Ending the Moral Rot on Wall Street, Part 1: William D. Cohan
What will it take for Americans to finally get the message that much of Wall Street, in its current form, is a corrupt enterprise in need of a top-to-bottom overhaul, a task that the year-old Dodd-Frank law, for all its verbosity, barely attempts?
There is ample evidence in the detritus left behind by the ebb tide of the worst financial crisis since the Great Depression. There are the thorough -- and thoroughly damning -- reports (along with thousands of pages of accompanying internal Wall Street documents) produced by the Financial Crisis Inquiry Commission and the Senate’s Permanent Subcommittee on Investigations. More was exposed by Anton Valukas, the chairman of the Chicago law firm Jenner & Block LLP, in his investigation of the accounting shenanigans engaged in by a handful of Lehman Brothers Holdings Inc. (LEHMQ)’s executives in the months leading up to that firm’s spectacular bankruptcy in September 2008.
Each examination revealed layer upon layer of behavior that should make us seethe with anger. These include the decision to manufacture and sell mortgage-backed securities that were stuffed with loans of questionable value, plus the worthless AAA ratings placed on them by ratings services paid by Wall Street to do so. Also the business model that encouraged bankers and traders to take asynchronous risk with other peoples’ money with the knowledge that by the time things went wrong, billions of bonus dollars would be paid out, and no effort would be made to hold anyone accountable.
Then there is the surfeit of lawsuits brought against Wall Street -- some since settled, some ongoing -- that add to our understanding of the deception. One example: the $550 million fine -- one of the largest ever -- that Goldman Sachs Group Inc. (GS) paid in July 2010 to the Securities and Exchange Commission. The penalty was assessed to settle a civil lawsuit questioning whether the bank provided enough information to investors about the efficacy of a squirrelly synthetic collateralized-debt obligation it manufactured and sold in April 2007, about four months after the firm had started to short the mortgage market with a vengeance.
Documents released along with the lawsuit showed that the bankers working on the deal, known as ABACUS-AC2007, questioned its efficacy. One of them, Fabrice Tourre, a Goldman vice president, wrote in a January 2007 e-mail that he was “standing in the middle of all these complex, highly levered, exotic trades he created without necessarily understanding all the implications of those monstruosities!!! Anyway, not feeling too guilty about this, the real purpose of my job is to make capital markets more efficient and ultimately provide the US consumer with more efficient ways to leverage and finance himself, so there is a humble, noble and ethical reason for my job ... amazing how good I am at convincing myself!!!”
In the same note, Tourre confided that there was “more and more leverage in the system ... the entire system is about to crumble at any moment ... The only potential survivor, the fabulous Fab.”
If this weren’t cynical enough, Goldman had by that time decided to make a huge proprietary bet against the mortgage market, while continuing to sell mortgage-backed securities to investors at 100 cents on the dollar. In 2007 alone, that short bet made Goldman almost $4 billion, almost a quarter of the $17.2 billion in pretax profit the firm made that year. Yet it didn’t disclose its short to the market until Oct. 4, 2007, well after the money had been made, and then only in an obscure letter to the SEC.
“During most of 2007, we maintained a net short sub-prime position and therefore stood to benefit from declining prices in the mortgage market,” the letter said. Apparently, there’s no crime in this kind of behavior. There should be.
Goldman wasn’t the only bank to display ethically challenged behavior. Consider the $154 million fine that JPMorgan Chase & Co. (JPM) paid to the SEC in June 2011 for doing pretty much the same thing. Or look at the $75 million fine that Citigroup Inc. (C) paid to the SEC in July 2010 for misrepresenting its balance-sheet exposure to mortgage-backed securities. Citi told investors it had $13 billion of exposure when it really had $50 billion.
Or there was the agreement by Bank of America Corp. (BAC) in February 2010 to pay the SEC a $150 million fine to settle charges that it misled its shareholders to persuade them to approve its September 2008 acquisition of Merrill Lynch & Co. Inc. The bank failed to tell its stakeholders that Merrill had paid its employees billions in bonuses at the same time it was losing billions in income.
Had the truth been known, Bank of America’s shareholders might have voted to scuttle the deal. But the firm’s executives, as well as the federal government, didn’t want that outcome, so they kept silent, and the deal went through unaltered. The federal judge who approved the settlement -- after the amount was increased almost fivefold -- correctly described it as “half-baked justice.”
Then there is the still-pending civil lawsuit filed by Preet Bharara, the U.S. attorney in Manhattan, against a mortgage-lending unit of Deutsche Bank AG, accusing it of lying about the quality of the home loans it issued. The U.S. is demanding repayment of hundreds of millions in losses suffered by the government. The Deutsche Bank unit “indulged in the worst of the industry’s lending practices,” Bharara said.
Boon for Lawyers
There’s much, much more. Indeed, the word at many Manhattan law firms these days is that legal action related to the financial crisis is keeping litigation departments busier than at any time before.
Was all of this immoral, unethical and illegal behavior a mere aberration, brought on in the years leading up to the financial crisis by an atypical combination of greed and hubris?
Sadly, no. Rather, it was of a piece with a continuous line of dubious behavior that has characterized parts of Wall Street for generations. In 1929, Goldman’s partners -- including the revered Sidney Weinberg, who led the firm for almost 40 years -- manipulated the stock of the Goldman Sachs Trading Corp., its publicly traded investment trust, to drive its price higher to win shareholder approval for a merger with another publicly traded investment trust. When the crash hit in October 1929, investors in the trading corporation lost almost everything and Goldman Sachs itself was nearly bankrupted.
Then there was Goldman’s self-serving behavior during the months leading up to the bankruptcy of the Penn Central Corp., in 1970 -- the largest failure to that date. Once again, Goldman almost went bankrupt as a result of defrauding its clients.
The most recent incidents weren’t even the first time in the first decade of the 21st century that Wall Street got collectively strung up. In April 2003, New York Attorney General Eliot Spitzer orchestrated a $1.4 billion “global settlement” between his state, the SEC and the New York Stock Exchange and 10 of the then-largest Wall Street firms, to penalize the banks for creating blatant conflicts of interest between their equity- research departments and their investment-banking divisions.
Spitzer’s investigation showed that Wall Street was willing to craft its research to its clients’ liking in exchange for investment-banking business, primarily in the form of assignments to underwrite lucrative IPOs of hot, technology companies.
One of the more painful facts about the recent financial crisis -- the consequences of which we are still suffering -- is that it was entirely avoidable. Doing so, however, would have required Wall Street’s bankers, traders and executives to show a certain self-enlightened prudence about the mountain of risk they were scaling rather than be driven by collective greed.
In other words, there might well have been a very different outcome to the events of 2007 and 2008 had Wall Street behaved as if it had genuine accountability for its actions, as it did when firms were private partnerships where stakeholders had their net worth on the line. Instead, the financial industry figured it would get bailed out by its friends in Washington because it was too interconnected to be allowed to fail.
That Wall Street executives have been able to avoid any shred of responsibility for their actions in the years leading up to the crisis speaks volumes not only about an abject ethical deterioration but also about the unhealthy alliance that exists between the powerful in Washington and their patrons in New York. Our collective failure to demand redress against a Wall Street culture that remains out of control is one of the more troubling facts of life in America today.
You would think that in the wake of the trillions of dollars spent bailing out Wall Street, a measure of contrition would be forthcoming. You would be wrong. While the rest of the country continued to suffer genuine economic hardship in 2010, bankers and traders and executives received about $150 billion in compensation. Is it any wonder then that we are repulsed when we come across the gloating of a banker at JPMorgan Chase, who upon being congratulated by a colleague for being hired to restructure the debt of one of the worst deals of the past decade -- the $8.5 billion leverage-larded acquisition of the Tribune Co. by the Chicago investor Sam Zell in December 2007 - - replied: “Tnx dude. Can you say ka-ching?”
This decay of Wall Street mores hasn’t gone unnoticed -- at least not by Bharara, the U.S. attorney for the Southern District of New York. In a speech in June to a group of financial journalists, a few weeks after his office won the high-profile conviction of the hedge-fund manager Raj Rajaratnam on 14 charges of insider trading, he wondered about the implications of widespread illegal behavior.
“The bigger and better question may not be whether insider trading is rampant, but whether corporate corruption in general is rampant, whether ethical bankruptcy is on the rise, whether corrupt business models are becoming more common?”
“Some of the most egregious securities frauds,” he added, have occurred “in some of the most prominent and powerful, publicly traded companies, consulting firms, accounting firms, and even law firms.”
These crimes are being committed, he said, by people who “have already made more money than could ever be spent in one lifetime and achieved more impressive success than could ever be chronicled in one obituary. And it begs the question, is corporate culture becoming increasingly corrupt?”
Yes, it certainly does raise that question.
In a subsequent column, I will propose some measures to restore public confidence in Wall Street.
(William D. Cohan, a former investment banker and the author of “Money and Power: How Goldman Sachs Came to Rule the World,” is a Bloomberg View columnist. The opinions expressed are his own.)
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