Tuesday, April 27, 2010

Thoughts on Goldman Sachs

See addendum below.

Goldman Sachs is taking a beating in the press because a Senate committee and the SEC are investing whether it engaged in wrongdoing by betting against the shaky mortgages fueling the housing boom and allegedly failing to disclose that fact to buyers of its "synthetic collateralized debt obligations."

The allegation of wrongdoing is an empirical question, of course, but a few things occur to me at this point:

Financial firms have been roundly criticized for their "herd mentality," that is, their incentive to run headlong into too-risky mortgage-backed instruments because everyone else was doing it. No firm wanted to be on the sidelines having to explain to its clients why everyone was making tons of money but them. Yet here Goldman went against the herd and it's coming under fire precisely for that reason. By betting against the sustainability of the boom on the basis of hedge-fund trader John Paulson's analysis, it injected needed information into the market. More information is always better than less, and there would be no social good from restrictions on short selling. Whether fraud was in the picture, I can't say, but I am confident that Goldman's hedge strategy -- and its delight over making money when mortgage-backed securities started losing value -- would have drawn criticism in any event. It's a no-win situation.

Second, the absolutely worst place to get to the bottom of things is in Congress. Every member of the committee has an overriding incentive to engage in demagoguery. Goldman Sachs is not exactly a positive household name, so which congressman will resist the temptation to denounce the company in public? If there is evidence of criminal activity, there are agencies for such investigations. This is not to say that those agencies are above demagoguery -- politically ambitious U.S. attorneys are notorious for it -- but at least we should be spared the spectacle of self-righteous congressmen pontificating on matters for which the Congress itself is heavily responsible. We already must suffer the obscenity of Chris Dodd and Barney Frank rewriting the financial rules to prevent, so they say, a repeat of the debacle that they themselves did so much to bring about. These people are the systemic risk. Enough is enough.

Finally, we must not lose sight of the fact that whatever Goldman did, it was in the context of a corporatist State, a banking cartel, and loose fiat money, in which Big Finance exercises extra-market power derived from the rules written by Congress and the regulatory agencies. These are hardly free-market enterprises, and it is no coincidence that former Goldman principals have their fingerprints all over the government's bailout response to the meltdown and the firm was a major beneficiary.

In an actual free market—without inflationary fiat money, implicit guarantees behind underwriters of dubious mortgages, and regulatory protection against open competition—a financial debacle such as we’ve seen is unlikely to have occurred. Even so, that doesn’t mean that everything that went on constitutes a crime.

Addendum, April 29: Rather than have the SEC or a criminal-justice agency pursue this case, the alleged victims -- if that's how they see themselves -- ought to sue Goldman Sachs and John Paulson and at least front the costs of adjudication, saving the taxpayers the money. It is noteworthy that at the Senate hearing, no "victim" testified. Do they not see themselves as victims? Perhaps not. These are sophisticated institutional investors, one of which had a hand in creating the bundle of mortgage-backed securities (MBS) that underlay the synthetic CDO. (It rejected some MBS in favor of others.) The other investor would have been able to examine the contents. Clearly, they knew they had a different outlook on the future of those MBS from those who bet against them. For every buyer, there's a seller, for every bull, a bear. One does not become a victim simply because one's outlook proved to be wrong.

Nevertheless, this is worth reading. Other links worth following that case doubt on the SEC case:

Sebastian Mallaby

Richard Epstein


Sheldon Richman said...

I deleted a comment that was nothing but an unidentified link to some website.

dennis said...

I find this case interesting, though I haven't read enough about it to comment too intelligently. It seems that Goldman is accused of setting something up to fail, shorting it and making, if I remember correctly, 15 million dollars. Now, to you or I 15 million dollars is a lot of money, but to a firm of Goldman's size that is a pretty insignificant sum, it hardly seems that they would risk so much for an amount that wouldn't even build a branch office somewhere. Maybe there is more to it but that makes no sense to me. I don't want to defend Goldman Sachs as such, they have long served the state and have been well rewarded for their service, but if they are going to "get what's coming to them" I'd rather it be for actual wrongdoing and not something that, from my admittedly uninformed position, seems kind of fishy.

Robert Higgs said...

I do not rule out the possibility that the present attack on Goldman serves, whether intentionally or coincidentally I do not know, merely to divert attention from the firm's much more serious wrongdoing (much of it, perhaps, completely legal -- the sort of thing that political-financial insiders do all the time).