In 1909, as the federal government was first moving towards regulation of the financial industry, J.P. Morgan is said to have told friends, “The time is coming when all business will have to be done in glass pockets.” Goldman Sachs is about to find that, for the financial world today, glass pockets are no longer good enough.
The SEC’s civil suit against Goldman charges that, through a partner company, the investment bankers packaged particularly troubled mortgages into collateralized debt obligations, the now notorious CDOs. After Goldman sold the allegedly designed-to-fail instruments, the partner shorted them. Goldman collected fees for assembling and marketing the package (later offset, the firm contends, by larger losses). The partner reportedly netted a billion dollars on its short positions.
The Wall Street Journal front page story characterized the SEC’s charges as the biggest Wall Street-Washington confrontation since the Michael Milken-Drexel case at the end of the 1980s. The Journal might have added that Milken’s was the most prominent of a larger package of investigations targeting the investment community. Despite a parade of so-called perp-walks, when financiers were led into custody as cameras clicked, almost none of those actions produced convictions. The Milken case led to a fine and prison time but remains controversial to this day. Many, myself included, believe justice was miscarried.
The public perception point here is that major financial players face a formidable communications obstacle when they become the targets of such sweeping legal actions. Most attorneys — both prosecutors and their own defense attorneys — and journalists don’t actually understand what investment bankers and securities traders do. The complexity of modern finance bewilders them. And they are predisposed to assume that complexity equals opacity and opacity equals fraud of one stripe or another.
As I write, the weekend after the SEC’s charges hit the papers, I am not offering a judgment on the case against Goldman, though the purchasers of the CDO were among the most experienced and sophisticated players in the financial world. If any buyers were capable of being intelligently beware, it was they. But I am saying that Goldman must learn to explain its business with unprecedented clarity, otherwise, the legal, political, and journalistic worlds will judge the company guilty and exact huge penalties long before any trial.
Morgan’s term “glass pockets” suggested passive transparency. Pull back the fabric; let in the light. Goldman will need actively to project the light outward, making the complex both simple and comprehensible. For an institution unaccustomed to talking to non-experts, the task is sure to prove formidable.