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Monday, April 26, 2010

"Thou Shall Not Bet Against A Bubble"

Nothing in the civil suit filed by the Securities and Exchange Commission alleges that Goldman Sachs caused the housing bubble or burst it.

The transaction at issue in that case was between highly sophisticated investment firms, and had no more to do with the housing market collapsing than your office pool had to do with who won the NCAA basketball tournament.

The housing bubble was created by Washington policies which created cheap money and lax lending practices, and millions of individual home buyers, mortgage brokers, and lenders who were all too willing to go along. Each of these people bet in favor of the bubble not only continuing, but growing.

Wall Street helped grease the wheels by packaging mortgages for resale, sometimes in confusingly (and sometimes misleadingly) structured products, which mostly were resold to sophisticated institutional investors. But as I have pointed out before, the mortgages were the core problem; no bad mortgages, no bad mortgage-backed securities.

The housing bubble burst for the same reason economic bubbles always have burst, since time immemorial: There were no greater fools left to pay higher prices. Only then did the people who bet in favor of the housing bubble, including most politicians, realize they had bet wrong. And the entire economy paid the price.

Some people, however, saw that a bubble was a bubble was a bubble, and that it only was a matter of time before it burst. And that appears to be the political crime for which Goldman Sachs is being charged by the Congress and Democratic politicians.

Goldman Sachs hedged its bets, and took short positions with regard to mortgage-backed securities (meaning that Goldman Sachs would make money if the value of the securities dropped).

But none of these short positions caused a single homeowner not to meet a mortgage payment, or a single buyer to walk away from the inflated sales price on a home.

Goldman Sachs is being vilified by Carl Levin (D-Mich) and the Obama administration because Goldman Sachs put in e-mails that its short positions proved profitable in a dropping housing market:

In a Nov. 17, 2007, email, Goldman's chief executive officer, Lloyd Blankfein, wrote to his top lieutenants in response to an upcoming New York Times story about how the firm had profited off the souring subprime market: "Of course we didn't dodge the mortgage mess. We lost money, then made more than we lost because of shorts."

Blankfein is one of the top executives to be questioned Tuesday by Levin.

In an Oct. 11 email that year, one Goldman employee, reacting to news that Moody's Investors Service had downgraded $32 billion in mortgage-related securities, wrote to a colleague: "Sounds like we will make some serious money."

"Yes, we are well positioned," the colleague responded.

Is this a crime? Is this even wrong?

All of the sudden, Democrats hate short sellers? Democrats don't seem to mind taking money for their think tanks and media operations from George Soros, who made billions by betting against currencies.

And why shouldn't Goldman Sachs have hedged its bets?

Should Goldman Sachs have been Lehman Brothers or Bear Stearns or AIG and so mismanaged its risk exposure that it either went out of business or was bailed out by the government? (Goldman Sachs received TARP money, which it paid back, but was not one of the failed institutions which led to the credit crisis.)

Are we now punishing those who engaged in intelligent and honest assessments of the economy, and acted responsibly despite the irresponsibility of Washington politicians?

Now about those e-mails. How about releasing all the e-mails of each Senator and staffer on the committee which will interrogate Goldman Sachs' executives? I would be willing to bet (long not short) that there would be far more scandalous material in the Congressional servers than anything said in the Goldman Sachs e-mails.

And while we're at it, can we please see the Congressional e-mails in which Democrats bet against the surge working in Iraq?

We really have reached the "silly season" of which Barack Obama has warned time and again, but the silliness is being perpetrated by this administration in its zeal to instigate class warfare and create enemies against whom to campaign.

We now are rewarding corporate failures with government bailouts, and berating and belittling the successful companies which were smart and honest enough to see that a bubble was a bubble was a bubble.

If we had more companies run like Goldman Sachs, and fewer run like Fannie Mae and Freddie Mac, we would not be in the mess we are in.

If we had more traders who made non-political assessments of economic viability and creditworthiness, and fewer Barney Franks and Chris Dodds whose political demagoguery was the air which filled the housing bubble, we all would have been better off.

The war being waged by the Obama administration and Congressional Democrats against Wall Street is nothing more than psychological projection, whereby the irresponsibility and recklessness of Washington politicians are attributed to the people who were least irresponsible and least reckless.

Worse yet, the new diktat in Washington appears to be, "Thou Shall Not Bet Against A Bubble."

Which is about the worst advice anyone could give, but not surprising considering that it comes from the same politicians who created the bubble in the first place.

Update: A good discussion of the nature of the securities at issue is set forth in an article by my colleague, Prof. Charles Whitehead, Shorting the SEC’s case against Goldman Sachs.

Related Posts:
Wall Street Was Not Where The Economic Meltdown Began
Obama's Plan In Two Words
Political Tulipomania

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  1. Every so-called reporter should read and understand this gem of an essay and go forth and promulgate its wisdom.

    But no. They're too busy carrying water. PLUS, as Greg Gutfeld said on Hannity's "great, great, great" panel last night, economics is hard.

    You make it look easy.

  2. Agreed, Obama IS and HAS BEEN into class warfare in Obvious (Tax the rich at each legislative juncture as a means of income redistribution)and more often in subtle ways (attitude and code words in his remarks-wish I could quickly dig out some examples).

    He needs to consider regulation on certain instruments that have been destructive like derivatives - sold throughout Wall Street.

    He cannot continue to recast every corner of the economy into a government-run activity.

  3. Community Reinvestment Act, Fannie, Freddie, and Dem policies caused the bubble. Defaulted mortgages burst it. Meanwhile, SEC regulators were watching something else altogether ...

    [For a light hearted take on our present peril]

  4. Today's political/economic climate appears to me like a coalition of children and adult players with the children having the upper hand.

    As someone who has been involved in the home building business for 20 years, I couldn't describe what the complex financial workings were, but knew somewhere something had to give. I would agree that if Goldman Sachs was hedging bets, they were smart.

    Eveyone involved in the home buying/buidling/remodeling business was not blind to the fact that it was out of whack. I remember a decade ago wondering along with my peers (in construction, real estate and local bankers) how long things would last. It appears only the government was clueless that there was a problem with buying large ticket items on credit with no money down or bogus income claims.

    From when I entered the business, homes (for the middle class), went from 2000 or under s.f., vinyl flooring, formica counters, two bath, single pitch ranches and two stories, to the 2500 to 4000 foot dual pitch hip/gable roofed McMansions. And the McMansions do not have vinyl and formica, but hardwood, ceramic tile, infloor heat, whirlpools, hot tubs, granite, professional kitchen equipment, tall/shaped ceilings, bonus rooms, finished basements, bedrooms and baths for every kid type of living. In other words, not only did the size increase, but the complexity as well. And the downpayments decreased. People bought on payments, not total cost.

    Now that the rest of us have caught on the disheartening this is that government seems to still be clueless.

  5. The creation of a synthetic is not an issue. Its done all the time. And if that is all they did it would be a giant nothing burger. But the creation of a synthetic designed to fail, then not disclosing that fact and passing it off as a AAA money good _investment_ on the long side is -- Fraud.

    How about GS underwriting an IPO and selling the equity inventory when they know that the company is committing every manner of accounting fraud ? Would that be OK? Nope.

    The mess they are in is becasue its just a Boiler Room type of deal on the security, not equity, side.

  6. Keith: Caveat Emptor? The folks who went long are QIBs.

    As QIBs, don't they have a fiduciary duty to conduct sufficent due diligence before investing the money entrusted to them? QIBs are paid outrageous compensation to analyze risk. If they did not analyze the underlying mortgage pool, but instead siomply relied on the AAA credit raing, isn't it questionable whether they met their obligation to perform the necessary due diligence?

    I'm sure the QIBs who went long have all kinds of CYA language in their investment agreements so they aren't liable, but it appears to me that on the surface they were the ones who may have acted recklessly.

  7. Its disclosure that matters. If you disclose that security X is dog doo doo and people want to buy it, well ya can't fix stupid. But if you hide the fact, not good.

    If say GS said here is a security it will throw off cash at 1000 bps/yr right up until it blows up which could be tomorrow or 5 years from now, becasue it was designed to fail, but until it does it will be money maker, wanna buy it ? And people do, and it blows up, so what. Sucks to be you.

    Again, its not the synthetic that is the issue, it is the lack of disclosure that amounts to fraud that is.




  8. Agreed. Would love to peruse emails from all the self-righteous buffoons involved in Goldman's "Inquisition". Bet you might find a few like this:

    "Sorry we can't release any emails right now, or regulate securities trading, as we're busy viewing porn."


    The SEC

  9. A liberal recently told me, "The free market terrifies me. There's no control, there's no rules. It scares me when people claim that we need to return to a laissez-faire type of government, because we have seen that option fail time and time again."

    When I heard that, it was like she was saying, "The earth is flat, it always has been, and you're blind if you don't see it."

    THAT is one of the fundamental problems in government today-- the decision to deliberatly not see the truth about something, because it's uncomfortable or unpleasant.

    P.S. And here I spent 4 years at Ithaca College with the mistaken belief that there was no one in Ithaca with any sense at all!