A Toxic System-An Inside Glimpse Into the Nefarious Operations of Goldman Sachs

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March 15, 2012

An Inside Glimpse Into the Nefarious Operations of Goldman Sachs

A Toxic System

by DARWIN BOND-GRAHAM

Goldman Sachs employee Greg Smith’s very public resignation, replete with a pointed letter published in the New York Times yesterday, has landed upon the investment bank like a bomb. Slamming a “toxic and destructive environment” within Goldman Sachs, Smith says the firm’s internal culture has devolved to the point where the entire staff not only tolerates, but expects workers at all levels, from senior partners to associates, to pursue nothing but ever-more sophisticated means of “ripping their clients off.”

Apologists for the financial sector —including the editors of the major business newspapers and television networks— predictably have shot back with a flurry columns and reports, mostly designed to discredit the former vice president by making fun of Smith and his concerns. If you strip away the ad hominem layers to these responses though, the core problems raised by Smith remain, and the reaction of the business press seems all the more absurd, for Goldman’s pesky turncoat isn’t saying anything that’s news to the public: Goldman Sachs is characterized by a toxic culture of greed? Stop the presses!

There is much more to be said about Goldman Sachs’ derivatives operation, however, and Smith’s provocative resignation provides an opportunity because he was working in the belly of it.

At the center of Smith’s critique are derivatives, the arcane financial instruments that transformed the world’s splintered national economies and regional banking systems into a single, if complicated, global system. Evangelists of derivatives claim they have made new heights of economic growth, trade, and prosperity possible. Critics have pointed out since the beginning of the derivatives boom in the 1980s how perfectly suited they are to fraud and systemic catastrophe via the greed of the few and the powerful.

Derivatives, many close observers have reminded us, were at the center the Enron meltdown, the demise of Long Term Capital Management, the Asian Financial Crisis, and most recently the Great Recession and its various flares, from the housing bubble that exploded from junked collateralized debt obligations, to the current Greek debt imbroglio and the credit default swaps haunting the background. In each case, and many less-known fiascos, derivatives traders in Wall Street’s leading banks played key roles either as the major villains, or enabling partners in vast crimes of information, leverage, and risk. Time and again we find derivatives at the center of scandalous greed. Now we have a high-profile banker denouncing not just some bad apples in his firm, but the firm’s entire culture.

There’s a deeper and more disturbing truth still further below the surface though. To get there it’s instructive to know a little more about Goldman’s derivatives operation, and the wider industry of which Goldman is a small part.

Who are the clients on the receiving end of Goldman’s “toxic and destructive” tendencies? Many times the victims have been other corporations, industrial firms with less sophisticated and perhaps naive financial officers. Quite often though
the victims of Goldman’s derivatives operation have been cities, counties, and local government agencies. A key client category for derivatives has been large local governments and agencies that issue hefty sums of long-term debt.

Goldman, and the handful of other global banks that dominate the derivatives industry, sold local governments on the idea that a particular set of derivative products could provide wondrous solutions to hedge against the risks inherent in issuing long term debt. The banks claimed that interest rate swaps could shield counties, cities, and agencies from possible spikes in floating interest rates attached to their bonds. Thus many governments agreed to complex, multi-decade deals involving the swapping of payments on fictive amounts of money associated with real debt. In no time at all interest rate swaps became the single largest category of derivatives, dwarfing all others.

Today interest rate swaps make up 82% of the total market in derivatives, measured by total notional amounts. This is partly the result of governments all over the world entering into interest rate swaps, agreeing to tie cash flows to trillions of notional dollars. What’s key is that none of this has required duplicity or reckless greed on the part of bankers at Goldman Sachs or other firms. Let’s be clear; this is a structural transformation of capitalism on a global scale, and it has sucked up all corporate and government entities into the new logic of hedging and efficiency. That a few powerful financial corporations have placed themselves in strategic positions to benefit from this structural shift should come as no surprise.

In California’s Bay Area multiple governments have come to find themselves on the paying end Goldman’s derivatives department where apparently traders referred to clients as “muppets.” The most obvious example is the city of Oakland where a chronic budget crisis has led to the shuttering of schools and cuts to elder services, housing, and public safety. Oakland signed an interest rate swap with Goldman in 1997. The terms of the deal, revised once in 2003, were typical of interest rate swaps except that Oakland’s financial officers, based on this author’s research and impressions, seem to have agreed to a somewhat higher fixed rate obligation than most other cities that signed swap deals for similar amounts of debt with comparable ratings. Oakland partly did this, I am guessing, to receive upfront payments of roughly $5 and $10 million from Goldman Sachs, cash that the city wished to have on hand immediately. The bank seemed eager to do this because the original terms, and renegotiated terms in 2003, were much to its favor. It would earn the $15 million back, and then some over the twenty-four year life of the swap.

Across the Bay, Goldman Sachs signed an interest rate swap agreement with the San Francisco International Airport in 2007 to hedge $143 million in debt. Today this agreement has a negative value to the Airpot of about $22 million, even though its terms were much better than those Oakland agreed to. The Airport, like Oakland, must now pay millions each year to Goldman Sachs until the agreement expires, or until the floating LIBOR interest rate rises enough to offset the net balance of payments. Goldman sold derivatives up and down California and across the United States to cities, counties, and agencies, promising them a means of reducing debt payments over the long haul.

Business press pundits who are now slamming Smith say it’s absurd to expect that Goldman Sachs was doing anything less than trying to make money off these deals, and that counter-parties to the firm’s dealings knew well what they were signing up for. This mischaracterizes the entire problem, however, and threatens to steer the conversation into a narrow, and politically irrelevant one about whether Goldman Sachs is or isn’t a den of fraud.

When governments signed up for interest rate swap deals with Goldman Sachs they certainly did know that the bank would be making money off the agreement, first in the form of up-front fees, and then off of savings produced by the pairing of comparative advantages in debt markets that interest rate swaps are designed to achieve. If you don’t understand that last point, don’t worry. What it means simply is that Goldman Sachs sold interest rate swap products to governments by promising to both protect a government against interest rate volatility, and to also likely reduce the overall long-term cost of borrowing money. It was supposed to be a win-win game.

The truly impressive thing about the whole derivatives market is that it is supposed to ratchet up the efficiency of the entire global economy, making dollars go much further, protecting all parties from volatility, transcending previous market barriers and smoothening flows of cash… at least in theory. The theory seemed to be working in the 1990s and through most of the 2000s. Goldman didn’t have to convince anyone of this for the results were plain to see.

That is hasn’t panned out in practice, that the whole derivatives-based economy nearly collapsed in 2008 and continues to falter, isn’t so much the result of Goldman’s toxic culture of greed as it is the outcome of a much more troubling feature of our economic system. While I agree with Smith’s observation —which is important because it’s based on insider knowledge— that Goldman Sachs is an especially predatory corporation, I see a larger pattern of power relations embodied in the new economy, structured as it is by derivatives, that isn’t based on any specific firm’s internal culture or corruption, or the supposed naivety and stupidity of financial officers in government and less profitable sectors of the economy.

Consider the fact that Goldman Sachs isn’t even the biggest fish in the pond, nor is it profiting the most from the blizzard of derivative products that structure the capitalist economy today. Of the five financial corporations that “dominate in derivatives,” as the U.S. Office of the Comptroller of the Currency puts it, Goldman Sachs ranks fourth, behind by Bank of America, Citibank, and far behind the absolute king of derivatives, JP Morgan Chase.

In February JP Morgan Chase let slip that it cleared $1.4 billion in revenue on trading interest rate swaps in 2011, making these instruments one of the bank’s biggest sources of profit. According to some reports, JP Morgan Chase made billions more in 2008 and 2009 when the financial crisis and federal response combined to make floating-to-fixed interest rate swaps into extremely profitable assets for the banks on the floating side of the deal. Similar things can be said for Mogan Stanley, HSBC, Wells Fargo, Bank of America, Bank of New York, and the dozens of smaller interest rate swap peddlers currently profiting from direct transfers of public dollars.

Are all these banks poisoned by toxic cultures of greed? Surely there are similarities in the internal cultures of large banks, and greed and a little sociopathic ability to profit from another’s loss is a professional asset in these sorts of organizations. In contemporary corporate culture the euphemism for this is “competition.”

Toxic culture and greed, or “competitiveness” if you prefer, in the investment banks isn’t a sufficient answer to why derivatives have become the foundation of today’s global economy, however. The criminal activities of some bankers driven by these more pervasive cultures can’t explain the economic crisis and the vast injustices that are being perpetrated still in the name of “economic recovery.” The interest rate swap crisis stinging local governments and enriching the banks is a case in point.

The windfall of revenue accruing to JP Morgan, Goldman Sachs, and their peers from interest rate swap derivatives is due to nothing other than political decisions that have been made at the federal level to allow these deals to run their course, even while benchmark interest rates, influenced by the Federal Reserve’s rate setting, and determined many of these same banks (the London Interbank Offered Rate, LIBOR) linger close to zero. These political decisions have determined that virtually all interest rate swaps between local and state governments and the largest banks have turned into perverse contracts whereby cities, counties, school districts, water agencies, airports, transit authorities, and hospitals pay millions yearly to the few elite banks that run the global financial system, for nothing meaningful in return. These perfectly legal cash flows measuring globally in the hundreds of billions, from the public to the banks, dwarf anything that is the result to fraud.

Back when the economy was in a “normal” stasis of growth, the early and mid-2000s, interest rate swaps and other derivatives promised security against risk, and a new vista for capitalism and public finance. Tellingly, when the crisis struck, swaps were allowed to become a one way flow of funds from the public to the banks. This shadow bailout for the banks has done considerable damage to already cash-strapped local governments suffering from declines in tax revenues and federal aid.

Whether Goldman Sachs is or isn’t an organization gripped by a toxic culture isn’t all that important when one considers the destructive impact that derivatives have had, and continue to have upon society. Capitalism as it functions today is completely dependent upon derivatives. Interest rates swaps are the single largest type of derivative, measured by notional amount, because they achieve an integration of different national, regional, and sectoral financial markets into one global financial system. It’s in the genetics of the project of financial globalization, fueled by derivatives, that the real problem lies, not in the internal culture of Goldman Sachs, or the illegal behaviors of some bankers across many firms. The real crime lies in perfectly legal and legitimated activities whereby a few powerful corporations design a system that puts the welfare of the world’s vast majority at grave risk. It’s the system that’s toxic. Goldman Sachs merely operates well within the toxicity.

Nevertheless, Greg Smith’s effort to pull back the curtain on one of the most nefarious and powerful corporations in history is most welcomed, especially for the deeper conversations it can stoke about the origins of the current crisis.

Darwin Bond-Graham is a sociologist and author who lives and works in Oakland, CA. He is a contributor to Hopeless: Barack Obama and the Politics of Illusion, forthcoming from AK Press.

http://www.counterpunch.org/2012/03/15/a-toxic-system/

An Insider’s View of Wall Street Criminality: Toxic Culture of Avarice and Fraud

By Andre Damon and Barry Grey

Global Research, March 15, 2012

World Socialist Web Site

Greg Smith, an executive director at Goldman Sachs, announced his resignation Wednesday in an op-ed piece in the New York Times, denouncing the bank's “toxic” culture of avarice and fraud.

Smith headed the firm’s United States equity derivatives business in Europe, the Middle East and Africa. In his column, entitled “Why I Am Leaving Goldman Sachs,” he describes a corporate environment that encourages and rewards big short-term returns gained through the bilking of clients and the general public. “It makes me ill how callously people talk about ripping their clients off,” he writes.

Speaking of one’s clients as “muppets” and describing deal-making as “ripping eyeballs out” are commonplace at Goldman, according to Smith. The way to advance at the Wall Street giant, he writes, is to persuade your clients “to invest in the stocks or other products that we are trying to get rid of,” get your clients “to trade whatever will bring the biggest profit to Goldman,” and trade “any illiquid, opaque product with a three-letter acronym.”

The column describes an operation in which laws and regulations requiring financial institutions to deal honestly with their clients and protect their interests are routinely violated. The insider’s indictment of Goldman Sachs highlights a broader process—the criminalization of American capitalism as a whole.

It confirm‎s from the inside that three-and-a-half years after Wall Street’s manic pursuit of super-profits triggered a global financial meltdown and the deepest slump since the Great Depression, nothing has changed in the boardrooms of corporate America. The same fraudulent and often illegal practices that enriched the financial aristocracy and plundered the rest of society continue unabated. The criminals at the top, having been bailed out with trillions of taxpayer funds, are making more money than ever, while millions of ordinary people are being driven into poverty and homelessness.

Education, health care, pensions are being gutted, wages are being slashed and more austerity is on the agenda because there is supposedly “no money.” Corporate profits and CEO pay, meanwhile, are setting new records.

This is an indictment not simply of Goldman Sachs, or even Wall Street alone, but rather the entire economic and political system. Every official institution—the White House, Congress, the courts, the media, the Democratic and Republican parties—is complicit.

Smith’s column was widely reported in the media. NBC Nightly News led its report Wednesday night with the story, interviewing a former chairman of the Securities and Exchange Commission who was brought on to deplore the type of practices described by the former Goldman executive. The ruling class is well aware that popular anger against Wall Street is rising and capitalism itself is becoming increasingly discredited in the eyes of millions of Americans—a process that found an initial expression‎ in the Occupy Wall Street protests. It is concerned that Smith’s piece will further fuel this sentiment.

The practices to which Smith points—and worse—are well known to the Obama administration and the financial regulatory agencies. In April of last year, the Senate Permanent Subcommittee on Investigations published a 640-page report outlining in detail the fraudulent and illegal practices of major banks that contributed to the September 2008 crash. Fully 260 pages of that report were devoted to Goldman Sachs. They explained chapter and verse, giving dates and naming names, how the bank defrauded its clients by selling them mortgage securities while betting against the same investments, without telling them it was doing so.

The committee also documented the complicity of the credit rating firms and federal regulators in the colossal mortgage Ponzi scheme that collapsed in 2007-2008, setting off a new world depression. It cited securities laws that had been violated by Goldman and two other banks it examined, Washington Mutual and Deutsche Bank, and referred this information to the Obama administration’s Justice Department.

The response of the White House was to do absolutely nothing. Not a single senior bank executive has been criminally charged, let alone imprisoned, for crimes that have devastated the lives of countless millions of people in the US and around the world. Instead, the White House has shielded the corporate criminals.

One Wall Street firm after another—Goldman Sachs, Bank of America, Citigroup, Countrywide Financial—has been allowed to settle charges filed by the Securities and Exchange Commission out of court, paying token fines while admitting no wrongdoing. That this continues is seen in the filing Monday in federal court of the sweetheart settlement between five major banks and the state and federal governments of charges arising from the banks’ illegal processing of foreclosures. The banks have merely to pay a combined fine of $5 billion for illegally throwing thousands of families out of their homes, with no admission of wrongdoing. In return, they get the quashing of state investigations that threatened to result in tens of billions in damages and fines.

Not only does the Obama administration protect the Wall Street criminals, it includes their representatives among its top personnel. To cite some examples:

* Mark Patterson, a former Goldman Sachs lobbyist, is the chief of staff to Treasury Secretary Timothy Geithner.

* Dianna Farrell, former financial analyst at Goldman Sachs, is deputy director of the National Economic Council.

* Jacob Lew, Obama’s chief of staff, was a top executive at Citigroup. He follows two other bankers chosen by Obama to head his White House operations—former JPMorgan executive William Daley and former Chicago investment banker Rahm Emanuel.

The criminalization of the American corporate-financial elite cannot be separated from the capitalist system itself. It is the product of a decades-long process of crisis and decay, in which the ruling elite has increasingly separated its wealth-making from the production of real value.

Manufacturing and the productive infrastructure have been decimated, while financial manipulation and speculation have come to dominate economic life. The working class has suffered a catastrophic decline in its social position at the same time that a parasitic financial aristocracy has come to exercise a de facto dictatorship over the political system.

Like all aristocracies, the American financial elite will not accept any infringement of its wealth and power. The working class must break its grip by mobilizing its strength in opposition to both parties of Wall Street and fighting for the establishment of a workers’ government and socialist policies, beginning with the nationalization of the banks and corporations and their transformation into public enterprises under the democratic control of the working people.

http://www.globalresearch.ca/index.php?context=va&aid=29782