The Corner

On Goldman, Is It ‘Should Have’ or ‘Had to’?

I try not to make up my mind on news about business and finance until hearing what Larry Kudlow has to say. Naturally, I’m very glad NR’s finance guru has weighed in on the SEC’s case against Goldman Sachs with characteristically keen insights. (I wrote about the case in Tuesday’s column.)

Larry provides an especially valuable time-line of the construction of the synthetic CDC (collateralized debt obligation) at issue. The time-line destroys any claim by the SEC that ACA Management was just a front used by Goldman to hide the role of John Paulson — the bearish participant who wanted the CDO constructed precisely so that he could bet against it.

That doesn’t end the matter. As Larry shows (and there can be no dispute about this), Paulson was a major participant even if he was neither nominally nor functionally the “portfolio selector” (ACA was). So Larry concludes, “It just seems to me that Goldman Sachs should have named Paulson in the offering circular for the CDO.”

Now, Larry qualifies his analysis by pointing out that he is not a lawyer. He’s drawing an ethical conclusion, not a legal one. I’m the other side of the coin: I am a lawyer, but not a finance guy. Larry knows enough about the law to be wildly successful in finance, and I know barely enough about finance to have prosecuted some securities fraud cases. Despite these different perspectives, we have common ground:  I agree that it would have been better practice for Goldman to disclose.

But even if one agrees that they should have disclosed, does that mean they had to disclose as a matter of law?

I don’t think so. Like Larry, I think of myself as a strong proponent of free-market capitalism. In my view, a free market principally polices itself. That’s the “free” part. The law should intervene only as a last resort to punish truly severe instances of misconduct – e.g., theft and misrepresentations that are crystal clear. Not everything that is unethical or arguably unethical ought to be illegal. Nor do we want unethical conduct, or the potential for unethical conduct, to be an invitation for government regulation. Almost always, government regulation is a “cure” that is worse than the disease.

Let me be more concrete. Larry does not limit his displeasure over Goldman’s sharp practices to its failure to name Paulson. He adds that his sources say “this CDO in question was weak and appeared designed to unravel quickly…. [It] lacked sufficient cash; its covenants were weak; and it afforded less investor protection than usual in order to provide higher yields.” If that’s true, it is indeed very disturbing. But shouldn’t the remedy for this be that Goldman Sachs’s name becomes mud in the business community?

As Holman Jenkins points out in today’s Wall Street Journal, and as I argued in yesterday’s column, the market we’re talking about here was comprised of highly sophisticated investors. Those who take long positions on synthetic CDOs know full well there are short-sellers on the other side. Why can’t we trust these pros to say that, if this is the way Goldman does business, no one should do business with Goldman? Why would we want government – which, on the whole, is geometrically more unethical than Wall Street – to start deciding what is ethical.

We are still on the rebound from healthcare legislation directly affecting a sixth of the economy (meaning that it impacts the whole economy). In that sorry episode, the political class wrote a bill that was 2700 pages long, that no one who voted on it read, that the public was not allowed to see throughout most of the debate, that those who were its chief architects admitted they were clueless about in terms of its content, and that turned out not to contain provisions the president insisted were in it – such that it needed to be amended before his signature was even dry. The enactment process was highly irregular, with proponents promising to ram it through by unconstitutional means until they were relatively certain they had the votes to ram it through by ostensibly proper means. And the “Hail Mary” pass proponents used at the end was book-cooking by the CBO which everyone knew was fraudulent – notwithstanding that Democrats relied on it with a straight-face – because, among other things, it failed to include the so-called “doc fix” for Medicare that would have added at least another quarter-trillion dollars to the costs.

If Wall Street tried to pull anything like that – if, to take another of countless examples, it kept trillions of dollars in liabilities off its books like the government does with Fannie Mae and Freddie Mac – you’d need a hundred new Gitmos for all the corporate execs the Left would be convicting without trial.

Shady dealing cannot be repealed. It is part of the human condition. But do we really want to invite this political class to say “had to” every time a corporation “should have” done something it didn’t? Can’t business police itself? Doesn’t it already police itself a lot better than government polices its own innumerable malfeasances?

This case is very reminiscent of Elliott Spitzer’s tenure as New York State Attorney General. Knowing litigation with a government is a losing proposition, Spitzer used the state’s preposterous Martin Act to pursue very dubious investigations and civil charges. Companies faced the dilemma of settling on onerous terms or incurring ruinous legal and reputational costs to fight the cases. It was what happens when you invite a highly political bully to be your all-purpose regulator. It was a business killer.

The Obama administration and congressional Democrats will make Spitzer look like a piker.

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