Goldman’s hubris

By Felix Salmon
December 1, 2009
Bethany McLean has a big 8,500-word profile of Goldman Sachs in the latest Vanity Fair, in which she somehow manages to get Lloyd Blankfein to recapitulate the famous words of GM president Charlie Wilson:

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Bethany McLean has a big 8,500-word profile of Goldman Sachs in the latest Vanity Fair, in which she somehow manages to get Lloyd Blankfein to recapitulate the famous words of GM president Charlie Wilson:

“I’m charged with managing and preserving the franchise for the good of shareholders, and while I don’t want to sound highfalutin, it is also for the good of America,” he says. “I’m up-front about that. I think a strong Goldman Sachs is good for the country.”

Except, really, it isn’t. The two richest and most powerful people at Goldman Sachs are Lloyd Blankfein and Gary Cohn, and they both came from J Aron, Goldman’s commodity-derivatives arm. (They’re also both photographed for this piece by Annie Leibovitz, which is an interesting wrinkle if you remember the story about how a Goldman-backed loan to Leibovitz almost drove her to ruin.)

There are two big differences between derivatives traders and investment bankers: the traders make much more money; and they operate in a world of zero-sum games where one man’s gain is another man’s loss. And at Goldman, as at other companies like JP Morgan, the traders started muscling onto the bankers’ turf by creating “synthetic bonds” out of zero-sum derivatives. The people buying those bonds thought they were getting something safe, protected by the fact that Goldman was holding the first-loss equity tranche. But inevitably they ended up losing while Goldman ended up gaining:

One new invention the Street created was something called a synthetic C.D.O., which was sort of like making a coin: you have to have two sides, heads and tails, long and short. In effect, the person who has tails, or is short, makes small payments to the person with heads as long as the securities that make up the C.D.O. are performing. If they blow up, then a big payment goes the other way…

If you owned the less risky slices, you might feel good if the equity owner were a smart guy who only stood to get paid after you did.

Except that might not be the way it worked, because the equity owner could also be the person who had the tails, or short, position. As several sources have described it to me, the numbers could work so that the equity investor would do decently if the security performed—but make a fortune if it went bad.

The equity owner could also play a role in selecting the mortgages on which that C.D.O. was based. So theoretically at least—and some suspect this is not just theoretical—the equity owner could choose securities that he thought had a good chance of going to hell…

Goldman defends this. “We own equity, we buy a credit- default swap, and we are hedging ourselves,” says Cohn. As for selecting the collateral, he says, “It’s no different. Our clients are smart, sophisticated institutions. They should know that’s the case.”…

When I ask one knowledgeable person about what happened to some of the deals that Goldman is rumored to have done, he responds with one word: “Torched.” Or as another person says about the bigger picture of the crisis, “Goldman’s management team was almost flawless in its execution. But how many people needed government help because of the things Goldman sold them?”

What Cohn characterizes here as a “hedge” can just as easily be seen as a way of structuring a set of opaque and complex derivatives trades so that Goldman ended up making money and its counterparties ended up losing. That’s good for Goldman; it’s not good for America. And indeed if any of Goldman’s trades fall into the category that Blankfein has labeled “clearly wrong”, these would surely be near the top of the list.

Then there’s Goldman’s prop trading:

Goldman now has a money-management business; a large private-equity business, meaning that while big buyout funds are Goldman’s clients they are also its competitors; and a proprietary trading business, which exists specifically to trade Goldman’s capital on Goldman’s behalf—so hedge-fund clients are also competitors. Across Goldman’s many trading businesses, the line is fuzzy as to when the firm is acting for itself and when it is acting on behalf of clients…

Blankfein says that only about 10 percent of Goldman’s profits come from purely proprietary trades, but there is no way any outsider can confirm that independently.

In my own conversations with Goldman Sachs flacks, they tend to be adamant that Goldman in fact does no proprietary trading at all: everything they do is part of serving clients, there’s no separate prop desk, and yes although the trading desk makes money, it does so by enhancing the prices and liquidity that Goldman can offer to clients. So it’s interesting that Blankfein admits to McLean that Goldman does have purely proprietary profits, even if they’re only 10% of the total. The fact is that what constitutes a proprietary trade is very ill-defined, and the argument rapidly devolves into semantics. But again, insofar as Goldman does have a prop-trading business, it’s definitely the kind of thing which Adair Turner would consider “socially useless”.

That said, Goldman’s clients really do value what it offers:

While some say they do business with Goldman because the firm’s omnipresence means they have to, there is another reason, which even its most bitter critics concede: Goldman is better. Why is that?, I ask a hedge-fund manager who has just finished his own heated explanation about how he doesn’t trust Goldman. “I can’t really tell you why it’s better. It’s just better,” he says. “It’s six p.m. in New York City, and Goldman will figure out how to get the right person in Hong Kong—a guy we’ve never spoken to—on the phone to walk us through exactly what we want to know. He’ll be fully knowledgeable.” He laughs. “Try the same thing with Citi. They can’t even figure out what they know, let alone how to take advantage of it.”

It’s just that Goldman’s clients tend to be people like this — hedge-fund managers who themselves are pretty socially useless. When it comes to ordinary taxpayers, the benefits we get from Goldman seem much smaller.

Goldman’s press releases about its spectacular earnings never mention government assistance of any kind. In June, the firm paid back the $10 billion in tarp funds it had taken. Taxpayers got a 23 percent return. As for the $21.6 billion in funds guaranteed by the F.D.I.C. that Goldman still has outstanding, a recent Congressional report estimates that it will save Goldman $2.4 billion over the life of the debt. But Cohn argues that that is actually costing the firm, in fees to the F.D.I.C. and interest, because it is excess liquidity. (When I repeat that to another Wall Streeter, he closes his eyes and says, “Please tell me Gary didn’t say that.”)

Oh, he said it. And he also said this:

When I ask Gary Cohn if he was worried about Goldman’s stock price, which plunged from $207.78 in February 2008 to $47.41 in November, he says, “It wasn’t scary at all.”

And if you believe that, I’ve got a mezz tranche of a synthetic CDO you’ll just love.

Update: Oops, sorry, I completely forgot that I’ve used this headline before. I guess it’s just too obvious.


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Hogwash. I’m sure Wilson’s business practices aren’t conducted with “the best interest of Americans” in mind. It may be a coincidence that what’s good for Goldman Sachs is also good for the U.S., but it’s definitely not the corporation’s primary goal, which is always PROFIT.

AT&T and Fannie also played the “what’s good for us is good for America”. In fact they took it further and played up the fear factor (AT&T used the cold war and Fannie used the 98 crisis and 01 tech bubble). Goldman is going down the same path and will end in the same pile.

Posted by Sam K | Report as abusive

Felix, you’re a good investigator, and fairly even-handed on things. Any chance you could do a review of the ‘Value Line Anomaly’, which has consistently outperformed the market over the last half century, and see if there’s some sort of error, or it really does work?==Bob

Posted by Bob | Report as abusive

So how the the $13B that the US gave to Goldman to cover their “hedge” good for the country? If they don’t get that $13B, and they are forced to negotiate with AIG for maybe 50% less, would that be bad for the country?We got a huge dose of what’s good for GM is good for America, I guess that’s why GM is bankrupt and the nation is in massive debt. I want to see how Goldman’s government subsidized profits benefit the rest of the nation, because so far it’s not obvious.

The GM original comment was “what’s good for the business of GM is good for the business of America.” That’s undeniable because GM makes cars and trucks, actual things that people drive, that businesses use, that we can export, that use steel and machine tools. These companies employed hordes of people, some highly skilled, some in R&D. And overall the business of GM generated massive wealth for ordinary Americans and huge tax revenues for local, state and the federal governments. Goldman does nothing of the sort.

Posted by jonathan | Report as abusive

We learn in the article that the “God’s Work” comment was a joke.I was hoping Blankfein was merely delusional about positive effects of Goldman’s activities. That I can live with.That he is a raw cynic frankly is much worse.

Posted by Dan Hess | Report as abusive

@jonathan, I appreciate the difference between Goldman and GM, but what’s good for GM may not necessarily be good fo America. When they were getting most of their profits from over-sized SUVs, the oil imports they caused weren’t good for the country. Abandoning pensions (however expensive and undeserved they may be) is good for GM, but not the country. If GM lost all of its competition and doubled their prices, it wouldn’t be good for America.The arrogance of both companies is ridiculous.

It’s important to be nuanced because Goldman is a mix of positive and harmful elements. There are a lot of useful things that Goldman does. Investment banking is certainly a meaningful business. Beyond that, trading can be very valuable in an economy because when assets are priced either too high (bubbles) or too low (undercapitalization) an economy can suffer terrible capital misallocations. We should be grateful for that.That said, Goldman does a lot that is harmful and some things that are possible illegal, all while benefitting enormously from taxpayer largess.A few of the harmful things they do:* Frontrun trades through their high frequency trading operations, which ought to be illegal* Use their network of alumni to achieve laws favorable to them (including dismantling much of the financial safety apparatus erected during the Great Depression)* Fight against true transparency in the derivatives markets, heighening systemic risk* Crush failing and improverished cities under contracts with unconscionable terms 9/ns/business-businessweekcom/* Engage in trading on a large scale in the face of enormous conflicts of interest.* The abundance of free liquidity in Goldman’s hands is a source of inflationary pressure on consumers even amid falling wages and employment.And a few of the ways they have benefitted from government and taxpayer largess:* Received 100 cents on the dollar in AIG bailout funds – a cash gift of many billions.* The delevering of an overlevered financial system would have crushed all of the major I-banks, including Goldman, were it not for government bailouts of housing, banks, consumers and much else.* Their Too-Big-To-Fail status and their inappropriate conversion into a bank holding company enable essentially free borrowing from both the markets and from the Fed. This is the greatest source of their huge profitability. Goldman does not engage in retail banking except as a tiny placeholder to access the Fed discount window.Add up the positives and negatives and Goldman is looking a little bit like Ted Kennedy right after Chappaquiddick. I wonder if they’ll spend the next 40 years trying to make things right…

Posted by Dan Hess | Report as abusive

PENCIL NECK BANKER GEEK(Pencil Neck Geeks, Freddie Blassie)WilliamBanzai7Back when I was a kid, life was going swell.Till something happened, blew every thing to hell.That night my daddy stumbled in, all pale and weak,Said “A woman up the block just gave birth to a banker geek.”Mom said, “Sell it to Greenspan’s subprime circus, what the heck.”Dad said, “Nope, this one’s a pencil neck.And if there’s one thing lower than a quantitative freak,It’s a grit eatin’, scum suckin’, pencil neck banker geek.”You see if you take a pencil that won’t hold lead,Looks like a pipe cleaner attached to a head,Add a buggy whip body with a brain that leaks,You got yourself a grit eatin’, pencil neck banker geek.(Chorus)Pencil neck geek, quantitative freak,Scum suckin’, swindler with a lousy physique.He’s a one man, no gut, bubble bloating streak.Nothin’ but a pencil neck banker geek.Soon the banker geeks were poppin’ bubbles all over downtown.You couldn’t hardly sneeze without knockin’ one down.After a nice juicy steak, if you need a toothpick,Just reach for a banker geek, they’ll do the trick.One day we cut one up for fish bait.Learned our lesson just a little bit late.Soon as the geek hit the Hudson drink, the water turned subprime red.Next day, sure enough, all the investor fish were dead.ChorusMost any night you know where I can be found.Yeah, stomping some banker geek’s head into the NYC ground.So keep the faith ’cause in SPITZER you can trust,I won’t give up ’til the last banker geek bites the dust.ChorusThey say, “these geeks come a dime a dozen.”I’m lookin’ for a guy named Geithner who’s supplin’ the dimes.It’s gonna be real hard times for all of theseGrit eatin’,Scum suckin’,Obama lickin’,Drop kickin’,Gut grindin’,2 Big 2 failin’,Nail bitin’,Glue sniffin’,Scab pickin’,Butt scratchin’,Bonus snatchin’,Sleezy,Smelly,Pepper bellied,Dirty, lousy, rotten, stinkin’, pinstriped bailout suckin freaks.Nothing but a pencil neck banker geek.Pencil neck geek.Pencil neck geek.Pencil neck geek.

“So how the the $13B that the US gave to Goldman to cover their “hedge” good for the country? …”I assume you are talking about the 12.9 billion that was paid to GS after the Fed loaned AIG 85 billion. GS’s cash went up 12.9 billion.4.8 billion in assets were returned to AIG immediately in the form of highly liquid agency securities. That reduced GS’s assets by 4.8 billion. 5.6 billion of the 12.9 billion was a payment for the CDOs to be transferred to ML III. So GS had to transfer ownership of 5.6 billion, marked to market, of CDOs to ML III. That shrank their assets by 5.6 billion.So once the transaction was complete, GS’s asset balance was increased by 2.5 billion, not 12.9 billion.And just to head people off the ridiculous dodges they always seem to make, GS could easily have sold those assets in the open market for 4.8 and 5.6.

Posted by JCH | Report as abusive

Good stuff, sir.It’s suprising to me nobody at Goldman has not been assasinated yet. Money makes people do evil things.

Posted by kthomas | Report as abusive

@Dan HessGS is not front-running their clients. If they were, their clients would simply go elsewhere to transact. HFT is *not* front-running.

Posted by Anon | Report as abusive

@Anon –No I did not say Goldman front-runs their clients. Trading ahead of your own clients is just one kind of front running and a foolish one at that. I think it is unlikely that Goldman does that.To help you understand how mainstream (and legal) front-running works, go back to the old-school model. A trader with an expensive seat on a trading floor would aim to figure out what institutional investors were doing and run to buy before the large institutional buys drove up the price. Conversely, if the institutional investor is selling, the trader would aim to sell or short ahead of that. I had a classmate at Cornell whose dad did just this. It was obviously ethically questionable, and does nothing but leaches the returns of larger players, but at least there is a limit to what a guy walking around a trading floor can do.Fast forward a decade. Now electronic trading programs are the order of the day. Firms like Goldman can use ultra high-speed trading programs to act very much like my classmate’s dad did, but on a grand scale. Software quickly spots trends due to buying and selling by major market buyers and sellers, and executes trades ahead of them. What was once small-time pickpocketing has morphed into a stealing of tens billions from all manner of investors but especially large funds. It is a big part of why most large funds are unable to beat the market.Here’s a little light reading to help you get up to speed: business/24trading.html?_r=3&ref=busines sFirms like Goldman justify themselves by saying this has always been done by folks like that floor trader. Now its just computerized. But really that is like justifying a power plant spewing tons of toxic waste by noting that the guy down the street has always dumped his motor oil in the storm drain.

Posted by Dan Hess | Report as abusive

@jch, if Goldman could have sold those assets for $5.6B, then why was it good for America that the govt paid them $12.9B? Their asset balance only increased by $2.5B, but they now had $12.9B in cash, instead of $10.4B (using your math) worth of assets that had unknown value.Those assets hadn’t defaulted at that time, the only reason AIG had to cover them was their collateral had lost value, and the CDSs they sold Goldman had a covenant that allowed payment if the collateral lost value. Instead of making Goldman whole for losses that hadn’t existed, the government could have just backed up AIG’s collateral.If this was no big deal, then Goldman wouldn’t have been in danger of collapsing itself. It woudln’t have changed into a bank so it could borrow money from the government for free.

Would the world be a better place if Goldman did not exist? Right now it is looking that way.They (along with some other Wall Street firms) really own the housing bubble and it’s subsequent collapse.  /real_estate/mortgage_lessons.fortune/i ndex.htmThere was a time, actually a period of many decades, when the customer came first but that era is history. But counterparties to Goldman in the past decade have been dealt ruinous losses.For one thing, if I were Goldman, I would dramatically reduce my involvement in derivatives, even if it is profitable, because it is a zero sum game (unlike most forms of investing). With most derivatives, Goldman’s wins must be their customers’ losses. That is no way to build a franchise.Until Goldman gets its former religion back about the customer being first, one should really think twice about being counterparty to any Goldman Sachs transaction.If Goldman has any decency, they will use their market leadership and insight to help avert systemic failure risks across the market. Present risk centers around sovereign governments with staggering and unsustainable debt burdens. Goldman is widely respected as the smartest, and perhaps they alone have the both the credibility and reach to help push governments away from fiscal collapse. Do they have the character to work in this way?Or will they just keep on the destruction trade in profitable silence?

Posted by Dan | Report as abusive