You can stop sending us emails about it now. A 6.5 hour train ride this weekend afforded us the luxury of reading Matt Taibbi’s controversial Rolling Stone story on Goldman Sachs (GS).
The basic argument is that Goldman Sachs has orchtestrated every major bubble, from the internet boom, to last year’s oil spike, and of course the housing bubble.
Now for the most thorough debunking, you should read Megan McArdle, who picks it apart line-by-line.
We’ll say, however, that the story is really not meant for an audience interested in a discussion of financial markets, as evidenced by his rhetorical style (almost everyone is simply an “arsehole”), and his ridiculous leaps in logic (e.g. Goldman lowering its IPO underwriting standards created the .com bubble… and that explains how Nortel had a peak valuation of over $300 billion, how?).
For now, let’s just focus on the housing bubble, which arguably is the only bubble that even matters, since it was so destructive. If you’re going to write an article about how Goldman is the “Great American Bubble Machine,” you better have a good argument that Goldman caused the housing bubble, otherwise the whole thing is pretty much worthless.
So how did Goldman Sachs cause the housing bubble? It got into CDOs, the game of buying, repackaging and selling mortgages.
Goldman used two methods to hide the mess they were selling. First, they bundled hundreds of different mortgages into instruments called Collateralized Debt Obligations. Then they sold investors on the idea that, because a bunch of those mortgages would turn out to be OK, there was no reason to worry so much about the lovely ones: The CDO, as a whole, was sound. Thus, junk-rated mortgages were turned into AAA-rated investments. Second, to hedge its own bets, Goldman got companies like AIG to provide insurance – known as credit-default swaps – on the CDOs. The swaps were essentially a racetrack bet between AIG and Goldman: Goldman is betting the ex-cons will default, AIG is betting they won’t.
There was only one problem with the deals: All of the wheeling and dealing represented exactly the kind of dangerous speculation that federal regulators are supposed to rein in. Derivatives like CDOs and credit swaps had already caused a series of serious financial calamities: Procter & Gamble and Gibson Greetings both lost fortunes, and Orange County, California, was forced to default in 1994. A report that year by the Government Accountability Office recommended that such financial instruments be tightly regulated – and in 1998, the head of the Commodity Futures Trading Commission, a woman named Brooksley Born, agreed. That May, she circulated a letter to business leaders and the Clinton administration suggesting that banks be required to provide greater disclosure in derivatives trades, and maintain reserves to cushion against losses.
Yeesh. It’s hard to know where to begin.
First there’s the stunning assertion that there was only one problem with the deals — namely that they were complex derivatives. Sorry, but CDOs aren’t derivatives. Maybe because both CDOs and CDSs start with ‘CD’ he thinks they’re close enough to just lump in together. But the distinction is more than semantic. His whole argument is that Goldman cronies conspired to torpedo regulation that would’ve regulated derivatives. So for his argument to make any sense, CDOs have to be derivatives — even though in reality, regulators tasked with managing that market wouldn’t have touched them.
But then, even if they were, this bit about cherry-picking a few example of derivative bets gone bad (Orange County, Procter & Gamble, etc.) strikes us a very weak argument that they were destined to be A Bad Thing.
In fact, Taibbi is really just repeating an annoying tendency of mainstream financial journalists and pundits, who claim that the problem with CDOs is that they were exotic and ‘not vanilla’. In fact, we might as well rename them ‘Complex CDOs’, since that’s how they are always referred. But that’s wrong. The problem wasn’t lack of regulation or their complexity — the problem is that they represented a bet on housing and that bet went horribly awry. What about that is so complex and hard to understand? If valuing CDOs were so impossible, whey did the collapse of that market in late 2007 precede the broader collapse of more normal securities?
Next he goes onto make another charge, that while Goldman was selling CDOs, they were also shorting them:
Not that Goldman was personally at any risk. The bank might be taking all these hideous, completely irresponsible mortgages from beneath-gangster-status firms like Countrywide and selling them off to municipalities and pensioners – old people, for God’s sake – pretending the whole time that it wasn’t grade-D horseshit. But even as it was doing so, it was taking short positions in the same market, in essence betting against the same crap it was selling. Even worse, Goldman bragged about it in public. “The mortgage sector continues to be challenged,” David Viniar, the bank’s chief financial officer, boasted in 2007. “As a result, we took significant markdowns on our long inventory positions …. However, our risk bias in that market was to be short, and that net short position was profitable.” In other words, the mortgages it was selling were for chumps. The real money was in betting against those same mortgages.
“That’s how audacious these arseholes are,” says one hedge-fund manager. “At least with other banks, you could say that they were just dumb – they believed what they were selling, and it blew them up. Goldman knew what it was doing.” I ask the manager how it could be that selling something to customers that you’re actually betting against – particularly when you know more about the weaknesses of those products than the customer – doesn’t amount to securities fraud.
“It’s exactly securities fraud,” he says. “It’s the heart of securities fraud.”
Now the first time we read this, our eyes were sort of skimming over it and we got to that last line that said “It’s exactly securities fraud… it’s the heart of securities fraud” and we stopped right there and looked up to see who said it. Turns out, it’s just an anonymous hedgie, who, given his anger, probably got fat at the CDO trough for a few years and then blew up. Boo-hoo.
But securities fraud this isn’t. As McArdle reminds Taibbi, there was this whole Eliot Spitzer-led inquisition on Wall Street to ensure that the left hand didn’t know what the right hand was doing — so a company can sell a product and its traders can be short it, and that’s OK. Again, it’s the opposite of what’s called securities fraud.
As an aside, it’s also total crap when he says that the securities were dumped to “old people” as though they were being sold at the corner to grandma and grampa. These pension funds may manage money for old people, but they weren’t being run by unsophisticates. They’re run by just the opposite — highly paid, sophisticated managers that knew exactly what they were buying.
He goes onto note that, like with the IPO boom, Goldman Sachs has faced lawsuits related to its dealings in this area, as if that’s damning (he talks about this elsewhere in the story, too). But the mere fact that someone is sued by angry investors, or the fact that a bank pays a fine to a regulator doesn’t mean anything, given the perfunctory lawsuits anytime someone loses gobs of money.
In addition to his failure to pin the housing bubble on Goldman Sahcs — which in our book dooms the whole thing — there’s one other odd thing about the article: the dog that doesn’t bark, the lack of evidence that the company’s vaunted entanglement in the public sector has proven to be so beneficial. Taibbi brings this up in the beginning, ticking off names of famous Goldman alums, but other than talking about their role in fighting derivatives regulation, they don’t seem to do a whole lot for the company. You’d think he’d explore that more.
That being said, there are two good points that come out of this. First is his prediction that cap-and-trade will prove to be the next bubble or at least market for financial chicanery. Of this we have little doubt, and it’s why Goldman and GE are so eager to create this new market where none currently exists.
He also pokes at a very interesting question on whether Goldman Sachs’ culture of risk changed at some point.
It also, oddly enough, had a reputation for relatively solid ethics and a patient approach to investment that shunned the fast buck; its executives were trained to adopt the firm’s mantra, “long-term greedy.” One former Goldman banker who left the firm in the early Nineties recalls seeing his superiors give up a very profitable deal on the grounds that it was a long-term loser. “We gave back money to ‘grownup’ corporate clients who had made bad deals with us,” he says. “Everything we did was legal and fair – but ‘long-term greedy’ said we didn’t want to make such a profit at the clients’ collective expense that we spoiled the marketplace.”
But then, something happened. It’s hard to say what it was exactly; it might have been the fact that Goldman’s co-chairman in the early Nineties, Robert Rubin, followed Bill Clinton to the White House, where he directed the National Economic Council and eventually became Treasury secretary.
Talk about having the story right in your face and then missing it. What changed in the 90s? Goldman transitioned from being partner-based to being public, a structure that many have cited as being crucial to being more tolerant of sloppy risk.
Of course, saying Goldman’s change was due to its involvement in the Clinton administration is way more sexy. And besides we don’t think the “Backstage with the Jonas Brothers!”-crowd really cares to read an article about the nuances of unpartnering.
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