A Goldman Opportunity

First, I would like to apologize for the excruciating pun that is the title of this article. That being said, the current SEC investigation of Goldman Sachs does so sweetly tee up President Obama's pitch for financial reform and provides him a free kick at punting it to the electorate, an advantage not available to him during the recent healthcare debate.

The story is as follows, the SEC is looking into allegations that Goldman Sachs was complicit in some extremely unethical trading practices by Paulson & Co, a hedge fund management company it contracted to advise some of its clients on investment opportunities.

The case focuses on Centralized Debt Obligations (CDO's), which are a type of financial instrument whose value is tied to an underlying set of assets. In this instance, the CDO's were "backed" by a set of subprime-mortgage bonds which had been hand-picked by Paulson & Co for inclusion in an investment portfolio. It is alleged that Paulson knew the portfolio was destined to fail and had in fact deliberately constructed it in such a way that the value could go nowhere but down. The health and value of the portfolio was misrepresented to clients of Goldman who were encouraged to put money into it. Traders at Goldman then "bet" on the housing bubble bursting and raked in colossal profits when it did.

Before we continue, l want to spend a brief moment on the concept of "betting" on stocks. This term is thrown around a lot and I don't have the deepest understanding of the concept, but I'll give explaining it my best shot. A stock is valued at $100 but I, as a trader, have information that leads me to believe the price will go down to $50 by close of business tomorrow. I approach an owner of the stock and 'borrow' it from them until that time in exchange for a lender's fee. I immediately sell the stock at the high price, then wait until the price drops the following day and buy it back. I then return the stock to its original owner (plus the lender's fee) and pocket the rest of the money. This is also known as 'short-selling' and, whilst the SEC doesn't mind the practice itself, problems arise when the market is deliberately manipulated.

There has been some backlash against the investigation with some analysts and commentators deeming it a waste of time and effort. Others, however, are happy to see a large financial house being called to account for its alleged irresponsible behavior. The investigation has gone global, too, with the United Kingdom and Germany starting their own inquiries (Germany, in particular, must declare a special interest; one of Goldman's clients most seriously affected in the scandal is IKB Deutsche Industriebank AG, a huge bank that has had its own problems in recent years, receiving no less than two bailouts to keep it afloat).

Which brings us to the forthcoming financial reform bill, championed by President Obama. The SEC investigation provides a great opportunity for the bill's sponsors to frame the passage of the bill as a fight back against the big banks who had for so many years operated recklessly and without any proper supervision, crippling the economy in the process.

The details of the case are far more complex than the simplistic treatment I have given them here (I freely concede I have not even scratched the surface), but that is actually the point of this article. The case appears to be a simple matter of right and wrong; upon this basis it is easy to pick a side (I assume I needn't go so far as to point out who the bad guy is in this dismal piece of theater) and therefore easier for Obama to explain the necessity of reform to the electorate.

The President did not have this advantage when the healthcare bill was going through; according to polls, people were generally happy with their healthcare plan so there was noone to demonize.

The communication aspect of policy-making is almost as important as the policies themselves, and noone knows how to kill a bill through poor messaging better than the Democrats. They need to take some cues out of the Republican playbook, from which phrases like 'Death Panel' and 'Pulling the Plug on Grandma' so powerfully and memorably came. The task for the Democrats is this: formulate some lapel-badge-sized talking points and repeat them until voters are saying them in their sleep.

This time around it should be much more straightforward; people losing their 401ks because of rogue trading practices is very, very bad, so financial industry reform has to be a good thing.

Even the Democrats can't screw this up, right?

Authors note: Thanks to Adam Martin for his input on this article.