As I noted in my earlier post, I don’t think the fact that Goldman Sachs was short of the residential mortgage securities market in 2007 (to the degree that it was) was, as the Senate investigations subcommittee seems to think, a scandal.
Politicians and regulators tend to be biased against short sellers, believing that going short is somehow wrong or unpatriotic. But the fact that Goldman protected itself better than other banks such as Lehman Brothers from the downturn was neither illegal nor wrong in itself.
So it is worth going through the accusations of the Senate subcommittee against Goldman one by one, and analysing which are – or are not – serious. Goldman executives including Lloyd Blankfein, its chairman and chief executive, will give evidence to the subcommittee on Tuesday.
We can take the six accusations in turn form the press release issued by Carl Levin, the subcommittee’s chairman, on Monday.
“From 2004 to 2007, in exchange for lucrative fees, Goldman Sachs helped lenders like Long Beach, Fremont, and New Century, securitise high risk, poor quality loans, obtain favorable credit ratings for the resulting residential mortgage backed securities (RMBS), and sell the RMBS securities to investors, pushing billions of dollars of risky mortgages into the financial system.”
Here, Goldman is being accused of encouraging reckless lending, which would be a problem if true. But the subcommittee would have to show it should have known that the mortgages were flawed.
Goldman itself says that it analysed the underlying mortgages in the collateralised debt obligations that it structured, and rejected many – although it now wishes it had rejected even more.
Conclusion: This could be significant but the case is unproven.
“Goldman Sachs magnified the impact of toxic mortgages on financial markets by re-securitising RMBS securities in collateralised debt obligations (CDOs), referencing them in synthetic CDOs, selling the CDO securities to investors, and using credit default swaps and index trading to profit from the failure of the same RMBS and CDO securities it sold.”
This accusation is a bit of a mash-up. It is not clear if the Senate is saying there was something inherently wrong in structuring synthetic CDOs, which was clearly a legal activity, or merely that Goldman was wrong in going on to hedge them.
Conclusion: A confused and weak accusation.
“”As high risk mortgage delinquencies increased, and RMBS and CDO securities began to lose value, Goldman Sachs took a net short position on the mortgage market, remaining net short throughout 2007, and cashed in very large short positions, generating billions of dollars in gain.”
Conclusion: This claim is exaggerated. Even if true, it would neither have been a crime nor unwise for Goldman to do it.
“Conflict between client and proprietary trading. In 2007, Goldman Sachs went beyond its role as market maker for clients seeking to buy or sell mortgage related securities, traded billions of dollars in mortgage related assets for the benefit of the firm without disclosing its proprietary positions to clients, and instructed its sales force to sell mortgage related assets, including high risk RMBS and CDO securities that Goldman Sachs wanted to get off its books, creating a conflict between the firm’s proprietary interests and the interests of its clients.”
It is not at all clear that Goldman “went beyond its role as marketmaker” in hedging its positions, for that is what marketmakers do. Defining this as “proprietary trading” is, I think, a distortion. However, Goldman is vulnerable to the accusation that it was not open with its clients.
I argued in my column last week that Goldman’s actions went against its own ethical standards because it professes to put its clients interests first.
Conclusion: Not necessarily a crime, but clearly embarrassing and arguably unethical.
“Goldman Sachs structured, underwrote, and sold a synthetic CDO called Abacus 2007-AC1, did not disclose to the Moody’s analyst overseeing the rating of the CDO that a hedge fund client taking a short position in the CDO had helped to select the referenced assets, and also did not disclose that fact to other investors.”
This is the Securities and Exchange Commission accusation against Goldman, which the subcommittee has endorsed.
Conclusion: The courts will decide, unless Goldman settles first.
Using naked credit default swaps. Goldman Sachs used credit default swaps (CDS) on assets it did not own to bet against the mortgage market through single name and index CDS transactions, generating substantial revenues in the process.
Yes, but there was nothing illegal about doing so. If politicians want to declare naked shorting illegal, they should do so. Until then, it is unfair to accuse Goldman of wrongdoing.
Conclusion: Hypocritical coming from the Senate.