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Kaboom!

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Explosive news. Not about the election, where things were quietish while the debate was digested, and not just about the Eyjafjallajökull volcano, which is bringing an eerie calm to those of us who live under a UK airport flightpath, while causing chaos and mayhem all over Europe. There’s also the news that Goldman Sachs are being charged with fraud by the Securities and Exchange Commission. The allegations concern the Collateralised Debt Obligations which the bank sold to its customers, and what sorts of shenanigans went on in the course of their manufacture.

Something like this has been coming for months. I’m going to quote something I wrote back in January:

In the US, the Congressional inquiry into the financial meltdown has been running under the chairmanship of Phil Angelides. (He’s the Democrat who lost the Californian gubernatorial race to Arnold Schwarzennegger.) He summoned the heads of the big investment banks before the commission. At the hearing, Angelides asked Lloyd Blankfein, Chairman of Goldman Sachs, about the fact that his firm bet hugely against the very same mortgage based securities that they were energetically selling to their clients. Goldman sold about $40 billion in mortgage securities, but in December 2006, they ‘came to the conclusion the mortgage was heading south’ and began dumping their own holdings. Angelides came up with a brilliant metaphor. He said that what Goldman did was ‘like selling a used car with faulty brakes and then buying an insurance policy on those cars’.

Blankfein’s answer was snapped back: ‘That’s what a market is.’ In other words, the buyers knew what they were doing, and the sellers were free to take a different view.

Is he right, though? What if the banks knew things about the mortgage-backed securities which they didn’t share with the customers? If you know what you are selling, but your buyer doesn’t know what he’s buying, is that really a market? Or is it something more sinister? The question is one relevant to far more banks than just Goldman, and it’s one in which the Securities and Exchange Commission, the US regulator, is taking an interest. If anyone out there quite fancies the idea of seeing some senior bankers disappear off in handcuffs, this is the question which might, just might, lead to its happening.

I’ve just been reading Michael Lewis’s brilliant new book The Big Short – I’m doing an event with him on Monday at the RSA, Eyjafjallajökull permitting – and you can’t finish that book without being certain that a lot of what went on in the creation of CDOs was wrong. Now the Feds are going to take a shot at proving it was also illegal. Wow! Kaboom!

Comments on “Kaboom!”

  1. danielr says:

    i am reading you IOU book and enjoying it very much.
    there is, however, a comment i want to add:
    C.K.Liu is an economist who, IN 2006 was alerting the world on the stupidity of Allan Greenspan rates policy.
    Mr. Liu is an economist teaching (i believe at Princeton), and is consultant of CHINA.
    i followed his indications, and since 2006 i started to place, WEEKLY, stop loss orders in my portfolio.
    that, simply, helped me emerge (with the small loss of the safety band i set), virtually unharmed from this debacle.

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