My younger son is always good for at least one Christmas gift book that is from out of left field. This year it was First as Tragedy, Then as Farce, by Slavoj Zizek. To complete the baseball analogy, Zizek plays just slightly to the fair side of the foul line, leaving most of left field pretty much unprotected. Nonetheless, the book is a fun read, and he makes a number of valid points. Here’s an excerpt from his discussion of Bernie Madoff:
Here one has to ask a naive question: did Madoff not know that, in the long term, his scheme was bound to collapse? What force denied him this obvious insight? Not Madoff’s own personal vice or irrationality, but rather a pressure, an inner drive to go on, to expand the sphere of circulation in order to keep the machinery running, inscribed into the very nature of the capitalist circulation process. In other words, the temptation to ‘morph’ legitimate business into a pyramid scheme is part of the very nature of the capitalist circulation process. There is no exact point at which the Rubicon was crossed and the legitimate business morphed into an illegal scheme; the very dynamic of capitalism blurs the frontier between ‘legitimate’ investment and ‘wild’ speculation, because capitalist is, at is very core, a risky wager that a scheme will turn out to be profitable, an act of borrowing from the future. (Emphasis added)
Now, as it happens, we learned (probably after the book was written) that Madoff pretty much always knew that he was running a Ponzi scheme, but a number of other items in the news this week reinforce Zizek’s larger point. First, while those selling derivatives and credit default swaps, are not, strictly speaking, engaging in a Ponzi scheme, what they are doing comes awfully close. The effects appear to be the same, in that the last guy on board is the big loser, except the “legitimate” practitioners of the art have designed a system in which the last guy standing is the taxpayer.
Before going on, let me give you the elements one must establish in court to prove fraud: that the wrongdoer has made representations of fact that he or she knows to be untrue; that those representations were made with the expectation that the victim would rely on those representations, and that the victim did in fact rely on those representations to his, her or their harm.
That is the definition for 99.9% of us, but not, apparently, for the folks at Goldman Sachs,who can’t even begin to see what the problem is with this:
In late October 2007, as the financial markets were starting to come unglued, a Goldman Sachs trader, Jonathan M. Egol, received very good news. At 37, he was named a managing director at the firm.
Mr. Egol, a Princeton graduate, had risen to prominence inside the bank by creating mortgage-related securities, named Abacus, that were at first intended to protect Goldman from investment losses if the housing market collapsed. As the market soured, Goldman created even more of these securities, enabling it to pocket huge profits.
Goldman’s own clients who bought them, however, were less fortunate.
Pension funds and insurance companies lost billions of dollars on securities that they believed were solid investments, according to former Goldman employees with direct knowledge of the deals who asked not to be identified because they have confidentiality agreements with the firm.
Goldman was not the only firm that peddled these complex securities — known as synthetic collateralized debt obligations, or C.D.O.’s — and then made financial bets against them, called selling short in Wall Street parlance. Others that created similar securities and then bet they would fail, according to Wall Street traders, include Deutsche Bank and Morgan Stanley, as well as smaller firms like Tricadia Inc., an investment company whose parent firm was overseen by Lewis A. Sachs, who this year became a special counselor to Treasury Secretary Timothy F. Geithner.
…
While the investigations are in the early phases, authorities appear to be looking at whether securities laws or rules of fair dealing were violated by firms that created and sold these mortgage-linked debt instruments and then bet against the clients who purchased them, people briefed on the matter say.
One focus of the inquiry is whether the firms creating the securities purposely helped to select especially risky mortgage-linked assets that would be most likely to crater, setting their clients up to lose billions of dollars if the housing market imploded.
Some securities packaged by Goldman and Tricadia ended up being so vulnerable that they soured within months of being created.
You might want to glance at the elements of fraud again, and see if there were any Goldman missed.
Lest you think there isn’t much evidence that Goldman represented these investment vehicles as good bets, read on:
Mr. Egol and Fabrice Tourre, a French trader at Goldman, were aggressive from the start in trying to make the assets in Abacus deals look better than they were, according to notes taken by a Wall Street investor during a phone call with Mr. Tourre and another Goldman employee in May 2005.
Only the financial industry can even try to argue that screwing its own customers is an honorable enterprise. In my much denigrated profession, it would be considered bad form indeed to bet (money, that is) that you would lose a case in which you were engaged. It’s called a conflict of interest, and even the most ethically blind lawyer would see that. But that level of insight has apparently been denied to the Titans of Wall Street.
Here’s where we get back to Zizek’s observation that fraud is inherent in the capitalist system. That’s probably overstating it (but not by much), but recently some non-lefties at Princeton purported to prove that it is inherent in the very financial derivatives that Goldman was selling:
In a result that may have implications for financial regulation, researchers from computer science and economics have revealed potentially impenetrable problems with the pricing of financial derivatives. They show that sellers of these investments could purposefully include pieces of bad risk that no buyer could detect even with the most powerful computers.
The research focused on collateralized debt obligations, or CDOs, an investment tool that combines many mortgages with the promise of spreading out and lowering the risk of default. The team examined what would happen if a seller knew that some mortgages were “lemons” and structured a package of CDOs to benefit himself. They found that the manipulation may be impossible for buyers to detect either at time of sale or later when the derivative loses money.
…
“Standard economics emphasizes that securitization can mitigate the cost of asymmetric information,” Brunnermeier said. “We stress that certain derivative securities introduce additional complexity and thus a new layer of asymmetric information that can be so severe it overturns the initial advantage.”
Now, this doesn’t necessarily prove that fraud is inherent in the system, only that it is well nigh impossible for the buyer to detect fraud on the part of sellers who, as a class, have no more scruples than a cat with a mouse. It means, among other things, that it was fully within Goldman’s power to structure the crap it was selling so that it would certainly fail (not a hard thing to do in any event), but in such a way that even the most wary would not be able to detect what Goldman had done, either at the time or later (i.e., no prison time for the Goldman guys and girls). Now, Goldman would have no incentive to do such a thing (other than the giant fees it gets for packaging and selling the crap) if it couldn’t make money betting against its own handiwork. But it can, and it does.
But it’s not inherent in the system. If Goldman employees were saints, or even people with some ethical standards, then this sort of thing would not happen. But if we assume that Goldman employees are not saints, or that they lack what most of us would consider ethical standards, then Zizek is right, at least so far as the financial industry is concerned. Fraud is inherent in the system, at least the way the system is structured today. I would be glad to follow Goldman’s example and place some bets: that when the dust settles next year, Congress will have done nothing to make this behavior explicitly criminal.
Note: I should mention, by the way, that the Times article to which I’ve linked above, is only an elaboration of a story reported by McClatchy almost two months ago, about which I commented at the time.
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