Annals of Goldman Sachs client relations, Michael Lewis edition

By Felix Salmon
March 1, 2010
Vanity Fair has a long excerpt from Michael Lewis's excellent new book, The Big Short. The excerpt follows Michael Burry, a hedge-fund investor who was almost too early getting short the subprime housing market, and who managed to annoy his investors mightily despite making them millions of dollars.

The excerpt includes a pretty scandalous tale about how Wall Street banks treated their clients when it came to providing them with reliable marks. But is it true? Here's what Lewis writes:

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Vanity Fair has a long excerpt from Michael Lewis’s excellent new book, The Big Short. The excerpt follows Michael Burry, a hedge-fund investor who was almost too early getting short the subprime housing market, and who managed to annoy his investors mightily despite making them millions of dollars.

The excerpt includes a pretty scandalous tale about how Wall Street banks treated their clients when it came to providing them with reliable marks. But is it true? Here’s what Lewis writes:

In the spring of 2007, something changed—though at first it was hard to see what it was. On June 14, the pair of subprime-mortgage-bond hedge funds effectively owned by Bear Stearns were in freefall. In the ensuing two weeks, the publicly traded index of triple-B-rated subprime-mortgage bonds fell by nearly 20 percent. Just then Goldman Sachs appeared to Burry to be experiencing a nervous breakdown. His biggest positions were with Goldman, and Goldman was newly unable, or unwilling, to determine the value of those positions, and so could not say how much collateral should be shifted back and forth. On Friday, June 15, Burry’s Goldman Sachs saleswoman, Veronica Grinstein, vanished. He called and e-mailed her, but she didn’t respond until late the following Monday—to tell him that she was “out for the day.”

“This is a recurrent theme whenever the market moves our way,” wrote Burry. “People get sick, people are off for unspecified reasons.”

On June 20, Grinstein finally returned to tell him that Goldman Sachs had experienced “systems failure.”

That was funny, Burry replied, because Morgan Stanley had said more or less the same thing. And his salesman at Bank of America claimed they’d had a “power outage.”

“I viewed these ‘systems problems’ as excuses for buying time to sort out a mess behind the scenes,” he said. The Goldman saleswoman made a weak effort to claim that, even as the index of subprime-mortgage bonds collapsed, the market for insuring them hadn’t budged. But she did it from her cell phone, rather than the office line. (Grinstein didn’t respond to e-mail and phone requests for comment.)

The whole point of being a broker-dealer is that you should be willing to make a two-way market and provide vaguely reliable marks in just about anything — rather than fall off the face of the planet for a week just when you’re needed most.

This story makes Goldman Sachs in particular look particularly bad — the bank which prides itself on superior risk management and being a provider of liquidity to the markets is now coming up with ludicrous excuses about “systems failure” and making furtive calls on an unrecorded cellphone trying to spin a highly-improbable tale that it doesn’t need to provide any more collateral because honestly the market isn’t crashing around its ears, the visible implosion of the Bear Stearns hedge funds notwithstanding.

But I’ve spent a chunk of this morning on the phone to Goldman Sachs, and they say the story isn’t true. Goldman’s clients, they say, including Burry, got their valuation reports for Friday June 15 and Monday June 18 on the next business day, as is standard practice: the valuations for June 15 were received on June 18 and the valuations for June 18 were received on June 19. The report on the 19th might have been received a bit later than normal — that might be the “systems failure” that Lewis refers to — but Goldman denies outright any suggestion that it was MIA between June 15 and June 20.

Goldman also denies the suggestion — made explicitly in the book, but not in the magazine excerpt — that conversations on Grinstein’s office phone would have been recorded. No, they say, conversations on that phone were not recorded.

The story of Goldman disappearing for a few days ties into Lewis’s bigger theory of what was going on at the time: that Goldman was net long the subprime market as late as June 2007, and then rushed to get short only when the Bear Stearns funds collapsed. A bit later in the book, Lewis has this footnote:

The timing of Goldman’s departure from the subprime market is interesting. Long after the fact, Goldman would claim it had made that move in December 2006. Traders at big Wall Street firms who dealt with Goldman felt certain that the firm did not reverse itself until the spring and early summer of 2007, after New Century, the nation’s biggest subprime lender, filed for bankruptcy. If this is indeed when Goldman “got short,” it would explain the chaos in both the subprime market and Goldman Sachs, perceived by Mike Burry and others, in late June. Goldman Sachs did not leave the house before it began to burn; it was merely the first to dash through the exit — and then it closed the door behind it.

If this is true, then it’s testament to Goldman’s fleetness of foot that it could turn so abruptly from being long to being short. But of course that kind of move is certain to have large repercussions in the market. And there’s a clear implication here that Goldman was mainly worried about Goldman at the time, and was happy leaving its clients, like Mike Burry, out in the cold while it scrambled to reposition its own book. That would definitely be something to bear in mind when Goldman tells you how client-focused it is, how it always puts clients first, and how it doesn’t really have much in the way of prop trading, it’s mainly just making markets for clients.

So, did Goldman only start cooperating with Burry once it had itself got short and was therefore on the same side of the trade as him?

The official Goldman story is actually not all that far from the one put forwards by Lewis. Goldman says that they started hedging their long mortgage positions at the beginning of 2007, but that they were still net long at that time, and that those hedges grew larger over the course of 2007 in general, and at the end of the second quarter in particular. In other words, the story from the Goldman PR operation is entirely consistent with Goldman becoming net short in June 2007 — which is also when, according to Burry and Lewis, it started becoming much happier to provide aggressively low marks on mortgage bonds, and aggressively high marks on the value of CDS on mortgage bonds. It wasn’t long before it was showing those marks not only to Burry but also to AIG, demanding billions of dollars in collateral against its own CDS position.

So where do I stand on the question of how Goldman in particular, and Wall Street in general, treated its clients at key points in the history of the subprime meltdown? I think that Wall Street was slow to mark CDS realistically, and I believe the story earlier in the book about how Bear Stearns would send out official marks on subprime CDS which were nowhere near the levels at which it would ever actually write new business. I think there was a spectrum in terms of how responsive and accurate the Wall Street banks were, and that the banks which were most short the subprime market — Deutsche and Goldman — were also the most responsive and accurate.

In other words, your experience as a client of a Wall Street bank was going to be much more pleasant if the bank was positioned on your side of the trade than it would be if the bank was positioned against you. Obscure instruments like credit default swaps on the senior tranches of synthetic subprime collateralized debt obligations are never going to be traded transparently on screens, and all traders have a tendency to give out marks in such a manner as to make their own books look good — especially at or near the end of the month. That might not be as true of Goldman as it was of Bear Stearns, but it will still always be a little bit true, at the margin.

I do believe that Burry was having difficulty getting through to Grinstein between June 15 and June 20 of 2007, even if the bank did manage to send him client valuation reports in that period. When any bank is going through turmoil in a highly volatile environment, it will always have a tendency to try save its own bacon before worrying about giving great service to relatively small clients. As I’ve said many times before, if you do a derivatives trade with Goldman, then Goldman is — at least in the first instance — taking an equal-and-opposite bet to yours. So don’t expect a lot of sweetness and light out of them if and when things start moving in your direction.


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