Friday, July 2, 2010

In Defense of Goldman-Sachs

Wall Street is the enemy. And if banks are bad, then surely Goldman-Sachs must be the Big Bad Wolf, right?

In recent weeks Goldman-Sachs executives have been paraded in front of hearing committees and held up as an enemy to the people. I can’t help myself. I have an opinion about this.

What is Goldman guilty of really?

The court will decide whether they actually “misstated and omitted key facts about a financial product tied to subprime mortgages”, as the SEC complaint alleges. Specifically, the SEC is saying that Goldman created a CDO (Collateralized Debt Obligation) for the hedge fund Paulson & Co. based on mortgage-back securities (specifically the ones that seemed most likely to fail), and that Goldman didn’t tell potential buyers that Paulson was shorting (or betting against) them. Does that make them responsible for the entire financial crisis?

What Goldman is most guilty of is making money when seemingly everyone else was losing money.

Let’s get real. Goldman-Sachs is an investment banking firm. They invest in securities going up, and they invest in securities going down. They are supposed to create investment vehicles. They regularly take out insurance policies on their investments. They are supposed to balance their risk – that’s their job. Their ultimate responsibility is to their shareholders.

They are supposed to make money.

If we are so desperate to find a scapegoat for the financial crisis, perhaps we should start with this list:

  • The consumers who purchased houses they couldn’t afford
  • The banks that agreed to give mortgages to these customers
  • The investment rating companies who over-rated the mortgage-backed securities and the CDOs
  • The buyers of the securities who failed to fully understand what they were buying
  • The lawmakers who failed to regulate financial products

It’s just starting to feel a little bit too much like a witch hunt. What do you think?

13 comments:

KarenG said...

How about the government who kept telling mortgage companies they needed to make loans to those who couldn't afford them "to allow every family to be part of the American dream," and then kept giving incentives to make it doable for the lenders. I am so sick & tired of this witch hunt. Everyone is looking for a scapegoat for this problem. It's a combination of greed, politics & stupidity from many sources. Your list is as good a one I've seen.

Colette said...

Karen, good point -- we should add the government incentives for unaffordable mortgages to the list.

js said...

Don't forget the biggest culprit of all; The Federal Reserve. Their is no greater incentive to purchase a home than cheap rates. Unfortunately, creating money out of thin air is the fuel of economic bubbles.

Indeed, Fed pump priming post 9/11 purposefully inflated the real estate bubble. Greenspan wanted people to "feel" richer by seeing their property values inflate. This was the Fed's only plan to spur economic growth following the '01 recession. (They are trying the same thing now of course...)

The only offensive aspect of Goldman-Sachs is its proximity and revolving door relationship to the Fed and Treasury. The current scapegoating parade in front of the media and congress is nothing but a wrist slap. GS received advanced warnings of the AIG decisions and continued preferential treatment from Paulsen, Geithner, and Bernanke.

For more...
http://mises.org/daily/2936

Anonymous said...

The financial services sector has grown sharply over the last 2 decades, from about 10% of GDP to just over 20%. From a macro perspective, one has to ask: Has society gained much at all from this growth? How do we justify this allocation (or siphoning off)of resources from the real economy to the financial services industry and banks? Is 'Wall Street' providing today more capital and doing so more efficiently and with greater safety to companies that provide real products and services than it did previously? The 'products' offered by the industry seem to serve the industry by generating fees without adding any true value. CMO's and derivatives were supposed to reduce risk and preserve capital, while making capital more available for productive uses. Clearly the products were defective.

In most other industries, such as pharmaceuticals, life insurance or autos, if products failed to perform as advertized for their customers as fundamentally and strategically as did the CMO's, both regulation and the courts & lawyers would provide both a means of redress and also restraint. This has not occured in financial services, and our worthies in government are sufficiently venal so that redress and restriant will not occur by existing and accepted means.

With regard to Goldman, one must remember that they almost went bankrupt during the crisis, and were saved by government (tax payer) resources and intervention. Due to the particularly benighted leadership in DC, they and their peers were allowed to use 40% of profits for incentive compensation instead of recapitalization. Oh, and the providing capital to companies is now such a quaint idea.

KarenG is on target by noting the widespread participation of our society in the building of the crisis. However, portraying Goldman as either victim or as more skilled than its peers doesn't wash (nor does it wash for JPMorgan Chase & the "almost free" acquisition of Bear Sterns). The entire situation is analagous to 'Bleak House'.

Anonymous said...

Fannie Mae and Freddie Mac were major culprits in the housing meltdown but have enjoyed immunity and exclusion from regulation be Democrats Chris Dodd and Barney Frank.

Why do you you think that has happened?

Colette said...

JS -- yes, let's add the FED to the list.

Anonymous -- you mentionned a key word -- "incentives" -- yup, this could be a great example of incenting the wrong behavior.

And Anonymous -- favoritism?

SteveB said...

A very strong second for Annonymous #2 comment ref Fannie and Freddie. And we still have no fix in for that! I smell a rat in D.D.

SteveB said...

I meant, of course, D.C.

Ted Pomeroy said...

Kudos to js! Yes, the Fed could have done its job and be the BC RA and take the keg tap to interrupt the party with a 50 bps rate hike. Geithner was right there at the New York Fed and did not forestall the madness by either yelling at the Wall Street CEO's or telling Greenspan to raise rates. GS? check out Paulson's book. GS kept $5 billion in unpledged treasuries in the vault so they could always get an overnite REPO in a crisis. That is how they raised their leverage so high in 2006 and Lehman, Bear and ML were dumb enough to try to match them. Mr. Paulson, where were those "special treasuries" in the notes to the financial statements? You were a public company and did you disclose this to Geithner while the rest of the Street tried to match you?

Dave E said...

The American 'dream' is Life, Liberty and the persuit of a morgage payment (or something like that). This what we mostly all strive for. It's pushed on us from every angle. We are led to believe it.
When someone comes along and says you can live the American dream, you can bet you are going to take it with both hands. Everyone says you 'can' afford this, it looks good and with house prices going up it's a no brainer, buy now, sell later, make a profit, buy another etc.
Everyone bought into this. People saw others living the American dream and wanted their part of it. I don't think that's too wrong.
The banks bought into it, the appraisers bought into it, the real estate agents loved it.

The difference is that 'ordinary' people are NOT financial professionals. Although we ordinary people should bear some responsibility for ourt actions, we also rely upon 'profesionals' to help us make intelligent desisions. It's not that we ordinary folks are too dumb to know a bear from a brick, but we all reply upon professionals at various points in our lives. The problem is that these professionals have also been sucked in to the 'dream' and they also make more money by encouraging us to buy the very stuff they are selling.
Basically we are trusting the sales people because we believe they are professionals and whilst I am not saying that is not the case, there is a conflict of interest there.

So basically, there is this low level of ordinary folk on both sides of the fence, buyers, realtors, bank mortgage loan officers, that believe in this dream because it is personal. It affects everyone at a personal level.

At a much higher level there are investmenet companies that deal in securities and god knows what. This stuff is NOT personal. When you are dealing with billions of dollars there's no way this is personal. This is business. These people should behave professionally and impartially to protect their investors, their customers and the companies share holders.


Of course we know that does not always happen which is why we have a government. As I might have said before, I believe one role of government is to level the playing field and to prevent people (that's us) from being taken advantage of in unscruplious ways. The problem is that the very people that the government 'should' be regulating are in bed, via lobbiests, with those in power. Why else would companies spend millions if not billions to influence the opinions of those in power. It's not because they want to do the best for us, the people, it because thay want as little interfearence as possible or they want the rules to favor them over someone else. How do you do that? You influence the people in power and you do that by financing their election campaigns.


So who or what was to blame?

I think in part the blame lies with a broken politcal system that values the dollar over the wishes and rights of the people. A political system that is generally driven by whoever has the largest funding instead of for the benefit of us all. The last time I looked the U in USA stood for 'United'. That means that we are all in this together. Business, government and we the people!
Was there some greed involved? Sure there was but I think that for the most part it was just ordinary people trying to get a leg up on the ladder and live that dream. I don't think there was anything wrong with that and I still don't. I still have hopes for the future (in spite of being badly burnt by property 'investments' that are sinking without trace) but overall I think that government will once again fail to really do what is needed and separate itself from the interests of business. The only difference now is that the majority of people are a lot more wary of the hype we are sold and I think it will be a long time before we the people actually really trust anybody again.

Dave E said...

The American 'dream' is Life, Liberty and the pursuit of a mortgage payment (or something like that). This what we mostly all strive for. It's pushed on us from every angle. We are led to believe it.
When someone comes along and says you can live the American dream, you can bet you are going to take it with both hands. Everyone says you 'can' afford this, it looks good and with house prices going up it's a no brainer, buy now, sell later, make a profit, buy another etc.
Everyone bought into this. People saw others living the American dream and wanted their part of it. I don't think that's too wrong.
The banks bought into it, the appraisers bought into it, the real estate agents loved it.

The difference is that 'ordinary' people are NOT financial professionals. Although we ordinary people should bear some responsibility for our actions, we also rely upon 'professionals' to help us make intelligent decisions. It's not that we ordinary folks are too dumb to know a bear from a brick, but we all reply upon professionals at various points in our lives. The problem is that these professionals have also been sucked in to the 'dream' and they also make more money by encouraging us to buy the very stuff they are selling.
Basically we are trusting the sales people because we believe they are professionals and whilst I am not saying that is not the case, there is a conflict of interest there.

So basically, there is this low level of ordinary folk on both sides of the fence, buyers, realtors, bank mortgage loan officers, that believe in this dream because it is personal. It affects everyone at a personal level.

At a much higher level there are investment companies that deal in securities and god knows what. This stuff is NOT personal. When you are dealing with billions of dollars there's no way this is personal. This is business. These people should behave professionally and impartially to protect their investors, their customers and the companies share holders.


Of course we know that does not always happen which is why we have a government. As I might have said before, I believe one role of government is to level the playing field and to prevent people (that's us) from being taken advantage of in unscrupulous ways. The problem is that the very people that the government 'should' be regulating are in bed, via lobbyists, with those in power. Why else would companies spend millions if not billions to influence the opinions of those in power. It's not because they want to do the best for us, the people, it because they want as little interference as possible or they want the rules to favor them over someone else. How do you do that? You influence the people in power and you do that by financing their election campaigns.


So who or what was to blame?

I think in part the blame lies with a broken political system that values the dollar over the wishes and rights of the people. A political system that is generally driven by whoever has the largest funding instead of for the benefit of us all. The last time I looked the U in USA stood for 'United'. That means that we are all in this together. Business, government and we the people!
Was there some greed involved? Sure there was but I think that for the most part it was just ordinary people trying to get a leg up on the ladder and live that dream. I don't think there was anything wrong with that and I still don't. I still have hopes for the future (in spite of being badly burnt by property 'investments' that are sinking without trace) but overall I think that government will once again fail to really do what is needed and separate itself from the interests of business. The only difference now is that the majority of people are a lot more wary of the hype we are sold and I think it will be a long time before we the people actually really trust anybody again.

Dave E said...

Sorry for the double post, it kept saying it could not process my comment (too big) but obviously it did!
Ruddy technology!

Colette said...

Dave E - no problem - every now and then blogger decides to act up. I didn't even realize there was a limit on the size of a comment.