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  1. AMLTrojan

    I don’t know, Brendan, the more I read — in particular some of the well-informed comments on the blog post linked above — the more I am inclined to believe that GS played this one pretty square, and looking backward to whine about them being unethical and inexcusable sounds increasingly like 20/20 hindsight. ACA and IBK met with Paulson multiple times and, apparently, never made much of an effort to understand the intentions of their counterparty. And regulation isn’t going to solve the problem. To wit:

    People at some point need to get the joke about what banks actually do. It’s not about taking deposits and lending money to job-creating commerical enterprises. It’s about taking every rule and regulation you operate within, every contract you can trade or dream up, and every customer who’ll accept your phone call, and out of all this finding ways to make yourself and your boss wealthy. Banks are nothing more than wealth-creation vehicles for management. In terms of business model, they’re just like hedge funds, but with cheaper capital (now much cheaper with the kind support recently provided). Clients, relationships and reputation are imporant insofar as they represent ways to make money. It’s really staggeringly simply, and certainly not illegal.

    In hindsight, so much now seems obvious, but then we have to ask ourselves, why did otherwise intelligent managers of other people’s money make such foolish decisions?

    One reason is groupthink, a problem that will never disappear so long as humans are around and making decisions.

    But since groupthink (and the most catastrophic examples thereof) tend(s) to occur as a result of small groups of folks being insulated from outside forces, one classical approach to breaking groupthink is to expose their thoughts to the analysis and evaluation of a diverse audience — in other words, to make their deliberations and records public. And the way to do that with investment banking is to require public exchanges and standard formats for contracts / securities / derivatives / equities.

    Unfortunately, even had these CDOs been formed in the light of day for investors to dissect and analyze, the market would still be slow to self-correct since the ratings agencies were asleep at the switch as well. After all, if you’re the head of a bank representing a group of pension agencies, why should you have to dig deep on investment vehicles rated Aaa?

    So, why were the ratings agencies asleep at the switch? Because they constitute an oligopoly and are insulated from competition, they have an economic incentive to be asleep at the switch so they can facilitate deals with all sides, and because they lack some of the same information that most investors do because of the complexities of these deals and the fact they are made in the dark. The solution here is to remove restrictions on the ratings agency business and allow more into the game in order to allow competition to identify the best raters.

    Finally, synthetic and derivative securities that are intended for hedging (read: insurance) purposes should be subject to some of the same rules as insurance. That is, they should not be vehicles for leveraging massive bets on speculative outcomes, but only for covering downside risk on your portfolio of assets.

    Unsurprisingly, this is the collective wisdom of some otherwise divergent commentators. The outcome of the SEC is essentially irrelevant, and indeed, the fact that GS refused to settle the case before it became public suggests this is yet another high profile government case that will end with a whimper rather than with a bang (see: Eliot Spitzer’s ferocious treatment of Wall Street firms in the early 2000s).

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