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April 29, 2010

Demagogues v. Goldman

Filed under: Finance — Steve Krupa @ 6:36 pm
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In 2008, Bear Stearns (founded 1923) and Lehman Brothers (founded 1850) were destroyed, after being in business for 85 and 158 years respectively, because they were not smart enough to reduce their long exposure to RMBS (Residential Mortgage Backed Securities) when there were clear signs of a potential market downturn.  Evidence, once again, that Wall Street plays a high stakes game where proper risk management is essential.   


Oddly, the Senate and the SEC have decided to make the best managed firm on Wall Street, Goldman Sachs, the focus of a witch hunt apparently designed to place Wall Street’s business activities front and center as the primary cause of the 2008 financial crisis (or what is now being referred to as the Great Recession).  The Demagogues (read: the Senate and SEC) seem determined to accuse Wall Street of fraud and unethical behavior designed to profit from a crashing housing and mortgage market.  It is a bold move, brilliantly timed in the midst of congressional debates around financial market regulatory reform.


Back on April 1, I got a little cheeky blogging about Matt Taibbi, the crazy-wonderful Rolling Stone journalist who is as passionate about vilifying Wall Street (and Goldman Sachs in particular) as Wall Street is about making money.  Matt’s claims of conspiracy are interesting (and funny).  On the serious side, I admitted concern over Wall Street’s political power, agreeing that Wall Street needed to take aggressive steps to reform itself, and expressing concern over whether unethical or criminal behavior might be discovered.


W/r/t unethical or criminal behavior, or lack there of, there is more accusing and not a lot of proving going on, especially if the SEC’s recent case against Goldman Sachs is representative of the best evidence gathered.  There is little doubt that Goldman Sachs pursued every possible angle to profit on a housing market run wild without demonstrating public concern regarding the systemic risk being created and its potential burden on society.  But is there any real evidence that they did anything unethical or illegal in the process?


The SEC thinks Goldman committed fraud in the issuance of a synthetic CDO (Collateralized Debt Obligation), called ABACUS AC-1, to ACA Capital and others in early 2007 because they did not disclose to investors the role of Paulson & Co. in the transaction (Paulson bought the short side of the deal and proposed several of the Reference Securities included in the CDO).    


Many in the Senate seem to think Goldman’s trading activities during the advent of the sub-prime mortgage crisis intentionally disadvantaged its clients, raising the specter of ethical violations, at a minimum.


I am not sure the SEC or the Senate can prove anything other than the inherent dog-eat-dog nature of financial trading, a little understood activity that for better or for worse is the bedrock of liquid markets and financial capitalism.


In the sales and trading business Goldman is not giving financial advice to its Clients, it is making a market in securities their Clients want to buy and/or sell.  That means they stand at the ready to provide a price at which they will execute a trade.  Goldman will attract Clients to their sales and trading business if they can be relied on to provide consistent pricing and liquidity.  The Clients, largely very aggressive and sophisticated financial institutions, recognize that Goldman may either be transacting for their own account or acting on behalf of a Client on the other side of the trade, and so it is accepted and known that Goldman is not financially aligned with their sales and trading Clients.  Further, Goldman’s Clients are trying to extract the best deal for themselves from Goldman in the trade.  These are big boys playing a high stakes game of I win and you lose.


So when a Client, like Paulson, comes to Goldman with interest in shorting (profiting from falling prices) RMBS, Goldman’s job is to find another Client interested in going long (profiting from rising prices) RMBS, put a deal together acceptable to both, and execute on the transaction by acting as its underwriter.  It seems to me that this is exactly what Goldman did w/r/t ABACUS AC-1.


Further, daily market making activities are inherently done with either a long or short bias depending on the condition of the trading book and the subjective preferences of the market maker.  Goldman clearly adopted a short trading bias near the advent of the sub-prime collapse, a business decision that seems to have contributed to saving the firm and its shareholder value (applause for the Goldman executives please), and an approach most other financial institutions (like the now dead Lehman) would have been wise to adopt at that time.  To argue that Goldman’s short bias acted against the interest of their Clients is as absurd as it is to suggest that Goldman should have purposely lost money on their trades.  Goldman’s Clients were clearly willing buyers and sellers and thought that they were getting the better of each of their trades with Goldman.  As with any trade, only one side will be right.


So I continue to wait for credible evidence that proves fraud, and given the weaknesses of both the SEC and Senate positions, I am doubtful it exists.  It seems I am left only with the opportunity to wince at the naked demagoguery.

April 1, 2010

On Wall Street: Is Matt Taibbi Wrong?

 Talkin’ Wall Street…


 A couple of opening points:

 (a)       I am a Wall Street alum (1994-98), I loved it there and it was my stepping stone to venture capital, my dream profession.

(b)       I believe that historically Wall Street’s financing of corporate growth and innovation has been a huge competitive advantage to the US.

(c)       On the one hand I think that Henry Paulson (as former US Treasury Secretary) is a patriot and helped save our country from economic collapse; on the other hand I think that he (Paulson) aided in creating the conditions for the crisis while he served as CEO of Goldman Sachs.

(d)       Wall Street is all about money, and that will never change.  It attracts extremely smart people who spend all of their time thinking of ways to make money.  Unfortunately many times Wall Street creativity spawns behavior that crosses ethical lines and on occasion becomes illegal.

(e)       Today, Wall Street has gotten completely carried away and needs to reform itself fast.  It is becoming an uncontrolled burden on the stability of its own milieu, the global financial system.


 This post catches me in the middle of reading two books on the financial crisis of 2008: On the Brink, by the aforementioned Henry Paulson, and Too Big to Fail (or maybe too big to carry or read, for that matter, we’ll see) by Andrew Ross Sorkin, a business reporter for the New York Times.  Both chronicle the action of what happened in the days before, during and after the financial crisis, but neither delves into the real causes for the crisis, or the questionable actions of its key participants. 

 This cannot be said for one Matt Taibbi.

Matt is the irreverent, liberally-biased, smart-ass, misanthropic, and, for many, insufferable contributing political editor (sports too) of Rolling Stone magazine.

 And I have grown to love him.

 Not for his technical grasp of Wall Street and all of its acronyms and crazy financial structures (he lacks this), but for his unmitigated, bone-quaking outrage.  As extreme as Wall Street is with its obsession with money for money’s sake, Matt is obsessed with Wall Street and its leader Goldman Sachs, marking it (them) the villain(s) in a calculated plot to control the world.

 The (once?) venerable Goldman Sachs provides Matt Taibbi with not only a villain, but also a synecdoche for Wall Street, which has now, unfortunately, become itself a populist synecdoche for anti-ethical greed, instead of the engine of capitalism and national wealth creation we all hope it would be.

 So let’s have some fun for a moment.

 Here is how Matt describes his villain:

 “The first thing you need to know about Goldman Sachs is that it’s everywhere. The world’s most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money…  What you need to know is the big picture: If America is circling the drain, Goldman Sachs has found a way to be that drain, an extremely unfortunate loophole in the system of Western democratic capitalism, which never foresaw that in a society governed passively by free markets and free elections, organized greed always defeats disorganized democracy.”

 – From Rolling Stone – Matt Taibbi – Inside the Great Bubble Machine

And its plot to rule the world:

“The mistake most people make in looking at the financial crisis is thinking of it in terms of money, a habit that might lead you to look at the unfolding mess as a huge bonus-killing downer for the Wall Street class. But if you look at it in purely Machiavellian terms, what you see is a colossal power grab that threatens to turn the federal government into a kind of giant Enron — a huge, impenetrable black box filled with self-dealing insiders whose scheme is the securing of individual profits at the expense of an ocean of unwitting involuntary shareholders, previously known as taxpayers.”

From Rolling Stone – Matt Taibbi – The Big Takeover

 And post-bailout:

 “The question everyone should be asking, as one bail-out recipient after another posts massive profits  – Goldman Sachs reported $13.4 billion in profits last year [2009], after paying out $16.2 billion in bonuses and compensation – is this:  In an economy as horrible as ours… where the hell did Wall Street’s eye-popping profits come?… A year and a half after they were minutes away from bankruptcy, how are [they] not only back on their feet again, but hauling in bonuses at the same rate they were during the bubble?”

 – From Rolling Stone – March 4, 2010 – Matt Taibbi – Wall Street’s Bailout Hustle

Matt’s writing is fun(ny), but his accusations, one being that Wall Street has obtained massive global power, seem pretty close to the truth, even if the details of his analysis bump against errors of nomenclature and the disadvantages of financial inexperience (Many a business reporter revile Matt and his errors.  For example see Megan McArdle  from Atlantic’s diatribe and its many links for a technical debunking of Matt’s work.  For what it is worth I don’t think Matt makes that many technical mistakes, and unlike most conspiracy theories his are worth considering and his writing is well worth reading as long as you can tolerate some cussing here and there.) 

Wall Street used to be about corporate finance, raising capital for corporations by selling debt (corporate bonds) and equity (e.g. IPOs) to public investors and providing liquidity by creating markets for the day-to-day exchange of these securities.  The firms made their profits by charging fees for underwriting new securities and trading in existing ones.

While corporate finance is still a part of Wall Street’s business, it has become small potatoes to its derivatives and proprietary trading businesses, businesses where rather than serve their trading customers, they compete with them.  In this business, not surprisingly, like Vegas, the “house” is set-up to win, and it does, unless your firm gets high-on-its-own-supply of risky underwritings, as was the case with Bear Stearns, Lehman, et al, in which case you go down in flames, unless of course you get bailed out…   

Essentially Matt Taibbi claims:  (1) that these firms have figured out more ways to bilk their clients than their clients could even imagine (again smart people obsessed with making money); (2) that many times these techniques cross ethical lines and might even be illegal; (3) that they are more than willing to bilk each other as well; and (4) that there are so many ex-Wall Streeters with regulatory and legal power that there is no chance for systemic punishment of, and thus no deterrent to, continuous bad behavior.

On this last point, it’s important to remember that it was a huge team of ex-Wall Streeters-in-government that engineered the bail-out and that the bail-out went well beyond the TARP money that was invested in firms like Goldman Sachs.  These ex-Wall Streeters-in-government also engineered: (a)  the bail-out of AIG, which was effectively the bail-out of all of the companies AIG owed money to (yes, Goldman was one) and (b) the conversion of Goldman Sachs and Morgan Stanley into bank holding companies that overnight allowed them to borrow massive amounts of money from the Federal Reserve (read: the US government) without the need for congressional approval, a move that effectively solved any threat to their liquidity.

All for the good of the nation and the world (of which I agree and approve, yes, we needed to save the finanical system).  And all for the continuation of massive profits and pay packages of the banks and their senior management, repsectively (no we did not need to save Wall Street’s plush lifestyle).

It confuses me to this day as to why the government does not own 85% of the equity in most of Wall Street.  Shouldn’t that have been the “market terms” for all of the bail-out investments, a la AIG?  (I will someday calculate how much profit the US government would have made if it would have taken meaningful equity stakes in these firms and sold it at today’s prices.)

You tell me – do you think Matt might have a point or two?  Is this not some kind of conspiracy?

Like most finance guys, I get most of my financial news from the Wall Street Journal, New York Times and CNBC, and I don’t hear any of them pursuing these questions in any meaningful way, and I wonder why?


Today I had coffee with an old hedge fund friend of mine and we came to the same conclusion.  Not different from the horror described by Arthur Jensen (played by Ned Beatty) in Paddy Chayefsky’s 1976 film Network, the world capital markets have become larger than and span well beyond the borders of sovereign nations, and the 2008 financial crisis proved more than ever that they carry much of the weight of the world.  Who do you think buys, markets and trades the debt and currencies of all sovereign nations?


Listen to Matt here:

Meet Arthur Jensen here:

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