Lloyd and Me: Goldman Hysteria, Revisited

In my last post, I suggested that the ranting in Congress over Goldman’s practices was a tad overdone, thus gleaning some interesting personal insults from Goldman-hating Seeking Alpha readers.

Guys, ya got me; Lloyd Blankfein bribed me to write that post.

Just kidding. Which is really too bad, because I imagine that a Goldman bribe would be the kind of dough that could put all of Octomom’s kids through college and grad school, with enough cash left over to bail out Greece.

Anyone who's spent any time on The Big Do-Over (or my old blog, Proxyland) knows that I’m not in the habit of writing stuff that would inspire Goldman Sachs to send me even one ugly firm-logo tote bag. But I always strive to be fair. And I just think that the portrayal of Goldman’s behavior by Senator Levin, and by much of the media, is becoming an unhelpful mash-up of:

- the SEC’s allegations in the Abacus case, which are plenty ugly, but are about a fraudulent failure to disclose, not about the firm's trading practices;

- some people's belated discovery that there’s no law on the books giving investment banks a fiduciary obligation to clients;

- genuine misunderstandings about industry lingo and the difference between institutional and retail markets;

- some vague notion that shorting in itself is evil; and

- the never-ceases-to-amaze-us reality that so many people got insanely rich doing stupid, venal, sleazy deals that we taxpayers then had to bail them out of. And that much of it was legal. And that they rarely show any remorse or gratitude. And that they’re still getting those huge goddamn effing bonuses.

Shucks, there goes my bribe.

Plus I don't get why all the fingers in Washington are pointing at Goldman. Let's reserve a few digits - maybe even the big one in the middle - for other firms that seem to have done similar stuff.

But I’ll say one thing for Mr. Levin’s hearing. By forcing an investment bank to explain on TV how the Street's principal trading business works, he’s given us a nice clear sight line into its short-termist, greed-driven business model. As Tom Brakke of The Research Puzzle said recently, "the firms act as if there is an inexhaustible supply of gullible clients."

Well, maybe there is, and maybe those clients will keep signing up for deals and paying the fees that feed The Great Big Wall Street Compensation Machine. But maybe not. Cynicism and distrust are spurting into the markets these days like ash from an unpronounceable volcano, and they might turn out to be our best friends.

Goldman Hysteria: Put Away Childish Things

Kenneth Griffin, head of the Citadel hedge fund, says it's "childish" to use the uproar over Goldman’s Abacus deal as a basis for regulatory reform.

I feel ya, Ken. There are good reasons to be angry at Goldman, but this is turning into an extended Congressional tantrum aimed at just one of the many players we should be mad at. And when I look at some of the silly things Congress is doing, I want to pat it on the head, hand it a Dum Dum Pop and say: “Run along now and let the grownups talk.”

Silly Thing #1: Punching out Goldman for trading "against clients."

Sorry to burst your giant Ground Ball Grape flavored Big League Chew bubble, Congress, but this is what happens in the big leagues. Some clients go long and some go short, so as long we live in this universe – you know, the one where the Volcker rule doesn’t exist and proprietary trading at banks does – dealers will often take positions opposite to a client's.

Sure, I still want to send Goldman to detention and confiscate its Gameboy Advance. But the (alleged) misconduct in the Abacus trade wasn't about the firm's trading positions; it was about playing games and keeping secrets. In this great post on Interfluidity, Steve Waldman explains why Goldman should have told Abacus investors that John Paulson, a "speculative short," had helped choose the assets to which the CDO was linked:

That information would not only have been material, it would have been fatal to the deal, because the CDO’s investors did not view themselves as speculators.

(Bethany McLean also hit on the disclosure point in her New York Times op-ed today, as we did here at TBDO last week.)

But folks in Congress keep trying to spin the Abacus case into a broad condemnation of proprietary trading/market-making practices that, even if they make some people hopping mad, are widespread and legal.

Silly Thing #2: Punching out Goldman for shorting the mortgage market and thus losing fewer billions than folks who went long.

Oh, come on, Congress. If you were a Goldman shareholder, you’d be applauding the firm's genius. (Especially compared to, say, Citi.) As Lloyd the B said in his recent letter to shareholders, doubts about "the future direction of prices" inspired the firm to cut its mortgage-related investments back in 2007. Having attended a high school where it was totally uncool to be smart, I don't think Goldman deserves a wedgie just for being less stupid about the housing market than its competitors or its institutional clients.

As Felix Salmon wrote today (after watching Senator Levin punch Goldman on TV for selling mortgage products while shorting them):

If Goldman wants to go short mortgages and its clients want to go long mortgages, then it makes perfect sense for Goldman to sell mortgages to its clients.

Silly Thing #3: Endlessly yakking, yakking, yakking about Goldman, Goldman, Goldman...

As if no other financial institution around here ever did a shady structured deal or shorted something while selling it to investors. Yes, maybe in the same universe where Joan Rivers is the only celebrity who’s ever had plastic surgery.

image credit: mobilegrocerydelivery.com

Citi, the FCIC, and The End of History

Yesterday I saw a preteen kid wearing a T-shirt that said: “I’m surrounded by idiots.” Bill Thomas, Vice Chair of the Financial Crisis Inquiry Commission, should totally have worn that shirt to the Commission’s last hearing.

As former high-paid Citi execs explained how the housing market's shocking, unforeseeable fall made them lose billions on what they'd thought were super-safe "super senior" CDO tranches, Mr. Thomas could barely contain himself. (Here’s the video from the hearing; Thomas gets rolling around 24 minutes in.) I’m not sure if the tone he took while questioning Citi’s former Chief Risk Officer, David Bushnell, is best described as Contempt Spiked With Incredulity or Incredulity Spiked With Contempt:

None of you ever heard the phrase ‘what comes up must come down’? You thought somehow housing was unique? Or are you familiar with other areas that never go down? Or why in the world would you pay anybody for risk management in the area of dealing with these securities if housing NEVER GOES DOWN?

To be fair, Citi’s risk models didn’t actually assume that housing prices would never go down, just that they wouldn’t go down quite so much. As Bushnell said in his written testimony:

Risk models, which primarily use history as their guide, assumed that any annual decline in real estate values would not exceed the worst case historical precedent. And since the beginning of World War II, nominal home prices in the United States had never decreased by more than five percent in any given year.

If I could pose my own questions to Mr. Bushnell and his fellow Wall Street risk managers, my tone would be one of bewilderment:

Question 1: Um, Mr. Risk Manager, does “history” only go back to the beginning of World War II? If so, kids sure are doing a lot of unnecessary homework.

Question 2: Did you happen to notice that your model historical period excluded the Great Depression?

Question 3: Forgetting all that, is it possible that the history of the housing market before the invention of mortgage-backed securities and CDOs wasn't even relevant? I mean, would you forecast the risk of airplane crashes based on how often they occurred in the 17th century?

Question 4: Did you ever hear that joke about what happens when you assume?

Later in the hearing, Mr. Bushnell confessed that he hadn't understood the need to stress-test for “things that have never happened before.” OK, sure, the people building financial risk models were math majors, not history majors. Still, I find it singularly odd that folks on Wall Street, the place that experienced 9/11 firsthand, would so readily believe that something catastrophic wouldn’t happen merely because it hadn’t happened before. I was in downtown Manhattan that day, and it sure changed my personal risk models.

Goldman and Paulson: Booty Call

The name Goldman gave to its now-famous synthetic CDO deal - Abacus 2007-AC1 - sounds like a cute, cuddly robot from a Pixar movie. Turns out, though, it was more like The Terminator.

The way Goldman put the deal together was overly cute, too. Whether or not the SEC complaint sticks, what the firm did here feels ethically wrong, with a capital WR.

Goldman’s April 18 press release previews its upcoming defenses. First and foremost, they remind us, this CDO wasn't sold to mindless innocents. They say that IKB, the German bank that lost big bucks on the deal, was "then believed to be one of the most highly-sophisticated CDO investors in the world." (Fun fact: Goldman has added the "then believed to be" language since its April 16 press release.)

Sure, you can argue, as a lawyer friend did in an e-mail today, that big institutional investors have "the right to be stupid." These guys employ their own number geeks and they ought to do their homework carefully and thoroughly, which happens to be the same thing I lamely suggested to my son last night. (I wonder if IKB vetted the Abacus deal while watching the NBA playoffs, IM'ing 57 friends at once and plowing through a giant bag of Pirate's Booty.)

But the sophisticated investor defense seems disingenuous in this case. The SEC complaint says that Goldman involved an outside analyst, ACA Management, precisely because it knew IKB wouldn't be comfortable without some nerdy folks around "to analyze and select the reference portfolio." Goldman's marketing document boasted that “no rated notes in any of ACA’s CDOs have ever been downgraded," and also that ACA and the investors had an "alignment of economic interest." (Which was true, since they were all taking the dark side of John Paulson's bet.) Strangely, nowhere in the 28 pages touting ACA's wonderfulness did Goldman say, “oh, and BTW, this CDO is packed with crud that Paulson pushed to include because he thinks it's ripe for shorting."

The invisibility cloak that Goldman stole from Harry Potter and threw over Mr. Paulson, and the heap of pirate’s booty Paulson walked away with, are almost beside the point. The real problem is that Goldman pretended it was designing a deal for folks who wished to go long the underlying collateral, when in truth it was doing the opposite.

I'm giving Bond Girl the last word on the SEC's complaint:

"Why the hell would anyone want to be a client of Goldman Sachs after reading this?"