Monday, April 19, 2010

Finance as Fraud Itself

This morning the Vulcan cloud of cinders is as good a commentary as we're going to get on the fragility of an economy that depends on unsustainble long range transport. 

Krugman is a bit late but still lucid defining the crisis as issuing from deliberate fraud. He mentions a good ProPublica piece on the same kind of toxic stuffing at a hedge fund with one of the stupid fake names bankers love - Magnetar, which immediately dissolves into several variants composed of amputated partwords stitched together by Dr. Frankenstein - Mangy-tar, eat-tar (from the French manger- to eat), eat nectar, magnet-star . . .)

A commentary on Goldman Sachs by Will Hutton gets at two other core issues in the rise of finance over the past 30 years in the Anglo-American version of capitalism (beyond the use of complexity to defraud one group of clients for the benefit of another).  The first is the abuse of independent professionals as fronts of legitimacy: clients couldn't see under the hood of the instruments they were buying, so they took the word of analysts on the basis of their professional stature and institutional affiliation.  "A court-appointed examiner found that collapsed investment bank Lehman knowingly manipulated its balance sheet to make it look stronger than it was – accounts originally audited by the British firm Ernst and Young and given the legal green light by the British firm Linklaters."

And in the Goldman Sachs case,
Goldman allegedly went one step further, according to the SEC actively creating a financial instrument that transferred wealth to one favoured client from others less favoured. If the Securities and Exchange Commission's case is proved – and it is aggressively rebutted by Goldman – the charge is that Goldman's vice-president Fabrice Tourre created a dud financial instrument packed with valueless sub- prime mortgages at the instruction of hedge fund client Paulson, sold it to investors knowing it was valueless, and then allowed Paulson to profit from the dud financial instrument. Goldman says the buyers were "among the most sophisticated mortgage investors" in the world. But this is a used car salesman flogging a broken car he's got from some wide-boy pal to some driver who can't get access to the log-book. Except it was lionised as financial innovation.

The investors who bought the collateralised debt obligation (CDO) were not complete innocents. They had asked for the bond to be validated by an independent expert into residential mortgage-backed securities – a company called ACA management. ACA gave the bond the thumbs-up on the understanding from Fabrice Tourre that the hedge fund Paulson were investing in it.
 Whether or not Goldman Sachs' Tourre lied to his investors and said that Paulson was investing in the CDO when in reality he seems to have made it as toxic as possible so he could bet it would collapse, as it did, the deeper point is that these transactions were confidence games, literally speaking.

The further issue is that the transactions had no value except in the confidence game that constructed them. Outside of that, they had no value, certainly not for society.  Hutton writes,
It is time to reframe the question. Banks and financial institutions should do what economy and society want them to do – support enterprise, direct credit to where it is needed and be part of the system that generates investment and innovation. Andrew Haldane – and the governor of the Bank of England – are right. We need to break up our banks, limit their capacity to speculate and bring them back to earth.
That would be to end high finance as we know it, because that does not invest in enterprise or places where credit is socially needed.  The returns there are lower than what it can get elsewhere.

In a similar spirit, see the Stiglitz presentation on financial reform at a large economics conference at Cambridge University a couple of weeks ago.  It comes from a world that doesn't yet exist.  Perhaps it will be revealed by the passing of the Vulcan cloud of ash.

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