Tuesday, April 27, 2010

Goldman Again - a post to please no-one

As I watch the senators grill the Goldman folk I have to say that I am both impressed with the way they have gotten up to speed on the industry and yet displeased about how much they seem yet not to understand. Their lack of understanding is their undoing. I have been listening to this testimony today for over nine hours and I would not describe the questions as targeting the key issues like a laser.

Levin is compulsive about Goldman's large - HUGE short (the absolute size of the short); he is also compulsive about the idea that Goldman 'should' be an advocate of the assets Goldman sells to customers. These are two misguided positions by Senator Levin. Sorry, Carl, my fellow Michigander.

If the raw size of Goldman's 'short' in the mortgage market is an issue because it can impact the whole market then the issue should be one of governing market positions in instruments:instrument by instrument. Goldman had a huge short FOR THE PURPOSE OF hedging its huge 'long' in a weak and declining market. I don't think that is/was Carl's point. I don;t think Carl ever really made a damaging point on this subject. Testimonies began at 10AM and this point emerged early on; Yet it took us until Blankfein's commentary late in the day for it to be explained to Levin that the act of being a principle necessarily puts the dealer and his customer on different sides of the trade and with completely opposite risks, at least initially.

If a dealer is selling to a customer in a rising market or buying securities from customers in a falling market both circumstances put the dealer firm at great risk to 'service' the desires of his customer. These risks or interests cannot be 'aligned'. But that IS the business of the securities firm. Hedging that risk and managing it is the crux of the business. If firms sought out clients with the same market views it had, it would never do business with them!

As for transparency, a friend of mine who has been a trader on Wall Street for a long time says the best skill l to being a trader is to play poker. If you played poker would you want your opponent to know what you held in your hand? Of course not. Dealers can't (read that as meaning 'ought not be required to'...) disclose their positions. Some of their customers are very sophisticated and would use that information against a dealer. Senators need to know that. Markets are adversarial. Each transactor needs to look after his or her own interests. Buyer beware! At the same time there are rules to promote fair play. That is the complication of markets; that the point the Senators are missing. 'Caveat emptor', yes, but seller be fair.

There are other business in in which firms undertake a true fiduciary responsibility for their clients. And Goldman is in some of those businesses. But those businesses are not about the deals the that the senators were taking about today.

Now all of this is very different from the charge that Goldman did not just trade securities but it created a security for a client that wanted the price of that security to fall. Now let's point out that while that is peculiar and seems reprehensible, if the deal is properly described there is nothing 'wrong' with it (it's not illegal).

Abacus 2007-AC1 (maybe they should have called it 'Icarus')
Goldman is accused in this one deal (Abacus) of not making a material disclosure related to the deal. Two aspects of this have emerged. Not only does Goldman argue that the role of Paulson need not be revealed- it was material. It was also said by Blankfein today said that he thinks ACA knew what Paulson was doing. We have earlier testimony that points out that Paulson was not in the end listed as being in the equity part of the deal something ACA would have known as it underwrote a good portion of the deal for which it had the responsibility for asset selection and which it insured. Even though there are allegations that Paulson had been originally represented as being an equity player in the end he was not there. Most of the discussion today has not been about that at all.

This Abacus structure is allegedly a security formed with the objective of having it fall in value. This conclusion about the intended performance of the security follows from the fact that the deal was being designed for a Goldman client who wanted to bet against the housing market. A Goldman committee described the deal as being like Goldman 'working an order' for their client, Paulson. The telling aspect of that phrase is that we know the client wanted to short the housing market and that when Goldman works an order it does so without putting it's capital at risk. So Goldman wanted to sell it all.

Yet Goldman operatives deny that the deal was designed to produce a weak security that would fail, although Goldman operatives admit that the firm did not plan to own any of it- it did get stuck with a piece it could not sell. That fact does not allow Goldman to say it was blameless.

When Goldman put Abacus together, the developing information from todays testimonies suggests, it sought a novice firm to insure the deal and to pick the securities, a firm that may have felt 'honored' to have been chosen to do a deal with Goldman. The real client, the Paulson-run hedge fund , the intended short-seller who wanted the deal to fail, was put in meetings with the asset insurer who wanted the deal to succeed. Germane to the case, we have seen documents leading us to believe that the Insurer for Abacus, ACA, thought Goldman's customer, Paulson had a equity position - not that he was a short-seller. Though Goldman puts this allegation in dispute.

We now have for the first time in today's testimony an allegation by the 'Fabulous Fab' that he told ACA that Paulson would be short. We also, interestingly have had a case of the 'fab fab' making errors in statements possibly because of his less-than-stellar grasp of English. He also has described some of his emails as inaccurate because he was in a hurry and being less than completely 'accurate' in his haste. These are two possible lines of defense he can use later on.

Various background documents produced, have quoted Goldman operatives as saying that Goldman did not want to do more business with sophisticated customers but that it wanted to transact more with others since the sophisticated customers were more likely to be on the same side of the trade as what Goldman wanted. That's a nice revelation.

Beyond Abacus
Goldman is confusing the issues in the case and so are the senators by not getting to the facts of the deal that has prompted this investigation and the charges by the SEC about Goldman's wrong-doing. The Senators are going beyond this deal and getting tripped up by confusing Goldman's role in this transaction with the idea of what a dealer does. There is no fiduciary responsibility for a dealer per-se, but there are securities laws. Goldman only has fiduciary responsibility when its firm undertakes that in some of the roles it does play apart from its role as dealer. But in the role of dealer it does not have its client's interests at heart. It is trying to trade and make money, but it still has rules it must follow. On the other hand when it underwrites or originates securities its participation is controlled by other securities laws. Being a dealer is not a license to engage in a free-for-all. The rules depend on whether the firm is trading listed securities or originating new paper or being an investment advisor, and so on.

Goldman is a complicated firm-as are most securities firms. Securities laws are complex. Derivative products are a rat's nest of troubles. Goldman had a number of emails whose contents once disclosed reflected badly on it. Some of this is just the stuff of securities markets and people who are under pressure and letting their guard down, blowing off steam, more than being underhanded. The talk about Goldman selling 'crap' is talk you'll find in every shop in Wall Street, as well as in used car lots and elsewhere. And... one man's crap is another man's fertilizer. It's hard to tell in these emails what is truth and what is just blowing off steam.

No trader thinks he is holding crap but he might call a security that after he sells it, especially if it falls in price. 'Crap' is often made obvious only after the fact. Salesman often have views that differ from that of the firm. Salesmen often think a company has underwritten or has created a security his customers don't want to buy and as a consequence, he does not want to be pushed to sell them. Sometimes the salesmen are right. Sometimes they are not.

The question is - in the case of Abacus - not was there 'pro and con' chatter nor 'did Goldman salesmen ever call it 'crap' (or a more vulgar term),' but was something illegal done? The senators lost their way. Michael Lewis's "Liar's Poker" would be a good book for the senators to read to get some perspective on how salesman work with customers and how they talk. I have worked on the assembly lines in Detroit and on Wall Street at a bank and at a securities firm as well as at the central bank, the Fed. I find the language used in on Wall Street as well as on Detroit's assembly lines has a lot in common.

The key here should be for the senators to pursue those charges that have to do with securities law violations or that have real moral character problems. They seem to have lost their way although they did score some points today.

One of the keys here is to poke through the complications to get at the real issues. The more we get into the complications of the industry, complications of the securities and complications of 'the deal' the more likely it is that Goldman wins. Complication works in Goldman's favor. When things are complex other things go wrong and sometimes that is seen as a result of the complication itself instead of being viewed as being the fault of those who were the transactors or deal architects who may have well understood the complex structure and used it to do no good and shield themselves.

Most disturbing to me is that Blankfein said he heard nothing today that makes him think that Goldman did anything wrong- really? Was he listening to the same stuff I was listening to? Or does he just have lower standards?


1 comment:


As far as goldman goes they should change their name to something else that reflects what they have become.