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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Does anyone know if this is being released on Kindle? Can’t find that info anywhere.

Posted by jaherman | Report as abusive

“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.”

Felix, this is bs. What you provide are sympathetic words for scumballs who spent all their time selling the CDO’s value to investors around the world but when the test of stress on the markets arrived these cowards discovered that their gonads disappeared and they just couldn’t squeal loud enough to give a bid. They have no problem making a market when times are good but cower when the markets are screaming insults in their faces, hell, that is the nature of markets…pathetic.

For the most part Americans have little room to complain when it comes to watching the government cradle these pigs when they began squealing. When the American Capitalists were asked would they give up their savings for the sake of future generations by allowing the free markets to discipline investores their was heard from the four corners of our land a giant SQUEAL!

Posted by csodak | Report as abusive

I read the article about Burry, and I have read countless articles about Goldman. And you don’t have to ask who I believe. The guy seems completely incapable of lying or even misrepresentation, which seems to be a basic attribute of most investment banks.

I don’t believe the book will be available on the kindle,that is the first thing I checked. Go to Amazon and click on the button requesting it in kindle form. Oh wait, it’s non-fiction, Felix won’t read it on the Kindle. :-)

Posted by OnTheTimes | Report as abusive

I think your final paragraph is misleading. Capital markets groups are in theory supposed to hedge all their positions so that they can make markets while not “betting” one way or the other. This is impossible to achieve in practice, but well-managed groups should and do come pretty close.
I don’t mean to be naive. I know the lines between banks and hedge funds – decidedly in the position-taker camp – have been blurred. But saying your derivatives dealer is betting on the opposite of what you’re betting on is too extreme.

Posted by Steed72 | Report as abusive

“His saleswoman, Veronica Grinstein, called him on her cell phone instead of from the office phone. (Wall Street firms now recorded all calls made from their trading desks.)”

That actually seems fairly explicit to me. It also seems correct. Yes, no doubt Grinstein had access to an unrecorded phone in the office, but so what? If the point were to protect Goldman – from accusations of selling unsuitable products, for example – I’m sure she would have used her regular phone on the desk.

“…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 is true, and the main victim of the trader is his or her own bank, which is why a competent bank would be working against this natural tendency. A pattern of rising marks at end-of-month is not very subtle; I thought Goldman were supposed to be the smart guys?

Posted by Greycap | Report as abusive

Greed is what Greed does and further fascination with these yahoos is unwarranted. Wall Street does little for society except line the pockets of CEOs. The mergers it creates sack jobs and security and I don’t think anybody would be crying a tear if Goldman went away. I work for and the mess that lands on our doorstep is crazy bad. We have the most read foreclosure story on the web as well as several job hunting stories.

Posted by zoomaster | Report as abusive

As an intern at Lehman Brothers in the IT portion of the CDS group, I can attest that we did have at least one massive system failure, which as far as I can tell was caused by trading volumes our systems could not handle. I seem to remember it being a bout of panic selling following the collapse of those two hedge funds, but I also remember it happening later in the summer near the end of my internship.

Being just the intern, I was not directly involved in dealing with the associated technical problems, but most of the team I was working with was.

Of course none of this means that any of the other investment banks’ infrastructure was as rickety as ours. In fact, I would sincerely hope not. I’m just saying it’s possible.

Posted by vgalis | Report as abusive

Instability is what was lacking in the system and still is. The systems are still unstable and will continue to be until controls put some dampening into the system. Then we might see a clearer picture of what really is there. There will continue to be problems with this rickety system until the investors demand accountability.

Posted by fred5407 | Report as abusive

This is a pure Goldman Sachs public relations fluff piece.

Everyone now knows the extent to which Goldman Sachs and its alumnus will go to for profit and power.

The AIG scandal, backdoor deals with the Treasury and Fed, frontrunning, currency swaps, derivatives, auction fraud, nondisclosure, misdirection, country distabilizing, rumor leaking, naked short selling, ad infinitum…

The only pity is that they get the most of the publicity while the partner in crime, JP Morgan Chase works in the shadows.

Until the Federal Reserve is audited and the FBI building is fumigated for corruption we will not know everything they have been up to.

Like why is the federal reserve allowed to pay these banks interest on the backs of taxpayers for doing nothing?

Why did the secretary of the treasury, past and present, call them so often during the crisis?

Why was GS and JPM given preferential treatment at the expense of taxpayers in almost every single bailout since the fall of 2007?

Why do GS and JPM, who commit fraud and crimes all over the world never get prosecuted?

Why are GS and JPM allowed to be leveraged to the point where they can bankrupt the entire United States ten times over?

Why does SEC and CFTC continue grant GS and JPM position limit exemptions in trading stocks and commodities?

Why does CFTC, LME and CME allow them to satisfy trade and margin requirements with questionable collateral?

I could go on all day. The point is that Goldman Sachs and JP Morgan Chase have become a serious threat to the United States of America and they must be broken up immediately if the republic is to survive!

Posted by bigkirb1 | Report as abusive

Should come as no surprise to you Felix. Market Makers out to lunch was standard during the April 1994 Brazil crisis and big time during both the Asian crisis in 1997 and the Russian meltdown Aug-Sep 1998. In fact LTCM collapsed because of a domino which began when the entire 5-bank Spanish Treasury M-M refused to answer calls for 2 days.. prompting Meriwether to request the Italian CB to intervene and call his counterpart in Spain…As for GS, when we were allocated domestic US corporate bonds which they underwrote between 1996 and 2005, they took 3 to 4 weeks to deliver because their MO was to over-allocate 15% (short) and then buy from the secondary markets at a discount to deliver to small institutions.. they are masters at front running their clients…and when a crisis hits its damn the clients, save GS.. The cabal of HF that participated in their short of VW shares in Germany, and suffered billions in losses, surely know what I mean..

Posted by Bludde | Report as abusive

The fed’s played their part in this charade as well. Paulson convinced Bush to bail out AIG knowing full well that billions of those dollars would end up at his old company, Goldman Sachs. Goldman essentially got the TARP dollars free and clear. While Bush and Paulson let one of Goldman’s main rivals, Lehman Bros go down the tubes. It’s great to have the Treasury Secretary doing your bidding.

Posted by justanotherjoe | Report as abusive

Excerpt from Risk Magazine article (Jan 2008), including comments from Goldman’s main market risk manager at time (Berry) – final few paras are most pertinent:

…On philosophical grounds, Goldman does not tend to put on enterprise-level macro hedges. “We think it’s very important that individual groups and traders are responsible for the businesses they run,” says Berry. “So, we don’t put on the short somewhere else – on another book. This kind of insurance trade tends to dilute individual responsibility in risk taking.”

Also, unlike many dealers, Goldman Sachs prefers to set risk limits at levels that it expects individual traders and businesses to bump up against during the course of a year. “We don’t want this to happen every day, but when it does, because of large customer trades or a change in market volatilities, for instance, it reinforces the need for dialogue and decision-making,” remarks Berry. In contrast to Goldman, many other firms set limits at relatively high levels that are very unlikely to be reached, except in the most extreme circumstances – by which time an unwieldy loss may have accumulated.

The quid pro quo here is that the risk management group has to be flexible in adapting those limits when opportunities arise or volatility regimes shift. In risk management, says Berry, there’s certainly an art to striking the right balance between assessing what’s likely and what’s merely plausible, and getting desks to react to this in the way they limit exposures or seek to build businesses.

“Perhaps a more important and difficult discipline surrounds what happens when potential warning signs emerge,” he explains. “We put a lot of effort into ensuring that our marks and risk measures are highly responsive, and that changes in these are quickly, cleanly and crisply communicated throughout the organisation.”

Towards the end of 2006, a sense of unease started to grow as the firm’s activities were, in effect, making it longer and longer US mortgage risk. It was around this time, other dealers tell Risk, that some savvy hedge funds and bank proprietary trading desks were starting to pile on short positions. “We could sense the firm getting longer US mortgage risk just as we perceived the risk in these positions was increasing,” Berry says. “That caused us to go through all our positions line by line to work out whether we were truly comfortable with this amount of long risk.”

It ran deep analysis of the firm-wide mortgage exposure, and the answer the firm’s risk management function, together with the relevant business heads and senior executives, came to was: no, it was not comfortable. Still, the opportunity for Goldman Sachs to drastically change its exposure before the turning of the mortgage market seemed limited, causing the firm to mark down the value of these assets early and recognise losses. These were immediately communicated to senior management.

“It appears that we were perhaps much quicker than others to recognise losses when the market moved,” explains Berry. It also started to increase the hedges on its mortgage exposures. “We realised we needed to take steps to hedge that risk in various derivative forms. This, of course, entails basis risk, so there was also a general effort to reduce our positions too,” he adds.

Other dealers say that during the first quarter of 2007, Goldman’s mortgage group had bought an extremely large amount of protection via the various sub-indexes of the ABX, which reference credit default swaps on US home equity loan asset-backed securities. One trader says that on an occasion near the end of the first quarter, Goldman appeared to trim this hedge by closing out a significant proportion of the ABX protection it had bought. The move, he hypothesises, was likely due to the firm’s risk limits being enforced rigidly in the face of severe spread volatility.

Posted by Noddy | Report as abusive

two points.

otc quotes are rarely two way. exchange rules often require a market maker to make a two way quote but that doesn’t happen upstairs.

also, the salesperson and most bank employees would presume the office phones might be recorded. a ‘paranoid’ culture is encouraged

Posted by randolfduke | Report as abusive

For a long tme I had to get “marks” for month end pricing on bonds. These were simply corp bonds for month end pricing. I would call to a couple of dealers and ask for a price on XYZ bonds, “89 by 89.50″. No, I’m not looking to sell just give a price for month end, I always called the shops where we were a big client, “oh, for pricing, 93 by 93.75.” Thanks, remember us the next time you make a trade! How the “marks” were done for CDS nonsense and other esoteric offerings, I can only shudder at the thought. They will always make enough people money to be considered worthy but the crews on the street are gansters pure and simple. Bear got on the wrong side of the trade and they were simply blown up in a few short months. They believed they actually had risk controls in place. Begleiter, of WSOP fame, was the head of “Strategy”. Good grief.

Posted by ruckandmaul | Report as abusive