Levin vs Blankfein

By Felix Salmon
April 27, 2010
pretty benign emails from Goldman, they got splashed all over the front page of the NYT; and today's batch of emails is causing a whole new set of headlines, even after today's WSJ story along similar lines.

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I am awed by Carl Levin’s ability to orchestrate press coverage of Goldman Sachs of late. When he released some pretty benign emails from Goldman, they got splashed all over the front page of the NYT; and today’s batch of emails is causing a whole new set of headlines, even after today’s WSJ story along similar lines.

Levin isn’t accusing Goldman of doing anything illegal, per se, but he’s on the warpath when it comes to the fact that Goldman went short the mortgage market. His list of email quotes is all about shorting the market, and so are his conclusions:

The Subcommittee’s nearly 18-month investigation found evidence that Goldman Sachs, contrary to the repeated public statements of the firm’s executives, made and held significant bets against the mortgage market – “short positions” in Wall Street terms…

As high risk mortgage delinquencies increased, and RMBS and CDO securities began to lose value, Goldman Sachs took a net short position on the mortgage market, remaining net short throughout 2007, and cashed in very large short positions, generating billions of dollars in gain…

Goldman Sachs used credit default swaps (CDS) on assets it did not own to bet against the mortgage market through single name and index CDS transactions, generating substantial revenues in the process.

Well, yes. If you have a substantial position in mortgages — and pretty much all banks had a substantial long position in mortgages come 2007 — then prudent risk management dictates that you try to hedge that position by selling what you can and putting on shorts in order to hedge what you can’t sell. What’s more, if you’re Goldman Sachs and you see the market going down, you’re going to be aggressive when it comes to putting on those short positions. That’s Wall Street.

As for Goldman helping to securitize subprime mortgages, yes, they did, but so did everybody else with a mortgage desk, and Goldman wasn’t even close to being the biggest.

Levin is convinced that if Goldman thought that mortgages were going down in value, and it still sold those mortgages to its clients, then that creates “a conflict between the firm’s proprietary interests and the interests of its clients”. But it doesn’t. If Goldman wants to go short mortgages and its clients want to go long mortgages, then it makes perfect sense for Goldman to sell mortgages to its clients.

I daresay that Levin is right when he complains that Goldman didn’t disclose its proprietary position to its clients, although I also suspect that if they asked the right people they probably would have explained their worries. But the fact is that Goldman wasn’t really making a big macro bet on the mortgage market failing, it was just making a large change to its own risk book in order to get away from what looked like a very dangerous position. If the mortgage market hadn’t tanked, Goldman would almost certainly still have made money. And while Levin talks portentiously about the “substantial profit” that Goldman made from its mortgage shorts, he never quantifies it or explains how he’s doing his sums. If he’s just looking at the short positions without looking at the offsetting long positions, that’s just silly.

Clearly Levin’s theatrics haven’t done much to impress Senate Republicans — or even Ben Nelson (D-Buffett): they blocked the financial regulation bill today, happy to be seen as obstructionist on financial reform even with Goldman dominating the headlines. Levin has, on the other hand, managed to muddy the waters surrounding Goldman a great deal, with the serious allegations about lack of adequate disclosure now being mixed up with all manner of vaguely-choate ideas about shorting and profiting off other people’s misery. It’s as though Goldman’s real sin here was not to lose as much money as everybody else when the housing market collapsed. If it had done, Levin would have much less to complain about.

Where does this leave Goldman? In a pretty tough spot, I’d say. The SEC case has severely damaged its reputation among its clients, while Levin and the press are doing their bit to undermine Goldman’s public image more generally. Right now, no accusation is too outlandish to throw against Goldman: if Ben Stein were to start accusing Jan Hatzius of deliberately talking down the US economy in order that Goldman could make money from bearish bets, as he’s been known to do in the past, the chorus of disapproval — against Stein, not against Goldman — would be much quieter than it was back then.

To Blankfein, I’m sure all of this seems horribly unfair. But the FT’s 2009 Man of the Year can’t whine about persecution. Instead, he should take the apology he’s already proferred, and make it more explicit: explain exactly which “things” Goldman participated in which were “were clearly wrong” and which Goldman has “reason to regret”. I’ve never got a very straight answer out of Goldman’s PR team on that front, although CDOs were certainly mentioned. Blankfein should be more forthright about that, and try as best he can to put a line under this whole episode.

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21 comments so far

Another good post. It’s no crime to be short. “It’s as though Goldman’s real sin here was not to lose as much money as everybody else when the housing market collapsed.” Right. Is Levin against the very idea of Wall Street moneymaking? If more people had been bearish on housing, we would have been better off. They did some unethical things but these were not it.

Some Democrats have taken lately to demonizing “Wall Street” (full stop) rather than discussing certain unethical practices specifically (frontrunning the market, trading with excessive leverage, use of CDSs without reserving for them, trading with cheap Fed funds, and use of knowledge of what clients are up to, to trade).

There are a lot to clean up but there are some like Levin who don’t seem to believe that there is a even baby in that bathwater.

Allocation of capital from savings into useful ventures, making of liquid markets, preserving capital from the foolishness of governments and from the bubbliciousness of a manic-depressive public, merging companies and efficiently redeploying assets after failure are the lifeblood of our economy. Wall Street is thoroughly essential and those who disagree simply don’t understand.

Wall Street needs to grab the wheel and talk about what is right and what is wrong or those who either don’t understand or don’t care will control the debate.

Posted by DanHess | Report as abusive

I don’t think you can blame it all on Democrats demonizing Wall Street. Wall Street has been doing a pretty darn good job shooting itself in the foot over the past few months. Goldman, B of A/Merrill, Citigroup etc. have just had appalling public relations strategy and it is coming back to haunt them. Arrogance isn’t a crime, but it does have consequences. In addition, when the bulk of your defense is to blame stupid investors for neglecting their diligence, no one is going to feel much sympathy for you when, like Goldman, you start getting a taste of your own medicine.

It would be nice if the leaders of “Wall Street” could step up and talk about the benefit they add to society, but I’m not so sure they know anymore.

So much of their energy the last few years has been spent on otherwise completely unproductive prop trading activities and sucking up to government officials, they might not have any handy examples of untainted value that they’ve created. Which, ultimately, is the point of Senator Levin’s hearings.

Posted by tja3 | Report as abusive

tja3, I think it is much simpler than that. If you are a politician looking to make some easy, pain-free headlines then who are you going to go after? The idiots who leveraged themselves up to the hilt to buy another McMansion, SUV and wide-screen TV? Not with the votes they cast. Or maybe the raa-raa media? But they might write nasty things about you. Far easier to go after banks because we all don’t like them anyway, they don’t vote and virtually no one really understands that what Mr Levin is spouting is pure drivel.

Posted by Danny_Black | Report as abusive

I think there is more of a potential conflict here than Felix acknowledges. If Goldman was only a market-maker and dealer with no prop desk, and if its goal was only to get market-neutral, that would be less troubling than the case when they do have large proprietary short positions, and they are also in the business of selling to clients. This is one of the arguments in favor of the Volcker Rule. It gets especially troubling in the case of synthetic CLOs which were specifically designed to allow Goldman to get short but which it sold to clients without disclosing this purpose. If Goldman is just a particularly large hedge fund, then it doesn’t have the same responsibility to its counterparties, but if it’s a systemically-important financial intermediary, there seems to be a different requirement.

Posted by o_nate | Report as abusive

It is very disappointing to see such a legalistic attitude from intelligent commentators like Felix. o_nate has it right: Goldman Sachs as a too-big-to-fail firm surely has an ethical responsibility somewhat greater than your average hedge fund hustler.

Posted by skeptic01 | Report as abusive

Felix – was that a Freudian slip about Ben Nelson? D-Buffett? Don’t you mean D-Nebraska? I can see how the two could be confused, but it is still quite humorous!

Posted by Gotthardbahn | Report as abusive

Felix, you seem to have changed allegiance. This is more like Spy versus Spy from the good old Mad Magazine with the role model political commentator and anarchist Alfred E Neuman as editor at large.

Maybe the German are stupid, listening to the leader of the Green Party justifying their involvement in Afghanistan, when much more than 50% of the nation is against it, and Merkel drowning the sinking Greece with admin, yes, I think they are. Then again, maybe these losses were intentional, let’s for argument sake say, to get tax breaks to fund American Air Force bases there.

Posted by Ghandiolfini | Report as abusive

If it weren’t for the part about Paulson backroom engineering the Abacus deal and Goldman omitting to mention that to anyone, then you would have a valid point. How does all that fit into your current poor Goldman is so misunderstood whine job. To hell with your whole all Wall Street is at least this bad and some of them even worse argument. We’re not talking about the rest of Wall Street. We’re talking about Goldman. This is the same Goldman that pulled off the backroom engineered bailout of AIG to their own tremendous benefit. That was the other Paulson ..

Posted by Woltmann | Report as abusive

I’m watching the senate hearing. It’s amazing to me how Blankfein dances around the issues. He was questioned about whether selling a long position to his clients on a security, while keeping a short position on that very security was a conflict of interest. He was unable to answer.

He refuses to believe that there was anything wrong with selling an investment GS believes to bad, to a client. He doesn’t acknowledge that this is not good business.

Posted by Benny_Acosta | Report as abusive

While it was darn funny to see Blankfein get confused but he was in such shock at how stupid the senators really were

Posted by STORYBURNcom_0 | Report as abusive

Good technical analysis. To put a finer point on it – Carl Levin = Demagogue.

[For a light hearted take on our present peril]

Posted by LibertyAtStake | Report as abusive

What spin! This is the kind of testimony that a jury of honest Americans would maximize the penalty for Blankfein and even some of the investigators. Does the left really think we are ignoring what the president, his cabinet and some of the big corps are doing? The emperor has no clothes and my children know.

Posted by docmej | Report as abusive

The idea is that as a bank you are supposed to work FOR your clients. GS wanted to get rid of a bunch of junk. It knew it was creating and selling junk. So why have it on the balance sheet in the first place? Why create “synthetic” products which are nothing more than simple bets and then put your own clients on what you believe to be the losing side? That’s where the conflict of interest comes in.

If I’m a car dealer and I have a lemon on the lot, it would be considered fraud to sell it to you. Why is it not considered fraud when a bank puts together a portfolio of failing investments and then sells them to its clients? It basically amounts to the same thing. How can I trust a financial institution to advise me on the one hand, when it sells me crap on the other? Offering advice to clients requires a certain amount of trust. Can you trust someone that would knowingly put you in what they believe to be a losing position? Of course not.

Goldman Sachs chose to prioritize its own profit above its duty to serve its clients. It could still have made a huge profit while protecting its clients or at least advising them against exposure that has a real chance of harming their business. But of course it simply could not do that because it was one of the major producers of this garbage.

Posted by Benny_Acosta | Report as abusive

Goldman being loosely scolded by Carl Levin is one thing, the people’s representatives taking meaningful action against the blatantly culpable parties on Wall Street is quite another.

Nitpicking Carl Levin is one thing, taking a meaningful stance on Goldman, who did not “lose money” – they may have lost *some money* on isolated MBS – but profited immensely from this macro scam and a series of other implosions on economies that couldn’t have been more destructive to the world if staged deliberately… that would be another thing entirely.

You ought to stick to that other thing, Felix.

Posted by HBC | Report as abusive

The only thing better than seeing Carl Levin lecture Goldman would have been to have Barney Frank lecture them. Meanwhile, Levin never mentioned how he and others forced Freddy and Fannie and banks to make risky loans to unqualified buyers “so everyone has a chance to be a homeowner…” This is true hyprocrisy at work! I would love to supeona Carl and ask him why he and his compatriots continue to spend money as if they have found a flowing well all the while a debt commmission is created to stop spending? These guys are losers and I can hardly wait to vote against all of them.

Buyer beware, evidently these firms who lost so much money completed significant due diligence and thought they were a good buy! Oops, they were wrong and the market nailed them. Sorry Carl, you are in over your head unfortuately for the few of us who understand derivatives and futures, you look really stupid. Its risk reward baby and perhaps you need to understand how it works.

Posted by BMWoverlandpark | Report as abusive

Well said, too bad this type of commentary can’t make it’s way into the press so that the average person is given a more appropriate view of the situation.

Posted by bob123 | Report as abusive

Would there be any merit in saying that Goldman was using borrowed financial acumen to an extent as it went short i.e. bet in favour of a fall in the mortgage markets mirroring client Paulson’s game plan? One would not expect Goldman to do so but there is no taking away from the fact the Paulson connection has been publicised heavily in the press. At best, Goldman could have avoided following in Paulson’s footsteps with respect to the ABACUS 1.

Posted by alliswell | Report as abusive

G.S just played by the rules. Let’s remember some of the people who made gambling with other people’s money so easy. All the good ‘ol boys who scrapped Glass-Steagall – Phil Gramm who added a clause to an appropriations bill forbidding the regulation of derivatives – Alan Greenspan, under whom the Fed failed in its regulatory role because he believed that markets were self regulating – William Donaldson, under whom the SEC relaxed how much capital banks needed to keep on hand to cover loses… There were lots of other players of both parties. They set the rules of the game.

Posted by newchum | Report as abusive

What GS did is exactly what every investment banking division has done and still does: push high fee products down the throat of private clients via their wealth management/private client division. As a rule in managing clients money, I have never, never sold a product coming out of firm’s investment banking division: structured products, crappy IPOs, MBS, etc. The fees are ridiculous but by dangling 3% to 5% payout to the financial consultant, the investment banks get this crap peddled to unsuspecting clients.

Furthermore, in the GS case, everyone says these were sophistcated institutional investors. Far from it. Most of the mortgage securities GS sold were to pension funds, the savings for mom & pop retirements. Yet they sold them some of the riskiest investments possible. Just now I see that my former employer’s pension has 1/3 of its assets with hedge funds who are making 2 & 20 off of my savings.

GS is criminal. They clearly stated in emails to move stuff off their own books into clients accounts when they knew the investments were toxic.

INvestment banks should NOT be part of private client/wealth management institutions. The conflicts are just too apparent and the client always suffers.

Posted by Acetracy | Report as abusive

It all depends on how you define ‘sell’ -
If by ‘sell’ you mean merely accepting an order from a client, then such practices are acceptable.
However, if by ‘sell’ you mean explaining to a potential buyer the advantages of buying a certain product from you, or from someone you represent, then such practices should change, because they are ethically flawed.

Posted by yr2009 | Report as abusive

If a teenager mows lawns and puts the money in the bank for college, he has always been able to trust that the money would be there when he graduated from high school. Banking has always been about trust. Only a fool does business with a banker he does not trust.

But if somebody puts money into a old age fund, and their fund manager deals with firms like Goldman, can he trust the money will be there at retirement. Just because Goldman calls themselves a bank does not mean you can trust them like the bank you grew up with?

I agree with the bloggers who urge Goldman to take a hit now, admit wrongdoing even when they might not be convicted in court. Sadly, their lawyers are like the tobacco company lawyers; several tobacco companies worked on a cigarette less likely to cause cancer, the so-called “safe cigarette”. But their lawyers told them not to do it, because marketing it as a safer cigarette would mean admitting their previous product was unsafe, and leave them open to lawsuits. Goldman’s lawyers are telling them there is no way to admit some fault and cut their losses, because doing so will lead to more investor lawsuits.

OK bloggers, putting all the comments aside about what will happen to Goldman, or should happen to Goldman, answer a simple question: would you feel safe investing your kid’s college fund with Goldman?

Posted by randymiller | Report as abusive
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