I’ve now read most, although not all, of today’s proceedings before the Senate’s Permanent Subcommittee on Investigations at which a number of Goldman Sachs employees testified. The proceedings were revealing in many ways. Here are some thoughts, more or less at random:
1) This was one of the rare Congressional hearings where it isn’t easy to tell the Democratic questioners from the Republicans. There is no political percentage in sticking up for Goldman Sachs, and I’m tempted not to do it either, since they have been a major supporter of the Democratic Party for some time, and currently are, I believe, lobbying in favor of the Democrats’ “regulatory reform” legislation. But, what the heck: we call them as we see them.
2) Questioning by the Senators was, as usual, ineffective. Mostly, they tried to cross-examine the Goldman employees based on emails that the government has obtained via subpoena. The process was painful due to the Senators’ lack of skill. It’s also probably true that the Goldman folks didn’t say quite everything that they knew. But, as one who spends much of his life poring over emails and other documents, looking for evidence I can use in depositions, I can say authoritatively that the Goldman emails aren’t bad. This is a relatively tame collection on which to try to hang some sort of scandal.
3) Today’s inquisition was a sideshow. Here is what really happened: there was a bubble in housing prices. The bubble was mostly the result of government policy–loose money, combined with pressure on banks to make bad loans to unqualified home buyers. It all worked for a while because Fannie Mae and Freddie Mac, under the leadership of Congressman Barney Frank and others, created a secondary market for shaky mortgages. Goldman Sachs participated in this market, downstream, along with many other players. But the whole thing wasn’t an accident or a conspiracy, it was government policy. The home price bubble could have only one possible result. All bubbles burst–there is nothing else they can do–and the bursting of a bubble is always painful. The whole disaster that began in 2008 was the inevitable result of government policy, which is why Senators are so anxious to pass the buck to Goldman Sachs.
4) The Senators, seemingly without exception, are embarrassingly ignorant of modern risk management techniques. They really don’t seem to understand how and why firms like Goldman Sachs hedge their exposure to various economic trends. The most coherent explanation of what Goldman did came from the firm’s Chief Financial Officer, David Viniar:
I’d like to give you a sense for how we managed our risk during the period leading up to the crisis.
Through the end of 2006, we were generally long in exposure to residential mortgages and mortgage-related products. In that December, however, we began to experience a pattern of daily losses in our mortgage-related P&L. P&L can itself be a very valuable risk metric, and I personally read it every day.
I called a meeting to discuss the situation with the key people involved in running the mortgage business. We went through our positions and debated views on the mortgage market in considerable detail.
While we came to no definitive conclusion about how the overall market would develop in the future, we became collectively concerned about the higher volatility and recent price declines in our subprime mortgage-related positions. As a result, we decided to attempt to reduce our exposure to these positions. We wanted to get “closer to home.”
We proceeded to sell certain positions outright and hedge our long positions in an attempt to achieve these results. As always, the clients who bought our long positions or other similar positions had a view that they were attractive positions to purchase at the price they were offered. As with our own views, their views sometimes proved to be correct and sometimes incorrect.
We continued to reduce our positions in these products over the course of 2007. We were generally successful in reducing this exposure to the extent that on occasion our portfolio traded short. When that happened, even if these short positions were profitable, given the ongoing high volatility and uncertainty in the market, we tended to attempt to then reduce these short positions to again get closer to home.
This situation reversed itself in 2008, however, when the portfolio tended to trade long. And as a result, despite the fact that our franchise enabled the firm to be profitable overall, we lost money on residential mortgage-related products in that year.
While the tremendous volatility in the mortgage market caused periodic large losses on long positions and large gains on offsetting short positions, the net of which could have appeared to be a substantial gain or loss on any day, in aggregate, these positions had a comparatively small effect on our net revenues.
In 2007, total net revenues from residential mortgage-related products, both longs and shorts together, were less than $500 million, approximately 1 percent of Goldman Sachs’ overall net revenues. And in 2007 and 2008 combined, our net revenues in this area were actually negative.
For Goldman Sachs, weathering the mortgage market meltdown had nothing to do with prescience or betting on or against anything. More mundanely, it had everything to do with systematically marking our positions to market, paying attention to what those marks were telling us, and maintaining a disciplined approach to risk management.
This explanation is actually pretty clear, but it is doubtful that any of the Senators understood it.
5) While not a single Senator distinguished himself, the most embarrassing was Carl Levin. He repeatedly misread emails and failed to understand the economics of Goldman’s transactions. This exchange was typical:
LEVIN: Now, on October 4, 2007, exhibit 46, you wrote the SEC, page three at the bottom. You say that, “It’s important to note we’re active traders of mortgage securities and loans and, with any of the financial instruments we trade, at any point in time, we may choose to take a directional view of the market and will express that view through the use of mortgage securities, loans, and derivatives.”
You may choose to take a directional view of the market. “Therefore, although we did have a long balance sheet exposure” — long balance sheet exposure — “to subprime securities in the past three years, albeit small, our net risk position was variously either long or short pending on the changing view of the market.” You had a changing view of the market.
For example, now this is the example of choosing to take a directional view of the market. “During most of 2007, we maintained a net short subprime position and therefore stood the benefit from declining prices in the mortgage market.” Was that true when you said it?
VINIAR: Absolutely and totally consistent what I said to you before.
LEVIN: All right.
VINIAR: We were largely short across 2007.
Levin and other Senators seemed to think that there was something “evil” about taking a short position–that all investors were somehow required to try to keep the housing bubble going. This is analogous to knowing how to add, but not how to subtract. Actually, of course, Goldman was entirely correct when it shorted securities that were based on rising home prices. A reader who has far more expertise in this area than I do writes:
If there had been easier and earlier shorting….that would have been a market signal possibly producing moderation in the pricing and a softer landing…one of the roles and social benefits of short selling….it lets market pricing more fully reflect views of asset value and puts downward pressure on pricing….in a bubble….that’s what you want…some balance to tame irrational exuberance….
These people are either ignorant or dangerous…..
Or, more likely, both.
6) It didn’t appear that a single Senator understands what is involved in making a market in a security.
7) News coverage has focused largely on Sen. Levin’s repeated quotation of a Goldman email that described a deal that Goldman was involved in as “shitty.” Levin’s repeated implication was that Goldman wrongfully foisted a “s****y” deal off on its customers. Liberals never seem to wonder whether it is really a great business strategy to sell s****y deals to one’s clients. I’ve invested in any number of deals that have gone bad, but I’ve never thought that my investment advisers were happy about it.
I can’t be sure because I haven’t seen the entire email chain, but I think the Goldman employee in question wasn’t saying that Goldman sold a s****y deal to its clients, but rather that the transaction had turned out to be s****y for Goldman. Here is the relevant exchange:
LEVIN: OK. Now, before you sold all that stuff that we just described in 166, $600 million of Timberwolf securities is what you sold, before you sold them, this is what your sales team were telling to each other. Got it, 105?
SPARKS: Yes, Mr. Chairman.
LEVIN: Look what your sales team was saying about Timberwolf. “Boy, that Timberwolf was one shitty deal.”
LEVIN: They sold that “shitty deal.” …
SPARKS: Some context might be helpful.
LEVIN: Context, let me tell you, the context is mighty clear. June 22 is the date of this e-mail. “Boy, that Timberwolf was one shitty deal.” How much of that “shitty deal” did you sell to your clients after June 22, 2007?
SPARKS: Mr. Chairman, I don’t know the answer to that. But the price would have reflected levels that they wanted to invest…
LEVIN: Oh, of course.
SPARKS: … at that time.
LEVIN: But they don’t know it’s a — you didn’t tell them you thought it was a shitty deal.
SPARKS: Well, I didn’t say that.
LEVIN: No. Who did? Your people, internally. You knew it was a shitty deal, and that’s what your…
SPARKS: And again, I…
LEVIN: … e-mail showed.
SPARKS: I think the context, the message that I took from the e-mail from Mr. Montag, was that my performance on that deal wasn’t good, and, I think, the fact that we had lost money related to that wasn’t good.
LEVIN: How about the fact that you sold hundreds of millions of that deal after your people knew it was a shitty deal? Does that bother you at all, you sold the customers something?
SPARKS: I don’t recall selling hundreds of millions of that deal after that.
8) I’m not a particular fan of either Goldman Sachs or Congress, but today’s hearing confirms that, given a choice, I’d rather have Goldman Sachs regulating Congress than Congress regulating Goldman Sachs. Goldman’s employees are much smarter, considerably more honest, and far more likely to have my interests at heart.