Just two days after a marathon 10-hour hearing before the Senate Permanent Subcommittee on Investigations, Goldman Sachs learned that it is the target in a criminal investigation conducted by the U.S. attorney in Manhattan. Goldman has been accused of fraud by the SEC (in a civil suit) in connection to the sale of complex securities (CDOs) tied to subprime mortgages. Allegedly, the CDOs were designed to fail. The charges have raised Goldman’s public profile and caused severe damage to its image as a company that serves the interests of its clients. The news of a federal probe could be a major hit to the bank’s short-term prospects and profitability. According to Friday’s Wall Street Journal:
“Federal prosecutors are conducting a criminal investigation into whether Goldman Sachs Group Inc. or its employees committed securities fraud in connection with its mortgage trading, people familiar with the probe say.
“The investigation from the Manhattan U.S. Attorney’s Office, which is at a preliminary stage, stemmed from a referral from the Securities and Exchange Commission… The SEC recently filed civil securities-fraud charges against the big Wall Street firm and a trader in its mortgage group….The criminal probe raises the stakes for Goldman, Wall Street’s most powerful firm.” (“Criminal Probe Looks Into Goldman Trading” Wall Street Journal)
The public is paying close attention to developments in the case and video clips from the senate subcommittee hearings have been widely circulated on the Internet and used as fodder by late-night comedians. The depth and severity of the ongoing recession has created a need to find a scapegoat, one company who more than any other embodies the recklessness and voracity which led to the biggest financial crisis since the Great Depression. Goldman Sachs is that company.
News of the investigation has already roused Wall Street and put fear in the hearts of hedge fund managers and investment bankers who wonder if they’ll be next in line. The public is likely to support aggressive action by the Department of Justice to hold the fraudsters accountable and to ensure that investors and homeowners are protected in the future. The question is whether the investigation is an honest attempt to reign in Wall Street or a political stunt to build support for President Obama’s financial reforms that are stuck in the senate?
On Thursday, Reuters reported that Goldman planned to settle its fraud case with the SEC. Apparently, CEO Lloyd Blankfein decided that it would be wiser to pay a hefty fine and put the matter behind him than risk another drubbing like he suffered earlier in the week before the senate subcommittee. Now that option has been taken off the table. A full-blown criminal investigation means that Blankfein will be spending his days trying to explain why misleading his clients is a laudable business practice and not a felony. And, for Goldman shareholders, the news is even worse. With the country already in a lather over Wall Street’s transgressions, the case could snowball into a reputation-busting main event. If the case goes to court, the networks will be stumbling over themselves to cover every lurid minute of the trial while deploying their footsoldiers to go through Blankfein’s personal file with a fine-tooth comb.
Wall Street Journal:
“Over the years, the government has been reluctant to criminally charge financial firms with wrongdoing because the charge itself can cause a business to implode. Some investing clients can’t or won’t trade with a firm facing such a taint.
Indeed, in the more than two-century history of the U.S. financial markets, no major financial firm has survived criminal charges. Securities firms E.F. Hutton & Co. and Drexel Burnham Lambert Inc. crumbled after being indicted in the 1980s. In 2002 Arthur Andersen LLP went bankrupt after it was convicted of obstruction of justice for its role in covering up an investigation into Enron Corp. The conviction was later overturned by the Supreme Court.”(“Criminal Probe Looks Into Goldman Trading” Wall Street Journal)
As the WSJ points out, the stakes couldn’t be higher. But is the SEC serious or is this just carefully choreographed political theater? No one knows for sure, but the markets aren’t going to like it, especially if their Golden boys start blabbering about where all the bodies are buried. That’s the nightmare scenario–“contagion”– one criminal investigation after another spreading through Wall Street like a virus. But it could happen. The word is out that the SEC’s new Director of Enforcement Robert Khuzami is eager to prove he’s got the sinew to take down the biggest firm on the street. There’s nothing that would make John Q. Public happier than seeing a phalanx of SEC regulators in full police regalia goosestepping through lower Manhattan. People are tired reading about bankers pulling in billions, and being fleeced by them.
The SEC wouldn’t make a move like this unless they had a pretty solid case. That means that Khuzami may be getting information from a disgruntled former employee, someone who knows how Goldman works from the inside. A criminal case means documentation, hard evidence, and proof of intent. That’s a tall order, and not one that the SEC would take lightly. After all, Khuzami vs. Goldman will be “winner take all” contest ; the 52 year old attorney will either be heaped with praise or face a career flame-out.
But Khuzami has his work cut out for him. Goldman will enlist every lawyer from Orlando to Portland to plead its case. And crossing swords with Blankfein will be the easy part. The hard part will be the rearguard action from the Geithner/Summers block within the administration. An attack on Goldman is an attack on Obama’s financial braintrust, and it’s bound to trigger a split within the White House. Remember how Geithner stuck his neck out to make sure that Goldman got 100 cents on the dollar for its credit default swaps (CDS) with AIG? Government officials don’t do that unless they’re working for the other side. Geithner is a Goldman loyalist, just like many other of Obama’s lieutenants.
What people want is justice. And revenge.
MIKE WHITNEY lives in Washington state and can be reached at [email protected]