The Fine Print: How Big Companies Use "Plain English" to Rob You Blind (28 page)

The problem is that while you might go to arbitration once in your life, the auto dealer or bank or stock brokerage on the other side of the table is a frequent customer. Arbitrators who rule for consumers tend not to get picked for future work. This record on how arbitrators tend to decide in accord with their stream of income is quite consistent, as studies have found examples of arbitrators who issued dozens of decisions in a single day, all in favor of the businesses who repeatedly hired them.

Economists call this the “repeat player” problem, and it brings us back to Barbara Keeton because it was one of the issues she faced in her dispute with Easterns Automotive and its egregious pricing on the unreliable Mazda it persuaded her to buy. Her court case seemed dead when it was picked up by two new American University law students, Natalie Huls-Simpson and Sheri Strickler. With help from Professor Elliott S. Milstein, who oversees the university’s legal clinic, they devised a creative new approach.

To Huls-Simpson, who grew up in much better circumstances than
Keeton, the difference between the car’s price and value “was a bit of a shock. I just did not realize that car dealerships would take advantage of a consumer to this extent.”

The clever argument the students devised was that, because the court case had been dismissed with prejudice, it was a final order and therefore Keeton was entitled to appeal whether that decision was fair. The trial judge had never considered whether it was fair or unreasonable that Keeton had to pay half of the arbitrator’s $200 hourly fee or that Easterns got to pick who would hear the case. The students also noted that the contract had a provision that gave Easterns a stronger hand than Keeton. While the contract forced Keeton into arbitration with no right to sue in court, Easterns retained the right to go to court against her. All of this and more, the student lawyers wrote, showed the contract was unconscionable and therefore unenforceable.

With the help of her enthusiastic young counselors, Keeton won the appeal. Wells Fargo could have gone back and fought the case. Instead it stopped trying to take her house and, to make the case go away, paid her some money, though it insisted the sum be kept confidential.

While Keeton came out all right in the end, the case did not help anyone else. This is another shortcoming in the law—even when systemic problems are identified, they can be hushed up with settlements. The
Seattle Times
in 2010 published a superb series about judges who improperly sealed court cases, putting people in danger from dangerous drugs and unsafe caregivers and helping suspected thieves hide their conduct. Any newspaper in the country could find similar abuses if it tried. Putting an end to sealing cases, especially commercial cases filed in public courts, is a much needed reform.

The reality is that consumers continue to be at risk of being forced into costly private arbitration where the rulings will come from arbitrators whose financial well-being lies in making awards that please those who decide whether they will get hired again in the future. That is not justice. But, once again, it helps explain why the haves do so much better in arbitration and in class-action court cases than the have-nots.

15.
Of all of
the bailed out banks, the sweetest deals were given to the derivatives trading house of Goldman Sachs. Goldman grew famous as an investment bank, marshaling vast sums of money from investors to build factories and all sorts of new enterprises; but in recent years, investment banking has accounted for just a tenth of its business. Instead, most of its profits come from trading in its own accounts and derivatives. In short, Goldman Sachs is less an investment bank than a new kind of casino.

The derivatives Goldman dreams up and sells are mostly zero-sum bets. One side bets the value of an asset or basket of assets will rise, the other that it will fall. These are actually worse than zero-sum games because the fat fees Goldman charges mean the final result is less than zero for the two parties to the deal. Goldman also places lots of these bets itself. And make no mistake, that is what most derivatives are—gambling. These bets are also a form of unregulated insurance. The premiums charged were not big enough to pay claims because no one thought they would ever actually have to pay off.

Most of these derivatives were credit default swaps, a kind of insurance against the risk that someone who owes money will not pay his or her debts. Against $15 trillion of U.S. mortgage bonds in 2008, Wall Street marketed credit default swaps with a face value of $67 trillion. Worldwide, traded swaps at their peak equaled $670 trillion or $100,000 for
every person on the planet, vastly more than all the wealth in the world. Those numbers made it a mathematical certainty that the swaps were mostly speculation, not commercial hedging.

When the time came to pay up and firms such as Lehman Brothers and Bear Stearns could not, the giant flow of cash that is Wall Street froze solid. No one knew who was holding more bad bets than they could pay. No one wanted their money in anyone else’s hands, even for a second, in case they shut down, as Lehman did. This was a mess that Alan Greenspan and many other top officials insisted no one saw coming, especially not the part involving mortgage securities. But there were at least a dozen journalists who got it right and alerted people. There were economists and critics who issued warnings, too. The handwriting was on the wall for those who, unlike Alan Greenspan, cared to pay attention.

When the Bush administration decided to rescue Wall Street, instead of letting the market do its job, one firm was favored above all others: Goldman Sachs.

FAVORITE SON

Taxpayer dollars paid off Goldman’s losing bets with AIG, the insurance giant. That cost you $13 billion or so. Goldman had told the government it was willing to take a loss on the deals, but gladly accepted one hundred cents on the dollar for bets that might have paid off in pennies.

Treasury Secretary—and former Goldman Sachs chairman and CEO—Hank Paulson arranged this and other deals. At a key moment, he also met with government officials about the bailouts. In the room was one outsider, Lloyd Blankfein, who succeeded Paulson as Goldman CEO.

In October 2008, Paulson invested $10 billion of your money into Goldman. He made the deal three weeks after Warren Buffett had also invested in Goldman. How did the deals compare? Buffett got a $500 million annual dividend. You invested twice as much, but got the same dividend. Buffett got the right to buy 11 percent of Goldman for $115 per share. You bought the right, for almost $7 more per share, to buy just 2 percent of Goldman. That was obviously a bad deal for taxpayers, but just how bad?

Using textbook valuation techniques, Leon Potok, the financial adviser to the United Steelworkers Union, compared the deals. What he found, in plain English, was that American taxpayers made a gift to
Goldman Sachs worth $5 billion. It amounted to more than $16 for every American, $64 for a family of four.

Later the Obama administration let Goldman buy back the securities. Goldman issued a statement saying taxpayers made a 22 percent annualized return on their money. That figure is correct, but it ignores three key facts. One, Goldman got to pick when to buy out the federal government’s investment, which would not be when it reached maximum gain. Two, the 22 percent return was not commensurate with the risks taxpayers took, especially compared to the deal Buffett made. Three, it ignored the $13 billion Goldman got from taxpayers when they paid off its bad (and possibly worthless) bets with AIG. All in all, taxpayers lost a bundle, the government saved Goldman from facing the rigors of the market for its mismanagement, and you were left with less while Goldman enjoyed more. And Goldman did not even thank you for your generosity.

As an extraordinarily profitable concern, Goldman should not have needed any help at all. Goldman made $39 billion in pretax profits in the three years 2009 through 2011. For every dollar that came in the front door, Goldman rang up an astounding twenty-nine cents as profit, triple the rate for large businesses overall. Even more astounding was how profitable Goldman was compared to American business as a whole during that three-year span. Goldman’s pretax profit in 2009 accounted for 1.5 percent of all the pretax profits earned by all six million corporations in America. For the three years 2009 through 2011, it reported close to a penny out of each dollar of pretax profit in America.

Even bigger than Goldman’s profit was the money paid in bonuses to its executives and traders. In those three years Goldman bonuses came to $44 billion. That is an average bonus of close to half a million dollars. For each dollar of pretax profit, the company paid out $1.12 in bonuses to executives and traders. Add the pretax profits and bonuses together, and sixty-one cents of each dollar that came in the door at Goldman stayed as profit or bonus.

In 2009 alone, Goldman bonuses accounted for three-tenths of one percent of all the salaries, wages and bonuses paid in America. Now a fraction of a penny may not sound like much, so let’s put it in context. Nearly 117 million people reported earnings from a job in 2009, but just 35,000 of them worked at Goldman. The average 2009 Goldman bonus represented more than a decade of work at the average wage earned by the 99 percent of Americans who make under $200,000 annually.

These riches meant Goldman could build a new corporate headquarters in Lower Manhattan that opened eight years after 9/11. The new
headquarters is remarkable for several reasons. It is two blocks long and forty-three stories high, every one of its 2.1 million square feet occupied by Goldman, including six trading floors. The address is simply 200 West Street. Nowhere is the Goldman Sachs name emblazoned on the building.

Thanks to its political connections, Goldman got taxpayers to pick up much of the tab. Goldman says the building cost $2.1 billion. It took out a mortgage for $1.65 billion, financed with Liberty Bonds, which were supposed to help stimulate the economy that Goldman had done such a fine job of crashing. Goldman’s share came to almost a fifth of all the Liberty Bonds available to rebuild Lower Manhattan after 9/11. Investors who bought the bonds get their interest free of federal, state and New York City tax. Because the bonds are tax-exempt, the interest rate Goldman paid was reduced, saving it about $175 million over thirty years. As usual, you will make up for that savings in higher taxes, fewer government services and more government borrowing. Think of your share as another part of your gifts to Goldman, adding to each family of four’s $64.00 another $2.16.

Tax-free financing was not the only tax benefit Goldman got. The state and city lavished at least $66 million of tax breaks on Goldman, for example, not requiring it to pay sales tax on all its new furniture the way a homeowner or small-business owner must. Then there was $49 million in job-training grants from government, welfare not for workers but for Goldman owners and executives. Meanwhile, many smaller businesses in Lower Manhattan said they could get little more than the time of day from the government as they tried to rebuild after the attacks on 9/11.

Greg LeRoy, who runs Good Jobs First, a small Washington nonprofit that uncovers subsidy deals and tries to get news coverage about them, considers the Goldman Sachs building “one of the most lavish giveaways in U.S. history.” That’s a big claim in the context of massive gifts in the past to politically connected businesses like the railroads, defense contractors and many others.

LeRoy explains, “After twenty years documenting outrageous subsidy deals, I thought I’d seen it all”—until he saw Goldman with its $39 billion in pretax profits over three years “hogging 9/11 reconstruction funds while small businesses languish.” Moreover, he observed, the “approval process is rushed and secretive, mocking taxpayers’ right to review and comment.”

Taxpayers are not the only ones Goldman abuses. Consider its role in
the $21 billion takeover of the El Paso Corporation, the owner of the pipeline that killed the twelve campers in New Mexico. A Delaware judge, Leo Strine, called what Goldman did in facilitating the sale “disturbing.” In the past, Goldman had been accused of having a conflict of interest involving Kinder Morgan, the owner of the pipeline. When founder Richard Kinder took Kinder Morgan private by buying out other shareholders, Goldman Sachs was his partner. Their tactics were such that the shareholders who were forced out sued. Goldman paid $200 million to settle the claim but, as has become standard, Goldman neither admitted nor denied wrongdoing.

In the deal before Judge Strine in early 2012, Goldman advised El Paso, recommending it accept Kinder Morgan’s offer for its shares. Some big El Paso shareholders thought they should get a lot more for their shares and they sued, too. In fact, Goldman had a huge interest in giving its client (El Paso) bad advice to sell itself cheap: Goldman owned almost one-fifth of Kinder Morgan and had two people on the Kinder Morgan board. The less El Paso shareholders got, the more Goldman’s Kinder Morgan stake would be worth. This is about as clear and obvious as any conflict of interest can be.

We’re not done. Douglas Foshee, the El Paso chief executive who personally negotiated the sale with Kinder Morgan’s Rich Kinder, wanted to carve out part of the property for himself in a later deal. The lower the price Kinder Morgan paid El Paso, the less Foshee would have to pay later to get the property he wanted. Goldman knew about this blatant conflict of interest, too, but went ahead anyway, advising El Paso shareholders to accept the lowball buyout offer from Kinder Morgan.

When these conflicts of interest became known, a second adviser was brought in—the banking firm of Morgan Stanley. The terms of its fee did not suggest it would be independent. Morgan Stanley was to be paid, the judge explained in his opinion, only if El Paso was sold to Kinder Morgan. If any other deal was reached, Morgan Stanley would get nothing. That, of course, created an incentive for Morgan Stanley to look favorably on a deal for which it would get $20 million versus any other deal, lest it be paid nothing. In this, Judge Strine noted, Goldman had narrowed the range of advice Morgan Stanley was likely to offer to only that which benefited Goldman.