Crony Capitalism in America 2008-2012, Chapter 9, “Government Sachs”: Revolving Door Prodigy and Power Behind the Throne

 Chapter 9 of Hunter Lewis’s new book

2012 GOP presidential candidate Herman Cain held that “Protesting Wall Street and the bankers is basically saying you are anti-capitalist.” 137 This was complete nonsense. Perhaps Cain was hoping for Wall Street campaign contributions. As a businessman, he should have known that Wall Street is not the center of market capitalism. It is just the opposite: the center of government-sponsored enterprise.

This is a game managed from Washington, with often bewilderingly complex, indeed unfathomable rules, just the place to enrich crony capitalists and fill political campaign coffers.

At the center of Wall Street stands Goldman Sachs, master of the crony influence game. As US Representative Peter DeFazio (D-Oregon) says, “They’ve been wired through the Clinton years, the Bush years, and before that, they have a lot of heavy hitters.” This is certainly confirmed by the record.138

Here are some influential people using the revolving door between Goldman Sachs and government:

Goldman Sachs gains immense political clout from this web of government connections. But the money it spends on lobbying, and the campaign funds it donates or raises, also contribute to its power. Its federal lobbying expenditure reached $4.6 million in 2010,142 the year the SEC charged the firm with civil fraud. Federal political donations rose to $290,500143 the month just prior to the announcement, when everyone already suspected what was coming, and for the two election cycles 2006–2008 and 2008–2010, and partial cycle 2010–8/2012 totaled $14.4 million.144 This made Goldman Sachs by far the biggest lobbying force and campaign contributor among financial firms.

What Goldman Sachs got in return:

1. Survival

Lehman Brothers, a chief rival of Goldman Sachs, collapsed in the fall of 2008. Its request to convert to a deposit-taking bank, which would have placed it under the protection of the federal government and given it access to limitless government cash, was denied by the Federal Reserve and Treasury Departments. Very shortly after Lehman’s bankruptcy, Goldman Sachs and Morgan Stanley were granted this same privilege.

Conversion to bank status immediately told the world that Goldman Sachs and Morgan Stanley would not be allowed to fail. But that was only the beginning. The two firms also received Troubled Asset Relief Program (TARP) funds, $10 billion to Goldman Sachs. They profited from a secret New York Fed loan at 0.01%, $30 billion to Goldman Sachs. They benefited from FDIC and other guarantees for their outside borrowing, $43.5 billion to Goldman Sachs. They were given access to the Fed’s general borrowing window for banks, which provided access to newly printed money at minimal rates (lower than market and even lower than inflation), a privilege that continues to this day. By moving more and more of their derivatives business to the new bank subsidiary, they could get implicit government insurance for that as well.

All of these maneuvers were only possible in the first place because former Goldman Sachs Co-CEO Robert Rubin, when secretary of the Treasury under President Clinton, led a repeal of the Glass-Steagall Act, a legislative initiative that had ensured plentiful Wall Street campaign contributions to Clinton. Glass-Steagall, passed during the Great Depression, prohibited any combination of deposit-taking banking with the kind of investment banking, trading, and speculating activities that provided most of Goldman Sachs’s profits. So, in effect, one former Goldman Sachs head laid the groundwork for Goldman Sachs to become a federally protected bank, his protégé in the Treasury Department, Tim Geithner, gave consent when it was needed in 2008, and another former Goldman Sachs head, Paulson, then Treasury Secretary, facilitated and blessed the maneuver.

At the same time, the US government also bailed out AIG, an insurance company that owed money to Goldman Sachs. Most knowledgeable observers assumed that the payout on mortgage securities protection contracts would be negotiated and reduced.

But on the instruction of New York Fed President Tim Geithner, AIG paid out every penny, a total of almost $13 billion. Geithner supporters later pointed out that the US government was eventually able to sell its stock in AIG back into the stock market at a high enough price to repay the bail-out, even with the indirect payoff to Goldman Sachs. But in reality the recovery of AIG bail-out funds was only possible because the stock market had been inflated sufficiently by US Federal Reserve pumping to sell back the AIG stock without a loss.

Goldman Sachs stated publicly that the extra $13 billion it received from AIG, courtesy of Tim Geithner, was not critical, because other hedges protected against an AIG default on the obligation. It is doubtful, however, that the other hedges, if they existed, would have paid off, and certainly not dollar for dollar. As the office of the Inspector General for TARP reported, the decision by Geithner to pay full price to Goldman Sachs “effectively transferred tens of billions of dollars of cash from the Government to AIG’s counterparties (such as Goldman Sachs).”145

It is also highly relevant that when Geithner ordered full payment by AIG to Goldman Sachs, using government funds, he knew that both Merrill Lynch and Citigroup had only a few months earlier taken large losses on their securities protection contracts with insurers. Merrill Lynch, for example, had accepted $500 million against a $3.7 billion claim on Security Capital Assurance Ltd. in late July 2008.146

Why then were firms devoted primarily to securities sales, trading, financial insurance, or just speculating brought under the protection of the federal government, and in the case of Goldman Sachs even allowed to pretend they were deposit-taking banks? The usual answer is that regulators considered them “too big to fail,” that is, so large that their failure would be too painful for the system to absorb. This is specious reasoning. There is no shortage of banks or securities firms in the US. If the giants had failed, their valuable assets and employees would have been absorbed by other, more prudent firms, and the economy would have gone on, stronger, not weaker, for the purging of unsuccessful speculators and rotten assets.

Even if one accepts the phony “too big to fail” rationale, why were Goldman Sachs and Morgan
Stanley saved when Lehman was abandoned? The most likely answer is that the secretary of the Treasury, Hank Paulson, at that moment had arrived from Goldman Sachs, where he had been CEO and also a major campaign fundraiser for President Bush. He and Fed President Geithner agreed that Goldman Sachs had to be saved.

Luckily for Morgan Stanley, both Paulson and everyone around him knew that they could not rescue Goldman Sachs alone among the then-non-banking  financial behemoths. It is a reasonable conjecture that Morgan Stanley got a free ride, mostly to provide cover for the Goldman Sachs rescue, especially after some Japanese investors provided additional outside capital.

As the crisis unfolded, Hank Paulson was initially constrained by federal ethics rules from speaking to the firm where he had spent his career or participating in decisions that affected it. But that was soon finessed. As New York Times reporter Andrew Ross Sorkin explained, “[Paulson] had enough of recusing himself. . . . [He] appreciated that the ‘optics’ of a waiver to engage with his former employer were problematic,
but he hoped it would remain a secret. . . .”147

The White House was consulted and in short order the Treasury ethics office granted the waiver based on an “overwhelming public interest.” Over the next few days, Paulson spoke to the CEO of Goldman Sachs, Lloyd Blankfein, over twenty times. He also brought in a group of Goldman executives to help manage the crisis. In a sense, management was “outsourced” to the firm that had the most to gain from what the government was doing. As a New York Magazine article noted, “The firm nearly went under even after the AIG bail-out.” Interestingly, when Tim Geithner came in as Treasury secretary under President Obama, the constant telephone contact between the Treasury secretary and the Goldman Sachs CEO continued unabated, with conversations almost every other day according to logs obtained under the Freedom of Information Act.

2. Legal Protection

Goldman Sachs also needed and got legal protection. During 2006 and 2007, it sold $40 billion of securities backed by poor quality home mortgages. By early 2007, it was buying securities that would make money if the mortgage securities tanked, including the contracts with AIG, but without telling the buyers of the mortgages.

Some of this is even on the record. An Australian fund, Basis Capital, bought $100 million of subprime mortgage securities from Goldman Sachs on June 2007, partly with borrowed money, after being told to expect a 60% return. A Goldman Sachs salesman sent an email describing the buyer as a “white elephant, flying pig and unicorn all at once,” by which he presumably meant he could not believe his luck in finding anyone so gullible. Only 16 days after the sale, Goldman Sachs was demanding more money from Basis to support the loan. Within a month, Basis had lost $37.5 million and was forced to file for bankruptcy.148

Professor Laurence Kotlikoff, a financial expert from Boston University, has said that the Securities and Exchange Commission should be very interested in any financial company that secretly decides a financial product is a loser and then goes out and actively markets that product or very similar products to unsuspecting customers without disclosing its true opinion. This is fraud and should be prosecuted.

But the SEC did not prosecute. It did not seem interested in any of this.

Was this in any way related to a Goldman Sachs vice president, Adam Storch, becoming the managing executive of the SEC’s enforcement division on October 16, 2009? 149 Or was the problem broader, as described by  investigative reporter Matt Taibi of Rolling Stone:

Criminal justice, as it pertains to the Goldmans and Morgan Stanleys of the world, is not adversarial combat, with cops and crooks duking it out in interrogating rooms and courthouses. Instead, it’s a cocktail party between friends and colleagues who from month to month and year to year are constantly switching sides and trading hats.150

No wonder a Goldman Sachs lobbyist was quoted by Politico saying in April 2010: “We are not against regulation. We’re for regulation. We partner with regulators.” 151

The SEC did file a civil fraud complaint against Goldman Sachs in April 2010, charging that it had  “rented” its name in 2007 to a fund operator who had bilked investors of $1 billion. During the period over which Goldman Sachs lawyers negotiated with SEC staff over this “Abacus” case, Goldman Sachs CEO Lloyd Blankfein visited the White House twice as an honored guest of President Obama. The fine of $550 million paid by Goldman Sachs three months later (without admitting guilt) represented only 4% of Goldman Sachs profits in 2007 and a tiny fraction of all the bail-out aid received earlier.

The SEC did not turn over its files to the Justice Department for prosecution, as it is legally required to do if it believes a crime has been committed. Nor did the Justice Department choose to investigate on its own. Even when the chairman of a Senate Committee, Carl Levin (D-Michigan), submitted a 650- page report to Justice stating that Goldman Sachs executives, including the CEO, had “clearly misled their clients and . . . misled the Congress [under oath in hearings],” the Department chose to sit on its hands and not investigate.152

What was going on here? During the Savings and Loan crisis of the 1980s, federal prosecutors filed over a thousand cases and won 90% of them.153 After the Crash, the Justice Department vigorously pursued fraud and other charges against small-time financial operators unconnected to the big Wall Street firms.154 Yet Wall Street remained untouched. Even when  MF Global, led by former US Senator and Governor (D-New Jersey) and former Goldman Sachs CEO Jon Corzine, announced that over $1 billion of its customers’ money had gone missing,155 there was great doubt that Justice would pursue the case.

Shortly after his election, President Obama reportedly told a group of Wall Street chief executives, gathered at the White House: “My administration is the only thing between you and the pitchforks.”156 Whose pitchforks? The Justice Department’s? Was the president holding back the investigators?

Goldman Sachs had been the second largest contributor to the Obama campaign, donating almost $1 million, multiples of what it had given to his Republican opponent, John McCain. Jon Corzine had been a “bundler” who brought in $500,000 to the 2008 campaign. Vice President Biden, before Corzine’s disgrace, praised him as the first person the president called for economic advice after the election.

So long as Wall Street remained unindicted, the checks would flow and, very importantly, could be cashed. Fear of indictment would mean more and more checks. Goldman Sachs contributions noticeably spiked the month before the SEC civil charge, fell right after the charges (to preserve appearances), only to ramp up again after the settlement.

Critics noted that the Justice Department was investigating the Macau casinos of Sheldon Adelson, billionaire contributor to Republicans.157 Why Adelson but not Democratic donors? It was also noteworthy that Attorney General Eric Holder left the Clinton Justice Department to join the law firm of Covington and Burling, before returning to Justice in the top job, and that Covington and Burling represented many Wall Street firms. Perhaps, it was speculated, Holder was not just thinking about campaign contributions from Wall Street, but also about future million dollar legal fees? The circumstances, including the lack of Wall Street prosecutions after the Crash, the size of Wall Street campaign contributions, and the spinning, not just revolving, door between Wall Street and government all contributed to suspicion.

3. Profits

The millions spent by Goldman Sachs on lobbying, campaign contributions, and hiring former government employees may have staved off bankruptcy during the Crash. They may also have provided important defenses against legal challenges. But government affiliated firms play offense as well as defense. They want to turn their government connections into profit, if possible enormous profit, and Goldman Sachs has been very successful in doing so. Goldman Sachs is now run from a massive new headquarters building in Manhattan. By locating across  from where the World Trade Center once stood, the firm was able to finance it with $1.65 billion of taxfree “Liberty Bonds.” Interest savings are expected to total $175 million over 30 years. State and city provided an additional $115 million in job-grant funds, tax exemptions, and energy discounts.158

Government connections conferred many other benefits. With Lehman Brothers gone and other former competitors such as Merrill Lynch a shadow of their old selves, competition for securities trades decreased and “spreads” (profits) increased. In some areas of the market post-Crash, Goldman Sachs enjoyed what former employee Anthony Scaramucci called “a near monopoly.”159

Had it passed, the Over-the-Counter Derivatives Markets Act of 2009 would have given Goldman Sachs and eight other banks government-sanctioned control over the entire derivatives market at a time when the Commodity Futures Trading Commission was led by Gary Gensler, a former Goldman senior executive. The 2010 Dodd-Frank Act did not go that far, but did seem to codify the “too big to fail” doctrine while pretending to do the opposite. Being “too big to fail” gave Goldman Sachs a significant competitive advantage when it borrowed money, whether from the Fed or from other parties. As Simon Johnson, former chief economist of the International Monetary Fund (IMF) explains:

Everyone I’ve spoken to in the last year or so regards Goldman and other big banks as implicitly backed by the full faith and credit of the United States Treasury. This lowers Goldman’s cost of funds, allows it to borrow more, and encourages . . . [it] to become even larger.160

A report from Moody’s, one of the leading bond rating agencies, indicated that presumed government backing of a Wall Street firm is worth “five notches.” This means that a security that would have been rated Baa3 rises to A2, which produces a sizeable reduction of interest expense.161 Moody’s by the way is also a government-sponsored enterprise. Much of its revenue derives from quasi-monopoly status granted by Washington.

In light of all this, it is hardly surprising that Wall Street profits in the three years following the Crash exceeded the eight years leading up to it. By the summer of 2009, Goldman Sachs’s salary and bonus pool had completely recovered from the Crash and stood at $11.36 billion (for six months). The share price, which hit an intra-day low of $47 had also recovered to $125, although still below the previous high.

Goldman CEO Lloyd Blankfein, sitting high in his Manhattan aerie, seemed uncharacteristically content
by the end of 2009:

I’m charged with managing and preserving the franchise for the good of shareholders, and while I don’t want to sound highfalutin, it is also for the good of America. I’m up-front about that. I think a strong Goldman Sachs is good for the country.162

Source: http://www.againstcronycapitalism.org/2013/11/crony-capitalism-in-america-2008-2012-chapter-9-government-sachs-revolving-door-prodigy-and-power-behind-the-throne/