The Wages of Hubris (II) – Goldman Sachs(?)

Currently, Goldman Sachs is under intense scrutiny. Matt Taibbi’s article for the July 2 Rolling Stone, “Inside the Great American Bubble Machine,” in which he blames Goldman for market bubbles since the 1920s, is an extreme version of the criticism, which Goldman no doubt could effectively rebut if it felt it had to, but, depending on the facts which are not all known, more recent criticism involving AIG and now Greece might be harder to shake off.

During the 1980s, two of the most important investment banks had similar names but apparently quite different corporate cultures.  They were, of course, Salomon Brothers and Goldman Sachs.  Salomon was especially an important firm in the government securities market and I would note that its research department produced interesting papers, some of which, such as those having to do with the pricing of zero-coupon securities, I found very useful in my work for Treasury at the time.  But Salomon's sense of its importance and invulnerability caught up with it when some of its officers thought they could get away with lying to the Treasury on the tender forms the firm submitted at auctions of Treasury securities.  In 1991, they got caught, and the resulting scandal eventually led to the firm being merged with Smith Barney, and its name disappearing as part of Citigroup.

Goldman has never been as brazen in dealing with the government as Salomon.  The firm makes great efforts to have good relationships with the government.  As evidence of their success at this, the SEC has in the past directed other government agencies to Goldman for explanations of their state of the art compliance programs.  It has also not hurt the firm’s reputation that many of its partners do a stint of government service  and, whatever else one might want to say about these Goldman alumni, they are smart.

Goldman’s record is not unblemished, though.  For example, on October 31, 2001, Goldman received word that Treasury had just announced that it would stop issuing 30-year bonds before the embargo on the news ended and traded on that information before it became generally know in the market.  Goldman’s CEO, Henry M. Paulson, claimed that the firm had not violated SEC rules (“Goldman Chief Denies Firm Violated Any SEC Rule,” New York Times, April 6, 2002).  However, the firm ended up settling with the SEC, disgorging $3.8 million in profits and $500,000 in interest and paying an additional $5 million penalty. Also, a Goldman employee was sentenced to almost three years in prison for his role in the affair.

This embarrassing history was, however, not mentioned when Paulson was later nominated and confirmed as Secretary of the Treasury.  Everyone seemed relieved that a man with a successful Wall Street career was taking over Treasury after being headed by two Secretaries who had received generally bad reviews and had been viewed as ineffective.  And however one might evaluate Secretary Paulson’s actions during the financial crisis, no one doubted his level of knowledge nor his influence in making policy.

Currently, as I have mentioned in a previous post, there are questions about Goldman’s relationship with AIG.  The New York Times  published an article about this a week ago, "Testy Conflict with Goldman Helped Push AIG to Edge."  However justified Goldman’s demands for collateral were from a weakening AIG, Goldman had to know at some point that its demands were increasing the risk of an AIG bankruptcy, in the wake of which the entire market, including Goldman, would suffer.  It appears we do not know the whole story here, and, as long as we do not, Goldman can expect there to be some suspicion directed its way.

Now it turns out that Goldman was helping out Greece in hiding its true fiscal situation through transactions Goldman arranged.  Simon Johnson, a former chief economist of the IMF, has been especially critical of Goldman on this. 

Given the threat to the euro of the Greek situation and what that means to the global monetary system, this affair could prove a challenge to Goldman.  It is quite possible that Europe will be able to muddle through this problem and any future ones (Portugal, Ireland, Italy, Spain?), but the dangers are real.  Of course, they are not Goldman’s fault; a reasonable argument is that Europe got too far ahead of itself in creating a single currency and that the UK was right to stay out.  But Goldman’s facilitating hiding fiscal problems will be examined.

The people who run Goldman are smart, and they may be able to ride out their current problems.  The facts, of course, may be more benign than one might now suspect.  But their actions and their success in making huge profits are getting unprecedented scrutiny.  They have much greater name recognition than they have ever had; for them, that is not a good thing.