The Banker Robbers

Lee Sustar

EVEN CONSPIRACY theorists couldn't make this stuff up: A plot by the most powerful Wall Street bank and a hedge fund kingpin to rev up subprime mortgaging lending in order to profit massively when the inevitable collapse finally came.

If a Securities Exchange Commission (SEC) lawsuit against Goldman Sachs is correct, the blowup of the housing market that began in 2007 was in part a controlled demolition engineered by Goldman and John Paulson, a hedge fund manager who got Goldman to create mortgage-backed securities that were meticulously designed to fail.

And if the New York Times is accurate, top Goldman executives--including CEO Lloyd Blankfein--were deeply involved, ordering traders to create ever more dog-dirt securities that would make big money for Goldman and John Paulson once the market crashed.

Investors in the esoteric products--known in the financial world as derivatives--that were designed to fail lost $1 billion. Paulson did rather better, pulling in an estimated $3.7 billion in 2007 and another $2 billion in 2008, even as the economy cratered.

Much of the media's coverage of the Goldman scandal has focused on the arcane details of the lawsuit. But the essentials are easy enough to understand.

A young Goldman Sachs trader, Fabrice Tourre, spotted the housing bubble back in 2005-2006, as did hedge fund boss John Paulson. When Paulson decided he wanted to bet on a big fall in home prices--and the default on mortgages and foreclosures that would result--he got Tourre to assemble securities--investment products known as collateralized debt obligations (CDOs)--tied to packages of mortgages that the two men believed would turn bad.

Paulson bought a piece of the CDOs, while Tourre, in turn, marketed them to other investors--including big banks like ABN/AMRO (now part of Royal Bank of Scotland).

But those investors were being played for suckers. While they bought CDOs that they believed would make them money, Paulson and Goldman Sachs were "shorting" them--that is, making a bet that their investments would turn worthless. They made this wager by purchasing credit default swaps (CDS)--essentially, a special form of insurance that would pay out an investment that went bad.

Sylvain Raynes, a financial consultant, explained the logic to the New York Times last year:

The simultaneous selling of securities to customers and shorting them because they believed they were going to default is the most cynical use of credit information that I have ever seen. When you buy protection against an event that you have a hand in causing, you are buying fire insurance on someone else's house and then committing arson.

As happens in other cases of arson, the fire spread out of control quickly. Financial firms that sold the credit default swaps--AIG, the world's largest insurer, was the biggest CDS dealer, but there were plenty of other companies involved--were on the hook to make payouts they couldn't remotely afford if the underlying investments went bad.

For example, ACA Capital Holdings Ltd., named in the SEC lawsuit against Goldman Sachs, was brought on board to insure the Abacus CDO created by Goldman and John Paulson to allegedly defraud investors. Incredibly, ACA insured some $50 billion in financial assets, even though it only had $400 million in capital and resources to pay claims.

Of course, Goldman Sachs bosses and John Paulson knew that ACA couldn't possibly meet its commitments. But that didn't matter, since they were passing all the risk onto others.

The inability of outfits like ACA--to say nothing of AIG--to pay their CDS obligations could only magnify the impact of any drop in the value of mortgage-backed securities. When the financial bottom fell out in the autumn of 2008, what might have been a typical recession morphed into the worst economic crisis since the Great Depression.

Credit markets seized up, creating a financial shockwave that has cost the U.S. economy at least 8 million jobs, wiped out $11 trillion in financial wealth, and caused even more immense economic suffering worldwide. The already rising foreclosure rate skyrocketed, and with unemployment rates stuck at around 10 percent, millions still remain at risk of losing their homes.

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IN RECENT testimony before Congress, assorted CEOs and other Wall Street bigwigs solemnly told us that they didn't see any of this coming, had nothing to do with it, and couldn't have stopped it in any case.

But in the Goldman lawsuit and beyond, the evidence is piling up that the best and brightest in the financial industry not only saw the housing bubble take shape, but also plotted to make it even bigger in order to profit when it burst.

In recent months, the big banks have returned to profitability and handed out huge bonuses, thanks to a massive government bailout. But that's okay, according to the Obama White House, because much of the government money that went to banks from the $700 billion Troubled Asset Relief Program (TARP) bank bailout has been repaid with interest.

In fact, the bailout goes far beyond TARP. It includes near-zero interest rates that inject free money into bank balance sheets, a panoply of special lending programs from the Federal Reserve Bank, and specialty regulatory changes that converted Goldman Sachs and other investment banks into bank holding companies to allow them to take advantage of these and other programs.

Then there's Goldman's hands-on--to put it mildly--approach to the federal government takeover of AIG to the eventual tune of $182 billion.

As the financial markets seized up in September 2008, Tim Geithner, then-president of the New York Federal Reserve Bank sat down with Goldman boss Blankfein and then-Treasury Secretary Hank Paulson (no relation to John) in order to cook up a rescue that involved AIG paying 100 cents on the dollar for its bad bets insuring mortgage-backed securities. As a result, some $14 billion of U.S. taxpayer money passed straight through AIG's books and into Goldman's coffers.

As the government's own inspector general for TARP, Neil Barofsky, put it, the Fed may have given a "backdoor bailout" to AIG's creditors, including Goldman. "Tens of billions of dollars of government money was funneled inexorably and directly to AIG's counterparties," he wrote. (Goldman, however, didn't even get the most from Uncle Sam's payout to AIG. That prize went to the French bank Societe Generale, which bagged $16.5 billion).

Certainly it came as no surprise that the George W. Bush administration was keen to tend to the interests of the big banks, especially Goldman. After all, Hank Paulson had been the company's CEO before taking over at Treasury.

But Obama's elevation of Geithner to Treasury Secretary ensured a continued friendly regime for Wall Street. And no wonder: Turns out that one of Geithner's top advisers, Lewis Sachs, formerly oversaw the CDO operations of Tricadia, another company that worked with Goldman Sachs to create rotten mortgage-backed securities, just like John Paulson.

"Some securities packaged by Goldman and Tricadia ended up being so vulnerable that they soured within months of being created," the New York Times' Gretchen Morgenson and Louise Story noted last year.

If people like Lewis Sachs could get away with this kind of operation, it was in no small part due to the financial deregulation pushed in the 1990s by Larry Summers, the former Treasury secretary who now serves as Barack Obama's top economic adviser.

With these kind of people in charge of economic policy, it's little wonder that many view the Democrats in the White House and Congress as just as cozy with Wall Street as the Republicans. Goldman employees even contributed $1 million to Obama's 2008 campaign, while hedge funds and private equity firms gave $2.9 million, according to the Center for Responsive Politics. This has given rise to the surreal specter of Republican senators attacking Obama from the left for his handling of Wall Street.

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NOW COMES the SEC lawsuit against Goldman. It may have been intended simply as vote-getter for Democrats in the November midterm elections--a way to build momentum to pass a proposed mild financial reform bill that Obama can portray as a curb on Wall Street greed. In fact, the SEC was playing catch-up to Morgenson and Story of the Times, who detailed the Goldman Sachs-John Paulson scam in a story published in December.

But by putting a harpoon into the biggest whale of all, the SEC has touched off a wider hunt by investigative journalists, powerful financial industry lawyers and ambitious prosecutors. Other Wall Street firms will become targets, too: The con game run by Goldman Sachs and John Paulson--creating mortgage-backed securities that were primed to turn toxic--was imitated by other players, large and small.

For example, investigative journalists at the nonprofit group ProPublica, Jesse Eisinger and Jake Bernstein, chronicled how a fairly obscure hedge fund, Magnetar, worked with most of the big Wall Street banks to create bad mortgage-backed securities similar to the one Goldman is alleged to have created for John Paulson. According to ProPublica:

At least nine banks helped Magnetar hatch deals. Merrill Lynch, Citigroup and UBS all did multiple deals with Magnetar. JPMorgan Chase, often lauded for having avoided the worst of the CDO craze, actually ended up doing one of the riskiest deals with Magnetar, in May 2007, nearly a year after housing prices started to decline. According to marketing material and prospectuses, the banks didn't disclose to CDO investors the role Magnetar played.

Many of the bankers who worked on these deals personally benefited, earning millions in annual bonuses. The banks booked profits at the outset. But those gains were fleeting. As it turned out, the banks that assembled and marketed the Magnetar CDOs had trouble selling them. And when the crash came, they were among the biggest losers.

Actually, though, the biggest losers are taxpayers. Many of the banks stuck with Magnetar's lousy CDOs were among those deemed too big to fail, and which therefore received a torrent of government cash.

When Tim Geithner's Treasury Department claims that the financial bailout has cost taxpayers "only" $89 billion, hold onto your wallet. As Gretchen Morgenson explained:

A major factor missing from Treasury's math is the vast transfer of wealth to banks from investors resulting from the Fed's near-zero interest-rate policy.

This number is not easy to calculate, but it is enormous. The Fed's rock-bottom interest-rate policy bestows huge benefits on banks because it allows them to earn fat profits on the spread between what they pay for their deposits and what they reap on their loans. These margins are especially rich on credit cards, given their current average rate of 14 percent and up.

Also included on the taxpayers' bill is the still-uncalculated cost of the nationalization of the mortgage giants Fannie Mae and Freddie Mac, the "government-sponsored enterprises" that own or guarantee most home mortgages. This past Christmas Eve, the White House quietly removed the $400 billion ceiling on the amount the government would pay to prop up Fannie and Freddie, suggesting that the final price tag will go far higher.

Together, Fannie and Freddie have $1.6 trillion in debt and hold $5 trillion in mortgaged-backed securities, much of which is worth far less than its stated value.

And that's not all. The 18 biggest banks have gotten at least $34 billion in subsidies as the result of special government loan programs, according to Dean Baker, co-director of the Center for Economic and Policy Research. The list could go on.

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IF YOU'RE having a hard time keeping track of all that government money flowing into the banks, well, that's the point. After the fury that followed the passage of the TARP bill in Congress last fall, politicians in both parties have learned to camouflage taxpayer subsidies to the banks.

Add it all up, and various government entities have either loaned, invested or guaranteed up to $13 trillion. Certainly, not all of that amount has or will be paid out. Still, the message is clear: When it comes to bailing out Corporate America, money is no object--as long as it's taxpayer money. Even when Wall Street fraudsters put that cash straight into their pockets.

Meanwhile, of the millions of people stuck with mortgages at exploding interest rates and collapsing home prices, only a small minority got a chance to participate in a government program that reduced mortgage payments--and even then only temporarily.

The recipients of the bailouts have turned out to be even more crooked than anyone outside Wall Street could imagine. In the past few months, investigations have uncovered widespread fraud at two defunct financial institutions.

For example, the investment bank Lehman Brothers, which went under in 2008, was found to have used off-the-books operations and special short-term loans known as repurchase agreements to hide its liabilities. That may be shocking to many--but it's standard operating procedure on Wall Street and across Corporate America.

Scandal also surrounds the corpse of Washington Mutual, one of the more notorious pushers of subprime loans. The Senate Permanent Subcommittee on Investigations recently detailed how WaMu----now absorbed into JPMorgan Chase--aggressively pushed sub-prime loans on borrowers in order to maximize its profits at the borrowers' expense.

The same scrutiny will now be brought to bear on the surviving institutions that, we were told, were too big to fail, lest their downfall drag the entire economy over a cliff as well. The individual named in the SEC lawsuit, Fabrice Tourre, is a relatively small fry at Goldman, despite pocketing $2 million by conning investors into buying the bad paper he concocted with John Paulson.

The question now is whether the widespread anger at the banks can be harnessed to take on the Wall Streets titans--and whether we can get organized to make them pay for the incalculable economic damage they've caused.

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