose number two! Obama’s policy-making will go down in the history of political science.”
Professor Stefano Harney, an expert in corporate governance, at Queen Mary University of London, believes that Obama’s craven capitulation to the banks’ power can partly be explained by fear.
“Government blindness to the iniquities of banks is partly because they are scared of them,” he said. “They are desperate to maintain their own credit ratings and afraid to have debts and deficits too clearly hedged, or marginalized by banks.” 
“Government leaders also believe more in the banks as a force for good than the bankers themselves. Obama certainly believes the US needs a strong banking sector and it’s the same with the British PM David Cameron, his chancellor George Osborne and deputy PM Nick Clegg. This British trio all comes from banking families so that’s the fraction of capital they are most familiar with.”
Goldman’s Network of Influence in Europe

But, Goldman’s alumni power is not confined to just the major American institutions. Cynical commentators have described Goldman’s network of influence in Europe as “like freemasonry”. The continent’s struggling economies increasingly look to Goldman for a panacea. In Italy, the new PM Mario Monti is the first senior adviser at Goldman Sachs to take charge of a Western nation. Similarly, Mario Draghi, the President of the European Central Bank, spent three years as managing director of Goldman Sachs International. The New Greek PM, Lucas Papademos, has more tenuous links with Goldman, but like Mario Monti in Italy he is another unelected banker. Papademos was Governor of the Bank of Greece from 2002-2010.

The policies selected by the Goldman elite running the major European economies then, of course, favor the banks. The consensus of opinion is that the creditors – the big banks - of bigger nations like Italy and Spain must be paid in full. This rigid policy has led to crippling austerity measures throughout Europe and rescue funds from the IMF.

Ironically, Goldman Sachs has been entrusted to determine the economic policies of Europe’s failing nations even though there is widespread evidence that they played a major role in precipitating the European crisis. Both Italy and Greece were advised by Goldman Sachs bankers on how to squeeze into the single currency by falsifying their economic data. This was done using complex derivatives to reduce the size of government debt, which could not be above 60 per cent of the size of the economy to qualify for the single currency.

In Greece, for example, which has never managed to adhere to the 60 per cent limit, Greece’s debt managers agreed a huge, dodgy deal with Goldman Sachs in 2002. The deal involved cross-currency swaps in which government debt issued in dollars and yen was swapped for euro debt for a certain period – then switched back later on.

These transactions are quite common, but this particular one was a “special” kind involving fictional exchange rates. The deception allowed Greece to receive a far higher sum than the actual euro market value of 10 billion dollars, or yen. In effect, Goldman secretly arranged additional credit of up to $1 billion, which did not appear in Greek’s economic data.

According to Stefano Harney, although Goldman may be offering advice to European governments, it is still looking out for number one.

“We are seeing the same conflicts of interest that we saw during the US sub-prime crisis. But this time it’s on a global scale with potentially even more disastrous consequences. Goldman, for example, was briefing the finance minister of Spain at the very same time as its bankers were taking out huge bets that Spain will not be able to sustain its debt.”

Harney says that many of the hot-shot bankers fired from Goldman Sachs’ mortgages desk have been re-hired on the emerging markets’ desk and are putting together the same kinds of high-risk deals.

“These scoundrels have not mended their ways and if anything they have seen opportunities to expand their business into the rest of the world in ways frightening to contemplate,” he said.

Harney added that Goldman’s bankers were selling a huge number of credit debt swaps (CDS). These are used to gamble on the economies of the BRIC countries, and also the Next 11 economies, such as Nigeria, Mexico and Turkey.

“The CDS market had fallen to 25-30 trillion dollars – still double the GDP of the US – but it’s now floating back up above 40 trillion and that’s largely because of CDS products in these emerging countries which have the same explosive capacity as the trashy sub-prime loans,” Harney said.

“But if Indonesia goes down, or Greece, the credit defaults won’t be honored and we will have the same crisis as last time except on a global scale. These are much less stable countries than the US. Their middle-classes are more precarious and their working classes are poorer. There is a much greater risk of major political unrest. Also, the stability of China and India prevented the 2008 crisis being worse. But next time around they will be far more exposed.”

Goldman Sachs: The Master of Engineered Crises?

The Machiavellian realities of Goldman’s betting on the global markets were revealed last September when a 54-page strategy report written by one of the bank’s top trading strategists was leaked to the Wall Street Journal. Alan Brazil’s report predicted that an economic collapse was coming. It said the US debt problem could not be resolved with more debt, that the euro crisis would deepen and that large numbers of European financial institutions were close to collapse. Brazil recommended buying a six-month put option on the euro versus the Swiss Franc, thus betting the euro would drop against the Franc, as well as buying a five-year credit default swap on an index of European corporate debt—the iTraxx 9 – in other words, betting these companies will default.
“Brazil is basically suggesting betting against whole countries and whole currencies,” said Harney.
“The Brazil report is a good example of Goldman’s power. They can load up against a place, and then they make it almost inevitable that it will fail. Investors say ‘look everyone is betting against this place surviving’, so the danger is they actually produce the effect of it.”
There is also an argument that Goldman thrives on precisely these types of engineered crises.
“Crisis is just a larger version of what they do every day. Goldman Sachs is in the business of creating risk and betting on the risk and crisis is a massive risk,” said Harney.
“Goldman is the best firm to handle it and now they can do on global scale. Unfortunately the rest of us are drawn against our will into their crazy games.”
And despite the dangers they pose, there is little sign of remorse.
“A lot of Goldman’s bankers are characterized by the philosophy that ‘this is the way the world is so why should I not be at the top of it?’”
“You don’t run into too many investment bankers any more who argue that they are reallocating capital to business. They know they are not doing that. Most have a neo-classical, cynical outlook. They say ‘the countries are coming to us for advice so why blame us’?”
William D. Cohan as such advocates what he calls ‘closing the casino’ to control the bankers’ excesses.
“For me, it all comes down to incentives. People do what they are rewarded to do and on Wall Street they get rewarded for taking big risks with other people’s money,” he said.
“I would cut compensation in half, and force the top 100 executives at each firm to have their entire net worth on the line like they used to do when Goldman was a private partnership. This is what I call ‘closing the casino’. It controls the risk-taking and risky trading that got many firms into trouble. Goldman did okay in the crisis, but it’s the exception that proves the rule. No other firm is as gifted as Goldman.”

William K. Black also argues that the bank’s power would be diminished if they were forced to shrink.
“First you don’t allow them to grow and, second, you say that within five years you must shrink to a level at which you no longer pose a systemic risk, which is getting under around US$50 billion. We should also consider bringing back the Glass-Steagall banking reforms. They worked, which was their primary sin.”
“Broadly speaking, before the banks destroyed it, we had a financial system that was working well.”
Author Suzanne McGee though is more cynical about the prospects of controlling the bankers.
“Short of modifying human DNA, I can’t see any way of legislating to stop them. You can create rules, but a really creative banker - of whom there are a lot – will find a way to tunnel under the wall, or get a ship and sail around them,” she said.
William K. Black shares McGee’s low view of the moral character of Goldman’s bankers:
“They are almost a cliché of bad capitalists. They are really pernicious for the world and it’s hard to think of any value they bring. It’s to be hoped they can hire people to train them to act as if they are humans, but I suspect they will remain utterly indifferent to their customers."
"The greatest miracle performed by Goldman is in persuading people to be their customers. Why would anyone go to Goldman as a customer? You are just asking to be scalped.”
Related Reading - How Goldman Sachs Became The Most Hated Bank on Earth


Courtesy David Smith aEconomy Watch(EconMatters author archive here)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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