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06/15/2010

Commentary: Goldman v. United States—What it Really Means


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“It is not what a lawyer tells me I may do; but what humanity, reason and justice tell me I ought to do.”

I invoked these words of the statesman and philosopher Edmund Burke to close my December 31, 2009, letter to Lloyd Blankfein. They now have particular resonance. I don’t know if, as the SEC has charged, Goldman committed fraud. However, to focus on the legal technicalities of the case is to miss the larger point. At its core, Wall Street’s failure, and Goldman’s, is a failure of moral leadership that no laws or regulations can ever fully address. Goldman v. United States is the tipping point that provides society with an opportunity to fundamentally rethink the purpose of finance. That reexamination will extend far beyond round one of financial reform and will be far more transformative.

Goldman faced a critical turning point in early 2009 and senior management sensed it. Lloyd Blankfein made gestures toward taking the high road, reflected in an op-ed that appeared in the Financial Times on February 8, 2009. That op-ed was the catalyst for an earlier letter, in which I stated:

“We are in extraordinary times, which call for unprecedented statesmanship from our financial leaders. As a trader by training, you grasp our predicament better than many leaders on Wall Street. But as a trader, you’ve not had the responsibility of global financial statesman. Until now.”

Blankfein responded to this letter, but in a less than satisfactory way. His subsequent conciliatory gestures turned out to be mostly self-serving and gratuitous. A friend, who now runs a major division of a “too big to fail” bank, summed it up as “a complete vacuum of leadership in our industry.” Blankfein’s later quip that Goldman was doing “God’s work” only highlighted this point.

The brush is dry; the gasoline is everywhere. Goldman v. United States is simply the match. Resolution will come only through genuine reform around four core issues that are at the heart of society’s disgust with Wall Street—its excessive greed, the injustices it has perpetrated, the conflicts of interest it exploits, and its overwhelming hubris.

As a civilized society, we reject extreme greed. The irony in Gordon Gekko’s “greed is good” mantra may have been lost on some people; we’ll see if the Wall Street sequel is less subtle. Philosophers and religions going back to Aristotelian times have warned us to resist greed’s temptations. Interestingly, there is no word in the modern lexicon for chrematistics, an ancient Greek term which, roughly translated, means “the use of money for the acquisition of wealth as an end in itself.” As Aristotle understood it, instruments of finance were to be employed not in chrematistics, but as means to an end, that end being oikonomike, the root of our word “economics.” Oikonomike did not imply unlimited wealth, but merely wealth necessary to live a good life.

Others have noted the difference between the “long-term greedy” culture that characterized Goldman under the leadership of Gus Levy and John Whitehead—a drive for success that always ensured client interests come first—and the unbridled, win-at-all costs greed that characterizes the firm today. Restoring that old culture will be difficult. Certainly a new management team and a transformation of Goldman’s business model are prerequisites.

Society also understands Wall Street’s failure to deliver on its public purpose: to channel savings into productive investment, to provide credit for legitimate consumer and business needs, and to maintain a financial system built on trust. Society will bear the extraordinary burden of those failures for generations to come, while the perpetrators of the related frauds and stupidities will not. Blankfein’s personal holdings of GS stock, which should have suffered material dilution as part of the bailouts, are now worth hundreds of millions of dollars, courtesy of the taxpayers. This is illegitimate wealth and a profound injustice. Historically, such injustice breeds serious social unrest. Wall Street does not appear to get this, or care.

Conflicts of interest are not new to Wall Street but are now shamelessly exploited with dangerous scale and complexity while firms claim to “manage” such conflicts. Indeed, Goldman states that it “embraces” conflicts as a central feature of its business model!

If we have learned anything from this financial crisis, it is that allowing Wall Street to continue to “manage” its own conflicts is antithetical to fairness and a recipe for disaster. Wall Street’s ability to generate excess profits is directly linked to its ability to exploit blatant conflicts of interest and their related information and power asymmetries. The structural elimination of these conflicts will significantly reduce the profitability of certain activities and will therefore be fiercely resisted. Some stock prices will suffer, some materially. But it is the only way to restore the trust upon which the health of the system depends.

I am not as cynical as some who suggest that Goldman intended to blow up AIG. But how can it be construed that purchasing credit insurance on AIG after privately loading it up with tens of billions of credit default swaps on toxic (and fraudulent) subprime risk is not trading on inside information? And did Goldman keep buying protection from unsuspecting counterparties while their billion dollar collateral dispute with AIG remained out of the public’s eye? Did they also buy puts on the stock? Furthermore, did Goldman purchase CDS protection on Greece after it aided and abetted apparent fraud by structuring off-the-books debt financing? Did it use this information for its own proprietary account but not for those of its clients, including its asset management clients (who in turn manage our pensions) to whom it owes a fiduciary duty? Even assuming that Goldman did nothing illegal, which may well be the case, it cannot be denied that Goldman’s business model is predicated on exploiting conflicts of interest.

Finally there is the issue of hubris. Wall Street attracts many smart people. But for those at the top, success has often bred arrogance. And the arrogance that presides over complex and “too big to fail”—or manage, and obviously too big to govern—financial firms is, as we have seen, dangerous to society. Wall Street was arrogant and ignorant. It remains arrogant and unrepentant. Society knows this, and its outrage is righteous and justified.

We are now faced with a conundrum. In the absence of statesmanlike leadership within the financial sector, our government must choose between two bad options. A weak response will virtually guarantee debacles of even greater magnitude in the future, an unacceptable choice. The necessary aggressive response may entail unintended consequences and bureaucratic inefficiencies. But Wall Street’s failure to exercise leadership informed by the dictates of humanity, reason, and justice must have consequences.

Rebuilding a resilient and trustworthy financial system that serves the needs of the real economy, oikonomike, rather than the self-interest of a few will be hard work. Evolving the practice of finance to productively fuel the transition of the economy to serve the needs of real people, while respecting the finite boundaries of the planet, will be an even greater challenge.

This is the great work of our age. Goldman v. United States is wake-up call we desperately needed. Let’s roll.

–John Fullerton is a former managing director of JPMorgan, Morgan’s representative on the Long Term Capital Oversight Committee, and founder of the Capital Institute, a new innovation center focused on financing the transition to a sustainable economic system. Fullerton’s 2009 correspondence with Lloyd Blankfein and the associated “Goldman Sachs Historic Speech” are available at www.capitalinstitute.org.

This commentary is adapted from a longer Capital Institute blog posted on April 26, 2010.

As an impartial, nonprofit forum for the finance and banking industries NYSSA encourages discussion and debate among its member and other professionals. Commentaries, however, should be taken as the sole opinion of the author(s) and not of NYSSA. If you would like to submit a commentary to the Finance Professional's Post, send your article to the editor.

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