My good friend and colleague Andrew Potter recently published his second book, called The Authenticity Hoax: How We Get Lost Finding Ourselves. It’s a challenging and fascinating examination of the modern pursuit of what is “real” and “genuine,” and whether that preoccupation has become self-defeating.
When news broke last Friday of the SEC’s decision to lay fraud charges against Goldman Sachs and one of its senior vice-presidents, I was reminded of the key themes of Potter’s book: the gap between appearance and reality, and the question of what’s more important, what is or what seems to be? This is more than idle philosophizing. It may be the issue that determines the course of post-crisis reform in the capital markets.
It’s rare that a case of apparent white-collar chicanery dredges up fundamental questions of philosophy, but this is no ordinary lawsuit. The prosecution of Goldman represents the first step in what is sure to be a far-reaching legal examination of the financial crisis of 2008 — 09.
The market gains of the past year have done little to cool public outrage over huge government bailouts and widespread job losses stemming from the sub-prime mortgage fiasco. The role that big firms like Goldman played in the crisis has gone largely unexamined and totally unpunished. Many of the executives that nearly crashed the global economy are back to hauling in staggering bonuses, and seem totally unrepentant. But that’s about to change.
The Securities and Exchange Commission’s allegations against Goldman are pretty simple at their heart. They say that the firm created a security called Abacus, packed full of the worst pile of distressed mortgages they could find. They selected these dodgy mortgages and created Abacus in consultation with hedge fund manager John Paulson. Then they allegedly sold Abacus to clients, without letting them know that Paulson planned to bet against it. It was, in other words, designed to fail. Goldman made hefty fees and commissions all down the line, and when Abacus crumbled, Paulson got rich at the expense of all those who bought the thing.
In the aftermath of the charges, Goldman stock fell more than 13%. Meanwhile, every wag on Wall Street began parsing the finer points of the charges and arguing over the strength of the SEC’s case. Is there anything illegal about designing a security to fail? Is Goldman obligated to disclose who’s involved in creating such products? All interesting questions for securities lawyers, and all utterly beside the point. This case is being fought in the court of public opinion, and Goldman has already lost.
Even if the deals in question are legal on a strict reading of the law, to the average person they stink to high heaven. They offend our basic sense of fair play, and they contribute to the spreading cynicism that the markets are rigged against ordinary investors.
If that notion is allowed to fester, it erodes the foundation of free and open markets and the capitalist system itself. The SEC and the U.S. government will rightly do whatever is necessary to ensure that the system is protected, and that means holding Goldman to account.
For now, the firm is saying it will fight the charges vigorously, but that’s just posturing. Regardless of what you think of the reality of the case, the appearance of Goldman’s behaviour is indefensible. Even if it could somehow win in court, the damage to its reputation could be fatal. Despite what the titans of Wall Street might believe, they’re called the public markets because that’s who they belong to. And the public is at Goldman’s gate, pitchforks and torches in hand.
We’re no longer in the realm of lawyers and regulations. We’re in the era of appearances, PR people, and the almighty sniff test. Abacus smells bad. And make no mistake, Goldman will pay the price for that.