Two planets collide for three hearings on Goldman
It was as if people from different planets had finally come together in the Dirksen Senate Office Building for Tuesday's big hearing on Goldman Sachs and its role in fomenting the financial crisis.
From Planet Washington were the members of the Senate's Permanent Subcommittee on Investigations, aging and slightly rumpled politicians of varying sophistication who had spent several months tutoring themselves about the fine points of synthetic CDOs and who only wanted the aliens before them to acknowledge how much havoc they had wreaked on the markets and the economy.
Their questions sounded more like speeches, their speeches more like questions, as they waved around copies of some of the tens of thousands of revealing documents and e-mails subpoenaed by the committee staff.
Sitting opposite were four brilliant young men from Planet Wall Street, each impeccably tailored in dark suits, white shirts and subtly colored ties, and each sporting that one-day growth of facial hair that holds some mysterious attraction to females in Lower Manhattan. Tutored by Goldman's army of lawyers, the four responded to each question with a question -- "What paragraph are you referring to?" "Do you mean the firm as a whole or just our group?" -- or with a parry suggesting that the question was based on false premises or a misunderstanding of how things worked.
The Fab Four made clear that there was no such thing as a bad deal or a crappy security, only mispriced risks. Nor were there winners and losers, only willing buyers and sellers. Concepts such as fairness, loyalty, shame and greed simply had no meaning on Planet Wall Street.
Finally, after five frustrating hours of talking past each other, everyone simply gave up. A new, slightly older and more accommodating panel of Goldman aliens was ushered in, followed finally by the firm's chief executive. The results were largely the same: The issues were never really joined, the conflicting viewpoints never resolved, the full story never told.
Much of the hearing focused on how Goldman went from having billions of dollars of exposure to the subprime mortgage market in the first half of 2006 to posting big profits from the implosion in that same market by the second half of 2007.
The more benign way to look at this dramatic rebound is that it speaks to Goldman's knack for anticipating the market and its willingness to break from the Wall Street herd. Many of us may be jealous of Goldman's success or suspicious of exactly how it came, but surely we are all better off than if Goldman had remained long on mortgages, tumbled into insolvency and required a big taxpayer bailout.
On the other hand, Tuesday's hearing highlighted two big fallacies in much of the current thinking about financial markets.
The first misconception is that having the ability to hedge positions on everything from copper prices to asset-backed securities is unquestionably good for the markets and the economy. Certainly it's useful if farmers can lock the price of their harvest before they plant their seeds, or if pension funds protect themselves from sudden increases or decreases in interest rates.
But as we learned from Tuesday's hearing, the ease with which a firm like Goldman can hedge against losses from esoteric financial instruments can make an investment bank rather sloppy about the securities it underwrites and distributes, or for which it serves as market maker. Indeed, that seems to be exactly what happened at Goldman, according to the documentary evidence uncovered by Sen. Carl Levin and his subcommittee staff.
Although Goldman analysts and traders had private doubts about the quality of the subprime mortgages coming out of lenders such as Washington Mutual and New Century Financial, the bank was more than willing to underwrite and make markets in securities based on those mortgages. Without the ability to hedge so easily and cheaply, Goldman and other investment banks might have been more careful about the securities they created and traded, and buyers would have been more careful about the ones they bought.
The other big fallacy is that investment banks that underwrite securities are actually standing behind them. What we learned on Tuesday is that when Goldman Sachs lends its good name to a new offering and sends its vaunted sales force out to peddle it to some teachers' retirement fund in Omaha or a savings bank in Bavaria, it doesn't actually mean that Goldman thinks people should buy it.
In fact, there's a good possibility that Goldman knows it's a dog, or suspects that the market is about to tank, and has already lined up a big customer who wants to short the entire issue. And as Goldman sees it, the firm has no legal or ethical obligation to inform those buyers of its views or its conflicting interests.
There was a time when issuers would pay a premium to have Goldman Sachs underwrite their securities, just as there was a time when investors would pay a premium to buy into a Goldman-sponsored offering.
Today, Goldman has fully monetized the value of its reputation, and anyone who pays such a premium is a fool.