Goldman Sachs Pays Fine, J. P. Morgan Announces Profit–Smoke and Mirrors on the Financial Front

Goldman Sachs agreed on July 15 to pay a $550 million dollar fine to settle SEC charges of misleading investors. J. P Morgan , also on July 15, announced a $4.8 billion profit for the second quarter. The devil is always in the details.

 

Goldman was accused by the SEC of defrauding investors by misrepresenting a securities product backed by sub-prime mortgages. Investors in the the product, named “Abacus,” were alleged to have lost over a billion dollars. The SEC claimed that the Abacus product was composed of securities selected by hedge fund manager John Paulson while at the same time his firm, Paulson & Co. made billions of dollars on investments that bet the same mortgage backed securities would flounder. The Huffington Post quotes analyst Sylvan R. Raines’ statement to the New York Times: “The simultaneous selling of securities to customers and shorting them because they believed they were going to default is the most cynical use of credit information that I have ever seen. When you buy protection against an event that you have a hand in causing, you are buying fire insurance on someone else’s house and then committing arson.

 

Goldman agreed to pay $300 million to the SEC and the remainder to the investors harmed in the Abacus deal.

 

Goldman stock rose 4.3% on the heels of the news of the settlement. Goldman’s profit for the first quarter of the year was $3.3 billion. Many observers expected the settlement to be more in the neighborhood of $1 billion.

 

J. P. Morgan surpassed analysts estimates when it announced its second quarter profit. Not all analysts were excited. As Dick Bove of Rochdale Securities said, “It saw a decline in its deposits, it saw a decline in its loans, it saw a decline in the fees that it created, it saw a decline in its margins and it saw a decline in its revenues. It was a terrible quarter.”

 

Anyone who’s worked for a publicly held company may have an inkling of how J. P. Morgan pulled off this amazing coup. It’s not magic in like Gandalf or Harry Potter. It’s sleight of hand like David Copperfield or Criss Angel. Bove explained: “They reduced their reserves, and they took money out of the reserves and put it into profit. Most, if you will, hardcore analysts who look at a company won’t accept that as being a valid way to increase earnings.”

 

Here we have two examples of the sort of behavior that is considered normal in finance. Many financial observers are calling the Goldman settlement a victory for the company. To put the amount of the settlement into perspective, consider that it’s about 3.4% of the firm’s 2009 bonus pool and about one sixth of the company’s announced first quarter 2010 profits. Goldman also skated on the two of the original charges in the SEC complaint, both of which required proof of fradulent intent. Goldman admitted only to presenting “incomplete information” to investors. Essentially Goldman took a plea bargain because it’s risk management folks calculated that it was the best deal.  J. P. Morgan engaged in behavior similar to an individual’s taking money out of a retirement account to deposit to the checking account to make up for a shortfall in pay.

 

People wonder why congress just passed a new package of financial regulations.  I’m wondering why the bill wasn’t a lot stronger than it is. 

 

Sources:

Huffington Post 1, Huffington Post 2, Marketplace, CNBC, Politics Daily

 

 

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Optimist who doesn't believe in progress. Class clown manque.

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