Goldman’s Not Wrong, But Blankfein Is
by lbej
I don’t feel bad for anyone on the other side of a Goldman trade. I know LOTS of these folks and they knew exactly what they were doing, same as the Goldman traders did. Nobody in the market thought Goldman traders were a bunch of saints working for the benefit of the downtrodden. Goldman is a bookmaker and Wall Street is Vegas. Now, if they fixed games, that’s illegal and they should be prosecuted. Hopefully that’s what the current investigation will sort out. But if the betting is legal (it was/is) and the games aren’t fixed…oh, well. Gamblers know the house usually wins and they bet anyway.
As for the housing market, it was a bubble, not a fraud. Those are two different things. In a fraudulent transaction the seller deliberately conceals known material information from the buyer–if the buyer had all the information he needed, he’d pay less or not buy at all. In a bubble transaction, the buyer has all the information he should need to know that he’s paying too much and he pays too much anyway. In a bubble economy fraud will occur, and there were definitely instances of fraud during the housing bubble. But fraud occurs during an economic depression as well. Thieves steal, and it’s illegal. Being delusional about asset values isn’t illegal. I understand CDOs, former SVP of market risk at a top 10 bank and all that. Read a prospectus, or better yet, pay a lawyer to read one and summarize it for you. But if you don’t understand CDOs, that’s okay. Just don’t buy one. I don’t understand guns. If I went to a gun shop and bought a gun and tried to load it and shoot it without taking any classes or reading any manuals and I blew my foot off as a result, whose fault is it? It’s my stupid fault. I know for a fact that many investors who qualified as ‘sophisticated’ under securities laws bought mortgage-backed instruments without understanding the cash flow structure of those instruments even a little bit. If you bought a PAC tranche of a CDO because you used to play Ms. Pac-Man when you were a kid, I hope you did blow your foot off.
So whatever for all the poor investors who lost out because Goldman hires a bunch of rats and it then gets a heads-up when the ship is sinking. Hire your own rats or get the hell off the ship before it leaves port. Blankfein, however, is making the ridiculous oblivious-but-well-compensated-CEO argument that Dick Fuld has been making for a year and a half, and that Ken Lay made almost a decade ago now. Let me break it down for you. You got two choices here, Mr. CEO: one, you did understand the material fraudulent or unethical behavior that occurred at your firm; or two, you did not understand. That’s it. You knew, or you didn’t know. If the answer is that you did know, you’re guilty of whatever crime was committed. If the answer is you didn’t know, then you are guilty of negligence and dereliction of your fiduciary duty to the shareholders of your company. In the former case, you should disgorge your pay–all of it–and go to jail. In the latter case, you should disgorge your pay but avoid jail. Americans simply must reject the idea that Lloyd Blankfein had no idea of the enormous risks his company was taking, risks that created a multi-billion dollar loss ultimately absorbed by the US taxpayer through the bailout of AIG, AND HE STILL SOMEHOW EARNED TENS OF MILLIONS OF DOLLARS for running the company taking those risks. He had his cake and he ate it, and then he realized he was out of cake, so he stole yours, America.
Dream of the Dragon 
Within our economic system and its rules, Goldman played the role it’s designed to play. It’s a manipulative corporation, playing the market with its considerable wealth, expertise, and ability to out-muscle competitors. And if it takes huge risks and outfoxes its clients, par for the course. I get that.
Blankfein, who very likely was party to withholding material information, is involved a very specific kind of fraud. And that’s different than just being terrible and greedy and better at the game than others. In playing dumb, he at the very least should forfeit his right to an insane salary. At most, he forfeits his soul and freedom for committing perjury.
Which brings me to my question for you. You were deeply entrenched in the banking world for quite some time and got an insider’s look at the ridiculous world of securities and derivatives and all that. Is the system itself something broken that needs to be fixed? Or abandoned? The fact that Goldman itself was in large part just doing its job and the collateral damage is acceptable makes me think the entire industry is bunk. Do you defend the current landscape of finance or condemn it?
I would say two things:
1. Most derivatives aren’t complex at all. They create payoffs for one party or the other based on (a) an underlying rate/asset/index/whatever and (b) a formula of some kind, usually a really simple binary one. They are also very useful for legitimate hedging. For example: an airline can buy forward contracts on gasoline or oil three, six, nine or more months out into the future, thereby locking in fuel costs and enabling them to budget that expense rather than risk going broke in two months for reasons totally beyond their control. That also means that if the price of oil drops, they wouldn’t make as much money as if they had waited to buy in the spot market, but they don’t care because they’re running a business and not speculating. Now, the other side of that trade may be a refiner looking to sell forward anticipated production (locking in revenues vs. locking in costs), but those hedging needs don’t always balance, and speculators do serve a legitimate economic role by stepping up to fill the void. The derivatives I’m most accustomed to dealing myself with are interest rate swaps. These are great because they enable a bank to take the kind of interest rate/balance sheet risk it wants to take (asset or liability sensitive, or interest-rate neutral) while providing the customer with the kind of loan (fixed or floating) he or she wants. Suppose you are a lender and your customer comes in and wants a fixed rate loan. If you already have a lot of floating rate liabilities and fixed rate assets (like loans), you’re liability-sensitive and you may not be willing to add more fixed rate assets. If you do and rates rise, your liabilities (floating) will reprice while your assets don’t (fixed), so your interest expense will increase much faster than your interest income. Of course, if the popular view is that rates are going to rise, that is exactly the time your clients are going to come to you looking to lock in current rates with a fixed-rate loan. Without interest rate swaps, the lender has to refuse to make the loan and an economic need is not met. But with the emergence of the derivatives market, the lender can make the fixed rate loan and simultaneously enter into a pay-fixed swap with a third-party swap dealer, exchanging the fixed payment it receives from the borrower for a floating rate payment from the swap dealer, ideally based on the same rate that the lender pays for his liabilities (otherwise you have what’s called basis risk). Thus the lender takes only the credit risk that he or she is trained to evaluate, the swap dealer takes the interest rate risk that he is trained to evaluate, and the borrower gets the loan he or she wants.
So derivatives aren’t all bad, but like anything else, they can be abused. And there are exotic derivatives out there. I just think it should fall to the people who enter into these deals to know what they’re getting into, and if you don’t understand it, don’t do it. The derivatives that are necessary aren’t complicated, and the derivatives that are complicated aren’t necessary. All of that assumes no fraud, collusion or other illegal market manipulation. Those things are already illegal, as they should be.
2. As for Goldman, it should have failed during the financial crisis in Fall 2008 along with AIG. My problem isn’t that capitalism doesn’t work, it’s that crony capitalism doesn’t work. Goldman took enormous risks, with its biggest bet being that it if it bet the entire financial system the government would have to cover the loss if it crapped out. The Matt Tabbi article in Rolling Stone 1099 explains that more compellingly than I can. And it’s not entirely the fault of the Republicans; the Clinton Administration is on the hook for this too, and there are prominent Goldman alums in both parties. If AIG had been allowed to go bankrupt in September 2008, my belief is that the economy wouldn’t have been much worse off than it was/is. We wouldn’t have had a repeat of the 1930s: the FDIC would’ve protected bank depositors and the reckless investment banks would’ve failed. The government said at the time that there was no way to unwind a failed institution. Well, there is: it’s called the bankruptcy code.
The bottom line for me is that capitalism is supposed to be boom-bust. If we don’t want that, we don’t want capitalism. That’s fine if that’s what the American people want, but they seem to think they want capitalism. If we do want capitalism, the companies that make billions when their bets pay off need to lose billions (and their companies if it comes to that) when the bets go bad. That didn’t happen, and it doesn’t make any more sense to a veteran banker like me than it does to you.
I found it interesting to learn that none of the actual bankers at Goldman were involved in this hearing, and that the company is now run at the top level only by traders.