Investment banks such as Goldman Sachs were self-interested promoters of risky and complicated financial schemes that helped trigger the crisis, said senator Carl Levin
Ladies and gentlemen,
Allow me to present the Greatest Show on Earth or How Wall Street brought the Financial Crisis on Itself. There is a cast of thousands, from the most famous to the most guilty. Never have so few made so much money from so many.
See how god’s bankers say: “Of course we didn’t dodge the mortgage mess. We lost money, then made more than we lost because of shorts.” Of course they are god’s bankers – they make money on the way up and make money on the way down.
See how the Financial Crisis Inquiry Commission (FCIC) and the US Senate Subcommittee Investigating Financial Crisis summon almost every week the stars from Wall Street to show how they did it.
The Senate subcommittee chairman, Democratic Senator Carl Levin, said: “Investment banks such as Goldman Sachs were not simply market-makers, they were self-interested promoters of risky and complicated financial schemes that helped trigger the crisis.
“They bundled toxic mortgages into complex financial instruments, got the credit rating agencies to label them as AAA securities, and sold them to investors, magnifying and spreading risk throughout the financial system, and all too often betting against the instruments they sold and profiting at the expense of their clients.”
Senator Carl Levin holds up paperwork while questioning a Goldman Sachs official. — Reuters
We must admire the United States for its high level of transparency and its willingness to go after the big guns. What these open hearings reveal is the degree of greed and fraud that Wall Street has perpetrated against the whole world in its pursuit of ever-growing profits.
Investors used to listen to these gods pontificate on the trend of the market and now realise that with proprietary trading, these gods are talking one book and trading also the other way. So if you believed them and bought the market up, they were probably selling the market down. This is known as “risk hedging”, but guess who pays when the market crashes?
The taxpayer bails the investment banks out and they are still laughing all the way to their golden bonuses.
April is the cruelest month, especially for Wall Street.
On April 7, the FCIC looked into the securitisation mess, beginning with the testimony of former Federal Reserve chairman Alan Greenspan. On April 13, the Senate subcommittee started the first of four major enquiries, which “examined how US financial institutions turned to high-risk lending strategies to earn quick profits, dumping hundreds of billions of dollars in toxic mortgages into the financial system, like polluters dumping poison upstream in a river.”
Coincidentally, on the same day, the Securities and Exchange Commission charged Goldman Sachs of fraud.
In the second hearing on April 16 on the role of the regulators, the subcommittee “showed how regulators saw what was going on, understood the risk, but sat on their hands or fought each other rather than stand up to the banks profiting from the pollution. Those toxic mortgages were scooped up by Wall Street firms that bottled them in complex financial instruments, and turned to the credit rating agencies to get a label declaring them to be safe, low-risk, investment grade securities.”
The third hearing on April 23 looked at the role of the credit rating agencies and the fourth hearing on April 27 considered the role of the investment bankers.
On hindsight, it was remarkable that the Wall Street bankers, who always had a good grip on what was happening in Washington, had clearly underestimated the public anger against them and their vulnerability.
The session on the credit rating agencies was most illuminating. There are three major rating agencies in the world that do most of the global credit rating business – Moody’s, Standard & Poor’s and Fitch. Most investors rely on the credit rating agencies to assess the quality of their investments, particularly bonds.
With the arrival of Basel bank supervision rules in the 1980s, bank regulators also use credit ratings to assess whether the capital-risk weights are appropriate. Thus, if a bank were to hold junk bonds, then the capital requirements would be higher. Of course, pension and money market funds use the credit ratings to distinguish between safe and risky investments.
The result is that having a AAA credit rating was very helpful to borrowing at cheap rates, whereas a downgrade would not only increase the cost of funds, but also cut off liquidity as investors dump the securities and refuse to hold such downgraded debt.
In the last 10 years, the three biggest credit rating agencies gave AAA ratings to the residential mortgage backed securities, or RMBS, and collateralised debt obligations, or CDOs that fuelled the derivative market bubble. Between 2002 and 2007, these agencies doubled their revenues, from less than US$3bil to over US$6bil per year. Between 2000 and 2006, investment banks underwrote nearly US$2 trillion in mortgage-backed securities, US$435bil or 36% of which were backed by subprime mortgages.
At the heart of the problem is the inherent conflict of interest of the credit rating agencies, because they charged fees for a “public good service”. The Senate subcommittee called this “like one of the parties in court paying the judge’s salary, or one of the teams in a competition paying the salary of the referee.”
The investors thought that they were buying super-safe securities rated AAA. But in reality, 91% of the AAA subprime RMBS issued in 2007, and 93% of those issued in 2006, have since been downgraded to junk status. It was the collapse of confidence in the ratings, which led to the withdrawal of liquidity in the market that triggered the meltdown in 2008.
This is only the beginning of the dirt that is coming out of Wall Street. The show will continue.
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