By Leon Gettler
IN HIS testimony to the Financial Crisis Inquiry Commission in January, Goldman Sachs chief executive Lloyd Blankfein was in no mood for apologising. The commission questioned Blankfein about the company's practice of selling mortgage securities and then placing bets against those securities. "That's what a market is,'' Blankfein said without hesitation.
What sort of market is it if buyers don't have all the information? Blankfein would say that's not the point - if you don't like the heat, get out of the kitchen.
Nothing has changed. The Securities and Exchange Commission has accused Goldman Sachs of investor fraud. In its response, the company has, in effect, told regulators to stick it. Blankfein is telling clients it is political, even though Goldman Sachs received a so-called Wells notice from the SEC nine months ago, warning that investigators wanted to bring a case.
Goldman Sachs might argue it is no coincidence the SEC lawsuit was filed on the eve of the Senate's financial services reform debate, but given public opinion polls, that argument is unlikely to win it many friends. This case will have political ramifications.
Democrats pushing through the financial reform bill claim it would prevent the kind of deals arranged by Goldman Sachs. This case has delivered United States President Barack Obama something he can use to show voters he is on their side. By using politics as a defence, Goldman Sachs is playing into that.
This is also a story of investors' irresponsible behaviour and bubble thinking - standard for Wall Street - that created subprime. It's also a political story about the disconnect between financial institutions and the US public enraged about billions spent propping up inept institutions and saving shareholders while ordinary folk received nothing, American-style "socialism for the rich".
If Wall Street is in shock about Goldman Sachs, it has failed to grasp that the political and public opinion landscapes have changed. US unemployment of about 10 per cent is now Obama's hurricane Katrina and polls show rising voter discontent over bailouts and financial institutions while joblessness remains stubbornly high.
A recent Pew survey revealed seven out of 10 Americans now distrust banks and financial institutions - and Goldman Sachs is the biggest - and that 61 per cent want stricter regulation of financial companies.
The Goldman Sachs lawsuit will become a yardstick of Obama's presidency and the likelihood of overhauling Wall Street's practices.
The SEC's case is no slam dunk. Greed is not the same as breaking the law and it is standard Wall Street practice to take positions on both sides of an investment. The regulator will have to prove Goldman Sachs was misleading institutional investors, who were quite capable of due diligence.
With reports that the SEC was split on party lines - SEC Chairman Mary Schapiro, an independent appointed by Obama, sided with two Democrats to go ahead with the legal claim while Republican commissioners voted against it - the regulator is playing a high-risk game. The SEC is desperate for a win after failing to stop Bernard Madoff and it has yet to successfully prosecute any big case coming out of the financial crisis.
Even if Goldman Sachs wins, things will never be the same. Its reputation is already tarnished. Described last year by journalist Matt Taibbi in Rolling Stone as the "great vampire squid wrapped around the face of humanity'', its brand will suffer as evidence comes out. The release of emails by the US Senate permanent subcommittee on investigations showing Goldman Sachs executives bragging that subprime was a chance to make serious money is just the start.
Goldman Sachs is being investigated by regulators around the world and it has been subpoenaed in a court filing seeking information about short-selling Lehman stock.
With distrust of government moving lock step with distrust of corporations, it's also the backdrop to events like the Tea Party phenomenon, which includes gun nuts, tax protesters, people opposing government-run healthcare, crazies who claim Obama was born in another country, racists and Sarah Palin. The financial meltdown has changed America's political landscape and polarised US society. Goldman Sachs and Wall Street have fuelled populist anger.
The US government pinged junk bond pioneer Michael Milken for the sins of the 1980s, it put Arthur Andersen out of business and rammed through Sarbanes-Oxley after Enron. That, along with rising public anger, is how regulation of big business works after a crisis.
Goldman Sachs and Wall Street seem to be out of touch with today's zeitgeist and the way regulation comes about. This case will reverberate. It might create the traction for harsher banking rules and enforcement of higher capital requirements. Bets on synthetic CDOs might also be banned. The vampire squid has given politicians a chance to fix corporate regulation.