Wednesday, July 15, 2009

A Partial Defense of Goldman

Goldman Sachs has apparently become Public Enemy #1.

Regarding Matt Taibbi's article on Goldman, I don't have much to add to Megan McArdle's pitch-perfect critique, which concludes that "Matt Taibbi is becoming the Sarah Palin of journalism." I read Taibbi's piece, and it was exactly as stupid as I expected. It's not even remotely serious, and can barely even claim to be based in reality. It was difficult to finish reading it, because it was one of those articles that's so bad it actually makes you embarrassed for the author.

I'm honestly surprised by how much "Goldman hatred" has spread to the general public (even before Taibbi's creative writing piece). I think it's completely unfounded. Of course, in the financial industry, "Goldman envy" (which often turns into "Goldman resentment") is a long-standing tradition—a sort of favorite pastime, if you will. But a lot of the conspiracy theories about Goldman that circulate through the Wall Street rumor mill are tongue-in-cheek. The current Goldman hatred is, I think, mostly sincere.

I've worked with Goldman frequently over the course of my career. I'm sure some people will take as proof that I'm some sort of Goldman shill, or that I've been "captured," but they're wrong, and there's probably nothing I can do about those people anyway. So take this for what it is.

I know this isn't a popular thing to say, but the truth of the matter is that Goldman is simply better than everyone else right now—more talented, more diligent, and much more thoughtful in its approach. (Matt Taibbi is so far out of his league it's not even funny.) I'm reminded of Rick Bookstaber's description of Salomon Brothers in A Demon of Our Own Design:

Going to Salomon [from Morgan Stanley] was like moving from a lumbering cargo plane to a fighter jet. Salomon Brothers was not like other firms on Wall Street. ... The atmosphere was reasoned and intellectual. Where discussions at Morgan Stanley seemed to be a concatenation of sound bites, at Salomon things were thought out. While at Morgan Stanley there was a hierarchy that demanded wending down the right path to bring out ideas, at Salomon a vice president who disagreed with the head of a trading desk would just walk up and discuss things. If what he said made sense, that was how it was done. Turf and status were trumped by the primacy of ideas.

Perhaps that sounds Pollyanna-ish, but I saw it happen regularly. (pp. 52-53)
This is a nice description of Goldman in the past decade. (Citigroup quickly gutted Salomon after their 1998 merger, famously disbanding Salomon's powerhouse fixed-income arb unit. Sandy Weill: worst CEO ever.) Goldman has a fundamentally different culture than other major banks—much like the culture Bookstaber described at Salomon—and it's immediately obvious when you work with them. There's a reason why Warren Buffett's Berkshire Hathaway is the largest investor in Goldman, and why Buffett injected $5bn into Goldman at the height of the crisis. They're very good at what they do. They make mistakes, of course, but not many, and they're generally not unforced errors.

I simply don't buy the argument that the bailout, or the financial crisis in general, proves that Goldman is guilty of wrongdoing. What happened last September was a bank run, pure and simple, and we've always known that what makes a bank run so dangerous is that it creates a classic coordination problem, which is indiscriminate in its destruction. If the market believes there will be a panic, then each individual firm has an incentive to liquidate assets and horde cash (because of anticipated margin calls and higher liquidity risk). But the more that firms dump assets into illiquid markets, the further asset prices fall, and the more cash they need to meet margin calls. Asset prices in a bank run are based on investors' idiosyncratic liquidity needs rather than fundamental value, so whether a bank fails or survives depends on the random liquidity needs of other, possibly unrelated investors, rather than the underlying strength of the bank's assets.

The point is that bank runs are irrationally destructive. The fact that Goldman was swept up by last September's financial crisis isn't proof of wrongdoing.

Yes, Goldman was bailed out by the taxpayers, but taxpayers also made money on the deal. Goldman paid back its TARP money. The argument that the $13bn it received from AIG should be regarded as bailout money is naïve. Goldman has repeatedly explained that it had collateralized and hedged its counterparty exposure to AIG—and if you want proof that they had hedged themselves, just look at AIG's own internal memos. Goldman was either going to collect that $13bn from AIG or its hedge counterparties. If AIG had been allowed to fail, Goldman would have collected the money from its hedge counterparties. That's what it means to be "hedged." Also, what if Goldman took $5bn of the $13bn it received from AIG and used it to pay someone like Fidelity? Would the AIG bailout then be a backdoor bailout of Fidelity? The argument has no logical end.

AIG paid out 100 cents on the dollar on its CDO CDS because Goldman wasn't in a position where an AIG failure would have been worse than accepting a haircut. If AIG failed, Goldman would have seized the posted collateral and collected the rest of the money from its hedge counterparties—so if AIG had offered 80 cents, Goldman would essentially have been choosing between 80 cents and 100 cents. Do you see why AIG paid out 100 cents on the dollar? As for the FDIC-backed debt that Goldman issued, they were just taking advantage of a program that was made available to them. That's what profit-maximizing firms do. There are no call provisions in the debt instruments, so there's nothing Goldman can do about it now. If you want to blame someone for not including a call provision, blame Sheila Bair.

Finally, the "Government Sachs" arguments are based on nothing more than rumor and innuendo, and are frankly insulting to the former Goldmanites working in the government. Why is it that anyone who has ever worked for Goldman is assumed to remain loyal to the firm long after they've left, and even after they've held jobs at other firms?

So there, that's my defense of Goldman. Take it for what it's worth.

19 comments:

a stranger said...

Taibbi actually kind of reminds me of Gretchen Morgenson. It's not that their facts are in dispute, it's more like they take the facts, make one or two very reasonable points, and then speedily run the rest of the article off a cliff. Whatever reason you could tease out of their articles is being promptly drowned out of existence.

Tom Lindmark said...

Not a bad defense but I don't think that it will stave off the pitchforks.

Any thoughts on why they didn't soft pedal the compensation issue for a year or two instead of going back to the status quo ante. I appreciate their right to do what they want wit their money but question their judgement on this issue. Maybe one of those rare mistakes you referred to.

Economics of Contempt said...

Tom,

I think they view the danger of losing top talent as outweighing the political risks (which they're definitely aware of). They were going to get blasted on compensation no matter what. If they dropped compensation to the level needed to actually avoid negative PR, it would be an exodus. That wasn't an option. And they're already resigned to the fact that new compensation regulations are coming. Paying enough to retain top talent probably won't make that worse.

Also, Q1 and Q2 were guaranteed to be blow-out quarters for the investment banks, but Q3 and Q4 won't be, so they're setting aside more now to reflect that.

Anonymous said...

You missed the point.

It's not whether the $ 13 billion is called a "bailout", or whether Goldman would have been whole without it.

It's the fact that the taxpayer paid $ 13 billion to Goldman, pure and simple.

shunted said...

There are many former Goldman employees at Treasury. I know nothing about finance and financial policy but the appearance of a blurring between regulator and corporate interests is there. It is natural for people to pick up on this because the topic is complicated and misunderstood. People look for patterns to make sense of what's happened. The obvious pattern, though not necessarily correct, is that Goldman and the government are in cahoots with each other.

There is probably nothing anyone can do or say to assuage these concerns. I'm reminded of your critique of Krugman for not understanding the political realities with regard to a second stimulus.

Wil Martindale said...

One might make the argument that Goldman isn't just smarter, but that they are smarter gamblers.

One might also say ( as in Barofsky's 250 page report) that the underlying securities they were hedging were fraudulently underwritten, fraudulently rated, collateralized and securitized so that fools like Cassano could be parted from their (our) money, and that Goldman knew that, smart gamblers that they are.

So in essence, Goldman, the smarter gambler, conned AIG out of OUR bailout money.

If being a smarter gambler gets you off the hook for being an accessory counterparty to fraud, then your defense is well founded.

PaxAmericana said...

With luck, we will get our own version of Robespierre, and he can weigh your arguments. As enhanced techniques are now approved by the US, we can expect to gather some very valuable intelligence regarding the late, great bubble.

Jim Glass said...

You, Megan and the rest give Tiabbi way, way more credit than he deserves by allocating so much space and effort to critiquing him.

I remember Taibbi when he was writing look-at-me lunacies for the free hand-out "NY Press", from which he got bounced for writing "The 52 Funniest Things About The Upcoming Death of The Pope" (which also got his boss, the hand-out's editor, fired).

That was four years ago. I don't think he's picked up an MBA in finance since the -- he's writing at the same level of education and understanding, and using the same ploys to get attention and a paying audience for himself.

And it works! As per all the write-ups he just earned on his Goldman story.

Of course, how he managed to jump from writing dead Pope jokes for give-away papers to landing a job where he's paid real money to write about the likes of Goldman Sachs ... well .... there are mysteries in life, and one can also wonder about what passes for the profession of journalism a lot of the time in this country.

Anonymous said...

Would your opinion be different if Goldman's AIG exposure were not hedged? Has the "fact" that this exposure was fully hedged been independently verified? Do the AIG internal memos actually provide the independent confirmation, or was AIG just discussing what Goldman said. Also, there is a lot of wiggle room in the terms "collateralized" and "hedged." What was the collateral, and what was it worth at the time? Goldman (not unreasonably) declines to say who its hedge counter-parties were, but aren't you at least a bit curious? Is there not some doubt in your mind as to whether, had AIG failed, some of those counter-parties might not have been able to pay Goldman? Maybe I am barking up the wrong tree. Maybe Goldman did nothing wrong. But given Goldman's strong connections with the Treasury Department, I think folks' suspicions are fair. And a defense that rests on taking Goldman's word for it is pretty lame.

Anonymous said...

From Felix Salmon at Reuters: "Goldman Sachs spokesman Lucas van Praag told me that in the wake of the events of the past year or two, Goldman?s partners have pretty much lost their appetite for going into public service."


Haha, now that the jig's up, now that their cover's been blown, they've lost their appetite for public service?? Gee, how will we ever survive without all these Goldman alumni running the Fed, the Treasury, the CFTC, the NYSE, etc.?? O Woe Is U.S.!!

Anne said...

So in that I'm far removed from Wall Street, living as I do in the Midwest, let me try to explain what you find so astonishing - the anger expressed toward Goldman these days.

Last fall, the outliers of the nation - those who don't work on Wall Street - were informed by the US Treasury Secretary (former Goldman CEO) that the economy would tank if he didn't get immediate and unregulated access to nearly a trillion dollars, which absolutely had to be paid out swiftly to the members of the financial community.

The reason for the crisis - from what we were told - was that the financial community handed out mortgages to people who had no hope of ever paying them back; these risky loans were packaged together, slapped with triple A ratings and sold to the highest bidders - usually pension funds, etc.

Paulson got his money - and he handed it out post-haste to the financial community.

And the economy tanked. Hundreds of thousands of jobs lost every month.

Dramatic losses seen in retirement funds and college savings accounts.

The middle class was reamed, quite frankly, by the catastrophe.

The bailed-out financial sector, by contrast, asked for and received large bonuses (all but the top seven or so wage earners in the firm.) Billions and billions of TARP dollars went to bonus the people within this community that had acted so very recklessly and profited so very greatly until the crash.

Thanks to Paulson's TARP, their bonuses were paid.

Concurrently, the ranks of the unemployed continued to grow in numbers.

Just months later, companies that have been the beneficiaries of some of the most remarkable federal interventions in the history of "the free market" are now posting record profits and planning for record bonuses.

Federal policy has created consolidation and reduced competition in a sector that was already "too-big-to-fail." However much we hate TBTF, we've created a policy where the little guys DO get to fail (witness CIT - and all the small businesses that do business with it.)

That Goldman bought up a bunch of AIG insurance says to me that they had billions in risky bets on their books. Perhaps they were fully hedged outside of their AIG insurance. So what? They bet big - and for them, the risky bets paid off. And the feds, after meeting with AIG and Blankfein, made sure AIG paid off the bets - i.e. federal money was used to cover AIG's debt to Goldman. Because the "free market" failed.

That Goldman execs are the best in the biz would mean nothing if the feds hadn't propped up the biz. They exist in a sector that is alive today thanks only to government intervention. (That's what Paulson led us to believe. If the sector was healthy but for few bad apples, shame on Paulson for lying to the public.)

So in today's free market, government is the solution, not the problem.

But only if you're in finance - and most particularly if you're at Goldman. And their federally supported success is obscenely different than the reality found in that other economy - the one outside the shadows of unregulated banking.

(And can I just ask - in this economy - where would Goldman's top talent go to make more money than at Goldman? That argument about "losing talent" if not provided with the right compensation is lame. Just lame.)

Anonymous said...

This is the first time i have seen your blog (via zerohedge) but i have to say, i just fell off my chair laughing that Anne from the midwest just completely demolished you with her comment, I have nothing really to add to her evisceration of your expertise, but if I could choose in the future between Anne's blog and yours, i'd take anne's. I think you fall into the classic expert trap that mistakes vast knowledge of the details with understanding of how the details fit together. Go Anne!

by the way, i am posting this comment as anonymous as its so lame to have an anonymous blog

ramster said...

Well Ann just took the word right outta my mouth, except that I'm not from the midwest:) so let me tack in a slightly different direction.

I read your blog because you clearly know what you're talking about and provide a credible alternate view to my regular finance related bookmarks , e.g. Naked Capitalism, Felix Salmon, Paul Krugman, etc. You're a window into the thinking of the financial class and you're a voice that's ready to go into the gritty detail. That being said, I'm definitely one the pitchfork crowd.

Fundamentally, you seem to have a forest for the trees problem, which is unsurprising given that you're looking at things as a bit of a technocrat. You understand the details with great expertise. I have no doubt that you understand CDS more than Matt Taibbi ever will. Yet you can't step back and note anything unusual or perturbing about the financial industry handing out billions in bonuses just after we were all told that the world was about to end. You can construct a worldview that reconciles this as perfectly reasonable yet for people not in finance (and not getting a cut of those billions), the cognitive dissonance is breathtaking. Especially given the obvious and pervasive influence of Wall Street in the formulation of economic policy.

Keating Willcox said...

ht democracy now

"I’m looking at a report from ABC News, Craig, “What Recession? The $170 Million Inauguration.” It says, “The country is in the middle of the worst economic downturn since the Great Depression, which isn’t stopping rich donors and the government from spending $170 million, or more, on the inauguration.” They say the actual swearing-in ceremony costs about $1.24 million. It’s the security, the parties, the Porta-a-Potty rentals that really run up the bill. “The federal government estimates that it will spend roughly $49 million on the inaugural weekend. Washington, D.C., Virginia and Maryland have requested another $75 million from the federal government to help pay for their share of police, fire and medical services.

“And then there is the party bill.”

Linda Douglass, spokesperson for the inaugural committee, says, “We have a budget of roughly $45 million.” That’s more than the $42.3 million in private funds raised by—or spent by President Bush’s committee in 2005 or the $33 million spent for Bill Clinton’s first inaugural in 1993."

Wall street gave this money, as a bribe to the winner. A bribe of almost a sixth of a million dollars from Wall Street GS whores to White House crooks. Taibbi is right. GS is loathesomely corrupt. Anne from the Midwest is spot on.

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embroidery bag said...

Any thoughts on why they didn't soft pedal the compensation issue for a year or two instead of going back to the status quo ante. I appreciate their right to do what they want wit their money but question their judgement on this issue. Maybe one of those rare mistakes you referred to.

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