Have you heard the one about how Goldman Sachs pissed off politicians and public finance officials by recommending that investors buy credit default swaps on municipal debt? Goldman, one of the top five municipal bond underwriters, has begun hawking credit default swaps on municipal debt now that the monoline bond insurers are viewed as inadequate to insure against debt.
To understand why this is a “scandal” it helps to turn off your cognitive functions for a bit. Your brain would tell you that a bank is supposed to give its investor clients recommendations regardless of its investment banking relationships with its underwriting clients. If you are particularly historically minded, your brain might even tell you there were huge scandals in the early years of this century when regulators accused investment banks of tailoring their analysis to benefit investment banking clients.
All that will interfere with your attempt to understand what’s got the public finance types up in arms. You see, public finance is famously corrupt. And public finance officials expect the kind of corruption that would normally raise alarms with regulators. This is why they feel free to describe Goldman’s selling credit default swaps to clients as “disturbing” or “distasteful.”
Last week New Jersey Assemblyman Gary S. Schaer, a Democrat who chairs the state legislature’sFinancial Institutions and Insurance Committee, wrote a letter to Goldman head Lloyd Blankfein instructing him to tailor the bank’s analysis to the capital market needs of New Jersey.
“New Jersey needs to maximise its presence in the credit markets, not to see its presence undermined,” Schaer wrote.
If you haven’t successfully shut down your cognitive ability yet, you might wind up imagining, for a moment, what would happen an attorney general were to turn up a similar letter from the chief financial officer of a corporation complaining that the bank that underwrote his debt wasn’t issuing bullish enough analysis.
“Ford Motors needs to maximise its presence in the credit markets, not to see its presence undermined,” would be grounds for prosecution.
ProPublica, a non-profit investigative-journalism shop founded by Paul Steiger, the former managing editor of The Wall Street Journal, got this awful idea rolling when it published an “investigative report” describing a September presentation to institutional investors on “Best Long and Short Strategies.”
Here’s how Bloomberg describes that report:
Goldman recommended buying credit-default swaps on “a basket of liquid State General Obligation credits with current and worsening fiscal outlooks,” including California, Florida, Nevada, Ohio, Wisconsin and Michigan.
The firm also recommended the derivatives on states with “significant unfunded pension” and other retiree obligations, including Illinois, Connecticut, Hawaii, New Jersey, Massachusetts and Nevada.
Of course, since Goldman issued that report, CDS on municipal debt has undergone a massive rally. But there you go again, letting your brain do the thinking for you.