Goldman Sachs Defines Kleptocracy For Its Investors

What is the concept of Kleptocracy? The Merriam-Webster dictionary defines Kleptocracy as "a government by those who seek chiefly status and personal gain at the expense of the governed." True, Goldman Sachs is not the government, anyway not yet that is, it would seem that they wanted status and personal gain at the expense (and demise) of their own sophisticated investors.

On Friday, 16 April 10:35am Est, the Securities and Exchange Commission (SEC) charged Goldman Sachs with fraud. Goldman allegedly defrauded its sophisticated investors by omitting important facts about financial products related to their sub-prime mortgage instruments.

The SEC alleges that Goldman marketed collateralized debt obligations (CDOs) based upon the profit/loss of sub-prime residential mortgage-backed securities. The allegations claim that Goldman did not inform its investors about the role that their associated hedge fund, Paulson and Co., played in the portfolio selection. The allegations continued to state that the hedge fund had taken short positions against the same CDO's that Goldman was advising its customers to buy.

"Goldman wrongly permitted a client that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio, while telling other investors that the securities were selected by an independent, objective third party," said Robert Khuzami, director of the SEC's enforcement division of enforcement.

By failing to advise their investors of Paulson's activities, Goldman's actions show their predisposition towards kleptocracy, personal gain at the expense of investors. Goldman Sachs stock lost over $12 billion in value on Friday from the Market's reaction to the charges. By now every securities attorney has filed civil lawsuits against Goldman.

If found guilty of the allegations, Goldman could be looking at a very large fine and millions in lawsuits. To date, the largest fine levied by the SEC is $160 million against Washington Mutual. What if Goldman pays the $160 million, or $500 million, or even a billion in fines? So what, this bank gave $16.2 billion bonuses to its employees in 2009. Even combine all the lawsuits, will it significantly affect the company? In January, Goldman reported net revenues of $45 billion and net earnings of $13.4 billion for 2009. Will they even miss $500 million? The SEC knows full well that the fine is trivial, Goldman probably made billions just on the derivatives trades. 200 hundred million fine is just the cost of doing business. If the civil charges/fines can't stop Goldman or even slow it down, why did the SEC bring charges?

Could it be that the SEC was giving Goldman Sachs notice to cease its lobbying efforts against Senator Dodd's bank reform bill? On April 14, just 2 days before the allegations were announced, Austin Goolsbee, part of the President's Council of Economic Advisers, told CNBC about being "stunned" that what stopped Dodds reform bill was derivatives trading.

"I thought everyone would be in agreement on [derivatives reform], except for, of course, the big banks," Goolsbee said. "The big banks have funded a massive lobbying effort through the Republican party." "I want to see the Republican party stand up and say, 'Yes we're for putting loopholes into the derivatives law so they remain transparent so that they aren't regulated and remain totally non-transparent.' I don't think they're going to do it." Two days later, Goldman Sachs is charged with fraud on derivatives trading.

On April 16, just after the release of the Goldman charges, Goolsbee said about Dodd's reform, "I'd say you go at it two ways. It's important to do it two ways. The first is the bill explicitly outlaws bailouts of that sense. You can't prop up a company. It absolutely requires if the company comes to failure, they have to be either liquidated or broken up into pieces and sold off with the management fired and the shareholders wiped out. So the first is you show the company that there are going to be consequences and that they cannot be propped up in the traditional bailout sense. And then on the second, you go at all of the ways in which these big financial institutions threaten to take down their neighbors and their other counter parties as they're called, derivatives being one of the most important. So derivatives, while being esoteric, if one company goes down, then all the companies that are connected with it threaten to go down. And if you sever that link, which is the fundamental of what the president is advocating, you make it easier to let the one guy go down without blowing up the system."

Here's an interesting observation. The SEC released the charges against Goldman on Friday, after 11:00am. Why did the SEC choose Friday at 11:00am? Why not earlier or later. They obviously knew about this for weeks. In fact, on Saturday it was revealed that the SEC had warned Goldman 9 months earlier that charges were coming. Then why release these charges on Friday? The affects of the release would have been much more harmful to the Market if the SEC had made the announcement Monday morning.

Why announce Friday morning? At 8:30am, Bank of America reported excellent earnings, and their stock rose over $1.25/share. The rise nearly reached their 52 week high. After the SEC's announcement, BofA's stock plummeted $1.43/share. All their expectations for upside valuation for the quarter were shattered. The SEC knew that BofA reported well that morning and followed their announcement with another statement. "The SEC continues to investigate the practices of investment banks and others involved in the securitization of complex financial products tied to the U.S. housing market as it was beginning to show signs of distress," said Kenneth Lench, chief of the SEC's structured and new-products unit. Could it be that the SEC sent a message to Bank of America and all the other big banks that were subsidizing the lobbying efforts to stop Dodd's reform bill? You are next.