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A provocative discussion of Goldman Sachs

Article for NYT:


The American economy remains in dire straits, with one worker in six unemployed or underemployed. Yet Goldman Sachs just reported record quarterly profits — and it's preparing to hand out huge bonuses, comparable to what it was paying before the crisis. What does this contrast tell us?

First, it tells us that Goldman is very good at what it does. Unfortunately, what it does is bad for America.

Second, it shows that Wall Street's bad habits — above all, the system of compensation that helped cause the financial crisis — have not gone away.

Third, it shows that by rescuing the financial system without reforming it, Washington has done nothing to protect us from a new crisis, and, in fact, has made another crisis more likely.

Let's start by talking about how Goldman makes money.

Over the past generation — ever since the banking deregulation of the Reagan years — the U.S. economy has been "financialized." The business of moving money around, of slicing, dicing and repackaging financial claims, has soared in importance compared with the actual production of useful stuff. The sector officially labeled "securities, commodity contracts and investments" has grown especially fast, from only 0.3 percent of G.D.P. in the late 1970s to 1.7 percent of G.D.P. in 2007.

Such growth would be fine if financialization really delivered on its promises — if financial firms made money by directing capital to its most productive uses, by developing innovative ways to spread and reduce risk. But can anyone, at this point, make those claims with a straight face? Financial firms, we now know, directed vast quantities of capital into the construction of unsellable houses and empty shopping malls. They increased risk rather than reducing it, and concentrated risk rather than spreading it. In effect, the industry was selling dangerous patent medicine to gullible consumers.

Goldman's role in the financialization of America was similar to that of other players, except for one thing: Goldman didn't believe its own hype. Other banks invested heavily in the same toxic waste they were selling to the public at large. Goldman, famously, made a lot of money selling securities backed by subprime mortgages — then made a lot more money by selling mortgage-backed securities short, just before their value crashed. All of this was perfectly legal, but the net effect was that Goldman made profits by playing the rest of us for suckers.

And Wall Streeters have every incentive to keep playing that kind of game.

The huge bonuses Goldman will soon hand out show that financial-industry highfliers are still operating under a system of heads they win, tails other people lose. If you're a banker, and you generate big short-term profits, you get lavishly rewarded — and you don't have to give the money back if and when those profits turn out to have been a mirage. You have every reason, then, to steer investors into taking risks they don't understand.

And the events of the past year have skewed those incentives even more, by putting taxpayers as well as investors on the hook if things go wrong.

I won't try to parse the competing claims about how much direct benefit Goldman received from recent financial bailouts, especially the government's assumption of A.I.G.'s liabilities. What's clear is that Wall Street in general, Goldman very much included, benefited hugely from the government's provision of a financial backstop — an assurance that it will rescue major financial players whenever things go wrong.

You can argue that such rescues are necessary if we're to avoid a replay of the Great Depression. In fact, I agree. But the result is that the financial system's liabilities are now backed by an implicit government guarantee.

Now the last time there was a comparable expansion of the financial safety net, the creation of federal deposit insurance in the 1930s, it was accompanied by much tighter regulation, to ensure that banks didn't abuse their privileges. This time, new regulations are still in the drawing-board stage — and the finance lobby is already fighting against even the most basic protections for consumers.

If these lobbying efforts succeed, we'll have set the stage for an even bigger financial disaster a few years down the road. The next crisis could look something like the savings-and-loan mess of the 1980s, in which deregulated banks gambled with, or in some cases stole, taxpayers' money — except that it would involve the financial industry as a whole.

The bottom line is that Goldman's blowout quarter is good news for Goldman and the people who work there. It's good news for financial superstars in general, whose paychecks are rapidly climbing back to precrisis levels. But it's bad news for almost everyone else.

By PAUL KRUGMAN
Published: July 16, 2009

 
Except for the silly title (a play on "The joy of sex"), a commendable article. The same holds with equal strength in England. Bumper bonuses are due to be divvied up. The government is the guarantor of last resort. And New Labour refuses to introduce a new regulatory framework. Talk about ideological bankruptcy ....
 
Yes, it's one of the few articles I've read on the subject that doesn't moralize about CDOs and whether you should make big bonuses while contributing little to society. The point is that the system is unchanged, the survivors uncowed, and the next bubble queued up.
 
Arguments that I read in these articles are questionable and some of them clearly irrelevant. It is interesting that all of them are personal, subjective. Even more interesting is that they came from people reading about markets from a paper.

By the way, GS had a large collateral on the contracts and AIG goes bankrupt, who gets the collateral?
Some people were expecting GS to make a donation, forget about any signed contract and give back all collateral. This is just one detail that is conveniently ignored in AIG argument.
Same way, public pressure to participate in TARP, main sources of profit (equity volume, reduced competition, BRIC, asset management), successful debt issuance with no backing from government and many others are ignored.

Now GS "stellar" results attract all the proletarian lightning directed at Wall Street. It would be interesting to see what is the "correct way" of producing profit in financial industry.

PS: VaR indicator is irrelevant, measurement is incomplete to asses risk of an entire company. It was proven in past 2 years. However looking at the number, the journalists assume huge one-sided risks taken by GS.
 
GS had a large collateral on the contracts and AIG goes bankrupt, who gets the collateral?

GS gets to keep the collateral it already has but the problem is Goldman was asking for more collateral (to the tune of 10+ billions). If AIG goes bankrupt, there is nothing to collect in terms of collateral.

VaR indicator is irrelevant, measurement is incomplete to asses risk of an entire company. It was proven in past 2 years.

Yes, VaR is somewhat irrelevant in absolute terms. It just gives you an idea of possible losses. HOWEVER, the change in VaR is very much relevant. If it goes up, it means that there is more risk being taken. That's the case here.
 
the continuing story:
http://trueslant.com/matttaibbi/
includes the piece bbw links above, which I thought far sounder than the Rolling Stone piece -- on which, cuttinpastin' my comment from elsewhere:

__________
"... it is true that Taibbi is laying too much at the feet of Goldman Sachs alone, but in terms of choosing Goldman as a proxy for Wall Street investment banks (and their serial malfeasance), it's as good a choice as any."

That's one of the problems with the piece, blithely shifting synecdoches around. On the dotcom bubble, CSFB & MER were more egregious. GS wasn't at the forefront on CDO issuance, esp wrt MBS, which they weren't originating unlike some other players, and "betting against" it didn't take place until mid-2007. Using GS as proxy also elides the effects of Glass-Steagall repeal (lots of capital capacity injected into the markets, and more competition for GS) and of the underlying free-market ideology prevalent regardless of party label (driving eg financialization of the commodities markets). While GS has adapted to and navigated through changing circumstances better than its peers, it was not controlling them: LEH went down for gaming the Bernanke put (eg attaching conditions to Korean capital injection the week prior), with immediate negative effect to GS & MS. Subsequent actions were predicated on the notion that it was better to have a financial system than not, not that it was better for GS.
I'm a Taibbi fan, but this'un doesn't meet his usual standard. But hey, even Hunter S. Thompson had off days. ...
__________

There's something Emmanuel Goldman about the whole thang, two-minute-hatewise. Remember Ben Stein's wacked NYT conspiracy peddling many moons ago (and Chris Dodd picking up on and running with it)?

Anyway, newsflash: GS isn't better and brighter brainwise, but they are organizationally more effective.
 
GS gets to keep the collateral it already has but the problem is Goldman was asking for more collateral (to the tune of 10+ billions). If AIG goes bankrupt, there is nothing to collect in terms of collateral.

If I remember correctly from David Viniar's conference call, the collateral that GS already had, covered most of the counter-party exposure. I am not sure where you got 10 billion. You may have more information than others. ;)
By the way, 10bn loss will not bring down a company that made consistent profits for years. So I find it hard to believe that even if 10bn was counter-party risk and everything is lost, GS would be close to bankruptcy.

Yes, VaR is somewhat irrelevant in absolute terms. It just gives you an idea of possible losses. HOWEVER, the change in VaR is very much relevant. If it goes up, it means that there is more risk being taken. That's the case here.

Not sure about that either. Perhaps GS stands to lose less now in a 5 standard deviation event then 6 months ago. Or maybe it can lose 10 times more.
The only thing I can say for sure is that some funds are in the market now that were not last Fall. So the VaR has increased. I think only a couple of people in GS can have a broad view to make such estimates.
 
Nice article, but I don't see new information.
There is a reference about total GS exposure to AIG of 13bn, however there is no mention about the percentage of collateral out of this sum. Without this number, it is impossible to say the immediate impact of AIG bankruptcy.
Definitely the wave after an AIG collapse would have wiped out entire companies. Personally, in those conditions, I think it would have lead to a deep financial crisis taking at least 5 years.
 
You didn't read the article, right? 13 billion is no the exposure. The exposure to AIG was multiples of that (BTW, it is not mention there).
 
Opinion: Resist The Urge To Punish Success
Washington Post - 19 Jul 2009 - By Mark Gimein
Copyright 2009, The Washington Post Co. All Rights Reserved

Money can't buy love? For proof, look no further than Goldman Sachs. Last week, the firm reported a spectacular quarterly profit -- close to $3.5 billion for the bank and about $385,000 in compensation for each employee for the first half of the year -- and right on cue, the braying began for the heads of the Goldmanites. Earlier this month, Rolling Stone's Matt Taibbi, in a comprehensive exercise in conspiracy mongering, primed the pump of outrage with his article "The Great American Bubble Machine." Now a chorus of supporters has chimed in, shocked that in a recession the evil Goldman could turn such profit.
The rhetoric of outrage has come full circle: Before, the villains were the banks that were stupid and greedy enough to fail; now the villains are those -- a small club, basically just Goldman and J.P. Morgan Chase -- that have been smart and greedy enough to succeed.

What began as an effort to keep the financial industry from repeating its mistakes has turned into, as at other points in history, an attack on the idea of trading profit. It is no longer enough that the banks should be reformed; the opportunity to make this kind of profit should be eliminated.

This now-fashionable line of attack is badly misguided. Goldman and J.P. Morgan are reaping great rewards as the last firms standing in a game in which everyone else has been cowed or crushed. Yes, they're able to do that partly because the government has kept the financial system afloat. (Would anyone really prefer that it had not?) But the essence of the outcry is that we must punish Goldman for having been right. This is a mistake.

Goldman-haters like to weave a narrative that connects the dots between Goldmanites and former Goldmanites who are supposed to rule the world in a one-degree-of-Goldman Sachs fashion. The list expands until, as Taibbi says, it becomes a list of everything, like those lists of members of the Trilateral Commission and the members of the Council on Foreign Relations so beloved by an earlier generation of conspiracy theorists.

The real objection of Taibbi and others is that Goldman, except for one bad quarter at the nadir of the financial crisis, has turned a profit. Big profit. Or, as some folks -- such as economist William K. Black, writing in the New York Times' Room for Debate blog -- like to say, obscene profit. (What obscene means no one is sure, except that they know it when they see it.)

The argument that if a company made a huge profit, it must have rigged the game has been made at just about every bank in periods of high profit. Occasionally -- as with the technology-stock boom, from which most banks walked away unscathed -- it turns out to be right.

More often, it turns out to be wrong. Drexel Burnham Lambert, which was supposed to have the junk bond market all figured out, is no more. Neither is Bear Stearns, which ostensibly had the secret to turning mortgages into infinite cash. In almost every case, the theory that a speculator has cheated in some mysterious way is proved untrue in some spectacular way.

Some markets have been successfully gamed and manipulated for the profit of a few key players. The Internet public offerings market -- in which Goldman was certainly a major player, though not, as Taibbi claims, any more culpable than others -- is one example.

The California energy market that was essentially cornered by Enron, Reliant Energy and a few other companies with catastrophic results was another. (That, by the way, was a market designed by government experts.)

There is nobody at this point who thinks regulators shouldn't play a big role in preventing this. Nor is it unreasonable for companies that benefit from what is essentially an implicit federal insurance plan in times of crisis -- and yes, that does mean Goldman -- to pay for it.

The attack on profit per se, however, goes beyond this. It takes aim at the wrong target, serves the wrong interests and will lead to wrong results.

The weak links in the financial system are not mainly the speculators who are reputed to be collecting obscene profits. They can just as well be government-sanctioned institutions -- think Fannie Mae -- that are supposed to be content with what are thought to be reasonable profits for what is ostensibly a socially desirable role.

Those institutions manage to combine a thoroughgoing incompetence with a vested interest in hiding what profit they do make -- again, think Fannie Mae -- and making the financial system as opaque as possible.

Worse, the attack on profit in itself creates the bizarre assumption that those who are making less in profit are operating more ethically. Nothing that we have seen since the great bank collapse should give anybody a reason to think that. The collapse of the mortgage bond market is a case in point. Goldman was certainly a player in this, but it was not the lead player by any means.

Who drove the mortgage bubble? Lenders such as Bank of America, Washington Mutual and Countrywide; investment banks such as Bear Stearns, Lehman Brothers and Britain's Royal Bank of Scotland that were leaders in mortgage-backed securities; and one-stop shop Citigroup, which packaged derivatives.

Conventional wisdom says that Goldman's profit must be the result of a formula that involves excessive risk. Former labor secretary Robert Reich points to Goldman's "value at risk" calculations to conclude that the government should limit Goldman's risk-taking.

How quickly we forget that just a few months ago, nearly all the formulas that were intended to explain the behavior of the bond markets and provide banks with the tools to manage their risk turned out to be useless -- or worse. A regulatory regime whose goal is to limit profit, in the hope of thereby limiting risk, is one that merely codifies the same bogus and incompetent thinking about risk that held sway in the financial industry during the mortgage bubble.

Does the financial system need reform? Yes, obviously, both in how bonds and mortgages are traded and at the ground level of how banks deal with their customers. But the way to do it is to keep banks from again making the kinds of idiotic blunders that have left half the banking industry defunct or on life support. The way to keep everything from again going wrong is not to punish Goldman for having been right.
 
Gimein is making a strawman argument: he's ascribing a ridiculous set of arguments to critics of Goldman Sachs and the finance industry generally and then taking potshots at the strawman he's constructed. It's disingenuous on his part. The essence of the outcry is not that GS should be punished for being right. Nor are "Goldman-haters" saying GS rules the world -- talk about intellectual dishonesty. This article is pitched at the level of a diatribe from Ann Coulter or Rush Limbaugh. It is so incoherent and so full of holes in reasoning I wouldn't know where to start. It's a harangue, not an argument.
 
Funny, I have the same feeling when reading Taibbi's articles :)
Who knows where the truth lies ...
 
Funny, I have the same feeling when reading Taibbi's articles.

And you are right with regard to Taibbi's first article. I've learnt more from the exchange between you and Alain than from anything else I've seen on the net. The arguments and counterarguments are technical.
 
Another article that will enrage the "wolves" on the forum :)


Commonsense: Don't Hate Goldman For Making Money
The Wall Street Journal - 22 Jul 2009 - By James B. Stewart
(Copyright (c) 2009, Dow Jones & Company, Inc.)

Given the public outcry to news of Goldman Sachs's recent record earnings, you would think many people would prefer Goldman had lost money. Does that really make sense?
I can understand why some people are upset since I've heard from many of them. Their argument is that Goldman Sachs, like other recipients of funds from the government's Troubled Asset Relief Program, might well have failed without taxpayer assistance. Now, without the slightest sign of being in any way chastened, Goldman bankers have gone out and earned so much that they stand to receive huge bonuses that rival or even surpass those at the height of the credit bubble for which they deserve at least some of the blame.

But let's think about this for a moment from Goldman's point of view.

I don't think anyone there would dispute that Goldman benefited, perhaps disproportionately, from steps the Treasury Department and Federal Reserve took to stabilize the financial system. The rescue of insurance giant AIG may not have had any direct benefit on Goldman (the company insists it was so well insured against an AIG demise that it wouldn't have lost money had AIG failed), but to the extent AIG's rescue helped prop up the financial system, Goldman and all other banks benefited. Like others, Goldman was able to issue government-backed debt to help maintain its liquidity. Goldman not only survived, but seems to have taken market share from competitors.

But Goldman didn't seek the capital injections it received under TARP. Like the other large recipients, its chief executive was summoned and told the TARP funds would be coming, and the terms on which Goldman would have to accept them were dictated by the Treasury. Those included the interest rate Goldman would pay and the grant of warrants.

Treasury had to make strong banks as well as weak ones take the money so as not to trigger runs on the weak banks. In that sense, by taking the TARP money, Goldman (and other strong banks, like J.P. Morgan Chase) rendered the U.S. a service.

It is also worth bearing in mind that Goldman bankers will be in line for large bonuses because the firm made a lot of money. This isn't a case, as AIG was perceived to be, of paying bonuses to people who lost money, costing shareholders and taxpayers billions. Goldman seems to have made most of the profits on its trading and underwriting business. In other words, it earned it. And if you think that's so easy, look at all the rivals that didn't fare nearly so well.

Goldman was also in the vanguard of banks that repaid their TARP money, with interest. So far the firm hasn't cost the taxpayers a dime. The government is still negotiating how to value the warrants. But as long as it holds them, the government is like a shareholder. Those warrants just got a lot more valuable thanks to Goldman's blow-out quarter.

If only all the government's investments worked out so well.

Goldman is hardly alone on Wall Street in making lots of money this past quarter. Just about anyone with the courage to invest in mid-March (as I strongly recommended at the time) has enjoyed a great run. There are plenty of hedge fund managers who will continue to haul down massive bonuses, but without the outrage Goldman has generated.

I'm not saying compensation in the financial industry makes sense. There may well be ways to align pay and bonuses with the long-term interests of firms and the financial system as a whole, which would be all to the good. But until the problem is addressed systemically, it hardly seems fair to pick on one firm just because it's so successful.

I've said before that rather than complain about the success of investment bankers, you might as well invest in them, as I have. For about $160, you can own a share of Goldman Sachs. That's not to say I'd be buying it now, after such a great quarter. In fact, I've been reducing my position (as I've reported), and, given the recent results, clearly sold too soon. But I'm not complaining. As both a shareholder and a taxpayer, I hope Goldman—and the other big banks—do well. That's the only way to restore the financial system to health.
 
Between those that say "Goldman can do no wrong" and "Goldman is a criminal", I'd instead say the truth should lie here:

Give the devil its due. But make no mistake, Goldman Sachs is no angel. Right now, I'm working an unpaid internship at FIXFlyer (Without the math and intellectual stimulation of quantland in any of its forms, I don't find this position as interesting as I thought I would although it's much better than the actuarial one in terms of my resume...it seems I'm doomed to not like anything too much where I don't do numbers for a living, so odds are, I'm heading to Rutgers for a statistics masters and later to another place for a PhD), and seeing the economy get no better (maybe because I'm working 10 hour days), well...As Gordon Gekko has said:

"Money itself isn't lost or made, it's simply transferred, from one perception...to another."

All trading "profits" are a zero-sum game. For all of the money you make, someone had to be on the other side of all of those other trades. For all of the money Goldman made for itself trading, someone took the other side of those and lost it. So mostly the thing that Goldman did in this regard is simply changed the name of the winners and losers (well, mainly the losers...Goldman winning is the status quo).

Look, I used to love Goldman Sachs. I thought they could do no wrong and simply indeed had the best and the brightest. That may still be the case. However...I can't, as someone with a conscience and a good heart and someone that likes fuzzy animals and green trees, stand idly by...

And not express my extreme discontent that there is a complete disconnect between Goldman's profits, and the state of the economy as a whole. Yes, I know some people want it more. But do only the Goldmanites and JPMorgan traders, of all of the smart people out there, want it more? What GS is doing isn't at all criminal, and indeed they may have earned every penny legally. And kudos to them.

But here's another example: an alumni from my college (she's a former Goldman MD), after rescinding someone's offer (or so I heard from another student...not mine, was too late to get an offer from her), when I told her in an email that I had a feeling things were rough at her firm (of course I forgot to explicitly state that I could very well be wrong...I need to get in the habit of doing that more often...it also got me rejected from a Bridgewater interview), she told me how great her firm was doing, and I felt like a complete idiot, and a bit shocked as to the different mesages. So I've come to this conclusion:

While some formar Goldman employees may indeed be salt of the earth, absolutely kind people (Emanuel Derman returned a couple of my emails before! A legend! Truly a good person if ever there was one), the organization as a whole doesn't do guilt. So long as Goldman wins, it doesn't matter to them as to who loses.

So what's good for Goldman may not be good for the rest of us.

That said...if I had to pick a good guy bank out of the entire planet, short of Google starting to lend its own cash, it would have to be Goldman Sachs.

Here's the reason why--it's as close to a meritocracy as we're going to get on Wall Street from the big houses in my opinion. If you're smart enough, you'll get your place there.

Furtehrmore, while indeed there may arise a conflict of interest from GS sending so many of its megastars to the treasury or other government positions (Government Sachs, anybody?), it is the only Wall Street firm that actually actively sends so many of its alumni to public service. In its heyday, neither Bear nor Citi nor Lehman nor any other bank on The Street has done so.

And if not for Hank Paulson, we might yet be in a worse Great Depression than in the 30s.

So that said, I think we're better off with Goldman here to stay (of course, it's a moot point) than we are without it. And by no small margin, either.

That said though, it really sucks to be on the outside looking in. Jealousy is ingrained into the cores of humanity, and if you claim you don't have a drop of it at this point in regards to this, I would be highly skeptical to trust you.
 
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