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They Just Can’t Help Themselves

March 4, 2010

An impish grin spreads across [Goldman CEO Lloyd] Blankfein’s face. Call him a fat cat who mocks the public. Call him wicked. Call him what you will. He is, he says, just a banker “doing God’s work” — The Sunday Times, November 8, 2009

Goldman Sachs is in the headlines again, this time for a transaction that helped the Greek government report artifically low debt. When you ponder this case, it is hard not to think about Enron.

In 2003, Citigroup and JP Morgan Chase paid a combined $236 million fine to the SEC for allegedly having helped Enron mislead investors. Enron had undertaken a series of complicated swap transactions. When the smoke cleared, these transactions were loans,but Enron reported the results as income instead of debt. The SEC complaint against Chase contains tidbits such as this e-mail excerpt from a Chase executive: “WE ARE MAKING DISGUISED LOANS … WITH AFEW [sic] EXCEPTIONS, THEY ARE UNDERSTOOD TO BE DISGUISED LOANS AND APPROVED AS SUCH.”

This is appalling, but in the end, neither Citi nor Chase admitted the SEC’s allegations. Both paid large fines and agreed in writing not to violate the antifraud provisions of the securities laws. Apart from the allegation that the banks helped Enron to mislead investors it’s not clear to me that either bank broke any additional laws. (Misleading investors is illegal but probably the banks would have fought hard in court had it come to that.) From the perspective of the banks, the SEC fine has to be like being sent to the principal’s office: They suffered humiliation, but not much harm. (Not being a lawyer, I am baffled that the SEC made the banks promise not to break securities laws. Can’t we take that for granted?)

Goldman appears to have done something similar in its deals with Greece. Details are scarce so I am making educated guesses. The best account I have seen is by Nicholas Dunbar writing in Risk Magazine in 2003. Prior to adopting the Euro as its currency in 2001, Greece had issued bonds denominated in yen and dollars. Greece and Goldman entered into swaps that converted these payments into Euros. This is a completely standard and common use of swaps.

However, the swaps were reportedly undertaken at “off-market” terms. Translation: Greece entered into swaps at disadvantageous future prices and made up the difference by immediately receiving money from Goldman. This was a loan from Goldman to Greece, but under European government accounting rules Greece was not required to report that it had borrowed money because the loan was embedded in a derivatives transaction.

For all the headlines about this story, it isn’t clear that the transactions had much effect. The Risk story stated: “There is no doubt that Goldman Sachs’ deal with Greece was a completely
legitimate transaction under Eurostat rules.” The reductions in Greek debt seem not to have been large. Goldman Sachs earned big fees, of course. In the end, it appears that Goldman did the same thing as Citi and Chase — helping an entity to disguise debt — but they (so far) haven’t received a timeout or been sent to the principal’s office.

Presume that Goldman violated no regulations. Nevertheless, isn’t it obvious that we don’t want banks to make profits by helping companies and countries to lie to investors and taxpayers? But the banks are unable to stop themselves. They are not charged with acting ethically, they are charged with making profits. If we expect them to voluntarily walk away from huge commissions we will be disappointed. (One report said that the Greek deal earned Goldman $300 million.) If we try to write highly specific regulations to stop them, we will be disappointed (“You said I couldn’t dip Little Suzy’s pigtails in the inkwell, but you didn’t say anything about the gluepot!”). We’re not going to outlaw swaps and other derivatives, because legitimate risk management has value.

Big banks will behave better when their customers are made to behave better. In the case of Greece, this means that accounting rules should have required Greece to report debt as debt, whether incorporated in a swap or not. Any why shouldn’t a government, of all entities, simply disclose these deals completely? If disclosure and better accounting had been in place, there would be no headlines today. Derivatives are at the center of many brouhahas because accounting for derivatives is complicated and sometimes inconsistent.

For better or worse, banking is amoral. Last November Blankfein said that Goldman was doing “God’s work”. He never said which deity he had in mind. Maybe Zeus?

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