The Goldman hearings

By Felix Salmon
April 27, 2010
official Goldman statements are strong, especially that of Fabrice Tourre:

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The Goldman Sachs hearings today are making for fascinating theater. The official Goldman statements are strong, especially that of Fabrice Tourre:

I never told ACA, the portfolio selection agent, that Paulson & Company would be an equity investor in the AC-1 transaction or would take any long position in the deal. Although I don’t recall the exact words that I used, I recall informing ACA that Paulson’s fund was expected to buy credit protection on some of the senior tranches of the AC-1 transaction. This necessarily meant that Paulson was expected to take some short exposure in the deal…

If ACA was confused about Paulson’s role in the transaction, it had every opportunity to clarify the issue. Representatives of Paulson’s fund participated directly in all of my meetings with ACA regarding the transaction. I do not ever recall ACA asking me or Paulson’s representatives if Paulson’s fund would be an equity investor. Indeed, ACA and Paulson had several discussions about the transaction and at least one meeting without any Goldman Sachs representatives present. Quite frankly, I am surprised that ACA could have believed that the Paulson fund was an equity or long investor in the deal.

As for the testimony of the rest of the Goldman executives, they’re all clearly singing from the same songbook: that although they might have been long at certain times and short at others, the main directive they were given was not directional, but was rather just to reduce the amount of risk on their books.

But in the actual hearings, the members of the Goldman mortgage desk are looking decidedly weak. They don’t answer questions, they keep on asking to double-check documents to run down the clock, they give narrow and unhelpful answers, and they generally act in a slippery and unsympathetic manner. Interestingly, Fabrice Tourre is the most straightforward and cogent of the lot.

I can see why it’s working out this way: the Goldman team has been briefed by their lawyers to be very careful about what they say, while the Senators are interested in grandstanding and scoring points.

Disappointingly, no one seems to have got any clarity on the biggest point of contention here. Goldman Sachs claims that it made less than $500 million on mortgages in 2007, while Senator Levin claims that it made $3.7 billion. That’s a big difference, and I’m not at all clear on how either of those numbers are calculated or which one is more reliable. Certainly a trade which made $3.7 billion wouldn’t come from an overarching strategy of trying to get “closer to home” at all times, as the Goldman executives are suggesting they did.

But whatever the truth of the matter is, these hearings are clearly bad for Goldman. Look over Fabrice Tourre’s right shoulder whenever he’s on camera: the other face in the frame is that of Goldman spokesman Michael DuVally. And it’s not a happy one.

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6 comments so far

Senator Levin said that GS made $3.7 billion on the “big” short, he also said GS lost $2.9 billion on its long positions, the difference is gross revenue so $500 million net plausible.
I am surprised at some of the GS people, amazingly dense…

Posted by alea | Report as abusive

Has anyone checked to verify that this Abacus had beads?

Posted by DonthelibertDem | Report as abusive


Sure they did — when men were warriors, women were damsels and Wall Street investment bankers were financial advisors; then les sans culotte started to default on mortgage debt, AIG stopped selling CDO insurance, and the GS krewe cannabalized them to bulk up the tranches in their new line of synthetics,
and strung plastic replicas into necklaces to give out to their buyers.

This, to me, was the weakest part of the Senators little theatrical revue — why couldn’t even one of them have probed GS on the architecture, substandard construction material and filler that went into making the Abacus1 tower, as well as why only certain floors ended up getting developed and their collapse hedged against?

Posted by avattoir | Report as abusive

I thought Ensign of Nevada made a very good point when one of the other senators described Wall Street as being like Las Vegas, and Ensign said Vegas was more honest.

The senators, and the Wall Street cheerleaders on CNBC are missing a central point. Remember in October of 2008, the credit markets froze up. Why? Because nobody trusted the information they were getting from counterparties. Congress passed Tarp with the idea of buying large numbers of mortgage backed securities and CDO’s, but that idea was quashed because nobody, not even the Goldman alum Henry Paulsen, could figure out what was in them, let alone price them.

The muddier the water, the more profit opportunity for speculators.

Let me say it another way. Goldman led the way to remove clarity from the market in financial securities. That lack of clarity froze the credit markets, which brought commerce in America to a standstill. The situation was very close to spiraling out of control to a second great depression, or something worse.

Blankfein, Geithner, both Paulsons, etux, need to be asked if they understand that our free market cannot function well when there is lack of clarity, poor quality information, people intentionally muddying the waters. Keep asking them over and over to explain how a free market can work when so many powerful players are muddying the waters.

Posted by randymiller | Report as abusive

Randy, way to get it backwards. GS was a market maker and produced marks for this “murky” market, sort of the exact opposite of what you are claiming.

The markets froze up because no one wanted to take even the smallest risk which is not surprising given a major broker dealer went bankrupt, another was bought in a hurry and a third nearly went to the wall whilst **money market** funds broke the buck.

The issue wasn’t that there was a lack of clarity in the market, it was that under the circumstances no one wanted to take the slightest bit of risk.

As a matter of curiosity, why do you think these products are somehow innately harder to price than say the common shares of Citigroup? The difference is liquidity, not that the products are somehow “more complex”. If you can come up with a good pricing model that consistently works for shares, many billions and a Nobel are waiting for you….

Posted by Danny_Black | Report as abusive


First, over-reliance on mathematical models is part of the problem. Black Scoles works…. except when it does not(and please take no offense if you are related to Fischer Black). Several of the people in the Chicago school have admitted that EMH has its limits.

Models have some value, as one of many indicators. Since I took my first class in economics 40 years ago, I have been puzzled by economists who assume that all buyers and sellers are perfectly rational. I worked in the economics reading room at college, and had opportunity to look at a lot of student dissertations on econometrics, and I was troubled by their over reliance on the quants. I have grown more troubled by the increasing numbers of physicists who are trying to bring the mindset of the physical sciences into economics.

A number of years ago quants were trying to predict human psychological behavior using computer models, and they came to the conclusions that there were no constants, or certainly not enough constants to make their models work.

When pricing stocks, combine the models with a prediction of herd mentality.

Consider something simpler-energy costs. One gallon of gasoline produces 124,000 BTU. I would need 1.25 ccf of natural gas to produce the same energy. A gallon of gas in western Iowa costs about $2.80 right now, 1.25 ccf of natural gas costs $.87, delivered to my house. So if we all had vehicles that could burn both, everyone would use natural gas until the point that natural gas and gasoline prices moved to some equilibrium.

My point is that the price of a gallon of gas should be determined by its replacement cost, whether that is electricity, diesel, CNG, etc. But in the short term, that is not possible because we do not have the technology in place to move back and forth between energy sources. In the long run, for instance a decade, if that price difference continues, technology will give us the ability to use natural gas in our vehicles, and we can move to equilibrium.

Another way is to look at the price of a barrel of oil. Oil industry execs have said that oil should be around $60 per barrel, based on the cost of replacing the last barrel produced, but oil continues to hover around $80 to $85. Two years ago, it was at $140. Why so high? Herd mentality. Two years ago we were all led to believe that oil was going to hit $200, so to a petroleum buyer, $140 seemed like a good buy.

My point. Pricing is not a science, especially in the short and near term. Quantitative modeling can give me some insight, but the idea of a computer using a model to do all our trading is not a sensible thing to do.

So, pricing the stock of financials is especially hard, because there is so much blue sky value there.

Posted by randymiller | Report as abusive
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