Frank Partnoy, a long-time Wall Street critic who wrote about the problem of off-balance sheet accounting trickery in our recent special report on financial reform, had a piece in FT this week arguing that the focus on Goldman Sachs is counter-productive and unfair:
More fundamentally, if the other big investment banks had made similar "net short" trades in 2007, there would not have been a financial crisis. Bear Stearns, Lehman Brothers and Merrill Lynch collapsed because they took massive positions in the opposite direction. Given the cost of government bail-outs, why chastise the only prudent investment bank?
One possible explanation for the focus on Goldman is that government officials do not understand modern markets. The Securities and Exchange Commission advertises itself as the "investor's advocate". Yet the investors in Goldman's Abacus 2007-AC1 deal were two large European banks, one of which, it is alleged in a separate private lawsuit, defrauded US pension funds by selling them similar subprime mortgage-backed investments. Why would the SEC advocate on behalf of a European bank against Goldman Sachs instead of on behalf of American investors against a European bank?
While I'm somewhat sympathetic to his case -- the recent congressional hearings grilling Goldman executives weren't hugely impressive -- ultimately Partnoy relies too much on the sophisticated investor canard and doesn't address the double-dealing at the heart of the SEC's lawsuit against the firm. He is essentially making the opposite mistake of the senators at the hearing: Goldman survived the crisis because of their short position on the housing market, which makes them prudent in Partnoy's eyes and immoral in the eyes of Sen. Carl Levin.
While the SEC's lawsuit has been deployed for political purposes, it is in reality asking a very specific question about disclosure that should be answered. Meanwhile, as ever, the real scandal is what is legal, and that is why the financial reform bill aims to address and regulate pernicious practices that were carried on by virtually everyone in the financial industry.
-- Tim Fernholz
