President Obama Fateful Error in Making Bush’s Goldman Sachs/AIG Scandal His Scandal

By William K. Black
Quito: June 3, 2015

We have known from the beginning that Lanny Breuer, who the Obama administration chose as its head of the Criminal Division in order to ensure that there would be no prosecutions of the banksters that led, and were enriched by the fraud epidemics that drove the crisis, would be a national embarrassment. Readers may recall that Breuer publicly admitted that what caused him to lose sleep was not the world’s most destructive fraud epidemics that ruined our economy or his grant of effective immunity to the banksters who led and became wealthy through those frauds. He lost sleep solely over his fear that if he held them accountable for the frauds that had bankrupted their corrupt banks those banks might be placed in receivership and honest managers appointed. (Of course, that isn’t how he phrased it, but that is what he was actually saying.)

An additional confirmation of that fact that Breuer was a national embarrassment was just made public in a New York Times article entitled: “U.S. Prosecutors Did Not Question Goldman on Financial Crisis in 2010 Meeting.”

Several people from the general counsel’s office at Goldman attended the March 5, 2010, meeting, including David N. Lawrence, who at the time was global head of the company’s business intelligence group.

Mr. Breuer arranged the meeting to sound out Mr. Lawrence’s views on how best to combat terrorism financing, given his experience in working with Wall Street banks to develop systems to prevent money laundering, the person briefed on the matter said.

This requires some context. Prior to Breuer’s meeting, Goldman had recently been bailed out – and saved many billions of dollars in losses by two acts of governmental intervention at AIG. Goldman, under the leadership of Hank Paulson, had purchased large amounts of toxic mortgage paper (primarily collateralized debt obligations (CDOs) “backed” largely by fraudulently originated loans. The CDO, therefore, would eventually suffer massive losses. Goldman’s managers purchased these toxic CDOs for the usual reasons explained by the “recipe” for accounting control fraud by a lender or purchaser of bad mortgage paper. The fraud “recipe” makes it a “sure thing” that the senior managers will be made wealthy through the purchase of terrible loans with a high nominal yield. This creates enormous, but fictional reported profits.

Under Hank Paulson, Goldman’s risk of loss on the toxic mortgage paper was supposedly eliminated by the purchase of credit default swaps (CDS) sold by AIG. This protection was illusory, however, because AIG’s managers in charge of CDS were also following the fraud recipe. AIG’s managers sold vast amounts of CDS “protection” cheaply – so much and so cheaply that AIG could not possibly pay the “protection” when, inevitably, the toxic CDOs that the CDS were supposedly protecting from loss inevitably imploded. Instead, AIG would be rendered insolvent.

As I will explain, after Paulson stepped down as head of Goldman his successors began an urgent effort to unload the toxic CDOs on Goldman’s customers. Paulson’s successor realized that the AIG CDS offered only illusory protection from loss.

The bailout of Goldman via AIG had two parts. The largely fraudulently-originated mortgages backing Goldman’s CDOs suffered crushing defaults as the housing bubble burst and the bad loans could no longer be refinanced to delay the loss recognition. The credit rating agencies, whose managers became wealthy by selling enormously inflated ratings to toxic CDOs and mortgage-backed securities (MBS) finally began to recognize reality and engaged in, by far, the greatest and quickest rating downgrades in history. This should have triggered AIG’s obligation to pay the CDS protection for vast amounts of toxic CDOs and MBS – but that would have rendered AIG insolvent and the CDO and MBS holders would have had to recognize vast losses. Other entities that sold CDS protection were in a similar position to AIG and they began negotiating deals to pay roughly 15 cents on the dollar of their obligation. It is better to get 15 cents on the dollar now than risk getting close to zero 18 months from now after the firm that sold you illusory CDS protection is liquidated in a bankruptcy proceeding. This kind of commercial workout is the norm in big finance.

Goldman had already received the twin direct bailouts provided by the Fed and Treasury (through the TARP program). Absent similar bailouts every one of the largest banks in the U.S. and the EU would have failed as the financial markets froze and the economy went into freefall.

But Goldman was the primary indirect beneficiary of two federal bailouts through AIG. The first bailout of AIG was the U.S. purchase of most of most of AIG’s equity at a price far above market value. Absent this bailout AIG would have had to declare bankruptcy in Fall 2008. This bailout was strongly pushed by what became the U.S. bailout troika – Ben Bernanke (the Fed Chairman), Timothy Geithner (President of N.Y. Fed), and Hank Paulson (Treasury Secretary). Yes, the same Hank Paulson who was made even wealthier by leading Goldman’s purchase of huge amounts of toxic CDOs and MBS and illusory CDS “protection” from AIG.

Goldman is known as “Government Sachs” because of its incestuous relationship with government. Bob Rubin had run Goldman before becoming President Clinton’s Treasury Secretary. The Bush and Obama administration were infested with Goldman alums in key positions. The Obama administration also had Rubin protégés like Geithner controlling most of the top financial positions. Indeed, for extensive periods every top Obama economics official has been a Rubin protégé.

While Geithner is famous for his faux indignation that people believed from his slavish devotion to furthering the interests of the wealthiest and most criminal banksters that he had worked at a Wall Street firm, everyone knows that the NY Fed is Wall Street. It functions for Wall Street’s CEOs, not the American people, regardless of what administration is in power. Geithner, who has now, formally, joined Wall Street and been made even wealthier, is one of the three most infamous financial regulators in U.S. history. He shares that dishonor with Bernanke and the worst-of-the-worst, Alan Greenspan. The Financial Crisis Inquiry Commission (and even the Fed’s own external report) confirm what we all knew – even among the embarrassment that was “Fed Lite” regulation globally, the NY Fed stood out as uniquely terrible because of its servile approach to the elite banksters.

The regional Fed banks were designed to be controlled by the banks rather than serve the essential role of a vigorous, independent regulator. They are structured to have a crippling institutional conflict of interest in that their boards of directors are controlled by the banks they are supposed to regulate. In the case of the NY Fed that meant that the board was controlled by the elite banksters leading the fraud epidemics that blew up the global financial system. The Federal Home Loan Banks had the same built-in conflict of interest, which Congress (correctly) decided was intolerable and ended in the 1989 FIRREA legislation.

The NY Fed’s corrupt institutional design was designed by Wall Street bankers to ensure that they would control the bank. Unlike the FHLBs, the NY Fed was also designed to be the pig that was always more equal than its eleven sister pigs. Wall Street’s control of the NY Fed does not simply give them greater influence over the Board of Governors of the Federal Reserve System (the federal agency) – it gives them decisive control over large aspects of the Fed’s operations.

Under Geithner, however, this inherently corrupt institutional design of the NY Fed was judged by him to be insufficiently corrupt. I will quote the entire article by the leading apologist for the Wall Street banksters, DealBook, to demonstrate that even as presented by apologists, the NY Fed under Geithner was simply a more sophisticated version of FIFA under Sepp Blatter.

Friedman Resigns as Chairman of New York Fed

By DEALBOOK  MAY 7, 2009 5:57 PMMay 7, 2009 5:57 pm

wbdb

Stephen Friedman, the chairman of the Federal Reserve Bank of New York, abruptly resigned on Thursday, days after questions arose about his ties to Goldman Sachs.

Mr. Friedman was chairman of the New York Fed at the same time that he was a member of Goldman’s board. He also had a substantial stake in the firm as the Fed was devising a solution to keep Wall Street banks afloat. Denis M. Hughes, deputy chairman of the board, will take over as the interim chairman, the New York Fed said in a statement. (Read Mr. Friedman’s letter after the jump.)

Because the New York Fed approved a request by Goldman to become a bank holding company, the chairman’s involvement in Goldman was a violation of Fed policy, The Wall Street Journal said in an article earlier this week.

The New York Fed asked for a waiver, which, after about two and a half months, the Fed granted, the newspaper said. During that time, Mr. Friedman bought 37,300 more Goldman shares in December, which have since risen $1.7 million in value.

In his resignation letter, Mr. Friedman said his public service on the board was being characterized as “improper” despite his compliance with the rules. “The Federal Reserve System has important work to do and does not need this distraction,” he said.

“With respect to Steve’s purchases of Goldman shares in December of 2008 and January of 2009, which have been the object of some attention lately, it is my view that these purchases did not violate any Federal Reserve statute, rule or policy,” Thomas C. Baxter, the general counsel of the New York Fed, said in a statement. “I enjoyed working with Steve, and will miss his contributions in the boardroom.”

Let us count the ways that this pattern indicates a total public policy failure and a demonstration of a pervasively corrupt culture. First, the NY Fed was supposed to regulate Goldman – yet Goldman and Friedman decided that what they should do was arrange to have a member of Goldman’s board of directors become the Chairman of the NY Fed’s board. The brazenness of this is staggering (except to Goldman, Friedman, and the NY Fed’s officers).

Second, the “defense” that what Friedman did “did not violate any Federal Reserve statute, rule or policy.” Earth to Baxter, Friedman, the Fed, the NY Fed, Geithner, and Goldman – no greater indictment of corruption is possible than your errant effort to defend Friedman. The Fed, despite nearly 100 years of experience with the corrupting effect of these blatant conflicts of interest – has not adopted even a “policy” to protect the public from even the most naked conflict of interest.

Third, Friedman owned considerable stock in Goldman and the NY Fed’s decisions were sure to have enormous implications for the value of that stock. Moral people do not need a “statute, rule or policy” to know that this is an intolerable conflict of interest that brings the entire Federal Reserve System into disrepute. But, of course, my last sentence is simply incomprehensible to an investment banker like Friedan. As with realtors, investment bankers think that what normal human beings consider a conflict to simply be a “synergy” that will make them wealthier.

Fourth, Friedman decided to compound the twin inherent conflicts of interest (his leadership position at Goldman and the NY Fed – which was supposed to regulate Goldman) and his large stock position in Goldman by buying considerably more Goldman stock while holding the position of Chairman of the board of directors of the NY Fed. He did so when a reasonable person would believe he had access to critical inside information (from both of this positions). And, to no one’s surprise, he made out like a bandit.

Fifth, Friedman’s actions actually did violate even the Fed’s pathetically weak conflict of interest policies – so the Fed waived them! After all, if you were Bernanke and thinking strategically about what the NY Fed desperately needed the only possible answers would be (1) more conflicts of interest and (2) increased domination by Goldman.

Sixth, Friedman had the audacity to complain that his “public service” (already compensated by over $1.7 million in stock appreciation just on his newly purchased Goldman shares) was being criticized by anyone with any shred of a conscience – a group that did not include the leadership of the NY Fed or Bernanke. One of the small, disgusting aspects of the Fed and the regional banks is that they allow the banks’ representatives to hold board seats with the Orwellian title of “public interest” directors. The dishonesty, corruption, and cynicism of the NY Fed does remind one of FIFA. There are, of course, no need for crude bribes at the NY Fed. Everyone knows how the game is played and that as long as the NY Fed remains a pathetic regulator its senior officers will be made wealthy by Wall Street once they leave the bank. Geithner took only a few months to belly up to the trough.

The second form of indirect bailout of Goldman by the U.S. was a major driver of the increase in Goldman’s stock price that added so greatly to Friedman’s wealth. As I explained, other sellers of CDS protection were engaging in the normal commercial process of cutting deals with the buyers of that protection to pay them roughly 15 cents on the dollar. AIG’s officers began negotiations to try to produce similar deals. But the Treasury and the NY Fed (with the concurrence of the Fed) ordered AIG’s officers to cease those negotiations and to pay AIG’s CDS counterparties 100 cents on the dollar. The largest AIG counterparty on these CDS deals, by a significant margin, was Goldman. But there were many huge bank counterparties that profited from this federal bailout – and every one of them had engaged in massive felonies. The indirect federal bailouts of these felons via AIG were typically larger than the fines that would eventually be assessed for their many felonies. In economic substance, therefore, they profited from their frauds.

Goldman’s prior chairman was the U.S. Secretary of the Treasury and a Goldman board member who was eagerly purchasing Goldman stock as these commercially insane orders were going out from the NY Fed and the Treasury for AIG to pay Goldman 100 cents on the dollar on the CDS. The NY Fed and the Treasury also ordered AIG not to disclose to its shareholders and to Congress that this was being done and not to disclose who the beneficiaries were of their order to pay the counterparties 100 cents on the dollar.

In addition to this commercial, public policy, and ethical travesty that would be scandalous even in the most corrupt nations of the world, it became public prior to Breuer’s meeting with Goldman that its primary means of avoiding the losses created by Hank Paulson’s huge purchases of toxic CDOs and MBS was to sell them to its customers. Goldman took this unethical action in league with John Paulson (no relation to Hank). The scam was that Goldman presented the toxic paper it was selling to its customers as selected for the high quality of the assets when in reality it was primarily selected by John Paulson on the basis of its terrible quality. Goldman won the more the customers lost. Hank Paulson’s successor as head of Goldman claimed this kind of conduct meant that Goldman was “doing God’s work.” That is a blasphemous slander of G-d.

The Goldman/AIG Scandal Was Bush’s Scandal

The scandals that I have described up to this point all occurred under President Bush. The obvious approach of the Obama administration – on the basis of good policy, ethics, and good politics would have been to draw a line under this conduct and announce that there was a new, honest, and vigorous sheriff in charge that was going to clean up Bush’s corrupt cesspool. Going after the frauds at AIG and Goldman would, logically, have been a top priority.

Obama Decided to Adopt, Rather than Condemn, Bush’s Scandal

But Obama chose to make Bush’s cesspool his cesspool. Obama did not simply retain the two catastrophic regulatory failures – Bernanke and Geithner. Obama promoted Geithner. Obama reappointed Bernanke – a partisan Republican and abject regulatory failure – to run the Fed. Obama continued Geithner and Bernanke’s policies of trying to hide the Bush administration’s disgusting orders to AIG to create a secret conduit to bail out criminal banks using federal funds. The fact that the largest portion of that secret federal bailout went to Bush’s Treasury Secretary’s firm to cover losses he was responsible for creating and that the rest of the secret bail out went to criminal banks that were ripping off the United States should have been a scandal of epic proportions and should have been an immense political boon to Obama and his Party. But Obama chose bad policy, bad politics, and bad ethics and made two of the three architects of the scandal his senior economic appointments. By doing so, Obama made Bush’s scandal his scandal. And that meant it is a scandal that neither the Republicans nor Obama wanted to be known by the public. As a result, it is known only to wonks instead of being the quintessential stump speech of the Democratic Party that would have rallied to its cause even many members of the Tea Party and energized Obama’s base.

In these circumstances the head of the Criminal Division should have been meeting with Goldman for one purpose – negotiating the terms of a guilty plea and the clawback of all of Goldman’s fraud proceeds. Of course, we know that Breuer never met with the banksters to demand that they plead guilty for leading these kinds of frauds. At the time Breuer met with Goldman the SEC enforcement staff had nearly completed its investigation of Goldman and was preparing to file its enforcement action. Breuer, as always, refused to prosecute any of Goldman’s, or its officers’ myriad frauds.

Now we know that when Breuer met with Goldman’s representatives he did not even raise the subject of Goldman (and its senior officers’) myriad frauds. In another proof of our family rule that it is impossible to compete with unintentional self-parody the title of Breuer’s invitation to Goldman for the meeting was: “Goldman Sachs re Anti-Fraud Task Force.” Presumably, Breuer invited the Sinaloa drug cartel to meet with his “Anti-Money Laundering Task Force.”

The poor New York Times, in an article dated June 3, 2015, ended its article about Breuer’s meeting with Goldman on this weak and misleading note.

Still, the meeting also underscores that the government relies on banks to serve as a front line in enforcing anti-money-laundering laws and other laws governing the financial pipeline. And ever since the Sept. 11, 2001, terror attacks, an important mandate of law enforcement has been to trace and root out the sources of funding for terrorist groups.

Because this was written in mid-2015 it is obscene that the authors ignore the fact that reality has proven the insanity of “the government rel[ying] on banks to serve as a front line in enforcing anti-money laundering [and sanctions] laws.” Investigations have demonstrated that the largest banks have committed over one million felonies in league with the world’s worst people (vicious drug cartels, leaders of genocide, funders of terrorism, and alleged funders of efforts to develop nuclear weapons). The largest banks eagerly aided and abetted these scum rather than serving as the “front line” against the criminals. No sentient prosecutor or regulator would “rely” on the largest banks to enforce these laws. We require the banks to enforce the laws – and we need to examine their compliance with the law intensively because we have documented that the world’s largest banks did not simply look the other way at such violations – they trained their staff and their customers on how to violate the law with impunity by systematically falsifying the records.

4 responses to “President Obama Fateful Error in Making Bush’s Goldman Sachs/AIG Scandal His Scandal

  1. All the more reason for government run banks. In the mean-time we get to experience this –

    IMF: Fed should wait until 2016 to raise interest rates
    http://www.usatoday.com/story/money/2015/06/04/imf-on-us-economy/28463227/

    and this –

    Fed’s Tarullo, BlackRock’s Fink cite bond market liquidity concerns
    http://in.reuters.com/article/2015/06/04/usa-fed-tarullo-policy-idINL1N0YQ1DV20150604

  2. Amazing story, Bill Black. Thanks again for enlightening us. Should be on the NYT front page! Keep it up!

  3. The “debt outstanding” of “domestic financial sector”, I think that’s the exact phrases used in Table D.3 of the Flow of Funds report from the Fed, shows debt expanding between 1996 and 2008 at 5.5 times the rate of economic GDP/person. It went from $4.7 trillion to over $17 trillion. It expanded from 59% of GDP to 116%. Isn’t someone pegged to watch the rate of credit and debt growth of the economy, and aren’t all alert bank economists aware of this? The monthly household debt load is regularly reported by the Fed, and the aggregate household debt was noted as pushing above 130% of GDP. That Paulson, the managers of AIG, etc. etc. were in the dark, pun intended, is hard to believe, to not believe. I wish there was a chorus of economists making this same claim. Without a chorus the claim will die out, it’s been almost 7 full years since Lehman fell. I’m reminded of an article critical of Geithner in Challenge Magazine. Harsh criticism. Andrew Sum, labor economist, said that 15 million lost their jobs and of the 8.75 million permanently without replacement, about 11% of all those employed, one in nine. The second scandal is that total household net worth, since 2008, has increased by 44%, by $25 trillion (30% adjusting for inflation and population growth), while simultaneously the median household has seen its life savings decline from $135,400 to $81,200, a 40.2% drop, and even larger if I’d adjust for inflation. I write the blog Economics Without Greed. http://benL8.blogspot.com. Can’t you find some other economists who can still complain about the scandal of Paulson, AIG, and all the insolvent banks that orchestrated their own self-destruction, and were ultimately rewarded lavishly for it? The counter-narrative is “oh well, who would have predicted that!”