Legislating a Conscience on Wall Street

++Lloyd Blankfein[http://search.newsweek.com/search?q=blankfein]++ doesn’t seem to feel responsible for anything beyond ++Goldman Sachs’ bottom line[http://www2.goldmansachs.com/our-firm/press/press-releases/current/pdfs/2010-q1-earnings.pdf]++. Nor should he, according to the meager mores of Wall Street. ++Goldman,[http://search.newsweek.com/search?q=goldman+sachs]++ you see, is a “market maker,” as Blankfein loves to repeat. This absolves the firm of any fiduciary responsibility for the deals it sets up for its clients. Creating “liquidity” in the markets, Blankfein believes, is ++Goldman’s only social responsibility[http://www.newsweek.com/id/236936]++. At a hearing of the Senate’s Permanent Subcommittee on Investigations on Tuesday, Chairman ++Carl Levin[http://topics.newsweek.com/politics/carl-levin.htm]++ repeatedly tried to get Blankfein to concede that Goldman was morally wrong to bet on the sly against securities that it had touted as solid investments to its clients. No, no, no, the Goldman CEO demurred, that’s not how the financial system works any more. “There’s been a change in the sociology of the business in the last ten to 15 years,” Blankfein explained patiently. “Somewhere along the line,” he said, big clients stopped asking investment banks for good advice and started to seek them out only to set up deals for them -- merely to underwrite the transactions and be on the other side of them. That forced Goldman to transform itself from a private partnership in the late ‘90s into a publicly traded company in order to obtain the big-time capital it needed to create such deals. It also apparently gave Goldman carte blanche to shaft any helpless investor on the other side of those transactions. Liquidity is all. Nothing else matters.

This is why the senators on the committee and Goldman’s finest so often seemed to be talking past each other on Tuesday, in a Mars and Venus kind of way. As Sen. Jon Tester put it: “It’s like we’re speaking a different language here.” Sen. Susan Collins asked the former head of Goldman’s mortgage department, Daniel Sparks, whether he felt an obligation to “act in the best interest of your clients,” Sparks refused to say yes. “I had a duty to act in a very straightforward way and very open way with my clients,” he responded. To Sparks it was an obvious distinction: Goldman has an obligation to act mainly in its own best interests, not its clients’. Goldman now exists mainly to supply its clients with products to buy, and during the bubble the riskier (or more high-yielding) they were the better. Caveat emptor. (Never mind that voluminous internal emails uncovered by Levin’s committee showed that Goldman wasn’t terribly straightforward or open either; for example, it avoided sophisticated hedge funds as clients because they’d want to take the short side of many bad deals along with Goldman.) What seemed a shocking breach of ethics to Levin, Collins and others in the hearing room was quotidian reality to the Wall Street men.

All in all, the hearing was another remarkable window into the long moral decline of Wall Street and banking from the ++heyday of J.P. Morgan[http://en.wikipedia.org/wiki/J._P._Morgan]++. The bulbous-nosed Morgan was no angel - he was the original “greed is good” guy -- but Morgan was the first in a line of great bankers who felt a larger social responsibility to the economy. During the Panic of 1907, Morgan had been the Rock of Wall Street, the man who calmly told the head of the New York Stock Exchange that he dare not close early to prevent panic selling and then called in his fellow bankers and told they had to pony up money to keep the Exchange afloat. Morgan played that role during a time when the best investment bankers on Wall Street underwrote the securities for and dispensed investment counsel to America’s corporate finest. Stock issuance was a closely held right granted to only the most blue-blooded of corporations. He also had a huge stake in the health of the real economy. Morgan was not only virtually a one-man Federal Reserve in his time--the Fed didn’t come into being until five years later--but he actually controlled huge industrial sectors: the railroads, the top three insurance companies, U.S. Steel. In subsequent eras top bankers had also had a sense of responsibility for the overall health of the financial system, people like Lewis Preston of JP Morgan and Walter Wriston of Citibank.

That all began to change as deregulation made investment banking less profitable, and as blue-chip corporations like IBM and General Motors found they didn’t need Wall Street as much as before. Their corporate ratings were often better and they sometimes had their own financing units. They could easily tap the commercial-paper market on their own. So whereas in the old days prestige came to those firms that worked their way up the credit scale to the blue chips, Wall Street’s white-shoe firms were motivated to look for less credit worthy new clients. That was ++Michael Milken’s [http://photo.newsweek.com/content/photo/2009/6/photos-madoff-and-other-white-collar-prisoners.html]++ great insight at Drexel Burnham in the 1980s as he began finding ways to issue “junk” bonds for buccaneering entrepreneurs, people who in previous periods would not have warranted a second look from the elite on the Street.

Just as importantly, the product lines in big-time banking began to change. Proprietary trading, once frowned upon in the best firms, became a necessity, as did the assumption of greater risk. And whereas Wall Street banks once had a stake in the loans they made and private partnerships like Goldman once staked their own capital, the securitization game dissolved any sense of liability that firms had for the success or failure of their products. Everyone thought risk was being dispersed through the bundling and securitizing of loans--now, of course, we know it wasn’t--but what no one noticed was that the sense of responsibility for the system was also being dispersed. Power and responsibility grew diffuse, even as systemic risk began linking everyone up and making even mid-sized firms too big to fail. But unlike the systemic risk problem, which is endlessly jawboned in Washington today, no one is really talking about the dispersion of responsibility problem.

The result is a horrifying mismatch between Wall Street’s vast power over the economy and its utter lack of conscience. Although Goldman has long been the most prestigious firm on the Street and therefore nominally the heir to the Morgan lineage, it has never matured into that older role. It couldn’t really afford any sense of noblesse oblige about the American economy. On the contrary: Goldman’s corporate ethos is clearly more that of a predator than a protector. Indeed, Goldman became known as the savviest and most prestigious firm on the street in part because it had no scruples about simultaneously betting against products it was selling. One reason for Goldman’s success was that as a firm it developed a sharper and more pervasive hedge-fund mentality before the other investment banks did.

Is there any way to change this now, so that the banks that remain the lifeblood of the U.S. economy are forced to think outside their walls? Yes, but only Washington can do it (as risky a proposition as that is too). It’s clear none of these big banks is going to able to grow a conscience on its own, not with the way the Street is structured today. That is why, along with new rules on capital and leverage and systemic risk, the forthcoming financial reform legislation--currently being held up by a Republican filibuster--should also include tough new rules on disclosure, transparency and corporate responsibility. It is also why a tough and empowered new Consumer Financial Protection Agency is an absolute necessity. Levin wants a new law that will explicitly make it a conflict of interest for a firm like Goldman not to reveal to clients that it is shorting some new security it is selling. And there’s no reason that can’t happen. As the free-market theorists never tire of telling us, the more information the better, right? It’s something we have to do, because J.P. Morgan ain’t coming back any time soon. Instead we’re stuck with Lloyd Blankfein.

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