Tuesday, April 27, 2010

The Goldman Goose?

Louise Story of the NYT reports, Panel’s Blunt Questions Put Goldman on Defensive:
Even before the first question was leveled inside the Senate chamber, Tuesday was going to be uncomfortable for Goldman Sachs.

But then the questions kept coming — and coming and coming.

Through the day and into the evening, Goldman Sachs officials met with confrontation and blunt questioning as senators from both parties challenged them over their aggressive marketing of mortgage investments at a time when the housing market was already starting to falter.

In an atmosphere charged by public animosity toward Wall Street, the senators compared the bankers to bookies and asked why Goldman had sold investments that its own sales team had disparaged with a vulgarity.

“The idea that Wall Street came out of this thing just fine, thank you, is just something that just grates on people,” said Senator Edward E. Kaufman Jr., a Democrat from Delaware, said. “They think you didn’t just come out fine because it was luck. They think you guys just really gamed this thing real well.”

But throughout a more-than-10-hour subcommittee hearing, current and former Goldman officials insisted that they had done nothing to mislead their clients. Time and again, the senators and the Goldman executives, among them the chairman and chief executive, Lloyd C. Blankfein, seemed to be talking past each other.

Among the Goldman retinue was Fabrice P. Tourre, a vice president who helped create and sell a mortgage investment that figures in a fraud suit filed this month by the Securities and Exchange Commission.

Mr. Tourre defended his role in the sale of the investment. In his opening remarks to the Senate Permanent Subcommittee on Investigations, Mr. Tourre declared: “I deny, categorically, the S.E.C.’s allegation. And I will defend myself in court against this false claim.”

Senate investigators are building on the S.E.C. case, which accuses Goldman of defrauding investors in a transaction called Abacus 2007-AC1.

The hearing was held against the backdrop of a debate about overhauling financial regulation. During the questioning, senators highlighted the need for greater openness and questioned the ethics of the financial sector.

At one point, the Goldman witnesses were asked what they would change in the regulatory system.

“Clearly some things need to be changed,” said Daniel L. Sparks, a former partner and head of the mortgage trading department in the Goldman Sachs Group, who was one of the four initial witnesses.

Steering away from financial jargon, the senators tried to put a human face on the questioning. Senator John Ensign, Republican of Nevada, declared that more transparency was needed “so we don’t end up hurting the little guys out there on Main Street.”

A Republican member, Senator Susan M. Collins of Maine, turned from one witness to the next as she asked repeatedly whether they felt a duty to act in the best interest of their clients. Only one of the four witnesses she questioned seemed to affirm such a duty outright.

In what almost added up to a light moment, Senator Mark L. Pryor, Democrat of Arkansas, said the public wanted to know what went wrong and “how we can fix it,” adding that Americans feel that Wall Street contributed to the financial crisis. “People feel like you are betting with other people’s money and other people’s future,” he said. “Instead of Wall Street, it looks like Las Vegas.”

Senator Ensign said he took offense at the comparison, saying that in Las Vegas the casinos do not manipulate the odds while you are playing the game. The better analogy, he said, would be to someone playing a slot machine while the “guys on Wall Street” were “tweaking the odds in their favor.”

The gap between Wall Street and the rest of the country was a recurring theme, with senators occasionally pointing out how much Goldman, and indeed the witnesses, had profited as the overall economy was headed for a plunge.

Senator Claire McCaskill, Democrat of Missouri, mentioned during her questioning that she was trying to “home in on why I have so many unemployed people” and lost money in pensions.

The questioning Tuesday put the Goldman witnesses on the defensive, with the senators expressing exasperation that they were deliberately dodging questions or stalling for time.

It was at 10:01 a.m., one minute late, when the session began with opening remarks from subcommittee chairman, Senator Carl Levin, Democrat of Michigan. The public galleries, accommodating roughly 100 people, were full and included four people dressed in mock stripped prison jumpsuits who jeered at the Goldman officials.

“How do you live with yourself, Fab?” one shouted as Mr. Tourre was ushered out of the chamber after his testimony.

A tone of confrontation was set at the beginning, with Senator Levin’s opening remarks. He said the questioning would focus on the role of investment banks in the financial crisis, and particularly on the activities of Goldman Sachs in 2007, which “contributed to the economic collapse that came full blown the following year.”

While the hearing had ramifications for the entire sector and the activities of lenders to make more money from risky mortgage loans, Senator Levin added, it was focusing on Goldman as an “active player in building this mortgage machinery.”

He said that while the S.E.C. suit and the courts would address the legality of its activities, “the question for us is one of ethics and policy: were Goldman’s actions in 2007 appropriate, and if not, should we act to bar similar actions in the future?”

In addition to Mr. Tourre and Mr. Sparks, Goldman executives testifying included Joshua S. Birnbaum, a former managing director in the structured products group trading, and Michael J. Swenson, another managing director in that group.

A second panel included David A. Viniar, executive vice president and chief financial officer, and Craig W. Broderick, the chief risk officer.

At one point Mr. Viniar prompted a collective gasp when Mr. Levin asked him how he felt when he learned that Goldman employees had used vulgar terms to describe the poor quality of certain Goldman deals. Mr. Viniar replied, “I think that’s very unfortunate to have on e-mail.”

Senator Levin then berated Mr. Viniar for not saying that he was appalled that Goldman employees even thought their deals were of poor quality, much less put it in e-mail. Mr. Viniar later apologized.

As the hearing stretched into the evening, Mr. Blankfein, Goldman’s chief, entered the chamber with an almost angry demeanor. In a brief prepared statement, he held tight to Goldman’s defenses.

Later, asked if he knew the housing market was doomed, Mr. Blankfein replied, “I think we’re not that smart.”

Mr. Blankfein was asked repeatedly whether Goldman sold securities that it also bet against, and whether Goldman treated those clients properly.

“You say betting against,” Mr. Blankfein said in a lengthy exchange. “The people who were coming to us for risk in the housing market wanted to have exposure that gave them exposure to the housing market, and that’s what they got it. The unfortunate thing, and it’s unfortunate, is that the housing market went south very quickly.”

Senator Levin pressed Mr. Blankfein again on whether the his customers should know what Goldman workers think of deals they are selling, and Mr. Blankfein reiterated his position that sophisticated investors should be allowed to buy what they want.

Mr. Blankfein was also pressed on the deal at the center of the S.E.C. case. He said the investment was not meant to fail, as the S.E.C. claims, and in fact, that the deal was a success, in that it conveyed “risk that people wanted to have, and in a market that’s not a failure.”

To which Senator Jon Tester, Democrat of Montana, replied, “It’s like we’re speaking a different language here.”

As I worked today, I listened to the hearings on C-SPAN. At times, they were endless, but there were many excellent points where my antennas went up.

Let me give you my general impressions. I wasn't very impressed with the morning panel which consisted of Mr. Tourre (aka 'Fabulous' Fab), Mr. Sparks, Mr. Birnbaum, and Mr. Swenson. They were evasive and I found them young and arrogant. They didn't impress me much; in fact, at times, they seemed like a bunch of amateurs.

The Goldman executive that impressed me today was the CFO, David Viniar. Leaving aside his dumb comment "that’s very unfortunate to have on e-mail,” Mr. Viniar was solid as a rock, answering tough questions straight on. Let me be blunt, if you have an investment firm, you want a guy like David Viniar as your CFO. In fact, after listening to Lloyd Blankfein, I am left wondering why isn't David Viniar Goldman's CEO?

As I suspected, the hearings were mostly a circus show. There is a lot of pent up anger on Main Street and the senators used this occasion to publicly scold the Goldman Sachs boys. Goldman made a killing shorting subprime mortgage structures while the working class were losing their homes and jobs. The senators used Goldman as their financial piñata, no doubt trying to score political points and set the stage for passing financial reform.

But these hearings aren't just about Goldman; they are about a Wall Street model that is fraught with conflicts of interest. I was surprised to see Citadel Investment Group founder Ken Griffin coming to Goldman's defense when he knows that investment banks are fraught with conflicts of interest.

Go back to read Soros' thoughts on alignment of interests. When investors allocate to funds managed by George Soros, Bruce Kovner, Ken Griffin, Steve Cohen, Ray Dalio, Paul Tudor Jones, John Paulson, Jim Simons, Louis Bacon, David Shaw, or any other elite hedge fund manager, they'll pay hefty performance fees, but at least they know that those managers have skin in the game. Their net worth is tied up in the funds they're managing. There is an alignment of interest.

That alignment of interest does not exist in the current investment banking model. It might exist (loosely) between Goldman and say, Citadel or other big hedge funds, because Citadel and those hedge funds do a lot of business with them, but I'll bet your bottom dollar it doesn't exist between Goldman and their dumb public pension fund clients. The latter are as sophisticated as grandma Jones (and many of them, even less so).

Alignment of interests. That was the key point Senator Levin was trying to make towards the end of the hearings when he grilled Lloyd Blankfein. Soros knows all about this point. He thinks risk-takers should start a hedge fund and take risks with their own capital:
“That would push the risk-takers who are good at taking risks out of Goldman Sachs into hedge funds, where they actually belong, because hedge funds take risks with their own capital, not with deposits and not with government guarantees,” he said.
You see if Goldman (and other investment banks) really cared about their clients, they'd be feeling the pains and gains right alongside them. That is the essence of these hearings, and the most important takeaway from today's circus show. You can't be selling products to clients that you're actively shorting in your proprietary trading books.

I leave you with the opening statement of the one senator that impressed me the most today, Senator Claire McCaskill. She reminds us that Casino Capitalism is threatening our standard of living, and unless we change course, we are doomed.

And one final thought. Goldman reversed course in the summer of 2006, right about the same time a senior investment analyst from PSP Investments was asking them about the best way to short the U.S. residential mortgage structured credit bubble. Now, if I can only find those emails!

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