Of all the stories to emerge about the financial service industry's perfidy during the real estate bubble, this one may be the most shocking to date: The New York Times reports that even while it was enthusiastically selling complex mortgage-backed securities to its customers, Goldman ("god's business") Sachs was betting against them by selling short.

One focus of interest, according to the report, "is whether the firms creating the securities purposely helped to select especially risky mortgage-linked assets that would be most likely to crater, setting their clients up to lose billions of dollars if the housing market imploded."

If there's anyone out there who would be surprised that Goldman and others deliberately bilked their customers in this way, I'm sure someone has a very nice bridge to sell you.

The Times story ran on December 23, which might explain why it hasn't gotten more attention. But regulators and lawmakers are going to take an interest--the SEC and the Financial Industry Regulatory Authority are investigating--and it's hard to believe that this won't continue to haunt Goldman and others in 2010.

The Huffington Post has launched a campaign designed to use public pressure (in the absence of any significant government interest in the issue) to hold the banking sector accountable for the pain it inflicted on the world over the past 12 months--and more importantly, to make it less likely that the industry will be able to benefit from inflicting such pain again in the future.

The liberal website has quite correctly focused in on the "too big to fail" problem, which more or less guarantees that the banking industry can make hugely profitable bets with your money during good times, secure in the knowledge that those bets will be covered by the federal government if things go bad.

You might think there's not much that individuals can be done to prevent this process repeating itself (especially since Congress seems quite happy to encourage it), and I suspect you're right. Still, the HuffPo campaign, which encourages people to move their accounts from the big four banks to smaller community institutions, will be an interesting test of the ability to organize a mass protest on the Internet.

"The big banks on Wall Street, propped up by taxpayer money and government guarantees, have had a record year, making record profits while returning to the highly leveraged activities that brought our economy to the brink of disaster," says Ariana Huffington. The response, which Huffington says is "populism at its best":

"If enough people who have money in one of the big four banks move it into smaller, more local, more traditional community banks, then collectively we, the people, will have taken a big step toward re-rigging the financial system so it becomes again the productive, stable engine for growth it's meant to be."

I'm skeptical that anyone can mobilize enough people to take this kind of action. Changing banks is a pain in the ass. And I also suspect that if the campaign did succeed, the big banks would simply buy up the community institutions.

Nevertheless, good luck. I think the HuffPo is tilting at windmills, but these are windmills worth tilting against.

If Goldman Sachs' decision to apologize (sort of, vaguely) for its role in the global economic crisis and to set aside $500 million to help thousands of small businesses recover from the recession was really--as some have suggested--a "public relations ploy," it is surely, dollar-for-dollar, the least effective investment in public relations in living memory.

If the reactions recorded here and here and here are any indication, Goldman's philanthropic gesture has not enhanced the investment bank's relationship with any of its key publics, and may in fact only have served to underscore the vast difference between what it takes out of the free market system and what it has chosen to give back.

As reputation management consultant and author Peter Firestein asks in his contribution to The New York Times' Room for Debate blog: "When was the last time a company voluntarily took half a billion dollars out of its own pocket, contributed it to the good of others, and still failed to erase the perception that the money amounted to nothing more than a fine or a sentence of community service?"

It's fascinating to me, after spending most of the past five years in Europe, that so many American companies still believe that corporate philanthropy is the same thing as corporate responsibility when in many cases--and this seems to me to be one of them--philanthropy is used as cheap and easy alternative to genuine responsibility: "If we toss a few thousand dollars their way, they'll let us continue operating the way we always have."

But the reactions above suggest that the media and the activist groups and the American public may be waking up to this ploy. They are not prepared to allow big oil companies to purchase the right to pollute the environment in exchange for a few thousand dollars donated to wildlife preservation and they are not prepared to all financial institutions the right to pollute the economy in exchange for a donation to help entrepreneurs.

If Goldman Sachs wants to be seen as a responsible company, as part of the solution rather than as part of the problem, it needs to come a lot cleaner about what it did wrong ("we participated in things that were clearly wrong," is, as the Times points out, irritatingly non-specific) and about what it is going to do to ensure that it doesn't make the same mistakes again. It needs to define what a responsible financial institution would look like, and then provide sufficient transparency so that people can judge whether it is living up to that standard of responsibility.

And it needs to commit to helping the federal government draw up regulations that would prevent the worst excesses of the past decade and provide real, meaningful penalties for firms that do not behave responsibly.

Goldman Sachs is a self-proclaimed "leader" in its industry. But there's a difference between being a leader and just being the biggest, or the richest, or the most powerful.

One of my favorite scenes in one of my favorite movies is the "trial" of Delta house, in which Tim Matheson manages to suggest that by bringing charges against the eponymous Animal House, the dean of Faber College is in fact attacking the entire education system, and the country as a whole, inspiring a walkout by his fraternity brothers with the immortal line: "You can do what you want to us, but we're not going to sit here and listen to you bad mouth the United States of America."

The clip came to mind after watching former Merrill Lynch chief executive John Thain--you may remember him as the guy who spent $1 million redecorating his office after destroying many times that amount in shareholder value--in a presentation to Wharton Business School, in which he responds to attacks on his personal excesses with the claim that "the American dream has been demonized."

This from a man whose greed and ego shattered the dreams of thousands of Americans.

William Cohan, whose book (House of Cards) on the origins of the financial crisis I am currently enjoying on my new Kindle, has an excellent and informative column for The Financial Times in which he warns--convincingly--that the recent profit numbers from giant banks like Goldman Sachs, Citigroup and Bank of America might not be quite as exciting as they first appear.

In fact, his column suggests that it's business as usual on Wall Street, which means that companies continue to use misleading numbers to create a false impression of robust financial health.

Says Cohan: "A true return of profitability on Wall Street will come with the return of public confidence in the way it does business. Concepts such as honesty and transparency are key, not a bunch of accounting gimmicks designed to manufacture profits and send markets soaring. The public will remain sceptical of the recovery--and the return of the investment banks--until then."

Just a random thought, but I wish people would stop referring to the search for the villains of the current financial crisis a witch hunt. The whole point of a witch hunt is that it's a hunt for something that doesn't exist. Whatever else you might think about Wall Street bankers, they're not a figment of the imagination.

There's all kinds of fun controversy brewing over AIG's use of four major public relations firms to help with communications, with various legislators demanding an investigation into the possible misuse of public funds and the media eager to amplify charges of PR dirty deeds, particularly over the compilation of a "dossier" critical of former chief executive Hank Greenberg, who has been on the offensive against his successors.

There are two issues. The first is whether AIG's increased spending on public relations is, in and of itself, justified. The second is whether there was anything unethical in compiling the dossier on Greenberg.

The first issue is the easier to address. AIG faces a host of complex challenges and as a result it is under increasingly intense scrutiny from a variety of stakeholders, including the media (but also including shareholders, customers, suppliers, employees and regulators). It's neither surprising nor inappropriate that AIG requires outside assistance in dealing with those stakeholders, and its communications chief, Nicholas Ashooh, is absolutely correct when he says that if AIG was not communicating with those stakeholders it would receive (and deserve) even more criticism.

For what it's worth, I'd wager that AIG is spending more on legal advice than it did before the crisis. I'd also wager that the company has three or four big law firms on retainer. I haven't seen any stories criticizing AIG for that. So I suspect that this criticism has more to do with a misunderstanding of--and prejudice toward--what public relations firms do.

What about the Greenberg dossier? I don't see any problem with AIG providing the media with its perspective on the former chief executive, who has been bitterly critical of the company's current management as he attempts to ensure that as little of the blame for its excesses as possible falls on him.

But it would surely have been smarter to provide the facts without the vindictive tone that underpin--and undercuts--them, and to avoid exaggeration, ensuring that every charge could be supported by the evidence. (The Journal says: "Not all of the allegations stand up to rigorous analysis, and some of the assertions seem to stretch the facts.") The company would have benefited from adopting a more dignified tone, and some of the criticisms now circulating among lawmakers and the media could have been avoided.

I'm feeling generous this morning, so I'm going to assume that this is the work of a lone, off-the-reservation attorney at Goldman Sachs well past retirement age who has absolutely no idea how the blogosphere works.

For a brief insight into what happens next, I would refer the idiot who filed suit against the blogger who set up goldmansachs666.com (known as Facts About Goldman Sachs) to the McLibel case, a lawsuit brought by McDonald's in the U.K.--where free speech protections are not nearly as strong as they are in the U.S.--against Greenpeace activists, and which continues to tarnish the company's reputation to this day.

In this case, Goldman has absolutely no chance of prevailing on the merits--the lawsuit is presumably an attempt to intimidate the critic in question into silence, since its claims of intellectual property rights infringement are entirely spurious--and will accomplish four things: first, it will drive more traffic to the critic's site, ensuring that many more people are exposed to his attacks on the company; and second, it will force many other bloggers to link to the beleaguered critic, ensuring that many, many, many more people are exposed to the attacks on the company; third, it will ensure that the criticisms make the jump from the blogosphere to the mainstream media; and fourth, it will make Goldman Sachs look like a clueless bully.

In other words, it's a dumbass legal strategy and a catastrophic public relations strategy.

Other than that, it's a smart play.

As the backlash against the backlash against the AIG bonuses begins to take hold, I hear and understand all the logical arguments about the company being able to attract and retain the best people. I hear and understand the argument that the hundreds of millions paid in bonuses are a drop in the ocean compared to the full cost of the bailout. I hear and understand the claims that a bill to tax bonus payments at close to 100% would have numerous unintended consequences.

I hear and understand all this, and I still believe that finding some way to punish the executives who accepted these bonuses is critically important. Because I still believe that the most important long-term challenge is restoring faith in the markets, and I don't see how that can be accomplished as long as we continue to reward incompetence, greed and arrogance.

James Surowiecki, blogging for the New Yorker, sort of gets it.

"Myriad experiments in behavioral economics have found that people are willing to pay to punish members of a group whom they believe to be shirkers or free-riders," he writes. "In other words, people are willing to make themselves worse off (they have to pay their own money) in order to insure that others don't get undeserved rewards.

"Economists call this "altruistic punishment" (because the punishers are putting the interests of the group ahead of their own interest), and argue that it played an important role in fostering cooperation. So even if people believed that getting the A.I.G. bonuses back would be a net loss for the economy, chances are they'd still want to do it.

"Getting all worked up about this money may not, strictly speaking, be rational, but I think that paradoxically, if some of this money is clawed back, it'll increase the chances that we'll be able to keep dealing with the ongoing crisis in a rational way in the future."

Where I disagree with Surowiecki is that I think getting worked up about all this money is entirely rational, because these payments suggest that Wall Street's worst practices--its determination to reward its own even for their worst failures and their most egregious excesses--continues, even in the face of the worst crisis of our lifetimes. It suggests a lack of seriousness about tackling the root of the problem.

That's why I think these retention bonuses should be turned into severance payments. Anyone who accepted even a dollar in bonus money should be let go.

Because as long as those individuals remain, the system will never be fixed, and confidence in it will continue to deteriorate.

In The New York Times this morning, Andrew Ross Sorkin presents the best case I have seen to this point for allowing executives at AIG to keep their bonuses--and I have to say I find it completely unconvincing.

Sorkin seems to make two interrelated points. First, that it would be a mistake to undermine confidence in the sanctity of contracts: "If you think this economy is a mess now, imagine what it would look like if the business community started to worry that the government would start abrogating contracts left and right." And second, that AIG executives might leave and take advantage of their knowledge of the company's vast problems to wreak further havoc on the financial system: "A.I.G. employees concocted complex derivatives that then wormed their way through the global financial system. If they leave -- the buzz on Wall Street is that some have, and more are ready to -- they might simply turn around and trade against A.I.G.'s book. Why not? They know how bad it is. They built it."

Both of these reasons, it seems to me, are arguments in favor of finding any way we can to cancel these bonus payments.

Let's take the second one first. Sorkin acknowledges that AIG executives "concocted" the derivatives that are a major part of the problems we now face. They were rewarded--outlandishly--at the time, for concocting them. He now suggests that they be rewarded again, as a bribe for not turning around and using them against us. This is not just a case of "negotiating with terrorists," but of capitulating to them. Whatever the cost of holding firm against this kind of blackmail, it will be cheap compared with the cost of sending the message that the blackmailers will be rewarded with public funds in the future.

As for the first case, the idea that contracts cannot or should not be renegotiated is at best a cultural construct--in many other cultures around the world, contracts are renegotiated all the time based on changes in circumstance. And let's be honest, American companies--insurance companies in particular--are adept at finding loopholes in contracts to deny policyholders payment, or making policyholders fight a prolonged legal battle to get the payments to which they are entitled. They seem perfectly comfortable using that tactic for evil; maybe it's time to use it for good.

At the very least, those employees who believe they are entitled to huge bonuses despite what has happened to their company should be made to fight for those bonuses in court, and to endure the public opprobrium that accompanies their desire to profit even further from the misery they have helped to inflict on ordinary Americans.

The final point, the one made by executives at these companies, is that they need to pay these bonuses to hang on to their key employees. That's an even more specious argument: any employee of AIG who would accept a bonus payment under the current circumstances may well have the knowledge and skills necessary for a high-level job in the financial world, but clearly lacks the character.

Any company that bends over backwards to keep such mercenaries on its books is actively working to erode trust in the financial system even further and prolonging the crisis of confidence that is wreaking havoc with the global economy. People who value a short-term payout over morality, integrity, and the long-term security of the system are the problem, not the solution, and the sooner they are purged from the corporate ranks the better.

ADD: Robert Reich makes a similar case at his blog.