Simon Johnson: Goldman Faces Special Audit and Possible Ban in Europe

"The crash has laid bare many unpleasant truths about the United States. One of the most alarming, says a chief economist of the International Monetary Fund, is that the finance industry has effectively captured our government - a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises. If the IMF's staff could speak freely about the U.S., it would tell us what it tells all countries in this situation; recovery will fail unless we break the financial oligarchy that is blocking essential reform." ~ The Atlantic Monthly, May 2009, by Simon Johnson

Regular readers will be aware of our thesis that the American Wall Street banks have become dominated by a culture of compulsive sociopaths who are incapable of reforming or restraining their greed. Like all addicts, they push the envelope looking for a new high, emboldened by each successful scam, the weakness of regulators, and the craven support of politicians, going further and further until at long last they go one step too far, with spectacularly destructive results.

Goldman Sachs may have reached that point. And as also suggested here, the rebuke may be coming from European and Asian nations who become weary of the extra-legal antics of the rogue American banks.

In the interests of harmony, the Europeans may once again bow to US pressure and continue to permit the Money Center privateers to roam through the interational financial system wreaking havoc, as they have been doing through the domestic US economy. It will be too bad if they do.

This is in no way an excuse for the Greek government. But what Simon Johnson is saying in this essay below is that Goldman is not only not blameless, but is enabling, complicit and perhaps even presenting the opportunity for market manipulation and fraud to other parties. Typically they like to 'package' these scams and take them from one customer to another, so that greed meets need, as a corrupting influence. It is no different than a bank engaging in money laundering in support of the criminal activity of another organization.

Is he right? Will the EU begin to act to curtail the transgressions of multinational banks based in the US? I think he may very well be. It is one thing to take on pension funds and speculators, and to run raids on companies. It is another thing to start taking on countries, and especially those not so alone and weak as Iceland.

And even more than that. If it ever comes to the light of day, the complicity of a few central banks and governments in the actions of one or two of the money center banks in manipulating several global commodity and asset markets may ignite a firestorm of a political scandal of epic proportions.

At the very least, it remains a practical imperative that the banks be restrained, the financial system reformed, and the economy brought back into balance, before there can be any sustainable recovery and stability.

And it is now apparent that Obama and the US Congress, for whatever reasons, are incapable of doing this. And yet, hope remains.

"It is said an Eastern monarch once charged his wise men to invent him a sentence to be ever in view, and which should be true and appropriate in all times and situations. They presented him the words: And this, too, shall pass away. How much it expresses. How chastening in the hour of pride. How consoling in the depths of affliction." Abraham Lincoln

Baseline Scenario
Goldman Goes Rogue - Special European Audit to Follow
By Simon Johnson

"...We now learn – from Der Spiegel last week and today’s NYT – that Goldman Sachs has not only helped or encouraged some European governments to hide a large part of their debts, but it also endeavored to do so for Greece as recently as last November. These actions are fundamentally destabilizing to the global financial system, as they undermine: the eurozone area; all attempts to bring greater transparency to government accounting; and the most basic principles that underlie well-functioning markets. When the data are all lies, the outcomes are all bad – see the subprime mortgage crisis for further detail.

A single rogue trader can bring down a bank – remember the case of Barings. But a single rogue bank can bring down the world’s financial system.

Goldman will dismiss this as “business as usual” and, to be sure, a few phone calls around Washington will help ensure that Goldman’s primary supervisor – now the Fed – looks the other way.

But the affair is now out of Ben Bernanke’s hands, and quite far from people who are easily swayed by the White House. It goes immediately to the European Commission, which has jurisdiction over eurozone budget issues. Faced with enormous pressure from those eurozone countries now on the hook for saving Greece, the Commission will surely launch a special audit of Goldman and all its European clients...

...Goldman will probably be blacklisted from working with eurozone governments for the foreseeable future; as was the case with Salomon Brothers 20 years ago, Goldman may be on its way to be banned from some government securities markets altogether. If it is to be allowed back into this arena, it will have to address the inherent conflicts of interest between advising a government on how to put (deceptive levels of) lipstick on a pig and cajoling investors into buying livestock at inflated prices.

And the US government, at the highest levels, has to ask a fundamental question: For how long does it wish to be intimately associated with Goldman Sachs and this kind of destabilizing action? What is the priority here - a sustainable recovery and a viable financial system, or one particular set of investment bankers?

To preserve Goldman, on incredibly generous terms, in the name of saving the financial system was and is hard to defend – but that is where we are. To allow the current government-backed (massive) Goldman to behave recklessly and with complete disregard to the basic tenets of international financial stability is utterly indefensible. (There is a case to be made that the money center banks, in particular Goldman and JPM, are sometimes acting as instruments of US foreign policy - Jesse)

The credibility of the Federal Reserve, already at an all-time low, has just suffered another crippling blow; the ECB is also now in the line of fire. Goldman Sachs has a lot to answer for."

Read the entire essay from Simon Johnson here

US GDP - Estimated Percentage by State

A regional view is probably more meaningful, but this is some useful information.

The Approaching US Dollar Reserve Currency Crisis

"US government debt is a safe haven the way Pearl Harbor was a safe haven in 1941."

No matter how they wrap it, spin it, try to hide it, we have seen an epic expansion in the US monetary base not seen since 1932.

This monetary expansion has not yet reached into the broader money supply figures because it is not reaching the public, despite the chant from the "Yes We Can" Kid. Bernanke has most of that liquidity bottled up in a few big banks collecting an easy riskless spread, with some of it chasing beta in the speculative markets.

Ben can talk a tough game, and jawbone rates with his plans to someday return to normalcy. But at the end of the day, the US is playing out a well worn script that is highly predictable.

There are three choices the Sith Lords at the Fed and their western central bank apprentices have at this point: inflation, inflation, and inflation.

The only question is how and when it will become obvious even to the most stubborn believers in the Dollar Über Alles. Ben will seek to control it, to unleash it from its cage very slowly, spread the pain to the US trading partners overseas.

The US dollar reserve currency status is faltering, but not yet under a serious assault. The monied elite will try to eliminate any serious competition, such as the euro or precious metals, by any and all means possible.

Greece is roughly 2.6% of the Eurozone GDP. California is 13% of the US.

How long they can continue this is anyone's guess. These things tend to play out slowly, over years. I do not expect the US dollar to fail precipitously in the manner of the Zimbabwe dollar or with Weimar Reichsmark, but rather to be devalued in a step-staggered manner, over time, until it stabilizes and the debts are liquidated.

When the US starts closing the greater portion of its 700+ overseas military bases, we will know that it has become serious about financial reform and balancing its books. Until then, all is posturing, self-interest, demagoguery, and deception.

Financial Times
A Greek crisis is coming to America
By Niall Ferguson
February 11 2010 02:00

It began in Athens. It is spreading to Lisbon and Madrid. But it would be a grave mistake to assume that the sovereign debt crisis that is unfolding will remain confined to the weaker eurozone economies. For this is more than just a Mediterranean problem with a farmyard acronym. It is a fiscal crisis of the western world. Its ramifications are far more profound than most investors currently appreciate...

Yet the idiosyncrasies of the eurozone should not distract us from the general nature of the fiscal crisis that is now afflicting most western economies. Call it the fractal geometry of debt: the problem is essentially the same from Iceland to Ireland to Britain to the US. It just comes in widely differing sizes.

What we in the western world are about to learn is that there is no such thing as a Keynesian free lunch. Deficits did not "save" us half so much as monetary policy - zero interest rates plus quantitative easing - did. First, the impact of government spending (the hallowed "multiplier") has been much less than the proponents of stimulus hoped. Second, there is a good deal of "leakage" from open economies in a globalised world. Last, crucially, explosions of public debt incur bills that fall due much sooner than we expect

For the world's biggest economy, the US, the day of reckoning still seems reassuringly remote. The worse things get in the eurozone, the more the US dollar rallies as nervous investors park their cash in the "safe haven" of American government debt. This effect may persist for some months, just as the dollar and Treasuries rallied in the depths of the banking panic in late 2008.

Yet even a casual look at the fiscal position of the federal government (not to mention the states) makes a nonsense of the phrase "safe haven". US government debt is a safe haven the way Pearl Harbor was a safe haven in 1941.

Even according to the White House's new budget projections, the gross federal debt in public hands will exceed 100 per cent of GDP in just two years' time. This year, like last year, the federal deficit will be around 10 per cent of GDP. The long-run projections of the Congressional Budget Office suggest that the US will never again run a balanced budget. That's right, never.

The International Monetary Fund recently published estimates of the fiscal adjustments developed economies would need to make to restore fiscal stability over the decade ahead. Worst were Japan and the UK (a fiscal tightening of 13 per cent of GDP). Then came Ireland, Spain and Greece (9 per cent). And in sixth place? Step forward America, which would need to tighten fiscal policy by 8.8 per cent of GDP to satisfy the IMF.

Explosions of public debt hurt economies in the following way, as numerous empirical studies have shown. By raising fears of default and/or currency depreciation ahead of actual inflation, they push up real interest rates. Higher real rates, in turn, act as drag on growth, especially when the private sector is also heavily indebted - as is the case in most western economies, not least the US.

Although the US household savings rate has risen since the Great Recession began, it has not risen enough to absorb a trillion dollars of net Treasury issuance a year. Only two things have thus far stood between the US and higher bond yields: purchases of Treasuries (and mortgage-backed securities, which many sellers essentially swapped for Treasuries) by the Federal Reserve and reserve accumulation by the Chinese monetary authorities.

But now the Fed is phasing out such purchases and is expected to wind up quantitative easing. Meanwhile, the Chinese have sharply reduced their purchases of Treasuries from around 47 per cent of new issuance in 2006 to 20 per cent in 2008 to an estimated 5 per cent last year. Small wonder Morgan Stanley assumes that 10-year yields will rise from around 3.5 per cent to 5.5 per cent this year. On a gross federal debt fast approaching $1,500bn, that implies up to $300bn of extra interest payments - and you get up there pretty quickly with the average maturity of the debt now below 50 months.

The Obama administration's new budget blithely assumes real GDP growth of 3.6 per cent over the next five years, with inflation averaging 1.4 per cent. But with rising real rates, growth might well be lower. Under those circumstances, interest payments could soar as a share of federal revenue - from a tenth to a fifth to a quarter.

Last week Moody's Investors Service warned that the triple A credit rating of the US should not be taken for granted. That warning recalls Larry Summers' killer question (posed before he returned to government): "How long can the world's biggest borrower remain the world's biggest power?"

On reflection, it is appropriate that the fiscal crisis of the west has begun in Greece, the birthplace of western civilization. Soon it will cross the channel to Britain. But the key question is when that crisis will reach the last bastion of western power, on the other side of the Atlantic.