Canadian Investment Review

Market Collapse Heads Into Round Two

Written by Tristram Lett on Monday, April 19th, 2010 at 2:41 pm

336112_9676What do the Roman Catholic Church and Goldman Sachs have in common? Both are locked in desperate contests to salvage their public images of trust with their constituents. Friday’s fraud charges by the SEC for alleged conflict of interest slashed over $12 billion off the market value of GS and caused markets around the world to reel.  This is a huge story and marks the beginning of round two in the pillorying of the American financial community.

Faith and financial dealings have an essential common element in trust.  Without it, neither can exist.  Goldman Sachs, it is alleged, made the egregious error of favouring one client over another without proper disclosure and in the process earned substantial fees. GS has been on the receiving end of a significant amount of public scrutiny of late-the lingering impression that senior executives have a direct pipeline to the White House, the accusations that they helped Greece obfuscate its massive debt problems from the EU using swaps, and now, assisting John Paulson, a hedge fund manager, make billions shorting subprime mortgages at the expense of its own clients.

The problem centers on the fact that they did not declare their conflict of interest to the clients who were the buyers of the toxic paper that Paulson’s hedge funds were selling. In particular what was not disclosed was the fact that Paulson selected the RMBSs (residential mortgage backed securities) that the ABACUS Trust was effectively shorting and instead implied it was an independent portfolio selection agent.  Potential investors were far less likely to be the counterparty to these transactions, at least at the offered price, if they knew Paulson was on the other side.

Financial prestidigitations such as these are legend on Wall Street as it seems it is an accepted fact that if you wish to condition your balance sheet for a public reporting, any manner of derivative can be created to favourably manipulate critical values during the reporting period.  One of the major issues with Lehman Bros was the fact that it had blurred its weak financial condition from the public until it was too late.

This promises to be a major donnybrook, with the SEC still nursing open wounds from its gross mishandling of the Madoff affair squaring off with the most prestigious of all American financial institutions.  There is a huge amount at stake for both as the SEC attempts to regain the public perception that it is a regulator with teeth and as Goldman Sachs strives to regain its reputation and trust with its clients.  The bell for round two has rung.

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