In April of 2010, Matt Taibbi, the untiring investigative reporter, wrote in Rolling Stone the single most epic lament to emerge from the 2008 financial collapse and subsequent worldwide economic turmoil. Describing the legendary and problematic firm Goldman Sachs, he wrote: “The world’s most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.”
The metaphor has stuck, and now people in the financial community, in government, in the Occupy Wall Street movement, populists, libertarians, Tea Party Republicans, even international policy makers and some at Goldman itself, repeat the moniker “vampire squid”, in part because it explains a lot about the many-tentacled profit-extraction machine the firm is devoted to being. It rings true.
The rising culture of resistance to remote extractive finance has led to major financial sector regulatory reform, a Consumer Financial Protection Bureau, and to repeated rounds of uncomfortably intimate “stress tests” for major banks, to determine whether their capital holdings are substantive, speculative or entirely too fictional. This week, it led to a high profile defection from Goldman Sachs, in which Greg Smith, an executive of the firm, resigned and published a New York Times op-ed explaining the many reasons he could not in good conscience continue to work there.
Among the reasons, he wrote: "It makes me ill how callously people talk about ripping their clients off". Smith argued that there is a culture of moral bankruptcy running so deep the firm seems to have morphed into an engine for profits of a specific kind that depend on working against client interest. Smith elaborated, explaining that the company was too important to the world financial markets to continue to behave in such a flagrantly “toxic” manner.
In his words:
To put the problem in the simplest terms, the interests of the client continue to be sidelined in the way the firm operates and thinks about making money. Goldman Sachs is one of the world’s largest and most important investment banks and it is too integral to global finance to continue to act this way. The firm has veered so far from the place I joined right out of college that I can no longer in good conscience say that I identify with what it stands for.
The Christian Science Monitor reminded readers this week that there is real credibility to this analysis:
The bank paid $550 million in 2010 to settle civil charges that it misled investors while selling them investments in the U.S. housing market as the bubble burst — even as Goldman reaped hundreds of millions from its own bets against housing.
Many have been critical of Goldman Sachs for allegedly altering its entire operating structure, at least in legal terms, in order to receive direct assistance from the United States government, to cover up or get rid of bad investments, even as it has—allegedly—continued to behave in a way that works deliberately against its clients’ interest.
So the question begins to arise: why have so many in the financial industry, among top economists and government policy makers, defended Goldman Sachs, as evidence continues to emerge that Taibbi’s characterization of a “great vampire squid” undermining sound policy and medium- to long-term economic stability, is the fairer view? A little conceptual back-and-forth might help to illustrate how policy regarding toxic finance has developed in the wake of the 2008 collapse.
Sympathy for the vampire squid: The argument has been made many times that “too big to fail” means “to useful to challenge”. Such institutions need to be massive, and highly connected, rooted in and reaching out to as many segments of the wider society, because this will have a constructive and even stabilizing effect on the wider society and the financial markets themselves… or so the argument goes.
No sympathy: The prevailing counter-narrative is that such a massive, highly connected financial institution, rooted in and reaching out to so many segments of the wider society, devolves from a purveyor of legitimate services, fostering genuine value for clients and society, into a wealth extraction engine, addicted to the kind of operations whereby the firm takes money without its business partners fully understanding how, or the degree to which their relationship with the firm might be detrimental to their own interests.
Sympathy: Finance is the foundation of a sound economy. Aggressive finance is the foundation of a boom economy. If we want the US economy to grow, as it did in the 90s and the 2000s, we need to let big banks operate in as unfettered a manner as possible—”laissez-faire”, let them be and do as they wish—so that fresh capital flows to as many people and institutions across the economy as possible.
No sympathy: Historically, it turns out that laissez-faire economic policies create unhealthy dynamics defined by a hyper-concentration of wealth and influence that routinely and systematically impedes the flow of fresh capital to newcomers and to those not already on the inside of the privileged coven of interests tied to what is—far from an open market—a rigged game. Goldman Sachs is increasingly facing criticism that its many “tentacles” are used to rig markets and financial products so that it will profit, even when everyone else sees wealth evaporating.
Sympathy: The atmosphere of deregulated overlapping financial markets, spanning personal banking, insurance, securities, commodities and real estate, put institutions like Goldman Sachs in a position of perhaps undue influence, but given that, they were required to develop complex mathematical systems for hedging against the corrosive tendencies of a financial system without adequate protections or firewalls.
No sympathy: The credit default swaps, mortgage-backed derivatives, anonymous hedge funds and subprime mortgage resale products, were specifically designed to distance the firm from risk, without reducing overall risk. It was a shell game that sometimes worked like a pyramid scheme, sometimes like a labyrinth of booby traps and “blood funnels” laced with a handful of sweeteners to tease investors into handing over their trust.
Conclusions: What we know about the period from 1998 through 2008, when the repeal of Glass-Steagall led to the compounded integration of financial firms, the overlapping of credit-based speculative investments, and an overly intimate relationship between banks and policy-makers, is that it led financial institutions to replace capital-in-reserve with speculative credit claims and financial instruments designed to make borrowing against future earnings easier, without revealing the ephemeral frame of the edifice.
In other words, banks gave into the temptations of a marketplace in which it became possible to use assets from one department to borrow against losses in another department, often using complex accounting methods to claim wealth against which it would then be possible to borrow from the government and from other financial institutions. The result was: not enough cash in the system to fund the wealth claims of the whole of the marketplace.
Overlap and redundancy were conducive to inflating the apparent wealth to which all had access, while the effect was to actually reduce the amount of real capital available to any given borrower or investor, except the most privileged. Credit default swaps and bundled mortgage-back securities were house-of-cards instruments, and from the market-wide global view of a firm like Goldman Sachs, all of this was actually self-evident. The numbers made the peril clear.
We know from the 2010 settlement that Goldman Sachs deliberately set about misleading its clients so that the firm could leverage the risk dispersed through the entire marketplace for its own benefit, even, if not especially, where that tactic would harm its own clients. Deliberate fraud was carried out, on the flimsy claim that if the clients really cared, they would figure it out for themselves.
This is the morally corrupt and corrosively “toxic” culture Greg Smith spoke of in his landmark op-ed for the New York Times last week. According to Smith, this culture still prevails, and is enough to make him viscerally uncomfortable with the very idea of continuing to work for this firm. He argues that every individual who has participated in this kind of toxic activity, and who holds this cultural view that profit-seeking is legitimate even where it directly attacks the interests of the clients with whom one claims to have a good faith contractual relationship, need to be purged from the financial markets.
The more significant question, ultimately, is how to eliminate a “culture” of corruption and hostility to client interest, if one must presume the innocence of people at work in the system affected by that corruption? Prosecutions could be one choice. Another could be conditional lending from all government institutions. Another could be new regulations that make specific types of misleading activities into federal crimes, with significant prosecutorial discretion to file independent charges for every individual act of fraud.
The stock market itself may also play a role: if testimony like that of Greg Smith affects the dominant views of media, the public and policy-makers, as well as investors, firms like Goldman Sachs will find it far more difficult to make money in the way that Smith and others allege they have been doing. Ultimately, while the presumption of innocence is a fundamental hallmark of a democratic society, and a necessary sophistication in the constructive deployment of public opinion for positive change, it is imperative that we not overlook the facts in evidence or the already proven corrosive quality of specific types of financial activity.
A solution might look like the following:
- A sound first step would be for shareholders to demand 100% accountability from all executives who in any way, shape or form, participated in anti-client behavior or in circumventing contractual or legal obligations.
- Parallel to this, a credible criminal investigation should be undertaken, based on solid evidence of deliberate wrongdoing that has already emerged in previous litigation or entered the public domain through media or testimony like that of Smith.
- The firm will ultimately have to begin to err on the side of total transparency, protecting client privacy, but not hiding its business methodology from clients, shareholders, legal authorities or the general public.
- Its survival will be determined not by the ability of highly placed allies to aid the firm in undue gain, but by its actual value to shareholders, clients, the financial marketplace and to society more broadly.
- If the numbers are not there to support its continued leadership of the top flight of financial sector firms, then it will lose that position, and the markets will force the firm to find its level or be “unwound” through a responsible bankruptcy process.
- Whether by shareholder takeover or by government involvement, a new fleet of top executives could come in who would be rewarded for transparency, solvency, and good-faith follow-through on client accounts.
The current round of US government “stress tests” has been highly criticized for allowing firms like Goldman Sachs to appear to be more stable and more founded on real wealth than in fact they are. A concerted effort will be needed, across economic reporting by the media, government examination and regulation of finance, and the financial sector itself, to discern precisely where the line is between real and fictional wealth claims, and urge all financial practitioners to move their firms back to activities and long-term projections based on real wealth, not fictionalized claims of future potential gain, esoteric financial instruments or rigging of public policy to favor bad actors.