In his column this morning Paul Krugman comments on the fraud suit against Goldman Sachs:
The main moral you should draw from the charges against Goldman, though, doesn’t involve the fine print of reform; it involves the urgent need to change Wall Street. Listening to financial-industry lobbyists and the Republican politicians who have been huddling with them, you’d think that everything will be fine as long as the federal government promises not to do any more bailouts. But that’s totally wrong — and not just because no such promise would be credible.
For the fact is that much of the financial industry has become a racket — a game in which a handful of people are lavishly paid to mislead and exploit consumers and investors. And if we don’t lower the boom on these practices, the racket will just go on.
I’m not versed enough in the intricacies of securities fraud to determine whether what Goldman Sachs did was in fact fraud. It sounds very much like the Magnetar trade, the creation of risky instruments with, apparently, the specific intent of shorting them.
It seems to me that a lot hinges on who knew what when and what their intentions might have been. When shorting your own instruments is a method of mitigating risk, that would appear to be benign. However, when you create a complicated financial instrument primarily so that you can take a short position on it, making more money on the short than could conceivably have been made through the instrument, that certainly sounds like a colloquial definition of fraud to me.
But Dr. Krugman is probably wrong that pending legislation can solve the problem. I note that Goldman Sachs was indicted under present law and apparently that wasn’t enough to discourage the practice. The incentives are huge and the likelihood of discovery relatively small.
Besides, we’re dealing with intelligent actors who are likely to respond with strategies to get around anything that Congress is likely to come up with. As I’ve said before I think we need to deal more with the incentives. So, for example, commissions should be paid based on the performance of any instrument throughout its life rather than solely based on current year sales.