Friday, April 16, 2010

Now is the time to inject some genuine transparency

Original posted in the FT by Gillian Tett:

Back in the 1990s, as America writhed in the aftermath of the Savings and Loans crisis, many hundreds of bankers were fined or put in jail as a result of their bubble-era misdemeanours.

Fifteen years later, however, as most of the global financial systems reels from another financial collapse, it is noteworthy just how little real retribution has been exacted on those responsible.

After all, the losses created by the subprime saga were worse than the S&L woes. Yet, thus far, few financiers have been brought to book. No wonder that the average voter in the US or Europe feels so angry: to most, the subprime saga seems like a giant “crime” without any punishment or justice.

But could this be about to change? Friday’s bold civil lawsuit by the Securities and Exchange Commission will undoubtedly prompt some to hope so.

To be sure, the precise details the case brought by the SEC look pretty arcane. (Essentially, what Goldman Sachs and one of its employees is accused of is using fraudulent techniques to construct and market mortgage-linked collateralised debt obligations, or bundles of complex debt).

However, the underlying principle is clear: what the SEC thinks that Goldman did is rig a CDO deal in a way that allowed it (and its hedge fund clients) to make fat profits. This is the banking equivalent, if you like, of a used car salesman flogging a vehicle that the salesman knows to be very dodgy, to a customer that has little chance of getting independent information.

Goldman itself denies wrongdoing. And to some non-bankers, it might seem a touch surprising that a suit of this kind could even be lodged against a Wall Street bank. After all, America has long prided itself on having a financial system based on free-market principles. And one of the most basic cornerstones of a “free market” system is the idea that information is supposed to flow freely, to create open competition; otherwise, it is a game rigged by powerful cartels.

But in reality, it has long been an open secret that “free market” principles did not really apply to many parts of the CDO world during the credit boom. On the contrary, back in the last decade, when banks were pumping out CDOs, the sector was so murky that it was easy for banks and hedge funds to engage in shady practices that enabled them to make a fast buck.

Thus while Goldman Sachs might have been the focus of Friday’s suit – and makes a tempting tatget for politicians – its practices were certainly not unique. I would not be at all surprised if other names eventually jump into the SEC gunsights too.

Of course, it remains to be seen in court whether any of this will actually produce convictions. Precisely because the subprime and CDO markets were so opaque during the credit boom, it was often very unclear what was legal – or not. Moreover, bankers were extremely adept at “innovating” to get round the law.

That could make it far harder for the government to win cases now than during, say, the S&L days. Anyone expecting to see that scale of legal retribution today will probably be disappointed.

Nevertheless, the most important lesson from Friday’s suit is that it shows exactly why the regulatory debate that is under way in Washington and Brussels matters so much. One reason why so much malfeasance flourished in the CDO world during the last decade was that it was not just lightly regulated, but also very opaque.

Now, belatedly, regulators are trying to rectify that: they are trying, for example, to create data warehouses to collect information about all the deals being done, or force banks to record the price of their deals.

But so far this drive towards greater transparency has proceeded at an achingly, shamefully, slow pace. That is partly because of political infighting, but also because many of the banks continue to fight real change.

However, the good news about Friday’s suit is that it could now strengthen the pressure to inject real transparency into the financial world. It may concentrate politicians’ mind too. If so, that would be a reason to cheer, almost irrespective of what now happens to the Goldman case.

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