Today’s marathon Senate Permanent Investigations Subcommittee hearing into Goldman Sachs’ (GS) role in the financial crisis found Goldman executives and senators talking past each other or driving each other to frustration with non-responses and no responses to loaded questions. Subcommittee Chair Carl Levin (D-IL) quickly expressed frustration that Goldman witnesses wouldn’t answer “yes” to his questions on whether Goldman had any obligation to disclose its short positions to clients it was unloading “crap” long positions upon as described in a Goldman email. Similarly, Senator Susan Collins (R-ME) kept asking if Goldman had a duty to act in the best interests of its clients, and she didn’t get an answer she was satisfied with either.
In my opinion, here’s what was going on.
1. Goldman will get sued for any admissions and probably faces plenty of lawsuits already. Obviously, it had to have a certain level of trust for its clients to do business with it. On the other hand, a market maker, like a used car dealer, is going to know a lot more about the value of a particular complicated security than most of its clients. Economists call that “information asymmetry.” Does a used car dealer act in the best interests of its clients? Sometimes, but not always, or maybe not all that often. It depends. Is there another used car dealer down the street? A clunker might be a ripoff at $2,000, but it could be a good deal at $1,000. That’s where today’s failure to communicate occurred. The senators wanted to look at particular transactions and not net overall positions without admitting that Goldman lost money on some and made money on others. The witnesses tried to explain that there were plenty of days when they didn’t know whether they were net long or net short, and there were days when their clients made lots of money and days when they lost a lot. The assets involved were open for inspection, but the buyers rarely delved deeply enough to see the housing finance bubble in 2006 when there was still time to doing something about it. In retrospect, there was too much credit creation by Goldman and a lot of other financial institutions, including the Fed, that, in the end, created heavy losses for a lot of people here and abroad who had no idea of the risks they were incurring. Obviously, Goldman ended up on top with plenty of taxpayer help. It has already bounced back while the unemployment rate hovers at 9.7%. An investor of long experience with Goldman and other investment banks I know told me recently that “Doing business with Goldman is like getting in bed with an alligator. It had better be well fed, or you could wake up without a leg. Goldman is very predatory.”
2. Congress bears as much responsibility for the financial crisis as Goldman does in my opinion. Congress pushed home ownership subsidies too hard for too long. Once Fannie Mae and Freddie Mac started securitizing subprime and Alt-A loans at the behest of Congress, it was only a question of time before the financial crisis would occur. If you’re a member of Congress terrified of possible voter retribution next November because you pushed homeownership on people who could never pay off a mortgage, kept regulators from doing their jobs, and were slow to contain the damage from the financial crisis, what would you do? That’s right, find somebody else to blame. Vote to keep your salary fixed and lambast Wall Street bonuses. Expose Wall Street greed, but hide your own greed for political power.
3. There’s plenty of blame to go around. Why should we be surprised that people at Goldman and in Congress and in the real estate market got greedy and followed the herd over the cliff? It’s in our genes. Behavioral economists are just beginning to get some respect within the profession for theories that say people act irrationally in certain situations. When we make lots of money, we think it’s because we’re smarter than everyone else. When we lose lots of money, we look for someone to blame. Why not admit that all of us are subject to such irrational impulses and that, therefore, we should adopt some rules that limit how much risk we can take on without adding capital and requiring more margin, and, above all, impose some tough disclosure and transparency rules. It’s been two years since the financial crisis broke into the open. It’s about time we passed financial regulatory reforms, as imperfect as they will be.