Letter 2 America for October 7, 2014

Dear America,

The farther we get temporally from the origins of the financial crisis of the last six years the more apparent it becomes that the solutions to the problems that caused it can be nothing short of deep philosophical changes in our concept of capitalism, which has been transmogrified from its original purpose of facilitating economic growth by making capital available to the singular purpose of allowing individuals to accrue personal wealth.  It is apparent not because of new revelations, but because the same revelations keep coming to the fore, and the same people continue to be involved.  Whether by coincidence or design, this past weekend saw such revelations in at least two instances, one on NPR--the national public radio program "This American Life" specifically--and the other in Friday's New York Times.  Both pieces were about the same story: the cozy relationship between Goldman-Sachs and the New York Federal Reserve branch, and the case of a particular regulator who was fired because she was too critical about it, if you ask her, or because she was just too difficult a person if you ask The Fed.  She filed a lawsuit on account of her "wrongful termination"--wrongful termination is a legal term of art for firing someone who had a reasonable expectation of retention for an invalid reason--and that lawsuit has now been dismissed.  Just for perspective, she has appealed the dismissal.

The young woman was hired for her intelligence and background in the financial industry, and she was assigned right from the start of her tenure to supervision of Goldman Sachs...probably the first or second largest problem for The Fed when the financial crisis occurred, and perhaps the highest profile institution when it comes to the issue of the need for scrutiny and supervision.  And shortly after she was placed in that role, an issue arose with regard to a deal between Goldman Sachs and another bank called Santander, which is the name that Banco Santander, a Spanish bank, goes by here, whose branches are popping up all over the place.  Bear in mind that the Spanish economy is in far worse shape than ours, and so are the Spanish banks.  What happened was a mirror image of one of the ways in which the big banks got into trouble in 2007.  Santander had some dubious assets on its books, which, because they involved money invested by Santander toward the end of making profits for the bank primarily rather than its customers, had the effect of diminishing the bank's retained capital.  Banks are required to keep "reserves" of a certain percentage of the total capital in the institution...that is to keep those assets idle and retained by the bank rather than invested...so that if some investment fails, the bank won't.  That percentage of the total amount that the bank has invested in loans and other capital transactions has changed pursuant to the Dodd-Frank Act, but it continues to be in single digits, so the protection for the public and the system that the reserve requirement represents is thin enough without it being eroded by sharp practices.  In the cases of the biggest banks that amounts to billions of dollars, which is a lot of money, but not so much if when it comes to feeding the chickens that sometimes come home to roost in investment banking, as they did in 2007 and 2008.  And in this case, Santander was below even the required figure, so they "sold" some of their riskier assets to Goldman Sachs for a period of time, after which Santander was required under the terms of the deal to buy them back, giving Goldman Sachs a profit on the deal, estimated in the NPR story to be tens of millions of dollars...just for holding those assets for about thirty days or so so that Santander wouldn't show them and thus have to cover them with reserves in the appropriate amount.  It was not illegal, but even some employees of The Fed characterized it as "legal but shady," and it's easy to see why.  Goldman Sachs was helping Santander hide the fact that it was undercapitalized under the law.  It was aiding and abetting by Goldman Sachs, or conspiring if you look at it in another way, toward the end of evasion of legal responsibility by Santander, and it was motivated simply by greed at Goldman and recklessness at Santander...neither being a laudable motivation for bankers.

When The Fed became aware of the transaction, the regulators felt compelled to confront Goldman Sachs regarding some of the details, among them that before Goldman did the deal, they would get a "no objection" from The Fed, which they claimed to have done as required by Santander, but which they never did in fact.  The leader of the team of regulators that had the meeting with Goldman executives said he wanted to fire a "shot across the bow" of these guys, presumably to discourage further instances of the same kind of legal but shady conduct, and specifically he said that he was going to tell them that since he never gave that imprimatur to the deal, how did they satisfy the requirement, but in the end, he simply lobbed the Goldman Sachs big boys a softball, which didn't really require that they account for their failure to do even that minima duty to Santander, The Fed, and hence the rest of us.  It may seem trivial...even technical...but if you think about it you can see why it was so critical.  The need for that "no objection" ruling was the only control The Fed had over Goldman, and Goldman just ignored it.  They went around the law no matter what anyone else might say about it...including the federal regulators charged with seeing to it that Goldman Sachs never brought the country to its financial knees again.  And because Carmen Segarra saw that and pointed it out, she got fired.

The story demonstrates that our chickens are being protected by nothing but foxes and other chickens.  What stands between us and more disasters like the great depression is a bunch of watchdogs who take their teeth out whenever they see a fox so as not to make him mad.  At least there are a few in congress who see the problem, and there are going to be hearings about these concerns: something important and non-partisan for a change.  But what will come of it is at best uncertain.  My fear is that the only thing that will change our form of capitalism--run by financiers whose only motivation is profit for themselves--is a collapse from which we cannot recover, and such a cataclysm wouldn't be any better for us than it would be for them.

Your friend,

Mike