Prophet Without ProfitThinking Non-Linear

My college history professor had an astute observation: “trust once lost cannot be easily regained.”  Naked Capitalism has two excellent posts today: “Is Blaming AAA Investors Wall Street Serving PR?” and “Has Obama Been a Success despite Suspicions of Crony Capitalism?” A common theme that both articles fail to fully articulate is– trust.  Trust is a commodity everyone now sells short.

Wall Street’s Treatment of Investors

In “Is Blaming AAA Investors Serving Wall Street PR?” Thomas Adams argues that Goldman Sachs and other clever bankers are pinning the blame on institutional investors who bought AAA-rated, collateralized debt obligations. Many of these securities turned out to be worthless. The investment banking community argues “caveat emptor,” but Adams convincingly rebuts:

The argument that the CDO market blew up because it was so complex and speculative is fundamentally flawed. Believe it or not, the bonds that caused the damage to AIG, the bond insurers, and banks were not highly speculative, high risk bonds. They were AAA securities and were supposed to be virtually free of credit risk. In many cases, they were “super senior” bonds – meaning they had another layer of protection above the AAA level to make them even safer than regular AAA bonds.

AAA securities were meant to be easily understood by any investor.  These products should not have required sophisticated analyses as Goldman and others now argue.

Adams cuts to the heart of the investment banker’s sin:

The problem with the CDO market, and a good chunk of the financial crisis, is that the participants took complex, highly volatile, highly risky and highly leveraged assets and passed a magic wand over them to turn them into AAA. Unfortunately, this process did nothing to remove the volatility, risk, complexity or leverage (in fact, the CDO made all of these worse). From the very start, the market for AAA CDO bonds backed by ABS collateral was a fraud….

Most telling is that the same investment banks selling these investments as AAA securities were simultaneously shorting the same securities to profit from their eventual default. See Banks that Bundled Bad Debt Also Bet Against It.

This is the new age of investment banking.  Would Sidney Weinberg the legendary head of Goldman Sachs bet against his own clients? I suspect not. Mr. Weinberg understood the basic value of trust.

What Price Success?

The Obama administration is extremely proud of stabilizing the economy.  In “Has Obama Been a Success Despite Suspicions of Crony Capitalism?” Edward Harrison addresses the large gap between the President’s words and deeds. Harrison bypasses Obama labels — liberal, a closet republican, technocrat — and instead examines the evidence:

The evidence, therefore, tends to demonstrate that we have witnessed an orchestrated campaign by the Bush and Obama Administrations to recapitalize too big to fail institutions by hook or by crook, bypassing Congressional approval if necessary. And when it comes to healthcare, both Congress and the White House have bent over backwards to keep the lobbyists onside. As I see it, our government has favored special interests in the past year of Obama’s tenure to our detriment.

Thus, banks or pseudo-banks are guaranteed survival (e.g. American Express, GE, Goldman Sachs and others) while Main Street (small businesses and community banks) is pushed to the back of the economic assistance line.

And consider other erosions of public trust by the Obama Administration:  an alphabet soup of federal guarantee programs, sham bank stress tests, suspended accounting rules, and favoritism toward health insurance companies and big pharmaceuticals in the current health care debate.

The Age of Cynicism

We live in an age of flawed short term thinking.  How do we make our numbers for the next quarter? How do we get through this financial crisis? How do we get a health care bill passed so we can claim victory? How do we win the 2010 elections?  Each “success” comes at a very high price.  America is a carefully woven social contract with trust as its bedrock.  But increasingly, cracks now appear in this bedrock of trust just when it is most needed.  Will public trust be completely gone when the inevitable next crisis occurs?