“On Wall Street, ‘Buyer Beware’ Takes on New Meaning”

When the Great Recession of 2008 began to take hold, millions of Americans felt as though they had been struck by a perfect storm. It seemed to come from nowhere and left historic levels of ruin in its wake. It up-ended lives and careers; it dashed people’s hopes and plans. Indeed, many people, including those in Maine, have yet to recover and still continue to struggle every day.

How did this happen? For myriad reasons, the ever-growing housing market bubble burst, taking the rest of the economy with it. Seemingly overnight, housing and real estate investments went from being red-hot commodities to ice cold burdens. As that rich river of revenue dried up, retirement portfolios and 401ks began to tank. Jobs were cut; salaries were frozen. Credit that had been so cheap began to evaporate – for consumers and for businesses. The optimistic consumer market turned sour and people grew fearful.

That reaction was appropriate. For millions of people, the foundation of the American dream, one’s home, suddenly became a questionable investment. It became a losing proposition. For too many Americans, their homes not only fell in value but also were valued at less than the money owed on their mortgages. Houses were “upside down,” financial experts said. They were “under water.”

Thousands of foreclosures followed. And across the economy, sector after sector began to decline, from the auto industry to retail, from construction to manufacturing. With less money to spend and job losses skyrocketing, consumers stopped spending. The spiral was in motion and the damage was stunning.

Perplexed, people began searching for answers. At first, many assumed that the events that wreaked havoc on the American economy were a force majeure – an act of God that was no one’s fault and that could not have been prevented.

But gradually the evidence accumulated that this was a man-made disaster. The economic collapse, linked so heavily to the overheated housing market, could have been lessened, or perhaps even avoided, had many financial institutions, including Wall Street investment banks, conducted themselves differently.

At a recent hearing before the Senate Permanent Subcommittee on Investigations, I questioned Goldman Sachs executives who had been called to testify as part of a series of hearings into the root causes of the Recession of 2008.

I questioned them about their business practices and their apparent conflicts of interest that put their firm’s financial interests ahead of the financial interests of their clients. As a result, some clients were kept in the dark about the extent of the risks they were taking and didn’t fully understand the true nature of the transactions Goldman Sachs was pitching.

At the same time that it was selling mortgage-backed securities containing toxic loans, Goldman Sachs “bet” that the housing market would slump. It wagered that the revved-up housing market would burn out, that prices would plummet, the sector would collapse like a house of cards. And by betting on that grim prospect, which unfortunately came to pass, Goldman Sachs made boatloads of money – billions of dollars in profit. It made money even as average Americans were losing their homes, their savings and their jobs, and even as their own clients capsized.

We all know the saying, “buyer beware.” We know there is a risk involved in almost any financial investment. But this system took that risk to an extreme. Most Americans looking at this scenario would have the same gut reaction: This is not right.

During the Goldman Sachs hearing, I asked the assembled executives a question that I think most people would want to know. I asked if they had a responsibility to act in the best interests of their clients. It was a simple “yes” or “no” question.

Incredibly, the witnesses didn’t want to answer that question. They worked hard to avoid a “yes” or “no” response.

While financial advisers do have a legal fiduciary responsibility to act in their clients’ best interests, investment bankers have no such legal obligation. They are free, in essence, to have conflicts of interests.
As the Senate moves forward on financial regulatory reform, we should explore ways to close conflict-of-interest loopholes. There are other reforms that should be included in the legislation. The bill should:

• Prohibit taxpayer-funded bailouts of ongoing businesses;
• Increase capital requirements as financial firms grow to provide a disincentive to their becoming “too big to fail;”
• Make clear to executives that if they mismanage a firm into insolvency, they will lose their jobs;
• Ensure that creditors face the same risk of loss they would in a bankruptcy court;
• Require those who originate mortgages to share the risk. This will help reduce the incentive to issue poorly underwritten loans;
• Create a council of regulators charged with identifying firms, products, or practices that pose a systemic risk to significant economic sectors;
• Impose greater transparency and more effective regulation of derivatives and other complex financial instruments; and
Provide protections for consumers. Our nation has drifted away from prudent financial practices, and we must learn from the abuses of the past to get our financial system in order and our economy back on track.