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Goldman Fraud Is Not Goldman’s Alone

April 19, 2010

Something that occurred to me as I learned of the Securities and Exchange Commission’s civil fraud suit against Goldman Sachs Friday (this New York Times piece has a link to the complaint): Who was buying mortgage-backed paper in mid 2007 and what were they thinking?

Anybody whose skull wasn’t filled with oatmeal knew by late 2006 that the housing market was headed down; all one had to do was stroll a neighborhood and see the crazy builds, check RealtyTrac and note the insane sales prices, or troll the blogs. And yet, so many people—many of them well-paid money managers—didn’t get it.

What was happening, we now know, was a market distortion of the first order. The Times had the Goldman/Abacus story months ago, complete with 31-year-old Fabrice Tourre selling the mortgage-backed dreck to the gullible so-called “sophisticated investors” managing public pensions and other large funds. What is clear now (and the Financial Times names seven other banks that received SEC subpoenas late last year) is that there was a whole class of people who not only “bet against the housing market,” but in doing so helped create financial sewage that inundated the economy.

Call them the Asshole Class.

ProPublica explains what should have and would have happened without the Asshole Class’ “wealth creation” strategies:

In late 2005, the booming U.S. housing market seemed to be slowing. The Federal Reserve had begun raising interest rates. Subprime mortgage company shares were falling. Investors began to balk at buying complex mortgage securities. The housing bubble, which had propelled a historic growth in home prices, seemed poised to deflate. And if it had, the great financial crisis of 2008, which produced the Great Recession of 2008-09, might have come sooner and been less severe.

A functioning capitalist economy is a self-correcting system; when too many people want to bet one way, the odds go against them, and that bet gets closed. What happened at Goldman—and many other banks, apparently—is that hedge funds invented a way to create more of what should have been a scarce commodity: craptastic home mortgages. ProPublica‘s piece looks at a fund called Magnetar:

Magnetar wasn’t the only market player to come up with clever ways to bet against housing. Many articles and books, including a bestseller by Michael Lewis, have recounted how a few investors saw trouble coming and bet big. Such short bets can be helpful; they can serve as a counterweight to manias and keep bubbles from expanding.

Magnetar’s approach had the opposite effect—by helping create investments it also bet against, the hedge fund was actually fueling the market. Magnetar wasn’t alone in that: A few other hedge funds also created CDOs they bet against. And, as the New York Times has reported, Goldman Sachs did too. But Magnetar industrialized the process, creating more and bigger CDOs.

The fraud at the top depended on a cesspool of fraud at the bottom—the other segment of the asshole class that has so far been ignored by prosecutors. Mortgage brokers, realtors, and other house flipper types knew the ship was going down, and plenty of them refinanced themselves, straw buyers, friends and relatives in 2007 and 2008 using fraudulent appraisals and other low-level scams. The two classes of fraudsters—million-dollar-a-year assholes at the bottom end; million dollar a day assholes at the top—act like an enormous barbell on the neck of the economy.

The man at the center of the Abacus deals, however, was not the 31-year-old Fabulous Fabrice named as a defendant by the SEC. It was John A. Paulson who, the Times‘ Gretchen Morgenson tells us, is “not a target” of the SEC’s suit.

As with the Magnetar deals, apparently Paulson’s business of stuffing turds into casings, selling them as Bratwursts, and then betting that a food-poisoning epidemic was imminent was “not illegal.” But as Democrats slouch toward ineffectual new regulations of people like Paulson, and Republicans cry “socialism” once again, it’s time to step back and see what Paulson—and guys like him, generally—are all about.

Members of the Asshole Class are extractors of wealth, though they believe—and never tire of claiming—that they are creators of wealth.

The Asshole Class has been with us always, from the first grifters and medicine shows, to the whipsaw stock-scammers like Jay Gould, to Charles Ponzi himself. But until recently, the Asshole Class has been a sideshow in the nation’s economic pageant. The great industrialists of past epochs—Carnegie, Rockefeller, DuPont, Ford—built fortunes with oil, steel, chemicals, cars. These men were not moral or fine, but they were not assholes. They, and the companies they founded, produced things of value.

In 1902, Rockefeller was the richest person in the U.S., with an audited fortune of some $200 million—equivalent to about $4.7 billion in today’s dollars.

In 2007, John Paulson “earned” $3.7 billion.

In 2008 he took home $2 billion more. So, in two years, this single asshole absconded with one billion dollars more than John D. Rockefeller was able to compile in 35 years, during the Gilded Age, by assembling and managing the most formidable monopoly that had yet been created.

Paulson accomplished his feat by “betting against” the housing bubble.

Paulson did not build anything. He did not create anything substantive. Paulson’s bets did not ameliorate the housing bubble and subsequent crash; they exacerbated them.

To understand how Assholes have taken over, we need only to compare John Paulson’s work, skills and output to those of John Rockefeller.

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