Goldman In Washington
Nothing else in the economy matters today, all eyes are firmly on the theatrics of the Senate hearings as Senator Levin’s committee grills various Goldman Sachs executives on the way in which that firm profited from the great crash that its own activities precipitated.
Anyone interested in the safety and soundness of our economy should take time to watch at least part of this hearing because it sets the entire crisis in context. The folks at Goldman, and I am sure at the other big banks, feel absolutely vindicated by their actions. They see no wrong. they feel no remorse. They affirm, when asked, that Goldman’s bonus structure is both fair and ethical. They see nothing untoward about trading against the deals they sell to others. And they have nothing to add to the question of regulation.
It is as if we are watching people from another planet.
My conclusion from today’s marathon session is that we will inevitably suffer more financial disasters in the years ahead. This is simply because the folks who inhabit the banking arena are not bankers. They are deal makers. That may sound like a nuanced argument, but I think it speaks volumes about the attitude and ethics on Wall Street.
None – not one – of the bankers on review could clearly articulate that they thought Goldman should have an ethical responsibility to its clients. Instead they all argued that they should ‘help’, ‘assist’, or ‘make markets’ for their clients.
This is not banking.
It is trading.
As one senator pointed out: it seems strange that Goldman makes more from its trading book than from its old fashioned investment banking book. The days of an investment bank being a reliable source of market data, and a facilitator to a client business is long gone. We have arrived at a more carnivorous era, where bankers actively take bets against the very assets they sell. And see nothing wrong in that activity. It is caveat emptor run amok.
There is far too much to discuss from the session, so I want to focus on a few salient points.
First: it is completely clear that Goldman has no problem in using the information it gleans from its client contacts in order to make profit for itself. Even if this means betting actively against those clients.
Time after time today we heard that Goldman is a ‘market maker’. This means that it acts passively when a client comes to it and asks to buy or sell assets. As a market maker Goldman is supposed to undertake the trade requested and quote the prices needed to accomplish that trade. Market makers have enormous access to the most important asset there is: information. Because of their constant conversation with clients they can glean what the amorphous market is thinking about the outlook. This enables a market maker to have more insight than other market players have. For instance, a pension company may be looking to buy assets of a certain maturity and comes to Goldman to execute that trade. Goldman gathers the prices and quotes them to the pension company, which has to decide whether to go ahead with the trade. The pension company’s decision will be based upon its own assessment of risk, and the suitability of the price quoted against that risk. Goldman has access to that information. More importantly, it has access to all the discussions surrounding that decision and to the risk appetite of its client. Goldman can add this to the information it gathers from other clients and so can establish a far more comprehensive view of the market than the pension company could.
This role as market maker is valuable to Goldman’s clients. And they trust Goldman to play that role as an unbiased facilitator. they also expect to be given some of the insight that Goldman possesses.
Obviously Goldman shares information.
But what comes across from today’s hearings is that it does not divulge everything. Rather, it appears to act neutrally as market maker, while simultaneously using the information it gathers to take its own position in the market.
So not only is Goldman a market maker, it is also an active market player.
Inevitably this leads conflicts of interest.
Except that Goldman denies that there is a conflict of interest. Instead it claims that it has every right to use whatever information it has for its own benefit, and that it does not have to reveal everything it knows or thinks about the market to its clients.
So when Goldman is aware that serious players are betting against a particular asset, and that it agrees with those players, it sees no ethical reason to disclose that fact to its clients who may have a different view.
This is indefensible.
A market maker has a privileged position. It has access to more information than other market players, most of whom are less frequent participants or whom are less privileged in the amount of information they can gather. Indeed, many of these less privileged players look to Goldman in order to get access to the necessary information they need.
So active players like hedge funds are less dependent on banks like Goldman, whereas less active players such as a pension fund or a municipality, are far more dependent.
Wall Street bankers seem to have forgotten this difference. Instead they hide behind the claim that pension funds etc are ‘sophisticated’ investors who are capable of making up their own minds about risk. This is true only up to a point. they key is that those sophisticated investors use the bankers input as a resource in their decision making. They are not immersed in the deal flow and therefore are less informed.
They are ripe for the picking.
It is clear that the two activities: market making and proprietary trading, if they are both under one roof, will lead to huge conflicts of interest and will disrupt the flow of information. Goldman’s successful short position against the mortgage market is now a classic example of this conflict.
Goldman did not see its role as advisor to investors who poured billions into securitized assets that Goldman was packaging for sale. It fulfilled the bare minimum responsibility to its clients. It sold assets that it knew were toxic, simply because it could find someone to buy those assets. It felt no obligation to warn anyone of its view or experience with those toxic assets. It left its clients to fend for themselves, while it quietly built trading positions to profit from the failure of the very stuff it was selling.
I don’t think this is illegal.
I do think it is unethical.
It certainly means that no one should trust Goldman’s view on anything. You just never know what they are not telling you.
A second observation I come away with from today’s hearing is simply that the accusation that ordinary people – mortgage borrowers – should be held accountable for the mess is far too simple.
The growth in the sub-prime mortgage market was stimulated in large part by the enormous appetite on Wall Street for assets to package and sell. Were it not for that demand it is highly likely that the bubble would have been far less dangerous and would certainly never have reached the excess it finally did. The bubble was created by Wall Street’s hunger for securitized assets. The flood of capital through Wall Street into these assets diverted billions from other uses – investing in factories for instance. The ruse used to set that diversion in motion was the apparent ability of Wall Street to convert rubbish loans – sub-prime mortgages that everyone knew were rotten – into pristine AAA investments.
There are very many investors whose in-house rules prohibit them from investing in low rated assets. Most pension companies fall into this category. Such investors need to be conservative because they hold a great responsibility to their customers – future retirees for instance. Such investors are always looking for a supply of very safe investments. And dealers like Goldman are always looking for a supply of safe assets to sell.
So the invention of the magic conversion of toxic into AAA opened up vistas of profit for the banks who could sell securitized assets by the boatload to pension companies and their like.
Once this nasty machine was in motion and the profits piled up, demand for the raw material shot up also.
Hence the sudden drop in underwriting standards, the explosion in sub-prime lending, and the run up in home prices.
The Wall Street hunger for profit drove the entire process.
But.
Having set the bubble on its way up, Wall Street, and Goldman in particular, saw no ethical problem with profiting from the bubble’s subsequent collapse.
Not only was the entire edifice based upon Wall Street’s incompetence – it horribly miscalculated its ability to perform magic – but it was amoral. That regular people were sucked into the bonus driven machine seems not to worry the bankers on display today. They were simply doing their jobs. That Wall Street’s greed drove mortgage lenders to induce people into borrowing that would never have occurred otherwise – because underwriting standards would have prohibited it – doesn’t enter their minds.
Instead they take great pride in their cleverness in seeing that there was a bubble – of their creation – and in being able to hedge against the implosion.
Heads they win.Tails you lose.
And we are supposed to acknowledge their genius. These are the same folks the banks ‘need’ to pay bonuses to in order that they can retain the ‘talent’. One of today’s participants made enough money that he was able to set up his own business. He expressed no remorse in his role in the mass destruction of the American households who were the fodder for his bonus claim.
Caveat emptor indeed.
One last observation: the culture gap between Wall Street and the rest of America is so large that I see no way to bridge it. These guys just don’t get it. They had no equity at risk, and yet caused the collapse of the dreams of millions of their fellow Americans. They just don’t comprehend that. To them everyone thinks the way they do. And if they don’t, they should. These are remorseless, hungry, smart and very dangerous people whose ethical framework is suspect to put it mildly. They see the world through the prism of short term profit. Nothing else matters.
When the real world failed to supply enough assets for them to meet their bonus goals they invented ‘synthetic’ assets. This was the final nail in the economy’s coffin. Once Wall Street had invented synthetic assets it could manufacture stuff to sell without regard to the number of mortgages in the country. A synthetic asset is one that has no real asset as its core. Instead it uses securitized and other processed assets as its ‘reference point’ for risk.
This would be like gambling with chips at a casino, but not actually paying for the chips. It would be like getting those chips on the basis of cash someone had used to buy another set of chips. Once the game is set up this way the players no longer are constrained by the amount of cash they have, but by the number of times the original amount of cash is ‘referenced’ when they need more chips. $10 can be used and re-used to justify the purchase of $100, or $1,000 or $1,000,000 worth of chips. All you need to do each time is to create a synthetic asset that refers back to the original cash. Wonderful if you can get away with it.
Wall Street did.
Not so wonderful when the original cash turns out to be rotten through. Then instead of that cash turning into a toxic asset, we are faced with multiples of the original amount. Many multiples.
What Wall Street did was to create and endless supply of chips with which to gamble. Those chips bore no relation to the actual size of the economy, to haw many houses there are, or even to how many loans were made. None of that ‘real world’ stuff mattered. What mattered was having an ever increasing supply of chips to gamble and make bonus quotas.
That the game destroyed the economy is nether here nor there.
As I sat watching the hearings I could but feel an intense fear for the economy. These bankers clearly failed to grasp what they had done. They ‘cared’ only so far as their ability to protect Goldman’s earnings. Their role in the epic recession was lost on them. They all profited from the run up and the run down. They are not unemployed. Nor are they impoverished. They are not even chastened.
It isn’t that they don’t care about America, its simply that they think America should be like them and make smart moves to enrich itself.
Welfare babies one and all. Yet self-regarding geniuses in their own minds.
And.
If the game doesn’t quite work out. There’s always someone there to bail you out and help you back on your well shod feet.
Isn’t that what taxpayers are for: to bail out Wall Street bankers so that they can keep on earning those bonuses?
