Wednesday, April 28, 2010

The Goldman Sachs Witch-Hunt

It is no shock that Goldman Sachs’s hearing before a Senate subcommittee yesterday was an episode in subterfuge and political posturing. However, the level of bipartisan vitriol and populist grandstanding was inexcusable.

The subcommittee, chaired by Senator Carl Levin (D-MI), hounded a number of Goldman Sachs executives for the better part of the day. This was no exercise in fact finding, but a brutal cross-examination by a biased plaintiff. Nearly every Senator (except at rare moments Tom Coburn (R-OK)) came with a pre-planned agenda to portray Goldman Sachs as an epitome of a rampant Wall Street-gone-bad that wrecked havoc on the poor innocent investor and America’s economy. The Senators repeatedly waved sensational, but otherwise meaningless, documents in the air, simplifying the extremely complex issues until they were a digestible, but un-nutritious mush ready to be consumed by the populist masses.

These politicians are not stupid. While their understanding of the financial markets is clearly limited, they obviously comprehend the intellectual dishonesty that they exhibited. It is hard to believe that such a display, coupled with the recent bogus charges brought against Goldman Sachs by the SEC (a decision which in relatively rare form was controversially split), was anything but motivated by the desire to force through a regulatory reform package. Even the Republicans, such as John McCain (R-AZ), who is in a tough reelection battle, walked to the ‘bash Wall Street’ drumbeat.

The fact of the matter is that there is little evidence that Goldman did anything wrong. While to the uninitiated it may be difficult to understand the market and readily easy to misconstrue it as misguided, this does not stand as evidence of wrongdoing.

To begin, Senator Levin attempted to cast Goldman as the bad guy for making a profit. It is ironic that those that realized the housing bubble was inflated (and thus helped to mitigate its wanton expansion), are now being chastised for being ahead of the curve. The Washington Post says it best,
[If Goldman did not bet against the market as early as it did t]he firm would have lost billions, and it might have wound up needing an even bigger bailout by U.S. taxpayers than it actually got. It could have ended up like Citigroup, which tried to ride the bubble until it was too late and had to be propped up with hundreds of billions of dollars in federal cash and credit guarantees.
There is nothing wrong with this behavior. It is done all the time and is, in fact, what keeps the markets going. Short sales are necessary and proper in markets – even if against a long-position controlled by the same entity. This sort of hedging protects institutions and the economy in the long-run. If the world of finance is too complicated in this regard, one only needs to look to that of farming or commodities to see the same practice. Farmers, for instance, will bet against agriculture to insure against the risk of crop failure.

Besides the criticism of profit-via-short, the committee also bashed Goldman for selling, what was termed in one of the infamous documents, a “shitty” product. Needless to say, the definition of “shitty” is subjective and quite unscientific, but even if a product could be objectively proven to be “shitty” is it wrong for a company to sell it? How many less-than-stellar consumer products are sold on a daily basis? It is up to the consumer – and in this case they were quite sophisticated investors – to evaluate their purchases. Ultimately, Goldman’s knowledge about how the product was constructed has no bearing on the ability of an individual investor to assess its quality.

Now to be clear, there were a myriad of mistakes made at all levels of the economy; however, the targeted witch-hunt is unfair. It misguides popular attention from the real issues. As a result simplistic solutions are proposed to solve non-existent problems, while the real issues are ignored. The characteristic problem is the desire to find the causation of bad outcomes in practices which only look odious with hindsight. This is poor logic. Fraud must be distinguished from both bad business and good business that had bad luck. Every decision relies upon an analysis of the probability of certain outcomes. Even if the analysis is done correctly sometimes that low-probability outcome will occur. Politicians inability to address this non-sound-bit ready fact and instead chose to bash Goldman Sachs is quite unfortunate.

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