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.